                       T.C. Memo. 2001-151



                     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 June 22, 2001.



         M and THEI were partners in IHCL, a limited
    partnership formed in 1981 to hold interests in Landmark
    and Gateway, two limited partnerships.     Landmark and
    Gateway were formed to construct, own, and manage
    separate hotel towers of a San Diego resort complex.
    Landmark and Gateway financed their hotel developments
    using nonrecourse debt.

         The IHCL partnership agreement provided that upon
    liquidation, the proceeds would be distributed only to
    those partners having positive capital accounts.   The
    partnership agreement did not require the partners to


     *
          This Memorandum Opinion supplements our Opinion in
Interhotel Co., Ltd. v. Commissioner, T.C. Memo. 1997-449 (1997),
vacated and remanded without published opinion 221 F.3d 1348 (9th
Cir. 2000).
                         - 2 -

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. D received
a non-pro rata (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, and THEI’s interest in
IHCL was reduced.

     D encountered financial difficulties and defaulted
on its contribution payment obligation. In 1987, the
special allocation of IHCL’s 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 respective partnership interests. Under this new
allocation, 85 percent of the losses went to THEI,
creating a substantial deficit balance 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 $14.8
million partnership capital account. At the time, THEI
had a negative $5.9 million partnership capital account
balance.

     Upon M’s reentry into IHCL, the IHCL partnership
agreement was amended to provide that IHCL’s income would
be allocated first to partners having negative capital
account balances and thereafter to the partners pro rata.

     IHCL’s   1991  information  return   reported  an
allocation of 99 percent of IHCL’s income to D through
June 20, 1991, and thereafter an allocation of 100
percent of the income to THEI. Respondent determined
that 99 percent of IHCL’s income after June 20, 1991,
should be allocated to M.

     In our original opinion in this case, we sustained
respondent’s position.   On appeal, the parties agreed
that a minimum gain chargeback should be included in the
Court’s calculations for purposes of the comparative
liquidation test of the partners’ interests under sec.
1.704-1(b)(3)(iii), Income Tax Regs.
                                  - 3 -

          Held:   In view of the parties’ agreement, the
     special allocation of 100 percent of IHCL’s income earned
     after June 20, 1991, to THEI is in accordance with the
     partners’ interests in IHCL and is therefore respected.
     See sec. 704(b).



     Kenneth W. Gideon, for petitioner.

     Gretchen A. Kindel, for respondent.



                   SUPPLEMENTAL MEMORANDUM OPINION


     JACOBS, Judge:      This case is before us on remand from the

Court of Appeals for the Ninth Circuit.            See Interhotel Co., Ltd.

v. Commissioner, 221 F.3d 1348 (9th Cir. 2000), vacating and

remanding without published opinion T.C. Memo. 1997-449.             Torrey

Hotel    Enterprises,   Inc.   (THEI),    is   a    California   corporation

organized and controlled by Douglas F. Manchester (Mr. Manchester).

THEI is the tax matters partner of Interhotel Company, Ltd. (IHCL),

a California limited partnership.          Mr. Manchester is the other

partner in IHCL.

     Respondent issued a notice of final partnership administrative

adjustment (FPAA) on April 11, 1995.       In relevant part,1 respondent


     1
          In addition to the amounts at issue, respondent
determined that Interhotel Co., Ltd. (the partnership whose
earnings are at issue here), had ordinary income from its
business activities in the amount of $404,950, rather than
$355,745, as reported on its Form 1065, U.S. Partnership Return
of Income, for 1991. Respondent further determined that the
partnership was entitled to "Other Deductions, Professional Fees"
                                                   (continued...)
                                     - 4 -

proposed increasing Mr. Manchester’s reported distributive share of

IHCL’s net income for 1991 by $814,296.           As a consequence of this

determination, respondent determined that Mr. Manchester should be

subject   to   adjustments     for    alternative   minimum     tax   and   tax

preference items totaling $23,490.              The issue for decision on

remand is whether the allocation of all of IHCL’s income to THEI

possessed economic substance or was made in accordance with the

partners’ interests in IHCL.

                                   Background

     We incorporate herein the findings of fact set forth in

Interhotel     Co.,   Ltd.    v.    Commissioner,    T.C.   Memo.     1997-449

(Interhotel Co. I) by this reference.            For convenience, we shall

summarize    the   relevant   facts    in    Interhotel   Co.   I.    We    also

incorporate herein the stipulations and exhibits in Interhotel Co.

I by this reference.

     Unless indicated otherwise, all section references are to the

Internal Revenue Code in effect for the year in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

     Prior to 1985, Mr. Manchester formed two limited partnerships,

Pacific Landmark Hotel, Ltd. (Landmark), and Pacific Gateway, Ltd.

(Gateway), to construct, own, and manage two hotel facilities at

the San Diego convention center. The two partnerships financed the


     1
      (...continued)
in the amount of $2,228, instead of $51,433, as reported.               The
parties resolved these issues prior to trial.
                                       - 5 -

construction       of   the   hotels    principally   through   the   use   of

nonrecourse borrowing.          For tax purposes, Landmark and Gateway

utilized accelerated depreciation methods.            These methods reduced

the partnerships’ tax bases in the hotel properties to amounts that

were less than the amount of debts the partnerships had incurred to

construct those properties.

        Mr. Manchester formed IHCL to hold 35.354-percent limited

partnership interests in Landmark and Gateway. Under the Agreement

of Limited Partnership of IHCL, dated October 3, 1985 (the IHCL

Original Agreement), Mr. Manchester held a .001-percent interest in

IHCL.    THEI held a 99.999-percent interest, both as a general and

limited partner.

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

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 contribute $19.8

million to IHCL.         Mr. Manchester then withdrew as a partner in

IHCL. Following this transaction, THEI held an 85-percent interest

in IHCL (an 84-percent limited partnership interest and a 1-percent

interest as the general partner).

     Dondi’s entry into IHCL was reflected in a “Restated and

Amended Agreement of Limited Partnership of IHCL”, dated November

29, 1985 (the IHCL Restated Agreement).           That agreement allocated

99 percent of IHCL’s net losses to Dondi, and 1 percent to THEI as
                                        - 6 -

the general partner.         The IHCL Restated Agreement further provided

that after approximately 5 years, the net losses were to be

allocated to the partners on a pro rata basis.                  Pursuant to the

IHCL Restated Agreement, IHCL’s net income was allocated to the

partners in the same ratio as net losses until such time as the

allocated amount of income equaled the amount of IHCL’s cumulative

net losses; thereafter, IHCL’s income would be allocated to the

partners pro rata.

      Moreover, as part of Dondi’s entry into IHCL, the limited

partnership agreements of Landmark and Gateway were amended to

allocate 90.91 percent of Landmark’s and Gateway’s net losses to

IHCL.

      IHCL maintained capital accounts for each of its partners.

The partnership agreements of IHCL, Landmark, and Gateway all

required that upon liquidation distributions to partners would be

made in accordance with the partners’ positive capital account

balances.

        By January 1986, Dondi had contributed $10.8 million of the

required $19.8 million to IHCL and agreed to pay the balance due

($9     million)     in    subsequent    quarterly    installments.            Dondi

encountered        financial    difficulties    and    failed     to    make     the

installment payment due January 6, 1987.                 (By that time, the

Federal    Deposit        Insurance   Corporation    (FDIC)   had      become   the

receiver for Vernon.)          As a result, in April 1987, THEI gave Dondi
                                      - 7 -

written notice, under section 4.3.4.2(d) of the IHCL Restated

Agreement, that Dondi’s 99-percent allocation of IHCL’s net losses

was terminated.         Pursuant to the IHCL Restated Agreement, IHCL’s

net   losses     were    then   allocated    to    the   partners      pro   rata    in

accordance with the 85:15 ratio reflecting the two partners’

interests.       As a consequence, 15 percent of the losses were

allocated to Dondi and 85 percent of the losses were allocated to

THEI.      The   special    allocation      of    IHCL’s      net   income   remained

unchanged, and IHCL’s Restated Agreement continued to allocate 99

percent of its net income to Dondi.

      In October of 1987, the Marriott Corp. (Marriott) obtained a

5-percent      general    partnership    interest        in    both   Landmark      and

Gateway.     Marriott also received an allocation of 95 percent of

Landmark’s net losses and 99 percent of Gateway’s net losses.

These allocations reduced the amount of losses Landmark and Gateway

previously allocated to IHCL.

      By the end of 1990, THEI’s capital account in IHCL was a

negative $5,920,614; principally, this was the result of the losses

generated between Dondi’s April 1987 default, and the reallocation

of losses to Marriott 6 months later.              In contrast, by the end of

1990, Dondi’s capital account in IHCL grew to $14,879,392.

      IHCL’s balance sheet as of the end of 1990 revealed the

following:
                               - 8 -

     Cash                                $7,955,796
     Unamortized 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

     On June 20, 1991, Dondi transferred its 15-percent limited

partnership interest in IHCL to the FDIC, as receiver for Vernon.

The FDIC transferred this interest in IHCL to Mr. Manchester in

exchange for his $5 million payment.   As a result, THEI held a 1-

percent interest as general partner and an 84-percent interest as

a limited partner.   Mr. Manchester, as Dondi’s successor, held the

remaining 15-percent limited partnership interest and succeeded to

Dondi’s capital account.

     On June 21, 1991, the parties executed a second amendment to

the IHCL Restated Agreement.    The second amendment provided that

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

negative capital account balances and, thereafter, to the partners

pro rata.

     At the end of 1991, the balance sheet of IHCL set forth its

book value as follows:

     Cash                                $9,098,388
     Unamortized 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

     IHCL filed a 1991 information return (Partnership Return of

Income) reporting the allocation of 99 percent of its net income to
                                   - 9 -

Dondi   through   June   20,   1991,   the   date    Dondi’s    interest     was

transferred to Mr. Manchester.         The 1991 return further reflected

that, after June 20, 1991, 100 percent of IHCL’s net income was

allocated to THEI.

     Respondent challenged the allocation of 100 percent of IHCL’s

net income to THEI; respondent determined that for the period after

June 20, 1991, Mr. Manchester should be allocated a portion of

IHCL’s net income.       Specifically, respondent determined that Mr.

Manchester’s distributive share of IHCL’s net income should be

increased by $814,296 and that his share of tax preference items

should be increased by $23,490.         This reallocation of IHCL’s net

income reflects the pre-June 20, 1991, 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.”

     In Interhotel Co. I, we held that the allocation of 100

percent of IHCL’s net income for 1991 to THEI lacked substantial

economic effect and was inconsistent with the partners’ interests

in   the   partnership.      Accordingly,     we    sustained    respondent’s

reallocation of the majority of that income to Mr. Manchester.                On
                                       - 10 -

appeal of our decision, the Court of Appeals for the Ninth Circuit

stated:

           The Internal Revenue Service concedes that it erred
      in convincing the Tax Court to refrain from including a
      minimum gain chargeback in the court’s calculations for
      purposes of the comparative liquidation test. Because of
      this concession, we VACATE the Tax Court’s decision and
      REMAND   for    further   proceedings,   findings,   and
      conclusions.

                                      Discussion

      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.    See sec. 704(a).             However, the partners’ ability to

allocate partnership items on a basis other than in accordance with

the partners’ interest in the partnership (i.e., non-pro rata

basis) is not unrestricted. The allocation of partnership items on

a   non-pro   rata    basis     (hereinafter      referred     to   as   a   “special

allocation”) either (1) must have substantial economic effect (as

opposed to the mere avoidance of tax), or if the allocation does

not have substantial economic effect, then (2) the partner’s

distributive share of partnership 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).        The regulations under section 704(b) describe in

detail not only the circumstances in which a special allocation
                               - 11 -

will have “substantial economic effect” but also the manner of

determining a partner’s “interest in the partnership”.

Substantial Economic Effect

     The   regulations   provide   that    a   special   allocation   of

partnership items is deemed to have substantial economic effect,

if, in the event there is an economic benefit or burden that

corresponds to an allocation, the partner to whom the special

allocation is made receives a corresponding benefit or bears a

corresponding burden. See sec. 1.704-1(b)(2)(ii), Income Tax Regs.

Moreover, the economic effect of the special 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.

     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
                                - 12 -

(3) any allocation of partnership income or gain.         A partner’s

capital account is decreased by the amount of partnership losses

and deductions allocated to such partner.       The capital account is

further 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.   See sec. 1.704-1(b)(2)(iv), Income

Tax Regs.

     The regulations governing the economic effect of special

allocations contain three tests that essentially serve as “safe

harbors”.    Special allocations are deemed to have economic effect

if they meet the requirements of any one of these safe harbor

tests.

     (1)    The Basic Test of Economic Effect

     The basic test for economic effect (with respect to special

allocations) is set forth in section 1.704-1(b)(2)(ii)(b), Income

Tax Regs. The test provides, in general, that a special allocation

will have economic effect if the partnership agreement contains

provisions that require:   (1) The determination and maintenance of

partners’ capital accounts 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 be distributed in

accordance with the partners’ positive capital account balances;

and (3) upon liquidation of the partnership, all deficit capital

accounts be restored to zero.
                               - 13 -

      With regard to the matter 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 be distributed to the partners in proportion to their positive

capital account balances.)     However, neither the IHCL Restated

Agreement, nor any of its amendments, require partners having

deficit capital account balances to restore the deficits to zero

upon liquidation of the partnership.       Accordingly, the special

allocation of 100 percent of IHCL’s net income for 1991 to THEI did

not meet all the requirements necessary to satisfy the basic test

of substantial economic effect.

      (2) Alternative Test of Economic Effect

      Limited partnership agreements (such as the IHCL Original

Agreement) 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 the deficit balance in that partner’s capital

account. Consequently, an alternative test for economic effect has

been developed to provide that special allocations of partnership

items may have economic effect even in the absence of an unlimited

deficit restoration requirement.
                                    - 14 -

      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 be reduced for any

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

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

reasonably expected increases to the partners’ capital accounts.

See 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 a partner to

accumulate a negative capital account that the partner need not

repay.

      The    alternative    test   also   requires    that    the   partnership

agreement provide for a “qualified income offset” (QIO).                 A QIO

provision automatically allocates income, including gross income

and gain, to a limited 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
                                       - 15 -

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), Income Tax Regs. (flush

language).

       In the present matter, 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”.            Although the second amendment to the

IHCL Restated Agreement does provide for a net income allocation to

pay off THEI’s deficit capital account, the second amendment falls

short of providing a QIO.           Rather, 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.                   Consequently, the IHCL

special allocation does not meet the alternative test of economic

effect.

       (3) Economic Equivalence Test

       There is a third economic effect “safe harbor”, 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
                                  - 16 -

economic effect, it will be deemed to have economic effect even if

it does not otherwise meet the formal requirements of the basic

test.

        In the present case, neither party maintains that the special

allocations in this complex multitiered partnership situation would

have the equivalent economic effect of meeting the basic test.

        (4)    Conclusion

        The special allocation of 100 percent of IHCL’s net income for

1991 to THEI does not have substantial economic effect.

Partners’ Interests in the Partnership

        (1)    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

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.
                                  - 17 -

     (2) The Comparative Liquidation Test

     Pursuant to section 1.704-1(b)(3)(iii), Income Tax Regs., a

partner’s   interest   in   the   partnership     is   determined   by   the

“comparative    liquidation   test”.       When    a   partner’s    special

allocation is consistent with the comparative liquidation test, the

special allocation is deemed to be in accordance with the partners’

interests in the partnership.          This test applies only when a

partnership’s special allocations lack economic effect under the

alternative test for economic substance set forth in section 1.704-

1(b)(2)(ii), Income Tax Regs.

     To satisfy the comparative liquidation test, the partnership

agreement must meet the first two parts of the basic test for

economic effect.   That is, the partnership agreement must provide

that (1) capital accounts are to be properly maintained, and (2)

liquidating distributions will be made only to partners with

positive capital account balances.          When both conditions are

satisfied, 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 partner would have received

in a hypothetical liquidation at the end of the prior year.

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
                              - 18 -

     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
     * * *.     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.]

     Both parties rely on the comparative liquidation test to show

their differing schemes.

     Respondent asserts that the comparative liquidation test of

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

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

forth in the FPAA.    First, respondent contends that if all of

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

proceeds would have been $8,958,778.     Respondent computes this

amount, using stipulated figures, 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
                                  - 19 -
     1
        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 on 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 of IHCL’s assets had

been sold at the end of 1991, the proceeds therefrom would be

$10,449,135.    This amount is computed as follows:

     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   for   distribution      upon

liquidation is $5,960,002 less than the positive capital account

balance of $14,879,392 for Dondi.

     At the end of the next year (1991, the year involved herein),

the net book value of IHCL’s assets was $10,449,135.             Respondent

contends that    under   the   IHCL    Restated    Agreement,   all   of    the

increase   in   book   value   would    have   been    distributed    to   Mr.
                                   - 20 -

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 account.

     Respondent concludes that the application of the comparative

liquidation test supports the determination made in the FPAA--i.e.,

that because at the end of 1991 Mr. Manchester was the only partner

having a positive capital account in IHCL, he would be the only

partner     eligible     to   receive   IHCL’s   liquidation   proceeds;

accordingly, all the post-June 20, 1991, income of IHCL must be

allocated to him.

Nonrecourse Debt Deductions

     Petitioner disagrees with respondent’s conclusion. Petitioner

contends that respondent erroneously failed to include in the

deemed liquidation proceeds approximately $7 million (relating to

deductions that were based upon nonrecourse debt) for both 1990 and

1991.    A brief discussion relating to tax principles involving the

calculation of the basis of property acquired through nonrecourse

debt financing and the calculation of gain required to be realized

from the disposition of such property is deemed beneficial in

understanding petitioner’s position.

        In a nonrecourse debt financing situation, the lender agrees

that it will not maintain a collection action directly against the
                                      - 21 -

debtor.       Rather, should the debtor default, the lender’s only

recourse is the institution of foreclosure proceedings with respect

to the property securing the debt.              Accordingly, if the value of

the property securing the debt falls below the amount of the debt,

it is the lender, not the debtor, who bears the risk of loss.

Nevertheless, it is well settled that for tax purposes, nonrecourse

debt incurred      to   acquire      property    constitutes   a   part   of    the

debtor’s cost basis in the property it has purchased.              See Crane v.

Commissioner, 331 U.S. 1, 14 (1947).              Accordingly, the amount of

debt     (even    nonrecourse        debt)      increases   the    amount       the

debtor/taxpayer       may   claim     for    depreciation   with    respect      to

encumbered property.        However, when the debtor disposes of the

property, the debtor must include in the amount realized from the

disposition of the property the amount of any remaining nonrecourse

debt to which the property is subject.               Thus, if the debtor has

taken    deductions     (such   as    depreciation    deductions)     that     have

reduced its 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.        See Commissioner v. Tufts, 461 U.S. 300, 307

(1983).

Minimum Gain and Minimum Gain Chargebacks

        The   aforementioned    nonrecourse       debt   principles   apply      to

partnerships.       If a partnership has acquired properties with
                                       - 22 -

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.       These     deductions–-called        “nonrecourse

deductions”--per se do not have economic effect because the lender

(and not the partnership or its partners) bears the economic risk

of loss with respect to the nonrecourse deductions.

     As applicable to 1991 (the taxable year at issue), temporary

regulations    exist     that    govern     the   allocation      of    deductions

attributable to nonrecourse debt.           These provisions are set forth

in section 1.704-1T(b)(4) and (5), Temporary Income Tax Regs., 53

Fed. Reg. 53161-53173 (Dec. 30, 1988), and involve the concepts of

“minimum gain” and “minimum gain chargebacks”.                  These provisions

represent the application of the Tufts principle in a partnership

context.

     “Minimum gain” is created when a partnership claims deductions

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.

     The event that triggers a “minimum gain chargeback” is one

which causes a decrease in partnership minimum gain.                   A triggering

event therefore occurs when a partnership disposes of property in

respect of which the partnership’s nonrecourse indebtedness exceeds
                                           - 23 -

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). To

illustrate,        assume    that      a    partnership     owed    $1   million    in

nonrecourse debt that it used to acquire depreciable property.                      If

the partnership claimed $200,000 in depreciation deductions (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 (sometimes called “phantom gain”2) that the partnership would

realize when it 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

that       is   allocated   to   the       partners   who   had    claimed   (as   pass

throughs) the nonrecourse deductions. These allocations of minimum




       2
          See Nadler v. Commissioner, T.C. Memo. 1992-383
(quoting Westin, The Tax Lexicon 413 (1989)), affd. without
published opinion 993 F.2d 1533 (2d Cir. 1993).
                                 - 24 -

gain increase the partners’ capital accounts3 as well as expose the

partners to income taxation on the amount of gain.

Minimum Gain and the Comparative Liquidation Test

     Petitioner     maintains   that   the   minimum   gain    chargeback

provisions required IHCL to realize approximately $7 million in

minimum   gain    chargebacks   with   respect   to    the    comparative

liquidation test.    Petitioner’s position is based on the following

theory:   although IHCL owned no property subject to nonrecourse

debt, it had ownership interests in Landmark and Gateway, both of



     3
          Specifically, sec. 1.704-1T(b)(4)(iv)(e), Temporary
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 * * *
                                        - 25 -

which did own such properties.             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.            In this regard, petitioner points to the

regulations governing allocation of nonrecourse deductions, which

expressly provide a “look-through” rule for situations involving

tiered partnerships.        Petitioner then posits that for purposes of

the nonrecourse deductions, the “look-through” rule is designed to

produce the same consequences for the upper tier partnership (here,

IHCL)   that    would     have    resulted   had    IHCL   directly   held   its

proportionate     share     of    the   properties    owned   by   Gateway    and

Landmark.      Petitioner concludes that under these regulations, had

Landmark or Gateway incurred minimum gains on the disposition of

their property, IHCL would be required to realize its proportionate

share of those gains.           See sec. 1.704-1T(b)(4)(iv)(j), Temporary

Income Tax Regs., 53 Fed. Reg. 53166 (Dec. 30, 1988).

     Continuing, petitioner asserts that a deemed liquidation of

IHCL under the comparative liquidation test would imply a deemed

liquidation of Landmark and Gateway as well, and hence, a sale of

their hotel properties.           The result of the disposition of those

properties would trigger minimum gain chargebacks to Landmark and

Gateway, and through them, a proportionate share to IHCL.

     Petitioner’s application of the comparative liquidation test

uses the same figures as respondent.             However, petitioner augments
                                - 26 -

those figures with substantial amounts of minimum gain chargebacks

for both 1990 and 1991.   As a first step, petitioner contends that

if all of IHCL’s assets had been liquidated at the end of 1990--the

year prior to the taxable year--the net liquidation proceeds would

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

     Assets

     Cash                                   $7,955,796
     Unamortized 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            7,369,977

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

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

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

account.   The $1,449,353 balance of the minimum gain chargeback

would then be allocated pursuant to the IHCL Restated Agreement as

it was in effect during 1990.       Thus, 85 percent (or $1,231,959)

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

allocated to Dondi. These allocations, when added to the partners’

capital accounts, yield a positive capital account of $1,231,959

for THEI and $15,096,769 for Dondi.      Together, they reflect total

partnership capital of $16,328,755--the amount of the previously

identified liquidation proceeds.
                              - 27 -

     As a second step, petitioner maintains that a liquidation of

all of IHCL’s assets at the end of 1991--the taxable year--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         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 1990,

the prior year. This increase consists of an additional $67,914 in

minimum gain chargebacks generated during 1991, plus partnership

income for 1991 of $1,490,387.   The total minimum gain would first

be used to eliminate THEI’s negative capital account of $5,920,614.

The balance of $1,517,277 would be distributed   in accordance with

the partnership agreement--that is, 99 percent to Dondi and 1

percent to THEI until June 20, 1991, when 100 percent would be

allocated to THEI.

     Respondent’s figures, showing a comparison of the partners’

capital accounts that reflect minimum gain chargebacks, are as

follows:
                                 - 28 -

                                            Dondi/
         Date             THEI            Manchester      Total

     12-31-91       $2,092,861        $15,794,195      $17,887,056
     12-31-90 minus 1,231,959          15,096,796       16,328,755
                                                        1
       Increase        860,902            697,399         1,558,301
     1
        These figures do not take into account a dispute over an
adjustment in IHCL’s ordinary income for 1991 of $16,402, an issue
which we address infra p. 41.

     Respondent concludes that, because a deemed liquidation would

produce the above results, its allocation of all the net income to

THEI after June 20, 1991, reflects the partners’ interests in the

partnership.

The Issue Revisited

     The contrast 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 Landmark and Gateway and the resulting minimum gain

chargebacks.

     In our initial examination of this issue, we agreed with

respondent.     In Interhotel I, we held that IHCL, as a minority

owner of Landmark and Gateway, lacked the legal capacity to force

Landmark and Gateway to dispose of the property that generated the

nonrecourse deductions.    Accordingly, upon liquidation, IHCL could

only dispose of its partnership interests in Landmark and Gateway.

Those partnerships, however, would continue to own the hotel

properties.     In the absence of some other event that triggered

minimum gain chargebacks (such as a repayment of the principal of
                                      - 29 -

the nonrecourse loans with new capital or profits from operations),

we concluded that a liquidation of IHCL under the comparative

liquidation test would not increase the partners’ capital accounts

sufficiently to eliminate THEI’s deficit account.                       Therefore,

because Mr. Manchester would continue to have the only positive

capital account on liquidation, we concluded that he alone would be

entitled    to    the    liquidation    proceeds.      Thus,       we    sustained

respondent’s determination that Mr. Manchester was chargeable with

all of IHCL’s income for 1991 under the comparative liquidation

test.

     Petitioner revised its argument on appeal to maintain that

there need not be a deemed sale of the hotel properties in order to

trigger the minimum gain chargebacks. On appeal, petitioner argued

that to generate such chargebacks, it would suffice that IHCL, a

pass-through      beneficiary    of    the     nonrecourse   deductions,       had

terminated       its    pass-through    connection     to    the        properties.

Respondent, having considered this revised argument, agreed.                    In

view of respondent’s concession as to the minimum gain chargebacks,

the Court of Appeals vacated our earlier decision and remanded the

case to us.

        Following the Court of Appeals’ remand of this case, we

instructed the parties either to submit an agreed decision document

or to file written status reports advising how we should implement

the Court of Appeals’ mandate.           The parties filed status reports
                                     - 30 -

informing us that neither party desired an evidentiary hearing. We

then ordered the parties to file briefs addressing the issues on

remand with appropriate computations in support of their respective

positions.

     It   is   apparent   that      respondent’s    concession   effectively

removes the basis for our original decision; namely, that a deemed

liquidation of IHCL would not trigger a minimum gain chargeback.

Petitioner now asserts that respondent’s concession requires a

determination in petitioner’s favor.          Petitioner maintains that a

comparative liquidation of IHCL in 1990 and in 1991 would produce

minimum gain chargebacks to THEI in both years, which chargebacks

would be sufficient to eliminate THEI’s negative capital account.

The result is that both partners would have positive capital

accounts.    Accordingly, petitioner maintains, the requirement that

liquidation proceeds be paid in accordance with positive capital

accounts shows that its allocations reflect the partners’ economic

interests in the partnership.         Respondent, however, contends that,

notwithstanding his concession, our original decision was correct,

based upon alternative evidentiary and legal arguments.

     Initially, in his brief on remand, respondent maintains that

petitioner     has   failed    to    substantiate    the   amounts   of   the

partnership minimum gains at issue. We disagree. We reviewed this

matter thoroughly during the trial of this case and see no reason

to revisit this issue.        Petitioner produced its accountant’s work
                                - 31 -

papers, which reflected how the amount of partnership minimum gain

would be derived.       Petitioner’s accountant substantiated these

figures through his testimony.        We found the accountant’s work

papers both accurate and internally consistent and the accountant’s

testimony credible.

     We are not persuaded otherwise by respondent’s assertion that

petitioner’s work papers are inconsistent with Schedule L of the

subsidiary   partnerships’    tax   returns.      Respondent    correctly

maintains that the amount of depreciation for Landmark reflected on

the work papers for 1990 exceeds the amount reflected on the

balance sheets attached to Form 1065, U.S. Partnership Return of

Income, for the same year. Petitioner, however, has explained that

the discrepancy results from utilizing highly accelerated forms of

depreciation then available for real estate on the accountant’s

work papers, while the balance sheets for Landmark, included on its

returns, were book balance sheets reflecting slower depreciation

rates.   A   schedule    entitled   “tax   depreciation”   in   Form   1065

substantiates the use of depreciation schedules, which produced

higher figures than those on the balance sheets reflected on

Schedule L of the same return.       Moreover, the amounts of claimed

depreciation set forth in Forms 1065, U.S. Partnership Return of

Income, for 1989, 1990, and 1991 are identical to the figures

utilized in the accountant’s work papers used to compute both

Landmark’s minimum gain and IHCL’s share of that minimum gain.           In
                                           - 32 -

the absence of further evidence, we again accept petitioner’s

figures as accurate.

      Next, respondent contends that, even if petitioner has proved

the     amount       of     IHCL’s     partnership     minimum     gain,    petitioner

improperly       included       this    amount   in    the    liquidation   proceeds.

Respondent argues that the minimum gain chargeback is only an

allocation of income, not income itself.                     Accordingly, respondent

concludes that, absent evidence that a liquidation of IHCL would

produce economic income or gain, it is improper to include minimum

gain in the figures produced by a liquidation.

      In our opinion, respondent misperceives the function of the

minimum       gain        chargeback.       Section     1.704-1T(b)(4)(iv)(a)(2),

Temporary Income Tax Regs., 53 Fed Reg. 53162 (Dec. 30, 1988),

states that when the amount of nonrecourse liability exceeds the

basis of the partnership’s property securing it, “a disposition of

such property will generate gain in an amount that is at least

equal    to    such        excess.”     (Emphasis     supplied.)      Although    this

“phantom” gain does not exist in the form of cash, it nevertheless

is taken into account for tax purposes.

      The regulations explain the relation of this phantom gain to

nonrecourse deductions as follows:

      Although an allocation of nonrecourse deductions cannot
      have economic effect, the amount of nonrecourse
      deductions allocated to any partner decreases such
      partner’s capital account.     Similarly, although the
      allocation to a partner of partnership minimum gain that
      is attributable to nonrecourse deductions claimed by the
                                      - 33 -

     partnership increases the partner’s capital account, the
     allocation cannot have economic effect because the
     minimum gain merely offsets nonrecourse deductions
     previously claimed by the partnership and does not
     necessarily bear any relationship to the value of
     partnership property.     Thus, minimum gain that is
     attributable to nonrecourse deductions claimed by the
     partnership must be allocated to the partners that were
     allocated such nonrecourse deductions to prevent such
     gain from impairing the economic effect of other
     partnership allocations. * * * [Id.]

     The    regulations     thus      implement     the    Tufts    doctrine     that

deductions based on nonrecourse financing will later be offset by

increased income, even though that income is not realized in an

economic    sense.       Here,    IHCL      had   passed   through     nonrecourse

deductions    to   its   partners.          The   regulations      require   that    a

subsequent deemed liquidation of IHCL generates gains, albeit

noncash, to offset previously claimed deductions.                      Those gains

increase the upper tier partners’ capital accounts pro tanto.

Respondent’s insistence that a deemed liquidation must produce

actual     economic   gains      to    offset     nonrecourse       deductions      is

inconsistent with the logic of Tufts.

     Other provisions of the regulations do not mandate a different

result.     Respondent     refers      to     language     of      section   1.704-

1T(b)(4)(iv)(e)(2), Temporary Income Tax Regs., 53 Fed. Reg. 53163

(Dec. 30, 1988), to the effect that if there is a net decrease in

partnership minimum gain, then each partner “must be allocated

items of income and gain for such year (and, if necessary, for

subsequent years)”.       Respondent argues the parenthetical language
                                      - 34 -

refers to situations where the net decrease in partnership minimum

gain    in   a   taxable   year    exceeds    the    income     and     gain   of   the

partnership for that taxable year.                  In such cases, respondent

maintains, the excess amount of the decrease in minimum gain must

be carried over and treated as a decrease in partnership minimum

gain for the following years, at least to the extent there is

equivalent partnership income and gain in those years.                       From this

premise,     respondent     argues    that   the    regulations        restrict     any

minimum gain chargeback to the amount of partnership income or gain

realized in a given taxable year. Accordingly, respondent asserts,

“before it can charge back any of the net decrease in partnership

minimum gain to the partners, petitioner must show that IHCL

realized income or gain on the liquidation.”                      Respondent then

points to his earlier conclusion that IHCL would have a loss on

liquidation, and concludes that, because there is not income or

gain on the liquidation, no minimum gain chargeback is allowed.

        We are not persuaded by respondent’s argument.                      We believe

that the quoted language does not apply to situations, such as that

here,    where    minimum    gain     chargebacks        are    generated      by   the

disposition of property in which the partnership’s nonrecourse

liabilities      exceed    its    basis.     In    the   latter       situation,    the

regulations      provide    that     sufficient      gain      will    be    generated

automatically, by operation of the Tufts principle, to equal the

amount of the minimum gain chargeback.               As the regulations state,
                                      - 35 -

such dispositions of property will automatically generate gain “in

an amount that is at least equal to” the minimum gain that must be

charged back.     Sec. 1.704-1T(b)(4)(iv)(a)(2), Temporary Income Tax

Regs., supra.     There is thus no occasion to carry over any "excess"

of a decrease in minimum gains.4

        Respondent   also   attacks    petitioner’s   assumption   that   the

allocation of minimum gain will suffice to offset IHCL’s negative

capital account.       Respondent argues that even if THEI properly

included IHCL’s partnership minimum gain in the computation of the

liquidation proceeds, IHCL improperly allocated enough of its

partnership minimum gain to THEI to offset THEI’s negative capital

account.      Respondent maintains that IHCL “has not computed each

partner’s share of partnership minimum gain.”

        We disagree.   As noted above, petitioner has demonstrated to

our satisfaction that IHCL’s share of the minimum gain chargeback

was $7,369,977 at the end of 1990, and $7,437,891 at the end of

1991.       Moreover, the applicable regulations provide that each



        4
          The regulations, however, do not provide that other
types of decreases in partnership minimum gain will, by
themselves, generate gain. For example, a partnership may choose
to pay down the principal of its nonrecourse debt. That payment
would diminish the amount by which the partnership’s liability
exceeds its basis in the property. Hence, the payment would
decrease minimum gain. The parenthetical language in the
regulation quoted by respondent apparently refers to that
possibility. In such cases, where the net decrease in minimum
gain exceeds annual income or gain, that language appears to
require allocations of minimum gain for subsequent years. That
matter, however, is not presently before us.
                                - 36 -

partner must be allocated items of income and gain to the extent of

the greater of (1) the partner’s share of the decrease in minimum

gain allocable to the disposition of partnership property subject

to nonrecourse liabilities, or (2) the deficit balance in such

partner’s capital account at the end of the year.        See sec. 1.704-

1T(b)(4)(iv)(e)(2), Temporary Income Tax Regs., supra.        Here, even

according   to   respondent’s   calculations,   THEI’s    share   of   the

decrease in minimum gain allocable to the disposition of property

is $3,042,812.5    THEI’s   negative capital account at the end of

1990, however, was $5,920,614.       Under the regulations, THEI is

allocated the greater of these amounts, that is, $5,920,614. Under

the comparative liquidation test, allocation of the latter amount

automatically is sufficient to eliminate THEI’s negative capital

account.

     Nor are we persuaded by respondent’s related contention that,

before taking into account any minimum gain chargebacks,          THEI’s

negative capital account of $5,920,614 must be increased by a

deemed obligation to restore $3,042,812.        As noted above, this

amount represents respondent’s computation of THEI’s        share of the

decrease in minimum gain allocable to the disposition of property.

Respondent contends that this restoration would provide a negative



     5
          Petitioner questions the accuracy of the $3,042,812
figure. Because of our resolution of this issue, we need not,
and do not, make specific findings as to whether the figure is
correct.
                                - 37 -

capital account of $2,877,802. Respondent then notes that section

1.704-1T(b)(4)(iv)(e)(2), Temporary Income Tax Regs. requires that

each partner must be allocated items of income and gain to the

extent of the greater of (1) the partner’s share of the decrease in

minimum gain allocable to the disposition of partnership property

subject to nonrecourse liabilities, or (2) the deficit balance in

such partner’s capital account at the end of the year.             Under

respondent’s theory, THEI would be entitled to a minimum gain

chargeback of only $3,042,812, its share of the minimum gain

chargeback,   because   that   amount    would   be   greater   than   the

recalculated deficit in its capital account of $2,877,802.

     Respondent’s argument that THEI must increase its capital

account is based upon an erroneous reading of the regulations.         The

regulations state:

     For purposes of §1.704-1(b)(2)(ii)(d) [the alternative
     test for economic substance], the amount of a partner’s
     share of partnership minimum gain shall be added to the
     limited dollar amount, if any, of the deficit balance in
     such partner’s capital account that such partner is
     obligated   to   restore.    *   *   *    [Sec.   1.704-
     1T(b)(4)(iv)(f)(2), Temporary Income Tax Regs., 53 Fed.
     Reg. 53164 (Dec. 30, 1988).]

This provision of the regulations is specifically designed to

provide a means for nonrecourse deductions to meet the alternative

test for economic substance, described supra.         The regulations do

so by treating a partner’s share of a minimum gain chargeback as an

amount the partner is required to restore to his or her capital

account. In the present case, however, neither the IHCL Original
                                         - 38 -

Agreement nor the IHCL Restated Agreement meets the alternative

test for economic substance because such agreements fail to provide

a QIO.       See supra pp. 14-15.          Accordingly, there is no “deemed

obligation” that THEI restore to its capital account its alleged

$3,042,812 share of the decrease in minimum gain allocable to the

disposition of property. Even if THEI had such an obligation, that

obligation would not operate to reduce the amount allocable to THEI

under the minimum gain chargeback.                The regulations provide that

such a restoration obligation is performed only “(after taking into

account * * * any changes during such year in partnership minimum

gain     and   in    the   minimum    gain    attributable        to   any     partner

nonrecourse debt)”.        Sec. 1.704-1T(b)(4)(iv)(e)(2)(ii), Temporary

Income Tax Regs., supra.             (Emphasis added.)           In this case, the

antecedent      changes     in    such    minimum    gain    were      their    total

elimination by operation of the Tufts principle in the partnership

regulations. After such changes, there was no minimum gain, and no

partner could have a share of minimum gain to restore to its

capital accounts.

Substantiality

       The     comparative       liquidation       test     of     section     1.704-

1(b)(3)(iii), Income Tax Regs., is ineffective if the economic

effect    of   the    resulting    allocations      is    “insubstantial”       under

section 1.704-1(b)(2)(iii), Income Tax Regs.                      In general, this

requirement of substantiality requires “a reasonable possibility
                                       - 39 -

that the allocation (or allocations) will affect substantially the

dollar amounts to be received by the partners from the partnership,

independent of tax consequences.”                 Id.     An allocation is not

substantial under these regulations if the allocation enhances the

after-tax economic position of at least one partner, and it is

likely that      the     after-tax    consequences       of    none   of   the    other

partners will be diminished.                See sec. 1.704-1(b)(2)(iii)(a),

Income Tax Regs.

        The   requirement      of    substantiality       is   another     provision

designed to ensure that allocations reflect economic reality.

Here,    IHCL    has     allocated    its    annual      income   away     from    Mr.

Manchester, who succeeded to Dondi’s large capital account, to

THEI, which had a substantial negative capital account.                           This

special allocation had an economic effect because it operated first

to eliminate THEI’s negative capital account and, by creating a

positive capital account for THEI, then to increase THEI’s share of

IHCL’s    assets    to    be   received     on    liquidation.         The   special

allocation also ended Mr. Manchester’s claims to additional income.

The   economic     benefit     to    THEI   and   economic      detriment    to    Mr.

Manchester combined to prevent the reallocation from failing the

requirement of the substantiality test.                 Accordingly, not only is

the special     allocation consistent with the partners’ interests in
                                - 40 -

the partnership, it is also “substantial” within the meaning of

section 1.704-1(b)(3)(iii), Income Tax Regs.6

The Facts and Circumstances Regulations

     Both parties have made alternative arguments based upon the

broad factors enumerated in the regulations as appropriate for

consideration in resolving issues of partners’ interests.              The

relevant regulations provide that “The determination of a partner’s

interest in a 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. Because of our

holding with respect to the comparable liquidation test, there is

no need to revisit the "facts and circumstances" issue.

Deficiencies After Remand

     Respondent, in his brief on remand, presented an issue that is

not directly related to inclusion of the minimum gain chargeback in

the comparative liquidation test.        Respondent maintains that the

recalculated   deficiencies   should   include   a   correction   to   the

decision submitted by the parties as a basis for the earlier

decision.   That correction concerns the treatment of an asserted




      6
           The comparative liquidation test also requires that
the result of the liquidations be adjusted for the items
described in (4), (5), and (6) of sec. 1.704-1(b)(2)(ii)(d),
Income Tax Regs. See sec. 1.704-1(b)(3)(iii)(b), Income Tax
Regs. Respondent asserts that these provisions, described under
the “alternate test” of economic substance, supra, are
inapplicable here. Petitioner does not disagree.
                              - 41 -

constructive distribution of $16,402 to IHCL.    Petitioner argues

that such correction cannot be made on remand; we disagree.

     The “law of the case” doctrine states that the decision of the

appellate court must be respected on remand, but the binding effect

of this doctrine does not extend to issues the appellate court did

not address.   United States v. Cote, 51 F.3d 178, 181 (9th Cir.

1995).   Under the similar, but broader “rule of mandate”, we may

not entertain a proceeding inconsistent with the remand.       Id.

Neither doctrine precludes a technical correction to reflect an

earlier agreement of the parties that was neither affirmed nor

addressed by the Court of Appeals when it vacated and remanded our

earlier decision.   The decision should reflect the correct tax

liability.

     To reflect the foregoing and the parties’ concessions,



                                         Decision will be entered

                                    under Rule 155.
