1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 5901 GREEN VALLEY CIRCLE 3 CULVER CITY, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 JUNE 21, 2011 10 11 CORPORATE FRANCHISE AND PERSONAL INCOME TAX HEARING 12 APPEAL OF 13 GERALD J. MARCIL AND CAROL L. MARCIL 14 NO. 458832 15 AGAINST PROPOSED ASSESSMENT OF 16 ADDITIONAL INCOME TAX 17 18 19 20 21 22 23 24 25 Reported by: Juli Price Jackson 26 CSR No. 5214 27 28 1 1 P R E S E N T 2 For the Board Jerome E. Horton of Equalization: Chair 3 Michelle Steel 4 Vice-Chairwoman 5 Betty T. Yee Member 6 George Runner 7 Member 8 Marcy Jo Mandel Appearing for John 9 Chiang, State Controller (per Government Code 10 Section 7.9) 11 Diane G. Olson Chief 12 Board Proceedings Division 13 14 For Board of Lou Ambrose Equalization Staff: Staff Counsel 15 Grant Thompson 16 Tax Counsel 17 For Franchise Tax David Gemmingen 18 Board: Tax Counsel 19 Ciro Immordino Tax Counsel 20 21 For Appellants: Layton L. Pace 22 Attorney 23 Gerald J. Marcil Taxpayer 24 25 ---oOo--- 26 27 28 2 1 2 5901 GREEN VALLEY CIRCLE CULVER CITY, CALIFORNIA 3 JUNE 21, 2011 4 ---oOo--- 5 MS. OLSON: We will continue to item B1, Gerald 6 J. Marcil and Carol L. Marcil. 7 Please come forward. 8 Board Proceedings has received contribution 9 disclosure forms for this morning's hearings from the 10 parties, agents and participants. All forms were 11 properly completed and signed. All parties, agents and 12 participants are on the alpha listing provided to your 13 office. 14 Each person sitting at the table will be asked 15 to introduce themselves and, if necessary, their 16 affiliation with the taxpayer for the record. 17 Ten minutes is allocated for the taxpayer's 18 opening presentation, followed by ten minutes for the 19 Franchise Tax Board's presentation and five minutes is 20 allocated to the taxpayer for rebuttal. 21 Mr. Horton? 22 MR. HORTON: Thank you very much. 23 Mr. Ambrose, will you please introduce the 24 issues in this case? 25 MR. AMBROSE: Yes, sir. 26 Good morning, Chairman Horton, Members of the 27 Board. The issues in this case are whether the 28 Appellants' limited partnership satisfy the requirements 3 1 for a like kind exchange pursuant to Internal Revenue 2 Code 1031 and, secondly, whether the Board has 3 jurisdiction to hear the post amnesty penalty appeal. 4 MR. HORTON: Thank you. 5 The taxpayer will have ten minutes to make 6 their presentation, at which time we will go to the 7 Department and then return to you on rebuttal. 8 Please commence with your presentation, 9 starting with your introduction for the record. 10 MR. PACE: All right, thank you so much, 11 Mr. Chairman and Board Members. My name is Layton Pace. 12 I am counsel for the Appellants. To my left is Gerald 13 Marcil, who is the Appellant. 14 I apologize in advance for reading from a 15 prepared statement. I'm afraid I'm not going to get 16 through ten minutes without looking at this. 17 MR. HORTON: Sure. 18 MR. PACE: The -- this matter is an appeal of a 19 Notice of Action dated April 30th, 2008 for the 20 Appellants' 2001 tax year for personal income taxes in 21 the approximate amount of $300,000. 22 The sole issue of this appeal for this Board to 23 decide is whether Hollywood Vista, HVA, completed a 24 valid, deferred like kind exchanges under IRC Section 25 1031. 26 Hereafter I'll just drop "Internal Revenue 27 Code" and just say "section." I wish to begin with what 28 I believe is an agreed upon position with Respondent and 4 1 that is that none of the transactions that happened 2 before November 20th, 2001 invalidated the 1031 3 exchange. That is stated in the case summary. It's 4 stated in the opening brief of Respondent. 5 The Appellants' position is that the 6 transactions which occurred on or after November 20th, 7 2001 did not invalidate the 1031 exchange. 8 The Appellant asserts that under two grounds. 9 First, HVA merged and consolidated with -- with a 10 limited liability company called Manchester Development, 11 LLC, or MD, LLC, with Hollywood Vista, HVA, surviving 12 for income tax purposes. 13 And that's because HVA -- HVA owned 60 percent 14 of the Manchester property. In a sense, the larger of 15 the two partnerships continues for income tax purposes 16 in a partnership merger under Section 708, regardless of 17 which entity dissolves with the Secretary of State. HVA 18 still held the Manchester property after the 19 transactions with MD, LLC. So, it didn't get rid of it, 20 it still had it. 21 Second, if it's found that there was no merger 22 under 708, HVA properly held its interest in the 23 Manchester property for purposes of 1031 under 24 longstanding case law. 25 I did prepare a diagram, which I thought might 26 help us understand the transaction. It's got two pages. 27 The first page shows on the left HVA. It shows it's 28 owned by the Marcils, 49 and a half, 49 and a half and 5 1 1 percent of a general partner, Woodglen, that they own. 2 It also shows that HVA owns its property, not directly, 3 but through a disregarded entity, a single member LLC, 4 but it's treated as if it directly owns it and reports 5 it as if it directly owns it. 6 On the left -- I'm sorry, on the right is MD, 7 LLC. And you'll see that it acquired a 40 percent 8 interest in the Manchester property. On the second page 9 you'll see as of December 20th, 2001 that HVA was no 10 longer there. The Lava Rock was completely empty, had 11 no assets and that MD, LLC was owned 40 percent by John 12 Walsh and 60 percent by the Marcils as community 13 property and that MD, LLC owned 100 percent of the 14 Manchester property. 15 And you'll see that the taxpayers believe that 16 because it was a merger under 708 of the Internal 17 Revenue Code, which California is conformed to, that 18 HVA is the continuing partnership -- the tax partnership 19 for this purpose. 20 In the opening brief, Appellants presented two 21 documents which showed how the merger happened. The 22 diagram didn't show how it happened. 23 What was presented was a grant deed signed by 24 HVA on December 15th, 2001, but also was submitted was a 25 Certificate of Cancellation that showed that HVA 26 liquidated and went out of existence on December 20th of 27 2001. 28 I'd now like Mr. Marcil to be put under oath. 6 1 MR. HORTON: Ms. Olson, please? 2 MS. OLSON: Please raise your right hand. 3 Do you swear to attest to tell the truth? 4 MR. MARCIL: Yes, I do. 5 MS. OLSON: Okay, that's good. 6 MR. PACE: I have some questions for him very 7 briefly. 8 Mr. Marcil, could HVA have continued to own the 9 60 percent interest in Manchester property indefinitely? 10 MR. MARCIL: Yes. 11 MR. PACE: Could MD, LLC have just as well 12 contributed its 40 percent interest in the Manchester 13 property to HVA? 14 MR. MARCIL: Yes, of course. 15 MR. PACE: Why did you and Mr. Walsh determine 16 to combine HVA and MD, LLC? 17 MR. MARCIL: Mr. Walsh called me in that month, 18 I think it was in December, and said that, you know, if 19 we combine the two, then we'll save two tax returns in 20 the -- and I think you have to pay $800 a year for -- 21 so, and instead of, you know, having to do that every 22 year, so, we combined the two and saved the $800 a year. 23 That was -- there was an LLC fee, minimum fee you have 24 to pay to the State. There's really no advantage to 25 keep both of them separate. 26 MR. PACE: So, if HVA and MD, LLC had not 27 combined, what would have been your economic interest 28 that you and your wife had in MD, LLC? 7 1 MR. MARCIL: 60 percent in the -- 2 MR. PACE: If it had not combined? 3 MR. MARCIL: Oh, if it had not combined? 4 In which entity? 5 MR. PACE: In MD, LLC? 6 MR. MARCIL: Then very small, I mean, it was no 7 -- for us, we hardly had any at that point, less than 8 2 percent and probably going to get down to see zero 9 because that was our agreement with John. 10 MR. PACE: Did you and your wife own your 11 membership interest in MD, LLC as community property? 12 MR. MARCIL: Yes, we did. 13 MR. PACE: I would now like to go into a more 14 detailed legal discussion. 15 A partnership merger consolidation under 16 Section 708 does not require a statutory merger under 17 the California Corporations Code for various reasons. 18 First, the language of Section 708 does not 19 require a statutory merger. When mergers need to comply 20 with State law merger statutes, the Internal Revenue 21 Code requires it, as it does with corporate mergers, it 22 says statutory mergers, not just mergers. 23 Second, there is a revenue ruling, 77-458, 24 which is directly on point that shows that you don't 25 need a statutory merger, all you need is a transfer of 26 assets and the liquidation of the partnership that 27 transferred the assets. 28 Third, conformity with the Internal Revenue 8 1 Code requires federal definitions, they're federal 2 terms. They're not something that you look for in the 3 State non tax code provisions. 4 Fourth -- and I think this is a really 5 compelling reason -- neither tax policy nor the purpose 6 of partnership mergers would be served if Section 708 7 required statutory mergers. 8 Section 708, unlike the corporate provisions 9 doesn't cause a transaction to be taxable or nontaxable. 10 Section 708, the section is entitled "Continuation of 11 Partnerships." Section 708 merely determines when a 12 partnership terminates. 13 Other Code Sections, 721 and 731, determine 14 whether it's a taxable event or not. Thus, limiting 15 partnership members -- is statutory -- statutory mergers 16 would effectively create an election by taxpayers. 17 If taxpayers combine in another way, they would 18 terminate the entity. If they combine in a statutory 19 merger, they would not. It would be an election. And 20 any time there's an election, you have to think 21 taxpayers will act rationally and the State will lose 22 revenue. 23 And the effect of terminating a partnership is 24 that you can bunch income or bunch losses. You kill the 25 year. You stop the year. Whatever happens to be there 26 goes to the people. 27 So, if they happen to have a lot of income and 28 they need losses, they'll terminate it when there are 9 1 losses. When they have a lot of losses and need income, 2 they'll terminate it when there's a lot of income. 3 The whole purpose of the section was not to 4 provide tax pretreatment of combinations, it was to 5 prevent taxpayers from forming a 1 percent or a very 6 small partnership and any time they didn't like the 7 elections, the accounting method, or they wanted to 8 bunch the income or the loss, they would then just merge 9 again. It would be like shedding a new skin and they'd 10 get differently -- wildly different tax treatments. So, 11 it was really an antiabuse provision. 12 I think, lastly, the regulations are internally 13 consistent with requiring statutory merger. The 14 regulations themselves actually have examples of 15 transferring interests over. They also have examples of 16 there being assets pushed down and then contributed back 17 in. 18 This transaction was a merger. First, the 19 documents that -- the grant deed and the certificate 20 effected a merger. 21 Second, it's not elective, it's a mandatory 22 treatment. Again, it's really kind of an antiabuse 23 provision. 24 Third, Appellants obtained 60 percent ownership 25 of MD, LLC as community property. 26 I want to go on down to the 1031 issues. While 27 supports deferring the gain of HVA, there are 28 longstanding cases, the Balker and Maloney cases 10 1 (verbatim), that say that if you continue your 2 investment, you don't cash out or use it for personal 3 prepares that you've met the holding purpose requirement 4 of 1031. 5 In this situation the steps for all tax 6 planning stop when HVA acquired the 60 percent undivided 7 interest in Manchester Properties on November 20th. 8 There's nothing more that had to be done to accomplish 9 any tax planning. There was no tax advantage again and 10 none alleged by the Franchise Tax Board for combining 11 the two entities together, other than saving the $800 12 fee. 13 MS. OLSON: Time has expired. 14 MR. HORTON: Thank you very much, sir, we will 15 return to you on rebuttal. 16 Would the Department please introduce yourself 17 for the record? You have ten minutes to make your 18 presentation. 19 MR. GEMMINGEN: Mind if we wait for my exhibit 20 that's being set up, please, sir, Mr. Chairman? 21 MR. HORTON: Sure. 22 MR. GEMMINGEN: Thank you. 23 And while we're doing that, if you could please 24 look to Tab 4 and 6? Tab 4 is just behind the green 25 divider, please, and then Tab 6, just before the yellow 26 divider. 27 MR. HORTON: Well -- 28 MR. RUNNER: I'm not organized that way. 11 1 MS. YEE: Can you -- Tab 4 of what, 2 Mr. Gemmingen? 3 MR. GEMMINGEN: I'm sorry, this black binder 4 our exhibits are in (indicating). 5 MR. HORTON: What black binder? 6 MS. YEE: We don't have -- 7 MR. HORTON: We don't have that. 8 MS. YEE: One second, here they come. 9 MR. GEMMINGEN: And -- 10 MS. YEE: Can you hang onto until -- 11 MR. HORTON: One second, take your time. 12 MR. GEMMINGEN: And also Tab 4, just for your 13 information, this same chart is found at Tab 4 as well. 14 If you could look -- or first direct yourself, 15 please, to the Tab 4 behind the green page? 16 MR. RUNNER: Behind the green page. 17 MR. HORTON: Certificate of Interests? 18 MR. GEMMINGEN: Yes, thank you, yes. 19 MR. HORTON: Okay. 20 MR. GEMMINGEN: As of May 9th, 2001. 21 MR. HORTON: We're there. 22 MR. GEMMINGEN: Okay. Ready to begin? 23 MR. HORTON: Yes. 24 MR. GEMMINGEN: Okay, thank you. 25 Good morning, Members of the Board, I'm David 26 Gemmingen, Tax Counsel of the Franchise Tax Board. 27 And with me is Ciro Immordino, also Tax Counsel 28 of the Franchise Tax Board. 12 1 So, as I discussed the appeals before your 2 Board today with my colleagues, the common question 3 among them was what really happened? And what 4 transactions did taxpayers undertake to achieve the 5 desired result, which they're now attempting to 6 disclaim? 7 Whether it's a partnership filing, partnership 8 tax returns and K-1's for 23 years followed by a current 9 denial of the existence -- existence of a partnership, 10 persons claiming acrimony, yet buying a multimillion 11 dollar home together, or, in my case, a single purpose, 12 specific entity, entering into a contract to buy 100 13 percent of the targeted real property long before a 14 separate, independent entity sought to sell its own 15 property. 16 Your Board's being asked to review all the 17 relevant circumstances and transactions to determine the 18 tax consequences based upon the substance and end 19 results of the action the associated parties undertook. 20 Respondent does not agree with Appellants' 21 counsel's suggestion that none of the transactions prior 22 to November are relevant at all. In fact, we briefed 23 that extensively and discussed the Step Transaction 24 Doctrine in going -- and discussed the Manchester 25 Development LLC's purchase agreement, which it entered 26 into in May of 2001 to acquire 100 percent of the 27 Manchester property. It is that intended result to 28 acquire the property, which is the reason why that 13 1 Hollywood Vista fails the 1031 transaction since at the 2 end of the year Manchester Development LLC actually 3 acquired and owned and retained 100 percent of the 4 Manchester property. 5 So, the primary issue is relatively simple, but 6 it's surrounded by a multitude of transactions and 7 entities. Qualifying like kind exchanges under 8 Section 1031 require the same legal entity that disposes 9 of real estate held for trade or business purposes 10 intend to and actually receive and retain replacement 11 real estate for trade or business purposes. Hollywood 12 Vista did not satisfy this required criteria. 13 Mr. Marcil had partnership interests in two different 14 entities and he and his wife effectively controlled and 15 owned 100 percent of Hollywood Vista, established in 16 1998, which owned the Vista Apartments. 17 And in May 2001, the year at issue, Mr. Marcil 18 formed the special purpose entity, Manchester 19 Development LLC, with John Walsh. And Mr. Marcil and 20 Mr. Walsh each owned one-half of Manchester Development 21 as of May 9th, 2001, as shown at the exhibit in front of 22 you. 23 Appellant's suggestion that they owned a very 24 negligible interest in Manchester Development prior to 25 December, stating that he owned less than 2 percent, is 26 clearly not supported by the Certificate of Interest 27 that Mr. Marcil signed before you in Exhibit -- at 28 Tab 4. 14 1 Furthermore, at Tab 6 in the -- before and 2 after the yellow sheet of paper there -- this is an 3 attachment to the operating agreement of Manchester 4 Development LLC. And the first tab as of May 2001 shows 5 that Mr. Marcil's member interest -- his ownership 6 interest is 50 percent. And, so, the suggestion that 7 2 percent is all he had is clearly not supported and one 8 of many attempted recharacterizations of the facts in 9 this case. 10 To put it simply, Manchester Development 11 contracted by itself and subsequently acquired 100 12 percent of the Manchester property in 2001, while a 13 separate entity, Hollywood Vista sold its primary asset, 14 the Vista Apartment building, in 2001. 15 And also in December 2001, the year at issue, 16 Hollywood Vista partnership formally dissolved its legal 17 existence by filing the appropriate documents with the 18 California Secretary of State. Thus, when an entity 19 sold its property and different entity acquired the 20 Manchester property. 21 Appellants' contention that a merger occurred 22 is a fiction and completely unsupported by the many 23 transactions and documents Hollywood Vista prepared and 24 are provided to you in the exhibit binder. 25 Mr. Marcil always intended that Manchester 26 Development acquire the Manchester property with the 27 result that Hollywood Vista did not acquire and hold 28 like kind replacement property for a valid 1031 15 1 exchange. 2 Manchester Development, while managed by 3 Appellant Marcil, was represented by legal counsel when 4 it contracted to buy the Manchester property. And 5 Appellant had co-authored a book on real estate 6 investment. So, the transactions that were engaged in 7 were not done inadvertently. 8 In fact, as provided at Tab 5 of your exhibit 9 book, Mr. Marcil certified that his representation that 10 Hollywood Vista was dissolving and terminating was true 11 and correct. 12 Appellants' argument presupposes a merger that 13 never occurred. And as stated by the US Supreme Court 14 in 1945, in a tax case involving who the gain from the 15 sale of real property should be attributed to, it 16 stated, 17 "The incidence of taxation depends upon the 18 substance of the transactions. The tax 19 consequences that arise from the gains of the 20 sale of real property are not finally to be 21 determined solely by the means employed to 22 transfer title, rather the transaction must be 23 viewed as a whole and each step, from the 24 commencement of negotiations to the 25 consummation of sale, is relevant. A sale by 26 one person can not be transformed for tax 27 purposes into a sale by another by using the 28 latter as a conduit through which to pass 16 1 title. To permit the true nature of a 2 transaction to be disguised by mere formalisms 3 to exist solely to alter tax liabilities would 4 seriously impair the effective administration 5 of tax policies of Congress. Likewise, the 6 acquisition of property by one entity cannot be 7 attributed to another when one's presence is 8 transitory and a conduit for pre-existing 9 funding obligations." 10 Appellant Marcil had contracted under his 11 operating agreement with Manchester Development to 12 individually and personally fund his portion, this 50 13 percent of -- for his 50 percent membership interest of 14 the -- so that entity could acquire the Manchester 15 properties. It was a personal obligation, which he used 16 Hollywood Vista to satisfy that personal obligation. 17 Sellers of Manchester property signed the grant 18 deed conveying 100 percent of the Manchester property to 19 Manchester Development alone in July 2001 -- it's in our 20 exhibit book -- long before Hollywood Vista entered into 21 any exchange agreements and months before the formation 22 of Lava Rock, the entity which Appellant used as a 23 conduit to fund his own personal contribution to 24 Manchester Development. 25 Manchester Development obtained its own tax ID 26 number, filed tax returns reporting its ownership of 100 27 percent of the Manchester property and never merged with 28 Hollywood Vista and deducted for tax purposes its 2001 17 1 organizational startup expenses. 2 Let us be clear, when Mr. Marcil wanted to 3 form, merge or terminate a legal entity or a partner's 4 interest in a partnership, he properly documented the 5 specific transaction. 6 When Mr. Marcil wanted to merge an entity, as 7 shown at Tab 7, where he merged Lava Rock and Manchester 8 Development, he filed the correct Certificate of Merger 9 with the California Secretary of State. 10 When he wanted to confirm his and Mr. Walsh's 11 respective ownership interests in Manchester 12 Development, as shown as the last page of Tab 6, he 13 documented it in writing. When the Appellant's 14 partnership redeemed the partner, as set out at Tab 3, 15 it did so in writing. And when Hollywood Vista 16 dissolved, it filed the appropriate dissolution papers 17 signed by Appellant, as found at Tab 5. 18 Moreover, the deed conveying the 60 percent 19 tenant in common interest from Lava Rock to Manchester 20 Development was not filed until March -- or not recorded 21 until March 18th, 2002, as shown at Tab 7, after 22 Hollywood Vista ceased to exist. Mr. Marcil 23 individually owned Lava Rock at the time of the 24 conveyance. 25 And the conveyance could not have been a merger 26 for three significant reasons. First, no merger was 27 ever planned or agreed to, contemplated and no 28 documentation exists -- contrary to Appellant's standard 18 1 and prudent business practices. Second, the partnership 2 interests in Manchester Development never changed. And 3 if there had been a merger, Mr. Walsh's interests in the 4 surviving entity should have been diluted, but it was 5 not, as demonstrated at Tab 4. And where initially, 6 Mr. Walsh was a 50 percent partner of Manchester 7 Development and Appellants owned all of Hollywood Vista, 8 and in the surviving entity, if there had been a merger, 9 Mr. Walsh's interest should have been 5/20ths, if it 10 would have -- let's say a quarter of the enterprise and 11 Appellants' interest in the survivor should have 12 increased up to 75 percent. 13 But as shown at the last page of Tab 6, when 14 there was a restatement of their operating agreement in 15 September of 2002, long after this purported December 16 merger, it was just simply a change from 50 percent to 17 60 percent and Mr. Walsh went down, at that point in 18 time, from 50 percent down to 40 percent. And, so, 19 there was no merger and Appellants' written documents 20 support that. 21 Also Appellant relies upon Revenue Ruling 22 77-458, but this revenue ruling was clarified at Revenue 23 Ruling 90-17, which is found at Tab 9. Also Appellant 24 neglects to inform your Board that even within Revenue 25 Ruling 77-458 there was a plan of merger, specifically 26 states that there was a plan. 27 And in this case there never was a plan and 28 Appellant, through his various documentations, could 19 1 have easily had a -- written a plan of his own or had 2 his legal counsel write it. It never occurred. 3 Thus -- and also the revenue ruling provided at 4 Tab 9, this Revenue Ruling 90-17, demonstrates how when 5 respective partnerships do actually merge and combine, 6 the parties' interests, as highlighted at page 2, at the 7 top of the page 2, will change as a result of that 8 merger if there are differing interests in the initial 9 partnerships. 10 And that's what we have here. Mr. Walsh has 11 only half of the one partnership, none of the other 12 partnership. When they combine, Mr. Walsh's interests 13 have changed, but yet it never changed. They retained 14 the initial membership and ownership interests that were 15 set forth in May 2001. This idea of a merger is a 16 complete fiction. 17 And Manchester Development's operating 18 agreement was restated in September 2002. No 19 consequences of Appellant's purported merger were ever 20 reflected in that restatement, rather, Mr. Marcil's 21 personal obligation to fund Manchester Development was 22 retained. 23 Appellant Marcil retroactively instructed 24 Stewart Title to change the title on the grant deed 25 conveying the property to Manchester Development and, as 26 found at Tab 1, just -- that's the last page of Tab 1, 27 his instructions, and it's found at Tab 1, just before 28 the pink dividing page -- Manchester Development paid 20 1 100 percent of the property transfer tax, that's 2 $44,800, and held itself out for property tax records as 3 the sole grantee of Manchester Property. 4 MS. OLSON: Time has expired. 5 MR. HORTON: Thank you very much for your 6 presentation. 7 On rebuttal? 8 MR. PACE: Yes, I have several points to make. 9 First, there is no requirement -- it's back to the -- 10 there was a Revenue Ruling 77-458, it says that you 11 don't have to have a statutory merger. It did say, 12 "plan of merger" in there, but it doesn't say, "written 13 plan of merger." And the regulations themselves don't 14 require a written plan of merger. 15 They obviously planned to combine two entities 16 together. And they obviously did it by transferring 17 assets and liquidating one of the entities. 18 I wanted to call your attention to this chart 19 again. All they would have had to have done is have 20 MD, LLC, at State law, transfer the 40 percent interest 21 and liquidate and have HVA own 100 percent. The 22 Franchise Tax Board wouldn't be disallowing this 23 transaction. It was just a mere form of choosing which 24 one liquidated. The tax law does not recognize that 25 differential. 26 In terms of this 90-17, it's a clarification, 27 it doesn't -- it just deals with a different code 28 section. It doesn't say that 77-458 is any different. 21 1 In terms of the transaction, it did start off 2 being that MD, LLC was going to buy 100 percent, but the 3 parties changed their deal. They obviously changed 4 their deal. They had different monies used to buy the 5 property. And as shown on the chart, and as Mr. Marcil 6 testified to you, his interest in MD, LLC would have 7 been very small. It wasn't 50 percent. They redid 8 their deal. MD, LLC had very little money in it until 9 it was funded in October to buy the property. It was 10 really just an empty shell that was initially set up. 11 They reworked their deal. 12 MR. MARCIL: And if it didn't merge, where's 13 the tax? 14 He says it didn't merge. 15 MR. PACE: Right. In terms of the merger of 16 the two entities, that was done to clean it up. 17 Mr. Marcil hired a different attorney to do that. 18 Mr. Marcil, did you ever merge two entities 19 together? Did you know about mergers? 20 MR. MARCIL: Yes, somewhat. We have done it 21 before. I mean, it's -- it's a nontaxable event. It 22 was supposed to be a nontaxable event too. 23 And just going back to what the gentleman over 24 there said, if you're saying that the merger didn't 25 occur, where is the tax then? Where is the tax 26 liability if he's correct? 27 That's what I have to say. 28 MR. PACE: Right. So, what I -- and I think in 22 1 terms of the Step Transaction Doctrine, it wasn't 2 briefed, for 1, and, 2, it wasn't part of the end 3 result. Here they acquired the property, they owned the 4 property the way they needed. 5 They didn't have to put it together as part of 6 any tax plan. They gained no advantage for putting it 7 together. HVA owned the property, didn't deed the 8 property until December 15th, 2001. 9 MR. HORTON: Thank you very much. 10 Member Yee? 11 MS. YEE: Thank you very much, Mr. Horton. 12 I want to pose a question to the Appellants, 13 just trying to get clear in my head what may have been 14 in your head at the time of some of these transactions. 15 If you could maybe elaborate a little bit as to 16 why you you don't believe the statutory requirements had 17 to be met in this demerger. Obviously, there had been 18 the merger that was effected between Lava Rock and -- 19 MR. GEMMINGEN: Manchester. 20 MS. YEE: -- MD, LLC. 21 But can you just kind of elaborate on what the 22 thinking was? I mean, you're familiar with the 23 statutory requirements and yet -- 24 MR. PACE: Yes. 25 MS. YEE: -- in this demerger, you -- 26 MR. PACE: The statutory requirements weren't 27 even in existence until 1994 and 1996. They were 28 relatively new. The partnership merger law had been 23 1 around since 1954. And it was always -- it was always 2 understood, I think in the federal, all the treatises 3 that you do this however you wanted to do it. 4 And mergers have the unnecessary complication 5 of having literally all of the liabilities, all of the 6 prior history come in. So, when people combine 7 partnerships for business purposes, they don't usually 8 like a merger, they'd rather take the assets out and 9 liquidate the entity. 10 If you get the same federal tax treatment, 11 State tax treatment because they're mergers under 708, 12 it doesn't really matter. And, so, people don't want to 13 do the State law merger of LLCs for liability 14 purposes. 15 MS. YEE: I mean in some ways I feel like 16 you're kind of picking and choosing when to ignore, kind 17 of, State law that governs mergers, but -- 18 MR. MARCIL: Can I speak on it? 19 MR. PACE: No, it's fine. I think not. 20 So, you don't have to -- that was -- that's in 21 the corporate law that you have to have mergers if you 22 want to reorg. It was never the requirement you needed 23 to have a merger. They didn't have merger statutes for 24 over 30 years after the enactment. So, people didn't 25 think that they had to merge for any tax reason. It was 26 a combination of two entities. The larger of the two of 27 them lives. 28 It's really an accommodation in the Corporate 24 1 Code law. They updated and put in the LLC Act. They 2 had revised acts, trying to make it more friendly so 3 people could do whatever they needed to do. It was just 4 another alternative as to how to do it. It isn't the 5 normal course that people use. Because, again, you take 6 on all the prior history, all the liabilities, all the 7 indemnification and people don't want to do that. 8 MS. YEE: Okay. But doesn't the revenue ruling 9 upon which you're basing your authority, doesn't that 10 recognize, I guess, the State law that governs mergers 11 as well? 12 MR. PACE: I think -- I think you have to 13 recognize State law. I think -- I think the deed and 14 Certificate of Cancellation does. And I think property 15 rights under tax law are predicated upon rights that 16 you're given under State law. 17 But the term "merger" is a federal concept 18 that's brought into the California tax law by 19 conformity. So, I really I don't think that you have to 20 comply with merger rules when it seems pretty clear 21 under the regs themselves that you can push assets out 22 or you can transfer interests in -- that there are 23 various ways to do it. 24 So, I think applicable jurisdictional law is, 25 in fact, met here by the grant deed and the liquidation 26 of HVA. 27 MS. YEE: Okay. And California law -- maybe an 28 Appeal -- a question to Appeals -- California law does 25 1 conform to the federal law in this entire area, yes? 2 MR. AMBROSE: Yeah, generally. 3 MS. YEE: Okay. 4 MR. AMBROSE: I mean -- 5 MR. PACE: There are no other regulations on 6 this point or rulings issued by the FTB. 7 MR. AMBROSE: Right. And if our statutes 8 conform, then we also follow the regulations, the 9 Treasury regs. 10 MR. PACE: The regulations weren't even 11 finalized until January of 2001. And they were -- they 12 were in the section of the regulations that dealt with 13 the form because if -- by the way you did it, you got 14 different basis rules, you got different liability 15 rules. 16 It wasn't that it was a merger or not a merger, 17 it was that the consequences of the merger could be 18 different and it actually gave taxpayers -- there was a 19 pro taxpayer vision that gave certainty now that if you 20 did it this way or did it that way, you knew how to 21 account for it -- not that you had a merger or not a 22 merger, that was in the general rule and the general 23 rule was untouched. 24 MS. YEE: Okay. I want to pose the same 25 questions to the Franchise Tax Board, if you could 26 comment? 27 MR. GEMMINGEN: Well, Appellant here is 28 suggesting any time one partnership conveys property to 26 1 another partnership, there is a deemed and automatic 2 merger and that, simply, isn't the case. 3 There has to be an agreement and a plan and an 4 understanding as well as a transfer of interests to the 5 conveying entity. And in this case there was no 6 conveyance of interests. 7 And Manchester Development, before the 8 transfer, the ownership structure was 50-50. Mr. Marcil 9 and Mr. Walsh. After the conveyance it was 50-50. 10 There was -- there was no merger. 11 So, in general, Appellant's counsel is correct 12 in the sense that the 708 regulations were designed to 13 determine what's the tax effect upon a merger as to -- 14 with respect to their capital account, whether they're 15 receiving -- say, if there's cash coming out, whether 16 any cash received would be in excess of the capital 17 account, which would then be taxable or whether there 18 was -- it should be treated as assets over merger, in 19 the sense that the -- one partnership be considered 20 contributing assets and in return and exchange for 21 partnership interest in the other partnership. That 22 exchange and the disbursement of the partnership 23 interests never occurred in this case. 24 And, so, to suggest there is a partnership 25 merger here, when they know very well how to do so -- as 26 demonstrated by the many documents here, is not -- is 27 unsupported. 28 MS. YEE: Mr. Pace, you were nodding your head, 27 1 are you -- 2 MR. PACE: Well, it's clear that in issuing 3 interests, 1, they're personal property, so, you don't 4 need routings when they transfer, and, 2, you know, I do 5 a lot of cancellation indebtedness work out and the 6 issue is if a partnership has a debt going and you issue 7 a capital interest, then you could have -- you could 8 have income. 9 And, so, the issue is what's an issuance? And 10 I think the mere booking of capital in an account, on 11 the books and records of the entity, is the issuance of 12 an interest. You don't need a certificate. There isn't 13 -- most LLCs and partnerships don't have certificates. 14 Right, the certificate that was done -- but you 15 don't need a certificate in order to issue a capital 16 account. It's really a book entry that you get credit 17 for. 18 MR. GEMMINGEN: Thank you. 19 As far as the book entries and the recognition, 20 Manchester Development's own balance sheet provided for 21 a contribution by Mr. Marcil individually, which was 22 simply -- that was with the respect to the Manchester 23 property. It designated him individually and that was 24 simply to satisfy his prior obligation under the 25 operating agreement. 26 MS. YEE: Okay. 27 MR. IMMORODINO: Pardon me, Mrs. Yee, if I 28 could go back through that merger issue? 28 1 MS. YEE: Yes. 2 MR. IMMORODINO: Mr. Pace commented that, you 3 know, people do not like mergers because of liability 4 purposes and the taxpayer swore under oath that there's 5 the option of having the Manchester property go into 6 either the HVA, LLC or the MD, LLC. 7 Real estate is held in single asset LLCs. You 8 have an LLC which holds one piece of real estate and 9 when you buy a new piece of real estate, you get a new 10 LLC. 11 And the reason is that there's a liability 12 attached to the LLC from the old property, even if you 13 sold it. It's still going to happen. You can still 14 sell -- you can still sue that LLC because it was the 15 owner. 16 In this this case, if Mr. Walsh had agreed to 17 have the Manchester property held by the HVA, LLC, then 18 he would have been -- then he would have assumed the 19 liability and potential lawsuit. And that if HVA, LLC 20 was sued in the future, then they they could have gone 21 after the Manchester property. 22 MR. GEMMINGEN: That could have resulted -- 23 because the initial property held by Hollywood Vista was 24 an apartment building. 25 MS. YEE: Right. 26 MR. GEMMINGEN: Say they had discovered mold 27 there, a tenant claimed to have respiratory illnesses 28 and sued. There is no way that these people are going 29 1 to allow the Manchester property to be encumbered by the 2 potential liability of, say, mold litigation. 3 They wanted to segregate and separate that 4 property, that business deal -- that business deal never 5 changed. 6 MS. YEE: Okay. Thank you, Mr. Chairman. 7 MR. HORTON: Thank you. 8 Further discussion, Members? 9 MS. MANDEL: Sure. 10 MR. HORTON: Ms. Mandel. 11 MS. MANDEL: So, do I understand the Franchise 12 Tax Board's position is that under no circumstances is 13 there a continuing partnership for 708 purposes unless 14 there's a corporate law statutory merger? 15 MR. GEMMINGEN: No, we're not stating that. 16 We're stating that there actually has to be action -- 17 more than just mere intent, there has to be action. 18 There has to be documentation that supports that. There 19 has to be issuance of partnership distributions. 20 Parties can create a partnership without a 21 written agreement, as we'll see -- 22 MS. MANDEL: I am talking about -- 23 MR. GEMMINGEN: -- in the next appeal. 24 And, so -- 25 MS. MANDEL: -- you know, I understand you're 26 probably working on a lot of cases -- 27 MR. GEMMINGEN: Yeah. 28 MS. MANDEL: -- but -- but the record in each 30 1 case is distinct. And I really don't want to hear -- 2 MR. GEMMINGEN: Okay. 3 MS. MANDEL: -- about other cases -- 4 MR. GEMMINGEN: I'm just trying -- 5 MS. MANDEL: -- as a way to influence this case 6 or use this case to influence those cases. 7 MR. GEMMINGEN: Well, no, but -- 8 MS. MANDEL: So, I'm focusing on this case. 9 MR. GEMMINGEN: Okay. To answer your question, 10 you don't necessarily have to file the correct 11 documentation necessarily with the State because we are 12 concerned, as all tax is, with substance over form. 13 As we -- as I mentioned earlier, it's not just 14 the mere formalities, it's what's actually happening. 15 And, so, if the parties undertake significant 16 action that can substantiated which demonstrates a 17 merger and the parties then in the resulting partnership 18 act as if -- in accordance with that merger, then a 19 merged partnership can be found. 20 MS. MANDEL: I'm sorry, say that last bit 21 again? 22 MR. GEMMINGEN: Well, it is possible to find a 23 merger -- a merged partnership from the combination of 24 two partnerships provided -- under the -- if its 25 substance indicates and the actual activities of that 26 entity demonstrate that there been a combination, a 27 reallocation of interests, a reallocation of profits and 28 losses to the resulting partners. 31 1 MS. MANDEL: So -- 2 MR. GEMMINGEN: And we'll look at what actually 3 happens. 4 MS. MANDEL: -- so, I guess in the end 5 analysis, it sounds like you're mostly -- you're 6 ultimately relying on the chart behind that you think 7 that the Marcils should have had a larger ultimate 8 interest in the MD, LLC than you think -- than they -- 9 than the 60 percent had there been a merger? 10 MR. GEMMINGEN: I think that -- this 11 demonstrates that position. But it's not our -- our 12 sole reason, but it certainly demonstrates that, this 13 chart (indicating). 14 MS. MANDEL: Mr. Pace, can you address their 15 chart and their concept that the Marcils should have had 16 a 75 percent interest in MD had there been a merger for 17 tax purposes or merger? 18 'Cause he's now saying it doesn't -- a merger 19 doesn't have to be a State law merger, which is kind of 20 how I understood their position. But they don't accept 21 that a merger happened, I guess, even for tax purposes 22 'cause they don't buy this -- the 75 percent is their 23 idea of where the Marcils should have wound up, based 24 on -- I guess, based on the documentation 25 MR. PACE: I'm very surprised that -- that's 26 not my understanding either. From the briefs, I thought 27 you had to be 6901 of the California Corporations Code. 28 MS. MANDEL: Okay. 32 1 MR. PACE: Okay. But, anyway, 75 percent 2 interest is more than 50 percent interest, so, I would 3 have said that it's even more certain that there was a 4 partnership merger if they had 75 percent. 5 Really the issue, I think the fundamental 6 problem here, is that the parties re-did their deal. 7 They originally were going to put cash into Manchester 8 to buy the property, but it turned out that Hollywood 9 Vista was going to sell. It was a much more ready to 10 source of cash to make the investment. They re-did it 11 so that Hollywood Vista bought 60 percent of the 12 property. 13 And, so, the -- the operating agreement, the 14 original purchase agreement, they amended those 15 documents. They -- they acted upon the amendments. 16 They actually did buy the 60 percent in HVA. They 17 actually did buy the 40 percent in Manchester 18 Development. They could have left them apart. They put 19 them together to save the $800. There was no tax plan. 20 No tax venture that put them together. So -- 21 MS. MANDEL: So, you're -- so, you're saying 22 the underlying documents they're relying on are not the 23 final documents for doing the deal? 24 MR. PACE: They didn't spend the time to revise 25 every time they redid their deal. I mean, they have two 26 of them. They can orally revise their document. That's 27 what they did. 28 MR. MARCIL: We had a six-month escrow. 33 1 MS. MANDEL: You dispute that they can revise 2 the documents? 3 MR. GEMMINGEN: I don't dispute that they can 4 revise them, but they actually did revise them three 5 times. And I have provided you one of the revisions at 6 Tab 2 and this occurred in the end of September and it 7 goes through October. And, again, Manchester 8 Development, LLC is the only party that is listed as the 9 purchaser of Manchester Development Property. 10 And, so, he states that they had revised their 11 deal and amended their deal to reflect Hollywood Vista's 12 entry, but that's not the case. Once again, the 13 documents establish that Manchester Development was the 14 sole intended grantee and was the intended party to 15 acquire the replacement property and Hollywood Vista 16 sold its property. 17 He asked where the tax comes from. The tax 18 comes from the Hollywood Vista's sale of the apartment 19 building. It had over a $3 million gain on the sale of 20 the property. And he was, essentially, a hundred 21 percent owner. That gain follows through. 22 And, also, I really have to object to this idea 23 that the Franchise Tax Board -- his statement that we 24 didn't brief Step Transaction Doctrine in our opening 25 brief. 26 If you read through page -- very quite simply, 27 all of page 26 discusses the Step Transaction Doctrine, 28 goes through the transactions that Manchester 34 1 Development engaged in. And, so, we -- we clearly 2 briefed this to your Board. 3 MS. MANDEL: I think what I was hearing from 4 the taxpayer was that the deal that was revised was the 5 ultimate deal for MD, LLC as an entity. 6 Mr. Marcil is nodding. 7 MR. MARCIL: Yes. 8 MS. MANDEL: He's nodding yes -- rather than 9 where the property, the underlying property that was 10 going to be held by MD, LLC was going to wind up and 11 that the taxpayers's argument is that the ultimate 12 property was going to wind up in MD, LLC. 13 The way that it was all going to be paid for 14 was revised and that their tax argument was that the 15 Marcils took their -- what was the other one called H -- 16 HVA, Hollywood Vista, LLC and that by virtue of 708 and 17 who's bigger in the end, that the who's bigger in the 18 end is Hollywood Vista as a partnership for tax 19 purposes, now in an entity, the entity's called, you 20 know, Manchester Development. 21 So that under that 77 revenue ruling, it's like 22 P1 and P2 smack together and the P1 people own more in 23 the end than the P2 people. So, for tax purposes, under 24 708, P1 is a continuing partnership. And, so, it just 25 keeps going. 26 That's -- that's how I understand the argument 27 about we changed how our our deal was working for this 28 underlying property of -- that -- I forget what kind it 35 1 was -- Manchester Property, but that for tax purposes, 2 when all the dust cleared, we, who had the bigger 3 interests, are -- are the partnership that we had and 4 these were in the form of LLCs to these partnerships is 5 the one that survived for tax purposes. 6 So, it -- it feels a little like there's mixing 7 and matching of -- of who owns underlying property with 8 what the partnership tax issue is that people are 9 talking about. And I guess that's why I was asking 10 about the 75 percent versus the 60 percent -- which I'm 11 not sure. 12 I understand 75 percent is still bigger than -- 13 than 50, but I guess what I'm kind of hearing is that 14 for purposes of the books and records at -- at the MD, 15 LLC level, that there was purportedly discussions, so 16 that the Marcils would have 60 percent in that -- in 17 that ultimate entity that, you know, comes out. So -- 18 MR. GEMMINGEN: Well, again we're all 19 presupposing that a merger actually occurred. And these 20 parties clearly knew how to undertake a merger and they 21 didn't undertake a merger. 22 MS. MANDEL: Okay. Now you're back -- now 23 you're back to State law. 24 MR. GEMMINGEN: Well, no, I'm not back -- 25 MS. MANDEL: So, I'm confused. 26 MR. GEMMINGEN: -- I'm -- I'm back to what they 27 actually did, what's the substance of the transactions 28 they did. 36 1 And this idea that there -- one swallowed the 2 other is not supported by what they actually did. 3 Hollywood Vista was used as a conduit as the funding 4 mechanism for Mr. Marcil's personal obligation for 5 Manchester Development. 6 And Hollywood Vista terminated. Hollywood 7 Vista filed a Certificate of Dissolution, as well as a 8 Certificate of Cancellation. 9 We need to look at, really, what actually 10 happened here, as I said in the very beginning. And 11 what's actually happened here is in May of 2001, before 12 Hollywood Vista even considered selling the apartment 13 building, the letter to the other partners didn't go out 14 until June of 2001, when Mr. Marcil wrote a letter to 15 Carina Taylor and that's -- that's in this book here as 16 well. 17 I can -- the idea here that was for Mr. Marcil 18 and Mr. Walsh to acquire Manchester Development and set 19 up a separate business transaction, a business 20 enterprise and that's what they did at the end of the 21 year. Within just a few months, that was accomplished. 22 And there never was a merger. And the deeds 23 that were signed by the sellers of Manchester Property 24 were signed in July. That was even before Mr. Marcil 25 and the Hollywood Vista did not even engage in any -- 26 enter exchange agreements with the purported qualified 27 intermediary until August. The deeds were already 28 signed in July. 37 1 And, so, this idea that there was a plan of a 2 merger, an intended merger is really just an 3 afterthought and an attempt to salvage taxes. The taxes 4 that they're trying to salvage -- they say that only 5 $800 is at issue. The tax at issue is the tax on this 6 -- on the sale of the Vista apartment, which generated 7 over $3 million in gain. And that's what -- this sort 8 of retroactive tax planning occurred and there never was 9 an intended merger as shown by the various documents 10 that they -- that they signed and prepared. 11 And, so, ultimately, Hollywood Vista sold 12 property. It did not receive and retain and hold like 13 kind of replacement property and that's why there's no 14 1031 exchange. 15 MS. MANDEL: Okay. I think now you're 16 rearguing your case, but I'd like Mr. Pace just to have 17 a brief moment to respond since -- 18 MR. PACE: I think when real properties are 19 being acquired, funding and financing is a big issue. 20 It always is. There are contingencies. And you sign a 21 document and you don't really know -- you sign a 22 purchase agreement, you think you're going to acquire 23 one way. But the money doesn't show up or you can't get 24 the financing. So, people rework their financing deals 25 all of the time to acquire property. 26 That's what happened here. It was determined 27 that HVA was going to sell its property, so, it was the 28 source of funds available to actually acquire a 60 38 1 percent interest. So, that's what the parties did and 2 it acquired it. 3 And the substance of this transaction is that 4 the larger interest in partnership, always in 5 partnership, continued on. The 40 percent could have 6 come in. Mr. Walsh's money could have come directly in. 7 HVA would have used the proceeds from the sale of its 8 property and completed an exchange. There wouldn't have 9 been any issue at all. 10 It's only because of the fiction that -- that 11 State law HVA went away that there is an issue here. 12 And the income tax law says, "We don't care about that. 13 We don't care about which one went away because we care 14 about which one continues and we want the larger of them 15 to continue." So, it doesn't matter which one you file 16 Secretary of State Certificate of Cancellation with. 17 This was a merger. 18 MR. HORTON: Mr. Runner. 19 MR. RUNNER: Yeah, let me -- I guess I'm am not 20 as hung up on this issue of percentage of ownership 21 issue. I think that's just -- whatever part of the deal 22 the deal was and the agreements then of those who went 23 into the deal. 24 The -- let me ask this to -- to FTB, again just 25 to try to get my hands around the procedure and if it 26 would have been different than -- in this idea of merger 27 versus the larger continuing versus the smaller. 28 But in a -- in a process, if MD had been folded 39 1 in to the HVA, leaving HVA as the remaining entity, it 2 would seem to me that under your argument that the 1031 3 exchange would have been valid. 4 MR. GEMMINGEN: Yes. 5 MR. RUNNER: Okay. 6 MR. GEMMINGEN: If -- if HVA had retained the 7 property. 8 MR. RUNNER: Right, okay. So -- so, now it's 9 just a matter of trying to decide -- again get to this 10 largest versus smallest entity issue is. 11 So, if that's the case, then it would be a 12 valid exchange, again the whole -- all of the monies, 13 all the issues and transactions are exactly the same, 14 it's just a matter of what it is that you called and 15 named the continuing entity; is that correct? 16 MR. GEMMIGEN: No, it's not what he called the 17 entity, no, it's what is the continuing entity. 18 MR. RUNNER: Okay. What is the -- okay, what 19 is it. Okay, that's fine. 20 Let me ask this, because one of the main issues 21 of discussion is that in your argument HVA goes away, 22 correct? 23 MR. GEMMIGEN: I beg your pardon? 24 MR. RUNNER: HVA goes away? 25 MR. GEMMINGEN: At the end of 2001? 26 MR. RUNNER: Yeah? 27 MR. GEMMINGEN: Yes, it terminates. 28 MR. RUNNER: Okay, it terminates. 40 1 Let me ask then the Appellant at this point, 2 because your argument is HVA doesn't go away. 3 So, help me understand. You filed all the 4 things saying HFA (verbatim) went away -- HVA went away, 5 but yet I think your claim is it still has a -- it still 6 has a tax purpose in that process. 7 Can you explain the tax purpose at that point 8 and why HVA doesn't go away? 9 MR. PACE: Yeah, it's the tax law of the 10 section. And the reason why again is that they didn't 11 want people to go able to terminate partnerships 12 because -- it was effectively an election by just the 13 way you combine them. They can combine them in other 14 taxfree ways. 15 And, so, if you pick and choose which one goes 16 away and that now causes it to terminate, then you'll -- 17 you'll enable partners to bunch income or do away with 18 bad elections or everything else that's bad. So, they 19 make this rule -- it's really -- as part of the law. 20 MR. RUNNER: You say, "They make this rule."? 21 MR. PACE: The Congress enacted a statute in 22 1954 -- 23 MR. RUNNER: Okay, so federal law? 24 MR. PACE: -- that said that -- right, which 25 has been conformed by California, that said in this -- 26 for continuation purposes, if the larger interest is the 27 one that continues on, that's the one we're going to say 28 continues on. 41 1 And it was to prevent people from forming new 2 entities that had very little in them and -- and 3 conveying assets or some other way and then it wasn't a 4 merger that caused the larger to continue, you'd have a 5 termination, you'd get rid of all the bad elections, you 6 would bunch income. 7 I mean, back in the '50s and '60s they had a 8 lot of rules when people had fiscal years that were like 9 March, April. People were scattered all over. They'd 10 form a partnership and they would want the partnership 11 income to fall within their taxable year or the 12 partnership loss to fall within their taxable year. 13 And, so, they would -- if they had the ability to 14 terminate partnerships whenever they wanted to by just 15 forming a shell partnership and going into them and not 16 having to continue on, there would have been a loss of 17 revenue. 18 MR. RUNNER: Okay. 19 MS. MANDEL: Question, Mr. Horton? 20 MR. HORTON: Mr. Runner? 21 MR. RUNNER: I'm done. 22 MR. HORTON: Ms. Mandel. 23 MS. MANDEL: For the lLCs, if -- if Hollywood 24 Vista was the -- was the continuing entity for tax 25 purposes -- or I guess I could ask it more generally, 26 when there's a continuing entity for tax purposes, then 27 what kind of partnership tax filing would we expect to 28 see, Mr. Pace? 42 1 Do we get a different tax ID number? Is it the 2 Manchester tax ID number? Was the -- was the 3 partnership return that was filed in terms of things 4 that would -- the tax attributes and things that would 5 continue from Hollywood Vista, was that -- do we know, 6 was that filing consistent with Hollywood Vista being 7 the continuing partnership or is there -- 8 MR. PACE: No, I think in -- in our briefs it 9 was set forth that the identification number on the 10 return should have been the HVA identification number. 11 It shouldn't have been the Manchester number on the 12 return. 13 But it's not elective. I think the accountant 14 didn't understand the larger MD shell survival when he 15 prepared the return. I think he looked at the way the 16 Certificate of Dissolution was prepared and that's how 17 the returns were prepared. 18 But it's not an election. It's -- I cited a 19 case which clearly says in the corporate context that if 20 you've done the transaction and you just don't report it 21 correctly, it doesn't invalidate the transaction. 22 MS. MANDEL: Thank you. 23 MR. HORTON: Thank you. 24 In that this is a 1031 exchange that involves 25 real estate, historically you've handled it quite 26 differently than you did this time. Is a there a reason 27 for that? 28 MR. PACE: I'm not sure I know what was 43 1 different about it. And I will tell you that there was 2 a reverse exchange. 3 (Unintelligible) 4 MR. HORTON: Okay. There was a reverse 5 exchange? 6 MR. PACE: Right, which there was a revenue 7 procedure, which again in the opening brief the 8 Respondent conceded was complied with. It happens when 9 the property that's to be sold can't be sold first. 10 MR. HORTON: Okay. 11 MR. PACE: It's an opportunity to buy the 12 property first. 13 MR. HORTON: I got it. What happened with 14 Mr. Woodglen's interest in HVA? 15 MR. PACE: It was a 1 percent general 16 partnership interest. It was an LLC and it was owned 17 50-50 by the Marcils. So, when HVA, at State law, 18 liquidated, its interests went out to the Marcils. 19 MR. HORTON: Department, any comments on that? 20 MR. GEMMINGEN: Well, Woodglen is still in 21 existence, the LLC, and it should have received an 22 interest in the purported resulting partnership. 23 MR. HORTON: In the merging -- 24 MR. GEMMINGEN: In the merging -- 25 MR. HORTON: -- partnership? 26 MR. GEMMIGEN: -- in the continuing 27 partnership. It did not receive an interest in that. 28 MR. HORTON: And that's under State and federal 44 1 law? 2 MR. GEMMINGEN: It's under -- it would be under 3 State and federal law in the sense that it should have 4 received -- as shown in that Rev. Ruling 90-19, at 5 Tab 9, that it should have been reflected and received 6 an interest in the surviving partnership, yes. 7 MR. HORTON: And it's your testimony that that 8 did not occur? 9 MR. GEMMINGEN: Yes, it did not occur. 10 MR. HORTON: Is it your belief it did occur 11 somehow? 12 MR. PACE: I think it did occur when the 13 property deeded over, the December 15 deed. I think 14 that the interest then, the capital account interest 15 that was credited then, immediately went out to the 16 Marcils. 17 MR. GEMMIGEN: If I might add? The operating 18 agreement, which was revised in September of 2002 of the 19 only entity that held the property, did not reflect any 20 ownership interest in Woodglen, LLC, it only shows the 21 two original partners of Manchester Development, 22 Mr. Walsh and Mr. Marcil. 23 MR. HORTON: Okay. Thank you very much. Is 24 there a motion, Members? 25 MS. YEE: Move to take the matter under 26 submission. 27 MR. HORTON: Moved by Ms. Yee to take the 28 matter under submission. Second by Ms. Mandel. 45 1 Objection? 2 Hearing none, such will be the order. 3 Thank you very much for your presentation 4 today. 5 MR. PACE: Thank you very much. 6 MR. HORTON: We will take the matter under 7 consideration later on this evening and send you a 8 written report of our decisions. 9 ---o0o--- 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 46 1 REPORTER'S CERTIFICATE. 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, JULI PRICE JACKSON, Hearing Reporter for the 8 California State Board of Equalization certify that on 9 JUNE 21, 2011 I recorded verbatim, in shorthand, to the 10 best of my ability, the proceedings in the 11 above-entitled hearing; that I transcribed the shorthand 12 writing into typewriting; and that the preceding pages 1 13 through 46 constitute a complete and accurate 14 transcription of the shorthand writing. 15 16 Dated: JANUARY 9, 2012 17 18 19 ____________________________ 20 JULI PRICE JACKSON 21 Hearing Reporter 22 23 24 25 26 27 28 47