DocketNumber： Docket No. 1448-94.
Citation Numbers： 1996 T.C. Memo. 555, 72 T.C.M. 1540, 1996 Tax Ct. Memo LEXIS 567
Judges： BEGHE
Filed Date： 12/23/1996
Status： Non-Precedential
Modified Date： 4/18/2021
Decision will be entered for respondent with respect to the determined deficiency and for petitioners with respect to the additions to tax.
MEMORANDUM FINDINGS OF FACT AND OPINION
BEGHE,
We hold that petitioner's distributive share of partnership gain that Pecaris realized on the sale of the Mall is $ 827,968, the amount determined by respondent, although we arrive at that destination by a somewhat different route than respondent would have had us follow. We reject respondent's determination of the additions to tax.
FINDINGS OF FACT
Some of the facts have been stipulated, and are so found. The stipulation of facts and attached exhibits are incorporated herein. When petitioners filed their petition, they resided in Ohio.
Petitioner was born in Greece and came to the United States at age 12. He attended grammar school in the United States, with his last grade level attended being the fifth grade at age 15.
Petitioner has been a commercial real estate broker for several years, acting primarily as a broker of strip shopping centers.
Petitioner has limited knowledge of Federal income taxes, and relied on professional advisers for tax advice and the preparation of his tax returns. Martin Sugarman, a certified public accountant, prepared petitioners' 1988 Federal income tax return in accordance with the instructions of Ken McPhaill, a tax 1996 Tax Ct. Memo LEXIS 567">*569 manager of a national accounting firm, who died prior to the trial of this case. Mr. McPhaill orally advised Coastal on the overall Federal income tax treatment of the transaction at issue, and his firm prepared Coastal's 1988 return of partnership income.
In 1975, petitioner, with Christ Spillas and Peter Boyas, formed Pecaris, an Ohio general partnership. Pecaris was formed to acquire commercial real estate, and acquired and held various properties.
Mr. Boyas provided the initial financing for Pecaris, but has had no role in its day-to-day affairs. Mr. Spillas collected and posted rents and paid payables, kept the books of the partnership, acted as the tax matters partner, and provided information to the accounting firm that prepared the partnership returns of income. Petitioner acted as managing partner, with the primary responsibility of identifying and proposing properties for purchase by Pecaris and acting on its behalf in the purchase and sale of properties.
In 1976, Pecaris purchased a strip shopping center known as the North Shore Mall (the Mall), located in Willowick, Ohio, at a cost of $ 2.8 million.
In April 1978, the terms of the Pecaris partnership 1996 Tax Ct. Memo LEXIS 567">*570 were memorialized in a written partnership agreement. Under the terms of the Pecaris partnership agreement, petitioner and Mr. Spillas each has a 25-percent interest in profits and losses, and Mr. Boyas has a 50-percent interest. The Pecaris partnership agreement contains no express provision regarding how it can be amended. However, in January 1985, petitioner and Messrs. Boyas and Spillas executed a written amendment to the Pecaris partnership agreement that replaced its original provisions concerning disposition of interests in the partnership on retirement or death of a partner.
At monthend November 1987, petitioner and Vincent Giorgi formed Coastal, an Ohio general partnership, for the purpose of acquiring, owning, leasing, and operating commercial real estate. Coastal was specifically formed for the purpose of acquiring the Mall.
From inception, the terms of the Coastal partnership were memorialized in a written partnership agreement, which provides that it can be amended only by written agreement of the partners. Under the terms of the Coastal partnership agreement, petitioner has a 90-percent partnership interest and Mr. Giorgi has a 10-percent partnership 1996 Tax Ct. Memo LEXIS 567">*571 interest, and their interests in cash-flow, profits, losses, and tax credits follow their partnership interests. The Coastal partnership agreement obligates the partners to contribute to the partnership, as initial capital, in proportion to their interests in the partnership, the amounts needed to acquire the Mall and provide initial working capital.
The Coastal partnership agreement designates Mr. Giorgi, who is a certified public accountant, as the tax matters partner. Mr. Giorgi is the financial manager of Coastal, and he consulted Mr. McPhaill in connection with the preparation of Coastal's initial book entries and 1988 return of partnership income.
On December 17, 1987, Pecaris and Coastal entered a written agreement under which Coastal agreed to purchase the Mall from Pecaris for $ 4.8 million, which Coastal agreed to pay upon the following terms: $ 100,000 in "Cash or check herewith as earnest money to be held in escrow by" HGM Hilltop Realty (HGM), a realty company for which petitioner worked as a broker; 3 $ 600,000 to be deposited in escrow; and $ 4.1 million, to be paid from the proceeds of a first mortgage nonrecourse loan to be obtained 1996 Tax Ct. Memo LEXIS 567">*572 by Coastal from Canada Life Assurance Co. (Canada Life). The $ 4.1 million amount of the mortgage loan was the maximum that Canada Life was willing to lend on the security of the Mall, based on Canada Life's valuation of the Mall at approximately $ 5.5 million and use of a 75-percent maximum loan-to-value ratio.
Also on December 17, 1987, petitioner, using a preprinted HGM commission agreement form, wrote a commission agreement between Pecaris and HGM for payment by Pecaris of $ 100,000 to HGM for effecting the sale of the Mall from Pecaris to Coastal. The commission agreement authorized "ESCROW AGENT * * * by irrevocable assignment, to disburse to HGM HILLTOP, REALTORS a check in the amount of $ 100,000.00". Petitioner signed this agreement as a partner of Pecaris; the HGM signature line was left blank.
Petitioner, as partner in both Coastal and Pecaris, was on both sides of the negotiation of the purchase agreement and the fixing of the purchase price. Messrs. Boyas and Spillas and petitioner 1996 Tax Ct. Memo LEXIS 567">*573 signed the purchase agreement on behalf of Pecaris, and Mr. Giorgi signed the purchase agreement on behalf of Coastal. Petitioner acted on behalf of both Pecaris and Coastal in consummating the transaction.
On the basis of Canada Life's valuation, the Mall had some value in excess of the stated purchase price of $ 4.8 million. However, there is no other evidence in the record that bears on the fair market value of the Mall or of petitioner's 25-percent partnership interest in Pecaris, either in gross or with respect to his partnership interest in Pecaris attributable to its ownership of the Mall. Petitioner's proportionate interest in the Mall was subject to liabilities and closing costs of $ 504,314, giving him a net equity interest in the Mall of $ 695,686, if its value should be deemed to be the agreed purchase price of $ 4.8 million. 4
Petitioner 1996 Tax Ct. Memo LEXIS 567">*574 hired Continental Title Co. (Continental) to provide escrow services and title insurance for the transaction. The conveyance, assignment, and transfer by Pecaris to Coastal of the Mall real property, leases, and tangible personal property all occurred in February 1988. The purchase agreement as written contemplated a straight sale of the Mall to Coastal for $ 4.8 million cash, and the fee paid to Continental was determined on the basis of that stated purchase price. 5 However, petitioner and Mr. Giorgi lacked the personal resources that would have enabled Coastal to pay the additional $ 700,000 in cash required to consummate the transaction for the stated purchase price of $ 4.8 million. The escrow and financing statements show that only $ 4.1 million of mortgage loan proceeds were deposited in the escrow account, and that the $ 700,000 shortfall was made up of credits in that amount.
The $ 700,000 of credits was attributable to two items: First, petitioner informed Continental, in writing, that HGM had "received a note from Coastal * * * in the amount 1996 Tax Ct. Memo LEXIS 567">*575 of $ 100,000 * * * in payment in full from Pecaris" to HGM of the commission due from Pecaris for petitioner's handling of the sale of the Mall. The record contains no evidence that the $ 100,000 deposit called for by the purchase agreement was ever made, or that any such note was issued by Pecaris or Coastal (see
In accordance with petitioner's instructions to Continental, the credits were shown by entries in the escrow account. Continental's escrow statement to Coastal showed a credit from Pecaris to petitioner in the amount of $ 700,000. Continental's escrow statement to Pecaris, in addition to showing the cash balances due petitioner and Messrs. Boyas and Spillas from the escrow account, showed a credit to petitioner of $ 600,000, and recited that the real estate commission had been paid to HGM by promissory note in the amount of $ 100,000.
Soon after the conveyance 1996 Tax Ct. Memo LEXIS 567">*576 of the Mall by Pecaris, Coastal recorded, in its general journal, a contribution to capital by petitioner in the amount of $ 700,000. Pursuant to the Coastal partnership agreement, petitioner intended, and was expected by Mr. Giorgi, to contribute or cause to be transferred to Coastal an interest in the Mall in lieu of a cash contribution. Petitioner made no other contribution to the capital of Coastal during 1988. Mr. Giorgi initially contributed $ 70,100 to the capital of Coastal, and an additional $ 6,151 later during the year. During 1988, petitioner and Mr. Giorgi received cash distributions from Coastal that exceeded their reported distributive shares of partnership income for the year.
Messrs. Boyas and Spillas received direct cash payments by Continental from the escrow account in proportion to their partnership interests, in the amounts of $ 1,391,566 and $ 695,783, respectively. Petitioner received a direct cash payment from the escrow account in the amount of $ 95,783, based on petitioner's $ 695,783 net interest in the Mall (equivalent to the interest of Mr. Spillas) minus the above-mentioned $ 600,000 credit. 6 These cash payments to the Pecaris partners represented the 1996 Tax Ct. Memo LEXIS 567">*577 bulk of the proceeds from the $ 4.1 million Canada Life mortgage loan that remained after the pay-off of the liabilities and closing costs to which the Pecaris partnership's interest in the Mall had been subject. According to the escrow statement prepared by Continental for Coastal, $ 78,063 of the mortgage loan proceeds was paid to Coastal as "excess loan proceeds".
Petitioner also received another cash payment from the escrow account in the amount of $ 30,000. This payment was a commission from Capco Enterprises, the mortgagee under the preexisting mortgage on the Mall that was satisfied as a result of the consummation of the transaction. See
Upon conveyance of the Mall from Pecaris to Coastal, petitioner's partnership interest in the Mall, by virtue of the difference between his interests in Pecaris and Coastal, increased from 25 percent to 90 percent, without any outlay of funds by him. As a result, petitioner's share of mortgage liabilities associated with the Mall increased from $ 441,336 (25 percent of the Capco Enterprises mortgage to which the Mall was subject in the hands of Pecaris) to $ 3,690,000 (90 percent of the Canada Life mortgage loan of $ 4.1 million to which the Mall became subject in the hands of Coastal at the time of the conveyance. 7
Messrs. Boyas and Spillas did not become aware of petitioner's partnership interest in Coastal, and of his participation on both sides of the transaction, until after the sale of the Mall had been consummated. 8 Upon being informed of petitioner's 1996 Tax Ct. Memo LEXIS 567">*579 participation in Coastal, they did not voice any objection or take any action against petitioner. The Pecaris partnership continues, with petitioner and Messrs. Boyas and Spillas retaining their respective partnership interests in the remaining assets and liabilities of the partnership.
Pecaris reported the transaction on its Form 1065 U.S. Partnership Return of Income as a sale of the Mall for $ 4.8 million with a realized and recognized gain of $ 3,311,873. 9 Pecaris used the $ 100,000 commission as an offset to reduce the gain reported on its 1988 return of partnership income as distributable to petitioner and Messrs. 1996 Tax Ct. Memo LEXIS 567">*580 Boyas and Spillas. Pecaris allocated the gain to its three partners in accordance with their interests in profits, as specified in the Pecaris partnership agreement. Accordingly, Pecaris reported petitioner's distributive 25-percent share of the gain from the sale, $ 827,968, on its Schedule K-1, and that is the amount of the adjusting increase in petitioner's gain as determined in respondent's statutory notice to petitioner.
Coastal and petitioner reported the transactions affecting petitioner's interest in the Mall as nontaxable transactions on their respective returns for 1988. The yearend tax balance sheet, Schedule L of Coastal's 1988 Form 1065, disregarded petitioner's capital contribution of $ 700,000 as having any effect for tax purposes on petitioner's capital account or on Coastal's basis in the Mall, and showed Coastal as having a cost basis in the Mall substantially less than $ 4.8 million, on the order of what 1996 Tax Ct. Memo LEXIS 567">*581 would have been approximately $ 4.1 million as of the time of the conveyance of the Mall by Pecaris to Coastal. 101996 Tax Ct. Memo LEXIS 567">*582 Petitioners reported no distributive share of gain to petitioner from Pecaris in respect of the Mall transaction on their 1988 Form 1040. Petitioners attached Form 8082 (Notice of Inconsistent Treatment or Amended Return) to their 1988 Form 1040, disclosing that petitioner was taking a position inconsistent with the Schedule K-1 filed by Pecaris. Petitioners' Form 8082 showed a reduction to zero in the amount of the Pecaris reported section 1231 gain of $ 827,968 attributed to petitioner and provided the following explanation: "Traded up Real Estate Interests in Like-Kind Exchange." Petitioners' Form 8082 did not disclose that the $ 100,000 real estate brokerage commission used by Pecaris as an offset in computing its gain on the sale of the Mall had not been included by petitioner in his gross income.
OPINION
We address one procedural or evidentiary issue and two sets of substantive tax issues: First, whether we are permitted to look beyond the terms of the purchase agreement and the Pecaris partnership agreement to determine the gain realized by Pecaris on the sale of the Mall; and second, the amount of the Pecaris gain for tax purposes and the amount thereof to be allocated to petitioner, and the correlative questions of the tax treatment of the credits or their equivalents received by Pecaris and petitioner and contributed by petitioner to the capital of Coastal. We then consider 1996 Tax Ct. Memo LEXIS 567">*583 the additions to tax.
I.
Respondent determined and continues to argue that Pecaris agreed to sell and did sell the entire Mall to Coastal for $ 4.8 million, and that petitioner's recognized gain on his distributive 25-percent share of partnership gain from the sale of the Mall is $ 827,968. Petitioners argue that the transaction should be treated as a sale by Pecaris of a 75-percent undivided interest in the Mall for $ 3.6 million, no part of the gain on which is allocable to him, and a distribution by Pecaris -- nontaxable to him under
Under petitioners' view, Pecaris was entitled to use 75 percent of its adjusted basis in the Mall in computing its gain on the receipt of the reduced purchase price of $ 3.6 million for the 75-percent undivided interest that it sold and the distributive shares of such gain to Messrs. Boyas and Spillas. Applying petitioners' view, those shares of gain would remain the same as reported by Pecaris and Messrs. Boyas and Spillas on their returns, and no part of the Pecaris gain would be allocable to petitioner. Also, under petitioners' view, the remaining 25 percent of the Pecaris adjusted basis in the Mall is attributable to the undivided 25-percent interest therein that petitioner claims was distributed to him by Pecaris and contributed by him to the capital of Coastal.
At the calendar call of the session of the Court at which this case was tried, respondent filed a motion in limine to "exclude all evidence 1996 Tax Ct. Memo LEXIS 567">*585 pertaining to an alleged oral modification made to the written sale agreement * * * as inadmissible pursuant to the principles espoused by the Tax Court in
1996 Tax Ct. Memo LEXIS 567">*587 Respondent argued that, under
Insofar as
We denied respondent's motion at the calendar call, "without prejudice to renew in the brief after we've had a trial". Respondent's brief in answer, after observing that "At this juncture, the motion in limine to preclude the After further reflection, and as noted by the Court (Motion Hearing Tr. 9) during the oral presentation of respondent's motion, it may well be that respondent imprecisely placed the focus of her motion on the wrong agreement. The record is clear that the purchase/sale Agreement, bolstered by the additional written instruments memorializing and consummating the sale of the Mall are entirely consistent with the manner in which Pecaris reported the transaction. Additionally, this consistency continues through the allocation of the gain from the transaction per the written Pecaris partnership agreement. 14 (Ex. D (par. 4.)) As suggested by 1996 Tax Ct. Memo LEXIS 567">*589 the Court, this partnership agreement may be the critical "agreement" which petitioner is attempting to modify. 14 Per the written partnership agreement, petitioner was entitled to share in one-fourth (25%) of the profits and losses of the Pecaris partnership enterprise.
The Court of Appeals for the Sixth Circuit has adopted the
In arguing that we should look beyond the express terms of the purchase agreement, petitioners don't contend that the agreement 1996 Tax Ct. Memo LEXIS 567">*590 was entered into under any mistake, undue influence, fraud, duress, or the like. Instead, petitioners dispute the substance of the transaction, asserting that the purchase agreement alone doesn't express the reality of the transaction as actually consummated by the parties.
We're satisfied that the Turning now to the question of consideration: "* * * the recitals of a written instrument as to the consideration received are not conclusive, and it is always competent to inquire into the consideration and show by parol or other extrinsic evidence what the real consideration was."
The foregoing analysis satisfies us that the entire record is available for our review to help us determine the gain realized by and recognized to Pecaris on the sale of the Mall. The record makes abundantly clear that the cash consideration paid by or on behalf of Coastal was substantially less than the stated purchase price of $ 4.8 million, thereby providing a toehold for petitioner's argument that we should not impute realized gain to Pecaris by reference to any more than the cash consideration actually paid and received. Cf.
II.
The parties have not shown us what the capital accounts of Pecaris actually looked like on its books before and after the Mall transaction. It seems likely, 1996 Tax Ct. Memo LEXIS 567">*593 from the way Pecaris reported the transaction on its partnership return and accompanying schedules, that Pecaris accounted for the credits as if they had been received from Coastal as cash equivalents or receipts that were included in the reported amount realized of $ 4.8 million, and then distributed to petitioner. On the Coastal side of the transaction, there's a disparity in the book and tax treatments of petitioner's participation in Coastal: Coastal recorded on its books a contribution to capital by petitioner in the amount of $ 700,000; on Coastal's tax balance sheet reconciliation of partners' capital accounts, petitioner is shown as having made no capital contribution. This disparity is reflected in Coastal's book and tax accounting for the receipt of the Mall, which was booked at a value that exceeds its tax basis by approximately the same amount as the equivalent amounts of the credits and petitioner's capital contribution.
It's the tax treatment of the credits, at both the Pecaris partnership and partner levels, over which the parties part company.
A.
1(a)
Having opened up the transaction for review, we must first determine the amount 1996 Tax Ct. Memo LEXIS 567">*594 of the Pecaris gain on its sale of the Mall to Coastal. Under
Since the amount of money received by Pecaris did not exceed $ 4.1 million, we must address whether the $ 700,000 credit is properly includable in the amount realized by Pecaris. In this connection, Mr. Berardinelli, the president of Continental, the escrow agent, testified that it's common practice in escrowed real estate transactions for the escrow agent to make offsetting or netting entries in the escrow account to reflect offsetting obligations and to pay the net amount due to the party entitled thereto. The additional consideration given by Coastal was the $ 700,000 credit to petitioner's capital account in Coastal. The
way in which the capital account credit served as a substitute for a $ 700,000 cash payment from Coastal to Pecaris can be seen by analyzing the network of obligations arising from 1996 Tax Ct. Memo LEXIS 567">*595 the sale of the Mall. Coastal was obligated to pay Pecaris $ 700,000 over and above the proceeds of the new mortgage financing. Through a combination of petitioner's actions and the profit-sharing provisions of the Pecaris partnership agreement, Pecaris was obligated to pay to petitioner or at his direction a total of $ 795,783, consisting of $ 695,783, the 25-percent distributive share of the net proceeds of the sale, plus the $ 100,000 brokerage commission. Petitioner was paid $ 95,783 from escrow, leaving an unpaid balance of $ 700,000 that was satisfied by the credits. Under the Coastal partnership agreement, petitioner was obligated to make a capital contribution of $ 700,000 to Coastal. Petitioner satisfied that obligation to Coastal by causing Pecaris to transfer to Coastal all right, title, and interest in the Mall, and Coastal credited $ 700,000 to petitioner's capital account; as a result, petitioner became the dominant partner in Coastal, with a 90-percent interest in capital and profits. There was thus a circle of obligations in the amount of $ 700,000, which were netted against one another and discharged without the need for settlement in cash. In sum, Coastal discharged 1996 Tax Ct. Memo LEXIS 567">*596 its obligation to Pecaris by satisfying the Pecaris obligation to petitioner by crediting him with a $ 700,000 capital contribution, and petitioner's obligation to Coastal was satisfied by his causing Pecaris to transfer to Coastal all right, title, and interest in the Mall for a cash consideration that was $ 700,000 less than Coastal was obligated to pay under the terms of the purchase agreement.
There is one other problematic element in the computation of the amount realized by Pecaris. The Coastal escrow statement discloses that there was a distribution to Coastal of $ 78,063 of excess mortgage loan proceeds. As a result, it appears that the cash proceeds of the sale of $ 4.1 million should be reduced by $ 78,063, because Pecaris did not receive that amount in cash. However, it also appears that the amount of the mortgage proceeds distributed to Coastal from the escrow account is approximately equal to Mall-associated liabilities of Pecaris for security deposits, real property taxes, and prepaid rents (see
(b)
Respondent, in computing the larger gain that she determined using an amount realized of $ 4.8 million, of course allowed the entire adjusted basis of the Mall to be used in computing the resulting gain. It's only petitioners, in their effort to leave the tax position of petitioner's Pecaris partners unaffected, but treat petitioner as having no share of the Pecaris partnership gain, who came up with the notion that what Pecaris sold was a 75-percent undivided interest in the Mall for $ 3.6 million. This led to petitioners' correlative argument that the Pecaris partnership was entitled to use only 75 percent of its basis in computing the gain on that sale.
Petitioners' argument suffers from a fatal flaw. Petitioner's recharacterization of the transaction as a sale by Pecaris of a 75-percent undivided interest in the Mall and a Pecaris distribution to petitioner, followed by a contribution by him to Coastal of a 25-percent undivided interest in the Mall, is contradicted by the express terms of the warranty deed. That deed conveyed to Coastal the entire 1996 Tax Ct. Memo LEXIS 567">*598 fee interest of Pecaris in the Mall. Under Ohio law, a partnership is an entity for the purpose of owning, conveying and acquiring property,
We therefore reject petitioners' correlative argument. We see no reason why the Pecaris partnership should not be entitled to use its entire adjusted basis in the Mall in computing its gain on the sale. That gain is $ 3,311,873, as computed by Pecaris and respondent. See
2.
Except as otherwise provided in this subtitle, the entire amount of the gain or loss, determined under this section, on the sale or exchange of property shall be recognized.
The question is whether any nonrecognition provisions of the Internal 1996 Tax Ct. Memo LEXIS 567">*599 Revenue Code apply to the Mall transaction to reduce the gain recognized to Pecaris to any amount less than the gain realized that we have already determined. Having rejected petitioner's argument that Pecaris distributed to petitioner a 25-percent undivided interest in the Mall, which he then contributed to Coastal in exchange for his partnership interest, we nevertheless observe that the creation of the partnership interest issued by Coastal to petitioner appears to have been an element of the consideration given and received by Pecaris. Petitioner so structured the transfer of the Mall to Coastal that the shortfall in the cash consideration was ultimately satisfied by his receipt of a 90-percent partnership interest in Coastal. We therefore ask whether
It seems that a transfer of appreciated property to a partnership in exchange for a partnership interest and cash can be treated in at least three different ways: (a) Part-sale part-contribution; (b) contribution followed by distribution of cash; or (c) contribution with a receipt of boot. See Hesch, Tax Management Portfolio 710, Partnerships; Overview, Conceptual Aspects and Formation A-98 to A-100 (1996). However, there also appears to be no authority that clearly governs the choice to be made.
None of these possibilities was raised or argued by the parties. We resist the temptation to tease out their varying tax consequences because there is nothing more in the documentation of the transaction that would allow it to be characterized more appropriately in any of these three ways than the part-sale to Coastal part-distribution by Pecaris to petitioner that we have already rejected. The overwhelmingly dominant aspect of the Mall transaction, supported both by its documentation and by the relative cash consideration paid and received, was a sale for cash. See sec. 1996 Tax Ct. Memo LEXIS 567">*601 707(a)(2)(B), enacted by the Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 73(a), 98 Stat. 591 (DEFRA), and DEFRA sec. 73(b), 98 Stat. 592;
B.
We now consider petitioner's share of the Pecaris gain as computed above. Under the Pecaris partnership agreement, petitioner has a 25-percent interest in profits and losses.
Petitioner did not disclose to Messrs. Boyas and Spillas, prior to consummation of the Mall transaction between 1996 Tax Ct. Memo LEXIS 567">*602 Pecaris and Coastal, that he was on the Coastal side of the transaction as its dominant partner. 14 Although petitioner testified that he participated in the negotiations on both sides of the transaction, along with Mr. Spillas and Mr. Giorgi, Mr. Spillas testified that the three Pecaris partners agreed on the purchase price. We don't believe that there were actual arm's-length negotiations between Pecaris and Coastal to fix the purchase price. If petitioner had made Messrs. Spillas and Boyas aware that he intended to take less cash by reason of the credits, they might well have agreed to recast the deal and provide for a special partnership allocation, which would have reflected petitioner's receipt of a nontaxable distribution as his only interest in the Mall, so that petitioner would not have been allocated any gain from the sale of the Mall. Or, if they had been made aware of the possibly higher value of the Mall, they might have required petitioner to find an additional investor in Coastal willing to pay additional cash consideration to obtain an interest in the Mall, so as to increase the overall purchase price and the cash distributions that they would have ultimately received. 1996 Tax Ct. Memo LEXIS 567">*603
Petitioner, who had his own tax advisers, neither apprised his partners of the possible excess value of the Mall nor asked them to amend the partnership agreement (which could have been effective for allocation purposes at any time before filing the Pecaris partnership return, sec. 761(c)), to provide a special allocation that would have relieved petitioner from recognizing his distributive share of Pecaris gain from the sale of the Mall. Petitioner's partners allowed him to handle the Mall sale, and petitioner organized the buying group without telling them until after the deal was done that he had a 90-percent interest in that group. The Pecaris partnership agreement was not amended to provide a special allocation of the gain from the Mall sale. As a result, petitioner is in a bind of his own making, bound 1996 Tax Ct. Memo LEXIS 567">*604 by the general partnership profit allocation provisions of the Pecaris partnership agreement. 15
Petitioners maintain that the general partnership allocation rules of
Section 761(c) requires that all partners agree to an amendment to the partnership agreement. At the time the transaction closed, petitioner's Pecaris partners were not aware of his interest as a Coastal partner in the other side of the transaction. Although Messrs. Boyas 1996 Tax Ct. Memo LEXIS 567">*605 and Spillas may have become aware of petitioner's participation in Coastal prior to the preparation and filing of the Pecaris partnership return, there is no evidence that they actually agreed to an amendment to the Pecaris partnership agreement. Petitioners' argument that there was a de facto amendment is belied by the way that Pecaris reported the transaction on its 1988 partnership return. 16
Petitioners argue that the definitions of partnership agreement and amendment of the partnership agreement are much more expansive, for the purpose of determining distributive shares of gain under
While the characterization of tax items is determined at the partnership level,
Petitioners also argue that any allocation to petitioner of gain from the sale of the Mall would not have "substantial economic effect" under
We need not accept petitioners' invitation to engage in an extended substantial economic effect analysis of the Pecaris partnership agreement. We don't have here the usual situation that
Petitioner presses the argument that the Pecaris partners' capital accounts were not kept in accordance with the
Accordingly, we hold that petitioner's distributive share of Pecaris partnership gain is recognized to him on the Pecaris partnership sale of the Mall. As a 25-percent partner of Pecaris, petitioner's distributive share of gain from the sale of the Mall is $ 827,968 (Pecaris gain of $ 3,311,873 x .25).
Before we address the additions to tax, we briefly advert to three issues lurking in the record that are not in issue: The $ 100,000 brokerage commission that was not the subject 1996 Tax Ct. Memo LEXIS 567">*611 of an additional adjustment by respondent; petitioner's pretrial motion, which we denied, for leave to amend petition to take account of any reduction in petitioner's reported taxable income from Coastal that would result from the increased basis of the Mall buildings and tangible personal property in the hands of Coastal attributable to taxing petitioner on a distributive share of Pecaris gain on the sale of the Mall; and the tax treatment of the value of the Mall in excess of $ 4.8 million, 90 percent of which was arguably appropriated by petitioner without the knowledge of his partners.
Petitioner received from Pecaris a cash distribution of $ 95,783 and total credits of $ 700,000, only $ 600,000 of which was attributable to his interest as a partner of Pecaris, and equatable with the cash distribution of $ 695,783 received by petitioner's equal partner in Pecaris, Mr. Spillas. The other $ 100,000 of credit was attributable to the brokerage commission in that amount that does not appear to have been paid, but which was used by Pecaris as an offset in computing its gain realized on the sale of the Mall. Although the record does not disclose whether it was HGM or petitioner who was 1996 Tax Ct. Memo LEXIS 567">*612 actually entitled to receive the commission or the nature or extent of the ownership or employment relationship between petitioner and HGM, it's clear that petitioner received the benefit of the credit in the computation for partnership accounting purposes of his capital contribution to Coastal. Inasmuch as the right to receive the commission arose not from petitioner's status as a partner of Pecaris, see, e.g.,
Petitioners filed a pretrial motion, which we denied, for leave to amend petition to compute the reduction in petitioner's taxable income from Coastal for 1988 that would result from the increased basis and depreciation of the Mall buildings and tangible personal property 1996 Tax Ct. Memo LEXIS 567">*613 attributable to taxing petitioner on a distributive share of Pecaris gain on the sale of the Mall. The record of this case as tried lacks the facts with respect to the relative values and amounts of purchase price allocable to land and buildings and other depreciable property needed to make a Rule 155 computation giving effect to the basis adjustment.
Because Canada Life valued the Mall at $ 5.5 million, Coastal's purchase of the Mall for $ 4.8 million, including the $ 700,000 credit, arguably yielded a windfall to Coastal, with 90 percent of the benefit accruing to petitioner. Any excess value of the Mall that petitioner appropriated should also be added to petitioner's gross income, resulting in a deficiency in excess of the amount determined by respondent. Although the actual value of the Mall may well have exceeded $ 4.8 million, based upon the amount that Canada Life was willing to lend on the security of the Mall, it would be sheer speculation for us to pick any value in excess of $ 4.8 million and use that figure to support charging petitioner with any additional income for tax purposes. Respondent has not moved to do so, and respondent would have had the burden of proving any 1996 Tax Ct. Memo LEXIS 567">*614 alleged excess value if we had allowed an amendment to respondent's answer to that effect. There having been no motion to amend the answer or argument to this effect by respondent, see sec. 6214(a), and in view of our uncertainty as to, and lack of evidence of, the actual amount of the excess, we have confined our analysis to the acknowledged fact that the Mall had a value no less than $ 4.8 million. Cf.
III.
A.
Respondent determined that petitioners are liable for an addition to tax for negligence under
Negligence is a lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances.
We find that the underpayment was not due to negligence or disregard of rules or regulations. Petitioner has limited knowledge concerning 1996 Tax Ct. Memo LEXIS 567">*615 Federal income taxes, and relied primarily on professional tax advisers and his partner in Coastal, who is a certified public accountant charged with its financial management, in preparing his 1988 tax return and disclosing the transaction at issue. Respondent relies on
Petitioners attached Form 8082 to their tax return, disclosing petitioner's treatment of the transaction at issue as being different from the way in which Pecaris treated the transaction. Although we disagree with the way in which the transaction was treated by petitioner for tax purposes, petitioners' Form 8082 disclosure convinces us that petitioner sufficiently 1996 Tax Ct. Memo LEXIS 567">*616 disclosed to his accountant his transactions with Pecaris, and that petitioners reasonably relied on the way in which their accountant treated the transaction on the joint return.
The characterization of the Mall transaction and partnership allocation rules present complex legal issues, on which there can be reasonable differences of opinion. See
B.
Respondent determined that petitioners are liable for the addition to tax for substantial understatement of income tax in 1988. Income tax is substantially understated if the amount of the understatement exceeds the greater of 10 percent 1996 Tax Ct. Memo LEXIS 567">*617 of the tax required to be shown on the return for the taxable year or $ 5,000.
Petitioners disclosed on Form 8082 that petitioner was treating the disposition of the Mall in a manner inconsistent with the treatment by Pecaris and his Pecaris partners. Although petitioners' Form 8082 did not apprise respondent of the exact nature of the controversy, petitioners' disclosure on their return for respondent flagged their omission from their 1988 gross income of $ 827,968 -- the amount of respondent's adjustment. See
To reflect the foregoing,
1. Unless otherwise identified, section references are to the Internal Revenue Code in effect for 1988, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. Marilyn Goudas has an interest in this case solely by virtue of having filed a joint 1988 Federal income tax return with her husband. Accordingly, all references to petitioner in the singular are to Carl Goudas.
3. There is no evidence in the record that the earnest money was ever placed in escrow or any indication of the nature or extent of the ownership or employment relationship between petitioner and HGM.↩
4. The liabilities and closing costs to which the Mall and a 25-percent interest therein were subject were as follows:
| Stated purchase price of Mall | $ 4,800,000 | |
| Capco Enterprises mortgage | $ 1,765,344 | |
| Security deposits | 35,445 | |
| Real property taxes | 23,380 | |
| Prepaid rents | 19,532 | |
| Adjustment for real estate commission | 100,000 | |
| Closing costs | 73,553 | 2,017,254 |
| Pecaris equity in Mall, valued | ||
| at $ 4.8 million | 2,782,746 | |
| 25 percent of stated purchase price of Mall | 1,200,000 | |
| 25-percent share of costs and | ||
| liabilities | 504,314 | |
| Petitioner's 25-percent equity in | ||
| Mall, if it should be valued at | ||
| $ 4.8 million stated purchase price | 695,686 |
5. In addition, the real property transfer tax of $ 4,800 represented a $ 1 payment per $ 1,000 paid as consideration for the transfer.↩
6. The difference between these amounts and the calculation
| 100 percent | 25 percent | |
| Pecaris equity in Mall, valued at $ 4.8 million | $ 2,782,746 | $ 695,686 |
| Interest on investment of | ||
| mortgage loan proceeds | 388 | 97 |
| 2,783,134 | 695,783 |
7. Canada Life viewed the transaction as both a refinancing of the Mall, and as a "buying out" by petitioner of the interests of the other Pecaris partners. In addition, the loan agreement stated that "The purpose of the loan is to provide permanent financing for the Real Property and to discharge all existing financing."↩
8. Mr. Spillas testified that he did not know the identity of the principal parties of Coastal at the time of the transaction, but became aware of petitioner's interest in Coastal prior to the filing of the Pecaris 1988 partnership return, which Mr. Spillas signed on behalf of Pecaris. Mr. Boyas testified that he did not recall when petitioner's identity as a partner in Coastal was revealed to him, but that the reason for his inability to recall was that he regarded petitioner's role on the other side of the transaction as unimportant.↩
9. On its 1988 Form 1065 and Form 4797, Pecaris reported and computed the gain on the sale of the Mall as follows:
| Gross sales price | $4,800,000 | |
| Cost or other basis plus | ||
| expenses of sale | $ 3,022,670 | |
| Depreciation allowed | 1,534,543 | |
| Adjusted basis | 1,488,127 | |
| Total gain | 3,311,873 |
10. The Coastal 1988 yearend Schedule L Tax Balance Sheet and schedules thereto do not disclose or show any note or other obligation of Coastal to HGM in respect of the $ 100,000 commission. The Coastal balance sheet and Schedule M Reconciliation of Partners' Capital Accounts show the following:
| Schedule L - Balance Sheet | ||||
| Assets | ||||
| Cash | $ 74,886 | Current liabilities | $ 102,026 | |
| Trade accounts and | ||||
| receivables | 78,159 | Mortgages, etc. | 4,071,244 | |
| Buildings and other | ||||
| depreciable assets | $ 3,459,502 | Partners' capital | (182,469) | |
| Minus depreciation | 113,936 | 3,345,566 | ||
| Land | 458,845 | |||
| Other assets | 33,345 | |||
| Total liabilities | ||||
| Total assets | 3,990,801 | and capital | 3,990,801 | |
| Schedule M - Reconciliation of Partners' Capital Accounts | |||||
| Capital | |||||
| beginning of | Capital | Capital | |||
| year | contributed | Income | Withdrawals | end of year | |
| Petitioner | - 0 - | - 0 - | $ 7,450 | $ 258,399 | ($ 250,949) |
| Giorgi | - 0 - | $ 76,251 | 329 | 8,100 | 68,480 |
| Total | - 0 - | 76,251 | 7,779 | 266,499 | (182,469) |
11. The rationale of allowing nonrecognition treatment to petitioner under
12. In
13. The
14. Petitioner's nondisclosures to Messrs. Boyas and Spillas may well have violated his fiduciary duty to them as his partners, but that's another story. See
15. In this connection, respondent's brief appropriately quoted:
For of all the sad words of tongue or pen, The saddest are these: "It might have been!" [John Greenleaf Whittier, Maud Muller, St. 53]↩
16. Mr. Spillas testified that he learned of petitioner's participation in Coastal before the Pecaris return was prepared, and that he thought that petitioner had some contact with Pecaris' accountant regarding "some modification," but did not know for certain whether petitioner and the Pecaris return preparer discussed modifying the Pecaris agreement. Mr. Spillas testified that he instructed the Pecaris return preparer to do what was necessary for the partnership to effectuate a correct filing.↩
Jack E. Golsen and Sylvia H. Golsen v. Commissioner of ... , 445 F.2d 985 ( 1971 )
david-h-ullman-and-claire-w-ullman-husband-and-wife-v-commissioner-of , 264 F.2d 305 ( 1959 )
Carlos and Jacqueline Marcello v. Commissioner of Internal ... , 380 F.2d 499 ( 1967 )
Estate of H. H. Weinert, Deceased, Jane W. Blumberg, and ... , 294 F.2d 750 ( 1961 )
thomas-l-freytag-and-sharon-n-freytag-v-commissioner-of-internal , 904 F.2d 1011 ( 1990 )
commissioner-of-internal-revenue-v-carl-l-danielson-and-pauline-s , 378 F.2d 771 ( 1967 )
Joan S. Schatten v. United States , 746 F.2d 319 ( 1984 )
In the Matter of Charles A. Steen, Debtor. Dick Dimond, ... , 509 F.2d 1398 ( 1975 )
Leonard C. Jaques, Sybil J. Jaques v. Commissioner of ... , 935 F.2d 104 ( 1991 )
In Re Estate of Binder , 137 Ohio St. 26 ( 1940 )
Jack Starr v. Commissioner of Internal Revenue, Samuel M. ... , 267 F.2d 148 ( 1959 )
albert-h-and-doris-g-throndson-v-commissioner-of-internal-revenue , 457 F.2d 1022 ( 1972 )
United States v. Basye , 93 S. Ct. 1080 ( 1973 )
Commissioner v. National Alfalfa Dehydrating & Milling Co. , 94 S. Ct. 2129 ( 1974 )
Bartels v. Birmingham , 332 U.S. 126 ( 1947 )
Don E. Williams Co. v. Commissioner , 97 S. Ct. 850 ( 1977 )
Freytag v. Commissioner , 111 S. Ct. 2631 ( 1991 )
Williams v. Commissioner , 64 T.C. 1085 ( 1975 )
Pallottini v. Commissioner , 90 T.C. 498 ( 1988 )