Long v. C. I. R.

• Decision Date: 17 September 1981
• Docket Number: No. 79-1585,79-1585
• Citation: 660 F.2d 416
• Parties: 81-2 USTC P 9668 Marshall LONG and Betty C. Long, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 416

660 F.2d 416

81-2 USTC P 9668

Marshall LONG and Betty C. Long, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 79-1585.

United States Court of Appeals Tenth Circuit.

Argued Nov. 12, 1980.

Decided Sept. 17, 1981.

Daniel C. Weary, Kansas City, Mo. (Dennis P. Wilbert, Kansas City, Mo., with him on the brief), of Blackwell, Sanders, Matheny, Weary & Lombardi, Kansas City, Mo., for petitioners-appellants.

Robert A. Bernstein, Washington, D.C. (M. Carr Ferguson, Asst. Atty. Gen., Gilbert E. Andrews, Michael L. Paup, and Joan I. Oppenheimer, Attys., Tax Div., Dept. of Justice, Washington, D.C., on the brief), for respondent-appellee.

Before McWILLIAMS, McKAY and LOGAN, Circuit Judges.

LOGAN, Circuit Judge.

Marshall Long and his wife Betty C. Long appeal from the judgment of the United States Tax Court sustaining the Commissioner's determination of income tax deficiencies on their 1971 and 1972 joint income tax returns. Marshall Long (taxpayer), a beneficiary of the estate of his father John C. Long, claimed deductions for his share of the estate's alleged unused long-term capital losses incurred during administration of the estate and carried over to him under Internal Revenue Code (IRC) § 642(h). The only issues on appeal are whether John C. Long's estate, which succeeded to the decedent's interest in the Long Construction Company partnership (Long Construction), incurred a long-term capital loss arising out of liquidation of that partnership and, if so, the amount of that loss.

The parties have stipulated to most of the essential facts. John C. Long (John) died testate on July 5, 1963, owning a 25% partnership interest in Long Construction; his son, taxpayer's brother, Robert W. Long (Robert) owned the remaining 75% partnership interest. John's last will and testament provided that his wife Bertha Long, Robert and taxpayer each would receive one-third of his estate. The partnership was obviously insolvent at John's death; it owed large sums to banks, and two lawsuits were pending against the estate claiming millions of dollars in damages. During the administration of the estate all claims against the partnership were settled. Since Robert apparently had no assets which could be reached to satisfy partnership debts other than his interest as beneficiary of John's estate, the estate paid all partnership debts even though the estate held a 25% interest. The estate then increased its basis in its partnership interest by the full amount of partnership obligations it paid. The partnership was ultimately liquidated, and the estate received $46,417.77 cash as the final distribution from the partnership. Since the estate's basis in the partnership interest, adjusted by its payment of all partnership obligations, exceeded the amount it received upon liquidation, the estate reported a long-term capital loss. When the estate was unable to utilize all of the loss on its income tax returns, the beneficiaries claimed a right to carry the loss forward to their personal returns. See IRC § 642(h).

In its final order of distribution closing the estate, the Probate Court of Jackson County, Missouri, found that Robert owed the estate $638,213.49, which included $633,561.62 arising out of the settlement of the partnership accounts. Applying the doctrine of equitable retention, Mo.Rev.Stat. § 473.630 (1978), ¹ the probate court offset Robert's distributive share of the estate against his indebtedness to the estate. After the offset nothing was left for Robert; the probate court accordingly ordered the administrator to distribute the entire residue of the estate equally between taxpayer and Bertha Long, the other residuary legatees. As a 50% beneficiary of the estate, taxpayer claimed one-half of the unused long-term capital loss on his income tax returns under IRC § 642(h). The Commissioner disallowed the deduction, concluding that the estate had not incurred a long-term capital loss. The Tax Court sustained the Commissioner's determination and found that although estate funds had paid 100% of the partnership liabilities, part of that payment came from Robert's distributive share. Marshall Long, 71 T.C. 1 (1978), op. on motion for reconsideration, 71 T.C. 724 (1979). It treated Robert as having paid his share of the partnership liabilities when the probate court ordered the offset of his distributive share against his indebtedness to the estate. The Court reasoned as follows:

"After paying the partnership liabilities, the estate sought and obtained a determination from the probate court that Robert Long, the other general partner and a beneficiary of the estate, was responsible for his 75-percent share of those liabilities. Robert's distributive share of estate assets was then used to offset his liability for the partnership debts and other claims previously paid by the estate. Thus, although the estate advanced the cash to pay those liabilities, it did not actually carry their full burden. The record is unclear on the extent to which the estate was able to obtain from Robert, through his share of the estate assets or otherwise, his contribution towards the partnership liabilities. In this regard, the burden of proof is on petitioner. Rule 142(a), Tax Court Rules of Practice and Procedure. As the record now stands, we must conclude that the estate did receive Robert's full contribution. There is nothing in the record indicating otherwise, and petitioner does not argue otherwise."

71 T.C. at 10 (emphasis added). Thus, the Court ruled that the estate could increase its basis in the partnership only by its 25% share of assumed partnership liabilities; the net effect of partnership liquidation, then, was that the estate realized a capital gain rather than a long-term capital loss.

We agree in all respects with the Tax Court's analysis, except for its holding that the record does not provide enough information to determine the amount Robert contributed toward payment of the partnership debt.

The death of John did not terminate the partnership, see IRC § 708(b)(1)(B); it continued with the estate as successor to John until the partnership was liquidated November 13, 1969. In calculating the estate's basis in the partnership interest, we must start by determining under IRC § 1014 the fair value of that interest, here agreed to be zero or no value. See id. § 742. This basis is then increased by the "estate's ... share of partnership liabilities, if any, on that date." Treas. Reg. § 1.742-1. The Tax Court allowed an immediate basis adjustment for the estate's 25% share of the bank loans owed at John's death. It held that because the lawsuit claims against the partnership were indefinite and contingent liabilities, they should not be recognized for basis adjustment purposes until the exact amounts of the liabilities were established. After the parties settled those suits, the Tax Court treated the settlement totals plus attorneys' fees incurred as partnership liabilities and permitted adjustment of the estate's basis in the partnership interest to the extent of its 25% interest. See 1 W. McKee, W. Nelson & R. Whitmire, Federal Taxation of Partnerships and Partners P 7.01(2) (1977). We agree with this approach and holding. The estate's basis is then further adjusted by the estate's distributive share of partnership income and losses incurred in the years the partnership operated prior to liquidation. IRC § 705(a). Further, when the estate assumed and paid Robert's 75% share of the partnership debt, the estate's basis was increased by that additional sum, to the extent the estate was unable to obtain contribution from Robert. See IRC § 752(a). The difference between the basis thus calculated and the cash received in the distribution at the time of final liquidation determines the recognized capital gain or loss. IRC § 731(a).

The record in the instant case shows that after paying the partnership liabilities, the estate sought and obtained the probate court's determination that Robert was responsible for 75% of these liabilities. Therefore, the probate court offset Robert's share of the estate assets against his 75% share of partnership liabilities and other debts he owed the estate.

The Missouri courts have held that a distributee's debt to the estate "is an asset of the estate in the hands of the administrator, who is charged with the duty of collecting it." State v. Ennis, 222 Mo.App. 713, 716, 7 S.W.2d 737, 739 (1928). See Thompson v. McCune, 333 Mo. 758, 63 S.W.2d 41 (1933). Furthermore, "(a) distributee who is indebted to the estate is not entitled to receive his distributive share without first deducting therefrom his indebtedness to the estate." Ennis, 222 Mo.App. at 716, 7 S.W.2d at 739. Accord, Gorg v. Rutherford, 31 S.W.2d 585, 588 (Mo.App.1930). Citing Thompson v. McCune, taxpayer contends the Tax Court misconstrued the Missouri doctrine of equitable retention and the effect of the offset decreed by the probate court. He argues that Robert's indebtedness to the estate was not offset against any of the "good" assets; rather, it was offset only against that portion of the estate's total assets consisting of Robert's debt to the estate. Since his indebtedness to the estate was a worthless asset, Robert gave up nothing in the equitable accounting, and having given up nothing, he contributed nothing. Taxpayer argues that notwithstanding the equitable accounting, the estate neither received nor retained any additional sums that could be considered Robert's contribution; the offset could constitute a contribution by Robert only if Robert's indebtedness were less than his distributive share, in which case he would have been entitled to some of the estate's assets other than his own indebtedness.

We do not think Missouri case law supports taxpayer's interpretation of the doctrine of equitable retention. Thompson, 63 S.W.2d at 44-45, states that

"(i)f the legatee or distributee...