Court Opinion

ID: 4337650
Source: CourtListenerOpinion
Date Created: 2018-11-14 03:28:26.617969+00
Date Added: 2024-06-11T14:48:11.723809
License: Public Domain

132 T.C. No. 18

                UNITED STATES TAX COURT

        ALEX AND LISET MERUELO, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 624-04.                Filed June 9, 2009.

     R issued Ps a notice of deficiency (NOD) for 1999
that contained determinations related to an entity
subject to the unified audit and litigation procedures
of the Tax Equity and Fiscal Responsibility Act of 1982
(TEFRA), Pub. L. 97-248, sec. 401, 96 Stat. 648. On
their 1999 Federal income tax return, Ps claimed a
deduction for a $4,538,844 loss that reportedly passed
through to them from a partnership they identified as
M. M was actually P-H’s single-member limited
liability company (LLC) that was a disregarded entity
for Federal tax purposes; the claimed loss actually
stemmed from IV, a five-member (one of whom was P-H)
LLC subject to TEFRA. IV reported on its 1999 return
that it incurred a loss and that $4,538,844 of the loss
passed through to M. IV’s return did not indicate that
M was a single-member LLC, that M was a disregarded
entity, or that P-H (rather than M) was actually IV’s
member. P-H did not file a return for M for 1999, and
R did not audit (or make any adjustments to) IV’s 1999
return during the 3-year period of limitations for
                         - 2 -

assessing tax attributable to partnership and affected
items from IV’s 1999 taxable year. R issued the NOD to
Ps shortly before the expiration of the 3-year period
of limitations for assessing tax as to Ps’ 1999 taxable
year, which coincided with the expiration of the 3-year
period of limitations for IV’s 1999 taxable year. The
NOD reflected: (1) Ps’ reporting that M was a
partnership and (2) R’s determination that secs. 465
and 704(d), I.R.C., precluded Ps’ deducting any of the
loss and that Ps were liable for an accuracy-related
penalty under sec. 6662, I.R.C. R learned during this
case that M was not a partnership but was a disregarded
entity. R also learned that Ps’ $4,538,844 claimed
loss was related to IV and related Ps’ claimed loss to
an ongoing grand jury investigation into tax shelters.
Afterwards, R informed the Court that R may still
determine that IV’s 1999 return contained a false or
fraudulent partnership item that would allow R to
assess tax related to the loss after the expiration of
the 3-year period of limitations applicable to IV. Ps
now move the Court to dismiss the case for lack of
jurisdiction, asserting that R issued the NOD
prematurely (i.e., before the completion of
partnership-level proceedings as to IV) because R
neither issued a notice of final partnership
administrative adjustment (FPAA) to IV for 1999 nor
accepted IV’s 1999 return as filed.
     Held: R did not issue the NOD prematurely because
R issued the NOD to Ps during Ps’ 3-year period of
limitations, without issuing an FPAA to IV during the
3-year period of limitations applicable to IV.
     Held, further, R’s determinations under secs. 465,
704(d), and 6662, I.R.C., implicate affected items that
require determinations at the partner level, and the
Court has jurisdiction to decide this case.

A. Lavar Taylor and Robert S. Horwitz, for petitioners.

Jonathan H. Sloat and Donna F. Herbert, for respondent.
                                 - 3 -

                               OPINION

     VASQUEZ, Judge:    Petitioners move the Court to dismiss this

case for lack of jurisdiction.    Petitioners petitioned the Court

to redetermine respondent’s determination of a $1,581,293

deficiency in petitioners’ Federal income tax for 1999 and a

$632,517 accuracy-related penalty under section 6662(h) (or

alternatively a lesser accuracy-related penalty under section

6662(a)).1   Respondent included that determination in a notice of

deficiency (NOD) that reflects respondent’s disallowance of a

$4,538,844 loss that petitioners claimed as a deduction.    The

loss stemmed from petitioner Alex Meruelo’s ownership interest in

Meruelo Capital Management, LLC (MCM), his single-member limited

liability company, and in turn MCM’s ownership interest in

Intervest Financial, LLC (Intervest), an entity subject to the

unified audit and litigation procedures of the Tax Equity and

Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, sec.

401, 96 Stat. 648.2    Respondent disallowed the loss because,

     1
        Section references are to the applicable versions of the
Internal Revenue Code (Code), unless otherwise stated. Some
dollar amounts are rounded to the nearest dollar. We use terms
in this Opinion to decide petitioners’ motion and do not express
any view on the validity of any of the entities or transactions
mentioned. See Soward v. Commissioner, T.C. Memo. 2006-262.
     2
        The parties agree that MCM is disregarded for Federal tax
purposes because it is a single-member limited liability company
that did not elect to be treated as a corporation. See sec.
301.7701-3(a), Proced. & Admin. Regs.
                               - 4 -

inter alia, petitioners failed to establish that the Code did not

limit or disallow any deduction as to the loss.    (Respondent has

since clarified that two provisions limiting or disallowing the

loss are sections 465 and 704(d).)     Respondent also determined in

the NOD that petitioners were liable for an accuracy-related

penalty under section 6662 with respect to their reporting of the

deduction of the loss.

     Petitioners argue that the Court lacks jurisdiction because

the NOD was issued prematurely and is invalid.    Such is so,

petitioners argue, because the deficiency and the accuracy-

related penalties are or are attributable to affected items of

Intervest, and respondent as of the time the NOD was issued had

neither issued a notice of final partnership administrative

adjustment (FPAA) to Intervest for 1999 nor accepted Intervest’s

return for 1999 as filed.   Even if the NOD was not issued

prematurely, petitioners argue alternatively, the Court lacks

jurisdiction because the affected items set forth in the NOD are

not in fact affected items.

     We disagree with petitioners on both points.    We hold that

the NOD was not issued prematurely and that the affected items

set forth in the NOD are affected items that require

determinations at the partner level.    We hold that we have

jurisdiction, and we will deny petitioners’ motion asserting to

the contrary.
                                  - 5 -

                               Background

I.    Petitioners

       Petitioners are husband and wife.    They filed a joint Form

1040, U.S. Individual Income Tax Return, for 1999 on or about

October 16, 2000.      They resided in California when they filed

their petition with the Court.

II.    MCM

       MCM was a limited liability company whose only member was

Alex Meruelo (Mr. Meruelo).      During 1999 MCM owned a 31.68-

percent interest in Intervest, a Delaware limited liability

company.      MCM did not file a Federal tax return for 1999.    For

1999, MCM was (by default) a disregarded entity for Federal tax

purposes because MCM did not file a Form 8832, Entity

Classification Election, electing to be treated as a corporation

for that year.

III.    Intervest

       A.    Identity of Intervest’s Other Members

       Intervest had four members in addition to MCM:    Ewing

Capital Management, LLC; Markerston Shield, LLC; Manchester

Overseas, LLC; and New Day, S.A.      Ewing Capital Management, LLC,

and Markerston Shield, LLC, were Delaware limited liability

companies, and their respective ownership interests in Intervest

were 35.64 percent and 24.75 percent.       Manchester Overseas, LLC,

was a Nevis limited liability company, and it owned a
                                - 6 -

6.93-percent interest in Intervest.     New Day, S.A., was a

Bahamian corporation, and it owned a 1-percent interest in

Intervest.

      B.   Intervest’s Form 1065 for 1999

      Intervest filed a Form 1065, U.S. Partnership Return of

Income, for 1999.    The return was filed on October 14, 2000.    The

return covered Intervest’s initial taxable year beginning on

December 13 and ending on December 31, 1999.

      Intervest’s return for 1999 reported that Intervest incurred

a $14,327,160 ordinary loss from engaging in foreign currency

transactions.    Intervest issued MCM a Schedule K-1, Partner’s

Share of Income, Credits, Deductions, etc., for 1999 that

reported an ordinary loss of $4,538,844 as a passthrough item

from Intervest to MCM.    Intervest’s return reported that MCM was

a “member” of Intervest.    Intervest’s return did not indicate

that MCM was a single-member limited liability company, that MCM

was a disregarded entity, or that Mr. Meruelo (rather than MCM)

was actually Intervest’s member for 1999 for Federal tax

purposes.

IV.   Petitioners’ Tax Return

      On their Form 1040 for 1999, petitioners claimed the

$4,538,844 loss as a passthrough item from MCM.     The return did

not identify Intervest, nor did the return state that Intervest
                                - 7 -

was the source of the loss.3   The return reported that MCM was a

partnership.    The return did not indicate that MCM was a single-

member limited liability company, that MCM was a disregarded

entity, or that Mr. Meruelo (rather than MCM) was actually

Intervest’s member for 1999 for Federal tax purposes.

V.   The NOD

      Respondent failed to obtain from petitioners for 1999 a

Form 872-I, Consent to Extend the Time to Assess Tax As Well As

Tax Attributable to Items of a Partnership.   On October 10, 2003,

shortly before the expiration of the normal period of limitations

for assessing tax as to petitioners’ 1999 taxable year, which

coincided with the expiration of the normal period of limitations

for assessing tax attributable to partnership and affected items

from Intervest’s 1999 taxable year, respondent issued the NOD to

petitioners.4   The NOD reflected petitioners’ reporting on their

      3
        Respondent asserts that he first learned that the loss
originated with Intervest when respondent was served with
petitioners’ petition. The petition references that MCM owned an
interest in Intervest.
      4
        The normal period of limitations on an assessment of
Federal income tax attributable to a partnership item (or to an
affected item) is 3 years after the filing of the taxpayer’s
return, except that the period shall not expire before the date
which is 3 years after the later of the due date of the
partnership return (determined without regard to extensions) or
the date the partnership return was actually filed. See secs.
6229(a), 6501(a); G-5 Inv. Pship. v. Commissioner, 128 T.C. 186,
189-190 (2007); Rhone-Poulenc Surfactants & Specialties, L.P. v.
Commissioner, 114 T.C. 533, 540-551 (2000); see also sec.
6501(b)(1) (providing that a return of tax filed before the last
                                                   (continued...)
                               - 8 -

1999 tax return that MCM was a partnership and that the

$4,538,844 loss had passed through to them from MCM.    The NOD

stated that petitioners were not entitled to deduct the loss and

that they were liable for an accuracy-related penalty under

section 6662.   The NOD stated that the only other adjustments to

petitioners’ reported taxable income were computational

adjustments made to petitioners’ itemized deductions pursuant to

section 68(a) and (b).

     The NOD stated that respondent disallowed petitioners’

claimed deduction for the loss because they failed to establish

that they had any basis in MCM, that a loss was sustained during

1999 in the amount claimed, that any loss was attributable to

them, or that the claimed loss (or any portion thereof), if

sustained, was allowable as a deduction under the Code.    The NOD

stated that any deduction of the loss also was disallowed because

petitioners had failed to establish that any deduction related to

the loss was not limited or disallowed by one or more sections of

the Code, including for example sections 165 and 465.    The NOD

stated that a deduction for the loss also was disallowed because

MCM was a sham for tax purposes, and the provisions of chapter 1,

     4
      (...continued)
day for timely filing shall be considered as filed on that last
day). We sometimes use the term “normal” in this context also to
include any period greater than the referenced periods agreed
upon pursuant to sec. 6501(c)(4) and/or sec. 6229(b).
                               - 9 -

subchapter K, including for example sections 705, 722, 732, and

752, could not be used to calculate their basis in MCM.

      The NOD stated as to the accuracy-related penalty that

respondent had determined that the 40-percent penalty of section

6662(a), (b)(3), (e), and (h) was proper because petitioners had

an underpayment of tax due to a gross valuation misstatement of

their outside basis in MCM.   Alternatively, the NOD stated,

respondent had determined that the 20-percent penalty of section

6662(a), (b)(1), and (c) was proper to the extent that section

6662(h) did not apply because petitioners had an underpayment of

tax due to negligence or disregard of rules and regulations.     As

a second alternative, the notice stated, respondent had

determined that the 20-percent penalty of section 6662(a),

(b)(2), and (c) was proper because petitioners had an

underpayment of tax attributable to a substantial understatement

of income tax.

VI.   No Audit of Intervest

      Respondent has not audited Intervest’s Form 1065 for 1999.

Nor has respondent notified Intervest that respondent is

beginning an audit of Intervest for 1999.   Respondent has not

issued an FPAA to Intervest for 1999.
                               - 10 -

VII.   Respondent’s Motion To Stay Proceedings

       On November 12, 2004, respondent responded to petitioners’

motion to dismiss by moving the Court to “stay the proceedings in

this case pending the resolution of a federal criminal

investigation whose progress and outcome may affect the

disposition of this case.”    Respondent’s motion stated that

respondent had just recently learned that petitioners’ reported

loss was generated in a tax shelter related to an ongoing grand

jury investigation into tax shelter activities and that the grand

jury investigation could affect or be affected by happenings in

this case.    The motion stated that if respondent learned that

       petitioner [sic] had, with the intent to evade tax,
       signed or participated, directly or indirectly, in the
       preparation of a partnership return which includes a
       false or fraudulent item, then in the case of partners
       participating, any tax imposed by Subtitle A which is
       attributable to any partnership item (or affected item)
       for the partnership taxable year to which the return
       relates may be assessed at any time. I.R.C. §
       6229(c)(1)(A).

            10. Furthermore, even if petitioners did not sign
       or participate directly in the filing of a false or
       fraudulent partnership return, the period for assessing
       tax attributable to partnership items related to a
       false or fraudulent partnership return is six years,
       rather than three years, from the date on which the
       partnership return was filed. I.R.C. § 6229(c)(1)(B).
       In the instant case, because Intervest’s return was
       filed on October 14, 2000, the period of limitations
       for assessing tax attributable to partnership items
       would remain open for purposes of conducting a
       partnership-level proceeding.

Respondent also noted in the motion that the Commissioner has a

longstanding policy generally to defer civil assessment and
                              - 11 -

collection until the completion of any related criminal

proceeding.5

     On November 18, 2004, the Court granted respondent’s motion

and stayed all proceedings in this case.   The Court later lifted

the stay to decide petitioners’ motion now before us.

                            Discussion

I.   Jurisdiction

      Petitioners move the Court to dismiss this case for lack of

jurisdiction.   We begin our analysis with some general tenets of

our jurisdiction.   This Court like other Federal courts is a

court of limited jurisdiction.   See Evans Publg., Inc. v.

Commissioner, 119 T.C. 242, 245-246 (2002).   Whether we have

jurisdiction over the subject matter of a dispute is an issue

that either party may raise at any time.   See Charlotte’s Office

Boutique, Inc. v. Commissioner, 121 T.C. 89, 102 (2003), affd.

425 F.3d 1203 (9th Cir. 2005).   Here, our jurisdiction rests on

our finding that the NOD issued to petitioners was valid and that

petitioners’ petition to this Court was timely.6   See Domulewicz

      5
        Neither party asserts, nor does the record establish,
that petitioners were or are under criminal tax investigation for
violation of an internal revenue law related to income tax. See
generally sec. 301.6231(c)-5T, Temporary Proced. & Admin. Regs.,
52 Fed. Reg. 6793 (Mar. 5, 1987) (rules under which the
partnership items of a partner are converted to nonpartnership
items when the partner is under criminal tax investigation).
      6
        Neither party disputes that the petition would be timely
if the NOD were valid. We find similarly and so conclude without
                                                   (continued...)
                                  - 12 -

v. Commissioner, 129 T.C. 11, 17 (2007); GAF Corp. & Subs. v.

Commissioner, 114 T.C. 519, 521 (2000).       Our jurisdiction, once

acquired, continues unimpaired until we enter our ultimate

decision and is unaffected by events that occur after the filing

of the petition.       See NT, Inc. v. Commissioner, 126 T.C. 191, 194

n.2 (2006); GAF Corp. & Subs. v. Commissioner, supra at 525.

II.    TEFRA in General

       We turn to some general tenets involving partnerships.

Partnerships are not subject to Federal income tax.       See sec.

701.       Partnerships are nevertheless required to file annual

information returns reporting their partners’ distributive shares

of income, gain, loss, deductions, or credits.       See sec. 6031;

see also Randell v. United States, 64 F.3d 101, 103 (2d Cir.

1995); Crowell v. Commissioner, 102 T.C. 683, 688-689 (1994).

Partners are required to report their distributive shares of

those items on their personal Federal income tax returns.         See

secs. 701, 702, 703, and 704.

       Before 1982 the Commissioner and the courts had to adjust

partnership items at the partner level.       See Adams v. Johnson,

355 F.3d 1179, 1186-1187 (9th Cir. 2004); Randell v. United

States, supra at 103; Maxwell v. Commissioner, 87 T.C. 783, 787

(1986).       Congress enacted the unified audit and litigation

       6
      (...continued)
further discussion.
                              - 13 -

procedures of TEFRA to remove the substantial administrative

burden occasioned by duplicative audits and litigation and to

provide consistent treatment of partnership items among all

partners in the same partnership.    See Adams v. Johnson, supra at

1186-1187; Randell v. United States, supra at 103; H. Conf. Rept.

97-760, at 599-600 (1982), 1982-2 C.B. 600, 662-663.    The proper

treatment of partnership items at the partnership level is

determined under the TEFRA procedures in a single, unified audit

and judicial proceeding.   See Adams v. Johnson, supra at

1186-1187; Randell v. United States, supra at 103; H. Conf. Rept.

97-760, supra at 599-600, 1982-2 C.B. at 662-663.

     The term “partnership items” includes any item of income,

gain, loss, deduction, or credit that the Secretary has

determined is more appropriately determined at the partnership

level than at the partner level.    See sec. 6231(a)(3); sec.

301.6231(a)(3)-1(a), Proced. & Admin. Regs.    The term does not

include an “affected item”, defined by statute as any item to the

extent the item is affected by a partnership item.    See sec.

6231(a)(5); Adkison v. Commissioner, 129 T.C. 97, 102 (2007).

     Affected items are of two types.    The first type is a

computational adjustment made to a partner’s tax liability to

reflect adjustments to partnership items.    See sec. 6231(a)(6).

When partnership-level proceedings are complete, the Commissioner

may assess computational adjustments against a partner without
                               - 14 -

issuing a notice of deficiency.   See secs. 6225(a), 6230(a)(1);

N.C.F. Energy Partners v. Commissioner, 89 T.C. 741, 743-744

(1987).

     The second type of affected item requires a partner-level

determination; it is an adjustment to a partner’s tax liability

(other than to reflect a penalty, addition to tax, or additional

amount relating to an adjustment to a partnership item) to

reflect the proper treatment of a partnership item that is

dependent upon factual determinations to be made at the partner

level.    See sec. 6230(a)(2)(A)(i); Domulewicz v. Commissioner,

supra at 22-24.   The normal deficiency procedures apply to

affected items that require partner-level determinations (other

than penalties, additions to tax, and additional amounts that

relate to adjustments to partnership items).   See sec.

6230(a)(2)(A)(i).   These procedures require the timely issuance

of an NOD as a precondition to the Commissioner’s assessment of a

deficiency or accuracy-related penalty related to affected items.

A valid NOD requires that any partnership-level proceeding

involving the related partnership be complete.   See sec. 6225(a);

GAF Corp. v. Commissioner, supra at 528; Maxwell v. Commissioner,

supra at 788.

     When an FPAA is issued to the partnership and a

partnership-level proceeding as to the FPAA is properly brought

in this Court, the partnership-level proceeding is complete when
                               - 15 -

our decision becomes final.    See sec. 6225(a)(2).   When the

Commissioner opts not to begin a partnership-level proceeding or

issue an FPAA within the normal period of limitations, the

partnership-level proceeding is considered complete when the

Commissioner accepts the partnership’s return as filed.     See

Roberts v. Commissioner, 94 T.C. 853, 860-861 (1990).      Whether

the Commissioner has accepted a partnership return as filed is a

question of fact that turns in part on a finding of whether the

Commissioner opted to allow the normal period of limitations to

expire without beginning a partnership-level proceeding.     See id.

III.    Positions of the Parties

       The parties agree that respondent has not begun a

partnership-level proceeding as to Intervest’s 1999 taxable year

and that the normal period of limitations with respect to

Intervest has expired as to that year.    Petitioners argue that

the NOD is invalid (and hence the Court lacks jurisdiction)

because respondent issued the NOD to them before accepting

Intervest’s return for 1999 as filed.    Petitioners support their

argument primarily with a reference to the above-quoted

statements in respondent’s motion to stay.    Petitioners also

point the Court to the grand jury investigation and to the

Commissioner’s general policy that a civil proceeding against a

taxpayer should not be commenced while the taxpayer is under

criminal investigation.    Petitioners conclude that respondent
                               - 16 -

deferred his decision on whether to audit Intervest’s return

until after the completion of the grand jury investigation and

any related criminal prosecution.

      Respondent acknowledges that the Court lacks jurisdiction to

decide any partnership item included in the NOD, e.g., whether

the disallowed loss was in fact generated by Intervest.

Respondent also concedes that he may no longer adjust Intervest’s

partnership items absent an exception to the normal period of

limitations.   Nevertheless, respondent argues that the affected

items included in the NOD properly remain in dispute.   Those

affected items, respondent asserts, include whether petitioners

were at risk under section 465 and whether petitioners had a

sufficient basis under section 704(d) to deduct any of their

reported loss.   Respondent also asserts that the accuracy-related

penalties are affected items to the extent the penalties do not

relate to partnership items.   As to petitioners’ argument that

the NOD was issued prematurely, respondent counters that

Intervest’s return for 1999 had been accepted as filed as of the

time the NOD was issued.

IV.   Timing of the NOD

      We agree with respondent that the NOD was not issued

prematurely and is valid.   Intervest is the partnership to which

the partnership items underlying the adjustments in the NOD

relate, and respondent has neither begun an audit of Intervest
                              - 17 -

nor notified anyone that respondent was beginning an audit of

Intervest.7   See sec. 6223(a).   Respondent therefore could not

have issued the NOD to petitioners before the completion of any

partnership-level proceeding involving Intervest in that

respondent never started any such proceeding in the first place.

Where, as here, the Commissioner has opted not to commence within

the normal period of limitations a partnership-level proceeding

as to an entity subject to TEFRA, section 6225(a) serves as no

restriction on the time within that period when the Commissioner

may issue an NOD related to the partnership.    It therefore was

proper for respondent to have issued the NOD to petitioners just

before the normal period of limitations was going to expire on

petitioners’ (and Intervest’s) 1999 taxable years.    Although

respondent may have later considered during this proceeding the

possibility of beginning a partnership-level proceeding as to

Intervest on account of fraud or the like, any such consideration

did not invalidate the NOD.

     Petitioners assert that this case is indistinguishable from

Soward v. Commissioner, T.C. Memo. 2006-262.    There, the Court

granted the Commissioner’s motion to dismiss for lack of

jurisdiction because the Commissioner had issued an NOD while

     7
        Because respondent did not commence a partnership-level
proceeding as to Intervest for 1999, for purposes of this
proceeding the parties are bound by the partnership items as
reported on Intervest’s return. See Roberts v. Commissioner, 94
T.C. 853, 862 (1990).
                               - 18 -

litigation with respect to the FPAA was ongoing.    The Soward case

is factually distinguishable from this case given that there but

not here an FPAA had been issued and litigation as to the FPAA

was ongoing when the NOD was issued.    Petitioners also assert

that respondent was required to wait until the expiration of the

normal period of limitations before issuing the NOD to them.      We

disagree.   As stated above, the Commissioner may issue an NOD

during the normal period of limitations applicable to a TEFRA

entity when at the time of such issuance he has accepted the

TEFRA entity’s return as filed.   Our opinions in Roberts v.

Commissioner, supra, and Gustin v. Commissioner, T.C. Memo.

2002-64, are consistent with this interpretation.    In both cases,

the NOD was issued before the normal period of limitations

expired as to the partnership but after the Commissioner had

accepted the partnership return as filed.

     We note for completeness that we recognize that the NOD at

issue referenced MCM (rather than Intervest) as the TEFRA entity

to which the adjustments in the NOD related.    Petitioners place

no weight on this fact in arguing that the Court lacks

jurisdiction over this case.   Neither do we.   Petitioners

reported on their 1999 tax return that they were deducting the

$4,538,844 loss as a passthrough item from a partnership,

identified by them as MCM, and petitioners’ return gave no

indication that MCM was actually Mr. Meruelo’s single-member
                                - 19 -

limited liability company that was a disregarded entity for

Federal tax purposes, or that the loss actually stemmed from

Intervest.    Nor did MCM or Intervest file with respondent any

document that would have placed petitioners’ reporting position

in question.    Respondent made his determination in the NOD on the

basis of all information that petitioners had supplied to him as

of the time that the NOD was issued.

V.   Characterization of the Affected Items

      We now turn to petitioners’ alternative argument.

Petitioners argue that the Court lacks jurisdiction because the

affected items set forth in the NOD are not in fact affected

items.   We disagree.   The three items in the NOD that respondent

has identified as affected items are in fact affected items that

require determinations at the partner level.

      First, respondent determined as an affected item that

petitioners were not at risk in an activity to which section 465

applies.     The ultimate limitation of deductions on account of the

amount for which a partner is at risk with respect to an activity

must be determined in a partner-level proceeding.     See Hambrose

Leasing 1984-5 Ltd. Pship. v. Commissioner, 99 T.C. 298 (1992);

sec. 301.6231(a)(5)-1(c), Proced. & Admin. Regs.; see also

Roberts v. Commissioner, 94 T.C. at 861.      Such a determination,

therefore, implicates an affected item that requires a

determination at the partner level.      We note that respondent has
                              - 20 -

informed the Court that respondent is looking outside the

partnership agreement to ascertain whether any “side agreements”

would have limited the amount for which petitioners were at risk.

     Second, respondent determined as an affected item that

section 704(d) also limited petitioners’ claim to a deduction of

any part of the disallowed loss.    This determination implicates

an affected item that requires a determination at the partner

level because the section 704(d) limitation restricts at the

partner level a partner’s ability to claim a partnership loss.

See Dial USA, Inc. v. Commissioner, 95 T.C. 1 (1990); sec.

301.6231(a)(5)-1(b), Proced. & Admin. Regs.; see also Gustin v.

Commissioner, supra.   A partner must establish his basis in the

partnership in order to deduct a partnership loss.    See sec.

704(d).

     Third, respondent determined as an affected item that

petitioners are liable for an accuracy-related penalty under

section 6662.   This determination implicates an affected item

that requires a determination at the partner level because the

imposition of such a penalty depends entirely upon our decision

on the first two affected items, which in turn are peculiar to

petitioners and not to Intervest.   See sec. 301.6221-1T(c),

Temporary Proced. & Admin. Regs., 64 Fed. Reg. 3838 (Jan. 26,

1999) (accuracy-related penalties are partner-level

determinations to the extent they are not attributable to an
                              - 21 -

adjustment to a partnership item); cf. sec. 6221 (penalties

attributable to an “adjustment to a partnership item” are

determined at partnership level).

VI.   Conclusion

      We conclude we have jurisdiction to decide this case.   We

have considered all arguments petitioners have made for a

contrary conclusion and, to the extent not discussed, we have

rejected those arguments as without merit.

      To reflect the foregoing,

                                         An appropriate order will

                                    be issued.