T.C. M em o . 2 0 1 6 -2 3 2

UNITED STATES TAX COURT

BOBBY R. HARGIS AND BRENDA J . HARGIS, Pet i ti o ners v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 1 4 7 16 -1 5
. Fi l edDecem b er 2 1 , 2 01 6
.
Crai g S. Lai r an d Bet s y Tu rn er, fo r p et i t i o n ers . An n Lo u i se Darn ol d , fo r res p o n d en t .

M EM ORANDUM FINDINGS OF FACT AND OPINION COHEN, Ju d g e: Res p o nd en t d et erm i n edd efi ci en ci es o f $ 15 3 ,7 8 2 an d $ 1 2 7 ,9 8 4 i n p et i t io ners ’ Fed eral i n co m e t ax fo r t ax ab le y ears 2 0 0 9 an d 2 0 1 0 , res p ect i vel y . Th e i s s ues fo r d eci s i o n are: (1 ) wh et her Bo b by Harg i s (p et i t i o n er) h ad s uffi ci en tb as i s i n h i s S co rp o rat i o n s t o al l ow h i m t o d edu ctth e l o ss es g en erat edb y

tho s e en t it ies i n t ax y ears 2 0 07 th ro ug h 2 0 10 ; (2 ) i f p et i t i o n er d i d- 2
-

[* 2 ] h av e s u ffi ci en tb as is t o d edu ctth e l o s s es , wh et h er h e m at eri al l y p art i ci p at ed i n the o p erat i o n s o f t h e S co rp o rat i o n s du ri n g th e y ears i n i s s u e, s o thatth e l o s s es p as s edth ro u g h t o h i m

fro m the co rp o rat i o n s s h o ul db e t reat edas l o s s es fro m
n o np as s i ve act iv i t i es ; (3 ) i f p et i t i o n er’ s l o s s es wi th res p ectt o th e S co rp orat i o n s
s h o u ldb e al l o wedas d educt i o n s an dtreat edas n o np as s i v e, wh et h er t h e i n co m e o r l o s s es o f p et i ti o n er Bren d a Harg i s (Bren d a Harg i s), d eri v edfro m h er o wn ers h i p i n t eres t s i n s ev eral LLCs , s h ou l dal s o b e t reat ed as n onp as s i v e b ecau s e t h e ren tal act i vi t i es o f t he LLCs m ay b e g ro up edwi th th e act i v i ti es o f t h e S co rp o rat i o n s ;
an d (4 ) wh et h er Bren d a Harg i s h ads u ffi ci en tb as i s i n h er o wn ers h ip i n t eres t s i n two o f th e LLCs t o al l ow h er t o d educth er p ro rat a s h ares o f l o s s es fro m th o s e
en t i t i es fo r t ax y ears 2 0 09 an d 2 0 1 0
. Un l es s o th erwi s e i n d i cat ed , al l s ect io n referen ces are t o th e In t ern al Rev enu e Co de i n effect fo r t h e y ears i n i s s u e, an dal l Ru l e referen ces are t o th e Tax Co u rtRu l es o f Pract i ce an dPro cedu re. FINDINGS OF FACT So m e o f t h e fact s h av e b een s ti p u lat ed , an dth e s t i p u l at edfact s are i n co rp o rat edi n o u r fi n d in g s b y th i s referen ce. Pet i t i o n ers res i d edi n Ark an s as at th e t i m e t h ey

fi l edth ei r p et i t io n .- 3
-

[* 3 ] Back g ro u n do n Pet it i o n ers ’ Bu s in es s es Pet i t i o ner an d Bren d a Harg i s are a m arri edco up l e wh o o v er t h e y ears h av e
earn eda l i v i n g b y

p art i ci p at i ng i n v ari ou s as p ect s o f t h e n u rs i n g h o m e i n du s try . Du ri n g the y ears 2 0 0 7 th ro u g h 2 0 1 0 , p et i ti o n er was th e 1 0 0 % o wn er o f s ev eral Ark an s as co rp o rat i o n s wh o s e p ri m ary b u si n es s was th e o p erat io n o f nu rs i n g h o m es (o p erat i n g co m

p an i es ). Each o f p et i ti o n er’ s o p erat i n g co m p an i es el ect edt o b e t reat edas a s m al l b u s i n es s co rp o rat i o n p u rs u an tt o s ect i o n 1 3 6 2
. Th e o p erat i n g co m

p an i es th em s el v es d i dn o to wn an y o f t h e real p ro p ert y , faci li t i es , o r eq u i p m en t th ey u s edi n o p erat i n g the n u rs i n g h o m es . In th e cas e o f each n u rs i n g h o m e o p erat i o n , th es e n eces s ary as s et s were h el db y an LLC (n u rs i n g h o m e LLCs ), wh i ch wo u l dl eas e t h em t o p et i t i on er’ s o p erat i n g co m p an y fo r a
m o nt h l y p aym en t . Bren d a Harg i s was a 2 5 % o r l es s m em b er i n each o f t h e
n u rs i n g h o m e LLCs th atren t edp ro p ert y t o p et i t io n er’ s o p erat i n g co m p an i es an d i n s ev eral o th ers thato wn edan dren t edp ro pert y t o o p erat i n g co m

pan i es o th er t h an p et i t i o n er’ s. Th e ro l e o f t h e o p erat i n g co m p an ies was t o m an ag e t h e d ay -t o -d ay b u s i n es s
o f ru n n i n g th e nu rs i n g h o m es . Fo r each n urs i ng h o m e p et i t i o ner h ireda l i cen s ed ad m i n is trat o r t o s up erv is e an dd i rect al l o perat i o nal as p ect s o f th e faci l it y d ai l y , i n cl u d i n g p at i en tad m i ss i o n s an dd i sch arg es , p at i en tb i l l i n g, n u rs i n g s erv i ces , fo o d- 4
-

[* 4 ] s erv i ces , h o u s ek eep i n g , an dfaci l i ty up k eep an d m ai n ten an ce. Pet i t io n er
s p o k e wi th th e ad m in i s trat o rs ath i s faci l i t i es o ver t h e p h o n e atl eas tweek ly , an d h e h el dm eet i n gs qu art erl y wi th al l th e ad m i n i s trat o rs h e em p l o y edi n a g i v en reg i o n . As o wn er o f t h e o p erat i n g co m pan ies , p et i t i o ner was co ns u l t edab o u tan d ap p ro v edal l h i ri n g d eci si o ns fo r k ey p o s i t i o ns atth e n u rs in g h om es , m etwi th th e h o m es ’ v en d ors an dap p ro v edn ew v en d o r co n tract s , an dap p ro v edal l b u s in es s p u rch as es th atex ceed ed$ 5 00
. Pet i t i o ner al s o p ers o n al l y v i s i t ed th e n u rs i n g h o m es o p erat edb y h i s
o p erat i n g co m

p an i es o n ce o r t wi ce a m o n th . Pet i t i o n er h adp as tex p eri en ce
wo rk i n g as a n u rs i ng h o m e i n s p ect o r fo r a St at e ag en cy , an ddu ri n g h i s v i si t s h e
wo u l dp h y s i cal l y

wal kth ro u gh an di ns p ectth e faci l it i es t o en s u re t h ey m ets afet y
s t an d ard s . Wh en p et i t i o n er fo un dth at m ai n ten an ce rep ai rs were n eed ed , h e wo u l d
o rd er an do v ers ee t h ei r co m p l et i o n . Duri n g h i s i n -p ers on v i s i t s p et i t i o n er wo u l d al s o h av e co n vers at i o n s wi th an dev al u at e t h e p erfo rm an ce o f s t aff m em b ers , ch eckth e qu al i ty o f t h e fo o db ei n g s erv edt o p at i en t s , an drev i ew th e b u s i nes s es ’
co s t s wi th th e ad m i n i s trat o rs . Fro m 2 00 7 t o 2 0 1 0 , p et i t i o n er was al s o an em pl o y ee o f Co o p er Ad m i n i s trat i v e Serv i ces (CAS). CAS was o wn edb y J im Co o p er (Co op er), wh o
was al s o a m em

b er o f t h e s am e nu rs i n g h o m e LLCs as Bren d a Harg i s . CAS- 5
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[* 5 ] co n tract ed w it h p et it i o n er’ s o perat i n g co m p an i es an dwas p ai d m o n th l y a fi xedp ercen tag e o f t he n u rs i n g h o m es ’ g ro s s rev en u es t o p ro v i d e a ran ge o f
acco u n t in g , p ayro l l , an db i l l i n g an dco l l ect i o n s erv i ces t o th e b u s i n es s es . CAS p ro v id edth es e s erv ices t o n u rs i n g h o m e b u s i nes s es o th er t h an p et i t i o n er’ s an d al s o p ro v i d edt o s u ch b u s i n es s es i n fo rm at i o n an d g u i d an ce rel at edt o i n du s try tren d s , reg ul at o ry co m

p l i an ce, an dri s km an ag em en t . Pet i t i o ner’ s ro le was t o s erv e as th e “ ey es an dears ” fo r CAS o n s i t e atth e
v ari o u s faci l i t i es CAS co n tract edwi th , an di n ad d i t i o n t o v i s i t i n g h i s o wn
o p erat i o n s o v er t h e co u rs e o f t h e m o n th p et i t io n er wo u l dv i si t n u rs i n g h o m es ru n b y o th er o p erat i n g co m

pan i es . Pet i t i o n er was p ai da s al ary b y CAS al l fo u r o f t h e y ears i n qu es t i on , an dh e recei vedn o co m p en s at i o n fro m

h i s o p erat i n g co m

p an i es du ri n g th o s e y ears . Lat er, p et i t i o n er ceas edwo rk in g fo r CAS an d s t art edrecei v i n g wag es fro m

h i s o wno perat in g co m

p an i es , p ro b ab l y

b eg i n ni n g i n 2 0 1 2
. Bu s i nes s M o d el an dFu nd i n g o f t h e Nu rs i ng Ho m e Bu s i n es s es Th e b u s i n es s m o d el s ub s cri b edt o b y th e n u rs i n g h o m e LLCs an dth ei r
m em b ers i n v o l v edt ak i n g o v er ru n d o wn o r d is tres sedn u rs in g h o m e o p erat i o n s , rev am pi n g th ei r faci l i t i es an dm an ag em en t , an dtran s fo rm i n g them i n t o p ro fi t ab l e b u s i n es s es . Th is s trat eg y o ft en req u i redl arg e, up fro nt cap i tal o u t l ay s t o b e m ad e t o ren o v at e an di n s o m e cas es reco n s tru ctth e n u rs in g h o m e faci l i t i es , an dev en- 6
-

[* 6 ] o n ce b u i l d i n g was co m p l et e i tt o o kt i m e t o g etth e b us i n es s es ru nn i ng ata p ro fi tab le l ev el . Duri n g th es e reb u i l d i n g p eri o d s cas h fl o w i n t o th e b u s in es s es
wo u l db e g reat l y

redu ced
. Thu s th e i n it i al p ro ces s o f “ res t art i n g ” a n u rs i n g h o m e
wo u l du s u al l y

g en erat e l arg e n eto p erat i n g l o s ses i n atl eas t th e fi rs to n e o r t wo t ax ab l e y ears fo l l o wi n g th e n u rs i n g h o m e LLC’ s acq u i s i t i o n o f t h e p ro p ert y . Pet i t i o ner’ s o p erat in g co m p an i es l ack edth e wo rk i n g cap it al n eed edt o b eg i n
o p erat i n g th e b u si n es s es . To m eeto p erat i n g ex p en s es att i m es wh en th e b u s i n es s es s u ffered rev en u e s h o rt fal l s , p et i t i o n er’ s o perat i n g co m p an i es rel i edo n
n u m ero u s l o an s fro m

v ari o u s s o u rces . Fo r t h e fi v e o p erat i n g co m pan i es wh o s e l o s s es are t h e s ub

jecto f res p o n d en t ’ s n o t i ce o f d efi ci en cy , Bax ter Co u n ty Nu rs in g Faci l i ty , In c. (Bax t er Co u nt y ), FCNRC, In c. (FCNRC), Co rn i n g Th erap y & Li v i n g Cen ter, In c. (Co rn i n g ), Rect o r Nu rs i n g & Reh ab Cen t er, In c. (Rect o r), an d Os ceo l a Th erap y

& Li v i n g Cen t er, In c. (Os ceo l a), t h es e l o an s fel l i n t o t h ree cat eg o ri es : (1 ) l o an s recei vedfro m th e n u rs i n g h o m e LLCs i n wh i ch Bren d a Harg i s h el dan i n t eres t(an d, i n t h e cas e o f o ne o f t he o p erat i n g co m p an i es , l o an s recei v edfro m

an i n d i v idu al n u rs i n g h o m e LLC m em ber) (LLC l o an s), (2 ) l o an s recei v edfro m

p et it i o n er’ s o ther o p erat i n g co m p an i es (i n t erco m

p an y l o an s ), an d (3 ) l o an s recei v edfro m

b an k s o r i n s t i tu ti o n s h av i n g n o co n n ect i o n wi th p et i t i o n er
o r t h e LLCs (co m

m erci al l o an s ).- 7
-

[* 7 ] Fo r al l o f t h e LLC l o an s an di n t erco m p an y l o an s , an d fo r s o m e o f th e
co m m erci al l o an s , p et i t i o n er s i g n edth e n o t es ev id en ci n g t h e l o an s i n h i s i n d i v i du al cap aci ty

as a co b o rro wer al o n g wi th h is o p erat i n g co m p an i es . W i th
res p ectt o t h es e l o an s p et i t i o ner s i gn edo n as a co b o rro wer, p ro ceed s were ad v an cedd i rect l y

b y th e l en d i ng en t i ty

t o th e co b o rro wi n g o p erat i n g co m pan y . To th e ex t en tp aym en t s b ecam e du e o n s u ch l o an s , th ey were m ad e b y

th e o p erat i n g
co m p an i es an dn o to u t o f p et i t io n er’ s p ers o n al acco u n t. Th e LLC n ot es an d i n t erco m p an y n o tes al l t o o kth e s am e “ s h o rtfo rm ” an d al l p ro vi d edfo r a t erm

o f s ev en y ears an dan i n teres trat e o f 0 % . Ano ral ag reem en tex i s t edb et ween p et i t i o n er an d t h e m em b ers o f t he n u rs i n g h o m e LLCs th atth e LLCs wo u l dl en dfu nd s t o th e o p erat i n g co m p an i es i f ex tra cas h was
n eed edt o m eetth e b u s i n es s es ’ o p erat i n g ex p en s es an dth e LLCs h ad s uffi ci en t
cas h res erv es o n h an d. Pet i t i o n er h i m s el f m ad e d eci s io n s t o m ov e fu n d s fro m o n e
o p erat i n g co m

p an y t o an o th er; an dh e rev iewedth e rel at i v e cas h fl o ws o f h i s
co m p an i es s ev eral t i m es a m on th t o d et erm i n e wh en an d wh ere s u ch l o an s were
n eces s ary t o k eep al l o p erat i o n s ru n n i n g s m oo thl y . M o s t o f t h e l o an s recei v edb y the fi ve o p erat i n g co m

pan i es n am edab o v e du ri n g th e y ears i n i s s u e were ei t h er LLC l o an s o r i n t erco m p an y l o an s . Th e
m ajo ri ty o f t h e LLC l o an s an di n t erco m p an y l o an s were fo r am o u nt s l es s th an- 8
-

[* 8 ] $ 1 0 0 ,0 0 0, an dthe p ro ceed s o f t h es e l o an s were u s ed p ri m ari l y b y th e b o rro wi ng co m

p an ies t o m eetb as i c o p erat i n g ex p en s es . Each o f t he o p erat i n g
co m p an i es al so en t eredi n t o atl eas t o n e co m m erci al l o anarran g em en twi th a l en d er u n rel at edt o ei th er p et i t i o n er o r t h e LLCs
. Al l o f th e co m m erci al n o t es b ore
an ag reed -up o n rat e o f i n t eres tan dcal l edfo r p eri o d i c p aym en t s . Th e t ab l e b el o w g i ves a s u m m ary o f t he co m

m erci al l o an s fo r wh i ch p et i t i o n er’ s o p erat i n g co m p an ies were co b o rro w ers : L ender B orrower(s) Petitioner Date Amount Universal Reinsurance Co. B ax ter County Coborrower October 2007 $183,470

B ax ter County Coborrower J u ly 2 0 09 372,035 F NCRC Coborrower October 2007 131, 821 F NCRC Coborrower J u ly 2 0 09 94,158 F armer’s B ank & Trust Co. Osceola (w/ one

nursinghome L L C) Guarantor December 2010 4,071,925

B ank of Oklahoma Corning& Rector

(w/ two other operating companies & three nursing home L L Cs) Guarantor August 2009 1,280,000 term loan, w/ construction loan not to ex ceed 3,360,000 Bo rro wi n g b y

th e Nu rs i n g Ho m e LLCs Th e n u rs i n g ho m e LLCs wo u ldal s o o n o ccas i o n b o rro w o r co bo rro w fu n d s , g en eral l y fo r t he p u rch as e o f t h e real p ro p ert y an d faci l i t i es th atwo u l d b e u s edfo r- 9
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[* 9 ] th e n u rs in g h om e b us i n es s es . Bren d a Harg is was a m em b er o f M el bo u rn e Pro p ert i es , LLC (M el b o u rn e Pro p ert i es ), wh i ch recei v eda l o an o f $ 2 m i l l i on fro m Li b ert y Ban ko f Ark an s as (Li b ert y Ban k ) i n Decem

b er 2 0 0 5. Bren d a Harg i s , p et i t i o n er, an dfo ur o th er i n d i v i du al s s ig n edg u aran ty ag reem en t s as s ecu ri ty

fo r th e Li b ert y

Ban kl o an . Th e Li bert y

Ban kl o an ag reem en td idn o t s tat e t h atth e l o an wo u l db e reco u rs e d eb tas t o i n d i v i du al m em b ers o f M el b o u rn e Pro p ert i es . Th e Fo rm s 1 0 6 5, U.S. Retu rn o f Part n ers h i p In co m e, fi ledb y M el b ou rn e Pro p ert i es fo r t h e t ax y ears 2 0 0 7 , 2 0 0 8 , an d2 00 9 d i dn o trep ortth e am ou n to f p art n ers hi p l i ab i l it i es ex i s t i n g atth e en d o f each o f t h o se t ax y ears an dd i dn o t i n cl u d e an al y s i s o f p artn ers ’ cap i t al acco un t s . Th e Sch edu l es K-1 , Part n er’ s Sh are
o f In co m e, Dedu ct i o n s , Cred i ts , et c., i s su edt o Bren d a Harg i s fo r 2 0 0 7 th ro u g h 2 0 0 9 d i dn o trep o rtth e am o u n t o f h er s h are o f p art n ers h i p l i ab i l i t i es aty earen do r g i v e an an al y s is o f h er cap i t al acco un taty earen d
. Bren d a Harg i s was al s o a m em b er o f Cl ay

Co un ty , LLC (Cl ay Co u nt y ), wh i ch was o n e o f s ev en co b o rro wers o n a l oan fro m Ban k o f Ok l ah o m a i n Au g u s t 2 0 0 9 . Th e Ban ko f Ok l ah o m a l o an p ro ceed s were fo r t h e p u rch as e o f t h e Co rn i n g
n u rs i n g h o m e p ro pert y

b y Cl ay Co u n ty an dfo r t h e co ns tru ct i o n o f a n ew faci l i t y
o n th atp ro p ert y . Th e ag reem en td i dn o ts t at e wh et h er o r h o w res p o ns i b i l it y fo r th e i n d eb t ed n es s was t o b e ap p o rt i o n edam o n g the s ev enen t i t i es l i st edas- 1 0 -

[* 1 0 ] co bo rro wers . Bren d a Harg i s , p et i t i o n er, an dtw o o th er i n d i v i dual s s i g n edas g u aran to rs o f t h e Ban k o f Ok l ah o m a l o an . Th e Ban ko f Ok l ah o m a l o an was n o t d es cri b edi n th e l oan ag reem en tas b ei ng reco u rs e, an d th e rem ed i es p ro v i d edfo r
up o n d efau l t d i dn o t i n cl u d e act i o n s ag ai n s t i nd i v i du al m em b ers o r s h areh ol d ers o f
an y o f t h e b o rro wi n g en t i t i es . Th e Fo rm 1 0 6 5 fi l edb y

Cl ay Co u n ty fo r 2 0 09 rep o rt ed p art ners h i p l i ab i l i t i es fro m

“ M o rt g ag es , n o t es , b o n d s p ay ab l e i n 1 y ear o r m o re” eq u al i n g $ 2 ,5 3 1 ,1 9 6 an dg av e an an al y si s o f p artn ers ’ cap i t al acco u n t b al an ces . Th e Sch edu l es K-1 i s s u edt o Bren da Harg i s fro m Cl ay Co u n ty fo r 2 0 0 9 an d 2 0 1 0 p ro v id edcal cu l at io n s o f Bren d a Harg i s’ cap it al acco u n tatth e en do f t h e t ax ab l e y ears . Th e Sch edu l es K-1 d i d n o t rep o rtth e am o u n to f h er s h are o f p art ners h i p l i ab i l i t i es fo r t h os e y ears . Lo s ses Rep o rt edo n Pet i t i o ners ’ Retu rn s an d th e No t i ce o f Defi ci en cy A nu m b er o f p et i t i o n er’ s o p erat i n g co m p an i es , i n cl u d i ng th e fi v e n am ed ab o ve, rep o rt edn eto p erat i n g l os s es fo r th e t ax ab l e y ears en d i n g Decem ber 3 1 , 2 0 0 7 , 2 0 0 8 , 2 0 0 9, an d2 01 0 . Th es e l o ss es were p as s edth ro u g h an d rep o rt edb y p et i t i o n ers o n th ei r jo i n tl y -fi l edFo rm s 1 0 4 0, U.S. In d i vi du al In co m e Tax Retu rn , fo r t h o s e s am e t ax y ears . Incal cu l at i n g th e l o s s es h e rep o rt edwi th res p ectt o th e
o p erat i n g co m

p an i es , p et it i on er each y ear cl ai m edan i n creas edt ax b as is i n th e- 1 1 -

[* 1 1 ] i n d eb t ed nes s o f t h e o p erat i n g co m p an i es o n the b as i s o f h i s p o s i ti o n as
co b orro w er, an di n s o m e i n s tan ces g u aran t o r, o f t h e l o an s recei v edb y th e
co m p an i es . Th e at tach edSch edu l es E, Supp l em en t al In co m e o r Lo s s , PartII, In co m e o r Lo s s fro m Part ners h i p an dS Co rp orat i o n s, rep o rt edth e l o s s es fro m p et i t i o n er’ s o p erat i n g co m p an ies as l o s s es fro m

n o npas s i v e act i v i ti es . Sev eral o f t h e n u rs in g h o m e LLCs al s o rep o rt edn eto p erat i n g l o s s es fo r t ax y ears 2 0 0 7 th ro u g h 2 0 1 0 . Bren d a Harg i s ’ p ro rat a s h ares o f th e LLC l o s s es were,
m o sto ft en , al s o rep o rt edo n p et i t i o n ers ’ Sch edu l es E as n o npas s i v e l os s es . Pet i t io n ers rep ort edo n th ei r jo i n tretu rn s l os s es fro m M el bo u rn e Pro p ert ies fo r 2 0 0 7 , 2 0 0 8 , an d 2 0 0 9, an dfro m Cl ay Co u nt y fo r 2 0 0 9 an d2 0 1 0
. W i th th ei r 2 0 0 8 jo i n tretu rn p et i ti o n ers b eg an rep o rt i n g a n eto p erat i n g l o s s carry o ver as p arto f “ Oth er In co m e”, rep o rt edo n l i n e 2 1 o f th ei r Fo rm s 1 04 0 . Fo r 2 0 0 9 an d2 0 1 0 , th e y ears t o wh i ch res p on d en t ’ s n o t i ce p ert ai n s, p et i t io n ers cl ai m edd edu ct i on s fo r n eto p erat i n g l o s s carry ov ers o f $ 6 3 7 ,5 2 3 an d$ 8 1 9 ,7 7 2 , res p ect i vel y . OnM arch 1 2 , 2 0 1 5 , res po n d en ti s s u eda n o t i ce o f d efi ci en cy p ro p os i n g t o t al ad ju s t m en t s o f $ 1 ,3 8 2 ,2 06 an d$ 1 , 9 0 0 ,8 9 8 t o p et i ti o n ers ’ t ax ab l e i n co m e fo r t h e y ears 2 0 0 9 an d2 0 1 0 , res p ect i v el y . Res po n d en td et erm i n edth at p et i t i o n ers ’ cl ai m edd edu ct i on s fo r n eto p erat i n g l o s s carry ov ers s h ou l db e co m p let el y- 1 2 -

[* 1 2 ] d i s al l o wedfo r b o th y ears 2 0 0 9 an d 2 0 1 0 o n th e b as i s o f h i s fi n d i n g th at p et i t i o n ers i m

p ro p erl y rep o rt edcert ai n l o s s es ari si n g fro m th ei r b u s i nes s act i v i t i es fo r 2 0 0 7 an d 2 0 0 8. Res p o n d en td et erm i n edp et it i o n er was n o ten ti t l edt o i n creas e h i s b as i s i n th e i n d eb t ed n es s o f t h e o p erat i n g co m p an i es b ecau s e o f h is p art i ci p at i o n as co b o rro wer o r g u aran t or o f t h e ab o v e-d es cri b edl o an s , an dfo r t h at
reas on res p o n d en td et erm i n ed p et i t i on er l ack eds u ffi ci en tb as i s t o d edu ctth e
o p erat i n g co m

p an i es ’ l o s s es fo r 2 0 0 7 an d2 0 0 8 . Ad d i t i o n al l y , res p o nd en t d et erm i n edp et i t i o n ers were n o ten t i t l edt o d edu ctth e 2 0 0 7 an d2 0 0 8 p as s th ro u g h l o s s es th ey

rep o rt edfro m

Bren d a Harg i s ’ i n t eres t i n M el b o u rn e Pro p ert ies , b ecau s e p et i ti o n ers h adfai l edt o es tab l i sh th atBren d a Harg i s h ads u ffi ci en tb as is i n h er i n t eres tfo r t h o s e l o s s es t o b e d edu ct i b l e. Res p o n d en tn ex td et erm i n eds ev eral ad ju s t m en t s t o p et it io n ers ’ Sch edu l es E fo r t h e t ax y ears 2 0 0 9 an d2 0 1 0. Ag ai n, res p o n d en td et erm i n ed p et i t io n er co u l d
n o ti n creas e h i s b as i s b y

th e l o an s recei v edb y

th e o p erat i n g co m

p an i es , an d cl ai m edl o s s es at tri b ut ab l e t o th o s e en t i t i es fo r 2 0 0 9 an d2 0 1 0 were red u cedb y
res p o n d en t, i n m o s tcas es t o zero . Res p o n d en tal s o d et erm in edp et i t i o n ers h ad fai l edt o s h o w th atBren d a Harg i s h ada s u ffi ci en t b as i s i n h er i n t eres ti n M el bo u rn e Pro p ert i es t o al lo w th em t o d edu cth er p ro rat a s hare o f l o ss fro m th at
en t i ty fo r 2 0 0 9 . Las t l y , res p o nd en td et erm i n edth ata l o s s rep o rt edb y p et i ti o n ers- 1 3 -

[* 1 3 ] fo r 2 01 0 fro m

Bren d a Harg i s ’ i n t eres ti n Cl ay Co u n ty s h o ul db e redu ced
s i nce p et i t i o n ers h ads i m il arl y fai l edt o es t ab l i sh th atBren d a Harg i s’ b as i s i n th at
en t i ty was s u ffi ci en t t o al l o w a d educt i o n o f t h e fu l l am o u n t . Th e l as tm ajo r ad

ju s tm en td et erm i nedb y

res p o n d en ti n th e n o t i ce o f d efi ci en cy

i n v o lv edth e ch aract eri zat i o n o f p et i t i o ners ’ i n co m e an dl o ss es d eri v ed fro m th e n u rs i ng h o m e LLCs
. Fo r t ax ab l e y ears 2 0 09 an d 2 0 1 0 , al l i n co m e an d l o s s es fro m

th e LLCs i n wh i ch Bren d a Harg i s o wn edi nt eres t s were rech aract eri zedb y

res p o n d en tas i n co m e o r l o s s es fro m p as s i ve act i v i ti es b ecau s e th e n u rs i n g h om e LLCs co n du ct edo n l y ren t al act i v i t ies
. Res p o n d en tal s o d et erm in edatth e t im e th e n o t i ce was i ss u ed thatp et i t i o n er d i dn o t m at eri al l y p art i ci p at e i n t h e o p erat i o ns o f t h e o p erat i n g co m p an i es . Ho wev er, i n ex h i b i ts at t ach edt o th e n o t ice o f d efi ci en cy , res p o n den td i dn o t rech aract eri ze an y

o f t he i n co m e o r l o s s es th atwere n o td i sal l owed
.

OPINION Pet i t io n er’ s Bas i s i n th e In d eb t ed n es s o f t h e Op erat i n g Co m pan ies Sect io n 1 3 6 6 (a)(1 ) p ro v i d es a s h areh o l der o f an S co rp o rat i o n s h al l t ak e i n t o acco u n th i s p ro rat a s h are o f t h e S co rp o rat i o n ’ s i t em s o f i n co m e, l o s s, d educt i o n o r cred i t fo r t h e S co rp o rat i o n ’ s t ax ab l e y ear en di n g wi th o r i n t h e
s h areh o ld er’ s t ax ab l e y ear. Sect i o n 1 3 6 6(d )(1 ) l i m i t s th e am o u n to f l o s ses an d- 1 4 -

[* 1 4 ] d edu ct i o ns th e s h areh o l d er m ay t ak e i n t o acco u ntfo r an y t ax ab l e y ear t o th e
s u m o f h i s ad ju s tedb as i s i n th e s to cko f t h e S co rp orat i o n p l u s h i s ad ju s t edb as i s i n “ an y i nd eb t ed n es s o f th e S co rp o rat i o n t o th e s h areh o l d er”. Sec. 1 3 6 6 (d )(1 )(B). An y l o s ses s o d i s al l o wed m ay b e carri edfo rwardi nd efi n i tel y . See s ec. 1 3 6 6 (d )(2 ). Sect io n 1 3 6 6 (d )(1 ) en su res th ata s h areh o ld er m ay n o td edu ct ex pen s es o f th e S co rp o rat io n b ey o n d th e ex t en to f h i s p ers o nal i n v es t m en ti n t h e co rp o rat i o n . Berg m an v . Un i t ed St at es , 1 7 4 F.3 d9 28 , 9 31 (8 th Ci r. 1 9 9 9 ). Th u s co u rt s h av e
co n si s t en t l y

h el dth att o i n creas e h i s b as i s i n an S co rp o rat io n a s h areh o l d er m u s t
m ak e an “ actual eco n o m i c o u t l ay ”. Id . at 9 3 0 n .6 (ci t i n g Perryv . Co m m i s s i o n er, 5 4 T.C. 1 2 9 3 , 1 2 9 5 -1 2 9 6 (1 97 0), aff’ d , 1 9 7 1 W L 2 6 5 1 (8 th Ci r. 1 9 7 1)). An y cl ai m edi n creas e i n a s h areh o l der’ s b as i s m us tb e b as edo n “ s o m e t ran s act i o n wh i ch wh en fu l l y

co n s umm at edl eftth e t ax pay er p o o rer i n a m at eri al s en s e.” Perryv . Co m

m i ss i o n er, 5 4 T.C. at 1 2 9 6 (qu o ti n g Ho rn e v . Co m m i s s i on er, 5 T.C. 2 5 0 , 2 5 4 (1 9 4 5)). Gen eral ly th en , s ect i o n 1 3 6 6 (d )(1 )(B) co n tem pl at es a d i rectl o anb y

th e
s h areh o ld er t o the co rp o rat io n u s i n g h i s o wn fu n d s , o r atl eas tu si n g fu nd s fo r wh i ch h e wi l l b e h el d u l t im at el y res p o n s i b l e. Oren v . Co m m i s si o n er, T.C. M em o . 2 0 0 2 -1 7 2 , aff’ d, 3 5 7 F.3 d8 5 4 , 8 5 8 (8 th Ci r. 2 0 04 ). Th i s Co u rt h as fo u n dth at- 1 5 -

[* 1 5 ] b as i s can b e creat edwh ere a s h areh ol d er b o rro ws fu n d s fro m a t h i rdp art y
an d th enu ses th o se fu nd s t o m ak e a l o an t o t h e co rp o rat i o n (a “ b ack -t o -b ack ” l o an ). See Ray n o r v . Co m m is s i o n er, 5 0 T.C. 7 6 2 , 7 7 1 (1 9 6 8 ); M i l l er v . Co m m i s s i o n er, T.C. M em o . 2 0 0 6 -1 2 5 , 2 0 06 W L 1 6 5 2 6 81 , at* 7 (ci t i n g Bo l d i n g v . Co m m i s s i o n er, 1 1 7 F.3 d2 7 0 (5 th Ci r. 1 9 97 ), rev ’ g T.C. M em o . 1 9 9 5 -3 2 6 ). Th e
s h areh o ld er can al s o i n creas e h i s b as i s i n the co rp o rat i o n b y l en d i n g m o ney

th ath e h as b orro wedfro m

an o th er wh o l l y

o wn eden t i ty , al th o u g h i n s u ch a cas e t h e
arran g em en ti s ey edwi th s cru t i n y an dth e t ax p ay er b ears the b u rd en o f d em o n s trat i n g thata g en u i n e i n d eb t ed n es s was creat edb et ween h i m s el f an dth e rel at ed en t i ty . See Oren v . Co m m i s s i on er, 3 5 7 F.3 d at8 58 ; Yat es v . Co m m i s s i o n er, T.C. M em o . 2 0 0 1 -2 8 0
. In an y ev en t , i ti s wel l s et t l ed th atfo r b as i s t o b e creat edfo r a s h areh o l d er
u n d er s ect i o n 1 3 6 6 (d )(1 )(B), t h e co rp o rat i o n’ s i n d eb t ed n es s m u s tru n “ di rect l y

t o th e s h areh o l d er.” Pras h k er v . Co m m i s s i on er, 5 9 T.C. 1 7 2 , 1 7 6 (1 97 2 ). No b as i s i s creat ed fo r a s h areh o l d er wh en fu n d s are ad v an cedt o an S co rp o rat i o n b y a
s ep arat e en t i ty , ev en o n e cl o s el y rel at edt o th e s h areh o l d er. Berg m an , 1 7 4 F.3 d at 9 3 2 . As i s o ft en s ai d , “ [n ] o fo rm o f i n d i rect b o rro wi ng , b e i tg u aran ty , s u ret y , acco m m o d at i o n , co m ak i n g o r o th erwi s e, g i ves ri s e t o i n d eb t ed n es s fro m th e
co rp o rat i o n t o th e s h areh o l d ers u n t i l an du n l es s th e s h areh ol d ers p ay p arto r al l o f- 1 6 -

[* 1 6 ] th e o b l ig at i o n. Pri o r t o th atcru ci al act , ‘ l i ab i li ty ’ m ay ex i s t , b u t n o td eb tt o th e s h areh o l d ers .” Rayn o r v . Co m m i s s i o n er, 5 0 T.C. at7 7 0 -7 7 1. In th i s cas e, t h e l o an tran s act i o n s were s tru ctureds o th atth e i n d eb t ed n es s o f p et i t i o n er’ s o p erat i n g co m p an ies ran d i rect l y fro m

th e o p erat i n g co m

p an i es t o th e l en d i n g en t i t i es . Fo r al l th e l o an s ati s s u e t he p ro ceed s were ad v an cedd i rect l y b y th e l en d i n g en t i t i es t o t h e o p erat i n g co m p an ies , an d t h e n o tes ex ecu t edb y th e
o p erat i n g co m

p an i es were p ay ab l e t o en t it i es s ep arat e fro m p et i t i o n er. On th e face
o f t h e n o t es th e o p erat i n g co m p an i es are n o t i n d eb t edt o p et i t i o n er fo r an yth i n g ; rat h er, p et i ti o n er i s l i s t ed as a co b o rro wer, an di n s o m e i ns t an ces , a g u aran t o r. Perh ap s ack n o wl ed g in g thatth e n o t es them s el v es ev id en ce n o “ i n d eb t ed n es s o f th e S co rp o rat io n[s ] t o th e s h areh o l der”, s ee s ec. 1 3 6 6 (d )(1 )(B) (em p h as i s ad d ed ), p et i t i o n ers em

p has ize t h e ex ten to f p et i t io n er’ s p ers o n al l i ab i l it y fo r t he b o rro wed
s u m s . Inp art i cu l ar, p et it i o n ers p o i n tt o th e fact th atp et i t i o n er s i g n edi n di v i du al l y
as a co b o rro wer o n al l o f t h e i n t erco m p an y an d LLC l o an s recei v edb y h i s
o p erat i n g co m

p an i es , as wel l as o n th e fo u r Un i v ers al Rei n s u ran ce Co . n o t es . Pet i t i o ners arg ue t h atu n d er Ark an s as St at e l aw a co b orro wer i s “ di rect l y l i ab l e” fo r rep aym en tan dth ath i s l i ab i l i ty “ i s th e s am e as i f t h e l oan were m ad e t o th e b o rro wer i n d i v i du al l y . ” Pet i t i o n ers b el iev e t h atthe as s u m pt io n o f
co b orro w er’ s l i ab i l i ty , wh i ch th ey s ay p ut“ [p et i t i o n er’ s ] o wn fu n d s * * * atri s k ”,- 1 7 -

[* 1 7 ] am o un t s t o an eco n o m i c o u t lay b y p et i t i o n er t h at s ho u l db e t reat ed , i n effect , as i n d eb t ed n es s o f t h e o p erat i n g co m p an i es t o h i m . Th i s i s, h o wev er, t h e
reas on i n g th at h as b een reject edb y th i s Co u rt an do th ers i n p ri o r cas es . Th o s e
cas es m ak e cl ear t h atth e b are p o ten t i al fo r l i ab i l i ty , wi th o u tm o re, wi l l n otb e
co n si d ereda real eco n o m i c o u t l ay b y a s h areh o l der. See, e.g ., Es t at e o f Leav i t tv . Co m m i s s i o n er, 9 0 T.C. 2 06 , 2 1 1 -2 1 2 (1 9 8 8 ), aff’ d , 8 7 5 F.2 d 4 2 0 (4 th Ci r. 1 9 8 9 ); Un d erwo o dv . Co m

m is s io n er, 6 3 T.C. 4 6 8 , 4 7 5 -4 7 6 (1 9 7 5 ), aff’ d , 5 3 5 F.2 d3 0 9 (5 th Ci r. 1 9 7 6 ); Perryv . Co m m i s s i o n er, 4 7 T.C. 1 5 9 , 1 63 -1 6 4 (1 9 6 6 ), aff’ d , 3 9 2 F.2 d4 5 8 (8 th Ci r. 1 9 6 8); Es t at e o f Bean v . Co m m i s s io n er, T.C. M em o . 2 00 0 -3 5 5 , 2 0 0 0 W L 1 7 0 6 7 1 4, at* 2 -* 3 , aff’ d , 2 6 8 F.3 d5 5 3 (8 th Ci r. 2 0 0 1 ). Th e reco rd rev eal s thatp et i t i o n er was n ev er h i m s el f s ub ject edt o t h e b u rd en
o f p ay i n g b ackth e am o u n t s b o rro w edb y h i s o p erat i ng co m

p an i es . Pet i t i o n er t es t i fi edattri al th atth ere were n o d efau l t s o n th e l o an s an dth ath e was n ev er cal l edo n t o m ak e an y p aym en t s o n th e l o an s p ers o n al l y . To th e ex t en tp aym en t s
were m ad e, t h ey

were m ad e b y

th e o p erat i n g co m

p an i es d i rect l y

b ack t o th e l en d ers . An y

i n t eres tp ai db y

th e o p erat i n g co m

pan i es o n th e i n d eb t ed n es s p res u m ab l y

was n o t rep o rt edas co n s tru ct i v e d iv i d en d s t o p et i t i o ner. Pet i t i o n er
n ev er p l ed g edan y

o f h i s p ers o n al p ro pert y

as co l l at eral fo r th e am o u n ts b orro wed b y h i s co m p an i es .- 1 8 -

[* 1 8 ] As co b o rro wer, p et it i o n er co u l dth eo ret i cal l y h av e b een req u i red t o m ak e p aym en t s t o t h e l en d ers wh en th ey b ecam e du e, an di n s uch a cas e i two ul db e p o s s i b l e t o s ay

th atp et i t i o n er’ s p aym en t s s ub ro g at edh i m t o th e ri g h t s o f t h e
o ri g i nal l en d er; i n th atcas e, t h e o p erat in g co m p an y wo u l db e d irect l y

i n d eb t edt o h i m . Ho wev er, p et i t i o n er was n ev er s o req u i red . So l o n g as p et i t i o n er’ s p ers o n al l i ab i l i ty rem ai n edo n l y

p o t en ti al , i two ul d b e i n co rrect t o s ay h e m ad e aneco n o m ic
o u t l ay th atl efth i m

“p o o rer i n th e m at eri al s en s e.” Th e d eb ts o f t h e o p erat in g
co m p an i es wh en th ey

were i ncu rredran fro m

th e b o rro wi n g co m

p an i es t o th e l en d i n g en t i t i es , an d atn o p o i n td i d p et i t io n er i n t erp o s e h i m s el f b et ween th e p art i es . Pet i t i o ners al s o rel y

o n th e cas e Sel fe v . Un i t edSt at es , 7 7 8 F.2 d 7 6 9 (1 1 t h Ci r. 1 9 85 ), fo r t h e p ro p o s it i o n th ata s h areh ol d er’ s g u aran ty o r co m ak i ng o f a th i rd -p art y l o an t o th e co rp o rat i o n s h o ul db e t reat edas an i n v es tm en tb y th e
s h areh o ld er i n the co rp o rat io n wh ere “ th e l en d er l o o k s t o th e s hareh o l d er as th e p ri m ary o b l i g or.” Pet it i on ers as ku s t o v i ew p et it i o n er’ s co m ak i n g an dg u aran t y
arran g em en t s co n s tru ct i v el y as b ack -t o -b ackl o an s fro m th e l en d ers t o p et i t i o n er
an d fro m p et i t io n er t o th e o p erat i n g co m p an i es . Th e “ s ub s t an ce o ver fo rm ” arg u m en tad v an cedb y p et i t i o n ers h ere h as b een
m o st l y reject edb y

th is Co u rti n p as tcas es . See, e.g
. , Es t at e o f Leav i ttv .- 1 9 -

[* 1 9 ] Co m

m i s si o n er, 9 0 T.C. at2 12 ; Fran k el v . Co m m is s io n er, 6 1 T.C. 3 4 3 (1 9 7 3), aff’ d , 5 0 6 F.2 d1 0 5 1 (3 dCi r. 1 9 74 ); Sh eb es t er v . Co m m i s s i o n er, T.C. M em o. 1 9 8 7 -2 4 6 , 1 9 87 W L 4 0 2 9 7 . A s h o wi n g t h atth e l en d i n g en ti ty was u s edb y th e t ax p ay er as h i s “ i n co rp o rat edp o ck etb o o k” h as b een reco g n i zedi n s om e cas es . See Yat es v . Co m

m i ss io n er, T.C. M em o . 2 0 0 1 -2 8 0 ; Cu l n env . Co m m is si o n er, T.C. M em o. 2 0 0 0 -1 3 9 , rev ’ d o n an o th er i s su e, 2 8 F. Ap p ’ x 1 1 6 (3 dCi r. 2 0 0 2 ). Th e Co u rti n Sel fe, 7 7 8 F.2 dat7 7 3 , reco g n i zedth at“ t ax p ay ers o rd i n ari l y are b o u n db y th e ‘ fo rm ’ o f t hei r t ran s act i o n an d m ay n o t arg u e t h atth e ‘ s ub s t an ce’ o f t h ei r tran s act io n tri g g ers d i fferen tt ax co n s equ en ces .” See al s o Do n E. W i l l i am s Co . v . Co m m i s s i o n er, 4 2 9 U.S. 5 6 9 , 5 7 9 (1 9 7 7); Co m m i s s io n er v . Nat ’ l Al fal fa Deh y drat i n g & M i n i ng Co ., 4 1 7 U.S. 1 3 4 , 1 4 9 (1 9 7 4 ). Es p eci al l y wh ere t h e
en t i t i es i n v o l v edi n a t ran s act i o n are each wh o l l y o wn edb y

th e t ax p ay er, th e t ax p ay er b ears a h eav y

b u rd en o f d em o n s trat in g th atth e s ub s t an ce o f t h e tran s act io n d i ffers fro m

i t s fo rm . Ru ckri eg el v . Co m m i s s i o n er, T.C. M em o . 2 0 06
- 7 8 , 2 0 0 6 W L 1 0 0 7 6 2 8 , at* 8 (ci t i n g Berg m an , 1 7 4 F.3 dat9 3 3 ). In th e cas e ath an dn o n e o f t h e p ro ceed s o f t he l o an ag reem en t s en t eredi n t o b y p et i t i o n er an dh is o perat i n g co m p an i es were ev er ad v an ced t o p et i ti o n er i n d i v i du al l y . W e th i nkth i s d i s t i n ct i o n i s cri ti cal . Whati n i t i al l y h ap p en edi n Sel fe
was a l o an t o the t ax p ay er d i rect l y , th e p ro ceed s o f wh ich s h e u s edt o i n v es ti n h er- 2 0 -

[* 2 0 ] fl ed g l in g b u s in es s . Sel fe, 7 7 8 F.2 dat7 7 0. On l y aft er t hatb ack -t o -b ack tran s act io n h adt ak enp l ace d idth e b an k i n s is t th atth e t ax p ay er refi n an ce t h e l i n e
o f cred i t i n the n am e o f th e b us i n es s . Id . at 7 7 0 -7 71 . Ev en th en th e Co u rt o f Ap p eal s rem an d edth e t ax p ay er’ s cas e t o th e Di s tri ctCo u rtfo r ad d i ti o n al fact u al fi nd i ng s o n th e i s s u e o f “ wh et h er o r n o t th e b an kp ri m ari l y l o o k edt o * * * [t h e t ax p ay er] fo r rep aym en t ”. Id
. at7 7 5. No n e o f t h e n o t es p et i t i o n er s i g n edas co b o rro wer o r g u aran t or were
co l l at eral i zedb y

p et it i on er’ s o wnp ro p ert y . Th e p l ed g e o f p ers o n al as s et s , wh i ch th e Co u rtfo u n dt o b e s p eci al l y i n d i cat iv e o f a real o u t l ay b y th e t ax p ay er i n Sel fe,
was n otm ad e b y

p et i t io ner h ere. See i d
. at7 7 2 n .7
. Al th o u g h p et i t i o n ers cl ai m o n b ri ef t h at“ al l o f * * * [p et i t i on er’ s ] as s et s s erv edas s ecu ri ty ” b ecau se “ th e p ract i cal effect o f t h e p l ed g e o f h i s i n d i v i du al l y o wn edp ro p ert y

v ers u s s i gn i n g an
o b l i g at i o n t o rep ay

th e l o an s i n d i v i du al l y

i s th e s am e”, t h ey

h av e ci t ed n o l eg al
au th o ri ty s up p ort in g th i s as s ert i o n . Las t ly , p et i t i o ners p ro vi dedn o co n vi n ci n g ev i d en ce t hatan y o f t h e l en d ers l o o k edt o p et it i o n er as th e p ri m ary o b l i g o r o n t h e l o an s recei v edb y th e o p erat i n g
co m p an i es . Th i s i s es peci al l y tru e wi th res p ectt o th e LLC l o an s an dth e i n t erco m p an y l o an s , wh i ch g en eral l y

l ack edthe i n d i ci a o f g enu i n e i n d eb t ed n es s . Th e LLC an d i n terco m

p an y l o an s h adn o i n t eres trat es an dn o rep aym en t- 2 1 -

[* 2 1 ] s ch edu l es , an dfro m th e reco rdi tap p ears l i k el y th atm o st o f t h es e l oan s were
n ev er actu al ly

rep ai d
. Pet i t i o ner t es t i fi edth atreg u l ar p aym en t s were g en eral ly n o tm ad e o n th e LLC an di n t erco m

p an y n o t es ; i n s t ead , p aym en t was d eferred u n ti l th e en d o f t h e
s ev en -y ear t erm , “ s in ce t h ere was n o i n t eres t i n vo l v ed .” Pet it i on ers d i s p o s edo f th ei r i n t eres ts i n the o p erat i n g co m p an ies an dth e nu rs i n g h o m e LLCs s o m et i m e i n 2 0 1 4 , p ro b ab l y

i n M ay , b y

s el l i n g th em

t o an o th er nu rs in g h om e LLC m em b er, Co o p er. Pet i t i o n ers ’ s al e p reced edth e d at e t h atp aym en t b ecam e du e fo r t h e g reat
m ajo ri ty o f t h e LLC an di n t erco m p an y n o t es . Inarri v in g ata s al es fi g ure fo r p et i t i o n ers ’ i n teres t s , Co o p er t es t i fi edth ath e fact o redi n t h e am o u n t s s t i l l
o u t s t an d i n g o n th e v ari o u s LLC an di n terco m p an y l oan s , al o n g wi th “ o th er l i ab i l i t i es i nv o l v ed ”, an du l ti m at el y h e s ai dh e “ b as i cal l y

as s u m edth es e l i ab i l i t i es
an d fo rg av e * * * [p et it i on er] th o s e l o an s p ers o n al ly , an db as i cal l y co ns i d ered th em t o b e p ai do ff up on m

y p u rch as e o f al l h i s s t o ck .” Pet i t i o ner co u ldn o t p ers o n al l y co n fi rm th atan y o f t h e LLC l o an s o r i n t erco m p an y l o an s were p ai d o ff du ri n g h i s t i m e as o wn er o f th e o perat i n g
co m p an i es . Fro m th e ev i d en ce i ts eem s th atn o d em an dfo r p aym en t was ev er
m ad e o n th e o p erat i n g co m p an i es wi th res pect t o t h es e l oan s ; cert ai n l y n o d em an d fo r p aym en twas ev er m ad e o n p et i ti o ner p ers on al l y .- 2 2 -

[* 2 2 ] W i th res p ectt o t h e Un i v ers al Rei ns u ran ce Co . l oan s th at p et i t io n er s i g n ed
as co b orro wer, p et i ti on ers p ro v i d edn o ev i d en ce reg ard i n g th e m ak i n g o f t h o s e l o an s th ats u g g es t s Un i v ers al Rei n s uran ce Co . co n s i dered p et i t i o n er, rat her t h an h i s o p erat i n g co m

p an i es , t o b e t h e o ne p ri m ari ly res p o n s i b l e fo r m ak i n g i n t eres t
an d p ri n ci p al p aym en ts . Pet i t i o n er was n ev er req u iredt o m ak e p aym en t s o n th e Un i vers al Rei n s u ran ce Co . l o an s fro m h i s p ers o n al acco u n t . Pet i t i o ner d is p o s edo f h i s i n t eres t s i n th e o p erat in g co m p an i es s h o rt l y

b efo re t h e p ri n ci p al am o u n t s o n th e fi rs ts eto f Un i v ers al Rei n s uran ce Co . n o tes b ecam e due. Th es e p ri nci p al p aym en t s ap p aren t l y were p arto f t h e l i ab i l i t i es as s u m edb y Co o p er up o n h i s p u rch as e o f p et i ti o n er’ s s t o ck
. No r can we co n cl u d e t h atth e b an k s co n si d eredp et i t i o n er t o b e t h e p ri m ary
o b l i g o r o n th e Farm er’ s Ban k& Tru s tan dBan ko f Ok l ah o m a l o an s th ath e s i g n ed
as a g u aran t o r. W e accep t p et it i o n ers ’ as ses s m en tth atth es e l arg e l o an s wo u l dn o t h av e b een m ad e b u t fo r p et i t io n ers ’ p ers o n al cred i two rt h in es s an dth ei r wi l l i ng n es s t o s i g n p ers on al g u aran t i es . Ho w ev er, p et i t i o n ers were n otth e o n l y g u aran to rs o f ei th er t he Farm er’ s Ban k& Tru s tl oan o r t h e Ban ko f Ok l ah o m a l o an . An di n an y

cas e, t h at a l oan wo u l d n o t h av e b een m ad e t o a co rp o rat i o n b ut fo r a s h areh o l d er’ s p ers o n al cred i two rt h i n es s an d g uaran ty o f rep aym en td oes n o t i n i ts el f i n d i cat e t hatthe b an kl o o k edt o th e s h areh o l d er fo r rep aym en t (o r- 2 3 -

[* 2 3 ] n eces s i t at e t h e co ncl u s i o n th atth e s h areh o l d er m ad e an o u t l ay i n p ro v i d i n g th atg u aran ty ). See, e.g
. , Sl ei m an v . Co m m i s s i o n er, 1 8 7 F.3 d1 3 52 , 1 3 5 8 (1 1 th Ci r. 1 9 99 ), aff’ g T.C. M em o. 1 9 9 7 -5 3 0 ; Es t at e o f Leav i t tv . Co m m i ss i o ner, 9 0 T.C. at2 1 5 ; Bro wn v . Co m m i ss i o n er, T.C. M em o . 1 9 8 1 -6 0 8 , 1 9 8 1 W L 1 1 0 0 8
. Pet i t i o ner’ s o p erat in g co m p an i es were n o tth e o n l y b orro wers fo r t h e Farm er’ s Ban k& Tru stan dBan ko f Ok l ah om a l o an s , an dwe th in k th e o p erat i ng
co m p an i es were n o tth e p ri m ari l y i n d eb t edco -b o rro wer i n th e cas e o f ei th er. Th e p ro ceed s o f b o th l o an s wen tt o w ard s th e p u rch as e o f real p ro p erty b y a co b o rro wi ng LLC an dwere n o tu s edb y p et i t io n er’ s o p erat i n g co m p an i es t o o p erat e th e n u rs i n g h om es . In deed , wi th res p ectt o th e Ban ko f Ok lah o m a l o an , p et i t i o n ers ’ wi tnes s Co o p er t es t i fi edth atth e en t i re b al an ce o f t hati n d eb t ed n es s

“ s h o u l dh av e b een al l o cat edt o Cl ay Co u n ty [LLC] ”. If we accep tth ats t at em en t
as tru e, t hen th e i s s u e o f wh et h er t h e b an kco n s i dered p et i t i o n er t o b e th e p ri m ary
o b l i g o r i s i rrel ev an t, b ecau s e t here was n o “ i n d eb t edn es s o f t h e S co rp o rat i o n [s ] ” th atco u l dcreat e s h areh o l d er b as i s fo r p et i t i o n er i n th e fi rs t p l ace. Pet i t i o ner’ s co m

p an i es were t h i n l y

cap i t al i zed , an dwe accep tthatatl eas t
s o m e o f t h e l en d ers wan t ed p et i t i o n er, wi th h i s s ub s t an t i al as s et s , t o b e l i ab l e fo r rep aym en ti n th e ev en tth e b u si n es s es fai l ed . If th e l en d ers s p eci fi cal ly wan t ed p et i t i o n er t o b e t h e p ri m ary o b l i g o r o n th e l o an s (an d, fo r t h atm at t er, i f p et i t i o n er- 2 4 -

[* 2 4 ] h i m s el f wan t edt o fi l l thatro l e), t hen th e tran s act i o n s co u l d h av e b een
s tru ctu redb y

ag reem en to f t h e p art i es s o th atp ro ceed s were l en td i rect l y t o p et i t i o n er an dth en co n tri b u t edb y p et i t i o n er t o th e o p erat in g co m p an i es . Th e l en d ers , i f t h ey

ex pect edp et i ti on er t o b e p ri m ari l y an dp ers o n al l y

res p o ns i b l e fo r rep aym en t , m i g h t h av e i n s i s t edo n a p l ed g e o f h i s p ers o nal as s et s as s ecu ri ty . Ab s en ts o m e o th er ev i d en ce d em o ns trat i n g th atth e l en ders treat ed p et i t i o n er as th e p ri m ary

o b l i g or o n th e l o an s h e co s ig n ed o r g u aran t eed , we
can n otco n cl u de t h atp et i t i o n ers ’ cas e fi t s wi thi n Sel fe’ s n arro w ex cep t i o n t o th e g en eral ru l e t h atthe i n deb t ed n es s o f t h e S co rp o rat i o n m u s tru n d i rect l y

t o th e
s h areh o ld er fo r th ati nd eb t ed n es s t o i ncreas e t h e s h areh ol d er’ s b as i s i n the S
co rp o rat i o n u n der s ect i o n 1 3 6 6(d )(1 )(B). W e d ecl i n e t o recas tth e fo rm o f th e l o an tran s act io n s en t eredi n t o b y p et i t i on er’ s o p erat i n g co m p an i es t o al i g n wi th wh at p et i t i o n ers n o w al l eg e are t h ei r u n d erl y in g s ub s t an ce. To th e ex t en t g en u i ne i n d eb t ed n es s was creat ed , we b el i ev e i n th is cas e t h at“ th e s ubs t an ce m at ch edth e fo rm ”. Harri s v . Un i t edSt at es , 9 0 2 F.2 d4 3 9 , 4 4 2 (5 th Ci r. 1 99 0 ) (qu ot i n g Bro wn
v . Co m m i s s i o n er, 7 0 6 F.2 dat7 5 6 ). Becau s e t he fo rm o f t h e t ran s act i o n s s h o w s th e i n d eb t ed n es s ex i s t edd i rect l y b et ween th e o perat i n g co m p an i es an dthe l en d ers , an db ecau s e p et i t i o n ers h av e n o t
s h o wnth atth e s ub s t an ce o f t h os e t ran s act i o n s s h o u l d b e v i ewedd i fferen t ly fro m- 2 5 -

[* 2 5 ] th ei r fo rm , we co n cl u d e th atp et i t i on er’ s ro l e as co m ak er o r g u aran t o r o f t h e
o p erat i n g co m

p an i es ’ n o t es d i dn o t en t i t l e h i m t o cl ai m b as is i n th e i n d eb t ed n es s
o f t h e o p erat i n g co m

p an i es u n d er s ect i o n 1 3 6 6 (d )(1 ). W e up h o l dres p o nd en t ’ s d et erm i n at i o n th atp et i t i o ners i m p ro perl y rep o rt ed the l os s es ari s i n g fro m cert ai n
o f t h e o p erat i n g co m

p an i es o wn edb y

p et i t i o n er duri n g th e t ax ab l e y ears 2 0 0 7 , 2 0 0 8 , 2 0 0 9 , an d 2 0 1 0. W e s us t ai n al l ad ju s t m en t s m ad e b y

res p o n d en to n th e b as i s o f t h atd et erm i n at i o n . Becau s e we fi ndres p o n d en twas co rrect i n d i sal l owi n g d edu ct io n s fo r t h e
o p erat i n g co m

p an i es ’ l o s s es rep o rt edb y p et i t io n ers duri n g 2 00 7 thro u g h 2 0 1 0 , i t i s u n n eces s ary

t o d eci de wh et h er t h o s e l o s s es were l o s s es fro m p as si v e o r
n o np as s i ve act iv i t i es . Th erefo re we d o n otco n s i d er t h e i s su e o f wh et h er p et i t i o n er “ m at eri al l y

p art i ci pat ed ” i n th e o p erat i o n s o f t h e o p erat i n g co m p an i es . W e al s o d o n otco n s id er wh et h er p et i t i o n ers p ro perl y co u l dh av e g ro up ed th e act i vi t i es o f t he n urs i n g h o m e LLCs wi th th e act i v i t i es o f t h e o p erat i n g co m p an i es
u n d er s ect i o n 1 .4 69 -4 (d )(1 ), In co m e Tax Reg s . , fo r t h e p u rp o s es o f d et erm i n i n g th e ch aract er an d am o u nt o f i n co m e o r l o s s es at tri b u t ab l e t o th o s e act i v it i es fo r t h e y ears i n i s s u e.- 2 6 -

[* 2 6 ] Pet i t i o n er Bren d a Harg i s ’ Bas i s i n M el b o u rn e Pro p ert i es an dCl ay Co u n t y LLCs Th e o n l y i s s u e l eftfo r o u r co n s i d erat i on i s wh et h er Bren d a Harg i s h ad
s u ffi ci en tb as i s i n h er m em bers h i p i n t eres t s i n two o f t h e n u rs i n g h o m e LLCs t o al l o w p et i t i o n ers t o d edu ct l o s ses fro m tho s e en t i t i es fo r t ax y ears 2 0 07 th ro u g h 2 0 1 0 . Res p o n den td i s al l o wedd edu ct i o ns fo r p et i ti o n ers ’ rep o rt edl o ss es fro m M el bo u rn e Pro p ert i es fo r t h e t ax y ears 2 0 07 , 2 00 8 , an d2 0 09 an da p o rt i o n o f a d educt i o n fo r a l o ss fro m Cl ay Co u n ty fo r 2 0 10 . Res p on d en t ’ s d et erm i n at i o n was th atp et i t i o n ers h ad n o ts ub m it t edad equ at e d o cu m en tat i on es t ab l is h i n g Bren d a Harg i s ’ b as i s i n t h es e t wo en ti ti es . Un d er ap p l i cab l e reg u lat i o n s , LLCs s u ch as th e n u rs i n g h o m e LLCs i n wh i ch Bren d a Harg i s h el di n t eres t s are t reat edth e s am e as p artn ers h i p s fo r Fed eral t ax p u rp o s es . See s ec. 3 0 1.7 7 01 -3 (a), Pro ced
. & Ad m i n . Reg s . A d edu ct i o n fo r a p art n er’ s d i s tri b u ti v e s h are o f p art n ers h i p l o ss es i s al lo wed o nl y t o th e ex ten to f th e ad ju s t ed b as is o f t h e p art n er’ s i n t eres t i n th e p art n ers hi p atth e en do f t he p art n ers hi p y ear i n wh i ch s uch l o s s o ccu rred . Sec. 7 04 (d ). An y i n creas e i n a p art n er’ s s h are o f l i ab il i ti es o f t h e p art ners h i p i s co n s i d ereda co n tri b u t i o n b y th e p art n er t o t h e p artn ers h i p an d , co n s equ en t l y , i n creas es th e b as i s o f t he p art n er’ s- 2 7 -

[* 2 7 ] i n t eres ti n the p art n ers h i p . See s ecs . 7 2 2 , 7 52 (a); s ec. 1 .7 5 2 -1 (b ), In co m e Tax Reg s . Pet i t i o ners p ro vi d ed ev i d en ce o f t h e Li b erty Ban kl o an an d the Ban ko f Ok l ah o m a l o an , wh i ch they co n t en ds upp o rt s a fi n d i n g th atBren da Harg i s h ad
s u ffi ci en tb as i s i n M el b o u rn e Pro pert i es an dCl ay Co u nt y , res p ect i vel y , fo r p et i t i o n ers t o rep o rtan d d educth er p ro rat a s hares o f l o s s es fro m th o s e LLCs fo r al l th e y ears i n i s s u e. Fo rm s 1 0 6 5 fi l edb y M el b o u rn e Pro pert i es an dCl ay Co u n t y
an d Sch edu l es K-1 i s s u edt o Bren d a Harg i s fro m th e t wo LLCs were al s o p ro v id ed
. W e d i dn o t d i s cu s s th e b u rd en o f p ro o f wi th res p ectt o p et i t io n er’ s b as i s i n th e o p erat i n g co m

p an i es b ecau s e t h e ev i d en ce was s u ffi ci en tt o d et erm i n e b y a p rep o n d eran ce t h atth e b o rro wi n g d i dn o tqu al i fy as a p ri m ary

o b li g at i on o r
eco n om i c o u t l ay

b y p et i ti on er. On th e m at t er o f Bren d a Harg i s ’ b as i s, h o wev er, p et i t i o n ers ’ ev id en ce i s n o t s uffi ci en tt o p ro v e h er b as is o r t o s hi ftthe b u rd en o f p ro o f t o res p on d en t u n d er s ect i o n 7 4 9 1 (a). Gen eral ly , p et i t i o ners b ear t h e b u rd eno f p ro v i n g th atth e ad ju s t m en ts s et fo rt h i n res p o n d en t ’ s n o t i ce o f d efi ci en cy were erro n eo u s . See Ru l e 1 4 2 (a); W el ch
v . Hel v eri n g , 2 9 0 U.S. 1 1 1 (1 9 3 3 ). Sp eci fi cal l y , p et i t i on ers m u s tp ro v e t h ei r
en t i t l em en tt o d edu ct i o n s . See INDOPCO, In c. v . Co m m i s s i o n er, 5 0 3 U.S. 7 9 , 8 4- 2 8 -

[* 2 8 ] (1 9 9 2 ); New Co lo n i al Ice Co . v . Hel v eri ng , 2 9 2 U.S. 4 3 5 , 4 4 0 (1 9 3 4). Pet i t io n ers b ear t h e b u rd en o f m ai n t ai n in g th e reco rd s n eed edt o es t ab l is h th ei r
en t i t l em en t . See s ec. 6 0 0 1 ; Hrad es ky v . Co m m is s i o n er, 6 5 T.C. 8 7 (1 9 7 5 ), aff’ d , 5 4 0 F.2 d8 2 1 (5 th Ci r. 1 9 7 6). In o rd er t o p ro v e t h ey were en t i tl ed t o d edu ctth e
n u rs i n g h o m e LLC l o s ses d is al l o wedb y res p o n d en t , p et i t i o n ers m u s tes t ab l i s h wi th s p eci fi ci ty Bren d a Harg is ’ b as i s i n M el b o u rn e Pro p ert ies an dCl ay Co u n t y . See s ec. 7 0 4 (d ); O’ Nei l l v . Co m m i s si o n er, 2 7 1 F.2 d 4 4 , 5 0 (9 th Ci r. 1 9 5 9 ) (“ Pro o f
o f b as i s i s a s p eci fi c fact wh i ch th e t ax p ay er h as th e b u rd en o f p ro v i ng .”), aff’ g T.C. M em o . 1 95 7 -1 9 3
. Pet i t i o ners h av e n o tp ro vi d edan y n u m eri c co m p ut at i o n s o f Bren d a Harg i s ’ b as i s i n M el b o u rn e Pro p ert i es an dCl ay Co u n ty fo r t h e y ears i n i s s u e. Th e Fo rm s 1 0 6 5 fi l edb y

M el b ou rn e Pro p ert i es an dthe Sch edu l es K-1 i ss u edt o Bren d a Harg i s fro m

M el b o u rn e Pro p ert i es fo r 2 0 0 7 th ro u g h 2 0 09 d o n o t rep ortth e t o t al
am ou n to f p art ners h i p l i ab i li t i es ex i st i n g i n tho s e y ears an dd o n o trep ortth e
am ou n to f p art ners h i p l i ab i li t i es al l o cat edt o h er. Th e Fo rm 1 0 6 5 fo r Cl ay

Co u n t y fo r 2 0 0 9 d oes rep ort s om e p art n ers h i p l iab i li t ies , b u ta Fo rm 1 0 65 fo r Cl ay

Co u nt y fo r 2 0 1 0 was n o tp ro v i d ed , an dth e Sch edu le K-1 i s s uedt o Bren d a Harg i s fro m Cl ay Co u n ty fo r 2 0 1 0 d o es n otrep o rtth e am o u n t o f h er s h are o f p art n ers h i p l i ab i l i t i es . No n e o f t h es e t ax fo rm s s t i p ul at edb y th e p art i es es t ab l i s h es that- 2 9 -

[* 2 9 ] Bren d a Harg i s h adan i n creas edt ax b as i s i n h er m em b ers h ip i n t eres t s o n
acco u n t of s h ares o f t h e LLCs ’ l i ab il i ti es . Pet i t i o ners i n tro du cedco p i es o f t h e Li b ert y Ban k an dBan ko f Ok l ah o m a l o an ag reem en t s , an dth ey arg ue t h ats o m e s h ares o f th o s e l i ab i l i t i es wo ul d h av e b een al l o cab l e t o Bren d a Harg is as a m em b er o f M el b ou rn e Pro pert i es an d Cl ay Co u n ty , res p ect i v el y . W e fi n dth e ex i s ten ce o f t he l oan ag reem en t s es t ab li s h es at
m o stth atth e n u rs i n g h o m e LLCs i n cu rred s om e am o u nto f l i ab i l i ti es i n t h e y ears th o s e l o an s were m ad e. Pet i ti o n ers p ro v i d edn o fu rt h er d o cu m en t ary ev i d en ce
ex p lai n i n g h o w an dt o wh atex t en tth e t wo l o an s affect edBren d a Harg i s ’ b as i s i n th e t wo en t i t i es . Pet i t i o ners p ro v i d edn o th i ng th at d efi ni t i v el y s h o w s wh at ad ju s t m en t s , i f an y , were m ad e t o Bren d a Harg is ’ b as i s i n th e y ears o f t h e l o an s o r i n the s ub s equen ty ears l ead i ng up t o th e d i sal l o wedl o s s es . Pet i t i o ner’ s wi tn es s Co op er t es t i fi edth at l i ab i li t ies o f t h e nu rs i n g h o m e LLCs were al l ocat ed am o n g m em b ers acco rd i ng t o th ei r o wn ers hi p p ercen t ag es , an d th is g en eral l y

s upp o rt s th e as s ert i o n th atBren d a Harg i s s h o u ldh av e b een al l o cat eds o m e s h are o f LLC l i ab i li t i es o n the b as i s o f t h e Li b ert y Ban kan dBan k
o f Ok lah om a l oan s . Ho wev er, t h e m ere p res en ce o f t h e l o an ag reem en t s an ds u ch g en eral i zedt es t i m o n y d o n o tal l o w u s t o d et erm i n e Bren d a Harg i s ’ co rrect b as i s i n h er m em b ers h ip i n teres t s fo r t h e y ears i n i s s u e. Pet i t io n ers ’ ev i d en ce i s s i m p l y t o o- 3 0 -

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p l et e t o es tab l i s h b as i s am o u n ts fo r Bren d a Harg is ’ i n t eres ts i n th e t wo
n u rs i n g h o m e LLCs
. To th e ex t en tth at Bren d a Harg i s ’ b as i s h as n o t b een ad equ at el y es t ab l i s h ed , res p o n d en t i s ju s t i fi edi n t reat i n g i tas zero . See Ru l e 1 4 2 (a); W el ch v . Hel v eri n g , 2 9 0 U.S. 1 1 1 . W e ag ree wi th res p o n d en tth atp et it i o n ers h av e n otm etthei r b u rd eno f p ro vi ng th atth ey were en t i t l edt o d edu ctth e l o s ses fro m M el b ou rn e Pro p ert i es an d Cl ay

Co u n ty th atres p on d en td is al lo wedi n th e n o t i ce o f d efi ci en cy . W e h av e co n s id eredal l arg u m en t s m ad e, an d , t o th e ex t en tn otm en t i o n ed , we co n cl ud e t hatth ey

are m o o t , i rrel ev an t , o r wi th o utm eri t. To refl ectthe fo reg o i n g , Deci s i o n wi ll b e en t ered fo r res p o n den t .