## Facts

- Multiple taxpayers were partners in Marc Equity Partners I, a limited partnership formed to acquire and operate apartment buildings near Buffalo, New York.
- The partnership operated on a calendar year and used the accrual method for tax purposes.
- By 1974–1975, the partnership faced serious financial distress, defaulted on mortgages, and lost one property to foreclosure.
- In 1975, the partnership obtained $300,000 in additional capital, contributed by (i) some existing limited partners, (ii) a general partner, and (iii) three new investors.
- Effective October 1, 1975, the partnership amended its agreement to create Class A (original limited partners) and Class B (contributors of additional capital, including both existing and new investors).
- The amendment reallocated 98% of all 1975 profits and losses to the Class B limited partners and 2% to the general partners, in consideration for the additional capital.
- The partnership incurred about $934,000 of losses in 1975.
- Class B limited partners claimed their distributive shares of 1975 losses on their individual returns, including losses attributable to periods before October 1, 1975.
- The Commissioner disallowed the portion of Class B partners’ claimed losses that accrued before October 1, 1975.

## Issues

1. Whether I.R.C. § 706(c)(2)(B) permits a partnership to retroactively reallocate losses accrued before new capital was contributed to partners receiving the allocation as consideration for that capital.
2. Whether, if such retroactive reallocation is impermissible, the partnership may instead allocate the year’s losses using a “year-end totals” method that spreads losses ratably over the year.
3. Whether a retroactive reallocation of losses to general partners is permissible when it is not tied to additional capital contributions.

## Decision

- The Tax Court held that § 706(c)(2)(B) did not allow reallocating pre-October 1975 losses to the Class B limited partners when the reallocation was made as a result of the additional capital contributions.
- The court held it was irrelevant that some Class B members were existing partners; the statutory bar applied to retroactive allocations purchased with new capital.
- The court upheld the retroactive reallocation of losses to the general partners because that reallocation was not made as a result of additional capital contributions.
- The court rejected the partnership’s attempt to use a year-end totals method to allocate 1975 losses ratably over the year.
- The Commissioner’s disallowance was sustained as to the pre-October 1, 1975 losses claimed by the Class B limited partners, with computations to be finalized under Rule 155.

## Legal Principles

- Under I.R.C. § 706(c)(2)(B), partnership items must be allocated by taking into account partners’ varying interests during the taxable year.
- Section 706(c)(2)(B) does not permit retroactive shifting of losses accrued before a midyear change to partners who receive the allocation as consideration for new capital contributed later in the year.
- The prohibition applies whether the contributing partners are new investors or existing partners increasing their interests.
- Retroactive reallocations not resulting from additional capital contributions may be respected when consistent with the partners’ arrangement and not used to transfer preexisting losses to capital contributed later.
- A partnership may not cure an impermissible retroactive allocation by switching after the fact to a year-end totals method that ignores when interests actually varied during the year.

## Conclusion

The Tax Court disallowed retroactive allocations of partnership losses accrued before October 1, 1975 to Class B limited partners because the allocations were made in exchange for additional capital, upheld a separate retroactive reallocation to general partners not tied to new capital, and refused to permit a year-end totals approach to spread the year’s losses ratably.


Lipke v. Commissioner, 81 T.C. 689 (1983)