Pritchett v. Comm'r of Internal Revenue
| Decision Date | 24 October 1985 |
| Docket Number | 18477-81,Docket Nos. 14586-81,27413-82.,18128-81,18127-81 |
| Parties | JERRY E. PRITCHETT AND PATRICIA D. PRITCHETT, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
85 T.C. 580
85 T.C. No. 35
JERRY E. PRITCHETT AND PATRICIA D. PRITCHETT, ET AL.,1 Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 14586-81
18127-81
18128-81
18477-81
27413-82.
United States Tax Court
Filed October 24, 1985.
Petitioners were limited partners in similar oil and gas drilling partnerships. They made initial cash contributions to their respective partnerships and agreed to make future additional cash contributions if called upon to do so by the general partners in order to satisfy fifteen year recourse notes executed by the partnerships in favor of a drilling company. During each year at issue, each partnership incurred a loss, and each petitioner claimed his distributive share of partnership loss in an amount which included both his actual cash contribution to the partnership as well as his proportionate share of the partnership's note. HELD: For purposes of section 465, I.R.C. (1954) each petitioner is at risk only to the extent of actual cash contribution to his partnership and not for his proportionate share of the partnership's note. Accordingly, the deduction allowable to each petitioner for his distributive share of partnership loss is limited to the amount of actual cash contribution to his partnership as of the close of the taxable year at issue.
[85 T.C. 581]
MARC MARMARO and MICHAEL CONSTAS, for the petitioners.
KARL D. ZUFELT, for the respondent.
JACOBS, JUDGE:In these consolidated cases, respondent determined the following deficiencies in petitioners' Federal income taxes:
+------------------------------------------------------------+
¦Docket No.¦Petitioners ¦Taxable year¦Deficiency¦
+----------+-------------------------+------------+----------¦
¦14586-81 ¦Jerry E. Pritchett ¦1977 ¦$33,336 ¦
+----------+-------------------------+------------+----------¦
¦ ¦and Patricia D. Pritchett¦ ¦ ¦
+----------+-------------------------+------------+----------¦
¦18127-81 ¦Donald R. Clifford ¦1977 ¦3,270 ¦
+----------+-------------------------+------------+----------¦
¦ ¦and Joyce K. Clifford ¦ ¦ ¦
+----------+-------------------------+------------+----------¦
¦18128-81 ¦Alex Indich ¦1977 ¦30,492 ¦
+----------+-------------------------+------------+----------¦
¦ ¦and Mira Indich ¦ ¦ ¦
+----------+-------------------------+------------+----------¦
¦18477-81 ¦Arthur Knox ¦1977 ¦7,175 ¦
+----------+-------------------------+------------+----------¦
¦27413-82 ¦Richard J. Buchbinder ¦1976 ¦11,583 ¦
+----------+-------------------------+------------+----------¦
¦ ¦and Voren L. Buchbinder ¦ ¦ ¦
+------------------------------------------------------------+
The issue for decision is whether petitioners, as limited partners in five similar limited partnerships engaged in oil and gas drilling operations, are at risk within the purview of section 465 2 for their proportionate shares of notes given by the partnerships to a drilling company under Turnkey Drilling Agreements. If petitioners are not at risk for their proportionate shares of these notes, then the deduction for their distributive shares of partnership losses are limited to the amounts of their cash contributions to the partnerships. If, however, petitioners are at risk for their proportionate shares of the partnership notes, then the deductions for their distributive shares o partnership losses are allowable in their entirety.
[85 T.C. 582]
Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference.
All petitioners resided in California when they filed their petitions. Each male petitioner 3 is a limited partner in one of five similar limited partnerships (cumulatively referred to as ‘the partnerships‘). The promoters and general partners of each partnership were Albert Prager and Michael Traiger. Each partnership was formed to conduct oil and gas drilling operations. One of the partnerships (T & P, Ltd.) was organized under California law in December, 1976; the other four were organized under Nevada law in December, 1977. The partnership in which each petitioner held an interest, the year formed, the amount of each partner's initial cash contribution thereto, and the total partnership capitalization for each of the five limited partnerships are as follows:
+-------------------------------------------------------------------+
¦ ¦ ¦ ¦Initial cash ¦Total ¦
+------------------+-----------+------+--------------+--------------¦
¦ ¦ ¦Year ¦contribution ¦partnership ¦
+------------------+-----------+------+--------------+--------------¦
¦Petitioner ¦Partnership¦formed¦to partnership¦capitalization¦
+------------------+-----------+------+--------------+--------------¦
¦Jerry Pritchett ¦Alluf, Ltd.¦1977 ¦$35,000 ¦$412,500 ¦
+------------------+-----------+------+--------------+--------------¦
¦Donald Clifford ¦Altar, Ltd.¦1977 ¦5,000 ¦645,000 ¦
+------------------+-----------+------+--------------+--------------¦
¦Alex Indich ¦Aaron, Ltd.¦1977 ¦35,000 ¦705,000 ¦
+------------------+-----------+------+--------------+--------------¦
¦Arthur Knox ¦Akiba, Ltd.¦1977 ¦5,000 ¦465,000 ¦
+------------------+-----------+------+--------------+--------------¦
¦Richard Buchbinder¦T & P Ltd. ¦1976 ¦12,500 ¦725,000 ¦
+-------------------------------------------------------------------+
All five partnerships engaged in drilling operations through a series of essentially identical transactions with Fairfield Drilling Corporation (Fairfield), a wholly owned subsidiary of Petroleum Development Corporation (PDC), a publicly held corporation. On December 29, 1977, Fairfield assigned to the partnerships (December 29, 1976, in the case of T&P) rights to certain oil and gas leases which it held. In exchange therefor, the partnerships agreed to pay Fairfield a royalty equal to 20 percent of the gross sales proceeds of the oil and gas extracted from the leased land, except that the royalty did not commence until the assignee-partnership received a specified amount of net profits. Concurrent with the assignment of the oil and gas leases, Fairfield and each partnership executed a
[85 T.C. 583]
Turnkey Drilling Agreement, a Completion and Operation Agreement, and an Equipment Lease Agreement. As a result of these agreements, Fairfield agreed to drill and develop the leased oil and gas properties of the partnership, and to provide all necessary equipment to commercially exploit all productive wells.
Pursuant to the Turnkey Drilling Agreement, each partnership paid cash and executed a recourse note to Fairfield in 1977 (1976 with respect to T & P) in amounts as follows:
+-----------------------------------------+
¦ ¦Amount ¦Amount ¦ ¦
+-----------+--------+----------+---------¦
¦Partnership¦of cash ¦of note4 ¦Total ¦
+-----------+--------+----------+---------¦
¦Alluf ¦$412,500¦$433,125 ¦$845,625 ¦
+-----------+--------+----------+---------¦
¦Altar ¦645,000 ¦677,250 ¦1,322,250¦
+-----------+--------+----------+---------¦
¦Aaron ¦705,000 ¦740,250 ¦1,445,250¦
+-----------+--------+----------+---------¦
¦Akiba ¦465,000 ¦488,250 ¦953,250 ¦
+-----------+--------+----------+---------¦
¦T & P ¦725,000 ¦761,250 ¦1,486,250¦
+-----------------------------------------+
Each note (the ‘Fairfield note‘) was non-interest-bearing and had a maturity of fifteen years. Each was secured by virtually all of the maker-partnership's assets. The principal for each Fairfield note was payable from the net cash available to the partnership as a result of its drilling operations. Only the general partners were personally liable under the Fairfield note; however, each Limited Partnership Agreement (as well as the Certificate of Limited Partnership) provided that in the event the Fairfield note was not paid in full at maturity, the limited partners of the maker-partnership would be personally obligated to make additional capital contributions to the maker-partnership sufficient to cover the deficiency once called upon by the general partners to do so. 5[85 T.C. 584]
Each partnership elected to employ the accrual method of accounting and to deduct intangible drilling costs (I.D.C.) as an expense pursuant to section 1.612-4, Income Tax Regs. Accordingly, each partnership deducted the entire amount paid to Fairfield (the total of the cash and the note) under the Turnkey Drilling Agreement in the initial year. As there was no income in that year, each partnership reported a loss equal to its entire I.D.C. 6
The Partnership Agreement provided that all losses were to be allocated among the limited partners in proportion to their respective capital contributions. 7 Each petitioner deducted his distributive share of the partnership loss, as set out in the following table (which also lists their cash contributions):
+--------------------------------------------+
¦ ¦Distributive¦Cash ¦
+------------------+------------+------------¦
¦Petitioner ¦loss ¦contribution¦
+------------------+------------+------------¦
¦Jerry Pritchett ¦$71,750 ¦$35,000 ¦
+------------------+------------+------------¦
¦Donald Clifford ¦10,250 ¦5,000 ¦
+------------------+------------+------------¦
¦Alex Indich ¦71,750 ¦35,000 ¦
+------------------+------------+------------¦
¦Arthur Knox ¦10,250 ¦5,000 ¦
+------------------+------------+------------¦
¦Richard Buchbinder¦25,625 ¦12,500 ¦
+--------------------------------------------+
Respondent disallowed the deduction taken by each petitioner for his distributive share of the partnership loss to the extent it exceeded his cash contribution.
[85 T.C. 585]
The ultimate question to be resolved is whether, as a limited partner, each petitioner may deduct his entire distributive share of partnership loss for the taxable year involved, or whether the deduction is limited to petitioner's actual cash contribution to his partnership. Resolution of this question depends upon whether each petitioner is at risk on the Fairfield note.
Generally, an individual may deduct, on his own tax...
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