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Limited partnership's absence of profit motive affirmed.

W claimed losses resulting from an investment in a limited partnership (LP) formed to acquire and install energy management systems (EMSs).The Tax Court disallowed W's deduction because the partnership did not have the requisite profit motive under Sec. 183, and focused on the EMS's inflated purchase price, speculative financing and the partners' lack of expertise. W appealed to the Tenth Circuit.


LP was ostensibly formed to acquire an EMS to be installed in a manufacturing plant (G) to provide a simple, yet technologically sophisticated method of energy management. First, however, the EMS was sold to S, an entity controlled by LP's promoter, for $337,500. By the time LP purchased the equipment (later in the same year), the purchase price had escalated to $10.35 million. Most of it was to be paid via a $9,004,500 nonrecourse note, payable solely from 80% of the gross income the EMS. All of the entities involved in this scheme were organized in the same year; none of the general partners or promoters had anything more than limited experience in the field of energy conservation and management. Also, there was no evidence that the EMS was ever installed at G or generated any actual energy savings.

Profit Objective

"For a deduction to be allowed it must be shown that the activity engaged in was operated with an actual and honest profit objective" (R.A. Hildebrand, 28 F3d 1024 (10th Cir. 1994) (citing Sec. 183))."The determination of whether an activity is engaged in for profit is to be made by reference to objective standards, taking into account all of the facts and circumstances of each case ... The taxpayer's objective must be to achieve an economic profit independent of tax considerations" (George Gianaris, TC Memo 1992-642). The court in Hildebrand noted that the taxpayer has the burden of establishing that "profit was the dominant or primary objective of the venture." According to Gianaris, courts particularly examine the individuals operating the partnership, "whose expertise is relied upon in making partnership decisions."

The Tax Court's conclusion that the LP was not intended to be a profit-making venture was based primarily on five objective factors: (1) the grossly inflated sales price paid for the EMS; (2) the large nonrecourse note with payment limited to a very speculative income source; (3) the lack of expertise in the energy-management field of LP'S general partner and promoters; (4) the application of the Kegs. Sec. 1.1832(b) factors (discussed below); and (5) the calculation of a negative net present value for LP.

Purchase Price

A key indicator of a venture entered into primarily to shelter taxes is the presence of a grossly inflated purchase price; Feliciano Soriano, 90 TC 44 (1988).The fact that LP purchased the EMS for $10.35 million only a few months after the same equipment sold for $337,500 indicates that LP's objective was to achieve grossly inflated tax benefits, not to make an economic profit. In addition, the nature of the financing used here--a 25-year nonrecourse note with interest well below that paid by government bonds and payment limited to funds received from speculative savings to be generated by the EMS--meant that LP would generate artificially inflated tax benefits, while virtually assuring that it would never repay the note in full.


W does not dispute that the general partner and promoters had only limited experience, if any, in energy management, and that he himself had none.

Other Factors

The Tax Court also applied the nine nonexclusive factors in Kegs. Sec. 1.183-2(b) to further support its conclusion. It found that LP had not been operated in a businesslike manner, because no books, records or financial statements had been offered as evidence. Likewise, there was no evidence that (1) W expended any time and/or effort in carrying on the business, (2) the EMS was expected to appreciate in value or (3) LP had any success in similar energy-saving ventures or had ever earned a profit from an EMS-related activity. None of these conclusions is clearly erroneous.

Present Value

W takes exception to the Tax Court's calculation of LP's net present value, based on a 25-year useful life for the EMS. The court refused to accord any weight to the expert's opinion that the equipment would last at least 30 years, citing the expert's lack of authority, factual support or data, and noting that the opinion was based on nothing more than his persona/belief. Indeed, the expert admitted he had never seen the EMS and was unfamiliar with its design. We find no error in the Tax Court's refusal to credit this opinion. In any event, the other bases supporting its decision are correct, and the decision is affirmable, irrespective of the present-value analysis.

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Author:Walford, Donald L.
Publication:The Tax Adviser
Date:Jun 1, 2005
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