1983 U.S. Tax Ct. LEXIS 87">*87
Petitioner-husband, in 1968, was unable to take his distributive share of ordinary losses sustained by a partnership in 1967 and 1968 under
80 T.C. 825">*825 OPINION
The Commissioner determined a deficiency in petitioners' Federal income tax for the taxable year 1969 in the amount of $ 65,351 together with an addition to tax for the same year under section 6653(a) in the amount of $ 3,268. Respondent has conceded the addition to tax and one of the adjustments contained in the statutory notice of deficiency.
The issue for decision is whether
This case was submitted fully stipulated; the stipulation of facts and exhibits are incorporated herein by this reference.
The petitioners, William and Sandra Sennett, timely filed a joint Federal income tax return for the taxable year 1969. The petitioners resided in California at the time of the filing of their petition in this case. References to petitioner in the 80 T.C. 825">*826 1983 U.S. Tax Ct. LEXIS 87">*90 singular will refer to William Sennett as we are concerned with the tax consequences of his partnership activities.
Professional Properties Partnership (PPP) was formed as a general partnership under the laws of the State of California. The original partnership agreement was executed on August 1, 1967, by the Maryelle Corp. and three individual partners, none of whom was petitioner. This partnership agreement was amended by an instrument executed in December of 1967. Under this amended partnership agreement, there were to be 17 partners whose interests in the partnership varied according to their contributions to the partnership. This instrument was executed by the Maryelle Corp., which was designated as the managing partner, and by the attorneys for the various partners who are represented in the instrument to have the authority to act for the partners. Petitioner became a partner of PPP under the terms of the amended partnership agreement, owning a 33.50-percent interest in exchange for a capital contribution of $ 135,000.
The business activities of PPP are set forth in
PPP filed a U.S. Partnership 1983 U.S. Tax Ct. LEXIS 87">*91 Return of Income (Form 1065) for the taxable year 1967 in which it reported an ordinary loss of $ 405,329. Petitioner's distributive share of this partnership loss was $ 135,785. Petitioner reported his allowable distributive share of the net loss of PPP for 1967 as $ 135,000.
Article III of the original PPP partnership agreement provided that "An individual capital account shall be maintained for each partner," that "The capital of the partnership shall consist of the obligation of the partnership actually paid by each partner," and that "The capital contribution of each partner shall consist of the capital invested by each partner as shown by the balance sheet rendered each year." At the beginning of 1968, the capital account of petitioner in PPP had a negative balance of $ 785. Petitioner made no capital contributions to PPP in 1968.
On November 26, 1968, petitioner and PPP executed an agreement for the sale of partnership interest. Under the terms of this agreement, petitioner sold to PPP his interest in PPP, effective December 1, 1968. This agreement further provided that:
2. PPP will purchase the interest of SENNETT in said Partnership for the sum of $ 250,000.00 payable1983 U.S. Tax Ct. LEXIS 87">*92 $ 25,000.00 each and every calendar year 80 T.C. 825">*827 commencing with 1969 with interest on the unpaid balance at 4%, with no interest for the first six months from and after January 1, 1969. The annual payment shall be $ 25,000.00 plus interest.
3. SENNETT agrees to pay to PPP in one lump sum the total share of loss allocated to the interest in PPP which SENNETT is hereby relinquishing and transferring to PPP. SENNETT shall be given up to and including one year from date to make such payment and should SENNETT fail to make such payment, the unpaid balance shall bear interest at the rate of 10% and carry attorney's fees and costs.
PPP, on its 1968 return, reported a negative capital account of $ 109,061 corresponding to that portion of partnership interest purchased from petitioner and retained by the partnership. This represented 80 percent of petitioner's interest in PPP. The remaining 20 percent was sold by PPP to a third party.
On May 15, 1969, petitioner and PPP executed an amended agreement for the sale of partnership interest. This amended sales agreement reduced the amount that PPP would pay petitioner for his partnership interest to $ 240,000 which would be without interest1983 U.S. Tax Ct. LEXIS 87">*93 if paid in full before December 31, 1969, and payable with 7-percent interest if one-half of the purchase price were paid in 1969 and the remaining balance paid in 1970. On this same date, PPP also executed a promissory note to petitioner in the amount of $ 240,000.
Petitioner signed the May 15, 1969, promissory note indicating that the note was satisfied in full. Petitioner, in 1969, paid PPP $ 109,061, which was equal to 80 percent of his share of PPP's accumulated ordinary losses.
On their 1969 Federal income tax return, petitioners reported $ 240,000 as long-term capital gain from the disposition of the installment obligation from PPP. On this same return, petitioners reported $ 109,061 as petitioner's distributive share of PPP's ordinary loss.
The Commissioner's notice of deficiency, mailed on June 7, 1972, disallowed in full petitioner's claimed deduction for the 1968 distributive share of PPP's 1967 and 1968 ordinary losses. In that notice of deficiency, the Commissioner set forth the following reasons for the disallowance:
(1) It has not been established that the partnership, in fact, sustained a loss in 1969
80 T.C. 825">*828 (2) It has not been established that any loss, if 1983 U.S. Tax Ct. LEXIS 87">*94 substantiated, should be recognized as bona fide for tax purposes.
These determinations relate to the validity of the underlying losses upon which petitioner's distributive share is based. In
The issue before us involves the operation of
(d) Limitation on Allowance of Losses. -- A partner's distributive share of partnership loss (including capital loss) shall be allowed only to the extent of the adjusted basis of such partner's interest in the partnership at the end of the partnership year in which such loss occurred.
1983 U.S. Tax Ct. LEXIS 87">*96 80 T.C. 825">*829 This final version of
(d) Limitation on Allowance of Losses. -- A partner's distributive share of partnership loss (including capital loss) shall be allowed only -- (1) to the extent of the basis of such partner's interest in the partnership, or (2) to the extent such partner is obligated to repay such loss as provided in section 737. [H. Rept. 1337, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess. 179 (1954), [bills].]
Subsection (d) of the House bill provides a limitation on the amount of partnership loss, ordinary or capital, allowable to a partner. A partner's distributive share of such loss will be allowed only to the extent of the basis of his interest in the partnership at the end of the partnership taxable year in which the loss occurred. Under the House bill, the entire loss is to be recognized immediately, and the amount thereof in excess of the basis1983 U.S. Tax Ct. LEXIS 87">*97 of the partner's interest was treated as a loan from the partnership to the partner. To the extent that the partner's obligation is canceled by the partnership, section 737 of the House bill provides that the partner will be treated as having received a distribution in money from the partnership.
Your committee has revised subsection (d) of the House bill to provide that
Subsection (d), as amended, may be illustrated as follows. Assume that a partner has a basis of $ 50 for his interest, and his distributive share of partnership loss is $ 100. Under this subsection, the partner's distributive share of the loss would be limited to $ 50, thereby decreasing the basis of his interest to zero. The remaining $ 50 loss would not be recognized, unless the partner makes a further contribution of $ 50. If, however, the partner repays the $ 50 loss to the partnership out of his share of partnership income for the following year, then the additional $ 50 loss will be recognized1983 U.S. Tax Ct. LEXIS 87">*98 at the end of the year in which such repayment is made.
[S. Rept. 1622, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess. 383 (1954). Emphasis added.]
(d)
1983 U.S. Tax Ct. LEXIS 87">*99 Respondent's argument is based upon the language of
Petitioners argue for allowance of the deduction under broad concepts of partnership taxation. They first discuss the personal nature of a partner's share of losses of the partnership. They point out that the partnership is merely a conduit of the partner's interest in the losses sustained by the partnership. Finally, they argue that the partner's distributive share of losses is suspended at the partner1983 U.S. Tax Ct. LEXIS 87">*100 level.
The portion of
SEC. 706. TAXABLE YEARS OF PARTNER AND PARTNERSHIP.
(c) Closing of Partnership Year. -- * * * * (2) Partner who retires or sells interest in partnership. -- (A) Disposition of entire interest. -- The taxable year of a partnership shall close -- 80 T.C. 825">*831 (i) with respect to a partner who sells or exchanges his entire interest in a partnership, * * *
Applying section 706(c)(2)(A)(i) to the facts in the instant case, the taxable year of PPP with respect to petitioner closed in December 1968, when he sold his entire interest in PPP. That being the case, petitioner paid 80 percent of his share of PPP's losses for 1967 and 1968 to PPP after the close of his last partnership year with PPP which fails to come within the provisions of
Even if section 706(c)(2)(A)(i) were not in the Internal Revenue Code, we would construe the quoted language of
Such a result is also consistent with our recent holding which follows1983 U.S. Tax Ct. LEXIS 87">*102 other decisions cited therein whereby we held that losses of a partnership cannot be allocated to partners who entered the partnership after the losses were sustained. 4
Respondent's position is also supported by the fact that
Petitioners argue that Mr. Sennett had a continuing obligation to pay PPP for his share of the 1967 and 1968 losses after selling his interest in PPP. We recognize that he undertook such an obligation in the agreement for the sale of his PPP partnership interest to PPP, but it is far from clear that he was otherwise obligated by virtue of the terms of the partnership agreement. Petitioner was not a partner in PPP when it was formed in August 1967. That original partnership agreement recited the parties' intent to conduct business as a general partnership. The amended partnership agreement dated in December 1967, in which petitioner first acquired his partnership interest in PPP, recited an express understanding that the partners had no liability in excess of their contributions. Moreover, petitioner did not even comply with the terms of the agreement of sale in paying PPP. The agreement provided1983 U.S. Tax Ct. LEXIS 87">*104 that he pay the total share of the loss allocated to the interest he was selling to PPP. Instead, he paid only 80 percent of that loss, leaving unpaid the 20 percent of his interest in the loss which PPP in the meantime sold to another party. Based upon the record before us depicting conflicting recitals of petitioner's liability, coupled with payment contrary to the agreement of sale and satisfaction of the agreement of sale without explanation of the discrepancy, we can draw no conclusion as to the source of petitioner's liability to pay PPP for his share of the losses. Even if we concluded that such liability continued beyond the sale of his partnership interest independently of the agreement of sale, it would not alter our construction of
80 T.C. 825">*833 Petitioners' focus upon the obligation to pay PPP for the losses is similar to the approach of the House version of
1983 U.S. Tax Ct. LEXIS 87">*105 We agree with respondent that petitioners may not, in 1969, deduct Mr. Sennett's share of the losses sustained by PPP in 1967 and 1968 equal to his payment to PPP of $ 109,061 in 1969 and that petitioners may, instead, as conceded by respondent, offset $ 109,061 against the proceeds received by them in 1969 from the disposition of the installment obligation of PPP.
1. All section references are the the Internal Revenue Code of 1954 as amended.↩
2. This is
3. Compare
4.
5. But cf.
