Kimberly is a developer of apartment complexes. Two years ago, she formed Deckside Apartments, a partnership, and initiates development of the Deckside Apartments complex. The Staten Investment Fund agrees to finance the development at an annual interest rate of 10%, secured by a mortgage on the property. However, state law limits the annual interest rate for noncorporate borrowers to 8%. To avoid this state usury law, Kimberly incorporates Hump Day, Inc., under state law. Kimberly is the only shareholder of Hump Day, Inc. The next day, Deckside Apartments and Hump Day, Inc., enter into a written agreement under which the corporation holds title to the apartments solely for the purpose of obtaining financing. Hump Day cannot convey, assign, or encumber the property without the permission of Deckside, has no obligation to maintain the property, assumes no liability regarding the financing, and is held harmless from any liability it might sustain as the agent for Deckside.
Staten Investment Fund agrees to provide the financing to Hump Day, Inc., as the corporate nominee of Deckside, provided that Kimberly personally guarantees the note. Upon completion of the apartments, Kimberly, through Hump Day, Inc., obtains the permanent financing from Staten and pays off the short-term construction loans that she had obtained to build the apartments. An apartment manager is hired to oversee the operation of the apartments. All rents collected are deposited to and expenses paid from an account opened by the partnership.
During the current year, the apartments generate substantial operating losses. Kimberly seeks your advice as to the proper treatment of these losses.