## Facts

- Individual taxpayers were limited partners in tiered limited partnerships that claimed indirect ownership interests in a Bakersfield, California department store subject to a sale–leaseback.
- A newly formed single-purpose corporation acquired the store and leased it back to the retailer under a long-term triple-net lease.
- The acquisition was financed by notes to institutional lenders secured by a mortgage/trust deed and an assignment of the lease and rents.
- Lease rents were structured to match the corporation’s required principal and interest payments on the notes, with rent dropping after the debt was fully paid.
- Interests in the financing corporation were later transferred to entities associated with the partnership promoters, and limited partners acquired interests through multiple partnership tiers.
- The partnerships reported substantial losses, primarily from depreciation on the building and interest on financing obligations, which flowed through to the limited partners’ individual returns.
- The IRS disallowed the claimed partnership losses and challenged deductions for payments made to promoters/general partners as currently deductible expenses.
- Experts offered competing views on whether the arrangement had economic viability apart from tax benefits.

## Issues

1. Whether the sale–leaseback and related partnership tiers constituted a genuine multiparty transaction with economic substance such that petitioners obtained tax ownership supporting depreciation and interest deductions.
2. Whether payments to promoters/general partners in connection with forming and marketing the partnerships were currently deductible or required capitalization as capital expenditures.

## Decision

- The Tax Court sustained the IRS’s disallowance of the limited partners’ distributive shares of partnership losses based on depreciation and interest.
- The court held the overall arrangement was not a genuine multiparty transaction with economic substance and did not transfer tax ownership of the property to the partnerships.
- The court held specified payments to promoters/general partners were nondeductible capital expenditures rather than currently deductible business expenses.
- Deficiencies were upheld, subject to computations.

## Legal Principles

- Depreciation and interest deductions from a sale–leaseback require that the taxpayer (directly or through a partnership) obtain tax ownership through a genuine multiparty transaction with economic substance.
- Substance controls over formal documentation; extensive lender control and rent streams effectively locked to debt service may show the purported owner lacks meaningful benefits and burdens of ownership.
- Where the taxpayer’s equity, risk, and profit potential are remote or illusory and the arrangement is explainable primarily by tax results, claimed ownership-based deductions may be denied.
- Payments to promoters or general partners made to create, acquire, or market partnership interests are generally capital expenditures and must be capitalized rather than deducted currently.

## Conclusion

The Tax Court treated the tiered-partnership sale–leaseback as lacking economic substance and denied depreciation and interest loss passthroughs to the limited partners, while requiring capitalization of promoter and general-partner payments tied to forming and selling the investment structure.


Hilton v. Commissioner, 74 T.C. 305 (1980)