                                              ISRAEL GREENWALD AND RUTH GREENWALD, ET AL., 1
                                                  PETITIONERS v. COMMISSIONER OF INTERNAL
                                                           REVENUE, RESPONDENT
                                               Docket Nos. 29126–11,           29244–11,                Filed May 21, 2014.
                                                            3203–12,            3212–12,
                                                            3213–12,            3215–12,
                                                            3216–12,            3217–12,
                                                            3218–12.

                                                 Ps owned interests in bona fide partnerships that were sub-
                                               ject to the tax audit and litigation procedures of I.R.C. secs.

                                           1 Cases   of the following petitioners are consolidated herewith: Brian

                                     308




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                                     (308)                         GREENWALD v. COMMISSIONER                                      309


                                               6221–6234. The partnerships liquidated, and the partnership
                                               items for the year of liquidation were determined in partner-
                                               ship-level proceedings. Following those proceedings, R issued
                                               notices of deficiency determining the partners’ gain on liquida-
                                               tion of the partnerships. Ps filed petitions in response to those
                                               notices of deficiency and later moved to dismiss for lack of
                                               jurisdiction, arguing that outside basis is a partnership item
                                               that should have been determined at the partnership level
                                               and that the notices of deficiency are invalid. Held: Gain or
                                               loss on the disposition of a bona fide partnership interest is
                                               an affected item that requires partner-level determinations if
                                               the amount of that gain or loss could be affected by a partner-
                                               level determination.

                                           Peter L. Banis, for petitioners.
                                           Nina P. Ching, for respondent.

                                                                                  OPINION

                                        BUCH, Judge: These cases involve affected items deficiency
                                     proceedings that follow from previous partnership-level pro-
                                     ceedings in this Court. 2 Petitioners filed a motion to dismiss
                                     for lack of subject matter jurisdiction, and their argument is
                                     that outside basis is a partnership item that had to be raised
                                     and determined in the prior partnership-level proceedings.
                                     Respondent argues that this Court has jurisdiction because
                                     outside basis is an affected item that requires partner-level
                                     determinations. Both parties, however, miss the mark. In
                                     these partner-level affected items proceedings, we have juris-
                                     diction to redetermine the amounts of any deficiencies attrib-
                                     utable to affected items that require partner-level determina-
                                     tions. Because partner-level determinations are required, we
                                     have jurisdiction to redetermine the deficiencies at issue.



                                     Auchter and Nancy Auchter, docket No. 29244–11; Paul H. Hildebrandt
                                     and Judith A. Hildebrandt, docket No. 3203–12; Michael Cohen and Susan
                                     Cohen, docket No. 3212–12; Bernard J. Sachs and Joan K. Sachs, docket
                                     No. 3213–12; David Kraus and Susan Kraus, docket No. 3215–12; Jona-
                                     than L. Levine and Sarah S. Levine, docket No. 3216–12; John A.
                                     Hildebrandt and Jean E. Hildebrandt, docket No. 3217–12; and David S.
                                     Marsden and Rosemary Marsden, docket No. 3218–12.
                                       2 Regency Plaza Assocs. of N.J. v. Commissioner, docket Nos. 7150–08

                                     and 7197–08 (decisions entered June 30, 2010).




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                                     310                 142 UNITED STATES TAX COURT REPORTS                                    (308)


                                                                               Background
                                       Petitioners in these consolidated cases resided in the fol-
                                     lowing locations at the time the petitions were filed: the
                                     Greenwalds, docket No. 29126–11, lived in New York; the
                                     Auchters, docket No. 29244–11, lived in New Jersey; Paul
                                     and Judith Hildebrandt, docket No. 3203–12, lived in New
                                     Jersey; the Cohens, docket No. 3212–12, lived in New York;
                                     the Sachses, docket No. 3213–12, lived in Maryland; the
                                     Krauses, docket No. 3215–12, lived in New York; the
                                     Levines, docket No. 3216–12, lived in New Jersey; John and
                                     Jean Hildebrandt, docket No. 3217–12, lived in New Jersey;
                                     and the Marsdens, docket No. 3218–12, lived in New Jersey.
                                       In laying out the facts, we focus on the Greenwalds. 3
                                       Mr. Greenwald was a limited partner in Regency Plaza
                                     Associates of New Jersey (Regency Plaza). Regency Plaza
                                     was subject to the unified partnership audit and litigation
                                     procedures of the Tax Equity and Fiscal Responsibility Act of
                                     1982 (TEFRA), Pub. L. No. 97–248, sec. 402(a), 96 Stat. at
                                     648. The partnership was involved in an apartment project
                                     that was managed by Republic Management, Inc., which also
                                     managed 14 other apartment projects insured by the Depart-
                                     ment of Housing and Urban Development. As a result of a
                                     transfer of a partnership interest, Regency Plaza attached a
                                     section 754 4 election to its 1995 Form 1065, U.S. Return of
                                     Partnership Income, which neither side claims was revoked.
                                       In 1996 Regency Plaza petitioned the U.S. Bankruptcy
                                     Court for the District of Massachusetts, Western Division, for
                                     relief under chapter 11. Just over a year after the petition
                                     was filed, the Circuit Court of the Sixth Judicial Circuit in
                                     and for Duval County, Florida, entered a final judgment of
                                     foreclosure. The partnership owned property that was subject
                                     to a mortgage in favor of Beal Bank, S.S.B., which mortgage
                                     was security for a nonrecourse debt against property owned
                                     by Regency Plaza. This judgment allowed Beal Bank to fore-
                                       3 This case has been consolidated with eight other cases. One of the

                                     other cases involves Regency Plaza, and the others involve a separate part-
                                     nership, Prince Manor Apartment Associates. Irrespective of the differing
                                     entities and petitioners, the dispositive facts are similar in all of the cases.
                                       4 Unless otherwise indicated, all section references are to the Internal

                                     Revenue Code in effect for the year at issue, and all Rule references are
                                     to the Tax Court Rules of Practice and Procedure.




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                                     (308)                          GREENWALD v. COMMISSIONER                                      311


                                     close its mortgage. Regency Plaza terminated on July 31,
                                     1997.
                                        Because Regency Plaza had failed to file any tax returns
                                     after filing its return for 1995, the Internal Revenue Service
                                     prepared substitute Forms 1065 on Regency Plaza’s behalf
                                     for the 1996 and 1997 taxable years using the 1995 return.
                                     On October 15, 2007, the IRS issued a notice of final partner-
                                     ship administrative adjustment (FPAA) to Regency Plaza for
                                     its taxable years ending December 31, 1996, and July 31,
                                     1997. In response to the FPAA, Brian and Nancy Auchter,
                                     partners other than the tax matters partner, filed petitions
                                     in the Tax Court. 5 Mr. Greenwald filed notices of election to
                                     participate in both cases. He also filed motions to have him-
                                     self appointed the tax matters partner. The Court granted
                                     these motions. The cases were consolidated and later settled.
                                        After the conclusion of the TEFRA proceeding respondent
                                     sent the Greenwalds a notice of computational adjustment
                                     pertaining to Regency Plaza’s 1996 and 1997 taxable years.
                                     Four days later, on September 23, 2011, respondent issued a
                                     notice of deficiency to the Greenwalds for their 1997 taxable
                                     year. The notice of deficiency made an adjustment to the
                                     Greenwalds’ long-term capital gain and made other cor-
                                     responding adjustments. The IRS included a spreadsheet
                                     with the notice of deficiency explaining how it had calculated
                                     the Greenwalds’ long-term capital gain. The spreadsheet
                                     refers to information taken from Regency Plaza’s 1996 and
                                     1997 Forms 1065 and the 1997 Schedule K–1, Partner’s
                                     Share of Income, Credits, Deductions, etc., for Mr.
                                     Greenwald. Again, the Forms 1065 were prepared by
                                     respondent on behalf of Regency Plaza, as was the Schedule
                                     K–1. After the notice of deficiency was issued, respondent
                                     revised the initial computational adjustments to allow for a
                                     rental real estate loss and a passive activity loss using
                                     information provided by the Greenwalds. The modified com-
                                     putational adjustments increased the Greenwalds’ deficiency
                                     by $42; however, respondent seeks only to enforce the defi-
                                     ciency as set forth in the original notice.
                                        These cases were calendared for trial at the Court’s trial
                                     session in Boston, Massachusetts. At the calendar call the
                                     parties moved to submit the cases under Rule 122. However,
                                           5 See   supra note 2.




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                                     312                 142 UNITED STATES TAX COURT REPORTS                                    (308)


                                     the Greenwalds (through their counsel) also stated that they
                                     wanted to submit additional evidence. The cases were
                                     recalled, and the Greenwalds explained that the evidence
                                     was documents from the attorney who represented another
                                     partnership and general partner in a criminal action by the
                                     United States for equity skimming with respect to Regency
                                     Plaza. Respondent objected to the documents because they
                                     were not relevant and because they had not been provided to
                                     respondent until the morning of the scheduled trial. To avoid
                                     a continuance, the Greenwalds withdrew the documents.
                                     Accordingly, these cases were submitted under Rule 122 and
                                     a briefing schedule was established. After the Greenwalds
                                     submitted their opening brief, they filed their motion to dis-
                                     miss. As a result, the briefing schedule was suspended, and
                                     the Court now turns to the jurisdictional question.

                                                                                Discussion
                                     I. Partnership and TEFRA Overview
                                        Partnerships are passthrough entities and, as such, are not
                                     responsible for paying Federal income tax. Instead, the part-
                                     ners report their shares of the partnership items on their
                                     own income tax returns. Sec. 701. Although the partnership
                                     does not file an annual income tax return, it must file an
                                     annual information return that identifies each partner’s
                                     share of income, deductions, and other tax items. Sec.
                                     6031(a).
                                        Congress passed TEFRA over 30 years ago. TEFRA’s uni-
                                     fied audit and litigation procedures were enacted to alleviate
                                     the administrative burden caused by duplicative audits and
                                     litigation. Samueli v. Commissioner, 132 T.C. 336, 340
                                     (2009). A goal of TEFRA was to ‘‘promote increased compli-
                                     ance and more efficient administration of the tax laws.’’ H.R.
                                     Conf. Rept. No. 97–760, at 600 (1982), 1982–2 C.B. 600, 662.
                                        Section 6221 provides that the tax treatment of all ‘‘part-
                                     nership items’’ is determined at the partnership level. The
                                     Secretary must mail each notice partner whose name and
                                     address is furnished a notice of the beginning of an adminis-
                                     trative partnership-level proceeding and an FPAA. Sec.
                                     6223(a). The determination of partnership items in a part-
                                     nership-level proceeding (either through a defaulted FPAA or




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                                     (308)                         GREENWALD v. COMMISSIONER                                      313


                                     a final court decision) is conclusive. 6 Once adjustments are
                                     made at the partnership level, the IRS will make any nec-
                                     essary partner-level changes, including changes to ‘‘affected
                                     items’’. If the adjustment to an affected item is merely com-
                                     putational and can be made without making additional
                                     partner-level determinations, the IRS can directly assess the
                                     tax due without having to follow the usual deficiency proce-
                                     dures. Sec. 6230(a)(1); sec. 301.6231(a)(6)–1T(a), Temporary
                                     Proced. & Admin. Regs., 52 Fed. Reg. 6790 (Mar. 5, 1987). 7
                                     However, if an adjustment to an affected item requires a
                                     partner-level factual determination, the IRS must follow defi-
                                     ciency procedures. Sec. 6230(a)(2)(A)(i); sec. 301.6231(a)(6)–
                                     1T(a), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6779
                                     (Mar. 5, 1987). 8
                                     II. Partnership Items
                                        A partner’s basis in his partnership interest is an affected
                                     item to the extent it is not a partnership item. Sec.
                                     301.6231(a)(5)–1T(b), Temporary Proced. & Admin. Regs., 52
                                     Fed. Reg. 6790 (Mar. 5, 1987). 9 A partnership item is ‘‘any
                                     item required to be taken into account for the partnership’s
                                     taxable year under any provision of subtitle A [Income
                                     Taxes] to the extent [the] regulations * * * provide that, for
                                     purposes of this subtitle, such item is more appropriately
                                     determined at the partnership level than at the partner
                                     level.’’ Sec. 6231(a)(3). The ‘‘critical element’’ is that the part-
                                     nership is required to make the determination. Sec.
                                           6 Except
                                                 in limited circumstances, refund suits for adjustments attrib-
                                     utable to partnership items are not permitted. Sec. 7422(h). And even
                                     then, any prior partnership item determination is conclusive. Sec.
                                     6230(c)(4); see also New Millennium Trading, L.L.C. v. Commissioner, 131
                                     T.C. 275, 280 (2008).
                                       7 This rule is now set forth in permanent regulations at sec.

                                     301.6231(a)(6)–1(a)(2), Proced. & Admin. Regs., which apply to taxable
                                     years beginning on or after October 4, 2001. Sec. 301.6231(a)(6)–1(c),
                                     Proced. & Admin. Regs.
                                       8 This rule is now set forth in permanent regulations at sec.

                                     301.6231(a)(6)–1(a)(3), Proced. & Admin. Regs., which apply to taxable
                                     years beginning on or after October 4, 2001. Sec. 301.6231(a)(6)–1(c),
                                     Proced. & Admin. Regs.
                                       9 Permanent regulations replaced the temporary regulations for taxable

                                     years beginning on or after October 4, 2001. Sec. 301.6231(a)(5)–1(f),
                                     Proced. & Admin. Regs.




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                                     301.6231(a)(3)–1(c)(1), Proced. & Admin. Regs. The failure of
                                     the partnership to actually make the determination does not
                                     prevent an item from being a partnership item. Id.
                                        Partnerships do not keep track of the partners’ outside
                                     bases, but they may be required to take a partner’s outside
                                     basis into account in some situations. For example, when a
                                     partner purchases an interest in a partnership, the partner-
                                     ship may elect under section 754 to make optional adjust-
                                     ments to the basis of partnership property. If such an elec-
                                     tion is made, the partner’s initial basis in the partnership is
                                     a partnership item. Sec. 301.6231(a)(3)–1(a)(3), Proced. &
                                     Admin. Regs. However, if the election is not made, the part-
                                     nership is not required to determine the partner’s initial out-
                                     side basis. Tigers Eye Trading, LLC v. Commissioner, 138
                                     T.C. 67, 117 (2012). Accordingly, a partner’s outside basis
                                     generally would be an affected item. Sec. 6231(a)(3); see
                                     Tigers Eye Trading, LLC v. Commissioner, 138 T.C. at 117.
                                     III. Jurisdiction
                                        The Tax Court is a court of limited jurisdiction and can
                                     exercise jurisdiction only to the extent provided by statute.
                                     Sec. 7442. Section 6214(a) provides the Court with jurisdic-
                                     tion to redetermine the correct amount of a deficiency as long
                                     as the taxpayer files a timely petition from a valid notice of
                                     deficiency. Sec. 6213(a). While the deficiency procedures gen-
                                     erally do not need to be followed so as to determine affected
                                     items flowing from a TEFRA partnership-level proceeding, an
                                     exception is carved out for affected items that require
                                     partner-level determinations. Sec. 6230(a)(2)(A)(i).
                                     IV. Precedents
                                       In their motion to dismiss, petitioners rely heavily on
                                     Tigers Eye Trading, LLC v. Commissioner, 138 T.C. 67. In
                                     Tigers Eye the parties stipulated that the partnership was a
                                     sham. Id. at 102. Accordingly, ‘‘[n]o additional facts [were]
                                     required to determine the absence of an outside basis’’
                                     because the partnership did not exist for Federal tax pur-
                                     poses. Id. at 119. Because no further determinations were
                                     necessary, outside basis was a partnership item. Id. More-
                                     over, that outside basis determination also resulted in a
                                     determination of the applicability of a gross valuation




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                                     (308)                         GREENWALD v. COMMISSIONER                                      315


                                     misstatement penalty. See sec. 6226(f) (giving the Court
                                     jurisdiction to determine ‘‘the applicability of any penalty,
                                     addition to tax, or additional amount which relates to an
                                     adjustment to a partnership item’’ for taxable years ending
                                     after August 5, 1997). No further partner-level determina-
                                     tions were required in that instance.
                                        The Supreme Court recently addressed this same issue in
                                     United States v. Woods, 571 U.S. ll, 134 S. Ct. 557 (2013),
                                     and came to the same conclusion. Again, the Court stated
                                     that where the partnership is a sham, no partner-level deter-
                                     minations are needed to determine outside basis because
                                     ‘‘once the partnerships were deemed not to exist for tax pur-
                                     poses, no partner could legitimately claim an outside basis
                                     greater than zero.’’ Id. at ll, 134 S. Ct. at 565–566. This
                                     flows from the fact that there can be no basis in an asset
                                     that does not exist, such as nonexistent partnership interest.
                                     The Court went on to say that ‘‘‘the basis misstatement and
                                     the transaction’s lack of economic substance are inextricably
                                     intertwined’’’. Id. at ll, 134 S. Ct. at 567 (quoting Bemont
                                     Invs., LLC v. United States, 679 F.3d 339, 354 (5th Cir.
                                     2012)). Thus, as with Tigers Eye, the Court held that outside
                                     basis is a partnership item when the partnership is held to
                                     be a sham, and the applicability of the gross valuation
                                     misstatement penalty arises as a preliminary determination.
                                     Even then, the penalty determination is ‘‘provisional’’. Id. at
                                     ll, 134 S. Ct. at 564. Notwithstanding this type of isolated
                                     situation in which outside basis is determined at the partner-
                                     ship level, the Supreme Court acknowledged that a court
                                     may otherwise need to determine ‘‘affected or non-partner-
                                     ship items such as outside basis.’’ Id.
                                        Even then, we do not determine basis in a vacuum. In
                                     these proceedings, we have jurisdiction to redetermine the
                                     amounts of deficiencies. See secs. 6230(a)(2)(A)(i), 6214(a). To
                                     determine the amount of a deficiency, any number of
                                     partner-level determinations may be required, even when
                                     components of the partner’s basis in a partnership interest
                                     are fixed as a result of one or more partnership-level deter-
                                     minations. If, for example, a partner sold a partnership
                                     interest, any deficiency relating to that sale would need to be
                                     determined at the partner level. The amount realized on that
                                     sale would be a partner-level determination even if all of the




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                                     components of the partner’s basis in the partnership interest
                                     may already have been determined at the partnership level.
                                       In these specific cases, the partners were charged with
                                     income as a result of the discharge of partnership liabilities;
                                     thus petitioners argue that no partner-level determinations
                                     are necessary. They are mistaken.
                                       Their outside basis is not fixed by partnership-level deter-
                                     minations, even in the case of a section 754 election. The Tax
                                     Court in Tigers Eye and the Supreme Court in Woods held
                                     that outside basis was a partnership item because the part-
                                     nerships were shams and thus no other determinations were
                                     necessary to preliminarily determine that a gross valuation
                                     misstatement penalty applied. That is not the case before us.
                                     The TEFRA proceeding regarding Regency Plaza did not
                                     determine that the partnership was a sham, and thus in
                                     these proceedings we must treat it as a bona fide partner-
                                     ship.
                                       Redetermining the amounts of deficiencies resulting from
                                     partnership-level adjustments will require that we look to
                                     the partners’ specific facts. For example, if a partner
                                     incurred litigation costs in the defense of the ownership of
                                     the partnership interest, those costs would be added to the
                                     partner’s outside basis, but they would not be taken into
                                     account as part of a section 754 election or any other part-
                                     nership-level determination. Cf. Lange v. Commissioner, T.C.
                                     Memo. 1998–161. To make such a determination, the IRS is
                                     required to follow deficiency procedures. Sec. 6230(a)(2)(A)(i).
                                       Determining that a partner did not incur such a cost is
                                     just as much a partner-level determination. As we have pre-
                                     viously stated: ‘‘Neither the Code nor the regulations there-
                                     under require that partner-level determinations actually
                                     result in a substantive change to a determination made at
                                     the partnership level.’’ Domulewicz v. Commissioner, 129
                                     T.C. 11, 20 (2007), aff ’d in part, rev’d in part sub nom.
                                     Desmet v. Commissioner, 581 F.3d 297 (6th Cir. 2009). In
                                     dicta, the Court of Appeals for the Sixth Circuit arguably
                                     took issue with this statement, stating that it ‘‘conflicts with
                                     TEFRA’s mandate to resolve all issues in a single proceeding
                                     against the partnership whenever possible.’’ Desmet v.
                                     Commissioner, 581 F.3d at 304. However, TEFRA’s mandate
                                     is that all partnership items be resolved in a single pro-
                                     ceeding. Sec. 6221. And the controlling statute explicitly




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                                     requires that, if partner-level determinations are necessary
                                     to determine the correct amount of tax, the IRS must follow
                                     deficiency procedures. Sec. 6230(a)(2)(A)(i). To ignore poten-
                                     tial partner-level determinations by assessing without fol-
                                     lowing deficiency procedures would have the effect of
                                     depriving partners of a prepayment forum where there is a
                                     dispute as to the amount or existence of partner-level deter-
                                     minations that could affect the amount of the assessment.
                                     Section 6230(a)(2)(A)(i) is specifically intended to give part-
                                     ners that prepayment forum.
                                        Under these facts, outside basis is an affected item
                                     requiring partner-level determinations, and we have subject-
                                     matter jurisdiction over these cases.
                                        To reflect the foregoing,
                                                                                 An appropriate order will be issued.

                                                                               f




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