Rev. Rul. 76-189

Advice has been requested concerning the Federal income tax consequences of the termination of a partnership under the circumstances described below.

At the beginning of the taxable year, taxpayer D purchased a one-third interest in the ABC partnership from taxpayer A. D thereby acquired a partnership interest with a basis of 15x dollars under section 742 of the Internal Revenue Code of 1954. The partnership's basis for D's share of its assets was 10x dollars. Since no election was in effect under section 754 to adjust the basis of partnership property with respect to the transfer of the partnership interest, the basis of the partnership assets attributable to D was not increased. The partnership sustained a net loss from its oprations for the taxable year of 24x dollars and a loss of 6x dollars from the sale of land used in its business for more than six months (section 1231 property). D's distributive share of partnership items of income, gain, loss, deduction, or credit described in section 702(a) consisted of 8x dollars of the partnership's taxable loss from its operations and 2x dollars of the partnership's section 1231 loss from the sale of the land. As a result of these losses, the basis of D's interest in the partnership, just prior to its termination at the end of the taxable year, was 5x dollars (15x dollars of original basis less the 10x dollars of losses) under section 705. At the time of its termination, the partnership had no assets or liabilities remaining.

Section 702(a) of the Code provides a general rule whereby, in determining a partner's income tax, the partner must take into account separately a distributive share of certain partnership items of income, gain, loss, deduction, or credit. Among the items required to be separately stated are gains and losses from sales or exchanges of property described in section 1231 (relating to certain property used in a trade or business and involuntary conversions). In addition, under section 702(a)(9), the partner must take into account such partner's distributive share of taxable income or loss, exclusive of items requiring separate computation.

Under section 705 of the Code, the adjusted basis of a partner's interest in a partnership is reduced by losses of the partnership.

Section 731(a) of the Code provides, in part, that in the case of a distribution by a partnership to a partner, loss shall not be recognized to such partner, except that upon a distribution in liquidation of a partner's interest in a partnership where no property other than money or unrealized receivables (as defined in section 751(c)) and inventory (as defined in section 751(d)(2)) is distributed to such partner, loss shall be recognized to the extent of the excess of the adjusted basis of such partner's interest in the partnership over the sum of any money distributed and the basis to the distributee of any of the above-mentioned unrealized receivables and inventory. Section 731 also provides that any gain or loss recognized under section 731(a) shall be considered as gain or loss from the sale or exchange of the partnership interest of the distributee partner.

Section 741 of the Code provides, in part, that in the case of a sale or exchange of an interest in a partnership, gain or loss shall be considered as gain or loss from the sale or exchange of a capital asset. Where a partnership having no assets terminates without distributing property, the provisions of section 731 apply as if an actual distribution had taken place.

Accordingly, for Federal income tax purposes, D has an ordinary deduction of 8x dollars derived from D's distributive share of the partnership's taxable loss under section 702(a)(9) of the Code; a section 1231 loss of 2x dollars derived from D's distributive share of the partnership's loss on the sale of the land; and a capital loss of 5x dollars under section 731(a) for the adjusted basis of D's partnership interest remaining on the date the partnership terminated.