Rev. Rul. 77-309

Advice has been requested concerning the allowance, for Federal income tax purposes, of a distributive share of partnership loss to a limited partner of a limited partnership that is itself a limited partner of another limited partnership.

A, a taxpayer, contributed 25x dollars on January 2, 1976, and became a limited partner with a 20 percent profits interest in AB, a newly-formed limited partnership. AB, in turn, contributed 100x dollars and became a limited partner with a 331/3 percent profits interest in ABC, another newly formed limited partnership. The principal activity of both limited partnerships is investing in real property. In 1976, ABC acquired an office building that was subject to a nonrecourse liability of 1200x dollars. ABC sustained a loss of 600x dollars for its calendar year ended December 31, 1976, a 200x dollars distributive share of which was allocable to AB. AB, in turn, sustained a loss of 250x dollars for its calendar year ended December 31, 1976, including its distributive share of ABC's loss for that year.

The specific question is whether A's distributive share of AB's loss is limited to the 25x dollars contributed by A in acquiring its limited partnership interest in AB.

Section 704(d) of the Internal Revenue Code of 1954 as amended by the Tax Reform Act of 1976 provides, in part, that a partner's share of partnership loss shall be allowed only to the extent of the adjusted basis of such partner's interest in the partnership at the end of the partnership year in which such loss occurred. For purposes of section 704(d), the adjusted basis of any partner's interest in the partnership shall not include any portion of any partnership liability with respect to which the partner has no personal liability. The preceding sentence shall not apply to any partnership the principal activity of which is investing in real property (other than mineral property).

Section 722 of the Code provides, in part, that the basis of an interest in a partnership acquired by a contribution of property, including money, to the partnership shall be the amount of such money and the adjusted basis of such property to the contributing partner at the time of the contribution.

Section 752(a) of the Code provides, in part, that any increase in a partner's share of the liabilities of a partnership shall be considered as a contribution of money by such partner to the partnership.

Section 752(c) of the Code 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 has 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) in the same proportion as they share in the profits.

Section 752 of the Code treats a partnership as an aggregation of individuals, each partner being required to account for such partner's share of the partnership liabilities. Under section 1.752-1(e) of the regulations, for purposes of section 752, limited partners shall share in nonrecourse liabilities to the extent of their allocable share of the fair market value of the underlying property as if they had personal liability for their share of such debts.

In the instant case, since AB is considered to share in ABC's nonrecourse liabilities as if it were personally liable, for purposes of section 704(d) of the Code, AB is considered to have nonrecourse liabilities of 400x dollars that are included in AB's adjusted basis for its limited partnership interest in ABC. For the purpose of deducting its distributive share of ABC's loss, AB's adjusted basis of its limited partnership interest in ABC on December 31, 1976, was 500x dollars that was comprised of the 100x dollars contributed by AB plus liabilities of 400x dollars representing 331/3 percent of ABC's nonrecourse liabilities at year end of 1,200x dollars. Since AB's adjusted basis for its limited partnership interest in ABC is greater than its 200x dollars distributive share of ABC's loss, section 704(d) of the Code does not limit the deductibility of the loss by AB.

A is considered to share in AB's share in ABC's liabilities so that A's adjusted basis for the limited partnership interest in AB under sections 722 and 752 of the Code consists of A's original contribution of 25x dollars and 20 percent (A's profit-sharing ratio in AB) of 400x dollars (AB's share of ABC's liabilities) or 80x dollars. Thus, A's adjusted basis for the limited partnership interest in AB is 105x dollars. A's distributive share of AB's loss is 50x dollars (20 percent of 250x dollars).

Accordingly, since A's adjusted basis for the limited partnership interest in AB, 105x dollars, is greater than its distributive share of AB's loss, 50x dollars, A is allowed to deduct A's entire distributive share of loss under section 704(d) of the Code, leaving A with an adjusted basis of 55x dollars for the limited partnership interest.

See Rev. Rul. 77-311, page of this Bulletin, for an example of the application of the principles of this Revenue Ruling in a two-tier partnership situation involving the retroactive allocation of a partnership loss.