Israel Greenwald & Ruth Greenwald v. Commissioner

142 T.C. No. 18

• Court: United States Tax Court
• Decided: May 21, 2014
• Docket: 29126-11, 29244-11, 3203-12, 3212-12, 3213-12, 3215-12, 3216-12, 3217-12, 3218-12
• Status: Published

Opinion

142 T.C. No. 18

UNITED STATES TAX COURT

ISRAEL GREENWALD AND RUTH GREENWALD, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 29126-11, 29244-11, Filed May 21, 2014. 3203-12, 3212-12, 3213-12, 3215-12, 3216-12, 3217-12, 3218-12.

Ps owned interests in bona fide partnerships that were subject to the tax audit and litigation procedures of I.R.C. secs. 6221-6234. The partnerships liquidated, and the partnership items for the year of liquidation were determined in partnership-level proceedings. Following those proceedings, R issued notices of deficiency

1 Cases of the following petitioners are consolidated herewith: Brian Auchter and Nancy Auchter, docket No. 29244-11; Paul H. Hildebrandt and Judith A. Hildebrandt, docket No. 3203-12; Michael Cohen and Susan Cohen, docket No. 3212-12; Bernard J. Sachs and Joan K. Sachs, docket No. 3213-12; David Kraus and Susan Kraus, docket No. 3215-12; Jonathan L. Levine and Sarah S. Levine, docket No. 3216-12; John A. Hildebrandt and Jean E. Hildebrandt, docket No. 3217-12; and David S. Marsden and Rosemary Marsden, docket No. 3218-12. -2-

determining the partners’ gain on liquidation of the partnerships. Ps filed petitions in response to those notices of deficiency and later moved to dismiss for lack of jurisdiction, arguing that outside basis is a partnership item that should have been determined at the partnership level and that the notices of deficiency are invalid.

Held: Gain or loss on the disposition of a bona fide partnership interest is an affected item that requires partner-level determinations if the amount of that gain or loss could be affected by a partner-level determination.

Peter L. Banis, for petitioners.

Nina P. Ching, for respondent.

OPINION

BUCH, Judge: These cases involve affected items deficiency proceedings

that follow from previous partnership-level proceedings in this Court.2 Petitioners

filed a motion to dismiss for lack of subject matter jurisdiction, and their argument

is that outside basis is a partnership item that had to be raised and determined in

the prior partnership-level proceedings. Respondent argues that this Court has

jurisdiction because outside basis is an affected item that requires partner-level

2 Regency Plaza Assocs. of N.J. v. Commissioner, docket Nos. 7150-08 and 7197-08 (decision entered June 30, 2010). -3-

determinations. Both parties, however, miss the mark. In these partner-level

affected items proceedings, we have jurisdiction to redetermine the amounts of

any deficiencies attributable to affected items that require partner-level

determinations. Because partner-level determinations are required, we have

jurisdiction to redetermine the deficiencies at issue.

Background

Petitioners in these consolidated cases resided in the following locations at

the time the petitions were filed: the Greenwalds, docket No. 29126-11, lived in

New York; the Auchters, docket No. 29244-11, lived in New Jersey; Paul and

Judith Hildebrandt, docket No. 3203-12, lived in New Jersey; the Cohens, docket

No. 3212-12, lived in New York; the Sachses, docket No. 3213-12, lived in

Maryland; the Krauses, docket No. 3215-12, lived in New York; the Levines,

docket No. 3216-12, lived in New Jersey; John and Jean Hildebrandt, docket No.

3217-12, lived in New Jersey; and the Marsdens, docket No. 3218-12, lived in

New Jersey.

In laying out the facts, we focus on the Greenwalds.3

3 This case has been consolidated with eight other cases. One of the other cases involves Regency Plaza, and the others involve a separate partnership, Prince Manor Apartment Associates. Irrespective of the differing entities and petitioners, the dispositive facts are similar in all of the cases. -4-

Mr. Greenwald was a limited partner in Regency Plaza Associates of New

Jersey (Regency Plaza). Regency Plaza was subject to the unified partnership

audit and litigation procedures of the Tax Equity and Fiscal Responsibility Act of

1982 (TEFRA), Pub. L. No. 97-248, sec. 402(a), 96 Stat. at 648. The partnership

was involved in an apartment project that was managed by Republic Management,

Inc., which also managed 14 other apartment projects insured by the Department

of Housing and Urban Development. As a result of a transfer of a partnership

interest, Regency Plaza attached a section 7544 election to its 1995 Form 1065,

U.S. Return of Partnership Income, which neither side claims was revoked.

In 1996 Regency Plaza petitioned the U.S. Bankruptcy Court for the District

of Massachusetts, Western Division, for relief under chapter 11. Just over a year

after the petition was filed, the Circuit Court of the Sixth Judicial Circuit in and

for Duval County, Florida, entered a final judgment of foreclosure. The

partnership owned property that was subject to a mortgage in favor of Beal Bank,

S.S.B, which mortgage was security for a nonrecourse debt against property

owned by Regency Plaza. This judgment allowed Beal Bank to foreclose its

mortgage. Regency Plaza terminated on July 31, 1997.

4 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. -5-

Because Regency Plaza had failed to file any tax returns after filing its

return for 1995, the Internal Revenue Service prepared substitute Forms 1065 on

Regency Plaza’s behalf for the 1996 and 1997 taxable years using the 1995 return.

On October 15, 2007, the IRS issued a notice of final partnership administrative

adjustment (FPAA) to Regency Plaza for its taxable years ending December 31,

1996, and July 31, 1997. In response to the FPAA, Brian and Nancy Auchter,

partners other than the tax matters partner, filed petitions in the Tax Court.5 Mr.

Greenwald filed notices of election to participate in both cases. He also filed

motions to have himself appointed the tax matters partner. The Court granted

these motions. The cases were consolidated and later settled.

After the conclusion of the TEFRA proceeding respondent sent the

Greenwalds a notice of computational adjustment pertaining to Regency Plaza’s

1996 and 1997 taxable years. Four days later, on September 23, 2011, respondent

issued a notice of deficiency to the Greenwalds for their 1997 taxable year. The

notice of deficiency made an adjustment to the Greenwalds’ long-term capital gain

and made other corresponding adjustments. The IRS included a spreadsheet with

the notice of deficiency explaining how it had calculated the Greenwalds’ long-

term capital gain. The spreadsheet refers to information taken from Regency

5 See supra note 2. -6-

Plaza’s 1996 and 1997 Forms 1065 and the 1997 Schedule K-1, Partner’s Share of

Income, Credits, Deductions, etc., for Mr. Greenwald. Again, the Forms 1065

were prepared by respondent on behalf of Regency Plaza, as was the Schedule

K-1. After the notice of deficiency was issued, respondent revised the initial

computational adjustments to allow for a rental real estate loss and a passive

activity loss using information provided by the Greenwalds. The modified

computational adjustments increased the Greenwalds’ deficiency by $42; however,

respondent seeks only to enforce the deficiency as set forth in the original notice.

These cases were calendared for trial at the Court’s trial session in Boston,

Massachusetts. At the calendar call the parties moved to submit the cases under

Rule 122. However, the Greenwalds (through their counsel) also stated that they

wanted to submit additional evidence. The cases were recalled, and the

Greenwalds explained that the evidence was documents from the attorney who

represented another partnership and general partner in a criminal action by the

United States for equity skimming with respect to Regency Plaza. Respondent

objected to the documents because they were not relevant and because they had

not been provided to respondent until the morning of the scheduled trial. To avoid

a continuance, the Greenwalds withdrew the documents. Accordingly, these cases

were submitted under Rule 122 and a briefing schedule was established. After the -7-

Greenwalds submitted their opening brief, they filed their motion to dismiss. As a

result, the briefing schedule was suspended, and the Court now turns to the

jurisdictional question.

Discussion

I. Partnership and TEFRA Overview

Partnerships are passthrough entities and, as such, are not responsible for

paying Federal income tax. Instead, the partners report their shares of the

partnership items on their own income tax returns. Sec. 701. Although the

partnership does not file an annual income tax return, it must file an annual

information return that identifies each partner’s share of income, deductions, and

other tax items. Sec. 6031(a).

Congress passed TEFRA over 30 years ago. TEFRA’s unified audit and

litigation procedures were enacted to alleviate the administrative burden caused by

duplicative audits and litigation. Samueli v. Commissioner, 132 T.C. 336, 340

(2009). A goal of TEFRA was to “promote increased compliance and more

efficient administration of the tax laws.” H.R. Conf. Rept. No. 97-760, at 600

(1982), 1982-2 C.B. 600, 662.

Section 6221 provides that the tax treatment of all “partnership items” is

determined at the partnership level. The Secretary must mail each notice partner -8-

whose name and address is furnished a notice of the beginning of an administrative

partnership-level proceeding and an FPAA. Sec. 6223(a). The determination of

partnership items in a partnership-level proceeding (either through a defaulted

FPAA or a final court decision) is conclusive.6 Once adjustments are made at the

partnership level, the IRS will make any necessary partner-level changes, including

changes to “affected items”. If the adjustment to an affected item is merely

computational and can be made without making additional partner-level

determinations, the IRS can directly assess the tax due without having to follow the

usual deficiency procedures. Sec. 6230(a)(1); sec. 301.6231(a)(6)-1T(a),

Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6790 (Mar. 5, 1987).7 However,

if an adjustment to an affected item requires a partner-level factual determination,

the IRS must follow deficiency procedures. Sec. 6230(a)(2)(A)(i); sec.

6 Except in limited circumstances, refund suits for adjustments attributable to partnership items are not permitted. Sec. 7422(h). And even then, any prior partnership item determination is conclusive. Sec. 6230(c)(4); see also New Millennium Trading, L.L.C. v. Commissioner, 131 T.C. 275, 280 (2008). 7 This rule is now set forth in permanent regulations at sec. 301.6231(a)(6)- 1(a)(2), Proced. & Admin. Regs. which apply to taxable years beginning on or after October 4, 2001. Sec. 301.6231(a)(6)-1(c), Proced. & Admin. Regs. -9-

301.6231(a)(6)-1T(a), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6779

(Mar. 5, 1987).8

II. Partnership Items

A partner’s basis in his partnership interest is an affected item to the extent it

is not a partnership item. Sec. 301.6231(a)(5)-1T(b), Temporary Proced. & Admin.

Regs., 52 Fed. Reg. 6790 (Mar. 5, 1987).9 A partnership item is “any item required

to be taken into account for the partnership’s taxable year under any provision of

subtitle A [Income Taxes] to the extent [the] regulations * * * provide that, for

purposes of this subtitle, such item is more appropriately determined at the

partnership level than at the partner level.” Sec. 6231(a)(3). The “critical element”

is that the partnership is required to make the determination. Sec. 301.6231(a)(3)-

1(c)(1), Proced. & Admin. Regs. The failure of the partnership to actually make

the determination does not prevent an item from being a partnership item. Id.

Partnerships do not keep track of the partners’ outside bases, but they may be

required to take a partner’s outside basis into account in some situations. For

8 This rule is now set forth in permanent regulations at sec. 301.6231(a)(6)- 1(a)(3), Proced. & Admin. Regs. which apply to taxable years beginning on or after October 4, 2001. Sec. 301.6231(a)(6)-1(c), Proced. & Admin. Regs. 9 Permanent regulations replaced the temporary regulations for taxable years beginning on or after October 4, 2001. Sec. 301.6231(a)(5)-1(f), Proced. & Admin. Regs. - 10 -

example, when a partner purchases an interest in a partnership, the partnership may

elect under section 754 to make optional adjustments to the basis of partnership

property. If such an election is made, the partner’s initial basis in the partnership is

a partnership item. Sec. 301.6231(a)(3)-1(a)(3), Proced. & Admin. Regs.

However, if the election is not made, the partnership is not required to determine

the partner’s initial outside basis. Tigers Eye Trading, LLC v. Commissioner, 138

T.C. 67, 117 (2012). Accordingly, a partner’s outside basis generally would be an

affected item. Sec. 6231(a)(3); see Tigers Eye Trading, LLC v. Commissioner, 138

T.C. at 117.

III. Jurisdiction

The Tax Court is a court of limited jurisdiction and can exercise jurisdiction

only to the extent provided by statute. Sec. 7442. Section 6214(a) provides the

Court with jurisdiction to redetermine the correct amount of a deficiency as long as

the taxpayer files a timely petition from a valid notice of deficiency. Sec. 6213(a).

While the deficiency procedures generally do not need to be followed so as to

determine affected items flowing from a TEFRA partnership-level proceeding, an

exception is carved out for affected items that require partner-level determinations.

Sec. 6230(a)(2)(A)(i). - 11 -

IV. Precedents

In their motion to dismiss, petitioners rely heavily on Tigers Eye Trading,

LLC v. Commissioner, 138 T.C. 67 (2012). In Tigers Eye the parties stipulated

that the partnership was a sham. Id. at 102. Accordingly, “[n]o additional facts

[were] required to determine the absence of an outside basis” because the

partnership did not exist for Federal tax purposes. Id. at 119. Because no further

determinations were necessary, outside basis was a partnership item. Id.

Moreover, that outside basis determination also resulted in a determination of the

applicability of a gross valuation misstatement penalty. See section 6226(f) (giving

the Court jurisdiction to determine “the applicability of any penalty, addition to tax,

or additional amount which relates to an adjustment to a partnership item” for

taxable years ending after August 5, 1997). No further partner-level determinations

were required in that instance.

The Supreme Court recently addressed this same issue in United States v.

Woods, 571 U.S. ___, 134 S. Ct. 557 (2013), and came to the same conclusion.

Again, the Court stated that where the partnership is a sham, no partner-level

determinations are needed to determine outside basis because “once the

partnerships were deemed not to exist for tax purposes, no partner could

legitimately claim an outside basis greater than zero.” United States v. Woods, 571 - 12 -

U.S. ___, ___, 134 S. Ct. 557, 565-566 (2013). This flows from the fact that there

can be no basis in an asset that does not exist, such as nonexistent partnership

interest. The Court went on to say that “the basis misstatement and the

transaction’s lack of economic substance are inextricably intertwined.” Id. at ___,

134 S. Ct. at 567 (quoting Bemont Invs., LLC v. United States, 679 F.3d 339, 354

(5th Cir. 2012)). Thus, as with Tigers Eye, the Court held that outside basis is a

partnership item when the partnership is held to be a sham, and the applicability of

the gross valuation misstatement penalty arises as a preliminary determination.

Even then, the penalty determination is “provisional”. United States v. Woods, 571

U.S. at ___, 134 S. Ct. at 564. Notwithstanding this type of isolated situation in

which outside basis is determined at the partnership level, the Supreme Court

acknowledged that a court may otherwise need to determine “affected or non-

partnership items such as outside basis.” Id.

Even then, we do not determine basis in a vacuum. In these proceedings, we

have jurisdiction to redetermine the amounts of deficiencies. See secs.

6230(a)(2)(A)(i); 6214(a). To determine the amount of a deficiency, any number of

partner-level determinations may be required, even when components of the

partner’s basis in a partnership interest are fixed as a result of one or more

partnership-level determinations. If, for example, a partner sold a partnership - 13 -

interest, any deficiency relating to that sale would need to be determined at the

partner level. The amount realized on that sale would be a partner-level

determination even if all of the components of the partner’s basis in the partnership

interest may already have been determined at the partnership level.

In these specific cases, the partners were charged with income as a result of

the discharge of partnership liabilities; thus petitioners argue that no partner-level

determinations are necessary. They are mistaken.

Their outside basis is not fixed by partnership-level determinations, even in

the case of a section 754 election. The Tax Court in Tigers Eye and the Supreme

Court in Woods held that outside basis was a partnership item because the

partnerships were shams and thus no other determinations were necessary to

preliminarily determine that a gross valuation misstatement penalty applied. That

is not the case before us. The TEFRA proceeding regarding Regency Plaza did not

determine that the partnership was a sham, and thus in these proceedings we must

treat it as a bona fide partnership.

Redetermining the amounts of deficiencies resulting from partnership-level

adjustments will require that we look to the partners’ specific facts. For example, if

a partner incurred litigation costs in the defense of the ownership of the partnership

interest, those costs would be added to the partner’s outside basis, but they would - 14 -

not be taken into account as part of a section 754 election or any other partnership-

level determination. Cf. Lange v. Commissioner, T.C. Memo. 1998-161. To make

such a determination, the IRS is required to follow deficiency procedures. Sec.

6230(a)(2)(A)(i).

Determining that a partner did not incur such a cost is just as much a partner-

level determination. As we have previously stated: “Neither the Code nor the

regulations thereunder require that partner-level determinations actually result in a

substantive change to a determination made at the partnership level.” Domulewicz

v. Commissioner, 129 T.C. 11, 20 (2007), aff’d in part, rev’d in part sub nom.

Desmet v. Commissioner, 581 F.3d 297 (6th Cir. 2009). In dicta, the Court of

Appeals for the Sixth Circuit arguably took issue with this statement, stating that it

“conflicts with TEFRA’s mandate to resolve all issues in a single proceeding

against the partnership whenever possible.” Desmet v. Commissioner, 581 F.3d at

304. However, TEFRA’s mandate is that all partnership items be resolved in a

single proceeding. Sec. 6221. And the controlling statute explicitly requires that,

if partner-level determinations are necessary to determine the correct amount of

tax, the IRS must follow deficiency procedures. Sec. 6230(a)(2)(A)(i). To ignore

potential partner-level determinations by assessing without following deficiency

procedures would have the effect of depriving partners of a prepayment forum - 15 -

where there is a dispute as to the amount or existence of partner-level

determinations that could affect the amount of the assessment. Section

6230(a)(2)(A)(i) is specifically intended to give partners that prepayment forum.

Under these facts, outside basis is an affected item requiring partner-level

determinations, and we have subject-matter jurisdiction over these cases.

To reflect the foregoing,

An appropriate order will be issued.