                      T.C. Memo. 1997-449



                    UNITED STATES TAX COURT



INTERHOTEL COMPANY, LTD., TORREY HOTEL ENTERPRISES, INC., TAX
                MATTERS PARTNER, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



   Docket No.   13017-95.              Filed September 30, 1997.




        M and THEI were partners in IHCL. IHCL was formed
   in 1981 to hold interests in both PGL and PLH, which were
   partnerships formed for the purpose of constructing,
   owning, and managing separate hotel towers of a resort
   complex located adjacent to the then-unbuilt San Diego
   Convention Center. IHCL's partnership agreement provided
   that upon liquidation, the liquidation proceeds would be
   distributed only to those partners having positive
   capital accounts. IHCL's partnership agreement did not
   require the partners to restore any deficits in their
   capital accounts upon liquidation of the partnership.
        In 1985, D agreed to invest $19.8 million in IHCL in
   exchange for a 15-percent interest in IHCL, together with
   a special allocation of 99 percent of IHCL's income and
   losses. Upon D's entry as a partner in IHCL, M withdrew
   as a partner of IHCL, and THEI's interest in IHCL was
   reduced.
                                 -2-

          D encountered financial difficulties. In 1987, the
     special allocation of gains and losses to D was
     terminated. Thereafter, the gains and losses of IHCL
     were allocated to THEI and D pro rata in accordance with
     their partnership interests. Following this allocation,
     a substantial deficit balance existed in THEI's
     partnership capital account.
          On June 20, 1991, M purchased D's interest in IHCL
     and thereafter succeeded to D's then-positive partnership
     capital account of $14.8 million. At that time, THEI had
     a negative $5.9 million partnership capital account.
          Upon M's reentry into IHCL, IHCL's partnership
     agreement was amended to provide that IHCL's income would
     be allocated first to partners having negative capital
     account balances and then to the partners pro rata. No
     amendment was made to IHCL's partnership agreement with
     respect to the allocation of losses, distributions of
     cash-flow, or liquidating distributions.
          IHCL's   1991   information   return   reported   an
     allocation of 99 percent of IHCL's income to D up to June
     20, 1991, and thereafter an allocation of 100 percent to
     THEI. Respondent determined that 99 percent of IHCL's
     income after June 20, 1991, should be reallocated to M as
     D's successor in IHCL.
          Held: Respondent's reallocation of 99 percent of
     IHCL's income to M for the period in issue is sustained.
     See sec. 704(b), I.R.C.



     J. Clancy Wilson, for petitioner.

     Paul B. Burns and Gretchen A. Kindel, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     JACOBS,    Judge:    Respondent   issued   a   notice   of   final

partnership administrative adjustment (FPAA) on April 11, 1995. In

relevant part,1 respondent proposed increasing by $814,296 the

     1
          In addition to the amounts at issue, respondent also
determined that Interhotel Co., Ltd., the partnership whose
                                                   (continued...)
                                   -3-

reported distributive share of allowable ordinary income of Douglas

F. Manchester (Mr. Manchester) with respect to Interhotel Co., Ltd.

(IHCL), a California limited partnership, for the taxable year

1991. As a result of this proposed increase, respondent determined

that Mr. Manchester, as a partner of IHCL, should also be subject

to adjustments for alternative minimum tax and tax preference items

totaling $23,490.    The issues for decision are whether IHCL's

allocation of the partnership items at issue either has substantial

economic effect or is consistent with the partners' interests in

IHCL. For the reasons set forth herein, our responses to both

inquiries are in the negative.     Therefore, we sustain respondent's

reallocation.

     Unless indicated otherwise, all section references are to the

Internal   Revenue   Code    as   in     effect   for   the   year   under

consideration.   All Rule references are to the Tax Court Rules of

Practice and Procedure.

                            FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.          The

stipulation of facts and the attached exhibits are incorporated

herein by this reference.


(...continued)
earnings are at issue here, had ordinary income from its
business activities in the amount of $404,950, not $355,745 as
reported on its Form 1065 for taxable year 1991. In addition,
respondent determined that the partnership was entitled to "Other
Deductions, Professional Fees" in the amount of $2,228, instead
of the $51,433 reported for the same year. The parties resolved
these issues by agreement prior to trial.
                                  -4-

        Torrey Hotel Enterprises, Inc. (THEI), the tax matters partner

of IHCL and petitioner in this case, is a California corporation.

All of the outstanding shares of stock of THEI were directly or

indirectly owned or controlled by Mr. Manchester or members of his

family.

Douglas F. Manchester, PLH, and PGL

        In October 1981, Mr. Manchester and his related companies

formed Pacific Landmark Hotel, Ltd. (PLH), a California limited

partnership.      PLH was formed for the purpose of constructing,

owning, and managing the first of two hotel towers of a resort

complex located adjacent to the then-unbuilt San Diego Convention

Center.     The first hotel tower was completed in April 1984.

        Mr. Manchester formed another limited partnership, Pacific

Gateway, Ltd. (PGL), for the purpose of constructing, owning, and

managing the second hotel tower.        In October 1985, PGL commenced

construction of the second hotel tower; it was completed in October

1987.

IHCL and THEI

        Mr. Manchester formed IHCL to hold interests in PLH and PGL.

Under the Agreement of Limited Partnership of IHCL, dated October

3, 1985 (the IHCL Original Agreement), the general and tax matters

partner of IHCL was THEI, which had a .999-percent interest in IHCL

as a general partner and a 99-percent interest as a limited

partner.    Mr. Manchester held the remaining .001-percent interest.
                                       -5-

     In 1985, the Home Savings Co. (Home Savings) agreed to provide

$208 million to be used as permanent financing for the first hotel

tower and as construction financing for the second hotel tower. As

a condition for its loans, Home Savings required Mr. Manchester and

his businesses to put up a letter of credit for $16 million.                THEI,

through IHCL,2 arranged for the $16 million letter of credit,

issued    by   Security   Pacific   National    Bank.    In   exchange,     IHCL

received a 35.354-percent limited partnership interest in both PLH

and PGL.

Dondi

     In    November    1985,   Dondi     Properties     (Dondi),    which    was

controlled     by   Vernon   Savings    and   Loan    Association   (Vernon),

invested in IHCL.     Dondi received a 15-percent limited partnership

interest in IHCL in exchange for its agreement to provide $19.8

million to the capital of IHCL.         As a result of this transaction,

THEI's limited partnership share in IHCL was decreased from 99

percent to 84 percent.       Mr. Manchester withdrew from IHCL.

     The entry of Dondi was reflected in a "Restated and Amended

Agreement of Limited Partnership of IHCL", dated November 29, 1985


     2
          Pursuant to the IHCL Original Agreement, THEI was
required to contribute certain letters of credit to the capital
of IHCL. THEI did not, however, receive any credit to its
capital account as a result of the issuance of any letter of
credit.
          Pursuant to the IHCL Original Agreement, Mr. Manchester
was required to contribute $150 to the capital of IHCL. The
record does not indicate whether Mr. Manchester, in fact, made
such a contribution.
                                -6-

(the IHCL Restated Agreement). That agreement allocated 99 percent

of the net losses of IHCL to Dondi and the other 1 percent to THEI

as the general partner.   After a period of approximately 5 years,

the net losses were to be allocated to the partners on a pro rata

basis. The income of IHCL was allocated to the partners, Dondi and

THEI, in the same ratio as net losses.      The allocation was to

continue until such time as IHCL's cumulative income equaled IHCL's

cumulative losses; thereafter, IHCL's income would be allocated to

the partners pro rata and in proportion to earlier distributions.

     In contrast to the allocations of income, section 5 of the

IHCL Restated Agreement made the following provisions for actual

distributions:

          5.1      Distribution   of  Cash   Available   for
     Distribution.    Cash Available for Distribution, as
     defined in Section 17, when distributed from time to
     time, shall be distributed to the Partners as follows:

               5.1.1.    First, upon the release of the
          letters of credit by the lender as referred to
          in subsection 4.3.5(a), then to the General
          Partner up to the amount to which the General
          Partner is entitled under Section 4.3.5(a).

               5.1.2.    Second, to the repayment of any
          Special Loans, pro rata, up to the full amount
          of the total principal amount of such Special
          Loans, plus accrued but unpaid interest
          thereon.

               5.1.3.   Thereafter, any remaining sum
          shall be distributed to the Partners, pro
          rata.
                                     -7-

     IHCL maintained capital accounts for each of its partners in

accordance with section 4.4 of the IHCL Restated Agreement.           That

provision states, in part:

          4.4. Capital accounts of Partners. An individual
     capital account shall be maintained for each Partner to
     which shall be credited the contributions of such partner
     to capital of the Partnership. * * * In the event a
     Partner transfers all or any portion of its Partnership
     Interest as permitted by this Agreement, the transferee
     shall succeed to the individual capital account and
     capital account balance of the transferor to the extent
     that such individual capital account and capital account
     balance relate to the transferred Partnership interest.

     In connection with Dondi's entry into IHCL, the limited

partnership agreements of PGL and PLH were amended to allocate

90.91 percent of their losses to IHCL.              At the same time, an

additional provision, section 6.5, "minimum gain chargeback", was

inserted    into   each   of   the   IHCL,   PLH,   and   PGL   partnership

agreements.    That provision stated, in part:

          (b) To the extent that the deficit Capital Account
     balances of one or more Partners attributable to
     Nonrecourse Deductions and determined after applying
     subparagraph (a) exceeds [sic] Minimum Gain, such
     Partners shall be allocated Net Income (or items thereof)
     in accordance with proposed or final Treasury regulations
     promulgated under Section 704 of the Code to the extent
     of and in proportion to the amounts of such differences.

     The partnership agreements of IHCL, PLH, and PGL all required

that, upon liquidation, distributions to their partners were to be

made in accordance with the partners' positive capital account

balances.    For example, the IHCL Restated Agreement provided that

liquidation proceeds were to be used first to pay debts and
                                      -8-

establish reserves. Thereafter, section 5.3.4 of the IHCL Restated

Agreement directed liquidation proceeds to go--

           To the payment to the Partners, who have positive
      capital account balances, in proportion to their positive
      capital account balances, of an amount equal to the sum
      of the positive balances in the Partners' capital
      accounts as of the date of such distribution, after
      giving effect to all contributions, distributions and
      allocations of Net Income, Net Loss and Gain for all
      periods, including the period during which such
      distribution occurs.

      As of December 31, 1985, THEI had a beginning capital account

value of zero.        For 1986, it had a negative capital account value

or   balance    of    $1,701,520   for   both   its   general   and   limited

partnership interests.         For the next 5 years, its negative capital

account balance consistently exceeded $5 million.           During the year

at issue, THEI did not have a positive capital account balance.

      By January 1986, Dondi had contributed $10.8 million to IHCL

and agreed to pay the $9 million balance in subsequent quarterly

installments.     Dondi, however, encountered difficulties and failed

to make its payment due January 6, 1987. Accordingly, in April

1987, THEI gave Dondi written notice, under section 4.3.4.2(d) of

the IHCL Restated Agreement, that Dondi's allocation of 99 percent

of IHCL's losses was terminated.         The IHCL Restated Agreement then

allocated the net losses of IHCL to the partners pro rata in

accordance     with    their   partnership   interests.     Thereafter,    15

percent of the losses were allocated to Dondi, reflecting its

limited partnership interest, and 85 percent of the losses were

allocated    to   THEI,    reflecting    both   its   general   and   limited
                                       -9-

partnership interests. This reallocation of losses created the

substantial deficit balance in THEI's capital account with IHCL.

Marriott Corp.

     In October 1987, the Marriott Corp. became a partner in PLH

and PGL.     It contributed cash and made loan guaranties to those

partnerships    in    exchange   for   a     5-percent   general   partnership

interest in each. Marriott also received an allocation of 95

percent of net losses from PLH and, initially, 99 percent of net

losses from PGL.      These allocations reduced the losses previously

allocated to IHCL.       The allocation of income, however, remained

unchanged.

     With regard to IHCL, 99 percent of that partnership's income

continued to be allocated to Dondi.            At the end of 1987, THEI had

a total deficit in its capital account of $5,010,171, while Dondi

had a positive capital account of $7,763,183, as a result of these

reallocations.       At the beginning of 1991, the capital accounts of

IHCL indicated a negative capital account totaling $5,920,614 for

THEI and a positive capital account of $14,879,392 for Dondi.

Transfer to FDIC and Mr. Manchester

     On June 20, 1991, pursuant to ongoing settlement negotiations,

Dondi transferred its 15-percent limited partnership interest in

IHCL to the Federal Deposit Insurance Corporation (FDIC), as

receiver for Vernon. FDIC then transferred this interest in IHCL to

Mr. Manchester in exchange for his $5 million payment. A first

amendment to the IHCL Restated Agreement, dated June 20, 1991,
                                   -10-

admitted Mr. Manchester as a substitute limited partner.               Dondi's

positive capital account was also transferred to FDIC and then to

Mr. Manchester.    As a result, THEI held a 1-percent interest as

general partner and an 84-percent interest as a limited partner.

Mr. Manchester held the remaining 15 percent in limited partnership

interests.

      The following day, the parties executed a second amendment to

the IHCL Restated Agreement.       The second amendment provided that

IHCL's income would be allocated first to the partners who had

negative capital account balances and, thereafter, to the partners

pro rata. The second amendment, however, made no pertinent changes

to   the   preexisting   allocation     of    gain,   allocation   of    loss,

distribution of cash-flow from operations, distribution of cash

from sale or refinancing, or liquidating distributions.

IHCL's 1991 Return

      Following execution of the second amendment, 100 percent of

IHCL's income was allocated to THEI, in view of its negative

capital account. IHCL accordingly filed a 1991 information return,

reporting the allocation of 99 percent of net income to Dondi

through June 20, 1991, the date Dondi's interest was transferred to

Mr. Manchester.    The 1991 return reflected that, after June 20,

1991, IHCL had allocated 100 percent of its income to THEI.

The FPAA

      Respondent   did   not   accept   the    allocation   of   the    second

amendment to the IHCL Restated Agreement to the extent that 100
                                       -11-

percent of partnership income was allocated to THEI. Rather,

respondent determined that Mr. Manchester should be allocated 99

percent of IHCL's net income for the period after June 20, 1991.

Accordingly, respondent proposed that Mr. Manchester's distributive

share of IHCL's income be increased by $814,296 and that his share

of tax preference items be increased by $23,490.                The reallocation

of income reflects the original allocation of income and losses to

Dondi: 1 percent to THEI and 99 percent to Mr. Manchester, as

Dondi's successor.         The FPAA stated that "the adjustments in the

distributive shares are determined in accordance with the partners'

interest in the partnership as the partnership has not shown that

the allocation per the return is an allowable allocation under the

provisions of the Internal Revenue Code."

                                      OPINION

       In    order   to   determine   whether     IHCL's   allocation    of   the

partnership items at issue either has substantial economic effect

or is consistent with the partners' interests in the partnership,

we    must    preliminarily     review        several   basic    principles   of

partnership taxation.

I.    Partnership Taxation

      A.    General Principles

       Section 701 provides that a partnership is not liable for

Federal income taxes; instead, persons carrying on business as

partners are liable in their separate or individual capacities for

the    income    taxes     arising     from     partnership     operations.   In
                                         -12-

determining his income tax, a partner must take into account his

"distributive share" of each item of partnership income, gain,

loss, deduction, and credit.             Sec. 702.    Each partner is taxed on

his distributive share of partnership income without regard to

whether the income is actually distributed to him.                      Sec. 1.702-

1(a), Income Tax Regs.

     Section 704(a) provides the framework for the determination of

a partner's distributive share of partnership income, gain, loss,

deductions,    or     credits    of     the   partnership.       In    general,   the

partnership agreement determines a partner's distributive share of

these items.    Sec. 704(a).          These provisions provide a great deal

of flexibility to taxpayers who do business in the form of a

partnership.     Partners        have     "great     latitude     in    determining

themselves by their partnership agreement what their distributive

shares will be."        Goldfine v. Commissioner, 80 T.C. 843, 849-850

(1983). However, the partners' ability to make special allocations

of partnership items is not unrestricted.                       The allocation of

partnership interests must have substantial economic effect.                      Sec.

704(b).   Moreover, "if * * * the allocation to a partner under the

agreement of income, gain, loss, deduction, or credit (or item

thereof) does not have substantial economic effect", then the

partner's distributive share of these items "shall be determined in

accordance     with    the      partner's       interest   in    the    partnership

(determined by taking into account all facts and circumstances)".

Sec. 704(b). Thus, in the absence of substantial economic effect,
                                         -13-

the Commissioner can reallocate partnership items in accordance

with the partners' interests in the partnership as determined under

section 1.704-1(b)(3), Income Tax Regs.

     In the instant case, respondent determined that the allocation

of all of IHCL's income for the latter part of 1991 to THEI lacks

substantial economic effect and is not deemed to be in accordance

with THEI's interest in IHCL. Therefore, respondent reallocated 99

percent of IHCL's income for the period following June 20, 1991, to

Mr. Manchester.         Petitioner disputes this reallocation.

     B.    The Section 704 Regulations

     The section 704(b) regulations describe in detail not only the

circumstances      in    which    a   partnership's    allocations      will    have

"substantial economic effect" but also the manner of determining a

partner's "interest in the partnership".

            1.    Substantial Economic Effect

                   a.     Basic Principles

     To    have     substantial        economic     effect,    the     partnership

allocations must reflect the actual division of income or loss

among the partners when viewed from the standpoint of economic,

rather than tax, consequences.            Goldfine v. Commissioner, supra at

851-852.    To this end, the regulations provide that an allocation

has substantial economic effect, if, in the event there is an

economic benefit or burden that corresponds to an allocation, the

partner    receiving       that    allocation     receives    the    corresponding

benefit    or    burden.    Sec.      1.704-1(b)(2)(ii),      Income    Tax    Regs.
                                  -14-

Additionally,   the   economic   effect   of   the   allocation   must   be

substantial; this requires "a reasonable possibility that the

allocation (or allocations) will affect substantially the dollar

amounts to be received by the partners from the partnership,

independent of tax consequences."         Sec. 1.704-1(b)(2)(iii)(a),

Income Tax Regs.

                b.    Capital Accounts

     Determinations of substantial economic effect, as well as

determinations of a partner's interest in the partnership, depend

upon an analysis of the partners' capital accounts. Generally

speaking, a partner's capital account represents the partner's

equity investment in the partnership.      The capital account balance

is determined by adding (1) the amount of money that the partner

contributes to the partnership, (2) the fair market value of

property the partner contributes (net of liabilities to which the

property is subject or which are assumed by the partnership), and

(3) any allocations of partnership income or gain.           A partner's

capital account is decreased, however, by the amount of money that

the partnership distributes to the partner, and by the amount of

any allocation to such partner of losses and deductions. The

capital account is also reduced by the fair market value of

property distributed to the partner, net of any liability that the

partner assumes, or to which the property is subject.        Sec. 1.704-

1(b)(2)(iv), Income Tax Regs.
                                          -15-

      Conceptually, if a partner has a positive capital account on

the date of liquidation, the partnership owes him that amount.                    If,

however, the partner has a negative capital account on the date of

liquidation,     the      partner    in   theory   owes     that   amount    to   the

partnership--or, as a practical matter, to those partners having

positive capital accounts.

                     c.   The Three Tests of Economic Effect

      The regulations governing the economic effect of partnership

allocations contain three tests that in a sense serve as "safe

harbors". Partnership allocations are deemed to have economic

effect if they are made pursuant to a partnership agreement that

meets the requirements of any one of these tests. An understanding

of how these tests operate helps to establish the background for

the parties' contrasting arguments.

                           (1)     The Basic Test

      The basic test for economic effect is set forth in the

regulations.     Section      1.704-1(b)(2)(ii)(b),          Income   Tax    Regs.,

provides, in general, that an allocation will have economic effect

if the partnership agreement contains provisions that require: (1)

The determination and maintenance of the partners' capital accounts

are   to   be   in    accordance      with   the    rules    of    section   1.704-

1(b)(2)(iv),     Income      Tax    Regs.;   (2)    upon    liquidation      of   the

partnership, the proceeds of liquidation are to be distributed in

accordance with the partners' positive capital account balances;

and (3) upon liquidation of the partnership, all partners having a
                                        -16-

deficit capital account must restore the amount of the deficit

balance    to   the    partnership.     These     three   requirements     are    a

distillation of earlier case law in which this Court analyzed

whether partnership allocations possessed substantial economic

effect.    See, e.g., Orrisch v. Commissioner, 55 T.C. 395, 403-404

(1970); Kresser v. Commissioner, 54 T.C. 1621 (1970).

     With respect to the case before us, the parties agree that the

IHCL Restated Agreement complies with the first two requirements.

The agreement provides that the partners' capital accounts will be

properly maintained and that liquidation proceeds will go to the

partners in proportion to their positive capital accounts. With

respect    to   the   third     requirement,     however,    neither     the   IHCL

Restated Agreement, nor any of its amendments, include a provision

requiring the partners to restore any deficits in their capital

accounts to the partnership upon liquidation.                Accordingly, it is

undisputed that the IHCL allocation at issue does not meet the

basic test of substantial economic effect.

                         (2)     Alternative Test of Economic Effect

     The   regulations        provide   an     alternative   test   of   economic

effect--one      which     accommodates         the   existence     of    limited

partnerships.         Limited    partnership     agreements    usually    provide

specific limits upon the amount the limited partners are required

to contribute to the partnership.                These limits on liability,

however, are inconsistent with the requirement in the basic test

that upon liquidation each partner must agree to repay any deficit
                                 -17-

in that partner's capital account. Consequently, the alternative

test for economic effect provides that allocations of a limited

partnership may have economic effect even in the absence of an

unlimited deficit restoration requirement.

       The alternative test begins by incorporating the first two

parts of the basic test.   As with the basic test, the partnership

agreement must provide for properly maintained capital accounts.

It must also provide that the proceeds of liquidation are to be

distributed in accordance with the partners' positive capital

account balances.    However, instead of a negative capital account

makeup requirement, the alternative test mandates a hypothetical

reduction of the partners' capital accounts. Specifically, the

alternative test requires that capital accounts must be reduced for

any distributions that, as of the end of the year, "reasonably are

expected" to be made, to the extent that such distributions exceed

reasonably expected increases to the partner's capital account.

Sec.   1.704-1(b)(2)(ii)(d),    Income   Tax    Regs.    By   requiring   a

prospective reduction of capital accounts, the alternative test

serves to preclude a limited partner from timing the receipt of

deductible partnership expenses in a way that permits the partner

to accumulate negative capital accounts that the partner is not

required to repay.

       Additionally, under the alternative test, the partnership

agreement must provide for a "qualified income offset" (QIO).             A

QIO provision   automatically   allocates      income,   including   gross
                                           -18-

income and gain, to a partner who has an unexpected negative

capital account, either as a result of partnership operations or as

a    result    of    making      the    adjustment       for        reasonably    expected

reductions.          The   QIO   must     operate      "in     an    amount   and   manner

sufficient      to     eliminate       such    deficit       balance     as   quickly   as

possible."      Sec. 1.704-1(b)(2)(ii)(d), flush language, Income Tax

Regs.

      In the present case, neither the IHCL Original Agreement nor

the IHCL Restated Agreement contains a provision requiring capital

account adjustments for reasonably expected distributions or a

"qualified income offset". To be sure, the second amendment to the

IHCL Restated Agreement does provide for a net income allocation to

pay   off     THEI's    deficit     capital         account.    However,      the   second

amendment falls short of the requirements for a QIO. The second

amendment allocates only net income, not "a pro rata portion of

each item of partnership income", allocated "in an amount and

manner sufficient to eliminate such deficit balance as quickly as

possible." Sec. 1.704-1(b)(2)(ii)(d), Income Tax Regs.                           Thus, the

second amendment was not designed to provide a prompt repayment of

unforeseen negative capital accounts. Rather, the partners are

permitted to accumulate very large deficit accounts over a number

of    years.     Petitioner        does       not    seriously        argue   otherwise.

Consequently, the IHCL partnership allocations fail to meet the

alternative test of economic effect.
                                 -19-

                      (3)   Economic Equivalence Test

      There is another economic effect "safe harbor" (which is of

limited application), referred to as the "economic equivalence

test". Section 1.704-1(b)(2)(ii)(i), Income Tax Regs., provides

that, in the event that an allocation would produce the economic

equivalent of meeting the basic test for economic effect, it will

be deemed to have economic effect even if it does not otherwise

meet the formal requirements of the basic test. This economic

equivalence test is likely to be met only by the least complicated

partnerships.    Here, neither party maintains that the allocations

in this complex multitiered partnership situation would have the

equivalent economic effect of meeting the basic test.       To the

contrary, the existence of large deficit capital accounts with no

obligation to repay would appear to preclude the meeting of that

test here.     Thus, the IHCL partnership fails to meet this "safe

harbor" test.

          2.    Partners' Interests in the Partnership

                 The General Rule

     Section 704(b) provides that an allocation of partnership

income, gain, loss, deductions, or credit (or item thereof) that

does not meet the requirements for substantial economic effect will

be "determined in accordance with the partner's interest in the

partnership".    This requirement, although less specific than the

test for economic effect, nevertheless requires that partnership

allocations be analyzed on the basis of their actual economic
                                            -20-

impact.       Accordingly, the regulations provide that an examination

of a partner's interest in the partnership "shall be made by taking

into account all facts and circumstances relating to the economic

arrangement of the partners."               Sec. 1.704-1(b)(3)(i), Income Tax

Regs.     There is, however, a specific provision in the regulations

on which petitioner and respondent both rely to demonstrate the

correctness of their respective positions in this case.                             To this

provision we now turn.

              3.      Special Rules for Determining Partners' Interests

        The   "partners'       interest"      regulations          contain    a     special

provision       for    "certain       determinations"         in    ascertaining          the

partner's interest in the partnership. This special provision

applies only when a partnership's allocations lack economic effect

under section 1.704-1(b)(2)(ii), Income Tax Regs.                        To satisfy this

special provision, the partnership agreement must meet the first

two parts of the basic test for economic effect. That is, the

agreement must         provide       both   that    capital    accounts       are    to    be

properly maintained and that liquidating distributions will be made

only to partners with positive capital accounts.                              When these

conditions      are    met,    the    special      provision       may   be   applied      to

determine       whether       the    allocations      are      in    accordance        with

partnership interests.

        Under the special provision, a partner's interest is measured

by comparing the amount the partner would receive in a hypothetical

liquidation at the end of the current year with the amount the
                                         -21-

partner would have received in a liquidation at the end of the

prior year.     This is referred to as the comparative liquidation

test.    Specifically:

     the partner's interests in the partnership with respect
     to the portion of the allocation that lacks economic
     effect will be determined by comparing the manner in
     which distributions (and contributions) would be made if
     all partnership property were sold at book value and the
     partnership were liquidated immediately following the end
     of the taxable year to which the allocation relates with
     the manner in which distributions (and contributions)
     would be made if all partnership property were sold at
     book   value  and   the   partnership   were  liquidated
     immediately following the end of the prior taxable year,
     and adjusting the result for the items described in (4),
     (5), and (6) of paragraph (b)(2)(ii)(d) of this section.
     A determination made under this paragraph (b)(3)(iii)
     will have no force if the economic effect of valid
     allocations made in the same manner is insubstantial
     under paragraph (b)(2)(iii) of this section. * * *

Sec. 1.704-1(b)(3)(iii), Income Tax Regs.

        Under the comparative liquidation test, if allocation of an

item of partnership loss or deduction is at issue, the regulation

requires that the loss or deduction be attributed to the partner

who would be required to make up a deficit in partnership assets

upon liquidation.

        Both parties maintain that this comparative liquidation test

applies to show that their allocation schemes are in accordance

with the partners' interests. The manner in which each applies the

test,     however,     differs.          Respondent's      application   of   the

comparative     liquidation       test    is    somewhat    less   complex    than

petitioner's.        Accordingly, we consider respondent's contentions

first.
                                -22-

     C.   Respondent's Contentions

     Respondent asserts that the comparative liquidation test of

section   1.704-1(b)(3)(iii),   Income   Tax   Regs.,    supports     the

allocation of all partnership income to Mr. Manchester, as set

forth in the FPAA.   First, respondent contends that if all IHCL's

assets had been sold at the end of 1990, the net liquidation

proceeds would have been $8,958,778. This amount, using stipulated

figures, is computed as follows:

Assets:

   Cash                                  $7,955,796
   Investment in Landmark                (1,358,431)
   Investment in Gateway                  2,328,218
                                             1
   Unamortized organization costs              39,388

      Total assets                                       $8,964,971

Liabilities:


   Accounts payable                            (6,193)
      Total liabilities                                      (6,193)

   Net proceeds                                           8,958,778

     1
          On   brief,   respondent   eliminated   the   unamortized
organization costs; thus, respondent's figures for total assets and
net proceeds are $39,388 less than indicated above.         Without
passing upon the correctness of this omission, we have included
these costs in order to make respondent's and petitioner's figures
more easily comparable.

     Next, respondent contends that if all the IHCL assets

had been sold at the end of 1991, the net liquidation proceeds

would have been $10,449,135.    This amount is computed as follows:
                                   -23-

Assets:

   Cash                                      $9,098,388
   Investment in Landmark                    (3,967,304)
   Investment in Gateway                      2,660,677
   Note receivable from THEI                  2,619,833
   Unamortized organization costs                39,388
     Total assets                                            $10,450,982

Liabilities:

   Accounts payable                                (1,847)
     Total liabilities                                            (1,847)

   Net proceeds                                               10,449,135

     Respondent asserts that, at the end of the first year (1990),

all the liquidation proceeds would have gone to Dondi, which was

the only partner to have a positive capital account.             Further,

respondent     claims   the   amount   available   upon   liquidation   is

$5,960,002 less than the capital account balance of $14,879,392 for

Dondi.    Respondent points out that, because there is no provision

in the IHCL Restated Agreement for a deficit makeup, THEI would not

have been required to make up the shortfall, although it had a

negative capital account totaling $5,920,614.

     At the end of the second year (1991), the net book value of

IHCL's assets exceeded $10 million. Respondent contends that under

the IHCL Restated Agreement all of the increase in book value would

have been distributed to Mr. Manchester, as successor to Dondi's

interest in IHCL, because Mr. Manchester was the only partner with

a positive capital account at the end of 1991.         Respondent points

out that the amount available for distribution is approximately $5

million less than the positive balance in Mr. Manchester's capital
                                         -24-

account. Again, because the IHCL Restated Agreement does not

contain a deficit makeup provision, THEI would not have been

required to make up the shortfall.

      Respondent concludes that the application of the IHCL Restated

Agreement supports the determination made in the FPAA--that Mr.

Manchester, who, at the end of 1991, had the only positive capital

account   in    IHCL,   would    have     been   the   only    party    to    receive

liquidation proceeds; accordingly, all the post-June 20, 1991,

income of IHCL must be allocated to him because he is the sole

partner with a positive capital interest in IHCL.

      D. Petitioner's Contentions

      Petitioner        disagrees        with    respondent's          conclusions.

Petitioner contends that respondent has erroneously failed to

include in the deemed liquidation proceeds approximately $7 million

for both 1990 and 1991 as "minimum gain allocations". Petitioners'

argument requires further exploration of the partnership allocation

regulations,     specifically       as    they   relate       to   allocations    of

nonrecourse deductions.

           1.    Partnership Minimum Gain

      A nonrecourse debt is one in which the lender, upon the

debtor's default, has as its only recourse the institution of

foreclosure proceedings with respect to the property securing the

debt. (In a nonrecourse debt situation, the lender has agreed that

it   will not    maintain    a   collection      action   against       the   debtor

personally.)     Thus, if the value of the property securing the debt
                                          -25-

falls below the amount of the debt, it is the lender, and not the

debtor, who bears the risk of loss.

       Nevertheless, it is well settled that nonrecourse liabilities

incurred to acquire property will constitute a part of the debtor's

cost       basis   in    the   property      it   has    purchased.       Crane    v.

Commissioner, 331 U.S. 1, 14 (1947).                 Accordingly, the debtor may

claim deductions attributable to that debt--such as deductions for

depreciation.3          However, when the debtor disposes of the property,

the debtor must include in its amount realized from the disposition

of the property the amount of any nonrecourse debt to which the

property is subject.           Thus, if the debtor has taken deductions

(such as depreciation deductions) that have lowered its cost basis

in   the     property     to   an   amount    less      than   the   amount   of   the

nonrecourse debt, the debtor must recognize gain at least to the

extent that its basis is exceeded by the amount of debt secured by

the property.       Commissioner v. Tufts, 461 U.S. 300, 307 (1983).

       These nonrecourse debt principles apply to partnerships.                    Not

surprisingly, application of these rules to partnership allocations

produces some fairly complicated situations.                   If a partnership has

       3
          A purchaser's basis in an asset is, initially, its
cost. Sec. 1012. The Supreme Court in Crane v. Commissioner,
331 U.S. 1 (1947), established that the cost basis of an asset
includes nonrecourse indebtedness borrowed to purchase the asset.
See Mayerson v. Commissioner, 47 T.C. 340, 351-352 (1966). The
Internal Revenue Code provides that the basis is to be adjusted
to take into account certain factors, such as deductions for
depreciation under sec. 167(g). Sec. 1016(a) provides that such
deductions lower the amount of the purchaser's basis in the
property.
                                            -26-

acquired    properties      with       nonrecourse        debt,          the   partnership's

deduction of expenses associated with these properties--such as

expenses for depreciation--may lead to a situation where the amount

of   nonrecourse     debt       exceeds     the    partnership's               basis    in   the

properties       securing       that      debt.           Such           deductions--called

"nonrecourse deductions"--per se do not have economic effect.                                The

lack of economic effect arises from the fact that the lender, and

not the partnership or its partners, bears the economic risk of

loss with respect to the nonrecourse deductions.

            2.    Minimum Gain Chargeback

      As   applicable      to    the    taxable         year       at    issue,      there   are

temporary    regulations         governing        the    allocation            of   deductions

attributable to nonrecourse debt.              These regulation provisions are

set forth as sections 1.704-1T(b)(4) and (5), Temporary Income Tax

Regs., 53 Fed. Reg. 53162-53173 (Dec. 30, 1988). The regulatory

provisions involve the concepts of "minimum gain" and "minimum gain

chargebacks".      These provisions represent the application of the

principle    of   Commissioner         v.    Tufts,      supra,          in    a    partnership

context.

      "Minimum     gain"        is   created       when        a        partnership     claims

deductions, such as deductions for depreciation, that decrease the

partnership's basis in a given property to an amount less than the

balance of the nonrecourse debt incurred in the acquisition of that

property.
                                  -27-

     The event that triggers a "minimum gain chargeback" is a

decrease in partnership minimum gain. That can occur, for example,

when a partnership disposes of property in respect of which the

partnership's nonrecourse indebtedness exceeds the partnership's

basis.   It is this type of event that, under Tufts, triggers the

realization of gain by the partnership, at least to the extent the

amount of the partnership's acquisition indebtedness exceeds the

partnership's basis in that property.    For example, assume that a

partnership owed $1 million in nonrecourse debt that it used to

acquire depreciable property.     If the partnership then claimed a

$200,000 depreciation deduction, which would lower its $1 million

basis in the property to $800,000, the $200,000 (the amount by

which the debt exceeds the partnership's basis) would be the

"minimum gain".   This $200,000 is the potential gain that the

partnership would realize as a "minimum gain" when the partnership

disposes of that property. Thus, if the lender foreclosed upon the

property, the partnership would realize at least a "minimum gain"

of $200,000, even though the partnership received no gain in an

economic sense.

     The $200,000 "minimum gain chargeback" is the minimum gain as

allocated to the partners in proportion to the amount of their

distributive   share   of   the   nonrecourse   deductions,   thereby

increasing their partnership capital accounts.4 Allocation of such

     4
          Specifically, sec. 1.704-1T(b)(4)(iv)(e), Temporary
                                                   (continued...)
                                 -28-

gain to the partners also increases the partners' exposure to

income taxation on the amounts of the gain.

          3. Petitioner's Application of Minimum Gain
          Provisions to a Tiered-Partnership Allocation

     Petitioner   maintains   that      the   minimum   gain   chargeback

provisions of section 6.5 in the IHCL Restated Agreement would

require IHCL to realize approximately $7 million in minimum gain

chargebacks in the deemed liquidation.        Petitioner's assertion is

based on the following theory:   although IHCL owned no nonrecourse

property itself, it had ownership interests in PLH and PGL, which


     4
      (...continued)
Income Tax Regs., 53 Fed. Reg. 53163 (Dec. 30, 1988), provides:

          (e) Minimum gain chargeback--(1) In general. If
     there is a net decrease in partnership minimum gain for
     a partnership taxable year, the partners must be
     allocated items of partnership income and gain in
     accordance with this paragraph (b)(4)(iv)(e) ("minimum
     gain chargeback").

          (2) Allocations required pursuant to minimum gain
     chargeback. If a minimum gain chargeback is required
     for a partnership taxable year, then each partner must
     be allocated items of income and gain for such year
     (and, if necessary, for subsequent years) in proportion
     to, and to the extent of, an amount equal to the
     greater of--

               (i) The portion of such partner's share
          of the net decrease in partnership minimum
          gain during such year that is allocable to
          the disposition of partnership property
          subject to one or more nonrecourse
          liabilities of the partnership; or

              (ii) The deficit balance in such
          partner's capital account at the end of such
          year * * *
                                        -29-

did    own    such   properties.    Petitioner       then   posits    that   IHCL's

ownership of interests in these lower tier partnerships is, in

effect, a proportionate ownership interest in the properties of

those lower tier partnerships as well.                Petitioner points to the

regulations governing allocation of nonrecourse deductions; these

expressly provide a "look-through" rule for situations involving

tiered partnerships.         Petitioner posits that for purposes of the

nonrecourse deductions, the "look-through" rule is designed to

produce the same consequences for the upper tier partnership, in

this case IHCL, that would have resulted had IHCL directly held its

proportionate        share   of   the   properties    owned   by     PGL   and   PLH.

Petitioner reasons that under these regulations, had PLH or PGL

incurred minimum gains on the disposition of their property, IHCL

would be required to realize its proportionate share of those

gains.       Sec. 1.704-1T(b)(4)(iv)(j), Temporary Income Tax Regs., 53

Fed. Reg. 53166 (Dec. 30, 1988); see T.D. 8237, 1989-1 C.B. 180,

206.

       Petitioner further contends that IHCL should be treated as

owning its proportionate share of PLH's and PGL's assets for

purposes of the comparative liquidation test of section 1.704-

1(b)(3)(iii), Income Tax Regs.            Thus, according to petitioner, a

deemed liquidation of IHCL would imply a deemed liquidation of PLH

and PGL as well; as a result, the disposition of those nonrecourse

properties (upon the liquidations of PLH and PGL) would trigger

minimum gain chargebacks to IHCL.
                                 -30-

        In making its point, petitioner uses the same figures as

respondent.    Petitioner   augments   those   figures,   however,   with

substantial amounts of minimum gain chargebacks for both 1990 and

1991.    First, petitioner contends that if all of IHCL's assets had

been liquidated at the end of 1990, the net liquidation proceeds

would have been $16,328,755.     This amount is computed as follows:

               Assets

        Cash                                     $7,955,796
        Organization costs                           39,388
        Investment in Pacific Gateway             2,328,218
        Investment in Pacific Landmark           (1,358,431)
        Liabilities                                  (6,193)
           Subtotal                               8,958,778


        1990 Minimum gain chargeback
          from Pacific Landmark1                  7,369,977


        Distributable liquidation
          proceeds at book value 1/1/91          16,328,755

     1
          Petitioner's   figures    include   only   minimum   gain
chargebacks traceable to the PLH partnership. Apparently, S.D.
Hotels, one of PGL's partners, guaranteed the payment of PGL's
obligation to Home Savings. This guaranty restricted use of PGL's
nonrecourse deductions to S.D. Hotels, which bore the economic risk
of loss on the property. See sec. 1.704-1T(b)(4)(iv)(h)(2),
Temporary Income Tax Regs., 53 Fed. Reg. 53164 (Dec. 30, 1988).

     Petitioner then contends that $5,920,614 of the minimum gain

chargeback would be used first to eliminate THEI's negative capital

account. The balance of the minimum gain chargeback, plus the

liquidation proceeds, would then be distributed pursuant to the

IHCL Restated Agreement as it was in effect during 1990. Thus,

according to petitioner, 85 percent, or $1,231,959, would             be
                                      -31-

allocated to THEI and 15 percent, or $217,404, would be allocated

to   Dondi.     These    allocations,   when     added       to    the   previously

accumulated     capital     accounts,   result    in     a    total      capital   of

$16,328,755--the amount of the previously identified liquidation

proceeds.

     Petitioner maintains that a liquidation of all of IHCL's

assets at the end of 1991 would yield proceeds of $17,887,056.

This amount is computed as follows:

              12-31-91 Deemed Liquidation

            Cash                                         $9,098,388
            Organization costs                               39,388
            Note receivable from THEI                     2,619,833
            Investment in Pacific Gateway                 2,660,677
            Investment in Pacific Landmark               (3,967,304)
            Liabilities                                      (1,847)
               Subtotal                                  10,449,135



            1991 Minimum gain chargeback
              from Pacific Landmark                          7,437,891


            Distributable liquidation
              proceeds at book value 12-31-91            17,887,026

     This $17,887,026 amount is $1,558,301 more than that for the

previous year (1990), consisting of an additional $67,914 in

minimum gain chargebacks, plus partnership income for 1991 of

$1,490,387.     The     total   liquidation   proceeds,       as    determined     by

petitioner, would again eliminate THEI's negative capital account.

These allocations, when added to the previously accumulated capital

accounts, result in a total capital of $17,887,056--the amount of
                                       -32-

the previously identified liquidation proceeds available for 1991.

Distributions would be made in accordance with the IHCL Restated

Agreement as it read at the end of 1991.             Petitioner asserts that

because   the    second    amendment     precluded     Mr.   Manchester   from

receiving any net income for 1991, THEI, the only other partner in

IHCL, would be allocated 100 percent of such income.

      E. Does the Comparative Liquidation Test                 Contemplate   a
      Liquidation of the Lower Tier Partnerships?

      The difference between respondent's and petitioner's theories

of the comparative liquidations arises from petitioner's contention

that a deemed liquidation of IHCL must also involve a deemed

liquidation of PLH and PGL (the lower tier partnerships) and the

resulting minimum gain chargebacks.

      Under the facts of this case, however, we do not believe that

the comparative liquidation test permits a deemed liquidation of

IHCL to include a deemed liquidation of PLH and PGL.

      Section 704 provides that we must determine the interests of

the   partners    in      accordance    with   all     relevant   facts   and

circumstances.     IHCL had a 35.354-percent interest in each of the

lower tier partnerships. As a limited partner with only a minority

interest in each of the lower tier partnerships, IHCL could not

control the lower tier partnerships. Thus, it could not force

partnership minimum gain chargebacks by requiring PLH and PGL to

dissolve or to dispose of their property in a way that caused a
                                  -33-

decrease in partnership minimum gain--and resulting chargebacks to

IHCL.

     Sections 11 and 15 of the IHCL Restated Agreement provide that

no partner has the right to sell substantially all the assets or

cause a dissolution of PLH.     Rather, under those provisions of the

IHCL Restated Agreement, an effective election to sell the assets

of the partnership, or to dissolve it, could come about only with

the concurrence of the majority of the limited partners, the

permission of the general partner, the permission of the San Diego

public authorities, and the permission of any lender who had the

right to approve such a dissolution.

        The statutory framework of the California Corporations Code

permits a partner to dissolve its partnership only in similarly

limited     circumstances.      Section    15681    of   the   California

Corporations Code (West 1991) provides in pertinent part:

        Section 15681. Nonjudicial dissolution.

          A limited partnership is dissolved and its affairs
     shall be wound up upon the happening of the first to
     occur of the following:

            (a) At the time or upon the happening of
            events specified in the partnership agreement.

            (b) Except as otherwise provided in the
            partnership agreement, written consent of all
            general partners and a majority in interest of
            the limited partners.

     Likewise,    section    708(b)   of   the   Internal   Revenue   Code

provides for a termination of a partnership if within a 12-month

period there is a sale or exchange of 50 percent or more of the
                                         -34-

total    interest   in     the   partnership      capital   or    profits.    Sec.

708(b)(1)(B); cf. Rev. Rul. 87-50, 1987-1 C.B. 157; Rev. Rul. 87-

51, 1987-1 C.B. 158.

       If IHCL were to liquidate, it would not have the power to

compel PLH or PGL to dissolve.             Nor could IHCL otherwise require

PLH or PGL to transfer its assets, either directly or indirectly.

Those properties would remain under the control of PLH and PGL.

Upon    liquidation    IHCL      could   distribute     only   its     partnership

interests in PLH or PGL. The distinction between a partner's

interest in a partnership and the partner's lack of interest in

partnership property is basic.              California law follows general

partnership   law     in   providing      that   "An   interest   in    a   limited

partnership is personal property and a partner has no interest in

specific partnership property."            Cal. Corp. Code sec. 15671 (West

1991 & Supp. 1995).        Federal tax law makes a similar distinction

between interests in partnerships and the holdings of partnerships.

As some commentators have explained, for purposes of the Internal

Revenue Code:

       The transferred interest is treated as a separate
       intangible asset, detached from the assets of the
       partnership. Accordingly, the various Code provisions
       governing the amount and character of gain or loss,
       basis, and holding period operate with respect to the
       transferred partnership interest, rather than the
       underlying partnership assets. * * *

McKee et al., Federal Taxation of Partnerships and Partners, par.

15.01, at 15-3 (3d ed. 1997).
                                       -35-

           We believe that because IHCL could not force PLH and PGL to

dispose of the property that generated the nonrecourse deductions,

petitioner's argument fails.           There would be no decrease in PLH's

or PGL's minimum gain upon a deemed liquidation of IHCL.                   Sec.

1.704-1T(b)(4)(iv)(d), Temporary Income Tax Regs., 53 Fed. Reg.

53163 (Dec. 30, 1988).              Thus, there would be no minimum gain

chargeback to IHCL. Sec. 1.704-1T(b)(4)(iv)(f), Temporary Income

Tax Regs., 53 Fed. Reg. 53163 (Dec. 30, 1988).               Correspondingly,

there would not be, as petitioner contends, an increase in the

partners' capital accounts sufficient both to eliminate THEI's

deficit account and to pay the positive capital account of Mr.

Manchester.           To the contrary, petitioner has failed to refute

respondent's position that Mr. Manchester alone would be eligible

to receive any gain upon liquidation of the partnership under the

IHCL       Restated    Agreement.   (That   agreement   mandates   that,   upon

liquidation, distributions are to be made in accordance with the

partners' positive          capital   account   balances.)   Accordingly,    we

reject petitioner's argument that allocation of partnership income

to THEI       is in accordance with the comparative liquidation test of

section 1.704-1(b)(3)(iii), Income Tax Regs.5




       5
          In this case, we expressly do not decide whether the
comparative liquidation test in sec. 1.704-1(b)(3)(iii), Income
Tax Regs., would take into account the dissolution of lower tier
partnerships when the upper tier partnership (whose allocations
are at issue) can compel such a dissolution.
                                           -36-

     F.     The Facts and Circumstances Regulations

     Both parties have made alternative arguments dependent upon

other    factors      listed   in    the    regulations        as   appropriate      for

consideration in resolving issues of partners' interests. The four

factors     to   be    considered     are:        (1)   The    partners'      relative

contributions; (2) the partners' interests in economic profits and

losses;    (3)   the    partners'      interests        in    cash-flow      and   other

nonliquidating distributions; and (4) the partners'                          rights to

distributions of capital upon liquidation. Sec. 1.704-1(b)(3)(ii),

Income Tax Regs.

        In this case, petitioner has failed to establish that these

four factors       support     its   position      that      THEI   rather    than   Mr.

Manchester should be allocated substantially all (99 percent) of

IHCL's income for the period after June 20, 1991.

        As to the first factor, i.e., contributions, neither THEI nor

Mr. Manchester (except for a possible $150 contribution) made any

contributions to IHCL. To be sure, THEI participated in some manner

in acquiring a loan guaranty for IHCL, but THEI was given no credit

in its capital account for such an endeavor.                         Mr. Manchester

invested $5 million, but he did so to acquire Dondi's interest in

IHCL; he did not invest in IHCL himself.

        In regard to the second factor, i.e., the partners' interests

in economic profits and losses, although the second amendment to

the IHCL Restated Agreement allocated all net income to THEI,
                                     -37-

petitioner has failed to refute respondent's determination that

this allocation did not comport with the partners' interests.

       The third factor, i.e., dealing with cash-flow, is addressed

in paragraph 5.1 of the Second Amendment to the IHCL Restated

Agreement.     It provides that partnership cash will be distributed

first to pay off any special loans (there apparently were none),

then to the partners to the extent of capital contributed, and then

to    the   partners   pro   rata.   Here,   THEI   has   made   no   capital

contribution.     Nor has THEI received any cash.         And its potential

pro rata receipt of cash from the partnership is too attenuated for

us to consider.

       We have already seen that the fourth factor, i.e., the right

to capital on distribution, favors Mr. Manchester, who had the only

positive capital account.

       In summary, this analysis of the "facts and circumstances"

factors does not support petitioner's position that 99 percent of

IHCL's net income for the period at issue is properly allocated to

THEI.

II.    Vecchio v. Commissioner

       Petitioner asserts that this Court has specifically approved

the allocation of partnership income to repay negative capital

accounts in Vecchio v. Commissioner, 103 T.C. 170 (1994). But

Vecchio is not a blanket approval of allocations to offset any

negative capital account. The present case materially differs from

Vecchio.     Here, THEI was always subject to the provision in the
                               -38-

IHCL Restated Agreement that liquidating distributions would go to

the partners with positive capital accounts. In contrast, the

partnership agreement in Vecchio provided that, upon sale of the

real property or liquidation, the limited partner was to receive

a return of its investment as well as payment of its negative

capital account balance before distributions could be made to the

other partners.    We therein approved an allocation of income to

restore a negative capital account.

     A number of other facts and circumstances underscore the

differences between Vecchio and the situation here.    In Vecchio,

the limited partner invested $776,000 in the partnership.   It did

so as an independent investor.    In the instant case, THEI never

made an affirmative investment in IHCL.   THEI, in fact, appears to

be no more than an accommodation entity, established and controlled

by its partner, Mr. Manchester, to serve his interests.

     Additionally, in this case there is no specific cash, like the

$1,986,913 at issue in Vecchio, available to pay both THEI for its

negative capital account and Mr. Manchester for his positive

capital account.   To the contrary, as demonstrated above, it would

appear impossible for IHCL to obtain a sufficient amount of money

because IHCL lacked the power to force the liquidation of the lower

tier partnerships.6


     6    Petitioner has attached to its reply brief several
Schedules C, derived from exhibits admitted at trial. Petitioner
makes reference to these schedules in an attempt to demonstrate
                                                   (continued...)
                                 -39-

     Under   these   circumstances,   we    conclude   that   petitioner's

reliance upon Vecchio is misplaced.

III.   Respondent's Prior Activities Do Not Require a Different
Result

     Petitioner argues that respondent accepted its partnership

allocations and capital account entries prior to 1991.          Petitioner

asserts that this acquiescence underscores the strength of its

argument that THEI should be allocated all the net income for the

period following June 20, 1991. We disagree. In general, the fact

that a taxpayer's treatment of an item on a tax return in a prior

year is accepted by the Commissioner's agents in audits of the

taxpayer's   prior    return   does   not     preclude   or    estop   the

Commissioner, in a later year, from determining that an item should

be treated differently. See Hawkins v. Commissioner, 713 F.2d 347,

351-352 (8th Cir. 1983), affg. T.C. Memo. 1982-451; Easter v.

Commissioner, 338 F.2d 968 (4th Cir. 1964), affg. per curiam T.C.

Memo. 1964-58; Estate of Emerson v. Commissioner, 67 T.C. 612, 617-

618 (1977); Coors v. Commissioner, 60 T.C. 368, 406 (1973), affd.

519 F.2d 1280 (10th Cir. 1975).


(...continued)
that a liquidation of PGL and PLH would provide adequate cash to
pay off THEI's negative capital account, repay Mr. Manchester's
positive capital account, and leave a surplus of cash to be
allocated pursuant to the 85-to-15 ratio specified in the IHCL
Restated Agreement. These schedules leave us with many
unanswered questions, especially with regard to the extremely
large negative capital account balances of PGL and PLH.
Petitioner's presentation of this argument has failed to convince
us that upon liquidation of IHCL, THEI would have completely
restored its negative capital account.
                                     -40-

     Petitioner    further      argues      that,     in     some    instances,

representations   made    by    respondent's        counsel    to   the   Court

precluded petitioner from presenting evidence regarding certain

issues   respondent    raised   on    brief.    We    have    reviewed    those

instances.    Most of those representations pertain to collateral

issues that we have found it unnecessary to address.                Instead, we

have decided this case on the basis of the issues presented at

trial and fully briefed thereafter, including the comparative

liquidation test of section 1.704-1(b)(3)(iii), Income Tax Regs.,

the "facts and circumstances" test of section 704(b), and the

applicability of Vecchio.

     The issues raised by the pleadings place upon the taxpayer the

burden of showing every necessary requirement to sustain its burden

of proof.    Axelrod v. Commissioner, 56 T.C. 248, 255 (1971).               In

the instant case, the FPAA, as well as the applicable sections of

the Internal Revenue Code and regulations, adequately set forth the

matters petitioner was required to demonstrate in order to carry

its burden of proof.     Petitioner has failed to carry its burden of

showing that respondent's reallocation of partnership income to Mr.

Manchester was erroneous.

     To reflect the foregoing and the parties' concessions,



                                                 Decision will be entered

                                            under Rule 155.
