Is the gain from selling a passive interest in a lower-tier partnership that owns New York real estate treated as New York source income for a nonresident partner?

Plain-English summary

Jamestown 16, L.P., a Georgia limited partnership whose partners are almost all German residents, held a 49.9% interest in a separate partnership, 589 Associates, LP (589 LP), whose main asset was a multi-tenant office building at 589 Fifth Avenue in New York City. Jamestown 16 was not a dealer in partnership interests, and it never used its stake in 589 LP for any New York business purpose - it was not pledged as loan collateral or otherwise put to work here. On March 1, 2006, Jamestown 16 sold its interest in 589 LP to an unrelated buyer and realized a gain. Jamestown 16 asked the Department whether that gain counted as New York source income.

The Department walked through the statutory framework for nonresident partners: under Tax Law § 632(a), a nonresident partner's New York source income includes only the portion of its distributive share connected with New York sources, determined consistently with § 631. Under § 631(b)(2), gains from intangible personal property (which includes a partnership interest) are New York source income only to the extent the property was employed in a business, trade, profession, or occupation carried on in New York. Because 589 LP was a "lower-tier partnership" beneath Jamestown 16's "upper-tier partnership," the tiered-partnership regulation, 20 NYCRR 137.6, also applied: the source and character of an item attributable to the lower-tier partnership passes through to the nonresident partner unchanged, regardless of the upper-tier partnership's own activities.

Applying these rules, the Department found that Jamestown 16 had never employed its 589 LP interest in a New York business activity. Following its own prior guidance in TSB-M-92(2)I and the advisory opinion in McDermott, Will & Emery, TSB-A-04(6)I, the Department concluded that the gain simply "funneling through" Jamestown 16 did not change that result. So the gain from selling the 589 LP interest was not income from intangible personal property employed in a New York trade or business, and it was not New York source income.

The location of 589 LP's underlying real estate in New York did not matter to the outcome - what mattered was whether Jamestown 16 itself put its partnership interest to use in a New York business. Since it had not, the gain escaped New York taxation.

What this means for you

Nonresident partners holding passive lower-tier partnership interests

If you hold an interest in an upper-tier partnership that itself owns an interest in a lower-tier partnership with New York assets, the location of the lower-tier partnership's real estate does not automatically make your gain from selling your interest New York source income. What matters is whether you (through the upper-tier partnership) actually employed that interest in a New York trade or business - for example, by using it as loan collateral or otherwise actively managing it here.

Documenting passive, non-business use of an interest

This ruling turned on facts showing the interest was never used for New York business purposes. If you want the same result, keep records showing the partnership interest was held purely as a passive investment - not pledged, not actively managed from New York, and not otherwise employed in a New York business or occupation.

Common questions

Q: Does it matter that the lower-tier partnership's only real asset was a New York City office building?
A: No. The location of the underlying real property does not by itself convert the gain on a sale of the partnership interest into New York source income; what controls is whether the selling partner employed its intangible partnership interest in a New York business.

Q: How does a "tiered partnership" structure affect the analysis?
A: Under 20 NYCRR 137.6, the source and character of an item attributable to a lower-tier partnership retains the source and character determined at the lower-tier level, and that character is not changed merely because the item passes through an upper-tier partnership to the nonresident partner.

Q: Would the answer change if the partner had pledged the interest as collateral for a New York loan?
A: Based on the ruling's reasoning, yes - the Department specifically noted Petitioner had not employed its holding in the lower-tier partnership in any New York business activity, "e.g., not as loan collateral or otherwise," implying that such use could produce a different result.

Q: What prior guidance did the Department rely on?
A: The Department followed its own Technical Services Bureau Memorandum TSB-M-92(2)I on gains from a nonresident's sale of a New York partnership interest, and its prior advisory opinion in McDermott, Will & Emery, TSB-A-04(6)I, which held that income from a lower-tier partnership trading intangibles for its own account did not become New York source income just because it flowed through an upper-tier partnership.

Citations and references

• Tax Law § 617(b) - an item of partnership income, gain, loss, or deduction has the same character for a partner as for federal income tax purposes
• Tax Law § 631(b)(2) - gains from intangible personal property are New York source income only to the extent the property was employed in a business, trade, profession, or occupation carried on in New York
• Tax Law § 632(a) - a nonresident partner's New York source income includes only the New York-connected portion of the partner's distributive share
• Tax Law § 632(e) - the character of partnership items for a nonresident partner is determined under § 617(b)
• 20 NYCRR 132.5(a) - a nonresident's gains from intangible personal property are New York source income only if the property was employed in a New York business
• 20 NYCRR 137.6 - in a tiered partnership, the source and character of a lower-tier partnership item retain the lower-tier determination and are unaffected by passing through the upper-tier partnership
• TSB-M-92(2)I (August 21, 1992) - gain from a nonresident's sale of an interest in a New York partnership generally is not New York source income
• McDermott, Will & Emery, TSB-A-04(6)I (October 25, 2004) - lower-tier partnership income trading intangibles for its own account did not become New York source income by passing through an upper-tier partnership

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2007.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a07_1i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-07(1)I
Income Tax
February 7, 2007

Office of Tax Policy Analysis
Technical Services Division
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I061117A

On November 17, 2006, a Petition for Advisory Opinion was received from Jamestown
16, L.P., c/o Russell D. Levitt and Robert Zonenshein, 3625 Cumberland Blvd., 12th Floor,
Atlanta, Georgia 30339.
The issue raised by Petitioner, Jamestown 16, L.P., is whether a gain from the sale by
Petitioner of an interest in a lower-tier partnership constitutes gain from the sale of intangible
personal property employed in a trade or business carried on in New York State.
Petitioner submits the following facts as the basis for this Advisory Opinion.
Petitioner is a Georgia limited partnership (upper-tier partnership) formed for the purpose
of acquiring, owning, operating, and selling three retail real estate investments described below.
Petitioner has never been a dealer in partnership interests. The general partner of Petitioner is
Jamestown, a Georgia general partnership. Jamestown has a 3% interest in Petitioner. The
remaining 97% interest is held by various limited partners, virtually all of whom are residents of
Germany.
On September 27, 1996, Petitioner became a 49.9% limited partner in 589 Associates, LP
(lower-tier partnership). The main asset of 589 Associates, LP (589 LP) is a multi-tenant office
building located at 589 Fifth Avenue, New York, New York 10017. The operations of 589 LP
were governed by an Amended and Restated Limited Partnership Agreement (the Agreement),
dated September 27, 1996. Section 8.1 of the Agreement provides that the business affairs and
properties of the partnership shall be managed by the general partner and sets forth the specific
powers of the general partner. The Agreement defines the general partner as being a certain
individual resident of New York who is unrelated to Petitioner. The Agreement further provides
that the property manager is a certain corporation unrelated to Petitioner. On March 1, 2006,
Petitioner sold its interest in 589 LP to an unrelated company. The sale resulted in a gain for
Petitioner and its partners.
In addition to its interest in 589 LP, Petitioner directly owned and operated a retail power
center in San Antonio, Texas (from December 11, 1996, until December 15, 2003) and a retail
power center in Seattle, Washington (from January 31, 1997, until December 30, 2003).
Petitioner has been directly and actively involved in those activities.
Petitioner has not employed its partnership holding in 589 LP in any New York business
activity (e.g., not as loan collateral or otherwise).

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While engaging in these three activities, Petitioner used separate accounting for these
three activities because this most accurately reflected the income and expenses attributable to
each activity. Petitioner reported these activities separately on Form 8825 for federal income tax
purposes and on the applicable state tax returns. Further, Petitioner reported gains (or losses)
from the sales of the retail power center properties using separate accounting in the states in
which the real property was situated.
Petitioner has been filing New York State partnership returns, Form IT-204.
Applicable law and regulations
Section 617(b) of the Tax Law provides, in part:
Character of items. Each item of partnership . . . income, gain, loss, or deduction
shall have the same character for a partner . . . under this article as for federal income tax
purposes. Where an item is not characterized for federal income tax purposes, it shall
have the same character for a partner . . . as if realized directly from the source from
which realized by the partnership . . . or incurred in the same manner as incurred by the
partnership . . . .
Section 631 of the Tax Law provides, in part:
(a) General. The New York source income of a nonresident individual shall be the
sum of the following: (1) The net amount of items of income, gain, loss and deduction
entering into his federal adjusted gross income, as defined in the laws of the United States
for the taxable year, derived from or connected with New York sources, including: (A)
his distributive share of partnership income, gain, loss and deduction, determined under
section six hundred thirty-two, and
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(2) The portion of the modifications described in subsections (b) and (c) of
section six hundred twelve which relate to income derived from New York sources
(including any modifications attributable to him as a partner. . .).
(b) Income and deductions from New York sources.
(1) Items of income, gain, loss and deduction derived from or connected with
New York sources shall be those items attributable to:
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(B) a business, trade, profession or occupation carried on in this state; or

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(2) Income from intangible personal property, including annuities, dividends,
interest, and gains from the disposition of intangible personal property, shall constitute
income derived from New York sources only to the extent that such income is from
property employed in a business, trade, profession, or occupation carried on in this state.
...
Section 632 of the Tax Law pertains, in part, to nonresident partners and provides, in
part:
(a) Portion derived from New York sources.
(1) In determining New York source income of a nonresident partner of any
partnership, there shall be included only the portion derived from or connected with
New York sources of such partner's distributive share of items of partnership income,
gain, loss and deduction entering into his federal adjusted gross income, as such portion
shall be determined under regulations of the [Commissioner of Taxation and Finance]
consistent with the applicable rules of section six hundred thirty-one.
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(e) Application of rules for resident partners . . . to nonresident partners . . . .
(1) A nonresident partner's distributive share . . . of items shall be determined
under subsection (a) of section six hundred seventeen.
(2) The character of partnership . . . items for a nonresident partner . . . shall be
determined under subsection (b) of section six hundred seventeen.
Section 132.5(a) of the Personal Income Tax Regulations (Regulations) provides:
Items of income, gain, loss and deduction attributable to intangible personal
property of a nonresident individual, including annuities, dividends, interest, and gains
and losses from the disposition of intangible personal property, do not constitute items of
income, gain, loss and deduction derived from or connected with New York State
sources, except to the extent attributable to property employed in a business, trade,
profession or occupation carried on in New York State. (See also section 3 of article XVI
of the New York State Constitution.)
Section 137.6 of the Regulations provides:

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Tiered partnerships. Where a nonresident partner is a member in a partnership,
and such partnership (hereinafter referred to as the "upper tier partnership") is a partner in
another partnership (hereinafter referred to as the "lower tier partnership"), the source and
character of such nonresident partner's distributive share of each partnership item of the
upper tier partnership which is attributable to the lower tier partnership retains the source
and character determined at the level of the lower tier partnership using the provisions of
section 137.1 and 137.5 of this Part. Such source and character are not changed by reason
of the fact that such item flows through the upper tier partnership to such nonresident
partner.
Opinion
Section 632(a)(1) of the Tax Law provides that the New York source income of a
nonresident partner of any partnership includes only the portion derived from or connected with
New York sources of such partner's distributive share of items of partnership income, gain, loss,
and deduction entering into the partner's federal adjusted gross income. The determination of
such portion must be consistent with section 631 of the Tax Law.
Pursuant to section 631(b) of the Tax Law, items of income, gain, loss, and deduction
derived from or connected with New York sources include those items attributable to a business,
trade, profession, or occupation carried on in New York State.
A gain or loss (whether treated as a capital gain or loss or ordinary gain or loss for federal
income tax purposes) from the sale of an interest in a New York partnership, except in certain
situations not present here, does not constitute gain or loss derived from or connected with
New York sources and is not includible as New York source income. (See Technical Services
Bureau Memorandum entitled New York Tax Treatment of Gains and Losses from the Sale by a
Nonresident or Part-Year Resident of an Interest in a New York Partnership, August 21, 1992,
TSB-M-92-(2)I.)
In McDermott, Will & Emery, Adv Op Comm T&F, October 25, 2004, TSB-A-04(6)I, it
was held that the nonresident partners= distributive shares of partnership income of an upper-tier
partnership attributable to an investment in a lower-tier partnership that trades in intangible
personal property solely for its own account was not New York source income under section
631(b)(2) of the Tax Law. The income attributable to the lower-tier partnership did not change
its character despite the existence of a tiered partnership where the partnership=s income was
funneled through the upper-tier partnership before its ultimate distribution or deemed
distribution.
In this case, Petitioner has not employed its partnership holding in 589 LP in any
New York business activity (e.g., not as loan collateral or otherwise). Petitioner did not use its
investment in 589 LP in a business, trade, profession, or occupation carried on in New York.
Following TSB-M- 92-(2)I, and McDermott, Will & Emery, supra, the fact that the gain from the

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sale of an interest in 589 LP will funnel through Petitioner will not change the result that a gain
from the sale of an interest in a New York partnership, except in certain situations not present
here, does not constitute gain derived from or connected with New York sources and is not
includible as New York source income.
Accordingly, the portion of Petitioner’s income attributable to the gain from the sale of
its interest in 589 LP does not constitute income from intangible personal property employed in a
trade or business carried on in New York and is not considered income from New York sources
pursuant to section 631(b)(2) of the Tax Law and section 132.5 of the Regulations.

DATED: February 7, 2007

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.