Rev. Rul. 66-325

Advice has been requested whether, in the circumstances described below, sections 754 and 743 of the Internal Revenue Code of 1954 may be applied so as to give the estate of a deceased member of a personal service partnership the benefit of an adjustment to the basis of the partnership's accounts receivable existing at the date of the decedent's death.

The decedent was a member of a two-man partnership engaged in the practice of medicine. The partnership reported its income on the cash basis method of accounting. At the time of the decedent's death, the firm had a substantial amount of accounts receivable, a small bank account and in addition, furniture and fixtures having only a nominal value. The partnership was continued in existence for well over a year after the decedent's death for the purpose of collecting its accounts receivable, paying its debts, and liquidating the interests of the two partners.

Under the terms of the liquidation agreement executed by the surviving partner and the estate of the deceased partner, after the payment of the firm's debts, the surviving partner was to receive a specified amount in cash and the estate was to receive the remaining proceeds of the partnership bank account and collections on the accounts receivable, together with the partnership furniture and fixtures.

The partnership filed a timely election under section 754 of the Code in respect to optional adjustment to basis of partnership property provided by section 743 of the Code.

Under the circumstances involved, the partnership is considered as having continued in existence during the liquidation period until the winding up of its affairs was completed. (See sections 1.708-1(b)(1)(i)( a ) and 1.708-1(b)(1)(iii)( a ) of the Income Tax Regulations.) Furthermore, since under the terms of the liquidation agreement payments were made to the deceased partner's estate in liquidation of the decedent's partnership interest, section 736 of the Code is applicable. Section 1.736-1(a)(6) of the regulations states that if a partner in a two-man partnership dies, and his estate or other successor in interest receives payments under section 736 of the Code the partnership shall not be considered to have terminated upon the death of the partner but shall terminate as to both partners only when the entire interest of the decedent is liquidated.

Since the payments to the decedent's estate which were attributable to the collection of the firm's accounts receivable were determined with reference to the income of the partnership, such payments must be considered as a distributive share to the recipient of partnership income within the scope of section 736(a) of the Code. Section 753 of the Code provides that the amount includible in the gross income of a successor in interest of a deceased partner under section 736(a) of the Code shall be considered income in respect of a decedent under section 691 of the Code.

The payments to the decedent's estate which were attributable to the collection of the firm's accounts receivable must be considered distributive share payments within the scope of section 736(a) of the Code, and hence income in respect of a decedent under section 753 of the Code. Consequently the value of the estate's right to receive them had to be excluded from its basis for the partnership interest acquired from the decedent, by reason of section 1.742-1 of the regulations. (Also see section 1014(c) of the Code.)

Accordingly, where the collection of accounts receivable represents income in respect of a decedent, the provisions of section 743 of the Code may not be applied so as to give the estate of a deceased member of a personal service partnership the benefit of an adjustment to the basis of the partnership's accounts receivable existing at the date of the decedent's death.