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Code §752 Authorities
The relevant authorities interpretig Code §752 support the conclusion that the Short Option
more likely than not is not a "liabilty" for puroses of Code §752. In Helmer

v. Commssioner. the

Tax Cour held that a tranfer of

money pursuant to an option agreement and the parership's

obligation to deliver propert upon exercise of

the Option did not create a parership liability for

puroses of Code §7 52.19 Furermore, analogy can be made to other fiancial intrents that may

or may not be treated as liabilities for puroses of Code §752, such as contigent or speculative
items. Although the Tax Cour recently held in Salina that a short sale does create a liability for
puroses of Code §752,2° the Tax Cour recognzed the contiuig authority of Helmer and the
differences between a short sale and an option. Moreover, the Salina cour's adoption of

the plai

and ordiar meang of the ter "liability" supports not treating a short option as a liabilty.
Although recently enacted legislation provides that a "liability" includes any fixed or contigent
obligation to make payment, without regard to whether such obligation or potential obligation is
otherwse taken into account, the legislation more likely than not does not apply to the Tranactions
for the reasons described below.i1

The Helmer Case
In the case of

Helmer v. Commssioner. the Tax Cour held that a parership's receipt of

money pursuant to an option agreement and the parership's obligation to ,deliver proper upon

1934 T.C.M. 727 (1975).

20 See Sala Parerhio LP. FPL GrouP. Inc. v. Commssioner. T. C. Memo 2000-352 (November 14, 2000).

21 See H.R 4577, which became Public Law No: 106-554.
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exercise of the option did not create a parerhip liability under Code §752.22 In that case, a

parership owned cerai real propert on which it granted a corporation a purchase option. In
consideration for

the option, the corporation paid cash to the parership. The parership distrbuted

the cash to its parers. The IR argued that the option agreement did not create a parership

liabilty under Code §752 and, thus, the distrbution of the option money caused the parers to
recognze gai under Code §73l (i.e., the distrbution of

the option money exceeded the parers'

ta bases in their parership interests).23 The parers argued that the parership's obligations

under the option agreement (i.e., to transfer the proper upon exercise of the option) created a
parerhip liability under Code §752 which increased the adjusted bases of their parership

interests.

The Tax Cour held for the IR, even though a disparty between parership inside and
outside basis resulted. The Tax Cour stated:
We are faced with a unque situation. Helmer Brothers received payments pursuant the option payments, porton of the option been exercised the options had not been terinated, nor had any by the optionee. Respondent, in hi& brief, conceded that the income from the option
to the option agreement when there was no forfeitue of any of

payments was deferrable by the parership until characterized as ordinar income

(because the default by the optionee) or capital gais (because of an exercise of the option by the optionee).

, *******
The moneys received under

the option agreement were free of restrctions except that

upon exercise of the option such amounts would be applied against the purchase price. Thus, the restrction only affected the character of the gain in the parership's
hands. It is ths lack of abilty to determe character of income (not any liabilty to
2234 T.C.M. 727 (1975).

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23 The Servce appears to have assered in other context that a contractual duty under an option constitutes a

liability. Cf Rev. RuL. 68-637, 1968-2 C.B 158, amplifing, Rev. Rul. 98-10,1998-1 LR.B. 11; Prv. Ltr. Rul. 79-51-128 (September

24, 1979); Prv. Ltr. Rul. 83-03-028 (October 15,1982). .

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repay or to perform) that causes the deferr of

the recogntion of

the income by the

parership until the option is either exercised or lapsed.
The Helmer case is a Memorandum Opinion, and while the Tax Cour has stated tht "we

consider neither revenue rulings nor Memorandum Opinons of ths cour to be controllig
precedent," numerous Tax Cour decisions neverteless routinely cite memorandum opinons as
precedent,24 The leading treatise on parership taxation, without mentionig Helmer's status as a
Memorandum Opinion, appear to view it as controlling authority.25
Revenue Ruling 73-301

hi addition, tle Helmer decision is consistent with Revenue Rulig 73-301,26 which held that

an unestrcted progress payment received by a parerhip did not create a "liability for puroses
of Code §752. In Revenue Rulig 73-301, a parership received cash progress payments on a

constrction contract reported under the completed contrct method and distrbuted the cash to its
parers.27 At issue was whether the parership's duty under the contract caused the advance

payments to constitute Code § 7 52 liabilities. If so, the cash distrbutions to the parers would not

24

Nicov. Commssioner, 67 T.C. 647 (1977), ajJdinpart andrev'd in

part

on other

grounds, 565 F.2d 1234

(2d Cir. 1977). See generly Sonners ard Water, "Tax Cour Memradmn Decisions-- What are They Wort?," 98

1N (LEXIS) 138-96 (July 20, 1998). See also Antoffv. United States, 86 AF 2d 2000-5724 (Augut 22, 2000),
where the 8th Circuit recently declaed unconstitutional a cour rue that "unpublished opinon are not precedent." The
cour's rationae in Anastaoffis tht, as far back as 1642, it has been the fuction of a

judge "not to mae, but to

declare the law, accordig to the golden mete-wad of the law and not by the crooked cord of discretion." i. E. Coke,

Institutes of the Laws of England 51 (1642). Furer, the Anastaoff cour clai tht the ability of a judge to deny
ongoing precedential treatment of a case exceeds the "judicial" natue of a judge's authority, as the tenn of Arcle il

of the Constitution were meant by the Framers.
25 McKee, Nelson and Whitme, Fedeal Taxation of

Parterships and Parters 17.01(1) (3rd Ed. 1997).

26 1973-2 CB 215.

271973-2 C.B. 216.

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have exceeded the bases of

the parers' interests, The IRS refused to accord Code §752 liabilty

treatment to the constrction contract, statig:

The progress payments ... received by the parership and reflected as 'deferred
income' on the books of

the parership.. represent amounts received on account of

serces performed on the contract not yet reported as gross income. Ths amount

together with the right of the parership to an additional payment .., for work
performed constitute 'unealzed receivables' with the meanng of

Section 751(c)

of the Code, and the progress payments are not a 'liability' as referred to in
Section 752 which increases the adjusted basis of the parership interests of the

parers. The income or loss from performance of the contract will afect the basis
of

the parership interest in the parers, as provided in Section 705(a), when such

income or 10ss is recognzed for Federal income tax puroses.
Accordigly, no increase in the adjusted basis of

the parership interests... is made as a result of the receipt by the parership of the advance payments with the
Section 752(a) of

meang of

the Code.

The IRS disallowed a Code §752 basis step-up, despite the resulting disparty between the inide
basis of the parership's assets and the outside basis of

the parership interests.

A parership which enters into a short option position is similar to the parership that
received advance payments in Rev. Rul. 73-301. Both contractual duties are uncert in amount
in that the parerships canot precisely calculate the cost of fulfiling such potential duties. Both
parerships are reportg their taxable income under specialized methods of accountig which
perit deferral of taxable income until completion of perormance under an executory contract.

, Accordigly, like the parers

in Rev. Ril. 73-301, the Parers here more liely than not should
the potential contractual duty associated with
the Short Option position by the Parership more

receive no Code §752 basis adjustment as a result of

the Short Option position, and the assumption of

likely than not should not be treated as the assumtion of a liability.

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Revenue Ruling 95-26

On March 9, 1995, the IRS held in Revenue Ruling 95-2628 that a short sale created a
parership liabilty with the meanng of

Code §752. In that ruling, a parership entered into a

short sale of securties on a nationa securties exchange. The parership's broker/dealer took
securties on hand and sold them on behalf of

the parership. The parership left the proceeds of

the sale with the broker as collateral and deposited additional cash with the broker as fuer
collateral. The parership was obligated to deliver identical securties to the broker to close out

the

short sale.

In concludig that the short sale created a parership liabilty with the meang of Code
§752, the IRS cited Revenue Ruling 88_77,29 where the IRS concluded tht accrued but unpaid

parership expenses and accounts payable are not liabilties with the meang of

Code §752 for

puroses of computig the adjusted basis of a parer's interest in a parership, except when such
liabilities result in the creation of, or an increase in, the basis of proper. The IRS concluded in

Revenue Ruling 95-26 that a short sale creates just such a liability for two reasons:30
28 1995-1 C.B. 798. See also Rev. Rul. 95-45, 1995-1 C.B. 53, regadig contrbutions of short positions to

corporate entities.
29 1988-2 C.B. 128.

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30 1995-1 C.B. 131, 132. Cuously, the IRS also cited Deput v. duPontto suport its conclusion that a short

sale is a liability for puroses of Code § 752. In Deputy v. duPont. the taayer entered into a short sale of securties
and agrd to pay to the lender of the securties the dividends paid on the securties durg the period that the short sae

reed ope.308 U.S. 488 (1940). The tapayer claied the amunt tht he paid to the lender as a deduction for
interest paid or accred on indebtedness under section 23(b) of the Inter Revenue Code of1928. The Supreme Cour
held tht the tapaye's obligaon to trfer the dividend to the lender did not constitute an indebtedness with the
meang of the statute, statig in perent par that "although an indebtedness is an obligation, an obligation is not

necessary an indebtedness." It is ilogical to cite a case holdig tht a short sale is not an "indebtedness" to support
the conclusion that a short sae is a "libilty."

It should also be noted that the IR took the opposite approach in Rev. RuL. 95-8 in which it cited Deputy v.
duPont to support the conclusion that income attributed to a short sale traction did not constitute wilated
debt-fianced income to a tax-exempt organtion because the short sale was merely an obligation. If

the stadards

for deterg whether somethg is a "liabilty" and an "indebtedness" ar the same, it should follow that if a short
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(1) a short sale creates an obligation to retu the borrwed securties; and
(2) the parership's basis in its assets is increased by sale of the amount of cash

received on the

the borrowed securties.

Thus, the Commssioner concluded tht the

parers ' bases in their interests in the parership should

be increased to reflect their shares of

the parership's liability.
proceeds in basis

The Serce's conclusion in Revenue Riling 95-26 that the inclusion of

automatically causes an obligation to be a "liability" has been criticized by commentators,31 as the

arguent has several wealesses:
1. It is inconsistent with Helmer and Rev. Ril. 73-301. In both the case and the ruling,
the cash received increased the'basis ofa parership's assets, yet that did

not cause

a "liabilty to come into existence forpuroses of

Code §752.

2. It is not supported by Rev. RuL. 88-77,32 the only authority cited explicitly in Rev.

RuL. 95-26. This rulig holds that accred but unpaid expenses and accounts payable are not liabilities of a cash basis parership for puroses of Code §752. The
Servce's stated rationale was that an obligation which does not give rise to basis is not a liability. The two subsequent rugs infer from ths holding that Rev. RuL. 88-

77 stands for the proposition that an obligation which does give rise to basis is a liability. However, Rev. RuL. 88-77 makes no such holdig, nor is it authority for such a holding.

sale obligation is not an "indebtedness," it is nota "liabilty either. The Tax Cour, however, recently held in Sala
tht the meang of "indebtedness" adopted in Deputy v. duPont is not necessary the same as "liabilty" under Code

§ 752. The Tax Cour stated: . ... the Supree Cours stateent in Deputy v. duPont. supra at 497, that "an obligation is not
necessary

an 'indebtedness"', which was diected at the tapayer's obligation to trfer an amunt

equivaent to the dividends paid on the borrowed securties to the lender, does not constitute a blanet

holding tht a borrower's obligation to close a short sale by retug the borowed securties to the

lender wi never be considered an indebtedess. Morever, petioner attemts to equate the term
"indebtednes", as contemplated under section 23(b) of

the Internal Revenue Code of 1928, with the

ter "liabilties" as used in secton 752, without any megf analysis or citation to precedent. We,
of cour, are in no way consed (nor prepard) to asume that a liabilty within the meg

of

section 752 must satisfy the defintion of an indebtedness as that ter is used elsewhere in the Code.

31 See, generally, Cungh "Short-Sale Obligations and Basis in Parership Interests," Tax Notes, Sept.

23, i 996 at i 663; McKee. et al. supra.
32 1988-2 C.B. 128.

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3. It results in a clealy wrong answer in other contexts. For example, assume that a
taxpayer borrows $1 OOx, buys an asset, pays down a porton of

with other the liability fuds, and then contrbutes the asset to a corporation subject to the liabilty. Under Code §358(d)/3 the taxpayer's basis in the corporation's stock is his origial $lOOx basis, reduced by the liability. Using the Servce's arguent, the basis would be the liability, resulting in a zero basis in the reduced by the origial ful amount of
corporation's stock.34

Furermore, the

legislative

history

of

Code §357(c)(3), also

relied

on by

the Servce

in

Rev.

Rut. 95-26, does not support the Servce's arguent that a short sale obligation is a liability. As
added by the 1978 Tax Act, Code §357( c )(3)(A)(i) excludes from the defition of a "liability" any
obligation the payment of

which would give rise to a deduction.35 Code § 357( c )(3)(B) then provides

that this exclusion shall not apply to any liability to the extent that "the incurrence of the liability
resulted in the creation of, or an increase in, the basis of any property". 36 The legislatve history of
ths provision provides as an example a cash-basis tapayer that purchases tools on credit and, before

33 Whle in theory the ter "liability" could mean diferent thgs under different Code sections, in practice
both Congress and the IR have indicated that the term as used in Code §§357, 358 and 752 are synonymous. In the
1984 Tax Act, Congress amended §704(c) to, inter alia, reque tht accounts payable contrbuted to a parership be
allocated to the contrbuting parer and not be treated as a liability of commttee report states that

the parership under Code, § 752. The conference

th treatment was intended to be "parlel to the ( 1978) amendmentto §357( c), which also "liabilty." H.R Conf. Rep. No. 861, 98th Congo 2d Sess., 1984-3

excludes deductible liabilities frm the defition of

(vol 2) C.B. nO-11. In Rev. RuL. 88-77, supra, the IR noted that: "The legislative history accompanyig the
Ruling 60-345 in favor of

amendment to §704(c) made by the Tax Reform Act of 1984 explicitly rejected the conclusion reached in Revenue Rev. Rul. 95-74,1995-2 an interpretation of §752 that is consistent with §357(c)." And in liabilities were not "liabilties" for puroses of Code C.B. 36, in support of its rug that contigent envinmenta
§§357 and 358, the Serce cited Rev. Rul. 88-77, which addresses the treatment of liabilties under Code §752.
Also, since Code §§357 and 358 work in tadem it is generaly

assumed that the term "liabilty" in both

sections are synonymous. See Rev. Rul. 95-74, 1995-2 C.B. 36, "Due to the parlel constrctions and interelated

fuction and mechancs of §§357 ard 358, liabilties that ar not included in the deteration under §357( c )(1) also
are not included in §358 deteration of

trferor's basis in the stock received in the §351 excbge(,)" citing, 68

T.C. 223 (1977), acq., 1980-2 C.B. 1; S. Rep. No. 1263, 95th Cong., 2d Sess. 183-85 (1978), 1978-3 C.B. 481-83.
34 Cf. Treas. Reg. § 1.56-3(b) (right to acquie stock tht is treated as securty for

puroses of Code §§354 and
355 has no pricipal amunt).
35 This exclusion from the defition of a libility for puroses of Code §357( c )(3)(A)(i) alo applies to Code
§358, since it is constred in

pari materia with Code §357(c)(3).

36 Emphasis added.

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paying for the tools, tranfers them along with the related obligation in a Code §351 transfer.37 In
the example, the incurence of the liability (not the receipt of

the tools) created basis in the tools

pending actual payment.

By contras, in the case of a short option, basis is created only because the seller receives
cash, not because he incured a liabilty. The mere incurence of

the liability could not create basis

in either case because of

the longstadig priciple that contigent and indefite liabilities assumed

by the purchaser of an asset are not par of

the cost basis of the asset. As noted above, a short option

position, parcularly a European-style, out-of-th~-money option, is less than contingent. It is
speculative.
Moreover, since the potential contrctul duty under

the short option is contingent, if instead

the option had been issued in consideration for

propert (e.g., machie tools or nonfctional foreign

curency), the basis of

the parerhip's propert would be zero. Thus, the IR position in Rev. Rul.

95-26 leads to the untenable conclusion that whether a short option is a "liabilty" depends on the
consideration received.38

Salina Partnership: Short Options Compared to Short Sales
37 S. Rep. No. 1263, 95th Congo 2d Sess. 183-185 (1978), 1978-3 C.B. 481-483.
38 In addition to its techncal deficiencies, Rev. RuL. 95-26 has quesonable pragmtic rafications. To protec

the fisc and perhaps for other policy reasons, the cour and the IR reguarly have avoided broad interretations of
parership liabilities under Code §752. The uncharcterticaly broad interpretation in Rev. RuL. 95-26 ha perhaps

,opened a flood gate for circumventig Code § 731 (a) and deferrg ta on cash distbutions that otherwe would exceed

the basis of a parer's interest.
A fuer examle of

the Serce's aversion to detenningtht a liabilty exsts for federa income ta puroses

post-retiement - mecal liabilties assumed from its parent by a newly crated subsidiar of a corporation wer not "liabilties" for puroses of Code §§357( c )(1) and 358. In that rug, the IR noted that such contigent liabilities had not yet been
is found in Rev. Rut. 95-74, in which the Servce rued tht contigent envinmenta liabilties and

taen into account by the parent corporation and therfore had neither given nse to deductions nor resulted in the

creation of, or increase in, basis in any proper of the parnt. The same reasonig is readily applied to the potential
which anses upon enterig into a short option position, and for the same reasons a short option position should not be found to be a liabilty.
contrctual duty

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On November 14, 2000, the Tax Cour issued another Memorandum Opinion, Sala
Parership LP. FPL Group. Inc. v. Commssioner,39 holdig that a lited parership's short
position in Treasur bils generated a parership liability under Code §752. In Salina. the lited,

parership took a substantial short position in U.S. Treasur bils and realied a $344 millon shortterm capita gain $337 millon of

which was allocated to one parer, FPL Group. In 1992, FPL
the distrbutive share of

Group claied a capital loss carover to offset nearly all of

the lited
had increased

parership's gai. Two year later

the limited parership was liquidated. FPL Group

its outside basis in its interest in the limted parership by the $337 million gai it had reported in

i 992 and claied large ordinar losses attbutable to its interest in the lited parership for
taxable years 1994 though 1997. The Tax Cour determed that the Treas bils generated a
liabilty under Code §752 that was not taken into account in 1992, and the lited parership

therefore did not realize a $344 millon short-term capital gain for the 1992 taable year.
The Servce argued that the short sale obligation was a "liability" under the broad definition
of "liabilities" adopted in Revenue Rulings 88-77 and 95-26, and that the inclusion of

proceeds in

basis automatically causes an obligation to be a "liability." Signficantly, the Tax Cour did not
adopt the Service's broad definition of "liabilities" contaied in these ruligs.40 Instead, the Tax
Cour held that "(i)n the absence of any indication that Congress intended otherise, we apply the
term (liabilities) takng into account its plai and ordinar

meang." The Tax Cour then looked

solely to the Black's Law Dictionar defition ofliabiltyto conclude that a short sale did consttute

39 T.e. Memo 2000-352 (November 14, 2000).
40 Although the Tax Cour

discusses Revenue Rulgs 95-26 and 88-77, nowhere in its opinon did it adopt the

Servce's reasonig in these rugs. Intead, the Tax Cour merely sumed these ruings as the authority relied upon by the Servce and held that these rugs do not conflct with Helmer or Revenue Rulg 73-301.
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a liability. Under the plain and ordiar meag ofliabilty, the Tax Cour concluded that a short sale was a "liability" because "Sala has a legally enforceable fiancial obligation to retu the
borrowed Treasur bils to Goldman Sachs and ABN." The Tax Cour also found it signficant that

Salia has treated the short sale as a liability on its balance sheet.41
By contrast, unlike the short sale where there is a fixed curent obligation to deliver the same
replacement securties, the grtor of an option incurs a legal obligation with respect to a Short
Option if, and only if, a payment is due with respect to the Short Option pursuat to its ters as a

result of the exchange rates on the date the Short Option expires. Because there is no curent
obligation under a short option position, there is more liely than not no liability under the plain and
ordinar meang of the term "liability" adopted by the Tax Cour in Salina.
The Tax Cour also recognzed in Salina the continuig authority of

Helmer. The taayer

in Salina argued that the short sale was not a liability under the open transaction priciples of
Revenue Rulg 73-301 and Helmer. The Tax Cour acknowledged that both Rev. RuL. 73-301 and
Helmer stand for the general proposition that amounts owed or paid to a parership or its parers

in a transaction that qualifies as an open transaction for tax puroses do not generate adjustments to

the parers' outside bases in their parership interests until the tranaction is closed and the ta
characteristics of

the traction can be determined. However, the Tax Cour went on to state tht

"the traction

must nevereless be examned to determe whether the parerhip incured related

liabilties that may require parer-level basis adjustments pursuant to section 752." Upon such an

41 Although the Tax Cour also noted that its conclusion was "consistent with the policy underling section
752," it should be emphasized that its decision was "(b lased upon" the plain and ordi meang of

the teo liability

and Dot on the underlyig policy of Code.
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examnation, the TaX Cour concluded that a Treasur short sale did result in creation of a liabilty,

while acknowledgig the Helmer cour's holdig that an option did not:
Although the two tractions are both considered open tractions for puroses of '
application of

the income ta, the tranactions are materially different for puroses

of analysis under section 752. The option payments that the parership received in Heimer v. Commssioner. supra, represented fixed payments on the sale of a parership asset that were free and clear of any clai for repayment or demand for
fuer servces. In contrast, Salina's gai or loss on the sale of

borrowed Treaur

bils was dependent upon the cost to Sala of fulfilling its obligation to replace the

borrowed Treasur bils. Consequently, we hold that Helmer v. Commssioner,
supra, does not support petitioner's position in ths case.
By recognzing the continuig authority of

Helmer, the Tax Cour made clear in Salina that
than a short option for puroses of

a short sale may be treated differently

Code § 7 52. To suarze,

the rationale applied in the case of a short sale, as in Rev. RuL. 95-26 and Salin!! more likely than

not does not apply to a potential contractual duty under a short option, for at least thee reasons:

L As previously discussed, Helmer stads squarely for the proposition that an option
position is not a liability.42
2. A potential contractual duty under a short option position does not meet the plain and

ordiar meang of a liability adopted by the Tax Cour in Sala. Unle the short
sale, where there is a fixed curent obligation to deliver the same replacement
securties (even if the dollar value of

that obligation will change with the pnce ofthe

item sold short), the grtor of an option incurs no contractual duty until and uness
the option is exercised. Since there is no curent obligation, there is no liability.43
3. The amount of the liability in Rev. RuL. 95-26 is equal to the amount of cash received for the short sale. The rationale in the ruling was that such amount is the amount included in the inside basis of the parership's assets (i.e., the cash received). As

explaied herein, ths rationale is suspect. Moreover, ths rationale was not given by

42 Although the cour in Helmer and Salina focus on the lack of any repayment obligation in Helmer if the
option was not exercised, it is signficant that the cour did not fid a liabilty with respect to the taayer's potential
obligation to deliver the proper upon exercise of the option. This potential obligation to deliver proper

of the option is simla to the potential contrctual obligation upon expirtion of the Short Option.

upon exercise

43 Treatig the Short Option as a liabilty if ther is, upon its termation, an amount due should yield the same
basis result See Section G.

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the Tax Cour in Salina, which did not address how the amount of

the liability should

have been detered. Neverteless, in the case of a short sale, the same result is

also consistent with a different rationale: the amount of the liability is the cas
received because that is the origial amount of

the obligation, i.e., the amount that the obligee could demand from the obligor were the "obligation" to matue on its

'date of issuance. It is not necessarly the amount that the obligor might have to pay the obligation.44 In the case of a short sale, ths amount the obligee to free himself of

is the origial cost of purchasing replacement securties. By contrast, in the case of
an out-of-the-money short option, the amount that the obligee could demand were the ' option to expire on that date is zero. Thus, even assuming that both the short sale and the option liabilty, unike the short the short option create "liabilities," the amount of sale liabilty, is zero.

Contingent or Speculative Commitments
The cour have consistently held that comntments which are contingent or speculative are
not liabilties forpuroses of

Code §752, a principle which the IR has consistently followed.45 The

IRS and the cours reason that contigent or speculative commitments canot give rise to basis.46

44 Accord, Rev. Ru1. 95-45, where the short seller received $l,OOOx in sale proceeds and contnbuted them in
a Code §351 tranfer when replacement securties would cost $800x. The trferee assumed the transferr's

obligations to deliver identical securties. The IR rued tht the assumed obligation wa a "liabilty" in the amount of

$1,OOOx. Simlaly, disregadig the OlD rues (which are an overlay on the common ta law of debt obligations and
in any event apply only afer a de minimis theshold), the amunt of a debt obligation is set when the obligation is isued. It does not change with fluctuations in interest rates or the issuer's crt ratig, even though these changes would afect

the value of the debt obligation and therefore the amount that an economicaly rationa issuer would pay the holder to discharge the debt. Also, while discharge of indebtedness income is meaured by the origial issue price and not by the face amount, for numerous other ta puroses the amowit of a debt obligation is its face amunt, i.e., the amount matuty. See. e.g., Code §§146(a), 453A(c)(4), 691(a)(5)(B). tht the holder would receive at

45 See LonlZ v. Commssioner. 660 F.2d 416 (10th Cir. 1981), affg., 71 T.C. i (1979); Brountas v.
Commssioner. 692 F .2d. 152 (1st Cir. 1982).

Grade WestemRaioad Co. v. United States, 505 F.2d 1266 (Ct. Cl. 1974); Leery & Rio v. Commssioner, 52 T.C. 367 (1969), affd., 451 F.2d 173 (9th Cir. 1971).
46 See Denver

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In Long v. Commssioner, the Tenth Circuit addressed whether certai contested claimsagaist a

parership were liabilties under Code §752.47 Holdig the clais were not, the court stated:48
The Tax Cour held that because the lawsuit clai agaist the parership were

indefinite and contigent liabilties, they should not be recognzed for basis
adjustment puroses until the exact amounts of the liabilities were established. Afer the pares setted those suits, the Tax Cour treated the settlement totals plus

attorneys' fees incured as parership liabilities and pertted adjustment of the
estate's basis in the parership interest to the extent of its -25% interest. See W. Partnerships and Partners McKee, W. Nelson & R. Whtmre, Federal Taxation of

-i7.0l(2) (1977). We agree with ths approach and holding.
Brountas v. Commssioner involved an oil and gas drlling parership investment paraly

paid with nonrecourse obligations that were to be satisfied only out of oil production payments.49
The First Circuit characterized the obligation as highy contigent and speculative and seemig "less

like the repayment obligation that tyically accompanes a recourse loan than lie a device for
. sharg business risks--the risks that accompany oil explorations. "50 Hence, the cour held, inter alia,
that the obligations were not parership liabilities for puroses of

Code §752.
the purchase
51

In Leery v. Commissioner, the cour held that a contractual duty to pay par of

price of a business out of "net profit" was too contigent to be included in the purchaser's basis.

The petitioners were unsuccessful in argug that, although the amount was contigent, the liability
itself was absolute.

47600 F.2d 416 (10 Cir. 1981), affg, 71 T.C. 1 (1979).
48 Emhasis added.

49692 F.2d 152 (1st Cir. 1982).
50692 F.2d at 158.

5\ 52 T.C. 367, 377-78.

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In determing whether a commtment is contigent, the analysis generally stops abruptly

at
52 In Denver & Rio Grande

the terms of

the contract if

those ters objectively impose a contigency.

Western Railroad Co. v. United States. the cour refused to allow the railroad taxpayer to include in
its cost basis of propert advances by a customer (used to build a "spur line'') which were repayable
only out of

proceeds from shipping above a certai anual tonmige for 10 years.S3 The taxpayer

argued that the commtment was not contigent because in light of the underlying facts and
circumstances it could be predicted with ''reasonable ceraity" that the advances would be repaid

in full. The cour rejected the arguent, stating that the subjective intent of the pares did not
matter. Absent a bindig obligation to repay all of

the advances at the time the subject deductions

were taen, the cour considered it "impossible" to value the duty assumed.

By its terms, enterig into a short put option position--parcularly one issued European style:
exercisable only at expiration--is both contigent and speculative. There is no certaity as to the

amount of the potential contractual duty until settlement. If at expiraton, the underlyig propert

has a value greater than the strke price, the option is wortess. In fact, the grantig of an
out-of-the-money option presents a more compellig instance of a contigent contractual duty than
those in the cases discussed above, because the option wrter's desired, if not exected, result is for
the value of

the option to decline.

52 See Denver & Rio Grande Weste Raoad Co. v. United States, supra; Lemery v. Commssioner, supra;
Priv. Ltr. Rul. 7704269550A (Apri26, 1977). ("When the documents, by their term, crte only contingent

obligations,

Cour ordiarly will not look beyond the documents to detere the intent of the pares. ").
S3 505 F.2d 1266 at 1269-70 (Ct. Cl. 1974).

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The All-Events Test for Determining a Liability
In a case involving short securties obligations, LaRue v. Commissioner. the Tax Cour held

that liabilties must meet the "all events" test of Code §461 (described below) in order to quaify as
"liabilties" for puroses of inclusion in a parer's basis in his parership interest. 54 With respect

to any item, the "all events" test is met if all events have occured which determe the fact of the
liabilty, and the amount of

the liability can be determined with reasonable accuracy.55

LaRue was a general parer of Goodbody and Co. ("Goodbody"), a large stock brokerage
fi. Due to the inability of record keeping technology at the time to keep up with tradng volume,

Goodbody incured large, unanticipated "back offce" liabilities. These back offce liabilities were
created by the following tyes of

transactions:

(1) Fails to Receive-- Securties which the broker should have purchased at a stated

price were not purchased. Gain or loss would be incured on these transactions measured by the difference between the customer's contract price and what the broker had to pay to obtain the securties. These transactions were the fuctional
equivalent of short sale transactions.
(2) Fails to Deliver-- Securties which the broker

thought were sold to another broker

but for which no "comparson" for proof could be provided. These securties then had to be sold and the gai or loss incured was measured by the difference between the original sales price and the actual proceeds received.
(3) Securties Differences-- These represented differences between the securties the

broker's records stated it should be holdig for its own or other's accounts and the securties actually "in the box." These resulted maily from incorrect deliveries, receipts, or thefts. Gai or loss was measured by the value of excess securties or their replacement cost.
(4) Dividend Erors-- The broker was responsible to its customers for dividends and interest on securties which it held as nomiee for its customers, i.e., securties held

54 90 T.C. 465 (1988). '

)

~~ Treas. Reg. §1.461-1(a).

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in "street name." If due it was stil

the broker failed to receive a dividend or interest payment when liable to its customer for such amount.

Due to the large losses generated by these back office problem and the withdrawal of capital
by subordinated lenders, Goodbody was in violation of

the New York Stock Exchange mium

capital requiements. At the same time, another brokerage fi, Merrll Lynch, agreed to acquie

Goodbody. The acquisition transaction raised the issue as to whether LaRue, and the other
Goodbodyparers, could include the back offce liabilties in the bases of their

parership interests.

The LaRue cour held that the Goodbody parers could not include these back offce

liabilities in their bases because the "all events" test had not been met. The cour said:

Because an accrual basis parership uses the 'all-events' test to determe when an
expense is deductible, we th that test may be properly used to determne when the

correspondig liabilty is includable in basis.
The cour stated that while Goodbody had a liability to its customers for their back offce failures, the amount of these liabilties was not determinable with reasonable accuracy until any
missing securties were purchased or excess securties sold at the market price.

Recently Enacted Legislaton
On December 21, 2000, President Clinton signed into law the Consolidated Appropriations

Act 2000 (the "Act"). Section 309 ofthe Act amends Code §§357 and 358 to prevent duplication

or acceleration ofloss though assumption ofliabilties in cert situons. New Code §358(h)(1)
provides: (1) the taXpayer must determine whether the basis of stock received as par of a tax-free
exchange exceeds its fai market value; and (2) if so, the shareholder must reduce the basis of such
stock by the amount of any

"liability" that is assumed in exchange for stock and does not otherwse
ths purose, new Code §358(h)(3) provides

reduce the transferor's basis due to the assumption. For

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that the term "liability" includes any fixed or contingent obligation to make payment, without regard

to whether such obligation or potential obligation is otherse taken into account under the Code.

Signficantly, new Code §358(h)(2) conta an exception from such treatent where the trade or
business or substatially all of

the assets with which the liabilty is "associated" are also transferred

to the controlled corporation. Ths new legislation is substantially similar to legislation proposed

by the Joint Commttee on Taxation ("Joint Commttee") on October 19, 1999 and the President's
Fiscal Year 2001 Revenue Proposals on Februar 1,2000. The effective date of

new Code §358(h)

is October 19, 1999, the same date as the intial Joint Committee Proposal.

'Although the Act only amends the provisions related to assumptions of liabilities by
controlled corporations, Section 309(c) of the Act authories and intrcts the Secretar of the

Treasur or his delegate to prescribe rules which provide appropriate adjustments in the case of
assumptions of liabilties by parerships to prevent acceleration or duplication of losses. The

effective date of

the àpplication of any such rues to parerships would be October 19, 1999 or such

later date as may be prescribed in such rules. It is highy likely that any later adoption of rues by
the Treasur Deparent or the Service comparable to Code §358(h) applicable to parerships
would have an effective date of

October 19, 1999. Thus, we address below the potential application
the Short Option.

of

ths new legislation to the Parership's assumption of

From the text of the new legislation, the prior proposals, the scant legislative history and
sumares of

the prior proposals, it appears that the new legislation was meant to elimiate those

ta strategies that use Code §357(c)(3) under which taxayers accelerate or duplicate losses by

separatig a contingent liabilty from the underlying asset with which such liabilty is associated.
For example, taxpayer owns real estate with contigent envionmental

liabilties associated with such

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. real estate. The tapayer causes a controlled corporation to assume the contigent environmental
liabilities but does not transfer the real estate to the corporation. histead, the tapayer trsfers cash
to the corporation in an amount equal to the expected environmental

liabilities. The tapayer takes

the position that its basis in the corporation's stock under Code §358 is the amount of cash
contrbuted to the corporation without reduction for the contmgent envionmental

liabilities. The

tapayer then sells the stock for a nominal amount and report a loss equal to the cash contrbuted

to the corporation. The corporation later obtais a deduction for the environmental 'liabilities
pursuant to Rev. RuL. 95-74.56 Thus, the tax strategy produces an accelerated loss for the taxpayer

and a duplicate deduction for the corporation, while the taxpayer keeps the underlyig real estate that
generated the liabilities. By

excludig from the new Code §358(h) treatment situtions where the

trade or business or substantialy all of the assets with which the liabilty is "associated" are also

transferred to the controlled corporation, Congress is targeting only those situtions where the
taxpayer retains a business or asset and transfers contingent liabilities related to such business or
asset to a controlled corporation.
The abuse tht Code §358(h) is intended to curb is not present in the Transactions described
herein. Presumably, the only asset tht initialy could be considered "associated"57 with the Short

Option is the option premium received on the sale of the Short Option. You used the Short Option
premium and other fuds to purchase the Long Option. Upon your purchase of

the Long Option, the

Ban required you to secure your potential contractual obligations under the Short Option with the

56 1995-2 C.B. 36.
57 A standad dictiona defintion of associate is "closely connected" or "closely related." Merran- Webster

International Dictionar of the English Laguage, Second Edition.
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Long Option. You then transfered the Long Option with the Short Option to the Parership.
Indeed the Ban has informed us that uness valuable collateral were substituted for the Long

Option, in order to assure that suficient assets were available in the event the potential contractual
obligation under the Short option became due, it would require that any tranfer of

the Short Option

be accompaned by a transfer of the Long Option. Thus, the only asset that could be considered
"associated" with the Short Option at the tie the Parership assumed the Short Option is the Long

Option. Because you transferred the Long Option with the Short Option, there has been no
separation of your potential contractual obligation under

the Short Option with any associated assets.

Indeed, you retaied no assets. Thus, it is more likely than not that the Short Option should not be
treated as a "liability" for puroses of

new Code § 358(h).

Conclusion
The plai and ordiar meang of

the term "liabilities" under Code §752 more likely than

not does not include a short option position such as the Short Option. This conclusion is supported
by the relevant authorities discussed above interretig the meanng of "liabilities" for

puroses of

Code §752. The Helmer case, a Tax Cour memorandum decision,

which is the closest authority,

unequivocally held that a short option position is not a liabilty for puroses of Code §752. The

recent Salia case, a Tax Cour memorandum decision holdig that a short sale is a liabilty,
acknowledges the contiuig authority of

the holdig in Helmer and distinguishes the option position

in Helmer from a short sale. Thus, based on these and other authorities discussed above, you should

more likely than not prevail on ths issue if challenged by the IR.

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F. YOUR TAX BASIS IN YOUR PARTNERSmp INTEREST WILL BE INCREASED . BY THE COST OF THE LONG OPTON POSITION CONTRIUTED, WITHOUT ADJUSTMENT FOR THE SHORT OPTION
In general, the basis of an interest in a parership is adjusted for contrbutions and
distrbutions made by a parer. A parer's tax basis is increased by the amount of money and the "

adjusted basis of propert contrbuted to the parership determed as of the date of contrbution,
and by the amount (if any) of gai recogned to the contrbutig parer at such time. Code section

722. The basis of a purchased interest is cost. Code section 742; Treas. Reg. sec. 1.742-1. A
parer's tax basis is decreased by the amount of

money or the adjusted basis of propert (other than

money) distrbuted to the parer other than in liquidation of the parership. Code section 733. If
the parership assumes liabilities of a parer in connection with his contrbution of propert to the
parership, such decrease in a parer's individual

liabilties is deemed to be a distrbution of money

to the parer by the parership. Code section 752(b). On the other hand, any increase in a parer's

share of

liabilities of a parership or in a parer's individual

liabilities by reason of

his assuption

of parership liabilities is deemed to be a contrbution of money by such parer to the

parership.

Code section 752(a). As discussed in Section E, these liabilities should, more likely than not, not
include the Short Option.
The adjusted basis of

the Long Option is its cost. Code section 1012. Accordingly, pursuant

to Code section 722, your tax basis in your Parership interest should be your cost basis increased
by the cost ofthe Long Option contrbuted, and you should more likely than not prevail on ths issue

if challenged by the IRS.

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G. TAX CONSEQUENCES DUE TO EXPIRTION OF TII OPTIONS
On April

17, 2000, the Long Option and the Short Option expired. Code section 1234

provides ,that options generally have the same chaacter in a taxpayer's hands as the underlying
propert would have in tht taxayer's hands. Because of

the special rules of Code section 988,

neither Euros nor Swiss Fracs would have the tax consequences of a capital asset to you or to the

Parershp.
Code section 988 provides special rues for the characterzation of gains or 10sses from

certai tranactions in foreign curency. In general, any disposition of any nonfctional curency
is treated as a "section 988 trsaction" and any

resultig gai or loss from such tranaction is treated

as foreign curency gai or loss (as the case may be). Code section 988(c)(I)(C). Any foreign

curency gain or loss is treated as ordinar income or loss (as the case may be). Code section
988(a)(I)(A). A nonfctional curency is a curency other th the dollar or the curency of

the

economic envionment in which a signficant par of the activities of a trade or business of the
taxpayer are conducted. (See Code section 985(b), which defies "fuctional curency.") Thus, for

you or for an entity such as the Parership, any curency other than U.S. Dollar would constitute

nònfctional curency, income or loss on which would be ordinar in natue, rather than capitaL.
Code section 1234A provides for capita treatment of income and losses from the expiration
of options in only one additional case: when the option is a Code section 1256 contract. As
discussed in Section D, the Options are not Code section 1256 contracts. Therefore, the loss realized

from the expiration of the Options is more likely than not ordiar loss. Consistent with the normal
rues of

parership accounting, Code section 705( a)(2)(A) provides that your basis in the Parership

wil be adjusted by your share of that loss.

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H. THE

CONTRBUTION

OF

YOUR

INTEREST

IN

JFWLC

TO

JFINC.

SHOULD

NOT BE TAXLE; BASIS is A CARYOVER BASIS
In general, no gai or loss is recogned upon a transfer of propert to a corporation by one

or more persons in exchange for stock in such corporation if imediately after such exchange, such
58 For these puroses, "control" is defied as
person or persons are in "control" of the corporation.

ownership of stock possessing at least 80 percent of

the total combined voting power of all classes

of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of
stock of the corporation.

59 Here, JFW Inc. has one class of stock, and you own 100 percent of all

such stock. Although no stock was actually issued by JFW Inc. in exchange for your contrbution
of the Parership interest, an actual issuance of

stock is not requied for Code §351 to applywhen

all the shareholders of a corporation contrbute proper to such corporation in the same proporton
as their interests in the corporation.60

Code §362(a) provides for JFW Inc. to take the contrbutor's basis in propert contrbuted
in a tax-free Code §351 exchange. Therefore, JFW Inc.'s tax basis in its interest in the Parership
should more likely than not be increased by the contrbutor's basis in the contrbuted interest as of
such contrbution.

58 Code §351(a); Treas. Reg. §1.51-1(a)(1).

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59 Code §368(c).
, 60 See Lessinger v. Commssioner. 872 F .2d 519 (2d Cir. 1989)( Code §351 applied to a propert trfer even

though no stock was issued; the actual issuance of shaes would have been a "meangless gestue"); Jackson v. Commssioner. 708 F.2d 1402 (9th Cir. 1983).
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