Petroleum corporation of texas inc and subsidiaries v

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Petroleum Corporation of Texas, Inc. and Subsidiaries v US (Petro) (as well as Holiday Village Shopping Center v. US) involved the application of the depreciation recapture rules when a corporation distributed an interest in a partnership to its shareholders in liquidation of the corporation. The taxpayers took the position that the recapture provisions did not apply since those provisions do not state that distribution of and interest in a partnership would trigger its application. Both courts in the Holiday case, as well as the District Court in Petro, took the contrary position. They held that depreciation recapture was required as if the corporation had distributed the partnership’s assets to the shareholders, not that they had distributed a single asset, namely the partnership interest itself. The Fifth Circuit did not extend the statutory meaning to say that the partnership interest should be treated as consisting of ownership in each of the partnership’s assets (an aggregate approach to Section 1245), in order to classify partner gain as capital or ordinary.Thus, we have the Fifth Circuit in Petro taking the statutory language alone to get to an entity-based solution. In contrast, the lower court in Petrol and the courts in Holiday went beyond the written words to determine that that aggregate approach is most consistent with Congressional intent with respect to the particular IRC provision at issue. They found that the purposed of the recapture provision was to tax at ordinary income rates,
that taxpayer who benefited from the depreciation deductions. These courts held that since the corporate partner benefited from the depreciation deductions passed through from the partnership, it should be the one to recapture the ordinary income upon sale of the asset by the way of a liquidating distribution to its shareholders, it is considered to have disposed of its share of the partnership assets with the depreciation recapture provisions applicable as they would be for any straight asset disposition.A strict statutory language approach was also followed by the Tax Court in E.J. Frankel v Comm’r. In that case, two individuals owned identical interests in a partnership and an S corporation. The partnership loaned money to the S corporation and each individual included the debt in his basis and deducted S corporation loss against it. The Court reviewed the applicable statutory language which clearly stated that the indebtedness must run directly to the shareholder in order to be included in basis. The Court also thought it would not be correct to ignore the partnership. Entity versus aggregate theories were only discussed in a footnote, as the Court looked strictly at the statutory language to reach its conclusion that the partnership loan to the S corporation could not be treated as a loan made by each partner. Thus, an entity approach was followed.

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