Commissioner v. Tufts

Facts

In 1970, a builder named Clark Pelt formed a partnership with the intent of constructing a 120-unit apartment complex. The partnership subsequently entered into a nonrecourse mortgage loan agreement with Farm & Home Savings Association (F & H) for a $1.85m loan for the complex. The partnership executed a note and a deed of trust in favor of F & H in return. Later on, four friends and relatives joined Mr. Pelt’s partnership but did not make any capital contributions until the completion of the apartment complex. In 1972, the partners ended up selling their interests to a third-party, Fred Bayles, for which he paid each partner up to $250. Bayles also assumed the $1.85m nonrecourse mortgage for the property. Prior to selling, the partnership had an adjusted basis of $1,455,740 in the property. Each of the former members reported a partnership loss of $55,740 on their federal income tax return, the difference between the partnership’s adjusted basis of $1,455,740 and the property’s fair market value of $1,400,000. The Commissioner of Internal Revenue objected to this accounting and asserted a deficiency on the theory that the partnership had realized the the full amount of the nonrecourse mortgage, meaning the partnership realized a gain of roughly $400,000 (the difference between the $1.85m mortgage and the 1.45m in adjusted basis).