DeNAPLES v. C.I.R.
674 F.3d 172 (2012)
Dominick DeNAPLES and Mary Ann DeNaples, Petitioners
COMMISSIONER OF INTERNAL REVENUE, Respondent.
Louis DeNaples and Betty A. DeNaples, Petitioners
Commissioner of Internal Revenue, Respondent.
Dominick DeNaples, Mary Ann DeNaples, Louis DeNaples, and Betty A. DeNaples, Appellants.
Nos. 11-2205, 14357-08, 14359-08.
United States Court of Appeals, Third Circuit.
Argued November 16, 2011.
Filed: March 19, 2012.
Layla J. Aksakal, David B. Blair, Alan I. Horowitz, (Argued), Joel C. Weiss, Miller & Chevalier, Washington, DC, Barry H. Frank, Archer & Greiner, Philadelphia, PA, for Petitioners-Appellants Betty DeNaples, Dominick DeNaples, Louis DeNaples, Mary Ann DeNaples.
Before: FUENTES, CHAGARES, Circuit Judges, and RESTANI, Judge.*
OPINION OF THE COURT
FUENTES, Circuit Judge.
Dominick, Louis, Betty, and Mary Ann DeNaples had an interest in real estate in Pennsylvania which the state condemned as part of the construction of the Lackawanna Valley Industrial Highway. To pay for the land, the state agreed to a settlement under which it would pay them $40.9 million, with interest, in five yearly installments. During the first three years of the agreement, the DeNaples excluded this interest from their federal income taxes as tax exempt interest under I.R.C. § 103, which permits exclusion of interest payments that are obligations of the state. The IRS issued to each couple a deficiency notice for $2.3 million, which was affirmed by the Tax Court. On appeal, the principal issue is whether Section 103 exempts from federal taxation the installment interest paid under an agreement that allowed the state to make yearly payments. We hold that it does.I.
The facts are not in dispute and were stipulated to before the Tax Court. Dominick DeNaples and Louis DeNaples were equal partners in D & L Realty, Rail Realty, Inc., F & L Realty, Inc., and Keystone Company.1 These entities owned an interest in several parcels of real property in Pennsylvania. The Commonwealth of Pennsylvania, through the Pennsylvania Department of Transportation, sought to acquire the property to build the Lackawanna Valley Industrial Highway. In 1993 and 1994, to permit construction to go forward, the State and the DeNaples entered into two Rights of Entry, which permitted the State to enter onto the land but did not alter the DeNaples' entitlement to just compensation.
In 1998, the State initiated condemnation proceedings against the properties in the Pennsylvania Court of Common Pleas by filing a Declaration of Taking pursuant to former 26 Pa. Stat. § 1-402(a). The DeNaples objected, contending that the declaration did not adequately describe the property. The court agreed and dismissed some of the suits. On the remaining suits, a jury trial was commenced and then stayed when the parties indicated that they had settled.
On November 7, 2001, the parties signed a memorandum of intent to settle. The DeNaples agreed that, in exchange for all their ownership interest in all the parcels of land, they would received compensation of approximately $40.9 million, of which $24.6 million would be allocated to principal, and $16.3 million would be allocated to
interest ("settlement interest"). There is nothing in the record that indicates why these numbers were selected.