Commissioner Prevails in Imposing Deficiency With Respect to At-Risk Recapture in Roy Zeluck, TC Memo 2012-98
Taxpayer invested $310,000 in an oil and gas partnership in 2001 consisting of cash of $110,000 and a subscription note issued by the taxpayer obligating him to pay $200,000 at the stated maturity date of December 31, 2009. The oil and gas partnership used the taxpayer’s, as well as the other investors’ notes a security on a “turnkey note” it issued to a drilling company. The taxpayer had signed an “assumption agreement” which had the legal effect of making him personally liable on the turnkey note (and security) to the extent of the amounts he was required to pay under the subscription note. For 2001 and 2002, the taxpayer-partner was allocated deductions(losses) of close to $300,000 which reduced his capital account balance from from $310,000 to $32,407. In 2003 the partnership terminated and distributed $32,407 to the taxpayer.
The taxpayer had not made payment of the principal amount on the $200,000 subscription note and failed to meet certain other requirements of the subscription agreement for interest payments. In auditing the taxpayer’s return, the Service issued a notice of deficiency determining that the taxpayer’s liability on the subscription note and assumption agreement became unenforceable in 2003. As a result, the Service contended that the taxpayer must include $200,000 in income for 2003. The taxpayer argued that if no liability existed in 2003, then the taxpayer was not liable on the same indebtedness as "nongenuine" as well when issued in 2001. As a result, since the statute of limitations for 2001 had expired, the Service could not challenge the taxpayer’s 2001 return.
Judge Goeke, in issuing a Memorandum opinion, found for the Commissioner holding: (i) the taxpayer’s liability on the subscription note and related assumption agreement, after reviewing the evidence submitted by both parties at trial, first became “nongenuine” in 2003; (ii) the taxpayer must recognize a $200,000 gain for 2003 under §465(e), at-risk recapture; and (iii) the taxpayer was liable for an accuracy related penalty of 20% under §6662.
Factor reflected by the case law to determine whether a genuine debt exists includes: (i) whether the promise to repay is in writing; (ii) whether interest is charged (and paid); (iii) whether a fixed schedule of payments is required (and paid); (iv) the presence of collateral to secure repayment; (v) whether the borrower had the ability to repay the debt; and (vi) whether the “lender” expected repayment to corroborate that the debt was real.
Section 465(e) provides for the recapture of losses where a taxpayer’s amount at risk in an activity is less than zero at the close of any taxable year by distributions, changes in the status of a debt from recourse to nonrecourse, or as in this case, “nongenuine”, or other similar arrangement which reduces the taxpayer’s risk of loss. In such event §465(e)(1)(A) requires the taxpayer to include in gross income from the at-risk activity an amount equal to such negative at-risk amount. The amount recaptured, however, is limited to the excess of the losses previously allowed in the subject activity over any amounts previously recaptured. The negative-at-risk amount added to income may later be treated as a deduction allocable to the activity in the first succeeding year if and to the extent that the taxpayer's at-risk amount is increased.
