FEDERAL TAXATION

April 2000

SALE OF A PARTNERSHIP INTEREST

By Bruce I. Panock, CPA

In Robert S. McDaniel, Jr. and W. Jane McDaniel, Petitioners v. Comm'r [T.C. Memo 1999-133 (filed April 22, 1999)], the Tax Court found that the taxpayer had not properly reported the gain from the disposition of a partnership interest, and that, due to the misreporting, the accuracy-related penalties under IRC section 6662(a) were due.

The Case

The taxpayer, a practicing attorney with a real estate specialization, purchased a general partnership interest in a real estate partnership. He and the other seven general partners caused the partnership to borrow monies on a nonrecourse basis in 1985. In a later refinancing from a second bank in 1989, McDaniel and each of the other general partners were required to execute personal guarantees with respect to the 1989 mortgage. The guarantees were unconditional as to all payments and obligations of the mortgage.

After the refinancing, the interests of five of the partners were purchased by the remaining three partners, one of whom was McDaniel. As part of the purchase, the bank expressly released the departing partners from any responsibility under the 1989 mortgage.

Due to negative cash flow, it was necessary for the remaining partners to make capital contributions to support the property. In 1992, McDaniel notified the remaining partners that he was no longer able to support the partnership cash flow requirements. By a quitclaim deed dated May 12, 1992, he transferred his entire interest to one of the other partners. As a result of having a negative capital account, McDaniel, in a corrective quitclaim deed dated September 9, 1993, transferred his interest in any of the partnership real estate to the partnership. At no time did the bank ever release McDaniel from his responsibilities under the 1989 mortgage.

The partnership filed for bankruptcy in 1992. The balloon payment under the 1989 mortgage came due in April 1993. The bank did not commence action to collect, pending the completion of the bankruptcy proceedings. No notices of any responsibility to make payment were sent to McDaniel; neither did the bank consider any release of McDaniel in any of its internal documents. In April 1994, the bank sent a notice demanding payment on the mortgage to the managing general partner. Alternative financing was arranged, and the 1989 mortgage was replaced. The McDaniel guarantee did not extend to this 1994 refinancing.

The partnership reported a "Final" K-1 to McDaniel in 1992 reflecting a capital gain in the amount of the negative capital account. McDaniel and his spouse filed Form 8082, Notice of Inconsistent Treatment or Amended Return, with their 1992 joint return. The McDaniels claimed that since they continued to be liable on the mortgages in an amount greater than the deficit account, they did not have a capital gain to report. The taxpayers did not report the capital gains from the disposition of the partnership interest in 1992 or any other year.

The IRC requires that the gains and losses be recognized when a taxpayer disposes of property and is relieved of any related liabilities. The parties to the case agreed that under IRC sections 752(b), 731(a), and 741, McDaniel had realized capital gain when he was relieved of the personal guarantees under the mortgage. The question that remained to be resolved was when such liabilities were relieved. McDaniel wanted to recognize the capital gain in 1993, as there were capital losses from other activities reported in that year. The IRS argued that the capital gains were recognizable in 1994, when the liabilities were relieved.

The parties turned to the governing Florida statutes, which provide that the release from liability occurs when three conditions are met. First, a person must agree to assume the existing obligations of a dissolved partnership. Second, the creditor of that partnership must know of the agreement by a person to assume the existing obligations of a dissolved partnership. Third, such creditor must consent to a material alteration in the nature or time of payment of those obligations.

When McDaniel left the partnership in 1992, there was no release of his guarantees by the remaining partners or the bank, in either oral or written form. Until the renegotiations and refinancing of the 1989 mortgage in 1994, McDaniel remained as a guarantor of the partnership obligation. The court found that McDaniel was not able to provide sufficient information to support the claim that the liabilities were released in the earlier year. When combined with the failure to report any income, the facts supported the assessment of the negligence penalties.

Planning Point

When a partner seeks to resign from a partnership, care must be taken to address all issues relating to the resignation. The timing of the recognition of any income as a result of such resignation must be reviewed in light of not only the Federal statutes but also, just as importantly, the relevant state statutes. *