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October 26, 1992


The opinion of the court was delivered by: HAROLD A. ACKERMAN

 ACKERMAN, District Judge:

 Plaintiffs William G. Becker, Jr. ("Becker") and Patricia B. Becker *fn1" instituted this action against the Internal Revenue Service ("IRS") on March 16, 1990 seeking a refund of federal income taxes for the 1982 tax year plus interest.

 This action arises from an investment entered into by Becker in a mining venture. The primary issue presented for resolution is whether this investment was a mere sham intended solely to generate tax benefits, or whether it was a bona fide transaction entered into with a profit motive.

 The matter proceeded to a non-jury trial. In accordance with Federal Rule of Civil Procedure 52(a), I shall now make findings of fact and conclusions of law.

 I. Findings of Fact

 Some of the facts have been stipulated and are found accordingly.

 A. The Investment

 Becker is a highly experienced attorney and a partner in a prestigious law firm in New Jersey. He has been a member of the New Jersey Bar since 1958 and specializes in general complex litigation. Becker has been making investments all his life. In 1982, he was in the 50% tax bracket.

 In August 1982, Becker was introduced to an investment opportunity in a silver mine in California, known as Panamint City Mines ("Panamint"), by James Celver. It appears that Celver was acting on behalf of Melby Investments, Inc. ("Melby"), the promoter of the venture. The mine was operated and controlled by Mineop Corporation ("Mineop"), whose president is George Pruett. *fn2"

 Becker recalled meeting with Celver at least three times to discuss the investment. Celver told Becker that he had visited the mine and that in his opinion it would be producing a substantial amount of silver within two to three years. Celver gave Becker various documents concerning the mine, including a prospectus and tax opinion.

 The prospectus states several times that a mining venture is extremely speculative, involves a high degree of risk, and should be engaged in only by those who can afford to lose their entire investment. In addition, the "Risk Factors" section of the prospectus provides in relevant part:

 Mining Interest Can Only be Speculative. Though assay reports have been completed . . . and certain pilot operations have indicated an available mineral reserve, no mineral recovery can be guaranteed or even expected in any mining operation. The investor is buying a specific, designated amount of minerals. Tonage [sic] is assigned on a "first come, first serve" basis, and therefore, no quality of claim or quantity of reserves can be determined for a specific investor . . . . By definition, a mining venture is a high risk, speculative investment only for those who can afford to lose the Offering price herein . . . .

 * * *

 Possible Thin Capitalization. Since this Offering provides a minimum of funds . . . and since the Company is planning on revenues from its own silver recoveries, and such income does not yet exist, there is a risk that any investment in this Offering will be in an undercapitalized and underfinanced business, which might, therefore, be unable to deal adequately with adversity.

 Operating Losses. The Company has had a loss from its operations thus far and has had a working deficit. There is no assurance that the Company will operate profitably in the future, and cash flow, if any, from the mining operations is not anticipated until the end of the third quarter for 1982, but no later than the first quarter of 1983. A failure to realize cash flow from mining production royalties within that period may adversely affect the Company's operations unless other sources of financing can be obtained . . . .

 * * *

 Unstable Silver Prices. Silver prices the last fifteen years have been unstable, and we give no predictions. Although no firm conclusions can be drawn about the future, it may be assumed that silver prices will greatly fluctuate until the overall economy is finally stabilized, if ever.

 In addition, the prospectus discusses a tax opinion prepared by an attorney. According to the prospectus, the attorney found that the mine "development costs are deductible because the existence of minerals in commercially marketable quantities, [sic] and this has been disclosed through exploratory activities."

 Becker received a copy of this tax opinion; he "looked" at some of the cases cited in the opinion and determined that they appeared "to make sense." *fn3"

 As part of the investment materials, Becker also received a one-page document, prepared by Melby, setting forth the benefits to the taxpayer from the investment. The words "Tax Leverage %" are displayed in bold capital letters close to the top of the page. Immediately below this heading, the document indicates that a cash down payment of $ 5,250, and a note for $ 15,000 will entitle the investor to "tax benefits" in the amount of $ 20,000. "Leverage on taxes" is calculated to be 380%.

 Further down the page, the potential "Benefits" of the investment are set forth in greater detail. The first benefit listed indicates that the taxpayer's expense deduction for 1982 would be $ 20,000. Next, the "Profit Potential" for a taxpayer in the 50% tax bracket is set forth. The first item taken into account is the taxpayer's "Dollar Savings on Expense Deduction," which is calculated to be $ 10,000. Next, the potential value from silver is calculated to be $ 24,000. *fn4" The $ 10,000 expense deduction is added to the potential value of silver, yielding a total of $ 34,000. The investor's cash down payment of $ 5,250 is subtracted from this amount, yielding "Profit on your Original Investment" of $ 28,750. Curiously, in calculating the investor's potential profit, the document fails to factor in the $ 15,000 promissory note.

 Finally, a letter from Melby addressed to the investor asks:


 A cost of $ 5,000 down, Recourse note of $ 15,000 at12%, you will net 4,000 OUNCES OF .9995 PURE SILVER, plus your note being paid off from earnings. THE SILVER IS CONSIDERED INVENTORY AND DOES NOT HAVE TO BE DECLARED AS INCOME UNTIL SOLD.

 The tax benefits to you in 1982 - $ 20,000 mining expense deduction. This is what you would call "HAVING YOUR CAKE AND EATING IT TOO."

 On the basis of his conversations with Celver and his review of the promotional documents, Becker invested in Panamint on September 13, 1982.

 As part of the investment, Becker entered into the following contractual relationships: 1) a contract for the purchase from Mineop of a "total of 2,000 tons of silver-bearing minerals, bearing a "net equivalent" *fn5" of two troy ounces of silver per ton. The purchase price of the silver was $ 250. 2) a second contract with Mineop for the mining and removal of silver bearing minerals from Panamint. For these services, Becker was to pay $ 20,000, in the form of an initial cash down payment of $ 5,000 and a full recourse promissory note for $ 15,000, payable to Melby. 3) the promissory note (referred to in the mining contract) was payable to Melby, with interest at the rate of 12% per annum. The note provided for yearly interest payments, payable on or before December 31. Principal was payable upon completion of the silver mining or December 31, 1987 (the date the mining contract expired), whichever was sooner. 4) an assignment and security agreement with Melby that provided Melby with full recourse as to principal due on the promissory note. The contract ...

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