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Orrisch v. Commissioner of Internal Revenue, 55 T.C. 395

Facts

In 1963, partners A and B formed a partnership to operate two apartment houses, agreeing to share profits and losses equally. In 1966, they amended the partnership agreement to allocate all depreciation deductions to partner A, with the understanding that A would pay taxes on any gains from the sale of the properties. The partnership incurred losses in 1966 and 1967, and the IRS determined that the special allocation was primarily for tax avoidance, leading to a dispute over the allowable deductions.

In May of 1963, Dominick J. and Elaine J. Crisafi (hereinafter the Crisafis) and petitioners formed a partnership to purchase and operate two apartment houses, one located at 1255 Taylor Street, San Francisco, and the other at 600 Ansel Road, Burlingame, Calif.

Issue

Whether the amendment to the partnership agreement allocating the entire amount of the depreciation deduction to petitioners was made for the principal purpose of avoidance of tax within the meaning of section 704(b) of the Internal Revenue Code.

The only issue presented for decision is whether tax effect can be given the agreement between petitioners and the Crisafis that, beginning with 1966, all the partnership's depreciation deductions were to be allocated to petitioners for their use in computing their individual income tax liabilities.

Rule

Under section 704(b) of the Internal Revenue Code, a special allocation of an item will be disregarded if its principal purpose is the avoidance or evasion of Federal income tax.

A special allocation of an item will be disregarded if its ‘principal purpose’ is the avoidance or evasion of Federal income tax.

Analysis

The court analyzed the circumstances surrounding the special allocation of depreciation and found that it was primarily aimed at tax avoidance rather than reflecting a legitimate business purpose. The evidence indicated that the allocation did not have substantial economic effect independent of tax consequences, as it was designed to minimize the overall tax liabilities of the partners without affecting their shares of partnership income or loss.

The evidence is persuasive that the special allocation of depreciation was adopted for a tax-avoidance rather than a business purpose.

Conclusion

The court concluded that the special allocation of depreciation was made for the principal purpose of tax avoidance, and therefore, the allowable depreciation for the years in question must be allocated equally between the partners.

Accordingly, the deduction for depreciation for 1966 and 1967 must be allocated between the parties in the same manner as other deductions.

Who won?

The Commissioner of Internal Revenue prevailed in the case, as the court upheld the determination that the special allocation of depreciation was primarily for tax avoidance.

Decision will be entered for the respondent.

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