In a recent Pennsylvania Supreme Court case, the court upheld the Commonwealth court’s decision that nonresident limited partners, in a partnership with the sole purpose of investing in property located in Pennsylvania, are responsible for Pennsylvania income taxes on their share of income from a discharge of debt as a result of a foreclosure. Wirth v. Commonwealth of Pennsylvania, PA Supreme Court, Nos. 82 MAP 2012, 83 MAP 2012, 84 MAP 2012, 85 MAP 2012, June 17, 2014.

Facts

In 1985, a partnership was formed pursuant to Connecticut law (the “Partnership”) for the sole purpose of purchasing and managing the property located in Pittsburgh, Pennsylvania (the “Property”). In total there were 735 limited partners; only 25 were Pennsylvania residents. All of the limited partners were passive investors and did not take part in the active management of the Property.

 

The Partnership purchased the Property in 1985 for $360 million; $52 million was paid in cash and the Property was pledged as collateral to obtain a nonrecourse note for the balance of $308 million.

In 2005, the Property was foreclosed on and the Partnership reported a gain equal to the unpaid balance and the accrued, compounded interest, totaling $2,628,491,551. The Pennsylvania Department of Revenue subsequently assessed an income tax against each of the limited partner’s share of the $2,628,491,551 gain.

Analysis/Holdings

The court first determined that the Commonwealth of Pennsylvania had the legal authority to impose an income tax on the nonresident limited partners because the limited partners had enough “contacts” with the Commonwealth. Next, the court held that the discharge of the nonrecourse debt associated with the foreclosure was a taxable event and subject to Pennsylvania income tax. Therefore, the nonresident limited partners were subject to Pennsylvania income tax on their share of the $2,628,491,551 gain. Lastly, the court held that the nonresident limited partners could not “off-set” their Pennsylvania income with losses from their partnership interests because those losses technically occurred in the state where the limited partner was domiciled.

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The above case emphasizes the need for an investor in a “flow through” entity, such as a partnership, to stay abreast of the changing tax landscape in Pennsylvania.

The income tax, real estate and partnership attorneys located at Astor Weiss Kaplan & Mandel, LLP have over 50 years of experience in assisting our clients navigate through the complex and evolving laws that affect all investors doing business in the Commonwealth of Pennsylvania.

Please call David Workman or Daniel R. Levine of our Tax practice group if you would like to discuss how Astor Weiss Kaplan & Mandel, LLP can counsel your business.