## Facts

- Safway Steel Scaffolds Company of Georgia was a closely held corporation whose sole shareholders, Charles and Richard Werner, also owned real property leased to Safway.
- In 1947, the Werners bought and assembled parcels of land in downtown Atlanta.
- On January 1, 1948, the Werners leased the land to Safway for 20 years at $2,400 per year; Safway also paid taxes and utilities.
- The lease allowed Safway to construct improvements but required that all attached improvements would become the Werners’ property upon lease expiration, with no renewal option.
- Safway constructed a building costing $128,025; the building had an approximately 34-year useful life.
- When the lease expired on December 31, 1967, the land and improvements reverted to the Werners under the lease terms.
- Safway and the Werners then entered a new lease requiring $21,600 annual rent, representing the fair market rental value of both land and building at that time.
- Safway deducted the full $21,600 as “rent” under 26 U.S.C. § 162(a)(3); the IRS disallowed $9,720, and the district court upheld the disallowance by allocating 45% of the payment to improvements as nondeductible.

## Issues

1. Whether the full $21,600 annual payment under the post-1967 lease was deductible as “rent” under 26 U.S.C. § 162(a)(3) despite the prior reversion of corporate-funded improvements to shareholder-lessors.
2. Whether the government was estopped from disallowing the deduction based on prior audits that did not challenge similar deductions.

## Decision

- The Fifth Circuit affirmed the district court’s judgment.
- The court held that Safway could not deduct the entire $21,600 as rent under § 162(a)(3).
- The court upheld the district court’s allocation treating 45% of the payment as attributable to improvements and therefore nondeductible.
- The court rejected Safway’s estoppel argument based on prior IRS audit treatment.

## Legal Principles

- A deduction under 26 U.S.C. § 162(a)(3) is allowed only for payments that are, in substance, reasonable rent for the use of property in the taxpayer’s trade or business.
- When a corporation leases property from shareholder-lessors, courts may scrutinize the transaction for non-arm’s-length terms and recharacterize amounts labeled “rent” based on economic substance.
- If corporate-funded improvements revert to shareholder-lessors without compensation, later payments attributable to the value of those improvements may be treated as a nondeductible distribution of earnings rather than rent.
- Prior IRS audit treatment, without a qualifying affirmative misrepresentation and legally sufficient reliance, does not estop the government from later enforcing the correct tax treatment.

## Conclusion

Because the shareholder-lessors received valuable improvements funded by the corporation through a non-arm’s-length reversion arrangement, the court sustained a reallocation of the later “rent” so that only the land-related portion was deductible under § 162(a)(3), while the portion attributable to the improvements was properly disallowed as nondeductible.


Safway Steel Scaffolds Co. of Ga. v. United States, 590 F.2d 1360 (5th Cir. 1979)