Rev. Rul. 74-40

Advice has been requested concerning the Federal income tax consequences to a limited partner in the situations described below.

Situation 1: L is a limited partner in partnership GL to which he contributed $10,000 in cash on its formation. His distributive share of partnership items of income and loss is 10 percent and he is not entitled to receive any guaranteed payments. The adjusted basis of his partnership interest at the end of the current year is $20,000. His proportionate share of partnership liabilities, on which neither he, the other partners nor the partnership have assumed any personal liability, is $15,000. The partnership has no other liabilities. L sells his interest in the partnership to M, an unrelated taxpayer, for $10,000 in cash. At the time of the transaction the partnership had no unrealized receivables or inventory items described in section 751 of the Internal Revenue Code of 1954 nor any goodwill and L had been paid his distributive share of partnership income.

Section 752(c) of the Internal Revenue Code of 1954 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.

Section 1.752-1(e) of the Income Tax Regulations provides, in part, that where none of the partners have any personal liability with respect to a partnership liability (as in the case of a mortgage on real estate acquired by the partnership without the assumption by the partnership or any of the partners of any liability on the mortgage), then all partners, including limited partners, shall be considered as sharing such liability under section 752(c) of the Code in the same proportion as they share the profits.

Section 1.752-1(d) of the regulations provides that where there is a sale or exchange of an interest in a partnership, liabilities shall be treated in the same manner as liabilities in connection with the sale or exchange of property not associated with partnerships. For example, if a partner sells his interest in a partnership for $750 cash and at the same time transfers to the purchaser his share of partnership liabilities amounting to $250, the amount realized by the seller on the transaction is $1,000.

Section 741 of the Code provides, in pertinent part, that in the case of a sale or exchange of an interest in a partnership, gain or loss shall be recognized to the transferor partner and shall be considered gain or loss from the sale or exchange of a capital asset, except as otherwise provided in section 751 of the Code (relating to unrealized receivables and inventory items which have appreciated substantially in value).

Accordingly, in the instant situation, the amount realized by L from the sale of his partnership interest is $25,000, consisting of cash in the amount of $10,000 and release from his share of partnership liabilities in the amount of $15,000. Since the adjusted basis of L's interest in the partnership is $20,000, he realized a gain of $5,000 determined under the provisions of section 741 of the Code.

Situation 2: The facts are the same as in situation 1, except that L withdraws from the partnership and the partnership distributes $10,000 to him in cash in complete liquidation of his interest in 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 731(a) of the Code provides, in pertinent part, that in the case of a distribution by a partnership to a partner (1) 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. Any gain recognized under section 731(a) shall be considered as a gain from the sale or exchange of the partnership interest of the distributee partner.

Section 731(c) of the Code provides, in part, that section 731 shall not apply to the extent otherwise provided by section 736 (relating to payments to a retiring partner or a deceased partner's successor in interest) and section 751 of the Code (relating to unrealized receivables and inventory items).

Section 736(b) of the Code provides, in pertinent part, that payments made in liquidation of the interest of a retiring partner or a deceased partner shall, to the extent such payments are determined to be made in exchange for the interest of such partner in partnership property, be considered as a distribution by the partnership and not as a distributive share of partnership income or guaranteed payment.

Section 1.736-1(b)(1) of the Income Tax Regulations provides, in pertinent part, that gain or loss with respect to distributions under section 736(b) of the Code will be recognized to the distributee to the extent provided in section 731 of the Code.

Accordingly, in the instant situation, distributions to L with respect to his partnership interest total $25,000 and consist of cash in the amount of $10,000 and a decrease in his share of the partnership liabilities in the amount of $15,000 that is considered under section 752(b) of the Code as a distribution of money to L by the partnership.

Furthermore, since the money distributed ($25,000) exceeds the adjusted basis of L's interest in the partnership immediately before the distribution ($20,000), he realizes a gain of $5,000 determined under the provisions of section 731(a) of the Code.

Situation 3: Instead of selling his interest L withdraws from the partnership at a time when the adjusted basis of his interest in the partnership is zero and his proportionate share of partnership liabilities, all of which consist of liabilities on which neither he, the other partners nor the partnership have assumed any personal liability, is $15,000.

Accordingly, L is considered to have received a distribution of money from the partnership of $15,000 and realizes a gain of $15,000 determined under the provisions of section 731(a) of the Code.