73 T.C. 1129">*1129 OPINION

Respondent determined the following income tax deficiencies against the petitioners:

Because of concessions by both petitioners and respondent, the 73 T.C. 1129">*1130 only issue for our decision is whether petitioners may deduct partnership losses allocable to the periods during the taxable years prior to the time petitioners acquired the particular partnership interests, which losses were allocated in accordance with the partnership agreement. Because of petitioners' concessions and due to the dates on which petitioners purchased the respective partnership interests in issue, only the 1972 tax year is involved in the case of the Marriotts, and only the 1973 tax year is involved in the case of the Suttons.

The facts in this case were fully stipulated. The stipulation of facts, first supplemental stipulation of facts, stipulation of partial settlement, and attached exhibits are incorporated herein by reference. The facts necessary for an understanding1980 U.S. Tax Ct. LEXIS 165">*169 of this case are as follows.

Petitioners Harry L. Marriott and Patricia Marriott, husband and wife, resided in Hopkins, Minn., at the time of the filing of their petition herein. They filed joint Federal income tax returns for 1972 and 1973. Petitioner Patricia Marriott is a party hereto solely by reason of having filed a joint return with her husband. Accordingly, reference will only be made to petitioner Harry L. Marriott (hereinafter Marriott).

Petitioners Lester Earl Sutton and Marjory R. Sutton, husband and wife, resided in Minnetonka, Minn., at the time of the filing of their petition herein. They filed joint Federal income tax returns for 1972 and 1973. Petitioner Marjory R. Sutton is a party hereto solely by reason of having filed a joint return with her husband. Accordingly, reference will only be made to petitioner Lester Earl Sutton (hereinafter Sutton). (Marriott and Sutton will sometimes hereinafter be referred to as petitioners.)

Metro Office Parks Co. (hereinafter Metro) is a Minnesota limited partnership formed on December 1, 1967. The general partners of Metro during 1972 and 1973 were John R. Neumeier and Metro Office Parks, Inc., a Minnesota corporation. 1980 U.S. Tax Ct. LEXIS 165">*170 There are 840 limited partnership units in Metro, each unit having a 1/840 interest in partnership capital, income, and loss. Metro keeps its books and prepares its tax returns on a calendar year and accrual method of accounting basis.

Metro constructed and operates an office complex in Bloomington, Minn. The office complex consists of seven office buildings, four underground parking garages, and one three-story 73 T.C. 1129">*1131 parking garage. The buildings were constructed one at a time between 1968 and 1974. One of the office buildings was sold on May 31, 1973.

On December 31, 1970, there were seven partners in Metro. Beginning in 1971, the ownership of Metro was broadened through (1) a public offering by Urban Land Investments, Inc., whereby it disposed of some of the 200 limited partnership units owned by it; (2) private placements by John R. Neumeier, whereby he disposed of some of the 200 limited partnership units owned by him; and (3) isolated sales of units by other partners. The offerings by both Urban Land Investments, Inc., and Neumeier were registered with the Securities Division of the Minnesota Department of Commerce.

At the end of 1971, there were 65 limited partners1980 U.S. Tax Ct. LEXIS 165">*171 and assignees of limited partners, most of whom entered the partnership during 1971. With the caveat that some persons acquiring interests were technically assignees, not yet having been formally made limited partners, there were 79 limited partners on December 31, 1972, and 95 limited partners on December 31, 1973.

The following is a summary of the transactions in partnership units of Metro for the years 1971, 1972, and 1973: ¹

73 T.C. 1129">*1132 These transactions were transfers of partnership units by a partner to a third person who was not a partner on December 31, 1970.

1980 U.S. Tax Ct. LEXIS 165">*172 Between 1971 and 1973, Sutton purchased three limited partnership units in Metro, one on September 10, 1971, one on January 2, 1972, and one on April 24, 1973. Only the losses allocated to the partnership unit purchased in April 1973 are at issue with regard to Sutton. He purchased that unit from an unidentified partner in Metro.

During December 1972, Marriott acquired five limited partnership units in Metro. He individually acquired two units on December 14, 1972, from Urban Land Investments, Inc. By this sale, Urban Land Investments, Inc., did not dispose of all of the units owned by it. On December 15, 1972, as one of a group of five individuals who purchased a total of 21 ² units under the name of Granite Group, Marriott acquired 3 limited partnership units. The Granite Group does not file a partnership income tax return.

Prior to1980 U.S. Tax Ct. LEXIS 165">*173 December 30, 1971, Metro's partnership agreement, as amended, provided that at the end of each fiscal year the net profits or losses of the partnership's operation for that year "shall be divided among * * * the Partners and Assignees proportionately in the ratio which the number of Units owned by each of them bears to the number of units then owned by all of them." Such net profits and losses were to be divided among successive owners of any unit, based on the number of days each was the owner of the unit, without regard to the results of partnership operations during the period in which each was the owner of the unit and regardless of the date upon which distributions were made. Distributions of substantially all of the cash available from the operating income of the partnership were to be made annually and were to be allocated among the partners in the ratio of the number of units owned by them to the total number of units owned on the date of distribution. The term of the partnership was 30 years from the date it commenced, December 1, 1967. The agreement also provided for the assignment of partnership interests and admission of the 73 T.C. 1129">*1133 assignees as substituted limited1980 U.S. Tax Ct. LEXIS 165">*174 partners without termination of the partnership.

On December 30, 1971, the partnership agreement was amended to provide for allocation of net income and losses as follows:

The net income and net losses of the Partnership in any fiscal year ending after December 31, 1970, as determined for federal income tax purposes, whether ordinary or capital, shall be allocated among the Limited Partners and their assignees in proportion that the number of Limited Partnership units owned by each at the end of the fiscal year bears to 840 Limited Partnership Units (being the total number of Limited Partnership Units outstanding).

The amendment also provided that upon termination and dissolution of the partnership, after payment of all creditors and repayment of all working capital contributions of the limited partners, the limited partners should share in the partnership assets in the proportions in which profits and losses were allocated as above.

Neither Marriott nor Sutton was involved in determining the profits-and-losses allocation for Metro.

Pursuant to the partnership agreement as amended on December 30, 1971, the full amounts of partnership losses for 1972 and 1973 were allocated to 1980 U.S. Tax Ct. LEXIS 165">*175 the capital accounts of the partners as of the end of each year. There were minor differences between the tax losses and the book losses, with the latter being allocated to the capital accounts, but those differences were not connected with the allocation. There were no distributions made to the limited partners in either 1972 or 1973.

Pursuant to the partnership agreement, the entire loss allocable to the five units owned by Marriott on December 31, 1972, was allocated to Marriott on Metro's 1972 partnership return and reported by Marriott on the 1972 joint return he filed with his wife. Similarly, the entire 1973 loss allocable to the three units owned by Sutton on December 31, 1973, was allocated to Sutton on Metro's 1973 partnership return and reported by Sutton on the 1973 joint return he filed with his wife.

In the statutory notices of deficiency, respondent determined that petitioners were not entitled to deduct that portion of the partnership losses allocable to the portion of the year prior to the time petitioners purchased the partnership interests. Thus, in the case of Marriott, a deduction was disallowed for that portion 73 T.C. 1129">*1134 of the losses allocable to Marriott's1980 U.S. Tax Ct. LEXIS 165">*176 five partnership units under the partnership agreement for the period prior to Marriott's purchase of the units in December 1972. Similarly, in the case of Sutton, a deduction was disallowed for the portion of the losses allocable to the partnership unit purchased by Sutton prior to the time he purchased the unit on April 24, 1973. ³

The issue for decision is whether petitioners may deduct the portion of the partnership losses allocable to their respective partnership units for the periods during the taxable years prior to the time petitioners acquired the partnership units.

Respondent advances two arguments in support of his determination that petitioners may not deduct losses which are allocable to the periods of time during the partnership's taxable years prior1980 U.S. Tax Ct. LEXIS 165">*177 to the petitioners' acquisition of their respective partnership interests. The first argument, which parallels the assignment-of-income principle, is that a taxpayer may not deduct a loss which he did not sustain. Since a part of the partnership losses should be allocated to the part of the year prior to petitioners' entry into the partnership, they are not entitled to deduct those losses. Respondent's second argument is that because section 706(c)(2)(B), I.R.C. 1954, ⁴ requires the partners from whom petitioners purchased the partnership units to determine their distributive share of losses by taking into account their varying partnership interests during the taxable year, so must petitioners.

In support of the allocation of the partnership's losses in accordance with the partnership agreement, petitioners argue: (A) section 706 cannot be interpreted to contravene1980 U.S. Tax Ct. LEXIS 165">*178 section 704(a) when subchapter K is read as a whole; (B) section 704(a) requires an allocation of the losses in accordance with the partnership agreement unless a contrary result is required by another provision of section 704; (C) section 704(b)(2), the only provision which could possibly negate the application of section 704(a), is not applicable because the partnership's profit and loss allocation provision was adopted for business purposes (to simplify the allocation process because of the number of limited 73 T.C. 1129">*1135 partners and the number of transactions involving limited partnership units) and not for tax avoidance purposes; and (D) the assignment-of-income doctrine is inapplicable.

The issue involved is one that has caused considerable uncertainty since subchapter K was first enacted in the 1954 Code because the literal application of sections 704(a) and 706(c)(2)(B) may produce inconsistent results where the provisions in the partnership agreement for allocation of profits and losses may differ from the provisions of section 706(c)(2)(A) and (B). The problem has been referred to as the retroactive allocation of partnership losses, ⁵ although, for reasons hereinafter stated, 1980 U.S. Tax Ct. LEXIS 165">*179 we do not find that to be a very apt description of what occurred here.

Partners are required by section 702(a) to report their "distributive [shares]" of the partnership's taxable income or loss. ⁶1980 U.S. Tax Ct. LEXIS 165">*180 Section 704(a) provides that a "partner's distributive share of income, gain, loss, deduction, or credit shall, except as otherwise provided in this section, be determined by the partnership agreement." ⁷Section 761(c) defines the term "partnership agreement" as including any modifications made to the agreement prior to the time prescribed by law for filing the partnership return. Partners do not have unbridled discretion, however, in providing in the partnership agreement for the determination of partners' distributive shares of items of income, gain, loss, etc. See sec. 704(b)(2). ⁸

1980 U.S. Tax Ct. LEXIS 165">*181

73 T.C. 1129">*1136 Section 706(c)(1) provides generally that the taxable year of a partnership shall not close as a result of the death of a partner, entry of a new partner, or liquidation or sale or exchange of a partner's interest, except if the partnership terminates or except as provided in paragraph (2) of the subsection.

Section 706(c)(2)⁹ provides for certain tax consequences to partners whose partnership interests change during the partnership's taxable year:

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

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

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

(B) Disposition of less than entire1980 U.S. Tax Ct. LEXIS 165">*182 interest. -- The taxable year of a partnership shall not close (other than at the end of a partnership's taxable year as determined under subsection (b)(1)) with respect to a partner who sells or exchanges less than his entire interest in the partnership or with respect to a partner whose interest is reduced, 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.

Nims, J., concurring: While I agree with the result reached by the majority, I find troubling the implications of language in the opinion such as "while * * * there may have been no retroactive shifting of distributive shares in a strict sense," and "The provision in the agreement for division of profits and losses among the owners of the units as of the end of the year was in accord, so far as we know, with the actual economic interest of the partners in the partnership."

It seems quite apparent that there was indeed a retroactive shifting of distributive shares. The effect of the December 30, 1971, amendment to the partnership agreement was to provide an automatic retroactive allocation to any limited partner admitted after the first day of any given partnership year. That is precisely what petitioners sought to achieve here.

Furthermore, I find nothing in the findings of fact to support the assertion that the amendment comports with the economic interests of the partners. Why, for example, would any intelligent1980 U.S. Tax Ct. LEXIS 165">*191 person buy into a partnership at the end of a year only to be saddled with a full year's operating losses -- except to obtain tax deductions?

I find it puzzling indeed that the majority, while ostensibly following Moore v. Commissioner, 70 T.C. 1024">70 T.C. 1024 (1978), makes the statement that "the transfers of partnership interests in these years did not effect a retroactive redivision of the partnership profits and losses different from that provided in the agreement as amended." As one might have assumed from Moore, the fact that the partnership agreement did, indeed, provide for retroactive allocations is irrelevant; rather, the mischief lies in the fact of the retroactive allocations themselves. It is also immaterial, though the majority opinion implies the contrary, that the partnership agreement was amended in a year prior to those 73 T.C. 1129">*1141 before the Court, rather than during or subsequent to those years; the problem remains the same.

I would further reiterate that, as we demonstrated in Moore, the conceptual basis for the disallowance of retroactive allocations where new partners are admitted is the overlay of the assignment-of-income doctrine1980 U.S. Tax Ct. LEXIS 165">*192 upon the mechanical contrivance here again postulated by the petitioners. Prior to the Second Circuit's decision in Rodman v. Commissioner, 542 F.2d 845">542 F.2d 845 (2d Cir. 1976), revg. on this issue T.C. Memo. 1973-277, and our decision in Moore, it had been argued, as petitioners argue, that sections 702(a), 704(a), and 761(c) reveal a legislative purpose to allow partners flexibility in determining inter se the incidents of their tax liability resulting from participation in a partnership; e.g., to allow retroactive allocations of losses to incoming partners. 70 T.C. 1024">Moore v. Commissioner, supra at 1030. In Moore, we quoted the Supreme Court speaking in New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 292 U.S. 435">440-441, as follows:

the taxpayer who sustained the loss is the one to whom the deduction shall be allowed. Had there been a purpose to depart from the general policy in that regard, and to make the right to the deduction transferable or available to others than the taxpayer who sustained the loss, it is but reasonable to believe that purpose would have been clearly expressed. 1980 U.S. Tax Ct. LEXIS 165">*193 And as the section contains nothing which even approaches such an expression, it must be taken as not intended to make such a departure.

As we said in 70 T.C. 1024">Moore v. Commissioner, supra at 1034, "the same observations are pertinent in the case before us. Subchapter K contains no clear expression of the intention to permit a partner to deduct losses which accrued prior to his entry into the partnership." In my judgment, we should take no step now which would in any way give the impression that we have receded from that position.