The respondent determined a deficiency of $3,733.86 against the petitioner for the calendar year 1947, on the ground that petitioner's loss on the liquidation of a partnership of which he was a member was not an ordinary loss but was a loss from the sale or exchange of a capital asset within the meaning of section 117, Internal Revenue Code of 1939. Subsequently, by leave of the Court, the respondent amended his answer to claim an increased deficiency of $4,419.90. The basis for the increase was the respondent's allegation that the sale of assets by the partnership to a corporation and the later liquidation of the partnership were not separate transactions but were steps in a single transaction by which the petitioner sold his partnership interest to a corporation controlled by himself, so that any loss sustained by him was not deductible as provided in section 24 (b) (1) (B).
FINDINGS OF FACT.
The facts are as stipulated by the parties, and the stipulation and its accompanying exhibits are incorporated herein by this reference.
Fritz Busche, the petitioner, was a resident of Mobile, Alabama, during the taxable year 1947 and filed his income tax return for that year with the collector of internal revenue for the district of Alabama.
The petitioner was a member of the partnership, Melba Creamery, from its formation on August 1, 1944, until its dissolution on or about March 31, 1947. The partnership was engaged in the processing and sale of dairy products in the Mobile area. Its income tax returns were filed on the basis of a fiscal year ending on March 31.
On April 1, 1946, the beginning of the partnership fiscal year, the membership of the partnership, the original capital of the partners, and the percentages of their interests in the partnership were as follows:
Percentage Original Name of partner of interest capital Fritz Busche ............................. 58 1/3 $28,000 F. E. McCray ............................. 16 2/3 8,000 J. Henry Von Sprecken .................... 25 12,000 At that time the basis of the petitioner's partnership interest was the same as its book value.
On December 1, 1946, the petitioner sold a 16 2/3 per cent interest in the total capital of the partnership to F. E. McCray. On January 10, 1947, McCray sold his entire 33 1/3 per cent interest in the partnership to the petitioner and to Von Sprecken. The petitioner thereby acquired an additional 29.626 per cent of the total capital interest of the partnership, for which he paid $40,000. This amount was $16,653.86 in excess of the book value of the interest.
In March 1947 all of the assets of the partnership with the exception of its bank account were transferred to Melba Creamery, Inc., an Alabama corporation. The books of the corporation show that it issued the following checks in payment for the assets of the partnership:
1947
March 29 ........................................ $15,000.00 March 29 ........................................ 3,000.00 March 31 ........................................ 42,554.69 March 31 ........................................ 5,238.58 March 31 ........................................ 18,545.17 ---------- $84,338.44
The total liabilities assumed by the corporation, as reflected in its journal, amounted to $38,963.55; those liabilities not assumed by the corporation were paid by the partnership. The partnership's real estate was transferred by deed, and the other assets were transferred by oral agreement and delivery.
On its return for the fiscal year ended March 31, 1947, the partnership reported total sales of depreciable and nondepreciable capital assets in the amount of $92,900.25; a total net profit thereon of $18,024.68, of which $16,953.10 represented profit derived from the sale of assets to the corporation; and a recognizable long-term capital gain of $9,012.34, distributable to the partners as follows:
Fritz Busche ................................. $6,425.17 J. H. Von Sprecken ........................... 2,587.17
The partnership, Melba Creamery, was for all purposes a continuing entity throughout its fiscal year ended March 31, 1947, and its basis in its assets for income tax purposes was not affected by the changes in partnership interests. The bases of the assets transferred to the corporation were the same as the amounts paid therefore with the exception of the following: Capital gain Description Basis to Amounts (or loss) partnership paid by reported by corporation partnership Furniture and fixtures, plant machinery and equipment $44,767.92 $44,000 ($767.92) Truck and delivery equipment 9,677.25 9,400 (277.35) Land ........................ 1,638.00 5,000 3,362.00 Buildings ................... 15,114.54 30,000 14,885.46 Investment real estate ...... 3,249.09 3,000 (249.09) All of the above assets had been held by the partnership for more than 6 months.
The shares of stock of Melba Creamery, Inc., were subscribed to as follows:
Shares
Fritz Busche .................................. 300 August Busche ................................. 100 Frank Von Sprecken ............................ 200 J. H. Von Sprecken ............................ 200 ---- Total ................................... 800
Its shares were issued on April 1, 1947, as follows:
Shares
Fritz Busche ..................................... 200 Olga S. Busche ................................... 100 Frank Von Sprecken ............................... 100 Lucy L. Von Sprecken ............................. 100 May C. Von Sprecken .............................. 100 J. H. Von Sprecken ............................... 100 August Busche .................................... 100 ---- Total ........................................ 800
Of the foregoing, Olga S. Busche and August Busche were the wife and brother of petitioner. Lucy L. Von Sprecken and Frank Von Sprecken were the wife and brother of J. H. Von Sprecken; and May C. Von Sprecken was the wife of Frank Von Sprecken.
The capital stock of the corporation was paid for by the issuance of two checks from the partnership bank account. The first of these was dated March 29, 1947, and was for $20,000, of which $15,000 was charged against the partnership capital account of petitioner and $5,000 against that of Von Sprecken. A second check was issued on March 31, 1947, and was in the amount of $60,000 of which $45,000 was charged against petitioner's capital account and $15,000 against Von Sprecken's capital account. Of the payment made by the petitioner $10,000 was advanced for the account of August Busche, as a loan, to pay for the latter's stock; $19,000 was advanced by petitioner for the account of Frank and May Von Sprecken, as a loan, to pay for their stock; $10,000 of the amount paid by the petitioner was for the stock issued to Olga S. Busche; and $20,000 was in payment for the stock issued to himself. Von Sprecken paid $20,000 for the shares of capital stock issued to himself and his wife.
After these two checks in payment for the stock of the corporation had been charged against the partners' capital accounts, two checks were issued by the partnership on April 1, 1947, payable to the partners as follows: $1,000 to Fritz Busche and $3,368.71 to J. H. Von Sprecken. Upon the issuance and satisfaction of these checks the partnership, Melba Creamery, had no further assets and had been completely liquidated and dissolved. There was an error in computation of amounts, however, resulting in an overpayment to petitioner of $532.67. This amount was refunded by petitioner, so that the total of the amounts charged against his capital account and received by him was $60,467.33.
In his income tax return for 1947 the petitioner reported $6,425.17 as his distributable share of the capital gain from the sale of partnership assets and a loss on dissolution of the partnership, determined as follows:
Basis of partnership interest ................... $77,121.19 Received in liquidation ......................... 60,467.33 ----------- Loss on liquidation ............................. $16,653.86
This loss is attributable to the difference between the $40,000 petitioner paid for McCray's interest in the partnership and the book value of this interest, $23,346.14.
In accordance with the stipulation of the parties, in the event it is found that there was a sale of assets by the partnership to the corporation and that such sale was a real bona fide transaction, the adjusted basis of petitioner's interest in the partnership for the purpose of computing gain or loss upon liquidation, sale, or other disposition of such interest, whichever is found to have taken place, is $77,121.19.
OPINION.
TIETJENS, Judge:
In his notice of deficiency the respondent considered the petitioner's loss on dissolution of the partnership a loss from the sale or exchange of a capital asset and not an ordinary loss as claimed by the petitioner on his return. Later, in an amendment to his answer, the respondent alleged that the sale of assets and dissolution of the partnership were one transaction whereby the petitioner sold his interest in the partnership to a corporation in which he owned, directly or indirectly, more than 50 per cent in value of the outstanding stock, so that deduction of any losses sustained by the petitioner is prohibited by section 24 (b) (1) (B), Internal Revenue Code of 1939. On the issue raised by amendment to his answer the respondent has the burden of proof.
SEC. 24. ITEMS NOT DEDUCTIBLE.
(b) LOSSES FROM SALES OR EXCHANGES OF PROPERTY. —
(1) LOSSES DISALLOWED. — In computing net income no deduction shall in any case be allowed in respect of losses from sales or exchanges of property, directly or indirectly —
* * * * * * *
(B) Except in the case of distributions in liquidation, between an individual and a corporation more than 50 per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;
* * * * * * *
(2) STOCK OWNERSHIP, FAMILY, AND PARTNERSHIP RULE. — For the purposes of determining, in applying paragraph (1), the ownership of stock —
* * * * * * *
(B) An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family;
(C) An individual owning (otherwise than by the application of subparagraph (B)) any stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner;
(D) The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants; and
* * * * * * *
If we telescope the various transactions set out in the stipulated facts it is our view that we start out with a partnership business and end up with the same business in the hands of a corporation with the petitioner, who was a former partner, owning, directly or indirectly, more than 50 per cent in value of the outstanding stock. We think this is a proper case for the application of section 24 (b) (1) (B).
Insofar as it relates to this case, that section prohibits the deduction of any losses from the sale or exchange of property, directly or indirectly, between an individual and a corporation where the individual owns, directly or indirectly, more than 50 per cent in value of the outstanding stock of the corporation. Part (b) (2) of this section sets forth the rules for determining stock ownership.
This section, in less comprehensive form, was first enacted in the Revenue Act of 1934 (sec. 24 (a) (6)), 48 Stat. 691, to put a stop to the practice of creating losses through transactions between members of a family and corporations controlled by them, where there was no actual realization of loss. It was brought to its present form by section 301 (b) of the Revenue Act of 1937, 50 Stat. 827, which enlarged the classes of transactions covered by the statute's prohibition and added to the rules for determining stock ownership. In the House debate on this section of the 1937 Act, Chairman Doughton of the House Ways and Means Committee explained its purpose as follows:
The evidence submitted to the joint committee disclosed that a considerable loss of revenue was resulting from the artificial taking and establishment of losses where property was shuffled back and forth between various legal entities owned by the same persons or person. These transactions seem to occur at moments remarkably opportune to the real party in interest in reducing his tax liability but, at the same time allowing him to keep substantial control of the assets being traded or exchanged. [81 Cong. Rec. 9019 (1937).]
The petitioner concedes that the minor losses on the sale of partnership assets to the corporation are not allowable because of the prohibition of section 24 (b) (1) (B). He maintains that this sale was made by the partnership entity, and that he realized an ordinary loss when the partnership was dissolved and its assets (consisting of cash) were distributed to the partners. The measure of his claimed loss is the basis of his interest in the partnership less the cash received by him on distribution. This difference is attributable to the amount in excess of the book value paid by petitioner for F. E. McCray's interest.
We are unable to agree that in applying section 24 the sale must be considered as made by the partnership entity, as distinguished from the individual partners. For some purposes of Federal tax law a partnership is regarded as an entity distinct from its members; its methods and periods of accounting may differ from those of its members; it is required to compute its income as a unit and to file an income tax return, though merely for informational purposes. Secs. 183, 187, and 188, I. R. C., 1939. But basically the partnership is treated as an aggregate of individuals who are co-owners of partnership property and to whom, in proportionate shares, the income of the partnership is taxed. Commissioner v. Whitney, (C. A. 2, 1948) 169 F.2d 562, certiorari denied 335 U.S. 892 (1948). This aggregate treatment of the partnership has been applied particularly in determining the effects taxwise of transactions between partnerships and corporations controlled by the partners, where it is sought to interpose the partnership entity between the individual partners and the corporation. See, for example, Commissioner v. Whitney, supra; Randolph Products Co. v. Manning, (C. A. 3, 1949) 176 F.2d 190; Western Transmission Corporation, 18 T.C. 818 (1952); Walnut Street Co. v. Glenn, (W. D., Ky., 1948) 83 F. Supp. 945. Thus, in keeping with the purpose of section 24 and the treatment generally accorded partnerships for purposes of Federal taxation, we consider the sale of partnership assets to have been made by the individual partners and not by the partnership entity. Commissioner v. Whitney, supra. This means that petitioner's losses on the sale transaction are not allowable, since in accordance with section 24 (b) (2) he is charged with owning the stock of his wife, brother, and his partner, which is over 50 per cent in value of the outstanding stock of the corporation.
We do not agree with the petitioner's argument that his loss was incurred not on the sale but on the dissolution of the partnership following the separate sale of its assets to the corporation. We have already held that in applying section 24 (b) (1) (B) the sale is to be considered as made by the individual partners, and that the deduction by the partners of any losses on the sale is prohibited. In our view this holding characterizes the entire transaction as simply a sale of partnership assets. There was only one transaction; not two. And even though it were conceded that the sale of the business by the partnership and the termination and liquidation of the partnership are to be treated as separable transactions for the purposes of this case, we do not see how that would help petitioner. As pointed out by the Second Circuit in Commissioner v. Whitney, supra:
Since the whole basis of the refusal of the deduction under § 24 (b) (1) (B) is that the transfer is not such a change of economic interest as to be considered executed or closed to the point of realization of loss to the former owner, there is nothing which would change the prohibition by the added fact, obviously a usual one in the situation, of termination of the partnership. There can be little reason for a transfer in substantial amount of firm assets to a corporation except the substitution of the corporate way of doing business for the former partnership one; and the prohibition of § 24 (b) (1) (B), unless it is to be meaningless, must be held to apply then equally or especially. * * * [Emphasis supplied.]
To hold otherwise and to permit the petitioner by the use of the partnership entity to embellish an essentially simple transaction by cutting it up into separate transactions would be directly contrary to the statutory prohibition.
Reviewed by the Court.
Decision will be entered for the respondent.