80 T.C. 1024 (1983)
BARTON BEEK and DOROTHY M. BEEK, et al.
COMMISSIONER of INTERNAL REVENUE, RESPONDENT
Nos. 10037-80, 10071-80, 10610-80, 10611-80, 14966-80.
United States Tax Court
May 19, 1983
In 1976, a cash basis partnership acquired real estate for $2 million, payable $300,000 in cash and $1,700,000 in a 10-year wraparound note, bearing interest at 81; 4 percent. That year, the partnership made several payments in reduction of the principal and interest due on the note for 1976 and 1977. Held, the portion of the payments attributable to interest for 1976 and 1977 are interest on indebtedness within the meaning of sec. 163(a), I.R.C. 1954, and do not represent additional payments of purchase price. Hudson-Duncan & Co. v. Commissioner, 36 B.T.A. 554 (1937), followed. Held, further, all interest described in sec. 163(a), I.R.C. 1954, is subject to the allocation rules of sec. 461(g), I.R.C. 1954, and therefore, under the latter section, the portion of such interest payments allocable to the year 1977 are not deductible in 1976.
Thomas R. Sheppard and Michael D. Fernhoff, for the petitioners.
Rosa Berman, for the respondent.
NIMS, Judge :
In these consolidated cases, respondent determined deficiencies and, by answer, alternative deficiencies, in petitioners' Federal income taxes for the taxable year 1976, as follows:
| Docket No.
|| per notice
|| per answer
The issues for decision are (1) whether a portion of each payment made by a partnership in 1976 pursuant to a land purchase contract constitutes interest on indebtedness within the meaning of section 163; 2 (2) whether, if interest within the meaning of section 163, certain of these interest payments are rendered nondeductible in 1976 by virtue of section 461(g) because they are allocable to 1977; and (3) whether, if section 461(g) is inapplicable to these interest payments, respondent may nevertheless disallow any deduction in 1976 for interest payments allocable to 1977 under the authority of section 446(b). All of the facts have been stipulated and are found accordingly. All of the petitioners, as well as Jean-Marie Sparling, executrix in docket No. 10071-80, resided in California at the time the respective petitions were filed. During the taxable year 1976, either one or both petitioners in each of the above dockets were limited partners of Crystal Wells Investors (hereinafter Crystal), a California limited partnership, were trustees of trusts which were limited partners of Crystal, or were partners in a partnership which was a limited partner of Crystal. In 1968, Crystal Wells Apartments, Ltd. (hereinafter C.W.L.), purchased real property located at 12472 Haster Street and 13061 Lampson Avenue, Garden Grove, Calif., for $1,550,000. Upon its purchase of the property, C.W.L. assumed a $1,448,700 obligation of its seller to Los Angeles Federal Savings. The obligation was secured by first deeds of trust on the property and had borne interest at the rate of 6 percent per annum. Upon C.W.L.'s assumption of the obligation, Los Angeles Federal Savings raised the interest rate to 6.75 percent per annum and required C.W.L. to make monthly payments of $9,465 for interest and principal reduction. Crystal was formed on August 16, 1976. On August 31, 1976, Crystal signed a " Long Form Security (Installment) Land Page 1027
Contract With Power of Sale," purchasing the above-described property from C.W.L. The contract provided for a $2 million total purchase price payable in paragraph 4, as follows: (a) Vendee shall pay to Vendor the sum of $300,000 (down payment) as and for a down payment. (b) The balance of the purchase price of $1,700,000 shall be paid by Vendee to Vendor and shall bear interest at the rate of 81; 4% per annum of any balance unpaid. Said sum shall be paid as follows: (i) $12,772 per month on the fifteenth day of each month through November 15, 1976; (ii) $153,264 per year commencing on December 15, 1976, and payable annually thereafter on the 15th day of December of each year; unpaid balance all due and payable on December 15, 1986.* * * C.W.L. further agreed to continue to make the payments to Los Angeles Federal Savings due on the first deed of trust notes. The unpaid principal balance of those notes, as of May 31, 1976, was $1,254,884.95. On October 1, 1976, October 6, 1976, November 1, 1976, and December 1, 1976, Crystal issued checks to C.W.L. each in the amount of $16,182.75. The difference between the amount of these checks and the $12,772 called for in paragraph 4 of the purchase contract was attributable to amounts for impound taxes and insurance. On December 23, 1976, Crystal issued a check payable to C.W.L. in the amount of $26,912 and a check payable to Los Angeles Federal Savings in the amount of $113,580. The $113,580 check was used by C.W.L. to prepay its 1977 principal and interest obligations to Los Angeles Federal Savings on the first deed of trust notes. Crystal employed the cash receipts and disbursements method of accounting in keeping its books and in computing its taxable income. On its Form 1065 for 1976, Crystal reported a deduction of $174,506 for " time-price differential" under section 163. This deduction represented a part of the payments made in 1976 by Crystal to or for C.W.L. under paragraph 4(b) of the land purchase contract. In his statutory notices of deficiency, respondent disallowed a portion of Crystal's 1976 loss deducted by each petitioner herein on the ground that only $46,191 of the $174,506 time-price differential deduction reported by Crystal represented interest on indebtedness properly allocable to the taxable year Page 1028
1976. By answer, respondent, in the alternative, increased each petitioner's deficiency on the ground that time-price differential is not interest within the meaning of section 163 and therefore the entire $174,506 of reported time-price differential must be added to the partnership's basis in the purchased property. This case essentially involves whether petitioners have found a " loophole" (to quote their general partner) in the applicability of section 461(g) to prepaid interest. Specifically, petitioners seek to deduct certain payments made by Crystal to or for C.W.L. in 1976 as interest described in section 163, but not interest described in section 461(g). They argue that section 461(g)'s limitations on deducting prepaid interest do not apply to all types of interest deductible under section 163, but only to interest which represents a charge for the use or forbearance of money. They further contend that the $174,506 of 81; 4-percent interest Crystal paid in 1976 on the $1,700,000 wraparound note is really time-price differential which does not represent a charge for the use or forbearance of money. Consequently, they say, section 461(g) does not apply to such interest payments. Respondent, on the other hand, contends that all interest deductible under section 163 is affected by the limitations of section 461(g). In addition, respondent argues that in the event we should find such a subcategory of prepaid interest to exist to which section 461(g) does not apply, deducting such interest in petitioners' cases would cause an impermissible material distortion of income under section 446(b). Alternatively, respondent argues that if section 461(g) is not applicable to the $174,506 of " interest" or " time-price differential" paid by Crystal in 1976, then all of that amount must have been additional purchase price which must be added to the partnership's basis in the property. Section 163(a) provides a deduction for " all interest paid or accrued within the taxable year on indebtedness." Section 461(g)(1) provides: (1) IN GENERAL .--If the taxable income of the taxpayer is computed under the cash receipts and disbursements method of accounting, interest paid by the taxpayer which, under regulations prescribed by the Secretary, is properly allocable to any period--
(A) with respect to which the interest represents a charge for the use or forbearance of money, and
Page 1029 (B) which is after the close...