Rev. Rul. 81-241

ISSUE

Are progress payments, received under a construction contract by a partnership that uses the completed contract method of accounting, treated in the year of withdrawal by the partners as distributions that are subject to the provisions of sections 731 and 751 of the Internal Revenue Code?

FACTS

X is a general partnership engaged in the construction business. X properly made an election to report the income from its various construction jobs on the completed contract method of accounting. X and all of its partners use the calendar year accounting period. In 1979, under the terms of its long term construction contracts, X received periodic payments for its jobs as various stages of the work were completed. These payments represented the only income of X in 1979. None of the contracts was completed in 1979. The payments received were credited to the partners' respective capital accounts.

During 1979, cash withdrawals were made periodically by the partners in proportion to their respective interests as advances against their respective distributive shares of income. The withdrawals made by the partners exceeded their adjusted bases in X. No notes were issued and no interest was charged on any withdrawals. X did not file an election under section 754 of the Code and the regulations thereunder pertaining to the optional adjustments to basis of partnership property in the case of a distribution of property.

LAW AND ANALYSIS

Under the completed contract method of accounting, gross income derived from long term contracts may be reported for the taxable year in which the contracts are finally completed and accepted. Under this method, there is deducted from gross income for such year all expenses that are properly allocable to the contract. Section 1.451-3(d)(1) of the Income Tax Regulations.

Section 703(b) of the Code provides that any election affecting the computation of taxable income derived from a partnership shall be made by the partnership with certain exceptions not applicable in this case.

Section 1.703-1(b)(1) of the regulations sets forth an example of such an election, the election of methods of accounting, and further provides that all partnership elections are applicable to all partners equally.

Section 702(a)(8) of the Code provides that each partner in determining the partner's own income tax, shall take into account separately the partner's distributive share of the partnership's taxable income or loss.

Section 731(a) of the Code provides that in the case of a distribution by a partnership to a partner, 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.

Section 731(c) of the Code provides that section 731 shall not apply to the extent otherwise provided by section 751 (relating to unrealized receivables and inventory items).

Section 1.731-1(a)(1)(ii) of the regulations provides that for purposes of sections 731 and 705 of the Code, advances or drawings of money or property against a partner's distributive share of income shall be treated as current distributions made on the last day of the partnership taxable year with respect to such partner.

Section 751(b)(1)(B) of the Code provides that to the extent a partner receives in a distribution partnership property (including money) other than unrealized receivables of the partnership or inventory items of the partnership that have appreciated substantially in value in exchange for all or a part of the partner's interest in such unrealized receivables or appreciated inventory items, such transaction shall be considered as a sale or exchange of such properties between the distributee and the partnership (as constituted after the distribution).

Section 1.751-1(b)(1)(ii) of the regulations provides that section 751(b) of the Code does not apply to a distribution to a partner that is not in exchange for the partner's interest in other partnership property. Thus, it does not apply to the extent that the distribution consists of the partner's share of section 751 property. Similarly, section 751(b) does not apply to current drawings or to advances against the partner's distributive share.

Rev. Rul. 73-301, 1973-2 C.B. 215, considers the consequences of cash withdrawals from a partnership under similar circumstances. The ruling concludes that progress payments received by the partnership are unrealized receivables within the meaning of section 751(c) of the Code and that, consequently, there is no increase in the bases of the partner's interests in the partnership when the partnership receives the payments. Rev. Rul. 73-301 further concludes that the cash withdrawals by a partner were not loans governed by section 707(a) but were partnership distributions received by the partner in his capacity as a partner.

In the instant case, there is no evidence that the withdrawals by the partners were loans that the partners were unconditionally obligated to repay or that a distributee partner's proportionate interest in any of the remaining partnership property was reduced as a result of the distributions.

Thus, the withdrawals of cash by the partners must be characterized as advances against the withdrawing partner's distributive share of partnership income. As advances, the withdrawals are treated as distributions on the last day of the partnership taxable year with respect to such partner. See sections 1.751-1(b)(1)(ii) and 1.731-1(a)(1)(ii) of the regulations.

HOLDING

Each partner in X must recognize gain to the extent that the sum of such partner's cash withdrawals in any partnership taxable year exceeds the adjusted basis of the partner's interest in the partnership.

In determining a partner's income tax for the taxable year in which a long term construction contract is finally completed, the partner must include the partner's distributive share of the partnership's income, gain, loss, deduction, or credit in accordance with the provisions of section 702(a) of the Code.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 73-300, 1973-2 C.B. 215, holds that money distributed to a partner in excess of the adjusted basis of that partner's partnership interest is, to the extent of the partner's interest in unrealized receivables of the partnership, treated as having been made in exchange for the partner's interest in the partnership's unrealized receivables in accordance with section 751(b)(1)(B) of the Code and is taxable as ordinary income. This is the correct result only if the distributions were not advances against the distributee partner's share of partnership income but, instead, were distributions in exchange for the distributee partner's interest in the partnership's unrealized receivables. Because Rev. Rul. 73-300 does not contain sufficient facts to support its conclusion, it is revoked.

Rev. Rul. 73-300 is revoked.