Opinion ID: 61651
Heading Depth: 2
Heading Rank: 4

Heading: Calculation of GMK's Outside Basis and Amount Realized

Text: The Government argues that the obligation to close a short sale is a liability for purposes of section 752, and the value of this liability is equal to the initial proceeds of the short sale. On Schedule D of its Form 1065, GMK stated that its outside basis in its partnership interest in Valiant was $104.5 Million. Both the Government and the Appellants agree that this figure is correct. The parties, however, arrive at the same figure by relying on different sections of the Code. A partnership and its partners do not recognize a gain or loss if the partner contributes property to the partnership in exchange for a partnership interest. I.R.C. § 721(a). In exchange for the contribution, the partner receives a partnership interest with an outside basis that is equal to the amount of such money and the adjusted basis of such property to the contributing partner at the time of the contribution. [12] Id. § 722. GMK calculated its outside basis by treating both the $2 Million initial deposit and the $102.5 Million short sale proceeds as cash that was contributed to the partnership under section 722, resulting in an outside basis equal to the cash contribution. See Treas. Reg. § 1.722-1. Because GMK concluded that the obligation to close a short sale was not a liability, it did not rely on section 752 to adjust its outside basis in Valiant. The Government agrees that the $2 Million initial deposit and the $102.5 Million short sale proceeds were cash contributions that increased GMK's outside basis in Valiant by the total amount of the contribution. However, the Government also believes that GMK's outside basis must be adjusted under section 752. A partner's outside basis is affected by the partner's share of partnership debt. [A]ny decrease in a partner's individual liabilities by reason of the assumption by the partnership of such individual liabilities, shall be considered as a distribution of money to the partner by the partnership, which will reduce the partner's outside basis in the partnership interest. Id. §§ 752(b), 705(a)(2), 733(1). Conversely, any increase in the partner's share of partnership liabilities shall be considered as a contribution of money by such partner to the partnership, which will increase the partner's outside basis in the partnership interest. Id. §§ 752(a), 705(a)(1). When calculating the partner's outside basis, sections 752(a) and (b) must be read together. Any decrease in a partner's share of individual liabilities under section 752(b) is netted against any increase in his share of partnership liabilities arising from the same transaction under section 752(a); only the net increase or decrease triggers a deemed contribution or distribution of cash. See Treas. Reg. § 1.752-1(f). GMK has a substituted basis in Valiant that is equal to the Trust's original outside basis in Valiant. When the Trust contributed the brokerage account to Valiant, it contributed $104.5 Million in cash and an obligation to close the short sale. Assuming that the obligation to close a short sale is a liability, the Trust's outside basis in Valiant after the transfer of the brokerage account is equal to the $104.5 Million cash contribution (per section 722) minus the $102.5 Million liability assumed by Valiant (per section 752(b)) plus the $102.5 Million share of partnership liability attributable to the Trust (per section 752(a)). Because the Trust owned a 99.99% interest in Valiant, the amount of liability assumed by Valiant was completely offset by the Trust's share of that liability. [13] See Treas. Reg. § 1.752-1(g), Ex. (1). Although the Government's use of section 752 does not reduce GMK's outside basis in Valiant below $104.5 Million, it does attribute a 99.99% share of the partnership liability to GMK. In contrast, by ignoring section 752, GMK claimed a $104.5 Million outside basis in Valiant on its tax return without claiming its corresponding share of the $102.5 Million partnership liability. Based on this reasoning, GMK claimed that it only realized $1.8 Million on the sale, which should not be increased because GMK was not relieved of any liability recognized under section 752 when it sold Valiant to Czerwinski. Under the entity approach, a sale of a partnership interest is treated as a disposition of a unitary capital asset, and the transferor generally recognizes gain or loss equal to the difference between his amount realized and his outside basis. See I.R.C. §§ 741, 742, 1001. In the case of a sale of a partnership interest, liabilities are treated in the same manner as liabilities in connection with the sale or exchange of property not associated with partnerships. Id. § 752(d). Thus, the amount realized by a partner who transfers his partnership interest includes not only cash and the fair market value of any other property received but also the transferor's share of partnership liabilities assumed by the transferee. See Treas. Reg. §§ 1.752-1(h), 1.1001-2(a)(1), Ex. (3); see also Comm'r v. Tufts, 461 U.S. 300, 308-09, 103 S.Ct. 1826, 75 L.Ed.2d 863 (1983) (When encumbered property is sold or otherwise disposed of and the purchaser assumes the mortgage, the associated extinguishment of the mortgagor's obligation to repay is accounted for in the computation of the amount realized.). A sale of a partnership interest triggers a deemed discharge of the transferor's share of partnership liabilities. See id. § 1.1001-2(a)(4)(v). According to the Government, when GMK sold its interest in Valiant to Czerwinski for $1.8 Million, it was also relieved of its share of partnership liabilities, which must be treated as an additional amount realized on the sale. Thus, GMK realized a total of $104.3 Million under section 752(d) when it sold its interest in Valiant to Czerwinski ($1.8 Million promissory note + $102.5 Million relief from its share of partnership liability). GMK's loss is calculated by subtracting its outside basis of $104.5 Million from its amount realized of $104.3 Million, for a total loss of $200,000. Because it did not treat Valiant's obligation to close the short sale as a liability, GMK calculated the amount realized on the sale as only $1.8 Million. If section 752 were applicable, then GMK would have been attributed a 99.99% share of Valiant's partnership liabilities ( i.e. $102.5 Million), and GMK's relief from this liability would have been treated as an additional amount realized under section 752(d). [14] See Treas. Reg. §§ 1.752-1(h) (If a partnership interest is sold . . ., the reduction in the transferor partner's share of partnership liabilities is treated as an amount realized under section 1001 and the regulations thereunder.) (emphasis added). Now we must address which parties' calculation is correct.