SHORT SALE OF SECURITIES CREATES PARTNERSHIP LIABILITIES, IRS RULES.

Rev. Rul. 95-26

ISSUE

Does the short sale of securities described below create a partnership liability under section 752 of the Internal Revenue Code?

FACTS

A and B are partners in partnership PRS. PRS enters into a short sale of XYZ securities on a national securities exchange. PRS's broker-dealer takes securities on hand and sells them on PRS's behalf. PRS leaves the cash proceeds from the sale with the broker- dealer as collateral and deposits additional cash as further collateral with the broker-dealer. PRS is obligated to deliver identical XYZ securities to close out the short sale.

LAW AND ANALYSIS

Section 722 provides that a partner's basis is increased by the amount of money the partner contributes to the partnership.

Section 752(a) provides that an increase in a partner's share of partnership liabilities is treated as a contribution of money by the partner to the partnership.

Rev. Rul. 88-77, 1988-2 C.B. 129, provides that partnership liabilities for purposes of section 752 include an obligation to the extent that incurring the liability creates or increases the basis to the partnership of any of the partnership's assets (including cash attributable to borrowings).

A short sale creates an obligation on the part of the seller to return the borrowed securities. See, e.g., Deputy v. du Pont, 308 U.S. 488, 497-98 (1940), 1940-1 C.B. 118 (a short sale creates an obligation although not an indebtedness). In addition, the cash received in the short sale is an asset of the partnership. Thus, the basis of the partnership's assets is increased. Therefore, PRS's short sale creates a liability under section 752, and the adjusted bases of the partnership interests of A and B are increased under section 722 to reflect their shares of the liability under section 752.

HOLDING

The short sale of securities described in this ruling creates a partnership liability under section 752.

For an analysis relating to whether short sale transactions give rise to unrelated business taxable income under section 512, see Rev. Rul. 95-8, 1995-4 I.R.B. 29.

DRAFTING INFORMATION

The principal author of this revenue ruling is Mary A. Berman of the Office of the Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mary A. Berman on (202) 622-3050 (not a toll free call).