Citron v. Comm'r of Internal Revenue, Docket No. 626-88.

• Citation: 97 T.C. 200,97 T.C. No. 12
• Decision Date: 05 August 1991
• Docket Number: Docket No. 626-88.
• Court: United States Tax Court
• Parties: B. PHILIP CITRON AND EMILY K. CITRON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

97 T.C. 200

97 T.C. No. 12

B. PHILIP CITRON AND EMILY K. CITRON, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 626-88.

United States Tax Court

Filed August 5, 1991.

P borrowed $60,000 and, along with three other limited partners, invested in a partnership (V) in order to produce a motion picture. The general partner was a corporation (C). The motion picture was made by use of the capital invested by the limited partners and no debt was incurred by V. Upon completion, the negative came into the possession of the executive producer (an unrelated third party which had certain rights in it). Controversy arose over possession of the negative, and V was unable to obtain the negative. V had a copy of the film (from which only poor quality copies could be made) and C decided to make an X-rated film from the copy. P and the other limited partners decided, at the end of 1981, not to advance any additional capital, not to become involved in the production of an X-rated movie, and to dissolve V. At the close of business 1981, V had no liabilities, had made no profit, and was not in possession of the negative. P did not expect to and did not receive any distributions from V and it was clear to all involved that P was to have nothing further to do with V. P asserts he is entitled to an ordinary loss equal to his capital investment in V and contends it was from theft or embezzlement or from abandonment. R argues alternatively that if a loss occurred, it was from a sale or exchange and should be characterized as capital and limited to $3,000 for 1981. HELD: P did not have a loss from theft or embezzlement. HELD FURTHER: P was entitled to an ordinary loss because no sale or exchange occurred in connection with his abandonment of the partnership interest. HELD FURTHER: The amount of P's basis and loss determined. Mortimer L. Laski, Kenneth G. Gordon, and Murray H. Falk, for the petitioners.

James S. Yan, for the respondent.

GERBER, JUDGE:

Respondent, in a statutory notice of deficiency, determined a $34,089 Federal income tax deficiency and a $1,704.45 addition to tax under section 6653(a)(1) ¹ for petitioners' 1981 taxable year. Respondent also determined an additional 50 percent of the interest due on the $34,089 deficiency under section 6653(a)(2) for the 1981 taxable year. The entire deficiency is attributable to the disallowance of a loss claimed by petitioners in connection with the Vandom Productions partnership. The primary issue for our consideration is whether petitioners are entitled to a loss either due to a theft or embezzlement or, in the alternative, due to abandonment. If petitioners are entitled to a loss, secondary issues involve the amount of the loss and whether it should be characterized as capital or ordinary.

FINDINGS OF FACT

The parties' stipulation of facts and attached exhibits are incorporated by this reference. Petitioners, who at all pertinent times were husband and wife, had their legal residence at 1490 Kenmore Road, Pasadena, California, at the time the petition was filed in this case. They filed a joint Federal income tax return for the 1981 taxable year. Petitioner B. Philip Citron (“petitioner” when used in the singular shall refer to B. Philip Citron) is a physician specializing in gastroenterology. He is the head of the Gastroenterology Department at Glendale Adventist Medical Center which is part of the Glendale Adventist Church. Emily Citron, a physician and the head of the Pediatric Chest Disease Department at Lake County Hospital, had no involvement in petitioner's investment in the Vandom Productions partnership (Vandom).

Petitioner became a limited partner in Vandom, a California limited partnership, on September 26, 1980, by the cash investment of $60,000. In addition to petitioner, at all times pertinent herein, there were three additional limited partners in Vandom, two of whom had also invested $60,000 in cash and one of whom had invested $90,000 in cash. Each of the four limited partners was entitled to a 10-percent share in the profits of Vandom. The general partner was entitled to any profits in excess of the combined 40-percent share of the limited partners. Each limited partner who invested $60,000 was entitled to 22.2 percent of losses and ownership of Vandom's capital. The limited partner who invested $90,000 was entitled to 33 percent of losses and ownership of Vandom's capital. Petitioner obtained the $60,000 by means of a loan from Crocker National Bank. Petitioners claimed a $12,213 interest deduction on their 1981 income tax return concerning the $60,000 loan from Crocker National Bank. No promissory notes or obligations were assumed by or for Vandom by the limited partners. No funds necessary for Vandom's operation were borrowed. Instead, Vandom's operation was funded by the capital contributions of the four partners.

The general partner of Vandom was Vandom, Inc. Robert Burge (Burge) was president of Vandom, Inc. Burge was a motion picture producer and director at the time Vandom was formed. At the time of trial, he had made four motion pictures and about 100 television commercials and was working on a movie entitled “Keaton's Cops,” starring Lee Majors, Abe Vigoda, and Don Rickles. Burge was also the president of Vandom Pictures, Inc., a Texas corporation, which eventually acquired the assets of Vandom, Inc. Vandom Pictures, Inc., was in the business of producing and distributing motion pictures.

The purpose of Vandom was to produce a motion picture to be named “Girls of Company C,” also known as “The Girls of Charley Company.” Burge wrote and developed the script for the motion picture in February 1980. The filming was completed in September 1980 and was the only movie made or activity conducted by Vandom. The completed movie film is referred to in the industry as the “negative.” Upon the completion of Vandom's activity concerning the negative, it was in the possession of Pacific Film Lab, a company in which neither Vandom nor Vandom, Inc., had an interest. In May 1981 Burge asked Pacific Film Lab for the negative for purposes of cutting and editing.

Joe Bardo (Bardo), doing business through a corporation known as “Millionaire Productions” (Millionaire), was an executive producer of the movie. Bardo was responsible for supplying the “below-line” services, which includes all services other than those provided by actors, producers, and directors (which are the “above-line” services). The above-line costs came out to about $47,000 and the below-line costs came out to about $153,000. Vandom, Inc., paid $140,000 on behalf of Millionaire for the below-line costs. Vandom incurred expenses of $249,167.80 for the production of the movie during 1980. Vandom's 1981 partnership return reflected $24,392 in accounts receivable as of the beginning of 1981. Bardo was also the subdistributor and videotape distributor of the movie. After the negative was delivered to Bardo, Burge made several requests for its return, which Bardo did not heed. Burge also had prior dealings with Bardo involving two other movies, and Burge believed that Bardo had improperly sold foreign rights to those movies and had not remitted money owed to Burge or his related entities.

At the time of Bardo's refusal to return the negative, Vandom retained a work print of the movie (a copy of the negative), which cannot be used to generally and commercially reproduce and release the type of movie Vandom was attempting to make. Burge advised the Vandom limited partners of Bardo's refusal and told them that the movie could not be made without the negative. Subsequently, Burge met three times with the limited partners between July and the end of December 1981. At the third meeting Burge explained that his attorneys' efforts to obtain the negative had been unsuccessful and that Bardo would not answer Burge's telephone calls. The limited partners were advised that an expensive ² and lengthy lawsuit would have to be brought against Bardo to recover the negative. Burge also advised the limited partners that with additional investment ² an X-rated version of the movie could be made from the work print which might allow the recovery of a portion of the investment in Vandom.

Respondent argues in this case that if we find that petitioner abandoned his partnership interest during 1981, such abandonment resulted in a sale or exchange within the meaning of section 741 because the partnership had a $3,560 liability at the end of its taxable year.

Petitioner counters that respondent is in error concerning the $3,560 liability. Petitioner points out that the $3,560 liability only appears as an opening balance on the balance sheet on Vandom's final return (Form 1065 for the 1981 year) and that no liabilities are reflected for the partnership as of the close of the 1981 year. The certified public accountant for Vandom testified and confirmed that there were no liabilities in reference to the limited partners. Because respondent has incorrectly interpreted the facts, his argument on this point must fail because there was no debt to be assumed by the partnership. It is also noted that the partnership return at the beginning of the 1981 year reflected deferred distribution costs and expenses in the amount of $3,560 as an asset. It would not be unreasonable to assume that the deferred expenses had been carried over from 1980 year-end operations, and that the deferral was reversed and the liability paid early in the 1981 year.

Respondent also argues that the abandonment would be a sale or exchange because petitioner may have received the benefit of an interest payment, during 1981, regarding his loan with Crocker National Bank. Although the record is not clear whether any such payments were made on petitioner's behalf during 1981, these payments, if made, were not made in liquidation of or exchange for petitioner's interest in Vandom or at the time of abandonment.

It is clear, however, that...