Memorandum Findings of Fact and Opinion

Respondent determined deficiencies in the income tax liability of petitioners for the years 1962, 1963 and 1964 as follows:

Petitioners deny the existence of any deficiency and claim an overpayment with regard to their amended return for 1962 in the amount of $744.70 on account of a claimed investment credit.

Findings of Fact

The petitioners are individuals, husband and wife, who presently reside at, and who at the time of filing of the petition in this case resided at, 2307 Windsor Road, Alexandria, Virginia. They filed an original and an amended joint federal1968 Tax Ct. Memo LEXIS 22">*27 income tax return for the calendar year 1962, and original returns only for the calendar years 1963 and 1964 with the district director of internal revenue, Richmond, Virginia. James T. McKay will be referred to hereinafter as "petitioner."

On February 24, 1958, petitioner, who was then living in California, acquired by purchase a one-third interest in a partnership known as National Guidex Company, with a principal place of business at 216 Market Street, San Francisco, California. The original partners were Charles Tracey and Glenn E. Van Deveere, who formed the partnership in 1956. The principal business activity of the partnership was the sale of advertising space in a folder known as a Guidex designed to be used by householders in designated areas of a particular city in connection with their local telephone directory. After the advertisements were sold and the folders were printed they were mailed in bulk to the locality where the advertisers carried on their businesses for distribution to the householders. The partnership kept its records on a cash basis and filed its federal income tax returns on a calendar year basis.

Petitioner purchased his interest in the partnership1968 Tax Ct. Memo LEXIS 22">*28 as a result of following up a "business opportunity" advertisement in a San Francisco newspaper. He became intrigued with the possibilities of the partnership and its potential in making money and purchased his interest in the partnership in order to capitalize on this potential. As petitioner testified, he was "trying to buy potential; not office furniture."

At the time petitioner acquired his interest in the partnership it employed two clerical employees and had at least ten commission salesmen in the Northern California area. It also conducted franchise operations in Chicago, Illinois; Gary, Indiana; Toledo, Ohio; Cleveland, Ohio; Hackensack, New Jersey; Detroit, Michigan; Honolulu, Hawaii and Miami, Florida, and was planning another franchise operation for St. Louis, Missouri.

Also, at that time the partnership was occupying premises which it had leased at 1005 Market Street, San Francisco. It had engaged an accountant, was maintaining a bank account and had a city license to do business.

On February 24, 1958 a written agreement was entered into between the petitioner James T. McKay, Charles Tracey and Glenn E. Van Deveere under which the petitioner obtained a one-third interest1968 Tax Ct. Memo LEXIS 22">*29 in the partnership in return for his payment of $25,000 to Tracey and Van Deveere and his assumption of one-third of the partnership liabilities totaling $5,579.12, or $1,859.71.

The written agreement contained the following pertinent provisions:

An inventory shall be taken as of this day and the books of account of the partnership shall be closed. Immediately thereafter the books of account shall be adjusted to reflect the assignment to JAMES T. McKAY of a one-third interest in the net worth of the partnership. * * *

This partnership shall continue for a period of ten (10) years from date and from year to year thereafter, unless sooner terminated.

At that time the assets appearing on the balance sheet of the partnership consisted of cash, loans and prepayments, office equipment and accounts receivable; and the partnership's adjusted basis and the fair market value of these assets were as follows: 1480

1968 Tax Ct. Memo LEXIS 22">*30 The petitioner's one-third proportionate share of the adjusted basis and fair market value of these assets of the partnership on February 24, 1958 was as follows:

The 1958 partnership return contained a timely election to apply the provisions of section 743(b) of the 1954 Internal Revenue Code. ² Pursuant to this election the partnership increased the adjusted basis of the partnership property, as to the transferee-petitioner only, by the excess of the transferee-petitioner's interest in the partnership of $26,859.71, over his proportionate share of the adjusted basis of the partnership property of $489.20, or a total of $26,370.51. The special basis adjustment to the transferee-petitioner1968 Tax Ct. Memo LEXIS 22">*31 of $26,370.51 was allocated by the partnership, as in column (c) below:

The unallocated portion of the special basis adjustment of $12,770.22 was not then assigned by the partnership to either tangible or intangible assets.

During the taxable years 1958 through 1961, the petitioner collected a portion of the partnership accounts receivable which he had treated as having a special basis to him of $13,600.29. On his federal income tax returns for the years 1958 through 1961, the petitioner noted the collection of these receivables but did not include them in gross income due to the fact that the amounts collected together1968 Tax Ct. Memo LEXIS 22">*32 with the bad debts charged off were not in excess of the special basis claimed by him of $13,600.29. However, petitioner's share of the amounts of the receivables collected or charged off were properly used by him in the reduction of his special basis therein which as of December 31, 1961, had been reduced to $4,896.72, and his adjusted basis with regard to his partnership interest had been reduced to $18,156.14. 1481

During the taxable years 1958 through 1961, the petitioner did not claim any deduction with respect to the unallocated portion of the special basis adjustment of $12,770.22, but the partnership claimed depreciation deductions with respect to the office equipment in which it had an adjusted basis, as of February 24, 1958, of $401.20.

Shortly after petitioner purchased the partnership interest in National Guidex Co. a corporation was organized by petitioner, Tracey and Van Deveere, each of whom owned 8 shares of its stock. Without any formal transactions between it and the partnership, the corporation commenced the conduct of the same business carried on by the partnership (including the collection of its accounts in return for a management fee) in the premises1968 Tax Ct. Memo LEXIS 22">*33 leased by the partnership and using the office equipment of the partnership which it leased on a month-to-month basis. The corporation had the same employees, commission salesmen and franchise operations. By the middle of 1959 Tracey and Van Deveere had ceased to have any connection with either the partnership or the corporation. After the middle of 1959 petitioner was alone in the business. Thereafter petitioner carried on the business by trying to solicit new business, to develop the product and to improve its saleability and "the potentiality of repeat business."

The taxable income of the partnership for the calendar years 1957 through 1961, as reflected on the federal income tax returns filed by the partnership were as follows:

Petitioner accepted employment with the U.S. Department of Commerce on December 8, 1961. In 1962 he learned that this employment would require him to live in Washington, D.C. At or about this time he decided to wind up the Guidex business in California. His income tax return for 1962 recites that the office equipment here in question was acquired by him on January 1, 1962, and1968 Tax Ct. Memo LEXIS 22">*34 that the liquidation of the partnership occurred as of December 31, 1961.

Opinion

KERN, Judge: There is little dispute between the parties with regard to the evidentiary facts in this proceeding, many of which have been stipulated. The parties are even in agreement with regard to some factual conclusions as to which the evidentiary facts are not clear, e.g., that the office equipment was used by the partnership in its business up to the time of its dissolution and thereafter by petitioner, and that the partnership assets (including the office equipment) were distributed to petitioner upon the dissolution of the partnership which took place on December 31, 1961. ³

Upon the undisputed facts contained in the record before us we decide the issues presented by the parties in favor of respondent, with the1968 Tax Ct. Memo LEXIS 22">*35 caveat that the amount of petitioner's basis in the office equipment and consequently the amounts of depreciation thereon properly allowable to petitioner should be slightly higher than the amounts used by respondent in his determination of deficiency, as respondent concedes on brief.

On this issue involving the proper basis to petitioner of the office equipment for purposes of computing his depreciation deductions during the taxable years petitioner contends that the proper basis to him as a transferee partner pursuant to the provisions of sections 743, 754 and 755 of the Code should be $12,770.22, the amount of the unallocated portion of the special basis adjustments provided by those sections. We set out in the margin hereof section 743(b) and section 755. ⁴ Petitioner predicates these contentions on the argument that the only 1482 property distributed to him on the liquidation of the partnership with regard to which an adjustment to basis could have been made ⁵ consisted of the office equipment and this property was depreciable in his hands over a ten year period beginning January 1, 1962.

1968 Tax Ct. Memo LEXIS 22">*36 Respondent originally determined that the basis of this property to petitioner was $377.76 with a remaining estimated life of five years. On brief respondent contends that the basis was $420.13. This small increase in petitioner's special basis conceded by respondent relating to the office equipment results from the adjustments to his partnership basis called for by section 705 on account of the distributions made to him by the partnership which were properly deducted from his basis as to the receivables instead of being reported in income. Consequently his adjusted basis relating to his partnership basis called for by section 705 to the receivables are to be considered under section 732(c) as being the respective amounts of $18,156.14 and $4,896.72. Respondent explains that the difference between these two figures, or $13,259.42 should be allocated among the assets of the partnership other than the accounts receivable in proportion to their adjusted basis to the partnership as required by section 732(b). We set out in the margin hereof section 732(b) and (c). ⁶ Respondent contends that these remaining assets consisted of the office equipment and a non-depreciable intangible asset1968 Tax Ct. Memo LEXIS 22">*37 which was in the nature of going concern value or good will or profit potential. By applying the provisions of Treasury Regulations 1.732-1(d)(vi) and 1.732-2(c) respondent computes that the proper allocation of petitioner's special basis is as follows:

The crucial questions are whether the partnership possessed any such non-depreciable intangible asset in 1958 and whether petitioner purchased a part thereof in that year to which a part of petitioner's special basis should be allocated.

1968 Tax Ct. Memo LEXIS 22">*38 Petitioner first argues that because the only specific references to the existence of an intangible which are contained in the pleadings are allegations of the petition with regard to "good will" which were denied in respondent's answer, we are 1483 precluded from finding the existence of any other intangible asset of the partnership, that the burden of proving the existence of good will or any other intangible as an asset of the partnership is on respondent, and that the facts of record are inconsistent with the existence of good will.

It is obvious that implicit in respondent's determination with regard to the depreciation deductions disallowed was a determination that petitioner was not entitled to increase his basis with regard to office equipment by assigning thereto in 1962 any part of the "unallocated portion of special basis adjustment" in the amount of $12,770.22. Petitioners' allegations of error are as follows:

The determination of the tax set forth in the said notice of deficiency is based upon the following errors:

(a)(i) The Commissioner decreased the amount of allowable depreciation on office equipment in each of the years 1962, 1963, and 1964, by changing1968 Tax Ct. Memo LEXIS 22">*39 the acquisitions basis of petitioners' cost from the claimed special adjusted basis of $12,770.22 on acquisition of a partnership interest to the sum of $666.67 as the basis of allowable cost for special adjusted basis.

(ii) Further, upon information and belief, the petitioners allege that it is the position of the Commissioner that the petitioners paid some $12,200 for "good will" and that this good will was contributed to the National Guidex Corporation, and that petitioners were entitled to capital loss in 1962 with carryover based on the worthlessness of this stock claimed in petitioners' 1964 return.

Paragraph 5(b) of their petition reads as follows:

(b) That petitioners' total cost basis of $26,859.71 for the partnership interest transferred was properly allocated as follows:

Thus the burden of proving "the absence of any assets other than office equipment" is on petitioners in addition to proving that good will was not an asset of the partnership.

In our opinion, petitioners have failed to carry their burden of proof. Indeed, the record as a whole supports a conclusion to the contrary. Petitioner was willing to and did pay over $26,000 for a one-third interest in a partnership at a time when one-third of the stipulated fair market value of its tangible assets was a little over $1,000 and one-third of the fair market value of its only other book asset (accounts receivable) was $13,600. ⁷ His own testimony was to the effect that he was not interested in the value of the specific partnership assets shown on its books (cash, loans and prepayments, office equipment and accounts receivable) but was "trying to buy potential [in making money]." Petitioner did not prove that this "potential" was anything other than an intangible asset either in the nature of going concern value, United States v. Cornish, 348 F.2d 175">348 F. 2d 175, or good will, Jack Daniel Distillery v. United States, 379 F.2d 569">379 F. 2d 569.1968 Tax Ct. Memo LEXIS 22">*41 See also Seaboard Finance Co. v. Commissioner, 367 F.2d 646">367 F. 2d 646, 367 F.2d 646">649-50, affirming a Memorandum Opinion of this Court, and Boe v. Commissioner, 307 F.2d 339">307 F. 2d 339, affirming 35 T.C. 720">35 T.C. 720.

Petitioners' second contention is that they are entitled to an investment credit as a result of the acquisition by petitioner James T. McKay of the office equipment from the partnership upon the partnership's liquidation. Assuming petitioner acquired the office equipment on January 1, 1962, both parties agree that the office equipment was "tangible personal property" which might constitute "section 38 property" as described in section 48(a)⁸ of the Code. The question then arises as to whether it is a "qualified investment," under the provisions of section 46(c)(1)(A) or (B), i.e., whether it 1484 is "new section 38 property" or "used section 38 property" as defined in section 48(b) and 48(c)(1). Both parties agree that it is not "new section 38 property" described in section 48(b). ⁹

1968 Tax Ct. Memo LEXIS 22">*42 The parties differ, however, on whether the definition of "used section 38 property" in section 48(c) applies to the office equipment in question. That section states, in pertinent part:

SEC. 48(c). Used Section 38 Property. -

(1) In General. - For purposes of the subpart, the term "used section 38 property" means section 38 property acquired by purchase after December 31, 1961, which is not new section 38 property. Property shall not be treated as "used section 38 property if, after its acquisition by the taxpayer, it is used by a person who used such property before such acquisition (or by a person who bears a relationship described in section 179(d) (2)(A) or (B) to a person who used such property before such acquisition). * * *

(3) Definitions. - For purposes of this subsection -

(A) Purchase. - The term "purchase" has the meaning assigned to such term by section 179(d)(2).

Petitioner maintains that he has complied with section 48(c) since he acquired the office equipment: (1) by "purchase," as defined in that section and other sections made applicable thereto by cross reference; 1968 Tax Ct. Memo LEXIS 22">*43 (2) from a different "person," namely the partnership in which he asserts he had a one-third interest by virtue of the written agreement to purchase a one-third interest in the partnership which he entered into on February 24, 1958; and (3) after midnight of December 31, 1961, the moment at which he contends the partnership terminated for tax purposes and presumably wound up its affairs for purposes of local California law. Respondent, on the other hand, argues that petitioner did not comply with the requirements of section 48(c) by meeting any of the conditions which the petitioner maintains that he met.

Section 48(c) as set out above, states that property which might otherwise be treated as "used section 38 property" cannot be so treated if, before its acquisition by a taxpayer it was used by a person bearing a relationship to the taxpayer described in section 179(d)(2)(A). Section 179(d)(2)(A), ¹⁰ describes such a person as a person from whom the acquisition of property would result in the disallowance of losses under section 707(b). And section 707(b)(1)(A)¹¹ describes such a person as a partnership in which the taxpayer as a partner owned directly or indirectly more than1968 Tax Ct. Memo LEXIS 22">*44 50 percent of either the capital interest or the profits interest.

1968 Tax Ct. Memo LEXIS 22">*45 Despite the terms of the agreement of February 24, 1958 under which petitioner initially purchased his partnership interest it appears that before the claimed dissolution of the partnership on midnight December 31, 1961 petitioner was a member of the partnership here involved in which he owned 100 percent of the capital interest, if indeed the partnership then existed and had not been dissolved prior to that date. In any event it is clear from the facts which we have before us in this record that we cannot make a finding that petitioner did not own "more than 50 percent of the 1485 capital interest, or the profits interest, in [the] partnership." Petitioner himself testified that Tracey and Van Deveere, his former partners, ceased to have any connection with the partnership by the middle of 1959 and that he had little, if any contact with either of them thereafter. His treatment of the assets of the partnership upon the alleged liquidation of the partnership on December 31, 1961, or January 1, 1962, and prior and subsequent thereto, indicates that he took over all of these assets under claim of right and without regard to any rights which might have been claimed by a former*46 partner. With regard to one of his former partners he testified that the partner "turned back his stock in the corporation" and "ceased to take part in the activities of the partnership or corporation" after November, 1958. He also testified that he was "alone in the business" after "the middle of 1959 definitely." All of this is consistent with his having acquired, prior to 1961, "more than 50 percent of the capital interest, or the profits interest, in [the] partnership." Petitioner has completely failed to prove the contrary, i.e., that he held a capital interest or a profits interest of 50 percent or less in the partnership immediately before its dissolution on midnight December 31, 1961.

For these reasons we conclude that the office equipment was not "used section 38 property" because, before its use by petitioner, it was used by a person related to petitioner in a manner described in the second sentence of section 48(c)(1). Therefore petitioner is not entitled to his claimed investment credit.

Decision will be entered under Rule 50.