White v. Commissioner, Docket No. 26101-89.
| Decision Date | 05 November 1991 |
| Docket Number | Docket No. 26101-89. |
| Citation | 62 T.C.M. 1181 |
| Parties | Matthew R. and Jill White v. Commissioner. |
| Court | U.S. Tax Court |
L.S. McCullough, Jr. and Craig F. McCullough, 800 Kennecott Bldg., Salt Lake City, Utah, for the petitioners. Joel A. Lopata, for the respondent.
Memorandum Findings of Fact and Opinion
By statutory notice dated August 2, 1989, respondent determined the following deficiencies in and additions to petitioners' Federal income tax:
Additions to Tax
Year Deficiency Sec. 6651(a)(1)1 Sec. 6661
1982 ................................... $22,017 $2,827 $ 5,504
1983 ................................... 62,618 -- 15,655
1984 ................................... 24,075 -- 6,019
1986 ................................... 34,927 -- 8,732
Following concessions,2 the issues for our decision are: (1) Whether respondent is precluded from assessing a deficiency against petitioners without first conducting a partnership level audit; (2) whether respondent erred in determining that amounts paid by a partnership as construction costs on a home represented cash distributions to petitioners pursuant to section 731(a); (3) whether the statute of limitations bars respondent from assessing a deficiency for tax years 1982 or 1984; (4) whether respondent erred in determining that petitioners are liable for additions to tax for substantial understatement of income tax liability for each of the years at issue; and (5) whether respondent erred in determining that petitioners are liable for an addition to tax for failure to timely file their 1982 tax return.
Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioners Matthew R. and Jill White, husband and wife, resided in Salt Lake City, Utah, when they filed their petition herein. Petitioners timely filed joint Federal income tax returns for calendar years 1983, 1984, and 1986. Their 1982 joint tax return was filed on October 20, 1983, which was beyond the due date of the return plus any extensions.
In 1979, petitioners purchased a parcel of undeveloped real property located at 5136 Haven Lane3 in Salt Lake City. Legal title to the property was held by a trust, but for purposes of this case, the parties have stipulated that the trust should be disregarded and that petitioners should be treated as jointly owning any interest in the property held by the trust.
On February 19, 1981, the M&J Investment Company (the partnership)4 was formed as a limited partnership pursuant to the laws of the State of Utah. Petitioners were the general partners and each held a 5-percent interest in this family partnership. Through Jeffery Thomas as custodian under the Utah Gifts to Minors Act, petitioners' four children were the limited partners and together held the other 90-percent interest. The partnership was initially capitalized with $26,000. Both business and personal assets were subsequently acquired by the partnership, either directly or through contributions made by petitioners. The partnership started operations sometime in 1982, and its assets ultimately included a small stock transfer agency, securities, boats, a family cabin, and snowmobiles.
In 1982, construction was begun on a residential home and other improvements upon the vacant Haven Lane property. Construction took several years and the total cost of the home, including the cost of the real property, was in excess of $850,000. Approximately 59 percent of the construction costs were paid by the partnership while the remaining costs were paid by petitioners directly. The partnership paid its part of the construction costs directly to the various contractors.
On or about August 5, 1983, petitioners borrowed $300,000 from Zions First National Bank (the bank) to finance a portion of the construction costs paid by them. To secure that loan, petitioners, in their individual capacities, granted the bank a security interest in the entire Haven Lane property by trust deed. As a result, the bank understood that it had a first mortgage on the property. Petitioners, in refinancing the mortgage, executed two further trust deeds in favor of the bank on November 19, 1987, and August 30, 1989. Both of these trust deeds were also executed by petitioners in their individual capacities.5
In December 1983, a warranty deed was prepared which purported to convey an interest in the property from petitioners to the partnership. The deed was executed; but it contained no legal description of the property, was not acknowledged, and was not recorded. In December 1989, a quitclaim deed was prepared which conveyed a 59-percent interest in the property to the partnership.
On its 1982 partnership return, the partnership reported that its assets included an investment in real estate of $120,221. The parties agree that this figure represents the amount paid by the partnership in 1982 on construction costs. The partnership's 1983 and 1984 original returns did not report the partnership as owning any real estate. Instead, certain amounts were reported as distributions to petitioners, and the parties agree that the amount of the distribution for 1983 also includes the $120,221 expended in 1982. The partnership's amended 1983 and 1984 returns, as well as its 1985 and 1986 returns, all filed after respondent's audit began, reflect that the partnership's assets included real estate assets in the amounts expended as construction costs during those years. In amending the 1983 and 1984 returns, the partnership reported that it distributed the same amounts as reported in the original return, but reported that there were contributions to capital in those years equal to the construction costs reported as distributed.
Petitioners and their children moved into the home in 1983 and lived there throughout the remaining years at issue. No lease agreement existed between petitioners and the partnership, and no rent payments were ever made to the partnership. Petitioners deducted in full the amounts paid as real estate taxes on their 1982 through 1986 individual tax returns.
Respondent determined that the amounts expended by the partnership as construction costs were not expended to acquire a partnership asset. Rather, he determined that those amounts constituted cash distributions to petitioners pursuant to section 731(a), resulting in unreported capital gains in the following amounts:6
Year Amount
1982 .......................... $ 48,398
1983 .......................... 120,352
1984 .......................... 47,172
1986 .......................... 78,567
Apparently due to mathematical errors in the partnership's determination of petitioners' bases in the partnership, the parties now stipulate that if the amounts paid by the partnership as construction costs are determined to be taxable under section 731(a), the following distributions will result in the following unreported capital gains:
Unreported
Capital
Year Distribution Gain
1982 ................... $109,718 $43,887
1983 ................... 157,833 63,133
1984 ................... 137,590 55.036
1986 ................... 212,665 85.066
Respondent also determined that petitioners were liable for additions to tax for substantial understatement of income tax liability for each of the years at issue under section 6661, and for failure to timely file their 1982 tax return under section 6651(a)(1).
OpinionThe first issue for decision is whether respondent is barred from assessing a tax against petitioners in the absence of partnership level proceedings. Sections 6221 through 6233 provide for unified partnership level audit and litigation procedures. Unless otherwise excepted, the tax treatment of any partnership item is determined at the partnership level. Sec. 6221. Petitioners claim that since respondent has not conducted a partnership level audit, he is precluded from adjusting items reported consistently by them on their individual tax returns. Respondent, on the other hand, argues that the partnership is excepted from the unified procedures because it is a "small partnership" as defined in section 6231(a)(1)(B), and no election was made to have the unified procedures apply. See sec. 6231(a)(1)(B)(ii).7
To fall within the small partnership exception, the partnership must have, inter alia, 10 or fewer partners each of whom is a natural person or an estate. Sec. 6231(a)(1)(B)(i)(I). Consequently, the exception is not applicable if any partner in a partnership is a "pass-thru partner" other than an estate. Sec. 301.6231(a)(1)-1T(a)(2), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6789 (Mar. 5, 1987). A "pass-thru partner" is defined as "a partnership, estate, trust, S corporation, nominee, or other similar person through whom other persons hold an interest in the partnership with respect to which proceedings under this subchapter are conducted." Sec. 6231(a)(9) (emphasis added).
In the instant matter, the partnership agreement was executed by petitioners, as general partners, and by Jeffery Thomas "as Custodian under the Utah Gift to Minors Act for" each of petitioners' children, as limited partners. At issue, then, is whether the definition of a "pass-thru partner" encompasses a custodian.
Utah law provides that the children are indefeasibly vested with legal title in their limited partnership interests. Utah Code Ann. sec. 75-5-603(1) (1978). Thus, the children were partners while the custodian was not. Sec. 6231(a)(2). In contrast, each person specifically defined as a "pass-thru partner" in section 6231(a)(9) would hold...
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