Rev. Rul. 70-355

A taxpayer paid 40,000x dollars for an interest as a limited partner in a partnership. However, his capital account was credited with an amount substantially less than 40,000x dollars. The partnership did not elect under section 754 of the Internal Revenue Code of 1954 to make the optional adjustments to the basis of the partnership property as provided under section 734(b) and section 743(b) of the Code.

The partnership agreement provided that losses would first be allocated against each partner's capital account to the extent thereof and any balance would be shared only by the general partners.

In a subsequent taxable year the partnership sustained a loss in its business operations, became insolvent, entered into bankruptcy proceedings, and dissolved. At the beginning of the taxpayer's taxable year for which the partnership sustained the loss, his capital account on the books of the partnership reflected a balance of 31,000x dollars and his distributive share of the partnership loss for that taxable year reduced his capital account to zero. There were no other transactions affecting his capital account during the year. The taxpayer's adjusted basis for his partnership interest at the beginning of the year of the bankruptcy was 40,200x dollars, and was reduced to 9,200x dollars by the loss sustained. The taxpayer did not receive cash or other consideration in liquidation of his interest.

Held, the taxpayer's loss as a result of the bankruptcy is 40,200x dollars composed of his distributive share of the partnership loss equal to his capital account at the beginning of the year, 31,000x dollars, and the balance of his adjusted basis of 9,200x dollars. This loss is deductible on his Federal tax return as an ordinary loss under section 165 of the Code.