Countryside, L.P. v. Comm'r , 95 T.C.M. 1006 ( 2008 )

T.C. Memo. 2008-3
UNITED STATES TAX COURT
COUNTRYSIDE LIMITED PARTNERSHIP, CLP HOLDINGS, INC.,
TAX MATTERS PARTNER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3162-05. Filed January 2, 2008.
CS, a limited partnership, owned real property R,
which CS sold in April of year 2. W and C were members
of CS. In late year 1, CS redeemed W’s and C’s
interests in CS by distributing to them its 99-percent
interest in a (newly formed) L.L.C., CLPP, which held a
99-percent interest in a second (newly formed) L.L.C.,
MP. MP owned four privately issued promissory notes in
the aggregate principal amount of $11.9 million
purchased with (1) an $8.55 million bank loan to CS,
the proceeds of which were contributed by it to CLPP,
which then contributed $8.5 million to MP, and (2) a
$3.4 million bank loan directly to MP. The notes were
neither listed nor traded on an established financial
market. On the distribution to W and C, each was
relieved of his share of CS’s liabilities, although
each retained, indirectly, his share of MP’s
liabilities. W and C reported no recognized gain on
account of the distribution. CS elected to step up its
basis in R.
Respondent alleges: (1) CLPP, MP, and all of the
late year 1 transactions should be disregarded as
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without economic substance and there was, in substance,
a cash distribution of over $11 million from CS to W
and C or, alternatively, a distribution of “marketable
securities”, as defined in sec. 731(c)(2), I.R.C., that
constituted money for purposes of sec. 731(a)(1),
I.R.C., and (2) CS is not entitled to step up its basis
in R.
W (a participating partner) moves for partial
summary judgment on the issue of whether he and C are
required to recognize gain on the year 1 distribution
to them (i.e., whether they are deemed to have received
money), and he concedes, for purposes of the motion,
that CLPP and MP may be disregarded, which results in a
deemed distribution of the notes from CS to W and C.
The issue for decision is whether the deemed
distribution of the notes from CS to W and C
constituted, in substance, a distribution of cash or,
alternatively, of “marketable securities”.
1. Held: Because the deemed distribution of the
notes to W and C (1) accomplished a legitimate business
purpose (to enable W and C to convert their shares of
CS’s equity in property R into interest-bearing
promissory notes) and (2) resulted in a change in their
economic position, the transactions which enabled them
to accomplish that result in a tax efficient manner may
not be disregarded for lack of economic substance.
2. Held, further, respondent has failed to
demonstrate that there is a genuine issue of material
fact regarding the status of the notes as nonmarketable
securities.
3. Held, further, CS’s deemed distribution of the
notes to W and C resulted in nonrecognition of gain to
them under secs. 731(a)(1) and 752, I.R.C.
Richard A. Levine and Elliot Pisem, for petitioner and
participating partner.
Jill A. Frisch, Barry J. Laterman, and Elizabeth P. Flores,
for respondent.
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MEMORANDUM OPINION
HALPERN, Judge: This case is a partnership-level action
based upon a petition filed pursuant to section 6226.1 The
petition was filed in response to respondent’s notice of final
partnership administrative adjustment (the FPAA) dated October 8,
2004. The case is before us on a motion for partial summary
judgment (the motion) by a participating partner, Arthur M. Winn
(participating partner or Mr. Winn), who until December 26, 2000,
was a limited partner in Countryside Limited Partnership
(Countryside). Respondent objects.
The FPAA alleges that a distribution by Countryside to Mr.
Winn and to Lawrence H. Curtis (Mr. Curtis), another limited
partner, on December 26, 2000, in liquidation of their
partnership interests in Countryside resulted in $12,055,192 of
capital gain to Mr. Winn and Mr. Curtis, cumulatively, for that
year. The FPAA also seeks to (1) deny to Countryside a basis
step-up, pursuant to section 734(b)(1)(B), for its property
remaining after the distribution to Mr. Winn and Mr. Curtis, (2)
require a basis reduction pursuant to section 743(b)(2) for
certain notes held by an L.L.C. in which Countryside, through
another L.L.C., owned a 98-percent interest, or, alternatively,
disregard both L.L.C.s, and (3) impose underpayment penalties
under section 6662.
1
Unless otherwise noted, all section references are to the
Internal Revenue Code in effect for the year at issue, 2000, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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The motion asks that we grant partial summary judgment that
(1) Countryside’s liquidating distribution to Mr. Winn and Mr.
Curtis in 2000 did not result in “a taxable event that gave rise
to * * * [income recognized to] Countryside or any of its
partners during 2000” and (2) “there is no adjustment to income,
gain, loss, deduction, or credit of Countryside or any of its
partners for 2000 arising from Countryside.”
A hearing on the motion (the hearing) was held in
Washington, D.C., on August 15, 2006.
Background
Summary Judgment
A summary judgment is appropriate “if the pleadings, answers
to interrogatories, depositions, admissions, and any other
acceptable materials, together with the affidavits, if any, show
that there is no genuine issue as to any material fact and that a
decision may be rendered as a matter of law.” Rule 121(b). A
summary adjudication may be made upon part of the issues in
controversy. Rule 121(a). In response to a motion for summary
judgment or partial summary judgment, “an adverse party may not
rest upon the mere allegations or denials of such party’s
pleading, but such party’s response, by affidavits or as
otherwise provided in this Rule, must set forth specific facts
showing that there is a genuine issue for trial.” Rule 121(d).
Facts on Which We Rely
On or about September 10, 1993, Countryside was formed as a
Massachusetts limited partnership to acquire, finance, own,
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develop, rehabilitate, construct, lease, operate, and otherwise
deal with real estate. Sometime thereafter, Countryside
acquired, owned, and operated a 448-unit residential property in
Manchester, New Hampshire (the Manchester property).
As of January 1, 2000, the partnership interests in
Countryside were held as follows:
General Partners Interest (%)
CLP Holdings, Inc.1 1.0
Lawrence H. Curtis 0.5
William W. Wollinger 0.5
Limited Partners
Arthur M. Winn 74.2
Lawrence H. Curtis 19.3
William W. Wollinger 4.5
Total 100.0
1
During 2000, Mr. Winn and Mr. Curtis were the
sole shareholders and directors of CLP Holdings, Inc.
On or about June 29, 2000, (1) Mr. Winn transferred a 5-
percent interest in Countryside to Mr. Curtis in exchange for
services performed by Mr. Curtis for Mr. Winn, and (2) both Mr.
Curtis and William W. Wollinger (Mr. Wollinger) ceased to be
general partners of Countryside as each’s 0.5-percent general
partnership interest was converted into a 0.5-percent limited
partnership interest. As a result of those changes, and through
December 25, 2000, the partnership interests in Countryside were
held as follows:
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General Partner Interest (%)
CLP Holdings, Inc. 1.0
Limited Partners
Arthur M. Winn 69.2
Lawrence H. Curtis 24.8
William W. Wollinger 5.0
Total 100.0
On or about September 18, 2000, WMC Realty Corp., by its
president, Mr. Winn, formed CLP Promisee L.L.C. (CLPP) under
Massachusetts law for the following stated purposes: (1) to
engage in the business of making investments in and owning
private bonds, notes, leases, debentures, and other nonmarketable
securities, (2) to make loans or issue and/or borrow, invest, and
lend money, (3) to acquire real or personal property necessary to
carry out such purposes, (4) to enter into contracts relating to
the same, (5) to engage in any activities directly or indirectly
related or incidental to such purposes, and (6) for any other
purpose permitted under law. Also, on September 18, 2000, AMW
Realty Corp., by its president, Mr. Winn, formed Manchester
Promisee L.L.C. (MP) under Massachusetts law for the same stated
purposes.
On October 27, 2000, WMC Realty Corp. contributed $86,364 in
cash to CLPP in exchange for a 1-percent interest in CLPP, and
AMW Realty Corp. contributed $85,859 in cash to MP in exchange
for a 1-percent interest in MP.
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Sometime in or about October 2000, Countryside borrowed
$8.55 million from Columbus Bank & Trust Co. (CB&T), and, on
October 30, 2000, (1) Countryside contributed that entire amount
in cash to CLPP in exchange for a 99-percent interest in CLPP,
and (2) CLPP contributed $8.5 million in cash to MP in exchange
for a 99-percent interest in MP. Therefore, on or about October
30, 2000, Countryside was a 99-percent shareholder in CLPP, and
CLPP was a 99-percent shareholder in MP.
On or about October 30, 2000, MP borrowed $3.4 million from
CB&T. Both CB&T’s $8.55 million loan to Countryside and its $3.4
million loan to MP were guaranteed by Mr. Winn, and the loan to
Countryside was secured by the Manchester property. Both loans
provided interest at an annual rate equal to the London Interbank
Offering Rate (LIBOR) plus 175 basis points. The due date was
May 1, 2001, for the $8.55 million loan to Countryside and
November 1, 2003, for the $3.4 million loan to MP.
On or about October 31, 2000, MP used the $8.5 million
received from CLPP and the $3.4 million borrowed from CB&T to
purchase four privately issued notes from AIG Matched Funding
Corp. (AIG) in the aggregate principal amount of $11.9 million
(the AIG notes). The AIG notes were for principal amounts of
$6.2 million, $2.6 million, $2.3 million, and $800,000. Each
note became due on October 31, 2010, although the holder of each
note possessed a right of redemption exercisable, in whole or in
part, on the fifth interest payment date (April 30, 2003). Each
note provided for interest at an annual rate equal to LIBOR minus
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55 basis points, before the fifth interest payment date, and
LIBOR minus 35 basis points thereafter. The AIG notes were
neither listed nor traded on an established financial market.
Paragraph 11(b) of the “further provisions” of each note
provided, in part, as follows:
(i) * * * upon the affirmative vote * * *, of the
holders of not less than 50 percent in aggregate
principal amount of the Notes then Outstanding * * * or
* * * with the written consent of the owners of not
less than 50 percent in aggregate principal amount of
the Notes then Outstanding * * * the Issuer and the
Guarantor may modify, amend or supplement the terms of
the Notes, in any way * * * provided, however, that no
such action may, without the affirmative vote of
holders of 100 percent in aggregate principal amount
Outstanding of the Notes, * * * change the due date for
the payment of principal or interest on the Notes
* * * .
As of October 30, 2000, MP assigned to CB&T a security interest
in two of the AIG notes, in the principal amounts of $2.6 million
and $800,000, as collateral for its $3.4 million loan from CB&T.
Pursuant to the terms of the assignment, MP deposited with CB&T
all of its right, title, and interest in the assigned AIG notes
and all payments under those notes.2
On December 26, 2000, Countryside distributed its 99-percent
interest in CLPP to Mr. Winn and Mr. Curtis in complete
liquidation of their respective partnership interests in
Countryside (the liquidating distribution). As a result of the
liquidating distribution, CLP Holdings, Inc., became a 16.7-
2
See app. A for a diagram of the statement of facts to
this point.
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percent general partner, and Mr. Wollinger became an 83.3-percent
limited partner in Countryside.
On or about January 26, 2001, Countryside and Stone Ends
Apartments L.L.C. (Stone Ends) executed a purchase and sale
agreement for Countryside’s sale to Stone Ends of the Manchester
property. That agreement was the culmination of negotiations
between Countryside and Stone Ends that began with an unsolicited
inquiry, in May or June 2000, from a representative of Stone
Ends. The sale of the Manchester property closed on or about
April 19, 2001, and, on that date or soon thereafter, Countryside
repaid to CB&T the $8.55 million loan plus accrued interest.
The AIG notes were redeemed from MP by AIG on or about April
30, 2003.
CB&T’s $3.4 million loan to MP was repaid in full on or
about January 5, 2004.
Respondent’s Motion To Compel Production of Documents
Respondent has moved the Court to compel petitioner (CLP
Holdings, Inc.) to produce certain documents (the motion to
compel production) as follows:
1. Provide all explanatory or promotional
materials related to the proposed and/or actual
transactions including but not limited to:
(a) educational, instructional, and
informational material;
(b) schematics, diagrams, and charts;
(c) economic, financial, and tax analyses;
(d) documents discussing potential risks
and/or benefits associated with the proposed
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transaction, including financial risks, tax risks,
audit risks;
(e) all other documents relating directly or
indirectly to the tax and/or financial
consequences of participating in the transaction.
2. Provide all legal, tax, accounting, financial
or economic opinions secured or received in connection
with the transaction.
Petitioner objects, principally on the grounds of privilege,
but has provided to both respondent and the Court a privilege log
and a revised privilege log. The revised privilege log lists 20
documents, all of which were (1) either addressed to, received
from, or copied to an attorney or C.P.A., (2) described as
“advice regarding tax law,” and (3) withheld from respondent on
the basis of a claimed privilege described, in each case, as
“attorney-client; Work Product; §7525.”3 In his response to
petitioner’s objection to the motion to compel production,
respondent does not dispute petitioner’s description of the
documents as “advice regarding tax law”. Rather, he alleges that
petitioner failed to sustain its claim that those documents are
privileged, and he requests that we “order the documents produced
or [,] alternatively, inspect the documents ‘in camera’ to
determine whether the asserted privilege or protection applies.”
The Court has not ruled upon the motion to compel
production.
3
Sec. 7525(a)(1) provides a limited privilege, equivalent
to the attorney-client privilege, to communications regarding tax
advice between a taxpayer and “any federally authorized tax
practitioner”.
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Discussion
I. Internal Revenue Code Provisions and Regulations
A. Code Provisions
1. Nonrecognition of Gain Issue4
4
In his objection to the motion, respondent states:
“Petitioner’s request that the Court determine that no income or
gain should be recognized by * * * Mr. Curtis and Mr. Winn is
inappropriate * * * [because] the Court does not have
jurisdiction over the resulting net tax effect on the partners”,
citing secs. 6226(f) and 6231(a)(3), which, in effect, limit our
jurisdiction in a partnership proceeding to the determination of
partnership items as defined in regulations. In his response,
participating partner argues that, under the applicable
partnership regulations, the amount and character of the
liquidating distribution and Mr. Winn’s and Mr. Curtis’s bases
for their partnership interests in Countryside are partnership
items. He concludes that, because we may make determinations
with respect to the amount and character of the liquidating
distribution and Mr. Winn’s and Mr. Curtis’s bases in
Countryside, it necessarily follows that we may determine whether
the liquidating distribution resulted in gain recognized to them.
Participating partner also points out that respondent’s
jurisdictional argument is somewhat disingenuous in the light of
the fact that the “Explanation of Items” included in the FPAA
increases 2000 capital gain to Mr. Winn and Mr. Curtis by
$12,055,192. Also, we have examined Exhibit A attached to that
explanation, which makes clear that respondent views the
liquidating distribution as a distribution of $12,055,192 to Mr.
Winn and Mr. Curtis, and he views each as having a zero basis in
Countryside, thereby attributing that amount of alleged gain to
them.
We agree with participating partner on this question of
jurisdiction. Although sec. 301.6231(a)(5)-1T(b), Temporary
Proced. & Admin. Regs., 52 Fed. Reg. 6790 (Mar. 5, 1987),
ambiguously provides that “[a] partner’s basis in his interest in
the partnership is an affected item to the extent it is not a
partnership item”, in this case, where Mr. Winn’s and Mr.
Curtis’s bases in Countryside are entirely determined by
partnership items, i.e., contributions to the partnership and
partnership-level operating losses, distributions, and
liabilities (see apps. B and C to this report and sec.
301.6231(a)(3)-1(a)(1)(i) and (v), (4)(i) and (ii), Proced. &
Admin. Regs.), it is appropriate to determine those bases in a
partnership proceeding. Moreover, as discussed infra, the
determinative issue in deciding whether Mr. Winn and Mr. Curtis
(continued...)
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The issue of whether any gain should have been recognized to
Countryside, Mr. Winn, and/or Mr. Curtis as a result of the
December 26, 2000, distribution of Countryside’s 99-percent
interest in CLPP is governed, in the first instance, by sections
731 through 733 and section 752.
Section 731(a)(1) provides, in pertinent part, that, in the
case of a partnership distribution to a partner, gain shall not
be recognized to the recipient partner “except to the extent that
any money distributed exceeds the adjusted basis of such
partner’s interest in the partnership immediately before the
distribution”. Section 731(b) provides: “No gain or loss shall
be recognized to a partnership on a distribution to a partner of
property, including money.”5 Section 731(c)(1) provides that,
for purposes of section 731(a)(1), the term “money” includes
“marketable securities”, which are to be taken into account at
fair market value as of the distribution date. Section
731(c)(2)(A) defines the term “marketable securities” to mean
“financial instruments * * * which are, as of the date of
distribution, actively traded (within the meaning of section
4
(...continued)
have gain recognized to them on the liquidating distribution is
whether that distribution constituted, in substance, a
distribution to Mr. Winn and Mr. Curtis of either money or
“marketable securities”, which are treated as money under sec.
731(c)(1). That issue involves a partnership item pursuant to
secs. 301.6231(a)(3)-1(a)(4)(ii) and (c)(3)(ii) and (iv), Proced.
& Admin. Regs. Therefore, we have jurisdiction to decide the
nonrecognition of gain issue.
5
Respondent does not allege that Countryside recognized
gain as a result of the liquidating distribution.
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1092(d)(1)).”6 Section 731(c)(2)(B)(ii) and (v) includes in the
meaning of the term “marketable securities” (1) “any financial
instrument which, pursuant to its terms or any other arrangement,
is readily convertible into, or exchangeable for, money or
marketable securities”, and (2) “interests in any entity if
substantially all of the assets of such entity consist (directly
or indirectly) of marketable securities”. The term
“substantially all” means 90 percent or more by value. Sec.
1.731-2(c)(3)(i), Income Tax Regs.
Section 732(b) provides that the basis of property (other
than money) distributed by a partnership to a partner in
liquidation of the latter’s interest shall be an amount equal to
the partner’s adjusted basis in such partner’s interest reduced
by any money distributed in the same transaction.
Section 752(a) provides that any increase in a partner’s
share of the liabilities of a partnership shall be considered as
a contribution of money by the partner to the partnership, and
section 752(b) provides that any decrease in a partner’s share of
the liabilities of a partnership shall be considered as a
distribution of money to the partner by the partnership.
Pursuant to section 733, in the case of a nonliquidating
distribution, any such decrease will, first, reduce the partner’s
basis in the partnership (but not below zero). To the extent
such decrease exceeds the partner’s basis in the partnership,
6
See sec. 1.1092(d)-1(a), Income Tax Regs. (“Actively
traded personal property includes any personal property for which
there is an established financial market.”).
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gain is recognized to the partner pursuant to section 731(a)(1).
If a transaction gives rise to both an increase and a decrease in
the partner’s share of partnership liabilities or the partner’s
individual liabilities, only the net decrease is treated as a
distribution of money to the partner by the partnership. Sec.
1.752-1(f), Income Tax Regs.
2. Basis Issues
As noted supra, the FPAA seeks to deny Countryside a basis
step-up for its property remaining after the distribution to Mr.
Winn and Mr. Curtis,7 and it also challenges the recognition of
MP as holder of the AIG notes with a basis equal to the purchase
price of the notes. Although those basis issues are not
addressed in the motion, respondent describes them as “integrally
related to the section 731 and section 752 issues”, and he cites
the totality of the transactions described supra, and the
elections giving rise to the basis results, as constituting “an
abusive tax avoidance result” (i.e., the indefinite or, possibly,
permanent nonrecognition of the gain on the sale of Countryside’s
assets), which should not be given effect. Because respondent’s
position in opposition to the motion relies, in part, upon the
alleged abusiveness of the combination of gain not being
recognized to Mr. Winn and Mr. Curtis, the basis step-up of
7
Schedule L, Balance Sheets per Books, included in
Countryside’s 2000 Form 1065, U.S. Return of Partnership Income,
on lines 9a and 11, reflects an $11,450,498 “step-up” in
Countryside’s bases for its “Buildings and other depreciable
assets” and its land ($11,655,277 total yearend basis increase
less $204,779 attributable to amounts expended for depreciable
property during 2000).
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Countryside’s post-distribution assets, and the failure of MP to
“step down” its basis in the AIG notes, all occurring in 2000, we
shall summarize the basis adjustments required or authorized
under the Code provisions governing liquidating distributions by
a partnership.
In pertinent part, section 754 provides that, if a
partnership files an election under regulations prescribed by the
Secretary, the basis of partnership property is adjusted, in the
case of a distribution of property, in the manner provided in
section 734. Under section 734(b)(1)(B), in the case of a
distribution in liquidation of a partner’s interest, a
partnership that has a section 754 election in effect shall
increase the adjusted basis of partnership property by the excess
of the adjusted basis of the distributed property to the
partnership immediately before the distribution over the basis of
the distributed property to the distributee, as determined under
section 732(b). Section 734(b)(1)(B) shall not apply, however,
if the distributed property is an interest in another partnership
with respect to which a section 754 election is not in effect.
Sec. 734(b) (last sentence).8
8
Respondent’s counsel acknowledges that CLPP had a sec.
754 election in effect at the time of Countryside’s distribution
of CLPP to Mr. Winn and Mr. Curtis on Dec. 26, 2000. In the
light of that election, participating partner takes the position
that the last sentence of sec. 734(b) does not apply to that
distribution and that, therefore, Countryside is entitled to the
reported basis step-up under sec. 734(b)(1)(B) and, as a result,
to reduced gain on the 2001 sale of the Manchester property.
Those issues of basis step-up and reduced gain are at issue for
taxable year 2001 in Countryside Ltd. Pship. v. Commissioner,
(continued...)
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Section 743(b) applies to a transfer, by sale or exchange,
of an interest in a partnership that has a section 754 election
in effect, and section 761(e) provides that any distribution by a
partnership of an interest in a partnership shall be treated as
an exchange for purposes of section 743. Pursuant to section
743(b)(2) the distributed lower tier partnership must decrease
the adjusted basis of its partnership assets by the excess of the
transferee partner’s proportionate share of the adjusted basis of
the partnership property over the basis of the transferee
partner’s interest in the partnership.9
B. Regulations
1. The Subchapter K Antiabuse Regulations10
Section 1.701-2, Income Tax Regs., constitutes a two-part
antiabuse rule directed at partnerships. The two parts are
generally referred to as the “abuse-of-Subchapter-K” rule and the
“abuse-of-entity-treatment” rule. See 1 McKee et al., Federal
8
(...continued)
docket No. 22023-05, which has been continued pending the outcome
of this case, although respondent raises the basis step-up issue
in this case as well.
9
The sec. 743(b)(2) basis step-down for CLPP’s assets
(primarily, its limited partnership interest in MP) is reflected
in CLPP’s 2000 Form 1065. Because MP did not make a sec. 754
election, it did not step down its basis for its assets
(primarily, the AIG notes). Therefore, MP did not report any
gain (almost all of which would have been taxable to Mr. Winn and
Mr. Curtis as the 99-percent limited partners in CLPP) on the
redemption of those notes in 2003.
10
Subch. K, ch. 1, subtit. A of the Internal Revenue Code
(subch. K), is entitled "Partners and Partnerships"; it sets
forth the rules for the income taxation of partners and
partnerships.
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Taxation of Partnerships and Partners, par. 1.05[1], at 1-14 (4th
ed. 2007). Only the first part of the rule (section 1.701-2(a)
through (d), Income Tax Regs.) is pertinent to this case.
Section 1.701-2(a), Income Tax Regs., is entitled “Intent of
subchapter K”. It states: “Subchapter K is intended to permit
taxpayers to conduct joint business * * * activities through a
flexible economic arrangement without incurring an entity-level
tax.” It further states that there are three requirements
“[i]mplicit in the intent of subchapter K”: (1) “The partnership
must be bona fide”, and the transaction(s) in question “must be
entered into for a substantial business purpose”, (2) the
transaction(s) must not violate substance over form principles,
and (3) the tax consequences under subchapter K “must accurately
reflect the partners’ economic agreement and clearly reflect the
partner’s income” unless any departure from that standard is
“clearly contemplated” by the applicable provision of subchapter
K or the regulations thereunder.
Section 1.701-2(b), Income Tax Regs., entitled “Application
of subchapter K rules”, provides, in pertinent part:
[I]f a partnership is formed or availed of in
connection with a transaction a principal purpose of
which is to reduce substantially the present value of
the partners’ aggregate federal tax liability in a
manner that is inconsistent with the intent of
subchapter K, the Commissioner can recast the
transaction for federal tax purposes, as appropriate to
achieve tax results that are consistent with the intent
of subchapter K * * * . Thus, even though the
transaction may fall within the literal words of a
particular statutory * * * provision, the Commissioner
can determine * * * that to achieve tax results that
are consistent with the intent of subchapter K * * *
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[t]he claimed tax treatment should * * * be adjusted or
modified.
Section 1.701-2(c), Income Tax Regs., applies a facts and
circumstances test in order to determine whether “a partnership
was formed or availed of with a principal purpose to reduce
substantially the present value of the partners’ aggregate
federal tax liability in a manner inconsistent with the intent of
subchapter K”, and section 1.701-2(d), Income Tax Regs., contains
11 examples intended to “illustrate the principles of paragraphs
(a), (b), and (c)”.
2. The Section 731 Antiabuse Regulation
Section 1.731-2(h), Income Tax Regs., provides in pertinent
part:
[I]f a principal purpose of a transaction is to achieve a
tax result that is inconsistent with the purpose of section
731(c) and this section, the Commissioner can recast the
transaction for Federal tax purposes as appropriate to
achieve tax results that are consistent with the purpose of
section 731(c) and this section. * * *
The regulation invokes a facts and circumstances test and
provides three examples. Id. Two find deemed distributions of a
partnership’s marketable securities to partners, and the third
permits a series of distributions of “multiple properties” to be
treated as “part of a single distribution”.
II. Arguments of the Parties
A. Participating Partner
Attached to the motion are exhibits containing computations
for Mr. Winn and Mr. Curtis that, for each, show (1) his share of
Countryside’s liabilities and his adjusted basis in his
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Countryside interest as of January 1, 2000, (2) the changes in
both his share of those liabilities and that basis between
January 1 and the December 26, 2000, liquidating distribution,
and (3) the effect of the liquidating distribution on his share
of those liabilities.
Participating partner represents that Mr. Winn’s adjusted
basis in his interest in Countryside immediately before the
liquidating distribution to him was $19,937,590, and the amount
of money considered distributed to him pursuant to section 752(b)
in connection with the liquidating distribution (i.e., the net
decrease in Mr. Winn’s share of Countryside’s and MP’s
liabilities resulting from the liquidating distribution) was
$19,656,762.11 Because the net decrease in Mr. Winn’s share of
those liabilities resulting from the liquidating distribution
($19,656,762) was less than his adjusted basis for his interest
in Countryside immediately before that distribution
($19,937,590), Mr. Winn argues that, pursuant to section
731(a)(1) (which limits the gain recognized to a partner on any
distribution from a partnership to the amount of money
distributed in excess of the partner’s adjusted basis in the
partnership at the time of the distribution), he realized no gain
on the liquidating distribution.
11
The exhibit states that the liquidating distribution
relieved Mr. Winn of $22,142,736 of Countryside’s liabilities in
existence as of Dec. 26, 2000, but that Mr. Winn’s retained
liability representing his share of CLPP’s share of MP’s $3.4
million (plus interest) liability to CB&T was $2,485,974,
resulting in net relief from liabilities for Mr. Winn of
$19,656,762.
- 20 -
Participating partner submits corresponding computations and
makes the same argument with respect to Mr. Curtis; i.e., because
the net decrease in Mr. Curtis’s share of Countryside’s and MP’s
liabilities resulting from the liquidating distribution (computed
to be $7,473,190) was less than his adjusted basis for his
interest in Countryside immediately before that distribution
(computed to be $7,760,895), pursuant to section 731(a), no gain
was recognized to Mr. Curtis on the liquidating distribution.12
Participating partner’s position that neither Mr. Winn nor
Mr. Curtis recognized gain on the liquidating distribution is
dependent upon his argument that the AIG notes were not
“marketable securities”, as defined in section 731(c)(2).13 In
support of that argument, participating partner has submitted two
affidavits. The first is the affidavit of Leslie J. Nanberg (Mr.
Nanberg), a registered investment adviser in Massachusetts and a
12
Participating partner’s computations for Mr. Winn and
Mr. Curtis are reproduced as apps. B and C.
13
Because the AIG notes constituted more than 90 percent
of MP’s assets, by value, and CLPP’s indirect interest (through
MP) in those assets constituted more than 90 percent of CLPP’s
assets, by value, on the date of the liquidating distribution,
Countryside’s liquidating distribution to Mr. Winn and Mr. Curtis
of a 99-percent interest in CLPP would be treated as a
distribution of money, for purposes of sec. 731(a), should the
AIG notes be considered marketable securities. See sec.
731(c)(2)(B)(v); sec. 1.731-2(c)(3)(i), Income Tax Regs.
Therefore, the status of the AIG notes as nonmarketable
securities (and, therefore, as property other than money for
purposes of sec. 731(a)) is crucial to participating partner’s
position, whether or not we disregard the separate existence of
CLPP and MP for Federal income tax purposes and treat the
liquidating distribution as a distribution of the AIG notes
themselves, an assumed scenario that participating partner
concedes for purposes of the motion.
- 21 -
principal in an investment advisory firm (the Nanberg affidavit).
Mr. Nanberg professes to be knowledgeable “regarding the trading
markets that may exist for various financial instruments and * *
* whether or not price quotations therefore [sic] are readily
available”. Mr. Nanberg, after finding that the AIG notes “were
not listed or traded on an established financial market” and that
“no such market existed for the * * * [AIG] Notes on Dec. 26,
2000, or at any time thereafter,” concludes that the AIG notes
“were neither liquid nor easily offset on Dec. 26, 2000 or at any
time thereafter.” The second is the affidavit of Samuel Ross
(Mr. Ross) who, in 2000, was the treasurer of AMW Realty Corp.
(the 1-percent general partner in MP) and was personally involved
in the negotiation and MP’s acquisition of the AIG notes. Mr.
Ross states that “[a]ll terms of the transaction in which * * *
[MP] acquired the * * * [AIG] Notes are contained * * * [in the
notes themselves and in the related documentation]”, and “[t]here
was no agreement, understanding, or arrangement, written or oral,
binding or non-binding, between * * * [MP and AIG] that modifies
the terms of * * * [those] documents.”
Participating partner argues that respondent’s reliance upon
the partnership antiabuse rules contained in the regulations is
misplaced. He argues that the purpose of respondent’s reliance
upon section 1.701-2, Income Tax Regs., is unclear; but that, if
it is cited in support of respondent’s argument that MP must
reduce the basis for its assets or, alternatively, that
Countryside may not increase the basis for its assets as a result
- 22 -
of the liquidating distribution, that regulation has no bearing
on the motion, which is addressed solely to the nonrecognition of
gain issue. Participating partner further argues that no matter
how respondent recasts the liquidating distribution pursuant to
section 1.701-2, Income Tax Regs. (i.e., as distributions of
interests in CLPP, MP, or of the AIG notes themselves),
respondent has not demonstrated an ability to overcome the facts
established by participating partner, which demonstrate that (1)
Mr. Winn and Mr. Curtis received nonmarketable securities, and
(2) the net decrease in their respective shares of Countryside’s
and MP’s liabilities did not exceed their respective bases in
Countryside. Participating partner also dismisses section 1.731-
2(h), Income Tax Regs., as inapplicable on the ground that it is
applicable only to circumstances “involving changes in
partnership allocations with respect to marketable securities and
distributions of nonmarketable securities by a partnership that
also owns marketable securities,” which, in substance, constitute
a manipulation by a partner of “the inherent flexibility of the
partnership form to acquire an increased interest in marketable
securities from a partnership without effecting a transaction in
the form of a distribution [of marketable securities].”
Participating partner reasons that “the provision should not have
any application to a partnership [Countryside] that owns no
marketable securities at all, either directly or indirectly.”
Participating partner also argues that the cases respondent
cites involving the disallowance of deductions arising out of
- 23 -
transactions that lacked business purpose or economic substance
are inapposite. That is because none of those cases constitutes
authority for disregarding Mr. Winn’s and Mr. Curtis’s share of
MP’s $3.4 million debt obligation to CB&T, which must be
respected for purposes of applying sections 731(a)(1) and 752 to
the liquidating distribution.
Lastly, participating partner argues that respondent has
failed to raise any genuine issue of material fact as to whether
(1) the AIG notes constituted nonmarketable securities and (2)
Mr. Winn’s and Mr. Curtis’s respective bases for their interests
in Countryside exceeded the amount of money they are deemed to
have received by virtue of the net decrease in their respective
shares of Countryside’s liabilities. In this regard,
participating partner states that respondent’s “theories,
assertions, and arguments” (e.g., that there may have been some
informal “arrangement” among Mr. Winn, Mr. Curtis, and AIG
whereby the AIG notes were readily convertible into, or
exchangeable for, money or marketable securities) are
insufficient to defeat the motion. In support of that statement,
participating partner cites the admonition in Rule 121(d) that
“an adverse party may not rest upon the mere allegations or
denials of such party’s pleading” but, instead, “by affidavits or
as otherwise provided in this Rule, must set forth specific facts
showing that there is a genuine issue for trial.”
- 24 -
B. Respondent
Respondent views the liquidating distribution, Countryside’s
sale of the Manchester property in 2001, and the redemption of
the AIG notes from MP in 2003 as giving rise to a series of
“integrally related” transactions pursuant to which “Winn and
Curtis effectively control [by means of their continued
ownership, through CLPP, of MP] their share of the proceeds from
the sale of * * * [the Manchester property], but have permanently
sheltered it from tax.” Respondent seeks to deny, to Mr. Winn
and Mr. Curtis, any deferral, beyond 2000, of their gain
attributable to the 2001 sale of the Manchester property. Thus,
he takes the position that the liquidating distribution
constituted a distribution of money to Mr. Winn and Mr. Curtis;
i.e., it was a distribution of money under (1) section 731(c)
and/or (2) the antiabuse rule of section 1.731-2(h), Income Tax
Regs. In addition, respondent disregards MP’s $3.4 million
liability to CB&T and Mr. Winn’s and Mr. Curtis’s respective
shares of that liability as offsets, under section 752(a), to the
deemed distributions of money to them under section 752(b) (i.e.,
as offsets to the decrease in their share of Countryside’s
liabilities arising from the liquidating distribution).
Consistently, respondent also disregards the $3.4 million of AIG
notes purchased by MP.
Respondent’s position with respect to the impact of the
liquidating distribution on Mr. Winn’s and Mr. Curtis’s 2000
- 25 -
Federal tax liabilities is summarized in paragraphs 23(h) and (q)
of his amendment to answer as follows:
Mr. Winn Mr. Curtis
Sec. 752(b) deemed
distribution of money1 $14,892,855 $4,402,714
Sec. 731(c)
distribution of money
(cash/securities)2 6,345,394 2,274,191
Total distribution of money 21,238,249 6,676,905
Basis3 (12,879,151) (3,798,080)
Total gain4 8,359,098 2,878,825
1
Respondent treats as a distribution of money to Mr. Winn
and Mr. Curtis, under sec. 752(b), only the relief from
Countryside’s liabilities existing as of Jan. 1, 2000. He
disregards the additional liabilities triggered by the CB&T loans
of $8.55 million to Countryside and $3.4 million to MP, Mr.
Winn’s and Mr. Curtis’s relief from the former, and the
modification of their respective shares of Countryside’s
liabilities resulting from Mr. Winn’s transfer of a 5-percent
limited partnership interest in Countryside to Mr. Curtis, all of
which are taken into account by participating partner on exhibits
attached to the motion. See apps. B and C.
2
These amounts are apparently derived from line 23
(Distributions of property other than money) of Mr. Winn’s and
Mr. Curtis’s Schedules K-1, Partner’s Share of Income, Credits,
Deductions, etc., attached to Countryside’s 2000 return.
3
Respondent treats as Mr. Winn’s and Mr. Curtis’s bases in
Countryside on the date of the liquidating distribution their
bases as of Jan. 1, 2000, thereby disregarding the basis
modifications resulting from the CB&T loans to Countryside and
MP, Mr. Winn’s transfer of a 5-percent limited partnership
interest in Countryside to Mr. Curtis, Countryside’s cash
distributions to Mr. Winn and Mr. Curtis during 2000, and
Countryside’s 2000 loss, all of which are taken into account by
participating partner. See apps. B and C.
4
The total alleged gain to both Mr. Winn and Mr. Curtis is
$11,237,923. That amount differs from both the gain to Mr. Winn
and Mr. Curtis alleged in the FPAA ($12,055,192), which
respondent conceded at the hearing is incorrect, and the revised
alleged gain to Mr. Winn and Mr. Curtis, which respondent’s
counsel stated at the hearing is $11,427,993. There is no
explanation in the record for the discrepancy between the first
and third amounts of alleged gain to Mr. Winn and Mr. Curtis.
- 26 -
At the hearing, respondent’s counsel conceded that the
amounts and computations set forth on the exhibits attached to
the motion (appendixes B and C) are arithmetically correct, but
respondent disputes participating partner’s computational results
on the basis of respondent’s disregard, for Federal income tax
purposes, of the CB&T loans, Mr. Winn’s transfer of a 5-percent
interest in Countryside to Mr. Curtis, and the formation and
separate existence of CLPP and MP. Respondent views those
transactions, culminating with the liquidating distribution, as
“designed to circumvent the provisions of Subchapter K and [as],
in substance, * * * equivalent to a distribution of cash to Winn
and Curtis.” He further alleges that “[t]he entire series of
transactions is a sham and should be disregarded for federal
income tax purposes * * * [and] recast * * * in accordance with
its substance”, which, in respondent’s view, is a distribution of
cash or a cash equivalent to Mr. Winn and Mr. Curtis.14
14
In the FPAA, the only transaction alleged to constitute
a “sham”, lacking in “economic substance”, is the formation and
distribution of CLPP and MP, an allegation that participating
partner concedes for purposes of the motion. In the amended
answer, however, respondent treats as “sham”, and disregards for
lack of “business purpose” and “economic effect”, not only the
distribution to Mr. Winn and Mr. Curtis of CLPP and MP, but also
the CB&T loans to Countryside and MP and the latter’s purchase of
the AIG notes, with the result that that “series of transactions”
is to be treated as “equivalent to a distribution of cash to Winn
and Curtis.” Respondent does not, in the amended answer,
identify the source of the roughly $8.5 million distribution of
money (“Cash/Securities”) that he considers Countryside to have
distributed to Mr. Winn and Mr. Curtis ($6,345,394 to Mr. Winn
and $2,274,191 to Mr. Curtis). At the hearing, however,
respondent’s counsel acknowledged that the source of that money
is the $8.55 million Countryside borrowed from CB&T. She would
not, however, acknowledge the reality for tax purposes of the
(continued...)
- 27 -
Respondent relies upon (1) caselaw employing the so-called
economic substance doctrine and (2) the subchapter K “anti-abuse”
regulations (sections 1.701-2 and 1.731-2(h), Income Tax Regs.),
in order to deny the application of the provisions of subchapter
K and the regulations thereunder that are relied upon by
participating partner, despite literal compliance therewith.
Respondent’s argument that the post January 1, 2000, transactions
lacked “economic substance” is premised on the fact that, because
the interest rate on the CB&T loans to CLPP and MP was 230 basis
points higher than the rate of interest earned on the AIG notes
(the interest detriment), those transactions made “no economic
sense”.
Respondent also opposes the motion on the ground that there
are material issues of fact regarding the true nature of the
economic arrangement among the partners in Countryside and the
circumstances surrounding the sale of the Manchester property to
Stone Ends. He also alleges that there are material issues of
fact regarding the marketability of the AIG notes, i.e., whether
there existed an “arrangement” with AIG whereby the notes were
“readily convertible” into cash, see sec. 731(c)(2)(B)(ii), and
whether CLPP and MP should be disregarded for Federal income tax
14
(...continued)
$3.4 million MP borrowed from CB&T because, as she explained,
that part of the transaction is “more abusive”. She stated:
“Well, the 3.4 is worse than the 8.5 because the 3.4 is down in
Manchester, [it is] associated with a note that is pledged to the
bank * * *, the interest differential is * * * [against the
partnership], and that’s basically all that is in that
partnership.”
- 28 -
purposes. The latter inquiry is relevant solely to the basis
issues15 because, as noted supra, participating partner concedes
that both CLPP and MP may be disregarded for purposes of the
motion; i.e., for purposes of the nonrecognition of gain issue.16
Lastly, respondent asserts that, because issues of (1)
economic substance and (2) tax avoidance motives on the part of
the partners in Countryside in structuring the liquidating
distribution are relevant to our decision on the motion, summary
judgment is precluded until we have resolved respondent’s motion
15
For example, if both CLPP and MP are disregarded, Mr.
Winn and Mr. Curtis are deemed to have received the AIG notes
directly as distributions in liquidation of their interests in
Countryside, and, assuming those notes are not treated as money
under sec. 731(c)(1)(A), each’s resulting basis in his notes is
determined from his partnership basis reduced by the amount of
his relief from Countryside’s liabilities on the distribution
date. See secs. 732(b) and 752(b). Stated numerically,
according to his computations, Mr. Winn’s basis for his share of
the AIG notes would be $280,828 ($19,937,590 - $19,656,762) and
Mr. Curtis’s basis for his share of those notes would be $287,705
($7,760,895 - $7,473,190). See apps. B and C. Alternatively, if
only CLPP is disregarded, then MP’s failure to make a sec. 754
election negates any basis step-up to Countryside for the
Manchester property. See sec. 734(b) (last sentence).
16
Respondent asks that, in this case, we address the
validity for Federal income tax purposes of CLPP and MP because,
assuming we decide that Mr. Curtis and Mr. Winn are not required
to recognize gain in 2000, thereby forcing respondent to attempt
to attribute taxable gain to them upon the redemption of the AIG
notes in 2003, his success in that effort may depend upon whether
Mr. Winn and Mr. Curtis are deemed, for Federal income tax
purposes, to have received (1) membership interests in CLPP or MP
or (2) the AIG notes themselves in 2000. Respondent fears that,
if he first raises the L.L.C. validity issue in litigation
limited to the 2003 taxable year, he may be whipsawed by a claim
that 2000 was the proper year for which to raise that issue. In
the light of participating partner’s concession, there is no need
to address the L.L.C. validity issue in deciding the motion, and
we will be able to address respondent’s fear of being whipsawed
when we resolve any remaining issues in this case.
- 29 -
to compel production. Respondent reasons that the documents
sought may be relevant to those issues and that it would be
“unfair” to grant the motion without first deciding respondent’s
motion to compel production.
III. Analysis
A. Impact of Respondent’s Motion To Compel Production
We first address respondent’s argument that we are precluded
from granting partial summary judgment to participating partner
until we have decided respondent’s motion to compel production.
As noted supra, petitioner’s revised privilege log describes
all of the documents listed therein and sought by respondent as
“advice regarding the tax law.” Respondent does not object to
that description of the documents, and he is willing to assume
arguendo that the only reason for the motion to compel production
“is to secure discovery regarding a tax avoidance motive”.
Participating partner concedes, however, that the liquidating
distribution was structured to defer tax by distributing to Mr.
Winn and Mr. Curtis property rather than cash. Indeed, he
concedes that tax avoidance (or, as participating partner’s
counsel would prefer to describe it, “tax planning”) was the sole
motivation for the formation of CLPP and MP, the CB&T loans, and
the purchase of the AIG notes, all steps taken to ensure that, in
redemption of their partnership interests, Mr. Winn and Mr.
Curtis received only property, and no cash. In the light of
those concessions, we cannot see how respondent can continue to
- 30 -
argue that there exists an issue as to the existence of a
predominant tax avoidance motive.
In support of that argument, respondent notes that, in two
complaints filed in the Court of Federal Claims on behalf of CLPP
and MP, respectively, it is alleged that both CLPP and MP and the
transactions in which they engaged “had economic substance and
business purpose and did not have a principal purpose to reduce
substantially the present value of * * * [Countryside’s]
partners’ aggregate tax liabilities in a manner inconsistent with
the intent of subchapter K.”17 We also note that, in a case in
this Court involving Countryside’s 2001 taxable year, Countryside
Ltd. Pship. v. Commissioner, docket No. 22023-05 (docket No.
22023-05), respondent denies Countryside’s $11,450,498 basis
step-up for the Manchester property, pursuant to section
734(b)(1)(B), which results in his increasing Countryside’s gain
on its 2001 sale of that property by like amount. Respondent’s
position in docket No. 22023-05 is premised, in part, upon his
disregard, for Federal income tax purposes, of CLPP, which had
made a section 754 election, and the failure of MP to make such
an election. See sec. 734(b) (last sentence). In defending the
basis step-up and resulting smaller gain on the sale of the
Manchester property, petitioner in docket No. 22023-05 alleges
that the FPAA “arbitrarily and erroneously determines that the
17
Both of those complaints involve challenges to
respondent’s adjustments to (1) the bases of the members in CLPP
for their membership interests therein and (2) MP’s bases for its
assets.
- 31 -
formation of CLP Promisee was a sham and lacked economic
substance * * * [and] that CLP Promisee should be disregarded and
all transactions engaged in by CLP Promisee treated as engaged in
directly by Countryside”.
In both the Court of Federal Claims actions and in docket
No. 22023-05, the issue of whether CLPP and/or MP should be
disregarded for lack of economic substance and/or business
purpose relates solely to the basis issues, not to the issue
involved in the motion; i.e., whether the liquidating
distribution resulted in the receipt by Mr. Winn and Mr. Curtis
of money, thereby causing taxable gain to be recognized to them.
Participating partner has, for purposes of that issue,
unequivocally conceded both that CLPP and MP may be disregarded
and that their formation and utilization to borrow money and
purchase the AIG notes were tax-motivated steps undertaken as
part of a plan to defer tax by distributing property rather than
cash. In the light of those concessions, we reject respondent’s
argument that we are precluded from granting partial summary
judgment to participating partner before deciding respondent’s
motion to compel production.
B. Economic Substance
1. Introduction
We view the statement in respondent’s amendment to answer
that, pursuant to the liquidating distribution, Mr. Winn and Mr.
Curtis each received an “I.R.C. § 731(c) distribution of money
(Cash/Securities)” as respondent’s allegation that the AIG notes
- 32 -
constituted marketable securities as defined in section 731(c)(2)
or, alternatively, that, even if they were nonmarketable, the
lack of economic substance surrounding their purchase and
distribution negates the ability of Mr. Winn and Mr. Curtis to
achieve nonrecognition of gain under sections 731(a)(1) and
752(a) and (b).18 That alternative argument (lack of economic
substance) is reiterated by respondent in opposing the motion.
We will first address what we consider to be respondent’s
alternative argument that, even if the AIG notes constituted
nonmarketable securities, the liquidating distribution must be
considered, in substance, a distribution of cash to Mr. Winn and
Mr. Curtis resulting in their recognition of gain.
2. Application of Goldstein v. Commissioner
Respondent seeks to disregard the CB&T loans and the
purchase and (because CLPP and MP are to be disregarded for
purposes of the motion) deemed distribution of the AIG notes
directly to Mr. Winn and Mr. Curtis. In support of that
position, respondent points to the interest detriment, which,
combined with transaction costs, necessarily resulted in an
arrangement that could not generate a profit to Countryside, and
which, therefore, was without business purpose. The principal
authority upon which respondent relies is Goldstein v.
18
At this point, we use the term “economic substance”
without attaching to it a precise meaning but only to encompass
the various grounds advanced by respondent for disregarding the
tax results claimed by participating partner, e.g., lack of
“business purpose or economic effect”, a “series of transactions
* * * [amounting to] a sham”, a “transaction * * * [that] makes
no economic sense”.
- 33 -
Commissioner, 364 F.2d 734 (2d Cir. 1966), affg. 44 T.C. 284
(1965).
In the Goldstein case, the taxpayer (Mrs. Goldstein, the
wife in a joint return filing) won over $140,000 in the Irish
Sweepstakes. In an effort to mitigate the tax impact of having
to report all her winnings in the year of receipt, her advisers
constructed a plan pursuant to which, before the end of that
year, she borrowed $945,000 from two banks, purchased $1 million
face amount Treasury 1.5-percent notes, and prepaid 4 percent
interest for 1.5 years on one bank loan and for approximately
2.75 years on the other. The total interest prepayment was over
$81,000, which the Goldsteins claimed as a deduction in the year
of payment under section 163(a). We denied the deduction on the
ground that “there was no genuine indebtedness established
between * * * [Mrs. Goldstein] and * * * [the banks].” Goldstein
v. Commissioner, 44 T.C. 298. The Court of Appeals for the
Second Circuit affirmed, but on a different basis. It agreed
with the dissenting opinion in this Court that the bank loans
were “‘indistinguishable from any other legitimate loan
transaction contracted for the purchase of Government
securities’”, Goldstein v. Commissioner, 364 F.2d at 737 (quoting
Goldstein v. Commissioner, 44 T.C. 301 (Fay, J., dissenting)),
and it found that we were in error in concluding that those loans
“were ‘shams’ which created no genuine indebtedness”, id. at 738.
It agreed, however, with our finding that Mrs. Goldstein entered
into the two bank loans “without any realistic expectation of
- 34 -
economic profit and ‘solely’ in order to secure a large interest
deduction * * * [to offset her sweepstakes winnings].” Id. at
740. The court found that Congress intended to limit interest
deductions under section 163(a) to interest on debt incurred for
“purposive activity”, and it held that that section did not
permit a deduction for the interest paid by Mrs. Goldstein where
the sole purpose of her borrowings was to generate tax deductible
interest. Id. at 740-742.
Because Countryside, like Mrs. Goldstein, could not
realistically profit from investing in the AIG notes at a lower
rate of return than it was required to pay on the loans used to
make that investment, respondent considers the facts in the
Goldstein case “analogous” and the result controlling of the
result herein. Participating partner responds: “Goldstein,
properly understood, stands for the limited proposition that,
when a taxpayer * * * [borrows] for the sole purpose of claiming
a tax deduction for the interest expense, the interest is not
deductible.” He notes that the Court of Appeals for the Second
Circuit respected the debt as bona fide, while disallowing the
interest deduction for lack of any “purposive activity” in
incurring the debt. He concludes: “There is no basis for
contending that a similar ‘purposive activity’ concept is present
in Code section 752, and there is thus no basis for attempting to
extrapolate from Goldstein to the present case.” We interpret
participating partner’s argument to be that, because neither
business purpose nor economic substance considerations affect the
- 35 -
validity of Countryside’s debt to CB&T (which, pursuant to
participating partner’s concession that CLPP and MP may be
disregarded, includes MP’s $3.4 million debt to CB&T), that debt
must be accepted as bona fide for purposes of sections 731(a)(1)
and 752.
Respondent’s reliance on Goldstein founders on the fact that
Countryside, rather than Mr. Winn and Mr. Curtis, occupies Mrs.
Goldstein’s position (paying more interest on the borrowings than
was received on the investment purchased with those borrowings).
The comparable issue in this case would be whether Countryside is
entitled to deduct the interest paid on the loans from CB&T.
Respondent has not raised an interest deductibility issue in this
case, and there is nothing, on that score, for us to resolve.
The Goldstein case, however, does support respondent’s
argument that literal compliance with the conditions for the
application of a particular Code section (in the Goldstein case,
section 163(a); in this case, sections 731(a)(1) and 752) does
not mandate application of the section where the transaction
giving rise to that application fails to comport with Congress’s
purpose in enacting the section. The question before the Court
of Appeals in Goldstein was, at heart, one of statutory
construction, i.e., determining whether, despite the broad scope
of section 163(a), Congress intended to allow an interest
deduction for interest paid on funds borrowed “for no purposive
reason * * * other than * * * securing * * * [a tax] deduction”.
Goldstein v. Commissioner, 364 F.2d at 742. Courts commonly
- 36 -
consider legislative purpose in construing tax (and other)
statutes. See 2A Singer, Sutherland Statutory Construction, sec.
48:3, at 549 (7th ed. 2007). While the precise language of both
sections 731(a) and 752 suggests that there is little uncertainty
in their application, we cannot lose sight of the fact that both
sections are part of a large and complex system of rules for
taxing partners and partnerships; viz, subchapter K. The purpose
of subchapter K, as set forth in the income tax regulations, is
“to permit taxpayers to conduct joint business (including
investment) activities through a flexible economic arrangement
without incurring an entity-level tax.” Sec. 1.701-2(a), Income
Tax Regs. Undoubtedly, sections 731(a) and 752 must be construed
in the light of the purpose of subchapter K. In the analogous
situation of determining whether a transaction fits within the
corporate reorganization provisions of the income tax, the
Supreme Court, in Gregory v. Helvering, 293 U.S. 465, 469 (1935),
famously said:
The legal right of a taxpayer to decrease the amount of
what otherwise would be his taxes, or altogether avoid
them, by means which the law permits, cannot be
doubted. * * * But the question for determination is
whether what was done, apart from the tax motive, was
the thing which the statute intended. * * *
Participating partner has failed to convince us that, in
considering the application of sections 731(a) and 752 to the
facts before us, an inquiry is not warranted into whether
Countryside, Mr. Winn, and/or Mr. Curtis engaged in any
“purposive activity” other than tax avoidance. Indeed, we have
held that there are circumstances in which the lack of “purposive
- 37 -
activity” or economic substance will defeat the application of
the provisions of subchapter K. See, e.g., Wilkinson v.
Commissioner, 49 T.C. 4, 10-13 (1967) (in which we (1)
disregarded, as without “economic significance”, the assignment
of an installment sale obligation to a partnership owned by the
obligees just before the obligees’ liquidation of the corporate
obligor, in which they were majority shareholders, (2) deemed
section 721, which would have protected the obligees from tax on
the deferred gain upon a bona fide assignment of the obligation
to the partnership, to be inapplicable, and (3) held that the
obligees were taxable on the deferred gain upon their liquidation
of the corporate obligor); Santa Monica Pictures, L.L.C. v.
Commissioner, T.C. Memo. 2005-104 (special allocation rules of
section 704(c) and carryover basis rules of section 723 deemed
inapplicable to shift built-in losses to the taxpayer in a
transaction lacking economic substance). The question is whether
there are circumstances present in this case that negate the
application of sections 731(a)(1) and 752(a) and (b) to provide
nonrecognition of gain to Mr. Winn and Mr. Curtis on the
liquidating distribution.
3. Did the Transactions in Question Lack Economic
Substance?
a. Introduction
As noted supra, participating partner concedes that the
liquidating distribution was structured to defer tax by
distributing to Mr. Winn and Mr. Curtis property rather than cash
and that tax avoidance was the sole motivation for the formation
- 38 -
of CLPP and MP, the CB&T loans, and the purchase of the AIG
notes, all in furtherance of that plan. Because participating
partner also concedes that the L.L.C.s may be disregarded for
purposes of the motion, the question before us is whether the
CB&T loans and the deemed purchase and distribution of the AIG
notes by Countryside also must be disregarded for lack of
economic substance with the result that the liquidating
distribution must be treated as equivalent to a cash distribution
to Mr. Winn and Mr. Curtis (despite its literal qualification for
nonrecognition of gain under section 731(a)(1)).
b. The Caselaw
In section III.B.2., supra we set forth the seminal language
from Gregory v. Helvering, supra at 469, requiring an inquiry
into what is now generally is referred to as “economic substance”
in order to determine whether to give effect to the
reorganization provisions of the income tax. We shall make a
like inquiry into the economic substance of the liquidating
distribution in order to determine whether to give effect to the
provisions of subchapter K here in issue; viz, sections 731(a)
and 752. That the so-called economic substance doctrine embodies
the foregoing principle of Gregory v. Helvering, supra, was
recently made clear by the Court of Appeals for the Federal
Circuit in Coltec Indus. Inc. v. United States, 454 F.3d 1340,
1353-1354 (Fed. Cir. 2006), which states:
The economic substance doctrine represents a
judicial effort to enforce the statutory purpose of the
tax code. From its inception, the economic substance
doctrine has been used to prevent taxpayers from
- 39 -
subverting the legislative purpose of the tax code by
engaging in transactions that are fictitious or lack
economic reality simply to reap a tax benefit. In this
regard, the economic substance doctrine is not unlike
other canons of construction that are employed in
circumstances where the literal terms of a statute can
undermine the ultimate purpose of the statute. * * *
The Court also observed that cases applying the economic
substance doctrine “recognize that there is a material difference
between structuring a real transaction in a particular way to
provide a tax benefit (which is legitimate), and creating a
transaction, without a business purpose, in order to create a tax
benefit (which is illegitimate).” Id. at 1357.
The Court of Appeals for the District of Columbia Circuit,
the court to which an appeal of this case most likely would
lie,19 also recognized the foregoing distinction in Boca
Investerings Pship. v. United States, 314 F.3d 625, 631 (D.C.
Cir. 2003), phrasing it in terms of the need for a legitimate
business purpose:
The business purpose doctrine * * * establishes
that while taxpayers are allowed to structure their
business transactions in such a way as to minimize
their tax, these transactions must have a legitimate
non-tax avoidance business purpose to be recognized as
legitimate for tax purposes. * * *
See also ASA Investerings Pship. v. Commissioner, 201 F.3d 505,
512 (D.C. Cir. 2000) (in “sham transaction” cases, “the existence
of formal business activity is a given but the inquiry turns on
19
Because petitioner states in its petition that
Countryside had no principal place of business when the petition
was filed, barring stipulation to the contrary, the venue for
appeal would appear to be the Court of Appeals for the District
of Columbia Circuit. See sec. 7482(b)(1) (flush language) and
(2).
- 40 -
the existence of a nontax business motive”), affg. T.C. Memo.
1998-305. But cf. ACM Pship. v. Commissioner, 157 F.3d 231, 248
n.31 (3d Cir. 1998) (“where a transaction objectively affects the
taxpayer’s net economic position * * * it will not be disregarded
merely because it was motivated by tax considerations”), affg. in
part and revg. in part T.C. Memo. 1997-115; N. Ind. Pub. Serv.
Co. v. Commissioner, 115 F.3d 506, 512 (7th Cir. 1997) (the cases
allowing “the Commissioner to disregard transactions which are
designed to manipulate the Tax Code so as to create artificial
tax deductions * * * do not allow the Commissioner to disregard
economic transactions * * * which result in actual, non-tax-
related changes in economic position”), affg. 105 T.C. 341
(1995).20
c. Analysis
In this case, the transactions that respondent seeks to
disregard, the CB&T loans and the deemed purchase of the AIG
notes by Countryside and their distribution to its majority-in-
interest partners, Mr. Winn and Mr. Curtis, were the means
20
The last four cited cases illustrate that the economic
substance doctrine has two prongs, an objective prong and a
subjective prong. The objective prong requires that the
transaction change the taxpayer’s economic position; the
subjective prong requires that the taxpayer have a nontax
business purpose for entering into the transaction. Although
there is apparently some dispute as to the manner in which the
various Courts of Appeals apply the two prongs, see, e.g.,
Stratton, “Government, Tax Bar Disagree Over Impact of Coltec”,
2006 TNT 212-1 (Nov. 2, 2006), it appears that the Court of
Appeals for the District of Columbia Circuit has applied them
disjunctively; i.e., a transaction will satisfy the economic
substance doctrine if it satisfies either the objective or
subjective prong of the test, see Horn v. Commissioner, 968 F.2d
1229, 1237-1238 (D.C. Cir. 1992), revg. T.C. Memo. 1988-570.
- 41 -
employed by Mr. Winn and Mr. Curtis, and agreed to by
Countryside, to allow Mr. Winn and Mr. Curtis to withdraw from
the partnership before the anticipated sale of the Manchester
property to Stone Ends. While the employed means were designed
to avoid recognition of gain to Mr. Winn and Mr. Curtis, those
means served a genuine, nontax, business purpose; viz, to convert
Mr. Winn’s and Mr. Curtis’s investments in Countryside into 10-
year promissory notes, two economically distinct forms of
investment.21
The Court of Appeals for the Second Circuit considered an
analogous set of facts in Chisholm v. Commissioner, 79 F.2d 14
(2d Cir. 1935), revg. 29 B.T.A. 1334 (1934). In Chisholm, the
taxpayer and the four other shareholders of a corporation granted
a 30-day option to buy their shares in the corporation to a
third-party corporation that, during the option period, gave the
optionors its nonbinding commitment to exercise the option before
it expired. The optionors were advised that, by forming a
partnership to sell the shares, they might postpone and,
possibly, escape the taxes that would otherwise become due on the
exercise of the option and their sale of the shares. For that
reason, they transferred the shares to a newly formed
21
While CLP Holdings, Inc., and Mr. Wollinger,
Countryside’s remaining partners, enjoyed 100 percent of the
benefits associated with Countryside’s ownership of the
Manchester property following Mr. Winn’s and Mr. Curtis’s
withdrawals as partners, they also bore 100 percent of the
burdens associated with that ownership. In other words, their
economic positions also changed as a result of the liquidating
distribution.
- 42 -
partnership, which sold the shares to the corporate buyer upon
the latter’s exercise of the option and continued to hold and
reinvest the proceeds of sale on behalf of its partners. Writing
for the court, Judge Learned Hand noted that the case was “on all
fours” with a previous decision of the court, Helvering v.
Walbridge, 70 F.2d 683 (2d Cir. 1934) (holding that, when
partners transfer property to a partnership that then sells the
property, taxation of any pretransfer appreciation in the
property’s value must await dissolution of the partnership)
except for the fact that, in Chisholm, the partnership “was
formed confessedly to escape taxation.” Chisholm v.
Commissioner, supra at 15. Citing Gregory v. Helvering, 293 U.S.
465 (1935), Judge Hand observed that the Supreme Court “was
solicitous to reaffirm the doctrine that a man’s motive to avoid
taxation will not establish his liability if the transaction does
not do so without it”, and he concluded: “The question always is
whether the transaction under scrutiny is in fact what it appears
to be in form”. Id. He further stated that “purpose may be the
touchstone, but the purpose which counts is one which defeats or
contradicts the apparent transaction, not the purpose to escape
taxation which the apparent, but not the whole, transaction would
realize.” Id. He determined that the taxpayer’s purpose, “to
form an enduring firm which should continue to hold the joint
principal and * * * invest and reinvest it”, was a legitimate
business purpose. Id. The court held for the taxpayer.
- 43 -
In another analogous case, Hobby v. Commissioner, 2 T.C. 980
(1943), in order to avoid anticipated redemptions of certain
preferred shares of stock and taxation of the resulting gain at
short-term capital gain rates, the taxpayer sold the shares to
friends before the scheduled redemptions, and he reported long-
term capital gains on the sales. The taxpayer’s friends paid for
the shares with borrowed funds. The taxpayer incurred no
liability for repayment of those loans. The Commissioner sought
to disregard the taxpayer’s stock sales as tax-motivated and
determined that the taxpayer’s gain was a short-term gain on the
redemption of the shares. Citing Chisholm v. Commissioner,
supra, we noted that the taxpayer’s “primary purpose to realize
the gain was a legitimate business purpose, even though it also
had a collateral favorable tax effect”, and held for the
taxpayer. Hobby v. Commissioner, supra at 985. Citing Hobby, we
reached the same result in Beard v. Commissioner, 4 T.C. 756
(1945), a case involving facts virtually identical to those in
Hobby. In Beard v. Commissioner, supra at 758, by making the
following observation, we echoed Judge Hand’s admonition in
Chisholm v. Commissioner, supra at 15, that the issue “always is
whether the transaction under scrutiny is in fact what it appears
to be in form”: “The Commissioner is * * * required to tax * * *
[the taxpayer] in accordance with what occurred, and he is not
permitted to distort the transaction by giving it an artificial
character upon which a larger tax could be imposed if it were
true.”
- 44 -
In this case, what “occurred” was a distribution of
nonmarketable22 notes in redemption of limited partnership
interests. Countryside undertook the distribution in order to
eliminate Mr. Winn and Mr. Curtis as limited partners. Mr. Winn
and Mr. Curtis agreed to the redemption in order to convert their
interests in Countryside into interest-bearing promissory notes.
All of the parties to the transaction had legitimate business
purposes, and the manner in which those parties accomplished
those purposes cannot be disregarded and converted by respondent
into a transaction (an exchange of Mr. Winn’s and Mr. Curtis’s
interests in Countryside for cash) that never occurred simply
because the transaction that did occur was tax motivated or, as
we stated in Hobby v. Commissioner, supra at 98523 “had a
22
As noted supra, we interpret respondent’s alternative
argument (i.e., alternative to his argument that the AIG notes
were marketable) to be that, even if the AIG notes were
nonmarketable, nonrecognition of gain under secs. 731(a)(1) and
752 is not achievable because of the lack of economic substance.
23
While we have not undertaken an exhaustive analysis of
all cases in which the Commissioner has invoked the economic
substance doctrine, we have not found any case applying that
doctrine in the manner sought by respondent herein. For example,
in Coltec Indus. Inc. v. United States, 454 F.3d 1340 (Fed. Cir.
2006), Boca Investerings Pship. v. United States, 314 F.3d 625
(D.C. Cir. 2003), and ACM Pship. v. Commissioner, 157 F.3d 231
(3d Cir. 1998), affg. in part and revg. in part T.C. Memo. 1997-
115, the tax-motivated transaction and/or the resulting favorable
tax impact on the taxpayer were simply disregarded. In Del
Commercial Props., Inc. v. Commissioner, 251 F.3d 210 (D.C. Cir.
2001), affg. T.C. Memo. 1999-411, and H.J. Heinz Co. v. United
States, 76 Fed. Cl. 570 (2007), the transaction that, in fact,
did occur was recast for tax purposes by disregarding only the
tax-motivated steps. In Gregory v. Helvering, 293 U.S. 465
(1935), and Goldstein v. Commissioner, 364 F.2d 734 (2d Cir.
1966), affg. 44 T.C. 284 (1965), the transaction that did occur
(continued...)
- 45 -
collateral favorable tax effect.” Moreover, that transaction
changed Mr. Winn’s and Mr. Curtis’s economic positions, thereby
satisfying both prongs of the economic substance doctrine. See
supra note 20. Likewise, the transaction changed the economic
positions of Countryside and its remaining partners, CLP
Holdings, Inc., and Mr. Wollinger, who, through Countryside,
increased their collective percentage ownership in the Manchester
property to 100 percent.
Respondent points to the interest detriment as his principal
justification for (1) disregarding, for lack of economic
substance, the transactions culminating in the liquidating
distribution and (2) substituting a deemed taxable distribution
of cash to Mr. Winn and Mr. Curtis. But, as noted supra, the
ultimate transaction (the distribution to Mr. Winn and Mr. Curtis
of the AIG notes) did accomplish a legitimate economic or
business purpose and altered Mr. Winn’s and Mr. Curtis’s economic
positions, as well as the economic positions of Countryside and
its remaining members, which gave it economic substance. The
interest detriment suffered by Countryside was an added, and very
minor, cost of the transaction by which Mr. Winn’s and Mr.
Curtis’s interests in the partnership were eliminated.24
23
(...continued)
was acknowledged to have occurred, but the sought-after tax
result was denied as contrary to legislative intent.
24
As noted supra note 14, respondent considers MP’s $3.4
million borrowing to be “more abusive” than Countryside’s $8.55
million borrowing. Although we find neither borrowing to be
“abusive”, we surmise that, whereas the $8.55 million borrowing
(continued...)
- 46 -
Morever, none of respondent’s arguments that a decision on
the motion is either unwarranted or premature in the absence of
additional fact finding are persuasive.
Respondent argues that Mr. Winn’s continuing guaranties to
CB&T and to Federal Home Loan Mortgage Corporation, issued in
connection with the CB&T loans to Countryside and MP,25 and his
24
(...continued)
was needed to provide funds for the AIG notes that were to
constitute the nontaxable distribution to Mr. Winn and Mr. Curtis
of their equity in the Manchester property, MP’s $3.4 million
borrowing, and Mr. Winn’s and Mr. Curtis’s assumption of
virtually all of the obligation to repay it by virtue of their
continuing ownership (through CLPP) of MP, served only to work a
reduction in the amount of money deemed distributed to them under
secs. 731(a) and 752(b) on account of the liquidating
distribution. Without that borrowing, and Mr. Winn’s and Mr.
Curtis’s subsequent assumption of almost all of the obligation to
repay it, they would have been deemed on account of the
liquidating distribution (and their concomitant relief from
Countryside’s liabilities) to have received distributions of
money from Countryside ($19,805,893 for Mr. Winn and $7,526,666
for Mr. Curtis) in excess of their respective bases in
Countryside ($17,600,747 for Mr. Winn and $6,923,414 for Mr.
Curtis). See apps. B and C. A gain would thus have been
recognized to each under sec. 731(a) ($2,205,146 for Mr. Winn and
$603,530 for Mr. Curtis). Apparently, in order to avoid that
gain, Mr. Winn and Mr. Curtis arranged with Countryside for a
distribution of encumbered property (in effect, almost $3.4
million of equally encumbered AIG notes), which reduced the
amount of money deemed distributed to them under secs. 731(a) and
752(b). While presumably a step taken for tax avoidance reasons,
it was part of a transaction that resulted in a change in the
form of Mr. Winn’s and Mr. Curtis’s investments (from limited
partners to interest-bearing note holders), which, for the
reasons stated herein, we view as imbued with economic substance.
Moreover, from Countryside’s standpoint, the $3.4 million
borrowing, at least in terms of cashflow, was not at all
“abusive” because the accrued interest (and, hence, the entire
interest detriment) with respect to that borrowing became the
indirect obligation of Mr. Winn and Mr. Curtis upon the
liquidating distribution. See apps. B and C.
25
In October 2000, Mr. Winn guaranteed Countryside’s
repayment to CB&T of a $3 million standby letter of credit with
(continued...)
- 47 -
and Mr. Curtis’s indirect interest in Stone Ends, acquired before
the closing of Stone Ends’ purchase of the Manchester property,26
show that they (and Mr. Winn in particular) maintained a
“continuing economic interest” in the Manchester property after
it was purchased by Stone Ends, which distinguishes this case
from both Chisholm v. Commissioner, 79 F.2d 14 (2d Cir. 1935),
and Hobby v. Commissioner, 2 T.C. 980 (1943). Respondent also
argues that Mr. Winn “was apparently confident that the sale of
the [Manchester] property * * * would occur” (and that,
therefore, Countryside would receive the funds needed to repay
the CB&T loans) when he executed the various guaranties of
Countryside’s and MP’s debt to CB&T in 2000. Respondent
concludes: “Further discovery on whether there was an agreement
regarding the sale of * * * [the Manchester property], before the
date of the purchase agreement, should be permitted.”
We do not agree that Mr. Winn’s and Mr. Curtis’s “continuing
economic interest” in the Manchester property after the 2001
purchase of the property by Stone Ends in any way compromises the
status of Chisholm and Hobby as supporting authorities for
25
(...continued)
respect to which Federal Home Loan Mortgage Corp. (FHLMC) was
made the beneficiary. FHLMC required the letter of credit in
connection with CB&T’s $8.55 million loan to Countryside in order
to protect its position as party to a credit enhancement
agreement with Countryside.
26
In order to provide Stone Ends with sufficient capital
to consummate its purchase of the Manchester property from
Countryside, an L.L.C. that was 98 percent owned by Mr. Winn and
Mr. Curtis family trusts acquired a 24.22-percent membership
interest in Stone Ends on Mar. 28, 2001, in exchange for a
capital contribution of $2,337,703.
- 48 -
participating partner’s position. That continuing interest does
not alter the controlling fact that, in 2000, Mr. Winn and Mr.
Curtis disposed of their partnership interests in Countryside in
exchange for nonmarketable securities.27 Moreover, the fact that
Stone Ends required an additional infusion of capital in 2001
before it could purchase the Manchester property from Countryside
at the agreed-upon purchase price negates the idea, suggested by
respondent, that there was a “done deal” for the sale of that
property to Stone Ends in 2000, even assuming that the parties
had reached an informal agreement regarding the terms and
conditions of sale during that year. See Chisholm v.
Commissioner, supra at 15 (agreement to exercise option “was
legally a nullity” since it did not correspond to the terms of
the option contract requiring payment, and not merely a promise
to pay, for exercise). Under the circumstances, we do not see
how respondent’s position could be enhanced by additional
discovery regarding the existence of an informal agreement for
the sale of the Manchester property in 2000.
27
Respondent also attempts to distinguish Hobby v.
Commissioner, 2 T.C. 980 (1943), on the basis of our emphasizing
in Hobby that the taxpayer did not cosign or guarantee the loans
to his friends that enabled them to purchase his shares, whereas
Mr. Winn did guarantee the loans used to purchase the AIG notes.
In Hobby, however, the taxpayer received cash for his shares, and
it was important to find that that cash came from the purchasers,
not the redeeming corporation, a finding that would have been
compromised if, in substance, the taxpayer had financed the
purchase of his own shares; i.e., had, in effect, used his
friends as conduits to deliver his shares to the redeeming
corporation in exchange for cash. In this case, Mr. Winn’s
guaranties helped to finance Countryside’s (and MP’s) acquisition
of nonmarketable securities, his receipt of which does not
trigger taxable gain under sec. 731(a)(1).
- 49 -
Nor do we agree with respondent that there is a need for
additional discovery of Mr. Winn, Mr. Curtis, their associates,
and others “regarding the purpose and effect” of the transactions
at issue and the reason for Mr. Winn’s transfer of a 5-percent
interest in Countryside to Mr. Curtis. There is no dispute that
the purpose of the transactions at issue was to enable Mr. Winn
and Mr. Curtis to exchange their limited partnership interests in
Countryside for the AIG notes, and the means selected to
accomplish that goal were concededly tax motivated. Moreover,
Mr. Winn’s transfer of a 5-percent interest in Countryside to Mr.
Curtis has no bearing on the tax results to Mr. Winn and Mr.
Curtis on the exchange of their interests in Countryside for the
AIG notes because, as participating partner points out, even if
that transfer had not taken place, their tax bases in Countryside
still would have exceeded their net liability relief under
section 752(a) and (b), resulting in no gain to either under
section 731(a)(1).
In short, respondent, in finding a lack of economic
substance, has erroneously focused on the tax-motivated means
instead of the business-oriented end. The transaction requiring
economic substance is Countryside’s redemption of Mr. Winn’s and
Mr. Curtis’s partnership interests therein. That the redemption
of a partnership interest in exchange for bona fide promissory
notes issued by an independent third party can serve a legitimate
business purpose is beyond cavil. The question is whether such a
redemption may be respected for tax purposes if the means
- 50 -
undertaken to accomplish it are chosen for their tax advantage.
On the facts before us, we conclude that the answer is yes.
d. Conclusion
Respondent’s proposed adjustment may not be sustained, and
the application of sections 731(a)(1) and 752 may not be
rejected, on the ground that the liquidating distribution lacked
economic substance.
C. Marketability of the AIG Notes
1. Introduction
As noted supra, participating partner has submitted two
affidavits in support of his position that the AIG notes were not
“marketable securities” within the meaning of section 731(c)(2).
The first is the Nanberg affidavit, in which Mr. Nanberg, a
registered investment adviser, concludes that the AIG notes “were
not listed or traded on an established financial market and no
such market existed for the * * * Notes on December 26, 2000, or
at any time thereafter.” On that basis, participating partner
argues that the AIG notes do not constitute “marketable
securities” under the general definition of that term in section
731(c)(2)(A). The second affidavit is the Ross affidavit, which
was submitted in response to respondent’s argument that an issue
of fact exists as to whether the AIG notes constituted marketable
securities under section 731(c)(2)(B)(ii). That section provides
that the term “marketable securities” includes any financial
instrument that “pursuant to its terms or any other arrangement,
is readily convertible into, or exchangeable for, money or
- 51 -
marketable securities”. In his affidavit, Mr. Ross states that
all of the relevant terms of the transaction in which MP acquired
the AIG notes are contained in the notes themselves or in related
documentation (which is attached to the affidavit), and that no
“agreement, understanding, or arrangement” existed that would
have modified the terms of the referenced documentation.
Respondent “agrees and would stipulate that the [AIG] Notes
* * * were not traded on an established securities market.” We
interpret that statement as respondent’s concession that the AIG
notes did not constitute marketable securities on the ground that
they were “actively traded (within the meaning of section
1092(d)(1)).” See sec. 731(c)(2)(A); sec. 1.1092(d)-1(a), Income
Tax Regs. Therefore, the issue regarding the marketability of
the AIG notes is whether, pursuant to any term of those notes (or
the related documentation) or any “arrangement” between MP and
CB&T, those notes were readily convertible into money or
marketable securities, thereby causing the notes to be
“marketable securities” under section 731(c)(2)(B)(ii).
2. Written Terms and Conditions of the AIG Notes
During the hearing, respondent’s counsel argued that there
is a factual issue regarding the marketability of the AIG notes
because (1) under paragraph 11(a) and (b) of the “further
provisions”, the notes are renegotiable upon the agreement of all
holders and (2) there is only one holder (MP or, for purposes of
the motion, Countryside), so unanimous agreement “shouldn’t be
too much of a problem”. Respondent’s counsel was referring
- 52 -
specifically to paragraph 11(b), which provides that the due date
for payment of principal or interest may be changed only upon
“the affirmative vote of holders of 100 percent in aggregate
principal amount Outstanding of the Notes”. Under paragraph
11(b), that vote by the holders would merely enable the parties
(the debtor, the issuer, and the guarantor) to renegotiate
(“modify, amend or supplement”) the payment due date. During the
hearing, respondent’s counsel acknowledged that, if the mere
right to renegotiate the terms of a note renders it marketable,
all promissory notes that did not specifically prohibit
renegotiation would have to be considered marketable. Morever,
respondent’s posthearing memorandum of law does not reiterate his
reliance on paragraph 11(b) as grounds for treating the AIG notes
as marketable securities. Rather, he stresses the likelihood
that AIG would, in fact, accommodate any request by participating
partner to modify or restructure the terms of the AIG notes. On
the basis of his posthearing submissions, we interpret
respondent’s position to be that the right to seek to renegotiate
the terms of the AIG notes does not, in and of itself, render the
AIG notes marketable under section 731(c)(2)(B)(ii) but, rather,
indicates the presence (or, at least the possibility, requiring
further factual inquiry) of an “arrangement” to modify the notes
in accordance with participating partner’s desires, including the
desire to “readily exchange the AIG * * * notes for cash.”
- 53 -
3. Existence of an Arrangement To Convert the AIG
Notes to Cash at the Holder’s Request
During the hearing, the Court, citing Rule 121(d),
admonished respondent’s counsel that her objection to the motion
was not accompanied by affidavits, nor had she moved for
additional discovery regarding the existence of a prohibited
“arrangement”. Subsequently, respondent’s counsel attempted to
obtain an affidavit from Kurt Nelson (Mr. Nelson), a vice
president at AIG during 2000-2002, who was personally involved in
the transactions pursuant to which MP purchased the AIG notes and
a related company, AMWLHC Bostonian Promisee L.L.C. (BP),
purchased $19 million in promissory notes from AIG (the BP-AIG
notes). The affidavit sought by respondent’s counsel was to
state that, if requested by a client, “it would be AIG’s
practice” to (1) renegotiate the terms of its notes, “provided it
was in AIG’s own economic or client-relationship interest”, and
(2) “provide a bid to * * * [purchase its notes] provided the
purchase did not affect AIG’s own cash management needs.” Mr.
Nelson refused to sign the requested affidavit and, instead,
executed an essentially identical affidavit with the important
exception that he would represent only that AIG “would consider”
renegotiating or modifying the terms of the AIG notes or
providing a bid to repurchase the notes.
As evidence of an “arrangement” to permit the AIG notes to
be “readily convertible” into cash, respondent cites
correspondence among representatives and employees of AIG and
associates of Mr. Winn establishing that AIG was willing to
- 54 -
structure the BP-AIG notes in accordance with instructions
received from the prospective client’s representative, and that,
after issuance, AIG was willing to modify those notes in
accordance with the purchaser’s wishes, even at a possible
financial loss.
We do not agree that any of the documents respondent refers
to constitute evidence of an “arrangement” that would render the
AIG notes marketable under section 731(c)(2)(B)(ii).
AIG’s willingness to “consider” a modification or repurchase
of the AIG notes does not constitute evidence of an “arrangement”
to convert the AIG notes into cash or marketable securities at
MP’s request, as it would be no more than standard business
practice for a bank or financial institution to at least consider
a customer’s request to modify the terms of its notes. Morever,
respondent’s counsel has made no representations to the Court
that she is able to get Mr. Nelson or anyone else on behalf of
AIG to testify that it was AIG’s “practice” to renegotiate the
terms of or to repurchase its notes.
Nor did AIG’s willingness to structure and, subsequently,
restructure the BP-AIG notes in accordance with the customer’s
wishes at a probable overall loss (on account of transaction
costs) indicate that the parties were not operating at arm’s
length then or later in connection with the AIG notes. An e-mail
from Mr. Nelson makes clear that that willingness (and, in
particular, the willingness to modify the note terms) was a
- 55 -
business decision in that he hoped it would assure the customer’s
purchase of a second note from AIG.28
Lastly, respondent suggests that a factual issue as to the
marketability of the AIG notes is indicated by AIG’s willingness
to allow the BP-AIG notes (and, therefore, by implication, the
AIG notes) to secure a collateralized bank line of credit. Here
again, the line of credit and the collateral therefor, including
the pledge of the BP-AIG notes, were all transactions negotiated
between parties operating at arm’s length. There is no evidence
of any prior arrangement between BP and AIG that the BP-AIG notes
would be used to secure the line of credit, and, even if there
had been, we do not agree that such an arrangement would have
justified treating the BP-AIG notes (and, by implication, the AIG
notes) as marketable securities. It is common to use property,
including a personal residence, to secure a bank loan or line of
credit, but that fact does not lead to the conclusion that such
property “is readily convertible into, or exchangeable for, money
or marketable securities” within the meaning of section
731(c)(2)(B)(ii).
4. Conclusion
Respondent has failed to satisfy the conditions of Rule
121(d) by submitting affidavits or otherwise setting forth facts
to show there is a genuine issue of material fact that would cast
doubt upon the status of AIG notes as nonmarketable.
28
The e-mail states: “I realize that they could go
elsewhere for the 2nd note, but I think AIG should get some
points for accommodating the revisions to the previous note.”
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D. Applicability of Rule 121(e)
On October 31, 2006, we filed respondent’s motion, pursuant
to Rule 121(d), to submit supplemental affidavits. In paragraph
5 of her declaration submitted in support of that motion,
respondent’s counsel states that “because the facts are in
control of Petitioner, Participating Partner and third parties,
Respondent is unable to present additional facts to support its
opposition to * * * [the motion].” In the body of that motion,
respondent argues that the foregoing “Paragraph 5 * * * like
Paragraph 38 of * * * [a prior declaration submitted by
respondent’s counsel] sets forth reasons supporting why
Participating Partner’s Motion for Partial Summary Judgment
should be denied”. In support of his argument, respondent cites
Rule 121(e), which provides as follows:
(e) When Affidavits Are Unavailable: If it
appears from the affidavits of a party opposing the
motion that such party cannot for reasons stated
present by affidavit facts essential to justify such
party’s opposition, then the Court may deny the motion
or may order a continuance to permit affidavits to be
obtained or other steps to be taken or may make such
other order as is just. If it appears from the
affidavits of a party opposing the motion that such
party’s only legally available method of contravening
the facts set forth in the supporting affidavits of the
moving party is through cross-examination of such
affiants or the testimony of third parties from whom
affidavits cannot be secured, then such a showing may
be deemed sufficient to establish that the facts set
forth in such supporting affidavits are genuinely
disputed.
By order dated April 18, 2007, we denied respondent’s motion
to file supplemental affidavits because of (1) respondent’s
inability (both past and prospective) to obtain the affidavit
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requested of Mr. Nelson and (2) the fact that counsel’s
declaration did “not contain any relevant facts and is
essentially an untimely presentation of additional argument in
opposition to Participating Partner’s Motion for Partial Summary
Judgment.” We now address respondent’s suggestion, in connection
with that motion, that Rule 121(e) provides grounds for the
denial of the instant motion.
In her prior declaration, respondent’s counsel alleges the
existence of “discoverable facts sufficient to raise or further
support the existence of * * * material issues of fact”. She
argues that “[d]iscovery from and cross examination of” Mr. Winn,
his partners and employees, AIG, and Stone Ends are “necessary to
secure complete information regarding the purpose and effect of
the transaction * * * the reason for the 5-percent transfer
between Winn and Curtis * * * [and] whether there was an
agreement regarding the sale of * * * [the Manchester property]
prior to the date of the purchase agreement and at the time of
the transaction in dispute.”
As discussed supra, (1) participating partner concedes that
the “purpose” of the transactions at issue was tax minimization,
a concession that does not result in a denial of the motion; (2)
the 5-percent transfer from Mr. Winn to Mr. Curtis does not
affect the tax results of the transactions at issue and is,
therefore, not material; and (3) there would be no adverse impact
upon participating partner’s position were we to find that there
was an informal (unwritten) agreement, in 2000, regarding the
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terms of the 2001 sale of the Manchester property to Stone Ends.
Moreover, regarding the “effect of the transaction”, we note that
respondent has already undertaken extensive discovery, and it is
sheer speculation on the part of respondent’s counsel that, by
additional discovery or (in a Perry Mason moment) by cross-
examination, she will be able to elicit an admission from any of
the potential witnesses that there was a binding “arrangement” to
allow the holder readily to convert the AIG notes into cash or
marketable securities. Indeed, both the Ross affidavit and the
fact that the AIG notes were held for 2-1/2 years before
redemption on the fifth interest payment date, in accordance with
their terms, clearly indicate that that was not the case. Under
the circumstances, respondent has not persuaded us that he will
be able to raise, through additional discovery, cross-
examination, or otherwise, a genuine issue of material fact
regarding the marketability of the AIG notes. Therefore, we find
no basis for denying the motion or ordering a continuance
pursuant to Rule 121(e).
E. Applicability of the Antiabuse Regulations
1. Section 1.701-2, Income Tax Regs.
The first of the three requirements “[i]mplicit in the
intent of subchapter K” is that “[t]he partnership must be bona
fide” and the transactions in question “must be entered into for
a substantial business purpose.” Sec. 1.701-2(a), Income Tax
Regs. Respondent does not dispute that Countryside is a bona
fide partnership, and we have found herein that the transactions
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in question were undertaken for a “substantial business purpose”;
i.e., to enable Mr. Winn and Mr. Curtis to withdraw their
investments in Countryside by exchanging their limited
partnership interests for the AIG notes. We have also found that
the transactions in question satisfied the second requirement;
i.e., that they not violate substance over form principles. Id.
Both in form and in substance, Mr. Winn and Mr. Curtis are deemed
to have exchanged interests in a real estate partnership for
promissory notes. Therefore, the remaining issue is whether the
transactions in question satisfy the third requirement; i.e.,
that the tax consequences under subchapter K clearly reflect
income and, if not, that the departure from that standard be
“clearly contemplated” by the applicable provisions of subchapter
K (in this case, sections 731(a)(1) and 752). Id.
Respondent, by attributing gain to Mr. Winn and Mr. Curtis
on the deemed receipt of the AIG notes in exchange for their
interests in Countryside, takes the position that their reporting
of no gain on that transaction did not clearly reflect their
income. Under section 1.701-2(b), Income Tax Regs., in cases in
which there is not a clear reflection of income, the Commissioner
may “recast the transaction for federal tax purposes” if the
partnership has been “formed or availed of in * * * a transaction
a principal purpose of which is to reduce substantially the
present value of the partners’ aggregate federal tax liability in
a manner that is inconsistent with the intent of subchapter K”.
Because we find that the transaction (1) was imbued with economic
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substance and (2) did, in fact, result in Mr. Winn’s and Mr.
Curtis’s receipt of nonmarketable securities, we find that their
reporting of no gain on the receipt of the AIG notes, pursuant to
section 731(a)(1), clearly reflected their income from that
transaction. Therefore, petitioner’s reporting of the
liquidating distribution as a distribution of property other than
money may not be “adjusted or modified” pursuant to section
1.701-2(b)(5), Income Tax Regs.29
2. Section 1.731-2(h), Income Tax Regs.
Participating partner argues, on the basis of the
illustrative examples contained in section 1.731-2(h), Income Tax
Regs., that “the provision should not have any application to a
partnership that owns no marketable securities at all, either
directly or indirectly”. Respondent describes that argument as
expressing “the untenable position” that section 1.731-2(h),
Income Tax Regs., does not apply “to situations where
partnerships create purportedly nonmarketable securities to
29
It may be that the totality of the actions taken by
Countryside, including the formation of CLPP and MP, the sec. 754
elections by Countryside and CLPP, and the absence of a sec. 754
election by MP, present grounds for concluding that there was not
a proper reflection of income thereby invoking the application of
sec. 1.701-2, Income Tax Regs. (and/or the economic substance
doctrine), in order to determine whether to deny a basis step-up
for Countryside’s assets (i.e., the Manchester property) and/or
either disregard CLPP and MP as sham entities or require a basis
step-down for the AIG notes held by MP. See sec. 1.701-2(d),
Example (8), Income Tax Regs. But the issues concerning
Countryside’s basis in the Manchester property or the holder’s
(or deemed holder’s) basis in the AIG notes pursuant to the
interaction among secs. 734(b), 743(b), and 754 are not germane
to the motion. Therefore, we do not address those issues.
- 61 -
distribute in lieu of marketable securities, or cash, to avoid
section 731(c).”
We interpret respondent’s statement as expressing tacit
agreement with participating partner that if, in fact, the AIG
notes were not marketable securities, as defined in section
731(c)(2), then section 1.731-2(h), Income Tax Regs., is
inapplicable to Countryside’s deemed distribution of the AIG
notes to Mr. Winn and Mr. Curtis. Because we have concluded that
the AIG notes did not constitute marketable securities, we assume
that respondent would concede that section 1.731-2(h), Income Tax
Regs., is inapplicable to the distribution of those notes.
In any event, we agree with participating partner that each
of the three examples contained in section 1.731-2(h), Income Tax
Regs., the first of which involves a change in partnership
allocations or distribution rights with respect to marketable
securities, the second, a distribution of substantially all of
the partnership assets other than marketable securities, and the
third, a distribution of multiple properties to one or more
partners at different times, involves circumstances that are not
present in this case. We also note that, in the preamble to the
final regulations under section 731(c), the Commissioner, in
response to a taxpayer request that there be “examples
illustrating abusive transactions intended to be covered by * * *
§ 1.731-2(h)”, stated that “the text of the regulations
adequately describes several situations that would be considered
abusive * * *, and * * * additional examples are unnecessary.”
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T.D. 8707, 1997-1 C.B. 128, 130. Thus, the examples contained in
the regulation, which are the only portion of the text of the
regulation describing “situations that would be considered
abusive”, presumably illustrate the universe of circumstances
considered abusive for purposes of section 731(c).30
Countryside’s deemed distribution of the AIG notes to Mr.
Winn and Mr. Curtis was not part of an abusive transaction as
described in section 1.731-2(h), Income Tax Regs.
IV. Conclusion
We conclude that the liquidating distribution, conceded by
participating partner (for purposes of the motion) to be a
distribution of the AIG notes, constituted a distribution of
nonmarketable securities resulting in nonrecognition of gain to
30
In a recent article, Gall & Franklin, “Partnership
Distributions of Marketable Securities”, 117 Tax Notes 687, 710
(Nov. 12, 2007), the authors conclude that neither the examples
in the legislative history of sec. 731(c)(7) (which authorizes
regulations “necessary or appropriate to carry out the purposes
of * * * [sec. 731(c)], including regulations to prevent the
avoidance of such purposes”) nor the examples in the antiabuse
regulation itself “involve the extension of the rules of section
731(c) to treat an asset that is not a marketable security as a
marketable security.”
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the recipients, Mr. Winn and Mr. Curtis, pursuant to sections
731(a)(1) and 752. Therefore, we shall grant the motion.31
An order granting participating
partner’s motion for partial summary
judgment will be issued.
31
If all of respondent’s arguments in this case, docket
No. 22023-05, and the Court of Federal Claims actions instituted
by CLPP and MP were to be sustained, the overall effect would be
to tax the gain realized on the sale of the Manchester property
three times: First, in 2000, to Mr. Winn and Mr. Curtis on the
liquidating distribution, a second time, in 2001, to Countryside
on the sale of the Manchester property, and a third time, in
2003, on AIG’s redemption of the AIG notes from MP. We suspect
that respondent’s position in these actions is intended to
completely offset what respondent considers to be participating
partner’s and petitioner’s goal of deferring indefinitely any tax
on that gain and to avoid any possibility of being whipsawed. In
addressing the motion, we decide only that the gain is not
recognized to Mr. Winn and Mr. Curtis in 2000 upon their receipt
of a 99-percent limited partnership interest in CLPP or,
alternatively, upon their deemed receipt of the AIG notes.
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APPENDIX A
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APPENDIX B
Computation of Winn’s Share of Countryside LP (Countryside) Liabilities
and Winn’s Basis in His Countryside Interest Immediately Before the 12/26/00 Distribution
I. Computation of Winn’s share of Countryside liabilities and Winn’s basis in his Countryside interest as of 1/1/00
A. As of 1/1/00, Winn’s share of Countryside liabilities was $14,892,855. See (1) below.
B. As of 1/1/00, Winn’s basis in his Countryside interest was $12,879,151. See (2) below.
Basis at start Contributions/(distributions) Taxable income/(loss) Increase/(decrease) in share Basis at end
Year of period of money during period for period1 of liabilities for period of period
1993 -0- $742 ($34,939) $13,044,133 $13,009,936
1994 $13,009,936 -0- (427,037) 2,956,835 15,539,734
1995 15,539,734 -0- (366,595) 27,937 15,201,076
1996 15,201,076 -0- (156,275) (326,417) 14,718,384
1997 14,718,384 (122,509) (234,813) (70,092) 14,290,970
1998 14,290,970 (37,500) (32,357) (231,673) 13,989,440
1999 13,989,440 (111,469) (490,952) (507,868) 12,879,151 (2)
Total 14,892,855 (1)
1
For 1993 through 2000, there was no partnership tax-exempt income and no nondeductible partnership expenditures as
described in sec. 705(a)(1)(B) and (2)(B).
II. Events from 1/1/00 until immediately before the 12/26/00 distribution affecting Winn’s share of Countryside
liabilities and Winn’s basis in his Countryside interest
A. Winn’s share of Countryside liabilities immediately before the 12/26/00 distribution
$14,892,855 Winn’s share of liabilities as of 1/1/00
(1,003,562) Decrease in share of liabilities attributable to transfer of a 5-percent interest. See (1)
below.
5,916,600 Winn’s share of the Countryside-CB&T $8,550,000 liability. See (2) below.
2,336,843 Winn’s share of MP’s $3,445,506 of liabilities. See (3) below.
22,142,736 Winn’s share of Countryside liabilities immediately before the 12/26/00 distribution
(1) On 6/29/00, Winn transferred a 5-percent interest in Countryside to Countryside
partner Curtis. This transfer decreased Winn’s percentage interest
in Countryside from 74.2 percent to 69.2 percent. The transfer resulted in a
$1,003,562 decrease in Winn’s share of Countryside liabilities, computed as Winn’s
$14,892,855 share of Countryside liabilities as of Jan. 1, 2000, multiplied by 5/74.2.
(2) In October 2000, Countryside borrowed $8,550,000 from Columbus Bank & Trust Co. (CB&T).
Winn’s 69.2-percent share of this liability was $5,916,600.
(3) In October 2000, Manchester Promisee L.L.C. (MP) borrowed $3,400,000 from CB&T. In addition,
on 12/26/00, MP had accrued $45,506 of unpaid interest expense. Immediately before
the 12/26/00 distribution, Countryside owned 99 percent of CLP Promisee L.L.C. (CLPP)
which, in turn, owned 99 percent of MP. Therefore, Countryside’s share of MP’s
liabilities was $3,376,940. Winn’s share of Countryside’s share of this liability
was $2,336,843, computed as $3,445,506 x 99% x 99% x 69.2%.
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B. Winn’s basis in his interest in Countryside immediately before the 12/26/00 distribution
$12,879,151 Winn’s basis as of 1/1/00
7,249,881 Net increase in Winn’s share of liabilities. See (1) below.
(59,942) Money distributed to Winn. See (2) below.
(131,500) Winn’s share of Countryside’s loss. See (3) below.
19,937,590 Winn’s basis in his Countryside interest immediately before the 12/26/00 distribution
(1) As calculated in II.A., Winn’s share of Countryside liabilities increased
from $14,892,855 as of 1/1/00 to $22,142,736 immediately before the 12/26/00
distribution, a net increase of $7,249,881.
(2) Winn received a distribution during that period of $59,942 in money per Schedule K-1.
(3) Winn’s share of taxable income/(loss) for that period was ($131,500) per Schedule K-1.
III. Effect of distribution to Winn in redemption of his interest in Countryside
A. The 12/26/00 distribution to Winn in redemption of his interest in Countryside reduced Winn’s share of
liabilities as follows:
$22,142,736 Winn’s total share of liabilities before the 12/26/00 redemption
(2,485,974) Winn’s continued liability. See (1) and (2) below.
19,656,762 Net decrease in Winn’s share of liabilities
(1) Under sec. 1.752-1(f), Income Tax Regs., only the net decrease in a partner’s share
of liabilities is treated as a distribution of money to the partner.
(2) Countryside distributed a 72.88-percent interest in CLPP to Winn in redemption of
his interest in Countryside. As a result, Winn was relieved of his $22,142,736
share of Countryside liabilities, but Winn retained a liability representing his
share of CLPP’s share of MP’s liabilities. Winn’s share of these liabilities was
$2,485,974, computed as $3,445,506 x 99% x 72.88%. Thus, the net decrease in Winn’s
share of liabilities was $19,656,762.
B. Because the $19,656,762 decrease in liabilities was less than Winn’s $19,937,590 basis in his interest in
Countryside, Winn recognized no gain on the distribution in redemption. See (1) below.
(1) Under sec. 731(a), no gain is recognized upon a distribution to a partner except
to the extent that any money distributed exceeds the adjusted basis of such partner’s
interest in the partnership immediately before the distribution.
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APPENDIX C
Computation of Curtis’s Share of Countryside LP (Countryside) Liabilities
and Curtis’s Basis in His Countryside Interest Immediately Before the 12/26/00 Distribution
I. Computation of Curtis’s share of Countryside liabilities and Curtis’s basis in his Countryside interest as of 1/1/00
A. As of 1/1/00, Curtis’s share of Countryside liabilities was $4,402,714. See (1) below.
B. As of 1/1/00, Curtis’s basis in his Countryside interest was $3,798,080. See (2) below.
Basis at start Contributions/(distributions) Taxable income/(loss) Increase/(decrease) in share Basis at end
of period of money during period for period1 of liabilities for period of period
Year
1993 -0- $198 ($9,325) $3,546,894 $3,537,767
1994 $3,537,767 -0- (113,954) 869,828 4,293,641
1995 4,293,641 -0- (97,825) 13,449 4,209,265
1996 4,209,265 -0- (41,702) (115,511) 4,052,052
1997 4,052,052 (60,000) (62,658) (71,564) 3,857,830
1998 3,857,830 (30,000) (8,634) (30,695) 3,788,501
1999 3,788,501 (49,725) (131,009) 190,313 3,798,080 (2)
Total 4,402,714 (1)
1
For 1993 through 2000, there was no partnership tax-exempt income and no nondeductible partnership expenditures as
described in sec. 705(a)(1)(B) and (2)(B).
II. Events from 1/1/00 until immediately before the 12/26/00 distribution affecting Curtis’s share of Countryside
liabilities and Curtis’s basis in his Countryside interest
A. Curtis’s share of Countryside liabilities immediately before the 12/26/00 distribution
$4,402,714 Curtis’s share of liabilities as of 1/1/00
1,003,562 Increase in share of liabilities attributable to transfer of a 5-percent interest. See (1) below.
2,120,400 Curtis’s share of the Countryside-CB&T $8,550,000 liability. See (2) below.
837,481 Curtis’s share of the MP’s $3,445,506 of liabilities. See (3) below.
8,364,157 Curtis’s share of Countryside liabilities immediately before the 12/26/00 distribution
(1) On 6/29/00, Curtis acquired a 5-percent interest in Countryside from Countryside
partner Winn. This transfer increased Curtis’s percentage interest
in Countryside from 19.8 percent to 24.8 percent. The transfer resulted in a
$1,003,562, increase in Curtis’s share of Countryside liabilities, computed as Winn’s
$14,892,855 share of Countryside liabilities as of Jan. 1, 2000, multiplied by 5/74.2.
(2) In October 2000, Countryside borrowed $8,550,000 from Columbus Bank & Trust Co. (CB&T).
Curtis’s 24.8-percent share of this liability was $2,120,400.
(3) In October 2000, Manchester Promisee L.L.C. (MP) borrowed $3,400,000 from CB&T. In addition,
on 12/26/00, MP had accrued $45,506 of unpaid interest expense. Immediately before
the 12/26/00 distribution, Countryside owned 99 percent of CLP Promisee L.L.C. (CLPP)
which, in turn, owned 99 percent of MP. Therefore, Countryside’s share of MP’s
liabilities was $3,376,940. Curtis’s share of Countryside’s share of this liability
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was $837,481, computed as $3,445,506 x 99% x 99% x 24.8%.
B. Curtis’s basis in his interest in Countryside immediately before the 12/26/00 distribution
$3,798,080 Curtis’s basis as of 1/1/00
3,961,443 Net increase in Curtis’s share of liabilities. See (1) below.
(21,482) Money distributed to Curtis. See (2) below.
22,854 Curtis’s share of Countryside’s income. See (3) below.
7,760,895 Curtis’s basis in his Countryside interest immediately before the 12/26/00 distribution
(1) As calculated in II.A., Curtis’s share of Countryside liabilities increased
from $4,402,714 as of 1/1/00 to $8,364,157 immediately before the 12/26/00 distribution,
a net increase of $3,961,443.
(2) Curtis received a distribution during that period of $21,482 in money per Schedule K-1.
(3) Curtis’s share of taxable income/(loss) for that period was ($22,854) per Schedule K-1.
III. Effect of distribution to Curtis in redemption of his interest in Countryside
A. The 12/26/00 distribution to Curtis in redemption of his interest in Countryside reduced Curtis’s share of
liabilities as follows:
$8,364,157 Curtis’s total share of liabilities, before the 12/26/00 redemption
(890,967) Curtis’s continued liability. See (1) and (2) below.
7,473,190 Net decrease in Curtis’s share of liabilities
(1) Under sec. 1.752-1(f), Income Tax Regs., only the net decrease in a partner’s share
of liabilities is treated as a distribution of money to the partner.
(2) Countryside distributed a 26.12-percent interest in CLPP to Curtis in redemption of
his interest in Countryside. As a result, Curtis was relieved of his $8,364,157 share
of Countryside liabilities, but Curtis retained a liability representing his share of
CLPP’s share of MP’s liabilities. Curtis’s share of these liabilities was $890,967,
computed as $3,445,506 x 99% x 26.12%. Thus, the net decrease in Curtis’s share of
liabilities was $7,473,190.
B. Because the $7,473,190 decrease in liabilities was less than Curtis’s $7,760,895 basis in his interest in
Countryside, Curtis recognized no gain on the distribution in redemption. See (1) below.
(1) Under sec. 731(a), no gain is recognized upon a distribution to a partner except
to the extent that any money distributed exceeds the adjusted basis of such partner’s
interest in the partnership immediately before the distribution.