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In July 1993, Salina filed a Form 1065 for the short tax year
December 28 to December 31, 1992, reporting portfolio income of
$700,713, investment expenses of $19,469, and a net short-term
capital gain of $344,234,365. On Schedule K-1, Partner’s Share of
Income, Credits, Deductions, Etc., attached to the return, Salina
allocated $337,343,455 of its short-term capital gain to FPL.
Salina concluded that it realized a $344,234,365 net short-
term capital gain following the December 30, 1992, liquidation of
its investments based upon a complex set of partnership basis
adjustment rules that were purportedly invoked upon FPL’s purchase
of its 98-percent Salina partnership interest. In particular,
relying on sections 708(b)(1)(B) and 732(b), and section 1.708-
1(b)(1)(iv), Income Tax Regs., Salina concluded that upon FPL’s
acquisition of its 98-percent partnership interest on December 28,
1992, (1) the partnership was deemed terminated, (2) the
partnership’s assets (consisting of $140 million in 2-year Treasury
notes and a $344,575,000 loan receivable due from ABN pursuant to
the Salina/ABN master repurchase agreement) were deemed distributed
in pro rata shares to the new Salina partners, and (3) those assets
were deemed recontributed to the partnership with a substituted
basis equal to the aggregate of the partners’ outside bases.
Relying on the aforementioned statutory and regulatory provisions,
Salina determined that its substituted basis (from its partners) in
its assets was less than the fair market value of the assets in the
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