ELLISTON v. COMMISSIONER OF INTERNAL REVENUE

DAWSON, Chief Judge, concurring:

I concur in the result reached in this case. However, I think further analysis of section 465 may be helpful.

The focus of this case is on that portion of section 465 (c)(2) which provides that —

A partner's interest in a partnership * * * shall be treated as a single activity to the extent that the partnership * * * is engaged in activities described in any subparagraph of this paragraph. [Emphasis added.]

It is upon the "express language" of this provision that the majority base their opinion. However, I do not think that such language alone is sufficient.

In attempting to apply the above passage of section 465 (c)(2), a number of questions arise. The first is, in the context of two-tier partnerships, who is the "partner" to whom this sentence of section 465 (c)(2) refers? Is the "partner" the petitioner or is it Dallas Associates? I think it must be petitioner.

Under section 465 (a), the "at risk" provisions apply —

In the case of a taxpayer (other than a corporation which is neither an electing small business corporation * * * nor a personal holding company * * *) engaged in an activity to which this section applies * * * [Emphasis added.]

Thus, the "partner" to whom reference is made in section 465 (c)(2) must be the "taxpayer" who is subjected to the "at risk" rules under section 465 (a), because one arrives at the specific provision of section 465 (c)(2) only by beginning at section 465 (a).

Although a partnership is a person as defined in section 7701 (a)(1) and, arguably, for some purposes, it may be a taxpayer as defined in section 7701 (a)(14) — "any person subject to any internal revenue tax," — it is not a taxpayer for purposes of the income tax. Section 701 provides that a partnership "shall not be subject to the income tax." For purposes of determining the income tax of its partners, as in the present situation, a partnership must be treated as an aggregate of its partners.

Furthermore, although Congress used the broad term "taxpayer" in section 465 (a), Congress did not intend that section 465 apply to a partnership as an entity. For example, if we assume in the instant case that all the partners in Dallas Associates were subchapter C corporations, section 465 would not be applicable (even as to the partnership of Dallas Associates), because such corporations are specifically excluded from the application of section 465.

Since, except for subchapter S corporations and personal holding companies, this provision does not limit the deductibility of amounts paid or incurred by corporations, the provision would not apply to a partnership in which all the partners are corporations (other than subchapter S corporations or personal holding companies). Similarly, if a partnership is comprised of both individual partners and corporate partners (other than subchapter S corporations and personal holding companies), the at risk provision applies to the individual partners but not the corporate partners. [Staff of Joint Comm. on Taxation, 94th Cong., 2d Sess., General Explanation of the Tax Reform Act of 1976, at 36 n. 2, 1976-3 C.B. (Vol. 2) 1, 48; emphasis added.]

See also H. Rept. 94-1515, at 412 n. 1 (1976). Therefore, in this case, the words "taxpayer" in section 465 (a) and "partner" in section 465 (c)(2) refer to the petitioner, while the word "partnership" in section 465 (c)(2) refers to Dallas Associates.

The next question that arises is whether Dallas Associates "is engaged in [the] activit[y]" of leasing any section 1245 property as provided in section 465 (c)(2). Dallas Associates is not directly conducting an activity of leasing section 1245 property; it is directly conducting a business of holding partnership interests. For the reasons previously stated, section 465 (c)(2), itself, cannot be used to solve the question of whether, for purposes of section 465, Dallas Associates is considered to be engaged in the activities of the second-tier partnerships because section 465 (c)(2) does not apply to Dallas Associates as a partner in the second-tier partnerships. Instead, I think it is necessary to look to the provisions of subchapter K.

Section 702 (a)(7) and the regulations thereunder require Dallas Associates to take into account separately its distributive share of each of the second-tier partnerships' income or losses from leasing activities. Thus, the character of such income or loss would be retained as income or loss from leasing activities under section 702 (b). In computing the taxable income of the second-tier partnerships, the income or loss from the leasing activities would be separately stated under section 703 (a)(1).

Therefore, through the operation of these partnership provisions, Dallas Associates would be treated as having income or loss from five leasing activities of the five second-tier partnerships and, thus, would be treated for section 465 (c)(2) purposes as engaged in five leasing activities. I think that it is only after one applies the provisions of subchapter K to characterize the leasing activities of the second-tier partnerships as those of the first-tier partnership that the clear language of section 465 (c)(2) permits the gains from the leasing activities to be netted against the losses from leasing activities. Absent a compelling reason to disregard the plain language of the statute, we must assume that Congress meant what it said and that the statutory language should be taken at face value.

In addition, it seems to me that, respondent was asking the Court to "look through" Dallas Associates and, for purposes of section 465 (c)(2) only, to treat petitioner's interest in Dallas Associates as an interest in each of the second-tier partnerships directly. If petitioner had not interposed Dallas Associates between himself and the second-tier partnerships, it seems that he could not have offset the gains against the losses of the second-tier partnerships.

The Commissioner has taken a similar position in Rev. Rul. 78-2, 1978-1 C.B. 202. In order to address the complicated issue of whether the optional adjustment to basis provisions of section 743 (b) apply to both tiers of a two-tier partnership when there is a sale or exchange of a partnership interest in the first-tier partnership, the Commissioner states as follows:

For purposes of sections 743 and 754 of the Code, a sale or exchange of an interest in X [first-tier partnership] or the death of a partner of X is considered to result in an adjustment to the basis of the property of Y [second-tier partnership] as though the transferee partner were a partner of Y. [Rev. Rul. 78-2, supra, 1978-1 C.B. at 202; emphasis supplied.]

Thus, in Rev. Rul. 78-2, the Commissioner treats an interest in a first-tier partnership as though it were an interest in the second-tier partnership directly. I use Rev. Rul. 78-2 not as authority, but merely to illustrate that respondent's position here is not unreasonable. I am reluctant to preclude the possibility of our holding in an appropriate case that a first-tier partnership must be "ignored" or "collapsed" for a specific purpose. The Commissioner and this Court are just beginning to address the complex issues which will surely arise with regard to multi-tier partnerships and the Code does not easily accommodate complex partnership structures, as evidenced by the instant case. Although I reach the same conclusion as the majority here, I am unwilling to completely block an avenue that I think should remain open.

FAY and HAMBLEN, JJ., agree with this concurring opinion.

NIMS, J., dissenting:

The majority's holding has the potential for opening a substantial loophole. It is undisputed that petitioner would be prohibited by section 465 from aggregating direct holdings in five separate partnerships. However, under the majority's ruling, a taxpayer similarly situated may now aggregate such holdings by the simple expedient of conveying them to a holding company partnership like Dallas Associates.

The "flush" language at the end of section 465 (c)(2) provides that "a partner's interest in a partnership * * * shall be treated as a single activity to the extent that the partnership * * * is engaged in activities described in [section 465 (c)(2)]." Dallas Associates is unquestionably a "partner," and if any one of the partnerships, such as ICL 001, in which Dallas Associates is a partner, were engaged in multiple activities, Dallas could aggregate those activities as a "single activity." But Dallas Associates, qua partner, should no more be able to aggregate the activities of the five separate partnerships than petitioner could do if he were a partner directly in such partnerships.

Section 465 may be initially puzzling because it disallows the aggregation of like-kind section 465 activities directly engaged in by a taxpayer while the "flush" language concurrently allows the aggregation of such activities if they are carried on together in a partnership. The purpose for permitting this apparent peculiarity, however, becomes quite obvious when one considers the application of the at-risk rules of section 465 to an operating partnership without the existence of the "flush" language. If aggregation were not permitted when activities were carried on in partnership form, the partnership would then be required to specify on each partner's Schedule K-1 the at-risk amount for each activity engaged in by the partnership.

For example, if a partnership invested in 50 separate leasing transactions, it would have to provide a breakdown of the at-risk amounts for each separate leasing transaction on each Schedule K-1 for each partner. The obvious intent of the "flush" language was to save operating partnerships from the unreasonable accounting and administrative burdens of providing such information.

This rationale does not justify the majority's extension of the "flush" language of section 465 (c)(2) to a holding company partnership like Dallas Associates. No conservation of accounting effort is achieved in the instant case by permitting aggregation because each of the second-tier partnerships must, in any event, issue a separate Schedule K-1. Because neither the language nor the obvious intent of section 465 permits aggregation in the case before us, we should not sanction it.

PARKER, J., agrees with this dissent.

WHITAKER, J., dissenting:

I must dissent from the result which the majority reaches in this case since, in my opinion, it has stretched section 465 beyond its permissible limit.

Section 465 (c) says, so far as relevant to the instant case:

(1) TYPES OF ACTIVITIES. — This section applies to any taxpayer engaged in the activity of —

* * * * * * *

(C) leasing any section 1245 property (as defined in section 1245 (a)(3)),

* * * * * * *

(2) SEPARATE ACTIVITIES. — For purposes of this section, a taxpayer's activity with respect to each —

* * * * * * *

(B) section 1245 property which is leased or held for leasing,

* * * * * * *

shall be treated as a separate activity. A partner's interest in a partnership * * * shall be treated as a single activity to the extent that the partnership * * * is engaged in activities described in any subparagraph of this paragraph.

The Senate Finance Committee explains this Code section in part in the following language:

In general, in the case of an activity engaged in by an individual, each motion picture film or video tape, item of leased equipment, farm, or oil and gas property is treated as a separate activity. However, in the case of a partnership or subchapter S corporation, all of the activities in the same category (i.e., all motion picture films and video tapes) are to be treated as one activity. Thus, the loss from the activity for any partner is that partner's loss from the partnership * * *

* * * * * * *

This "at risk" limitation applies to all individual taxpayers who invest in an equipment leasing activity, including both individuals who invest for their own account and those who do so through another entity such as a partnership or a subchapter S corporation. * * *

* * * * * * *

Under the at risk rule as it applies to equipment leasing, the taxpayer is considered to be in a leasing activity if he has an ownership interest, either direct or indirect, in section 1245 property (as defined in sec. 1245 (a)(3)) which is leased or held for leasing. * * *

[S. Rept. 94-938, at 51, 85 (1976), 1976-3 C.B. (Part 3) 89, 123. Fn. ref. omitted.]

It is my opinion that the merging or netting of section 465 activities is only to be permitted within the confines of a single partnership which is actually carrying on the activities, and then only with regard to similar section 465 activities. The difficult issue which the majority happily ignores is whether the aggregation rules under section 465 (c)(2) should apply to the investment partnership so that this netting can be allowed with respect to the losses realized by an investment partnership from its investments in operating partnerships. This issue is not resolved by merely insisting upon recognizing the existence of Dallas, the first-tier partnership, as a partnership. I agree with the majority that Dallas should be recognized as a partnership; I disagree, however, that its losses from its investments in five separate limited partnerships may be netted. To do this is to ignore the separate existence of the five second-tier partnerships.

A slight variation of the facts of the instant case serves better to illustrate the application of section 465 (c)(2). Let us assume that Dallas, the investment partnership, has a limited partnership interest in only two limited partnerships, ICL and ICL 001. Let us further assume that ICL has a single equipment leasing activity but that ICL 001 is engaged in leasing two separate properties. There is nothing in the Code which permits consolidation of the activities of separate partnerships. Thus, the gains and losses from ICL and from ICL 001 cannot be combined at that level, although it is clear that the gains and losses from the two equipment leasing activities carried on by ICL 001 can be amalgamated and are to be treated as a single activity in the hands of each of its partners under section 465 (c)(2). If we further assume that ICL realizes gains and that the amalgamation of the two activities of ICL 001 results in a net loss, Dallas would have a gain from one partnership and a loss from the other.

The majority allows petitioner, as the partner in first-tier Dallas, again to amalgamate its gains and losses from the two second-tier partnerships. In order to do this, one must characterize Dallas as a separate entity rather than an aggregation of its partners. In this respect, the majority and concurring opinion fall into inconsistency.

The majority by implication and the concurring opinion expressly reach their result by applying sections 702 (a)(7) and 702 (b) to maintain in the hands of Dallas the character of the gains and losses realized by the second-tier operating partnerships. Section 702 (a)(7) only applies to preserve the character an item would have in the hands of the operating partnership if by reason of such characterization the item could affect the taxpayer's tax liability. Therefore, to reach the result that items are separately stated for section 702 (a)(7) purposes, the majority and concurring opinion must look through Dallas, the partnership, to find a taxpayer, i.e., petitioner. In effect, Dallas is treated as an aggregation of its partners rather than a separate distinct entity. With this, I agree. This is consistent with section 465 (c)(1), which directs us to look to section 1245 property and then ascertain whether the taxpayer has either a direct or an indirect interest in it. But we must consistently apply the aggregate concept, not only in the characterization of the gains and losses which flow up to petitioner but also in viewing his leasing activities. When we do that, we find that petitioner, one of the aggregate partners that comprise Dallas, must be treated under section 465 (c)(2) as engaged in the activities of five separate partnerships. He merely steps into Dallas' shoes to the extent of his partnership interest. This is consistent with the structure of section 465 because the limitations imposed therein are only applicable to taxpayer-partners in their aggregate capacity. The majority and the concurring opinion, on the other hand, after applying the aggregate concept to the second-tier gains and losses then apply the entity concept so as to place Dallas constructively in the activities of its limited partnerships. In so doing, that part of the legislative history is ignored which directs one to tie the taxpayer indirectly into the section 1245 property, in effect for this purpose to look through Dallas. Therefore, in my judgment, such amalgamation under section 465 (c)(2) is to be permitted only with respect to activities that are engaged in by one of the five separate partnerships and not with respect to gains and losses from activities of the investment partnerships that should be analyzed as an aggregation of its partners. It is judicial legislation for us to add to the statute a concept which is not there either by expressed statutory language or expressed legislative intent and which actually is contrary to the stated purpose of the provisions of section 465.

I would therefore hold that through Dallas as a limited partner in each of the five second-tier partnerships, petitioner to the extent of his partnership interest was engaged in the separate activities of five different partnerships and is not allowed to net the profits and losses received from these five separate partnerships for purposes of determining his distributive share of the gains or losses. It follows that respondent's determination should be sustained.

WILBUR, PARKER, and KÖRNER, JJ., agree with this dissent.