internal_revenue_service number release date index number --------------------- ---------------------------- ------------------------------------------ --------------------------------- -------------------------------------------- - department of the treasury washington dc person to contact --------------- id no ------------- telephone number --------------------- refer reply to cc psi b07 - plr-133440-03 date date a b c d e ------------------------------------------------------- ------------------------------------------------------------------ ----------------------------------------------------------- ------------------------------------------------------------- --------------------------------------------------------------------------------- legend ---------------------------------------------------------------------------------------------------------------- --------- --------------------------- ------------------------------ ------------------------------------------------------- ------------------------------------------------- ---------------------------------------- ---------------------------- ------------------------------------ --------------------------------------- -------------------------------------- ---------------------------------------------------- ----------------------------------------------- -------------------------------------- -------------------------- ---------------------------- ------------------------- ---------------------- ------------------------ ----------------------- ------------------ ---------------------- f g h i j t u v w x y z date date date date date date date date ------------------ ----------- ------ ------ ------ ------ ------ ---------------------------------- ------------------------------------------- date m n o p q r site x site y dear -------------- this letter responds to a letter dated date submitted on behalf of a by its authorized representative requesting rulings under sec_29 and sec_702 of the internal_revenue_code the facts as represented by a and a's authorized representative are as follows a is a delaware limited_liability_company that is classified as a disregarded_entity for federal tax purposes a owns a facility facility for the production of solid synthetic_fuel from coal b is a delaware limited_liability_company and owns all of the membership interest in a b is classified as a disregarded_entity for federal_income_tax purposes c is a delaware limited_partnership and owns all of the membership interest in b because b is treated as disregarded_entity for federal tax purposes c is treated as owning b’s membership interest in a because a is treated as a disregarded_entity for federal tax purposes c is treated as owning all of the assets of a d a delaware limited_liability_company owns a limited_partnership_interest in c e a delaware corporation owns a general_partnership interest in c c has made and is expected to continue to make periodic cash capital contributions to b which are then contributed to a in order to enable a to pay operating_expenses the facility was built pursuant to a construction_contract entered into on date between x as buyer and y and or z as seller on date the construction_contract was assigned from x to t and from t to v on date the construction_contract was assigned from v to u on date the construction_contract was assigned from u to w the construction_contract provides for liquidated_damages of at least five percent of the cost of the facility it also includes a description of the facility to be constructed a completion date and a price the construction_contract is valid under state law on date u received plr-9818012 which ruled that the construction_contract constitutes a ‘binding written contract’ within the meaning of sec_29 a seeks plr-133440-03 confirmation of the prior rulings received in light of changes in the ownership of and a relocation of the facility on date h acquired the facility from w thereafter h contributed the facility to a the facility was constructed at site x a represents that the facility was in a condition or state of readiness and availability for its specifically assigned function and was operational before date the facility was designed with the ability to be moved from one site to another depending on the availability price quality and location of coal feedstock on date a relocated the facility from site x to a new location at site y this relocation occurred because of a’s inability to obtain sufficient coal feedstock at site x and a lack of demand for synthetic_fuel in the region of site x following this relocation the fair_market_value of the original property comprising the facility at site x was more than percent of the facility’s total value the cost of the new property plus the value of the original property further all essential components of the facility are retained at site y and the production capacity of the facility has not significantly increased at site y effective date a entered into a facility operating_agreement with f an unrelated party for the operation and maintenance of the facility under this agreement f will provide services to a in connection with the relocation operation and accounting for the facility f is reimbursed for specified costs in connection with the start-up of the facility and up to dollar_figurem of its costs in relocating the facility in each case with interest but is required to bear a portion of the costs of upgrading site y to accommodate the facility for its other services f is paid a fee of dollar_figuren for each ton of synthetic_fuel sold subject_to certain inflation adjustments f is required to fund certain operational expenses of the facility and is reimbursed for such expenses with interest except that f is responsible for expenses that exceed budgeted costs in certain circumstances pursuant to an exclusive coal feedstock supply agreement entered into as of date between a and f a is required to purchase the coal feedstock for the facility from f during the initial months of operation of the facility f agrees that the price of certain minimum quantities of the coal feedstock will not exceed by more than dollar_figureo the sales_price of the synthetic_fuel produced by the facility following the initial months of operation f will sell coal feedstock to a at a price that is determined by reference to the market price plus a supply fee of dollar_figurep per ton of coal feedstock supplied which upon renewal of the agreement is subject_to adjustment for inflation f is entitled to a bonus procurement fee as an incentive to purchase coal feedstock at the least possible cost under the agreement f agrees to procure coal feedstock that will result in the production of qualified_fuel and that meets minimum quality standards and to test the coal feedstock to determine whether these standards are satisfied a also entered into an exclusive agreement for marketing of synfuel product plr-133440-03 pursuant to the amended and restated binder supply agreement dated date between a and i a purchases chemical change agent from i for use at the facility a will pay dollar_figurer per ton of synthetic_fuel produced and sold by the facility for the chemical change agent provided by i this purchase_price is subject_to an annual inflation adjustment and adjustments for a change in the application rate above or below a target rate or in the cost of certain components i has initially entered into a chemical change agent supply agreement with j an affiliate of f for j to act as the exclusive supplier to i of the chemical change agent to be sold to a with f under this agreement a appoints f as the exclusive agent for the marketing of synthetic_fuel produced by the facility the agreement authorizes f to enter into contracts on behalf of a to sell synthetic_fuel produced by the facility under this agreement f agrees to remit to a all amounts received from the sale of the synthetic_fuel less a a barge transloading fee of dollar_figureq per ton b a brokerage fee of dollar_figurep per ton and c transportation fees paid to third parties upon extension of this agreement the marketing fee is subject_to adjustment for inflation all sales of synthetic_fuel produced by the facility will be to unrelated persons pursuant to the amended and restated contract management agreement dated as of date between a and g an unrelated party g will manage the operation of the facility on behalf of a under this agreement g will monitor the performance of f propose and monitor f’s compliance with the annual budget perform certain of a’s obligations and otherwise enforce the rights of a under certain contracts including a’s right to terminate those contracts in the event of specified cost overruns by f under the operating_agreement g may propose changes to the type and percentage of binder used by the facility and is responsible for determining that the operation of the facility will comply with specified guidelines in consideration for the performance of its services g will receive a management fee equal to dollar_figureq per ton of qualified_fuel as specially defined under the management agreement produced by the facility the facility consists of an integrated facility for the production of a solid synthetic_fuel from coal the process which occurs in the facility consists of the following steps i thoroughly mixing coal feedstocks with a chemical change agent in a mixer blender auger ii feeding metered amounts of the coal feedstock and chemical change agent mixture into a roll briquetter and iii compressing the mixture into synthetic_fuel in the first_phase of the production process coal feedstocks are mixed in a pug mill with an organic resin emulsion chemical change agent in the second_phase of the production process the mixture of coal feedstock and chemical change agent is introduced via conveyors and feed hoppers into roll briquetters the combination of the chemically reactive agent the mixing process and processing through the roll briquetters results in the formation of a solid synthetic_fuel agglomeration referred to herein as synthetic plr-133440-03 fuel the facility utilizes coal feedstock and chemical reagents that meet the requirements of revproc_2001_34 2001_1_cb_1293 in the past the facility has used various feedstock sources and chemical reagents as described in a’s letter_ruling request a has engaged recognized experts in coal combustion chemistry to conduct tests on synthetic_fuel samples produced by the facility using each reagent identified in the request for rulings these tests are described in a’s letter_ruling request based on this testing of the reagents the experts have concluded that there was a measurable significant change in the chemical composition of the resulting synthetic_fuel compared to the unreacted coal feedstocks and chemical reagent c allocates receipts from the sale of synthetic_fuel among its partners in accordance with the partnership interests of d and e as set forth in c’s partnership_agreement the rulings requested by a are as follows the construction_contract constitutes a binding written contract in effect the facility is placed_in_service for purposes of sec_29 on the date that it the synthetic_fuel produced by the facility is a solid synthetic_fuel produced from coal feedstock that differs significantly in chemical composition from the coal from which it is produced and thus constitutes a qualified_fuel within the meaning of sec_29 before date within the meaning of sec_29 was placed in a condition or state of readiness and availability for its specifically assigned function as described in regulations sec_1_46-3 and sec_1_167_a_-11 to produce synthetic_fuel production from the facility will be attributable solely to c within the meaning of sec_29 and c will be allowed the credit as determined under sec_29 for synthetic_fuel produced by the facility and sold by a to unrelated persons prior to date relocation of the facility after date or replacement of parts after that date will not result in a new placed_in_service_date for the facility for purposes of sec_29 if the fair_market_value of the original property that is incorporated into the facility exceeds of the total fair_market_value of the facility immediately following the relocation or replacement provided the facility was placed_in_service within the meaning of sec_29 any sec_29 credit allowed to c may be passed through to and allocated among plr-133440-03 the partners of c under the principles of sec_702 in accordance with the partners’ interest in c at the time the sec_29 credits are allowed for purposes of the sec_29 credit a partner’s interest in c is determined based on a valid allocation of the receipts from the sale of the sec_29 credit synthetic_fuel provided the facility was placed_in_service within the meaning of sec_29 prior to date the facility will continue to be treated as placed_in_service before date if sold to a new owner after such date or if c terminates within the meaning of sec_708 b’s purchase of the facility and subsequent contribution to a will not affect the date that the facility was placed_in_service for purposes of sec_29 therefore c will be allowed the sec_29 credit for synthetic_fuel produced by the facility and sold to unrelated persons before date ruling_request sec_29 allows a credit for qualified_fuels sold by the taxpayer to an unrelated_person during the taxable_year the production of which is attributable to the taxpayer the credit for the taxable_year is an amount equal to dollar_figure adjusted for inflation multiplied by the barrel-of-oil_equivalent of qualified_fuels sold sec_29 defines qualified_fuels to include liquid gaseous or solid synthetic fuels produced from coal including lignite including such fuels when used as feedstocks in revrul_86_100 1986_2_cb_3 the service ruled that the definition of the term synthetic_fuel under sec_48 and its regulations is relevant to the interpretation of the term under sec_29 former sec_48 provided a credit for the cost of equipment used for converting an alternate_substance into a synthetic liquid gaseous or solid fuel revrul_86_100 notes that both sec_29 and former sec_48 contain almost identical language and have the same overall congressional intent namely to encourage energy conservation and aid development of domestic energy production under sec_1_48-9 of the income_tax regulations a synthetic_fuel must differ significantly in chemical composition as opposed to physical composition from the alternate_substance used to produce it coal is an alternate_substance under sec_1 c i of the income_tax regulations resume issuance of rulings under sec_29 for processes that do not go beyond the processes approved in the rulings issued prior to in revproc_2001_30 2001_1_cb_1163 the service announced that it will plr-133440-03 sec_3 of revproc_2001_34 provides that the service will issue rulings that a solid fuel other than coke produced from coal is a qualified_fuel under sec_29 if the conditions set forth below are satisfied and evidence is presented that all or substantially_all of the coal used as feedstock undergoes a significant chemical change the conditions are that the feedstock coal consists of coal fines or crushed coal comprised of particles the majority of which by weight are no larger than inch the feedstock coal is thoroughly mixed in a mixer a with styrene or other monomers b with quinoline c9h7n or other organic resin and left to cure for several days c with ultra heavy hydrocarbons or d with an aluminum and or magnesium silicate binder following heating to a minimum temperature of degrees fahrenheit and the treated feedstock is subjected to elevated temperature and pressure that results in briquettes pellets or an extruded fuel product or the taxpayer represents that the omission of this procedure will not significantly increase the production of the facility over the remainder of the period during which the sec_29 credit is allowable based on the representations of a and a’s authorized representative and the test results submitted by a we conclude that the conditions of revproc_2001_34 are met and that the process and reagents used in the facility as described in a’s ruling_request produce a significant chemical change to the coal transforming the coal feedstock into a solid synthetic_fuel from coal therefore we further conclude that a by using the process and reagents described in the request for rulings and the facility produces a solid synthetic_fuel from coal that constitutes a qualified_fuel within the meaning of sec_29 ruling_request sec_29 and f provide that sec_29 applies with respect to qualified_fuels which are produced in a facility placed_in_service after date and before date and which are sold before date sec_29 modifies sec_29 in the case of a facility producing qualified_fuels described in sec_29 which qualified_fuels include solid synthetic fuels produced from coal or lignite sec_29 provides that for purposes of sec_29 a facility shall be treated as placed_in_service before date if the facility is placed_in_service before date pursuant to a binding written contract in effect before date sec_29 provides that if the facility is originally placed_in_service after date sec_29 shall be applied by substituting date for date plr-133440-03 a contract is binding only if it is enforceable under local law against a taxpayer and does not limit damages to a specified amount eg by use of a liquidated_damages provision a contract provision limiting damages to an amount equal to at least five percent of the total_contract_price for example should be treated as not limiting damages the construction_contract executed prior to date provides for liquidated_damages of at least five percent of the total_contract_price and includes such essential features as a description of the facility to be constructed a completion date and a price therefore we conclude that the construction_contract is a binding written contract in effect before date within the meaning of sec_29 ruling requests and sec_29 and f of the code provide that sec_29 applies with respect to qualified_fuels which are produced in a facility placed_in_service after date and before date and which are sold before date sec_29 of the code modifies sec_29 in the case of a facility producing qualified_fuels described in sec_29 which qualified_fuels include solid synthetic fuels produced from coal or lignite sec_29 provides that for purposes of sec_29 such a facility is to be treated as placed_in_service before date if the facility is placed_in_service before date pursuant to a binding written contract in effect before date sec_29 provides that if the facility is originally placed_in_service after date sec_29 is to be applied by substituting for the date therein date to qualify for the sec_29 credit the facility must be placed_in_service before date pursuant to a binding written contract in effect before date while sec_29 does not define placed_in_service the term has been defined for purposes of the deduction for depreciation and the investment_tax_credit property is placed_in_service in the taxable_year the property is placed in a condition or state of readiness and availability for a specifically assigned function sec_1_167_a_-11 and sec_1_46-3 of the income_tax regulations placed_in_service has consistently been construed as having the same meaning for purposes of the deduction for depreciation and the investment_tax_credit see revrul_76_256 1976_2_cb_46 when property is placed_in_service is a factual determination and we express no opinion on when the facility was placed_in_service revrul_94_31 1994_1_cb_16 concerns sec_45 which provides a credit for electricity produced from certain renewable resources including wind the credit is based on the amount of electricity produced_by_the_taxpayer at a qualified_facility during the 10-year period beginning on the date the facility was originally placed_in_service and sold by the taxpayer to an unrelated_person during the taxable_year revrul_94_31 holds that for purposes of sec_45 a facility qualifies as originally placed_in_service even plr-133440-03 though it contains some used_property provided the fair_market_value of the used_property is not more than percent of the facility's total value the cost of the new property plus the value of the used_property revrul_94_31 concerns a factual context similar to the present situation consistent with the holding in revrul_94_31 provided the facility was placed_in_service prior to date within the meaning of sec_29 relocation of the facility after date or replacement of parts of the facility after that date will not result in a new placed_in_service_date for the facility or otherwise prevent the facility from continuing to be treated as originally placed_in_service prior to date if the fair_market_value of the property used at the original facility is more than percent of the facility’s total fair_market_value immediately following the relocation or replacement the cost of the new equipment included in the facility plus the value of the property used at the original facility revrul_94_31 describes a windfarm that consists of an array of wind turbines towers pads transformers roadways fencing on-site power collection systems and monitoring and meteorological equipment notwithstanding that the windfarm consisted of all of these items the ruling concludes that the facility for purposes of sec_45 is confined to the property on the windfarm necessary for the production of electricity from wind_energy emphasis added the present situation is similar to revrul_94_31 thus for purposes of determining a facility’s total fair_market_value at the time of relocation or replacement a facility consists of the process equipment directly necessary for the production of the qualified_fuel starting at the immediate input of the coal and chemical reagents to the pug mills or mixers including any coal hoppers and reagent tanks directly feeding the pug mills or mixers through the output from the briquetters or other forming equipment including output hoppers if any hence each facility’s total fair_market_value includes the process equipment such as pugmills or mixers the briquetters or other forming equipment the equipment necessary to interconnect such equipment the electrical instrumentation control systems and auxiliaries related to such equipment including the structures that house such electrical instrumentation and control systems the foundation platform s for the above- referenced equipment and an appropriate allocation of the engineering project management overhead and other costs assignable to the relocation of such equipment and construction a facility’s total fair_market_value does not include costs associated with the purchase and installation of equipment that supports the operation of the facility but is not directly necessary for the production of the qualified_fuel such as coal beneficiation or preparation equipment eg crushers screens dryers or scales other material handling or conveying equipment eg stacking tubes transfer towers storage bunkers mobile equipment or conveyors certain site improvements eg fencing lighting earthwork paving separate office and bathhouse trailers for facility personnel and buildings if a building for purposes of sec_168 of the code and other administrative assets plr-133440-03 sampling and quality control are necessary for operational control of a production facility however a particular type of sampling equipment generally is not necessary for the production of qualified_fuel thus the costs of sampling equipment are excluded from the facility’s total fair_market_value unless the particular sampling equipment is necessary for operational control of the facility ruling_request sec_29 allows a credit for qualified_fuels sold by the taxpayer to an unrelated_person during the taxable_year the production of which is attributable to the taxpayer under sec_7701 taxpayer means any person subject_to any internal revenue tax furthermore sec_7701 provides that when used in title_26 where not otherwise distinctly expressed or manifestly incompatible with the intent thereof person will be construed to mean and include an individual trust estate partnership_association company or corporation for federal_income_tax purposes under sec_301_7701-2 of the income_tax regulations a business_entity that has a single owner and is not a corporation is disregarded as an entity separate from its owner a will own the facility and through an agent a will operate and maintain the facility and sell the resulting qualified_fuel however a is a single member limited_liability_company owned by b a single member limited_liability_company owned by c a limited_partnership for federal_income_tax purposes a and b are disregarded entities treated in the same manner as a branch or division of c accordingly for purposes of sec_29 c is the taxpayer because it is a limited_partnership a taxpayer under sec_7701 that is deemed to own the facility to operate and maintain the facility and to sell the resulting qualified_fuel therefore all production of qualified_fuel from the facility will be attributable solely to c within the meaning of sec_29 and c will be entitled to the sec_29 credit for the production of qualified_fuel from the facility that is sold to unrelated persons ruling_request sec_29 allows a credit for qualified_fuels sold by the taxpayer to an unrelated_person during the taxable_year the production of which is attributable to the taxpayer sec_7701 provides that taxpayer means any person subject_to any internal revenue tax generally under sec_7701 the term person includes an individual a_trust estate partnership_association company or corporation plr-133440-03 sec_702 provides that each partner determines the partner’s income_tax by taking into account separately the partner’s distributive_share of the partnership’s other items of income gain loss deduction or credit to the extent provided by regulations prescribed by the secretary sec_1_702-1 provides that the distributive_share is determined as provided in sec_704 and sec_1_704-1 sec_704 provides that a partner’s distributive_share of income gain loss deduction or credit is except as otherwise provided in chapter of subtitle a of title_26 determined by the partnership_agreement sec_704 provides that a partner’s distributive_share of income gain loss deduction or credit or item thereof is determined in accordance with the partner’s interest in the partnership determined by taking into account all facts and circumstances if the partnership_agreement does not provide as to the partner’s distributive_share of income gain loss deduction or credit or item thereof or the allocation to a partner under the agreement of income gain loss deduction or credit or item thereof does not have substantial economic_effect sec_1_704-1 provides that allocations of tax_credits and tax_credit recapture except for sec_38 property are not reflected by adjustments to the partners’ capital accounts thus these allocations cannot have economic_effect under sec_1 b ii b and the tax_credits and tax_credit recapture must be allocated in accordance with the partners’ interests in the partnership as of the time the tax_credit or credit recapture arises if a partnership expenditure whether or not deductible that gives rise to a tax_credit in a partnership_tax_year also gives rise to valid allocations of partnership loss or deduction or other downward capital_account adjustments for the year then the partners’ interests in the partnership with respect to such credit or the cost giving rise to it are in the same proportion as the partners’ respective distributive shares of the loss or deduction and adjustments see sec_1_704-1 example identical principles apply in determining the partners’ interests in the partnership with respect to tax_credits that arise from receipts of the partnership whether or not taxable based on the information submitted and the representations made we conclude that assuming the solid synthetic_fuel produced and sold qualifies for the sec_29 credit the credit will be allowed to c and the credit may be passed through to and allocated among the partners of c under the principles of sec_702 in accordance with each partner’s interest in c as of the time the credit arises for purposes of the sec_29 credit a partner's interest in c is determined based on a valid allocation of the receipts from the sale of the sec_29 credit qualified_fuel the sec_29 credit has always been a time sensitive credit in that eligibility for the credit is determined when facilities or wells producing qualified_fuels are placed in ruling_request plr-133440-03 service and when the qualifying fuels are produced and sold to unrelated persons for example the sec_44d credit as originally enacted in the crude_oil windfall profit tax act of was generally available for the production and sale of alternative fuels after date and before date on property that first began production after date congress has extended the sec_29 credit four times the placed-in-service deadline and the period for claiming the sec_29 credit were extended in the technical_and_miscellaneous_revenue_act_of_1988 for placed_in_service omnibus budget reconciliation act of for placed_in_service and for the end of the credit_period energy policy act of for placed_in_service and for the end of the credit_period and small_business job protection act of date for placed_in_service it is clear from the legislative_history of sec_44d that congress intended the credit to apply to facilities placed_in_service after and that the placed-in-service deadline in sec_29 must be read as applying to when the facility is first placed_in_service within the applicable dates the placed-in-service deadlines contained in sec_29 and sec_29 focus on the facility and not the owner of the facility the legislative_history of sec_44d clearly shows that congress wanted to encourage the production of new alternative fuels from facilities first placed_in_service after and not provide a tax incentive for production capacity in service before sec_29 demonstrates that congress knows how to preclude transferees of facilities from claiming the sec_29 credit that provision provides that the extension of the period for placing facilities in service after does not apply to any facility that produces coke or coke gas unless the original_use of the facility commences with the taxpayer accordingly the determination of whether a facility has satisfied the placed-in- service deadline under either sec_29 or sec_29 is made by reference to when the facility is first placed_in_service not when the facility is transferred or sold to a different taxpayer sec_708 provides that a partnership shall be considered as terminated if within a twelve-month period there is a sale_or_exchange of percent or more of the total interest in partnership capital and profits sec_1_708-1 provides that if a partnership is terminated by a sale_or_exchange of an interest the following is deemed to occur the partnership contributes all of its assets and liabilities to a new partnership in exchange for an interest in the new partnership and immediately thereafter the terminated partnership distributes interests in the new partnership to the purchasing partner and the other remaining partners in plr-133440-03 proportion to their respective interests in the terminated partnership in liquidation of the terminated partnership either for the continuation of the business by the new partnership or for its dissolution and winding up sec_1_708-1 applies to terminations of partnerships under sec_708 occurring on or after date as discussed above the placed-in-service deadline in sec_29 and sec_29 must be read as applying to when the facility is first placed_in_service within the applicable dates the placed-in-service deadlines contained in sec_29 and sec_29 focus on the facility and not the taxpayer owning the facility accordingly the placed-in-service deadline under sec_29 and sec_29 g a is determined by reference to when the facility is first placed_in_service therefore provided the facility was placed_in_service prior to date within the meaning of sec_29 the sale of the facility after date will not result in a new placed_in_service_date for the facility for purposes of sec_29 for the new owner further a termination of c under sec_708 will not preclude the reconstituted partnership from claiming the sec_29 credit for the production and sale of synthetic_fuel to unrelated persons ruling_request as discussed above the placed-in-service deadline in sec_29 and sec_29 must be read as applying to when the facility is first placed_in_service within the applicable dates the placed-in-service deadlines contained in sec_29 and sec_29 focus on the facility and not the taxpayer owning the facility accordingly the determination of whether a facility has satisfied the placed-in- service deadline under sec_29 and sec_29 is made by reference to when the facility is first placed_in_service not when the facility is placed_in_service by a transferee taxpayer therefore we conclude that b’s purchase of the facility and subsequent contribution to a will not affect the date that the facility was placed_in_service for purposes of sec_29 provided the facility was placed_in_service prior to date within the meaning of sec_29 c will be allowed the sec_29 credit for synthetic_fuel produced by the facility and sold to unrelated persons prior to date accordingly based on the representations of a and a’s authorized representative we conclude as follows the synthetic_fuel produced by the facility is a solid synthetic_fuel produced from coal feedstock that differs significantly in chemical composition from the coal from which it is produced and thus constitutes a qualified_fuel within the meaning of sec_29 before date within the meaning of sec_29 the construction_contract constitutes a binding written contract in effect the facility is placed_in_service for purposes of sec_29 on the date that it provided the facility was placed_in_service within the meaning of sec_29 plr-133440-03 was placed in a condition or state of readiness and availability for its specifically assigned function as described in regulations sec_1_46-3 and sec_1_167_a_-11 to produce synthetic_fuel production from the facility will be attributable solely to c within the meaning of sec_29 and c will be allowed the credit as determined under sec_29 for synthetic_fuel produced by the facility and sold to unrelated persons prior to date relocation of the facility after date or replacement of parts after that date will not result in a new placed_in_service_date for the facility for purposes of sec_29 if the fair_market_value of the original property that is incorporated into the relocated facility exceeds of the total fair_market_value of the facility immediately following the relocation or replacement the partners of c under the principles of sec_702 in accordance with the partners’ interest in c at the time the sec_29 credits are allowed for purposes of the sec_29 credit a partner’s interest in c is determined based on a valid allocation of the receipts from the sale of the sec_29 credit synthetic_fuel provided the facility was placed_in_service within the meaning of sec_29 prior to date the facility will continue to be treated as placed_in_service before date if sold to a new owner after such date or if c terminates within the meaning of sec_708 the date that the facility was placed_in_service for purposes of sec_29 therefore provided the facility was placed_in_service prior to date within the meaning of sec_29 c will be allowed the sec_29 credit for synthetic_fuel produced by the facility and sold to unrelated persons before date any sec_29 credit allowed to c may be passed through to and allocated among b’s purchase of the facility and subsequent contribution to a will not affect the conclusions drawn and rulings given in this letter are subject_to the requirements that the taxpayer i maintain sampling and quality control procedures that conform to astm or other appropriate industry guidelines at the facility or facilities that are the subject of this letter ii obtain regular reports from independent laboratories that have analyzed the fuel produced in such facility or facilities to verify that the coal used to produce the fuel undergoes a significant chemical change and iii maintain records and data underlying the reports that taxpayers obtain from independent laboratories including raw ftir data and processed ftir data sufficient to document the selection of absorption peaks and integration points plr-133440-03 except as specifically ruled upon above we express no opinion concerning the federal_income_tax consequences of the transaction described above specifically we express no opinion on when the facility was placed_in_service for purposes of sec_29 this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent temporary or final regulations pertaining to one or more of the issues addressed in this ruling have not yet been adopted therefore this ruling may be modified or revoked by the adoption of temporary or final regulations to the extent the regulations are inconsistent with any conclusion in this ruling see dollar_figure of revproc_2002_1 i r b however when the criteria in dollar_figure of revproc_2002_1 are satisfied a ruling is not revoked or modified retroactively except in rare or unusual circumstances in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to a's authorized representatives copy for sec_6110 purposes enclosure cc sincerely s joseph h makurath senior technician reviewer office of associate chief_counsel passthroughs special industries


t c summary opinion united_states tax_court deborah y and donald j everhart petitioners v commissioner of internal revenue respondent docket no 2897-03s filed date deborah y and donald j everhart pro sese laurie a nasky for respondent goldberg special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect at the time the petition was filed the decision to be entered is not reviewable by any other court and this opinion should not be cited as authority unless otherwise indicated subsequent section references are to the internal_revenue_code in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure respondent determined a deficiency in petitioners’ federal_income_tax of dollar_figure and an accuracy-related_penalty in the amount of dollar_figure pursuant to sec_6662 for the taxable_year after a concession by petitioners the issues for decision are whether petitioners failed to report income received by petitioner donald j everhart from ronald muhammad for contracting work and whether petitioners are liable for an accuracy-related_penalty in the amount of dollar_figure pursuant to sec_6662 for the taxable_year background some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference petitioners resided in chicago illinois on the date the petition was filed in this case petitioners timely filed a federal joint income_tax return for the taxable_year during taxable_year donald j everhart petitioner was a contractor licensed by the city of chicago petitioner was retained in that capacity by ronald muhammad mr muhammad to perform construction services at rental property owned by mr muhammad 1petitioners conceded that they failed to include in gross_income for taxable_year dollar_figure of interest_income to do the necessary repairs mr muhammad obtained a home rehabilitation loan of dollar_figure from wells fargo home mortgage inc petitioner was the general contractor of record on this home rehabilitation loan wells fargo home mortgage inc issued the proceeds of mr muhammad’s home rehabilitation loan on date and date by checks jointly payable to both mr muhammad and petitioner in the amounts of dollar_figure and dollar_figure respectively both mr muhammad and petitioner endorsed these checks mr muhammad deposited the proceeds from these checks into his bank account at shore bank wells fargo home mortgage inc also issued to petitioner a form 1099-misc miscellaneous income for taxable_year reflecting a distribution to petitioner of nonemployee compensation in the amount of dollar_figure at the beginning of their work relationship petitioner and mr muhammad did not enter into any contract outlining the scope of the work to be performed petitioner testified he and mr muhammad entered into a contract later in taxable_year however no contract was offered into evidence at trial petitioner received and negotiated the following checks totaling dollar_figure drawn on mr muhammad’s shore bank account payable to petitioner date check memo amount tax from wells fargo dumpster dollar_figure big_number roof final payment for heating soffit for kitchen roofing material front roof shingles roofing rubbish closet drywall wiring intercom recess lighting big_number 1st ½ payment for concrete for basement big_number copping chps bricking of 1st floor big_number plumbing roofing labor roof bal big_number final payment concrete basement big_number big_number insulation drywall flashing big_number electrical drywall carpentry total dollar_figure roofing labor material drywall installation electrical labor drywall tax petitioner also maintained a checking account with shore bank during taxable_year during the period from date through date petitioner made deposits in his shore bank account as follows date amount dollar_figure big_number total dollar_figure during the period from date through date petitioner wrote checks totaling dollar_figure drawn on his shore bank account as follows date check description payable to deborah everhart payable to cash memo roof material payable to cash memo material plumb payable to cash memo material memo expense payable to cash memo material payable to cash memo labor payable to cash payable to cash memo expense payable to capital one memo collection sec_11 payable to cash memo expense payable to deborah everhart payable to julius jone sec_11 payable to kozmiwski memo mckey pogue memo apple sec_11 payable to cash memo material payable to cash payable to deborah everhart memo labor payable to cash payable to cash payable to cash memo expense memo expense memo expense memo expense payable to cash payable to cash payable to cash payable to cash payable to cash payable to cash payable to cash memo expense payable to cash payable to cash memo expense amount dollar_figure payable to cash payable to deborah y everhart memo donald everhart loan payable to cash payable to cash payable to cash payable to cash payable to cash total dollar_figure petitioner also signed a document entitled final waiver of lien which was dated date this document acknowledged petitioner’s receipt of dollar_figure for labor and material furnished for the renovation of mr muhammad’s rental property by notice_of_deficiency respondent determined that petitioners failed to report on their federal_income_tax return for the taxable_year income earned by petitioner received from mr muhammad for contracting work in the amount of dollar_figure respondent also determined that petitioners are liable for an accuracy-related_penalty in the amount of dollar_figure pursuant to sec_6662 for the taxable_year discussion in general the commissioner’s determination set forth in a notice_of_deficiency is presumed correct and the taxpayer bears the burden of showing that the determination is in error rule a 290_us_111 as one exception to this rule sec_7491 places upon the commissioner the burden_of_proof with respect to any factual issue relating to liability for tax if the taxpayer maintained adequate_records satisfied the substantiation requirements 2this amount was determined by the form 1099-misc miscellaneous income from wells fargo home mortgage inc which reported nonemployee compensation of dollar_figure less self employment_tax deduction of dollar_figure cooperated with the commissioner and introduced during the court_proceeding credible_evidence with respect to the factual issue although neither party alleges the applicability of sec_7491 we conclude that the burden_of_proof has not shifted to respondent with respect to the unreported income respondent has the burden of production with respect to the accuracy-related_penalty however sec_7491 116_tc_438 therefore petitioner bears the burden of showing that the deposits made to his account checks cashed and checks written on his account were not includable in his income as determined by respondent bank_deposits have been held to be prima facie evidence of income 87_tc_74 64_tc_651 affd 566_f2d_2 6th cir unreported income as stated previously respondent determined that petitioners failed to report income in tax_year in the amount of dollar_figure however petitioner argues that such payments were made pursuant to a contractor relationship he had with mr muhammad and therefore petitioner claims he was merely a conduit between mr muhammad and the subcontractors that petitioner hired to perform the work sec_61 defines gross_income as all income from whatever source derived unless otherwise provided the supreme court has consistently given this definition of gross_income a liberal construction in recognition of the intention of congress to tax all gains except those specifically exempted 348_us_426 see also 716_f2d_693 9th cir all realized accessions to wealth are presumed taxable_income unless the taxpayer can demonstrate that an acquisition is specifically exempted from taxation revg 79_tc_398 however pursuant to sec_162 a taxpayer may deduct ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on his or her trade_or_business a taxpayer is engaged in a trade_or_business if the taxpayer is involved in the activity with continuity and regularity and with the primary purpose of making a profit 480_us_23 893_f2d_656 4th cir affg 91_tc_686 petitioner has the burden of proving that he was engaged in a trade_or_business and as stated previously that the deposits made to his account checks cashed and checks written on his account were not includable in his income as determined by respondent rule a 503_us_79 292_us_435 welch v helvering supra petitioner does not deny that he received the payments from mr muhammad in the amounts determined by respondent in any event substantial evidence was presented which leads us to the conclusion that petitioner received the amounts calculated by respondent petitioner asserts that such payments were not income to him but advances made by mr muhammad to pay subcontractors and purchase materials for the renovation of mr muhammad’s rental property petitioner also asserts that he received the payments as agent for mr muhammad petitioner contends that he functioned merely as a conduit through which mr muhammad purchased labor and materials for the renovation project with the result that the payments received from mr muhammad are not taxable to him petitioner does not clearly explain the legal basis for this position and he cites no cases in support thereof we would agree that a taxpayer need not treat as income moneys which he did not receive under a claim of right which were not his to keep and which he was required to transmit to someone else as a mere conduit see 56_tc_530 affd 492_f2d_286 7th cir see also 5_tc_691 parker v commissioner tcmemo_1985_263 on the other hand if a taxpayer receives moneys under a claim of right and without restriction or limitation as to the disposition of the moneys then the taxpayer has received income even though it may still be claimed that he is not entitled to retain the money and even though he may be liable to restore its equivalent see 286_us_417 assuming petitioner was correct in his conduit or agency argument he would still have to substantiate that the deposits made to his account checks cashed and checks written on his account were not includable in his income however the record as a whole in the present case leads to the inescapable conclusion that petitioner was a self-employed contractor licensed by the city of chicago during taxable_year and that petitioner was the general contractor of record on the wells fargo home mortgage inc rehabilitation loan therefore it is unnecessary to consider petitioner’s conduit or agency argument sec_162 allows a deduction for ordinary and necessary business_expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business to be ordinary the transaction that gives rise to the expense must be of a common or frequent occurrence in the type of business involved 308_us_488 to be necessary an expense must be appropriate and helpful to the taxpayer’s business welch v helvering supra pincite deductions are a matter of legislative grace and the taxpayer bears the burden of proving that he is entitled to any deduction claimed rule a new colonial ice co v helvering supra this includes the burden of substantiation 65_tc_87 affd per curiam 540_f2d_821 5th cir sec_6001 and the regulations promulgated thereunder require taxpayers to maintain records sufficient to permit verification of income and expenses as a general_rule if the trial record provides sufficient evidence that the taxpayer has incurred a deductible expense but the taxpayer is unable to adequately substantiate the precise amount of the deduction to which he or she is otherwise entitled the court may estimate the amount of the deductible expense and allow the deduction to that extent bearing heavily against the taxpayer whose inexactitude in substantiating the amount of the expense is of his or her own making 39_f2d_540 2d cir however in order for the court to estimate the amount of an expense the court must have some basis upon which an estimate may be made 85_tc_731 without such a basis any allowance would amount to unguided largesse 245_f2d_559 5th cir it appears from the testimony presented at trial that petitioner and mr muhammad had a loose work relationship in which mr muhammad would supply sums of money to petitioner in the form of cash and checks petitioner would then use these moneys to pay off expenses_incurred in the renovation of mr muhammad’s rental property any surplus or net profit was used to pay petitioner’s personal debts both petitioner and mr muhammad testified that they had receipts which could substantiate the expenditures of the renovation project however such receipts were lost or stolen neither petitioner nor mr muhammad attempted to contact third parties to receive duplicate receipts and neither individual attempted to reconstruct a list of such expenditures at trial petitioner elicited testimony from robert blacher mr blacher who was a subcontractor who did concrete work in the renovation of mr muhammad’s rental property mr blacher testified that he received payment of dollar_figure for his services from petitioner petitioner also elicited testimony from rafiq ahmad mr ahmad who did drywall work in the renovation project mr ahmad testified that he received payment of approximately dollar_figure for his services from petitioner petitioner offered into evidence copies of the aforementioned checks and applicable bank statements petitioner also testified that these payments were made for the renovation project petitioner also testified that the proceeds from these payments were used to pay for the labor and materials incurred in the renovation project based upon all of the facts and circumstances of this case we find that petitioner’s general contracting business had gross_income of dollar_figure in taxable_year we further find that petitioner has substantiated business_expense deductions relating to his general contracting business of dollar_figure for taxable_year as a result petitioners realized net_income of dollar_figure for the taxable_year in issue from petitioner’s general contracting business accuracy-related_penalty as stated previously respondent determined that petitioners are liable for an accuracy-related_penalty pursuant to sec_6662 with respect to the underpayment attributable to the unreported income of petitioner sec_7491 provides that the commissioner shall have the burden of production in any court_proceeding with respect to the liability of any individual for any penalty addition_to_tax or additional_amount specifically sec_7491 which wa sec_3it is possible that petitioner has incurred business_expense deductions in excess of this amount however due to petitioner’s lack of clear records petitioner is unable to substantiate further deductions and we are unable to estimate any further deductions under the rule in 39_f2d_540 2d cir enacted by the internal_revenue_service restructuring and reform act of rra publaw_105_206 sec a 112_stat_726 provides as follows sec_7491 penalties --notwithstanding any other provision of this title the secretary shall have the burden of production in any court_proceeding with respect to the liability of any individual for any penalty addition_to_tax or additional_amount imposed by this title as previously stated sec_7491 is effective with respect to court proceedings arising in connection with examinations commencing after date rra sec c 112_stat_727 there is no dispute that the examination in the present case commenced after date sec_6662 imposes a 20-percent penalty on the portion of an underpayment attributable to any of various factors one of which is negligence or disregard of rules or regulations sec_6662 negligence includes any failure to make a reasonable attempt to comply with the provisions of the internal_revenue_code including failure to keep adequate books_and_records or to substantiate items properly sec_6662 sec_1_6662-4 income_tax regs sec_6664 provides that the penalty under sec_6662 shall not apply to any portion of an underpayment if it is shown that there was reasonable_cause for the taxpayer’s position and that the taxpayer acted in good_faith with respect to that portion the determination of whether a taxpayer acted with reasonable_cause and in good_faith is made on a case-by-case basis taking into account all the pertinent facts and circumstances sec_1 b income_tax regs the most important factor is the extent of the taxpayer’s effort to assess his proper tax_liability for the year id it is clear that petitioner was negligent with respect to the dollar_figure that was received by him through his general contracting business petitioner did not keep adequate books_and_records or otherwise substantiate the dollar_figure as required by the internal_revenue_code thus the amount of the accuracy- related penalty applicable to petitioners’ unreported income for taxable_year requires computation from the foregoing reviewed and adopted as the report of the small_tax_case division to reflect petitioners’ concessions and our resolution of the disputed matters decision will be entered under rule


department of the treasury int ernal revenue service washington d c o f f i c e o f c h i e f c o u n s e l date number release date cc psi spr-110119-00 uilc internal_revenue_service national_office chief_counsel_advice memorandum for associate area_counsel lmsb from william c sabin jr senior technician reviewer cc psi branch subject lease_stripping theory chief_counsel_advice is not binding on examination or appeals and is not a final case determination this document is not to be used or cited as precedent disclosure statement chief_counsel_advice is open to public inspection pursuant to the provisions of sec_6110 the provisions of sec_6110 require the service to remove taxpayer identifying information and provide the taxpayer with notice of intention to disclose before it is made available for public inspection sec_6110 and i sec_6110 also authorizes the service to delete information from chief_counsel_advice that is protected from disclosure under u s c sec_552 b and c before the document is provided to the taxpayer with notice of intention to disclose only the national_office function issuing the chief_counsel_advice is authorized to make such deletions and to make the redacted document available for public inspection accordingly the examination appeals or counsel recipient of this document may not provide a copy of this unredacted document to the taxpayer or their representative the recipient of this document may share this unredacted document only with those persons whose official tax_administration duties with respect to the case and the issues discussed in the document require inspection or disclosure of the chief_counsel_advice hypothetical a a corporation owns depreciable equipment subject_to pre-existing user leases a and b a thinly capitalized partnership engage in a sale-leaseback of the equipment b issues a note to a for the equipment the payments due under the terms of b’s note approximate the rental payments due under the lease a retains spr-110119-00 the option to buy the equipment back at the end of the lease_term and also retains all risks associated with the leased equipment the residual_value of the equipment at the end of the lease_term is minimal b has a majority percent partner c who is exempt from united_states taxation b subsequently sells the rent receivables from a to a bank for cash thereby accelerating the income due under the lease b allocates to c the tax-exempt partner c’s respective share of the accelerated income b uses the cash to pay off its note to a d a corporation is a subsidiary of e also a corporation e is the parent of a consolidated_group which includes d b contributes the equipment to d in exchange for preferred d stock in a purported sec_351 transaction at the same time e transfers property to d in exchange for additional d common_stock the amount of the property e transfers to d is sufficient for e to count as a transferor in the purported sec_351 transaction since d is a member of the e consolidated_group the e consolidated_group is entitled to utilize the depreciation_deductions generated by the depreciable equipment such depreciation_deductions will be limited to adjusted_basis of the property interest acquired by d in the purported sec_351 transaction sec_167 law and analysis in order to determine the tax consequences of the purported sec_351 transaction it is necessary to characterize the nature of the interest transferred to d by b as well as the amount of basis properly allocable to such property in the sale_and_leaseback transaction prior to the income strip the parties transferred the equipment as a whole after the income strip however the equipment bifurcated into two distinct time-based property interests by analogy to property law these interests can be viewed as a term-of-years interest followed by a remainder_interest at the time of the lease_strip b realized the full benefit of the leasehold for the duration of the lease period because b has accelerated and received all the income associated with the lease since the lease covers nearly the entire useful_life of the property the remainder_interest is of minimal value in terms of the leasehold period b holds nothing of value that can be transferred because the remainder value is negligible accordingly b is transferring nothing greater than a remainder_interest to d in determining the tax consequences of b’s transfer of the remainder_interest to d it is necessary to allocate basis to both the term of years and the remainder_interest initially b’s basis in the equipment is equal to its cost sec_1012 at the point the equipment is bifurcated into a term-of-years interest and a remainder_interest the purchase_price must be allocated between the two interests in order to determine the basis of each such allocation is generally based on the relative fair_market_value of the assets 84_tc_476 although the burden would be on the taxpayer to prove the relative fair spr-110119-00 market_value of each asset it would appear that under the facts presented in this paper since the residual_value of the remainder_interest is minimal b’s basis in it would be quite low furthermore if d acquired the remainder_interest in a valid sec_351 transaction d’s basis in such property would be the same as b’s basis in such property sec_362 a as noted above the e group’s depreciation deduction for the remainder_interest would be limited to this adjusted_basis sec_167 this treatment is supported by analogous case law for example the supreme court has recognized that oil_and_gas reserves are a wasting asset and the corresponding depletion is akin to the depreciation of machinery 310_us_404 in 287_us_551 the supreme court addressed the issue of the right of a transferor of a mineral lease to retain a depletion_allowance associated with the lease after the purported sale the transferor had retained a right to dollar_figure to be paid out of the oil produced and saved from the field id pincite in addition to reporting income on its tax_return from this contract the transferor deducted a depletion_allowance based on the value of the oil in place id pincite the commissioner denied the deduction based upon the conclusion that the transfer of the lease was a sale and the transferor no longer had any ownership that would allow it to take a depletion_allowance id the supreme court disagreed and allowed the depletion_allowance on the theory that despite the transfer of the legal_interest in the minerals the transferor had retained a right to share in the oil produced later the supreme court elaborated that in palmer the stipulation for royalty out of oil operated to save to them an economic_interest in the oil sufficient to entitle them to deduct from their income derived from the oil an allowance for depletion if palmer had retained no interest in the oil he would have been entitled to no deduction on account of depletion ownership was essential 301_us_655 with the lease_strip a future stream of income has been reserved to the transferor b who has accelerated it and allocated it to c its tax-exempt partner as with the transferor of the mineral lease it is b’s retained ownership that leads to the conclusion that b and not e through the consolidated_group should receive the depreciation_deductions similarly in revrul_77_413 1977_2_cb_298 the service ruled that the amount_realized from a sale of real_property does not include the value of a 20-year possessory interest retained in the property and that the adjusted_basis of the property should be allocated between the interests sold and the interest retained in the proportions that their respective market values bear to the fair_market_value of the entire property the ruling states that whether the seller who has retained a term of years has done so as an owner depends on whether the seller has retained the benefits_and_burdens_of_ownership spr-110119-00 in 46_tc_363 acq 1967_2_cb_1 the tax_court addressed the question of whether a petitioner realized rental income when it purchased a building but allowed the seller to retain occupancy for ½ years rent-free although the court ruled that the seller did not retain ownership it did so based upon an analysis of the benefits_and_burdens_of_ownership id pincite see also 18_tc_405 the term sale is given its ordinary meaning and is generally defined as a transfer of the ownership of property for money or for a promise to pay money 380_us_563 a transaction is a sale if the benefits_and_burdens_of_ownership have passed to the purported purchaser 106_tc_237 77_tc_1221 courts have considered the following factors relevant in determining whether the benefits_and_burdens_of_ownership passed a b c d e f g h whether the transaction was treated as a sale 54_tc_1215 acq 1971_2_cb_3 whether the obligors on any notes were notified of the transfer of the notes id which party serviced the notes id 51_tc_1049 acq c b xxv whether payments to the transferee corresponded to collections on the notes united surgical t c pincite town country t c pincite whether the transferee imposed restrictions on the operations of the transferor that are consistent with a lender-borrower relationship united surgical t c pincite 319_fsupp_441 n d ga which party had the power of disposition 421_f2d_442 5th cir cert_denied 400_us_827 which party bore the risk of loss 426_f2d_115 6th cir cert_denied 400_us_827 which party had the potential for gain united surgical t c pincite town country t c pincite the last two factors are generally the most pivotal determiners however the overall concentration should focus on the economic_substance of the transaction 556_f2d_1107 ct_cl in our hypothetical all the gain has been stripped by b and then allocated to c a meanwhile has retained all the risks associated with the equipment see 88_tc_702 discussing the benefits and burdens test applicable to a spr-110119-00 sale leaseback situation d and e through the consolidated_return have neither the benefits nor burdens of ownership we do not propose moreover that the lease be broken out as a separate amortizable asset that remains with the seller the tax_court has rejected attempts by buyers to separately amortize a favorable lease 33_tc_1048 aff’d 286_f2d_573 4th cir cert_denied 366_us_960 40_bta_768 aff’d f 2nd 7th cir cert_denied 314_us_673 although it is analogous we are not presented with a lease on real_property rather the sale should be seen as a sale of less than a full interest in equipment with a remainder_interest going to the buyer basis should be allocated accordingly additionally although 42_tc_1122 acq 1965_2_cb_4 appears to run counter to these arguments the court did not have this issue squarely before it in apex petitioner sold all of its rental rights to equipment to murdock acceptance corp murdock and thereafter sold the equipment subject_to murdock’s rights in the equipment to equipment inc ei murdock had a right of recourse against petitioner in the event of default by the lessee and all three parties were interrelated id pincite the issues presented to the court were whether the basis should be allocated between the cost_basis of the equipment and the rental or lease rights petitioner had sold or whether the petitioner could allocate its entire basis to the equipment and deduct a loss on its sale of the equipment id pincite the commissioner primarily argued that the sale of the reversionary_interest to ei was a sham and that ei never received the benefit and burdens of ownership id pincite the tax_court however found that there was no lack of substance to the dealings because all three corporations had business activity and purpose and profited independently from the deal id pincite the court found that the petitioner was entitled to use his entire basis and deduct the loss from the sale of the machines the court dismissed the cost_basis allocation theory noting that sec_1_61-6 which provides that when a part of a large property is sold the cost is apportioned among the several parts did not apply as the regulation related to the sale of a tract of land followed by a sale of a portion of it the court did not address the issue of basis allocation to a reservation of a term of years in depreciable equipment because the commissioner did not primarily argue basis allocation and rather urged that ei received no ownership at all we believe that apex is not dispositive of this issue please call if you have any further questions associate chief_counsel passthroughs special industries by william c sabin jr passthroughs special industries branch


third party communication none date of communication not applicable office_of_chief_counsel internal_revenue_service memorandum number release date cc corp b03 ------------------ postf-138950-13 uilc date date to saima ghafoor lb_i hmp e from mark jennings branch chief branch corporate -------------------- attorney branch corporate legend lossco date date date date date ---------------------------------------- ------------------ ------------------ ---------------- ------------------ ---------------------- first investors ----------------------------------------------------------------------------- ------------------------------------------------------------------------------------------ ------------------ investor -------- investor ------------------------------ investor -------------------- postf-138950-13 investor ------------------------------------------------------------------------ a -------------- b ----------- c d e f g h i ------------- ---------- ------------- ------------- --------------- -------------- --------------- this memorandum responds to your request for assistance in the above named case this advice is based on the facts that you have previously sent to us and may not all be reproduced here this advice may not be used or cited as precedent summary since lossco was a loss_corporation at the end of its first taxable_year after formation it is subject_to the loss limitation rules of sec_382 in that year in that year acquisitions of lossco stock occurred on date date date and date the regulations count all stock acquisitions after the first one as a testing_date from which to measure the amount of the percentage of owner shift measured by value caused by the stock acquisition lossco argues that its first three stock acquisitions should be integrated and treated as one acquisition because they were part of a plan to provide the initial capitalization for lossco and they occurred before lossco engaged in any business activity lossco agrees that date was after the start of business activity the change_of_ownership of percent shareholders from each stock acquisition in this case is such that if the acquisition on date is treated separately from those on date sec_1 and date will be a testing_date within the testing_period of date and lossco will have an ownership_change on date but if the stock acquisitions on the three dates are treated as one acquisition_date will not be a testing_date and so date will not be within the testing_period of date and lossco will not have had an ownership_change on date postf-138950-13 issues did lossco experience an ownership_change on date under sec_382 conclusions this memorandum discusses the relevant provisions of sec_382 its legislative_history and its regulations as well as other relevant law the memorandum also provides guidance as to relevant factual development and litigation hazards the memorandum does not make a final recommendation as the inquiry involved is fact dependent facts on date prior to the issuance of any lossco stock lossco entered into an agreement the agreement with first investors to sell them convertible preferred_stock this convertible preferred_stock was issued on date for dollar_figurea this amount was deposited in a money market account the next day the agreement gave investor and investor an option to purchase convertible preferred_stock on date lossco issued restricted common_stock to four employees consultants pursuant to employment agreements entered into three to four weeks before date these four individuals are unrelated to the first investors and not involved in the agreement date will not be mentioned hereafter since the relative value of the common_stock to the convertible preferred_stock is so low it turned out to have had no effect on when lossco had an ownership_change on date pursuant to the option in the agreement lossco issued b shares of convertible preferred_stock to investor in exchange for dollar_figurec if investor had not exercised its option to purchase convertible preferred_stock then the first investors would have been obligated to purchase percent of the amount of stock investor purchased on date on date pursuant to the option in the agreement investor purchased d shares for dollar_figuree lossco was a loss_corporation for the tax_year that included date through date lossco claims that date was the date it commenced business operations on date f shares of convertible preferred_stock were issued to new or existing percent shareholders for dollar_figureg investor and investor two new percent shareholders purchased h shares of this total for dollar_figurei postf-138950-13 law and analysis sec_382 generally limits the amount the sec_382 limitation of a loss corporation's loss_carryovers and built-in losses that can be offset against the corporation's taxable_income in years after an ownership_change the sec_382 limitation is defined by sec_382 as the loss corporation's value before the ownership_change multiplied by the applicable long-term tax-exempt_bond rate defined in sec_382 a loss_corporation is defined by sec_382 as a corporation with a net_operating_loss or net_unrealized_built-in_loss as defined by sec_382 the pivotal event that triggers the operation of sec_382 is an ownership_change which occurs under sec_382 whenever immediately after i an owner shift involving a percent shareholder or ii any equity_structure_shift the percentage of stock of the loss_corporation owned by one or more percent shareholders has increased by more than percentage points over the lowest percentage of stock of the loss_corporation or any predecessor_corporation owned by such shareholders at any time during the testing_period under sec_382 preferred_stock which is convertible into another class is considered stock for purposed of sec_382 as provided in sec_382 determinations of the percentage of stock held by any person is made on the basis of value under sec_382 the testing_period is generally the three-year period ending on the day of any owner shift involving a percent shareholder or equity_structure_shift for an ownership_change to occur there must be an increase of percentage points by one or more percent shareholders the increase of each percent shareholder is determined separately comparing the percent shareholder’s percentage of stock ownership immediately after the close of the testing_date with that shareholder’s lowest percentage ownership during the testing_period all increases during the testing_period are aggregated to determine whether the percentage_point increase has occurred during the testing_period sec_1_382-2t sec_382 states that a testing_period shall not begin before the earlier of the first day of either the first taxable_year from which there is a carryforward of a loss or of an excess_credit to the first post-change_year or the taxable_year in which the transaction being tested occurs similarly sec_1_382-2t states that the testing_period may begin on the first day of the first year in which a loss occurs under sec_1_382-2 a loss_corporation is required to determine whether an ownership_change has occurred immediately after any owner shift or issuance or transfer each date on which a loss_corporation is required to make a determination of whether an ownership_change has occurred is referred to as a testing_date all computations of increases in percentage ownership are to be made as of the close of the testing_date under these facts convertible preferred_stock was first issued on date and convertible postf-138950-13 preferred_stock was issued on date and other dates up to and including date if date is a testing_date because it is viewed separately from date which would mean the testing_period for date would include date an ownership_change will have occurred on date if instead date is not a testing_date because it is viewed as integrated with date as part of the initial capitalization of lossco then the integrated transaction could not be either an owner shift or equity_structure_shift as defined in sec_1_382-2t because at the beginning of the transaction lossco had no percent shareholders from which to measure whether a percent increase in percentage of stock ownership had occurred thus the testing_period for date would not include date and lossco would not have an ownership_change on date for example assume stock of a start-up was issued on two different dates two months apart by a loss_corporation where both issuances of stock were part of the initial capitalization of the loss_corporation and they both occurred before business activity had started these facts do not present the abuse of trafficking in net_operating_loss carryovers that sec_382 was designed to prevent congress was concerned with situations where the shareholders who bore the economic burden of nols no longer hold a controlling_interest in the corporation h rept pincite 1986_3_cb_1 in this example the shareholders who purchased stock on the two different dates were both the initial investors under the taxpayer’s plan for the corporation’s initial capitalization and both equally bore the economic burden of the nols arising after business activity commenced the purpose of the statute would not have been served by treating the second acquisition as a testing_date within the testing_period of a subsequent testing_date litigation hazards --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- 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--------------------------------------------------------------------------------------------------------------------- postf-138950-13 ----------------------------------------------------------------------------------------------------- please call if you have any questions