                         T.C. Memo. 2004-5



                      UNITED STATES TAX COURT



    LIFE CARE COMMUNITIES OF AMERICA, LTD., A FLORIDA LIMITED
 PARTNERSHIP, ROBERT W. MCMICHAEL, A PARTNER OTHER THAN THE TAX
                  MATTERS PARTNER, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 21683-94.             Filed January 5, 2004.


     B. Gray Gibbs, for petitioner.

     Francis Mucciolo, for respondent.


             MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:   By Notice of Final Partnership Administrative

Adjustment (FPAA) dated August 8, 1994, respondent determined

that the purchase and sale of partnership interests between

partners Robert McMichael (petitioner), Hudson Fowler, and

Raymond Smith were effective on June 30, 1990, rather than on

January 13, 1989, and the correct distributive shares of
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partnership income, loss, deductions, and credits were determined

based on their ownership percentages in accordance with section

706.1       After concessions, the sole issue for decision is whether

petitioner was divested of his ownership interest in Life Care

Communities of America, Ltd., on January 12, 1989, or June 30,

1990.

                             FINDINGS OF FACT

        In October 1981, petitioner, Hudson D. Fowler, Jr. (Fowler),

and Raymond N. Smith (Smith) formed FMS Properties, Inc., a

Florida corporation (FMS), which developed a life care retirement

center (retirement center).       FMS became the sole general partner

of FMS Properties, Ltd., a limited partnership (partnership),

formed in December 1981.       In January 1982, the partnership’s name

was changed from FMS Properties, Ltd. to Life Care Communities of

America, Ltd.       Other entities created by petitioner, Smith, and

Fowler, included Bentley Village, Inc., a Florida not-for-profit

corporation (Bentley Village), and Life Care Communities

Management Corporation, a Florida business corporation

(management company).       In the aggregate, FMS, the partnership,

Bentley Village and the management company, directly and

indirectly, owned and operated the retirement center.       Bentley



        1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect during the years in issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
                                - 3 -

Village ran the daily operations and the management company

provided sales and management services.   Petitioner was managing

partner of the partnership, president of FMS, vice president of

the management company, and president of Bentley Village.

     In July 1985, Smith and Fowler used their combined voting

power to remove petitioner from his managerial positions and

exclude him from all further business activities.   In addition,

Smith and Fowler transferred the contracts held by the management

company to Constellation Services, Inc., an entity controlled by

Smith and Fowler.   In response, in 1987, petitioner filed a

lawsuit, against Smith and Fowler alleging civil theft,

conversion of assets, and embezzlement.

     The lawsuit settled pursuant to an agreement, dated January

12, 1989 (1989 agreement).   As part of the 1989 agreement,

petitioner received $200,000.   During settlement negotiations,

the parties agreed that petitioner would either sell his interest

to Smith and Fowler or purchase Smith and Fowler’s interests.     To

effect the change in ownership of the partnership and the other

entities, the 1989 agreement provided the following options:    (1)

Petitioner had until September 30, 1989, to purchase Smith and

Fowler’s interests for $8 million (i.e., $4 million each); (2)

Smith and Fowler could, prior to September 30, 1989, terminate

petitioner’s option by purchasing petitioner’s interest for $4

million; or (3) if petitioner did not exercise his option to
                                - 4 -

purchase Smith and Fowler’s interests prior to September 30,

1989, Smith and Fowler would be obligated to purchase

petitioner’s interest for $2,370,000.    By letter dated November

16, 1989, Smith and Fowler informed petitioner that they would

purchase his interest pursuant to the 1989 agreement.      No

provision in the 1989 agreement, however, precluded petitioner

after January 12, 1989, from participating in the affairs of the

partnership.

     On June 30, 1990, petitioner, Smith, and Fowler executed a

purchase agreement (1990 agreement) providing for the transfer of

petitioner's interest to Smith and Fowler for $2,570,000.       The

1990 agreement recharacterized the $200,000 paid pursuant to the

1989 agreement as part of the purchase price.   The parties

executed a $2 million promissory note with the balance of the

purchase price (i.e., approximately $370,000) to be paid at

closing.

     In 1990, petitioner sought a distribution to cover his 1989

tax liabilities relating to his distributive share of partnership

income.    Prior to 1989, the only distributions made to

petitioner, Smith, and Fowler were to assist them in paying their

tax obligations resulting from their distributive shares of

partnership income.   In 1989 and 1990, however, the partnership

used most of its income to make payments relating to its receipt

of a $20 million loan and made no distributions.
                               - 5 -

     On April 18, 1990, petitioner was released from liability

relating to the loan.   On October 11, 1990, Smith and Fowler

filed with the Florida Department of State a Certificate of

Amendment To Limited Partnership removing petitioner as general

and limited partner.

     The partnership issued petitioner Schedules K-1 (Form 1065,

Partner’s Share of Income, Credits, Deductions, Etc.), which

reflected petitioner's distributive share of partnership items,

relating to 1989 and 1990.   Petitioner, however, excluded such

items after January 12, 1989, from his Federal income tax returns

for those years.   On June 27, 1994, respondent sent an FPAA,

relating to 1989 and 1990, to Smith as tax matters partner of the

partnership.   Smith did not file a petition for readjustment of

partnership items pursuant to section 6226(a).   On August 8,

1994, respondent sent an FPAA, relating to 1989 and 1990, to

petitioner, which determined that petitioner transferred

ownership in the partnership on June 30, 1990, rather than

January 12, 1989, and that he was, therefore, a partner whose

distributive share included partnership income accrued through

June 30, 1990.

     Respondent also determined that petitioner was liable for

the income tax accrued through June 30, 1990, on his pro rata

share of FMS and the management company’s income.   Following

respondent’s determination, petitioner paid the income taxes
                                 - 6 -

relating to FMS and the management company and filed a refund

suit in the United States District Court for the Middle District

of Florida.    On June 10, 1998, the District Court entered a

judgment against petitioner and determined that petitioner

transferred his shares in FMS and the management company to Smith

and Fowler on June 30, 1990.    On November 16, 1999, the Court of

Appeals for the Eleventh Circuit affirmed the District Court’s

judgment.

     At the time the petition was filed, the partnership

maintained its principal place of business in Naples, Florida.

                                OPINION

     Petitioner contends that on January 12, 1989, the 1989

agreement divested him of his partnership interest.2    Respondent

contends that petitioner was not divested of his interest until

June 30, 1990, the date of the purchase agreement.     We agree with

respondent.

     In 1986, Smith and Fowler voted to remove petitioner from

his management position.     In 1987, petitioner filed a lawsuit for

damages and ultimately reached a settlement with Smith and

Fowler.     The 1989 agreement provided a number of options to

effect the change in ownership of the partnership.     Petitioner’s


     2
        Sec. 7491 is inapplicable because the examination of
petitioner's returns began before the statute's effective date.
Thus, petitioner bears the burden of proof on all questions of
fact. Rule 142(a); Monahan v. Commissioner, 109 T.C. 235, 236
(1997).
                                 - 7 -

interest was not transferred on January 12, 1989.      In fact, on

that date the parties had not yet decided which option would be

exercised.     There is insufficient evidence to alter our

construction of the unambiguous terms of the agreement.

        In the alternative, petitioner contends that he did not

receive any distributions after January 12, 1989, and, therefore,

any allocation to him of partnership income accrued after that

date lacks substantial economic effect.      We disagree.

        The substantial economic effect requirement involves a two-

part analysis:     the allocation must be found to have economic

effect, and such economic effect must be substantial.       Sec.

1.704-1(b)(2)(i), Income Tax Regs.       In order for an allocation to

have economic effect, it must be consistent with the underlying

economic arrangement of the partners.      Sec. 1.704-1(b)(2)(ii)(a),

Income Tax Regs.     Although the partnership did not make any

actual distributions to petitioner, Smith, or Fowler in 1989 and

1990, its income was used to make payments relating to the $20

million loan.     Pursuant to section 752(b), the partnership is

deemed to have made distributions to all partners liable for such

loan.     Sec. 752(b); sec. 1.702-1(a), Income Tax Regs.; United

States v. Basye, 410 U.S. 441, 453 (1973).       In 1989, all of the

partners were liable for the loan, and petitioner was liable for

the loan until at least April of 1990.      Thus, in 1989 and 1990

petitioner received an economic benefit consistent with the
                               - 8 -

underlying economic arrangement of the partners.   Sec. 1.704-

1(b)(5), Example (4)(ii), Income Tax Regs.   Petitioner failed to

address whether or not the economic effect of the allocation was

substantial.   Consequently, we conclude that petitioner has

failed to establish that the economic effect of the allocation

was not substantial.   Accordingly, we sustain respondent’s

determination.

     Contentions we have not addressed are irrelevant, moot, or

meritless.



                                         Decision will be entered

                                    under Rule 155.
