T.C. Memo. 1999-179
UNITED STATES TAX COURT
MATO L. MARINOVICH AND DAPHNE MARINOVICH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 36934-86, 21754-89. Filed May 28, 1999.
John T. Morin and Edward S. Saviano, for petitioners.
Elizabeth Girafalco Chirich, for respondent.
MEMORANDUM OPINION
SWIFT, Judge: This matter is before us in these
consolidated cases on respondent's motion for summary judgment
with regard to the deductibility as a loss under section
165(c)(2) of the amount of cash invested in a tax shelter
partnership.
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Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue.
Background
Petitioners invested in White Rim Oil and Gas Associates,
1980 (White Rim), a Utah limited partnership that was part of a
group of tax-oriented limited partnerships that had the stated
general objective of, among other things, investing in enhanced
oil recovery technology for the recovery of oil and natural gas.
The parties herein stipulate that White Rim's transactions,
for all relevant purposes, were identical to those of Technology
Oil and Gas Associates, 1980 (Technology 1980), one of the
partnerships involved in our test case opinion in Krause v.
Commissioner, 99 T.C. 132 (1992), affd. sub nom. Hildebrand v.
Commissioner, 28 F.3d 1024 (10th Cir. 1994). Further, other than
petitioners' claim for loss deductions under section 165 with
respect to the amount of cash invested in White Rim, petitioners
agree to be bound by Krause with respect to the disallowance of
tax deductions relating to White Rim's claimed losses, interest
expense deductions, and investment credit.
When the petitions were filed, petitioners resided in New
York, New York.
During 1980, 1981, 1982, and 1983, petitioners invested in
White Rim by transferring to White Rim $75,000 in cash and by
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executing in favor of White Rim promissory notes in the total
face amount of $385,000. Petitioners made no payments on the
promissory notes.
On their Federal income tax returns for 1980, 1981, and
1982, petitioners claimed large losses, interest expense
deductions, and an investment credit relating to their investment
as limited partners in White Rim. On audit, respondent
disallowed these claimed losses, interest expense deductions, and
investment credit.
In the Krause v. Commissioner, supra, test cases, we
analyzed, primarily at the partnership level, the objective of
the particular partnership activities and transactions involved
in Krause. We concluded that the partnership activities and
transactions were tax-motivated and did not have the requisite
profit objective to support the losses claimed, and we sustained
respondent's disallowance of the claimed losses relating to the
taxpayers’ investments in the partnerships. We found that the
transactions did not constitute legitimate for-profit business
transactions. Also, on the ground that the underlying debt
obligations did not constitute genuine debt, we sustained
respondent's disallowance of the claimed interest deductions
relating thereto, and we imposed an increased interest rate under
section 6621(c). We did not sustain respondent's determinations
under sections 6653(a)(1) and (2), 6659, and 6661 of additions to
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tax for negligence, for valuation overstatements, and for
substantial understatements of tax.
As indicated, our findings and holdings in Krause v.
Commissioner, supra, were affirmed by the U.S. Court of Appeals
for the Tenth Circuit.
For purposes of this motion for summary judgment,
petitioners concede that no profit objective existed at the White
Rim partnership level, and respondent concedes that profit
objective existed at the individual partner level.
Discussion
Under section 165(a), deductions are allowed for losses
sustained during the taxable year not compensated for by
insurance or otherwise.
Under section 165(c)(2), in order for individual taxpayers
to be entitled to loss deductions with respect to funds invested
in partnerships, the underlying partnership transactions must
have economic substance, and, at the partner level, the
individual taxpayers must have had a profit objective for
investing in the partnerships. See Illes v. Commissioner,
982 F.2d 163, 165 (6th Cir. 1992), affg. per curiam T.C. Memo.
1991-449; Farmer v. Commissioner, T.C. Memo. 1994-342; Wright v.
Commissioner, T.C. Memo. 1994-288.
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Even if taxpayers invest in the partnerships with the
individual objective of making a profit, taxpayers are not
entitled to deduct out-of-pocket cash invested in the
partnerships as losses under section 165(c)(2) if the partnership
transactions lack economic substance. See Illes v. Commissioner,
supra at 165; Hoffpauir v. Commissioner, T.C. Memo. 1996-41;
Schafer v. Commissioner, T.C. Memo. 1994-569; Farmer v.
Commissioner, supra; Wright v. Commissioner, supra; Daoust v.
Commissioner, T.C. Memo. 1994-203; Omerza v. Commissioner, T.C.
Memo. 1992-206.
Further, our finding in Krause v. Commissioner, supra
at 176, that the transactions were tax-motivated and “did not,
and do not, constitute legitimate for-profit business
transactions,” imported that the transactions lacked economic
substance. See Ferguson v. Commissioner, 29 F.3d 98, 102 (2d
Cir. 1994), affg. Peat Oil & Gas Associates v. Commissioner,
100 T.C. 271 (1993); Nickeson v. Commissioner, 962 F.2d 973, 976
(10th Cir. 1992), affg. Brock v. Commissioner, T.C. Memo. 1989-
641; Gardner v. Commissioner, 954 F.2d 836, 839 (2d Cir. 1992),
affg. per curiam Fox v. Commissioner, T.C. Memo. 1988-570; Bohrer
v. Commissioner, 945 F.2d 344, 348 n.5 (10th Cir. 1991), affg.
Glass v. Commissioner, 87 T.C. 1087 (1986); Kirchman v.
Commissioner, 862 F.2d 1486, 1492-1493 (11th Cir. 1989), affg.
Glass v. Commissioner, 87 T.C. 1087 (1986).
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Contrary to the above authority and for the limited purpose
of determining the deductibility of losses under section
165(c)(2) relating to the amount of cash invested in
partnerships, petitioners argue that the absence of a profit
objective at the partnership level should be irrelevant, and the
profit objective test should be measured only at the individual
partner level. Petitioners rely on Echols v. Commissioner, 935
F.2d 703, 709 (5th Cir. 1991), revg. and remanding 93 T.C. 553
(1989), as supporting a loss deduction for the amount of cash
they invested in White Rim.
In Echols, however, the profit objective of the partnership
was not at issue. The Echols case involved what was treated as a
legitimate for-profit partnership, and the Court of Appeals for
the Fifth Circuit addressed only the timing and manifestation of
the taxpayers' abandonment of their interest in the partnership
and the worthlessness of their interest in the partnership.
Because the profit objective of the partnership was not
challenged, the Court of Appeals for the Fifth Circuit in Echols
examined only the profit objective at the individual investor
level.
The parties stipulate that White Rim's transactions, for all
relevant purposes, were identical to those of Technology 1980,
one of the partnerships involved in Krause v. Commissioner,
99 T.C. 132 (1992), in which we concluded that the activities and
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transactions of the partnerships were tax-motivated and did not
constitute legitimate for-profit business transactions.
Petitioners agree to be bound by Krause v. Commissioner, supra,
with respect to the activities of White Rim. Therefore, we
conclude that the activities and transactions of the White Rim
partnership, like those of Technology 1980, were not legitimate
profit-oriented business dealings and lacked economic substance.
Because the activities and transactions of the White Rim
partnership lack economic substance, petitioners are not entitled
to a loss deduction under section 165(c)(2) for their cash
investment in the White Rim partnership, notwithstanding their
individual profit objective in investing in the partnership.
To reflect the foregoing,
An appropriate order will be
issued.