Rev. Rul. 84-102

ISSUE

What are the consequences to the partners under section 751(b) of the Internal Revenue Code when a new partner joins the partnership under the circumstances described below?

FACTS

A, B, and C were equal partners in partnership P. At the time of the transaction described below, the value of each partner's interest was 25x dollars. D acquired a 25 percent interest in P by contributing 25x dollars to P. Prior to D's contribution, the liabilities of P totaled 100x dollars, and each partner's share of the liabilities was approximately 33.3x dollars. In addition, the unrealized receivables of P (as defined in section 751(c) of the Code) were 40x dollars, and each partner's share of the unrealized receivables was approximately 13.3x dollars. After the contribution by D, each partner's share of the liabilities of P was 25x dollars; A, B, and C's share of P's liabilities each decreased by approximately 8.3x dollars. Furthermore, each partner's share of P's unrealized receivables was 10x dollars; A, B, and C's share of the unrealized receivables each decreased by approximately 3.3x dollars.

LAW AND ANALYSIS

Section 721(a) of the Internal Revenue Code provides that no gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.

Section 722 of the Code provides 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.

Section 752(a) of the Code provides 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(b) of the Code provides that any decrease in a partner's share of the liabilities of a partnership shall be considered as a distribution of money to the partner by the partnership.

Pursuant to sections 733 and 731(a)(1) of the Code, a distribution of money by a partnership to a partner results in a reduction of the partner's basis in the partnership interest and, to the extent the distribution exceeds basis, capital gain to the partner. However, section 731(c) provides that section 731 shall not apply to the extent otherwise provided by section 751. See also sections 1.731-1(a)(1) and 1.751-1(b) of the Income Tax Regulations.

Section 751(b)(1)(B) of the Code provides that, to the extent a partner receives a distribution of partnership property (including money) other than property described in section 751(a)(1) or (2) in exchange for all or part of the partner's interest in partnership property described in section 751(a)(1) or (2), such transaction shall be considered a sale or exchange of such property between the distributee partner and the partnership. Section 751(a)(1) of the Code refers to the "unrealized receivables" of a partnership as defined in section 751(c) of the Code.

In the instant case, A, B, and C are each treated as having received a cash distribution from P of 8.3x dollars in accordance with section 752(b) of the Code. Of this amount, 3.3x dollars is treated under sections 731(c) and 751(b)(1)(B) as being received by each partner in exchange for the interest in unrealized receivables given up. The remaining 5x dollars is treated in accordance with section 731(a) of the Code.

Although D has a 10x dollar interest in the unrealized receivables of P upon becoming a partner, section 751(b) of the Code has no application with respect to D. There is no actual or deemed distribution of property from P to D as required by 751(b). Further, D has an "increased" interest in the unrealized receivables of P as a result of becoming a partner. Any distribution of property (other than property described in section 751(a)(1) or (2)) from P to D would have to result in a decreased interest in the unrealized receivables for 751(b)(1)(B) to apply.

HOLDING

The tax consequences to D of becoming a partner are determined under sections 721, 722 and 752(a) of the Code. D is treated as having contributed 50x dollars, the actual contribution of 25x dollars plus the deemed contribution of 25x dollars under section 752(a), in exchange for the partnership interest. D's basis in the partnership interest is 50x dollars in accordance with section 722 of the Code. Section 751(b) does not apply to new partner D because there is no actual or deemed distribution of property from P to D.

Partners A, B, and C are each treated as having received a distribution of 8.3x dollars under section 752(b) of the Code. Of this amount, 3.3x dollars is treated under section 751(b)(1)(B) as being received by each partner in exchange for the interest in unrealized receivables given up.