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IRA acquired the equipment subject to pre-existing liens and
leases and the rights and interests of the lessees and
intermediaries under their respective agreements. Since the
equipment was so heavily encumbered, the value of IRA's equity
interest was not sufficient incentive for it to pay the notes in
the absence of the payment of rent. Estate of Franklin v.
Commissioner, supra. Furthermore, IRA would have no incentive
for paying the notes on the respective deferral dates because the
equipment would have had little, if any, value at that time.
A note which does not represent genuine indebtedness can
neither be included in basis nor support a deduction for interest
expense. See Knetsch v. United States, 364 U.S. 361 (1960);
Deegan v. Commissioner, 787 F.2d 825, 827 (2d Cir. 1986).
Therefore, the tax effect of our holding on this issue is
twofold. First, the principal amounts of the long-term notes
must be eliminated from IRA's depreciable basis. Second, all
deductions for interest, including the interest prepayments
represented by the short-term notes to the various entities, are
disallowed.
Accordingly, we sustain respondent's determinations in all
respects as to this issue.58
58
In view of our holding on this issue, sustaining
respondent's determination that the computer leasing transactions
IRA or Cedilla Invest. entered into lacked economic substance,
the Court need not decide the issue of IRA's income adjustments
(continued...)
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