PARTNER IN CASH BASIS PARTNERSHIP MAY NOT INCREASE BASIS WITH ACCRUED BUT UNPAID PARTNERSHIP EXPENSES AND ACCOUNTS PAYABLE.

Rev. Rul. 88-77

ISSUE

For purposes of computing the adjusted basis of a partner's interest in a cash basis partnership, are accrued but unpaid expenses and accounts payable "liabilities of a partnership" or "partnership liabilities" within the meaning of section 752 of the Internal Revenue Code?

FACTS

A is a partner in P partnership. P files returns on a calendar year basis and uses the cash receipts and disbursements method of accounting. At the close of the taxable year at issue, P's accrued expenses and accounts payable consisted of 100x dollars for interest expense and accounts payable of 200x dollars for services received.

LAW AND ANALYSIS

Section 722 of the Code provides that a partner's basis is increased by the amount of money the partner contributes to the partnership.

Section 752(a) of the Code provides that any increase in a partner's share of the liabilities of a partnership, or any increase in a partner's individual liabilities by reason of the assumption by the partner of partnership liabilities, is treated as contribution of money by the partner to the partnership.

Rev. Rul. 60-345, 1960-2 C.B. 211, holds that, for purposes of section 752 of the Code, the term "liabilities" includes a cash basis partnership's obligations for the payment of outstanding trade accounts, notes, and accrued expenses.

The present issue is similar to that arising under section 357(c) of the Code when property and liabilities are contributed to a controlled corporation in exchange for stock. For purposes of determining the basis of the stock received in the exchange under section 358 and any gain that must be recognized on the exchange under section 357(c), section 357(c)(3) provides that the term "liabilities" shall not include obligations the payment of which would give rise to a deduction or that would constitute a guaranteed payment under section 736(a). This rule is subject to an exception found in section 357(c)(3)(B) for liabilities the incurrence of which resulted in the creation of, or an increase in, the basis of any property. Section 357(c)(3) was added by the Revenue Act of 1978.

The legislative history accompanying the amendment to section 704(c) made by the Tax Reform Act of 1984 explicitly rejected the conclusion reached in Revenue Ruling 60-345 in favor of an interpretation of section 752 that is consistent with section 357(c). See H.R. Rep. No. 861, 98th Cong., 2d Sess. 856-857 (1984), 1984-3 (Vol. 2) C.B. 110, 111.

Under P's method of accounting, P's obligations to pay amounts incurred for interest and services are not deductible until paid. For purposes of section 752 of the Code, the terms "liabilities of a partnership" and "partnership liabilities" include an obligation only if and to the extent that incurring the liability creates or increases the basis to the partnership of any of the partnership's assets (including cash attributable to borrowings), gives rise to an immediate deduction to the partnership, or, under section 705(a)(2)(B), currently decreases a partner's basis in the partner's partnership interest. The preceding sentence uses the term "assets" to include capitalized items that are properly allocable to future periods, such as organizational expenses and construction period expenses.

The liabilities incurred by P for interest expense and services do not create or increase the basis of a partnership asset or give rise to a deduction when incurred. Therefore, for purposes of computing A's adjusted basis in P, A may not treat P's accrued expenses and accounts payable as a liability of the partnership.

HOLDING

For purposes of computing the adjusted basis of a partner's interest in a cash basis partnership, accrued but unpaid expenses and accounts payable are not "liabilities of a partnership" or "partnership liabilities" within the meaning of section 752 of the Code.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 60-345 is revoked.

This does not apply to any partnership tax year beginning prior to September 19, 1988, the publication date of this revenue ruling.

DRAFTING INFORMATION

For information regarding this revenue ruling, contact Richard H. Manfreda on (202) 566-3244 (not a toll-free call).