The opinion of the court was delivered by: Garibaldi, J.
Argued September 15, 1998
On certification to the Superior Court, Appellate Division.
This appeal involves the tax treatment under the New Jersey Gross Income Tax Act, N.J.S.A. 54A:1-1 to 10-12 (the "Act"), of a taxpayer's gain realized from the sale of his partnership interest. The primary issue concerns the proper method for calculating a taxpayer's cost basis for a partnership interest and, specifically, whether that cost basis should be the purchase price or the taxpayer's federal adjusted basis (his purchase price less the losses deducted on his federal income tax returns). In addition to reducing taxpayer's federal adjusted basis, those losses also provided the taxpayer with a federal income tax benefit. However, because those losses were not deductible on the taxpayer's New Jersey gross income tax returns, they provided taxpayer with no tax benefit under the Act.
This appeal arises from a tax deficiency assessed against Sidney and Dorothy Koch. *fn1 The facts are stipulated.
In 1988, Koch purchased a limited partnership interest in US Cable of Tri-County, Ltd. ("US Cable") for $75,000 in cash. He also agreed to be personally liable for a portion of US Cable's indebtedness to a third party. Between December 31, 1987, and the sale of his interest in US Cable in 1988, the amount of such indebtedness for which Koch was personally liable was $136,895.
From 1983 through 1987, Koch was allocated $218,161 of US Cable's losses. Koch deducted $211,895 of those losses on his federal income tax returns. Accordingly, as of December 31, 1987, Koch's federal income tax basis for his interest in US Cable was reduced to zero. His capital account in the partnership was reduced from $75,000 to negative $136,895, which equals the $75,000 initial cash purchase price, less the deductible losses of $211,895. The remaining $6,957 of the losses so allocated to Koch during those years could not be deducted by him for federal income tax purposes.
In 1988, pursuant to an Agreement for Sale, Koch sold his entire interest in US Cable for (i) $125,000 in cash, (ii) an additional constructive payment of $143,161 *fn2 that eliminated the deficit in his capital account, and (iii) a release from the creditors of US Cable of his personal liability for the partnership's debt.
On his 1988 federal income tax return, Koch reported an "amount realized" of $268,161 in connection with the sale of his interest in US Cable, computed by adding the cash received ($125,000) and reversal of his negative capital account ($143,161). Due to the losses he deducted in prior years, Koch had no basis in the partnership for federal income tax purposes. Thus, the entire amount realized on the sale of his partnership interest was taxable income. He reported $217,785 as capital gain and $50,376 as depreciation recapture income.
On his 1988 New Jersey gross income tax return, Koch reported $50,000 as net gain from the sale of his partnership interest. That amount was the difference between the sale proceeds of $125,000 and the $75,000 price paid for his partnership interest. Koch did not reduce the initial cost basis of his partnership interest by US Cable's losses allocated to him because those losses are not deductible under the Act.
The Director, Division of Taxation ("Director") redetermined Koch's 1988 New Jersey gross income tax liability. The Director concluded that, with respect to the sale of his interest in US Cable, Koch's basis in that partnership interest was exactly the same as his basis for federal income tax purposes. Accordingly, Koch was required to report the same amount of gain for New Jersey gross income tax purposes as he reported for federal income tax purposes.
Koch filed a complaint with the Tax Court, asserting primarily that the Act does not require a taxpayer to reduce the basis of his partnership interest by partnership losses that are not deductible under the Act. Therefore, he did not have to use the federal adjusted basis of his partnership interest in calculating the gain from the sale of that interest.
The Tax Court disagreed and concluded that, in determining gain or loss under the Act, adjusted basis for federal income tax purposes must be used and no exception shall be made even where the taxpayer was unable to take advantage of the partnership losses under the Act. Koch v. Director, Div. of Taxation, 15 N.J. Tax 387, 394 (Tax Ct. 1995).
Koch appealed to the Appellate Division, who in an unpublished per curiam opinion affirmed the Tax Court for substantially the reasons stated by that court. We granted certification. 152 N.J. 12 (1997).
Koch asserts that the central issue is whether the Act requires him to reduce the basis of his partnership interest by the partnership losses for which he received no benefit under the Act. He claims that to do so results in a taxable capital gain greater than his economic gain. He contends that such a result violates the plain language of N.J.S.A. 54A:5-1c ("section 5-1c"), which provides for the adoption of federal methods of accounting and ...