T.C. M em o . 2 0 1 7 -1 1 4

UNITED STATES TAX COURT

THOM AS E. WATTS AND M ARY E. WATTS, Pet i t i o n ers v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t RW M ANAGEM ENT, LTD., J RWM A N AGEM ENT, LLC, TAX M ATTERS PARTNER, Pet i ti o n er v . COM M ISSIONER OF INTERNAL REVENUE, Res p o nd en t

Do ck etNo s . 1 8 8 8 2 -1 3 , 1 9 97 3 -1 3
. Fi l edJ u n e 1 4 , 2 0 1 7
.

Dav i dL. M cGee an dW il l i am V. Li n n e, fo r p et i t i o n ers . Cl i n t J . Lo ck e, Edwi n B. Cl ev erd on , an dHo race Cru m p fo r res p o n den t .

M EM ORANDUM FINDINGS OF FACT AND OPINION NEGA, Jud g e: By a n ot i ce o f d efi ci en cy d at edM ay

2 0, 2 0 1 3 , res p o n d en t d et erm i n edd efi ci en ci es i n th e Fed eral i n co m e t ax o f p et i t io n ers Th om as E. an d M ary E. W at t s (Edwi n an dM ary W at t s) fo r t ax ab l e y ears 2 0 0 7 , 2 0 0 8 , an d2 0 0 9-2
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[* 2 ] (y ears ati s su e) an di m po s edaccu racy -rel at edp en al t i es u n d er s ect i o n 6 6 6 2 as fo l l o w s : 1

Year Defi ci en cy Pen al ty s ec. 6 6 62 (a) 2 0 0 7 $ 5 2 2 ,4 1 8 $ 10 4 ,4 8 4 2 0 0 8 1 1 2 ,3 1 7 2 0,4 6 3 2 0 0 9 9 7,9 1 7 1 9,5 8 3 OnAu g u s t1 5 , 2 0 1 3, Edwi n an dM ary W at t s t i m el y

fi l eda p et i t i o nwi th th i s Co u rt fo r red et erm i n at io n . By n o t ice o f fi n al p art n ers h i p ad m i n i s trat i v e ad ju s t m en t (FPAA) d at edM ay 2 8 , 2 0 1 3 , res p o n d en trech aract eri zeda $ 7 5 4 ,0 77 l o ss as a cap i tal l o s s , rat h er t h an
an o rd in ary

l o s s , fo r t h e t ax ab le y ear 2 0 07 o f RWM an ag em en t, Lt d . (RW M ), an d i m p o s edan accu racy -rel at edp en al ty u nd er s ect i on 6 6 6 2. OnAu g u s t2 7 , 2 0 1 3 , J RWM an ag em en t LLC, th e t ax m at t ers p art n er fo r RW M , fi l ed a p et i t i o n fo r read ju s tm en to f p art n ers hi p i tem s u n d er s ect i o n6 2 2 6. Th es e cas es were co n s ol i d at edfo r t ri al , b ri efi n g , an do p i n i o n . Aft er
co n ces si o n s b y

Edwi n an dM ary

W at t s , th e fo l l o w i n g i s s ues rem ai nfo r d eci s i o n :

1 Un l es s o th erwi s e i nd i cat ed , al l s ect i o nreferen ces are t o th e In t ern al Rev enu e Co de (Co d e) i n effect fo r t h e rel ev an ty ears . Al l Ru l e referen ces are t o th e Tax Co u rt Ru l es o f Pract ice an dPro cedu re. Al l m on et ary am ou n t s are ro u n dedt o th e n eares td o ll ar.-3
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[* 3 ] (1 ) wh et h er p et i t i o n ers ’ l o s s es o nth e d i s p os al o f t h ei r i n t eres t s i nEW GS Part ners (Part n ers h i p ) i n t ax y ear 2 0 0 7 are cap it al , an d(2 ) wh et h er p et it i on ers are l i ab l e fo r t he s ect i o n 6 6 6 2 (a) accu racy -rel at edp en al ty fo r t h e y ears at i s s ue. 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 dare s o fo u n d. Th e s t ip u l at i o n o f fact s an dth e at t ach ed ex h i b i ts are i n co rp o rat ed h erei nb y th i s referen ce. Pet i t io n ers Edwi n an dM ary W at t s res i d edi nFl ori d a atth e t i m e t h atth e p et i t i o n
was fi l edatd o ck et No . 1 8 8 8 2 -1 3 . RW M was o rg an i zedan do p erat edi n Fo rt W al t o n Beach , Fl o ri d a, at th e t i m e t hatth e p et i t i o n was fi l ed atd o ck et1 9 9 7 3 -1 3
. RW M i s a l i m it edp art ners h i p . J RWM an ag em en t, LLC (J RW ), s erv es as i t s g en eral an dt ax m at t ers p art n er. J RWi s a s i n gl e-m em ber LLC. Ro n n i e W at t s wh o l l y o wn s J RWan di s th e o n l y o th er p art ner i nRW M
. 2 A Bri ef Hi s t o ry o f Go l f Bro thers Edwi n an dRo n n i e W at t s (W at t s b ro th ers ) fo u n d edEdwi n W at t s Go l f Sh o p s (Go l f) i n 1 9 6 8 , wh en th ey o p en eda s m al l p ro s h o p co n ces s i on atth e Fo rtW al t o n Beach Go l f Cl ub . Fro m th e o n s et , th e W at t s b ro th ers m ai nt ai n ed cl o s e fam i li al co n tro l o f Go l f’ s o p erat i o n s . Ov er t h e y ears , o wi n g t o t h e W at t s

2 Fo r cl ari ty , we d i s t i n g u i s h Ro n ni e W at t s , RW M , an dJ RWo nl y wh ere n eces s ary . W e o th erwi s e refer t o al l th ree as Ro n n i e W at t s .-4
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[* 4 ] b ro th ers ’ s k i l l an ds av v y , Go l f d ev el o p edi n t o a s tro n g reg i o n al b ran d
o p erat i n g i n 4 0 l o cat io n s acro s s th e Gu l f Co as t . Th e W at t s b ro th ers o wn edth e real es t at e u n d erl y i n g 2 7 o f t h o s e l o cat i o n s i n ad di t i o n t o Go l f’ s co rp o rat e o ffi ce
an d m ai n wareh o u se. By 2 0 03 Go l f was d oi n g n earl y $ 2 0 0 m i l l io ni n an nu al
s al es , em p l o y edh u nd red s , an dwas at tract i ng th e i n t eres to f p o t en t i al b u y ers an d i n v es t o rs . In i t i al l y , th e W at t s b ro th ers were h es i t an tt o s el l o r s u rren d er co n tro l o f Go l f, b utev en tu al l y

W el ls p ri n g , a p ri v at e eq u i ty fi rm , p ro p o s edan arran g em en t th ey fo u n dp al at ab l e. W el ls p ri n g o ffered t o p u rch as e Go l f fo r ro u g h l y $ 9 3
m i l l io n , b u tt o d o s o i n a way wh i ch al l o wedthe W at t s fam i l y t o ret ai n an equ i ty i n t eres t : jo i n W el l sp ri n g i n fo rm i n g a p art n ers h i p t o wh o l l y o wnGo lf. Th e o ffer al s o res p ect edth e b ro th ers ’ o wn ers h i p o f t h e real es t at e l o cat i o n s b y p ro v id i n g th atGo l f wo u ld rem ai n th e b ro th ers ’ p ay i n g t en an t. M os tat tract i v e t o the W at t s b ro th ers , h owev er, was W el l sp ri n g’ s ex pres s d es i re t o k eep th e b ro thers o nb o ard t o m an ag e Go l f’ s d ay -t o -d ay o p erat i o n s . Th e W at t s b ro th ers ag reedt o W el l sp ri n g ’ s t erm s an dco n s umm at edth e d eal i n Decem b er 2 0 0 3
. OnDecem

b er 2 , 2 0 03 , Edwi nW at t s ’ wh o l l y o wn edfl o wth ro u g h en t i t i es , Edwi n W at ts Ho ld i n g Co
. (EW HC) an d W at ts M an ag em en t-5
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[* 5 ] (W M), fo rm edPart n ers h i p , a Del aware p art n ers h i p . 3 Part n ers h i p ’ s ex cl u s i v e p u rp os e was t o o wnGo l f. OnDecem ber 4 , 2 0 0 3 , Edwi n W at t s an d W el l s p ri n g --t h ro ug h i t s wh o ll y o wn eds ubs i d i ary

W S Go l f Acqu i s i t i o n s , In c.--ex ecu t eda p u rch as e ag reem en twh erei nEdwi n W at t s s ol d W el l s p ri n g 4 an 8 0 .5 % i n t eres ti n th e n ewl y fo rm edPart n ers h i p fo r $ 9 3 m i l l i o n . Of thatam o u n t , Edwi n rei n v es t ed ap pro x i m at el y $ 8 m i l l i o n i n t o Part n ers h i p . Si m u l t an eo u s l y

wi th t h e ex ecu t i o no f t he p u rch as e ag reem en t , Edwi nW at t s
an d W el l s p ri ng en t eredi n t o an am en dedan dres t at edp art ners h i p ag reem en t (ag reem en t ) refl ect in g W el l s p ri n g ’ s p urch as e an ds t atu s as th e m ajo ri ty o wn er o f Part ners h i p . Th e ag reem en twas draft edi n acco rd an ce wi th an ds ub jectt o Del aware l aw an dg o v ern edth e p art n ers ’ ro l es , ri g ht s , an dres p o n s i bi l i t i es as p art n ers i n Part n ers h i p ; th e ag reem en t reco g n i zedb o th W el l s p ri n g an dEdw i n W at t s as Part n ers hi p ’ s g en eral p art n ers . Rev iewi n g the Ag reem en tTerm s Th e ag reem en tes t ab li s h edtwo cl as s es o f p artn ers h ip i n t eres t s : p referred
an d co m m o n . Th e ag reem en t d efi n edth e p referred i nt eres t s b y d i s t i n gu i s h i n g

3 Fo r cl ari ty , we d i s t i n g u i s h EW HC, W M, an dEdwi nW at t s o n l y wh ere n eces s ary . W e o th erwi s e refer t o al l th ree as Edwi nW at t s .

4 Si m i l arl y , we d is t i ng u i s h W S Go l f Acqu i s i t i o n , In c., an d W el l s p ri n g o n l y wh ere n eces s ary . W e o th erwi s e refer t o b o th en t i t i es as W el l s pri n g .-6
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[* 6 ] th em fro m th e co m m o n i n t eres t s b y

way o f t h e ri g h ts , p o wers , an dp ri v i l eg es
acco rd edt o th e p referred i n t eres t s . An y p art n er o wn i n g p referred i n t eres t s was d efi n edb y

th e ag reem en tt o b e a “ Preferred Part n er”. W el l s p ri n g ’ s en ti re 8 0 .5 % i n t eres tco m p ri s edp referred i n t eres ts . Edwi n
o wn edtwo tran ch es o f co m m o n i n t eres t s , am o u n t i n g t o 1 8 .5 % an d 1 % o f t h e t o t al Part ners h i p i n teres t s . Po wers o f t h e Preferred Part n er Wh i l e t h e p referred an d co m m o n cl as s es v o t edt o g et h er as a s i ng l e cl as s , th e two cl as s es d i v erg edb y

way o f th e ri g h t s , p owers , an d p ri v i l eg es ex cl u s i v el y g ran t edt o th e o wn er o f p referred i n t eres t s . Th o s e p referred p art n ers h el d t h e p o wer t o ap p o i n tth ree o f fi v e b o ardm em bers , ex cl us i v e ri g h t s o f fi rs trefu s al o n
res al es o f Part n ers h i p i n teres t s , an dth e ab i l it y t o co n v ertthei r p referred i n t eres t s t o co m m o n atth ei r d i s cret i o n o r i nth e ev en to f an IPO. Th e ag reem en tal s o
en t i t l edth e p referred p art n ers t o ex cl u s i v e g u aran t eedan n u al p aym en t s , a ret i rem en to b l i g at i o n p aym en t , an dp referen t i al p ri ori ty i nPart n ers h ip l i qu i d at i n g d i s tri b u t i o n s s ub o rd i n at e t o cred i t o rs b u ts up eri o r t o th e co m m o np art n ers . Great er Th an 5 0 % Preferred St ak e Po wers Th e ag reem en tp ro vi dedad d i t i o n al ri g h t s an dp o wers t o p referred p artn ers
o wn i n g 5 0 % o r m o re o f t h e o u t s t an d i ng p referred i n t eres t s . Th o se p art ners h el d-7
-

[* 7 ] th e ex cl u s i ve p o w er t o ap pro v e o r v et o an y am en d m en tt o the ag reem en t , an y i s su an ce o f ad d i ti o n al Part n ers h i p i n t eres t s , o r Part ners h i p ’ s en g ag em en t i nan y

“ Ex i t/ Reo rg an i zat i o n ” t ran s act i o n . Th es e p referred p art n ers were al s o p ro v i d ed drag -al o n g ri g h t s em

po weri n g th em

t o fo rce t h e m i n o ri ty

p artn ers t o s el l th ei r i n t eres t s t o th e p referred p art ner’ s ch o s en p u rch as er. Ex i t/ Reo rg an i zat i o n Tran s act i on s Gen eral ly , s ect i o n 3 .4 (b ) o f t he ag reem en td efi n ed an ex i t/reo rg an i zat i o n tran s act io n as o ne res u l t i n g i n th e co n v ey an ce o f al l o r s ub s t an t ial l y al l o f Part ners h i p ’ s as s et s , o r t h e co n s o l i d at i o n , m erg er, l i qu i d at i o n , o r t ran s fer o f g reat er t h an 8 0 % o f o u t st an d in g Part n ers h i p i n t eres t s . Sh o u l d Part n ers h i p en t er an
ex i t/reo rg an i zat io n tran sact i o n , s ect i o n3 .4 (c)(i ) o f t h e ag reem en ten t i t l edth e p referred p art n ers p art y t o the t ran s act i on t o co n s id erat i o ni nan am o u n tas cal cu l at edb y

a fo rm u l a i n s ect i o n 1 0 .9
. Fo r t h e p u rp o ses o f s ect i o n s 3 .4 an d1 0 .9 , th e ag reem en tv i ewed th e s al e o f th e p referred i n t eres t s i n an ex it/reo rg an i zat io n as th e s al e o f anequ i v al en tnu m b er
o f s h ares i n th e p referred p art n er i t s el f, th erei nd efi n edas th e s yn o nym o u s

“ Co rp o rat e Part n er”. 5

5 Fo r ex am

p l e: W el ls p ri n g ’ s s al e o f p referred i nt eres t s , u n der t h e ag reem en t , wo u l dn o tb e t reat edas a s al e o f p referred i nt eres t s b u t wo ul di n s t eadco n st i tu t e (co n ti n u ed ...)-8
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[* 8 ] Th e Ex i t/ Reo rg an i zat i o n Val u at i o n o f t h e Preferred Part n er Sect io n 1 0 .9 o f th e ag reem en tp ro v i d edthatth e p er s h are/ i nt eres t
co n si d erat io n du e a p referred p art n er u n d er s ect i o n3 .4 m u s t equal “ (A) t h e s u m

o f (x ) t h e am o u n t s uch Co rp o rat e Part n er wo u l db e en ti t ledt o o b t ai nu n d er Sect i o n 1 1 ats u ch t i m e i f t h e Part n ers h i p were t o l i qu i d at e, m in u s the l i ab i l i ti es o f t h e Co rp o rat e Part n er, p l u s (y ) t h e ‘ Co rp o rat e Part n er Ex ces s Val u e’ [ 6 ] d i vi d edb y (B) th e n u m b er o f o u t s t an di ng equ i ty s ecu ri t i es o f s u ch Co rp o rat e Part n er o nth e d at e
o f s u ch Tran s fer”. Sect i o n 1 1 Pro v id i n g Li qu i dat i o n Pri o ri ty Sect io n 1 1 (c) o f t he ag reem en tp ro v i d edthe p ri o ri ty o rd er fo r th e d i s tri b u t i o n o f Part n ers h i p l i qu i d at i o np ro ceed s , as ap p li cab l e fo r m ak i n g t h e req u i redcal cu lat i o n s u n d er s ect i o n s 3 .4 an d1 0.9 . Itp ro v i d ed , g en eral l y , th at l i qu i dat i o n p ro ceed s fi rs th adt o b e u s edt o s at i s fy an y Part n ers h i p d eb t s , l i ab i l i t i es , an do b l i g at i on s . An y rem ai n i n g p ro ceed s th en h adt o b e u s edt o s at i s fy

5 (...co n t in u ed ) th e s al e o f an equ i v al en tnu m b er o f s h ares i n W S Go l f Acqu i s i t i o ns , i t s wh o l l y o wn edh ol d i n g co m

p an y d i rect l y o wn i n g th e Part n ers h i p i n t eres t s . 6 Sect i o n 1 .1 o f the ag reem en td efi n es “ Co rp o rat e Part n er Ex ces s Val u e” as th e s u m o f al l cas h an d“ Perm it t edTem po raryIn v es t m en t s ” h el db y th e co rp o rat e p art n er. Sect i o n 1 .1 d efi n es p erm i t t edt em p o raryi n v es t m en t s as l o w -ri s k i n v es t m en t s , s u ch as Treas u ri es , CDs , m o ney m ark etacco u n t s , an d P-2 o r A-2 co m m erci al p ap er.-9
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[* 9 ] an y accru edb u tu npai d“ Preferred Paym en tOb l i g at i o n s ” (PPO), “ Preferred Ret i rem en tOb l i gat i o n s” (PRO), an dPreferred Al l o cat i o n s . 7 Nex t, th e ag reem en t
en t i t l edth e p referred p art n ers t o p ro ceed s i nam o u n ts equ al t o t h ei r “ In i t i al Cap i t al Acco u n t s ,” redu cedb y

the am ou n t s o f an y

PROs th ey

m ay h av e recei v ed , fo l l o w edb y

d i s tri b ut i o n o f p ro ceed s t o th e co m m o np art n ers i nam o u n t s equ al t o th ei r i n i t i al cap i tal acco u n t s. On l y o n ce t hes e p ri o ri ty cat eg ori es were s at i s fi ed
wo u l dth e co m

m o n an d p referred p art n ers s h are an y rem ai n i n g l i qu i dat i o n p ro ceed s. In i t i al Cap i t al Acco u n t s : A Defi n edTerm

“ In i t i al Cap i t al Acco u n t ” was a d efi n edt erm , o r rat her a d efi n edv al u e. Sect i o n 1 .1 o f t h e ag reem en td efi n edW el l s p ri n g ’ s i n i t i al cap i t al acco un t as $ 8 5 .5
m i l l io n , wh i ch wo u ldb e i n creas edb y th e “ Cas h As s et s” refl ect ed o n th e “ Fi n al Cl o si n g Cas h As set s St at em en t ,” as th os e t erm s were d efi nedi nth e p u rch as e ag reem en t . 8 Th e ag reem en t , referri n g t o th e co m m on p art n ers co l l ect i v el y , v al u ed

7 As d et ai l edi n art i cl e VI o f t h e ag reem en t , th es e p ro v i s io n s ap p ear t o i l lu s trat e t h e ag reem en t ’ s s t an d ardp art n ers h i p acco u n t i n g an dt ax i t em al l o cat i o n p ract i ces .

8 Ag ai n , th e t erm

“ Pu rch as e Ag reem en t ” refers t o th e s ep arat e ag reem en t wh erei n Edwi n W at t s s ol d W el l s pri n g i t s 8 0 .5 % i nt eres t i nPart n ers h i p fo r ap p ro x i m at el y $ 9 3 m i l l i o n . Al th o u g h th e p u rch as e ag reem en twas ex ecu t ed s i m u l t an eo u s l y

wi th t h e ag reem en t an dp ro m i s s o ry n o te i nth e reco rd , p et i t i o n ers

(co n ti n u ed ...)-1 0
-

[* 1 0 ] Edw i n W at t s ’ In i ti al Cap i t al Acco u n tas $ 7,9 4 5 ,0 0 0, wi th n o p ro v i s i o nfo r
an y i n creas e o r d i m i nu t i o n th ereo f. 9 Th e Preferred Paym en tan dRet i rem en tOb li g at i o n s Sect io n 1 2 .1 o f th e ag reem en ten t it l edth e p referred p art ners t o recei v e PPOs , wh i ch were an n u al g u aran t eedp aym en t s o f 8 .4 % o nth e PROs . Th e p referred p art n ers were en t i t l edt o recei v e PPOs u n ti l th e earl ies t o f a p artn ers h i p l i qu i dat i o n , the co n v ers io n o f p referred i n t eres t s t o co m m o ni n t eres t s , an
ex i t/reo rg an i zat io n tran sact i o n , o r Decem b er 4 , 2 0 08
. Sect io n 1 2 .1 o f th e ag reem en tal s o en t i tl edthe p referred p art n ers t o recei v e PROs , a g u aran teedp aym en t o f $ 5 2 .7 5 m il l io n . Th e p referred p art n ers were
en t i t l edt o recei ve PROs up o n t h e earl i es t o f a p art n ers h ip l iqu i d at i on , th e
co n vers io n o f p referred i nt eres t s t o co m m o ni n t eres t s , an Ex i t/ Reo rg an izat i o n tran s act io n , o r Decem

b er 4 , 2 0 0 8
.

8 (...co n t in u ed ) d i dn o t o ffer t h i s ag reem en t i n t o ev i d en ce.

9 Sect i o n 5 .2 p ro v id eda s ep arat e d efi n it i on fo r “ Cap it al Acco un t ” t h at refl ect edth e g en eral ly

u n ders t o o d d efi n i t i o n o f t hatt erm . Th ere, t h e cap i tal acco u n t refl ect edeach p art n er’ s i n i t i al cap it al acco un tv al u e i n creas edb y an y ad d it i o n al cap it al co n tri bu t i o n s m ad e b y o r g ai n s al l o cat edt o t h atp art n er, d ecreas edb y l o s s es al l o cat edo r d i s tri b u t i on s m ad e t o t h atp art n er, m ai n tai n edi n acco rd an ce wi th Co d e s ec. 7 04 (b ).-1 1
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[* 1 1 ] Th e ag reem en t p ro v i d edth atPart n ers h i p co u lds at i s fy b o th th e PPO an dth e PRO b y m ean s o f o ffs etag ai n stan y cu rren to b l i g at io n s o wedt o Part n ers h i p b y th e p referred p art n ers . Si m

u l t an eo u s l y

wi th th e ex ecu ti o n o f t h e ag reem en t , W el l s p ri n g p ro v i d edPart n ers h i p a p ro m is s o ry n o t e, wi th p ri n ci p al an di n teres t t erm s i d en t i cal t o tho s e o f t h e PPO an dth e PRO. Th is was a t erm n o te wi th n o p ro v is i o n s fo r accel erat i o n, p ay ab le o nDecem b er 4 , 2 0 0 8. Fi n al Part n ers h ip Own ers h ip By 2 0 0 7 a n u m

b er o f t h e co m

m o ni n t eres t s h adch an g edh an d s. Edw i n W at t s ’ o wn ers h i p s t ak e, as h el db y EW H C an d W M , h add i m i ni s h edt o 9 .2 % an d 0 .5 % , res p ect i v el y . Ro n n i e W at t s , h o wev er, n ow o wn ed7 .7 6% o f t h e co m m o n i n t eres t s th ro u gh RW M
. Th e rem ai n i n g 2 .5 % o f t h e co m m o ni n t eres t s were s p l it b et ween a m em

b er o f th e ex t en d edW at t s fam i l y an da W el l sp ri n g -ap p o i n t ed
m em b er o f t h e b o ardo f d i rect o rs . W el l s p ri n g ’ s Des i re t o Sel l In 2 0 0 6 W el l s p ri n g b eg an l o o k i n g t o s el l i t s i n v es t m en t i nPart n ers h i p . W el l s p ri n g en g ag edUBS t o d ev el op a m ark etfo r Part n ers h i p an dv etp ro s p ect i v e p u rch as ers . As UBS d ev el o p edan dth en wh it t ledd o wnth e b u y er p o o l , i t s en t
s eri ou s i n qu i ri es t o the W at t s fam i l y fo r fu rt h er en g ag em en t. Owi n g t o th ei r i n t i m at e kn o wl ed g e o f Go l f’ s ret ai l o p erat i o n s an dth ei r cri t ical rel at io ns h i p s wi th-1 2
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[* 1 2 ] th ei r v en d ors an dcu s t o m ers , th e W at ts b ro th ers were an i m p o rt an t el em en t
o f W el l s p ri n g ’ s s al e o f i t s Part n ers h i p i n t eres t . Wh en th e m ark etd ev el o p m en tp eri oden d ed , o n ly two n am es s u rfaced as
s eri ou s p o t en t i al p u rch as ers : Su nCap i t al (Su n), a p ri v at e equ i ty fi rm , an dDi ck ’ s Sp o rt i n g Go od s (Di ck ’ s ), a m ajo r ret ai l er l o ok i ng t o ex p an di t s fo otp ri n t i nth e reg i o n al g o l f m ark et . Th e W at t s b ro th ers were u ni m p res s edwi th Di ck ’ s . Whi l e Di ck ’ s ex p res s ed i t s d es ire t o i n teg rat e t he W at t s b ro th ers an dth e Go l f b ran di n t o i t s o wnco rp o rat e fam i l y , Di ck ’ s rep res en t at i o n s d i dn o t s p eakt o the W at ts b ro th ers ’ g reat es t
co n cern s. Th e W at t s b ro thers kn ew t h e fat e awai t i n g reg io n al ch ai n s acq u i redb y Di ck ’ s : b ran d ex t i nct i o n , l o cat i o nco n s o li dat i o n , an dth e el i m i n at i o no f redu n d an t
s t aff. Th es e o ut co m es were an at h em a t o th e W at t s b ro th ers ’ p ri n ci p al b u s i n es s
an d p ers on al co n cern s . Th e W at t s b ro th ers s ti l l ret ai n edo wn ers h i p o f t h e ret ai l
an d b u s i n es s o ffi ce l ocat i o ns l eas edt o Go l f, wh i ch p ro v i ded th e fam i l y wi th an
an n ual i n co m e s tream o f $ 4 .4 m i l l io n . Ad d i t i o nal l y , Go l f em p l o y edh un dred s , m an y o f wh o m

th e W at t s b ro th ers h ad kno wnfo r y ears an dco n s i d eredfam i l y . A
s al e t o Di ck ’ s m ean t an u n d es i rab l e o u t co m e fo r t he W at t s b ro th ers . A s al e t o Su n , h owev er, d i dn o tp res en t th e W at t s b ro th ers wi th the s am e
co n cern s. Su n , an o th er p ri vat e eq u i ty fi rm , was at tract i v e t o th e b ro th ers fo r t h e-1 3
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[* 1 3 ] s am e reas o n s W el ls p ri n g h ad wo nth em o v er y ears earl ier: au t o n om y i n
o p erat i n g Go l f an da co nt in u eds tream o f ren t al i nco m e. Th e W at t s b ro th ers v o icedt o W el l s p ri n g th ei r o p p o s i t i o nt o a s al e o f th e Part ners h i p t o Di ck ’ s. Th e b ro th ers ev en th reat en edt o wal kaway fro m th e b u s i n es s i n p ro t es t . Al th o u g h Su n ’ s b i dwas ro u g h l y $ 3 5 m i l l i o nl es s th an Di ck ’ s b i do f $ 12 0 m i l li o n , th e W at t s b ro th ers i m p l o redW el ls p ri n g t o s el l t o Su n . W el l s p ri n g s o l dt o Su n . 1 0 On M ay 1 6 , 2 0 0 7 , th e co ll ect i v e p art n ers
ex ecu t eda p u rch as e ag reem en twi th Su n (Su n s al e). Th e p u rch as e ag reem en t p ro v id eda n o m i n al p u rch as e p ri ce o f $ 85 m i l l i o n, t o b e ad ju s t edup o ncl o s i n g , refl ect i v e o f cl o si n g co s t s , ex p en s es , an dPart n ers hi p ’ s fi n al wo rk in g cap i t al an d i n d eb t ed n es s . Atth e cl o s in g, Su n p ai d $ 8 7 m i l l i o nfo r al l o f Part n ers h i p . Ap p ro x i m at el y $ 4 3 .8 m i l l i o n o f t h atam o u n t cam e i nth e fo rm o f Su n ’ s p aym en to f Part ners h i p

1 0 Oth er t h anp et i t i o n ers ’ u n co rro bo rat edt es t i m o ny , the reco rd d o es n o t i n d i cat e wh atm o ti v at ed W el ls p ri n g ’ s d eci s i o nt o s el l t o Su n . No rep res en tat i v e o f W el l s p ri n g was cal l edt o t es t i fy , an d n o d o cu m en t at i o nrefl ect in g b id s , p ro p o s al s , n eg ot i at edt erm s , o r ag reem en t s were en t eredi n t o ev id en ce. Pet i t i o ners ’ th eo ry

o f t h e cas e d o es n o treco n ci l e t h e $ 3 5 m i l l i o nd i fferen ce b et ween th e p urp ort ed Di ck ’ s an dSu nb id s . W el l s p ri n g h el dex cl u s i v e p o wer t o s el l al l o f Part n ers h i p , t o drag al o n g th e co m m o np art n ers . Pet i t io n ers av o id ed d i s cu s s i o n o f W el l s p ri n g ’ s drag -al o n g ri g h t s an dd idn o t ad dres s an y p o t en t i al d am ag e t h e W at t s b ro th ers ’ p ro t es t s an dh o l d o u tth reat s m ay h av e i n fl i ct edo nan y p o t en t i al s al e t o Di ck ’ s , an d whet h er t h is m ay h av e res ul t edi nSu n ’ s effect i v el y b ei n g th e b u y er o f l as tres o rt .-1 4
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[* 1 4 ] d eb t s t o Reg i o ns Ban k
. Ex cl u s i v e o f fees an do th er s al es ex p en s es , Su np ai d th e fi nal $ 3 4 .6 m i l l i o n i n p ro ceed s d i rect l y t o W el l s pri n g , i n cas h b y wi re t ran s fer. Th e co m m o n p art n ers --i n cl u d i n g p et i ti o ners --recei v edn on e o f t h es e fi n al cas h p ro ceed s. Th e Part i es 2 0 07 Tax Retu rn s Th e W at t s b ro th ers l o n g t i m e acco u n t an tHarry Gat es p rep aredth ei r 2 0 0 7 i n d i v i du al an d en t i ty -l ev el t ax return s ati s su e h ere. M r. Gat es h ads erv edas th e W at t s b ro th ers ’ p ri m ary

acco u nt an tan d ad v i s er fo r o v er 3 5 y ears , b u t , h e was n ot
as k edt o p art ici p at e i n , o r co ns u l twi th th em b efo re t he Su ns al e. Aft er t h e Su n s al e cl o s ed , th e W at t s b ro th ers i n fo rm edM r. Gat es th atth ey h ad d i sp o s edo f t h ei r i nt eres ts i n Part n ers h i p b utth atth ey h adrecei v edn o cas h p ro ceed s fro m

th e d i s p o s it i on . Th ey

p ro v i d edM r. Gat es wi th al l d ocu m en t s rel ev an t t o th e Su n s al e. M r. Gat es d et erm i n edth atth e m os tap p ro p ri at e m an n er
o f rep o rt i n g th e W at t s b ro th ers ’ d i s p o s al o f t hei r Part n ers h i p i n t eres t s , fo r t ax p u rp os es , was t o treat th e t ran s act i o nas an ab an do n m en to f th ei r p art n ers h i p i n t eres t s , g en erat i n g an o rd i n ary l o s s. Wh en res p o n d en ts el ect edth e W at t s b ro th ers ’ retu rn s fo r ex am in at i o n , M r. Gat es rep res en t edp et i ti o n ers atth e ad m in i s trat i ve l ev el an dd efen d edh i s d eci s i o n t o treatth i s as an ab an d on m en t . M r. Gat es al s o cred ib ly t es ti fi edattri al reg ard i n g-1 5
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[* 1 5 ] h i s treat m en to f t h e t ran s act i o nfo r t ax p u rp o s es an dth e i n fo rm at io nab o u t th e t ran s act i o n p ro v i d edt o h i m b y th e W at t s b ro th ers . OPINION I. Pet i t i o ners ’ Pri m ary Arg u m en t : Sub s tan ce Ov er Fo rm Th e p art i es d o n o t d is p u t e t h e am o u n t s res p o nd en tu s edi nh i s d et erm i n at i o n s, as res p o n d en tu s edth e am o u nt s reco g n izedan d rep o rt edi n p et i t i o n ers ’ retu rn s . 1 1 In s t eadth e d efi ci en cy d is p u te fo cu s es o n res p on d en t ’ s d et erm i n at i o n s as t o th e ch aract er o f t h e p et i t i o n ers ’ l os s es cl ai m edo n t h e d i s p o s al
o f t h ei r Part n ers h i p i n t eres t s . In co n tras tt o thei r o ri g i n al retu rn p o s i t i o n s , p et i t i o ners i n vi t e t h i s Co u rtt o
rev i ew t h e t o t al i ty

o f t h e Su n s al e i nan al t ern at e l i gh t . Pet i t i on ers as s ertth atth ey

1 1 Ex cl u s iv el y

o n b ri ef--i n co n

jun ct i o nwi th t h ei r ren ewedp u rs u i t o f o rd i n ary ab an do n m en tl o ss es , ad dres s ed , i n fra, s ect i o n II--p et i t i o n ers arg u e fo r an i n creas e i n the am o u n t s cl ai m ed as b as es o f t h ei r Part n ers h i p i n t eres ts . Pet i t i o ners ap p ear t o s u g g es tth e b as es rep o rt ed i n th ei r i n i t i al return s , an du s edth ro u g h o u t l i t i g at i o n , are n o taccu rat e. Pet i t io n ers n ei th er rai sedi nth ei r p et i t i o n s an y erro r wi th res p ect t o b as i s , n o r at t em

p t edt o p res en tfact s o r l it i gat e t h i s i s s u e attri al
. “ Is s u es rai s edfo r t h e fi rs tt im e b y b ri ef are n o tp ro p erl y

b efo re” t h is Co u rt . Aero Ren t al v . Co m

m i s s i on er, 6 4 T.C. 3 3 1 , 3 3 8 (1 97 5 ) (ci t in g Nas h v . Co m m i s s i on er, 3 1 T.C. 5 6 9 (1 9 5 8 ), an dTh eat re Co nces s i o n s , In c. v . Co m m is s io n er, 2 9 T.C. 7 5 4 (1 9 5 8 )). Th u s we “ wi l l n o tco n s i d er t hi s arg u m en t ”, as p et i t i o n ers “ h ad n u m ero u s o p p o rtu n i t ies t o rai s e t h i s i s s u e, b utfai ledt o d o s o ”; an db ecau s e t h ey d i dn o t d o s o th en , we n ow d eem th i s arg u m en twai v ed , es p eci al l y i nth e l i g h to f th e l i k el y p reju d i ce t o res p on d en t . Id .; s ee al s o Di L eo v . Co m m i s s i o n er, 9 6 T.C. 8 5 8 , 8 9 1 (1 9 9 1), aff’ d , 9 5 9 F.2 d1 6 (2 dCi r. 1 9 92 ); Arm co , In c. v . Co m m i s s i o n er, 8 8 T.C. 9 4 6 , 9 6 3 n .8 (1 9 8 7 ).-1 6
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[* 1 6 ] ag reedt o s u rren d er t o W el l sp ri n g an y s al e p ro ceed s du e th em t o i ncen t i v i ze W el l s p ri n g ’ s s al e t o Su n . Pet i ti o n ers ’ arg u e t h is was d o n e wi th the ai m o f p res erv i ng thei r Go l f-rel at eds tream o f ren t al i n co m e an ds av i n g the jo b s o f t h ei r
em pl o y ees (co ll ect i v el y , th e i n cen t i ve t h eo ry ). Pet i t i on ers ’ i n cen t iv e t h eo ry arg u es th atth e fo rm

o f t h e Su n s al e, as d o cu m en t edan do ri g in al l y rep o rt ed , fai l s t o
co m p o rtwi th i ts eco n o m i c real i ty . Pet i t i o n ers arg u e t h at we can as cert ai n
eco n om i c real i ty

o n l y b y lo o k i n g th ro u g h the Su ns al e. Th ey u rg e u s t o ex am i n e th e t ran s act i o n as a s eri es o f co m p o n en t s t ep s , an dt o fi n d the ex i s t en ce o f an
u n d o cu m en t edo ral ag reem en t wi th W el ls p ri n g . Pet i t i o ners arg ue t h atreco g n i t i o no f t he fo ll o wi n g co m p on en t s tep s wi l l
accu rat el y

refl ectth e eco n o m i c real i ty o f t h e Su ns al e: (1 ) p et i t i o n ers o ral l y
o ffered t o s u rren d er t h ei r p ro rat a s h are o f an y s al e p ro ceed s t o W el l s p ri n g, i n
ex ch an g e fo r W el ls p ri n g’ s ag reem en tt o s el l t o Su n , an o ffer t h atW el l s p ri n g accep t ed ; (2 ) up o n ex ecu t i o n o f t h e Su ns al e, p et i t io n ers co n tri b ut edth ei r p ro ceed s t o thei r v ari o us fl owt hro u g h real es t at e h ol d i n g co m p an i es ; an d (3 ) th o s e
co m p an i es i n s t an t an eo u sl y

p ai dth o s e co n tri b u t edp ro ceed s t o W el l s p ri ng , p u rs u an t t o th e o ral ag reem en t . Pet i t i o ners arg ue t h es e t ran s act i on s res u l t edi n thei r real izat i o no f actu al p ro ceed s fro m

th e Part n ers h i p s al e. Th ei r p aym en t s o f th os e p ro ceed s t o-1 7
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[* 1 7 ] W el l s p ri n g , th en , g av e ri s e t o th e am o rt i zab l e i n t an g i b le t h ey s eek t o
am ort i ze h ere. W e are u n m o v edb y p et it i on ers ’ th eo ry . Wh en th e fo rm

o f a t ran s act i on d o es n o t co i n ci d e wi th th e eco no m i c real i ty , th e s ub s t an ce o f t h e t ran s act i o n rat h er t h an i t s fo rm s h ou l dd et erm in e t h e t ax
co n seq u en ces . Co m

m i s si o n er v . Co u rt Ho l d i n g Co ., 3 2 4 U.S. 3 3 1 , 3 3 4 (1 94 5 ); Gl aci er St at e El ec. Sup p l y Co
. v . Co m

m i s s io n er, 8 0 T.C. 1 0 47 , 1 05 3 (1 9 8 3 ). Tax pay ers m ay

as s erts ub s t an ce-o v er-fo rm arg u m en t s ; h o wev er, i ns u ch s i tu at i o n s t ax p ay ers m ay face a h i gh er t h an u s u al b u rd en o f p ro o f. Gl aci er St at e El ect . Sup p l y Co . v . Co m

m i s s i o n er, 8 0 T.C. at 1 0 5 3 -1 0 54 . No twi th st an d in g
res p o n d en t’ s arg u m en ts reg ard i n g th e ap p l icat i o no f Co m m i ss i o n er v . Dan i el s o n , 3 7 8 F.2 d7 7 1 (3 d Ci r. 1 9 67 ), v acat i n g an drem an d i n g 4 4 T.C. 5 4 9 (1 9 6 5 ), co u rt s h av e l o n g h el dth att ax p ay ers m u s tad du ce “ s tro n g p ro of” t o es t ab l i s h attri al th ei r
en t i t l em en tt o a n ew p o s i t i o n thati s atv ari an ce wi th a p o s i t i o n rep o rt edi nth ei r
o ri g i nal retu rn s . Brad l ey v . Un i t edSt at es , 7 3 0 F.2 d7 1 8, 7 2 0 (1 1 th Ci r. 1 9 8 4 ) (ci t i n g Co m

m is s i o n er v . Nat ’ l Al fal fa Deh y drat i n g & M i l l i n g Co ., 4 1 7 U.S. 1 3 4 , 1 4 7 (1 97 4 )); Led o u x v . Co m m i s s i o n er, 7 7 T.C. 2 9 3 , 3 0 8 (1 9 8 1 ), aff’ d p er cu ri am 6 9 5 F.2 d1 3 20 (1 1 th Ci r. 1 98 3 ). To ad o p tp et it i o n ers ’ i n cen t i v e t h eo ry req u ires u s t o h o l dthatp et i t i on ers were ab i n i t i o en t it l edt o a p ro rat a s h are o f t he p ro ceed s fro m an y s al e, t h atth e-1 8
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[* 1 8 ] ag reem en t ’ s t erm s p ro v i dedth em an eco n o m ic en ti t lem en tt o p ro p ert y o r ri gh t s t h atth ey

co u l dthen n eg o t i at e t o s u rren d er. As d i s cu s s edb el o w , we reject p et i t i o n ers ’ th eo ry

b ecau s e i t wo u l dreq u i re u s t o i g n ore t he u n am bi g u o u s t erm s o f th e Ag reem en t b et w een p et i t io n ers an dW el l s p ri n g. W e tu rn i n i t i al l y

t o p et i ti o n ers ’ arg u m en tth ats u rren d eri n g t o W el l s p ri n g th ei r p urp o rt eden t i t l em en tt o a p ro rat a s hare o f th e Su ns al e p ro ceed s res u l t edi n th e creat io n o f an am o rt i zab l e i n t an g i b l e. A. Am o rt i zab l e In t an g i b l e A t ax p ay er m

u s t cap it al i ze an ex p en d i tu re wh en i t : (1 ) creat es o r i m p ro v es
a s ep arat e an dd is t in ctas s et , (2 ) p ro du ces a s ig n ifi can tfu tu re b en efi t , o r (3 ) i s i n cu rredi n co n n ect io n wi th th e acq u i si t i o n o r creat i o n o f a cap i t al as set . Ly ch u k
v . Co m m i s s i o n er, 1 1 6 T.C. 3 74 , 3 8 5 -3 8 6 (2 00 1 ). Cap i tal ex p en d i tu res , u n l i k e
o rd i n ary an dn eces s ary

b u s i n es s ex p en s es , m

u s tb e reco v ered o ver t im e. INDOPCO, In c. v . Co m

m i s s i o ner, 5 0 3 U.S. 7 9 (1 9 9 2 ); s ee al s o s ecs . 2 6 3 , 1 6 7 , 1 9 7
. Th e am ort i zat i o n o f an ex p en di ture b eg i n s wi th d et erm i ni n g the am o u n to f th e cap i t al o u t l ay , es t ab li s h i n g th e b as i s t o b e am o rt i zed
. Bas i s i s th e cap it al co st i n cu rredb y

a t ax p ay er wh en b uy i n g , creat i n g , o r i m p ro vi n g an as s et . Secs . 1 6 7 , 1 9 7 , 1 0 1 1 , 1 0 1 2
. A t ax pay er cl ai m i n g an am o rt i zat i o nd edu ct i o n b ears th e b u rd en-1 9
-

[* 1 9 ] o f es tab l i s hi n g i t s d ep reci ab l e b as i s fo r t hatex p en s e’ s acco u n t . See Cl u ckv . Co m m i s s i o n er, 1 0 5 T.C. 3 2 4 , 3 3 7 (1 9 9 5); Rei nb erg v . Co m m i s s io n er, 9 0 T.C. 1 1 6 , 1 3 9 (1 9 8 8). Pet i t io n ers ’ i n cen t i v e th eo ry rel i es o nth e p res um

p t i o nthatth e t erm s o f t h e ag reem en tg u aran t eedth em ri g h t s t o a p ro rat a s h are o f th e s al e p ro ceed s. It i s th i s s h are o f s al e p ro ceed s th atth ey cl ai m t o h av e s u rren dered , g i v i n g ri s e t o th e t ax b en efi t --t h e reco v ery o f b as i s--t h ey n ow s eekan d b ear t h e b u rd eno f p ro vi ng . B. Ap p li cat i o n o f Del aware Co n tract Law To d et erm i n e i n t eres t s i n an dri g ht s t o p ro p ert y fo r Fed eral t ax p u rp os es , we ap p ly th e rel ev an tSt at e l aw. Un i t edSt at es v . Nat ’ l Ban ko f Co m m erce, 4 72 U.S. 7 1 3 , 7 2 2 (1 9 8 5); W o o ds v . Co m m i ss i on er, 1 3 7 T.C. 1 5 9 , 1 6 2 (2 01 1 ). Th e ag reem en tb et ween p et i t i o n ers an dW el l s p ri n g g o vern edth ei r ri g h t s as p art n ers . Becau s e th e ag reem en tco n t ai n eda ch o i ce-o f-l aw p ro v i s i o n s peci fy i n g Del aware l aw, we ap pl y th e l aw o f t h atSt at e i ni n t erp ret i n g th e p ro v i s i o n s o f t he ag reem en t . A p art n ers h i p ag reem en t g o vern edb y Del aware l aw wi l l b e i n t erp ret ed
u s i n g p ri n ci p l es o f co n tractl aw. No rt o nv . K-Sea Tran s p . Part n ers L.P., 6 7 A.3 d 3 5 4 , 3 6 0 (Del . 2 0 1 3). “ T h e p ri m ary g o al o f co n tract i n t erp ret at io ni s t o ‘ at t em p tt o fu l fi l l , t o th e ex ten tp o s si b le, t h e reas o n ab l e s h aredex p ect at i o n s o f t h e p art i es at th e t i m e t h ey

co n tract ed ’ .” Co m

ri e v . En t eras y s Net wo rk s , In c., 8 3 7 A.2 d1 , 1 3-2 0
-

[* 2 0 ] (Del . Ch . 2 0 0 3 ) (qu o t i n g U.S. W es t , In c. v . Ti m e W arn er, In c., 1 9 9 6 Del
. Ch . LEXIS 5 5 , at* 28 -* 29 (J un e 6 , 1 9 9 6 )). Un l es s th ere i s an am

b i g u i ty i n o r an i n t ern al co nfl i ctam o ng co nt ract p ro v is i o n s , co u rt s m

u stg iv e effect t o the p art i es ’ i n t en t i o n s as refl ect edwi th i n th e fo u r co rn ers o f th e ag reem en t , co n s tru i n g th e ag reem en tas a wh o l e an dg i v i n g effect t o al l p ro v i s i o n s th erei n. GM G Cap it al In v s ., LLC v
. Ath en i an Ven tu re Part ners I, L.P., 3 6 A.3 d7 7 6 , 7 7 9 -7 8 0 (Del . 2 0 1 2 ). Am b i gu it y d oes n o tari s e “ m erel y

b ecau s e t h e p art i es d i s p u t e” wh at th e
co n tract l an g u ag e m ean s. Al t a Berk el ey VI C.V. v . Om

n eo n , In c., 4 1 A.3 d3 8 1 , 3 8 5 (Del
. 2 0 1 2 ). Am

b i g u i t ies ari s e o n l y

wh en th e t erm s o f t h e co n tract are fai rl y
s u s cep t i b l e o f d ifferen ti n t erp ret at i o n s o r carryd i fferen tm ean i n g s . GM GCap i t al In v s ., LLC, 3 6 A.3 dat7 8 0 . Am b i gu i ty d o es n o tex i s twh en th e co u rtcan d et erm i n e t h e m ean i n g o f a co nt ract wi th o u t an y g u i d e o th er t h an a kn o wl ed g e o f th e s i m p l e fact s o n wh i ch , fro m

th e n ature o f l an gu ag e i ng en eral , i t s m ean i n g d ep en d s . AT&T Co rp . v . Li l l i s , 9 5 3 A.2 d 2 4 1 , 2 5 2 (Del . 2 0 0 8 ) (ci t i ng Lo ri l l ard To b acco Co . v . Am . Leg acy Fo u n d ., 9 0 3 A.2 d7 2 8 , 7 3 9 (Del . 2 00 6 )). A co n tract ’ s d efi n edt erm s wi l l co n tro l wh en th ey es t ab l i s h th e p art ies ’ i n t en ti na m an n er “ th at
a reas on ab l e p ers on i n th e p o s it i o no f ei ther p arty wo u ldh av e n o ex p ect at io n s-2 1
-

[* 2 1 ] i n co n s i s ten twi th t h e co n tract l an g u ag e.” GM G Cap i t al In v s ., LLC, 3 6 A.3 d at7 8 0
. C. In t erp ret i n g th e Part n ers h ip Ag reem en t 1
. Preferred St atu s Th e ag reem en td efi n eda “ Preferred Part n er” as an y p art n er o wn i n g

“ Preferred In t eres t s .” Sect i o n 3 .2 o f t h e ag reem en td efi n ed the p referred i n t eres t s b y d i s t i n g u i sh in g them

fro m th e co m

m o ni nt eres t s b y

way o f th e ri g h t s , p o wers
an d p ri v i l eg es acco rd edt o th e p referred i n t eres t s . Th ro u g h o u tth e ag reem en t W el l s p ri n g was cl earl y

an du n am

b i g uo u s l y d es cri bedas th e p referred p art n er, an d i t s o wn ers h i p s t ak e co m

p ri s ed p referred i n t eres t s . Ho wev er, p et i ti o n ers co n t en dth atn o n e o f t h e p art n ers was i na p referred p o s i t i on an dth atW el l s p ri n g wo u ldach i ev e p referred p art n er s t atu s o nl y wh en i t p ai dth e Part n ers hi p t h e p ri n ci p al o nth e $ 5 2
. 7 5 m i l l i o n p ro m i s s o ry n o te. Pet i t io n ers ci t e fo r t h is p ro p o s it i o ns ect i on 1 2 .1 o f t h e ag reem en t , th e p ro vi s i o n g o v ern i n g th e PPO an d t h e PRO. Pet i t i o ners ’ co n t en t i o n ru n s co n traryt o th e u nam b i g uo u s t erm s o f t h e ag reem en t . 1 2 No wh ere i n th e ag reem en twere t h e p referred i n t eres ts ’ s tatu s ,

1 2 Th i s co n t en t i o n al s o ru n s co n traryt o th e fact s p res en t edattri al
. W el l s p ri n g ap p o i n t edth ree o f t h e fi ve m em b ers o f t h e b o ardo f d i rect ors , recei v ed (co n ti n u ed ...)-2 2
-

[* 2 2 ] p o wers , ri gh t s , o r p ri v i leg es s ub j ect edt o co n t i n gen cy

o r qu al ifi cat i o n . Had p et i t i o n ers an dW el l s p ri n g i n t en d edt o co n st rai no r m ak e co n t i n g en tan y p referred
s t atu s, ri g h t s o r p o wers , they co u l dh av e eas i l y

d o ne s o . Th ey

d i dn ot . Th e
m ean i n g o f t h e ag reem en t , i n th i s reg ard , i s o b v i o u s.

2
. Ex i t/ Reo rg an i zat i on an dCo n s i d erat i o n Th ereu n d er As rel ev an th ere, s ect i o n 3 .4 (b ) o f t h e ag reem en tcl earl y d efi n edan
ex i t/reo rg an i zat io n tran sact i o n as an y tran s act i o ntran sferri n g o wn ers h i p o f 8 0 %
o r m ore o f t h e t o t al Part n ers h i p i n t eres t s . Atth e t im e o f th e Su ns al e, W el l s p ri n g
o wn edm o re th an 8 0% o f t h e t ot al Part n ers h i p i n t eres ts . W el l s p ri n g ’ s d i v es t i n g i t sel f o f i t s Part n ers h i p i n t eres t s i nth e Su n s al e co n s t i tu t edan ex i t/reo rg an i zat i o n tran s act io n . Sect i o n 3 .4 (c) o f th e ag reem en tp ro v i d edthat , i nth e ev en to f an
ex i t/reo rg an i zat io n tran sact i o n , an y p referred p art n ers p art i ci p at i n g i nth e tran s act io n were en t i t l edt o co n s i d erat i o nfo r th ei r i n t eres t s as cal cu l at edu n d er
s ect i on 1 0 .9
. Th e fo rm u l a i n s ect i o n 1 0 .9 o f t h e ag reem en t es t ab l i sh eda p er-i n t eres tv al u e fo r t h e p referred i n t eres t s s o l d i n an ex i t/reo rg an i zat i o n t ran s act io n . Th i s fo rm u l a

1 2 (...co n t i nu ed ) o ffs et t i n g PPO p aym en t s , an dl i k el y ex erci s edo r at t em

p t edt o ex erci s e i t s drag al o n g ri g h t s t o tri g g er t h e co m pl et e s al e o f th e Part n ers h i p . W el l s p ri n g h el dan d ex erci s edp referred s tatu s an dp o wer.-2 3
-

[* 2 3 ] es t ab l is h edth atv al u e as th e qu o t i en to f (1 ) t h e s um o f th e p referred p art n er’ s ri g ht s t o p ro ceed s i n a h y p o th et i cal Part ners h i p l i qui d at i o n u n d er s ect i o n 1 1 o f t h e ag reem en t, p lu s o r m i n u s (2 ) t h e n et o f cert ai nex t ern al v ari ab l es , al l d i v i d edb y

(3 ) t he o u t s t an di n g equ i ty i nt eres t s o f t h e p art n er i t s el f. 3
. Sect io n 1 1 : Li qu i d at i o n Pro v i s i o ns an d Pri o ri ty Sect io n 1 1 (c) l ai do u t Part n ers hi p ’ s l iqu i d at io nd i st ri b u t i o n p ri o ri ty . Inan actu al o r co n s tru ct i v e l i qu i dat i o n , th e p referred p artn er wo u l drecei v e p aym en t
s at i s fy i ng an y

accru edb u tu np ai dPPO, 1 3 PRO, 1 4 o u t s t an d i n g p referred al l o cat i o n s , 1 5 an d th e ad

ju s tedb al an ce o f t he p referred p art n er’ s i n i t i al cap it al
acco u n t . 1 6 Th e p referred p artn er’ s l i qu i d at i o n p o s i t i on was s ub o rd i nat e t o Part ners h i p cred i t ors , b u ts up eri o r t o th at o f al l co m m o n p art n ers .

1 3 As d efi n ed i n s ect io n 1 2 .1 , PPOs were an an n ual 8 .4 % o nth e $ 52 .7 5 m i l l io n p aym en tm ad e t o W el l s p ri ng .

1 4 As d efi n ed i n s ect io n 1 2 .1 , th e PRO co n s t i tu t eda $ 5 2
. 7 5 m i l l i o np aym en t t o b e m ad e t o W el l s p ri n g o n th e earl i er o f, am o n g o th ers , an ex i t/reo rg an i zat i o n tran s act io n o r Decem

b er 4 , 2 0 0 8
. 1 5 As d et ai ledi n art i cl e VI o f t h e ag reem en t , thes e p ro v i s i o ns ap p eared t o i l lu s trat e Part n ers h i p ’ s s t an d ardacco u nt i ng an dt ax p ract i ces .

1 6 In ad di t i o n t o th e ad

ju st m en t s d i s cu s s edi n , an d as s o ci at edwi th n o t e 9 , s up ra, s ect io n 1 1 (c) p ro v i d eda l i qu i d at io n -s p eci fi c ad ju st m en tt o th e p referred p art n er’ s i n i ti al cap i t al acco u n t , redu ci n g th e acco u ntv al u e equ al t o t h e am o u n t d i s tri b u t edo r o ffs eti n s at i s fact i o no f t he PRO.-2 4
-

[* 2 4 ] Wh en th e p art i es cl o s edth e s al e, Su n p ai d$ 4 3.7 9 m il l io nt o Reg i o n s Ban k , ex t i n g u i s h i n g Part n ers h i p ’ s d eb t . Acco rd in g l y , i na h y p o th et i cal l i qu i d at io n W el l s p ri n g ’ s p referred l i qu id at i o n p o s i t i o n s were n o l o n g er s ub ord i n at e t o Part ners h i p cred i t ors . As su m i ng arg uen d o thatPart ners h i p o wedW el l sp ri ng n o
accru edb u tu np ai dPPO, PRO, o r p referred al l o cat i o n s th atm i g h t h av e o th erwi s e i n creas edth e t o t al am o u n t du e W el l s p ri n g , th en W el l s p ri n g was en t i t l edt o reco v er t o the g reat es tex t en tp os s i b l e i t s i n it i al cap it al acco u n to f $ 8 5 .5 m i l l i o nfro m th e p ro ceed s o f t h e h y

p o th et i cal s ect i o n1 1 Part n ers hi p l i qu i d at i o n . 4
. Fi n al Sect i o n 1 0 .9 Op erat i o n W e can n o td et erm i n e W el l s p ri n g’ s en t i t l em en tu n d er s ect io n1 0.9 as th e
reco rdi s d ev o i d o f an y

ev i d en ce reg ard i ng th e v al ues fo r t h e v ari ab l es d efi n edi n th e ag reem en tth atm i g h th av e i n creas edo r d ecreas edth e am o un to f W el ls pri n g ’ s
en t i t l em en t . Pet it i o n ers d i d n o tp ro v i d e th e Co u rtwi th an y ev id en ce t h atm i g h t h av e p ro v en h el pfu l i n d et erm i n i n g th e p reci s e am o u nto f co n s i derat io n due W el l s p ri n g i n t h e Su n s al e. In fact p et i ti o n ers --attri al an do nb ri ef--en t irel y av o i d d i s cu ss i n g s ect i o n 1 0
o f t h e ag reem en t . Pet i t io ners s i m i l arl y av o i d d i s cu s s i n g s ect i on 3 .4 , the l i qu i dat i o n p ri o ri ty

p ro v i s i o n s , o r t h e i m

p acto f an y

rel ev an td efi n edt erm s o r W el l s p ri n g ’ s $ 8 5.5 m i ll i o n i n i t i al cap i t al acco u n t . Th ey m ad e n o effo rtt o ad dres s,-2 5
-

[* 2 5 ] ex am i n e, co n st ru e o r ev en al l eg e an y am b i g u it y wi th in the t erm s o f th e ag reem en t . Pet i t io ners d i dn otev en o ffer t es ti m o n y as t o th ei r o wnp ers o n al kn o wl ed g e an d un d ers tan d i n g o f t h es e p ro v is i on s . Th ey o ffered n o Part n ers h i p b al an ce s h eet s , b o o k s , au d i ts t at em en t s , o r o th er acco un t i n g reco rd s as ev i d en ce o r
ex h ib i t . Pet it i on ers cal l edn o m em b ers o f W el ls p ri n g o r Su nt o t es t i fy an d
co rro b o rat e th ei r t h eo ry

attri al
. Pet i t i o ners ’ arg u m en tb eg i n s wi th a co n cl u s i o n : Th ey were en t it l edt o a p ro rat a s hare o f t h e cas h p ro ceed s fro m th e Su n s al e. Iten ds th ere, t o o . Pet it i o n ers ’
co n cl u s o ry

p res u m p t i o n ru n s co n traryt o th e u n am bi g u o u s wo rd i n g o f t h e ag reem en t . Sect i on s 3 .4 (c) an d 1 0 .9 d i dn o tp ro v i d e fo r a p ro rat a s p l i t ; they p ro v id edW el l s p ri n g a p ri o ri ty p aym en t fo r i t s i n t eres t s i nth e ev en to f an
ex i t/reo rg an i zat io n tran sact i o n , b y d efi n it i on th e t ran s act i o nat i s su e h ere. It is cl ear t o u s th atth es e are n eg o t i at edco n tract p ro v is io n s m ean t t o n arro w th e p referred p art n er’ s ex po s ure t o ri s k , as are arg u ab l y al l th e p owers co n ferred b y th e ag reem en to n th e o wn ers o f p referred i n t eres t s . Inth e ev en tth e m ark et ab l e
v al u e o f W el l s p ri n g ’ s Part n ers h i p s t ak e s li p p edb el o w i t s i n i t i al i n v es t m en t -- refl ect edi n th e ag reem en tas i t s i n i ti al cap i t al acco u n tv al ue--t hes e p ro v is i on s
o p erat e t o reco v er W el l s p ri n g ’ s i n ves t m en t t o th e g reat es t ex ten tp o ss i bl e, ev en i f th atreco v ery co m es atth e ex p en s e o f t h e m in o ri ty p art ners .-2 6
-

[* 2 6 ] W e are as k edt o co n cl u de t hatp et i t i o ners were en t i t l edt o a p ort i o no f t h e
cas h p ro ceed s fro m

th e Su n s al e. Becau s e o f t h e l acko f m at eri al fact s, we can n o t
as cert ai n th e t o t al p ro ceed s t o wh i ch th e ag reem en ten t i t l edW el l s p ri n g i nth e Su n
s al e. An d as a co ro l l ary , b ecau s e p aym en to f W el l s p ri ng ’ s p ri o ri ty p o s i t i o n s i s a p red i cat e co ns id erat i o n , we can n o ts u rm i s e wh at --i f an y --p ro ceed s p et i t i o ners m ay h av e b een en t i t l edt o . Pet i t i o ners fai ledt o es t ab l i s h th ey were en t i t l edt o an y

cas h p ro ceed s fro m th e Su n s al e. It fo l l o ws , th en , th atp et i t i on ers co u ldn o t o ffer t o s u rren d er s u ch p ro ceed s t o en t i ce o r i n cen t i v i ze W el l s p ri ng ’ s s al e t o Su n . 1 7 Acco rd i n g l y , th e
am ort i zab l e ex p en s e o f p et i t io ners ’ i n cen t i ve t h eo ry fai l s fo r l acko f p ro o f as t o th ei r p urp o rt edb as es . W e d ecl i n e t o fu rt h er co ns i d er p et i t i o n ers ’ req u es tfo r am o rt i zat i o n. W e
n eed no tad dres s wh et h er t h i s p u rp o rt edi n cen t i ve p aym en ts h ou l db e cap i t al i zed i n t o th e ex i s t i n g l eas es o r o th er as s et s , n o r wh et h er th e p urp o rt edco n tract u al ag reem en tb et ween the W at t s b ro th ers an dW el l sp ri ng m i g h th av e creat eda
s ep arat e an d d i s ti n ct l y b arg ai n ed -fo r am o rt i zab l e as set , as p et it io n ers h av e fai l ed

1 7 Pet i t i o ners d i dn o t ad v an ce an y o ther o st en s i b l e s ou rce o f fu n d i n g fo r t h ei r i n cen t i v e t h eo ry

(e.g ., th ei r o wnl i qu i dcap i t al , as s u m p t i o n o f d eb t s , et c).-2 7
-

[* 2 7 ] t o m eetth ei r b urd eno f p ro v in g th ey i n cu rred th e ex p en se u n d erl y i n g t h e
n o w-cl ai m edam o rt i zat i o n d edu ct i o n . D. Lat en tAm

bi gu i t i es Un d er Del aware l aw, a l at en tam bi g u i ty m ay ex i s twh en th e s eem i n g l y
u n equi v o cal t erm s o f a co n tract are ren d ered am b i gu o u s b y ex tri n s i c ci rcu m s t an ces t o wh ich th e co nt ract refers . See Kl ai r v . Rees e, 5 3 1 A.2 d2 1 9 , 2 2 3 (Del . 1 9 8 7 ). Del aware l aw, h o wev er, s t i l l req u i res a d et erm in at i o n th ata co n tract i s am b i g u o u s o n i t s face--o p en t o co m p et i n g reas o nab l e i n t erp ret at i o n s --b efo re
co u rt s m ay

co n s tru e a l at en t am

b i g u i ty an d co n s i d er ex tri n s i c ev i den ce t o ai di n
u n d ers t an d i n g i t s t erm s. See Ci n ci n n at i SM SA v . Ci nci n n at i Bel l Cel l u l ar Sy s . Co ., 1 9 9 7 Del . Ch . LEXIS 1 0 9 , at* 1 1 -* 1 8 (1 99 7 ), aff’ d , 7 0 8 A.2 d9 8 9 (Del
. 1 9 9 8 ); s ee al so M o t o rs Li qu i d at i o nCo . v . Al l i an z In s uran ce Co ., 2 0 1 3 Del . Sup er. LEXIS 6 0 5 , at* 1 4 (2 0 1 3 ); U.S. W es t , In c. v . Ti m e W arn er In c., 1 9 9 6 Del . Ch
. LEXIS 5 5 , at* 3 1 n .1 0 (1 9 9 6 ); Bel l At l . M eri d i an Sy s. v . Oct el Co m m c’ n s Co rp ., 1 9 9 5 Del . Ch . LEXIS 1 5 6 , at* 1 8 n .5 (1 9 9 5). Pet i t i o ners co n t en dth ei r i n cen t iv e t h eo ry h arm o n i zes th e zero -p ro ceed s
res u l t o f t h e Su n s al e wi th t h ei r p ro rat a en t i t l em en tu nd er t h e ag reem en t ; th at W el l s p ri n g ’ s s t atu s as a p referred p art n er was co n t i n g en to n the rep aym en t o f a p ro m i s s o ry

n o t e. Pet i t i o n ers h av e n o ti n v i tedo u r at t en t i o n t o an y co n tract-2 8
-

[* 2 8 ] l an g u ag e th at m i g h t s upp o rtth ei r p o s i t i o n s, n o r h av e t h ey p res en t edan y
reas on ab l y

d ev el o p edi n t erp ret at i o no f an y t erm o r p ro v i s io no f th e ag reem en t . As d i scu s s ed , th e p ro v is i o n s o f t h e ag reem en tare u n am b i gu o us o nthei r face, an d p et i t i o n ers ’ p res u m

p t i on s are cl earl y

ato d d s wi th th o s e p ro v i s i o n s . Th e reco rd
an d fact s b efo re u s o ffer n o h i nto f l at en tam b i gu i ty : Ob

ject i v el y , th e zero p ro ceed s res ul t o f t h e Su n s al e d o es n o tco n trad i ctth e t erm s o f t h e ag reem en tas ap p li edt o th e fact s p res en t ed
. Co n seq u en t l y , we h o l dp et i t io n ers h av e fai l edt o s at i s fy th ei r b u rd en o f p ro o f. II. Pet i t i o ners ’ Al t ern at i v e Arg u m en t : AnAb an d o nm en tLo s s Onb ri ef p et i t i o n ers ret reat t o th ei r o ri g i n al retu rn p o s i t i o n , 1 8 arg u i n g th ati f we rejectth ei r i ncen t i v e t h eo ry , th en we m us treco g n i ze t h e t ran s act i o nas an
o rd i n ary ab an d o n m en t l o s s u n d er s ect i o n1 6 5. A. Bu rd en o f Pro o f Th e Co m m is s i o n er’ s d et erm i n at i o n s are p res u m edco rrect , an dt ax p ay ers g en eral l y b ear t h e b u rd en o f p ro v in g en t i t l em en tt o th e d edu ct io ns th ey cl ai m .

1 8 Oth er t h anm en t i o n i ng i tas an aft ert h o u g h t --as th e l as ts en ten ce i n p et i t i o n ers ’ o p en i n g s t at em en t--t h i s arg u m en t ap p ears n o wh ere el s e i nth e reco rd
. Pet i t io n ers d i dn o tp res en tan y ev i d en ce as t o th i s co n t en ti o n attri al . Arg u ab l y , p et i t i o n ers ab an d o n edth i s arg u m en tb efo re p et i t i o ni n g th i s Co u rtfo r red et erm i n at i o n .-2 9
-

[* 2 9 ] Ru l e 1 4 2 (a); W el ch v . Hel v eri n g , 2 90 U.S. 1 1 1, 1 1 5 (1 9 3 3 ); INDOPCO, In c.
v . Co m m i s s i o n er, 5 0 3 U.S. 7 9, 8 4 (1 9 9 2 ). In cert ai nci rcu m s t an ces , the b u rd en o f p ro o f s h i ft s t o th e Co m

m i s si o n er wh en a t ax p ay er i n tro du ces cred i b l e ev i den ce wi th res p ect t o an y rel ev an t fact u al i s su e. Sec. 7 4 9 1(a)(1 ). Pet i t i o n ers d o n o t
co n ten d , an d th e reco rdd o es n o tes tab l i s h , th at we o u g h t s hi ftt o res p o n d en tth e b u rd enas t o an y

i s s u e o f fact . W e t herefo re d ecl i n e t o d o s o . B. Sect io n 7 4 1 o r Sect i o n1 65 ? Gen eral ly , s ect i o n 7 4 1 req u i res thatt ax p ay ers reco g n i ze as cap i t al al l g ai n s
o r l o s s es real i zedi n th e s al e o r ex ch an ge o f a p art n ers h i p i n teres t --ex cep tt o th e
ex t en ts ect i o n 7 51 ap p l i es . 1 9 To th e ex t en tth ata n o n co rp o rat e t ax p ay er i ncu rs cap i t al l o s s es , th e t ax p ay er m ay d edu ct tho s e cap i t al l o s ses cu rren t l y ag ai ns t cap i t al g ai n s an d up t o $ 3 ,0 0 0 o f o rd i n ary i nco m e. Secs . 1 6 5 (f), 1 2 1 1(b ). Sect i o n 1 6 5 (a) p ro v i d es t ax pay ers o rd i n ary l o s s d edu ct i o n s fo r ab an d o n m en t l os s es . To qu al i fy fo r an ab an do n m en tl o s s , a t ax p ay er m u s td em o n s trat e t h at : (1 ) t h e tran s act io n u n der rev i ew d o es n o tco n s t i tu t e a s al e o r ex ch an g e an d(2 ) h e o r s h e ab an do n edth e as s et , i nt en t i o n al l y an d affi rm at i v el y , b y

o v ertact . Sec. 1 .1 6 5 -2 ,

1 9 Nei th er p art y

rai s edan y

arg u m en tn o r p res en tedan y ev i den ce o f u n real i zed recei v ab l es o r i n v en t o ry h el db y th e Part n ers h i p , fo recl o s i n g o u r co n si d erat io n o f an y p o rt i o n o f a p o t en t i al l os s recei v i n g o rd i n ary treat m en tu n d er s ec. 7 5 1.-3 0
-

[* 3 0 ] In co m e Tax Reg s . ; s ee Ci tro nv . Co m m i s s io n er, 9 7 T.C. 2 0 0, 2 0 9-2 1 5 (1 9 9 1) (ci t i n g M i d d l et on v . Co m m i s s i o n er, 7 7 T.C. 3 1 0 , 3 1 9 -3 2 4 (1 9 81 ), aff’ d , 6 9 3 F.2 d1 2 4 (1 1t h Ci r. 1 9 82 )). Sub ject t o th e p ro h i b it i o n o ns al es o r ex ch an g es g i v i n g ri s e t o o rd i n ary ab an do n m en tl o ss es , p art ners h i p i n t eres t s m ay b e ab an d on ed . Ech ol s v . Co m m i s s i o n er, 9 3 5 F.2 d7 0 3 (5 th Ci r. 1 9 91 ), rev ’ g an drem an d in g 9 3 T.C. 5 5 3 (1 9 8 9); Ci tro n v . Co m

m i s s i o n er, 9 7 T.C. at 2 1 3
. Wh en a p art n er i s rel iev edo f h i s o r h er s h are o f p artn ers h i p l i ab i l i t i es , th e p art n er i s d eem ed t o recei v e a d i s tri b u ti o n o f cas h . Sec. 7 5 2 (b ). Sect i on 7 3 1 (a) req u i res d i s tri b u t io ns t o p artners t o b e t reat edas p aym en t s ari s i n g fro m th e s al e o r
ex ch an g e o f a p art n ers h ip i n teres t . Secs . 7 5 2 (b ), 7 31 (a); Ci tro n v . Co m m i s s i o n er, 9 7 T.C. at2 1 4-2 1 5 n . 1 1 . Thu s , o rd i n ary ab an do n m en tl o s ses m ay ari se o n l y

i n a
n arro w ci rcu m s t an ce wh ere t h e p art ner: (1 ) was n o tp ers o n al l y l i ab l e fo r t h e p art n ers hi p ’ s reco u rs e d eb ts o r (2 ) was l i m i t edi nl i ab i l i ty an do th erwi s e n o t
ex p os edt o an y

eco no m i c ri s ko f l o s s fo r t h e p art n ers hi p ’ s n on reco u rs e l i ab i l i t i es . See s ec. 7 5 2 (b ), (d ); s ec. 1 .7 52 -3 , In co m e Tax Reg s .; s ee al s o Co m m i ss i o ner v . Tu ft s , 4 6 1 U.S. 3 00 (1 9 8 3 ). Res p o n d en td et erm i n edp et i ti o n ers ’ d i s p o s al o f th ei r Part n ers hi p i n t eres t s d i dn o t fal l wi th i n th es e n arro w ex cep t i o n s. Acco rd i ng l y , res po n d en t-3 1
-

[* 3 1 ] rech aract eri zedp et i t io ners ’ l o s s es fro m o rd i n ary ab an d o nm en tl o s s es t o cap i t al l o s s es o n th e s al e o r ex ch an g e o f t h e i n t eres t s . In co n t es t i n g th i s d et erm i n at i o n , p et i t i o ners were t as k edwi th th e b u rd en o f p ro v in g res p o n d en t ’ s d et erm i n at i o ni n co rrect . Pet i t i o n ers h av e n o t m etth i s b u rd en . Pet i t i o n ers p res en t edn o d o cu m en taryo r t es t im o n i al ev id en ce t o es t ab l i s h th ei r el i g i b i l i ty

fo r an ab an d o n m en tl o s s d edu ct i o n . Pet i t i o n ers fai l edt o p ro v e th ei r i n d i v i du al s h ares o f an y Part n ers h i p l i ab i l i t i es , cap i t al res t o rat i o no b l i g at i o n s , o r l ackth ereo f, i n th e l i g h to f d o cu m en taryev i d en ce s ug g es t i n g o th erwi s e. Ad d i t i o n al l y , p et i t i o n ers d i d n o to ffer an y ev i d en ce o r an al y s is as t o h o w th ei r act i on s co n s t i tut edan i n t en t i o n al an d o v ertm an i fes t at io no f ab an d o ni n g th ei r Part ners h i p i n teres t s . In n earl y ev ery fi l i n g wi th the Co u rt , an d attri al , p et it i o n ers rep eat ed l y ch aract eri zedth e ab an d on m en tl o s s p o s i t i o n s t ak en o nth ei r retu rn s as erro n eo u s . 2 0 To th atex t en t , we ag ree. Acco rd i n g l y , res p o nd en t ’ s d et erm i n at io ni s s u s t ai n ed
.

2 0 Fo r ex am

pl e: Pet i t i o n ers s t i p u l at ed th atth ey were “ n o t en t i t l edt o o rd i nary l o s s es ” o n th e “ s al e o f t h ei r p art n ers h i p i n t eres t s i n EW GS” an dth atth ey are “ l i ab l e fo r cap i t al g ai n s o n th e s al e o f t h ei r” Part n ers h ip i n t eres t s .-3 2
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[* 3 2 ] III. Th e Sect i on 6 66 2 Pen al ty A. Gen eral ly Sect io n 6 6 6 2 (a) an d(b )(1 ) an d(2 ) i m p o s es a p en al ty

i nan am o u n t equ al t o 2 0 % o f t h e p ort io n o f an u nd erp aym en tat tri b u t ab le t o n eg l i g en ce, d is reg ardo f
ru l es o r reg u l at i o n s , o r a s ub st an t i al u nd ers t at em en to f i n co m e t ax . Th i s accu racy rel at ed p en al ty

wi ll n o t ap p l y

t o an y p o rt i o no f an u n derp aym en tfo r wh i ch a t ax p ay er es t ab l i s h es th ath e o r s h e h adreas o nab l e cau s e an d act edi ng o odfai th
. Sec. 6 6 64 (c)(1 ). In th e n ot ice o f d efi ci en cy i s s u edt o p et i t i o n ers Edwi n an dM ary W at t s , res p o n d en t d et erm i nedth ey were l i ab l e fo r t he s ect i o n 6 6 6 2 p en al ty fo r al l th ree o f th ei r y ears ati s s u e. In th e FPAA res p o nd en t d et erm i n edp et i t i o ner RW M was al s o l i ab l e fo r t he s ect i o n 6 6 6 2 p en al ty , as rel at edt o i t s s al e o f Part ners h i p i n t eres t s . Th e d et erm i n at i o n o f wh et h er p et i t i o n ers act edwi th reas o nab l e cau s e an d i n g o o dfai th i s m ad e o n a cas e-b y -cas e b as i s , t ak i n g i nt o acco u n tal l th e p ert i n en t fact s an dci rcu m s t an ces , i n cl u d i n g th ei r effo rt s t o as s es s th ei r p ro p er t ax l i ab i l i ty , th ei r kno wl ed g e an d ex p eri en ce, an d t h e ex t en tt o wh i ch th ey rel i ed o n t h e ad v i ce
o f a t ax p ro fes s i o n al
. See s ec. 1 .6 6 6 4 -4 (b )(1 ), In co m e Tax Reg s . As t o RW M , th i s d et erm i n at i o ni s m ad e atth e p art n ers h i p l ev el , t ak i n g i n t o
acco u n t th e s t at e o f m i n d o f t h e g en eral p art n er. Sup eri o r Trad i ng , LLC v
.-3 3
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[* 3 3 ] Co m

m i s si o n er, 1 3 7 T.C. 7 0 , 9 1 (2 0 1 1 ), aff’ d , 7 28 F.3 d 6 7 6 (7 th Ci r. 2 0 1 3 ). Ro n n i e W at t s , as th e s ol e “ own er” o f t h e p art n ers o f RW M , was th e o n ly i n d i v i du al wi th au th o ri ty t o acto n b eh al f o f RW M , an dthu s h i s act i o n s are p ert i nen ti n es t ab l i sh i ng a reas o n ab l e cau se d efen s e fo r RW M
. Wh et h er a t ax pay er h as reas o nab l e cau s e wi th i nth e m ean i n g o f s ect i o n 6 6 6 4 (c) m ay

d ep en d up on wh et h er th e t ax pay er ex erci sed“ ord i n ary b u s in es s care
an d p ru d en ce” i n rel y i ng o n t h e t ax ad v i ce o f h i s o r h er ch o s enp ro fes s i o n al
. Neo nat ol o gy

As so cs ., P.A. v . Co m

m i ss i on er, 1 1 5 T.C. 4 3 , 9 8 -9 9 (2 0 00 ), aff’ d , 2 9 9 F.3 d2 2 1 (3 d Ci r. 2 0 02 ). B. Reas on ab l e Cau s e an dGo odFai th W e u n ders t an dp et i t i o n ers t o co n t en dth atn o p en al ty s h o u l d b e i m

p o s ed ag ai n s tth em , wi th res p ectt o th ei r l o s s es o nth e s al e o f t h ei r Part n ers h i p i n t eres t s , b ecau s e th ei r i n i t i al retu rn p o s i t i o nwas t ak en wi th reas on ab l e cau s e an di ng o o d fai th , o r m ore p art i cu l arl y , i n rel i an ce o nth e ad v ice o f th ei r l o n g t i m e acco un t an t , M r. Gat es . M r. Gat es cred i bl y

t es t i fi edth atp et i t i on ers p ro v i d edh i m wi th al l p ert i n en t fact s an dm at eri al s n eces s ary t o accu rat el y

rep o rtth ei r t ax l i ab i l i t i es o nth e s al es o f th ei r Part n ers h i p i n t eres t s . M r. Gat es t es ti fi ed h is res earch l ed h i m t o d et erm i n e th ey co u l drep ort th e d i s p os i ti o n as an ab an do n m en tl o s s o f o rd i n ary ch aract er, a-3 4
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[* 3 4 ] p o s i t i o n M r. Gat es d efen d edas th ei r rep res en t at i v e th ro u g h o ut thei r p rep et i t i o n ad m i n i st rat i v e p ro ceed i n g s . Wh i l e M r. Gat es ’ d et erm i n at i o n was i n co rrect , i twas reas o n ab l e an d p ru d en tfo r p et i ti o n ers t o rel y o n h i s ad v i ce an dd i rect i o nas t o th e i n tri cat e s ub ject
m at t er ath an d . M r. Gat es s erv edas th ei r acco un t an t an dad v i ser fo r o v er 3 0 y ears , an d h ads u ffi ci en tex peri en ce an d ex p ert i s e i nth e fi el d t o ju st ify h i s ret en t i o nb y th e W at ts fam i l y

an dthei r rel i an ce o nh i s p ro fes s i o n al o pi n io n . W e h ol dth at p et i t i o n ers are n otl i ab l e fo r t h e s ect i o n 6 6 6 2 (a) p en al ty fo r th e p ort i on o f t h e
u n d erp aym en t ari s i ng fro m th e erro n eo u s rep o rt i n g o f t h e s al e o f t h ei r Part n ers h i p i n t eres t s i n 2 0 0 7 . See W al k er v . Co m m i s s i on er, T.C. M em o . 2 0 1 6 -1 5 9 , at* 1 0
- * 1 2 ; s ee al so Rawl s Trad i n g , L.P. v . Co m m i s s i o n er, T.C. M em o . 2 0 1 2 -3 4 0
. In reach i n g o u r h o ld in g s , we h av e co n s i dered al l arg u m en t s m ad e, an d , t o th e ex t en tn o t m en t io n ed ab o v e, we co n cl u d e t h ey are m o ot , i rrel ev an t , o r wi th o u t
m eri t .-3 5
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[* 3 5 ] To refl ectth e fo reg o i n g , Deci s i o n wi ll b e en t eredfo r
res p o nd en t i nd o ck et No . 1 9 9 7 3 -1 3, ex cep t wi th res p ectt o th e accu racy -rel at edp en al ty
u n der s ect io n6 6 6 2 (a). Deci s i o n wi ll b e en t eredu n d er Ru l e 1 5 5 i nd o ck et No . 1 8 8 8 2 -1 3
.