T.C. Memo. 1996-283
UNITED STATES TAX COURT
PARKER PROPERTIES JOINT VENTURE, PDW&A, INC., A PARTNER
OTHER THAN THE TAX MATTERS PARTNER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
TWENTY MILE JOINT VENTURE, PND, LTD., TAX MATTERS
PARTNER, Petitioner v. COMMISSIONER OF
INTERNAL REVENUE, Respondent
Docket Nos. 18386-92, 18387-92.1 Filed June 19, 1996.
Theodore Z. Gelt and Ellen O'Brien Kauffmann, for
petitioners.
Theodore Z. Gelt, for the intervenor, Nicholson Enterprises,
Inc., the tax matters partner, in docket No. 18386-92 only.
Frederick J. Lockhart, Jr., for respondent.
1
These cases were consolidated for purposes of trial,
briefing, and opinion.
- 2 -
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: Respondent, for the taxable year ended
June 28, 1988, mailed separate notices of final partnership
administrative adjustment to the tax matters partners of Parker
Properties Joint Venture (Parker Properties) and Twenty Mile
Joint Venture (Twenty Mile). In these notices, respondent
increased Parker Properties' and Twenty Mile's incomes by
unreported cancellation of indebtedness income of $3,419,963 and
$1,395,492, respectively.
The issues remaining for our consideration are: (1) Whether
the partnerships realized income from cancellation of
indebtedness; and, if so, (2) the amount of such income.
All section references are to the Internal Revenue Code in
effect for the year in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
FINDINGS OF FACT2
Background
At the time the petitions were filed, Parker Properties’ and
Twenty Mile’s principal places of business were in Parker,
Colorado.3
2
The stipulations of fact and the exhibits are incorporated
by this reference.
3
The petition of Philip D. Winn & Associates, Inc. (PDW&A),
(continued...)
- 3 -
These cases concern real estate investments of R. James
Nicholson (Mr. Nicholson), Philip D. Winn (Mr. Winn), and David
A. Gitlitz (Mr. Gitlitz), and several related entities, during
the late 1980's. Empire Savings, Building & Loan Association
(Empire), a Colorado savings and loan association, participated
directly as the lender of funds to purchase the realty and
indirectly through its wholly owned subsidiary, E.S.L. Corp.
(ESL), as an investor in the investing entities.4
Parker Properties and Twenty Mile are partnerships formed,
at Empire’s suggestion, for the purposes of acquiring,
developing, and selling the real estate under consideration.
Both entities were accrual method taxpayers during the relevant
years.
3
(...continued)
a notice partner of Parker Properties Joint Venture (Parker
Properties) for the year at issue, was filed in docket No. 18386-
92. Sec. 6226(b)(1). The tax matters partner of Parker
Properties, Nicholson Enterprises, Inc. (Nicholson Enterprises),
did not cause a petition for readjustment of partnership items to
be filed within the period specified by sec. 6226(a). However,
Nicholson Enterprises timely elected to intervene in docket No.
18386-92 in accordance with sec. 6226(b) and Rule 245(a). PND,
Ltd. (PND), is both the notice partner and tax matters partner of
Twenty Mile Joint Venture (Twenty Mile) for the year at issue,
and its petition was filed in docket No. 18387-92.
4
Empire's equity investment was made based on the
understanding that it was permitted by thrift industry
regulations. It was also understood that industry regulations
required that this type of investment be made through a
subsidiary.
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Parker Properties
Parker Properties was formed in August 1983 by Nicholson
Enterprises, Inc. (Nicholson Enterprises), Philip D. Winn &
Associates, Inc. (PDW&A), and ESL. Nicholson Enterprises and
PDW&A each received a 25-percent interest in Parker Properties,
and ESL received a 50-percent interest. Parker Properties’
initial capital contributions were as follows: PDW&A, $500;
Nicholson Enterprises, $500; and ESL, $1,000. There were few, if
any, additional capital contributions made by the partners over
the life of Parker Properties.
Parker Properties obtained financing from Empire for the
acquisition of real estate from Bankers Trust (the Bankers Trust
property). Empire lent $10 million to Parker Properties to
acquire the Bankers Trust property and an additional $2 million
for property improvement and operating expenses. The loan was
evidenced by a $12 million promissory note dated August 30, 1983,
payable to Empire. This note was signed by officers of the joint
venturers ESL, Nicholson Enterprises, and PDW&A; and by Messrs.
Gitlitz, Nicholson, and Winn, individually. The $12 million note
was secured by the Bankers Trust property without recourse to
Parker Properties but with recourse to Mr. Nicholson as to 12.5
percent of the loan balance, and Messrs. Winn and Gitlitz each as
to 6.25 percent of the loan balance. Parker Properties claimed
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interest expense deductions on the debt to Empire and
Commercial.5
Twenty Mile
During 1985, after success in the development of the Bankers
Trust property, the Parker Properties investors acquired another
parcel (the Clarke property) in or near the town of Parker. The
investors used Twenty Mile as the joint venture partnership for
acquisition of the Clarke property. The joint venture agreement
was completed on April 16, 1985, by and between PND and ESL, each
receiving a 50-percent interest in Twenty Mile. PDW&A and
Nicholson Enterprises were the general partners of PND.6 The
initial capital contributions from the Twenty Mile partners were
as follows: PND, $1,000; ESL, $1,000. Similar to the situation
with Parker Properties, there were few, if any, additional
5
In addition to the loans from Empire, funding was obtained
through the issuance of tax free metropolitan district bonds.
Metropolitan districts are quasi-municipal entities that can
issue tax free debt. Such districts have been utilized to
provide utility enhancements in the absence of a true
municipality or in the presence of a municipality incapable of
issuing debt.
Parker Properties also assumed an obligation of Bankers
Trust to purchase water and sewer taps as secured by a letter of
credit issued by Empire. The obligation was subject to annual
tax liability to support the retirement of bonds for improving
and widening certain streets in the town of Parker.
6
Twenty Mile also had two additional limited partners, each
with small interests: The seller of the Clarke property and a
real estate broker.
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capital contributions made by the partners over the life of
Twenty Mile.
Empire lent Twenty Mile $3,500,000 (with a maximum limit of
$6 million) for acquisition and development of the Clarke
property. The loan was evidenced by a $6 million promissory note
dated April 16, 1985, from Twenty Mile to Empire, and signed by
an officer of ESL and by officers of Nicholson Enterprises and
PDW&A as the general partners of PND, and Messrs. Gitlitz,
Nicholson, and Winn, individually. The debt was secured by the
Clarke property, without recourse to Twenty Mile, but with
recourse to the three individuals in the same percentages used
for Parker Properties.
Parker 480 Joint Venture
A third parcel was acquired by Parker 480 Joint Venture
(Parker 480) (which is not a party in this case). The Parker 480
agreement was entered into on June 26, 1985, by and between A. &
P.D.W. Limited Partnership (APDW), consisting of the PDW&A
partners; and N-4 Associates (N-4), which included Mr. Nicholson
and his family.
Parker 480 partners contributed capital, as follows: APDW,
$500; N-4, $500. Empire was the lender with an "equity incentive
participation" or "equity kicker".7
7
The "equity kicker" is defined in the $3,500,000 note as
50 percent of the equity in the property secured by the deed of
(continued...)
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The $3,500,000 Empire lent to Parker, was evidenced by a
June 26, 1985, promissory note, which was subscribed to by Parker
480 and Messrs. Gitlitz, Nicholson, and Winn, individually. The
note was nonrecourse as to Parker 480, and recourse as to the
individuals in Parker Properties and Twenty Mile.
The Agreement in Controversy
On April 30, 1987, Commercial Federal Savings & Loan
Association (Commercial) acquired Empire and ESL from its holding
company, Baldwin United Corp., which was then in a chapter 11
bankruptcy proceeding. Accordingly, Commercial was the successor
in interest to Empire’s loans and involvement in the subject
partnerships. Due to a declining real estate market, Commercial
did not want to be associated with the joint ventures through ESL
or extend any additional credit to the real estate venturers. It
was Commercial’s wish to dispose of the debt and equity interests
it had in the joint ventures.
Commercial met with Parker Properties and Twenty Mile
partners during the summer of 1987. At that meeting, Commercial
expressed its desire to liquidate its positions as a creditor
and, through ESL, an investor in Parker Properties and Twenty
Mile. It was Commercial’s desire for the partners of Parker
7
(...continued)
trust. "Equity" is described in the same instrument as the net
sales proceeds on any portion of the property sold and the deemed
net sales proceeds of the remaining property with the deemed
sales price determined by an agreed-to appraisal process.
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Properties and Twenty Mile to obtain new funding to liquidate
Commercial’s and its subsidiaries’ (Empire and ESL) positions in
the joint ventures for as much cash as possible. However,
Commercial realized that the collateral real property had
declined in value. Consequently, Commercial was willing to
accept less than the outstanding balances of the loans in order
to liquidate its interests in the ventures.
Acceding to Commercial’s wishes, in late 1987, the investing
partners negotiated with Sun Savings & Loan Association (Sun
Savings) for financing to liquidate Commercial’s interests.
Although Sun Savings was willing to finance the liquidation of
Commercial's interest in the partnerships, the investing partners
were not willing to pay the minimum amount of cash that
Commercial would accept. To adjust for the shortfall, Commercial
suggested that certain of its Denver area apartment mortgages
(apartment mortgages) be purchased in connection with the
transaction. These negotiations, however, did not result in an
agreement.
In March 1988, representatives of the investing partners
entered into negotiations with Capitol Federal Savings & Loan
Association (Capitol Federal) to arrange for financing to
liquidate Commercial's joint ventures interests. In a letter
dated April 19, 1988, Commercial made a proposal to Mr. Winn that
Commercial liquidate its creditor’s position through Empire and
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its investor position through ESL. Commercial’s proposal offered
that: (1) Commercial would sell all of its interests in Parker
Properties and Twenty Mile for $7 million; (2) Commercial would
release Messrs. Gitlitz, Nicholson, and Winn from individual
liability on the Parker 480 loan; (3) Commercial would sell the
apartment mortgages for $12.5 million; (4) Commercial and ESL
would be released from all liabilities as a partner, on
outstanding letters of credit, and on any other contracts and
obligations; and (5) the transaction would be completed no later
than May 15, 1988.
On April 21, 1988, representatives of Commercial, ESL, and
Capitol Federal met with the investing partners and their
attorney to discuss the plans to liquidate Commercial's
interests. One possibility was to replace the Commercial loans
with those of another lender. Another possibility was to include
the Parker 480 property in the transaction, perhaps with an
increased purchase price. Capitol Federal would assume the $2
million sewer tap letter of credit, and the investing partners
would indemnify Commercial from any known liabilities. The sale
of the $12.5 million apartment mortgage notes was also suggested
as a possible condition.
On June 20, 1988, Commercial’s attorney faxed a rough draft
of the agreement to the investing partners’ attorney. This draft
included the following typed language:
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WHEREAS, [ESL] is willing to sell its joint venture
interest in Parker Properties and Twenty Mile for the
sum of $10,000.00 and Commercial is willing to accept
the sum of $10,990,000.00 in full settlement and
satisfaction of its above-described loan balances, all
subject to fulfillment of the terms of this Agreement,
and Parker Properties is desirous of purchasing such
joint venture interests and paying the outstanding
balances of the loans to Commercial as adjusted.
The draft agreement also provided that Parker Properties would
pay ESL $10,000 for its interest in Parker Properties and Twenty
Mile. In addition, Parker Properties was to pay Commercial
$7,990,000 cash and deliver a $3 million promissory note.
Handwritten just above the terms of the agreement appeared the
following: "WHEREAS Prior closing Commercial will contribute
capital to and reduce indebtedness - ESL wholly owned subs".
On June 22, 1988, the investing partners' attorney faxed
Commercial and its attorney a followup letter outlining the
transaction and referring to "what the borrower would like the
transaction to look like." The letter contained the following
chart which detailed "how the transaction would result":
Convert to
Debt Equity Forgive To be Paid Note
Parker Properties $9,319,963 $3,419,963 --- $2,900,000 $3,000,000
Twenty Mile 3,395,492 1,395,492 --- 2,000,000 ---
Parker 480 3,256,910 --- $156,910 3,100,000 ---
Total 15,972,365 4,815,455 156,910 8,000,000 3,000,000
On June 28, 1988, Commercial’s accountant was asked to
provide his comments "from a tax standpoint." Based on his
understanding of the proposed agreement, the accountant opined
that:
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It is fairly obvious in the agreement that Commercial
is forgiving approximately $4.8 million of debt. The
equity interest received is worthless and Commercial
intends to charge off the portion of the debt so
exchanged. The charge off will be taken during the
year ending June 30, 1988, and will be listed along
with Commercial's other loans charged off.
Ultimately, on the same day, after the tax advice had been
sought and received on the proposed transaction, the terms of the
draft agreement were integrated into a virtually identical final
agreement (the Agreement). The Agreement was reached between
Messrs. Gitlitz, Nicholson, and Winn, individually, and PDW&A,
Nicholson Enterprises, Parker Properties, Twenty Mile, Parker
480, ESL, and Commercial. The Agreement provided that Commercial
was contributing approximately $4.8 million of additional capital
through debt reduction to Parker Properties and Twenty Mile on
behalf of ESL. However, the terms of the Agreement also provided
that ESL would then convey its interests in both Parker
Properties and Twenty Mile (which was to include the $4.8 million
capital contribution by Commercial) to Nicholson Enterprises and
PDW&A for $5,000 each. Parker Properties, Twenty Mile, Parker
480, and their respective partners agreed to indemnify Commercial
and ESL from any claims made against them. The transaction was
to close on or before June 28, 1988.
Regarding the apartment mortgages, a separate agreement was
entered into between Commercial and Riverbank Acquisition
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Associates (Riverbank)8 on June 16, 1988. Riverbank agreed to
purchase the apartment mortgages for $12,100,000, which the
parties agree was $650,000 in excess of their fair market value.
Approximately 7 months after the closing of the Agreement,
Commercial sent Parker Properties and Twenty Mile each a form
entitled, "Acquisition or Abandonment of Secured Property" (Form
1099-A), reflecting income from the cancellation of indebtedness
in the amounts of $3,419,963 and $1,395,492, respectively.
Parker Properties and Twenty Mile each reported these amounts as
other income. However, the joint ventures then reported an
offsetting "other deduction" on their respective tax returns with
the following disclosure: "The partnership received a 1099 * * *
described as income from forgiveness of indebtedness. This was
not reported as income since it resulted from a contribution to
capital rather than from debt relief." Commercial, however,
claimed the above-mentioned amounts as an ordinary loss from the
cancellation of indebtedness. As a result, Commercial entered
into an agreement with the investors which provided that the
investors would hold Commercial harmless from any claims that may
arise from its issuing the Forms 1099-A.
8
Riverbank was at all relevant times a Colorado general
partnership of which Riverbank Denver, Inc., and Residual
Acquisition Corp. were general partners. Residual Acquisition
Corp. was 100 percent owned by David A. Gitlitz.
- 13 -
On or near May 15, 1990, Commercial filed a Form 1120X,
"Amended U.S. Corporation Income Tax Return", for the taxable
year ended June 30, 1988, in order to exclude some previously
taxed dividends. When respondent examined the claim reported in
the amended return, Commercial agreed to include ESL's share of
cancellation of indebtedness income attributable to its interests
in the joint ventures which had not been included in ESL’s tax
returns. Finally, Commercial agreed to an ordinary income
adjustment to restore ESL's negative capital accounts in the
joint venture partnerships to zero, and Commercial was allowed
capital loss treatment for the sale of the interests.
ULTIMATE FINDINGS OF FACT
Parker Properties’ and Twenty Mile’s agreement with
Commercial resulted in cancellation of indebtedness income.
OPINION
The partnerships obtained financing from Empire.
Subsequently, Empire’s successor in interest, Commercial, decided
to disassociate itself from the partnerships. Commercial and the
partners, after negotiations, reached an agreement. Respondent
and petitioners disagree as to the effect of the agreement on the
partners’ Federal income tax.
Respondent determined that Parker Properties and Twenty Mile
received $3,419,963 and $1,395,492 in income in 1988 from the
cancellation of indebtedness, respectively. Petitioners argue
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that the restructuring that they attempted was in form and
substance a contribution to capital to each partnership. We must
decide whether petitioners realized income from the cancellation
of indebtedness. If there was a cancellation of indebtedness
resulting in income to petitioners, we must decide the amount
recognizable. Petitioners have the burden of showing that
respondent’s determination is in error and/or that the amounts in
controversy were capital contributions. Rule 142(a).
Petitioners assert that the conversion of the loan into a
partnership capital interest is a nonrecognition event under
section 721. Section 721 provides: "No gain or loss shall be
recognized to a partnership or to any of its partners in the case
of a contribution of property to the partnership in exchange for
an interest in the partnership." We must decide if the substance
of these transactions was the same as the form in which the
partnerships attempted to cast it. Section 1.721-1, Income Tax
Regs., provides in relevant part: "In all cases, the substance
of the transaction will govern, rather than its form." See
Colonnade Condominium, Inc. v. Commissioner, 91 T.C. 793, 813
(1988).
Section 61(a)(12) provides that gross income includes
"Income from discharge of indebtedness". The parties agree that,
before the execution of the Agreement, the items in question were
debts of Parker Properties and Twenty Mile owed to Empire and,
- 15 -
later, Commercial. Petitioners, nonetheless, have attempted to
structure the extinguishment of their debt as capital
contributions. Thus, petitioners believe that the form should be
respected for Federal tax purposes.
Taxpayers may attempt to structure their transactions in
such a way as to lessen their tax burden. Gregory v. Helvering,
293 U.S. 465 (1935). Partners may attempt to structure the
substance of their transactions by choosing the form of the
transactions. Otey v. Commissioner, 70 T.C. 312 (1978), affd.
per curiam 634 F.2d 1046 (6th Cir. 1980). Ordinarily, "taxpayers
are * * * bound by the form of their transaction while the
Government can attack that form if it does not represent the
substance of the transaction." Newhall Unitrust v. Commissioner,
104 T.C. 236, 243 (1995). Petitioners contend that we should
respect the form they have chosen which is reflected in the
Agreement. "Whether a debt has been discharged is dependent on
the substance of the transactions. Mere formalisms arranged by
the parties are not binding in the application of the tax laws."
Cozzi v. Commissioner, 88 T.C. 435, 445 (1987) (citing
Commissioner v. Court Holding Co., 324 U.S. 331 (1945)).
Beginning in the summer of 1987, shortly after acquiring
Empire, Commercial desired to terminate both its investor and
debtor-creditor relationships in the joint ventures. Commercial
requested that the investing partners obtain funding to ensure
- 16 -
that Commercial would be removed from the joint ventures, while
receiving as much cash as possible. The agreement terms,
however, cast this as a contribution to capital by entities
seeking complete financial disassociation from the partnerships.
The April 19, 1988, letter prepared on behalf of Commercial
expressed the continuing desire to end its relationship with
Parker Properties and Twenty Mile, including its equity
involvement through ESL. On April 25, 1988, Commercial’s
attorney prepared a memorandum to the client’s file which
detailed the April 21 and 22, 1988, meetings. That memorandum
contains mention of Mr. Nicholson negotiating with Sun Savings
"for enough funds to take out Empire entirely."
Petitioners maintain that the Agreement provided for a
capital contribution in excess of $4.8 million. However, the
June 20, 1988, draft of the Agreement indicated that ESL was
willing to sell its interests in Parker Properties and Twenty
Mile for a mere $10,000. Petitioners counter that this is
because Commercial was ultimately relieved of exposure to over $8
million in liabilities, and, thus, there was a valid business
purpose.
We find, however, that any such liability relief was a
practical consequence of the plan. Commercial wanted out of the
joint ventures entirely; it was not seeking to cancel the debt in
order to become a new investor. Furthermore, ESL sold its
- 17 -
"interest" for a relatively nominal sum ($10,000) shortly after
the questioned transaction. The substance of this transaction
was separation from the joint ventures, and this was inconsistent
with a capital contribution. By issuing Forms 1099-A and
reporting income from the cancellation of indebtedness,
Commercial and ESL treated the arrangement as a cessation of
their interest and cancellation of indebtedness.
The June 20, 1988, draft agreement contains the statement
that the parties desired the cancellation of the partnerships’
indebtedness. It was not until 8 days later, i.e., after tax
advice was obtained and the final agreement prepared, that any
mention of a contribution to capital occurred. This is
illustrative of the plan--Commercial wanted out of its creditor
status; any purported capital contribution was a mere provision
that was not otherwise in sync with the plan. Petitioners did
not enter into the Agreement to increase or expand their capital
structure. Cf. Perlman v. Commissioner, 27 T.C. 755, 758 (1957),
affd. 252 F.2d 890 (2d Cir. 1958).
Commercial’s accountant, in his June 28, 1988, memorandum,
suggests the true nature of the transaction. Notwithstanding the
fact that tax advice was sought, Commercial’s accountant was
asked to review the draft agreement, the terms of which were
incorporated into the final agreement. Based on his independent
review, the accountant concluded that the draft agreement was
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simply a device through which nearly $4.8 million of debt would
be forgiven and that any equity interest received by ESL would be
worthless. Noting that Commercial intended to write off the
portion of debt that would be extinguished, the accountant found
that to be consistent with the treatment of other loans that were
charged-off for the year ended June 30, 1988.
Having found that the transaction resulted in cancellation
of indebtedness income, we must next decide the extent to which
petitioners must recognize income. Petitioners argue that, under
Fulton Gold Corp. v. Commissioner, 31 B.T.A. 519 (1934), there
were no accessions to their wealth because the debt cancellation
did not free assets as it would have if the nonrecourse debt had
been recourse. However, in Gershkowitz v. Commissioner, 88 T.C.
984, 1010 (1987), this Court held that a reduction in the amount
of an undersecured, nonrecourse debt by one who was not the
seller of any property securing the debt results in cancellation
of indebtedness income. See also Commissioner v. Tufts, 461 U.S.
300, 307 (1983) (nonrecourse mortgage tantamount to a true loan;
its forgiveness triggers cancellation of indebtedness income,
notwithstanding a lesser fair market value of the collateral than
the balance of the debt).
The partnerships’ transactions with Commercial arose from
debt workouts generated by a depressed real estate market.
Parker Properties and Twenty Mile borrowed funds from Empire on a
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nonrecourse basis as to the partnerships, secured by the real
estate which was the subject of each joint venture. In
Commissioner v. Tufts, supra, the collateral for the loan was not
retained by the borrowers upon debt cancellation. Petitioners
argue that, because they retained their collateral and settled
their debt with cash, their facts are distinguishable from Tufts,
and, thus, they should only recognize income to the extent of the
fair market value of the collateral. In Gershkowitz v.
Commissioner, supra, the taxpayers did retain collateral and pay
with cash. In Gershkowitz v. Commissioner, supra at 1014, the
taxpayers were required to recognize gain from the cancellation
of indebtedness to the extent that the balance of the debt
exceeded the cash paid on extinguishment.9
In line with Gershkowitz, we hold that the partnerships
realized income to the extent that their loan balances exceeded
the consideration paid to Commercial on extinguishment.10 This
9
Respondent’s analysis in Rev. Rul. 91-31, 1991-1 C.B. 19,
also reaches this result. In Rev. Rul. 91-31, respondent
concluded that Commissioner v. Tufts, 461 U.S. 300 (1983), and
Gershkowitz v. Commissioner, 88 T.C. 984 (1987), required
cancellation of indebtedness income to be recognized to the
extent of the principal reduction by the “nonselling” lender of
an under-secured, nonrecourse debt. Such is the case here. See
also Rev. Rul. 82-202, 1982-2 C.B. 36, wherein respondent’s
analysis concludes that United States v. Kirby Lumber Co., 284
U.S. 1 (1931), requires a taxpayer, whose nonrecourse debt
balance was reduced by the lender, to recognize cancellation of
indebtedness income in an amount equal to the debt reduction.
10
The parties agree that unpaid interest incurred on the
(continued...)
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income must be recognized by the partners of Parker Properties
and Twenty Mile as a separately stated item under section
702(a)(7), subject to the limitations of section 108 at the
partner level. Sec. 108(a), (d)(6); see also Estate of Newman v.
Commissioner, 934 F.2d 426, 427 n.1 (2d Cir. 1991), revg. T.C.
Memo. 1990-230; Gershkowitz v. Commissioner, supra at 1009.
Finally, petitioners contend that, because Riverbank
purchased apartment mortgages for an amount $650,000 in excess of
their fair market value, any cancellation of indebtedness income
should be reduced by this amount. Although Commercial received
approximately $650,000 more than it would have, we must consider
whether that excess inures to petitioners’ benefit for purposes
of determining taxable income.
Petitioners seek a reduction of recognizable income for the
excess payment. The payments, however, were not made on behalf
of partnerships for which respondent made determinations.
Accordingly, the $650,000 excess payment does not result in a
special allocation. See, e.g., Klein v. Commissioner, 25 T.C.
1045 (1956). Nor is this an instance where a partner is selling
or contributing property to the partnership. See, e.g., secs.
10
(...continued)
debt is included in the cancellation of indebtedness income
realized by the joint ventures to the extent that the obligation
to pay interest was forgiven.
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707(a), 721; Barenholtz v. Commissioner, 77 T.C. 85 (1981); Otey
v. Commissioner, 70 T.C. 312 (1978).
The partnerships paid $650,000 less than Commercial was
willing to accept. Therefore, Riverbank (not a party in these
cases) purchased nearly $11.5 million mortgages for just over 5
percent, or $650,000, above their fair market value. This
enabled the partnerships to achieve debt relief from Commercial
and also provided Riverbank with new mortgages. Parker
Properties and Twenty Mile did not pay the $650,000.
Both parties to the transaction had a business purpose for
its consummation; Commercial realized cash on the sale of the
mortgages, and Riverbank obtained assets. As part of the
purchase, Riverbank, not the partnerships, is entitled to account
for their acquisition. Furthermore, if the conditions warranted,
Riverbank (not the partnerships) might be entitled to any
potential bad debt deductions. See generally sec. 166. To hold
that the partnerships should reduce their cancellation of
indebtedness income by the $650,000 another entity paid would
ignore the realities underlying the separate mortgage purchase
agreement and the practical effects of Riverbank’s separate role
as the buyer. Accordingly, the partnerships are not entitled to
reduce their income by the $650,000 premium paid by Riverbank.
To reflect the foregoing,
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Decisions will be entered
under Rule 155.