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
- 10 -

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.
- 11 -

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
- 12 -

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.
- 13 -

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
- 14 -

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
- 15 -

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,
- 16 -

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.
- 17 -

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
- 18 -

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
- 19 -

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
- 20 -

$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
- 21 -

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
- 22 -

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
- 23 -

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).
- 24 -

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
- 25 -

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
- 26 -

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'
- 27 -

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.