116 T.C. No. 2



                UNITED STATES TAX COURT



   ARON B. KATZ AND PHYLLIS A. KATZ, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent


Docket Nos. 460-96, 780-97,          Filed January 12, 2001.
            181-98.

     P-H, a calendar year taxpayer, owned interests in
several calendar year partnerships. P-H filed a
bankruptcy petition on July 5, 1990. P-H included the
portions of his distributive shares attributable to the
period prior to his bankruptcy filing on his separately
filed 1990 income tax return. The remainder of those
distributive shares were reported by P-H’s bankruptcy
estate.

     Held: The manner in which the distributive share
of a partner in bankruptcy is allocated between the
partner and the bankruptcy estate is not a “partnership
item” under sec. 6231(a)(3), I.R.C. Accordingly, such
allocation need not be resolved in a partnership-level
proceeding pursuant to the uniform audit and litigation
procedures of secs. 6221-6234, I.R.C.

     Held, further, where a partner’s bankruptcy estate
retains beneficial ownership of a partnership interest
as of the close of the partnership taxable year, the
partner’s distributive share for the entire partnership
taxable year is reportable by the bankruptcy estate.
See secs. 706(a), 1398(e), I.R.C.
                                 - 2 -

     Laurence E. Nemirow, Josh O. Ungerman, and William R.

Cousins III, for petitioners.

     James E. Archie, for respondent.



                                OPINION


     VASQUEZ, Judge:   This matter is presently before the Court

on petitioners’ motion to dismiss for lack of jurisdiction.      In

the event petitioners’ motion to dismiss is not granted, the

parties have filed cross-motions for summary judgment1 pursuant

to Rule 121.2   As discussed below, we shall deny petitioners’

motion to dismiss and motion for summary judgment, and we shall

grant summary judgment in favor of respondent.

                            Background

     Petitioners resided in Boulder, Colorado, at the time their

petition was filed in this case.    The following summary of the

relevant facts is based on the parties’ stipulations and attached

exhibits.




     1
        The motions were originally filed as motions for partial
summary judgment. Yet, subsequent to the filing of these
motions, the parties settled with respect to all other issues
remaining in the case. Accordingly, we drop the “partial”
modifier and treat the motions as requesting summary judgment in
favor of the movant.
     2
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                               - 3 -

     During 1990, petitioner Aron B. Katz (Mr. Katz) held limited

partnership interests in a number of partnerships.   Each of the

partnerships used the calendar year for tax reporting purposes,

as did Mr. Katz.

     On July 5, 1990, Mr. Katz commenced a bankruptcy proceeding

in the U.S. Bankruptcy Court for the Southern District of New

York by filing a petition for relief under chapter 7 of the U.S.

Bankruptcy Code.   Mr. Katz did not make an election under section

1398(d)(2) to bifurcate his 1990 taxable year into two short

taxable years on account of his bankruptcy filing.   Accordingly,

Mr. Katz’ individual income tax return for 1990, on which he

claimed the status of a married person filing separately, covered

the entire calendar year.

     On account of Mr. Katz’ bankruptcy proceeding, some of the

partnerships undertook an interim closing of the books with

respect to Mr. Katz’ partnership interest in determining his

distributive share of partnership tax items for 1990.   In doing

so, each of these partnerships subdivided the distributive share

determined in respect of Mr. Katz’ interest for the entire 1990

partnership taxable year (the 1990 calendar year distributive

share) into two categories:   The first consisted of those items

attributable to the period prior to July 5, 1990 (the prepetition

items), and the second consisted of those items attributable to

the remainder of the 1990 calendar year (the postpetition items).
                              - 4 -

The prepetition items were specifically allocated to Mr. Katz in

his individual capacity, while the postpetition items were

allocated to Mr. Katz’ bankruptcy estate.

     A number of partnerships, however, made no attempt to

subdivide the 1990 calendar year distributive share between Mr.

Katz and his bankruptcy estate.   Rather, each of these

partnerships issued a Schedule K-1, Partner’s Share of Income,

Credits, Deductions, etc., to Mr. Katz reflecting the entire 1990

calendar year distributive share.   With respect to these

partnerships, Mr. Katz undertook an interim closing of the books

on their behalf, allocating the prepetition items to himself and

the postpetition items to his bankruptcy estate.    Mr. Katz

explained each such allocation through a Form 8082, Notice of

Inconsistent Treatment or Administrative Adjustment Request

(AAR), attached to his 1990 tax return.

     The prepetition items from the 1990 calendar year

distributive shares which were allocated to Mr. Katz in the

manner described above resulted in losses totaling $19,122,838

(the prepetition partnership losses).3    This amount made up most

of the $19,262,795 net operating loss (NOL) Mr. Katz reported for

his 1990 taxable year.


     3
        The bulk of the prepetition partnership losses was
generated by a partnership entitled Century Centre Associates,
Ltd. This partnership allocated $18,569,842 of overall loss to
Mr. Katz with respect to the period prior to July 5, 1990, while
allocating to Mr. Katz’ bankruptcy estate $33,381,880 of overall
income with respect to the remainder of 1990.
                               - 5 -

     By notice of deficiency, respondent disallowed the NOL

carryovers petitioners deducted on their jointly filed income tax

returns for tax years 1991 through 1994, to the extent that the

carryovers were attributable to the prepetition partnership

losses.   Respondent contends that the prepetition partnership

losses belonged to and were properly reportable by Mr. Katz’

bankruptcy estate, as opposed to Mr. Katz individually.      No

notice of final partnership administrative adjustment (FPAA)

under section 6226 has been issued to any of the partnerships

with respect to taxable year 1990.

                             Discussion

     Petitioners’ first challenge to respondent’s disallowance of

the NOL carryovers is that respondent was without authority to

make such a determination.   Accordingly, petitioners move that

the case be dismissed for lack of jurisdiction.      In the event the

matter is not resolved on jurisdictional grounds, petitioners

move for summary judgment on the ground that the prepetition

partnership losses were properly reported by Mr. Katz in his

individual capacity.   Respondent has filed a cross-motion for

summary judgment with respect to this issue.      We begin with

petitioners’ jurisdictional argument.

A.   Petitioners’ Motion To Dismiss for Lack of Jurisdiction

     Petitioners argue that respondent’s notice of deficiency is

invalid to the extent it disallows the NOL carryovers petitioners

deducted for the tax years at issue.      Petitioners contend that
                                - 6 -

the NOL carryovers constitute “affected items” governed by the

unified audit and litigation procedures and that respondent has

failed to comply with those procedures by not first proceeding

against the relevant partnerships.

     1.   TEFRA Procedures

     The unified audit and litigation procedures were enacted as

part of the Tax Equity and Fiscal Responsibility Act of 1982

(TEFRA), Pub. L. 97-248, sec. 401(a), 96 Stat. 648, and are

commonly referred to as the TEFRA procedures.4   The TEFRA

procedures provide a method for adjusting “partnership items” in

a single, unified partnership proceeding, rather than in separate

actions against each partner.   See sec. 6221.   In general, the

Commissioner is precluded from assessing a deficiency

attributable to a partnership item until after the completion of

the partnership-level proceeding.    See sec. 6225(a).   The same

prohibition extends to the assessment of a deficiency

attributable to an “affected item”, as the tax treatment of such

an item is dependent on the treatment of a partnership item.

E.g., Dubin v. Commissioner, 

, 328 (1992); N.C.F.

Energy Partners v. Commissioner, 

, 743-744 (1987);

Maxwell v. Commissioner, 

, 792 (1986).    Accordingly, a

notice of deficiency issued prior to the completion of the


     4
        The TEFRA procedures, effective for partnership taxable
years beginning after Sept. 3, 1982, have been amended since
their enactment and now constitute secs. 6221 through 6234.
                                - 7 -

partnership-level proceeding is invalid to the extent it relates

to a partnership item or an affected item.    See GAF Corp. v.

Commissioner, 

, 524-526 (2000).

     No FPAA was issued by respondent and no partnership-level

proceedings have been commenced regarding the prepetition

partnership losses in the present case.   Accordingly, if the NOL

carryovers at issue constitute affected items as petitioners

contend, we must grant the motion to dismiss on the basis that

the notice of deficiency is invalid as it relates to those items.

With this procedural framework in mind, we turn to the issue of

whether the NOL carryovers may be properly characterized as

affected items under the TEFRA procedures.

     2.    Definition of Affected Item and Partnership Item

     Section 6231(a)(5) defines an “affected item” as any item to

the extent such item is affected by a partnership item.   See also

N.C.F. Energy Partners v. Commissioner, supra at 743-745; Maxwell

v. Commissioner, supra at 792-793; sec. 301.6231(a)(5)-1T,

Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6790 (Mar. 5,

1987).    Section 6231(a)(3) defines the term “partnership item” as

any item required to be taken into account for the partnership’s

taxable year, to the extent the regulations establish that such

item is more appropriately determined at the partnership level

than at the partner level.   The regulations include in the

definition of a partnership item each partner’s share of items of
                                  - 8 -

income, gain, loss, deduction, or credit of the partnership.        See

sec. 301.6231(a)(3)-1(a)(1)(i), Proced. & Admin. Regs.

     3.      Bankruptcy Regulation

     The Secretary is authorized to identify by regulations

certain instances in which the treatment of an item as a

partnership item under the TEFRA procedures will interfere with

the effective and efficient enforcement of the Internal Revenue

Code.     See sec. 6231(c)(2).   The Secretary has identified the

bankruptcy of a partner as one such instance.      See sec.

301.6231(c)-7T(a), Temporary Proced. & Admin. Regs. (the

bankruptcy regulation), 52 Fed. Reg. 6793 (Mar. 5, 1987), which

provides as follows:

     (a) Bankruptcy. The treatment of items as partnership
     items with respect to a partner named as a debtor in a
     bankruptcy proceeding will interfere with the effective
     and efficient enforcement of the internal revenue laws.
     Accordingly, partnership items of such a partner
     arising in any partnership taxable year ending on or
     before the last day of the latest taxable year of the
     partner with respect to which the United States could
     file a claim for income tax due in the bankruptcy
     proceeding shall be treated as nonpartnership items as
     of the date the petition naming the partner as debtor
     is filed in bankruptcy.

If the bankruptcy regulation applies to convert a partnership

item into a nonpartnership item, the effect of the conversion is

to except the item from the TEFRA procedures.      The tax treatment

of the item therefore may be determined in accordance with the

deficiency procedures applicable to the partner’s individual tax

case.     See Computer Programs Lambda, Ltd. v. Commissioner, 89
                                - 9 -

T.C. 198, 203 (1987).

     4.     Relevant Partnership Item Inquiry

     The parties believe that our jurisdiction in this case turns

on whether the bankruptcy regulation operates upon the

prepetition partnership losses.    Respondent argues that the

regulation converts the prepetition partnership losses from

partnership items to nonpartnership items, while petitioners

contend that such losses fall outside the scope of the

regulation.    We, however, believe that the jurisdictional issue

before us is more appropriately resolved on other grounds.

Respondent does not challenge the propriety of the prepetition

partnership losses.    Rather, respondent contends only that those

losses should have been reported by Mr. Katz’ bankruptcy estate

as opposed to Mr. Katz in his individual capacity.    Thus, even if

we assume that the bankruptcy regulation does not operate to

convert the prepetition partnership losses to nonpartnership

items,5 we are left with the issue of whether the manner in which

partnership items are allocated between a partner in bankruptcy

and the partner’s bankruptcy estate is a determination which,

pursuant to the TEFRA procedures, must be made at the partnership

level.    We therefore shall determine our jurisdiction based on

the resolution of this latter issue.


     5
        As the determination of whether the bankruptcy regulation
converts the prepetition partnership losses to nonpartnership
items is not necessary to our decision, we leave that
determination for another day.
                                - 10 -

           a.   Fundamental Principles Relating to a Partner in
                Bankruptcy and the Partner’s Bankruptcy Estate

     We begin our discussion with a review of some fundamental

principles relating to the bankruptcy of an individual debtor.

When an individual files a chapter 7 petition in bankruptcy, a

bankruptcy estate is created as a separate entity for purposes of

both bankruptcy law and tax law.    See 11 U.S.C. sec. 541(a)

(1994); sec. 1398.6   The estate succeeds to all legal and

equitable interests of the debtor in property, as well as certain

tax attributes of the debtor.    See 11 U.S.C. sec. 541(a)(1); sec.

1398(g).   The estate computes its tax liability in the same

manner as a married individual filing a separate return, see sec.

1398(c), and the chapter 7 trustee is responsible for filing tax

returns throughout the duration of the bankruptcy proceeding,

see sec. 6012(b)(4); see also 11 U.S.C. sec. 704(8) (1994).

           b.   Allocation Inquiry as Framed by Petitioners

     Petitioners contend that the manner in which the prepetition

partnership losses are allocated “among the partners” constitutes

a partnership item under the TEFRA procedures.    We agree with

petitioners as to the merit of this proposition.    As provided in

section 6226(f), the manner in which partnership items are


     6
        Sec. 1398 was enacted as part of the Bankruptcy Tax Act
of 1980, Pub. L. 96-589, sec. 3, 94 Stat. 3397. Sec. 1398 does
not apply to all types of bankruptcy proceedings but rather only
to proceedings under ch. 7 (relating to liquidations) or ch. 11
(relating to reorganizations) of the U.S. Bankruptcy Code in
which the debtor is an individual. See sec. 1398(a).
                              - 11 -

allocated among the partners is a determination which this Court

may make in the course of a partnership-level proceeding:

          SEC. 6226(f). Scope of Judicial Review.–-A court
     with which a petition is filed in accordance with this
     section shall have jurisdiction to determine all
     partnership items of the partnership for the
     partnership taxable year to which the notice of final
     partnership administrative adjustment relates, the
     proper allocation of such items among the partners, and
     the applicability of any penalty, addition to tax, or
     additional amount which relates to an adjustment to a
     partnership item. [Emphasis added.]

Since the allocation of partnership items among the partners may

be resolved at the partnership level, it follows that such

allocation is itself a partnership item under the TEFRA

procedures.   See Rule 240(b)(2) (defining a “partnership action”

as an “action for readjustment of partnership items” under

section 6226); see also H. Conf. Rept. 97-760, at 611 (1982),

1982-2 C.B. 600, 668 (stating that “Neither the Secretary nor the

taxpayer will be permitted to raise nonpartnership items in the

course of a partnership proceeding”).

     While we agree with petitioners that the manner in which

partnership items are allocated among the partners is a

determination that must be resolved at the partnership level, we

note that respondent is not seeking to allocate the prepetition

partnership losses from Mr. Katz to one or more other partners of

record in the subject partnerships.    Rather, respondent questions

the allocation of partnership losses between one partner of

record and that partner’s bankruptcy estate.   Accordingly, the
                              - 12 -

relevant allocation is not expressly within the scope of section

6226(f).   See, e.g., Hang v. Commissioner, 

, 80 (1990)

(describing an allocation of subchapter S items between a

shareholder of record and the purported beneficial owner of such

shares as not expressly within the scope of section 6226(f)).7

           c.   Proper Allocation Inquiry

     The issue that we must decide is, once a partnership has

allocated partnership items in respect of the interest of a

partner who has commenced a bankruptcy proceeding during the

partnership taxable year, whether the subdivision of those items

between the partner and his bankruptcy estate constitutes a

partnership item under the TEFRA procedures.   Resolution of this

is tantamount to determining whether a partner in bankruptcy and



     7
        Pursuant to the S corporation audit and litigation
procedures (S corporation procedures), secs. 6241 through 6245, a
“subchapter S item” is defined as “any item of an S corporation
to the extent regulations prescribed by the Secretary provide
that, for purposes of this subtitle, such item is more
appropriately determined at the corporate level.” Sec. 6245.
The tax treatment of a subch. S item generally must be determined
in a corporate-level proceeding. See sec. 6241.
     The S corporation procedures were enacted shortly after the
TEFRA procedures as part of the Subchapter S Revision Act of
1982, Pub. L. 97-354, sec. 4(a), 96 Stat. 1691. (The S
corporation procedures were repealed as of Dec. 31, 1996, by the
Small Business Job Protection Act of 1996, Pub. L. 104-188, sec.
1307(c)(1), 110 Stat. 1781.) Sec. 6244 makes certain provisions
of the TEFRA procedures relating to partnership items applicable
to subch. S items, except as modified or made inapplicable by the
regulations. Among the incorporated provisions is sec. 6226,
which governs the judicial determination of partnership items.
See sec. 6244(2); see also S. Rept. 97-640, at 25 (1982), 1982-2
C.B. 718, 729.
                              - 13 -

his bankruptcy estate should be treated as separate “partners”

for purposes of section 6226(f).

                i.   Should a Debtor and His Bankruptcy Estate Be
                     Treated as One or Two Partners?

     We believe that a partner in bankruptcy and his bankruptcy

estate are appropriately treated as a single partner for purposes

of TEFRA procedures.8   While the bankruptcy estate arises as a

distinct legal entity upon the debtor’s filing of a petition for

relief, the estate cannot be characterized as unrelated to the

debtor.   Rather, the bankruptcy estate functions as the debtor’s

economic proxy, created to facilitate the disposition of the

debtor’s property pursuant to the Federal bankruptcy laws.   It is

between these two related entities that the beneficial ownership

of a single partnership interest will change hands through the

course of the bankruptcy proceeding.   See 11 U.S.C. sec.

541(a)(1) (1994) (initial transfer to the bankruptcy estate); id.

sec. 554(a) (permitting bankruptcy trustee to abandon property of

the estate that is burdensome or of inconsequential value); id.

sec. 726(a)(6) (distribution to the debtor of any property of the

estate that remains after allowed claims have been satisfied).

When viewed from the perspective of the partnership in its

determination of each partner’s distributive share of partnership


     8
        Mr. Katz and his bankruptcy estate each satisfy the
definition of a partner under sec. 6231(a)(2). However, we do
not interpret this characterization as requiring that the two be
treated as separate partners under the TEFRA procedures.
                               - 14 -

tax items, a partner in bankruptcy and his bankruptcy estate are

properly considered as one and the same.

                ii.   Is the Allocation of a Partner’s Distributive
                      Share Between the Partner and His Bankruptcy
                      Estate a Determination That Should Be Made at
                      the Partnership Level?

     The TEFRA provisions and the accompanying legislative

history reflect a desire on the part of Congress to have only

those items that are more appropriately determined at the

partnership level constitute the subject of a partnership-level

proceeding.   See secs. 6221, 6231(a)(3); H. Conf. Rept. 97-760,

at 600 (1982), 1982-2 C.B. 600, 662.    The determination of the

manner in which items of income, gain, loss, deduction, and

credit are allocated among the various partners in a partnership

is one best made at the partnership level, because the allocation

to one partner necessarily affects the allocation to another.

Not surprisingly, the partnership must provide the distributive

shares of each of its partners in its information tax return.

See Schedule K-1 to Form 1065, U.S. Partnership Return of Income.

Yet once the partnership has determined the distributive share of

a partner who happens to be in bankruptcy, there exists no

statutory obligation upon the partnership to subdivide the

distributive share between such partner and his bankruptcy

estate.9   This stands to reason, as such a suballocation will



     9
        This fact will be illustrated in our discussion infra of
the merits of the allocation of the prepetition partnership
losses as between Mr. Katz and his bankruptcy estate.
                             - 15 -

have no effect on the remaining partners.   The subdivision of

partnership tax items between the two related but independently

taxed entities is thus not a determination “required to be taken

into account for the partnership’s taxable year” as contemplated

by section 6231(a)(3).

     5.   Conclusion as to Jurisdictional Issue

     We hold that the manner in which the distributive share of a

partner in bankruptcy is allocated between the partner in his

individual capacity and his bankruptcy estate is not a

partnership item under the TEFRA procedures.   Accordingly, the

merits of such an allocation need not be resolved in a

partnership-level proceeding, but rather may be resolved in a

proceeding at the partner level such as the present one.10

Petitioners’ motion to dismiss for lack of jurisdiction shall be

denied.

B.   Parties’ Cross-Motions for Summary Judgment

     The parties have each moved for summary judgment with

respect to whether the prepetition partnership losses were to be

reported by Mr. Katz or his bankruptcy estate.     Summary judgment

may be granted only if it is demonstrated that no genuine issue

exists as to any material fact and that a decision may be entered


     10
        We note that our holding is consistent with Gulley v.
Commissioner, T.C. Memo. 2000-190, which addressed in a partner-
level proceeding the proper allocation of partnership losses
between a taxpayer in bankruptcy and the taxpayer’s bankruptcy
estate. The jurisdictional issue, however, was not addressed in
that case.
                               - 16 -

as a matter of law.   See Rule 121(b); Sundstrand Corp. v.

Commissioner, 

, 520 (1992), affd. 

 (7th

Cir. 1994).   As there exists no factual dispute pertaining to the

disputed allocation, we shall address the legal issue before us.

     Gross income of a bankruptcy estate is defined as the gross

income of the debtor to which the estate is entitled pursuant to

the U.S. Bankruptcy Code.    See sec. 1398(e)(1).    Under bankruptcy

law, the bankruptcy estate is entitled to the income generated by

property of the estate, see 11 U.S.C. sec. 541(a)(6), and a

debtor’s partnership interest becomes property of the estate upon

the filing of the bankruptcy petition, see id. sec. 541(a)(1).

Gross income of the estate, however, does not include amounts

received or accrued by the debtor prior to the commencement of

the bankruptcy proceeding.    See sec. 1398(e)(1).   Gross income of

the debtor is that which remains after excluding those items

which are included in gross income of the estate.     See sec.

1398(e)(2).

     With section 1398 in mind, we turn to the relevant

provisions governing the income taxation of partners and

partnerships.   A partner must include in gross income his share

of income, gain, loss, deduction, or credit for any taxable year

of the partnership ending with or within the partner’s taxable

year.   See sec. 706(a); see also sec. 1.706-1(a)(1), Income Tax

Regs.   The critical date under this provision is the last day of
                               - 17 -

the partnership taxable year, for it is on this day that the

partner is treated as receiving his share of the aforementioned

partnership tax items.   See Gulley v. Commissioner, T.C. Memo.

2000-190.

     1.     Respondent’s Position

     Respondent contends that the general rules recited above are

sufficient to determine the proper reporting of the prepetition

partnership losses as between Mr. Katz individually and Mr. Katz’

bankruptcy estate.    Respondent’s two-step analysis proceeds as

follows:    First, under section 706(a), the partnerships are

treated as distributing Mr. Katz’ 1990 distributive share of

partnership tax items on December 31, 1990, the last day of the

taxable year of each such partnership.    Second, given that Mr.

Katz’ bankruptcy estate succeeded to the partnership interests on

July 5, 1990, and held beneficial ownership of such interests on

December 31, 1990, all the 1990 calendar year distributive shares

(which include the prepetition partnership losses) belonged to

and were reportable by Mr. Katz’ bankruptcy estate under section

1398(e)(1).    Respondent’s analysis is consistent with the

treatment of the issue in 15 Sheinfeld et al., Collier on

Bankruptcy, par. TX13.04[2][d] (15th ed. rev. 2000):

     Thus, the partnership would allocate the entire year’s
     income or loss to the person who is the partner on the
     last day of the partnership’s taxable year. If the
     debtor partner’s bankruptcy estate still exists when
     the partnership’s taxable year ends, the estate, not
     the debtor partner, would receive the allocation. * * *
     [Fn. ref. omitted.]
                              - 18 -


     Petitioners argue that respondent’s analysis is flawed.

Petitioners invoke several Code provisions which they contend

require a partnership to allocate to a partner in bankruptcy the

portion of his distributive share for the partnership taxable

year which is attributable to the period prior to the

commencement of the partner’s bankruptcy proceeding.    We address

these arguments below.

     2.   Petitioners’ Arguments under Section 1398

          a.   Section 1398(d)(2)

     Petitioners contend that the failure to allocate the

prepetition partnership losses to Mr. Katz individually is

tantamount to forcing a section 1398(d)(2) short taxable year

election upon Mr. Katz with respect to his partnership interests.

Pursuant to section 1398(d)(2), a debtor may elect to divide the

taxable year in which he files bankruptcy into two short years,

the first of which ends on the day prior to the commencement of

the bankruptcy proceeding and the second of which begins on the

bankruptcy commencement date.11   If, however, the debtor declines


     11
        A debtor’s Federal income tax liabilities attributable
to taxable years which have closed prior to the commencement of
the bankruptcy proceeding are assumed by and collectible from the
bankruptcy estate. See 11 U.S.C. sec. 101(10) (1994) (definition
of “creditor”); id. sec. 502(a) (general rule regarding allowance
of claims against the bankruptcy estate). Accordingly, if the
debtor makes the sec. 1398(d)(2) election, his tax liability for
the first short taxable year becomes an allowable claim against
the bankruptcy estate as a claim arising prior to the bankruptcy
                                                   (continued...)
                             - 19 -

to make the section 1398(d)(2) election, the debtor’s taxable

year is determined without regard to the bankruptcy proceeding.12

See sec. 1398(d)(1).

     Petitioners contend that, even though Mr. Katz chose not to

make the section 1398(d)(2) election, the allocation of the

prepetition partnership losses to his bankruptcy estate

effectively forces such an election upon him.   Petitioners’

argument proceeds along the following lines:    First, had Mr. Katz

made the section 1398(d)(2) election, the prepetition partnership

losses would have been allocated to Mr. Katz, thereby generating

an NOL for the first short taxable year.   Second, as a

consequence to the making of the section 1398(d)(2) election, the

bankruptcy estate would have succeeded to Mr. Katz’ NOL

carryovers that existed as of July 5, 1990 (the first day of the

second short taxable year), pursuant to section 1398(g)(1).

Third, since the allocation of the prepetition partnership losses

directly to the estate has the same result as allowing those


     11
      (...continued)
filing. See In re Johnson, 190 Bankr. 724, 726 (Bankr. D. Mass.
1995); In re Moore, 132 Bankr. 533, 534 (Bankr. W.D. Pa. 1991);
In re Mirman, 98 Bankr. 742, 745 (Bankr. E.D. Va. 1989); In re
Turboff, 93 Bankr. 523, 525 (Bankr. S.D. Tex. 1988).
     12
        In the absence of a sec. 1398(d)(2) election, the
debtor’s tax liability for the entire year in which the
bankruptcy proceeding commences is collectible directly from the
debtor individually, with no portion being collectible from the
bankruptcy estate. See In re Smith, 210 Bankr. 689, 692 (Bankr.
D. Md. 1997); In re Johnson, supra at 726; In re Moore, supra at
534; In re Mirman, supra at 745; In re Turboff, supra at 525.
                             - 20 -

losses to be inherited by the estate through the NOL carryover,

the allocation of those losses to Mr. Katz’ bankruptcy estate is

the equivalent of Mr. Katz’ making the section 1398(d)(2) short-

year election.

     Petitioners’ argument is flawed in a number of respects,

with the principal error lying in the first assumption–-that the

prepetition partnership losses would have been allocated to Mr.

Katz individually under section 1398(e) had he made the section

1398(d)(2) short-year election.   Under section 706(a), a

partner’s share of partnership loss is distributed as of the last

day of the taxable year of the partnership.   Given that section

1398(d)(2) affects only the taxable year of the partner, the

short-year election has no effect on the date on which the

partnership loss is deemed to be distributed by the partnership.

In other words, even if Mr. Katz had made the section 1398(d)(2)

election, the prepetition partnership losses would not have been

distributed by the partnerships until the close of the respective

partnership taxable years pursuant to section 706(a).   See

Purintun, “Partnerships and Partners in Bankruptcy”, 11 J.

Partnership Taxn. 342, 346 (1995) (“whether or not the debtor

partner makes the short taxable year election, the distributive

share of income or loss from the entire partnership taxable year

in which the partner’s bankruptcy petition is filed should be

included in the return of the estate”); American Bar Association
                               - 21 -

Section of Taxation, “Report of the Section 108 Real Estate and

Partnership Task Force: Part II”, 46 Tax Law. 397, 448-449 (1993)

(concluding that “when an individual files bankruptcy prior to

the close of the partnership’s taxable year, his bankruptcy

estate would get the benefit or detriment of the partnership

income or loss for the entire year” and noting that “the section

1398(d) short period election to treat the debtor’s taxable year

of bankruptcy filing as two taxable years would not affect the

result”).    As petitioners’ argument rests upon a faulty

assumption, we reject it.

            b.   Section 1398(b)(2)

     Petitioners note that section 1398(b)(2) provides that “the

interest in a partnership of a debtor who is an individual shall

be taken into account under this section in the same manner as

any other interest of the debtor.”      Petitioners then contend

that, since income or loss received during the prepetition period

on property other than a partnership interest was taxable to Mr.

Katz individually under section 1398(e), section 1398(b)(2)

mandates that the portion of the partnership income or loss

attributable to the prepetition period must also be allocated to

Mr. Katz in his individual capacity.

     Petitioners read section 1398(b)(2) out of context.      Section

1398(b)(2) provides as follows:
                                - 22 -

          (2) Section does not apply at partnership
     level.–-For purposes of subsection (a), a partnership
     shall not be treated as an individual, but the interest
     in a partnership of a debtor who is an individual shall
     be taken into account under this section in the same
     manner as any other interest of the debtor. [Emphasis
     added.]

When read in conjunction with section 1398(a) (providing that

section 1398 applies only to certain bankruptcy proceedings in

which the debtor is an individual), the purpose of the first

portion of section 1398(b)(2) is to render section 1398

inapplicable to a partnership in bankruptcy.      The second portion

of section 1398 (upon which petitioners base their argument) is

properly interpreted as a clarification that even though section

1398 does not apply to a partnership in bankruptcy, it

nonetheless governs the tax treatment of a partnership interest

of an individual in bankruptcy.    Section 1398(b)(2) is thus not

intended to articulate a specific manner in which the income or

loss from a partnership interest is to be divided between a

partner and his bankruptcy estate.       Rather, such specifics are

addressed in section 1398(e).    Petitioners’ reliance upon section

1398(b)(2) is misplaced.

     3.   Petitioners’ Argument Under Section 706(d)(1)

     Section 706(a) provides that the distributive share of

income or loss for the entire partnership taxable year is deemed

to be distributed to the holder of the partnership interest as of

the close of the partnership taxable year.      Given that Mr. Katz’
                               - 23 -

bankruptcy estate held beneficial ownership of the partnership

interests as of the close of the various partnership taxable

years, it is incumbent upon petitioners to identify an exception

to the section 706(a) general rule in order for the prepetition

partnership losses to be allocated to Mr. Katz in his individual

capacity.   In this regard, petitioners offer section 706(d)(1).

     Petitioners argue that the varying interests rule under

section 706(d)(1) was triggered when Mr. Katz filed his chapter 7

petition in bankruptcy.   Section 706(d)(1), enacted as part of

the Deficit Reduction Act of 1984 (DEFRA), Pub. L. 98-369, sec.

72, 98 Stat. 494, 589, provides in pertinent part as follows:

          (1) In general.–- * * * if during any taxable year
     of the partnership there is a change in any partner’s
     interest in the partnership, each partner’s
     distributive share of any item of income, gain, loss,
     deduction, or credit of the partnership for such
     taxable year shall be determined by the use of any
     method prescribed by the Secretary by regulations which
     takes into account the varying interests of the
     partners in the partnership during such taxable year.
     [Emphasis added.]

In particular, petitioners contend that Mr. Katz experienced a

“change in interest” under section 706(d)(1) when his ownership

interests in the partnerships were extinguished by the operation

of 11 U.S.C. sec. 541(a)(1).   The argument follows that each

partnership was required under section 706(d)(1) to make an

allocation in respect of Mr. Katz’ extinguished interest.

     Respondent contends that section 706(d)(1) has no

application to a transfer of a partnership interest pursuant to
                              - 24 -

11 U.S.C. sec. 541(a)(1).   As explained below, we agree.   See

Gulley v. Commissioner, T.C. Memo. 2000-190 (“Petitioner’s

transfer of his interest in * * * [the partnership] to the

bankruptcy estate was not a change in interest requiring an

allocation of his distributive share of * * * partnership items

between himself and the bankruptcy estate for purposes of section

706(d)(1).”).

     Section 706(d)(1) cannot be read in isolation.   It must be

read in the larger context of section 706, particularly section

706(c).   Prior to its amendment by DEFRA (discussed infra) but

following its amendment by the Tax Reform Act of 1976, Pub. L.

94-455, sec. 213(c)(1), 90 Stat. 1547, section 706(c)(2) provided

as follows:

          (2) Partner who retires or sells interest in
     partnership.–-

               (A) Disposition of entire interest.–-The
          taxable year of a partnership shall close–-

                     (i) with respect to a partner who sells
                or exchanges his entire interest in a
                partnership, and

                     (ii) with respect to a partner whose
                interest is liquidated * * *.

          Such partner’s distributive share of items
          described in section 702(a) for such year shall be
          determined, under regulations prescribed by the
          Secretary, for the period ending with such sale,
          exchange, or liquidation.

               (B) Disposition of less than entire
          interest.--The taxable year of a partnership shall
          not close * * * with respect to a partner who
                                - 25 -

           sells or exchanges less than his entire interest
           in the partnership or with respect to a partner
           whose interest is reduced (whether by entry of a
           new partner, partial liquidation of a partner’s
           interest, gift, or otherwise), but such partner’s
           distributive share of items described in section
           702(a) shall be determined by taking into account
           his varying interests in the partnership during
           the taxable year. [Emphasis added.]

     The language used in the prior version of section 706(c)(2)

reveals that it served two distinct but complementary functions.

First, former section 706(c)(2) identified certain events

(triggering events) which required the partnership either to

close its taxable year with respect to a partner or to determine

a partner’s distributive share by taking into account the change

in the partner’s interest which had occurred over the course of

the partnership taxable year.    Second, former section 706(c)(2)

addressed the manner in which a partner’s distributive share was

to be determined as a result of the occurrence of a triggering

event.

     DEFRA amended section 706(c)(2) by severing its two

functions and moving the second over to newly enacted section

706(d).   In particular, the provisions of former section

706(c)(2) emphasized above were stricken and consolidated to form

the general rule set out in section 706(d)(1).13   The purpose

behind this consolidation was to facilitate the addition of


     13
        Subsec. (d) was added to sec. 706 by sec. 72(a) of the
Deficit Reduction Act of 1984 (DEFRA), Pub. L. 98-369, 98 Stat.
494, 589. The deletions from sec. 706(c)(2) were mandated by
DEFRA sec. 72(b), captioned “Conforming Amendments.”
                              - 26 -

specific rules in later portions of section 706(d) aimed at

curbing the retroactive allocation of deductions to late-entering

partners through the use of the cash method of reporting, see

sec. 706(d)(2), or through the use of tiered partnerships, see

sec. 706(d)(3).   The conference report accompanying DEFRA

explains as follows:

           The Tax Reform Act of 1976 amended the partnership
     provisions to preclude a partner who acquires his
     interest late in the taxable year from taking into
     account partnership items incurred prior to his entry
     into the partnership (“retroactive allocations” of
     partnership losses). The 1976 Act provided that when
     partners’ interests change during the taxable year,
     each partner’s share of various items of partnership
     income, gain, loss, deduction, and credit is to be
     determined by taking into account each partner’s
     varying interest in the partnership during the taxable
     year.

          Some taxpayers argue that the 1976 Act rule may be
     avoided in the case of tiered partnership arrangements
     on the theory that losses sustained by the lower-tier
     partnerships are allocable to the day in the upper-tier
     partnership’s taxable year on which the lower-tier
     partnership’s taxable year closes. Similarly,
     partnerships using the cash receipts and disbursements
     method of accounting have avoided the retroactive
     allocation rules by deferring actual payment of accrued
     deductions until near the end of the partnership’s
     taxable year. [H. Conf. Rept. 98-861, at 855 (1984),
     1984-3 C.B. (Vol. 2) 1, 109; emphasis added.]

     The origins of section 706(d)(1) reveal that it was not

intended to articulate an additional “change of interest”

triggering event which would require the application of special

rules to determine a partner’s distributive share for the

partnership taxable year in which the change occurred.   Rather,
                              - 27 -

the reference in section 706(d)(1) to a “change in any partner’s

interest” is properly interpreted as a reference to those events

articulated in section 706(c)(2).   In short, section 706(d)(1)

assumes the occurrence of a triggering event; it does not provide

for one.

     Thus, contrary to petitioners’ assertions, the determination

of whether section 706(d)(1) requires the subdivision of a

partner’s distributive share between the partner individually and

the partner’s bankruptcy estate cannot be made with reference to

section 706(d)(1) alone.   Rather, it must first be determined

whether a transfer from a debtor to his bankruptcy estate

pursuant to 11 U.S.C. sec. 541(a)(1) constitutes a triggering

event under section 706(c)(2).

     To the extent Mr. Katz’ partnership interests were affected

by the filing of his chapter 7 bankruptcy petition, they were

completely terminated.   Accordingly, the relevant provision of

section 706(c)(2) is subparagraph (A), which addresses

dispositions of an entire partnership interest.   The

determination of whether the transfer of Mr. Katz’ partnership

interests to his bankruptcy estate constitutes a sale, exchange,

or liquidation under section 706(c)(2)(A) is rather

straightforward.   Section 1398(f)(1) dictates that the transfer

of property from a debtor to his bankruptcy estate which occurs

by reason of the bankruptcy filing shall not be treated as a

disposition for purposes of any provision of the Internal Revenue
                              - 28 -

Code which assigns tax consequences to a disposition.    See also

Gulley v. Commissioner, T.C. Memo. 2000-190; Smith v.

Commissioner, T.C. Memo. 1995-406.     As the transfer of Mr. Katz’

partnership interests to his bankruptcy estate did not constitute

a triggering event under section 706(c)(2), Mr. Katz did not

thereby experience a “change in interest” under section

706(d)(1).   Section 706(d)(1) thus has no application to this

case.

     4.   Conclusion as to Disputed Allocation

     We hold that the prepetition partnership losses were

properly reportable in their entirety by Mr. Katz’ bankruptcy

estate pursuant to sections 706(a) and 1398(e).14    We therefore

sustain respondent’s disallowance of the NOL carryovers claimed

by petitioners for tax years 1991 to 1994, to the extent those

carryovers are attributable to the prepetition partnership losses

Mr. Katz claimed on his separately filed return for 1990.




     14
        To the extent not discussed in this opinion, we find
petitioners’ arguments in favor of a contrary holding to lack
merit.
                        - 29 -

To reflect the foregoing,

                                 An appropriate order will be

                            issued denying petitioners’ motion

                            to dismiss, denying petitioners’

                            motion for summary judgment, and

                            granting respondent’s motion for

                            summary judgment, and decisions

                            will be entered under Rule 155.