PARTNER MUST DECREASE BASIS IN PARTNERSHIP INTEREST BY SHARE OF PARTNERSHIP'S BASIS IN PROPERTY CONTRIBUTED TO CHARITY.

Rev. Rul. 96-11

ISSUE

[1] If a partnership makes a charitable contribution of property, are the partners' bases in their partnership interests decreased to reflect the contribution?

FACTS

[2] A and B each contribute an equal amount of cash to form PRS, a general partnership. Under the PRS agreement, each item of income, gain, loss, and deduction of the partnership is allocated 50 percent to A and 50 percent to B. PRS has unencumbered property, X, with a basis of $60x and a fair market value of $100x. PRS contributes X in a transaction that qualifies as a charitable contribution under section 170(c) of the Internal Revenue Code. The charitable contribution is not subject to the limitations of section 170(e)(1).

LAW AND ANALYSIS

[3] Section 170(a) allows as a deduction any charitable contribution (as defined in section 170(c)) payment of which is made within the taxable year. The deduction provided by section 170(a) is subject to the limitations of section 170(b).

[4] Section 1.170A-1(c)(1) of the Income Tax Regulations provides that, if a charitable contribution is made in property other than money, the amount of the contribution is the fair market value of the property at the time of the contribution reduced as provided by section 170(e)(1) and paragraph (a) of section 1.170A-4, or section 170(e)(3) and paragraph (c) of section 1.170A-4A.

[5] Section 703(a)(2)(C) provides that the taxable income of a partnership is computed in the same manner as in the case of an individual except that the deduction for charitable contributions provided in section 170 is not allowed to the partnership. However, under section 702(a)(4) each partner takes into account separately the partner's distributive share of the partnership's charitable contributions (as defined in section 170(c)).

[6] Section 1.170A-1(h)(7) provides that a partner's distributive share of charitable contributions actually paid by a partnership during its taxable year may be allowed as a deduction in the partner's separate return for the partner's taxable year with or within which the taxable year of the partnership ends, to the extent that the aggregate of the partner's share of the partnership contributions and the partner's own contributions does not exceed the limitations in section 170(b).

[7] Section 705(a)(1) provides that the adjusted basis of a partner's interest in a partnership shall be increased by the sum of the partner's distributive share for the taxable year and prior taxable years of: (1) taxable income of the partnership as determined under section 703(a); (2) income of the partnership exempt from income tax; and (3) the excess of the deductions for depletion over the basis of the property subject to depletion.

[8] Section 705(a)(2) provides that the adjusted basis of a partner's interest in a partnership shall be decreased (but not below zero) by distributions by the partnership and by the sum of the partner's distributive share for the taxable year and prior taxable years of: (1) losses of the partnership; and (2) expenditures of the partnership not deductible in computing its taxable income and not properly chargeable to capital account.

[9] The adjustments to the basis of a partner's interest in a partnership under section 705 are necessary to prevent inappropriate or unintended benefits or detriments to the partners. Generally, the basis of a partner's interest in a partnership is adjusted to reflect the tax allocations of the partnership to that partner. This ensures that the income and loss of the partnership are taken into account by its partners only once. In addition, as provided in section 705(a)(1)(B) and (a)(2)(B), adjustments must also be made to reflect certain nontaxable events in the partnership. For example, a partner's share of nontaxable income (such as exempt income) is added to the basis of the partner's interest because, without a basis adjustment, the partner could recognize gain with respect to the tax- exempt income, for example, on a sale or redemption of the partner's interest, and the benefit of the tax-exempt income would be lost to the partner. Similarly, a partner's share of nondeductible expenditures must be deducted from the partner's basis in order to prevent that amount from giving rise to a loss to the partner on a sale or a redemption of the partner's interest in the partnership. See H.R. Rep. No. 1337, 83d Cong., 2d Sess. A225 (1954); S. Rep. No. 1622, 83d Cong., 2d Sess. 384 (1954).

[10] In determining whether a transaction results in exempt income within the meaning of section 705(a)(1)(B), or a nondeductible, noncapital expenditure within the meaning of section 705(a)(2)(B), the proper inquiry is whether the transaction has a permanent effect on the partnership's basis in its assets, without a corresponding current or future effect on its taxable income. Pursuant to section 703(a)(2)(C), the contribution of X by PRS is not taken into account by PRS in computing its taxable income. Consequently, the contribution results in a permanent decrease in the aggregate basis of the assets of PRS that is not taken into account by PRS in determining its taxable income and will not be taken into account for federal income tax purposes in any other manner. Therefore, for purposes of section 705(a)(2)(B), the contribution of X, and the resulting permanent decrease in partnership basis, is an expenditure of the partnership not deductible in computing its taxable income and not properly chargeable to capital account. Cf. section 1.701-2(f), Example 2 (requiring adjustments under section 705(a)(2)(B) for reductions in the basis of stock held by a partnership following an extraordinary dividend under section 1059).

[11] Reducing the partners' bases in their partnership interests by their respective shares of the permanent decrease in the partnership's basis in its assets preserves the intended benefit of providing a deduction (in circumstances not under section 170(e)) for the fair market value of appreciated property without recognition of the appreciation. By contrast, reducing the partners' bases in their partnership interests by the fair market value of the contributed property would subsequently cause the partners to recognize gain (or a reduced loss), for example, upon a disposition of their partnership interests, attributable to the unrecognized appreciation in X at the time of this contribution. Under the PRS agreement, partnership items are allocated equally between A and B. Accordingly, the basis of A's and B's interests in PRS is each decreased by $30x.

HOLDING

[12] If a partnership makes a charitable contribution of property, the basis of each partner's interest in the partnership is decreased (but not below zero) by the partner's share of the partnership's basis in the property contributed.

DRAFTING INFORMATION

[13] The principal author of this revenue ruling is Terri A. Belanger of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Ms. Belanger at (202) 622-3080 (not a toll-free call).