Appeals from the United States District Court for the Central District of Illinois, No. 84-3053 -- Richard Mills, Judge.
Easterbrook, Ripple and Kanne, Circuit Judges.
Michael J. Scully and Peter D. Scully, as trustees of nine trusts established for members of the Scully family, brought this action against the United States seeking a refund of $274,583 in income taxes paid by the trusts. The trustees argued that the trusts were entitled to the refund because the trusts had sold 980 acres of real estate at a loss of more than $500 per acre. The district court granted the government's motion for summary judgment on the ground that section 267(b)(5) of the Internal Revenue Code of 1954 (Code) disallowed the loss. The trustees appealed. During the pendency of that appeal, the government changed its position and concluded that section 267(b)(5) did not disallow the loss, but that section 267(b)(6) did so. Based on the government's change of position, this court remanded the case to the district court so that the trustees could file a motion seeking relief from the district court judgment under Rule 60(b) of the Federal Rules of Civil Procedure.*fn1 On remand, the district court denied the trustees' motion and reaffirmed its earlier judgment. It adhered to its earlier view that section 267(b)(5) was the applicable section and that this section disallowed the trusts' claimed loss. The trustees, in accordance with the earlier ruling of this court, then filed an appeal from the district court's denial of the Rule 60(b) motion that was consolidated with their earlier appeal.
We conclude that the loss was properly disallowed. However, we affirm the judgment of the district court on the ground that Code section 165 does not permit deduction of the loss, and not on the rationale relied upon by the district court.
In the 1850's, William Scully, a native of Ireland, purchased 46,000 acres of land in central Illinois. Rather than farm this land himself, Mr. Scully chose to lease the land in a fashion similar to the one his family had used in Ireland for many years. Under this system, the typical lease term was only one year, but the tenants were assured that their lease would be renewed if they paid their rent promptly in cash and if they properly maintained their property. The tenants were required and encouraged to construct and maintain buildings, fences and other improvements. If the tenant wished to move or retire, he was entitled to sell his improvements to a succeeding tenant, if acceptable to Mr. Scully, as if those improvements were personal property.
Most of the 46,000 acres have remained in the Scully family ever since, and the practices instituted by William Scully are still respected. The family itself refers to the practice as the "Scully Tradition." The land is managed today by Michael and Peter Scully, the grandchildren of William, with the help of two agents, from offices in Lincoln and Dwight, Illinois. They arrange the leases, collect the rents, pay the taxes, maintain the drainage system, and ensure that the tenants abide by the leases. Many of the tenants belong to families that have leased the same land from the Scullys for three or four generations. The tenants have erected valuable improvements on the land, aggregating $10 million or more, and they rely on the Scully Tradition to safeguard their investments. Michael and Peter Scully agree that it is important that the property stay in the family.
In 1959 title to the land was in Thomas Scully, the son of William and the father of Michael and Peter. In that year, Thomas created two trusts (the Buying Trusts), one for the benefit of Michael's children, the other for the benefit of Peter's children. Thomas placed some of his land into those trusts. The terms of the Buying Trusts provided that the trust estate should be divided into shares of equal value for each of Michael's and Peter's children, with Michael and Peter serving as co-trustees. If Michael or Peter should have additional children, the trust estate was to be redivided so that each child would have an equal share. The Buying Trusts' dispositive provisions provided that two-thirds of the annual income from the trusts was to be paid to the children after they reached the age of 21, and one-third was to be added to corpus. The Buying Trusts were to terminate ten years after the death of the last to die of the children of Michael and Peter living in 1959. When any of the children died during the term of the Buying Trusts, that child's descendants would succeed to that interest per stirpes.
Thomas died in 1961. By his will, one-half of his adjusted gross estate was placed in a marital trust for the benefit of his wife Violet. She was given a general power of appointment over the assets in the marital trust "as she shall direct in her Will." If she did not exercise the power of appointment, the property in the marital trust was to be added to, and disposed of, as part of Thomas' residuary estate.
Violet died on August 9, 1976. At that time, more than 7,000 acres of the Scully land was held in the marital trust. In her will, she exercised the power of appointment and directed that most of this land be divided into equal trusts for the benefit of each of Michael's and Peter's children (the Selling Trusts).*fn2 Michael and Peter were named co-trustees of the Selling Trusts. All relevant provisions of the trusts were the same as for the Buying Trusts, with two exceptions. First, all income of the Selling Trusts, instead of two-thirds of the income, was to be distributed to the children once they reached the age of 21. Second, the Selling Trusts were to terminate ten years after the death of the last ...