Rev. Rul. 78-2

Advice has been requested whether, under the circumstances described below, certain partnerships may utilize the optional adjustment to basis under section 743 of the Internal Revenue Code of 1954.

X, an investment partnership, was formed for the purpose of holding interests in operating real estate partnerships. X is a partner of partnership Y, an operating real estate partnership.

The specific question presented is whether the optional adjustment to basis under section 743(b) of the Code will be available to both X and Y when there is a sale or exchange of a partnership interest in X or the death of a partner of X, and both X and Y have made an election under section 754 to adjust the basis of partnership property on a sale or exchange of a partnership interest or on the death of a partner.

Section 743(a) of the Code provides the general rule that the basis of partnership property shall not be adjusted as the result of a transfer of an interest in a partnership by sale or exchange or on the death of a partner unless the election provided by section 754 is in effect with respect to such partnership.

Section 743(b) of the Code provides that, in the case of a transfer of an interest in a partnership by sale or exchange or upon the death of a partner, a partnership with respect to which the election provided in section 754 is in effect shall (1) increase the adjusted basis of the partnership property by the excess of the basis to the transferee partner of such partner's interest in the partnership over the partner's proportionate share of the adjusted basis of the partnership property, or (2) decrease the adjusted basis of the partnership property by the excess of the transferee partner's proportionate share of the adjusted basis of the partnership property over the basis of such partner's interest in the partnership. Section 743(b) further provides that the increase or decrease shall be an adjustment of basis to the transferee partner only.

Section 754 of the Code provides, in part, that if a partnership files an election, in accordance with regulations prescribed by the Secretary of the Treasury, the basis of partnership property shall be adjusted, in the case of a transfer of a partnership interest, in the manner provided in section 743. Such election shall apply with respect to all transfers of interests in the partnership during the taxable year with respect to which such election was filed and all subsequent years.

For purposes of sections 743 and 754 of the Code, a sale or exchange of an interest in X or the death of a partner of X is considered to result in an adjustment to the basis of the property of Y as though the transferee partner were a partner of Y.

Accordingly, upon the transfer of an interest in X by sale or exchange or on the death of a partner of X during a taxable year with respect to which elections under section 754 of the Code are in effect for X and Y, the adjustment to the basis of partnership property under section 743(b) will include, (a) an adjustment to X's partnership interest in Y and (b) an equivalent basis adjustment to Y's property with respect to X and the transferee partner of X only. Compare Rev. Rul. 77-309, 1977-2 C.B. 216, concerning the allowance of a distributive share of partnership loss to a limited partner in a limited partnership that is itself a limited partner of another limited partnership.