REVENUE RULING EXAMINES OPTIONAL BASIS ADJUSTMENTS FOR PARTNERSHIPS AFTER DISTRIBUTIONS.

Rev. Rul. 92-15

ISSUES

(1) An upper-tier partnership (UTP), has an interest in a lower- tier partnership (LTP), and both partnerships have elections in effect under section 754 of the Internal Revenue Code. If UTP distributes property to a partner and, as a consequence of the distribution, adjusts the basis of its interest in LTP under section 734(b), does LTP also adjust the basis of its property under section 734(b)?

(2) An upper-tier partnership (UTP) distributes its interest in a lower-tier partnership (LTP) to a partner of UTP, while both partnerships have elections in effect under section 754 of the Code. If section 732(a)(2) applies to limit the distributee partner's basis in the distributed partnership interest, does UTP increase the basis of its undistributed property to the extent provided in section 734(b)(1)(B)?

FACTS

A and B are partners in partnership UTP, each with a 50 percent interest in the capital, profits and losses of the partnership. A's partnership interest in UTP has an adjusted basis of zero and a fair market value of 160x dollars. UTP has no liabilities and only two properties, capital asset X and a 10 percent interest in the capital, profits and losses of partnership LTP. Asset X has an adjusted basis to UTP of 140x dollars and a fair market value of 240x dollars. UTP's interest in LTP has an adjusted basis to UTP of 30x dollars and a fair market value of 80x dollars.

LTP has no liabilities and only two properties, capital asset Y and noncapital asset Z. Asset Y has an adjusted basis of 200x dollars and a fair market value of 700x dollars. Asset Z has an adjusted basis of zero and a fair market value of 100x dollars. UTP's share of the adjusted basis of LTP's properties is 20x dollars.

For the taxable year in which the events described in Situations 1 and 2 occur, UTP and LTP make valid elections under section 754 of the Code. Capital assets X and Y, and noncapital asset Z, are not assets described in section 751. Section 732(d) does not apply to A.

SITUATION 1

UTP distributes one-half of capital asset X to partner A, in order to reduce A's 50 percent interest in UTP to 20 percent, and increase B's interest to 80 percent. The distribution reduces the value of A's partnership interest in UTP to 40x dollars.

SITUATION 2

UTP distributes its partnership interest in LTP to partner A, in order to reduce A's 50 percent interest in UTP to 33 percent. The distribution reduces the value of A's partnership interest in UTP to 80x dollars.

LAW AND ANALYSIS

Section 734(a) of the Code provides that the basis of partnership property is not adjusted as the result of a distribution of property to a partner unless the partnership has an election in effect under section 754 of the Code.

Section 743(a) of the Code provides that the basis of partnership property is not adjusted as the result of a transfer of an interest in a partnership unless the partnership has an election in effect under section 754 of the Code.

Section 754 of the Code provides that if a partnership files an election in accordance with regulations prescribed by the Secretary, the basis of partnership property is adjusted, in the case of a distribution of property, in the manner provided in section 734(b), and, in the case of a transfer of a partnership interest, in the manner provided in section 743(b).

Section 734(b) of the Code provides that, in the case of a distribution of property to a partner, a partnership that has a section 754 election in effect increases or decreases the adjusted basis of partnership property under specified circumstances. Under section 734(b)(1)(A), the amount of increase is the amount of any gain recognized to the distributee partner with respect to the distribution. Under section 734(b)(1)(B), in the case of distributed property to which section 732(a)(2) applies, the amount of increase also includes the excess of the adjusted basis of the distributed property immediately before the distribution over the basis of the distributed property to the distributee. The partnership does not make the adjustment described in the preceding sentence if the distributed property is an interest in another partnership that does not have an election in effect under section 754 of the Code.

Section 732(a)(1) of the Code provides that the basis of property (other than money) distributed by a partnership to a partner other than in liquidation of the partner's interest is generally equal to the property's adjusted basis to the partnership immediately before the distribution. Section 732(a)(2), however, limits the basis of the property to the distributee partner to the adjusted basis of the partner's interest in the partnership reduced by any money distributed in the same transaction.

Section 734(c) of the Code requires the allocation of any basis adjustment among partnership properties in accordance with section 755 of the Code.

Section 743(b) of the Code provides that, in the case of a transfer of an interest in a partnership by sale or exchange or upon the death of a partner, a partnership that has a section 754 election in effect increases or decreases the adjusted basis of partnership property under specified circumstances.

Section 743(c) of the Code requires the allocation of any basis adjustment among partnership properties in accordance with section 755 of the Code.

Section 755(a)(1) of the Code provides that the basis adjustment is allocated among partnership properties in a manner that reduces the difference between the fair market value and the adjusted bases of those properties. Section 755(b) provides that in applying the allocation rules of section 755(a), increases or decreases in the adjusted basis of partnership property arising from a distribution of, or a transfer of an interest attributable to, (1) capital assets and property described in section 1231(b) ("capital assets"), or (2) any other property of the partnership, are allocated to partnership property of like character.

Section 1.755-1(b)(1) of the Income Tax Regulations provides that where there is an adjustment to the basis of undistributed partnership property under section 734(b)(1)(B) of the Code, the adjustment is allocated to remaining partnership property of a character similar to that of the distributed property.

Section 1.755-1(a)(1)(ii) of the regulations provides that if there is an increase in basis to be allocated to partnership assets, such increase must be allocated only to assets whose values exceed their bases and in proportion to the difference between the value and basis of each. No increase may be made, however, to the basis of any asset the adjusted basis of which equals or exceeds its fair market value.

Section 741 of the Code provides that, except as provided in section 751, the gain or loss from the sale or exchange of an interest in a partnership is considered to be a gain or loss from the sale or exchange of a capital asset.

Section 708(b)(1)(B) of the Code provides that a partnership is considered terminated if, within a 12 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 regulations provides that the liquidation of a partnership interest is not a sale or exchange for purposes of section 708(b)(1). Section 761(e) provides that, for purposes of sections 708 and 743, any distribution of an interest in a partnership (not otherwise treated as an exchange) is treated as an exchange.

SITUATION 1

UTP distributes one-half of capital asset X to partner A, reducing the value of A's partnership interest to 40x dollars. Under section 732(a)(1) of the Code, A's basis in the distributed half of asset X would be equal to the basis of the distributed half of asset X to UTP immediately before the distribution, or 70x dollars. Section 732(a)(2), however, limits A's basis in the distributed half of asset X to A's basis in its UTP partnership interest, or zero. Because UTP has a section 754 election in effect, under section 734(b)(1)(B), UTP increases the adjusted basis of its remaining property by 70x dollars, the excess of the adjusted basis of the distributed property to UTP immediately before the distribution (70x dollars) over the basis of the distributed property to A (zero).

Section 755(b) of the Code and section 1.755-1(b)(l) of the regulations provide that the basis adjustment to undistributed partnership property under section 734(b)(1)(B) is allocated to remaining partnership property of a character similar to that of the distributed property. UTP's remaining property is the undistributed half of asset X and its interest in LTP, both of which, like asset X, are capital assets. Section 755(a) generally requires a reduction of the difference between the fair market value and the adjusted basis of undistributed property. In this case, the undistributed half of asset X and UTP's partnership interest in LTP each have a difference of 50x dollars between fair market value and adjusted basis. Section 1.755-1(a)(l)(ii) requires that a section 734(b) basis increase be allocated among partnership assets in proportion to the difference between the value and the basis of each. Accordingly, the 70x dollar basis adjustment is allocated equally among UTP's two assets, so that UTP increases its basis in the undistributed half of asset X from 70x dollars to 105x dollars, and increases its basis in LTP from 30x dollars to 65x dollars.

Because both UTP and LTP have made elections under section 754 of the Code, it is appropriate to treat UTP's distribution of one- half of asset X to A and the subsequent 35x dollar increase to UTP's basis in LTP as an event that triggers a section 734(b) basis increase of 35x dollars to UTP's share of LTP's assets. Under section 755(b) of the Code and section 1.755-1(b)(1) of the regulations, the basis adjustment to undistributed partnership property under section 734(b)(1)(B) is allocated to remaining partnership property of a character similar to that of the distributed property. Accordingly, LTP increases its basis in UTP's share of asset Y from 20x dollars to 55x dollars. This adjustment to basis is for UTP only and does not affect the basis in LTP property of other partners of LTP. No adjustment is made to UTP's share of LTP's basis in noncapital asset Z.

Although A's interest in UTP is reduced from 50 percent to 20 percent, the reduction of A's interest in UTP is effected by a distribution, which is not considered a sale or exchange of a UTP interest for purposes of section 708 of the Code. Cf. section 1.708- 1(b)(1)(ii) of the regulations.

Under the facts addressed by this ruling, UTP and LTP were allowed to increase the basis of undistributed property. Under other circumstances, upper- and lower-tier partnerships might be required to decrease the basis of undistributed property in accordance with the principles described above. For example, if a partner in an upper-tier partnership (with a section 754 election in effect) is distributed property in liquidation of the partner's interest, and the partner has a higher basis in its partnership interest than in the distributed partnership property, the upper-tier partnership must decrease its adjusted basis in its remaining partnership property under section 734(b)(2) of the Code. If this adjustment results in a reduction in the upper-tier partnership's basis in its partnership interest in a lower-tier partnership (which also has a section 754 election in effect), the lower-tier partnership must decrease its adjusted basis in the upper-tier partnership's proportionate share of the lower-tier partnership's assets under section 734(b)(2) as well.

SITUATION 2

UTP distributes its partnership interest in LTP to partner A, reducing A's 50 percent interest in UTP to 33 percent. Under section 732(a)(2) of the Code, A's basis in the distributed LTP interest is equal to A's basis in its UTP partnership interest, or zero. Because both UTP and LTP have section 754 elections in effect, under section 734(b)(1)(B), UTP increases the adjusted basis of its remaining property (asset X) by 30x dollars, the excess of the adjusted basis of the distributed property to UTP immediately before the distribution (30x dollars) over the basis of the distributed property to A (zero).

UTP makes the above basis adjustment only because both UTP and LTP have elections in effect under section 754 of the Code. See the last sentence of section 734(b), which limits the applicability of section 734(b)(1)(B).

Under section 761(e) of the Code, UTP's distribution of its interest in LTP is treated as an exchange of the interest in LTP for purposes of section 743. Because LTP has a section 754 election in effect, under section 743(b)(2) LTP would decrease the adjusted basis of its property by 20x dollars, the excess of A's proportionate share of the adjusted basis of LTP's property (20x dollars) over the basis of A's interest in LTP (zero). However, section 1.755-1(a)(1)(iii) of the regulations prevents LTP from decreasing the basis of either of its assets because both asset Y and asset Z have fair market values which equal or exceed their bases.

Under section 761(e) of the Code, UTP's distribution of its interest in LTP is treated as an exchange of a 10 percent interest in LTP for purposes of the partnership termination provisions in section 708. See Rev. Rul. 87-50, 1987-1 C.B. 157. The reduction of A's interest in UTP is not considered a sale or exchange for purposes of section 708. Cf. section 1.708-1(b)(1)(ii) of the regulations.

HOLDINGS

(1) If partnership UTP and partnership LTP have elections in effect under section 754 of the Code, if UTP distributes property to a partner and one of UTP's undistributed properties is an interest in partnership LTP, and if UTP adjusts the basis of its interest in LTP under section 734(b), then this adjustment is an event that is deemed to require LTP to adjust the basis of its property under section 734(b) by the same amount. This adjustment to basis is for UTP only and does not affect the basis in LTP property of other partners of LTP.

(2) If partnership UTP distributes its interest in partnership LTP to a partner of UTP while both partnerships have elections in effect under section 754 of the Code, and if section 732(a)(2) applies to the distributed partnership interest, UTP increases the basis of its undistributed property to the extent provided in section 734(b)(1)(B).

DRAFTING INFORMATION

The principal author of this revenue ruling is Dexter A. Johnson of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. Johnson on (202) 566-4751 (not a toll-free call).