Rev. Rul. 79-205

ISSUES

When a partnership makes a nonliquidating distribution of property, (1) is a partner permitted to offset the increase in the partner's liabilities against the decrease in the partner's liabilities in determining the extent of recognition of gain or loss, and (2) is partnership basis adjusted before or after the property distribution?

FACTS

A and B are general partners in M, a general partnership, which was formed for the purposes of owning and operating shopping centers.

On December 31, 1977, M made nonliquidating distributions in a single transaction of a portion of its property to A and B. A and B are equal partners in M. M, A and B are calendar year taxpayers. No assets of the type described in section 751(a) of the Internal Revenue Code of 1954 were distributed by M to either A or B.

Immediately prior to the distribution A had an adjusted basis for A's interest in M of 1,000x dollars, and B had an adjusted basis for B's interest in M of 1,500x dollars. The property distributed to A had an adjusted basis to M of 2,000x dollars, and was subject to liabilities of 1,600x dollars. The property distributed to B had an adjusted basis to M of 3,200x dollars and was subject to liabilities of 2,800x dollars. A's individual liabilities increased by 1,600x dollars by reason of the distribution to A. B's individual liabilities increased by 2,800x dollars by reason of the distribution to B. A's share and B's share of the liabilities of M each decreased by 2,200x dollars (1/2 of 1,600x + 1/2 of 2,800x dollars) by reason of the distributions. The basis and fair market value of the properties distributed were greater than the liabilities to which they were subject.

LAW

Section 705(a) of the Code provides, in part, that the adjusted basis of a partner's interest in a partnership shall be the basis of such interest determined under section 722 decreased (but not below zero) by partnership distributions as provided in section 733.

Section 722 of the Code provides, in part, that the basis of a partnership interest acquired by a contribution of money shall be the amount of such money.

Section 731(a)(1) of the Code provides that in the case of a distribution by a partnership to a partner gain shall not be recognized to such partner, except to the extent that any money distributed exceeds the adjusted basis of such partner's interest in the partnership immediately before the distribution.

Section 732(a)(1) of the Code provides that the basis of property (other than money) distributed by a partnership to a partner other than in liquidation of the partner's interest shall, except as provided in section 732(a)(2), be its adjusted basis to the partnership immediately before such distribution.

Section 732(a)(2) of the Code provides that the basis to the distributee partner of property to which section 732(a)(1) is applicable shall not exceed the adjusted basis of such partner's interest in the partnership reduced by any money distributed in the same transaction.

Section 733 of the Code provides that in the case of a distribution by a partnership to a partner other than in liquidation of a partner's interest, the adjusted basis to such partner of the interest in the partnership shall be reduced (but not below zero) by the amount of any money distributed to such partner and the amount of the basis to such partner of distributed property other than money, as determined under section 732.

Section 752(a) of the Code provides that any increase in a partner's share of the liabilities of a partnership, or any increase in a partner's individual liabilities by reason of the assumption by such partner of partnership liabilities, shall be considered as a contribution of money by such partner to the partnership.

Section 752(b) of the Code provides that any decrease in a partner's share of the liabilities of a partnership, or any decrease in a partner's individual liabilities by reason of the assumption by the partnership of such individual liabilities, shall be considered as a distribution of money to the partner by the partnership.

Section 752(c) of the Code provides that for purposes of section 752 a liability to which property is subject shall, to the extent of the fair market value of such property, be considered as a liability of the owner of the property.

ANALYSIS & HOLDING

In general, partnership distributions are taxable under section 731(a)(1) of the Code only to the extent that the amount of money distributed exceeds the distributee partner's basis for the partner's partnership interest. This rule reflects the Congressional intent to limit narrowly the area in which gain or loss is recognized upon a distribution so as to remove deterrents to property being moved in and out of partnerships as business reasons dictate. See S. Rep. No. 1622, 83rd Cong., 2nd Sess., page 96 (1954). Here, since partner liabilities are both increasing and decreasing in the same transaction offsetting the increases and decreases tends to limit recognition of gain, thereby giving effect to the Congressional intent. Consequently, in a distribution of encumbered property, the resulting liability adjustments will be treated as occurring simultaneously, rather than occurring in a particular order. Therefore, on a distribution of encumbered property, the amount of money considered distributed to a partner for purposes of section 731(a)(1) is the amount (if any) by which the decrease in the partner's share of the liabilities of the partnership under section 752(b) exceeds the increase in the partner's individual liabilities under section 752(a). The amount of money considered contributed by a partner for purposes of section 722 is the amount (if any) by which the increase in the partner's individual liabilities under section 752(a) exceeds the decrease in the partner's share of the liabilities of the partnership under section 752(b). The increase in the partner's individual liabilities occurs by reason of the assumption by the partner of partnership liabilities, or by reason of a distribution of property subject to a liability, to the extent of the fair market value of such property.

Because the distribution was part of a single transaction, the two properties are treated as having been distributed simultaneously to A and B. Therefore, all resulting liability adjustments relating to the distribution of the two properties will be treated as occurring simultaneously, rather than occurring in a particular order.

TREATMENT OF PARTNER A

A will be deemed to have received a net distribution of 600x dollars in money, that is, the amount by which the amount of money considered distributed to A (2,200x dollars) exceeds the amount of money considered contributed by A (1,600x dollars). Since 600x dollars does not exceed A's basis for A's interest in M immediately before the distribution (1,000x dollars), no gain is recognized to A.

Under section 732(a) of the Code, the basis to A of the property distributed to A is the lesser of (i) the adjusted basis of the property to the partnership (2,000x dollars), or (ii) the adjusted basis of A's partnership interest (1,000x dollars) reduced by the amount of money deemed distributed to A (600x dollars). Therefore, the basis of the property in A's hands is 400x dollars. Under section 733, the adjusted basis of A's partnership interest (1,000x dollars) is reduced by the amount of money deemed distributed to A (600x dollars) and by the basis to A of the distributed property (400x dollars). The adjusted basis of A's partnership interest is therefore reduced to zero.

TREATMENT OF PARTNER B

B will be deemed to have made a net contribution of 600x dollars, that is, the amount by which the amount of money considered contributed by B (2,800x dollars) exceeds the amount of money considered distributed to B (2,200x dollars). In applying sections 732(a) and 733 of the Code to B, the adjustment to B's basis in B's partnership interest attributable to the liability adjustments resulting from the distributions will be treated as occurring first, and the distribution of property to B as occurring second. By so doing, B's basis for the distributed property is increased and B's basis in B's partnership interest is decreased. This allocation gives greater effect to the general rule of section 732(a)(1), which provides for the partner to have the same basis in distributed property as the partnership had for that property.

Therefore, the first step is that B's basis for B's partnership interest (1,500x dollars) is increased under sections 722 and 705(a) by the amount of the net contribution deemed made by B (600x dollars), and is equal to 2,100x dollars. Next, under section 732(a) of the Code, the basis to B of the property distributed to B is the lesser of (i) the adjusted basis of the property to the partnership (3,200x dollars), or (ii) the adjusted basis of B's partnership interest (2,100x dollars) reduced by the amount of money deemed distributed to B (zero). Therefore, the basis of the property in B's hands is 2,100x dollars. Under section 733, the adjusted basis of B's partnership interest (2,100x dollars) is reduced by the amount of money deemed distributed to B (zero) and by the basis to B of the distributed property (2,100x dollars). The adjusted basis of B's partnership interest is therefore zero.