investment memorandum expressly referred to this guaranty as follows, "Alanthus will guaranty [sic] all of the Lessee's obligations to [Tiger Lily]." The written guaranty agreement provided as follows:

does

ALANTHUS CORPORATION (the "Guarantor") hereby unconditionally guarantee to [Tiger Lily] *** the prompt and full performance and observance of all of the covenants, conditions and agreements of [A-F Associates] *** including, without limitation, the full and prompt payment when due, whether by acceleration or otherwise, in accordance with the terms of the Lease, of rent and all other sums payable by [A-F Associates] to [Tiger Lily], whether absolute or contingent, secured or unsecured, matured or unmatured, and without regard to any grace periods provided for in the Lease, including, without limitation, payment of any stipulated loss value, deficiency payments, and all other sums due upon an Event of Default by [A-F Associates]

In addition to Alanthus' guarantee, Alafund Associates provided to Tiger Lily and its limited partners essentially the same unconditional guarantee with respect to the obligations of A-F Associates under the lease of the computer equipment from Tiger Lily except that Alafund Associates' obligations under its guarantee did not come into effect until after the user rent achievement date.

A chart depicting the general organization and structure of the above transactions has been stipulated by the parties and appears infra p. 446.

Under a remarketing agreement of May 31, 1979, Alanthus was appointed exclusive remarketing agent for Tiger Lily for 7 years after the termination of the lease with A-F Associates. For its remarketing efforts, Alanthus was to be paid fees typical for such services.

Investments in Tiger Lily and Losses Claimed

On May 31, 1979, petitioner executed a subscription agreement pursuant to which he became obligated to contribute $10,000 to the capital of Tiger Lily in exchange for a limited partnership interest in Tiger Lily. Petitioner contributed $6,500 to Tiger Lily upon execution of the subscription agreement, and he executed a promissory note in favor of Tiger Lily in the amount of $3,500, payable on February 15, 1980.

Other investors executed subscription agreements obligating them to contribute a total of $638,083 to the capital of Tiger Lily. Tiger Lily received $638,083 in capital contributions, $421,289 of which was contributed in cash and the remainder of which was represented by promissory notes.

On its Federal partnership information tax returns (Forms 1065) for 1979 through 1982, Tiger Lily reported losses of $1,014,273, $576,155, $346,927, and $266,573, respectively, and investment interest expense of $268,933, $474,550, $458,807, and $151,241, respectively. Petitioners claimed the following amounts as petitioner's allocable share of Tiger Lily's losses and deductions: 1979-$17,785; 1980– $18,157; 1981-$5,342; and 1982-$4,105. On audit, respondent disallowed all losses and expenses claimed relating to petitioner's investment in Tiger Lily.

Legal Analysis

In Levy v. Commissioner, 91 T.C. 838, 862-865 (1988), we explained generally the legal principles applicable to the atrisk issue as follows. Under section 465, where individual investors or closely held corporations engage in the leasing of depreciable property, any loss with respect to the leasing activity is allowed only to the extent the investors are financially at risk with respect to the obligations of the leasing activity at the close of the taxable year. Sec. 465(a)(1) and 465(c)(1)(C).3

Investors generally are considered to be financially at risk with respect to investments in leasing activities to the extent they contribute money to the activities. Sec. 465(b)(1)(A). Investors also are considered to be financially at risk with respect to debt obligations of leasing activities to the extent they are personally liable for repayment of the debt obligations or to the extent they have pledged property, other than the property used in the activities, as security for the borrowed amounts. Sec. 465(b)(2).4

'Sec. 465 was added to the Internal Revenue Code by the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1520, and applies to tax years beginning after Dec. 31, 1975. *Sec. 465(b)(2) provides as follows:

(2) BORROWED AMOUNTS.-For purposes of this section, a taxpayer shall be considered at risk with respect to amounts borrowed for use in an activity to the extent that he

(A) is personally liable for the repayment of such amounts, or

With respect to particular debt obligations, investors will be regarded as personally liable for such obligations within the meaning of section 465(b)(2)(A) if they are ultimately economically liable to repay the obligations in the event funds from the investment activities are not available to repay the obligations. The critical inquiry is who is the obligor of last resort, and the scenario that controls is the worst case scenario, not the best case. The fact that other investors or participants remain in the "chain of liability" does not detract from the at-risk amount of investors who have the ultimate liability. In determining which investors or participants in a transaction are ultimately financially responsible for the debt obligations, the substance of the transaction controls. Melvin v. Commissioner, 88 T.C. 63, 75 (1987), affd. per curiam 894 F.2d 1072 (9th Cir. 1990); Pritchett v. Commissioner, 827 F.2d 644, 647 (9th Cir. 1987), revg. and remanding 85 T.C. 580 (1985); Follender v. Commissioner, 89 T.C. 943, 949-950 (1987). See also Raphan v. United States, 759 F.2d 879, 885 (Fed. Cir. 1985), cert. denied 474 U.S. 843 (1985).

The above limitation on debt obligations with respect to which investors will be considered at risk is expressly reflected in the statutory scheme. Section 465(b)(4)5 provides that even though investors nominally may be personally liable with respect to debt obligations, for tax purposes they will not be considered at risk for the debt obligations if their ultimate liability with respect to the debt obligations is protected against loss through "nonrecourse financing, guarantees, stop loss agreements, or other similar arrangements." The language "other similar arrangements" is not specifically defined in the Code or in the legislative history, but the legislative history evidences concern with situations in which investors are effectively immunized from any realistic possibility of suffering an economic loss even

(B) has pledged property, other than property used in such activity, as security for such borrowed amount (to the extent of the net fair market value of the taxpayer's interest in such property).

No property shall be taken into account as security if such property is directly or indirectly financed by indebtedness which is secured by property described in paragraph (1).

"Sec. 465(b)(4) provides as follows:

(4) EXCEPTION.-Notwithstanding any other provision of this section, a taxpayer shall not be considered at risk with respect to amounts protected against loss through nonrecourse financing, guarantees, stop loss agreements, or other similar arrangements.

though the underlying transaction is not profitable. Larsen v. Commissioner, 89 T.C. 1229, 1272-1273 (1987), on appeal (9th Cir., Dec. 12, 1988); Melvin v. Commissioner, supra at 70-71; Bennion v. Commissioner, 88 T.C. 684, 692 (1987); Porreca v. Commissioner, 86 T.C. 821, 838 (1985); S. Rept. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49, 87.

As we have previously stated (see Melvin v. Commissioner, 88 T.C. at 75-76), particularly relevant to our analysis of this issue is the direction given to the Treasury by Congress in the Deficit Reduction Act of 1984, in response to the decision of the Claims Court in Raphan v. United States, 3 Cl. Ct. 457 (1983). In that case, the Claims Court made a determination of liability, or lack of liability, based primarily on the form of the transaction and on certain labels used by the parties to the transaction. In response to the Claims Court decision in Raphan, Congress specifically directed the Treasury to promulgate regulations under section 752 to consider the substance and not merely the form of the financing, and particularly to consider current commercial lending practices with respect to guarantees, assumptions, and indemnities. Sec. 79, Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 494, 597; H. Rept. 98-861 (Conf.), at 869 (1984), 1984-3 C.B. (Vol. 2) 123. We also believe it appropriate and incumbent on us to take into account under section 465(b)(4), the substance and the commercial realities of the financing arrangements presented to us by each transaction.

As applied particularly to a highly leveraged, taxoriented, equipment leasing transaction (and depending on the issues raised), the above principles require us to analyze the substance and the commercial realities of all material aspects of the transaction. Neither the form chosen, the labels used, nor a single feature of the transaction generally will control.

*In Raphan v. United States, 3 Cl. Ct. 457 (1983), the Claims Court held that because none of the partners were personally liable on a partnership debt obligation, each limited partner was allowed to increase his basis in his investment in the partnership by his pro rata share of the partnership debt. The Claims Court treated the liability of the general partner under his "guarantee" of the partnership debt as a secondary liability since the word "guarantee" generally connotes a secondary liability vis-à-vis the primary obligor. Raphan v. United States, supra at 465-466. The Court of Appeals for the Federal Circuit reversed the Claims Court and held that in spite of the use by the parties of the term "guarantor," the general partner was personally liable for the partnership debt because he ultimately was liable therefor. Raphan v. United States, 759 F.2d 879, 886 (Fed. Cir. 1985), cert. denied 474 U.S. 843 (1985).