Demirjian v. Commissioner
29 A.F.T.R.2d (RIA) 72, 457 F.2d 1 (1972)
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Rule of Law:
Under Section 703(b) of the Internal Revenue Code, any tax election affecting the computation of a partnership's taxable income, including the nonrecognition of gain from an involuntary conversion under Section 1033, must be made by the partnership as an entity, not by the individual partners.
Facts:
- Anne and Mabel Demirjian dissolved their corporation, Kin-Bro Realty Corporation, and its chief asset, an office building, was conveyed to them as 'partners trading as Kin-Bro Real Estate Company'.
- The Demirjians filed a trade name certificate indicating their intent to conduct a real estate investment business as Kin-Bro Real Estate Company.
- On September 12, 1962, the office building, which was the partnership's sole operating asset, was involuntarily sold to the Newark Housing Authority through a condemnation proceeding.
- The net proceeds from the condemnation sale were distributed equally to Anne and Mabel.
- Anne and Mabel each used their individual shares of the proceeds to purchase separate replacement properties in their individual capacities.
- The partnership, Kin-Bro Real Estate Company, never reinvested the proceeds or purchased a replacement property.
Procedural Posture:
- Anne and Mabel Demirjian filed amended 1962 joint tax returns reporting only a portion of the gain from the condemnation sale.
- The Commissioner of Internal Revenue disagreed with their computation and assessed tax deficiencies against them, asserting the § 1033 election was invalid.
- The taxpayers petitioned the U.S. Tax Court to challenge the Commissioner's finding of deficiencies.
- The Tax Court affirmed the Commissioner's decision, ruling in favor of the government.
- The taxpayers, as petitioners, sought review of the Tax Court's adverse decision in the U.S. Court of Appeals for the Third Circuit.
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Issue:
Does Section 703(b) of the Internal Revenue Code require a partnership, rather than its individual partners, to make the election and replacement of property to qualify for nonrecognition of gain under Section 1033 following an involuntary conversion of partnership property?
Opinions:
Majority - Van Dusen, J.
Yes. Section 703(b) of the Internal Revenue Code requires that the election and replacement under § 1033 be made by the partnership. The court first determined that the property was owned by a partnership, Kin-Bro Realty, based on how the Demirjians held title, filed trade name certificates, and conducted their business. The court then reasoned that the Internal Revenue Code treats a partnership as an entity for the purposes of computing and reporting income. Section 703(b) explicitly mandates that any election affecting the computation of a partnership's taxable income must be made by the partnership itself. An election for nonrecognition of gain under § 1033 directly affects this computation. This entity-level approach prevents the confusion that would arise if each partner made separate elections for partnership income. Therefore, the individual replacements made by the partners were ineffective, and the gain from the conversion must be recognized by the partnership and passed through to the partners.
Analysis:
This decision solidifies the 'entity theory' of partnership taxation for the purpose of making tax elections. It establishes a clear precedent that elections affecting partnership income, such as the nonrecognition of gain under § 1033, are not severable and cannot be made by individual partners for their distributive shares. This ruling reinforces the administrative goal of treating the partnership as the central unit for income computation to avoid complexity and inconsistency. Consequently, partners in similar situations must ensure that the partnership entity itself takes all necessary steps to elect and reinvest proceeds to defer gain, as individual actions will be deemed legally ineffective.
