SCOTUS Reports

Tag: Partnership Basis

  • Rock Bordelon and Torie Bordelon v. Commissioner of Internal Revenue, T.C. Memo. 2020-26: Personal Guarantees and At-Risk Rules in Tax Deduction Cases

    Rock Bordelon and Torie Bordelon v. Commissioner of Internal Revenue, T. C. Memo. 2020-26 (United States Tax Court, 2020)

    In a significant tax ruling, the U. S. Tax Court held that personal guarantees can establish sufficient at-risk amounts to allow deductions for losses from business activities. The decision affirmed that Rock Bordelon’s guarantees for loans to his business entities, Many LLC and Kilgore LLC, made him personally liable, thus enabling him to claim over $1. 5 million in previously disallowed losses. This ruling clarifies the application of the at-risk rules under I. R. C. § 465 and the impact of personal guarantees on a taxpayer’s basis in partnerships under I. R. C. § 704(d), offering guidance for taxpayers and tax professionals on the deductibility of business losses.

    Parties

    Rock Bordelon and Torie Bordelon, as petitioners, against the Commissioner of Internal Revenue, as respondent. The Bordelons were the taxpayers seeking redetermination of tax deficiencies determined by the Commissioner.

    Facts

    Rock Bordelon was engaged in the healthcare business, owning Allegiance Health Management, Inc. (AHM), a medical services company, and Allegiance Hospital of Many, LLC (Many LLC), which he formed to purchase and own a hospital in Louisiana. In 2008, Many LLC and AHM borrowed a $9. 9 million loan (Many Loan) from Union Bank, secured by the hospital and its equipment, with Bordelon executing a personal guarantee as required by the USDA. Many LLC was treated as a disregarded entity for federal tax purposes, with its income and expenses reported on Bordelon’s Schedule C. Bordelon also owned a 90% interest in Allegiance Specialty Hospital of Kilgore, LLC (Kilgore LLC), a partnership, which borrowed $550,000 in 2011 (Kilgore Loan) from Home Federal Bank, with Bordelon as the sole guarantor. The IRS challenged Bordelon’s claimed loss deductions for 2008 related to Many LLC and Kilgore LLC, asserting he was not at risk under I. R. C. § 465 and lacked sufficient basis in Kilgore LLC under I. R. C. § 704(d).

    Procedural History

    The IRS issued notices of deficiency for the tax years 2008-2011, disallowing loss deductions related to Many LLC and Kilgore LLC on the grounds that Bordelon was not at risk under I. R. C. § 465 and lacked sufficient basis in Kilgore LLC under I. R. C. § 704(d). The Bordelons timely filed petitions with the U. S. Tax Court seeking redetermination of the deficiencies. The Commissioner raised the at-risk issue regarding the Kilgore Loan at trial. The court held that Bordelon’s personal guarantees established sufficient amounts at risk and increased his basis in Kilgore LLC, allowing him to deduct the previously disallowed losses.

    Issue(s)

    Whether Rock Bordelon’s personal guarantees for the Many Loan and the Kilgore Loan established sufficient amounts at risk under I. R. C. § 465 and increased his basis in Kilgore LLC under I. R. C. § 704(d) to allow him to deduct the losses related to Many LLC for 2008 and Kilgore LLC for 2011?

    Rule(s) of Law

    Under I. R. C. § 465, a taxpayer’s loss deductions are limited to the amount for which the taxpayer is considered “at risk,” which includes amounts borrowed with respect to the activity, to the extent the taxpayer is personally liable for repayment or has pledged non-activity property as security. I. R. C. § 465(b)(2)(A), (B). A taxpayer is not considered at risk for amounts protected against loss through nonrecourse financing or guarantees. I. R. C. § 465(b)(4). Under I. R. C. § 704(d), a partner’s loss deduction is limited to his adjusted basis in the partnership, which is increased by the partner’s share of partnership liabilities to the extent the partner bears the economic risk of loss for the liability. 26 C. F. R. § 1. 752-1(a)(1), Income Tax Regs.

    Holding

    The Tax Court held that Bordelon’s personal guarantee of the Many Loan established sufficient amounts at risk under I. R. C. § 465, entitling him to deduct the losses related to Many LLC for 2008. Furthermore, Bordelon’s personal guarantee of the Kilgore Loan increased his basis in Kilgore LLC under I. R. C. § 704(d) and established amounts at risk under I. R. C. § 465, entitling him to deduct for 2011 his share of suspended losses disallowed for 2008.

    Reasoning

    The court applied the “worst-case scenario” analysis to determine whether Bordelon was personally liable for the Many Loan and the Kilgore Loan under I. R. C. § 465(b)(2)(A). The court found that Bordelon was the “obligor of last resort” for both loans, as he had no right to meaningful reimbursement from the primary obligors (Many LLC and AHM for the Many Loan, and Kilgore LLC for the Kilgore Loan) in the event of default. The court also considered the “realistic possibility” of economic loss under I. R. C. § 465(b)(4) and found that Bordelon was not protected against loss, as there were no other guarantors or recourse obligations for the loans. For the Kilgore Loan, the court applied the “constructive liquidation” test under 26 C. F. R. § 1. 752-2(b), Income Tax Regs. , and found that Bordelon’s guarantee made the loan recourse to him, increasing his basis in Kilgore LLC under I. R. C. § 704(d). The court’s reasoning relied on prior case law, including Brand v. Commissioner, 81 T. C. 821 (1983), Abramson v. Commissioner, 86 T. C. 360 (1986), and Melvin v. Commissioner, 88 T. C. 63 (1987), which established the principles for determining personal liability and protection against loss under the at-risk rules.

    Disposition

    The Tax Court ruled in favor of the Bordelons, allowing them to deduct the disallowed 2008 Many LLC loss deductions and the 2011 Kilgore LLC loss deductions. Decisions were to be entered under Rule 155.

    Significance/Impact

    This decision clarifies the application of the at-risk rules under I. R. C. § 465 and the impact of personal guarantees on a taxpayer’s basis in partnerships under I. R. C. § 704(d). It provides guidance for taxpayers and tax professionals on the deductibility of business losses, particularly in cases involving personal guarantees of business loans. The ruling emphasizes the importance of the “worst-case scenario” and “realistic possibility of economic loss” analyses in determining whether a taxpayer is at risk for borrowed amounts. The decision also highlights the significance of the “constructive liquidation” test in determining whether a partnership liability is recourse to a partner, affecting the partner’s basis in the partnership. This case may influence future tax planning and litigation involving personal guarantees and the at-risk rules.

  • Long v. Commissioner, 71 T.C. 724 (1979): When a Partner’s Contribution Affects Partnership Basis

    Long v. Commissioner, 71 T. C. 724 (1979)

    A partner’s contribution to partnership liabilities cannot increase another partner’s basis in the partnership.

    Summary

    In Long v. Commissioner, the Tax Court addressed whether an estate could increase its basis in a partnership by paying partnership liabilities with funds partially belonging to another partner, Robert Long. The court held that the estate’s basis could not be increased by Robert’s contribution, emphasizing that only the partner assuming the liability could claim a basis increase. The court rejected the estate’s arguments on factual grounds and the legal effect of Robert’s contribution, affirming the principle that a partner’s basis cannot be increased by another partner’s payment of partnership liabilities.

    Facts

    Marshall Long, as the beneficiary of an estate, claimed capital loss carryovers from the estate’s termination. The estate succeeded the decedent’s interest in a partnership, which was liquidated in 1969. Disputes arose over basis adjustments for partnership liabilities. The estate argued for an increased basis due to payments of partnership liabilities, but some payments were made with funds belonging to Robert Long, another partner and beneficiary of the estate. The probate court noted that Robert’s share of the estate offset his share of partnership liabilities.

    Procedural History

    The Tax Court initially ruled against the estate’s claim for a basis increase in Long v. Commissioner, 71 T. C. 1 (1978). The estate filed a motion for reconsideration under Rule 161 of the Tax Court Rules of Practice and Procedure, which led to the supplemental opinion in 71 T. C. 724 (1979).

    Issue(s)

    1. Whether the estate could increase its basis in the partnership by paying partnership liabilities with funds partially belonging to another partner?

    Holding

    1. No, because the estate’s basis could not be increased by another partner’s contribution to partnership liabilities.

    Court’s Reasoning

    The court applied the rule from Section 752(a) of the Internal Revenue Code, which governs basis adjustments for partnership liabilities. The court found that Robert Long’s share of the estate was used to offset his share of partnership liabilities, and thus, the estate could not claim a basis increase for liabilities paid with Robert’s funds. The court emphasized that the estate had complete control over Robert’s share, and the timing of the probate court’s order did not affect the tax consequences. The court rejected the estate’s factual claims due to insufficient evidence and dismissed arguments about prejudice, noting that the issue of Robert’s contribution was known and discussed by both parties.

    Practical Implications

    This decision clarifies that a partner’s basis in a partnership cannot be increased by another partner’s payment of partnership liabilities, even if those payments are made with funds belonging to the other partner. Practitioners must carefully track the source of funds used to pay partnership liabilities to ensure proper basis adjustments. This ruling impacts estate planning and partnership agreements, requiring clear delineation of liability assumptions. Subsequent cases have reinforced this principle, ensuring that only the partner directly assuming a liability can claim a basis increase.

  • Casey v. Commissioner, 38 T.C. 357 (1962): Adjusting Partnership Basis and Depreciation Methods in Tax Law

    Casey v. Commissioner, 38 T.C. 357 (1962)

    In partnership taxation, a partner’s basis in their partnership interest is subject to adjustments for contributions, income, losses, distributions, and liabilities; furthermore, changes in depreciation methods require the consent of the Commissioner of Internal Revenue unless arbitrarily withheld.

    Summary

    Casey v. Commissioner involves a tax dispute concerning the adjusted basis of partners’ interests in a real estate partnership and the permissible depreciation methods for a hotel owned by the partnership. The Tax Court addressed several issues, including the calculation of partnership basis, the determination of useful life and salvage value of depreciable assets, and the necessity of obtaining the Commissioner’s consent to change depreciation methods. The court upheld the Commissioner’s determinations on several points, emphasizing the importance of accurate partnership accounting and adherence to established depreciation methods unless proper consent for change is secured.

    Facts

    A real estate partnership was formed by two brothers, A.J. and P.J. Casey. Upon their deaths, their interests passed to trusts. The partnership continued between the trusts, owning several properties, including the Hotel Casey. Disputes arose regarding the adjusted basis of the partners’ interests, the basis of partnership land, the useful life and salvage value of the Hotel Casey, and the permissibility of retroactively changing depreciation methods. The partnership had consistently used the straight-line depreciation method. After the partnership’s liquidation in 1955 and distribution of assets to the trusts as tenants in common, the trusts sought to retroactively change to a declining balance depreciation method for 1956.

    Procedural History

    The Commissioner of Internal Revenue determined deficiencies in the petitioners’ income tax for 1955 and 1956, challenging the partnership’s and later the trusts’ calculations of basis and depreciation. The petitioners contested these deficiencies in the United States Tax Court. The Tax Court issued an opinion addressing multiple issues related to partnership basis, depreciation, and changes in accounting methods.

    Issue(s)

    1. Whether the Commissioner correctly determined the adjusted bases of the partners’ interests in the partnership’s real property.
    2. Whether the Commissioner correctly determined the basis of the partnership’s land.
    3. Whether the Commissioner correctly determined the useful life and estimated salvage value of the Hotel Casey for depreciation purposes.
    4. Whether the petitioners could retroactively change their method of computing depreciation on the Hotel Casey from the straight-line method to a declining balance method without the Commissioner’s consent.

    Holding

    1. Yes, the Commissioner’s determination of the adjusted bases of the partners’ interests in the partnership real property was largely upheld, with some adjustments by the court.
    2. Yes, the Commissioner correctly determined the basis of the partnership’s land to be its historical cost.
    3. The court modified the Commissioner’s determination, finding the remaining useful life of the Hotel Casey was 10 years as of January 1, 1955, and 9 years as of January 1, 1956, but upheld the 10% salvage value determination.
    4. No, the petitioners could not retroactively change their depreciation method without the Commissioner’s consent, which was not arbitrarily withheld.

    Court’s Reasoning

    Basis of Partnership Interests: The court analyzed Section 705 of the 1954 Code, detailing adjustments to partnership basis. It addressed specific adjustments contested by petitioners, including a 1948 adjusting entry, 1955 excess withdrawals, liabilities assumed upon liquidation, undistributed income, and 1936 capital contributions. The court meticulously reviewed partnership accounts, stipulations, and relevant tax regulations to determine the correct adjusted basis. Regarding liabilities, the court cited 26 C.F.R. § 1.742.1, stating, “The basis of a partnership interest acquired from a decedent is the fair market value of the interest at the date of his death * * *, increased by his estate’s or other successor’s share of partnership liabilities, if any, on that date.” The court rejected petitioners’ argument against including liabilities in the initial basis, finding the regulation valid and consistent with Code provisions and Crane v. Commissioner.

    Basis of Partnership Land: The court held that the basis of the land remained the historical cost to the partnership, rejecting the petitioners’ estoppel argument based on the Commissioner’s prior erroneous 1936 determination. The court reasoned that the original partnership was never liquidated, and the petitioners did not demonstrate any detrimental reliance on the prior incorrect determination.

    Depreciation of Hotel Casey: The court determined the useful life of the Hotel Casey based on expert testimony and economic factors, finding a 10-year remaining useful life as of January 1, 1955, and 9 years as of January 1, 1956. The court weighed the testimony of both expert witnesses, giving more credence to the petitioners’ expert who had long-term familiarity with the hotel’s economic conditions. The court found respondent’s reliance on a rejected purchase offer to be flawed in assessing the hotel’s economic value. However, the court upheld the Commissioner’s 10% salvage value determination due to lack of evidence from petitioners to refute it.

    Depreciation Methods: The court upheld the Commissioner’s disallowance of the retroactive change in depreciation method. Citing Income Tax Regs. sec. 1.167(e)-1 and section 446(e) of the 1954 Code, the court emphasized that changes in depreciation methods require the Commissioner’s consent. The court stated, “The 1954 regulations are explicit that any changes in the method of computing the depreciation allowance with respect to a particular account is a change in a method of accounting requiring consent, excepting only a change from the declining balance method to the straight line method.” Since petitioners used the straight-line method and did not obtain consent to change, and no arbitrary withholding of consent was shown, the court ruled against allowing the retroactive change to the declining balance method.

    Practical Implications

    Casey v. Commissioner provides critical guidance on several partnership tax principles. It underscores the necessity for meticulous record-keeping in partnerships to accurately track partner basis adjustments, including contributions, distributions, income, losses, and liabilities. The case clarifies that a partner’s initial basis in an inherited partnership interest includes their share of partnership liabilities at the time of inheritance, consistent with both Code and regulatory interpretations. Furthermore, it reinforces the principle that taxpayers must adhere to their established depreciation methods and obtain the Commissioner’s consent before implementing changes, especially retroactive ones. This case serves as a reminder that while taxpayers can challenge the Commissioner’s determinations on useful life and salvage value, they bear the burden of proof and must present compelling evidence to overcome the presumption of correctness. The decision highlights the Tax Court’s reliance on expert testimony and economic realities in determining depreciation matters, moving beyond purely physical assessments of assets.