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B. The Redlands Mortgage and the Bogus Encumbrances
In 1995, petitioners were general partners (with about a
one-third interest) in a California general partnership that
owned a 78-unit apartment building in Corona, California. The
partnership had used the proceeds of a $3.4 million loan from
Redlands Federal Bank to buy the building. By 1995, the value of
the building had declined substantially, and the partnership
stopped making payments on the Redlands mortgage.
On April 29, 1995, Redlands instituted foreclosure
proceedings against petitioners and the other partners. Attorney
Steven Smith (Smith) represented petitioner in that litigation,
which was settled in April 1996. Petitioner owed Smith legal
fees of about $41,000 for his representation.
During the Redlands litigation, petitioner became concerned
that he would become personally liable for the unpaid balance of
the Redlands mortgage. Donald Sieveke (Sieveke), a California
attorney who specialized in bankruptcy law and who rented office
space from petitioner during some of the years in issue, advised
petitioner to encumber his assets to avoid having to divest
himself of assets if he had to file a petition in bankruptcy.
In 1995, petitioners created bogus promissory notes and
deeds of trust to make it appear that their properties were
encumbered and to protect their assets from creditors such as
Redlands Federal. Petitioners executed documents creating: (1) A
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