EUGENE A. WRIGHT, Circuit Judge:
This case requires us to apply collateral estoppel principles in the tax context. The taxpayers, Donald and Judith Peck, entered into a 30-year lease of real property in 1974 from their controlled corporation. The lease terms did not change for the first five years. In a prior action, the Tax Court found that the Pecks' rent deductions under the lease for 1974, 1975 and 1976 must be reduced by the full amount of gardening expenses and 25% of the property taxes and mortgage payments under 26 U.S.C. § 482.
In this action, the IRS assessed deficiencies against the Pecks for 1977 and 1978 based on their rental deductions in connection with the same lease. The Tax Court applied collateral estoppel, and held that because the terms of the lease for these two years were the same as those for the first three years, the parties were bound by the courts' determination in Peck I in computing the amount of rent deductions. Peck v. Commissioner, 90 T.C. 162, 168 (1988).
The doctrine of collateral estoppel (issue preclusion) is intended to limit the number of times a defendant may be forced to litigate the same claim or issue, and to promote efficiency in the judicial system by putting an end to litigation. Gilbert v. Ben-Asher, 900 F.2d 1407, 1409-10 (9th Cir.1990). The doctrine provides that "once an issue is actually litigated and necessarily determined, that determination is conclusive in subsequent suits based on a different cause of action but involving a party or privy to the prior litigation." United States v. ITT Rayonier, Inc., 627 F.2d 996, 1000 (9th Cir.1980).
The Supreme Court explained the application of collateral estoppel in the tax context in Commissioner v. Sunnen, 333 U.S. 591, 68 S.Ct. 715, 92 L.Ed. 898 (1948). After articulating special concerns with respect to the doctrine's application in tax actions, id. at 598-99, 68 S.Ct. at 720, the Court adopted what has come to be known as the "separable facts" doctrine:
Id. 333 U.S. at 601, 68 S.Ct. at 721 (emphasis added) (citations omitted). The Court concluded:
Id. at 601-02, 68 S.Ct. at 721 (citing Tait v. Western Md. Ry. Co., 289 U.S. 620, 53 S.Ct. 706, 77 L.Ed. 1405 (1933)).
The Court's decision in Montana v. United States, 440 U.S. 147, 99 S.Ct. 970, 59 L.Ed.2d 210 (1979), calls Sunnen's separable facts doctrine into question. Starker v. United States, 602 F.2d 1341, 1346 (9th Cir.1979). The Court limited the application of Sunnen to cases where there has been a significant "`change in the legal climate.'" Montana, 440 U.S. at 161, 99 S.Ct. at 977 (quoting Sunnen, 333 U.S. at 606, 68 S.Ct. at 723); Starker, 602 F.2d at 1347. Two circuits have concluded that the Sunnen separable facts doctrine is not good law after Montana. American Medical Int'l, Inc. v. Secretary of Health, Education and Welfare, 677 F.2d 118, 120 (D.C.Cir.1981) (per curiam); Hicks v. Quaker Oats Co., 662 F.2d 1158, 1167 (5th Cir.1981).
There is conflicting authority in this circuit as to whether Sunnen's separable facts doctrine is still alive.
We need not decide whether the separable facts doctrine is still good law. Assuming, without deciding, that the more restrictive Sunnen test applies, we hold that the Tax Court properly used the collateral estoppel doctrine in this case.
The issue litigated and decided in Peck I was the proper amount of rent deductions under the Pecks' 1974 lease with its controlled corporation. Applying the clearly erroneous standard, we upheld (1) the Tax Court's determination that it was "`highly unlikely an unrelated lessee in petitioners' position would have paid $24,870 per year for the use of the land while also carrying responsibility for taxes, mortgage payments, and gardening expenses,'" and (2) the Tax Court's finding that the appropriate rent deductible under the lease for the three years at issue was the amount stated in the lease reduced by the gardening expenses and 25% of the property taxes and mortgage payments. Peck I, 752 F.2d at 472-73.
In deciding whether collateral estoppel applies under Sunnen, we must determine whether this proceeding involves "the same set of events or documents and the same bundle of legal principles that contributed to the rendering of the first judgment." 333 U.S. at 602, 68 S.Ct. at 721. We focus on whether the legal relationship changed over the relevant time period. See Southwest Exploration Co. v. Riddell, 362 F.2d 833, 837 (9th Cir.1966) (applying collateral estoppel in the computation of depletion deductions when the legal relationship between the parties had not changed from the time period which was the subject of the prior action); Jones v. United States, 466 F.2d 131, 135-36 (10th Cir.1972) (applying collateral estoppel in determining the character of payments received under a contract which contained terms which did not change over the relevant time period), cert. denied, 409 U.S. 1125, 93 S.Ct. 938, 35 L.Ed.2d 257 (1973); Sydnes v. Commissioner, 647 F.2d 813, 815 (8th Cir.1981) (applying collateral estoppel in determining the character of payments under the same mortgage considered in a prior action).
The legal relationship in this case is a lease. The test for determining whether rent payments are reasonable is "whether the sum paid is in excess of what the lessee would have been required to pay had he dealt at arm's length with a stranger." Mackinac Island Carriage Tours, Inc. v. Commissioner, 455 F.2d 98, 100 (6th Cir.1972) (applying 26 U.S.C. § 162, which allows deductions from gross income for ordinary and necessary business expenses).
In the context of a long-term lease, the determination of what is a reasonable term is made as of the date of its inception. See Brown Printing Co. v. Commissioner, 255 F.2d 436, 440 (5th Cir.1958) (applying the predecessor to 26 U.S.C. § 162); William E. Davis & Sons, Inc. v. Commissioner, 41 T.C.M. (CCH) 1263 (1981) (in determining whether the terms of a lease are reasonable, the court examines its provisions in light of the facts and circumstances existing at the time it was executed).
The only difference between this action and Peck I is the tax years involved. Peck I involved the first three years of the lease.
The Pecks argue that their complaint in this action raises a factual issue different from those raised in Peck I. Specifically, they alleged here that they did not transfer to their controlled corporation in 1974 any liabilities on the real property subject to the lease. They added this fact to their complaint based on the dissenting opinion in Peck I, which stated that the Tax Court erred in reducing the rent amount by 25% of the mortgage payments because the corporation did not assume or pay any portion of the mortgage. 752 F.2d at 473 (Beezer, J., dissenting).
This fact is neither new nor separable. It existed at the inception of the lease in 1974. Moreover, the dissenting opinion itself indicates that this issue was before the panel in Peck I. The majority apparently rejected it. In essence, what the Pecks are arguing is that the majority's decision was wrong. Even if we agreed that Peck I was decided incorrectly, this is an insufficient basis to defeat the application of collateral estoppel. See Sydnes, 647 F.2d at 815 (holding that a suit seeking a redetermination of the identical question of a tax statute's application based on the assertion that the court's opinion in the prior suit contains "untrue statements" is barred).
The Tax Court correctly determined that the controlling facts in this action are the same as those in Peck I.
Finding that the facts are not separable does not end our inquiry. We next determine whether the legal principles have changed significantly since the first action. Sunnen, 333 U.S. at 600, 68 S.Ct. at 720; Montana, 440 U.S. at 155, 99 S.Ct. at 974. If so, collateral estoppel does not apply.
Finally, the Pecks argue that the Tax Court's opinion in McDonough v. Commissioner, 43 T.C.M. (CCH) 1273 (1982), controls the outcome of this case. The Tax Court held in that case that because the first action turned on a failure of proof, it could not decide the subsequent case on the basis of collateral estoppel. Id. at 1282. The Pecks rely on the language in Peck I which indicated that they had failed to meet their burden of persuasion in the Tax Court, 752 F.2d at 473, and argue that McDonough operates to prevent the application of collateral estoppel.
The decision in Sunnen and the purposes of the collateral estoppel doctrine do not support the rule stated in McDonough, and we reject it. As the Tenth Circuit has noted:
Jones, 466 F.2d at 136.
The gist of the Pecks' argument is that the Tax Court and this court were wrong in Peck I. In this action, they would like to introduce evidence to show that the dissenting judge was correct.
They will not get the opportunity. The issues presented here were necessarily decided in Peck I. There has been no change in the controlling facts or legal principles. Collateral estoppel applies.
LEAVY, Circuit Judge, dissenting:
In Peck I, the tax court held that the transfer served a legitimate business purpose, and it concluded that the Commissioner could not "disallow" the deduction because section 482 authorized him only to "distribute, apportion, or allocate" certain items. Peck v. Commissioner, 43 T.C.M. (CCH) 291, 295 (1982).
The court went on to hold in favor of the Commissioner on the contention that the rent deduction should be reduced by the amount of those additional payments for expenses directly attributable to the land transferred to the corporation (as distinguished from payments attributable to the improvements retained by the taxpayers). Id. The holding in footnote 8 of Peck I is as follows:
Id. at 296.
I dissent from the majority holding that the formula in footnote 8 binds the taxpayers
The lease calls for an adjustment of the rent after five years based upon the Consumer Price Index. The lease as written is, as far as we know, enforceable under local law. If the taxpayers are bound for the years 1977 and 1978 by a formula allocation, then I fear they will be bound by the same formula for the entire remaining life of the lease. By applying collateral estoppel to the narrow question of the Commissioner's power under section 482, the majority may have rewritten the terms of the lease. If the deduction claimed by the taxpayers needs to be reallocated to avoid the ills that section 482 was designed to prevent, it should be done only on a year by year basis.