Countryside Limited Partnership v. Commissioner

Arthur Winn and Lawrence Curtis (collectively, the partners) (plaintiffs) held 95 percent of a real estate partnership (the partnership). After adjusting for liabilities, the partners had a zero basis in their partnership interests. The partners’ interests were liquidated and redeemed by the partnership, with the partnership issuing $12 million worth of private notes issued by AIG (the AIG notes). The AIG notes were not marketable securities, because they were not listed or traded on a financial market. The partnership hoped the redemption would qualify for nonrecognition under § 731(a) of the Internal Revenue Code based on the partners’ adjusted basis in the partnership. The Commissioner of Internal Revenue (the Commissioner) (defendant) argued the AIG notes were marketable securities under § 731(c), which would trigger tax liability for $12 million in gain. To support his argument, the Commissioner cited § 731(c)(2)(A), which explained that any financial instrument that was readily convertible into money or marketable securities would be considered a marketable security for the purposes of § 731(c). Further, the Commissioner cited Treasury Regulation 1.731-2(h) (the treasury regulation), which provided that the Commissioner may reclassify transactions that are intended to achieve tax results inconsistent with § 731(c). The treasury regulation provided three examples of transactions in which a partnership distributed rights to purportedly nonmarketable securities to avoid tax liabilities under § 731(c). Two of the examples involved distributions of partnership assets, excluding marketable securities, to partners, and the third involved a change in partnership allocations with respect to marketable securities. The partners petitioned the United States Tax Court for a redetermination, arguing that the AIG notes were not marketable securities and were not distributed as part of a tax-avoidance scheme.