Rothstein v. United States

Alexander Rothstein (plaintiff) started a real estate holding company called Industrial Developers, Inc. (IDI) in 1951 with a partner, Abraham Savin, with each receiving 300 shares of IDI stock. In 1957, Alexander transferred 300 shares of IDI to an irrevocable trust for his three children. Alexander’s wife, Reba, was the trustee. The trust was to distribute any dividends received on IDI stock, but no dividends were ever paid. In October 1964, Alexander bought Savin’s shares for $500,000. On November 13, 1964, Alexander bought from Reba, as trustee, the trust’s 300 shares for $320,000 via an unsecured promissory note bearing 5 percent annual interest. Alexander made the timely payments. In January 1965, Alexander dissolved IDI, transferred all assets to himself, and replaced an existing mortgage for under $200,000 with a new mortgage of $700,000, which Alexander used to pay Savin. Alexander then gave a second mortgage of $320,000 to his wife as trustee. In the Rothsteins’ 1965 income tax return, they reported a short-term capital loss of $33,171 on the IDI deal and a deduction for $16,000 in interest paid to the trust under the mortgage. The government (defendant) disagreed, finding a deficiency on the basis that Alexander was considered the owner of the trust and could not deduct interest paid to himself. The government’s reasoning was that a loan without adequate security from a subservient trustee would be classified with Alexander as the trust’s owner. The government also argued that Alexander’s claimed basis of $320,000 for the stock should be reduced to $30,000 (the original cost of the stock), as the transfer was from Alexander to himself. Alexander paid the deficiency and sued. During the ensuing litigation, Alexander died, so Alexander’s estate (plaintiff) continued the litigation. At trial, the matter was heard by a judge with an advisory jury. The court entered judgment for the government, and Alexander’s estate appealed.