51 T.C.M. (CCH) 1587
BURTON R. PITTLER AND ELIN PITTLER, Petitioners
COMMISSIONER OF INTERNAL REVENUE, Respondent
United States Tax Court
July 28, 1986
John P. Kelly, for the petitioners.
John O. Kent and Ross Paulson, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined deficiencies in petitioners' Federal income taxes of $7,630 in 1975 and $726 in 1976. After a concession by petitioners, the sole issue for decision  is whether the partnership Royal Kuhio XI engaged in bona fide transactions during the years in issue, which would give rise to deductible losses by petitioners as limited partners in the partnership.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioners were husband and wife and resided in Tarzana, California, at the time they filed their petition herein. Petitioners timely filed 1975 and 1976 joint Federal income tax returns with the Internal Revenue Service Center at Fresno, California.
During the years in issue, petitioners were limited partners in a partnership, Royal Kuhio XI (RK-11). RK-11 was 1 of 49 real estate tax shelter partnerships promoted and sold by the Cal-Am Corporation in 1975. In 1975 and 1976, RK-11 purported to conduct certain real estate transactions for which it reported on its partnership returns for those years expenses in excess of income. Petitioners claimed deductions for their distributive share of the partnership losses on their 1975 and 1976 tax returns. The deductions were disallowed by respondent.
The following entities were associated with the RK-11 transactions in issue:
| Cal-Am Corporation
| Legal Mortgage Corporation
| Bio-Science Resources, Inc.
| Go Publishing Company, Inc.
| Joseph R. Laird, A Professional Corporation
|| (Laird Inc.)
| Kenneth J. Fisher, Inc.
|| (Fisher Inc.)
At all times relevant here, attorney Joseph R. Laird (Laird) was the president and Kenneth J. Fisher (Fisher) was the secretary, treasurer, and/or vice president of Cal-Am, LMC, BIO, and GO. Another officer of Cal-Am was Kenneth A. Yates (Yates). Laird was president of Laird Inc., and Fisher was president of Fisher Inc. FORMATION OF RK-11 In 1975, under the direction and control of Laird and Fisher, Cal-Am distributed to select individuals Private Offering Memorandums to promote 49 real estate limited partnerships. The primary objective of the promotion was to encourage those individuals to invest in a limited partnership that would produce tax deductions primarily for interest. Petitioners received and read such a memorandum regarding RK-11. The RK-11 memorandum was dated November 1, 1975, and contained the following introductory statement: The Partnership will be formed for the purpose of acquiring condominium units and a parcel of undeveloped real property. The partnership will be financed from capital contributions made by limited partners, an option to purchase payment made by Legal Mortgage Corporation and a nonrecourse loan by K. J. Fisher, Inc. The purchase of both the condominium units and the land will involve one year's prepayment of interest. In addition to the interest, 20 points will be paid to the seller of the condominiums in consideration of acceptance of a purchase money note providing for interest at 7 1/2 % per annum and requiring installment payments over a period of 35 years. For the land, 25 points will be paid to the seller in consideration of a purchase money note providing for interest at 5.4% per annum and requiring installment payments over a period of 35 years. Following purchase, an option to purchase both the condominium units and the land parcel will be granted to Legal Mortgage Corporation in consideration of an option deposit (See: ‘ Option to Purchase‘ - Page 4). In addition to the prepaid interest and loan points, the partnership will make payments for legal and set-up management for 1975 post-organizational services. It is expected that the partnership will operate at a loss for an indeterminate period. The partnership expenses during this period are to be paid from partnership receipts and additional nonrecourse loans from K. J. Fisher, Inc. or from funds of the General Partner. The partners are required to make a loan to GO Publishing Company, Inc. of an amount equal to their capital contribution to the partnership. The loans by the partners to GO will be in each case evidenced by a note secured by a deed of trust. The note will provide for interest at 6% per annum accruing from January 1, 1976. GO will sell the condominium units to the partnership. BIO will sell the land parcels to the partnership. Legal Mortgage Corporation will have the option to purchase the partnership properties. Fisher, Inc. will make the initial nonrecourse loan and will be required to make further nonrecourse loans if and when necessary to carry out the partnership business. Laird, Inc. will receive a legal fee for post-organizational services. All of the above referred to corporations have a common control through Fisher and Laird. The partnership's investment policy was described in the memorandum as follows: ‘ To create a sound real estate investment. To realize tax losses through deductions currently allowable under the Internal Revenue Code.‘ A schedule in the memorandum included the following information:
| Interest (A.I.T.D.)
| Interest (N.R.L.)
| Operating Expense
| Legal & Set-Up Management
| Partners Total Contributions (Capital and Loans to GO)=
| Write-Off per $1,000 (Total Contributions)
|| $ 3,512
| Partners Total Capital Contributions =
| Write-Off per $1,000 (Capital Contributions)
|| $ 7,024
petitioners also received an Offeree Questionnaire, a Subscription Agreement, and a copy of the RK-11 Partnership Agreement. The Private Offering Memorandum and the Partnership Agreement described the condominiums to be purchased as follows:
| Royal Kuhio
|| - Honolulu, Hawaii
| Specific Units
|| - 1307,1309,1310
Petitioners completed the Offeree Questionnaire, which required personal and financial information, and on December 30, 1975, they executed the Subscription Agreement to become limited partners in RK- 11. In that agreement, petitioners represented that, among other things, they received the Private Offering Memorandum and they accepted and adopted the Partnership Agreement. The signature page of the Subscription Agreement contained the following notations in bold type: The (condominium) units have not been registered under the Securities Act of 1933. Transfer or other disposition of the units is restricted and may not be made without an appropriate opinion of counsel. The condominium units will not be ready for occupancy until August, 1976. By letter dated December 30, 1975, Laird, as president of Cal- Am, notified petitioners that they were accepted as subscribers to RK-11 and that their $6,000 contribution had been received. That payment, however, was in the form of a cashiers check to the order of Cal-Am and dated December 31, 1975. Also on December 30, similar letters were written to other investors in RK-11. On December 31, 1975, Certificates of Limited Partnership were filed for most of the 49 partnerships, including RK-11, with the Recorder's office for the County of Los Angeles, California. The Certificate for RK-11 identified one general partner, Cal-Am, with a $600 contribution and one limited partner, Brian J. Ginsburg, M.D., with a $3,000 contribution. An Amendment of Certificate of Limited Partnership was filed for RK-11 on January 20, 1976. The Amendment identified an additional general partner, Fisher, with no contribution, and 13 limited partners, including petitioners, with total contributions of $29,400. Another Amendment was filed in 1980 that identified Kings Point Corporation (Kings), a private corporation with which Laird was associated, as a new general partner; Fisher was reclassified as a limited partner. THE LAND On November 1, 1975, BIO executed a Contract of Sale purporting to sell an 80-acre tract of land (the land) to RK-11 for $458,000 (approximately $5,725 per acre). The land was part of a 977-acre tract of undeveloped property held by Seniel Ostrow as trustee for a certain family trust. The purchase price of the land included a down payment of $8,000 cash and a nonnegotiable, nonrecourse promissory note for $450,000. The promissory note, dated December 31, 1975, was secured by the land. It acknowledged, without further explanation, an underlying encumbrance on the property and included the following terms of payment: (a) Loan Points of $112,500.00 (i.e., 25 points at 1%). (b) Prepaid interest for the period from November 1, 1975 to December 31, 1976 at 5.4% per annum payable on or before December 31, 1975 in the amount of $28,350.00. (c) Interest only monthly installments commencing on January 31, 1977 and continuing and including an installment on December 31, 1980. (d) Monthly installments of principal and interest in the amount of $2,605.00 commencing on February 1, 1981 and continuing approximately 30 years until the Note is paid in full. The Contract of Sale and...