Judge David Gustafson allows the kicker (profit on disposition; IRS didn’t challenge the net cashflow kicker) in Alexander Deitch, T. C. Memo. 2022-86, filed 8/25/22. For the backstory on Alex and his partner, see my blogpost “TEFRA Kicks the Kicker,” 8/25/21 (no, that’s no typo; it’s the anniversary).

Judge Gustafson takes a comprehensive look at the financing Alex got for the project, a turnkey  shopping center and outpatient facility for a hospital. Praise be, a GA real estate deal that isn’t a boondockery.

The lender, a life insurance company, wanted an above-marked fixed interest rate, plus the net cashflow and sale kickers as additional interest, and papered the deal accordingly. And of course the loan documentation provided that there was no partnership, co-venture, joint tenancy, or anything else between lender and borrower. And no sharing of losses.

IRS and Alex stiped that the lender had no relationship with or interest in any of petitioners’ entities, there was a real debt (!), and that this was an arms’-length deal.

Again, stipulate, don’t capitulate.

IRS challenges only the sale kicker as nondeductible. Alex had always treated the cashflow kicker as interest every year, but treated the sale kicker as a separate interest item on the Form 8825 for year of sale. IRS agreed post-trial that if the sales kicker was an equity distribution, Alex would not have the capital gain on the sale, the lender would.

TEFRA, which figured in my blogpost above-cited, is off the table, as this is a small partnership. Alex and his partner are individuals. But if, as IRS contends, there’s a partnership between the lender and the LLC, then small partnership doesn’t apply, the existence of a partnership is a partnership item that can’t be decided in a deficiency proceeding, there never was a FPAA, so no jurisdiction.

But Tax Court can always determine its own jurisdiction. So Judge Gustafson looks to see if there was a partnership or a debtor-creditor relationship. If the latter, jurisdiction and Alex wins; if the former, no jurisdiction, pay the tax and sue for a refund.

The parties acted as lender and borrower. The lender only advanced what the loan documents required. Alex ran the property. True, the project was very thinly capitalized; the loan proceeds were entirely expended on buying and fixing up the property. Alex had essentially no cash in the deal. Judge Gustafson brushes that off. “But while it is true that the operation of the Rome property was capitalized almost exclusively with debt, we cannot view this factor in a vacuum. The parties stipulated that the loan from [lender] to [Alex] was genuine indebtedness, and we do not disregard that stipulation to consider whether inadequate capitalization might be a sign of equity rather than debt.” T. C. Memo. 2022-86, at p. 34.

The parties never operated in joint name, Alex kept the books but the lender’s only involvement was making sure it got the cashflow kicker. Each party filed separate tax returns. The loan terms gave lender no more control than any commercial lender would get in like. circumstances.

IRS tries Section 707(c) guaranteed payments by a partnership to cover the sales kicker, but that founders on the stipulation. If the debt is real, game over.

And the sales kicker is interest, and deductible per Section 163(c).

A Taishoff “Good Job” goes to the Chamberlain Hrdlicka team.

Takeaway- It’s not only petitioners who stipulate their case away.