1 Unless otherwise indicated, section references are to the

Internal Revenue Code in effect for the years at issue. All Rule

references are to the Tax Court Rules of Practice and Procedure.

T.C. Memo. 1997-512

UNITED STATES TAX COURT

WILLIAM AND ARLENE G. KINGSTON, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

 Docket No. 15409-95. Filed November 17, 1997.

 William and Arlene G. Kingston, pro se.

 Elizabeth P. Flores, for respondent.

MEMORANDUM OPINION

 WELLS, Judge: This case was assigned to Special Trial Judge

D. Irvin Couvillion pursuant to section 7443A(b)(4) and Rules

180, 181, and 183.1 The Court agrees with and adopts the opinion

of the Special Trial Judge, which is set forth below.
- 2 -

OPINION OF THE SPECIAL TRIAL JUDGE

COUVILLION, Special Trial Judge: In separate notices of

deficiency, respondent determined the following deficiencies and

additions to tax against petitioners for the years indicated:

 Additions to Tax 

 Sec. Sec. Sec.

Year Deficiency 6653(a)(1) 6653(a)(2) 6661

1985 $ 6,293 $ 314 

* $1,573

1986 10,186 

 1509 *1 2,546

*50 percent of the interest due on the underpayment attributable to

negligence.

1These additions to tax, for 1986, are under sec. 6653(a)(1)(A) and (B).

Respondent also determined increased interest, under section

6621(c), for each of the years at issue.

The issues for decision are: (1) Whether respondent timely

issued the aforementioned notices of deficiency to petitioners,

and, if so, (2) whether petitioner William Kingston (petitioner)

was "protected against loss" within the meaning of section

465(b)(4) with respect to his pro rata share of partnership debt

obligations arising from sale-leaseback transactions engaged in

by a partnership, and (3) whether petitioners are liable for the

additions to tax under sections 6653(a) and 6661(a) and the

increased interest under section 6621(c). 

Some of the facts were stipulated, and those facts, with the

annexed exhibits, are so found and are incorporated herein by

reference. At the time the petition was filed, petitioners'

legal residence was West Bloomfield, Michigan.
- 3 -

 Petitioners filed joint Federal income tax returns for 1985

and 1986. On their returns, petitioners claimed deductions of

loss and investment interest expense (the claimed deductions)

relating to Hambrose Leasing 1985-3 (the partnership) in the

following amounts:

Year Loss Investment Interest Expense

1985 $13,903 $1,082 

1986 21,538 2,190

This case involves two sale-leaseback transactions among the

following entities: CIS Leasing Corp. (CIS), a New York

corporation with principal offices in Syracuse, New York;

Comdisco, Inc. (Comdisco), a Delaware corporation with principal

offices in Rosemont, Illinois; Charterhouse Leasing Associates

Limited Partnership (Charterhouse), a Connecticut limited

partnership; Hambrose Reserve Ltd. (Hambrose), a Delaware

corporation; M & J Holding Corp. (M & J), a Delaware corporation

that was the sole shareholder of Hambrose and the general partner

of Charterhouse; and Hambrose Leasing 1985-3 (the partnership), a

partnership engaged in the equipment leasing business.

The Sale-Leaseback Transactions

The transactions can be described in general terms as

follows: CIS and Comdisco purchased IBM computer equipment with

a specified amount of borrowed funds. CIS and Comdisco then

leased the computer equipment to various end users. CIS and

Comdisco then sold the computer equipment to Charterhouse,
- 4 -

2 The parties stipulated that the $1,196,254.74 represented

the total amount financed through third party lenders for the

purchase of the Initial Equipment. Since there is no indication

from the record that any cash, or other funds, was paid to

acquire the Initial Equipment, the Court surmises that the total

amount financed represented the total purchase price of the

Initial Equipment.

subject to the original financing and user leases. Charterhouse

then sold the equipment to Hambrose, subject to the original

financing and user leases. Hambrose then simultaneously leased

the equipment back to Charterhouse. Hambrose then sold the

equipment to the partnership, subject to the original financing

and user leases, and also assigned to the partnership all rights

under the equipment lease between Hambrose and Charterhouse. 

Upon completion of all of the transactions, the partnership owned

the computers, the end user companies used them, and

Charterhouse, Hambrose, and the partnership traded streams of

financing payments and lease payments.

The Initial Equipment

CIS financed, on a nonrecourse basis, the purchase of

certain IBM computer equipment (the Initial Equipment), for a

total purchase price of $1,196,254.74.2 The purchase was

financed through four different third party lenders, and all of

the Initial Equipment was leased by CIS to four different actual

end users of the equipment. Charterhouse then paid CIS an

aggregate purchase price of $474,415 for the Initial Equipment,

$18,978 of which was paid in cash, and the balance of $455,437
- 5 -

being represented by various installment notes, which were

nonrecourse obligations of Charterhouse and were secured by the

Initial Equipment.

On or about March 29, 1985, Hambrose purchased the Initial

Equipment from Charterhouse for $474,415, subject to the liens of

the original third-party lenders, the original purchaser, and the

end user leases. This $474,415 purchase price was payable as

follows: $23,000 in cash on May 8, 1985, and $451,415 by an

unsecured installment note. Concurrent with Hambrose's purchase

of the Initial Equipment from Charterhouse, Hambrose leased back

the Initial Equipment to Charterhouse pursuant to the terms of a

wrap lease (Initial Equipment Wrap Lease), which provided for

fixed rent, payable in four consecutive annual installment

payments of $153,212 each, with the first payment due on

March 31, 1986.

On or about March 29, 1985, the partnership purchased the

Initial Equipment from Hambrose for $474,415 subject to all the

liens of the original third-party lenders, a lien on and security

interest in the Initial Equipment in favor of Hambrose, and

subject to the user leases and the Initial Equipment Wrap Lease. 

This $474,415 purchase price was payable as follows: $1,000 in

cash on the closing in October 1985; $27,000 in cash on or before

December 31, 1985; and a $446,415 promissory note (secured by the

Initial Equipment) that was payable in four consecutive annual
- 6 -

3 Hambrose Leasing v. Commissioner, 99 T.C. 298, 301, 312

(1992).

4 The parties stipulated that this $18,019,633.11 represented

the total amount financed through third party lenders for the

purchase of the Additional Equipment. Since there is no

indication from the record that any cash, or other funds, was

paid to acquire the Additional Equipment, the Court surmises that

the total amount financed represented the total purchase price of

the Additional Equipment.

installment payments of $153,212 each, with the first payment due

on March 31, 1986. This note was nonrecourse as to the

partnership.3 In conjunction with the partnership's purchase of

the Initial Equipment, Hambrose assigned to the partnership the

Initial Equipment Wrap Lease, as a result of which the four

consecutive annual rent payments of $153,212 each would be paid

to the partnership by Charterhouse.

The Additional Equipment

CIS and Comdisco financed, on a nonrecourse basis, the

purchase of certain additional IBM computer equipment (the

Additional Equipment) for a total purchase price of

$18,019,633.11.4 They financed the purchase of this Additional

Equipment through six different third-party lenders and leased

the Additional Equipment to six different end users. 

Charterhouse purchased the Additional Equipment from CIS and

Comdisco in two separate purchase transactions, one each for the

Additional Equipment under each user lease. The total purchase

price for all the Additional Equipment was $15,643,832, of which
- 7 -

5 The difference between the total purchase price for

Charterhouse and the amount of CIS's and Comdisco's financing is

not explained in the record.

6 Hambrose purchased the Additional Equipment pursuant to a

purchase commitment given by it to Charterhouse earlier in the

year.

$1,183,487 was paid in cash and $14,460,345 by various

installment notes.5 These installment notes were nonrecourse

obligations as to Charterhouse.

Hambrose then purchased the Additional Equipment from

Charterhouse for $15,420,834, subject to all other liens and

leases, including the liens of the original third-party lenders,

CIS, Comdisco, and the user leases.6 The $15,420,834 purchase

price was payable by $1,400,000 in cash and the remaining

$14,020,834 by an installment note, bearing 13.17722 percent

interest per annum, and payable in seven annual installments of

principal and interest as follows:

Year Amount 

1986 $ 570,167 

1987 3,421,004 

1988 3,421,004 

1989 3,421,004 

1990 3,421,004 

1991 3,421,004 

1992 3,421,004

Concurrent with Hambrose's purchase of the Additional Equipment

from Charterhouse, Hambrose leased the Additional Equipment back

to Charterhouse pursuant to a wrap lease (Additional Equipment

Wrap Lease).
- 8 -

The purchase agreement between Hambrose and Charterhouse

contained the following provision for indemnification:

6. Indemnification.

Seller [Charterhouse] will indemnify Purchaser [Hambrose]

and protect, defend and hold it harmless from and against

any and all loss, cost, damage, injury or expense,

including, without limitation, reasonable attorney's fees,

wheresoever and howsoever arising which Purchaser or its

subsidiaries or stockholders, or any of its, or their,

directors, officers, agents, employees, stockholders or

partners, may incur by reason of any material breach by

Seller of any of the representations by, or obligations of,

Seller set forth in this Agreement or by reason of the Bulk

Sales Laws of any jurisdiction. * * *

The Additional Equipment Wrap Lease contained the following

provision for indemnification:

18. Indemnification

18.1 Lessee [Charterhouse] will indemnify Lessor

[Hambrose] and protect, defend and hold it harmless from and

against any and all loss, cost, damage, injury or expense,

including, without limitation, reasonable attorneys' fees,

wheresoever and howsoever arising which Lessor or its

subsidiaries or shareholders, or any of its or their

directors, officers, agents, employees, stockholders or

partners, may incur by reason of any breach by Lessee of any

of the representations by, or obligations of, Lessee

contained in this Lease or in any way relating to or arising

out of this Lease; the Equipment, claims of holders of the

Lien or Underlying Leases; * * *

The Additional Equipment Wrap Lease also stated that

Charterhouse's obligation to pay "all rental charges payable"

under the Additional Equipment Wrap Lease would be "absolute and

unconditional under all circumstances." Furthermore, under the

Additional Equipment Wrap Lease, Charterhouse (the lessee) waived

"any right of set-off under state or federal law, counterclaim,

recoupment, defense or other right which Lessee may have against
- 9 -

7 The figures for these rental payments listed on the

Additional Equipment Wrap Lease submitted into evidence differ

slightly from those figures listed in the Stipulation of Facts

signed by the parties. However, since the exact amount of these

figures is not pertinent to our determination of the issues in

this case, the Court hereby accepts the figures listed in the

Stipulation of Facts signed and submitted by the parties.

Lessor or anyone else for any reason whatsoever". The annual

fixed rental payments due Hambrose from Charterhouse under the

Additional Equipment Wrap Lease were identical to the installment

payments due Charterhouse from Hambrose under the installment

note described above.7

Immediately following the purchase of the Additional

Equipment by Hambrose, the partnership purchased the Additional

Equipment from Hambrose for $15,420,834, subject to all other

liens and leases, including those of the original third-party

lenders, the original purchasers, Hambrose and Charterhouse, and

subject to the Additional Equipment Wrap Lease, the original

purchaser leases, and the end-user leases. The $15,420,834

purchase price was paid by $1,542,083 in cash, and the remaining

$13,878,751 by a Limited Recourse Installment Promissory Note

(Limited Recourse Note), which was secured by the Additional

Equipment, bears a 14-percent per annum interest and payable in

eight installments with the first installment of $921,917 due at

the time of closing. The remaining installment payments were due

as follows:
- 10 -

8 The figures for the payments listed on the Limited Recourse

Note submitted into evidence differ slightly from those figures

listed in the Stipulation of Facts signed by the parties. 

However, since the exact amount of these figures will not be

pertinent to our determination of the issues in this case, the

Court hereby accepts the figures listed in the Stipulation of

Facts signed and submitted to the parties.

Year Amount8 

1986 $ 570,167 

1987 3,421,004 

1988 3,421,004 

1989 3,421,004 

1990 3,421,004 

1991 3,421,004 

1992 3,421,004

The Limited Recourse Note contained the following deferral

provision:

5. Deferral, etc.

5.1 Deferral. Maker [the partnership] shall have the

right to defer payment of the Principal Amount and interest

as the same becomes due under this Note if and to the extent

any amount of rent or other sums due to Maker under an

agreement of even date (the "Lease"), between * * *

[Charterhouse], as lessee, and Maker, as lessor is not

received by Maker as the same becomes due (the "Past Due

Sum"). The amount of principal and interest so deferred

will become due and payable at such time as, and to the

extent that, Maker receives from Charterhouse the Past Due

Sum; provided, however, that no interest shall accrue on the

principal and interest payments so deferred; provided,

further, however, that the amount of interest and principal

so deferred shall become due and payable on Jan. 1, 1992;

whether or not Maker shall have received the Past Due Sum on

or before such date.
- 11 -

The Limited Recourse Note provided further that the partnership's

obligation under such note, and each limited partner's assumed

personal liability thereunder, would be "absolute and

unconditional under all circumstances." Further, in the Limited

Recourse Note, the partnership waived "any right of set-off under

state or federal law, counterclaim, recoupment, defense or other

right which the [partnership] may have against [Hambrose] or

anyone else for any reason whatsoever".

The Purchase Agreement and Assignment of Right between the

partnership and Hambrose (Purchase Agreement) for the Additional

Equipment contained the identical "absolute obligation" and setoff waiver provisions as the Limited Recourse Note. The Purchase

Agreement also contained an indemnification provision nearly

identical to that contained in the Additional Equipment Wrap

Lease (i.e., Hambrose indemnifying the partnership for loss

resulting from Hambrose's breach of any provision of the Purchase

Agreement).

Both the Limited Recourse Note and the Purchase Agreement

required each of the limited partners to severally, and not

jointly, assume personal liability for his or her pro rata

portion of the Limited Recourse Note that was equal to $114,578

per partnership unit for each limited partner. Also, the Limited

Recourse Note and the Purchase Agreement both provided that all

payments made on the Limited Recourse Note would first be applied
- 12 -

to that portion of the amounts due for which no partner had

personal liability. In other words, in the event that the

Limited Recourse Note was not paid in full by the partnership,

any remaining unpaid portion of such note would be that for which

the partners had assumed personal liability. Under such

circumstances, the partners would be called upon to pay their pro

rata share of the unpaid amounts due on the Limited Recourse

Note.

Pursuant to the provisions of the Purchase Agreement, the

Additional Equipment Wrap Lease was assigned to the partnership

by Hambrose. Consequently, the rental payments under the

Additional Equipment Wrap Lease were paid by Charterhouse

directly to the partnership.

The Partnership

The partnership was organized in March 1985, under the laws

of the State of Connecticut, to engage in the equipment leasing

business. Investments in the partnership were offered through a

private offering memorandum (POM). The partnership offered 70

units of partnership interests at a price of $40,000 per unit. 

The purchase price was payable in full in cash on subscription or

payable $9,200 cash and the balance payable by two Investor Notes

in the amount of $15,400 each, bearing 12-percent interest

(payable annually). The principal of each of these Investor
- 13 -

Notes was due February 3, 1986, and February 2, 1987,

respectively.

As a condition of becoming a limited partner, an investor

was also required to assume recourse debt of $114,578 per

partnership unit purchased, which represented his or her

proportionate share of the Limited Recourse Note executed by the

partnership in connection with the purchase of the Additional

Equipment from Hambrose. The subscription agreement included the

following provision:

(c) The Subscriber [petitioner] understands that

pursuant to the Partnership Agreement, * * * he is agreeing

to be personally liable for his proportionate share of the

Partnership Equipment Note [Limited Recourse Note] to

Hambrose Reserve Ltd. ("Hambrose Reserve") and interest

thereon equal to $114,578 per Unit. Such personal liability

gives Hambrose Reserve the right, at maturity, to pursue a

Limited Partner directly for the amount of the unpaid

balance of his pro rata share of the portion of the

Partnership Equipment Note for which the Limited Partners

are personally liable. The liability of each Limited

Partner is several and not joint. The Subscriber further

understands that the portion of principal and interest on

the Partnership Equipment Notes for which the Limited

Partners are personally liable will not be paid until after

the nonrecourse portion of principal and interest thereon

has been paid in full.

In other words, Hambrose had the right to pursue a limited

partner directly for the amount of the unpaid balance of his or

her pro rata share of the assumed portion of the Limited Recourse

Note at maturity, which could extend to as late as January 1,

1992 (if the deferral provisions in the Limited Recourse Note
- 14 -

9 Petitioner paid $4,600 cash on Nov. 1, 1985, and signed an

Investor Note in the amount of $15,400, which he paid on over the

following 2 years.

applied; otherwise a limited partner's liability would apply as

each installment of the Limited Recourse Note became due).

Petitioner's Decision To Invest

On November 1, 1985, petitioner executed subscription

documents to purchase one-half of one unit in the partnership,

for which he paid a total of $20,000 cash over the period from

November 1985 through June 1987.9 Pursuant thereto, petitioner

was required to, and did, therefore, assume personal liability

for his pro rata portion of the Limited Recourse Note in the

amount of $57,289.

Procedural Background

Respondent issued two Notices of Final Partnership

Administrative Adjustment (the FPAA's) to the partnership for the

tax years 1985 and 1986 on April 20, 1992. On July 17, 1992, the

partnership filed a petition with this Court challenging the

correctness of the FPAA, but making no claim that it was not

timely. That case was captioned Hambrose Leasing v.

Commissioner, under docket No. 16262-92 (Hambrose II).

On September 1, 1992, this Court issued its opinion in a

related case, pertaining to the 1984 tax year, Hambrose Leasing

v. Commissioner, 99 T.C. 298 (1992) (Hambrose I). In Hambrose

I, this Court held that the issue of whether a partner is at risk
- 15 -

under section 465 must be decided in a partner-level proceeding,

not in a partnership-level proceeding. In that opinion, the

Court also decided that, for purposes of any subsequent

litigation involving the partnership, the installment note for

the Additional Equipment was nonrecourse as to the partnership. 

Id. at 303, 312. The decision in that case was entered on

September 24, 1992, and became final on December 23, 1992.

On October 6, 1993, this Court granted respondent's "Motion

to Dismiss for Lack of Jurisdiction as to I.R.C. Section 465 and

To Strike" in Hambrose II, and all references to the "at risk"

issue were, therefore, stricken from the pleadings. On May 27,

1994, this Court entered a decision in Hambrose II based on a

stipulated settlement agreement under Rule 248(a) in which

respondent accepted as filed the partnership items for the

taxable years 1985 and 1986 of the partnership. This decision

became final on August 25, 1994.

On May 19, 1995, respondent issued statutory notices of

deficiency to petitioners, one for the 1985 tax year and one for

the 1986 tax year, in which the claimed deductions for 1985 and

1986 with respect to the partnership were disallowed, and

additions to tax and increased interest were asserted.

Untimely Notice

The first issue for decision is whether respondent timely

issued notices of deficiency to petitioners in this case. 
- 16 -

10 Consistent with this Court's decision in Hambrose Leasing v.

Commissioner, 99 T.C. 298 (1992), the deductions at issue are

"affected" items.

Section 6229(a) provides that respondent has 3 years from the

date of the filing of the partnership return in which to assess

the tax based on any partnership or "affected" item.10 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 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. Since, in

the instant case, it is undisputed that the applicable

limitations period was open when two FPAA's were issued to the

partnership, and that the partnership timely filed a petition in

this Court based on such FPAA's, the period of limitation for

issuing notices of deficiency was suspended, under section

6229(d), for 1 year after the decision in the partnership

proceeding before this Court became final.

The parties agree that the period of limitation for issuing

notices of deficiency for affected items is suspended for 90 days

plus 1 year following the entry of the decision in the

partnership proceeding. The parties disagree, however, as to the
- 17 -

date upon which the decision was entered in the partnership

proceeding.

Respondent contends that the decision in the partnership

proceeding was entered on May 27, 1994, when this Court entered

the decision based on the stipulated settlement agreement. 

Respondent contends further that this decision became final on

August 25, 1994, which is 90 days following entry of the

decision. Therefore, respondent argues, under section 6229(d),

the period of limitation was suspended until August 25, 1995,

which is 1 year from the date the decision became final. Since

the subject notices of deficiency were issued on May 19, 1995,

respondent argues that the deficiency notices were timely issued.

Petitioners contend that the decision in the partnership

proceeding was entered on October 6, 1993, the date this Court

granted respondent's motion to dismiss for lack of jurisdiction

with respect to the at-risk issue under section 465. Petitioners

argue further that this decision became final on January 4, 1994,

which is 90 days following the entry of such "decision". 

Therefore, petitioners argue, under section 6229(d), the period

of limitation was suspended only until January 4, 1995, which is

1 year from the date the "decision" became final. Since the

relevant notices of deficiency were not issued until May 19,

1995, petitioners argue that the notices were not timely issued.
- 18 -

In support of their position, petitioners rely on section

7459(c) and the case of Armstrong v. Commissioner, T.C. Memo.

1992-328, affd. 15 F.3d 970 (10th Cir. 1994), for the proposition

that a dismissal for lack of jurisdiction is tantamount to a

decision of this Court. Section 7459(c) provides:

(c) Date of Decision.--A decision of the Tax Court

(except a decision dismissing a proceeding for lack of

jurisdiction) shall be held to be rendered upon the

date that an order specifying the amount of the

deficiency is entered in the records of the Tax Court

or, in the case of a declaratory judgment proceeding

under part IV of this subchapter, or under section 7428

or in the case of an action brought under section 6226

or section 6228(a), the date of the court's order

entering the decision. If the Tax Court dismisses a

proceeding for reasons other than lack of jurisdiction

and is unable from the record to determine the amount

of the deficiency determined by the Secretary, or if

the Tax Court dismisses a proceeding for lack of

jurisdiction, an order to that effect shall be entered

in the records of the Tax Court, and the decision of

the Tax Court shall be held to be rendered upon the

date of such entry. [Emphasis added.] 

Indeed, in Hambrose II, this Court did grant a motion to dismiss

for lack of jurisdiction, but only as to a single issue in the

case, not as to the entire proceeding. By granting the motion to

dismiss for lack of jurisdiction with respect to the at-risk

issue under section 465, this Court did not dismiss the entire

partnership proceeding but, rather, dismissed only that portion

of the proceeding that related to the at-risk issues under

section 465. Consequently, under section 7459(c), a decision in

Hambrose II was not rendered on October 6, 1993, the date the

Court granted respondent's motion to dismiss for lack of
- 19 -

11 A stipulated decision, though generally not subject to

appeal except on jurisdictional grounds, Clapp v. Commissioner,

875 F.2d 1396 (9th Cir. 1989), is still considered a reviewable

decision that becomes final 90 days after entry of decision. 

Pesko v. United States, 918 F.2d 1581 (Fed. Cir. 1990); Sherry

Frontenac, Inc. v. United States, 868 F.2d 420 (11th Cir. 1989);

Security Indus. Ins. Co. v. United States, 830 F.2d 581 (5th Cir.

1987) (all cited in Ripley v. Commissioner, 105 T.C. 358, 362

(1995), revd. on other grounds 103 F.3d 332 (4th Cir. 1996)).

jurisdiction with respect to the at-risk issue. On the contrary,

the decision in Hambrose II was rendered on May 27, 1994, the

date this Court entered a decision based on the stipulated

settlement agreement. Furthermore, petitioners' reliance on the

case of Armstrong v. Commissioner, supra, is misplaced because

the Court in that case dismissed a petition; i.e., an entire

proceeding, for lack of jurisdiction. Petitioners' argument on

this issue is without merit.

On this record, the Court holds that a decision was entered

in the partnership proceeding on May 27, 1994, which decision

subsequently became final on August 25, 1994.11 The Court holds

further that the notices of deficiency were timely issued to

petitioners under section 6229(a) because the notices were mailed

on May 19, 1995, which was within 1 year after the decision in

the partnership proceeding became final.

At-Risk

The second issue for decision is whether petitioner was

"protected against loss" within the meaning of section 465(b)(4)

with respect to his pro rata share of the Limited Recourse Note,
- 20 -

for which he assumed personal liability. Since respondent first

raised this issue in the answer, respondent bears the burden of

proof. Rule 142(a).

Section 465(a) provides that deductions with respect to

liabilities of the type involved in this case are allowable only

to the extent the taxpayer is "at risk". A taxpayer's amount at

risk includes the amount of money and the basis of property

contributed to an activity. Sec. 465(b)(1)(A). Also, a taxpayer

is considered at risk for amounts borrowed with respect to the

activity. Sec. 465(b)(1)(B). The statute defines amounts

borrowed with respect to an activity as including "amounts

borrowed for use in an activity to the extent that * * * [the

taxpayer] is personally liable for the repayment of such

amounts". Sec. 465(b)(2)(A).

Respondent agrees that the partnership's sale-leaseback

transactions had a business purpose with economic substance, were

engaged in for profit, and that the partnership's equipment was

correctly valued. Respondent further agrees that petitioner was

"at risk" in the amount of his $20,000 investment, which

consisted of $4,600 cash and the $15,400 Investor Note that

petitioner executed upon purchasing his interest in the

partnership, and for which he was personally liable.

Respondent also agrees that petitioner assumed a pro rata

share of the Limited Recourse Note. Respondent contends,
- 21 -

however, that petitioner was not at risk for his pro rata share

of the Limited Recourse Note as to which he assumed personal

liability because of section 465(b)(4). Section 465(b)(4)

provides:

(4) Exception.--Notwithstanding any other

provision of this section, a taxpayer shall not be

considered at risk with respect to amounts protected

against loss through nonrecourse financing, guarantees,

stop loss agreements, or other similar arrangements.

Respondent does not contend that petitioner was protected from

loss by guarantees or stop loss agreements. However, respondent

argues that petitioner was protected from loss by nonrecourse

financing and "other similar arrangements", as provided in

section 465(b)(4).

In determining whether a taxpayer is protected from loss

within the meaning of section 465(b)(4), the majority of Courts

of Appeals that have addressed this issue have applied the

"realistic possibility" or "economic reality" test. See Waters

v. Commissioner, 978 F.2d 1310 (2d Cir. 1992), affg. T.C. Memo.

1991-462; Young v. Commissioner, 926 F.2d 1083 (11th Cir. 1991),

affg. T.C. Memo. 1988-440 and Cohen v. Commissioner, T.C. Memo.

1988-525; Moser v. Commissioner, 914 F.2d 1040 (8th Cir. 1990),

affg. T.C. Memo. 1989-142; American Principals Leasing Corp. v.

United States, 904 F.2d 477 (9th Cir. 1990) (sometimes cited as

Baldwin v. United States). Under the economic reality test, the

courts examine whether "a transaction is structured--by whatever
- 22 -

method--to remove any realistic possibility that the taxpayer

will suffer an economic loss if the transaction turns out to be

unprofitable." American Principals Leasing Corp. v. United

States, 904 F.2d at 483. The economic reality test was applied

by this Court in Levien v. Commissioner, 103 T.C. 120, 126

(1994), affd. without published opinion 77 F.3d 497 (11th Cir.

1996).

However, the Court of Appeals for the Sixth Circuit, to

which an appeal in this case would lie, has disagreed with the

majority of circuits and has adopted a "worst-case scenario" test

for the determination of whether a taxpayer is protected from

loss within the meaning of section 465(b)(4). See Martuccio v.

Commissioner, 30 F.3d 743 (6th Cir. 1994), revg. T.C. Memo. 1992-

311; Emershaw v. Commissioner, 949 F.2d 841 (6th Cir. 1991),

affg. T.C. Memo. 1990-246. Under the "Golsen rule", "where the

Court of Appeals to which appeal lies has already passed upon the

issue before us, efficient and harmonious judicial administration

calls for us to follow the decision of that court." Golsen v.

Commissioner, 54 T.C. 742, 757 (1970), affd. 445 F.2d 985 (10th

Cir. 1971). The Court of Appeals for the Sixth Circuit has

spoken definitively on the "at-risk" issue as it relates to this

case. Consequently, in the instant case, this Court is bound to

apply the "worst-case scenario" standard in determining whether
- 23 -

petitioners were protected from loss within the meaning of

section 465(b)(4).

Respondent acknowledges, on brief, that no single feature of

a transaction controls as to whether a taxpayer is protected from

loss. However, respondent contends that, in this case, a

combination of factors, including the nonrecourse nature of the

indebtedness involved in the transaction, the circularity of

payments, and the deferral provisions in the Limited Recourse

Note, effectively protected petitioner from loss within the

meaning of section 465(b)(4).

The Court first examines respondent's assertion that the

existence of nonrecourse financing protected petitioner from loss

under section 465(b)(4). Where a partner is personally liable

for his share of partnership nonrecourse debt by virtue of his

assumption of the nonrecourse liability, the presence of that

same nonrecourse liability cannot also be said to be a factor

insulating him from risk. See Hayes v. Commissioner, T.C. Memo.

1995-151; Wag-A-Bag Inc. v. Commissioner, T.C. Memo. 1992-581,

and cases cited therein.

Respondent next asserts that the circular nature of the

payments, i.e., the fact that the partnership's debt payments

under the Limited Recourse Note were exactly offset by the rental

payments it received from Charterhouse, protected petitioner from

loss. The circularity of the payments is set forth in the
- 24 -

stipulation and the stipulated documents as well as in the POM. 

The Court of Appeals for the Sixth Circuit has observed that such

a structure:

minimizes the need for a large initial cash outlay by any of

the * * * partners. It does not minimize the risk that "the

taxpayer will suffer any out-of-pocket loss if the

transaction is unsuccessful." * * * The circle of

offsetting obligations does nothing to affect this risk, let

alone eliminate it, realistically, probably, or otherwise. 

* * * [Emershaw v. Commissioner, 949 F.2d 841, 850 (6th

Cir. 1991); affg. T.C. Memo. 1990-246.]

Finally, respondent argues that the various provisions for

indemnification contained in the Purchase Agreement and the

Additional Equipment Wrap Lease protected petitioner from loss

under section 465(b)(4). Upon analyzing an indemnification

provision in a purchase agreement that parallels that of the

Purchase Agreement in the instant case, the Court of Appeals held

that such an indemnification clause did not protect the

petitioner from loss within the meaning of section 465(b)(4). 

Martuccio v. Commissioner, 30 F.3d 743, 751 (6th Cir. 1994),

revg. T.C. Memo. 1992-311.

The sale-leaseback transactions in issue in Emershaw v.

Commissioner, supra, and Martuccio v. Commissioner, supra, are

indistinguishable from the transaction in issue in the instant

case. In Emershaw v. Commissioner, supra, CIS purchased certain

computer equipment, financing the purchase with nonrecourse bank

loans, and leased the equipment to end-users. CIS then sold the

equipment to Program Leasing Corporation (Program), which gave a
- 25 -

small downpayment and an installment note for the balance of the

purchase price. Program then sold the equipment to LEA, the

partnership in which the taxpayer Emershaw was a partner. LEA

paid a small downpayment and for the balance gave Program a

partial recourse installment note equal to the installment note

Program had given CIS. LEA then leased the equipment back to CIS

for monthly rent payments equal to the monthly payments LEA owed

on its note to Program. The payments on the lease and various

notes were made by offsetting bookkeeping entries pursuant to

letter agreements between the parties.

In Martuccio v. Commissioner, supra, the principals, Tiger,

Elmco, and the taxpayer, Martuccio, were in the same positions,

respectively, as CIS, Program, and the LEA partners were in the

Emershaw transaction. The principals in both of those cases

paralleled the principals CIS, Comdisco, Charterhouse, Hambrose,

the partnership, and petitioner in the instant case.

In Emershaw v. Commissioner, supra, the Court of Appeals for

the Sixth Circuit held, as discussed previously, that the

circular offsetting structure of payments in the three-party

sale-leaseback transaction, similar to that presented in this

case, did not by itself constitute protection from loss under

section 465(b)(4). Emershaw v. Commissioner, 949 F.2d at 848. 

Upon examining the similar sale-leaseback transaction in issue in

Martuccio v. Commissioner, supra, the Court of Appeals for the
- 26 -

Sixth Circuit held that, under the "worst-case scenario"

standard, neither the existence of an indemnification clause in

the taxpayer's purchase agreement nor the nonrecourse nature of

the note to the original purchaser of the equipment protected the

taxpayer from loss within the meaning of section 465(b)(4). 

Respondent has failed to present facts in this case that would

distinguish the transaction in the instant case from those in

Emershaw v. Commissioner, supra, and Martuccio v. Commissioner,

supra. Therefore, the reasoning applied, and results reached in

those cases equally apply to the instant case.

On this record, under the standards prescribed by the Court

of Appeals for the Sixth Circuit, the Court here holds that

petitioner is not "protected from loss" within the meaning of

section 465(b)(4). Petitioners are, therefore, entitled to the

loss and investment interest expense deductions claimed on their

1985 and 1986 Federal income tax returns. Petitioners are

sustained on this issue.

Additions

The remaining issue is whether petitioners are liable for

the additions to tax under sections 6653(a) and 6661(a), and the

increased interest under section 6621(c), for each of the years

in question. Since the Court holds for petitioners on the at

risk issue, there exists no underpayment to which the additions
- 27 -

to tax under sections 6653(a) and 6661(a), and the increased

interest under section 6621(c) may be applied.

To reflect the foregoing,

Decision will be entered

for petitioners.