t c memo united_states tax_court salina partnership lp fpl group inc a partner other than the tax_matters_partner petitioner v commissioner of internal revenue respondent docket no filed date in fpl incurred a substantial capital_loss on the sale of a subsidiary in date gs an investment bank persuaded fpl to invest in a domestic limited_partnership s newly formed at gs’s request by two affiliates of abn an international bank based in the netherlands s at gs’s suggestion took a substantial short position in u s treasury bills fpl purchased a 98-percent limited_partnership_interest in s to take advantage of desired tax benefits and to enhance its return on its short-term fixed-income investments immediately following fpl’s investment s closed its short position in u s treasury bills relying on a series of complex partnership basis_adjustment provisions s concluded that it realized a dollar_figure million short-term_capital_gain of which dollar_figure million was allocated to fpl fpl thereupon claimed a capital_loss_carryover from to offset nearly all of its distributive_share of s’s capital_gain -- - during and most of s pursued a sophisticated investment strategy s was liquidated in fpl which had increased its outside_basis in its interest in s by the dollar_figure million gain it had reported in claimed large ordinary losses attributable to its interest in s for the taxable years through r issued a notice of final_partnership_administrative_adjustment to s determining that s did not realize a dollar_figure million short-term_capital_gain for the period ended date on the alternative grounds that fpl’s initial investment in s was a sham in substance and or s failed to properly compute its substituted_basis from itss partners pursuant to sec_752 i r c fpl filed a timely petition_for_readjustment in its capacity as a notice_partner of s held fpl’s investment in s was not a sham in substance inasmuch as fpl invested in s in order to achieve legitimate business objectives independent of purported tax benefits and fpl’s investment produced objective economic consequences held further r’s adjustments are sustained on the ground that s’s short position in treasury bills generated a partnership_liability within the meaning of sec_752 i r c which liability s failed to account for in computing its substituted_basis from its partners in its assets robert t carney and paul s manning for petitioner sergio garcia--pages john t lortie and gary f walker for respondent memorandum findings_of_fact and opinion jacobs judge respondent issued a notice of final_partnership_administrative_adjustment fpaa to caraville corporation n v the tax_matters_partner tmp of salina partnership lp hereinafter salina or the partnership setting forth adjustments to the partnership’s tax_return for its taxable_year ended date respondent subsequently mailed a copy of the fpaa to fpl group inc fpl or petitioner a salina notice_partner fpl in its capacity as a partner other than the tmp filed a timely petition_for_readjustment contesting the fpaa see sec_6226 the issue for decision is whether the partnership realized a short-term_capital_gain of dollar_figure for the taxable_year ended date the situation presented in this case is one in which normal roles of the parties appear to be reversed inasmuch as fpl is defending salina’s reporting of the dollar_figure million gain against respondent’s assertion that salina realized a short- term capital_gain of only dollar_figure respondent’s determination is based on alternative grounds including arguments that fpl’s purchase of a 98-percent partnership_interest in salina was a sham in substance and salina erred in failing to apply sec_752 in computing its substituted_basis from its partners in its assets the parties stipulated that venue for purposes of appeal is to the u s court_of_appeals for the eleventh circuit see sec_7482 b the parties agree that if petitioner prevails the amount of the partnership’s interest_income is dollar_figure for the period in question whereas if respondent prevails the amount of the partnership’s interest_income is dollar_figure q4e- unless otherwise indicated section references are to the internal_revenue_code in effect for and rule references are to the tax_court rules_of_practice and procedure all dollar amounts are rounded findings_of_fact some of the facts have been stipulated and are so found the stipulated facts and exhibitss are incorporated herein by this reference i fpl fpl the stock of which is publicly traded is a holding_company and the parent of various wholly owned subsidiaries including florida power and light co florida power the largest electric public_utility in the state of florida and fpl capital group fpl capital fpl filed consolidated_returns with its various subsidiaries during the period in question a fpl officers paul evanson assumed the position of chief financial officer of fpl on date prior to joining fpl mr evanson’s professional experience included years as a tax specialist at arthur andersen a large firm of certified public accountants and years as president and chief operating officer of lynch corp prior to his employment at arthur andersen mr evanson was awarded a juris doctor degree from columbia university school of law and an ll m in taxation degree from new york university james higgins fpl’s vice president for taxes was responsible for all income_tax planning research and compliance dilek samil fpl’s corporate treasurer was responsible for financial forecasting and analysis in addition ms samil was responsible for managing fpl’s long-term and short-term funding needs fpl’s long-term funding needs normally were satisfied by issuing debt and equity securities while fpl’s short-term funding needs were met through the company’s normal cash-flow and the issuance of commercial paper jeffrey holtzman fpl’s assistant treasurer was primarily responsible for bank relations and assessing fpl’s investments michael wynn an fpl financial analyst was responsible for various cash management activities and special projects b fpl’s restructuring plan cash-flow in early fpl decided to restructure its operations by selling noncore businesses and focusing on its utility businesses particularly florida power between and fpl sold a number of its subsidiary businesses including colonial penn group cpg --an insurance holding_company telesat--a cable television operation alandco--a real_estate subsidiary turner foods- -a citrus producer and a separate banking business during fpl raised cash through a secondary stock offering fpl also had excess cash-flow from normal operations -- - fpl usually held its short-term investments in commercial paper with rates of return averaging dollar_figure percent c fpl’s capital_loss sale of cpg on its consolidated_income_tax_return for fpl reported a capital_loss of dollar_figure attributable to its sale of cpg fpl carried back approximately dollar_figure million of the cpg loss to taxable years prior to on its consolidated_income_tax_return for fpl claimed a loss carryover of approximately dollar_figure million attributable to its cpg loss respondent issued a notice_of_deficiency to fpl for among other years and respondent determined in pertinent part that fpl had understated the amount of its cpg loss subject_to disallowance pursuant to sec_1 income_tax regs fpl filed a petition for redetermination with the court docket no contesting respondent’s determination regarding the correct amount of its cpg loss and challenging the validity of sec_1 income_tax regs il the partnership proposal a goldman sachs co stamps fpl was a client of goldman sachs co goldman sachs a large investment bank goldman sachs had advised fpl with regard sec_1 a income_tax regs states the general_rule that no deduction is allowed for any loss recognized by a member of the affiliated_group with respect to the disposition of stock of a subsidiary - to both the purchase of cpg in and the sale of the company in at all relevant times david a ackert was a vice president at goldman sachs in mr ackert developed an investment strategy called special treasury and mortgage partnership units stamps the stamps strategy employed leveraged and hedged investments in short-- term u s treasury securities mortgage-backed_securities and other arbitrage positions in fixed-income securities in an effort to provide a cash investment vehicle for corporate or institutional clients seeking above-market returns the stamps strategy was designed not only as an investment strategy but also involved accounting tax and legal considerations mr ackert concluded that it would be preferable for corporate investors to pursue the stamps investment strategy through a partnership that would allow the investor the possibility of off balance_sheet accounting treatment mr ackert believed that off balance_sheet accounting treatment was essential to making the stamps strategy appealing to potential investors because to the extent that the program required a leveraged position the investor’s balance_sheet would reflect the net amount of its investment without showing any related debt b bea associates maps in conjunction with the creation of the stamps investment strategy mr ackert approached mark silverstein vice president --- - and portfolio manager at bea associates bea an investment advisory and cash management firm based in new york to inquire whether bea would be interested in serving as the investment adviser and portfolio manager for potential investors in the stamps strategy mr silverstein agreed to work with mr ackert’s clients on the understanding that bea would be compensated for its services through management fees computed as a percentage of the assets under its direction bea recognized as a leading fixed-income portfolio manager utilized an investment strategy with similarities to stamps known as mortgage arbitrage partners or maps the maps strategy included leveraged and hedged investments in u s treasury securities asset-backed securities mortgaged--backed securities and international and corporate bonds though comparable in some respects with the stamps strategy the maps strategy contemplated investments in a broader array of securities with maturities approximately to months of shorter duration c mr ackert’s proposal to fpl mr ackert was aware that fpl had incurred a substantial capital_loss on its sale of cpg in in early date mr ackert met with fpl representatives in florida and proposed that fpl purchase a 98-percent limited_partnership_interest in a preexisting domestic limited_partnership controlled by an international bank for the purpose of investing in the stamps --- - strategy mr ackert promoted the stamps strategy as a means to increase the return on fpl’s short-term fixed-income investments at the same time mr ackert informed fpl that it should rely upon its own independent accounting legal and tax advisers regarding the consequences of the stamps investment strategy during a private meeting with mr higgins mr ackert suggested that the partnership’s investments could be arranged so that upon entry into the partnership fpl would recognize a capital_gain for federal_income_tax purposes and simultaneously create a built-in_loss in its partnership_interest in late date mr ackert introduced mr silverstein to fpl’s representatives mr silverstein took the opportunity to explain the maps investment strategy and to offer bea’s investment services to fpl in mid-date fpl representatives met with mr silverstein at bea’s new york office at fpl’s request mr silverstein presented fpl with several analyses of the financial risks and rewards associated with the maps investment strategy under a variety of economic scenarios using treasury bills with a then percent annual rate of return as a benchmark mr silverstein projected that the maps strategy would allow fpl to earn between and percent over current treasury bill yields however mr silverstein cautioned that he could not guarantee a specific return inasmuch as fpl’s investment would be subject_to market risks fpl’s representatives concluded that the company -- - could earn a higher return under the maps strategy relative to historic returns that it had earned investing in short-term commercial paper fpl began preparations to enter into the proposed partnership in early date on date mr silverstein issued a memorandum to mr wynn at fpl stating that he was in the process of arranging credit with certain securities dealers and requesting information from fpl regarding the partnership on date margaret watson a vice president for chemical bank chemical forwarded a memorandum to mr wynn stating that chemical had assigned an account number to a multi-currency master custody account for a partnership identified as new coral partnership upon receipt of the memorandum mr wynn struck the reference to new coral partnership entered the name salina partnership and forwarded the memorandum to mr silverstein at bea d abn amro bank n v abn amro bank n v abn is a large_bank based in the netherlands with international operations during jaap van burg an attorney served as an assistant managing director at two abn affiliates known as abn amro trust co n v abn trust and n v fides in date concurrent with his discussions with fpl mr ackert informed mr van burg that he had a client that might be interested in pursuing the stamps investment strategy and inguired whether abn would be interested in forming a partnership for use in connection with that strategy mr ackert informed mr van burg that the partnership would be most marketable to his client if the partnership held a dollar_figure million short position in treasury bills mr van burg obtained approval for abn to participate in the transaction as outlined by mr ackert itt salina partnership on date and date abn formed two limited_liability companies caraville corporation n v caraville and pallico corporation n v pallico caraville and pallico initially were each capitalized with dollar_figure abn controlled caraville and pallico through abn trust and n v fides as managing directors respectively both of which were in turn owned by abn as foreign entities abn caraville and pallico were not subject_to u s income_tax caraville owned the stock of aldershot corp on date aldershot corp paid a dividend of dollar_figure to caraville a formation of the partnership on date caraville and pallico formed salina as a limited_partnership under the laws of the state of delaware the salina partnership_agreement stated in pertinent part that the partnership was organized to invest in permitted_investments a term defined as obligations of the united_states and obligations of any agency that are backed by the full faith and credit of the united_states with remaining terms to maturity of no more than years mortgaged-backed securities with a stated maturity of no more than years and certain repurchase and reverse repurchase contracts on date caraville contributed dollar_figure in exchange for a 1-percent general_partnership interest in salina while pallico contributed dollar_figure in exchange for a 99-percent limited_partnership_interest the funds that pallico contributed to salina were transferred to pallico through a revolving credit agreement between abn and escorial corporation n v an abn affiliate managed by abn trust mr van burg assumed that abn also was the source of caraville’s contribution to salina the partnership_agreement stated that the partnership would pay a quarterly management fee of dollar_figure to caraville b salina’s short_year december through on date salina opened a custodial_account with abn’s new york office on date salina purchased through abn u s treasury notes with a face value of dollar_figure million for a price of dollar_figure net of dollar_figure accrued interest the treasury notes each bore an interest rate of percent and were due to mature on date salina financed approximately one-half of the purchase_price of the treasury notes through a master repurchase_agreement with goldman sachs the - - salina goldman sachs master repurchase_agreement under which salina borrowed dollar_figure from goldman sachs and collateralized the loan with a portion of the treasury notes it had purchased ’ salina treated the goldman sachs loan as a liability on its opening balance_sheet as of date on date consistent with mr ackert’s earlier request to mr van burg salina entered into a short_sale of u s treasury bills with a face value of dollar_figure million for a price of dollar_figure the treasury bills were due to mature on june ‘ repurchase agreements repos and reverse repurchase agreements reverse repos are frequently used by dealers in government securities financial institutions and others as methods for temporary cash management interest rate arbitrage or the borrowing of securities used in the course of a dealer’s business in a repo transaction the first party eg a dealer sells securities generally u s treasury and federal_agency securities to a second party e g a customer and simultaneously agrees to repurchase a like amount of the same securities at a stated price generally greater than the original sales_price on a fixed future date repo transactions from the viewpoint of the seller such as a dealer provide financing to acquire newly issued government securities or other portfolio assets from the viewpoint of the purchaser a repo transaction provides a means by which funds can be invested for a desired period while holding as collateral a virtually risk-free asset in the event the seller breaches its agreement to repurchase see 88_tc_860 n one commentator has described a short_sale as follows more completely a short_sale may be defined as consisting of two transactions the taxpayer’s sale of property typically securities borrowed from another person typically a broker and the subsequent closing out of the short position by the taxpayer’s delivery of securities to the person who loaned the securities that were sold continued -- salina completed the short_sale transaction described above to the extent of dollar_figure million executed through goldman sachs and dollar_figure million executed through abn to complete delivery of the treasury bills salina entered into a master repurchase_agreement with abn the salina abn master repurchase_agreement under which salina lent dollar_figure to abn and abn collateralized the loan with the treasury bills that salina sold short salina treated the amount it was due from abn under the salina abn master repurchase_agreement dollar_figure and accrued interest thereon dollar_figure as assets on its opening balance_sheet salina treated the amount of continued in the absence of statutory guidance the treatment of short_sale transactions would be unclear because the first transaction is in form a sale but gain_or_loss cannot be computed because the taxpayer’s cost for the securities is unknown whereas the second transaction is in form the repayment of a loan fn ref omitted bittker lokken federal taxation of income estates and gifts par pincite 2d ed the strategy of a short_sale is that by the time the security is covered the seller will have acguired the security by purchasing it on the open market at a price lower than that for which it was sold thereby making a profit another way to cover a short position is to use the security obtained ina reverse_repo transaction reverse_repo transactions are the mirror images of repo transactions----securities are purchased by the first party subject_to the obligation of the second party to repurchase them notwithstanding the first party’s obligation to sell in a reverse_repo transaction a like amount of the same securities back to the second party the first party generally is entitled to use the securities in transactions with third parties see price v commissioner supra pincite nn -- - the treasury bills that it sold short dollar_figure as a liability on its opening balance_sheet for the period december through salina earned dollar_figure on its investments for an annualized return of dollar_figure percent c fpl’s investment in salina on date mr evanson obtained authorization from fpl’s board_of directors to invest in the salina partnership the minutes of the date board_of directors’ meeting state in pertinent part the chairman reported that the officers of the corporation were considering investing approximately dollar_figure million of the funds raised from the sale of common_stock in for future capital requirements in an investment_partnership these funds were not needed immediately and were currently invested in short-term securities yielding a little more than per annum investing in the partnership would increase the return on the funds substantially and still keep them available for capital expenditures as needed in addition the partnership could engage in certain transactions that could utilize certain of the tax losses from the sale of colonial penn mr evanson then explained the proposed investment activities of the partnership fpl conditioned its participation in the partnership upon salina’s agreements to appoint mr silverstein as its investment manager and liquidate its investments by date salina agreed to fpl’s conditions on date salina executed a financial advisory agreement appointing - bea to serve as its financial adviser with respect to all securities and property with an initial value of dollar_figure held by chemical bank on date caraville pallico and fpl executed an amended partnership_agreement that included an expanded list of permitted_investments the partnership agreed to pay quarterly management fees to caraville totaling dollar_figure during and the partnership_agreement states that the partnership would be obliged to redeem fpl’s partnership_interest or dissolve and liguidate at fpl’s request on date goldman sachs issued a letter to fpl stating that fpl did not rely upon goldman sachs for advice or information relating to the financial legal tax_accounting or other matters in connection with fpl’s investment in salina on date fpl transferred dollar_figure to pallico in exchange for a 98-percent limited_partnership_interest in salina fpl treated dollar_figure of its dollar_figure payment to pallico as capital invested in the partnership the dollar_figure includes dollar_figure representing pallico’s share of salina’s net partnership gain during the period december to pallico retained dollar_figure of the dollar_figure payment that it received from fpl pallico transferred dollar_figure to abn--the same amount that fpl treated as its capital_contribution to salina- -in partial repayment of the loan that abn provided to pallico in connection with the formation of salina in addition pallico made the following payments on behalf of fpl payee amount purpose andrews kurth llp dollar_figure legal fees abn amro bank big_number fees goldman sachs big_number brokerage fees ms samil recalled negotiating the dollar_figure fee paid to goldman sachs none of fpl’s representatives specifically recalled negotiating the fees paid to andrews kurth llp or abn the dollar_figure million amount_paid to abn represented abn’s fee for forming the salina partnership arranging the partnership’s investments to satisfy fpl’s tax planning objectives and allowing abn’s affiliates to remain in the partnership so that fpl could pursue its short-term investment objectives fpl did not deduct the fees that it paid to abn goldman sachs and andrews kurth llp on its tax_return nor did it include the amount of these fees in its salina capital_account the parties agree that fpl’s adjusted_basis in salina as of date should be increased by the amount of these fees d liguidation of salina’s original investments on date mr silverstein recommended that salina liguidate its existing investments so that mr silverstein could reinvest the proceeds pursuant to the maps investment strategy on the same day salina provided bea with written authorization to liquidate its investments on date mr silverstein - - closed salina’s short position in treasury bills by directing the purchase of treasury bills with a face value of dollar_figure million fora price of dollar_figure on date mr silverstein sold salina’s long position in treasury notes for dollar_figure and repaid goldman sachs approximately dollar_figure million representing the amount borrowed under the salina goldman sachs repo agreement the proceeds of these transactions were held in bank_deposits pending mr silverstein’s reinvestment of those amounts under the maps strategy after date for financial reporting purposes salina realized a book gain of dollar_figure for the period december through eb salina’s investments date - date after date mr silverstein actively managed salina’s investments pursuant to the maps strategy mr silverstein executed approximately big_number trades on behalf of salina between date and date earning management fees of approximately dollar_figure in the process during the period date to date bea prepared monthly transaction and performance summaries detailing all of salina’s transactions for the particular month in addition mr silverstein routinely communicated with salina’s partners in order to apprise them of market developments and bea’s strategy salina conducted regular partnership meetings attended by representatives of fpl caraville and pallico at salina’s date partnership meeting the partners decided to direct bea to decrease the leverage in salina’s portfolio in order to reduce the partnership’s level of risk during salina earned a gross return of approximately percent under the maps strategy after paying bea’s_ fee caraville’s management fee and other partnership fees salina’s net return was approximately percent during the maps strategy was hindered by rising interest rates during salina had no earnings under the maps strategy fef salina’s termination and liquidation on date fpl requested that caraville liquidate salina accordingly on date salina was liquidated and its assets were distributed to its partners fpl received a total_distribution of dollar_figure consisting of dollar_figure in cash and dollar_figure in mortgage-backed_securities the record does not reflect the specific amounts distributed to caraville and pallico or the ultimate disposition of those distributions iv tax reporting a salina’s partnership returns in date salina filed a u s partnership income_tax return form_1065 for the short tax_year december to date reporting investment_income of dollar_figure investment_expenses of dollar_figure and unrealized trading profits of dollar_figure - - in date salina filed a form_1065 for the short tax_year december to date reporting portfolio_income of dollar_figure investment_expenses of dollar_figure and a net_short-term_capital_gain of dollar_figure on schedule_k-1 partner’s share of income credits deductions etc attached to the return salina allocated dollar_figure of its short-term_capital_gain to fpl salina concluded that it realized a dollar_figure net short- term capital_gain following the date liquidation of its investments based upon a complex set of partnership basis_adjustment rules that were purportedly invoked upon fpl’s purchase of its 98-percent salina partnership_interest in particular relying on sec_708 b and b and sec_1 b iv income_tax regs salina concluded that upon fpl’s acquisition of its 98-percent partnership_interest on date the partnership was deemed terminated the partnership’s assets consisting of dollar_figure million in 2-year treasury notes and a dollar_figure loan receivable due from abn pursuant to the salina abn master repurchase_agreement were deemed distributed in pro_rata shares to the new salina partners and those assets were deemed recontributed to the partnership with a substituted_basis equal to the aggregate of the partners’ outside bases relying on the aforementioned statutory and regulatory provisions salina determined that its substituted_basis from its partners in its assets was less than the fair_market_value of the assets in the - hands of the partnership upon liquidation of its investments on date salina concluded that it realized a dollar_figure short-term_capital_gain representing the difference between salina’s purported substituted_basis in its assets and their fair_market_value salina filed a form_1065 for reporting income of dollar_figure fpl’s distributive_share of salina’s net_income was dollar_figure salina filed a form_1065 for reporting a loss of dollar_figure b fpl’s income_tax return on its original consolidated_income_tax_return fpl reported a dollar_figure capital_gain attributable to its distributive_share of the capital_gain that salina purportedly realized upon the liquidation of its investments on date fpl offset a substantial portion of the aforementioned capital_gain by reporting a loss carryover attributable to its sale of cpg after accounting for the loss carryover fpl reported and paid additional income_tax of dollar_figure attributable to its salina investment on its income_tax return in date fpl filed an amended_return for reporting an increase in the amount of its cpg loss available for carryover from and claiming a refund of dollar_figure fpl claimed that it was entitled to a greater loss carryover from on the ground that - the loss_disallowance_rules prescribed in sec_1 income_tax regs are invalid after reporting dollar_figure as its distributive_share of salina’s net_short-term_capital_gain for the period december through fpl added that amount to its original capital_investment in salina dollar_figure to arrive at a total outside_basis in the partnership of dollar_figure fpl later adjusted its basis to account for its distributive_share of salina’s items of income and expense for the taxable years and as well as the value of the cash and mortgaged-backed securities that salina distributed to fpl in liquidation of its interest in date as of date fpl claimed an adjusted tax basis in salina of dollar_figure which it allocated to the mortgage-backed_securities as fpl received payments on the mortgage-backed_securities during and fpl reported ordinary losses determined by computing the excess of its basis in those assets over the amount_realized in the amounts of dollar_figure dollar_figure dollar_figure and dollar_figure respectively v fpaa as previously stated respondent issued an fpaa setting forth adjustments to salina’s partnership return for the period ending date relying on alternative theories respondent disallowed dollar_figure of the dollar_figure net_short-term_capital_gain that salina reported for the taxable_year ending december - - leaving a corrected net_short-term_capital_gain of dollar_figure petitioner filed a timely petition_for_readjustment contesting the fpaa opinion salina computed its short-term_capital_gain for its taxable_year ended date pursuant to a complex set of tax basis_adjustment provisions contained in subchapter_k partners and partnerships of subtitle a of the internal_revenue_code the code we begin our analysis with a review of the statutory provisions in question pursuant to sec_701 and sec_702 a partnership is treated as a flow-through_entity for purposes of federal income_taxation see 410_us_441 722_f2d_695 11th cir affg 78_tc_471 as such a partnership’s items of income gain loss deduction and credit pass through the entity to its individual partners consequently although respondent adjusted salina’s partnership return by substantially reducing the amount of the net_short-term_capital_gain reported for the period ended date the ultimate impact of this adjustment is to substantially reduce fpl’s distributive_share of the gain which in turn nearly eliminates the ordinary losses that fpl reported on its tax returns for and -- - sec_706 provides the general_rule that a partnership’s taxable_year shall not close upon the sale_or_exchange of a partner’s interest in the partnership except among other events in the case of a termination of the partnership sec_708 b provides that a partnership shall be considered terminated if within a 12-month_period there is a sale_or_exchange of percent or more of the total interest in the partnership’s capital and profits see p d b s109_tc_423 relying upon sec_708 b b salina concluded that fpl’s purchase of a 98-percent partnership_interest caused a technical_termination of the partnership on date the regulations underlying sec_708 provide special rules governing the deemed_distribution of partnership assets in the event of a partnership_termination specifically sec_1 b iv income_tax regs provides in pertinent part iv if a partnership is terminated by a sale_or_exchange of an interest the following is deemed to occur the partnership distributes its properties to the purchaser and the other remaining partners in proportion to their respective interests in the partnership properties and immediately thereafter the purchaser and the other remaining partners contribute the properties to a new partnership either for the continuation of the business or for its dissolution and winding up following a deemed_distribution pursuant to sec_1 b iv income_tax regs sec_732 provides - - sec_732 distributions in liquidation ---- the basis_of_property other than money distributed by a partnership to a partner in liquidation of the partner’s interest shall be an amount equal to the adjusted_basis of such partner’s interest in the partnership reduced by any money distributed in the same transaction pursuant to sec_732 and sec_723 upon the recontribution of the property back to the partnership the partnership’s substituted_basis in the property is equal to the adjusted_basis of the property in the hands of the contributing_partner based upon these provisions salina concluded that its assets were deemed distributed to fpl caraville and pallico and immediately thereafter deemed recontributed to the partnership with bases equal to the partners’ outside bases in the partnership respondent determined that salina is not entitled to rely upon the provisions outlined above citing several alternative grounds economic_substance respondent first contends that fpl’s investment in salina during the period december through should be disregarded for tax purposes as a sham in substance in so arguing respondent asserts that the court should segregate fpl’s investment in salina into two parts fpl’s investment in salina during the period december through and fpl’s investment in salina during the period date through the dissolution and liquidation of the partnership in date although respondent concedes that fpl had a valid - - business_purpose for investing in salina during the latter period respondent contends that fpl’s entry into the partnership was structured solely to provide the company with a perceived tax_benefit respondent argues in pertinent part in effect there were two partnerships as a matter of economic_substance the first partnership’s destiny was to accomplish a specific tax purpose in its predetermined life span of hours this partnership is an economic sham in contrast the second partnership had the legitimate role of implementing mr silverstein’s investment strategy commencing on date the economic_substance of this partnership is not disputed respondent contends that goldman sachs fully aware that fpl had incurred a large capital_loss on the sale of cpg arranged for abn to form salina and orchestrated salina’s dollar_figure million short position in treasury bills so that following fpl’s investment in the partnership and the immediate liquidation of the partnership’s investments salina would realize a substantial paper capital_gain continuing respondent maintains that fpl would be able to use its cpg capital_loss_carryover to offset its distributive_share of the salina capital_gain while simultaneously creating an equivalent built-in_loss in its salina partnership interest-- -a loss that fpl would be able to realize at will through its control of salina in this regard respondent maintains that fpl improperly used its investment in salina to avoid the 5-year limitation on the use of loss_carryovers set forth in sec_1212 respondent argues that fpl’s investment in salina during the initial investment period lacked economic_substance because fpl had -- p7 - no intention to profit from salina’s investments under the stamps strategy inasmuch as fpl always intended for those investments to be immediately liquidated and reinvested under the maps strategy respondent further asserts that there is no evidence of significant negotiations between fpl and abn prior to fpl’s investment in salina and the dollar_figure million in fees paid to goldman sachs and abn are nothing more than fees for the perceived tax benefits underlying the transaction petitioner counters by claiming that salina was formed and operated as a legitimate investment_partnership and that fpl invested in salina solely to enhance the returns on its short-term investments petitioner maintains that although fpl understood that salina would realize a substantial capital_gain upon the liquidation of its investments in late fpl viewed any such transaction as tax neutral insofar as fpl had a large capital_loss_carryover the cpg loss to offset any gain it is well settled that taxpayers generally are free to structure their business transactions as they please even if motivated by tax_avoidance considerations see 293_us_465 81_tc_184 affd in part revd in part and remanded 752_f2d_89 4th cir however to be accorded recognition for tax purposes a transaction generally is expected to have economic_substance which is compelled or - - encouraged by business or regulatory realities is imbued with tax- independent considerations and is not shaped solely by tax- avoidance features that have meaningless labels attached 435_us_561 see 113_tc_254 this principle which finds its origin in gregory v helvering supra is better known as the economic_substance_doctrine a sham_transaction is one which though it may be proper in form lacks economic_substance beyond the creation of tax benefits 924_f2d_1018 11th cir affg 93_tc_378 an evaluation whether a transaction is a substantive sham generally requires a subjective inquiry whether the transaction was carried out for a valid business_purpose independent of tax benefits and a review of the objective economic_effect of the transaction see karr v commissioner supra pincite 862_f2d_1486 11th cir affg 87_tc_1087 see also 157_f3d_231 3d cir affg in part and revg in part on another ground tcmemo_1997_ 909_f2d_1360 9th cir affg in part revg and remanding in part on another ground 89_tc_1229 affg tcmemo_1987_628 affg sturm v commissioner tcmemo_1987_625 and affg moore - - v commissioner tcmemo_1987_626 868_f2d_851 6th cir affg 88_tc_386 only after we conclude that a transaction is not an economic sham do we review the tax consequences of the transaction under the code see acm partnership v commissioner tcmemo_1997_115 affd in part and revd in part on another ground 157_f3d_231 3d cir a taxpayer may establish that a transaction was entered into for a valid business_purpose if the transaction is rationally related to a useful nontax purpose that is plausible in light of the taxpayer’s conduct and economic situation compag computer corp subs v 113_tc_214 citing acm partnership v commissioner supra see kirchman v commissioner supra pincite1 a taxpayer may establish that a transaction has objective economic consequences where the transaction appreciably affects the taxpayer’s beneficial_interest see 364_us_361 quoting 248_f2d_399 2d cir hand j dissenting see also acm partnership v commissioner f 3d pincite 115_f3d_506 7th cir affg 105_tc_341 stated differently a transaction has economic_substance if it offers a reasonable opportunity for profit exclusive of tax benefits see 87_tc_1471 and cases cited therein generally there must be a reasonable expectation that -- - nontax benefits will meet or exceed transaction costs see 861_f2d_494 7th cir affg 87_tc_1087 modest profits relative to substantial tax benefits are insufficient to imbue an otherwise dubious transaction with economic_substance see 94_tc_738 saba partnership v commissioner tcmemo_1999_359 contrary to respondent’s position we decline to analyze the economic_substance of the disputed transaction by focusing solely on events occurring during the period december through segregating fpl’s investment in salina into two parts as respondent suggests would violate the principle that the economic_substance of a transaction turns on a review of the entire transaction see kirchman v commissioner supra pincite4 winn-dixie stores inc v commissioner supra pincite although we agree with respondent that goldman sachs structured fpl’s purchase of the salina partnership_interest to provide fpl with a perceived tax_benefit this factor standing alone is insufficient to render the transaction a sham in substance considering all the facts and circumstances we conclude that fpl entered into the salina transaction to achieve a valid business_purpose independent of tax benefits the record demonstrates that fpl entered into the salina partnership for the primary purpose of enhancing the return on its short-term investments each of fpl’s --- - representatives testified convincingly on this point moreover their testimony was bolstered by their detailed review and consideration of the proposed investment and the minutes of the board_of director’s meeting approving the investment we need not dwell on respondent’s contention that fpl failed to evaluate fully the stamps investment strategy we are convinced that fpl evaluated the stamps strategy in sufficient detail to determine that the strategy presented greater market risk than it was willing to accept fpl invested in salina on the condition that salina’s stamps portfolio would be promptly liquidated and reinvested under the maps strategy there is no dispute that fpl carefully evaluated the potential risks and rewards of the maps strategy fpl’s due diligence included two meetings with mr silverstein moreover at fpl’s request mr silverstein presented fpl with several analyses of the financial risks and rewards associated with the maps investment strategy under a variety of economic scenarios we are convinced that fpl’s investment in salina provided a reasonable opportunity for fpl to earn profits independent of tax benefits as previously discussed fpl carefully evaluated the potential risks and rewards of the maps strategy mr silverstein although the minutes also mention a potential tax_benefit associated with the investment we infer that fpl did not consider the tax_benefit to be paramount to the transaction rather merely ancillary or collateral thereto - - projected that under normal market conditions the maps strategy would allow fpl to earn between and percent over treasury bills which were then yielding approximately percent in fact respondent concedes that mr silverstein’s projections were reasonable relying upon sheldon v commissioner supra and saba v commissioner supra respondent contends that the transaction lacked economic_substance on the ground that fpl’s potential profits were de_minimis when compared with the potential tax_benefit in particular respondent reasons that while fpl stood to earn approximately dollar_figure million annually on its investment the transaction provided the potential for fpl to save up to dollar_figure million in taxes respondent’s computation of dollar_figure million is based upon the assumption that fpl would have been unable to use any of its cpg loss during the applicable 5-year loss carryover period prescribed in sec_1212 c respondent’s view of the potential tax_benefit associated with fpl’s salina investment is significantly inflated the record reveals that fpl was in the process of restructuring its operations by selling noncore businesses in order to concentrate on its utility businesses fpl’s sale of cpg was undertaken as part of this restructuring we are convinced that as of late fpl reasonably anticipated that it would realize substantial capital_gains over the next several years on the sale of various - - subsidiaries including telesat alandco turner foods and a separate banking business on the basis of the record presented we conclude that fpl would have used most if not all of its cpg loss within the 5-year period for reporting loss_carryovers under sec_1212 accordingly although we shall not attempt to precisely quantify the potential value of the tax_benefit associated with fpl’s investment in salina we are satisfied that the potential profits associated with the investment were not de_minimis relative to the perceived tax_benefit sec_752 having concluded that fpl’s investment in the salina partnership was not a sham in substance we now review the disputed transaction on its merits respondent maintains that salina substantially overstated the amount of its short-term_capital_gain by failing to treat its obligation to return the treasury bills that it sold short as a liability under sec_752 sec_752 provides sec_752 treatment of certain liabilities -- a increase in partner’s liabilities ---any increase in a partner’s share of the liabilities of a partnership or any increase in a partner’s individual liabilities by reason of the assumption by such partner of partnership liabilities shall be considered as a contribution of money by such partner to the partnership assuming that salina’s obligation to close its short_sale constituted a partnership_liability under sec_752 respondent posits that fpl’s pro_rata share of the liability would have - - increased fpl’s outside_basis in its partnership_interest thereby increasing salina’s substituted_basis in its assets following the deemed termination of the partnership pursuant to sec_1 b iv income_tax regs such an increase in salina’s substituted_basis would have virtually eliminated the short-term_capital_gain that salina reported following the closing of its short position respondent relies upon revrul_88_77 1988_2_cb_128 and the preamble to sec_1_752-1t temporary income_tax regs fed reg date in support of the proposition that salina’s obligation to close out its short_sale by returning treasury bills to abn and goldman sachs represents a partnership -- liability within the meaning of sec_752 ’ although acknowledging that salina’s obligation to replace the borrowed securities was secured under the salina abn master repurchase_agreement under which salina lent dollar_figure to abn and abn collateralized its loan with the treasury bills that salina sold short respondent asserts that salina incurred an obligation in the amount of dollar_figure million that should be considered a liability under sec_752 the various provisions of subchapter_k of the code blend two approaches the entity and the aggregate approaches for taxation of partnerships and partners see coggin automotive corp v commissioner t c slip op pincite see also s rept pincite 83d cong 2d sess the entity the portion of the preamble to sec_1_752-1t temporary income_tax regs fed reg date that respondent relies upon states in pertinent part the allocation of partnership liabilities among the partners serves to equalize the partnership’s basis in its assets inside_basis with the partners’ bases in their partnership interests outside_basis the provision of additional basis to a partner for the partner’s partnership_interest will permit the partner to receive distributions of the proceeds of partnership liabilities without recognizing gain under sec_731 and to take deductions attributable to partnership liabilities without limitation under sec_704 d which limits the losses that a partner may claim to the basis of the partner’s interest in the partnership by equalizing inside and outside_basis sec_752 simulates the tax consequences that the partners would realize if they owned undivided interests in the partnership’s assets thereby treating the partnership as an aggregate of its partners t d 1989_1_cb_180 - - approach which recognizes a partnership as an entity separate and distinct from its partners is reflected in part in sec_703 which provides that items of income gain loss deduction and credit are determined at the entity or partnership level the aggregate approach which recognizes a partnership as an aggregate of its partners is reflected through provisions such as sec_701 and sec_702 which provide that partnership items are passed through the partnership to its individual partners for purposes of imposing income_tax see 410_us_441 in an effort to avoid distortions in income_tax reporting associated with the blending of the entity and aggregate approaches within subchapter_k congress enacted a number of provisions that generally are intended to equate the aggregate of the partnership’s inside bases in its assets with the aggregate of its partners’ outside bases in their partnership interests see mckee et al federal taxation of partnerships and partners par pincite 3d ed mckee the carryover-basis rules contained in sec_722 which provide that a partner’s basis in his partnership_interest equals the amount of money plus the adjusted_basis of property contributed to a partnership generally results in a matching of inside and outside bases upon the formation of a partnership see 540_f2d_427 5th cir affg tcmemo_1974_78 similarly adjustments to basis prescribed under sec_705 to account for income and -- - expenses from partnership operations generally preserve the balance between inside and outside bases see id finally sec_752 prescribes bases adjustments to reflect increases and decreases in a partner’s share of partnership liabilities see 90_tc_465 under sec_752 an increase in a partner’s share of partnership liabilities is considered a contribution of money which results in an increase in the partner’s basis in his partnership_interest see sec_1_752-1 income_tax regs the practical impact of the basis_adjustment prescribed in sec_752 has been described as follows if a partnership borrows money the basis of its assets increases by the amount of cash received even though the receipt of the borrowed funds is not income by treating the partners as contributing cash in an amount equal to their shares of the debt inside outside_basis equality is preserved and distortions are avoided tf a liability for borrowed money were not added to the partners’ bases they could be taxed on a distribution of the borrowed cash even though there is no gain inherent in the partnership’s assets a similar result could occur if a partnership incurs a purchase money liability to acquire property since the liability is added to the partnership’s basis in the property mckee supra par pincite see 674_f2d_342 5th cir affg in part and revg in part on another ground tcmemo_1979_491 in the instant case the parties disagree whether salina’s s on the other hand sec_752 provides that a decrease in a partner’s share of partnership liabilities is considered a distribution of cash to the partner which results in a decrease in the partner’s outside_basis in his partnership_interest - - obligation to close out its short_sale transaction by returning the treasury bills that it borrowed from abn and goldman sachs represents a liability within the meaning of sec_752 resolution of this issue is complicated by the lack of a definition of liabilities within subchapter_k or the underlying regulations although the commissioner has not adopted a definition of the term liabilities within the controlling regulations the commissioner has addressed the subject in earlier temporary regulations and revenue rulings in revrul_88_77 1988_2_cb_128 the commissioner revoked revrul_60_345 1960_2_cb_211 and concluded that accrued but unpaid partnership expenses and accounts_payable obligations that arguably would satisfy the plain meaning of liabilities are not liabilities within the meaning of sec_752 for purposes of computing the adjusted_basis of a partner’s interest in a partnership using the cash_method_of_accounting ’ in so concluding the commissioner drew an analogy to the computation of a shareholder’s basis under sec_357 when a shareholder contributes property and liabilities to a controlled_corporation in in revrul_60_345 1960_2_cb_211 the commissioner concluded with no analysis that in computing the adjusted_basis of a partner’s interest in a partnership using the cash_method_of_accounting for purposes of determining the extent to which the partner would be allowed a deduction for his distributive_share of the partnership’s loss for the year pursuant to sec_704 the term liabilities under sec_752 includes the partnership’s obligation to pay outstanding trade accounts notes and accrued expenses -- -- exchange for stock the commissioner noted that congress had provided that a shareholder’s basis generally is not increased by liabilities the payment of which would give rise to a deduction except for liabilities the incurrence of which resulted in the creation of or an increase in the basis of any property ’ the commissioner also found it significant that in amending sec_704 under the deficit_reduction_act_of_1984 publaw_98_369 98_stat_494 congress expressly rejected revrul_60_ supra stating in the legislative_history that accrued but unpaid items should not be treated as partnership liabilities for purposes of sec_752 on the basis of these factors the commissioner interpreted sec_752 as follows under p’s method_of_accounting p’s obligations to pay amounts incurred for interest and services are not deductible until paid for purposes of sec_752 of the code the terms liabilities of a partnership and partnership liabilities include an obligation only if and to the extent that incurring the liability creates or increases the basis to the partnership of any of the partnership’s assets including cash attributable to borrowings gives rise to an immediate deduction to the partnership or under sec_705 b currently decreases a partner’s basis in the partner’s partnership_interest rev_rul 1988_2_cb_129 sec_357 generally provides that a taxpayer who transfers property to a corporation with liabilities in excess of adjusted_basis is considered to have realized a gain sec_357 c a generally provides that for purposes of a sec_351 exchange liabilities in excess of adjusted_basis are excluded from consideration if the liability would give rise toa deduction or if it would be considered a distributive_share or guaranteed_payment under sec_736 sec_357 b provides that subparagraph a shall not apply to a liability to the extent that the incurrence of the liability resulted in the creation of or an increase in the basis of any property -- - a few months after issuing revrul_88_77 supra the commissioner issued sec_1_752-1t g temporary income_tax regs fed reg date defining liability in pertinent part as follows g liability defined ----except as otherwise provided in the regulations under sec_752 an obligation is a liability of the obligor of purposes of sec_752 and the regulations thereunder to the extent but only to the extent that incurring or holding such obligation gives rise to-- the creation of or an increase in the basis of any property owned by the obligor including cash attributable to borrowings a deduction that is taken into account in computing the taxable_income of the obligor or an expenditure that is not deductible in computing the obligor’s taxable_income and is not properly chargeable to capital for reasons that are unclear the final regulations under sec_752 do not contain a definition of the term liabilities see sec_1_752-1 income_tax regs in revrul_95_26 1995_1_cb_131 the commissioner addressed the question presented herein whether a partnership’s short_sale of securities creates a liability within the meaning of sec_752 the revenue_ruling states that a partnership entered into a short_sale of securities on a national securities exchange the partnership’s broker-dealer took securities on hand and sold them on behalf of the partnership the partnership left the cash - al --- proceeds from the sale with the broker-dealer as collateral and deposited additional cash with the broker-dealer as further collateral the partnership was obligated to deliver identical_securities to the broker-dealer to close out the short_sale on these facts the commissioner concluded that the short_sale created a partnership_liability within the meaning of sec_752 citing revrul_88_77 supra for the proposition that a liability under sec_752 includes an obligation to the extent that incurring the liability creates or increases the basis to the partnership of any of the partnership’s assets including cash attributable to borrowings the commissioner reasoned that a short_sale creates such a liability inasmuch as a short_sale creates an obligation to return the borrowed securities citing 308_us_488 and the partnership’s basis in its assets is increased by the amount of cash received on the sale of the borrowed securities see revrul_95_26 supra pincite accordingly the commissioner concluded that the partners’ bases in their partnership interests were increased under sec_722 to reflect their shares of the partnership’s liability under sec_752 petitioner first asserts that sec_752 is simply inapplicable in particular petitioner maintains that the substantial difference between salina’s inside_basis in its assets and fpl’s outside_basis in its partnership_interest is dictated by - -- sec_1233 and sec_1 a income_tax regs which require a short_sale to be treated as an open_transaction for income_tax purposes because a short_sale of securities is treated as an open_transaction for income_tax purposes and income_recognition is deferred until the transaction is closed with the replacement of the borrowed shares pursuant to sec_1233 petitioner reasons that sec_705 requires that any adjustments to the partners’ outside bases in their partnership interests be deferred until the short_sale is closed in connection with this argument petitioner contends that the commissioner’s position in revrul_95_26 supra conflicts with revrul_73_301 1973_2_cb_216 and the court’s holding in helmer v commissioner tcmemo_1975_160 we are not convinced that the treatment of a short_sale as an open_transaction for income_tax purposes under sec_1233 is controlling with respect to the proper treatment of the transaction for purposes of the partnership basis_adjustment provisions contained in subchapter_k petitioner’s argument overlooks the disparate policies that sec_1233 and sec_752 are intended to promote sec_1233 affords open_transaction treatment to a short_sale ie defers recognition of gain_or_loss until the ‘1 a short_sale of securities is treated as an open_transaction for income_tax purposes because the taxpayer’s ultimate gain_or_loss on the transaction cannot be determined until the taxpayer purchases securities to replace those that were borrowed and sold in the first leg of the transaction see sec_1_1233-1 income_tax regs -- - short_sale is closed to clarify and simplify the tax treatment of a transaction that is something of a hybrid see 423_f2d_485 4th cir affg 51_tc_235 in contrast the basis_adjustment provisions contained in subchapter_k including sec_705 and sec_752 are intended to avoid distortions in the tax reporting of partnership items by promoting parity between a partnership’s aggregate inside_basis in its assets and its partners’ outside bases in their partnership interests for present purposes we observe that the provisions of sec_1233 and sec_752 are mutually exclusive in other words the conclusion that a partnership’s short_sale of securities creates a partnership_liability within the meaning of sec_752 thereby increasing the partners’ outside bases in their partnership interests does not create tension or conflict with the deferred recognition of gain_or_loss prescribed for short_sale transactions under sec_1233 further we are not persuaded that the commissioner’s position in revrul_95_26 supra conflicts with revrul_73_301 supra or the court’s holding in helmer v commissioner supra the pertinent facts in revrul_73_301 supra are as follows during abc partnership which reported its income on the completed_contract_method was awarded a 2-year contract for the construction of a building during abc had performed all the services required under the contract in order to be entitled to receive -- -- progress payments totaling dollar_figurex during abc received total progress payments of dollar_figurex and incurred liabilities for total costs of dollar_figurex the facts stated in the revenue_ruling reveal that the commissioner allocated a pro_rata share of the dollar_figurex liabilities for costs incurred under the contract to the partners for purposes of determining their adjusted bases in their partnership interests on these facts the commissioner framed the issue to be addressed as whether the deferred income of 100x dollars as of date representing progress payments on the contract represents liabilities of a partnership within the meaning of sec_752 of the code and as such additions to basis of the partnership interests of the partners rev_rul 1973_2_cb_216 the commissioner concluded that the progress payments gualified as unrealized_receivables under sec_751 as opposed to liabilities within the meaning of sec_752 in this regard the revenue_ruling states that the income or loss from performance of the contract will affect the basis of the partnership interests of the partners as provided in sec_705 when such income or loss is recognized for federal_income_tax purposes revrul_73_ supra pincite emphasis added in sum the partners were not permitted to adjust their outside bases with reference to the dollar_figurex in progress payments that the partnership received during until income or loss from the transaction would be recognized for tax purposes however the commissioner recognized that the - - partners were entitled to increase their outside bases by a pro_rata share of the dollar_figurex of liabilities for construction costs that the partnership incurred in in generating the progress payments in helmer v commissioner supra the taxpayers were partners in a partnership that had entered into an agreement granting a third party an option to purchase real_estate in which the partnership held a two-thirds interest during the term of the option agreement the partnership retained the right to possess and enjoy profits from the property in question and there was no provision in the option agreement for repayment of the amounts paid under the agreement should the agreement terminate during the years in issue the taxpayers received payments directly from the third party pursuant to the option agreement---- amounts that the partnership listed as distributions to the taxpayers on its books and tax returns during the years in issue the taxpayers received partnership_distributions and had the partnership pay personal expenses in excess of their adjusted bases in the partnership the commissioner determined that although the option payments qualified as deferred income at the partnership level the taxpayers nevertheless were subject_to income_tax to the extent that they had received distributions from the partnership in excess of their adjusted bases in their partnership interests in response the taxpayers argued that -- - their adjusted bases in their partnership interests should be increased by their pro_rata shares of the option payments which they characterized as partnership liabilities under sec_752 the court agreed with the commissioner that no liability within the meaning of sec_752 arose upon the partnership’s receipt of the option payments the court noted that there were no provisions in the option agreement for repayment of or restrictions on the option payments further the court emphasized that income attributable to the option payments was subject_to deferral at the partnership level due only to the inability of the partnership to determine the character of the gain not because the partnership was subject_to a liability to repay the funds paid or to perform any services in the future we are not convinced that either revrul_73_301 supra or helmer v commissioner tcmemo_1975_160 provides a sound basis for determining whether a short_sale transaction generates a partnership_liability within the meaning of sec_752 on the one hand both authorities stand for the general proposition that amounts owed or paid to a partnership or its partners in a transaction that qualifies as an open_transaction for tax purposes do not generate adjustments to the partners’ outside bases in their partnership interests until the transaction is closed and the tax characteristics of the transaction can be determined on the other hand in revrul_73_301 supra the commissioner recognized that a7 - the partners therein were entitled to immediate adjustments to their outside bases equal to their pro_rata shares of the partnership’s liabilities for costs incurred in qualifying for the progress payments similarly helmer v commissioner supra suggests that a partnership_liability under sec_752 may arise where a partnership receives payments in a transaction that qualifies as an open_transaction for tax purposes if the partnership is subject_to a liability to repay the funds or to perform any services in the future in sum the authorities that petitioner relies upon demonstrate that although the amounts received by a partnership in an open_transaction generally are not characterized as a liability under sec_752 the transaction must nevertheless be examined to determine whether the partnership incurred related liabilities that may require partner-level basis adjustments pursuant to sec_752 in light of these competing considerations we reject petitioner’s argument that the commissioner’s reasoning in revrul_95_26 1995_1_cb_131 conflicts with revrul_73_301 supra and the court’s holding in helmer v commissioner supra petitioner attempts to draw an analogy between the option payments that the partnership received in helmer v commissioner supra with the cash proceeds that salina received on its sale of the borrowed treasury bills although the two transactions are both considered open transactions for purposes of application of -- - the income_tax the transactions are materially different for purposes of analysis under sec_752 the option payments that the partnership received in helmer ov commissioner supra represented fixed payments on the sale of a partnership asset that were free and clear of any claim for repayment or demand for further services in contrast salina’s gain_or_loss on the sale of borrowed treasury bills was dependent upon the cost to salina of fulfilling its obligation to replace the borrowed treasury bills consequently we hold that helmer v commissioner supra does not support petitioner’s position in this case as an alternative to its open_transaction argument petitioner cites 308_us_488 for the proposition that salina’s short_sale of treasury bills did not generate a partnership_liability within the meaning of sec_752 petitioner’s reliance on deputy v du pont supra is misplaced in deputy v du pont supra the taxpayer entered into a short_sale of securities and agreed to pay to the lender of the securities the dividends_paid on the securities during the period that the short_sale remained open the taxpayer claimed the amount that he paid to the lender as a deduction for interest_paid or accrued on indebtedness under sec_23 of the internal_revenue_code of the supreme court questioned whether the taxpayer’s obligation to transfer the dividends to the lender constituted an --- - indebtedness within the meaning of the statute stating in pertinent part that although an indebtedness is an obligation an obligation is not necessarily an ‘indebtedness’ id pincite nevertheless the supreme court’s rejection of the taxpayer’s argument was more firmly rooted in the court’s holding that the disputed payments did not constitute a payment of interest within the meaning of the statute see deputy v du pont supra pincite petitioner’s interpretation of deputy v du pont supra for the proposition that salina’s short_sale obligation is not an ‘indebtedness’ that constitutes a ‘liability’ under sec_752 of the code overstates the supreme court’s holding in that case in the first instance the supreme court’s statement in deputy v du pont supra pincite that an obligation is not necessarily an ‘indebtedness’ which was directed at the taxpayer’s obligation to transfer an amount equivalent to the dividends_paid on the borrowed securities to the lender does not constitute a blanket holding that a borrower’s obligation to close a short_sale by returning the borrowed securities to the lender will never be considered an indebtedness moreover petitioner attempts to equate the term indebtedness as contemplated under sec_23 of the internal_revenue_code of with the term liabilities as used in sec_752 without any meaningful analysis or citation to precedent we of course are in no way constrained nor prepared -- - to assume that a liability within the meaning of sec_752 must satisfy the definition of an indebtedness as that term is used elsewhere in the code although petitioner asserts that salina’s short_sale of treasury bills did not result ina partnership_liability within the meaning of sec_752 petitioner does not offer the court a definition of the term liability to support its position as previously indicated the term liability is not defined in either the code or the commissioner’s final regulations under sec_752 in the absence of any indication that congress intended otherwise we apply the term taking into account its plain and ordinary meaning see eg deputy v du pont supra pincite black’s law dictionary 7th ed defines the term liability in pertinent part as follows the quality or state of being legally obligated or accountable legal responsibility to another or to society enforceable by civil remedy or criminal punishment a financial or pecuniary obligation xk kek based upon the aforementioned meaning of the term liability and consistent with the policy underlining sec_752 we hold that salina’s obligation to close its short_sale by replacing the treasury bills that it borrowed from goldman sachs and abn represented a partnership_liability within the meaning of sec_752 in particular as part and parcel of its short_sale of the neither petitioner nor respondent argues that the current regulations provide insight on the question presented -- - treasury bills salina had a legally enforceable financial obligation to return the borrowed treasury bills to goldman sachs and abn significantly salina reported the obligation as a liability on its opening balance_sheet consistent with the preceding discussion we sustain respondent’s adjustment to salina’s tax_return inasmuch as salina’s partners were required to increase their outside bases in their partnership interests to reflect their pro_rata shares of the aforementioned liability a final matter petitioner observes that sec_1 b iv income_tax regs was amended effective date to eliminate the basis_adjustment provision underlying the present dispute ’ because the regulation was amended prospectively it is of no aid to this court in deciding the question presented in this case see eg compag computer corp subs v 113_tc_214 under the circumstances we need not consider the parties’ remaining arguments to reflect the foregoing and the agreement of the parties see supra note decision will be entered pursuant to an amendment to sec_1_708-1 iv income_tax regs effective date constructive partnership terminations are no longer treated as deemed distributions of partnership assets pursuant to the amendment the new partnership is now required to take a carryover_basis from the old partnership under rule


department of the treasury internal_revenue_service washington d c contact person id number telephone number date jan s n ole c0 t employer_identification_number legend dear sir or madam this is in response to your letter requesting rulings as amended regarding the federal tax consequences associated with the transactions described below m is a t nonprofit corporation and is recognized as exempt from federal_income_tax under sec_501 of the intermal revenue cade the code as an organization described in sec_501 of the code m specializes in the treatment of and teaching and research related to disorders of the eye ear nose throat head and neck m has been a teaching affiliate of n for many years m’s chiefs of ophthalmology and otolaryngology hold appointments as chairs of the respective departments at n and are consequently responsible for all eye and ear nose throat head and neck teaching activities at each of the p teaching hospitals all n students undertaking ophthalmic clerkships route through m you represent that while emphasizing its particular speciaities m’s charter contemplates a broad range of activities in support of the health care of the community you indicate that unlike most of the other major teaching hospitals in the area m and it affiliates are not part of a targer health care system which includes other hospitals and medical centers you state that the longstanding relationship between m and r described below as close and interdependent affiliates not subject_to common corporate control has been extremely successful without the need for a more forma corporate affiliation you further indicate that it is also generally believed that m would not be a candidate for inclusion in one of the other larger medical systems at least in part because of this affiliation with r r is a t nonprofit corporation and is recognized as exempt from federal_income_tax under sec_501 of the code as an organization described in sec_501 of the code r is an acute care and teaching hospital located immediately adjacent to m you state that r enjoys world renown as a leading medical center and teaching facility r is one of the principal teaching hospitals of n you state that r and m are organizationally separate members of unrelated corporate groups however as described more particularly below r and m have long shared a close professional affiliation u is also a t nonprofit corporation and is recognized as exempt from federal_income_tax under sec_501 of the code as an organization described in sec_501 of the code uis a rehabilitation hospital located in s and is affiliated with r u is organized as a sister charitable corporation of r sharing with r the r parent as its sole corporate member u maintains fifteen specialized programs in every field of rehabilitation like r and m u is a teaching hospital affiliated with n due largely to an enhanced ability to provide its health care services on an outpatient basis as a principal result of advances in medical technology you indicate that m has developed a current excess capacity of space in its main facility in which to provide inpatient care accordingly m has sought to make use of this excess capacity in a manner to further its charitable purpose of providing health care to the community consistent with its position as a member of the p teaching hospital system and with its close affiliation with r described below pursuant to a lease dated v between m and u the lease m agreed to lease to u space in the facility consisting of approximately w square feet on a single floor of the facility ptus an additional x square feet of storage space the lease provides among other things that the space be used by u solely as an inpatient unit of up to beds of a rehabilitation or long term care hospital providing post acute medical_care or rehabilitation services the unit parties that the space in question be operated as a separate_unit of u and not as a unit of m the unit will be operated under u's hospital license and the patients will be admitted to the unit as patients of u while it is anticipated that m patients who are discharged to u would in the first instance be admitted to the unit the parties have not agreed to set_aside beds or otherwise give m patients preference in this regard in this regard you state that it is intended by the because the unit will be located within m it is believed that the number of patients discharged from m to u may increase since this proximity and accompanying convenience for m physicians will facilitate continuity of care patients of m who would otherwise have remained at m for longer periods may instead be discharged to the unit at u you indicate that such transfer from the sick bed environment of an inpatient unit to a continuing care rehabilitation unit is viewed as desirable for patient care and is increasingly encouraged by health care insurers patients discharged from r directly to the unit will enjoy these benefits you state that in essence the facility will serve in part as the rehabilitation facility for m and relieves m of the need for funding and operating its own rehabilitation facility you state that the term of the lease is for five years from the date of u's receipt of a certificate of occupancy for the space subject_to extension upon good_faith negotiation by the parties at the end of that term under the lease in addition to the space you state that m is also responsible for providing utilities to the unit including utility requirements specific to a hospital setting such as compressed air control air vacum carbon dioxide medical gases and chemical waste lines the lease gives u the right to make alterations and improvements to the leased premises at its own expense with such alterations or improvements to become the property of m on termination of the lease the lease also gives u the 4s right to expand into any additional space on the floor where the unit is located should m decide to make space available for rental anytime during the term of the lease agreement the lease requires m to give u a right_of_first_refusal if m proposes to enter into a lease of space the lease provides for payment of two principal categories of rent by u and m basic rent is payable monthly in advance for the first year subject_to adjustment in subsequent years based on charges in the consumer_price_index rent for repairs maintenance utilities and other services or rmus rent’ is payabte in the first year so called additional rent’ is payable from time to time under the terms of the lease and consists of miscetlaneous charges and fees associated with defaults by u you state that m believes that the terms of the lease represents reasonable commercial terms you further state that the m building in which the leased premises are located is subject_to acquisition_indebtedness within the meaning of sec_514 of the code you state that the acquisition_indebtedness is in the form of qualified c bonds described in sec_145 based on the above you have requested a ruling that the leasing of space to u in accordance with the terms of the lease dated y will not constitute the operation of an unrelated_trade_or_business pursuant to sec_513 of the intemal revenue code sec_509 of the code provides an exemption from federal_income_tax for organizations described in sec_501 including organizations that are organized and operated exclusively for charitable educational or scientific purposes sec_1_501_c_3_-1 of the federal_income_tax regulations regulations provides that the term charitable is used in sec_501 of the code in its generally accepted legal sense in the general law of charity the promotion of health is considered to be a charitable purpose restatement trusts sec_368 and sec_372 iv scott on trust sec_3 ed sec_368 and sec_372 sec_511 of the code imposes a tax on unrelated_business_income of organizations described in sec_501 sec_512 and ii of the code in referencing unrelated_business_taxable_income indicates that in the case of rent except as provided in subparagraph b there shall be exciuded i all rents_from_real_property including property described in sec_1245 and ii all rents from personal_property including for purposes of this paragraph as personal_property any property described in sec_1245 teased with such real_property if the rents attributable to such personal_property are an incidental amount of the total rents received or accrued under the lease determined at the time the personal_property is placed_in_service sec_512 b of the code provides that notwithstanding paragraph or in the case of debt-financed_property as defined in sec_514 there shall be included as an item_of_gross_income derived from an unrelated_trade_or_business the amount ascertained under sec_514 and there shali be allowed as a deduction the amount ascertained under sec_514 sec_513 of the code defines an unrelated_trade_or_business as any trade_or_business the conduct of which is not substantially related to the exercise of the organization's exempt purposes or function blo sec_1_513-1 of the regulations provides in part that a trade_or_business is related to exempt purposes only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes and it is substantially related for purposes of sec_513 of the code only if the causal relationship is a substantial one thus for the conduct_of_a_trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or the performance of the services from which the gross_income is derived must contribute importantly to the accomplishment of exempt purposes sec_1_513-1 of the regulation which references dual use of assets or facilities provides that in certain cases an asset or facility necessary to the conduct of exempt functions may also be employed in a commercial endeavor in such case the mere fact of the use of the asset or facility in exempt functions does not by itself make the income from the commercial endeavor gross_income from related trade_or_business the test instead is whether the activities productive of the income in question contributes importantly to the accomplishment of exempt purposes sec_514 and ii of the code in defining debt-financed_property excludes any property substantially alt the use of which is substantially related aside from the need of the organization for income or funds to the exercise or performance of such organization of its charitable educational or other purpose or function constituting the basis for its exemption under sec_501 or ji any purpose to which clause i does not apply to the extent that its use is so substantially related you represent that due largely to an enhanced ability to provide its health care services on an outpatient basis as a principal resuit of advances in medical technology m has developed a current excess capacity of space in its main facility in which to provide inpatient care as a result m has sought to make use of this excess capacity in a manner to further its charitable purpose of providing health care to the community by entering into the lease with u for the excess space you further represent that it is intended by the parties that the space in question be operated as a separate_unit of u and not as a unit of m the unit will be operated under u's hospital license and the patients will be admitted to the unit as patients of u nevertheless you indicate that the lease has been entered into in large part to further m's own purpose of providing an adjacent and convenient rehabilitation facility to which m's own patients may be transferred as needed this lease relieves m of the need to fund and operate its own rehabilitation facility on the premises accordingly based on the facts and representations set forth we rule that the lease of the space to u outlined in your lease dated y will not constitute an unrelated_trade_or_business within the meaning of sec_513 of the code and will not result in debt-financed_income within the meaning of sec_514 this ruling is based on the understanding that there will be no material changes in the facts upon which it is based this ruling does not address the applicability of any section of the code or regulations to the facts submitted other than with respect to the sections described this ruling is directed only to the organization that requested it sec_6110 of the code provides that it may not be used or cited as precedent we are informing your key district_director of this action please keep a copy of this ruling in your permanent records sincerely a cansteg cty tyo nii ven rcl manager exempt_organizations technical group


t c summary opinion united_states tax_court thomas a schroeder petitioner v commissioner of internal revenue respondent docket no 4207-06s filed date thomas a schroeder pro_se angela j kennedy for respondent cohen judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect when the petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case unless otherwise indicated all section references are to the internal_revenue_code in effect for the year in issue respondent determined a deficiency of dollar_figure in petitioner’s federal_income_tax for petitioner does not dispute the deficiency but claims that his former spouse should be held liable for one-half of it background some of the facts have been stipulated and the stipulated facts are incorporated in our findings by this reference petitioner resided in indiana at the time that his petition was filed during petitioner was married to kathi schroeder petitioner and kathi schroeder divorced in for more than years prior to and during petitioner was a limited_partner in franklin ridgewood associates limited_partnership petitioner made the investment and signed the necessary papers because kathi schroeder did not participate in matters involving investments on the partnership return petitioner alone was shown as the partner receiving distributions of income kathi schroeder was not shown as a partner during petitioner received distributed income and interest_income from franklin ridgewood associates limited_partnership in the total amount of dollar_figure on date petitioner and kathi schroeder filed a joint form_1040 u s individual_income_tax_return for the income of dollar_figure received from franklin ridgewood associates limited_partnership was not reported on that return in the notice_of_deficiency respondent determined a deficiency of dollar_figure attributable to the failure to report the partnership income on petitioner’s return discussion petitioner’s contention in this case is that his former wife should be required to pay one-half of the deficiency and interest attributable to the failure to report partnership income during the petition alleges that petitioner and his former wife both shared the benefits of the partnership throughout their marriage she shared in the distribution of all assets including the value of the limited_partnership and she had the ability to pay her fair share of the tax sec_6013 provides that if a joint_return is filed the tax is computed on the individuals’ aggregate income and liability for the resulting tax is joint_and_several see also sec_1_6013-4 income_tax regs a fundamental characteristic of joint_and_several_liability is that the internal_revenue_service irs at its option may proceed against the taxpayers separately and may obtain a separate judgment against each see 44_tc_420 the decision to assess or not assess tax against one of the spouses who filed a joint_return does not prevent the irs from proceeding against the other see id see also 98_tc_383 petitioner was a partner in the partnership that was the source of the unreported income in issue therefore the court has no basis for limiting petitioner’s liability to percent as he requests petitioner does not qualify for sec_6015 relief because he admits to receiving and failing to report the items of income petitioner does not qualify for relief under sec_6015 because he cannot establish that he did not know or had no reason to know that there was an understatement_of_tax when he signed the return see sec_6015 and petitioner testified that he was unaware of the understatement on the return because he did not receive the form for reporting distributions from the partnership and he relied on his accountant to prepare the return in view of his long-held interest in the partnership however he should have known that his income from the partnership was not included on the return and that an understatement would result because the items giving rise to the deficiency were directly allocable to petitioner sec_6015 does not provide any avenue for relief see also sec_1_6015-3 income_tax regs stating that erroneous items of income are allocated to the spouse who was the source of the income finally it is not inequitable to hold petitioner liable for the deficiency since he fails one of the threshold conditions for relief ie the income_tax_liability from which the requesting spouse seeks relief is attributable to an item of the other spouse revproc_2003_61 sec_4 2003_2_cb_296 to reflect the foregoing decision will be entered for respondent