Jose Gracia and Nancy Gracia - Page 4

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          September 15, 1995, petitioner executed a contribution agreement            
          and pursuant to its terms contributed $220,000 to the                       
          partnership’s bankruptcy estate in exchange for release of “all             
          claims or potential claims of creditors against * * *                       
          [petitioner] arising out of or related to” the partnership.                 
               On December 19, 1995, the bankruptcy court entered an order            
          approving the contribution agreement.  In its order, the                    
          bankruptcy court specifically discharged and released petitioner            
          from any and all liability to the trustee and the bank arising              
          out of or relating to the partnership, petitioner’s status as a             
          general partner in the partnership, and the April 9, 1985,                  
          personal guaranty agreement.  In addition, the bankruptcy court’s           
          order released petitioner from “the claims or potential claims of           
          all creditors” of the partnership.  The bankruptcy court further            
          ordered that petitioner “is subject to the jurisdiction of the              
          Bankruptcy Court.”                                                          
          Tax Reporting                                                               
               For the 1995 tax year, the partnership issued petitioner a             
          Schedule K-1, Partner’s Share of Income, Credits, Deductions,               
          etc., allocating to him $195,120 of discharge of indebtedness               
          income.  Petitioners excluded this entire amount from their gross           
          income as reported on their joint 1995 Federal income tax return.           
          Notice of Deficiency                                                        
               By notice of deficiency, respondent determined that the                
          $195,120 of discharged debt should be included in petitioners’              
          1995 income.                                                                





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