Coloman v. C. I. R.
| Decision Date | 14 July 1976 |
| Docket Number | No. 74-2537,74-2537 |
| Citation | 540 F.2d 427 |
| Parties | 76-2 USTC P 9581 Eugene COLOMAN and Louise D. L. Coloman, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. |
| Court | U.S. Court of Appeals — Ninth Circuit |
Before TRASK and KENNEDY, Circuit Judges, and CONTI, * District Judge.
These are consolidated appeals from the decision of the United States Tax Court (T.C.Memo. 74-78, March 28, 1974) upholding the Commissioner's determination of deficiencies in appellants' income tax for the years 1967 through 1970. During those years taxpayers claimed on their tax returns loss deductions arising from certain corporate stock they held which they allege became worthless. The Tax Court held that the taxpayers had failed to establish any basis in the stock, that its basis was, therefore, zero, and by implication that the Commissioner's disallowance of the loss deductions taken, and the corresponding assessment of deficiencies, was correct. We affirm.
Taxpayers, husband and wife, with two others, formed a dry cleaning business in 1962 which they operated as a partnership until March, 1964, at which time they incorporated the business in California under the name of Village Valet, Inc. All assets and liabilities of the partnership were transferred to the corporation, and the partners took stock in the corporation in exchange. 1
In September 1970 the corporation was dissolved and liquidation begun. Taxpayers took possession of some of the corporation's equipment and reopened the business at a new location as a sole proprietorship. The taxpayers reported in 1970 a portion of the loss attributable to the stock's allegedly having become worthless; the remainder of the loss was carried back to 1967, 1968, and 1969 as a net operating loss.
Under Section 358(a) of the Internal Revenue Code, 2 the basis of stock received from a corporation is equal to the basis of the property exchanged for that stock. Here, the taxpayers exchanged their partnership interest for the corporate stock; therefore, the basis of their stock would be the carryover basis of their partnership interest.
Taxpayers' basis in their partnership interest is determined by the provisions of subchapter K (Sections 701-711). As a general rule, a partner's basis in a newly formed partnership will be the same as his adjusted basis in the property he exchanged for his interest, plus any money contributed. Section 722. This initial basis is further adjusted for increases or decreases in partnership liabilities assumed by the individual partners. Section 752(a) and (b). In addition, the initial basis is continually adjusted by virtue of the ordinary activities relating to the partnership vis-a-vis the individual partners; for example, Section 705(a) provides that the basis of a partner's interest is to be increased by his distributive share of the partnership's taxable income for each year, his distributive share of tax-exempt partnership income, and the excess of deductions for depletion over the basis of property subject to depletion. Similarly, basis is decreased (but not below zero) by distributions by the partnership to the partner as provided in Section 733, and by the sum of his distributive share for the current and prior taxable years of partnership losses, and non-deductible and non-capitalizable partnership expenditures. Furthermore, Section 704 provides, in determining the partner's distributive share for purposes of gain or loss, that such ratios and amounts shall be determined by the partnership agreement, and, if the agreement is not lacking in substance, the partners themselves can determine their distributive shares as to total gain or loss, or to individual items of income, gain, loss, deduction and credit. See Orrisch v. Commissioner, 55 T.C. 395 (1970).
Thus, in order to establish the basis in the interest in the partnership at the time the corporation was formed (which in turn would be the basis in the corporate stock at the time of incorporation), the taxpayers had to establish to the Tax Court's satisfaction (1) the initial basis in the partnership interest at the time the partnership was formed, and (2) the amount of any adjustments thereto by virtue of the activities of the partnership, pursuant to Section 705(a), and/or by virtue of assumptions of liabilities by other partners, pursuant to Section 752.
The burden of so establishing rested on the taxpayers. Welch v. Helvering, 290 U.S. 111, 54 S.Ct. 8, 78 L.Ed. 212 (1933). Establishing basis is a factual matter, Vaira v. Commissioner of Internal Revenue, 444 F.2d 770 (3rd Cir. 1971), and the Commissioner's determination is accepted by the Tax Court as presumptively correct. J. M. Perry & Co. v. Commissioner of Internal Revenue, 120 F.2d 123 (9th Cir. 1941). The fact that basis may be difficult to establish does not relieve a taxpayer from his burden. O'Neill v. Commissioner of Internal Revenue, 271 F.2d 44 (9th Cir. 1959).
The testimony presented by the taxpayers did not, in the Tax Court's opinion, meet this burden. About the only evidence relevant on the basis issue was the husband's taxpayer's unverified statement that he had contributed property "worth" $28,000 to the partnership in the form of a second deed of trust. 3 But, as the Service notes, the "worth" or value of a piece of property may be quite different from its basis in the taxpayer's hands, and this is the basis that the taxpayers failed to prove. Thus, the Tax Court concluded that the taxpayers had not established their initial basis in the partnership interest.
Moreover, there was insufficient evidence of what adjustments to this basis may have been necessary during the course of operations of the partnership, according to the provisions of Sections 705, 733 and 752. Thus, taxpayers failed in several important respects to establish the basis in the partnership interest at the termination of the partnership, so as to satisfy the general statutory requirements found in Sections 722, 733, 752 and 705(a).
However, taxpayers argue on appeal 4 that the alternative rule of Section 705(b) should have been applied by the Tax Court, and should now be applied here. Under Section 705(b), the Commissioner is empowered to prescribe by regulations the circumstances under which the adjusted basis of a partner's interest in a partnership may be determined by reference to his proportionate share of the adjusted basis partnership property upon a termination of the partnership. The rule promulgated to implement this section, found in 26 CFR § 1.705-1(b) and set forth in full in the margin, 5 states that the alternative method may be used "where circumstances are such that the partner cannot practicably apply the general rule set forth in section 705(a)." Even under the alternative rule, adjustments to basis may be necessary to reflect discrepancies arising as a result of contributed property, transfers of partnership interests, or distributions of property to the partners.
Presumably to bring themselves within section 705(b), taxpayers presented evidence in the form of testimony by the corporation's accountant that at the time of incorporation, the corporation's books showed a "net worth" of $25,103.87. (R.T. at 14). From this figure, the accountant computed the taxpayers' basis in the partnership interest to be approximately $16,000. The Tax Court refused to accept the basis figure proposed by the taxpayers for the reason that it was based on figures supplied to the accountant by the taxpayers and not independently verified by the accountant.
We find no error in the lower court's refusal to accept the taxpayer's basis figure. Taxpayers had the burden of establishing basis, which...
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