This section contains the nature of the case and procedural background.

The Sam Houston Company sold Knetsch (P) ten 30-year maturity deferred annuity bonds each in the face amount of $400,000 bearing interest at 2.5% compounded annually. The purchase price was $4,004,000. D gave a check for $4,000 and signed a $4,000,000 nonrecourse annuity loan for the balance. The notes bore 3.5% interest and were secured by the annuity bonds. The interest was payable in advance and P prepaid the first year’s interest of $140,000. The table and loan values at the end of the first year were to be $4,100,000. The contract allowed P to borrow any excess in value above his debt without waiting until the end of the year. Five days after the purchase P loaned $99,000 for which he gave his notes bearing 3.5% interest. That interest was payable in advance and P prepaid the $3,465 interest. P deducted the interest payments of $143,465 on his 1953 taxes. The second year on the contracts began on December 11, 1954, and payments to be made in advance totaling $143,465 were due on a debt of $4,099,000 with a cash or loan value of $4,204,000 on December 11, 1955. P then made his payments and deducted the $147,105 from his 1954 taxes. P terminated the contract on December 27, 1956, with a debt of $4,307,000 and surrendered the bonds and got $1,000 in cash. The contract called for a monthly annuity payment of $90,171 at maturity when P would be 90 and if P held to maturity and continued to borrow the cash value the annuity would be $43 per month. The trial judge held that there was no commercial value to the transactions and there was no real intent that P become indebted to Sam Houston and that no economic gain could be achieved without regard to the tax consequences and that basically the transaction was a sham. P appealed.

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