                        T.C. Memo. 1996-283



                      UNITED STATES TAX COURT



     PARKER PROPERTIES JOINT VENTURE, PDW&A, INC., A PARTNER
         OTHER THAN THE TAX MATTERS PARTNER, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

         TWENTY MILE JOINT VENTURE, PND, LTD., TAX MATTERS
               PARTNER, Petitioner v. COMMISSIONER OF
                    INTERNAL REVENUE, Respondent



     Docket Nos. 18386-92, 18387-92.1     Filed June 19, 1996.



     Theodore Z. Gelt and Ellen O'Brien Kauffmann, for

petitioners.

     Theodore Z. Gelt, for the intervenor, Nicholson Enterprises,

Inc., the tax matters partner, in docket No. 18386-92 only.

     Frederick J. Lockhart, Jr., for respondent.



     1
       These cases were consolidated for purposes of trial,
briefing, and opinion.
                                - 2 -


               MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:    Respondent, for the taxable year ended

June 28, 1988, mailed separate notices of final partnership

administrative adjustment to the tax matters partners of Parker

Properties Joint Venture (Parker Properties) and Twenty Mile

Joint Venture (Twenty Mile).    In these notices, respondent

increased Parker Properties' and Twenty Mile's incomes by

unreported cancellation of indebtedness income of $3,419,963 and

$1,395,492, respectively.

     The issues remaining for our consideration are:     (1) Whether

the partnerships realized income from cancellation of

indebtedness; and, if so, (2) the amount of such income.

     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, unless otherwise

indicated.

                          FINDINGS OF FACT2

Background

     At the time the petitions were filed, Parker Properties’ and

Twenty Mile’s principal places of business were in Parker,

Colorado.3

     2
       The stipulations of fact and the exhibits are incorporated
by this reference.
     3
         The petition of Philip D. Winn & Associates, Inc. (PDW&A),
                                                     (continued...)
                               - 3 -


     These cases concern real estate investments of R. James

Nicholson (Mr. Nicholson), Philip D. Winn (Mr. Winn), and David

A. Gitlitz (Mr. Gitlitz), and several related entities, during

the late 1980's.   Empire Savings, Building & Loan Association

(Empire), a Colorado savings and loan association, participated

directly as the lender of funds to purchase the realty and

indirectly through its wholly owned subsidiary, E.S.L. Corp.

(ESL), as an investor in the investing entities.4

     Parker Properties and Twenty Mile are partnerships formed,

at Empire’s suggestion, for the purposes of acquiring,

developing, and selling the real estate under consideration.

Both entities were accrual method taxpayers during the relevant

years.




     3
      (...continued)
a notice partner of Parker Properties Joint Venture (Parker
Properties) for the year at issue, was filed in docket No. 18386-
92. Sec. 6226(b)(1). The tax matters partner of Parker
Properties, Nicholson Enterprises, Inc. (Nicholson Enterprises),
did not cause a petition for readjustment of partnership items to
be filed within the period specified by sec. 6226(a). However,
Nicholson Enterprises timely elected to intervene in docket No.
18386-92 in accordance with sec. 6226(b) and Rule 245(a). PND,
Ltd. (PND), is both the notice partner and tax matters partner of
Twenty Mile Joint Venture (Twenty Mile) for the year at issue,
and its petition was filed in docket No. 18387-92.
     4
       Empire's equity investment was made based on the
understanding that it was permitted by thrift industry
regulations. It was also understood that industry regulations
required that this type of investment be made through a
subsidiary.
                                 - 4 -


Parker Properties

     Parker Properties was formed in August 1983 by Nicholson

Enterprises, Inc. (Nicholson Enterprises), Philip D. Winn &

Associates, Inc. (PDW&A), and ESL.       Nicholson Enterprises and

PDW&A each received a 25-percent interest in Parker Properties,

and ESL received a 50-percent interest.       Parker Properties’

initial capital contributions were as follows:       PDW&A, $500;

Nicholson Enterprises, $500; and ESL, $1,000.       There were few, if

any, additional capital contributions made by the partners over

the life of Parker Properties.

     Parker Properties obtained financing from Empire for the

acquisition of real estate from Bankers Trust (the Bankers Trust

property).   Empire lent $10 million to Parker Properties to

acquire the Bankers Trust property and an additional $2 million

for property improvement and operating expenses.       The loan was

evidenced by a $12 million promissory note dated August 30, 1983,

payable to Empire.   This note was signed by officers of the joint

venturers ESL, Nicholson Enterprises, and PDW&A; and by Messrs.

Gitlitz, Nicholson, and Winn, individually.       The $12 million note

was secured by the Bankers Trust property without recourse to

Parker Properties but with recourse to Mr. Nicholson as to 12.5

percent of the loan balance, and Messrs. Winn and Gitlitz each as

to 6.25 percent of the loan balance.       Parker Properties claimed
                                - 5 -


interest expense deductions on the debt to Empire and

Commercial.5

Twenty Mile

     During 1985, after success in the development of the Bankers

Trust property, the Parker Properties investors acquired another

parcel (the Clarke property) in or near the town of Parker.       The

investors used Twenty Mile as the joint venture partnership for

acquisition of the Clarke property.     The joint venture agreement

was completed on April 16, 1985, by and between PND and ESL, each

receiving a 50-percent interest in Twenty Mile.    PDW&A and

Nicholson Enterprises were the general partners of PND.6    The

initial capital contributions from the Twenty Mile partners were

as follows:    PND, $1,000; ESL, $1,000.   Similar to the situation

with Parker Properties, there were few, if any, additional




     5
       In addition to the loans from Empire, funding was obtained
through the issuance of tax free metropolitan district bonds.
Metropolitan districts are quasi-municipal entities that can
issue tax free debt. Such districts have been utilized to
provide utility enhancements in the absence of a true
municipality or in the presence of a municipality incapable of
issuing debt.
     Parker Properties also assumed an obligation of Bankers
Trust to purchase water and sewer taps as secured by a letter of
credit issued by Empire. The obligation was subject to annual
tax liability to support the retirement of bonds for improving
and widening certain streets in the town of Parker.
     6
       Twenty Mile also had two additional limited partners, each
with small interests: The seller of the Clarke property and a
real estate broker.
                                 - 6 -


capital contributions made by the partners over the life of

Twenty Mile.

     Empire lent Twenty Mile $3,500,000 (with a maximum limit of

$6 million) for acquisition and development of the Clarke

property.     The loan was evidenced by a $6 million promissory note

dated April 16, 1985, from Twenty Mile to Empire, and signed by

an officer of ESL and by officers of Nicholson Enterprises and

PDW&A as the general partners of PND, and Messrs. Gitlitz,

Nicholson, and Winn, individually.       The debt was secured by the

Clarke property, without recourse to Twenty Mile, but with

recourse to the three individuals in the same percentages used

for Parker Properties.

Parker 480 Joint Venture

     A third parcel was acquired by Parker 480 Joint Venture

(Parker 480) (which is not a party in this case).      The Parker 480

agreement was entered into on June 26, 1985, by and between A. &

P.D.W. Limited Partnership (APDW), consisting of the PDW&A

partners; and N-4 Associates (N-4), which included Mr. Nicholson

and his family.

         Parker 480 partners contributed capital, as follows:   APDW,

$500; N-4, $500.     Empire was the lender with an "equity incentive

participation" or "equity kicker".7

     7
       The "equity kicker" is defined in the $3,500,000 note as
50 percent of the equity in the property secured by the deed of
                                                   (continued...)
                                - 7 -


     The $3,500,000 Empire lent to Parker, was evidenced by a

June 26, 1985, promissory note, which was subscribed to by Parker

480 and Messrs. Gitlitz, Nicholson, and Winn, individually.      The

note was nonrecourse as to Parker 480, and recourse as to the

individuals in Parker Properties and Twenty Mile.

The Agreement in Controversy

     On April 30, 1987, Commercial Federal Savings & Loan

Association (Commercial) acquired Empire and ESL from its holding

company, Baldwin United Corp., which was then in a chapter 11

bankruptcy proceeding.    Accordingly, Commercial was the successor

in interest to Empire’s loans and involvement in the subject

partnerships.    Due to a declining real estate market, Commercial

did not want to be associated with the joint ventures through ESL

or extend any additional credit to the real estate venturers.     It

was Commercial’s wish to dispose of the debt and equity interests

it had in the joint ventures.

     Commercial met with Parker Properties and Twenty Mile

partners during the summer of 1987.     At that meeting, Commercial

expressed its desire to liquidate its positions as a creditor

and, through ESL, an investor in Parker Properties and Twenty

Mile.    It was Commercial’s desire for the partners of Parker

     7
      (...continued)
trust. "Equity" is described in the same instrument as the net
sales proceeds on any portion of the property sold and the deemed
net sales proceeds of the remaining property with the deemed
sales price determined by an agreed-to appraisal process.
                               - 8 -


Properties and Twenty Mile to obtain new funding to liquidate

Commercial’s and its subsidiaries’ (Empire and ESL) positions in

the joint ventures for as much cash as possible.   However,

Commercial realized that the collateral real property had

declined in value.   Consequently, Commercial was willing to

accept less than the outstanding balances of the loans in order

to liquidate its interests in the ventures.

     Acceding to Commercial’s wishes, in late 1987, the investing

partners negotiated with Sun Savings & Loan Association (Sun

Savings) for financing to liquidate Commercial’s interests.

Although Sun Savings was willing to finance the liquidation of

Commercial's interest in the partnerships, the investing partners

were not willing to pay the minimum amount of cash that

Commercial would accept.   To adjust for the shortfall, Commercial

suggested that certain of its Denver area apartment mortgages

(apartment mortgages) be purchased in connection with the

transaction.   These negotiations, however, did not result in an

agreement.

     In March 1988, representatives of the investing partners

entered into negotiations with Capitol Federal Savings & Loan

Association (Capitol Federal) to arrange for financing to

liquidate Commercial's joint ventures interests.   In a letter

dated April 19, 1988, Commercial made a proposal to Mr. Winn that

Commercial liquidate its creditor’s position through Empire and
                                - 9 -


its investor position through ESL.      Commercial’s proposal offered

that: (1) Commercial would sell all of its interests in Parker

Properties and Twenty Mile for $7 million; (2) Commercial would

release Messrs. Gitlitz, Nicholson, and Winn from individual

liability on the Parker 480 loan; (3) Commercial would sell the

apartment mortgages for $12.5 million; (4) Commercial and ESL

would be released from all liabilities as a partner, on

outstanding letters of credit, and on any other contracts and

obligations; and (5) the transaction would be completed no later

than May 15, 1988.

     On April 21, 1988, representatives of Commercial, ESL, and

Capitol Federal met with the investing partners and their

attorney to discuss the plans to liquidate Commercial's

interests.   One possibility was to replace the Commercial loans

with those of another lender.   Another possibility was to include

the Parker 480 property in the transaction, perhaps with an

increased purchase price.   Capitol Federal would assume the $2

million sewer tap letter of credit, and the investing partners

would indemnify Commercial from any known liabilities.     The sale

of the $12.5 million apartment mortgage notes was also suggested

as a possible condition.

     On June 20, 1988, Commercial’s attorney faxed a rough draft

of the agreement to the investing partners’ attorney.     This draft

included the following typed language:
                                   - 10 -


     WHEREAS, [ESL] is willing to sell its joint venture
     interest in Parker Properties and Twenty Mile for the
     sum of $10,000.00 and Commercial is willing to accept
     the sum of $10,990,000.00 in full settlement and
     satisfaction of its above-described loan balances, all
     subject to fulfillment of the terms of this Agreement,
     and Parker Properties is desirous of purchasing such
     joint venture interests and paying the outstanding
     balances of the loans to Commercial as adjusted.

The draft agreement also provided that Parker Properties would

pay ESL $10,000 for its interest in Parker Properties and Twenty

Mile.     In addition, Parker Properties was to pay Commercial

$7,990,000 cash and deliver a $3 million promissory note.

Handwritten just above the terms of the agreement appeared the

following:     "WHEREAS Prior closing Commercial will contribute

capital to and reduce indebtedness - ESL wholly owned subs".

     On June 22, 1988, the investing partners' attorney faxed

Commercial and its attorney a followup letter outlining the

transaction and referring to "what the borrower would like the

transaction to look like."       The letter contained the following

chart which detailed "how the transaction would result":

                               Convert to
                  Debt         Equity     Forgive    To be Paid   Note
Parker Properties $9,319,963   $3,419,963   ---      $2,900,000   $3,000,000
Twenty Mile        3,395,492    1,395,492   ---       2,000,000      ---
Parker 480         3,256,910       ---    $156,910    3,100,000      ---
   Total          15,972,365    4,815,455 156,910     8,000,000    3,000,000

        On June 28, 1988, Commercial’s accountant was asked to

provide his comments "from a tax standpoint."          Based on his

understanding of the proposed agreement, the accountant opined

that:
                               - 11 -


     It is fairly obvious in the agreement that Commercial
     is forgiving approximately $4.8 million of debt. The
     equity interest received is worthless and Commercial
     intends to charge off the portion of the debt so
     exchanged. The charge off will be taken during the
     year ending June 30, 1988, and will be listed along
     with Commercial's other loans charged off.

     Ultimately, on the same day, after the tax advice had been

sought and received on the proposed transaction, the terms of the

draft agreement were integrated into a virtually identical final

agreement (the Agreement).   The Agreement was reached between

Messrs. Gitlitz, Nicholson, and Winn, individually, and PDW&A,

Nicholson Enterprises, Parker Properties, Twenty Mile, Parker

480, ESL, and Commercial.    The Agreement provided that Commercial

was contributing approximately $4.8 million of additional capital

through debt reduction to Parker Properties and Twenty Mile on

behalf of ESL.   However, the terms of the Agreement also provided

that ESL would then convey its interests in both Parker

Properties and Twenty Mile (which was to include the $4.8 million

capital contribution by Commercial) to Nicholson Enterprises and

PDW&A for $5,000 each.   Parker Properties, Twenty Mile, Parker

480, and their respective partners agreed to indemnify Commercial

and ESL from any claims made against them.   The transaction was

to close on or before June 28, 1988.

     Regarding the apartment mortgages, a separate agreement was

entered into between Commercial and Riverbank Acquisition
                                - 12 -


Associates (Riverbank)8 on June 16, 1988.   Riverbank agreed to

purchase the apartment mortgages for $12,100,000, which the

parties agree was $650,000 in excess of their fair market value.

     Approximately 7 months after the closing of the Agreement,

Commercial sent Parker Properties and Twenty Mile each a form

entitled, "Acquisition or Abandonment of Secured Property" (Form

1099-A), reflecting income from the cancellation of indebtedness

in the amounts of $3,419,963 and $1,395,492, respectively.

Parker Properties and Twenty Mile each reported these amounts as

other income.   However, the joint ventures then reported an

offsetting "other deduction" on their respective tax returns with

the following disclosure:   "The partnership received a 1099 * * *

described as income from forgiveness of indebtedness.    This was

not reported as income since it resulted from a contribution to

capital rather than from debt relief."    Commercial, however,

claimed the above-mentioned amounts as an ordinary loss from the

cancellation of indebtedness.    As a result, Commercial entered

into an agreement with the investors which provided that the

investors would hold Commercial harmless from any claims that may

arise from its issuing the Forms 1099-A.




     8
       Riverbank was at all relevant times a Colorado general
partnership of which Riverbank Denver, Inc., and Residual
Acquisition Corp. were general partners. Residual Acquisition
Corp. was 100 percent owned by David A. Gitlitz.
                                - 13 -


     On or near May 15, 1990, Commercial filed a Form 1120X,

"Amended U.S. Corporation Income Tax Return", for the taxable

year ended June 30, 1988, in order to exclude some previously

taxed dividends.   When respondent examined the claim reported in

the amended return, Commercial agreed to include ESL's share of

cancellation of indebtedness income attributable to its interests

in the joint ventures which had not been included in ESL’s tax

returns.   Finally, Commercial agreed to an ordinary income

adjustment to restore ESL's negative capital accounts in the

joint venture partnerships to zero, and Commercial was allowed

capital loss treatment for the sale of the interests.

                     ULTIMATE FINDINGS OF FACT

     Parker Properties’ and Twenty Mile’s agreement with

Commercial resulted in cancellation of indebtedness income.

                                OPINION

     The partnerships obtained financing from Empire.

Subsequently, Empire’s successor in interest, Commercial, decided

to disassociate itself from the partnerships.    Commercial and the

partners, after negotiations, reached an agreement.   Respondent

and petitioners disagree as to the effect of the agreement on the

partners’ Federal income tax.

     Respondent determined that Parker Properties and Twenty Mile

received $3,419,963 and $1,395,492 in income in 1988 from the

cancellation of indebtedness, respectively.   Petitioners argue
                               - 14 -


that the restructuring that they attempted was in form and

substance a contribution to capital to each partnership.     We must

decide whether petitioners realized income from the cancellation

of indebtedness.   If there was a cancellation of indebtedness

resulting in income to petitioners, we must decide the amount

recognizable.   Petitioners have the burden of showing that

respondent’s determination is in error and/or that the amounts in

controversy were capital contributions.     Rule 142(a).

     Petitioners assert that the conversion of the loan into a

partnership capital interest is a nonrecognition event under

section 721.    Section 721 provides:   "No gain or loss shall be

recognized to a partnership or to any of its partners in the case

of a contribution of property to the partnership in exchange for

an interest in the partnership."    We must decide if the substance

of these transactions was the same as the form in which the

partnerships attempted to cast it.      Section 1.721-1, Income Tax

Regs., provides in relevant part:    "In all cases, the substance

of the transaction will govern, rather than its form."     See

Colonnade Condominium, Inc. v. Commissioner, 91 T.C. 793, 813

(1988).

     Section 61(a)(12) provides that gross income includes

"Income from discharge of indebtedness".     The parties agree that,

before the execution of the Agreement, the items in question were

debts of Parker Properties and Twenty Mile owed to Empire and,
                               - 15 -


later, Commercial.   Petitioners, nonetheless, have attempted to

structure the extinguishment of their debt as capital

contributions.   Thus, petitioners believe that the form should be

respected for Federal tax purposes.

     Taxpayers may attempt to structure their transactions in

such a way as to lessen their tax burden.      Gregory v. Helvering,

293 U.S. 465 (1935).   Partners may attempt to structure the

substance of their transactions by choosing the form of the

transactions.    Otey v. Commissioner, 70 T.C. 312 (1978), affd.

per curiam 634 F.2d 1046 (6th Cir. 1980).      Ordinarily, "taxpayers

are * * * bound by the form of their transaction while the

Government can attack that form if it does not represent the

substance of the transaction."    Newhall Unitrust v. Commissioner,

104 T.C. 236, 243 (1995).   Petitioners contend that we should

respect the form they have chosen which is reflected in the

Agreement.   "Whether a debt has been discharged is dependent on

the substance of the transactions.      Mere formalisms arranged by

the parties are not binding in the application of the tax laws."

Cozzi v. Commissioner, 88 T.C. 435, 445 (1987) (citing

Commissioner v. Court Holding Co., 324 U.S. 331 (1945)).

     Beginning in the summer of 1987, shortly after acquiring

Empire, Commercial desired to terminate both its investor and

debtor-creditor relationships in the joint ventures.      Commercial

requested that the investing partners obtain funding to ensure
                              - 16 -


that Commercial would be removed from the joint ventures, while

receiving as much cash as possible.    The agreement terms,

however, cast this as a contribution to capital by entities

seeking complete financial disassociation from the partnerships.

     The April 19, 1988, letter prepared on behalf of Commercial

expressed the continuing desire to end its relationship with

Parker Properties and Twenty Mile, including its equity

involvement through ESL.   On April 25, 1988, Commercial’s

attorney prepared a memorandum to the client’s file which

detailed the April 21 and 22, 1988, meetings.    That memorandum

contains mention of Mr. Nicholson negotiating with Sun Savings

"for enough funds to take out Empire entirely."

     Petitioners maintain that the Agreement provided for a

capital contribution in excess of $4.8 million.    However, the

June 20, 1988, draft of the Agreement indicated that ESL was

willing to sell its interests in Parker Properties and Twenty

Mile for a mere $10,000.   Petitioners counter that this is

because Commercial was ultimately relieved of exposure to over $8

million in liabilities, and, thus, there was a valid business

purpose.

     We find, however, that any such liability relief was a

practical consequence of the plan.     Commercial wanted out of the

joint ventures entirely; it was not seeking to cancel the debt in

order to become a new investor.   Furthermore, ESL sold its
                               - 17 -


"interest" for a relatively nominal sum ($10,000) shortly after

the questioned transaction.    The substance of this transaction

was separation from the joint ventures, and this was inconsistent

with a capital contribution.    By issuing Forms 1099-A and

reporting income from the cancellation of indebtedness,

Commercial and ESL treated the arrangement as a cessation of

their interest and cancellation of indebtedness.

     The June 20, 1988, draft agreement contains the statement

that the parties desired the cancellation of the partnerships’

indebtedness.   It was not until 8 days later, i.e., after tax

advice was obtained and the final agreement prepared, that any

mention of a contribution to capital occurred.    This is

illustrative of the plan--Commercial wanted out of its creditor

status; any purported capital contribution was a mere provision

that was not otherwise in sync with the plan.    Petitioners did

not enter into the Agreement to increase or expand their capital

structure.   Cf. Perlman v. Commissioner, 27 T.C. 755, 758 (1957),

affd. 252 F.2d 890 (2d Cir. 1958).

     Commercial’s accountant, in his June 28, 1988, memorandum,

suggests the true nature of the transaction.    Notwithstanding the

fact that tax advice was sought, Commercial’s accountant was

asked to review the draft agreement, the terms of which were

incorporated into the final agreement.    Based on his independent

review, the accountant concluded that the draft agreement was
                              - 18 -


simply a device through which nearly $4.8 million of debt would

be forgiven and that any equity interest received by ESL would be

worthless.   Noting that Commercial intended to write off the

portion of debt that would be extinguished, the accountant found

that to be consistent with the treatment of other loans that were

charged-off for the year ended June 30, 1988.

     Having found that the transaction resulted in cancellation

of indebtedness income, we must next decide the extent to which

petitioners must recognize income.     Petitioners argue that, under

Fulton Gold Corp. v. Commissioner, 31 B.T.A. 519 (1934), there

were no accessions to their wealth because the debt cancellation

did not free assets as it would have if the nonrecourse debt had

been recourse.   However, in Gershkowitz v. Commissioner, 88 T.C.

984, 1010 (1987), this Court held that a reduction in the amount

of an undersecured, nonrecourse debt by one who was not the

seller of any property securing the debt results in cancellation

of indebtedness income.   See also Commissioner v. Tufts, 461 U.S.

300, 307 (1983) (nonrecourse mortgage tantamount to a true loan;

its forgiveness triggers cancellation of indebtedness income,

notwithstanding a lesser fair market value of the collateral than

the balance of the debt).

     The partnerships’ transactions with Commercial arose from

debt workouts generated by a depressed real estate market.

Parker Properties and Twenty Mile borrowed funds from Empire on a
                                - 19 -


nonrecourse basis as to the partnerships, secured by the real

estate which was the subject of each joint venture.    In

Commissioner v. Tufts, supra, the collateral for the loan was not

retained by the borrowers upon debt cancellation.     Petitioners

argue that, because they retained their collateral and settled

their debt with cash, their facts are distinguishable from Tufts,

and, thus, they should only recognize income to the extent of the

fair market value of the collateral.     In Gershkowitz v.

Commissioner, supra, the taxpayers did retain collateral and pay

with cash.    In Gershkowitz v. Commissioner, supra at 1014, the

taxpayers were required to recognize gain from the cancellation

of indebtedness to the extent that the balance of the debt

exceeded the cash paid on extinguishment.9

     In line with Gershkowitz, we hold that the partnerships

realized income to the extent that their loan balances exceeded

the consideration paid to Commercial on extinguishment.10    This

     9
       Respondent’s analysis in Rev. Rul. 91-31, 1991-1 C.B. 19,
also reaches this result. In Rev. Rul. 91-31, respondent
concluded that Commissioner v. Tufts, 461 U.S. 300 (1983), and
Gershkowitz v. Commissioner, 88 T.C. 984 (1987), required
cancellation of indebtedness income to be recognized to the
extent of the principal reduction by the “nonselling” lender of
an under-secured, nonrecourse debt. Such is the case here. See
also Rev. Rul. 82-202, 1982-2 C.B. 36, wherein respondent’s
analysis concludes that United States v. Kirby Lumber Co., 284
U.S. 1 (1931), requires a taxpayer, whose nonrecourse debt
balance was reduced by the lender, to recognize cancellation of
indebtedness income in an amount equal to the debt reduction.
     10
          The parties agree that unpaid interest incurred on the
                                                      (continued...)
                               - 20 -


income must be recognized by the partners of Parker Properties

and Twenty Mile as a separately stated item under section

702(a)(7), subject to the limitations of section 108 at the

partner level.    Sec. 108(a), (d)(6); see also Estate of Newman v.

Commissioner, 934 F.2d 426, 427 n.1 (2d Cir. 1991), revg. T.C.

Memo. 1990-230; Gershkowitz v. Commissioner, supra at 1009.

     Finally, petitioners contend that, because Riverbank

purchased apartment mortgages for an amount $650,000 in excess of

their fair market value, any cancellation of indebtedness income

should be reduced by this amount.   Although Commercial received

approximately $650,000 more than it would have, we must consider

whether that excess inures to petitioners’ benefit for purposes

of determining taxable income.

     Petitioners seek a reduction of recognizable income for the

excess payment.   The payments, however, were not made on behalf

of partnerships for which respondent made determinations.

Accordingly, the $650,000 excess payment does not result in a

special allocation.   See, e.g., Klein v. Commissioner, 25 T.C.

1045 (1956).   Nor is this an instance where a partner is selling

or contributing property to the partnership.   See, e.g., secs.




     10
      (...continued)
debt is included in the cancellation of indebtedness income
realized by the joint ventures to the extent that the obligation
to pay interest was forgiven.
                              - 21 -


707(a), 721; Barenholtz v. Commissioner, 77 T.C. 85 (1981); Otey

v. Commissioner, 70 T.C. 312 (1978).

     The partnerships paid $650,000 less than Commercial was

willing to accept.   Therefore, Riverbank (not a party in these

cases) purchased nearly $11.5 million mortgages for just over 5

percent, or $650,000, above their fair market value.   This

enabled the partnerships to achieve debt relief from Commercial

and also provided Riverbank with new mortgages.   Parker

Properties and Twenty Mile did not pay the $650,000.

     Both parties to the transaction had a business purpose for

its consummation; Commercial realized cash on the sale of the

mortgages, and Riverbank obtained assets.   As part of the

purchase, Riverbank, not the partnerships, is entitled to account

for their acquisition.   Furthermore, if the conditions warranted,

Riverbank (not the partnerships) might be entitled to any

potential bad debt deductions.   See generally sec. 166.   To hold

that the partnerships should reduce their cancellation of

indebtedness income by the $650,000 another entity paid would

ignore the realities underlying the separate mortgage purchase

agreement and the practical effects of Riverbank’s separate role

as the buyer.   Accordingly, the partnerships are not entitled to

reduce their income by the $650,000 premium paid by Riverbank.

     To reflect the foregoing,
- 22 -


     Decisions will be entered

under Rule 155.
