California rejects FTB's partnership-sale sourcing rule, limits REIT dividend deductions, and the IRS expands crypto-staking guidance as the Tax Court reinforces partnership loss requirements.
Four developments deserve attention this week: a significant California Office of Tax Appeals decision involving the sale of partnership interests by nonresidents; another California decision restricting duplicative tax benefits claimed by real estate investment trusts; a U.S. Tax Court opinion illustrating the limits on partnership loss deductions; and new IRS guidance providing greater certainty for exchange-traded cryptocurrency investment trusts.
The California decisions are particularly important because both have been published with proposed precedential designations. Neither is currently final precedential authority. The IRS guidance, by contrast, is effective administrative guidance, while the federal Tax Court decision is a memorandum opinion applying established law.
California Rejects FTB's Approach to Taxing Nonresident Partnership Sales
One of the week's most consequential developments is Appeals of Burch and Carden, 2026-OTA-527P, published by the California Office of Tax Appeals in October 2026.
The case concerns a fundamental distinction in partnership taxation: whether selling an ownership interest in a partnership should be treated differently from selling the partnership's underlying assets.
The taxpayers were California nonresidents who indirectly owned interests in Tory Burch LLC, the fashion company, through an investment partnership. When that partnership sold portions of its Tory Burch interests, part of the resulting gain was attributable to unrealized receivables and inventory—commonly called hot assets.
Under Internal Revenue Code §751(a), gain attributable to these assets is generally treated as ordinary income rather than capital gain.
The Franchise Tax Board maintained that §751(a) did more than change the character of the income. Under FTB Legal Ruling 2022-02, the agency treated the transaction as though the underlying partnership had sold its hot assets, with the resulting income allocated to its partners. Because Tory Burch conducted business in California, FTB argued that a portion of the gain constituted California-source income.
The OTA rejected that interpretation.
Relying heavily on the D.C. Circuit's decision in Rawat v. Commissioner, 108 F.4th 891 (D.C. Cir. 2024), the OTA concluded that §751(a) changes the character of gain but does not transform a sale of a partnership interest into a deemed sale of partnership assets.
The transaction therefore remained a sale of intangible personal property. Under Revenue and Taxation Code §17952, gain from the sale of such property by a nonresident generally is not California-source income unless the property has acquired a California business situs.
The OTA reversed FTB's adjustments in full. Office of Tax Appeals
Why It Matters
This decision could have substantial consequences for nonresident owners selling interests in partnerships conducting business in California.
If the decision becomes precedential, it would directly undermine FTB Legal Ruling 2022-02 and restrict the agency's ability to use §751(a) as an independent basis for sourcing partnership-sale proceeds to California.
The ruling does not establish that every nonresident partnership-interest sale escapes California taxation. Business situs, the nature of the ownership structure, and whether the income arises from partnership operations rather than a sale of an ownership interest remain important distinctions.
For taxpayers facing California assessments involving partnership-interest sales, Burch provides potentially valuable authority for challenging FTB's sourcing methodology.
Current status: The opinion is designated pending precedential. It is not yet final precedential authority.
Primary authority: Read the official OTA opinion — Burch and Carden (PDF)
Caifornia Limits REITs' Ability to Claim Two Tax Benefits on the Same Dividends
In Appeal of Kimco Realty Corporation and Subsidiaries, 2026-OTA-482P, the OTA addressed the interaction between California's intercompany-dividend elimination rules and the federal dividends-paid deduction available to real estate investment trusts.
Kimco, a REIT operating shopping centers, received dividends from a wholly owned taxable REIT subsidiary included in its California combined reporting group.
For California purposes, Kimco eliminated those dividends under Revenue and Taxation Code §25106, which generally prevents intercompany dividends from being taxed again within a unitary group.
Kimco also claimed the dividends-paid deduction under IRC §857(b)(2)(B), which allows qualifying REITs to deduct dividends distributed to shareholders.
The combined result was favorable: the subsidiary's dividends were eliminated for California purposes, while the REIT also received the benefit of a federal deduction incorporated into its California tax computation.
The OTA rejected this treatment.
By a 2–1 vote, the panel held that Kimco could eliminate the intercompany dividends under §25106 but could not simultaneously retain the dividends-paid deduction attributable to those same dividends.
The majority concluded that permitting both benefits would produce an impermissible double tax benefit. FTB's additional assessments of approximately $204,000 for 2014 and $82,000 for 2015 were sustained.
Judge Greg Turner dissented, arguing that the governing statutes did not authorize the majority's limitation.
The OTA also denied Kimco's petition for rehearing in a companion opinion, 2026-OTA-483P. Office of Tax Appeals
Why it Matters
The decision is particularly relevant to REITs with taxable REIT subsidiaries included in California combined reporting groups.
It also illustrates the broader difficulty of reconciling federal tax preferences with California's separate corporate tax rules.
The dissent highlights a potentially important statutory interpretation dispute, particularly where California generally incorporates a federal deduction but also mandates a separate adjustment to income.
Current status: Both opinions are pending precedential, not yet final precedential authority.
Primary authority: Read the official OTA opinion — Kimco Realty Corporation (PDF)
Tax Court Rejects Nearly $6.9 Million in Partnership Loss Deductions
On October 7, the U.S. Tax Court issued West v. Commissioner, T.C. Memo. 2026-105, addressing whether a partner who contributed services rather than capital could deduct substantial partnership losses.
The taxpayer participated in a commodities-trading partnership with another individual who supplied the venture's capital.
The taxpayer contributed management services and was entitled to share in partnership profits and losses. He also executed a promissory note payable to his co-partner to address losses allocated to him.
When the partnership incurred substantial losses, the taxpayer claimed he was entitled to deduct approximately $6.9 million and carry unused losses back to a prior tax year.
The Tax Court rejected the deduction.
Under IRC §704(d), partnership losses are deductible only to the extent of a partner's adjusted basis in the partnership interest.
The Court concluded that the taxpayer's contribution of services did not establish the necessary basis. His promissory note was payable to the other partner personally, not to the partnership, and did not constitute a capital contribution establishing outside basis.
The Court also considered IRC §465, which limits deductions to amounts a taxpayer has at risk in an activity. The borrowing arrangement failed to establish the required amount at risk because the lender was another person with an ownership interest in the activity.
The Court additionally sustained adjustments involving unreported income reconstructed from bank deposits, insufficiently substantiated business expenses, and accuracy-related penalties. Leagle
Why it Matters
West is a useful reminder that economic exposure, contractual loss allocations, tax basis, and amounts at risk are distinct concepts.
An agreement to share partnership losses does not automatically create the tax basis necessary to deduct them.
Partnerships combining one partner's capital with another partner's services should carefully document capital contributions, debt obligations, guarantees, and partnership liabilities before allocating losses.
Authority: This is a Tax Court memorandum opinion, rather than a regular published opinion. It principally applies established partnership tax rules rather than announcing a new legal standard.
Opinion: West v. Commissioner — T.C. Memo. 2026-105. The opinion is also available through the U.S. Tax Court's official opinion search under docket 17890-19.
IRS Expands Safe Harbor for Cryptocurrency Investment Trusts
On October 6, the IRS issued Revenue Procedure 2026-20, expanding and replacing its earlier guidance concerning cryptocurrency staking by certain investment trusts.
Staking generally involves committing digital assets to support transaction validation on a proof-of-stake blockchain network. Participants may receive additional digital assets as rewards.
For an exchange-traded cryptocurrency investment trust, staking has presented a significant federal tax question: Could engaging in staking cause the trust to be treated as conducting an active business rather than merely holding investments?
That distinction matters because many exchange-traded cryptocurrency products are structured as investment trusts and grantor trusts for federal income tax purposes.
Revenue Procedure 2026-20 establishes a detailed safe harbor allowing qualifying trusts to engage in staking without jeopardizing those classifications.
The guidance addresses several operational issues, including the use of multiple custodians and staking providers, arrangements for maintaining liquidity, permissible staking activities, and the handling of staking rewards.
Generally, the safe harbor applies to qualifying exchange-traded trusts holding cash and one type of proof-of-stake digital asset.
Existing qualifying trusts receive a six-month transition period beginning October 6, 2026, to modify trust agreements and operating procedures. After that period, trusts may no longer rely on the superseded Revenue Procedure 2025-31 safe harbor. IRS
Why it Matters
The guidance provides greater structural certainty for investment sponsors developing exchange-traded cryptocurrency products.
It potentially permits trusts to generate staking rewards while retaining the federal tax classification on which their investment structures depend.
However, the IRS expressly declined to address several other issues, including whether staking income constitutes effectively connected income or unrelated business taxable income.
The safe harbor should therefore not be interpreted as a comprehensive determination of the federal tax consequences of cryptocurrency staking.
Current status: Revenue Procedure 2026-20 is effective for taxable years ending on or after October 6, 2026. It is operative IRS guidance, not a proposed regulation.
Primary authority: IRS Revenue Procedure 2026-20 (PDF)
The Week's Practical Takeaway
The California partnership-sale decision is the week's most significant development for conventional tax planning and controversy work. Its rejection of FTB Legal Ruling 2022-02 could materially affect California taxation of business sales involving nonresident partnership owners.
The Kimco decision warrants attention from REITs and corporate taxpayers navigating the interaction between federal deductions and California combined-reporting rules.
At the federal level, West illustrates the continuing importance of properly establishing partnership basis and amounts at risk, while Revenue Procedure 2026-20 reflects the IRS's effort to accommodate developing digital-asset investment structures within existing tax-classification rules.
No newly enacted federal or California legislation is included in this week's principal developments. The significant changes discussed above arise from administrative decisions, a Tax Court memorandum opinion, and IRS guidance.
Disclaimer: This article is provided for general informational purposes only and does not constitute legal or tax advice. Tax laws and administrative interpretations change, and the application of any rule depends on the particular facts and circumstances. Readers should consult qualified tax and legal advisers before taking action based on the developments discussed above.