T.C. Mem o. 2 01 3- 14 9

UNITED STAT ES TAX COURT

LORI M. MI NGO AND JOHN M. MI NGO, Peti ti on ers v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No s. 1 77 53 -0 7, 2 19 06 -1 0. Fil edJu ne 12 , 20 13
.
Haro ldA. Chamberl ai n, fo r pe ti ti on ers . Andrew Mi ch ael Tikti n a ndDerekP. Ric hm an , forres po nd en t.

MEMORANDUM OPINION PARIS , Ju dg e: In the se co ns ol id at edcas es , res po nd en t i ss ue d two n ot ic es of de fic ie nc y , tak in g a lt ern at iv e p os it io ns with re sp ectto th e rep orti ng of pe ti ti on ers ’ sa le of apa rtn ers hi p i nt eres t i n t ax y ear 2 00 2. OnMay 23, 2 00 7,
res po nd en t i ss ue d ano ti ce o f de fic ie nc y to pe ti ti on ers fortax y ear 2 00 3- 2 -

[* 2] de te rm in in g aFed eral in co m e ta x d efi ci en cy of $ 45 ,51 0. OnJu ly 21, 2 01 0,
res po nd en t i ss ue d ano ti ce o f de fic ie nc y to pe ti ti on ers fortax y ear 2 00 7 al te rn at iv el y

de te rm in in g aFed eral in co m e ta x d efi ci en cy of $ 59 ,52 7 a ndan accu racy-rela te d p en al ty und er s ect io n 6 66 2( a) of $ 11 ,90 5.4 0. Re sp on de nt 1
co nc ed es th atpe ti ti on ers are n otli ab le forth is accu racy-rela te d p en al ty. Pet it io ne rs see k re de te rm in at io n o f th e ab ov e-s ta te d d efi ci en ci es . The is su es forde ci si on are: (1 ) whe th er p et it io ne rs are en ti tl edto rep ort the sal e o f pe ti ti on er Lo ri M
. Mi ng o’s p artne rs hi p i nt eres t as anin st al lm en t s al e fo r th e p orti onof t he pro ceed s at tri bu tabl e to th atpa rtn ers hi p’s u nr eal iz edrece iv ab le s; (2 ) whe th er, i f pe ti ti on ers are n oten ti tl edto rep ort the po rti on of M rs . Mi ng o’s p artne rs hi p p ro ceed s at tri bu tabl e to un real iz edrece iv ab le s as an in st al lm en t s al e, pe ti ti on ers ’ rep orti ng of t ha t s al e co ns ti tu te d the ele ct io n o f an
acco un ti ng m etho d u nd er s ect io n 4 46 su chth atsec ti on 48 1( a) ap pl ie s; (3 ) ad di ti on al ly, if s ect io n 4 81 (a) ap pl ie s, wh ethe r pe ti ti on ers m us t reco gn iz e o rd in ary in co m e o f $1 26 ,24 0 u nd er s ect io n 4 81 (a) fo r ta x year 20 03 as a res ul t o f res po nd en t’s ch an ge of t he ir a cco un ti ng m etho d wi th res pe ctto th e sa le ; Unl es s o th erwi se in di cat ed , sec ti on refe ren ces are t o the ap pl ic ab le 1 ve rs io ns of t he Int ern al Rev enue Co de , andRu le refe ren ces are t o the Tax C ou rt Ru le s o f Prac ti ce an d P ro cedur e.- 3 -

[* 3] (4 ) al te rn at iv el y , whethe r pe ti ti on ers m us t re co gn iz e o rd in ary in co m e o f $1 26 ,24 0 fr om

th e sa le of M rs . Min go ’s in te res t i n the pa rtn ers hi p’s unr eal iz ed
rece iv ab le s fo r ta x year 20 07 when th e in st al lm en t n ot e is su edinth e sa le of M rs . Mi ng o’s p artne rs hi p i nt eres t was sat is fie d i n fu ll ; (5 ) whe th er, i f pe ti ti on ers m us t re co gn iz e $ 12 6,2 40 as o rd in ary in co m e fo r ta x year 20 03 or 2 00 7, p et it io ne rs are en ti tl edto a de crea se inrep orte d l on g- te rm cap it al ga in s i n the same am ou ntfortax y ear 2 00 7; an d (6 ) whe th er p et it io ne rs are en ti tl edto a lo ng -te rm cap it al lo ss of $ 21 7,4 02 fo r ta x year 20 07 with re sp ectto th e co nv ers io n o f th e in st al lm en t n ot e rec ei ve d fro m th e sa le of M rs . Min go ’s partn ers hi p i nt eres t. Bac kg ro un d The pa rti es subm itte d the se cas es forde ci si on ful ly sti pu la te d u nd er Ru le 12 2( a). The st ip ul at io n o f fac ts fil edon Octo be r 7, 2 01 1, s up pl em en te d o n M arch 5 a ndApri l 2 7, 2 01 2, an d a m en de d o n M ay 1, 2 01 2, i s i nc or

po rat edhe rei n b y

th is refe ren ce. Pet it io ne rs res id edinTexa s atth e ti m e th ei r pe ti ti on s wer e fi le d. Pet it io ne rs are h us ba ndan d wi fe an d wer e m arri edforth e y ears at i ss ue . Mrs . Min go joi ne d P ric ewat erh ou se Co op ers , LLP (PW C) s om et im e b efo re t ax y ear 2 00 2. Mr s. M in go was apa rtn er i n the m an ag em en t co ns ul ti ng an d te ch no lo gy serv ic es bu si ne ss (co ns ul ti ng bu si ne ss ) of PW C unt il tax y ear 2 00 2,- 4 -

[* 4] whe n P W C s ol d i ts co ns ul ti ng bu si ne ss to Int ern at io na l Bu si ne ss Mac hi ne s Co rp or at io n (I BM)
. 2 As an in it ia l s te p i n the tra ns act io n, PwC C, L.P. (PwCC), apa rtn ers hi p, was fo rm edinApri l o r May 20 02 . PwCC was own edby certa insubs id iarie s o f PWC. As p artof t he tra ns act io n, PWC tra ns ferr edit s co ns ul ti ng bu si ne ss to PwCC. Am on g the ass et s PWC tra ns ferr edto PwCC were it s co ns ul ti ng bu si ne ss ’
un co ll ect edacco un ts rece iv ab le forservi ces itha d p rev io us ly rend ered(un real iz ed
rece iv ab le s) . PW C th entra ns ferr edto each of t he 41 7 c on su lt in g p artne rs (co ll ect iv el y , con su lt in g p artne rs ) anin te res t i n P wCC an d c as h i n e xc hang e fo r th e p artne r’s in te res t i n P W C. Mrs . Min go was o ne of t he se pa rtn ers , andsh e rece iv eda pa rtn ers hi p i nt eres t i n P wCC an d c as h fr om PW C in ex ch an ge forhe r pa rtn ers hi p i nt eres t i n P W C. The va lu e o f Mrs . Min go ’s partn ers hi p i nt eres t i n P wCC as of Oc to be r 1, 20 02 , was $ 83 2,0 90 , of wh ic h $ 12 6,2 40 was a ttrib ut ab le to he r in te res t i n pa rtn ers hi p u nr eal iz edrece iv ab le s. Onth atda te , PW C cau se d i ts subs id iarie s t o se ll th ei r res pe ct iv e in te res ts inPwCC t o IB M. At the same tim e, th e co ns ul ti ng pa rtn ers so ldth ei r res pe ct iv e in te res ts inPwCC t o IB M i n e xc hang e fo r
Herei na fte r, th e st ep s t ak ento acco m pl is h thi s s al e are refe rredto , as a 2 who le , as the tra ns act io n.- 5 -

[* 5] co nv ert ib le pro m is so ry no te s. At t he en d o f th e tr an sa ct io n, IB M o wne d 10 0% o f th e co ns ul ti ng bu si ne ss . On Oct ob er 1 , 20 02 , IBM g av e Mrs . Min go a co nv ert ib le pro m is so ry no te (n ot e) fo r $8 32 ,09 0 i n e xc ha ng e fo r he r in te res t i n P wCC. The $1 26 ,24 0 at tri bu tabl e to he r in te res t i n p artne rs hi p u nr eal iz edrece iv ab le s was in cl ud edin th atface va lu e. The n ot e in cl ud edth e fo ll owi ng term s: (1 ) Mrs . Min go ha d the rig htto co nv ertall or a ny po rti on of t he unpa id pr in ci pa l b al an ce i nt o IB M co m m on st oc k a t an y

ti m e aft er the fir st
an ni ve rs ary of

clo si ng . Howev er, an y

su chco nv ers io n h adto be in in crem en ts of $ 1,0 00 pri nc ip al am ou nt s o r fo r th e en ti re u np ai d p rin ci pa l. (2 ) un le ss th e n ot e is co nv ert edin to IBM s to ck , IBM wo ul d p ay in te res t o n th e unp ai d p rin ci pa l b al an ce s em iann ua ll y . (3 ) th e o ut st an di ng pri nc ip al am ou ntof t he no te an d a ny accru edan d unp ai d in te res t was du e an d p ay ab le on th e fi fth an ni ve rs ary of th e tr an sa ct io n’s cl os in g (i .e., Octo be r 1, 2 00 7)
. On the ir 2 00 2 F ed eral in co m e ta x re tu rnan d o n an att ach edFo rm 62 52 , In st al lm en t Sa le Inc om e, pe ti ti on ers rep orte d the sal e o f Mrs . Min go ’s in te res t i n PwCC a s an in st al lm en t s al e. The s el li ng pri ce, g ro ss pro fit , andco nt ractpri ce- 6 -

[* 6] were l is te d a s $ 83 2,0 90 . Peti ti on ers di d n otreco gn iz e an y in co m e rel at in g t o th e n ot e o th er tha n i nt eres t i nc om e o n the ir 2 00 2 F ed eral in co m e ta x re tu rn . Pet it io ne rs di d n otco nv ertan y po rti on of t he no te du rin g t ax y ears 20 02 , 20 03 , 20 04 , 20 05 , and20 06 . Peti ti on ers als o d idno t re po rt a ny inc om e o th er tha n in te res t i nc om e fro m

th e n ot e fo r an y

of t ho se y ears . Dur in g t ax y ear 2 00 7 p et it io ne rs co nv ert edth e en ti rety of the no te ina se rie s o f tr an sa ct io ns . On Feb ru ary 26 , 20 07 , pet it io ne rs co nv ert eda po rti on of th e n ot e in to sh ares of I BM s to ckwort h $ 92 9,7 65 . Also on Feb ru ary 26 , 20 07 , pe ti ti on ers so ldth os e sh ares of I BM s to ckfor a to ta l o f $8 99 ,28 7. OnOcto be r 1, 20 07 , pet it io ne rs co nv ert edth e rem ai nd er o f th e n ot e in to sh ares of I BM s to ck
worth$2 83 ,49 4. Pe ti ti on ers rep orte d the fol lo win g i te m s o f lo ng -te rm cap it al ga in
an d l os s i n c on ne ct io n wi thth e co nv ers io n o f th e n ot e o n S ch edul e D, Cap it al Gain s an d Lo ss es , of the ir a m en de d 2 00 7 F ed eral in co m e ta x re tu rn : Des cri pt io n o f pr op erty Date

acqui red Date so ld Sal es pri ce Co st ba si s Gain

(lo ss ) Exc ha ng e o f in st al lm en t ob li ga ti on 10 /1 /2 00 2 2/ 26 /2 00 7 $9 29 ,76 5 -0
- $9 29 ,76 5 Exc ha ng e o f in st al lm en t ob li ga ti on 10 /1 /2 00 2 10 /1 /2 00 7 28 3,4 94 -0
- 28 3,4 94- 7 -

[* 7] Debt co nv ert edto st oc k (n on ta xabl e) 10 /1 /2 00 2 10 /1 /2 00 7 (2 17 ,40 2) -0
- (2 17 ,40 2) Pet it io ne rs rep orte d n etlo ng -te rm cap it al ga in s o n S ch edul e D of th ei r 20 07 ta x re turnas $ 99 5,8 57 . Peti ti on ers cal cu la te d the ir t ax on th is am ou ntto be $1 45 ,16 8 a ndti m el y

pa idth e sa m e. Ina le tt er d at edDecem

be r 27 , 20 06 , res po nd en t i nf orm edpe ti ti on ers th at th ei r 20 03 joi ntin co m e ta x re tu rn , whi chwas fi le d t im el y un de r pr op er ex te ns io ns on Octo be r 15 , 20 04 , hadbe ensel ect edfor a rem ot e ex am in at io n. OnMay 23, 20 07 , res po nd en t i ss ue d t o p et it io ne rs a no ti ce o f de fic ie nc y fortax y ear 2 00 3. In th e n ot ic e res po nd en t d et erm in edth atth e am ou ntMrs . Min go rece iv edin20 02 for he r pa rtn ers hi p i nt eres t i n P wCC, t o the ex te ntitwas a ttrib ut ab le to pa rtn ers hi p un real iz edrece iv ab le s, co ul d n otbe rep orte d u nd er the in st al lm en t m etho d. Res po nd en t d et erm in edth atMrs . Min go ’s rep orti ng of the sal e insu cha m an ne r co ns ti tu te d the est ab li sh m en t o f anacco un ti ng m etho d fo r th e p ur po se s o f se ct io n 44 6 a ndim

po se d ach an ge of a cco un ti ng m etho d a dju st m en t u nd er s ect io n 4 81 (a) fo r ta x year 20 03 . The ad jus tm en t re su lt edinpe ti ti on ers ’ reco gn iz in g o rd in ary in co m e o f $1 26 ,24 0 fo r ta x year 20 03 , th e am ou ntof M rs . Min go ’s partn ers hi p in te res t tha t was att rib ut ab le to un real iz edrece iv ab le s. OnAug us t 9 , 20 07 ,- 8 -

[* 8] pe ti ti on ers ti m el y

fil eda pe ti ti on inth is Co urt fo r red et erm in at io n o f th e de fic ie nc y

fortax y ear 2 00 3. On J ul y 21 , 20 10 , res po nd en t i ss ue d t o p et it io ne rs a no ti ce o f de fic ie nc y for ta x year 20 07 . In thi s n ot ic e res po nd en t d et erm in edth at , if re sp on de ntwas n ot pe rm it te d t o i ns ti tu te a m etho d o f acc ou nt in g c ha ng e und er s ect io n 4 81 (a) fo r ta x y ear 2 00 3, the am ou ntMrs . Min go rece iv edinsat is fact io n o f th e n ot e intax y ear 20 07 , to th e ex te ntatt rib ut ab le to pa rtn ers hi p u nr eal iz edrece iv ab le s, wo ul d b e pr op erl y cla ss ifi edas o rd in ary in co m e. The e ffec t o f th is de te rm in at io n was to in crea se pe ti ti on ers ’ or di na ry in co m e b y

$1 26 ,24 0 fo r ta x year 20 07 . The de te rm in at io n fu rth er d et erm in edth atpe ti ti on ers were l iabl e fo r ad di ti on cap it al ga in of $ 92 ,13 3 fo r ta x year 20 07 . This in crea se co ns is te d o f th ree c om po ne nt s: (1 ) anin crea se to sh ort-t erm cap it al ga in s o f $9 71 fro m pe ti ti on ers ’ sa le of IBM st oc k o n F eb ru ary 26 , 20 07 ; (2 ) th e d is al lo wan ce o f pe ti ti on ers ’ cl ai m edlo ng -te rm cap it al lo ss of $2 17 ,40 2 fr om

Mrs . Min go ’s con ve rs io n o f th e n ot e in to IBM s to ck ; an d (3 ) a reduc ti on inrep orte d l on g- te rm cap it al ga in s o f $1 26 ,24 0 a s a co ns eque nc e o f th e d et erm in at io n tha t:- 9 -

[* 9] (a) i f am ou nt s re cei ve d a ttrib ut ab le to un real iz edrece iv ab le s wer e

reco gn iz edas o rd in ary in co m e fo r ta x year 20 03 , Mrs . Min go wou ld ha ve a ba si s i n the no te of $ 12 6,2 40 ; o r (b ) if am ou nt s re cei ve d a ttrib ut ab le to un real iz edrece iv ab le s wer e reco gn iz edas o rd in ary in co m e fo r 20 07 , Mrs . Min go wou ldha ve a reduc ti on incap it al ga in be cau se of t he recl as si fic at io n o f th is in co m e. Res po nd en t’s n ot ic e o f de fic ie nc y als o d et erm in edanaccu racy-rela te d pe na lty un de r se ct io n 6 66 2( a) o f $1 1,9 05 .40 ; h owe ve r, res po nd en t h as si nc e co nc ed edth atpe ti ti on ers are n otli ab le forth is pe na lty . On Oct ob er 4 , 20 10 , pe ti ti on ers ti m el y

fil eda pe ti ti on inth is Co urt fo r rev ie w of re sp on de nt ’s de te rm in at io n fo r ta x year 20 07
. Dis cu ss io n I. Ins ta ll m en t M etho d R ep orti ng of Un real iz edRece iv ab le s Sect io n 4 53 (a) p ro vi de s tha t, ex cep t as othe rwis e p ro vi de d, i nc om e fro m an in st al lm en t s al e sh al l b e ta ke n i nt o a cco un t u nd er the in st al lm en t m etho d. An in st al lm en t s al e is de fin edas adi sp os it io n o f pr op erty wher e atlea ston e p aym en t is to be rece iv edaft er the clo se of t he tax ab le y ear i n wh ic h the di sp os it io n o ccu rs . Sec. 4 53 (b )(1 ). The i ns ta ll m en t m etho d i s d efi ne d a s a m etho d u nd er wh ic h the- 10 -

[* 10 ] in co m e rec og ni zedforany tax ab le y ear f

ro m a di sp os it io n i s tha t p ro po rti on of th e p aym en ts rece iv edinth aty ear wh ic h the gro ss pro fit(rea li zedor t o b e real iz edwhenpa ym en t i s co m pl et ed ) be ars to th e to ta l co nt ractpri ce. Sec . 45 3( c). Inth e cas e o f a s al e o r ex ch an ge of apartn ers hi p i nt eres t, g ai n o r lo ss reco gn iz edto th e tr an sf

ero r is co ns id eredga in or l os s fr om th e sa le or e xc ha ng e o f a cap it al ass et , exc ep t as othe rwis e p ro vi de d b y sec ti on 75 1. Se c. 74 1. Se ct io n 75 1( a) p ro vi de s tha t the am ou ntrece iv edby a tran sf ero r pa rtn er i n e xc ha ng e fo r al l o r pa rt o f a p artne rs hi p i nt eres t s ha ll be co ns id eredas a n am ountreal iz edfro m th e sa le or e xc ha ng e o f pr op erty othe r th ana cap it al ass et , to th e ex te ntsu ch
am ountis att rib ut ab le to un real iz edrece iv ab le s o r in ve nt ory it em s o f th e pa rtn ers hi p. Th e te rm

“un real iz edrece iv ab le s” in cl ud es , to th e ex te ntno t pr ev io us ly inc lu di bl e in in co m e und er the m etho d o f acc ou nt in g u se d b y th e pa rtn ers hi p, an y

rig ht s (c on tra ctua l o r ot he rwis e) t o p aym en t fo r se rv ic es ren de red
orto be ren de red . Sec. 7 51 (c)( 2)
. The pu rp os e o f se ct io n 7 51 is to pre ve ntth e co nv ers io n o f po te nt ia l
or di na ry in co m e in to cap it al ga in when a pa rtn ers hi p i nt eres t i s s ol d o r ex ch an ge d. See M ad or in v. Co m

m is si on er, 8 4 T.C. 6 67 , 68 2 (1 98 5) . The eff ectof s ect io n 7 51 is to sev er ce rta inin co m e it em s t o e ffec tu at e th is pu rp os e. Fo r th e am ou ntof a pa rtn ers hi p i nt eres t at tri bu tabl e to in ve nt ory or u nr eal iz edrece iv ab le s d es cri be d i n- 11 -

[* 11 ] se ct io n 7 51 , th e ta x c on se qu en ces to th e tr an sf erri ng pa rtn er ar e “ th e sam e ta x c on se qu en ces whi chwou ldbe acco rd edanin di vi du al en tre pr en eu r.” H.R. Rep t. No . 83 -1 33 7, at70 -7 1 (1 95 4) , 19 54 U.S.C.C.A.N. 40 17 , 40 98 ; S. Re pt . No. 83 -1 62 2, at99 (19 54 ), 19 54 U.S.C.C.A.N. 46 21 , 47 32 . Esse nt ia ll y , th e tra ns ferr in g p artne r is tre at edas d is po si ng of s ect io n 7 51 pro pe rty “ in de pe nd en tl y of th e res t o f hi s p artne rs hi p i nt eres t.” H.R. Re pt . No. 8 3- 13 37 , supr a at70 , 19 54 U.S.C.C.A.N. at 4 09 7; S. Rep t. No . 83 -1 62 2, s up ra at98 , 99 , 19 54 U.S.C.C.A.N. at47 31 , 47 32 . It fo ll ows th atth e p orti onof g ai n a ttrib ut ab le to sec ti on 75 1 pr op erty inth e sa le or e xc ha ng e o f a p artne rs hi p m ay on ly be rep orte d u nd er the in st al lm en t m etho d t o the ex te ntth atin co m e rea li zedon a di rectsal e o f su ch pr op erty wou ldbe rep ortabl e und er the in st al lm en t m etho d. Gro ss in co m e in cl ud es th e fai r m ark etva lu e o f pr op erty or s erv ic es rece iv ed in ex ch an ge for

othe r se rv ic es . Sec. 6 1( a); Bak er v . Comm is si on er, 8 8 T.C. 1 28 2, 12 88 (19 87 ); B ad el l v . Comm is si on er, T.C. Mem o. 2 00 0- 30 3; sec . 1.6 1- 2( d) (1 ), In co m e Tax Reg s. Inth e co nt ex t o f a d ire ctsal e, Mrs . Min go was e ss en ti al ly gi ve n apro pe rty int eres t (apo rti on of t he no te ) inex ch an ge forth e ri gh t t o c ol le ct unpa idam ou nt s i n s at is fact io n o f se rv ic es he r pa rtn ers hi p h adpre vi ou sl y ren de red (unr eal iz edrece iv ab le s) . Stan di ng alo ne , th is tra ns act io n i s a b art er ex ch an ge , on e in whi cha ta xp ay er wo ul d p ro pe rly repo rt t he pro ceed s as ord in ary in co m e o n h is- 12 -

[* 12 ] Fed eral in co m e ta x re tu rnforth e y ear i n wh ic h the ex ch an ge oc cu rred
. Abs en t s om e au th or ity

to th e co nt rary, a tax pa y er wo ul d b e unabl e to de fer
reco gn it io n o f su chin co m e to a subs eque nty ear. InSo ren se n v . Comm is si on er, 2 2 T.C. 3 21 (19 54 ), a ta xp ay er was gi ve n se ve ral op ti on s t o p ur ch as e st oc k a s co m pe ns at io n fo r hi s s erv ic es . He so ldth es e op ti on s ra th er tha n e xe rci si ng th em an d a tt em

pt edto rep ort h is ga in un de r se ct io n 44 (b ), I.R.C. 1 93 9, the pre de ces so r to sec ti on 45 3. Th e Co urt h el d tha t the in st al lm en t s al e p ro vi si on s d idno t ap pl y to th e sa le be cau se “ [t]he pro vi si on s o f
se ct io n 4 4 re late on ly to the rep orti ng of i nc om e ari si ng fro m th e sa le of p ro pe rty on th e in st al lm en t b as is . Tho se pro vi si on s d o n otinan ywis e p ur po rt t o re late to th e rep orti ng of i nc om e ari si ng by w ay of c om pe ns at io n fo r se rv ic es .” So ren se n v . Co m m is si on er, 2 2 T.C. at34 2. The reas on in g o f th e Co urt i n S or en se n s ti ll ho ld s tru e. Nothi ng insec ti on 45 3 o r it s as so ci at edleg is la ti ve hi st ory su gg es ts th atCo ng res s i nt en de d t o a ll ow ta xp ay ers to esc ap e th e b as ic pri nc ip le s o f rev enue reco gn it io n b y de ferr in g co m pe ns at io n fo r se rv ic es un de r th e in st al lm en t m etho d. Pe ti ti on ers do no t di sp ut e th at$1 26 ,24 0 o f th e $ 82 3,0 90 face va lu e o f th e n ot e was att rib ut ab le to un real iz edrece iv ab le s o f th e PwCC pa rtn ers hi p. As il lu st rat edab ov e, th os e un real iz edrece iv ab le s, i f so ldina di rectsal e, wou ldno t b e el ig ib le forin st al lm en t- 13 -

[* 13 ] m etho d re po rti ng un de r se ct io n 4 53 . Accor di ng ly, th e g ai n re al iz edon Mrs . Mi ng o’s p artne rs hi p i nt eres t, t o the ex te ntatt rib ut ab le to pa rtn ers hi p u nr eal iz ed
rece iv ab le s, was li ke wis e in el ig ib le forin st al lm en t m etho d re po rti ng un de r se ct io n 45 3. Pe ti ti on ers sh ou ldha ve pro pe rly repo rte d a n a dd it io na l $ 12 6,2 40 of o rd in ary in co m e o n the ir 2 00 2 F ed eral in co m e ta x re tu rnin st eadof r ep orti ng itun de r th e in st al lm en t m etho d. II. Tax Year 2 00 3 Sect io n 4 46 (a) re qu ire s a t ax pa y er t o c om pu te tax ab le in co m e und er the
m etho d o f acc ou nt in g i t re gu larly us es inke ep in g i ts bo ok s. Sec ti on 44 6( b) pr ov id es th atif the m etho d o f acc ou nt in g re gu larly us edby the tax pa y er d oe s n ot cl earl y refl ecttax ab le in co m e, th e co m pu tati on of t ax ab le in co m e sh al l b e m ad e un de r su chm etho d a s, i n the Co m m is si on er’s o pi ni on , do es cle arl y refl ectin co m e. The Co m m is si on er’s au th or ity

un de r se ct io n 4 46 (b ) rea ch es no t o nl y to ov eral l
m etho ds of a cco un ti ng bu t al so to a ta xp ay er’s m etho d o f acc ount in g fo r sp eci fic it em s o f in co m e an d e xp en se . FordMo to r Co . v. Co m m is si on er, 1 02 T.C. 87 , 10 0 (1 99 4) , aff’d, 7 1 F .3d20 9 (6 th Cir . 19 95 ); Wang v. Co m m is si on er, T.C. Mem o. 19 98 -1 27
. A cha ng e in acco un ti ng m etho d i nc lu de s a c ha ng e in th e o ve ral l p lan o f
acco un ti ng forgro ss in co m e o r de du ct io ns or ach an ge inth e tr eat m en t o f an y- 14 -

[* 14 ] m at eri al it em

us edinsu chov eral l p lan. Se c. 1.4 46 -1 (e)( 2) (ii )(a) , Inc om e Tax Reg s. A “ m at eri al it em ” in cl ud es an y it em th atin vo lv es th e p ro pe r ti m e fo r th e in cl us io n o f th e it em

inin co m e o r th e ta ki ng of ade du ct io n. Id . An
acco un ti ng pra ct ic e in vo lv es th e p ro pe r ti m e fo r rep orti ng in co m e whe n i t m erel y po stpo ne s the rep orti ng of i nc om e rat he r th anpe rm an en tl y av oi di ng th e rep orti ng of in co m e o ve r th e ta xp ay er’s l ife ti m e. W ayne Bo lt& NutCo . v. Co m m is si on er, 93 T.C. 50 0, 5 10 (19 89 ). As d is cu ss edab ov e, th e p orti on of the no te att rib ut ab le to un real iz ed
rece iv ab le s s ho ul d h av e b eenpro pe rly char act eri zedas o rd in ary in co m e fo r 20 02
. The ele ct io n t o u se th e in st al lm en t m etho d h ere c an no t ch an ge th e ch arac te r of th e am ountatt rib ut ab le to un real iz edrece iv ab le s, n orwou lditres ul t i n the av oi da nc e of in co m e o ve r pe ti ti on ers ’ li fet im e. The re su ltwou ldm erel y de lay th e reco gn it io n o f su chord in ary in co m e fro m tax y ear 2 00 2, wh ere i t s ho ul d h av e pr op erl y be enreco gn iz ed , to tax y ear 2 00 7. Pe ti ti on ers ’ us e o f th e in st al lm en t
m etho d t o re po rt t he no te im pl ic at es th e p ro pe r ti m in g fo r rep orti ng in co m e. Acco rd in gl y , th e sa le of M rs . Min go ’s partn ers hi p i nt eres t i s a “ m at eri al it em ” fo r th e p ur po se s o f se ct io n 1 .44 6- 1( e)(2 )(i i)( a), In co m e Tax Reg s. Altho ug h am etho d o f acc ou nt in g m ay ex is t wi th ou t the ne ces si ty of a pa tt ernof c on si st en t treat m en t o f anit em , inm os t i ns tanc es anacco un ti ng m etho d- 15 -

[* 15 ] is no t es tabl is he d fo r anit em witho utsu chco ns is te nttre atm en t. Id
. Pet it io ne rs ele ct edto rep ort the sal e o f Mrs . Min go ’s partn ers hi p i nt eres t o n the in st al lm en t m etho d b y

att ach in g aFo rm

62 52 to th ei r joi nt20 02 Fed eral in co m e ta x re turn . For t ax y ears 20 03 th ro ug h 2 00 6 p et it io ne rs fil edtax returns refl ect in g on ly int eres t i nc om e fro m th e n ot e. Intax y ear 2 00 7 p et it io ne rs rep orte d the pr oc eed s fr om

th e sa le whenMrs . Min go co nv ert edth e n ot e in to IBM s to ckas wou ldtypic al ly be p ro pe r un de r th e in st al lm en t m etho d o f rep orti ng in co m e. The refo re, p et it io ne rs est ab li sh eda pa tt ernof c on si st en t treat m en t u nd er the in st al lm en t m etho d o f rep orti ng forth is m at eri al it em . Onc e th e Co m

m is si on er d et erm in es th ata ta xp ay er’s m etho d o f acc ou nt in g do es no t cl earl y

refl ectin co m e, he ha s b ro addi sc ret io n t o s el ecta m etho d o f
acco un ti ng th athe be li ev es pro pe rly refle ct s the in co m e o f th e ta xp ay er. RACM P Ent ers . v. Co m

m is si on er, 1 14 T.C. 21 1, 2 19 (20 00 ). The C omm is si on er’s de te rm in at io n m ay

be ch al le ng edon ly upo n the sh owi ng of abu se of d is cret io n. Id . Whe th er an ab us e o f di sc ret io n o ccu rredde pe nd s upo n wh ethe r th e Co m m is si on er’s d et erm in at io n i s wi th ou t s ou ndba si s i n fa ctor l aw. Id. The fo reg oi ng an al y si s h as sh own th e p ro ceed s fr om th e sa le of M rs . Mi ng o’s p artne rs hi p, t o the ex te ntth os e p ro ceed s wer e at tri bu tabl e to pa rtn ers hi p un real iz edrece iv ab le s, were no t ab le to be rep orte d u nd er the in st al lm en t m etho d- 16 -

[* 16 ] of acco un ti ng . Suc h p ro ceed s s ho ul d p ro pe rly hav e b eenrep orte d a s or di na ry in co m e in th e y ear t he y

were re cei ve d a s p et it io ne rs were n oten ti tl edto de fer i nc om e rec og ni ti on to a la te r y ear. Itis cle ar tha t p et it io ne rs ’ ch os en acco un ti ng m etho d d idno t cl earl y refl ectin co m e wit h re sp ectto th e p orti onof t he
no te att rib ut ab le to pa rtn ers hi p unr eal iz edrece iv ab le s. Res po nd en t ch an ge d p et it io ne rs ’ m etho d o f acc ou nt in g wi th res pe ctto pa rtn ers hi p u nr eal iz edrece iv ab le s fr om th e in st al lm en t m etho d u nd er s ect io n 4 53 to th e cas h re cei pt s an d d is burs em en ts m etho d. Hadth e cas h re cei pt s an d di sb ur se m en ts m etho d b eenad op te d a t the ti m e o f th e sa le , pet it io ne rs wou ldha ve pr op erl y rep orte d $ 12 6,2 40 of o rd in ary in co m e fo r ta x year 20 02 fro m th e un real iz edrece iv ab le s. Su chrep orti ng wou ldha ve cle arl y refl ect edin co m e fo r ta x year 20 02 . Res po nd en t’s d et erm in at io n t o i ni ti at e a ch an ge inpe ti ti on ers ’
acco un ti ng m etho d was no t wi th ou t s ou ndba si s i n fa ctor l aw an d, the refo re, was no t an ab us e o f di sc ret io n. Sect io n 4 81 (a) p ro vi de s tha t i n c om pu ti ng a ta xp ay er’s t ax ab le in co m e aft er a ch an ge of a cco un ti ng m etho d h as oc curred , th ere s ha ll be tak enin to acco un t th os e ad jus tm en ts whi chare d et erm in edto be ne ces sa ry so le ly by reas on of t he ch an ge inord er t o p rev en t am ou nt s fr om be in g dup li cat edor o mitte d. A se ct io n 48 1( a) ad jus tm en t m ay

in cl ud e am ou nt s at tri bu tabl e to tax y ears ou ts id e th e p eri od- 17 -

[* 17 ] of li m it at io ns on ass es sm en t. Bo sa m iav. Co m m is si on er, 6 61 F.3d25 0, 2 57
- 25 8 (5 thCir . 20 11 ), aff’g T.C. Me m o. 2 01 0- 21 8. Re sp on de ntm ad e a s ect io n 48 1( a) ad jus tm en t o f $1 26 ,24 0 fo r ta x year 20 03 , th e y ear f or whi chres po nd en t in it ia te d the ch an ge of a cco un ti ng m etho d. Th is ad jus tm en t was ne ces sa ry

to rem edy th e o m is si on of o rd in ary in co m e th atoc cu rredfortax y ear 2 00 2 a s a r es ul t of pe ti ti on ers ’ im

pe rm is si bl e el ect io n t o u se th e in st al lm en t m etho d. Acco rd in gl y , res po nd en t’s d et erm in at io n tha t p et it io ne rs ha d a dd it io na l o rd in ary in co m e o f $1 26 ,24 0 fo r ta x year 20 03 is su st ai ne d. III. Tax Year 2 00 7 A. Basi s i n the Not e Sect io n 4 53 B p ro vi de s tha t i f anin st al lm en t o bl ig at io n i s s ol d o r ex ch an ge d, ga in or l os s s ha ll res ul t t o the ex te ntof t he di ffer en ce b etweenth e b as is of t he ob li ga ti on an d the am ou ntreal iz edinth e sa le . Und er s ect io n 1 01 1, the ad jus te d ba si s fo r de te rm in in g the ga in or l os s fr om th e sa le or o th er d is po si ti on of pr op erty , when ev er ac qu ire d, s ha ll be th e b as is de te rm in edun de r se ct io n 1 01 2, ad jus te d a s p ro vi de d i n s ect io n 1 01 6. Se ct io n 1 01 2 p ro vi de s tha t, g en eral ly, th e ba si s o f pr op erty

sh al l b e th e co stof s uc h p ro pe rty. Secti on 10 16 pro vi de s tha t pr op er ad jus tm en ts to ba si s i n re sp ectof p ro pe rty sh al l i n a ll cas es be m ad e fo r ex pe nd itur es pro pe rly char ge ab le to cap it al
.- 18 -

[* 18 ] Mrs . Min go was i ss ue d the no te at n o c os t t o h er. The refo re, h er i ni ti al ba si s i n the no te was z ero . Howev er, res po nd en t ag rees th atinfin di ng th at pe ti ti on ers m

us t re co gn iz e $ 12 6,2 40 of o rd in ary in co m e rel at in g t o p artne rs hi p un real iz edrece iv ab le s i n 2 00 3, p et it io ne rs sh ou ldbe affo rd eda ba si s ad jus tm en t in th atam ou nt . Res po nd en t fu rth er ag rees th atth e ap pl ic at io n o f th atba si s s ho ul d
res ul t i n ade crea se inpe ti ti on ers ’ rep orte d l on g- te rm cap it al ga infortax y ear 20 07 . Accor di ng ly, pe ti ti on ers are af fo rd eda reduc ti on inrep orte d l on g- te rm cap it al ga in of $ 12 6,2 40 fortax y ear 2 00 7. B. Lon g- Term

Cap it al Los s Gen eral ly, ta xp ay ers m ay cla im as ade du ct io n a ny los s s us ta in eddurin g the ta xabl e y ear a ndno t co m pe ns at edforby ins ur an ce o r ot he rwis e. Sec. 1 65 (a). Los se s fr om

sal es or e xc ha ng es of c ap it al ass et s ar e al lo wedto th e ex te nt pr es cri be d i n s ect io ns 12 11 an d 1 21 2. Se c. 16 5( f). Und er tho se li m it at io ns , no nc or po rat e ta xp ay ers m

us t fi rs t o ffs etcap it al lo ss es ag ai ns t capi ta l g ai ns . On the ir 2 00 7 re tu rnpe ti ti on ers cla im eda lo ng -te rm cap it al lo ss of $2 17 ,40 2. Th e en try relat edto th is lo ss was l ab el ed“ de btco nv ert edto st oc k (n on -ta xabl e)”. Re sp on de ntdi sa ll owe d thi s l os s, cl ai m in g tha t p et it io ne rs “ do no t- 19 -

[* 19 ] ha ve ba si s inth e [N]ote an d h av e n otothe rwis e subs tant ia te d the ir [ 3 ]
en ti tl em en t t o the lo ss ”. On the work sh eetth e p rep arerus edto pre pare Sc he du le D of p et it io ne rs ’ 20 07 return, the re i s a num eri cal bre ak do wn o f ho w th e $ 21 7,4 02 cla im edcap it al lo ss was c al cu la te d. Pe ti ti on ers , us in g the m ark etpri ce o f th e IBM st oc k a t the ti m e th e n ot e was is su ed , di vi de d the st oc k p le dg edinth e n ot e in to sh ares at tri bu tabl e to pa rtn ers hi p u nr eal iz edrece iv ab le s an d s ha res no t at tri bu tabl e to pa rtn ers hi p u nr eal iz edrece iv ab le s. Th e res ul ti ng sp li t re fle ct s tha t 1 ,83 4.6 17 sh ares of I BM s to ckwere at tri bu tabl e to pa rtn ers hi p unr eal iz edrece iv ab le s (v al ue d a t $ 12 6,2 40 at t he is su an ce o f th e n ot e) an d 1 0,1 27 .16 2 t o the rem ai nd er (v al ue d a t $ 69 6,8 50 at t he is su an ce o f th e n ot e). Pet it io ne rs ap pl ie d thi s al lo cat io n t o the st oc k p ric e atth e ti m e th e n ot e was red eem edto asc ert ai n the am ountof app reci at io n a ll oc ab le to sh ares of s to ck at tri bu tabl e to pa rtn ers hi p u nr eal iz edrece iv ab le s. Pet it io ne rs de te rm in edth at $9 1,1 62 of app reci at io n was all oc ab le to th e 1 ,83 4.6 17 sh ares attrib ut ab le to pa rtn ers hi p u nr eal iz edrece iv ab le s. Th is $9 1,1 62 of app reci at io n, wh enad de d t o

Res po nd en t’s s ta te m en t re fers to hi s fi nd in gs at the ti m e o f di sa ll owa nc e, 3 th e fo reg oi ng an al y si s n otwiths tand in g.- 20 -

[* 20 ] th e $ 12 6,2 40 att rib ut ab le to un real iz edrece iv ab le s, equa ls th e $ 21 7,4 02 th at pe ti ti on ers cla im edas acap it al lo ss . Pet it io ne rs ’ po si ti on ap pe ars to be th at , if the y were l iabl e to pa y

tax on th e $1 26 ,24 0 p orti on of t he no te attrib ut ab le to un real iz edrece iv ab le s i n 2 00 2, the n th ey wou ldha ve to have so lda po rti on of t he st oc k e qu al to th atam ou ntto sat is fy th e li ab il ity . Had the y

so ldth atpo rti on of the st oc k, i t wo ul d n otha ve ha d the op po rtu ni ty to ap pr eci at e o ve r th e li fe o f th e n ot e, an d the refo re p et it io ne rs sh ou ld
no t b e li ab le to pa y

tax on th e am ou ntof app reci at io n a ll oc ab le to th atpo rti on of th e n ot e. Howev er, p et it io ne rs ’ po si ti on is m is gu id ed . Whi le itm ay ha ve be ena m at te r of eco no m ic ne ces si ty bas edon pe ti ti on ers ’ li qu id ity at the ti m e, pe ti ti on ers were n otrequi redby any au th or ity to sel l s to ckto sat is fy

th ei r 20 02 tax li ab il ity . Hadpe ti ti on ers pa idth e li ab il ity fro m an ot he r so ur ce atth e ti m e, th ey wou ldha ve be enen ti tl edto a ba si s o f $1 26 ,24 0 i n the no te . Part it io ni ng th e n ot e o nl y furth er il lu st rat es th e p oi ntth atpe ti ti on ers wou ldst il l h av e b eenli ab le for$9 1,1 62 of cap it al ga in with re sp ectto th os e sh ares att rib ut ab le to un real iz edrece iv ab le s, the di ffer en ce b etweenth e $ 12 6,2 40 ba si s i n tho se sh ares an d the $2 17 ,40 2 s al e p ric e. Eve n i f th e Co urt wer e to gra ntpe ti ti on ers ’ arg um en t tha t the st oc k h adto be so ldin20 02 to sat is fy th e li ab il ity , pet it io ne rs ’ po si ti on is un te nabl e. Had- 21 -

[* 21 ] pe ti ti on ers so lda po rti on of t he st oc k a ndpa id$1 26 ,24 0 t o the IRS, the y wou ldno t h av e h ada ri gh t o f acc es s t o tha t m on ey an ym or e. They woul d fo rfei t al l ri gh t t o a ny app reci at io n o r in te res t tha t wo ul d re su ltfro m th e in ve st m en t o f th atm on ey . Peti ti on ers wou ldha ve ne ve r be enaffo rd edth e o pp ortu ni ty to am as s th e $ 91 ,16 2 o f ap pr eci at io n a ttrib ut ab le to th atpo rti onof t he st oc k. Gran ti ng th ei r arg um en t, p et it io ne rs ha ve be entre at edto anun de ni ab le acce ss io n t o wea lth whi chwou ldno t h av e o ccu rredha d the y sat is fie d the ir l iabi li ty tim el y . See Co m m is si on er v . Glen sh aw Glas s C o., 3 48 U.S. 42 6, 4 31 (19 55 ). Inacco rd an ce wi th th e p rece di ng sec ti on , pet it io ne rs wil l b e al lo wedto cl ai m ba si s i n the no te of $ 12 6,2 40 fortax y ear 2 00 7 fo r am ou nt s tha t wi ll be pa id in sat is fact io n o f th e Co urt’s d et erm in at io n wi th res pe ctto tax y ear 2 00 3. With
res pe ctto th e rem ai ni ng $9 1,1 62 pe ti ti on ers cla im edas acap it al lo ss fortax y ear 20 07 , res po nd en t’s d et erm in at io n i s s us ta in ed
. All othe r ad

jus tm en ts refl ect edon pe ti ti on ers ’ 20 03 an d 2 00 7 s ta tu to ry no ti ces of d efi ci en cy

are co m pu ta ti on al
. To re fle ctth e fo reg oi ng , Deci si on s wi ll be en te red
un de r Ru le 15 5.