*44 Decision will be entered for the respondent.
Held,
*424 Respondent determined deficiencies in petitioners' 1974 and 1975 Federal income taxes of $ 4,202.37 and *425 $ 10,390.96, respectively. The issues for decision are: (1) Whether petitioner Edward Casel's distributive share of his partnership loss for 1974 and 1975 should be reduced pursuant to
FINDINGS OF FACT
Some of the facts have been stipulated and are found accordingly.
Edward Casel (hereinafter petitioner) and Janice G. Casel, husband and wife, resided in Moorestown, N.J., at the time they filed their petition in this case. They filed joint Federal income tax returns for 1974 and 1975 with the Internal Revenue Service Center, Holtsville, N.Y.
Issue 1.At all times relevant hereto, petitioner was a 50-percent partner in a partnership known as Edward Casel and Arthur Karpf, et al. (hereinafter referred as to the partnership). The ownership of the remaining 50 percent of the partnership was divided equally among Arthur Karpf, Henry Karpf, and Robert Karpf, none of whom was related to petitioner.
On August 1, 1973, the partnership purchased the Chelsea Towers Apartments, a rental apartment*49 complex, from the U.S. Department of Housing and Urban Development (hereinafter HUD), in exchange for a purchase-money mortgage (hereinafter referred to as the HUD mortgage agreement) in the amount of $ 2,340,000. The HUD mortgage agreement provided, inter alia, the following:
(d) The books and accounts of the operations of the mortgaged property *426 and of the project shall be kept in accordance with the requirements of the Secretary [of HUD].
(e) Within sixty (60) days following the end of each fiscal year the Secretary [of HUD] shall be furnished with a complete annual financial report based upon an examination of the books and records of mortgagor prepared in accordance with the requirements of the Secretary [of HUD] * * *
Among the items which had to be included in the partnership's annual financial report to HUD were a balance sheet showing all prepaid and deferred items, a profit and loss statement, an earned surplus statement, a statement of capital or other surplus, and a statement of receipts and disposition of funds. HUD further required the financial report to be prepared on an accrual basis, which was also the method the partnership employed to compute its taxable*50 income during the years in issue.
The Chelsea Towers Apartments (hereinafter referred to as Chelsea Towers) was managed by Casel Agency, Inc., a New Jersey corporation which was wholly owned by petitioners and their two children. At all relevant times herein, Casel Agency, Inc., was on the cash receipts and disbursements method of accounting.
During 1974 and 1975, the partnership encountered serious financial problems which made it unable to make its mortgage payments to HUD. Notwithstanding such financial difficulty, petitioner knew that the partnership could pay management fees of $ 17,830 and $ 17,298 owed to Casel Agency, Inc., for 1974 and 1975, respectively, but he was not certain about the legality of the partnership's making payments to his family's corporation while not making payments on the HUD mortgage. Consequently, the partnership retained Leslie Carson (hereinafter Carson), an attorney and a former Acting General Counsel of HUD, to advise it on the legality of the matter. 2 Carson advised the partnership not to make any payments to Casel Agency, Inc., while the partnership was delinquent on its mortgage payments because HUD might construe such action as a conversion*51 of funds which should have been paid to *427 the Government and refer the matter to the U.S. Department of Justice for possible criminal action.
The partnership followed Carson's advice and did not pay any management fees to Casel Agency, Inc., in 1974 or 1975. 3 In addition, the partnership did not pay such fees within 2 1/2 months of the close of each respective year. Nevertheless, on the partnership's 1974 and 1975 income tax returns (Forms 1065), the partnership accrued and deducted the management fees owed to Casel Agency, Inc., in the amounts of $ 17,830 and $ 17,298, respectively.
On his 1974 and *52 1975 joint Federal income tax returns, petitioner claimed deductions of $ 8,915 and $ 8,649, respectively, as his distributive share of partnership losses attributable to the unpaid accrued management fees owed to Casel Agency, Inc. In the notice of deficiency, however, respondent disallowed those claimed deductions.
Issue 2. Deductibility of Real Estate Taxes and InterestOn March 5, 1975, First Peoples National Bank of New Jersey (hereinafter FPNB) obtained a foreclosure judgment in the Superior Court of New Jersey on a mortgage it held on office property (hereinafter the property) which was located in Willingboro, N.J., and owned by C. W. March Realty Co., Inc. On March 10, 1975, FPNB obtained a writ of execution from the Superior Court of New Jersey directing the sheriff of Burlington County, N.J., to sell the property.
The property was scheduled to be sold at the sheriff's sale on May 15, 1975. Prior to the sheriff's sale, petitioners entered into an agreement with FPNB which provided that if no competitive bids were made at such sale, FPNB would purchase the property for $ 100 and then assign the property to petitioners for $ 372,344.17, which was the amount that FPNB*53 was prepared to bid at the sale.
The sheriff's sale was held on May 15, 1975. One of the conditions of such sale was that the property would be sold subject to all real estate taxes and interest accrued thereon, *428 and sheriff's fees. FPNB was the only bidder at the sale, and it purchased the property for $ 100.
On May 30, 1975, petitioner paid $ 18,013.37 to the tax collector of Willingboro, N.J., for outstanding real estate taxes and interest that had encumbered the property for the following tax quarters:
| 1974 | ||
| 2d | Quarter tax | $ 3,701.74 |
| Interest | 443,40 | |
| 3d | Quarter tax | 3,169.80 |
| Interest | 288.35 | |
| 4th | Quarter tax | 3,169.80 |
| Interest | 203.25 | |
| 1975 | ||
| 1st | Quarter tax | 3,435.77 |
| Interest | 129.24 | |
| 2d | Quarter tax | 3,435.77 |
| Interest | 36.17 | |
Of the $ 18,013.37 paid by petitioner for real estate taxes and interest with respect to the property, $ 16,857.21 was attributable to the tax items encumbering the property during the time it was owned by the mortgagor, C.W. March Realty Co., Inc., or the trustee during the period that such corporation was in a bankruptcy proceeding.
On June 3, 1975, FPNB assigned all of its right, title, and interest in the property to*54 petitioners. On July 17, 1975, the sheriff of Burlington County, N.J., conveyed the property to petitioners by sheriff's deed.
On petitioner's 1975 joint Federal income tax return, he claimed a deduction for real estate taxes and interest which included the $ 16,857.21 that was attributable to the tax items encumbering the property during the time it was owned by the mortgagor, C.W. March Realty Co., Inc., or the trustee during the period that such corporation was in a bankruptcy proceeding. In the notice of deficiency, respondent disallowed petitioner's claimed deduction for real estate taxes and interest to the extent of $ 16,857.21.
OPINION
Issue 1.We must determine whether respondent properly applied
* * * *
(2) Unpaid expenses and interest. -- In respect of *55 expenses, otherwise deductible under section 162 or 212, or of interest, otherwise deductible under section 163, --
(A) If within the period consisting of the taxable year of the taxpayer and 2 1/2 months after the close thereof (i) such expenses or interest are not paid, and (ii) the amount thereof is not includible in the gross income of the person to whom the payment is to be made; and
(B) If, by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not, unless paid, includible in the gross income of such person for the taxable year in which or with which the taxable year of the taxpayer ends; and
(C) If, at the close of the taxable year of the taxpayer or at any time within 2 1/2 months thereafter, both the taxpayer and the person to whom the payment is to be made are persons specified within any one of the paragraphs of subsection (b).
(b) Relationships. -- The persons referred to in subsection (a) are:
* * * *
(2) An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;
* * * *
(c) Constructive Ownership of Stock. *56 -- For purposes of determining, in applying subsection (b), the ownership of stock --
* * * *
(2) An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family;
* * * *
(4) The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants; and
Sec. 1.267(b)-1(b). Partnerships. (1) Since
(i) To the related partner to the extent of his distributive share of partnership deductions for losses or unpaid expenses or interest resulting from such transactions, and
(ii) To the other person to the extent the related partner acquires an interest in any property sold to or exchanged with the partnership by such other person at a loss, or to the extent of the related partner's distributive share of the unpaid expenses or interest payable to the partnership by the other person as a result of such transaction.
[Emphasis added.]
See also sec. 1.267(b)-1(b)(2), example (1), Income Tax Regs.
Petitioner does not dispute the applicability of
*59 Since the issue before us turns upon whether an aggregate *431 or entity theory of partnerships was intended to be embodied in
Section 24(b)(1)(B), 1939 Code, 5*61 the predecessor provision to
When the 1954 Code was adopted, section 707(a) specifically treated a partnership as a separate entity with which its partners could transact business. As to those situations not involving a transaction between a partner and his partnership, however, the conference report at the time of the enactment of the 1954 Code specifically states:
Both the House provisions and the Senate amendment provide for the use of the "entity" approach in the treatment of the transactions between a partner and a partnership which are described above. No inference is intended, however, that a partnership is to be considered as a separate entity for the purpose of applying*62 other provisions of the internal revenue laws if the concept of the partnership as a collection of individuals is more appropriate for such provisions. An illustration of such a provision is section 543(a)(6), which treats income from the rental of property to shareholders as personal holding company income under certain conditions. [H. Rept. 2543, 83d Cong., 2d Sess. 59 (1954). Emphasis added.]
See also
In
Notwithstanding*63 the aforementioned case law and legislative *433 history, petitioners argue that an entity theory of partnerships should be applied in construing
When the 1954 Code was adopted by Congress, the conference report, discussed and excerpted in part above, clearly stated that whether an aggregate or entity theory of partnerships should be applied to a particular Code section depends upon which theory is more appropriate to such section.
Petitioner also argues that
First, there is no evidence in the record that HUD required the partnership to be an accrual basis taxpayer, but only that the partnership use an accrual method of accounting in its financial reporting. We have held in
Finally, petitioner argues that in the event we find that
We must determine whether petitioners may claim a deduction for payment of back real estate taxes, and interest accrued thereon, on property that they purchased at a sheriff's sale, which was subject to unpaid real estate taxes.
Section 164(a)(1) allows a deduction for local real property taxes, except as otherwise provided in such section. Section 164(c)(2) disallows the deduction for "taxes on real property, to the extent that subsection (d) requires such taxes to be treated as imposed on another taxpayer." Section 164(d) provides, in pertinent part, the following:
SEC. 164(d). Apportionment of Taxes on Real Property Between Seller and Purchaser. --
(1) General rule. -- For purposes of subsection*69 (a), if real property is sold during any real property tax year, then --
(A) so much of the real property tax as is properly allocable to that part of such year which ends on the day before the date of the sale shall be treated as a tax imposed on the seller, and
(B) so much of such tax as is properly allocable to that part of such year which begins on the date of the sale shall be treated as a tax imposed on the purchaser.
Petitioners, as assignees of a foreclosing mortgagee, FPNB, purchased property sold at a sheriff's sale subject to unpaid real estate taxes and interest accrued thereon, and petitioners paid such taxes and interest. While the petitioners do not dispute that such a sale occurred, they contend that they should be able to deduct back taxes and the interest accrued thereon because the sheriff, the seller of the property, cannot claim those deductions as he was not the owner of the property. Respondent, on the other hand, maintains that although sections 163 and 164 allow deductions for *70 interest and real property taxes, respectively, a taxpayer must capitalize as part of his purchase price for property any back taxes and interest which he pays that accrued prior to his ownership interest. For the reasons set forth below, we hold for respondent.
We do not think it is a relevant consideration that the sheriff is unable to claim a deduction for the real estate taxes which were due on the property prior to the sale. Sections 164(c)(2) and 164(d)(1)(B) clearly mandate that petitioners may only claim a current deduction for "so much of the tax as is properly allocable to that part of such year which begins on the date of the sale." On May 15, 1975, the property was sold at the sheriff's sale to FPNB. On May 30, 1975, petitioner paid the local property tax collector $ 18,013.37 to cover the taxes that were owed on the property, from the period beginning with the second quarter of 1974 through the second quarter of 1975. 9 On June 3, 1975, FPNB assigned to petitioners all of its right, title, and interest in the property by virtue of its bid at the sheriff's sale.
*71 As assignees of FPNB, the foreclosing mortgagee, petitioners' rights to deductions under sections 163 and 164 certainly cannot be greater than the rights that FPNB would have had if there had been no assignment. It is well settled that a mortgagee who forecloses on property cannot deduct real *437 estate taxes which have accrued thereon prior to the date of purchase; payments for such taxes are considered capital expenditures to be added to the cost of the property. 10
*72 To reflect the foregoing,
Decision will be entered for the respondent.
Footnotes
1. All statutory references are to the Internal Revenue Code of 1954 as amended and in effect for the years in issue.↩
2. At the time the partnership retained Leslie Carson, he was not employed by HUD or any other Government agency.↩
3. Since Casel Agency, Inc., was a cash basis taxpayer, it did not include the unpaid management fees in income for 1974 or 1975.↩
4. These fees were not paid by the partnership during 1974 or 1975, nor were they paid within 2 1/2 months of the close of each respective year.↩
5. Using essentially identical language to
sec. 267(b)(2) , sec. 24(b)(1)(B), 1939 Code, provides, in pertinent part, the following:SEC. 24. ITEMS NOT DEDUCTIBLE.
(b) Losses from Sales or Exchanges of Property. --
(1) Losses disallowed. -- In computing net income no deduction shall in any case be allowed in respect of losses from sales or exchanges of property, directly or indirectly --
* * * *
(B) Except in the case of distributions in liquidation, between an individual and a corporation more than 50 per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;
We further note that sec. 24(c), 1939 Code, provides, in language very similar to that appearing in
sec. 267(a)(2) , as follows:SEC. 24(c). Unpaid Expenses and Interest. -- In computing net income no deduction shall be allowed under section 23(a) [predecessor provision of sec. 162], relating to expenses incurred, or under section 23(b) [predecessor provision of sec. 163], relating to interest accrued --
(1) If such expenses or interest are not paid within the taxable year or within two and one-half months after the close thereof; and
(2) If, by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not, unless paid, includible in the gross income of such person for the taxable year in which or with which the taxable year of the taxpayer ends; and
(3) If, at the close of the taxable year of the taxpayer or at any time within two and one-half months thereafter, both the taxpayer and the person to whom the payment is to be made are persons between whom losses would be disallowed under section 24(b).↩
6. Sec. 24(b)(2)(C), 1939 Code, attributed to an individual who owned any stock in a corporation, any stock owned by his partner. This attribution rule is now incorporated in
sec. 267(c)(3)↩ .7. See also
Nash Miami Motors, Inc. v. Commissioner, T.C. Memo 1964-230">T.C. Memo. 1964-230 , affd. without discussion of this issue358 F.2d 636">358 F.2d 636 (5th Cir. 1966), cert. denied385 U.S. 918">385 U.S. 918↩ (1966).8. Petitioner has not cited any specific provisions of Federal law which would apply if the partnership had paid the management fees to Casel Agency, Inc., while the partnership was delinquent on its HUD mortgage payments.↩
9. Petitioners commenced ownership of the property during the second quarter of 1975. Of the $ 18,013.37 which petitioner paid to the local property tax collector, respondent disallowed $ 16,857.21, the amount allocable to the tax items encumbering the property during the time that it was owned by the mortgagor, C. W. March Realty Co., Inc.↩
10. We note that this rule is generally applicable to all purchasers and not merely to foreclosing mortgagees.
Lifson v. Commissioner, 98 F.2d 508">98 F.2d 508 , 510 (8th Cir. 1938), affg.36 B.T.A. 593">36 B.T.A. 593 (1937);Hyde v. Commissioner, 64 T.C. 300">64 T.C. 300 , 306↩ (1975).