## Facts

- Outer Drive East Corporation (Outer Drive), a wholly owned subsidiary of Jupiter Corporation, was the majority owner and general partner of Randolph Outer Drive Venture (the Venture).
- Empire Properties (Empire) was a limited partner and minority owner in the Venture.
- Under the partnership agreement, Outer Drive loaned the Venture $4,000,000 for a construction project.
- The Venture later reorganized to raise money to repay Outer Drive’s $4,000,000 loan by admitting two new limited partners (the Wilkows).
- Outer Drive wanted to remain in control of the Venture’s management after the reorganization, and the Wilkows did not want any control role.
- The Wilkows were admitted with a 20% partnership interest and received a guaranteed annual return that was unique to them.
- The Wilkows provided value to the Venture through both a capital contribution and a loan.
- The Wilkows’ 20% interest was carved entirely out of Outer Drive’s partnership interest; Empire’s percentage interest did not change.
- Shortly after the Wilkows were admitted, the Venture used proceeds of the Wilkows’ loan to repay Outer Drive’s $4,000,000 loan.
- The Venture also distributed the remaining amounts from the Wilkows’ loan and capital contribution to Outer Drive and Empire.
- The Commissioner of Internal Revenue treated the amounts received by Outer Drive as proceeds from Outer Drive’s sale of a portion of its partnership interest (a taxable transaction).
- Outer Drive contended the amounts it received were a partnership distribution governed by I.R.C. § 731, which generally allows nonrecognition of gain on money distributed by a partnership unless the money exceeds the partner’s adjusted basis in its partnership interest.

## Issues

1. Whether the cash received by Outer Drive in connection with the admission of the Wilkows was, in substance, consideration for a taxable sale of a portion of Outer Drive’s partnership interest rather than a nonrecognition partnership distribution under I.R.C. § 731.
2. Whether the steps—admitting the Wilkows, their loan and capital contribution, repayment of Outer Drive’s loan, and the related distributions—should be treated together to determine the transaction’s tax character.

## Decision

- The court entered judgment for the United States and denied Jupiter/Outer Drive’s refund claim.
- The court sustained the Commissioner’s determination that the amounts Outer Drive received were taxable proceeds from a sale of a portion of Outer Drive’s partnership interest to the Wilkows.
- The court rejected Outer Drive’s attempt to treat the cash it received as a nonrecognition distribution under I.R.C. § 731.

## Legal Principles

- Federal tax treatment follows the substance of a transaction rather than the labels or mechanics used to carry it out.
- When new investors enter a partnership and the economic effect is that an existing partner’s interest is reduced while that partner receives cash funded by the new investors, the payment may be treated as consideration for a sale or exchange of a partnership interest.
- I.R.C. § 731’s nonrecognition rule for partnership distributions does not apply when the payment is, in substance, sale proceeds for a transferred partnership interest, even if the funds move through the partnership.
- In determining tax consequences, courts may evaluate a multi-step arrangement as a single transaction when the steps are closely connected and collectively produce the economic result at issue.

## Conclusion

Jupiter Corp. v. United States held that, given the Wilkows’ entry on special terms and the near-immediate flow of their contributed funds to the existing partners along with a reduction of Outer Drive’s ownership, the transaction functioned as a taxable sale of part of Outer Drive’s partnership interest rather than a nonrecognition partnership distribution under § 731.


Jupiter Corp. v. United States, 2 Cl. Ct. 58 (1983)