Citron v. Commissioner

B. PHILIP CITRON AND EMILY K. CITRON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 626-88

United States Tax Court

97 T.C. 200; 1991 U.S. Tax Ct. LEXIS 71; 97 T.C. No. 12;

August 5, 1991, Filed

*71 Decision will be entered under Rule 155.

P borrowed $ 60,000 and, along with three other limited partners, invested in a partnership (V) in order to produce a motion picture. The general partner was a corporation (C). The motion picture was made by use of the capital invested by the limited partners and no debt was incurred by V. Upon completion, the negative came into the possession of the executive producer (an unrelated third party which had certain rights in it). Controversy arose over possession of the negative, and V was unable to obtain the negative. V had a copy of the film (from which only poor quality copies could be made) and C decided to make an X-rated film from the copy. P and the other limited partners decided, at the end of 1981, not to advance any additional capital, not to become involved in the production of an X-rated movie, and to dissolve V. At the close of business 1981, V had no liabilities, had made no profit, and was not in possession of the negative. P did not expect to and did not receive any distributions from V and it was clear to all involved that P was to have nothing further to do with V. P asserts he is entitled to an ordinary loss equal *72 to his capital investment in V and contends it was from theft or embezzlement or from abandonment. R argues alternatively that if a loss occurred, it was from a sale or exchange and should be characterized as capital and limited to $ 3,000 for 1981. Held: P did not have a loss from theft or embezzlement. Held further: P was entitled to an ordinary loss because no sale or exchange occurred in connection with his abandonment of the partnership interest. Held further: The amount of P's basis and loss determined.

Mortimer L. Laski, Kenneth G. Gordon, and Murray H. Falk, for the petitioners.

James S. Yan, for the respondent.

GERBER, Judge. CHABOT, KORNER, SHIELDS, WRIGHT, PARR, WELLS, RUWE, COLVIN, HALPERN, and BEGHE, JJ., agree with the majority opinion. NIMS, C.J., concurs in the result only. HAMBLEN, J., did not participate in the consideration of this opinion. SWIFT, J., dissenting. PARKER, COHEN, JACOBS, and WHALEN, JJ., agree with this dissent.

GERBER

*201 Respondent, in a statutory notice of deficiency, determined a $ 34,089 Federal income tax deficiency and a $ 1,704.45 addition to tax under section 6653(a)(1)¹ for petitioners' *73 1981 taxable year. Respondent also determined an additional 50 percent of the interest due on the $ 34,089 deficiency under section 6653(a)(2) for the 1981 taxable year. The entire deficiency is attributable to the disallowance of a loss claimed by petitioners in connection with the Vandom Productions partnership. The primary issue for our consideration is whether petitioners are entitled to a loss either due to a theft or embezzlement or, in the alternative, due to abandonment. If petitioners are entitled to a loss, secondary issues involve the amount of the loss and whether it should be characterized as capital or ordinary.

FINDINGS OF FACT

The parties' stipulation of facts and attached exhibits are incorporated by this reference. Petitioners, who at all pertinent times were *74 husband and wife, had their legal residence at 1490 Kenmore Road, Pasadena, California, at the time the petition was filed in this case. They filed a joint Federal income tax return for the 1981 taxable year. Petitioner B. Philip Citron ("petitioner" when used in the singular shall refer to B. Philip Citron) is a physician specializing in gastroenterology. He is the head of the Gastroenterology Department at Glendale Adventist Medical Center which is part of the Glendale Adventist Church. Emily Citron, a physician and the head of the Pediatric Chest Disease Department at Lake County Hospital, had no *202 involvement in petitioner's investment in the Vandom Productions partnership (Vandom).

Petitioner became a limited partner in Vandom, a California limited partnership, on September 26, 1980, by the cash investment of $ 60,000. In addition to petitioner, at all times pertinent herein, there were three additional limited partners in Vandom, two of whom had also invested $ 60,000 in cash and one of whom had invested $ 90,000 in cash. Each of the four limited partners was entitled to a 10-percent share in the profits of Vandom. The general partner was entitled to any profits in excess*75 of the combined 40-percent share of the limited partners. Each limited partner who invested $ 60,000 was entitled to 22.2 percent of losses and ownership of Vandom's capital. The limited partner who invested $ 90,000 was entitled to 33 percent of losses and ownership of Vandom's capital. Petitioner obtained the $ 60,000 by means of a loan from Crocker National Bank. Petitioners claimed a $ 12,213 interest deduction on their 1981 income tax return concerning the $ 60,000 loan from Crocker National Bank. No promissory notes or obligations were assumed by or for Vandom by the limited partners. No funds necessary for Vandom's operation were borrowed. Instead, Vandom's operation was funded by the capital contributions of the four partners.

The general partner of Vandom was Vandom, Inc. Robert Burge (Burge) was president of Vandom, Inc. Burge was a motion picture producer and director at the time Vandom was formed. At the time of trial, he had made four motion pictures and about 100 television commercials and was working on a movie entitled "Keaton's Cops," starring Lee Majors, Abe Vigoda, and Don Rickles. Burge was also the president of Vandom Pictures, Inc., a Texas corporation, *76 which eventually acquired the assets of Vandom, Inc. Vandom Pictures, Inc., was in the business of producing and distributing motion pictures.

The purpose of Vandom was to produce a motion picture to be named "Girls of Company C," also known as "The Girls of Charley Company." Burge wrote and developed the script for the motion picture in February 1980. The filming was completed in September 1980 and was the only movie made or activity conducted by Vandom. The completed *203 movie film is referred to in the industry as the "negative." Upon the completion of Vandom's activity concerning the negative, it was in the possession of Pacific Film Lab, a company in which neither Vandom nor Vandom, Inc., had an interest. In May 1981 Burge asked Pacific Film Lab for the negative for purposes of cutting and editing.

Joe Bardo (Bardo), doing business through a corporation known as "Millionaire Productions" (Millionaire), was an executive producer of the movie. Bardo was responsible for supplying the "below-line" services, which includes all services other than those provided by actors, producers, and directors (which are the "above-line" services). The above-line costs came out to about $ 47,000*77 and the below-line costs came out to about $ 153,000. Vandom, Inc., paid $ 140,000 on behalf of Millionaire for the below-line costs. Vandom incurred expenses of $ 249,167.80 for the production of the movie during 1980. Vandom's 1981 partnership return reflected $ 24,392 in accounts receivable as of the beginning of 1981. Bardo was also the subdistributor and videotape distributor of the movie. After the negative was delivered to Bardo, Burge made several requests for its return, which Bardo did not heed. Burge also had prior dealings with Bardo involving two other movies, and Burge believed that Bardo had improperly sold foreign rights to those movies and had not remitted money owed to Burge or his related entities.

At the time of Bardo's refusal to return the negative, Vandom retained a work print of the movie (a copy of the negative), which cannot be used to generally and commercially reproduce and release the type of movie Vandom was attempting to make. Burge advised the Vandom limited partners of Bardo's refusal and told them that the movie could not be made without the negative. Subsequently, Burge met three times with the limited partners between July and the end of*78 December 1981. At the third meeting Burge explained that his attorneys' efforts to obtain the negative had been unsuccessful and that Bardo would not answer Burge's telephone calls. The limited partners were *204 advised that an expensive ² and lengthy lawsuit would have to be brought against Bardo to recover the negative. Burge also advised the limited partners that with additional investment 2 an X-rated version of the movie could be made from the work print which might allow the recovery of a portion of the investment in Vandom.

Petitioner had no expertise in the movie industry and relied upon Burge's statements. The limited partners had no contractual requirement to advance additional money beyond their $ 60,000 investments. Petitioner and the other three limited partners decided that they did not want to advance additional money or participate*79 in the conversion of the work print to an X-rated film. Petitioner believed that it could damage his professional reputation and jeopardize his position with Glendale Adventist Medical Center, where he was the only "non-Adventist" on the staff of an Adventist Church affiliated hospital. At that same third meeting during December 1981, petitioner advised Burge that he did not wish to advance more money or participate in any of the proposed future activities of Vandom. At that meeting the limited partners voted to dissolve Vandom. There was no written agreement reflecting the dissolution or evidence indicating that documentation of the dissolution had been filed with the California Secretary of State. Thereafter, Burge instructed the certified public accountant to prepare a final tax return for Vandom because there would be no further activity for the partnership and that there should be a complete write-off of the investment. The accountant inquired whether there would be future income and Burge advised that there would be no income from the film. The accountant prepared the partnership return reporting a $ 270,000 loss.

The Balance Sheet (Schedule L) attached to Vandom's 1981*80 partnership return reflected the following amounts as of January 1, 1981:

Assets
Accounts Receivable	$ 24,392.20
Production Costs	245,607.80
Deferred Distribution Costs & Expenses	3,560.00
Total Assets	$ 273,560.00
Liabilities & Capital
Accounts Payable	$ 3,560.00
Capital	270,000.00
Total Liabilities & Capital	$ 273,560.00

*205 No assets, liabilities, or capital were reflected as of December 31, 1981, on Vandom's 1981 Schedule L attached to its partnership return. Per Vandom's certified public accountant, Vandom had no liabilities at the end of the 1981 year. Vandom's 1981 return reflected only $ 3,560 of accounts payable as of the beginning of the taxable year, with an offsetting asset in the form of a deferred expense. No liabilities were reflected in connection with the limited partners' relationship with Vandom.

Under the terms of the partnership agreement, the general partner was to pay, from profits, the interest on the limited partners' loans. Vandom did not have any "profits" from inception through December 31, 1981. The partnership agreement provided that any interest payments "from profits shall become an account receivable ³ and *81 be repaid from future profits prior to distribution of profits as set forth in Article IX - DISTRIBUTION OF PROFITS." Article IX provided for the distribution of profits as between limited and general partners and for the use of profits to return capital to the limited partners. Under the partnership agreement, the limited partners were not liable to repay any interest payments, and in any event, repayment was conditional upon the existence of profits. Vandom had made at least one payment to petitioner in connection with the limited partners' loans from Crocker National Bank, but the record does not reflect the specific amount of such payment. In the early part of petitioner's repayment of his Crocker National Bank loan, the interest portion approximated $ 3,000. The "accounts receivable" balance of $ 24,392 at the beginning of 1981 may have represented payments of interest regarding the limited partners. If it did represent interest payments regarding each limited partner, then *206 $ 6,000 of interest would have been paid or reimbursed concerning petitioner. Petitioner's initial basis in his partnership interest was $ 60,000. Petitioner's adjusted basis in his limited partnership*82 interest as of December 31, 1981, was $ 54,000.

At the end of 1981 petitioner did not expect to receive anything back from the Vandom Limited partnership interest. The Vandom partnership agreement, article XIV(b), provides that the partnership shall pay the value of a limited partner's interest within three months after termination of his interest. Petitioner did not receive any amount under article XIV(b).

The accountant prepared a Schedule K-1 for each of the limited partners' 1981 taxable year. Petitioner's Schedule K-1 reflected a loss of $ 60,000 and he *83 claimed a $ 60,014 loss on Schedule E of his 1981 income tax return. Per the accountant, no financial transaction occurred for Vandom after December 31, 1981. On December 31, 1981, a copyright was filed for the movie at the United States Copyright Office. After that time, petitioner did not have any business contact with Burge for the purpose of further discussion concerning Vandom. After Vandom ceased operating, Vandom, Inc., acquired possession of the working print and made an X-rated version of the movie entitled "Foxholes" and on April 9, 1982, also filed a lawsuit against Bardo. The lawsuit concerned whether Millionaire had been awarded the sole worldwide distribution rights to three movies, including the one in issue here. On June 3, 1982, Vandom, Inc., transferred by contract the distribution rights to the movie to Citrus Productions, Inc., an apparently unrelated entity. On September 15, 1983, a California State court ordered Millionaire to turn over a negative of the movie, but also permitted Millionaire to retain a duplicate original (negative) for purposes of distribution. Respondent disallowed the entire $ 60,014 loss claimed by petitioners.

OPINION

Petitioners*84 claimed a $ 60,000 ordinary loss, in connection with the investment as a limited partner. Although the loss was first shown as a loss reflected on a Schedule K-1, for purposes of this case it is claimed alternatively as a theft or *207 embezzlement loss, or as a loss due to abandonment. ⁴ We first consider whether petitioners incurred a "theft or embezzlement" loss.

Theft or Embezzlement Loss

Section 165(a) enables a deduction for "any loss sustained during the taxable year and not compensated for by insurance or otherwise." Concerning theft losses, section 165(a) is applicable for the year "in which the taxpayer discovers such loss." Sec. 165(e). If in the year of discovery there is a claim for reimbursement that*85 has a reasonable prospect for recovery, a loss is not considered sustained until the tax year in which it can be ascertained with reasonable certainty. Secs. 1.165-1(d)(3) and 1.165-8(a)(2), Income Tax Regs. Petitioners bear the burden of proving a deductible loss, Clapp v. Commissioner, 321 F.2d 12, 14 (9th Cir. 1963), and they must establish the extent and amount of the loss, Hort v. Commissioner, 313 U.S. 28, 33, 85 L. Ed. 1168, 61 S. Ct. 757 (1941).

The law of the jurisdiction where the loss is sustained is applicable to determine whether a theft or embezzlement has occurred. Bellis v. Commissioner, 540 F.2d 448, 449 (9th Cir. 1976); Luman v. Commissioner, 79 T.C. 846, 860 (1982). Section 484(a) of the California Penal Code (West 1988), in pertinent part, defines "theft" as follows:

Every person who shall feloniously steal, take, carry, lead, or drive away the personal property of another, or who shall fraudulently appropriate property which has been entrusted to him, or who shall knowingly and designedly, by any false or fraudulent representation or pretense, defraud any other person of money, labor or real or personal*86 property, * * * is guilty of theft. * * *

The taking of property is not theft in the absence of an intent to steal. People v. Butler, 65 Cal. 2d 569, 421 P.2d 703, 55 Cal. Rptr. 511 (1967). The crime of theft includes theft by embezzlement. People v. Krupnick, 165 Cal. App. 2d 755, 332 P.2d 720, 722 (1958).

The facts here show that Bardo, acting through Millionaire, refused to turn the negative over to Burge after he had *208 made demand for it. Millionaire, however, was the executive producer, responsible for below-line expenses, and possessed certain distribution rights regarding the movie. Additionally, the pleadings in the lawsuit between Burge and Bardo do not focus solely on ownership, but upon who was entitled to certain of the distribution rights. Finally, the California State court ordered that Bardo turn over a negative to Burge, but that Bardo would be entitled to retain a negative (duplicate original).

Based upon those facts, respondent argues that petitioners have failed to show that a theft and/or an embezzlement occurred under California law. Petitioner counters that this case is similar to Sammons v. Commissioner, T.C. Memo. 1986-318,*87 affd. in part and revd. in part on other issues 838 F.2d 330 (9th Cir. 1988). In Sammons v. Commissioner, supra, embezzlement under California law was considered in connection with the taxpayer's payment of $ 12,000 to an individual for a horse which was never delivered to the taxpayer. Petitioner argues that we should draw an inference from the facts of this case that Bardo intended to unlawfully deprive Vandom of its property and that Bardo had converted the property to his own use. Respondent counters that the facts of this case are distinguishable from those in Sammons. We agree with respondent. In Sammons, the taxpayer's unsuccessful efforts to find and/or successfully sue the embezzler-seller supported the conclusion that the appropriation constituted an embezzlement. In this case, petitioner's partnership had turned the negative over to Millionaire for an agreed purpose and Millionaire had certain distribution rights concerning the movie. Millionaire's refusal was not equivalent to the embezzler's actions in Sammons and we so hold.

Abandonment Loss

Having decided that petitioners did not show that there had *88 been a theft or embezzlement under California law, we next consider whether petitioner abandoned his partnership interest during the 1981 taxable year and, if he did, the amount of his loss and whether it is ordinary or capital.

To be entitled to deduct an abandonment loss under section 165, a taxpayer must show: (1) An intention on the *209 part of the owner to abandon the asset, and (2) an affirmative act of abandonment. United States v. S. S. White Dental Manufacturing Co., 274 U.S. 398, 71 L. Ed. 1120, 47 S. Ct. 598 (1927); A. J. Industries, Inc. v. United States, 503 F.2d 660, 670 (9th Cir. 1974); CRST, Inc. v. Commissioner, 92 T.C. 1249, 1257 (1989), affd. 909 F.2d 1146 (8th Cir. 1990).

In determining a taxpayer's intent to abandon, the "subjective judgment of the taxpayer * * * as to whether the business assets will in the future have value is entitled to great weight and a court is not justified in substituting its business judgment for a reasonable, well-founded judgment of the taxpayer." A. J. Industries, Inc. v. United States, supra at 670. Here, respondent does not dispute the fact that petitioners may *89 have formed an intent to abandon the partnership interest. Respondent places emphasis on the argument that petitioners have failed to show an affirmative act of abandonment during 1981. Petitioners counter that the record does reflect affirmative acts of abandonment. Specifically, petitioner points out that he told Burge at the December 1981 meeting that he would not provide additional money to the partnership and that he would not become involved in the making of an X-rated film. Petitioner also stated to Burge that he would not have anything further to do with the partnership and the movie. Petitioner also refers us to the fact that the limited partners voted to dissolve ⁵ the partnership at the December 1981 meeting. Thereafter, Burge told the accountant to file the final partnership return for the period ending December 31, 1981.

*90 Little has been written concerning the abandonment of a partnership interest.⁶Tangible property is capable of physical abandonment, but abandonment of a partnership interest (an intangible property interest) should be accompanied by some express manifestation. Considering the passive *210 nature of a limited partnership interest, the need to manifestly express the intent to abandon is especially important. See, e.g., Dycus v. Belco Industries, Inc. 569 P.2d 553, 555 (Okla. Ct. App. 1977). California has adopted the Uniform Limited Partnership Act, and Cal. Corp. Code sec. 15518 (West 1977) defines a limited partnership interest as "personal property." We could find no reason to treat this personal property ⁷ differently from other types of personal property. In Echols v. Commissioner, 935 F.2d 703 (5th Cir. 1991), revg. 93 T.C. 553 (1989), the Circuit Court held that a partner could and did abandon his partnership interest for Federal tax purposes. In so holding, it was pointed out that neither Texas State law nor the Internal Revenue Code or underlying regulations specified physical methods or legal procedures for abandoning*91 an interest in a partnership. Accordingly, we proceed to decide whether petitioner abandoned his limited partnership interest during 1981.

An affirmative act to abandon must be ascertained from all the facts *92 and surrounding circumstances, United California Bank v. Commissioner, 41 T.C. 437, 451 (1964), affd. per curiam 340 F.2d 320 (9th Cir. 1965), and "the Tax Court [is] entitled to look beyond the taxpayer's formal characterization." Laport v. Commissioner, 671 F.2d 1028, 1032 (7th Cir. 1982), affg. a Memorandum Opinion of this Court. "The mere intention alone to abandon is not, nor is non-use alone, sufficient to accomplish abandonment." Beus v. Commissioner, 261 F.2d 176, 180 (9th Cir. 1958), affg. 28 T.C. 1133 (1957).

Respondent relies on two cases in support of his argument that petitioners have failed to show an affirmative act of abandonment during 1981. In A.J. Industries, Inc. v. United States, 503 F.2d at 674, the U.S. Court of Appeals for the Ninth Circuit held that an "option to salvage, which might never have been exercised" was insufficient to reflect *211 an affirmative act of abandonment. Instead, that court held that the abandonment occurred in the next year when the option was exercised. In this case, however, petitioner, as a limited partner, told Burge, who*93 was president of Vandom's general partner that he would not come up with additional funds and would have nothing further to do with the partnership and movie. Thereafter, petitioner, along with the other three limited partners, agreed to dissolve the partnership. After that point in 1981, Burge pursued the X-rated movie through another entity and pursued legal action against Bardo and his company. Petitioner did not have any further dealings with, had no expectations to receive anything, and received nothing from Vandom or Burge after December 1981.

Respondent also relied upon Echols v. Commissioner, 93 T.C. 553, but that case was reversed by the Court of Appeals for the Fifth Circuit on July 15, 1991, after completion of the briefing in this case. In that case the taxpayer was a 37.5-percent partner in a partnership which had (as its sole asset) undeveloped real property purchased in anticipation of an adjacent highway project. After the highway project stalled due to local opposition and the real estate market went into a slump, another 37.5-percent partner transferred his interest to the taxpayer in exchange for the taxpayer's assumption of the recourse*94 debt outstanding on the realty. The remainder of the debt was nonrecourse. The taxpayer and the remaining 25-percent partner attempted to and finally sold a 50-percent interest in the realty to a third party who defaulted on his payment after a little more than one year. Thereafter, the taxpayer met with the 25-percent partner and informed him that he would no longer make payment of his 75-percent portion of the mortgage and taxes. The taxpayer also offered to convey his interest to anyone who would assume his portion of the partnership debt. At that time, the value of the realty had declined to less than the mortgage balance. The taxpayer did nothing more during that year and claimed a capital loss. The next year the mortgagees foreclosed on the realty. Under those facts, we held that there was a failure to manifest abandonment through some act apparent to those outside the partnership, as distinguished from the case of *212 Middleton v. Commissioner, 77 T.C. 310, 322 (1981), affd. per curiam 693 F.2d 124 (11th Cir. 1982). See Echols v. Commissioner, 93 T.C. at 555-558. The Court of Appeals for the Fifth Circuit, however, *95 held that abandonment should not be viewed solely from a partnership perspective and that the taxpayer's actions were sufficient to constitute an abandonment of his partnership interest during 1976. Echols v. Commissioner, 935 F.2d 703 (slip op. at 4816-4817). There is no requirement that a taxpayer relinquish title in order to establish a loss if such "loss is reasonably certain in fact and ascertainable in amount." Middleton v. Commissioner, 77 T.C. at 322.

In this case, the partners borrowed the money necessary to produce the movie, and they were personally obligated to pay the debt even if no movie or asset was ever in existence. In other words, there were no interested parties, such as mortgagees, to whom to manifest the abandonment. The limited partners here voted to dissolve and abandon the interest or rights that they may have had in the negative. They were not interested in participating in the conversion of the working print into an X-rated movie, and petitioner communicated to the general partner that he no longer had any interest in the partnership or the movie. Based upon those events and that communication, Burge proceeded*96 (without the financial assistance or involvement of petitioner) to make an X-rated movie and to pursue through legal action the negative held by Bardo and his company. We find the facts of this case to be distinguishable from those in the cases cited by respondent. ⁸ Here, petitioner manifested his intent to abandon by an overt act of abandonment to the parties in interest (the general partner *213 and all limited partners). Burge proceeded to close down the partnership (directing that a final partnership return be filed) and to treat the movie and the rights to it as no longer belonging to the limited partners, including petitioner.

*97 Having found that petitioner abandoned his interest in the partnership as of the end of 1981, we must now decide whether the loss is capital or ordinary. If petitioner's loss is from the sale or exchange of a capital asset, the amount of capital loss allowable for the taxable year is the lower of $ 3,000 or the excess of capital losses over capital gains.

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