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In 1990, Diplomat Associates, then a two-person partnership,
defaulted on its mortgage notes. The creditor, a mortgage lender
unrelated to either partner, foreclosed upon the apartment
building. On May 30, 1991, the building was sold at auction for
$544,000. Subsequently, the creditor obtained a deficiency
judgment of approximately $870,000 against Diplomat Associates
and its two partners on the outstanding balance of the notes. By
the end of 1991, Diplomat Associates had no assets and only a
liability for the unpaid balance of the notes.
Diplomat Associates filed a return for 1991, purporting to
be a final return. On that return, Diplomat Associates reported
a section 1231 loss of $352,061, the difference between the
partnership's remaining tax basis in the property ($896,061) and
the foreclosure sale price. On his 1991 tax return, Phillip
claimed a deduction for $176,031, one-half of the loss.
In the notice of deficiency, respondent disallowed the
entire section 1231 loss deduction on the ground that Phillip had
not disposed of his entire interest in Diplomat Associates within
the meaning of section 469(g). Additionally, in the notice of
deficiency, respondent disallowed net operating loss (NOL)
deductions of $32,322 for 1992, $70,982 for 1993, and $89,466 for
1994. The NOL deductions were attributed to suspended passive
activity losses from Diplomat Associates carried over from years
prior to 1991. Respondent disallowed each NOL deduction on the
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