Larson v. Comm'r of Internal Revenue

• Citation: 66 T.C. 159
• Decision Date: 27 April 1976
• Docket Number: 5266-73,Docket Nos. 5530-72,5267-73.
• Parties: PHILLIP G. LARSON, ET AL.,1 PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

66 T.C. 159

PHILLIP G. LARSON, ET AL.,1 PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket Nos. 5530-72

5266-73

5267-73.

United States Tax Court

Filed April 27, 1976.

Stanton H. Zarrow and Frederick A. Richman, for the petitioners.

Nicholas G. Stucky, for the respondent.

Petitioners owned limited partnership interests in two real estate syndications organized under the California Uniform Limited Partnership Act. The sole general partner in each partnership was a corporation, independent of the limited partners, organized for the purpose of promoting and managing such syndications. Under State law, the partnerships would be dissolved by the bankruptcy of the general partner. The general partner invested no funds in the partnerships and its interests were subordinated to those of the limited partners. The limited partners had the right to vote to remove the general partner. Limited partners' income rights were transferable with the consent of the general partner, which consent could not be unreasonably withheld. A transferee of a limited partner's capital interest, if the transfer was at fair market value, had the right to become a substituted limited partner without the consent of any member. Held: The partnerships possessed the corporate characteristics of centralized management and free transferability of interests and lacked the corporate characteristics of continuity of life and limited liability, and had no other significant corporate or noncorporate characteristics. They are taxable as partnerships defined in sec. 7701(a)(2), I.R.C. 1954, and not as corporations within the meaning of sec. 7701(a)(3) and sec. 301.7701-2, Proced. & Admin. Regs.

TANNENWALD, Judge:

Respondent determined deficiencies in Federal income taxes as follows:

+------------------------------------------------------------------+
                ¦Docket No.  ¦Petitioner               ¦Taxable year  ¦Deficiency  ¦
                +------------+-------------------------+--------------+------------¦
                ¦            ¦                         ¦              ¦            ¦
                +------------+-------------------------+--------------+------------¦
                ¦5530-72     ¦Phillip G. Larson        ¦1968          ¦$6,744      ¦
                +------------+-------------------------+--------------+------------¦
                ¦5266-73     ¦American Precision Metals¦1969          ¦3,703       ¦
                +------------------------------------------------------------------+
                

                          1970 1,810
                5267-73 Phillip G. Larson 1966 1,409
                

  1969 5,943
                  1970 6,389
                

Other issues having been disposed of by mutual agreement of the parties, the sole issue remaining for decision is whether the limited partnerships involved in this proceeding constitute associations taxable as corporations within the meaning of section 7701(a)(3).²

An opinion was filed in this case on October 21, 1975. On November 5, 1975, petitioners filed a ‘Motion for Reconsideration by the Full Court’ which was denied. The motion was referred to the trial judge as a motion for reconsideration of the opinion. The trial judge granted this motion and the Court's opinion was withdrawn on November 7, 1975.

FINDINGS OF FACT

Some of the facts have been stipulated by the parties. Such facts and the exhibits attached thereto are incorporated herein by this reference.

Phillip G. Larson, petitioner in docket Nos. 5530-72 and 5267-3 (hereinafter petitioner), was a legal resident of Burlingame, Calif., at the time he filed his petitions herein. Petitioner filed Federal individual income tax returns for the calendar years 1968 to 1970, inclusive, with the Internal Revenue Service Center at Ogden, Utah. During the taxable years 1968, 1969, and 1970, petitioner was a limited partner in Mai-kai Apartments (hereinafter Mai-Kai), a limited partnership formed under the laws of the State of California. During the taxable year 1970, petitioner was also a limited partner in Somis Orchards (hereinafter Somis), a limited partnership formed under the laws of the State of California.³

American Precision Metals, petitioner in docket No. 5266-73 (hereinafter referred to as American), was a corporation with its principal office in Burlingame, Calif., at the time it filed its petitioner herein. American filed its Federal corporation income tax returns for the calendar years 1969 and 1970 with the District Director of Internal Revenue at San Francisco, Calif. American was a limited partner in Somis during 1969 and 1970.

Grubin, Horth & Lawless, Inc. (hereinafter GHL), a California corporation, the sole general partner of both Mai-Kai and Somis, was formed April 2, 1968, primarily to organize so-called ‘real estate syndications' as limited partnerships under the laws of the State of California. GHL kept its books on the basis of a fiscal year ending March 31. GHL had a paid-in capital of $21,300. From its incorporation to March 31, 1974, its capital and surplus ranged between a maximum of $49,593 at the close of the fiscal year 1970 to a minimum of $18,764 as of the fiscal year 1974. Cash on hand was generally negligible, GHL organized both Mai-Kai and Somis and managed and administered the partnership properties. The assets and liabilities of GHL, as shown by its tax returns, may be summarized as follows:

+---------------------------------------+
                ¦           ¦FYE Mar. 31—             ¦
                +-----------+---------------------------¦
                ¦Assets 1  ¦1969  ¦1970  ¦1971  ¦1972  ¦
                +-----------+------+------+------+------¦
                ¦           ¦      ¦      ¦      ¦      ¦
                +-----------+------+------+------+------¦
                ¦Cash       ¦$8,756¦0     ¦0     ¦0     ¦
                +---------------------------------------+
                

Accounts receivable
                Partnerships         11,435 $12,661
                Partners             12,400 50,000  $48,780 $32,779
                Other                153    66,769
                

Other current assets      100 2,901 200
                Loans to stockholders 926
                

Other investments               2,500
                Depreciable assets       913    4,924   9,908   9,908
                Accumulated depreciation (54)   (851)   (2,112) (3,690)
                Intangible assets        376    376     376     376
                Accumulated amortization (75)   (150)   (225)   (300)
                Total assets             34,828 136,331 59,627  39,273
                

Liabilities  
                Accounts payable            1,058
                Mortgages and notes payable 10,176 44,500
                Other current liabilities   237    42,238 39,383  14,619
                Loans from stockholders     1,577
                Total liabilities           13,048 86,738 39,383  14,619
                Capital stock               21,300 21,300 21,300  21,300
                Retained earnings           480    28,293 (1,056) 3,353
                Total equity                21,780 49,593 20,244  24,653
                

The citrus groves were part of a 10,000 acre property owned by Kaiser Aetna known as Rancho Las Posas. At the time of their acquisition by Somis Orchards the citrus groves were planted with lemons, grapefruit, and oranges. The property was suitable, however, for possible future residential or commercial use. Kaiser Aetna, the seller of the property, had begun the formulation of an overall master plan for the development and marketing of the entire Rancho Las Posas property. A part of the consideration paid by Somis Orchards to Kaiser Aetna for the citrus groves related to Kaiser Aetna's agreement to enhance the value of the citrus groves through Kaiser Aetna's development of the comprehensive master plan and commencement of sales and marketing activities. Somis contracted with Kaiser Aetna to have the citrus groves remain in Kaiser Aetna's master plan and for the citrus groves to be managed by Kaiser Aetna in the interim.

GHL's capital contributions to Somis consisted of the transfer to the partnership of GHL's rights to acquire the citrus groves under the purchase contract negotiated by GHL. In addition, GHL assigned to Somis the management contract negotiated by GHL for management of the citrus groves by Kaiser Aetna.

A total of 44 limited partners contributed $420,000 in cash to Somis. ⁵ Each limited partner also executed a series of promissory notes reflecting annual contributions to be made by the limited partners during the 8 years following the formation of Somis. Of the total 44 limited partners in Somis, 26 joined the partnership in 1969, making capital contributions totaling $265,000. The remaining 18 limited partners joined the limited partnership in 1970.

At the time Somis was formed, it was contemplated that a total of $560,000 would be raised. However, in 1970, Somis sold one-fourth of the citrus groves to L. T. Anderson Construction Co. and L. T. Anderson, who executed and delivered to Kaiser Aetna their promissory notes for that portion of the citrus groves acquired from Somis. Somis' obligation to Kaiser Aetna under the first and second installment notes was thereafter reduced by 25 percent to a total of $2,575,875.

The partnership agreement and certificate signed by GHL and the Somis limited partners were generally similar to those of Mai-Kai, with the following material differences:

(1) The initial 15-year term could be extended by a 51-percent vote of limited partners.

(2) The general partner could not sell or pledge more than 45 percent of the partnership's assets or refinance the property without the approval of 51 percent of the limited partnership interests.

(3) The general partner was allowed additional compensation for organizational services, and an ‘incentive’ fee equal to a percentage of cash flow in excess of a stated amount.

(4) Profits, proceeds from sales of assets, and liquidation proceeds were allocated, 15 percent to the general partner and 85 percent to the limited partners. The general partner had no interest in cash flow.

(5) Fifty-one percent of the limited partnership interests could elect to terminate the partnership. The same percentage could vote to remove the general parter, in which event the partnership would terminate unless 51 percent of the limited partnership interests elected to form a new partnership to continue the business. On removal, the general partner would be paid the value of its interest, as determined by arbitration.

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