We therefore have two sections within subchapter K that 76 T.C. 512">*523 attempt to define the distributive share of a partner: section 704, which provides generally that the partnership agreement shall determine 1981 U.S. Tax Ct. LEXIS 150">*170 the partner's distributive share of profits and losses, and section 706(c)(2)(B), which provides that the distributive share of a partner, who has transferred part of his interest by sale or exchange or whose interest is otherwise reduced, shall be determined by taking into account his varying interests in the partnership during the taxable year. In 70 T.C. 1024">Moore v. Commissioner, supra, and 73 T.C. 1129">Marriott v. Commissioner, supra, this Court held that, where there is a transfer of a partnership interest during the taxable year, section 706(c)(2) supersedes section 704. 70 T.C. 1024">70 T.C. 1032; 73 T.C. 1129">73 T.C. 1139. The question in the instant case is not whether section 706(c) supersedes section 704(a). We must decide whether section 706(c) applies to the admission of new partners or only applies to the transfer by a partner of a partnership interest.

Petitioners argue that section 706(c)(2)(B) governs only situations where less than an entire interest is sold or exchanged. Petitioners reason that admission of a new partner is not a sale or exchange and therefore section 706(c)(2)(B) is inapplicable. Respondent, on the other hand, argues that any reduction of a partner's capital interest in the partnership 1981 U.S. Tax Ct. LEXIS 150">*171 triggers the application of section 706(c)(2)(B) and that the retroactive allocation of partnership losses is prohibited. In respondent's view, section 706(c)(2)(B) applies to both the sale or exchange of a partnership interest by an existing partner as well as to the reduction in an existing partner's interest solely by reason of the admission of a new partner. Partners therefore must allocate losses to reflect their varying interests in the partnership during the taxable year.

After the phrase "with respect to a partner whose interest is reduced," the Tax Reform Act of 1976 inserted the parenthetical "whether by entry of a new partner, partial liquidation of a partner's interest, gift, or otherwise." Petitioners contend that the 1976 amendment establishes that section 706(c)(2)(B) was inapplicable prior to 1976 where the partner's interest was acquired directly from the partnership, as in the instant case.

76 T.C. 512">*524 A review of the legislative history does not provide the conclusive interpretation of section 706(c)(2)(B) prior to 1976 that petitioners urge upon this Court. To the contrary, the purpose of the amendment appears to be clarification, not modification, of the law as it existed. 1981 U.S. Tax Ct. LEXIS 150">*172 The report of the Joint Committee on Taxation recognized that the law prior to 1976 was unclear:

Under prior law, it was unclear whether * * * [sec. 706(c)(2)(B)] pertained to the situation where a partner's proportionate interest in the partnership was reduced as the result of the purchase of an interest directly from the partnership. Consequently, it was unclear whether an incoming partner, who purchased his interest directly from the partnership, would be subject to the rule of including partnership income and loss according to his varying interests during the year. * * * [Staff of Joint Comm. on Taxation, 94th Cong., 2d Sess., General Explanation of the Tax Reform Act of 1976, p. 92 (Comm. Print 1976).]

Therefore, the purpose of the 1976 amendment was --

to make it clear that the varying interests rule of this provision is to apply to any partner whose interest in a partnership is reduced, whether by entry of a new partner who purchased his interest directly from the partnership, partial liquidation of a partner's interest, gift, or otherwise. Correspondingly, the provision is to apply to the incoming partner so as to take into account his varying interests during the year. In 1981 U.S. Tax Ct. LEXIS 150">*173 addition, regulations are to apply the same alternative methods of computing allocations of income and loss to situations falling under section 706(c)(2)(B) as those now applicable to section 706(c)(2)(A) situations (sale or liquidation of an entire interest). * * * [Staff of Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1976, supra at pp. 93-94. Emphasis added.]

Accordingly, we find that the varying interest rule of the Tax Reform Act of 1976 codified prior law and therefore is equally applicable to the years in issue.

Petitioners further contend that the "reduced interest" language relied on by respondent refers to an economic interest and not a capital interest. We believe that the reference in subchapter K to a partner's "interest" can be a reference either to the capital interest or to the profit and loss interest of each partner. We will not define that term differently in section 706(c)(2)(B). Petitioners in effect request the Court to consider the fair market value of the original partners' equity in the partnerships, both before and after the transfer, to redetermine whether the original partners' interests have been "reduced" and whether section 706(c)(2)(B)1981 U.S. Tax Ct. LEXIS 150">*174 is applicable. To ignore the common meaning of the term "interest" and to create an equity test within section 76 T.C. 512">*525 706(c) would not further the purposes of the section or subchapter K. As construed by this Court, the purpose of section 706(c)(2)(B) is to insure that the transferor of a partnership interest reports his share of partnership profits and losses prior to the transfer. We will not construe section 706(c)(2)(B) in such a manner as to allow petitioners to do indirectly what they could not do directly by requiring, in effect, an appraisal of the partnerships' assets, before and after the admission of new partners.

Prior to the admission of the new partners, petitioner Richardson owned 50-, 33.3-, and 25-percent capital interests in the three partnerships, respectively. After the admission of the new partners, he had effectively transferred all but 1 percent of his capital interest in each of the partnerships. We find that the admission of the new partners resulted in a reduction of the original partners' interests within the meaning of section 706(c)(2)(B). Accordingly, the original partners must report their distributive shares of partnership items for the period prior to 1981 U.S. Tax Ct. LEXIS 150">*175 and after the admission of the new partners in accordance with their varying interests in the partnerships during the year. They are prohibited from making a retroactive allocation to the new partners.

Having found section 706(c)(2)(B) applicable, we must determine the proper method of computing allocation of income or losses to each period. As previously noted, the regulations under section 706(c)(2)(B) provide no specific formula. Petitioners seek to utilize an interim closing of the books method, and respondent contends that such a method was not permissible under section 706(c)(2)(B) prior to 1976.

In 70 T.C. 1024">Moore v. Commissioner, supra, we stated that any reasonable method of allocating profits and losses for the period prior to and after the sale or exchange of partnership interests is acceptable. 70 T.C. 1024">70 T.C. 1035. See Marriott v. Commissioner, 73 T.C. 1129">73 T.C. 1139. We reached this conclusion by relying on the regulations under section 706(c)(2)(A), which address the method of allocation on the sale or exchange of a partner's entire interest in the partnership. See sec. 1.706-1(c)(2), Income Tax Regs. See also 70 T.C. 1024">Moore v. Commissioner, supra at 1035.

In Moore, Marriott, and the instant case, 1981 U.S. Tax Ct. LEXIS 150">*176 we have indicated that it is our belief that section 706(c)(2)(B) was enacted to put on par a partner who transfers a partial interest in a partnership 76 T.C. 512">*526 with one who sells or exchanges an entire interest. To support this conclusion, we note that the Tax Reform Act of 1976 included both clarifying amendments to section 706(c) and the requirement that regulations be promulgated to allow allocation under subsection (b) as were allowed under section 706(c)(2)(A). See Staff of Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1976, supra. As stated earlier, we view the amendments to this section as clarifying restatements of the then-existing law. Accordingly, petitioners may use an interim closing of the books method, allocation of yearend totals of income or loss ratably over the year, or any other reasonable method.

In the statutory notices, respondent allocated 1/365 of the partnerships' total losses for 1974 to the new partners. Petitioners contend that the allocation under the partnership agreements, which would give 99 percent of the total losses for 1974 to the new partners, is reasonable. Alternatively, they contend that they are entitled to utilize the 1981 U.S. Tax Ct. LEXIS 150">*177 interim closing of the books method. Respondent contends that an interim closing of the books is unreasonable in the instant case because the deductible expenses paid on December 31, 1974, represent in part expenses incurred during the January 1 to December 30, 1974, period and therefore cannot properly be allocated to the new partners. Respondent contends that, if an interim closing of the books is allowable, the petitioners must establish with precision the exact expenses incurred and paid on December 31, 1974. Unlike the situation in Moore, the parties here agree on the amount of income and losses allocable to each period but dispute the propriety of allocating expenses paid on December 31, 1974, but incurred prior to that date, to the new partners.

Respondent's position is set forth in his brief as follows:

The basis for respondent's contention is that, if instead of purchasing an interest in the partnership that owns property that generates deductible expenses, the taxpayer purchases a direct individual interest in the property itself, the taxpayer would not be permitted to deduct the expenses to the extent that they were incurred and sustained prior to the purchase. Respondent 1981 U.S. Tax Ct. LEXIS 150">*178 contends that a taxpayer should not be permitted to use an end of the year acquisition of an interest in a partnership to obtain deductions that he could not obtain if he had purchased an undivided interest in the property itself.

Thereafter, respondent cites a number of cases that stand for the proposition that the purchaser's assumption of a deductible 76 T.C. 512">*527 expense of the seller, which accrued prior to the time of the acquisition of the property, constitutes a capital expense of the purchaser and not a deductible expense.

We believe the respondent's position is without merit. It is well recognized that subchapter K dictates that the deductibility and timing of a deduction is determined at the partnership level and by the method of accounting utilized by the partnership. W. McKee, W. Nelson & R. Whitmire, Federal Taxation of Partnerships and Partners, par. 9.02[1], pp. 9-5 to 9-7 (1977). Respondent has conceded that the expenses here in issue were all ordinary and necessary business expenses of the partnerships for their tax years ended December 31, 1974. The record clearly established that each of the partnerships was in financial trouble and suffered from a severe cash flow problem. 1981 U.S. Tax Ct. LEXIS 150">*179 The utility bills of the apartment complexes were in arrears and the mortgage company was considering foreclosure proceedings. The contributions of the new partners were utilized to reduce the cash flow problems and to pay the outstanding expenses of the partnerships. While the partnerships are the trees which grew the fruit, it was the new partners' contributions which ripened the fruit to deductibility. Since the partnerships utilized the cash method of accounting and the allocation of the losses occurring on December 31, 1974, to the new partners was reasonable and reflected economic reality, we find that petitioners may utilize the interim closing of the books method for the purposes of allocating the partnerships' losses.

We now must decide the propriety of respondent's contention that the old partners' bases in the partnerships must be determined on the last day of the partnerships' taxable years. ⁶

Section 704(d) provides generally that a partner's distributive share of partnership losses shall be allowed only to the extent of the adjusted basis of such partner's interest 1981 U.S. Tax Ct. LEXIS 150">*180 in the partnership at the end of the partnership year in which such losses occurred. ^{71981 U.S. Tax Ct. LEXIS 150">*181} 76 T.C. 512">*528 Respondent maintains that for purposes of the section 704(d) loss limitation, petitioners must determine the bases of their partnership interests on December 31, 1974, the end of the partnership year. Petitioners, however, contend that had the original partners "sold" their interest on December 30, 1974, their bases for loss limitation purposes would have been determined on that date. By analogy to the sale situation, petitioners contend that the partnership year should be closed and that we should determine their bases on December 30, 1974, and not December 31, 1974, when applying the section 704(d) loss limitation. While we sympathize with petitioners, we cannot agree.

Admission of new partners is not in all respects identical to a sale or exchange of a partnership interest. In the former situation, the transaction is between the new partners and the partnership. The latter situation involves a transaction between a new partner and an existing partner. When a partner sells his entire interest in a partnership, the partnership year as to that partner is closed. See sec. 706(c)(2)(A). Further, the regulations under section 705 specifically provide that a partner's adjusted basis must be determined as of the date of the sale. This is true on the sale of either an entire interest or a partial interest in the partnership. See sec. 1.705-1(a)(1), Income Tax Regs.^{81981 U.S. Tax Ct. LEXIS 150">*182} An adjustment in basis is necessary in order to determine the selling partner's true gain or loss on the sale of the partnership interest. However, on the admission of a new partner no such adjustment is necessary.

Section 706(c)(2)(B), which we have found applicable, specifically provides that the partnership year shall not close on the date when a new partner is admitted. In the face of this statutory authority and in the absence of any other section or regulation which would support the basis adjustment sought by petitioners, we find for respondent on this issue. Section 752(b) requires petitioners Richardson and Schneider to treat the amount of liability removed as a section 733 cash distribution on the date the new partners were admitted. Section 705(a)(2) 76 T.C. 512">*529 operates to reduce their adjusted bases in the partnerships by the amount of the section 733 cash distribution. Finally, for the purposes of determining the partners' section 704(d) limits, the partners' adjusted bases in the partnerships first must be reduced by any cash distributions under section 733 before taking into account their distributive share of partnership losses. See sec. 1.704-1(d)(2), Income Tax Regs.1981 U.S. Tax Ct. LEXIS 150">*183 Respondent's calculation comports with these provisions in all respects. It is for these reasons that we sustain respondent on this issue.

The next issue for our determination is whether petitioner Richardson is entitled to reduce his gain realized under section 731 upon the admission of new partners in an amount equal to his proportionate share of partnership liabilities that were not assumed by the new partners. Respondent submits that the record has failed to "clearly establish the specifics of the alleged additional liabilities or whether such liabilities have already been accounted for in the basis computation stipulated by the parties." We disagree with respondent.

Richardson and Dyer testified that the following indebtedness of each partnership was not assumed by the new partners upon entry into the partnerships but remained the sole and personal responsibility of the old partners:

76 T.C. 512">*530 We 1981 U.S. Tax Ct. LEXIS 150">*184 find this testimony credible and convincing. We find that petitioners have established that these liabilities existed in the amounts stated above at the time the new partners entered the partnerships and became the sole and personal obligations of the old partners. We therefore hold that, to the extent such liabilities are allocable to Richardson, his section 752(b) deemed distribution determined by respondent will be reduced as will his concomitant section 731 gain.

We next must decide whether certain payments made by each partnership to Richardson on December 31, 1974, for management and consulting services and noncompetition fees were income in 1974. Initially, we must determine whether it was proper for respondent to raise this issue in a motion at trial. The payments in question were made partly in cash and partly by the execution of promissory notes by each partnership as follows:

1981 U.S. Tax Ct. LEXIS 150">*185 Richardson did not include these fees in income in his 1974 Federal income tax return. The notice of deficiency addressed to Richardson did not propose any adjustment to his 1974 return with respect to the unreported receipt of these payments. At trial, we granted respondent's motion, over Richardson's objection, to amend his answer to claim an increased deficiency in income tax for 1974 for the unreported income represented by the checks received from the partnerships. On brief, respondent claimed that the unreported income included fees received in the form of checks and promissory notes. Richardson argued that respondent was barred by statute from claiming the increased deficiency and that the issue is not otherwise properly before the Court.

Section 6212(c) restricts respondent's right to determine an additional deficiency when a timely petition has been filed with the Tax Court. However, section 6214(a) provides this Court 76 T.C. 512">*531 with the "jurisdiction to redetermine the correct amount of the deficiency even if the amount so redetermined is greater than the amount of the deficiency, notice of which has been mailed to the taxpayer." Under Rule 41, Tax Court Rules of Practice and Procedure, 1981 U.S. Tax Ct. LEXIS 150">*186 this Court may permit amendment of the pleadings "when justice so requires" or "to conform to the proof." In exercising our broad discretionary powers pursuant to Rule 41, we find that justice requires amendment of the pleadings herein. We can find no substantial prejudice to Richardson that results from the granting of this motion. See Estate of Horvath v. Commissioner, 59 T.C. 551">59 T.C. 551 (1973), and cases cited therein.

Richardson argues that section 6212(c) bars respondent from amending his answer because such amendment is tantamount to the sending of a second statutory notice. We disagree. Richarson relies on Hickman v. Commissioner, 24 B.T.A. 438">24 B.T.A. 438 (1931), and McCue v. Commissioner, 1 T.C. 986">1 T.C. 986 (1943). His reliance is misplaced, however, because both of those cases involved the actual issuance of a second statutory notice. In the instant case, the amendment is not a second statutory notice. We have granted respondent's motion to amend his answer pursuant to our authority under section 7453 and Rule 41, Tax Court Rules of Practice and Procedure, and, therefore, this issue was properly raised before this Court.

Under the circumstances, because respondent has asserted an increased deficiency 1981 U.S. Tax Ct. LEXIS 150">*187 at trial, the burden of proof rests in his corner. Rule 142(a), Tax Court Rules of Practice and Procedure. It is uncontroverted that petitioner Richardson received the subject checks from the partnerships during 1974. Therefore, petitioner Richardson has clearly acceded to wealth and must report the amount of the checks as income in the year received. Sec. 61. See also Commissioner v. Glenshaw Glass Co., 348 U.S. 426">348 U.S. 426, 348 U.S. 426">431 (1955).

However, respondent further asserts that the face amounts of the promissory notes received by Richardson, a cash basis taxpayer, in 1974 from the partnerships also should have been included in income in that year. As we pointed out in Ennis v. Commissioner, 17 T.C. 465">17 T.C. 465, 17 T.C. 465">470 (1951), only "cash or its equivalent" constitutes income to a cash basis taxpayer. We further stated that "In determining what obligations are the 'equivalent of cash' the requirement has always been that the obligation, like money, be freely and easily negotiable." 17 T.C. 465">17 T.C. 470. 76 T.C. 512">*532 Respondent has not offered evidence concerning the negotiability or transferability of the subject promissory notes. Respondent has failed to meet his burden of proof. We therefore hold that the face 1981 U.S. Tax Ct. LEXIS 150">*188 amount of such promissory notes are not includable in Richardson's income in 1974.

Petitioner Richardson has asked the Court for attorney's fees under the Civil Rights Attorney's Fees Awards Act of 1976, 42 U.S.C. sec. 1988. In Key Buick Co. v. Commissioner, 68 T.C. 178">68 T.C. 178, 68 T.C. 178">184 (1977), affd. 613 F.2d 1306">613 F.2d 1306 (5th Cir. 1980), we held that this Court has no authority to award attorney's fees. On appeal, the Fifth Circuit, where an appeal lies in the instant case, stated:

We are not in accord, however, with the conclusion of the Tax Court that it may never award attorney's fees under any circumstances because it is not empowered to assess costs in actions before it. In any instance in which a taxpayer is cast in a defendant's role before it, sec. 1988 empowers the Tax Court to award attorney's fees and assess same as costs. [613 F.2d 1306">613 F.2d at 1309.]

In order for Richardson to receive attorney's fees, we must find that (1) Richardson was "cast in a defendant's role," and (2) respondent acted in an unreasonable, harassing, or frivolous manner in asserting the aforementioned additional deficiency. See Jones v. United States, 613 F.2d 1311">613 F.2d 1311, 613 F.2d 1311">1313 (5th Cir. 1980). We have, in the main, sustained respondent's 1981 U.S. Tax Ct. LEXIS 150">*189 position with respect to the additional deficiency. Respondent's conduct was not unreasonable, harassing, or frivolous. To the contrary, he acted properly in fulfilling his duties as a Government official and public servant. Therefore, petitioner Richardson's request for attorney's fees is denied.

To reflect the foregoing,

Decisions will be entered under Rule 155.