TRANSFER OF 50 PERCENT INTEREST IN A PARTNERSHIP THROUGH A SECTION 368(a)(1) REORGANIZATION WILL NOT TERMINATE PARTNERSHIP.

Rev. Rul. 87-110

ISSUES

(1) If a corporation transfer an interest in a partnership to another corporation in a transaction qualifying under sections 361(a) and 368(a)(1) of the Internal Revenue Code, is the transfer an exchange of an interest in partnership capital and profits subject to section 708(b)(1)(B)?

(2) Is gain or loss recognized to the transfer corporation when the partnership interest is exchanged?

FACTS

X corporation owned a 50 percent interest in the capital and profits of XZ partnership. Pursuant to a reorganization under section 368(a)(1) of the Code, X transferred its assets, including the 50 percent interest in XZ, to Z corporation solely for Y stock in a transaction qualifying under section 361(a). The liabilities of X assumed by Y in the reorganization did not exceed X's basis in the assets transferred. The business of XZ was continued in a partnership composed of Y and Z.

LAW AND ANALYSIS

Section 361(a) of the Code provides that no gain or loss is recognized to a transferor corporation that is a party to a reorganization on any exchange of property pursuant to the plan or reorganization.

The term "reorganization" is defined in section 368(a)(1) of the Code.

Section 741 of the Code provides that, in the case of an exchange of an interest in a partnership, gain or loss shall be recognized to the transferor partner.

Section 708(a) of the Code provides that an existing partnership shall be considered as continuing if it is not terminated.

Section 708(b)(1)(B) of the Code provides that a partnership will be considered terminated if within a twelve-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.

Section 1.708-1(b)(1)(ii) of the Income Tax Regulations provides that, for purposes of section 708(b)(1)(B) of the Code, a sale or exchange includes a sale or exchange to another member of the partnership. However, a disposition of a partnership interest by gift (including assignment to a successor in interest), bequest, or inheritance, or the liquidation of a partnership interest, is not a sale or exchange for purposes of this subparagraph. Furthermore, the contribution of property to a partnership does not constitute such a sale or exchange.

In Rev. Rul. 81-38, 1981-1 C.B. 386, a 50 percent partnership interest was transferred to a corporation in a transaction qualifying under section 351(a) of the Code. Section 351(a) provides that no gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control of the corporation. Rev. Rul. 81-38 holds that, under the facts of the ruling, the section 351 exchange is also an exchange within the meaning of section 708(b)(1)(B). Rev. Rul. 81- 38 further holds that, although section 741 would otherwise require recognition of gain, section 351 provides for nonrecognition treatment.

Similarly, if the assets exchanged in a transaction described in sections 361(a) and 368(a)(1) of the Code include an interest in a partnership, there has been an exchange of the partnership interest for purposes of section 708(b)(1)(B). Furthermore, although section 741 would otherwise require recognition of gain, section 361 applies to provide nonrecognition treatment of any gain realized on the exchange by the transferor corporation.

However, a section 361 exchange of a partnership interest made pursuant to a plan of reorganization qualifying under section 368(a)(1)(F) of the Code is not an exchange for purposes of section 708. In a section 368(a)(1)(F) reorganization, there is virtually no change in the identity of the shareholders and their interests or in the assets involved. See Rev. Rul. 66-284, 1966-2 C.B. 115. The provisions governing corporate reorganizations recognize this unique feature of reorganizations qualifying under section 368(a)(1)(F). See section 381(b); section 1.381(b)-1(a)(2) of the regulations. Finally, section 368(a)(1)(F) reorganizations involve only one operating company. See H.R. Rep. No. 97-760, 97th Cong., 2d Sess. 541, 1982-2 C.B. 600, 634.

HOLDINGS

(1) The transfer by a corporation of its interest in the capital and profits of a partnership to another corporation in a transaction qualifying under sections 361(a) and 368(a)(1) of the Code is an exchange for purposes of section 708(b)(1)(B), unless the reorganization qualifies under section 368(a)(1)(F). Accordingly X's transfer of Y of its 50 percent interest in the XZ partnership causes a termination of that partnership under section 708(b)(1)(B). For the effect of the transfer with respect to a closing of the partnership year, see section 706(c). For the tax treatment of the transferee corporation where a section 754 election is in effect, see section 743. For the federal income tax treatment of the transferee corporation and the continuing partners upon termination of the partnership, see section 1.708-1(b)(1) of the regulations and Rev. Rul. 86-73, 1986-1 C.B. 282.

(2) Since the transfer qualifies under section 361(a) of the Code, no gain or loss is recognized to the transferor corporation upon the transfer of its assets, including its partnership interest, to the transferee corporation solely for the stock of the transferee corporation. However, for situations in which the transferor corporation may recognize gain under section 357(c), see Rev. Rul. 75-161, 1975-1 C.B. 114, and compare Rev. Rul. 80-323, 1980-2 C.B. 124.

DRAFTING INFORMATION

The principal author of this revenue ruling is Theresa Abell of the Individual Tax Division. For further information regarding this revenue ruling contact Ms. Abell on (202) 566-3822 (not a toll-free call).