On May 26, 2020, the Tax Court issued a Memorandum Opinion in the case of Gluck v. Commissioner (T.C. Memo. 2020-65). The issues before the court in Gluck v. Commissioner were (1) whether the Tax Court had jurisdiction to redetermine a deficiency based upon an adjustment disallowing like-kind exchange treatment, which was a “computational adjustment” within the meaning of IRC § 6231(a)(6); and (2) whether the Tax Court nevertheless had jurisdiction to redetermine the penalty resulting from the “computational adjustment.”
Background to Gluck v. Commissioner
The tale of Larry Gluck’s real estate boondoggle is a cautionary one. The record does not reflect, nor does the court insinuate, that Gluck was trying to do anything untoward when he attempted (and completely overcomplicated) an IRC § 1031 exchange of his $10.2m gain on a New York condo by purchasing a share in the replacement property not outright, but through the acquisition of an interest in the partnership that owned the building (G&P).
There are literally thousands of buildings in New York owned outright by little old ladies who would have been more than willing to sell to Larry for $10.2m and an agreement to come over for dinner once an a while, but Larry had his heart set on this building, and if that meant acquiring a partnership interest to effectuate his like-kind exchange deferral of gain, then, dagnabbit, that’s what he was going to do.
The Partnership Interest Exception
The IRS selected Gluck’s 2012 return for examination and issued a timely notice of deficiency that disallowed the deferral of gain under IRC § 1031 and determined an accuracy-related penalty. Unbeknownst to Larry, a partnership interest is not an eligible “replacement property” under IRC § 1031, and, as such, the like-kind exchange treatment does not apply to the exchange of interests in a partnership. See IRC § 1031(a)(2)(D).
Deficiency Jurisdiction Under TEFRA
The partnership that Gluck bought (or tried to exchange) into was subject to TEFRA audit procedures, as it did not qualify as a “small partnership” due to one or more of its partners being a disregarded entity, a partnership, a trust, an S corporation, an estate, or a nominee or similar person. IRC § 6231(a)(1)(B). Gluck argued that G&P, and, therefore Gluck (through his LLC, Gluck, LLC) could not be a partner, nor could TEFRA apply in the first place. Reasonable arguments, but ultimately unavailing, as we’ll see.
Although the Tax Court normally has jurisdiction to redetermine a deficiency if a taxpayer receives a notice of deficiency and timely petitions this Court, IRC § 6213(a); IRC § 6214(a), the Code restricts deficiency jurisdiction where a TEFRA partnership is concerned. See, e.g., IRC § 6230(a)(1). Thus, deficiency proceedings do not apply to the assessment or collection of any “computational adjustment” made with respect to a partner in a TEFRA partnership. Id.
Computational Adjustment to Affected Item
It just so happens that the IRS’s argument in support of its motion for summary judgment in Gluck was that the adjustment to Gluck’s tax liability (attributable to disallowance of like-kind exchange treatment) was a “computational adjustment,” which is defined as the change in the tax liability of a partner which properly reflects the treatment under TEFRA of a “partnership item.” IRC § 6231(a)(6). A partnership item, in turn, is an item that is “more appropriately determined at the partnership level than at the partner level.” IRC § 6231(a)(3); see Blonien v. Commissioner, 118 T.C. 541, 551 (2002), supplemented by T.C. Memo. 2003-308.
Whether a person is a partner in a partnership is generally a “partnership item.” See Blonien, 118 T.C. at 551-52 (holding that this Court has no jurisdiction to consider, in a deficiency case, a taxpayer’s argument that he was not a partner in a partnership). Indeed, the very existence of a valid partnership is, itself, a “partnership item.” Tigers Eye Trading, LLC v. Commissioner, 138 T.C. 67, 98-99 (2012), aff’d in part, rev’d in part, 616 F. App’x 426 (D.C. Cir. 2015).
The proper treatment of “partnership items” (and penalties relating to adjustments to partnership items) is determined in a partnership-level TEFRA proceeding. See IRC § 6221; Malone v. Commissioner, 148 T.C. 372, 375 (2017). With respect to “affected items,” which is to say, items personal to the taxpayer/partner that require “partner-level” determinations, such affected items are determined in deficiency proceedings involving the individual partners. See IRC § 6230(a)(2)(A)(i); Treas. Reg. § 301.6231(a)(6)-1(a)(3).
There is, however, one critical exception to the necessity of a partner-level TEFRA determination. If an adjustment to an affected item is merely computational and can be made without making additional partner-level determinations, the IRS can directly assess the tax due without having to follow the usual deficiency procedures. Malone, 148 T.C. at 375-76; Treas. Reg. § 301.6231(a)(6)-1(a)(2).
G&P’s Ownership vel non of the Building
Gluck’s primary argument is that he did not exchange his interest in the IRC § 1031 exchange for a partnership interest, because G&P was not a valid partnership and/or G&P did not own the building. The Tax Court held that the validity of G&P as a partnership and the question of whether G&P owned the building were both “partnership items,” because, for TEFRA purposes, the term “partnership item” encompasses all legal and factual determinations underlying the determination of the partnership’s income, credit, gain, loss, deduction, etc. See Treas. Reg. § 301.6231(a)(3)-1(b).
Thus, unless G&P owned the building, it was not the proper party to report rents as income, and unless G&P owned the building, it was not entitled to claim depreciation deductions (and other expense deductions). Thus, whether or not G&P owned the building involves legal and factual determinations that underlie the determination of G&P’s items of income and deduction. “G&P’s ownership vel non of the building” is, thus, a “partnership item” that must be determined in a partnership-level TEFRA proceeding.
But There was no Partnership Level Proceeding
The Tax Court notes that the IRS did not initiate a partnership level proceeding involving G&P, but it did examine Gluck’s return for 2012. G&P provided Gluck, LLC with a Schedule K-1 and filed a Form 1065 (Partnership Return) reporting Gluck, LLC’s ownership interest in and income from G&P. However, when Gluck claimed like-kind exchange treatment on his 2012 Form 1040, Gluck adopted the position that Gluck, LLC had acquired a direct ownership interest in the apartment building and the land beneath it, not a partnership interest as reported by G&P. Gluck’s position, therefore, is inconsistent with G&P’s position.
Each partner in a TEFRA partnership must treat partnership items consistently with the treatment of such partnership item on the partnership return. IRC § 6222(a). If a partner fails to do this, he must provide the IRS with notice “identifying the inconsistency.” IRC § 6222(b)(1)(B); Samueli v. Commissioner, 132 T.C. 336, 340 (2009); Treas. Reg. § 301.6222(b)-1(a). Gluck, however, did not identify such inconsistency by submitting a Form 8082 (Inconsistent Partnership Item) or otherwise notify the IRS that Gluck was adopting a return position inconsistent with the information that G&P furnished them on Schedule K-1.
The Dread “Computational Adjustment” Rears Its Head
If a partner adopts an inconsistent position on his return, a computational adjustment may be made before a TEFRA proceeding concludes – or in this case, even without a TEFRA proceeding. IRC § 6222(c). Because Gluck LLC’s interest in G&P was a partnership item, the IRS’ disallowance of deferral under IRC § 1031 was a change in Gluck’s tax liability that properly reflected G&P’s treatment of a partnership item. Much to Gluck’s dismay, this is the very definition of a “computational adjustment.” See IRC § 6231(a)(6). But there are exceptions to this rule, Gluck proclaimed.
The decision of whether IRC § 1031 treatment was available to him did not require a factual determination at the partner-level. If he was a partner (a partnership-level determination) then he was not entitled to IRC § 1031 deferral, end of analysis. Thus, the Tax Court determined that the IRS was correct in asserting that the adjustment was computational in nature at the partnership-level, and therefore deficiency procedures didn’t apply. Therefore, the court lacked jurisdiction to redetermine the deficiency on IRC § 1031 entitlement grounds.
A Brief Word on Penalties
Deficiency procedures do not apply to “penalties, additions to tax, and additional amounts that relate to adjustments to partnership items.” IRC § 6230(a)(2)(A)(i). Accuracy related penalties determined under IRC § 6662(a), however, are non-partnership items. See Malone, 148 T.C. at 378. Therefore, the Tax Court possessed jurisdiction regarding the penalty issue.Add to favorites