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No Loss Recognized on Partnership Liquidation


FSA 1993-1084

DATED
DOCUMENT ATTRIBUTES
  • Institutional Authors
    Internal Revenue Service
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    partnerships, distributions, gain or loss
    partnerships, related-party transactions
    bad debt deduction
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 1999-2524 (7 original pages)
  • Tax Analysts Electronic Citation
    1999 TNT 95-30
Citations: FSA 1993-1084

 

INTERNAL REVENUE SERVICE

 

MEMORANDUM

 

CC:FS:* * *

 

* * *

 

 

date: * * *

 

 

to: Regional Counsel, * * *

 

Attn:* * *

 

 

from: Assistant Chief Counsel

 

(Field Service)

 

 

subject: * * *

 

I.R.C. section 731, 707(a), 166

 

 

[1] This memorandum is in response to your request for field service advice dated * * *

 

[2] ISSUES

 

 

1. Whether * * * recognized a loss under I.R.C. section 731 upon liquidation of the * * * and * * * partnership * * *?

2. Whether under the rationale Rev. Rul. 93-7, 1993 I.R.B. 4, * * * recognized any capital loss on the liquidation of * * *

3. Whether * * * is entitled to a bad debt deduction for loans made to a co-partner and to * * *

 

[3] CONCLUSIONS

 

 

1. No, we do not believe that * * * should recognize a capital loss on the liquidation of * * * under section 731.

2. We do not believe that the rationale of Rev. Rul. 93-7 is applicable to the loan transactions in this case or to the liquidation of * * *

3. * * * may be entitled to bad debt deductions for loans to * * * and * * * provided that * * * and * * * can establish that the loans became worthless during the taxable years at issue.

 

FACTS

 

 

[4] * * * was originally incorporated in * * * on * * * Its stockholders were * * * and * * * Each corporation owned * * * or * * * shares of * * * is wholly owned by * * * is owned by the * * * family. * * * was in the business of purchasing cattle for the purposes of fattening them and then selling them to slaughterhouses. On * * * the articles of incorporation of * * * were amended in order to change the name to * * *.

[5] The * * * through * * * taxable years are at issue. During those time periods, * * * was the common parent of the * * * Group and it filed consolidated federal income tax returns with its subsidiary, * * * owns all of the stock of * * *

[6] * * * obtained its financing from two banks, * * * and * * * It had a $* * * line of credit with the * * * and a $* * * line of credit with * * * The line of credit with * * * was increased to $* * * during the period from * * * to * * *.

[7] In the early * * * and * * * began doing business with a cattleman named * * * On * * * and * * * formed a general partnership. Each partner was to share in * * *% of the profits and losses of the partnership. Although not entirely clear, it appears that shortly after the formation of the * * * partnership * * *, * * * transferred his interest to * * * 1 This company is owned by * * * and his wife * * *

[8] Both * * * and * * * began lending money to * * * individually so that he could participate in various cattle investments. As of * * * had lent $* * * to * * * and * * * had lent him $* * * In addition, * * * on * * * lent * * * $* * * The note for this loan was due on * * * The note was secured by * * * partnership interest in * * * The total amount of loans to * * * or * * * was $* * * The parties involved seem to treat * * * and * * * as the same person. * * * is probably the alter ego of * * * The loans mentioned above were carried on the books and records of * * * as "Note Receivable - * * *"

[9] * * * also lent * * * money. On * * * renewed and increased an outstanding promissory note to * * * for $* * * As of * * * owed * * * approximately $* * * share of the debt was $* * *

[10] Unbeknownst to his business partners * * * had been borrowing large amounts of money from the * * * As collateral he pledged the same cattle that had been pledged to * * * and * * * The petitioners contend that they discovered this fraudulent conduct in * * *

[11] On * * * filed for bankruptcy. On * * * dissolved. A small amount of cash, vehicles and other equipment was distributed to * * * Upon liquidation, the notes payable account from * * * to * * * was divided between the two partners. * * * allocable share of that debt was $* * * In * * * pleaded guilty to bank fraud in the United States District Court for the * * *

[12] On * * * filed its consolidated federal income tax return for the * * * taxable year and claimed a bad debt deduction of $* * * On its * * * return, it claimed a bad debt deduction in the amount of $* * *

[13] The Revenue Agent's Report and the Notice of Deficiency, issued on * * * disallowed these bad debt deductions. The notice states that "since the bad debts did not become worthless during the taxable years ended * * * and * * * no deduction is allowable." * * * and * * * filed a petition from the notice in Tax Court on * * * In the Tax Court petition, * * * and * * * claim that in the alternative they are entitled to theft loss deductions for the amounts in issue.

 

DISCUSSION

 

 

Issue 1: Loss on Dissolution

[14] The tax consequences to the partners upon the liquidation of a partnership are generally governed by sections 731, 732, and 735. 2 Under section 731(a), loss is generally not recognized upon a distribution by a partnership to a partner. An exception is that loss is recognized by a partner upon a distribution in liquidation of a partner's interest in the partnership, and only where no property other than money, unrealized receivables and inventory items are distributed to that partner. Loss is recognized by the partner to the extent the adjusted basis of the partner's interest in the partnership immediately before the distribution exceeds the amount of money distributed plus the adjusted basis to the distributee of the unrealized receivables and inventory items distributed. Treas. Reg. section 1.731-1(a)(2) provides that if a distributee partner receives any property other than money, unrealized receivables, or inventory items, no loss is recognized.

[15] Section 731 also provides that any loss recognized under section 731(a) shall be considered a loss from the sale or exchange of the partnership interest of the distributee partner. Under section 741, the loss is characterized as capital.

[16] The traditional view has been that losses that occur on the liquidation of a partnership are capital losses. Miller v. United States, 33 F.2d 854, 860(Cl. Ct. 1964). See also Pietz v. Commissioner, 59 T.C. 207 (1972); Rev. Rul. 76-189, 1976-1 C.B. 181. Your postion is that * * * should recognize a capital loss on the liquidation of * * * under section 731. You specifically rely on Rev. Rul 76-189, and Pinson v. Commissioner, T.C. Memo. 1990-234, which reflect the traditional view. 3

[17] However, it is our position that no loss was recognized by * * * under section 731 on the liquidation of * * * As previously stated, in order for a distributee partner to recognize a loss on a liquidating distribution, the partner must only receive in the distribution money, unrealized receivables or inventory items. If any other type of property is received by the distributee partner, no loss is recognized. Treas. Reg. section 1.731-1(a)(2). Since the partnership distributed assets to * * * (vehicles & equipment) which do not qualify as money, unrealized receivables, or inventory items, no loss is recognized on the liquidating distribution under section 731.

Issue 2: Applicability of Rev. Rul. 93-7 1999-2524

[18] In your memorandum, you also rely on Rev. Rul. 93-7, 1993- 4 I.R.B. 5, for the proposed position that * * * is entitled to a capital loss upon liquidation.

[19] Rev. Rul. 93-7, holds that if a partnership acquires indebtedness of a partner, and the partnership distributes that debt to the partner so that the debt is extinguished, the distribution of property rules apply to determine the consequences to the partner. The ruling holds further that the partner will recognize gain or loss to the extent the fair market value of the debt differs from the basis of the debt determined under section 732.

[20] We do not think that Rev. Rul. 93-7, is applicable to this situation for the following reasons. First, we are not dealing with the indebtedness of a partner in this case -- the debt is partnership debt owed to a partner acting in the capacity of a third-party creditor. I.R.C. section 707(a). Second, in Rev. Rul. 93-7, the debt was acquired by the partnership from a third-party whereas here the debt was incurred by the partnership to a third-party. Rev. Rul. 93-7, is based on the proposition that a distribution by the partnership of a partner's note to that partner is a distribution of property. The distribution of a partnership's note to its partners on liquidation is not a distribution of property. Therefore, the analysis and consequences set forth in Rev. Rul. 93-7, are inapplicable in this case.

Issue 3: Tax Consequences of the Loan Transactions

[21] The central issue in the present case is whether * * * is entitled to a bad debt deduction for the loans made to a co-partner and to the partnership. Section 707(a) will govern. the treatment of the loan between * * * and * * * while the normal rules for the tax treatment of loans will govern the loans between * * * and * * *

[22] Under section 707(a), a loan of money by a partner to a partnership is treated as a transaction between unrelated parties so long as the advance is a bona fide loan and does not closely resemble a capital contribution. Treas. Reg. section 1.707-1(a). All facts and circumstances should be considered and a general debt-equity analysis is applied to determine if the advance to the partnership is a loan or a capital contribution. Hambuechan v. Commissioner, 43 T.C. 90 (1964); Rev. Rul. 72-135, 1972-1 C.B. 200.

[23] The loan between * * * and * * * appears to be a bona fide loan. Therefore, for purposes of the loan transaction, * * * is treated as a third party-creditor and not as general partner. When such a recourse loan arises state law generally provides that all the general partners, including * * * are personally liable on such debt. 4

[24] When a general partner makes a bona fide loan to a partnership, and such a loan is not repaid upon the liquidation of the partnership, the lending partner may have a bad debt loss deductible under section 166(a) or a nonbusiness bad debt loss deductible only as a short-term capital loss under section 166(d). However, when the lending partner is a corporation section 166(d) is not applicable. I.R.C. section 166(d)(1). In the context of loans by a partner to a partnership, two issues arise as to the amount and timing of any bad debt deduction. The first is the amount of potential bad debt deduction allowed to the general partner. The second is whether the debt is wholly or partially worthless during the taxable year.

[25] First, with regard to the amount of the potential bad debt deduction, it is our position that the lending partner is entitled to a deduction only in the amount of the debt that is due and uncollectible from the other general partners. As a rule, all general partners are individually liable for partnership debts, however, there exists a right of contribution among the general partners. Rev. Rul. 72-505, 1972-2 C.B. 102. Therefore, while the lending general partner is personally liable on his own obligation, the lending partner will have a right of contribution from the other general partners for each partner's share of the total obligation. When these partners are unable to make this contribution, the lending partner is entitled to a bad debt deduction in this amount. 5 Therefore, in the present case, provided the requirements of section 166 are otherwise met, * * * would be entitled to a bad debt deduction for * * * share of the debt of * * *

[26] Second, for a lending partner to prove entitlement to a bad debt deduction the debt must be worthless during the taxable year. Hill v. Commissioner, T.C. Memo. 1987-424. In the present case, * * * must prove that * * * is unable to pay its share of the debt. Rev. Rul. 72-505; TAM 8006009 (November 1, 1979). Further, * * * must also prove the timing of the worthlessness. Leon Perlin Company, Inc. v. Commissioner, T.C. Memo. 1993-79. There is no standard test for determining worthlessness in a given year. Id. The bankruptcy of the debtor, while an indication of worthlessness, is not conclusive. Id. See also Treas. Reg. section 1.166-2(c). Whether the debt between * * * and * * * is worthless must also be established under these same tests.

[27] Whether the debt was worthless during the years at issue in this case appears to be the only dispute between the taxpayer and the Service with regard to the loan transactions. While Exam has taken the position that the debts did not become worthless in the applicable years, we do not have sufficient facts to confirm this position. Furthermore, you did not specifically request that we address this issue. Accordingly, we do not opine on whether any of these debts became worthless in the years at issue. If needed, we would be willing to provide such advice as factual development occurs.

[28] If you have any further questions, please contact * * * on 202-622-* * *

[29] This document may include confidential information subject to the attorney-client and deliberative process privileges, and may also have been prepared in anticipation of litigation. This document should not be disclosed to anyone outside the IRS, including the taxpayer(s) involved, and its use within the IRS should be limited to those with a need to review the document in relation to the subject matter or case discussed herein.

 

FOOTNOTES

 

 

1 Note that this would have caused a termination and subsequent reformation of the partnership under I.R.C. section 708(b)(1)(B).

2 If the partnership is not completely liquidated, section 736 will govern the tax treatment of the partners whose interests are being liquidated.

3 This ruling, however, was seriously questioned by the Tax Court in Citron v. Commissioner, 97 T.C. 260 (1991). Consequently, the Service will no longer advance the position of this ruling in litigation. Because of the courts reliance on Rev. Rul. 76-189 in Pinson, it is also questionable precedent at the current time.

4 Each partner also receives basis in the debt under section 752 to the extent they bear the economic risk of loss. I.R.C. section 752. Compare Treas. Reg. section 1.752-2(c)(1) (In the case of a nonrecourse loan by a general partner to a partnership, the lending partner is the only partner who bears the economic risk of loss and as such gets debt basis under section 752).

5TAM 8006009 (November 1, 1979). We note, however, that some commentators believe that the entire amount of the loan is deductible even though the lender is a member of the partnership. Willis, Pennell and Postlewaite, Partnership Taxation, section 113.03 n.12. We do not agree with this view.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Institutional Authors
    Internal Revenue Service
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    partnerships, distributions, gain or loss
    partnerships, related-party transactions
    bad debt deduction
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 1999-2524 (7 original pages)
  • Tax Analysts Electronic Citation
    1999 TNT 95-30
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