IN THE COMMONWEALTH COURT OF PENNSYLVANIA

John K. Houssels, Jr., : Petitioner :

:

v. : No. 867 F.R. 2015

: Argued: June 6, 2018 Commonwealth of Pennsylvania, : Respondent :

: Commonwealth of Pennsylvania, : Petitioner :

:

v. : No. 49 F.R. 2016

: Argued: June 6, 2018 John K. Houssels, Jr., : Respondent :

BEFORE: HONORABLE MARY HANNAH LEAVITT, President Judge

HONORABLE RENÉE COHN JUBELIRER, Judge

HONORABLE P. KEVIN BROBSON, Judge

HONORABLE PATRICIA A. McCULLOUGH, Judge

HONORABLE ANNE E. COVEY, Judge

HONORABLE MICHAEL H. WOJCIK, Judge

HONORABLE ELLEN CEISLER, Judge

OPINION NOT REPORTED

MEMORANDUM OPINION

BY JUDGE BROBSON F ILED: November 2, 2018

This personal income tax (PIT) matter returns to us following remand

to the Board of Finance and Revenue (Board) for recalculation of the amount of

Pennsylvania PIT owed by Petitioner John K. Houssels, Jr. (Taxpayer or Houssels).

See Houssels v. Commonwealth (Pa. Cmwlth.

, No. 757 F.R. 2008, filed Jan. 3, 2012)2

(en banc) ( Houssels I

), exceptions overruled , (Pa. Cmwlth. No. 757 F.R. 2008, filed

Aug. 16, 2012) (en banc) ( Houssels II ), aff’d sub nom. Wirth v. Commonwealth

,

95 A.3d 822 (Pa. 2014) ( Wirth ), cert. denied sub nom. Houssels v. Pennsylvania

,

135 S. Ct. 140 5 (2015). On remand, the Board reassessed Taxpayer’s tax liability

at $103,397, “ plus appropriate penalties and interest, less any payments and credits

on his account.” 1 B oth Taxpayer and the Pennsylvania Department of Revenue

( Department or Revenue) challenge aspects of the Board’s reassessment on remand.

We affirm.

I. BACKGROUND

A. Houssels I

, Houssels II , and Wirth

Taxpayer, a resident of the State of Nevada , invested as a limited

partner in 600 Grant Street Associat e s Limited Partnership (Partnership), a

Connecticut limited partnership, which owned a building in the City of Pittsburgh

(Property) that went into foreclosure in 2005. In 2008, the Department assessed

Taxp ayer for his pass

- through share of the P artnership’s income 2 realized from the

1 The Board issued two orders on remand, an original order dated September 16, 2015, and
a corrected order dated November 12, 2015. Neither party explains the occasion or necessity for

the corrected order. For purposes of our disposition, then, we will treat both as a single order.

2 With respect to taxability of partners, Section 306 of the Tax Reform Code of 1971

(Code), Act of March 4, 1971, P.L. 6, as amended

, added by the Act of August 31, 1971, P.L. 3 62,
72 P.S. § 7306, provides, in relevant part:

[A] partnership as an entity shall not be subject to the tax imposed by this article,
but the income or gain of a member of the partnership in respect to said partnership
shall be subject to the tax and tax s hall be imposed on his share, whether or not
distributed, of the income or gain received by the partnership for its taxable year
ending within or with the member’s taxable year.3

foreclosure of the Property. Section 303 of the Code 3 sets forth eight separate classes

of income subject to the PIT. The class of taxable income at issue here is “[n]et

gains or income from disposition of property.” Section 303(a)(3) of the Code. 4

In Houssels I

, we summarized the details of financial arrangement

giving rise to the foreclosure and the assessed PIT liability therefrom:

[ Partnership ] , organized under Connecticut law, purchased the Property for $360 million. Of this
$360 million purchase price, the Partnership financed $308 million with a Purchase Money Mortgage Note (PMM Note) secured only by the Property. The PMM Note was nonrecourse, meaning that the Partners hip and the lender agreed that the lender’s only recourse for nonpayment of the obligations under the PMM Note was to pursue foreclosure of the Property. As the name of the Partnership suggests, the Partnership’s primary purpose was the ownership and mana gement of the Property.

Interest on the PMM Note accrued on a monthly basis at a rate of 14.55%. If, however, the monthly accrued interest exceeded the net operating income of the Partnership, the Partnership was not required to pay the

3 Act of March 4, 1971, P.L. 6, as amended

, added by the Act of August 4, 1971 , P.L. 97,

72 P.S. § 7303.

4 Section 303(a)(3) of the Code, setting forth the class of income at issue here is quite
lengthy. The general class description provides:

Net gains or income from disposition of property. Net gains or net income,

less net loss es, derived from the sale, exchange or other disposition of property,
including real property, tangible personal property, intangible personal property or
obligations issued on or after the effective date of this amendatory act by the
Commonwealth; any pub lic authority, commission, board or other agency created
by the Commonwealth; any political subdivision of the Commonwealth or any
public authority created by any such political subdivision; or by the Federal

Government as determined in accordance with acc epted accounting principles and
practices.

In addition to providing this general description of the class, the General Assembly also expressly
exempted several specific transactions from the class. See id. § 7303(a)(3)(iii)

- (vii). None of these
exceptions, however, apply to the particular type of property disposition in this case.4 excess ( i.e. , the amount of monthly accrued interest less monthly net operating income). Instead, the accrued but unpaid excess would be deferred and, thereafter, compounded on an annual basis subject to the same interest rate as the principal amount of the PMM Note.

The original maturity date of the PMM Note was November 1, 2001. In 1998, the lender and the Partnership amended the PMM Note to extend the maturity date to January 2, 2005.

Houssels purchased a limited partnership interest of approximately 0.151281% (one uni t) in the Partnership on or about October 19, 1984, for $148,889

— $1,589 in cash and a promissory note of $147,300. Houssels paid the promissory note in full on or about March 11, 1992. Houssels was a passive investor in the Partnership. He never partici pated in the management of the Partnership or the Property.

Over the years, the Partnership’s net income from operations did not keep pace with projections. The Partnership actually incurred losses from operations for financial accounting, federal income tax, and PIT purposes every year of its existence. For PIT purposes, the Partnership allocated its annual losses from operations to each partner, including Houssels.

Because of the Partnership’s dismal operations, the Partnership paid less monthly interes t on the PMM Note than it had projected. Under the terms of the PMM Note, this led to a greater amount of accrued but unpaid interest over the years. According to the Offering Memorandum, the Partnership projected accrued but unpaid interest on

the PMM N ote at maturity (November 1, 2001, later extended to January 2, 2005) to be approximately $300 million. It also projected that upon sale of the Property at maturity, there would be enough proceeds to pay off the principal and accrued interest on the PMM

N ote, with additional funds available to distribute to the partners as a return on their investment. At the date of foreclosure, the Partnership had an accrued but unpaid interest obligation of approximately $2.32 billion. The Partnership had used approxi mately $121,600,000 of this amount to offset its income from operations that would otherwise have been subject to PIT. Neither the5 Partnership nor Houssels derived any PIT benefit from the

remainder.

The lender foreclosed on the Property on

June 30, 2005. By that time, what began as a $308 million Partnership liability on the PMM Note had grown into a liability of more than $2.6 billion, of which only $308 million represented principal. Neither the Partnership nor its individual partners received any cas h or other property as a result of the foreclosure. That same year, the Partnership terminated operations and liquidated. Houssels did not recover his capital investment (original investment less return of capital) in the Partnership at

foreclosure or li quidation. Indeed, Houssels did not receive any cash or other property upon liquidation of the Partnership.

Revenue assessed PIT for calendar year 2005 as a result of the foreclosure on the Property (Assessment). Houssels filed an appeal with Revenue’s B oard of Appeals (BOA) on June 29, 2007. On December 28, 2007,

. . . BOA denied Houssels’ appeal. Houssels appealed BOA’s determination to the Board, which denied his request for

relief from

. . . BOA’s determ ination on September 19, 2008.

Houssels I , sl ip op. at 1

- 2 (footnotes omitted) (record citations omitted)

.

Taxpayer appealed the Board’s determination to this Court. In his

appeal, Taxpayer raised issues identical to those raised by the petitioner and

addressed by this Court in Marshall v. Commonwealth , 41 A.3d 67 (Pa. Cmwlth.)

(en banc) ( Marshall I

), exceptions overruled , 50 A.3d 287 (Pa. Cmwlth. 2012) (en

banc) ( Marshall II

), aff’d sub nom. Wirth v. Commonwealth

, 95 A.3d 822 (Pa. 2014)

( Wirth ), cert. denied , 135 S. Ct. 140 (2015). Incorpo rating by reference our decision

in Marshall I , this Court , in Houssels I

, affirmed the Board’s assessment of PIT, but

remanded the matter to the Board for determination of the adjusted basis of the

Property at foreclosure and recalculation of the PIT due from Taxpayer.

Incorporating by reference our decision in Marshall II , this Court overruled6

Taxpayer’s exceptions in Houssels II

. In Wirth , the Pennsylvania Supreme Court

affirmed our decision on every issue.

B. Proceedings Following Remand

After the Sup reme Court issued its decision in Wirth , Taxpayer filed,

or refiled, Pennsylvania PIT returns for tax years 1985 through 2005, reporting

thereon his p ass

- through share of the operating losses of the Partnership during those

years. (Joint Supplemental Stip ulation of Facts ¶ 3( b ) (dated Oct. 25, 2017)

. ) The

Court has reviewed copies of the returns, filed under seal. As reflected in the parties’

stipulations, the Partnership took deductions on its federal tax forms, including a

deduction for the accrued but unpaid interest on the PMM Note, which contributed

to the Partnership’s annual operating loss and, consequently, zero tax liability from

inception through foreclosure. (Joint Stipulation ¶¶ 40, 53, 54.)

Taxpayer reported on the filed/refiled Pennsylvania returns his

pass

- through share of the Partnership’s “[n]et income (loss) from rental real estate

activities,” as reported to him by the Partnership on IRS Schedule K

- 1 (Form 1065)

for each of these years. Taxpayer disclosed these annual losses on his Pen nsylvania

Individual Income Tax Returns as Section 303(a)(4) class income

— “Net gains or

income derived from or in the form of rents, royalties, patents and copyrights.”

72 P.S. § 7303(a)(4).

Before the Board on remand, with respect to calculating the adjusted

basis of the Property upon foreclosure, the parties’ dispute focused on depreciation.

Specifically, Taxpayer and the Department offered competing views on how to apply

Section 303(a.2) o f the Code, 72 P.S. § 7303(a.2). This section allows for a

depreciation deduction against income: “In computing income, a depreciation

deduction shall be allowed for the exhaustion, wear and tear and obsolescence of7

property being employed in the operati on of a business or held for the production of

income.” Section 303(a.2) of the Code. It also provides how to calculate the

adjusted basis of depreciated property:

The basis of property shall be reduced, but not below zero, for depreciation by the greate r of:

(1) The amount deducted on a return and not disallowed, but only to the extent the deduction results in a reduction of income; and

(2) The amount allowable using the straight

- line method of depreciation computed on the basis of the property’s adjuste d basis at the time placed in service, reasonably estimated useful life and net salvage value at the end of its reasonably estimated useful economic life, regardless of whether the deduction results in a reduction

of income.

Section 303(a.2) of the Code. Both parties refer to this provision as the “minimum

straight

- line depreciation provision,” because regardless of the extent to which a

taxpayer benefits from the allowable depreciation deduction, the basis of the

depreciated property must be reduced, at a minimum, by the amount of depreciation

allowable using the straight

- line method of depreciation.

The parties’ dispute centered around the effective date of the minimum

straight

- line depreciation provision. Section 303(a.2) was added to the Code by

sectio n 9 of Act 89 of 2002. 5 Section 34 of Act 89 of 2002 provides that

Section 303(a.2) of the Code “shall apply to taxable years beginning after

December 31, 2000.” Taxpayer argued that this language meant that the minimum

straight

- line depreciation provision should only be applied for tax years 2001 and

thereafter and, therefore, did not mandate a minimum downward basis adjustment

for straight

- line deprec iation in years preceding the 2001 tax year. The Department

5 Act of June 29, 2002, P.L. 559.8

offered a competing interpretation. In its view, Section 303(a.2) relates to the

calculation of income. In this case, the income in question is the gain on disposition

of the Property, which oc curred in 2005. Accordingly, because the income event

occurred after the effective date of Section 303(a.2), the minimum straight

- line

depreciation provision applied to calculate the adjusted basis of the Property from

inception through foreclosure and, c onsequently, any gain upon disposition.

The Board refused to address Taxpayer’s tax benefit rule argument,

holding that this Court and the Pennsylvania Supreme Court ruled finally on the tax

benefit rule’s application in this case and that the tax benefit rule was not within the

scope of the remand order. With respect to the depreciation issue, the Board sided

with Taxpayer’s interpretation. Taxpayer now appeals the Board’s refusal to

consider his tax benefit rule argument, and the Department appeals the Board’s

interpretation and application of Section 303(a.2) of the Code.

II. DISCUSSION

This Court adequately addressed all of the issues in this appeal in our

opinion in Marshall v. Commonwealth of Pennsylvania , ___ A.3d ___ (Pa. Cmwlth.,

Nos. 863 F.R. 20 15 and 50 F.R. 2016, filed __________) . We incorporate that

opinion by reference and reach the same conclusions in this case.

III. CONCLUSION

For the reasons set forth above, we affirm the Board’s assessment of

Taxpayer’s PIT liability in all respects.

P. KEVIN BROBSON, Judge

Judge Fizzano Cannon did not participate in the decision of this case.IN THE COMMONWEALTH COURT OF PENNSYLVANIA

John K. Houssels, Jr., : Petitioner :

:

v. : No. 867 F.R. 2015

: Commonwealth of Pennsylvania, : Respondent :

: Commonwealth of Pennsylvania, : Petitioner :

:

v. : No. 49 F.R. 2016

: John K. Houssels, Jr., : Respondent :

O R D E R

AND NOW, this 2 nd day of November , 2018, the order of the Board of

Finance and Revenue is AFFIRMED.

Unless exceptions are filed within 30 days pursuant to

Pa. R.A.P. 1571(i), this order shall become final.

P. KEVIN BROBSON, JudgeIN THE COMMONWEALTH COURT OF PENNSYLVANIA

John K. Houssels, Jr.

, :

Petitioner :

: No. 86 7 F.R. 2015

v. :

: Com monwealth of Pennsylvania, :

Respondent :

Commonwealth of Pennsylvania, :

Petitioner :

: No. 49 F.R. 2016

v. :

: Argued: June 6, 2018 John K. Houssels, Jr., :

Respondent :

BEFORE: HONORABLE MARY HANNAH LEAVITT, President Judge

HONORABLE RENÉE COHN JUBELIRER, Judge

HONORABLE P. KEVIN BROBSON, Judge HONORABLE PATRICIA A. McCULLOUGH, Judge

HONORABLE ANNE E. COVEY, Judge HONORABLE MICHAEL H. WOJCIK, Judge HONORABLE ELLEN CEISLER, Judge

OPINION NOT REPORTED

CONCURRING OPINION

BY JUDGE McCULLOUGH FILED: November 2, 2018

I join in the Majority’s affirmance of the Board of Finance and

Revenue’s application of section 303(a.2) of the Tax Reform Code of 1971 1

1 Act of March 4, 1971, P.L. 6, as amended , added by the Act of June 29, 2002, P.L. 559,

72 P.S. §7303(a.2).PAM

- 2

concerning minimum straight

- line depreciation. However, I concur with the

Majority’s affirmance of the Board’s refu sal to apply the tax benefit rule to reduce

the personal income tax (PIT) liability of John K. Houssels, Jr. , for the reasons set

forth in my Concurring Opinion in Marshall v. Commonwealth of Pennsylvania

, ___
A.3d ___ (Pa. Cmwlth., Nos. 863 F.R. 2015 and 50 F.R. 2016, filed November 2,

2018 ).

________________________________ PATRICIA A. McCULLOUGH, Judge