Tax Court Holds Gain or Loss on Disposition of Partnership Interest Is an Affected Item. (Parker Tax Publishing June 19, 2014)

Gain or loss on the disposition of a bona fide partnership interest is an affected item that requires partner-level determinations if the amount of that gain or loss could be affected by a partner-level determination, even where Code Sec. 754 elections are in effect. Greenwald v. Comm'r, 142 T.C. No. 18 (5/21/14).

Israel Greenwald was a limited partner in Regency Plaza Associates of New Jersey (Regency Plaza), a partnership involved in property development. Regency Plaza was subject to the unified TEFRA partnership audit and litigation procedures. As a result of a transfer of a partnership interest, Regency Plaza attached a Code Sec. 754 election to its 1995 Form 1065, U.S. Return of Partnership Income. In 1996, Regency Plaza filed for bankruptcy and, just over a year later, the bankruptcy was finalized. The partnership owned property that was subject to a mortgage in favor of Beal Bank, which mortgage was security for a nonrecourse debt against property owned by Regency Plaza. The bankruptcy judgment allowed Beal Bank to foreclose its mortgage, and Regency Plaza liquidated in 1997.

The partnership items for the year of liquidation were determined in partnership-level proceedings. Following those proceedings, the IRS issued notices of deficiency to the partners determining the partners' gain on the liquidation of the partnership, which was based on their outside basis in the partnership. The partners argued that outside basis is a partnership item that should have been determined at the partnership level and that the notices of deficiency were invalid. The partners cited the Tax Court's decision in Tigers Eye Trading, LLC v. Comm'r, 138 T.C. 67 (2012), in which the court held that the determination of outside basis of a sham partnership interest was a partnership item and should have been raised and determined in the prior partnership-level proceeding. In the instant case, the IRS argued that the Tax Court has jurisdiction because outside basis is an affected item that requires partner-level determinations.

The Tax Court held that gain or loss on the disposition of a bona fide partnership interest is an affected item that requires partner-level determinations if the amount of that gain or loss could be affected by a partner-level determination. The Tax Court noted that this issue was addressed in U.S. v. Woods, 134 S. Ct. 557 (2013), concluding that, where a partnership is a sham, no partner-level determinations are necessary to determine outside basis because once partnerships are deemed not to exist for tax purposes, no partner can legitimately claim an outside basis greater than zero. This flows from the fact that there can be no basis in an asset that does not exist, such as nonexistent partnership interest. However, the Tax Court noted that, in the instant case, the partnership at issue was not a sham. Unlike the taxpayers in Woods, the court observed, the outside basis of the partners in this case is not linked to a sham transaction, but rather to specific partner-level facts.

According to the Tax Court, redetermining the amounts of deficiencies resulting from partnership-level adjustments required looking to the partners' specific facts. For example, the court said, if a partner incurred litigation costs in the defense of the ownership of the partnership interest, those costs would be added to the partner's outside basis, but they would not be taken into account as part of a Code Sec. 754 election or any other partnership-level determination. To make such a determination, the IRS is required to follow deficiency procedures. Under these facts, the court concluded, outside basis is an affected item requiring partner-level determinations, and the Tax Court has jurisdiction over these cases.

For a discussion of TEFRA audit procedures, see Parker Tax ¶28,505. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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