t c memo united_states tax_court wayne a mcfadden petitioner v commissioner of internal revenue respondent docket no filed date john m walker for petitioner h clifton bonney jr for respondent memorandum findings_of_fact and opinion beghe judge respondent determined the following deficiencies and accuracy-related_penalties with respect to petitioner’s federal_income_tax accuracy-related_penalty year deficiency sec_6662 a dollar_figure dollar_figure big_number dollar_figure unless otherwise indicated all section references are to the internal_revenue_code in effect for the years at issue and all rule references are to the tax_court rules_of_practice and procedure after concessions the issues for decision are whether petitioner correctly computed his basis in a parcel of real_property he acquired and sold at a loss in or in the alternative is entitled to a nonbusiness_bad_debt deduction in for a loan to petitioner’s daughter and her former boyfriend we hold petitioner overstated his basis and the resulting loss on the sale of the property that he computed on his return and is entitled to a nonbusiness_bad_debt deduction findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and attached exhibits are incorporated by this reference petitioner resided in foster city california when he filed the petition in this case petitioner is an attorney licensed to practice law in the state of california he maintains an office in san mateo california under the name law offices of wayne a mcfadden petitioner’s practice includes real_estate law family law and civil litigation petitioner has two daughters stephanie and kari mcfadden and three sons johnathan rob and christian mcfadden on date petitioner established a profit-sharing_plan entitled the law offices of wayne a mcfadden profit sharing plan the profit-sharing_plan or the plan petitioner was the fiduciary and sole beneficiary of the plan the record does not indicate the times and amounts of petitioner’s contributions to the plan in petitioner caused the plan to make separate loans to stephanie and johnathan the loans to enable each of them to make a downpayment on a townhouse in hercules california fach loan was for dollar_figure with an interest rate of percent petitioner viewed the loans as business transactions and required stephanie and johnathan each to execute a note secured_by a first deed_of_trust on the townhouse that she or he purchased stephanie and johnathan made regular payments on their loans in stephanie asked petitioner for another loan at the time she was dating david payne david a plumber who lived - in atascadero california atascadero is approximately hours south of hercules stephanie lived in hercules while working as an accountant for a construction company and would travel to atascadero on weekends to see david stephanie and david had become interested in purchasing a particular residential property in atascadero but neither had the financial ability to do so they wanted to live in the house refurbish it and eventually resell it in addition to his plumbing skills david had experience framing houses stephanie and david felt that with david’s craft skills and experience they could make most of the desired improvements to the house themselves stephanie asked petitioner if he would lend her and david the funds they needed to purchase and improve the property petitioner as the fiduciary of his profit-sharing_plan was willing to lend funds from his plan to stephanie and david petitioner viewed the loan as an appropriate investment for his profit-sharing_plan and was diligent in reviewing the feasibility of stephanie and david’s proposal petitioner inquired about the location and condition of the property and the nature and extent of the proposed improvements petitioner consulted real_estate agents to confirm the adequacy of the security of a potential loan he believed that stephanie had real_estate talent and that david’s craft skills provided an opportunity to enhance the - - value of the property at a minimal labor cost stephanie and david told petitioner that david would make approximately percent of the improvements in exchange for dollar_figure per month petitioner concluded that the loan to stephanie and david would give the plan an opportunity to earn a percent return petitioner agreed to lend stephanie and david funds from his profit-sharing_plan for part of the purchase_price and all the subsequent improvements to the atascadero property in date petitioner as the plan’s fiduciary made the first in a series of loans totaling dollar_figure to stephanie and david from his profit-sharing_plan the purpose of the loans was to make the downpayment on residential property in atascadero california and postacquisition improvements the loans were made over an 18-month period beginning in date and ending in date the amounts of the loans varied from dollar_figure to dollar_figure petitioner believed that his only recourse in the event of default would be to the atascadero property on date stephanie and david purchased a single-family residence in atascadero california for dollar_figure with stephanie acquiring an 80-percent interest and david a percent interest the residence had two bedrooms three bathrooms and was situated on acres of land stephanie and david financed the purchase of the atascadero property by obtaining a dollar_figure loan from the great western bank the great -- - western loan in exchange for a note secured_by a first deed_of_trust to the atascadero property the balance of the purchase_price was financed by the loans to stephanie and david from petitioner’s profit-sharing_plan david moved into the residence on the atascadero property shortly after the purchase and immediately began making improvements stephanie continued to work and live in hercules but traveled to atascadero on the weekends to be with david and to help him with the improvements when stephanie and david acquired the property stephanie intended to reside there full time when her financial situation improved at no time did stephanie become a full-time resident of the atascadero property the improvements made by stephanie and david included paving the driveway converting the existing carport to living space building a new carport bathroom jacuzzi and master bedroom with a full bath and adding two fireplaces david was paid dollar_figure per month out of the funds borrowed from petitioner and as expected made approximately percent of the improvements by all accounts the craftsmanship on the residence was well regarded the improvements were completed after approximately year and the property was listed for sale shortly thereafter in stephanie and david first listed the atascadero property for sale with a real_estate agent on date at an asking - price of dollar_figure the asking price remained dollar_figure for approximately months but failed to generate any offers stephanie and david reduced the price to dollar_figure in approximately date despite the reduction the atascadero property still failed to generate any offers stephanie and david’s real_estate agent attributed the lack of interest toa soft market and was of the opinion that a further reduction to dollar_figure would be necessary to generate any offers stephanie and david were unwilling to reduce the price further and took the property off the market in date with the hope that market conditions would improve on date stephanie and david consolidated the loans hereinafter the atascadero loan by executing a note secured_by second deed_of_trust in favor of petitioner’s profit-- sharing plan the note states that stephanie and david are individually jointly and severally liable for the outstanding balance of dollar_figure plus percent interest from date until paid compounded annually the note was due months after the date of the note date or upon the sale transfer conveyance or encumbering of the property the note recites that the holder may proceed against the makers independently the note is secured_by a second deed_of_trust and assignment of rents to the atascadero property - stephanie and david made unsuccessful attempts to sell the atascadero property at different times over the next years stephanie and david leased the property to tenants during some portions of the period that they owned the property david lived on the atascadero property during periods he and stephanie could not find tenants in stephanie and david ended their relationship at some point during or before stephanie sold her townhouse in hercules and built a home in oakland california in which she resided while stephanie lived in oakland her mother experienced health problems and moved in with her in respondent examined petitioner’s profit-sharing_plan and trust respondent determined that the loans to stephanie and johnathan and the atascadero loan to stephanie and david were prohibited_transactions under sec_4975 because they were made to disqualified persons as defined by sec_4975 respondent reguired stephanie and johnathan to correct the prohibited loans by returning the outstanding loan balances to the plan by date and that they each pay a 5-percent excise_tax and interest johnathan and stephanie repaid the outstanding balances of their loans by date with respect to the atascadero loan respondent offered to allow the transaction to be corrected in either of two ways - first the outstanding loan principal could be returned to the plan plus the interest the plan would have earned in all of and the first day of respondent determined that the interest should be percent the rate historically earned by the plan respondent calculated the outstanding principal plus interest on the atascadero loan to be dollar_figure respondent computed this figure by adding the principal of the atascadero loan dollar_figure to the dollar_figure outstanding balance of stephanie’s loan the interest on the outstanding amount as determined by respondent was dollar_figure the total amount required to be returned to the plan on date for correction was dollar_figure in the alternative respondent offered to allow petitioner to take an early deemed_distribution of stephanie and david's note on date and agree to pay a 10-percent additional tax for an early distribution prior to age under sec_72 respondent determined that the amount of the distribution should be dollar_figure which would have to be reported as income on petitioner’s federal_income_tax return the record does not indicate how respondent calculated the value of the note secured_by the second deed_of_trust in exchange for petitioner’s taking the deemed_distribution of the note and paying the sec_72 additional tax respondent agreed that petitioner would not be liable for any other taxes interest or penalties with respect -- - to the loan to stephanie and david stephanie would be required to pay a 5-percent excise_tax and interest totaling dollar_figure respondent informed petitioner that no closing_agreement would be executed if he accepted the terms of either offer according to the examining agent it was not the practice of respondent to use closing agreements to resolve profit-sharing_plan disputes except in cases of fraud and when a case is selected for review a closing_agreement would not be used to resolve the dispute with petitioner because it did not fall within either exception the dispute would be resolved when petitioner performed according to the terms of the agreement petitioner agreed to a deemed_distribution pursuant to the terms offered by respondent on date as the profit-- sharing plan’s fiduciary petitioner assigned stephanie and david’s note secured_by the second deed_of_trust to the atascadero property to himself as beneficiary of the plan petitioner wa sec_58 years old at the time of the distribution in the beginning of stephanie accepted a job in dallas texas stephanie lived in a rented apartment in texas for more than half of continued to make the mortgage payments on her home in oakland where her mother resided and made payments on the great western loan on the atascadero property the monthly payments on the great western loan were dollar_figure david did not make any payments on the great western loan on date petitioner’s accountant notified him the amount of the deemed_distribution was incorrect because stephanie had repaid the outstanding balance on her loans prior to date according to petitioner’s accountant the amount of the distribution should have been reduced by dollar_figure from dollar_figure to dollar_figure respondent agreed with this reduction by summer stephanie was experiencing financial difficulties from having to make monthly payments stephanie informed petitioner that she could no longer continue making payments on the great western loan and was going to default petitioner became concerned that he would lose his security_interest in the atascadero property if great western foreclosed on the first deed_of_trust petitioner’s fears were aggravated when he discovered a state tax_lien on the atascadero property when he asked stephanie about her other assets out of which his note could be satisfied stephanie told him she had nothing petitioner suggested to stephanie that she was morally obligated to sell the oakland home to satisfy his note during their conversations petitioner learned that stephanie was contemplating filing for bankruptcy protection petitioner consulted a bankruptcy lawyer who advised that any gain from a sale of the oakland home would be exempt from stephanie’s creditors petitioner also had conversations with david about the debt petitioner felt that david honestly wanted the loan to be paid but concluded that david was not in a position to make payments in date after consulting with a real_estate agent about the value of the atascadero property petitioner accepted a deed in lieu of foreclosure to the atascadero property from david and stephanie to avoid losing his security_interest the deed states that it is in full satisfaction of the obligations secured_by the first deed_of_trust in favor of great western the deed was executed by david on date and by stephanie on date the fair_market_value of the atascadero property was dollar_figure at the time the deed was executed the outstanding balances on the loans from great western and petitioner’s profit-sharing_plan were dollar_figure and dollar_figure respectively at the time the deed was conveyed to petitioner neither stephanie nor david had made any principal payments on the atascadero loan petitioner did not pursue a judgment in the california courts for the balance of the loan because he believed that california’s antideficiency statute section 580b of the california civil procedure code precluded any recovery petitioner made the monthly payments on the great western loan from date through date petitioner paid - - the earthgquake and homeowner’s insurance and the property taxes on the atascadero property in date on date petitioner sold the atascadero property to bryan dunnivan for dollar_figure mr dunnivan took the property subject_to the great western first deed_of_trust and gave petitioner a note for dollar_figure secured_by a deed_of_trust to the atascadero property on date stephanie sold her oakland home in stephanie also purchased a house in dallas texas which she sold in for a gain of dollar_figure stephanie earned dollar_figure and dollar_figure in and respectively on his federal_income_tax return petitioner reported the dollar_figure early distribution in gross_income and calculated a tax of dollar_figure for an early distribution under sec_72 petitioner claimed a dollar_figure short-term_capital_loss from the sale of the atascadero property petitioner calculated a dollar_figure basis in the property consisting of dollar_figure the amount owed him by stephanie and david when he took the deed in lieu of foreclosure plus dollar_figure the amount outstanding on the note held by great western petitioner acknowledges but does not explain the dollar_figure difference between the basis he claimed on his return dollar_figure and the sum of the two amounts he used to calculate the basis dollar_figure dollar_figure dollar_figure petitioner did not claim any deduction for a worthless_debt on his return in response to respondent’s denial of the - - capital_loss on the sale of the atascadero property claimed by petitioner in his return petitioner in his petition claimed a capital_loss deduction for the debt in the amount outstanding on the atascadero loan opinion the issues for decision are whether petitioner correctly calculated his basis in computing a loss on the sale of the atascadero property or in the alternative is entitled to a deduction under sec_166 for a worthless nonbusiness_debt respondent’s determination in the notice_of_deficiency is presumed correct and petitioner bears the burden of proving it 1s incorrect rule a 290_us_111 we hold that petitioner incorrectly calculated his basis in the atascadero property petitioner’s basis in the atascadero property was dollar_figure which entitles petitioner to a dollar_figure loss on the date sale of the property to bryan dunnivan for dollar_figure additionally we hold that petitioner is entitled to a dollar_figure deduction for a nonbusiness_bad_debt under sec_166 for ‘ sec_7491 which is effective for court proceedings that arise in connection with examinations commenced after date places the burden on the commissioner in certain circumstances however petitioner has not contended nor is there evidence that the examination of his return commenced after date or that sec_7491 applies petitioner’s basis in the atascadero property petitioner contends that his basis in the atascadero property for the purpose of computing his loss on its sale to bryan dunnivan was dollar_figure this is the sum of the outstanding balances of the two notes secured_by the property the dollar_figure note held by great western and the dollar_figure note received by petitioner as a distribution from his profit-sharing_plan petitioner is mistaken sec_1012 sets forth the fundamental proposition that the basis_of_property shall be the cost of such property it is well settled that the cost of property to a mortgagee who receives a voluntary conveyance on account of a debt is the property’s fair_market_value see 120_f2d_517 9th cir kohn v commissioner 16t c affd 197_f2d_480 2d cir sargent v commissioner tcmemo_1970_214 it is as if the debtor had sold the property to an outsider for cash and then used the cash to reduce the debt commissioner v spreckels supra any portion of the debt not satisfied by the conveyance may be deducted under sec_166 to the extent the taxpayer can prove worthlessness id kohn v commissioner supra the case at hand differs slightly from the cited cases because it involves a junior lienholder’s acquiring property - encumbered with a senior lien like the cited cases petitioner’s basis in the atascadero property is its fair_market_value but the existence of the great western mortgage requires additional explanation as to how we arrive at the fair_market_value basis in the case at hand petitioner’s recourse_debt owed him by stephanie and david on the atascadero loan was satisfied to the extent of dollar_figure the amount by which the property’s fair market value--dollar_figure--exceeded the great western note secured_by the first deed of trust---dollar_figure---and is a cost of the property to petitioner in addition petitioner took the property subject_to the great western note secured_by the first deed_of_trust which had an outstanding balance of dollar_figure on the date petitioner acquired the property a purchaser’s basis under sec_1012 includes genuine indebtedness to which the property is subject 544_f2d_1045 9th cir affg 64_tc_752 103_tc_501 the genuine nature of the great western loan is not in dispute petitioner respected the debt to which the property was subject and made payments on the great western loan to protect his interest in the atascadero property the outstanding balance on the great western loan---dollar_figure---is included in petitioner’s cost_basis - petitioner’s basis in the atascadero property is dollar_figure which is the fair_market_value as stipulated by the parties on the date he acquired the property and is also the sum of the extent to which his debt was satisfied--dollar_figure--and the balance of the great western loan to which the property was subject--- dollar_figure on date petitioner sold the atascadero property to bryan dunnivan for dollar_figure respondent has not argued that the date sale was not at arm’s length we hold that petitioner is allowed a dollar_figure short-term_capital_loss for on the sale of the property to mr dunnivan sec_166 deduction when a creditor receives property on account of a recourse_debt the debt is considered satisfied to the extent of the value of the property acquired commissioner v spreckels supra pincite the unpaid balance of the debt may be deducted under sec_166 if and to the extent that the taxpayer can establish its worthlessness id kohn v commissioner supra litzenberg v commissioner tcmemo_1988_482 shaheen v commissioner tcmemo_1982_445 sargent v commissioner supra see also sec_1_166-6 income_tax regs in the case at hand when petitioner accepted the deed in lieu of foreclosure the atascadero loan the balance of which was dollar_figure was satisfied to the extent of dollar_figure the amount - - stephanie would have received had she sold the property for cash subject_to the great western first deed_of_trust and paid the cash to petitioner as discussed below petitioner is entitled to treat the excess of the atascadero loan dollar_figure asa worthless nonbusiness_debt under sec_166 sec_166 allows a deduction for any debt that becomes worthless within the taxable_year sec_166 the parties agree that the atascadero loan was a nonbusiness_debt a nonbusiness_debt is any debt that is not created or acquired in connection with a trade_or_business of the taxpayer sec_166 a in the case of nonbusiness_debt the deduction is treated as a loss from the sale_or_exchange of a capital_asset held for not more than year sec_166 b taxpayers seeking to avail themselves of the so-called bad_debt deduction must prove the existence of a bona_fide debt as defined by sec_1_166-1 income_tax regs and that the debt became wholly worthless during the tax_year in which it was deducted sec_1_166-5 income_tax regs on reply brief respondent insinuates that the loan payments from petitioner’s profit-sharing_plan to stephanie and david were gifts rather than bona_fide debt this position is diametrically opposed to the characterization respondent has given the payments since throughout the course of the examination of the profit-sharing_plan and trust the settlement discussions regarding the prohibited_transactions and the trial and subsegquent briefs in the case at hand respondent has repeatedly referred to the funds advanced to stephanie and david as loans and debt respondent has clearly had ample opportunity to take the position that the funds were in reality gifts but waited until the final installment of the briefing schedule respondent cannot unbake the cake by springing this argument on petitioner and the court this late in the game for completeness we shall discuss whether the atascadero loan was bona_fide debt bona_fide debt is debt that arises from a debtor-creditor relationship based upon a legally valid and enforceable obligation to pay a fixed or determinable sum of money see sec_1_166-1 income_tax regs whether a debtor- creditor relationship exists depends on all the facts and circumstances and generally no one fact is determinative an essential question is whether there is a good-faith intent on the part of the recipient of the funds to make repayment and a good- faith intent of the person advancing the funds to enforce repayment in determining whether such intent exists we consider all the evidence and we evaluate whether there was a reasonable expectation of repayment in light of the economic realities at the time the funds were advanced see 54_tc_905 intrafamily transfers are subject_to close scrutiny and may - - be presumed to be gifts the presumption may be rebutted by an affirmative showing that at the time of the transaction there was a real expectation of repayment and a real intent to enforce the collection of the asserted debt see estate of van anda v commissioner t cc affd per curiam 192_f2d_391 2d cir some of the factors we consider when determining whether there is a debtor-creditor relationship with a reasonable expectation of repayment are whether there is a note or other evidence_of_indebtedness interest is charged there is a fixed schedule for repayment security or collateral is requested there is any written loan agreement a demand for repayment has been made the parties’ records reflect the transaction as a loan repayments have been made and the borrower was solvent at the time of the loan see hunt v commissioner tcmemo_1989_335 the case at hand presents enough of the above indicia to satisfy us that there was a debtor-creditor relationship the atascadero loan is evidenced by a note executed by stephanie and david in favor of petitioner the note was secured_by a second deed_of_trust to the atascadero property and interest was charged at a rate well above the applicable_federal_rate ’ see in date when stephanie and david received the first disbursement of funds the applicable_federal_rate was dollar_figure percent for short-term loans with an annual period of continued - sec_7872 in addition petitioner testified that he viewed the atascadero loan as an investment for his profit-sharing_plan stephanie testified that the funds were loans and that she had always intended to repay the amounts borrowed we found petitioner and stephanie to be credible forthright and believable in all respects the advances from petitioner’s profit-sharing_plan to stephanie and david were bona_fide debt we go on to examine whether the debt became worthless in the worthlessness requirement for nonbusiness debts is interpreted strictly the deduction is unavailable if evena modest fraction of the debt can be recovered 321_f2d_331 5th cir last vestige of value must have disappeared affg tcmemo_1962_40 clanton v commissioner tcmemo_1995_416 partial worthlessness is insufficient sec_1_166-5 income_tax regs this hard line approach is taken because the parties to nonbusiness debts are typically members of the same family the requirement of total worthlessness minimizes the opportunities for taxpayers to claim deductions for gifts to family members 87_f3d_197 7th cir to prove the worthlessness of a nonbusiness_debt a taxpayer must be able to point to some particular event or group of fact sec_2 continued compounding in date when the loans were consolidated the rate was dollar_figure percent see revrul_90_1 1990_1_cb_155 revrul_91_41 1991_2_cb_352 -- - that proves worthlessness coborn v commissioner tcmemo_1998_377 citing am offshore inc v commissioner 97_tc_579 affd 205_f3d_1345 8th cir petitioner must establish sufficient objective facts from which worthlessness could be determined 50_tc_813 affd per curiam aftr 2d ustc par 9th cir a debt is considered worthless when there are reasonable grounds for abandoning hope that the debt will be repaid the decision must be made in the exercise of sound business judgment 54_tc_239 legal action is not required to enforce payment where the surrounding facts and circumstances indicate that in all probability the action would not result in an enforceable judgment in favor of the lender sec_1_166-2 income_tax regs the determination by the trier of fact that a debt has become worthless requires an examination of all the facts and circumstances 326_us_287 14_tc_1282 petitioner contends he had two grounds for concluding the atascadero loan was worthless in first he argues that stephanie’s financial condition in had deteriorated to the point where he would have been unable to recover any of the outstanding balance from her second petitioner contends that - - section 580b of the california code of civil procedure section 580b prevented him from obtaining a deficiency judgment against either stephanie or david for the balance of the debt in effect rendering worthless the balance of the note respondent contends that petitioner either made a gift to stephanie and david when he did not take collection action or that he failed to prove the debt was worthless respondent emphasizes that stephanie earned dollar_figure and dollar_figure in and respectively and sold houses in both of those years respondent also disputes the application of section 580b petitioner’s decision to take a deed in lieu of foreclosure to the atascadero property and conclude that the outstanding balance of the atascadero loan was worthless in under sec_166 reflected an exercise of sound business judgment petitioner’s inguiries into the ways in which stephanie might satisfy the debt refute respondent’s argument that petitioner made gifts to stephanie and david and support the conclusion that the debt was worthless in stephanie was in dire economic straits from having to service both the great western loan and the loan on her home in oakland as well as pay rent on an apartment in texas stephanie informed petitioner that she had to keep her apartment in texas where she lived and worked and that she was unwilling to evict her mother to sell -- - the oakland home her only option was to cease making payments on the great western loan great western would then have foreclosed on its first deed_of_trust which would have resulted in petitioner’s second deed_of_trust being forfeited to the senior lienholder nevertheless petitioner inquired into the value of stephanie’s home in oakland with the view to convincing her to sell the home and use the proceeds to satisfy her debt to petitioner however stephanie’s financial condition had deteriorated to the point where she was contemplating filing for bankruptcy a bankruptcy attorney advised petitioner that the gain from any sale of the oakland home would be exempt from creditors after his discussions with stephanie in which she informed him that she had nothing petitioner concluded that the only asset out of which she could satisfy her debt was the atascadero property we are unmoved by respondent’s argument that stephanie’s income in would have enabled her to make payments to wn petitioner a taxpayer is not required to wait until some turn of the wheel of fortune may bring the debtor into affluence ’ 54_tc_239 quoting minneapolis st paul sault ste marie r r co v united_states ct_cl our concern is whether petitioner exercised sound business judgment when he concluded the debt was worthless in petitioner has established that - - in he did not believe stephanie would be able to make payments on his debt and that it was worthless petitioner also had conversations with david about the debt petitioner testified credibly that he believed that even though david was honest and wanted the debt paid he did not have the means to make payments petitioner also consulted a real_estate broker concerning the value of the atascadero property petitioner took a deed in lieu of foreclosure to protect his security_interest and to salvage part of the debt he was owed in addition to stephanie’s and david’s inability to pay petitioner’s decision that the debt was worthless was based on section 580b of the california code of civil procedure petitioner believed that section 580b barred him from pursuing an action to recover the outstanding balance from either stephanie or david section 580b provides that no deficiency judgment may be obtained-- after a sale of real_property for failure of the purchaser to complete his contract of sale or under a deed_of_trust or mortgage given to the vendor to secure payment of the balance of the purchase_price of that real_property or under a deed_of_trust or mortgage on a dwelling for not more than four families given to a lender to secure spetitioner did not claim a bad_debt deduction on his return even though he believed the debt was worthless in petitioner was under the mistaken impression that the proper tax treatment of the worthless_debt was to account for it as part of his basis in the atascadero property petitioner’s misunderstanding of the proper tax treatment does not alter our conclusion that he reasonably believed the debt was worthless in - - repayment of a loan which was in fact used to pay all or part of the purchase_price of that dwelling occupied entirely or in part by the purchaser cal civ proc code sec 580b west while both petitioner and respondent devoted substantial space in their briefs attempting to persuade the court to adopt their respective views of the proper construction of section 580b we need not resolve this guestion in the light of stephanie’s and david’s inability to pay we view petitioner’s conclusion that the unsatisfied portion of the atascadero loan was worthless as an exercise of sound business judgment to give effect to the foregoing conclusions decision will be entered under rule although the application of cal civ proc code sec 580b west to petitioner’s loan is not clear the policy behind the statute and its liberal application by the california courts roseleaf corp v chierighino p 2d cal purpose of sec 580b is to place the risk of inadequate security on the lender bmp prop dev v melvin cal app 3d purchase money includes funds used to satisfy the purchase_price and funds used for other purposes that are an integral part of the consummation of the transaction prunty v bank of am cal app 3d courts have accorded sec 580b a reading that often goes beyond the bounds of the statutory language suggest that petitioner’s decision to avoid the financial and time costs of risky litigation was reasonable


t c no united_states tax_court charles e and sherrie r strange petitioners v commissioner of internal revenue respondent docket no filed date ps paid state nonresident income_tax to nine states on net royalty income derived from their interests in oil_and_gas wells located within those states ps reported all their royalty income on schedules e supplemental income and loss which they attached to their federal_income_tax returns in calculating their total net royalty income petitioners deducted the state income taxes they paid consequently petitioners deducted the state nonresident income taxes in computing their adjusted_gross_income for the years at issue held the addition of sec_164 i r c by the revenue act of publaw_88_272 sec a 78_stat_19 did not change the existing law with respect to the deduction of state income taxes held further state nonresident income taxes are not attributable to property held for the production of royalties and therefore are not deductible under -- - sec_62 i r c in computing ps' adjusted_gross_income held further state nonresident income taxes are not deductible as a trade_or_business expense under sec_62 i r c 45_tc_145 affd per curiam 363_f2d_36 4th cir followed l robert legoy jr and kurt o hunsberger for petitioners paul l dixon for respondent opinion parr judge respondent determined deficiencies of dollar_figure dollar_figure and dollar_figure in petitioners’ federal income taxes for the taxable years and respectively the sole issue for decision is whether state nonresident income taxes paid on net royalty income are deductible for purposes of determining adjusted_gross_income we hold they are not background this case was submitted fully stipulated under rule ' the stipulation of facts and the attached exhibits are incorporated herein by this reference petitioners resided in ‘unless otherwise indicated all rule references are to the tax_court rules_of_practice and procedure and all section references are to the internal_revenue_code in effect for the taxable years at issue las vegas nevada at the time they filed their petition in this case during the years at issue petitioners owned interests in oil_and_gas wells the properties located in the states of alabama california colorado louisiana michigan mississippi new mexico oklahoma and utah the nine states fach of the nine states imposed an income_tax on nonresidents who derived income from an income-producing activity within that state petitioners received royalties from the properties and paid a nonresident income_tax to each state on the net royalty income gross royalty income minus production taxes overhead and operating_expenses and allowances for depletion derived from the properties located only within that state petitioners reported all their royalty income on schedule e supplemental income and loss which they attached to their federal_income_tax returns in calculating their total net royalty income petitioners deducted the state income taxes they paid in addition to the expenses that they deducted in calculating their state nonresident incomes consequently petitioners deducted the state nonresident income taxes in computing their adjusted_gross_income for the years at issue in computing their taxable_income petitioners elected to take the standard_deduction allowed by sec_63 instead of itemizing their deductions - discussion sec_164 provides inter alia that state income taxes are allowed as a deduction for the taxable_year within which they are paid_or_accrued this section was added to the code by the revenue act of the act publaw_88_272 sec z207 a 78_stat_19 before the act the code did not specifically list the deductible taxes thus according to petitioners the preexisting law was changed by the act to provide unequivocally for the deduction of the state income taxes for the purpose of calculating adjusted_gross_income and when read together sec_62 and a specifically provide that state sic income taxes attributable to property held for the production of royalties are deductible from an individual's gross_income to compute the individual's adjusted_gross_income we disagree the general_rule under the law before the act was that state_and_local_income_taxes paid_or_accrued by an individual were deductible as itemized_deductions for federal_income_tax purposes see h rept 88th cong 1st sess c b part the act specifically provides for the continued deductibility of state_and_local_income_taxes in this manner while in the interest of tax equity and ease of compliance denying the deduction of certain other taxes devoting any revenue gain from the denial of those other - - deductions to further tax_rate reductions see id c b part pincite accordingly the act did not change the existing law with respect to the deduction of state income taxes sec_62 provides that in the case of an individual the term adjusted_gross_income means gross_income minus inter alia the deductions allowed by part vi sec_161 and following which are attributable to property held_for_the_production_of_rents_or_royalties see also sec_1_62-1t temporary income_tax regs fed reg date same sec_1_62-1t temporary income_tax regs fed reg date taxes are deductible in arriving at adjusted_gross_income only if they constitute expenditures directly attributable to a trade_or_business or to property from which rents or royalties are derived petitioners contend that the state nonresident income taxes they paid were attributable to property held for the production of royalties and are therefore deductible in computing adjusted_gross_income we disagree the concept of adjusted_gross_income was first incorporated by congress into the code by adding subsection n to sec_22 i r c in the individual income_tax act of ch sec a 58_stat_231 see s rept par of sec_22 i r c provided that the term adjusted_gross_income means gross_income minus the deductions continued - - 78th cong 2d sess c b the legislative_history to sec_22 i r c states the proposed sec_22 of the code provides that the term adjusted_gross_income shall mean the gross_income computed under sec_22 less the sum of the following deductions deductions allowed by sec_23 of the code which are attributable to a trade_or_business carried on by the taxpayer not consisting of services performed as an employee deductions allowed by sec_23 which are attributable to rents and royalties the deductions described in clause above are limited to those which fall within the category of expenses directly incurred in the carrying on of a trade_or_business the connection contemplated by the statute is a direct one rather than a remote one for example property taxes paid_or_incurred on real_property used_in_the_trade_or_business will be deductible whereas state income taxes incurred on business profits would clearly not be deductible for the purpose of computing adjusted_gross_income similarly with respect to the deductions described in clause the term attributable shall be taken in its restricted sense only such deductions as are in the accounting sense deemed to be expenses directly incurred in the rental of property or in the production of royalties x kk s rept supra c b pincite emphasis added see also h rept 78th cong 2d sess c b the state nonresident income taxes were imposed upon continued other than those provided in pars for trade and business deductions for certain deductions of life tenants and income beneficiaries of property or for losses from sales or exchange of property allowed by sec_23 which are attributable to property held_for_the_production_of_rents_or_royalties petitioners' net royalty income not upon property held for the production of royalties moreover as the state income taxes were imposed on petitioners' net royalty income the state income taxes were not an expense directly incurred in the production of that income see eg bulloch accountants' cost handbook 3d ed expenses are expired costs that were used to produce revenue accordingly we find that the state nonresident income taxes paid_by petitioners are not attributable to property held for the production of royalties furthermore we find that the taxes are not otherwise deductible as a trade_or_business expense in computing petitioners' adjusted_gross_income sec_1_62-1t temporary income_tax regs supra provides that to be deductible for the purposes of determining adjusted_gross_income expenses must be those directly and not those merely remotely connected with the conduct_of_a_trade_or_business for example taxes are deductible in arriving at adjusted_gross_income only if they constitute expenditures directly attributable to a trade_or_business or to property from which rents or royalties are derived thus property taxes paid_or_incurred on real_property used in a trade_or_business are deductible but state taxes on net_income are not deductible even though the taxpayer's income is derived from the conduct_of_a_trade_or_business id the committee reports and the regulations specifically state that state taxes on net_income are not deductible for the purpose - - of computing adjusted_gross_income finally in 45_tc_145 affd per curiam 363_f2d_36 4th cir we held that a taxpayer is not entitled to deduct in computing his adjusted_gross_income the state_income_tax he paid on income he received as his share of the net business income derived from certain partnerships see also lutts v united_states aftr 2d ustc par s d cal in the instant case petitioners paid state nonresident income taxes on their net royalty income which derived from their interests in oil_and_gas wells the state income taxes were not expenses attributable to property held for the production of royalties or expenses directly incurred in the production of royalties accordingly we hold that the state nonresident income taxes paid_by petitioners are not deductible for the following the enactment of sec_22 i r c the commissioner amended regulation sec_111 by adding sec_29 n -i1 which provided that state income taxes were not deductible in determining adjusted_gross_income even though the taxpayer's income was derived from the conduct_of_a_trade_or_business see t d c b in 45_tc_145 affd per curiam 363_f2d_36 4th cir the issue was decided pursuant to the provisions of sec_62 i r c as amended the provisions of sec_62 of the code are substantially the same as the provisions of sec_22 of the code see id pincite furthermore sec_62 which is in effect for the taxable years at issue is the same as sec_62 i r c as amended --- - purpose of computing adjusted_gross_income in reaching our holdings herein we have considered each argument made by the parties and to the extent not discussed above find those arguments to be irrelevant or without merit to reflect the foregoing decision will be entered for respondent -in this case if petitioners had not elected to take the standard_deduction the state income taxes that petitioners paid would be deductible from their adjusted_gross_income as an itemized_deduction see sec_63 sec_161 subject_to the limitation imposed by sec_68


internal_revenue_service number release date index number ----------------------------------------------- --------------------------- --------------------- -------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------------------- id no ---------------- ---------------- telephone number -------------------- refer reply to cc psi b03 plr-131385-18 date date legend --------------------------------------------------------------------------------------------- -------------------------------------- -------------------------------------------------------- ---------------------------------------------------------------------------- --------------------- ------------------ -------------------- ------------ ----------------------- ------ ------ ------ ------ x trust trust a b c state date year year year year dear -------------- plr-131385-18 this letter responds to a letter dated date and subsequent correspondence submitted on behalf of x by x’s authorized representative requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to make an election under sec_754 of the internal_revenue_code code facts the information submitted states that x is a state limited_partnership formed on date as of year x’s partners were trust a’s revocable_trust and trust b’s revocable_trust a died during year and b a’s successor died in year c died during year x inadvertently failed to file a timely election under sec_754 for year year or year x represents that it has acted reasonably and in good_faith and that the granting of relief will not prejudice the interests of the government law and analysis sec_754 provides in part that if a partnership files an election in accordance with the regulations prescribed by the secretary the basis of the partnership property is adjusted in the case of a transfer of a partnership_interest in the manner provided in sec_743 such an election shall apply with respect to all distributions of property by the partnership and to all transfers of interests in the partnership during the taxable_year with respect to which the election was filed and all subsequent taxable years sec_1_743-1 of the income_tax regulations provides that the basis_adjustment constitutes an adjustment to the basis of partnership property with respect to the transferee only no adjustment is made to the common_basis of partnership property thus for purposes of calculating income deduction gain and loss the transferee will have a special basis for those partnership properties the bases of which are adjusted under sec_743 and the regulations the adjustment to the basis of partnership property under sec_743 has no effect on the partnership's computation of any item under sec_703 sec_1_754-1 provides in part that an election under sec_754 to adjust the basis of partnership property under b with respect to a transfer of an interest in a partnership shall be made in a written_statement filed with the partnership return for the taxable_year during which the transfer occurs for the election to be valid the return must be filed not later than the time prescribed by sec_1 e including extensions thereof for filing the return for the taxable_year sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as an election whose due_date is prescribed by a regulation plr-131385-18 published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make the election sec_301_9100-2 provides the rules governing automatic extensions of time for making certain elections sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time for regulatory elections that do not meet the requirements of sec_301_9100-2 under sec_301_9100-3 a request for relief will be granted when the taxpayer provides evidence including affidavits described in sec_301_9100-3 to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and the grant of relief will not prejudice the interests of the government conclusion based solely on the information submitted and the representations made we conclude that the requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied as a result x is granted an extension of time of days from the date of this letter to make an election under sec_754 effective for its year taxable_year and thereafter the election should be made in a written_statement filed with the appropriate service_center for association with x's return for its year taxable_year a copy of this letter should be attached to the election this ruling is contingent on x and x's owners filing amended returns within days of the date of this letter properly reporting the consequences of the election under sec_754 this ruling is also contingent on x adjusting the basis of its properties to reflect any sec_734 or sec_743 adjustments that would have been made if the sec_754 election had been timely made these basis adjustments must reflect any additional_depreciation that would have been allowable if the sec_754 election had been timely made regardless of whether the statutory period of limitation on assessment or filing a claim_for_refund has expired for any year subject_to this grant of late relief any depreciation deduction allowable for an open_year is to be computed based upon the remaining useful_life and using property basis as adjusted by the greater of any depreciation deduction allowed_or_allowable in any prior year had the sec_754 election been timely made additionally the partners of x must adjust the basis of their interests in x to reflect what that basis would be if the sec_754 election had been timely made regardless of whether the statutory period of limitation on assessment or filing a claim_for_refund has expired for any year subject_to this grant of late relief specifically the partners of x must reduce the basis of their interests in x in the amount of any additional_depreciation that would have been allowable if the sec_754 election had been timely made furthermore x and its owners plr-131385-18 agree to amend their year taxable_year returns to be filed consistently with sec_1 j except as specifically set forth above we express or imply no opinion concerning the federal tax consequences of the facts described above under any other provision of the internal_revenue_code and the regulations thereunder in addition sec_301_9100-1 provides that the granting of an extension of time for making an election is not a determination that the taxpayer is otherwise eligible to make the election this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent this ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office that not verified any of the material submitted in support of the ruling_request it is subject_to verification on examination in accordance with the power_of_attorney on file with this office we are sending copies of this letter to x's authorized representative sincerely associate chief_counsel passthroughs special industries by _____________________________ caroline e hay assistant to the branch chief branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service number release date index number ----------------------------------------------------- ---------------------------------- ----------------------------- ---------------------------- - department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------------- id no ------------- telephone number --------------------- refer reply to cc psi plr-165630-04 date january ----------------------------------------------------------- ------------------- ----------------------- ---------------------------------- --------------------------------------- -------------------------------- --------------------------------------------------------------------------------------- re -------------------------------------------------------- legend trust x decedent date child child child bank ---------------------------------------------------------------------------- city state spouse a b c d e f year date court g ------------ ------------ ----------------------------------- ------------------------------ --------------------------- ----------------------------- --------------------------- ---------------------- ---------------------- ------- --------------------------- -------------------------------------------------------- -------------------------- -------------------------- -------------------------- h i dear --------------- this is in response to a letter dated date submitted on your behalf by your authorized representative requesting rulings on the gift generation- skipping transfer gst and income_tax consequences of a proposed change_of advisory committee members of trust x will created three separate and equal trusts for the benefit of his three children their spouses and their issue child trust child trust and child trust pursuant to the terms of decedent’s will bank was appointed trustee of all trusts created under the will decedent died on date which was prior to date decedent's the facts submitted and representations made are as follows under clause b of decedent's will the income of each trust is to be paid in reasonable installments to the child for whose benefit it is set apart and upon the child's death to the deceased child's spouse to whom the child was married at the time of decedent's death and after the death of such spouse to the child's issue per stirpes if prior to the death of the last survivor of decedent’s children a child should die leaving no spouse or issue surviving the deceased child's trust is to be divided equally between the trusts for the two surviving children thereafter if a second child should die leaving no spouse or issue surviving the entire property in the two trusts is to be held as one trust for the benefit of the last survivor of decedent’s children clause c of decedent's will provides that the trusts shall terminate upon the death of the last to die of decedent's children and the spouses to whom they were married at the time of decedent's death upon termination the property in each trust is to be paid over to the issue per stirpes of the child for whose benefit the trust was created under clause of his will decedent appointed child child and child as an advisory committee any two of whom by writing signed by them were given the power with respect to the trusts created under the will to a direct decedent’s executor and trustee as to what action is to be taken by it as owner of shares of corporate securities in the voting of b c d such securities or in consenting to or protesting against proposed corporate action direct the executor and trustee as to sales of property held by it either as executor or trustee and sales and purchases of property shall be made by decedent's executor and trustee upon the direction and approval of the advisory committee remove the trustee at any time by instrument in writing designating as successor trustee a corporate fiduciary having its principal_place_of_business in city state and give its consent so that decedent's executor and trustee may borrow money when it is considered by the advisory committee that the borrowing of such money is for the benefit of any trust estate the will further provides that when any member of the advisory committee dies or becomes unwilling to act or incapable of acting the other two members are to select a person to fill the vacancy by a writing signed by the remaining members and delivered to the trustee if two members are deceased or unwilling to serve or become incapable of serving the remaining member is to select two other persons to fill the two vacancies by delivering a writing signed by the remaining member to the trustee at any time there are only two members of the committee such two members are to have full power to act but in case of disagreement between the two members the chief_executive_officer of trustee is to serve as the third member of the committee until such time as a third member is selected in the manner provided at any time there is only one member of the advisory committee alive and willing to and capable of taking action the one member is to have the power to exercise the powers of the committee but only during such time as he does not have a reasonable opportunity to select two members to fill the vacancies any member of the advisory committee who is not a beneficiary of a_trust under decedent’s will is to be paid compensation_for his services at the present time child child child and the spouses of child and child are deceased the spouse of child is still living the child trust the child trust and the child trust will terminate on the death of spouse of child child died in year survived by spouse and four children a d e and f on date by order of court the child trust was divided into four separate trusts each consisting of a one-fourth interest in each asset and each having spouse as the income_beneficiary for her lifetime trust x was created for the benefit of d and his descendants the current members of the advisory committee of trust x are a b and c a b and c have entered into an agreement of sequential resignations and successor appointments in accordance with the terms of decedent's will that will become effective upon the receipt of favorable rulings from the service under the agreement b will be deemed to have resigned as an advisor and a and c the remaining advisors will be deemed to have appointed i as an advisor thereafter c will be deemed to have resigned as an advisor and a and i will be deemed to have appointed g as an advisor immediately thereafter a will be deemed to have resigned as an advisor and i and g the remaining advisors will be deemed to have appointed h as an advisor thus the new advisory committee for trust x will consist of i g and h provisions set forth in decedent's will for the advisory committee as described above it is also represented that no additions have been made to the child trust or to trust x since decedent's death it is represented that the new advisors will operate in accordance with the the following rulings are requested the proposed resignation of advisors and appointment of successor advisors with respect to trust x will not subject trust to the application of the generation- skipping transfer gst tax under sec_2601 of the internal_revenue_code and applicable regulations the proposed resignation of advisors and appointment of successor advisors with respect to trust x will not result in any taxable gift_for federal gift_tax purposes the proposed resignation of advisors and appointment of successor advisors with respect to trust x will not result in the recognition of gain_or_loss for federal_income_tax purposes to trust x or any beneficiaries of trust x ruling sec_2601 of the internal_revenue_code imposes a tax on every under section a of the tax_reform_act_of_1986 act and section generation-skipping_transfer which is defined under sec_2611 as a taxable_distribution a taxable_termination and a direct_skip a of the generation-skipping_transfer_tax regulations the gst tax is generally applicable to generation-skipping transfers made after date however under section b a of the act and sec_26_2601-1 the tax does not apply to a transfer under a_trust that was irrevocable on date but only to the extent that such transfer is not made out of corpus added to the trust after date or out of income attributable to corpus so added sec_26_2601-1 provides rules for determining when a modification judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the gst tax under sec_26_2601-1 will not cause the trust to lose its exempt status sec_26_2601-1 provides that a modification will not cause an exempt trust to be subject_to the gst tax if the modification does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification and the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust a modification of an exempt trust will result in a shift in beneficial_interest to a lower generation beneficiary if the modification can result in either an increase in the amount of a generation-skipping_transfer or the creation of a new generation-skipping_transfer a modification that is administrative in nature that only indirectly increases the amount transferred will not be considered to shift a beneficial_interest in the trust sec_26_2601-1 example considers a situation where a_trust is modified by decreasing the number of trustees the modification pertains to the administration of the trust and does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation than the person or persons who held the beneficial_interest prior to the modification in addition the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust therefore the modification will not subject the trust to the provisions of chapter accordingly the proposed resignation of the current advisors and the appointment of successor advisors with respect to trust x is a modification that is administrative in nature this modification does not shift any beneficial_interest in trust x to any beneficiary who occupies a generation lower than the persons holding the beneficial interests further the proposed modification will not extend the time for vesting of any beneficial_interest in trust x beyond the period provided under the provisions of decedent's will or constitute an addition to trust x accordingly the proposed changes will not cause trust x to lose its gst exempt status under sec_26_2601-1 ruling sec_2501 provides that a tax computed as provided in sec_2502 is hereby imposed for each calendar_year on the transfer of property by gift during such calendar_year by any individual resident or nonresident sec_2511 provides that subject_to the limitations contained in chapter the gift_tax imposed by sec_2501 will apply whether the transfer is in trust or otherwise whether the gift is direct or indirect and whether the property is real or personal tangible or intangible sec_2512 provides that if a gift is made in property the value thereof at the date of the gift shall be considered the amount_of_the_gift sec_2512 provides that where property is transferred for less than adequate_and_full_consideration in money or money s worth the amount by which the value of the property exceeded the value of the consideration shall be deemed a gift based on the facts submitted and representations made we conclude that the proposed resignation of the current advisors and the appointment of successor advisors with respect to trust x will not change the beneficial interests in trust x otherwise provided for under the terms of decedent's will therefore based on the facts submitted and representations made we conclude that the proposed change_of advisors of trust x will not result in a taxable gift_for federal gift_tax purposes sec_1001 provides that the gain from the sale_or_other_disposition of ruling sec_61 provides that gross_income includes gains derived sec_1001 states that the amount_realized from the sale_or_other_disposition from dealings in property and under ' a from an interest in a_trust property shall be the excess of the amount_realized there from over the adjusted_basis provided in ' for determining gain and the loss shall be the excess of the adjusted_basis provided in ' for determining loss over the amount_realized of property shall be the sum of any money received plus the fair_market_value of the property other than money received under ' c except as otherwise provided in subtitle a the entire amount of gain_or_loss determined under ' on the sale_or_exchange of property shall be recognized sec_1_1001-1 of the income_tax regulations provides that the gain_or_loss realized from the conversion of property into cash or from the exchange of property for other_property differing materially either in_kind or in extent is treated as income or loss sustained issue of when a sale_or_exchange has taken place that results in realization of gain_or_loss under sec_1001 in cottage savings a financial_institution exchanged its interests in one group of residential mortgage loans for another lender's interests in a different group of residential mortgage loans the two groups of mortgages were considered substantially identical by the agency that regulated the financial_institution concluded that sec_1_1001-1 reasonably interprets sec_1001 and that an exchange of property gives rise to a realization event under sec_1001 if the properties exchanged are materially different in defining what constitutes a material difference for purposes of sec_1001 the court stated that properties are different in the sense that the supreme court of the united_states in cottage savings u s pincite 499_us_554 concerns the is material to the code so long as their respective possessors enjoy legal entitlements that are different in_kind or extent cottage savings u s pincite the court held that mortgage loans made to different obligors and secured_by different homes embody distinct legal entitlements and that the taxpayer realized losses when it exchanged interests in the loans cottage savings u s pincite appointment of replacement advisory committee members will take place in accordance with the existing terms of the trust moreover the successor advisory committee members must abide by the same terms and conditions of the trust as the current advisory committee members accordingly the proposed resignation of the current advisory committee members and the immediate appointment of their successors once done will merely be an exercise of the administrative provisions of the trust and will not result in the recognition of gain_or_loss for federal_income_tax purposes to the trust or any beneficiaries the resignation of current advisory committee members and the subsequent in accordance with the power_of_attorney on file with this office a copy of this the rulings contained in this letter are based upon information and except as expressly provided herein no opinion is expressed or implied letter is being sent to your authorized representative concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination provides that it may not be used or cited as precedent this ruling is directed only to the taxpayer s requesting it sec_6110 sincerely yours _________________________ katherine a mellody senior technician reviewer office of the associate chief_counsel passthroughs and special industries enclosure copy for sec_6110 purposes


internal_revenue_service number release date index number --------------------------------- ------------------------- -------------------- ------------------------ - department of the treasury washington dc third party communication none date of communication not applicable_person to contact ----------------------- id no ------------- telephone number --------------------- refer reply to cc corp b05 plr-151592-05 date february -------------------------------- ----------------------------------- ---------------------------- ---- ------------------------- legend distributing ---------------------------------------------------------- business x activity1 activity2 a shareholder a ------------------------------------------------------------- b shareholder b ------------------------------------------------------------- c d dollar_figuree controlled ---------------------- --------------------- -------------- -------- ------- ---- --------------------------------- plr-151592-05 ----------------------------------------------------------- dollar_figuref dear ------------ distributing requesting rulings under sec_355 and sec_368 of the internal_revenue_code the code with respect to a proposed transaction additional information was received in letters dated date and date this is in response to a letter dated date submitted on behalf of ------------- distributing is an s_corporation engaged in business x with activity1 and activity2 distributing files its federal_income_tax return using the cash_method with a tax_year ending december distributing has supplied information indicating that it has had gross_receipts and operating_expenses representative of the active_conduct_of_a_trade_or_business for each business for each of the past five years distributing has one class of stock outstanding owned approximately a by shareholder a and b by shareholder b distributing owns approximately c acres of land upon which its business operations are conducted distributing has been in operation since d the fair_market_value of its assets total an estimated dollar_figuree shareholder a focuses on distributing’s activity1 and shareholder b focuses on distributing’s activity2 which is located miles from activity1 shareholder a and shareholder b’s efforts produce nearly dollar_figuref in gross_income annually transactions is proposed the proposed transaction is a split-off for what is represented to be a valid business_purpose the following series of i ii iv distributing will create controlled a wholly-owned subsidiary distributing will contribute half of its assets to controlled in return for of the stock in controlled iii distributing will distribute of the controlled stock in return for of shareholder a’s distributing stock thereafter shareholder a will own of controlled similarly shareholder b will own of distributing distributing has made the following representations with respect to the proposed transaction a the fair_market_value of the controlled_corporation stock and other consideration to be received by each shareholder of the distributing_corporation will be approximately equal to the fair_market_value of the distributing_corporation stock surrendered by the shareholder in the exchange plr-151592-05 b no part of the consideration to be distributed by the distributing_corporation will be received by a shareholder as a creditor employee or in any capacity other than that of a shareholder of the corporation c the five years of financial information submitted on behalf of the distributing_corporation is representative of the corporation’s present operation and with regard to such corporation there have been no substantial operational changes since the date of the last financial statements submitted d following the transaction the distributing and controlled corporations will each continue independently and with its separate employees the active_conduct of its share of all the integrated activities of the business conducted by the distributing_corporation prior to consummation of the transaction e the total adjusted bases and the fair_market_value of the assets transferred to the controlled_corporation by the distributing_corporation each equals or exceeds the sum of the liabilities assumed by the controlled_corporation plus any liabilities to which the transferred assets are subject f the liabilities assumed in the transaction and the liabilities to which the transferred assets are subject were incurred in the ordinary course of business and are associated with the assets being transferred g the distributing_corporation neither accumulated its receivables nor made extraordinary payment of its payables in anticipation of the transaction h no intercorporate debt will exist between the distributing_corporation and the controlled_corporation at the time of or subsequent to the distribution of the controlled_corporation stock i payments made in connection with all continuing transactions if any between the distributing and controlled corporations will be for fair_market_value based on terms and conditions arrived at by the parties bargaining at arm’s length j no two parties to the transaction are investment companies as defined in sec_368 and iv k the distribution of the stock or stock and securities of the controlled_corporation is carried out for the following corporate business purposes to match the properties by character shareholder expertise and geographic proximity to remove the present stalemate of strategies and to give each shareholder strategic control_over properties complementary to his expertise thereby allowing each to maximize the potential of the land unfettered by any connection with the other the distribution of the stock or stock and securities of the controlled plr-151592-05 corporation is motivated in whole or substantial part by one or more of these corporate business purposes l the transaction is not used principally as a device for the distribution of the earnings_and_profits of the distributing_corporation or the controlled_corporation or both m there is no acquisition of stock of the distributing_corporation or any controlled_corporation including any predecessor or successor of any such corporation that is part of a plan or series of related transactions within the meaning of sec_1_355-7 that includes the distribution of the controlled_corporation stock above we have concluded that based solely on the information submitted and the representations set forth the transfer by distributing of part of its assets in exchange for all of the common_stock of controlled followed by the distribution of all the controlled stock to the distributing shareholder will constitute a reorganization within the meaning of sec_368 of the code distributing and controlled will each be a_party_to_a_reorganization within the meaning of sec_368 of the code distributing will recognize no gain_or_loss upon the transfer of assets to controlled in exchange for controlled stock as described above sec_357 and sec_361 controlled will recognize no gain_or_loss on the receipt of the assets in exchange for all the shares of controlled sec_1032 controlled's basis in the distributing assets received by controlled in the transaction will be the same as the basis of such assets in the hands of distributing immediately prior to the transaction sec_362 controlled's holding_period of the distributing assets received by controlled in the transaction will include the period during which such assets were held by distributing sec_1223 no gain_or_loss will be recognized by and no amount will otherwise be included in the income of the distributing shareholder on its receipt of controlled stock in the distribution sec_355 the basis of the controlled stock in the hands of the distributing shareholder will be the same as the basis of the distributing stock held immediately before the exchange by such shareholder sec_358 plr-151592-05 the holding_period of the controlled stock received by the distributing shareholder will include the holding_period of the distributing stock held by such shareholder provided that such shareholder held the distributing stock as a capital_asset on the date of the distribution sec_1223 no gain_or_loss will be recognized to distributing upon the distribution of its controlled stock sec_361 except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter the rulings contained in this letter are based on facts and representations submitted by the taxpayer and accompanied by a penalties of perjury statement executed by an appropriate party this office has not verified any of the materials submitted in support of the request for rulings verification of the information representations and other data may be required as part of the audit process moreover no information provided by the taxpayer has been reviewed and no determination has been made regarding whether the proposed transaction i satisfies the business_purpose requirement of sec_1_355-2 of the income_tax regulations ii is used principally as a device for the distribution of the earnings_and_profits of the distributing_corporation or the controlled_corporation or both see sec_355 of the internal_revenue_code and sec_1_355-2 or iii is part of a plan or series of related transactions pursuant to which one or more persons will acquire directly or indirectly stock representing a 50-percent_or_greater_interest in the distributing_corporation or the controlled_corporation see sec_355 and sec_1_355-7 this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent a copy of this letter must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter_ruling plr-151592-05 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative cc sincerely _douglas c bates______________ douglas c bates assistant to the branch chief branch office of associate chief_counsel corporate