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used in a trade or business. However, since the LLC never owned
the Fitch Property, any reconveyance reported by the LLC was
wholly fictitious.
As part of tax planning advice from Rob Lambert, petitioners
and the Partnership were advised to report the gain from the sale
of the Fitch Property as cancellation of indebtedness income on
their 1994 return, which is not recognized after the application
of section 108. Petitioners simply failed to report the
transaction on any tax return.
As noted previously, the Partnership filed an amended 1993
tax return in which it stated that a deed in lieu of foreclosure
was delivered on May 27, 1994, and that the Form 1099-A issued by
AAL showing that the transaction occurred in 1993 was “wholly
inaccurate” and that AAL erred in reporting the transaction in
1993. It further alleged that the subject property had been
previously transferred to the LLC pursuant to a tax-free
partnership division and that the LLC would correctly report the
transaction. In reliance on the advice received from Rob
Lambert, the LLC, on its Form 1065 for 1994, reported the section
1231 gain as cancellation of debt income excluded from gross
income pursuant to section 108(a)(1)(B) by applying the
insolvency test at the entity level; i.e., the LLC was insolvent
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