110 T.C. No. 17
UNITED STATES TAX COURT
ESTATE OF ROBERT W. QUICK, DECEASED, ESTHER P. QUICK,
PERSONAL REPRESENTATIVE, AND ESTHER P. QUICK, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8588-97. Filed March 16, 1998.
P was a limited partner in a partnership subject
to the unified audit and litigation provisions of the
Tax Equity and Fiscal Responsibility Act of 1982
(TEFRA), Pub. L. 97-248, sec. 402(a), 96 Stat. 324,
648. R issued notices of computational adjustment to
Ps, pursuant to which deficiencies for taxable years
1987 through 1990 were assessed. In the computational
adjustment notices for 1989 and 1990, R recharacterized
Ps' distributive share of partnership losses for those
years as passive for purposes of sec. 469, I.R.C. R
thereafter issued affected items notices of deficiency
to Ps for 1987 through 1990 in which additions to tax
and accuracy-related penalties were determined, based
on the computational adjustments. Secs. 6653(a)(1)(A)
and (B), 6659, 6661, 6662(a), I.R.C. Ps moved for
summary judgment, claiming that the period of
limitations for assessment for 1989 and 1990 has
expired such that Ps' share of partnership losses
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cannot be recharacterized as passive, and that Ps are
entitled to, among other things, refunds for
overpayments as well as net operating losses for those
years based on favorable adjustments at the partnership
level for 1989 and 1990. R objects to Ps' motion.
Both Ps and R moved to amend their respective pleadings
pursuant to Rule 41, Tax Court Rules of Practice and
Procedure.
1. Held: Ps' motion for leave to file amendment
to petition and R's motion for leave to file amendment
to answer are granted. Rule 41(a), Tax Court Rules of
Practice and Procedure.
2. Held, further, Ps' motion for summary judgment
denied; the statutory period of limitations does not
preclude R's recharacterization of Ps' distributive
share of partnership losses for 1989 and 1990 as
passive losses subject to the limitations set forth in
sec. 469, I.R.C. Secs. 6229(a) and (d),
6230(a)(2)(A)(i), I.R.C.
Kevin M. Bagley and Mitchell B. Dubick, for
petitioners.
Gretchen A. Kindel, for respondent.
OPINION
NIMS, Judge: This matter is before the Court on the
following three motions: (1) Petitioners' Motion for Leave to
File Amendment to Petition pursuant to Rule 41(a); (2)
respondent's Motion for Leave to File Amendment to Answer
pursuant to Rule 41(a); and (3) petitioners' Motion for Summary
Judgment filed pursuant to Rule 121.
Unless otherwise indicated, all section references are to
sections of the Internal Revenue Code in effect for the years at
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issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.
Respondent determined additions to, and penalties on, the
Federal income tax of petitioners for the taxable years 1987
through 1990 as follows:
Additions to Tax Penalties
Year Sec. 6653(a)(1)(A) Sec. 6653(a)(1)(B) Sec. 6659 Sec. 6661 Sec. 6662(a)
1987 $3,253 50 percent of the $6,284 $11,031
interest due on
$65,053
1988 727 1,824 2,114
1989 $8,423
1990 19,293
The issues for decision are:
1. Whether to grant the parties' respective motions to
amend their pleadings; and
2. Whether the statutory period of limitations bars
respondent from recharacterizing petitioners' distributive share
of partnership losses as passive losses subject to the
limitations set forth in section 469.
Petitioners resided in West Palm Beach, Florida, at the time
they filed their petition.
Background
The background facts related below are derived from the
pleadings, the exhibits attached thereto, and other materials in
the Court's records, including the uncontroverted written
representations of the parties. To the extent we draw inferences
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and conclusions of a factual nature, they are based upon
materials forming a part of the record.
During the years at issue, Robert W. Quick (Robert) was a
limited partner in Water Oaks, Ltd. (Partnership), a Florida
limited partnership. (Robert died on or about May 23, 1997,
shortly after the petition was filed. On July 11, 1997,
petitioners moved, pursuant to Rule 63, to substitute Esther P.
Quick as the personal representative for the Estate of Robert W.
Quick. Petitioners' Motion for Substitution of Party was granted
by Order of the Court dated July 15, 1997, and the caption was
amended accordingly.) At all relevant times, the Partnership was
a so-called TEFRA partnership whose tax treatment is determined
under the unified partnership audit and litigation provisions
(subchapter C of chapter 63) added by the Tax Equity and Fiscal
Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, sec. 402(a),
96 Stat. 648.
The Partnership owned and operated the Water Oak Estate
Mobile Home Park (Park) in Lady Lake, Florida. During the years
at issue, a portion of the lots located in the Park was leased to
mobile home owners, while the remaining lots were in the process
of development.
Petitioners reported their distributive share of losses from
the Partnership as passive losses on their joint Forms 1040, U.S.
Individual Income Tax Return, for 1987 and 1988. (The record
does not reflect the extent of such losses for those years.)
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Petitioners reported losses from the Partnership of $331,425 (32
percent of $1,035,702 total partnership loss) and $400,125 (32
percent of $1,250,391 total partnership loss) on their joint 1989
and 1990 returns, respectively, as nonpassive losses.
On September 8, 1994, respondent wrote a letter to
petitioners' representative admonishing petitioners to file
amended returns for 1989 and 1990 "to reflect the proper
treatment of the losses from * * * [the Partnership]" as passive,
or face the issuance of a notice of deficiency for those years.
The general 3-year period of limitations for making assessments
for 1989 and 1990, as extended by Form 872, Consent to Extend the
Time to Assess Tax, expired on June 30, 1995. No amended returns
were filed by, and respondent did not issue a deficiency notice
to, petitioners prior to that date.
On November 14, 1994, respondent issued a Notice of Final
Partnership Administrative Adjustment (FPAA) disallowing certain
deductions claimed by the Partnership for its taxable years 1987
through 1990. Blaine B. Quick, a partner other than the TMP,
petitioned this Court at docket No. 4745-95 on March 27, 1995.
On March 13, 1996, the Court entered a decision (Decision)
in docket No. 4745-95. The Decision sets forth adjustments to
certain partnership items which are favorable to respondent for
the years 1987 and 1988, and favorable to the Partnership for the
years 1989 and 1990. Specifically, the Decision adjusts losses
reported on line 21, Ordinary income (loss) from trade or
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business activities, of the Partnership's Forms 1065, U.S.
Partnership Return of Income, for 1987 through 1990 as follows:
Year Adjustment
1987 $1,070,445
1988 677,229
1989 (311,234)
1990 (290,088)
Under the Decision, petitioners' share of Partnership losses was
increased to 48 percent of the adjusted Partnership losses for
1989 and 1990, or $646,529 and $739,430, respectively.
Petitioners subsequently filed Forms 1040X, Amended U.S.
Individual Income Tax Return, for taxable years 1989 and 1990.
Applying the adjustments contained in the Decision to their
original returns, petitioners claimed overpayments in the amounts
of $71,602 and $12,889, and net operating losses of $68,270 and
$278,658, for 1989 and 1990, respectively. Petitioners also
filed amended returns for 1987 and 1988, claiming overpayments in
the amounts of $93,467 and $19,689, respectively, as a result of
net operating loss carrybacks from 1989 and 1990.
On February 19, 1997, respondent made computational
adjustments on Forms 4549-A, Income Tax Examination Changes, to
petitioners' taxable years 1987 through 1990. For 1987 and 1988,
the computational adjustments reflect the adjustments to
partnership items set forth in the Decision for those years, and
determine deficiencies in the amounts of $65,053 and $14,538,
respectively. For 1989 and 1990, respondent determined
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deficiencies in the amounts of $48,366 and $101,879,
respectively, which reflect respondent's position that all of the
Partnership's losses for those years (including the losses
reported prior to the entry of the Decision) should be
recharacterized as passive losses in petitioners' hands, subject
to the limitations of section 469. On March 17, 1997, respondent
assessed the deficiencies for 1987 through 1990 arising from the
foregoing computational adjustments.
On March 7, 1997, respondent issued to petitioners affected
items notices of deficiency for 1987 and 1988 determining
additions to tax only, based on the computational adjustments for
those years. On March 14, 1997, respondent issued to petitioners
penalties-only affected items deficiency notices for 1989 and
1990, based on the computational adjustments for those years.
Based on information subsequently received from petitioners'
counsel, respondent abated the assessments for 1989 and 1990 and,
with petitioners' consent, attempted to rescind the related
penalties-only March 14, 1997, notices pursuant to section
6212(d). However, upon learning of respondent's intention to
issue new affected items notices of deficiency for 1989 and 1990
determining both deficiencies and penalties, petitioners revoked
their consent to rescind the March 14, 1997, notices in a letter
to respondent dated April 24, 1997. On May 1, 1997, petitioners
filed the petition herein.
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On May 2, 1997, respondent issued additional affected items
deficiency notices to petitioners for 1989 and 1990, in which
deficiencies and accuracy-related penalties pursuant to section
6662(a) were determined. On August 4, 1997, petitioners filed a
petition in docket No. 16483-97 regarding the May 2, 1997,
notices, alleging that they are void as second notices pursuant
to section 6212(c). Petitioners subsequently filed a motion to
dismiss for lack of jurisdiction, and respondent filed a notice
of no objection. On November 28, 1997, the Court granted
petitioners' motion to dismiss.
On July 2, 1997, respondent filed the answer herein,
alleging that the penalties determined in the March 14, 1997,
notices are affected items, and that such notices are therefore
timely pursuant to section 6229(a) and (d).
Petitioners filed a motion for summary judgment herein on
August 18, 1997. On September 3, 1997, petitioners filed a
motion for leave to file an amendment to the petition.
Respondent filed a notice of objection (notice) to petitioners'
motion for summary judgment on September 8, 1997. On September
15, 1997, respondent filed a motion for leave to file an
amendment to answer. The foregoing motions and notice were each
accompanied by a supporting memorandum of points and authorities.
Discussion
We must first decide whether to grant petitioners' and
respondent's respective motions to amend their pleadings. We
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must then decide whether to grant petitioners' motion for summary
judgment.
I. Motions to Amend the Pleadings
Rule 41(a) provides in pertinent part that
A party may amend a pleading once as a matter of
course at any time before a responsive pleading is
served. * * * Otherwise a party may amend a pleading
only by leave of Court or by written consent of the
adverse party, and leave shall be given freely when
justice so requires.
Whether a motion seeking amendment should be allowed lies within
the sound discretion of the Court. Rule 41(a); Law v.
Commissioner, 84 T.C. 985, 990 (1985).
In determining the justice of a proposed amendment, we must
examine the particular circumstances in the case before us. Law
v. Commissioner, supra at 990. We consider, among other factors,
whether an excuse for the delay exists and whether the opposing
party would suffer unfair surprise, disadvantage, or prejudice if
the motion to amend were granted. Id.; Nolte v. Commissioner,
T.C. Memo. 1995-57, affd. without published opinion 99 F.3d 1146
(9th Cir. 1996); Estate of Ravetti v. Commissioner, T.C. Memo.
1992-697; Spain v. Commissioner, T.C. Memo. 1978-270.
A. Respondent's Motion for Leave To File Amendment to
Answer
Respondent first seeks leave to amend the answer to allege
that petitioners' distributive share of partnership losses should
be recharacterized as passive losses for purposes of section 469
(the section 469 issue), and that such recharacterization
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constitutes an "affected item" within the meaning of section
6231(a)(5) such that section 6229 applies to extend the period of
limitations for making assessments in this case.
Petitioners object to respondent's motion, claiming that the
"cause of justice" is not served by allowing respondent to amend
the answer. Petitioners argue that respondent was cognizant of
the section 469 issue at least as early as September 8, 1994, at
which time respondent's agent warned petitioners' representative
in writing that deficiency notices for 1989 and 1990 challenging
petitioners' nonpassive characterization of their share of
Partnership losses would be forthcoming unless petitioners filed
amended returns for those years. Petitioners further note that
the invalid May 2, 1997, notices clearly allege that the section
469 issue is an affected item, and that these notices were issued
approximately 2 months before respondent filed the answer in the
instant case. Petitioners maintain that respondent's failure to
affirmatively allege the foregoing in the pleadings at any time
prior to the motion to amend the answer amounts to an inexcusable
delay and should be treated as a waiver or concession of such
argument.
There is nothing in the record which would support a finding
that petitioners will suffer unfair surprise or prejudice as a
result of our granting respondent's motion. In fact, petitioners
have been aware of the arguments respondent now wishes to
affirmatively allege for some time. See Waterman v.
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Commissioner, 91 T.C. 344, 351 (1988). Such awareness is
evidenced by petitioners' concerted effort to preempt
respondent's ability to raise the section 469 issue generally and
to refute its status as an affected item as a matter of law in
their motion for summary judgment filed before respondent moved
to amend the answer.
Nor have petitioners convinced us that the delay was due to
a failure on the part of respondent to exercise reasonable
diligence. Prior to moving for leave to file an amendment to
answer, respondent attempted to rescind the March 14, 1997,
notices in order to issue corrected notices after discussions
with petitioners' counsel. Respondent was prevented from issuing
valid notices when petitioners revoked their consent to withdraw
the March 14, 1997, notices. Furthermore, the motion for leave
to file amendment was filed 2 and one-half months from the filing
of the original answer, which does not strike the Court as
dilatory under the circumstances. See Waterman v. Commissioner,
supra; Wendorff v. Commissioner, T.C. Memo. 1995-258.
Based on the above discussion, we shall grant respondent's
motion for leave to file the foregoing amendments to the answer.
See, e.g., Waterman v. Commissioner, supra at 351; Spain v.
Commissioner, supra.
Respondent further seeks leave to amend the answer to assert
increased deficiencies in the amounts of $97,033 and $114,768,
and increased penalties pursuant to section 6662(a) in the
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amounts of $10,984 and $3,661, for taxable years 1989 and 1990,
respectively.
Under section 6214(a), this Court has jurisdiction to
consider a claim by the Commissioner for an increased deficiency
and penalties asserted before the entry of a final decision.
Ferrill v. Commissioner, 684 F.2d 261, 265 (3d Cir. 1982), affg.
per curiam T.C. Memo. 1979-501; Henningsen v. Commissioner, 243
F.2d 954, 959 (4th Cir. 1957), affg. 26 T.C. 528 (1956); Law v.
Commissioner, supra at 989. Section 6214(a) does not, however,
give the Commissioner an unqualified right to amend the answer to
claim an increased deficiency, addition to tax, or penalty.
Commissioner v. Estate of Long, 304 F.2d 136, 141-143 (9th Cir.
1962). As with other amendments, we must consider whether
granting respondent's motion will surprise and/or unfairly
disadvantage petitioners. See generally Estate of Horvath v.
Commissioner, 59 T.C. 551, 555 (1973).
Respondent's motion was made prior to the entry of a final
decision in this case. Moreover, the assertion of additional
deficiencies and penalties comes in response to petitioners'
contention that respondent is estopped from reissuing notices of
computational adjustment to correct what respondent believes are
erroneous abatements for 1989 and 1990. Thus, we conclude that
petitioners will suffer no undue surprise or prejudice as a
result of this amendment, and respondent's motion on this score
is therefore granted. Cf. Hanley v. Commissioner, T.C. Memo.
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1990-53. The burden of proof as to new matters and increased
deficiencies pleaded in the amended answer will be upon
respondent. Rule 142(a).
B. Petitioners' Motion for Leave To File Amendment to
Petition
Petitioners seek leave to amend their petition to allege in
greater detail the facts necessary to establish the amount of net
operating losses that they contend may be carried back to 1987
and 1988, as well as the amount of refunds due them for those
years stemming from what they contend are the "proper"
computational adjustments for 1989 and 1990. Petitioners further
seek to amend their petition to allege that respondent's
application of the higher interest rate imposed on tax motivated
transactions pursuant to section 6621(c) to the assessments for
1987 and 1988 is in error.
Respondent has stated in writing that, if the Court were to
grant respondent's motion to amend the answer, respondent would
withdraw any objection to petitioners' motion to amend the
petition. Accordingly, we will grant petitioners' motion. Rule
41(a).
II. Petitioners' Motion for Summary Judgment
Among other things, in their motion for summary judgment,
petitioners ask the Court to: (1) Find that the proper
characterization of their distributive share of partnership
losses is neither an affected item nor a partnership item for
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purposes of determining whether the period of limitations for
making assessments has run; (2) find that the proper
computational adjustments for 1989 and 1990 result in no
deficiencies in tax or penalties for those years; (3) order
respondent to refund overpayments for taxable years 1989 and
1990, with interest; and (4) find that petitioners incurred net
operating losses for 1989 and 1990 which may be carried back to
their taxable years 1987 and 1988.
A motion for summary judgment may be granted if the
pleadings and other materials demonstrate that no genuine issue
of material fact exists and a decision can be rendered as a
matter of law. Rule 121(b); Sundstrand Corp. & Consol. Subs. v.
Commissioner, 98 T.C. 518, 520 (1992), affd. 17 F.3d 965 (7th
Cir. 1994). The moving party bears the burden of proving that
there is no genuine issue of material fact, and factual
inferences are read in a manner most favorable to the party
opposing summary judgment. Dahlstrom v. Commissioner, 85 T.C.
812, 821 (1985); Jacklin v. Commissioner, 79 T.C. 340, 344
(1982).
Respondent objects to petitioners' motion for summary
judgment on the grounds that it in part seeks the resolution of
matters as to which genuine issues of material fact remain. We
agree. However, because we are satisfied that no genuine issue
exists as to any of the material facts concerning whether the
period of limitations for making assessments for 1989 and 1990
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has expired, we conclude that partial summary adjudication is
appropriate as to that issue in this case. Rule 121(c).
Section 6501(a) provides generally that respondent has 3
years from the date the return was filed in which to assess the
tax. Section 6501(o) provides a cross-reference to section 6229,
which extends such period in the case of adjustments pertaining
to partnership items or affected items.
Section 6229(a) provides in general that respondent has 3
years from the date of the filing of the partnership return in
which to assess the tax based on any adjustment to a partnership
item or affected item. However, if an FPAA is issued before the
end of the 3-year period of limitations of section 6229(a), that
period is suspended for the time during which a partnership-level
proceeding may be brought under section 6226 and, if such a
proceeding is timely brought, until a decision in that proceeding
becomes final, and for 1 year thereafter. Sec. 6229(d).
Sections 7481 and 7483 provide generally that a decision of this
Court becomes final, in the absence of a timely filed notice of
appeal, 90 days from the date the decision is entered.
The parties do not dispute that the section 6501(a) period
of limitations for issuing notices of deficiency to petitioners
pursuant to section 6212, as extended by Form 872, expired on
June 30, 1995, prior to the issuance of any such deficiency
notice to petitioners, unless section 6229(a) and (d) applies to
suspend such period. Here, the Decision became final on June 11,
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1996. The notices were issued on March 14, 1997, less than one
year thereafter. Thus, if section 6229 applies, it is beyond
question that the March 14, 1997, notices are timely.
Section 6229 was enacted as part of the unified partnership
audit and litigation provisions of TEFRA sec. 402(a), 96 Stat.
648. The TEFRA rules, codified at sections 6221 through 6233,
segregate adjustments attributable to an individual's interest in
partnerships which are subject to the TEFRA statutes from all
other adjustments which can be made to the individual's return.
Maxwell v. Commissioner, 87 T.C. 783, 787-788 (1986). So-called
TEFRA adjustments generally can be made only after all
partnership proceedings are completed. White v. Commissioner, 95
T.C. 209, 211 (1990); Roberts v. Commissioner, 94 T.C. 853, 859
(1990); N.C.F. Energy Partners v. Commissioner, 89 T.C. 741, 743-
745 (1987); Maxwell v. Commissioner, supra at 790-793.
If we determine that the section 469 issue, as petitioners
contend, does not involve a partnership item or affected item
adjustment, then section 6229 does not operate to suspend the
period of limitations. Sec. 6501. Under this scenario,
respondent concedes that petitioners' distributive share of
petitioners' losses for 1989 and 1990 could not be
recharacterized as passive, and, therefore, that petitioners
would be entitled to refunds for those years based on the
partnership-level adjustments.
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TEFRA adjustments are of two varieties: Partnership item
adjustments and affected item adjustments. Section 6231(a)(3)
defines a partnership item as follows:
SEC. 6231(a)(3) Partnership item.--
The term "partnership item" means, with respect to a
partnership, any item required to be taken into account
for the partnership's taxable year under any provision
of subtitle A to the extent regulations prescribed by
the Secretary provide that, for purposes of this
subtitle, such item is more appropriately determined at
the partnership level than at the partner level.
Such items include items of income, gain, loss, deduction or
credit of the partnership, and each partner's share thereof.
Sec. 301.6231(a)(3)-1(a)(1)(i), Proced. & Admin. Regs.
The term "affected item" is defined as "any item to the
extent such item is affected by a partnership item." Sec.
6231(a)(5); see White v. Commissioner, supra at 211; Maxwell v.
Commissioner, supra at 790-791.
The term "nonpartnership item" means an item which is (or is
treated as) not a partnership item. Sec. 6231(a)(4).
Partnership item adjustments can be made to an individual's
return solely through computational adjustments. Sec. 6230(a).
Affected item adjustments, on the other hand, can be made either
through computational adjustments or deficiency proceedings,
depending on the nature of the particular affected item. Sec.
6230(a); Brookes v. Commissioner, 108 T.C. 1, 5-6 (1997); Jenkins
v. Commissioner, 102 T.C. 550, 554 (1994); N.C.F. Energy Partners
v. Commissioner, supra at 744-745. If there are no partner-level
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factual determinations which must be made relating to the
affected item, the tax resulting from the adjustment of the
affected item must be assessed through a computational
adjustment. Secs. 6230(a)(1) and 6231(a)(6). If there are
factual issues which must be determined at the partner level,
then respondent's permitted means of making the adjustment is
through the issuance of a deficiency notice pursuant to section
6230(a)(2)(A)(i). N.C.F. Energy Partners v. Commissioner, supra
at 744-745.
A. The section 469 issue does not involve a partnership
item.
Section 469(a)(1) provides generally that no passive
activity loss claimed by a taxpayer during any taxable year is
allowable as a deduction. Section 469(d)(1) provides that the
term "passive activity loss" means the amount, if any, by which
the aggregate losses from all passive activities for the taxable
year exceed the aggregate income from all passive activities for
such year. Section 469(c) provides generally that the term
"passive activity" means any activity which: (1) Involves the
conduct of any trade or business; and (2) in which the taxpayer
does not materially participate. In general, a taxpayer is
treated as materially participating in an activity only if the
taxpayer is involved in the operations of the activity on a basis
which is: (1) Regular; (2) continuous; and (3) substantial.
Sec. 469(h)(1). A passive activity, by definition (effective for
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the years in question), includes any rental activity, regardless
of whether the taxpayer materially participates in such rental
activity. Sec. 469(c)(2) and (4). (We note that, effective for
taxable years beginning after December 31, 1993, section
469(c)(2) has been modified by the provision of special rules in
section 469(c)(7) for taxpayers in the real property business.
Omnibus Budget Reconciliation Act of 1993, Pub. L. 103-66, sec.
13143(a), 107 Stat. 312, 440.)
Respondent's principal argument is that the section 469
issue is more appropriately determined at the partnership level
and is therefore subject to computational adjustment. Sec.
6231(a)(3), (6). In that connection, respondent claims to have
erred in abating the assessments for 1989 and 1990; that the
penalties determined in the March 14, 1997, notices are both
timely and proper; and that new notices of computational
adjustment reassessing deficiencies for those years can be issued
to petitioners.
In arguing that the section 469 issue involves a partnership
item subject to TEFRA adjustment rules, respondent posits that
the Partnership's losses stem from rental activity for the years
in issue, a per se passive activity under section 469(c)(2).
Thus, according to respondent, a partner-level factual
determination as to the extent of petitioners' participation in
the Partnership's activities is unnecessary. (Respondent argues
that no partner-level determination is required even as to the
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$25,000 offset to passive income provided by section 469(i) for
taxpayers who "actively participate" in a rental real estate
activity insofar as section 469(i)(6)(C) provides that a limited
partner is deemed not to actively participate in such activity
except as provided by regulation, and no such regulation permits
a limited partner to claim active participation in rental real
estate activity for 1989 and 1990.) Respondent invites our
attention to line B of the Partnership's returns for 1989 and
1990, which describes the principal product or service of the
Partnership as "rentals".
Petitioners concede that, should the Court determine that
the Partnership's returns for 1989 and 1990 are to be construed
as reporting that the Partnership's losses derive from rental
activity within the meaning of section 469(c)(2), then the
characterization of those losses in the hands of petitioners
would constitute a partnership item. But petitioners do not
concede that the Partnership's reporting is to be so construed.
Rather, petitioners argue that the Partnership reported its
losses as arising from a trade or business that was not rental
activity on its returns and attached Schedules K and K-1 for
those years. Thus, petitioners claim that factual issues
regarding the extent of their participation in the Partnership's
activities must be resolved before their distributive share of
the Partnership's losses can be characterized as passive or
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nonpassive. As a result, petitioners maintain that the section
469 issue does not involve a partnership item. Sec. 6231(a)(3).
We conclude that the Partnership reported its losses as
arising from trade or business activity (other than rental
activity) on its returns for the years in dispute. (In reaching
our conclusion, we note that we are not making an inappropriate
review of the partnership's returns. See Roberts v.
Commissioner, 94 T.C. at 862.) The Partnership reported its
income and expense on its returns for 1989 and 1990 immediately
below the following statement: "Caution: Include only trade or
business income and expenses on lines 1(a) through 21 below." In
addition, lines 2 and 3 on the Schedules K require the
Partnership to report its income or loss arising from rental
activities. Respondent's instructions for these lines refer the
reader to Publication 925, Passive Activity and At-Risk Rules,
for the purpose of defining rental activities. The Partnership
left lines 2 and 3 blank for its taxable years 1989 and 1990.
Moreover, line 1 of the Schedules K-1 reports the partners'
distributive share of the Partnership's losses as arising from
trade or business activities.
It is true, as respondent points out, that line B of the
Partnership's returns for 1989 and 1990 describes the principal
product or service of the Partnership as "rentals". Contrary to
respondent's contention, however, such a description is not
dispositive of the nature of the Partnership's activity for
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purposes of section 469(c)(2). Although the general rule under
section 1.469-1T(e)(3)(i), Temporary Income Tax Regs., 53 Fed.
Reg. 5702 (Feb. 25, 1988), is that the receipt of gross income
from holding tangible property for use by customers constitutes a
rental activity, section 1.469-1T(e)(3)(ii), Temporary Income Tax
Regs., supra, provides a number of exceptions to the general
rule, such that an activity involving the holding of tangible
property for use by customers does not necessarily amount to per
se passive "rental activity" within the ambit of section
469(c)(2).
Finally, notwithstanding respondent's assertions, lines
19(b) and 20(b), Analysis of total distributive income/payment
items by type of partner, of the Schedules K for 1989 and 1990,
respectively, which reported losses as largely passive to the
limited partners, are not substantively equivalent to reporting
partnership activities as rental activities within the meaning of
section 469(c)(2). The reported passive losses could have arisen
either from rental activity or from a trade or business that did
not consist of rental activity. Respondent's instructions for
completing Schedules K for the years in question direct
partnerships to classify a partner's losses as passive if the
partnership does not know the character of the losses in the
hands of the partner, irrespective of the partnership activity.
In light of the above, we conclude that the Partnership
reported its losses as arising from trade or business activity
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for 1989 and 1990. Since no adjustment was made during the
partnership-level proceeding as to the character of the activity,
respondent is bound by the reporting position of the Partnership.
See Doe v. Commissioner, 80 AFTR2d 97-5535, 97-1 USTC par. 50460
(10th Cir. 1997), affg. in part and revg. in part T.C. Memo.
1993-543; Roberts v. Commissioner, 94 T.C. at 862.
Having concluded that the Partnership reported its losses as
arising from trade or business activity, we think it ineluctable
that the characterization of such losses as active or passive in
the hands of petitioners is not a partnership item within the
meaning of section 6231(a)(3) and the accompanying regulations.
Determining whether or not petitioners materially participated in
such activity for purposes of section 469 has no effect on any
item that would affect all of the partners' respective returns,
nor does it have any effect on any item on the Partnership's
return or on the Partnership's books and records. See Roberts v.
Commissioner, 94 T.C. at 861.
B. The section 469 issue involves an affected item
requiring a partner-level factual determination.
We now turn to consider respondent's alternative position
set forth in the amended answer that the section 469 issue
involves an affected item such that section 6229(a) and (d)
applies to suspend the period of limitations. Sec.
6230(a)(2)(A)(i).
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Petitioners contend that section 301.6231(a)(5)-1T,
Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6790 (Mar. 5,
1987), neither mentions section 469 nor suggests that the
characterization of losses as passive or nonpassive be treated as
an affected item. From such silence petitioners conclude that
the section 469 issue involves a nonpartnership item within the
meaning of section 6231(a)(4), to which section 6229 does not
apply. Petitioners state in this regard that "Since the
partnership items adjusted by the decision [i.e., the amount of
losses] are irrelevant to the nature, duration, or quality of
petitioners' participation in the partnership's activities, the
[section] 469 issue cannot be an affected item under section
6231(a)(5)."
Although the affected items regulations do not expressly
mention section 469, we do not think that the regulations are
meant to provide an exhaustive list of such items. See, e.g.,
Jenkins v. Commissioner, 102 T.C. at 555 (holding that section
104(a) classification by partner of a guaranteed payment is an
affected item).
Furthermore, we question petitioners' assumption in their
memorandum that "an item on a partner's return can be an affected
item if and only if the partner's treatment of that item is
dependent, in the first instance, on a partnership item
adjustment." (Emphasis added.) Petitioners have cited no
authority for this narrow interpretation of the scope of section
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6231(a)(5), and we have found none. On the contrary, section
6231(a)(5) itself provides that the term "affected item" means
"any item to the extent such item is affected by a partnership
item." (Emphasis added.) See also Maxwell v. Commissioner, 87
T.C. at 790-791 ("An item whose existence or amount is dependent
on any partnership item is an affected item.") (Emphasis added.)
As we said in Hambrose Leasing v. Commissioner, 99 T.C. 298,
308 (1992): "partnership liabilities should be determined and
taken into account at the partnership level whenever such
determination produces a uniform effect on the partners."
(Emphasis added.) Such is not the case where, as here, the
treatment of one partner's activities (vis-a-vis the partnership)
as passive or nonpassive has no impact on the treatment of
another partner's activities. In such case, a uniform effect on
the partners is not produced.
We therefore conclude that the characterization of losses as
either passive or nonpassive in the hands of a partner is an
affected item under section 469, and we so hold.
Finally, petitioners argue that
If respondent asserts that the [section] 469 issue is
an affected item for 1989 and 1990, respondent must
also admit that the computational adjustments for 1987
and 1988 should not have been made, since they involved
an item requiring a partner level determination.
Notwithstanding petitioners' assertions, our conclusion that the
characterization of losses in the hands of petitioners for 1989
and 1990 constitutes an affected item is not inimical to
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respondent's authority to issue notices of computational
adjustment rather than deficiency notices to petitioners for
their taxable years 1987 and 1988 upon the completion of the
partnership level proceeding. Respondent never sought to
recharacterize petitioners' distributive share of partnership
losses for 1987 and 1988 as passive--petitioners had already
reported them as such on their returns for those years. Rather,
the computational adjustments for 1987 and 1988 simply reflect
the partnership-level adjustments set forth in the Decision for
those years. Since the amount of losses in the hands of
petitioners is conclusively a partnership item, sec.
301.6231(a)(3)-1(a)(1), Proced. & Admin. Regs., and since the
Decision had become final, such item was properly subject to
computational adjustment. Sec. 6225(a); Maxwell v. Commissioner,
87 T.C. at 788.
We have considered each of the remaining arguments of the
parties and, to the extent that they are not discussed herein,
find them to be either not germane or unconvincing.
In light of the foregoing, we hold that the section 469
issue involves an affected item, such that the statutory period
of limitations does not bar respondent from asserting additional
deficiencies and accuracy-related penalties for 1989 and 1990 as
set forth in the amended answer. Sec. 6229(a) and (d).
Accordingly, petitioners' motion for summary judgment is denied.
Factual issues (including the nature and extent of petitioners'
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participation in the Partnership's activities) which are
determinative of respondent's right to assess deficiencies and
penalties, or petitioners' right to claim overpayments for the
years at issue, among other things, must be resolved in future
proceedings.
To reflect the foregoing,
An appropriate order granting
petitioners' motion for leave to
file amendment to petition and
respondent's motion for leave to
file amendment to answer, and
denying petitioners' motion for
summary judgment, will be issued.