Commissioner v. Tufts

A general partnership (plaintiffs) formed to build an apartment complex. The partnership obtained a nonrecourse mortgage on the building in the amount of $1,851,500, and the partners made capital contributions in the amount of $44,212. For the next two years, each partner took depreciation deductions totaling $439,972. In light of their capital contributions and depreciation deductions, their adjusted basis in the property in 1972 was $1,455,740. But due to economic problems in the area, the partnership was unable to pay the mortgage, which still had a balance of approximately $1,850,000. Each partner sold his share to a third party, who assumed the nonrecourse mortgage. A dispute arose regarding the complex's sale value for tax purposes. The partners calculated the sale value as the property's fair market value, which was about $1,400,000. Because the property's market value was less than the property's adjusted basis, each partner reported a loss of $55,740 from the sale. However, the Commissioner of the Internal Revenue Service (defendant) calculated the property's sale value as the $1,850,000 balance of the transferred mortgage. Because the mortgage balance was higher than the property's adjusted basis, and determined the partnership had realized a capital gain of about $400,000. The tax court agreed with the commissioner. The court of appeals reversed. The United States Supreme Court granted certiorari.