Gefen v. Comm'r of Internal Revenue

• Decision Date: 30 December 1986
• Docket Number: Docket No. 18900-82.
• Citation: 87 T.C. 1471,87 T.C. No. 85
• Parties: SIDNEY J. GEFEN AND LOIS I. GEFEN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

87 T.C. 1471

87 T.C. No. 85

SIDNEY J. GEFEN AND LOIS I. GEFEN, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 18900-82.

United States Tax Court

Filed December 30, 1986.

Petitioner-wife invested in a limited partnership that purchased and leased computer equipment. She also executed a limited partner guarantee by which she assumed personal liability for her pro rata share of the partnership's recourse indebtedness.

HELD, the partnership's transactions were supported by economic substance. HELD FURTHER, the partnership's purchase and lease of the computer equipment were activities that were engaged in for profit. HELD FURTHER, petitioner-wife was entitled to include in her partnership basis her pro rata share of the partnership's recourse and nonrecourse liabilities. HELD FURTHER, petitioner-wife was at risk within the meaning of sec. 465, I.R.C. 1954, for her pro rata share of the partnership's recourse indebtedness. Daniel S. Abrams and Gerald A. Rosenberg, for the petitioners.

Marwin A. Batt, Roland Barral, and Robert A. Wagner, for the respondent.

STERRETT CHIEF JUDGE.

By notice of deficiency dated April 27, 1982, respondent determined deficiencies in petitioners' Federal income taxes for the calendar years 1977, 1978, and 1979 in the amounts of $10,513.66, $8,376.65, and $9,420.60, respectively. By amendment to his answer, respondent alleged that the correct deficiency for 1977 is $10,479.00, and that the deficiencies for 1978 and 1979 should be increased in the amounts of $7,692.35 and $1,546.40, respectively. The deficiencies resulted from respondent's determination that petitioners were not entitled to deduct losses and interest expenses attributable to an investment by petitioner Lois I. Gefen in a limited partnership. After concessions, the issues for decision are (1) whether the partnership's transactions were supported by economic substance; (2) whether the partnership was engaged in an activity for profit; (3) whether petitioner Lois I. Gefen was entitled to include in her partnership basis her allocable share of partnership liabilities; and (4) whether petitioner Lois I. Gefen was at risk within the meaning of section 465 ¹ for her allocable share of the partnership's recourse indebtedness.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.

Petitioners, Sidney J. Gefen and Lois I. Gefen, are husband and wife. At the time the petition was filed in this case, they resided in Jacksonville, Florida. Their joint Federal income tax returns for the years in question were filed with the Office of the Internal Revenue Service in Atlanta, Georgia.

THE PARTNERSHIP

Dartmouth Associates (the Partnership) was formed in 1976 by Integrated Resources, Inc. (Integrated), as a limited partnership under the Uniform Limited Partnership Act of the State of Connecticut. ² Integrated formed the Partnership in order to have a partnership available for investment in real estate. The Partnership's Limited Partnership Agreement and Certificate of Formation of Limited Partnership were amended on or before July 27, 1977, to permit the Partnership to enter into the trade and business of owning and leasing computer equipment.

The general partners of the Partnership were IR-Oak Corporation (IR-Oak), a wholly owned subsidiary of Integrated, and Bernard Kaplan, the president of Underwriters' Service Agency, Inc., also a wholly owned subsidiary of Integrated. IR-Oak and Bernard Kaplan contributed in cash $5,060 and $506, respectively, as their capital contributions to the Partnership. Donald Olsen, the initial limited partner, contributed in cash $506 as his capital contribution to the Partnership.

In July of 1977, the Partnership acquired, and commenced the business of owning and leasing, computer equipment. The equipment was manufactured by the International Business Machines Corporation (IBM), and was designated by IBM and known generally as a System 370 Model 168 computer. The Partnership's gross income and deductions were derived principally from owning and leasing this computer equipment.

Commencing in September of 1977, the Partnership distributed a confidential private placement memorandum (the Confidential Memorandum) and offered for sale to a limited number of qualified investors limited partnership interests aggregating a 98.8 percent interest in the Partnership. Pursuant to this offering, the limited partners other than the initial limited partner contributed $499,928 as their aggregate capital contribution to the Partnership.

The Confidential Memorandum stated that the Partnership's investment objectives were the potential increase in equity in the computer equipment through the amortization of loans used to purchase the equipment, a small net cash flow during the term of the computer lease, a profit from the re-lease or sale of the equipment at the expiration of the lease, and current tax benefits. The Confidential Memorandum also contained discussions of the general economic, legal, and tax consequences of both the Partnership's activities and an investment in the Partnership.

Schedule A of the Confidential Memorandum projected that the Partnership's investment in the computer equipment would generate tax losses in the early years of the investment but that, beginning in 1982, substantial taxable income would result, even though little net cash flow was expected from the computer lease and even if the computer equipment had no value at the expiration of the lease.

Schedule B of the Confidential Memorandum projected the cumulative economic effects, after tax, of an investment in the Partnership for investors in tax brackets of 55, 60, and 70 percent, using values of the computer equipment at the expiration of the lease of 0, 10, 16, 25, 30, and 40 percent of the equipment's original cost. This schedule indicated that an investor's return was dependent on the value of the computer equipment at the expiration of the lease (the residual value), and that an investor could expect an economic benefit from an investment in the Partnership, after tax, if the computer equipment retained a value of at least 16 percent of the equipment's original cost. Although the Confidential Memorandum provided no assurance that the computer equipment would have any residual value, it contained an appraisal of the equipment by an independent appraiser that stated that it was reasonable to expect that the equipment would have a value in excess of $745,000 at the expiration of the lease. Schedules A and B of the Confidential Memorandum appear in Appendix A attached hereto.

The Partnership reported its income and expenses on the accrual method of accounting and used the calendar year as its taxable year. The Partnership's books and business records consisted of checking account statements, checkbook stubs, accountant workpapers, and annual financial statements.

PETITIONER'S INTEREST IN THE PARTNERSHIP, THE LIMITED PARTNER GUARANTEE, AND PETITIONER'S OBLIGATION TO MAKE ADDITIONAL CONTRIBUTIONS TO THE PARTNERSHIP

Petitioner Lois I. Gefen (petitioner) acquired her interest in the Partnership by paying $24,996.50 (4.94 percent of the Partnership's aggregate capital contributions) in cash to the Partnership in October of 1977. She was a limited partner in the Partnership on December 31 of each of the Partnership taxable years 1977 through 1983. At all times relevant to this proceeding, she had a 4.94 percent interest in the Partnership's capital, profits, and losses.

As a condition to her admission to the Partnership as a limited partner, petitioner was required to and did execute and deliver to the Partnership a Limited Partner Guarantee (the Guarantee). The Guarantee stated that petitioner assumed personal liability for her pro rata share (4.94 percent) of the Partnership's recourse indebtedness of $1,030,000. In pertinent part, the Guarantee reads as follows:

DARTMOUTH ASSOCIATES LIMITED PARTNER GUARANTEE

WHEREAS, the undersigned is a limited partner of Dartmouth Associates, a Connecticut limited partnership (the ‘Partnership‘) and

WHEREAS, The Partnership is personally liable under certain circumstances to Sun Life Insurance Company of America (the ‘Lender‘) for an aggregate amount of $1,030,000 (the ‘Recourse Amount‘) under the terms, and subject to the conditions and limitations, of Section 5 of a Security and Loan Agreement (the ‘Loan Agreement‘), dated as of June 15, 1977, as amended, between the Lender and the Partnership, such Recourse Amount constituting a portion of the indebtedness of the Partnership under the Loan Agreement.

WHEREAS, each of the limited partners (the ‘Limited Partners‘) of the Partnership, as a condition to their admission as Limited Partners, are required by the Partnership personally to guaranty a pro rata portion of the Recourse Amount.

NOW, THEREFORE, in consideration of the premises and for other good and valuable consideration, receipt of which is hereby acknowledged and subject to the conditions set forth below, THE UNDERSIGNED ASSUMES PERSONAL LIABILITY FOR REPAYMENT OF A PORTION OF THE RECOURSE AMOUNT and guarantees to the Lender as follows:

1. Subject to the provisions of, and conditions and limitations set forth in, Paragraph 4 below, Section 5 of the Loan Agreement and Section 5(c) of the Limited Partnership Agreement (the ‘Partnership Agreement‘) of the Partnership, the undersigned hereby UNCONDITIONALLY GUARANTEES TO THE LENDER, ITS SUCCESSORS AND ASSIGNS, THE DUE AND PROMPT COLLECTION, IN ACCORDANCE WITH THE TERMS THEREOF, of up to $101,764 of the Recourse Amount per Unit of Limited Partnership Interest in the Partnership purchased by the undersigned.

2. This undertaking shall operate as a continuing guarantee and shall remain in full force and effect until January 1, 1982. THE UNDERSIGNED'S OBLIGATION HEREUNDER IS NOT CONTINGENT UPON SIMILAR...