Tiered Partnerships and the Two-Year Disguised-Sale Presumption: Lessons from PIMLICO, LLC v. Commissioner of Internal Revenue (2d Cir. 2025)

1. Introduction

The Second Circuit’s summary order in PIMLICO, LLC v. Commissioner addresses an increasingly familiar theme in partnership taxation: attempts to harvest large losses by routing assets through multilayer partnership structures. At issue was whether a Brazilian transferor’s contribution of distressed trade receivables (“duplicatas”) to a U.S. partnership, promptly followed by cash distributions funded by a new U.S. investor, should be respected as a non-taxable capital contribution or re-characterised as a taxable “disguised sale” under Internal Revenue Code §707(a)(2)(B) and the Treasury Regulations.

The Tax Court found— and the Second Circuit affirmed— that the facts triggered the per se two-year presumption of a disguised sale and that the taxpayer failed to rebut that presumption. The decision provides a useful road-map for how courts will examine timing, funding sources, and partner transience when tiered entities are involved, even though the ruling is technically non-precedential. Practitioners should read the opinion as a caution that the IRS and courts will “look through” complex partnership chains and infer a disguised sale from bank-record breadcrumbs alone.

2. Summary of the Judgment

• The court reviewed the Tax Court’s legal conclusions de novo and factual findings for clear error.
• Under Treas. Reg. §1.707-3(c)(1), if a contribution and distribution occur within two years, they are presumed to be a sale unless the facts “clearly establish” otherwise.
• The panel held that (i) Santa Bárbara’s contribution of duplicatas to XBOXT (upper-tier partner), (ii) the immediate downstream contributions to PIMLICO and PICCIRC, and (iii) the near-contemporaneous $300,164 cash transfer back to Santa Bárbara funded by new investor John Howard, collectively fell squarely within the two-year window.
• PIMLICO’s evidentiary objections were deemed waived; on the merits, the court found multiple “badges of sale” (disproportionate distribution, funding supplied by another partner, transitory partner status) unrebutted.
• Result: The claimed $22.7 million loss was disallowed; the Tax Court’s judgment was affirmed.

3. Analysis

3.1 Precedents Cited and Their Influence

The panel leaned heavily on three prior authorities:

1. Virginia Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d 129 (4th Cir. 2011)
   – Emphasised susceptibility to manipulation and endorsed a flexible, substance-over-form approach to disguised-sale analysis. The Second Circuit echoed Virginia Historic’s warning against mechanical box-checking and duplicated its holistic methodology.
2. Route 231, LLC v. Commissioner, 810 F.3d 247 (4th Cir. 2016)
   – Another disguised-sale case in which timing and funding sources drove the result. It provided a template for finding sales even when contributions travel through multiple entities.
3. Buyuk LLC v. Commissioner, T.C. Memo 2013-253
   – The Tax Court had relied on Buyuk to show that use of new-partner cash to redeem the original partner is a classic badge of a disguised sale. The Second Circuit cited Buyuk to validate the Tax Court’s factual parallels.

3.2 The Court’s Legal Reasoning

• Applicability of Regulation §1.707-3(c)(1) Presumption: Because the contribution (Aug 2002) and distribution (no later than Jan 2003) fell within two years, the burden shifted to PIMLICO to “clearly” prove the transaction was not a sale.
• Badges of Sale: The court specifically highlighted:
  • Partner “Howard’s” infusion of precisely $300,164, which was traceable (via bank records) to Santa Bárbara’s redemption— satisfying badge (iv) “funding by another partner”.
  • The disproportionate nature of the distribution relative to Santa Bárbara’s remaining interest— badge (ix).
  • Santa Bárbara’s transitory presence— a factor not listed in the regs but endorsed in Virginia Historic.
• Waiver and Evidentiary Issues: Because PIMLICO never objected to the bank statements at trial, it could not raise authenticity or foundation arguments on appeal (citing Millea).
• Entrepreneurial-Risk Test: The court implicitly accepted that Santa Bárbara bore no ongoing risk associated with the duplicatas once it was cashed out— confirming that the later payment was not dependent on partnership success.

3.3 Potential Impact of the Judgment

Although a “summary order” lacks formal precedential force, it is nonetheless persuasive authority and it reflects how the Second Circuit is likely to handle similar disputes. Key implications:

1. Tiered-Entity Scrutiny: Courts will consolidate the timeline across multiple partnership tiers when applying the two-year presumption.
2. Tracing Through Bank Records Is Enough: Detailed contractual rights are unnecessary; circumstantial money-flow evidence suffices.
3. Evidentiary Waiver Is Fatal: Taxpayers must object contemporaneously to preserve evidentiary challenges.
4. Pre-AJCA “Built-in Loss” Loophole Qualified: Even before §704(c)(1)(C) closed the loophole, courts may still neutralise tax benefit schemes through the disguised-sale doctrine.
5. Valuation and Loss-Harvesting Transactions: Practitioners can expect more IRS focus on distressed-asset contributions paired with quick cash-outs.

4. Complex Concepts Simplified

• Disguised Sale: A transaction structured to look like a contribution (nontaxable) and later distribution (nontaxable) but economically equivalent to a taxable sale.
• Two-Year Presumption (Reg. §1.707-3(c)): If a partner contributes property and receives cash/property within two years, it is presumed to be a sale; taxpayer bears the burden of disproving.
• Entrepreneurial Risk: The idea that a genuine partner’s return depends on partnership profits; if payment is fixed/risk-free, it indicates a sale.
• Built-in Loss: An asset whose fair market value (FMV) is lower than its tax basis; selling such asset creates a deductible loss. Prior to 2004, new partners could buy an interest and inherit another partner’s built-in loss.
• Duplicatas: Trade receivables commonly used in Brazil; here, they were distressed, i.e., worth far less than face value.
• Tiered Partnership: Multiple partnerships stacked on one another, often used to shift attributes or disguise transfers.

5. Conclusion

PIMLICO reinforces that the Treasury’s disguised-sale rules have real teeth and will pierce through layers of entities and carefully staged steps. When cash ends up in the original contributor’s hands within two years, paid for by a new partner intent on monetising a tax loss, courts are unlikely to be sympathetic— even if the transaction’s paperwork omits an explicit sale agreement. For advisors, the case is a stark reminder that timing, funding source, and partner continuity are the dominant factors in §§707/704 planning, and that silence at trial can doom appellate arguments.