## Facts

- Taxpayers were limited partners in five similar limited partnerships formed to conduct oil and gas drilling operations.
- Each partnership contracted with Fairfield Drilling Corporation to drill and develop wells and provide equipment and expertise.
- Under turnkey arrangements, each partnership paid Fairfield some cash and also executed a non-interest-bearing, 15-year recourse note secured by substantially all partnership assets.
- Note principal was payable from partnership net income if drilling succeeded.
- The notes imposed direct personal liability only on the general partners.
- Partnership agreements required limited partners, if the notes were unpaid at maturity, to make additional capital contributions upon a call by the general partners to cover any deficiency.
- The partnerships used accrual accounting and elected to expense intangible drilling costs, generating partnership losses allocated to limited partners proportionally to their capital contributions.
- The IRS disallowed deductions attributable to losses financed by the recourse notes, asserting the limited partners were not “at risk” under I.R.C. § 465; alternatively, the IRS argued § 465(b)(3) applied because Fairfield had an impermissible role in the activity.
- The Tax Court held the limited partners were at risk only to the extent of their actual cash contributions and did not reach the IRS’s alternative § 465(b)(3) argument.

## Issues

1. Whether limited partners were “at risk” under I.R.C. § 465 for amounts represented by partnership recourse notes to the driller when limited partners were not direct obligors on the notes but faced potential capital-call obligations.
2. Whether, even if the limited partners were otherwise at risk, I.R.C. § 465(b)(3) denied at-risk treatment because the creditor (Fairfield) had an impermissible role in the activity.

## Decision

- The Ninth Circuit rejected the Tax Court’s rationale that the limited partners categorically lacked at-risk amounts beyond their cash contributions.
- The court vacated the Tax Court’s disposition to the extent it rested on that rationale.
- The court remanded for consideration of the IRS’s alternative theory under § 465(b)(3) regarding Fairfield’s impermissible role as creditor in the activity.

## Legal Principles

- At-risk status under I.R.C. § 465 turns on the taxpayer’s real exposure to economic loss, not solely on formal labels such as limited-partner status or whether the taxpayer signed the underlying note.
- Enforceable contractual obligations that can require a limited partner to contribute additional capital to satisfy partnership debt may create at-risk exposure, even if only the general partners are direct note obligors.
- Even when an arrangement appears to place taxpayers at risk under § 465(b)(1)–(2), § 465(b)(3) may still bar at-risk treatment where the creditor’s involvement in the activity exceeds a permissible lender role, requiring a fact-specific inquiry.

## Conclusion

The Ninth Circuit held the Tax Court used an overly rigid approach in limiting limited partners’ at-risk amounts to cash contributions and remanded for the Tax Court to assess whether § 465(b)(3) nonetheless precluded at-risk treatment due to the creditor’s impermissible role in the oil-and-gas activity.


Pritchett v. Commissioner, 827 F.2d 644 (9th Cir. 1987)