Rev. Rul. 84-15
1984-1 C.B. 158.
Internal Revenue Service
Revenue Ruling
PARTNERSHIPS; BASIS OF PARTNER'S INTEREST; BASIS OF PARTNERSHIP
PROPERTY; CONTRIBUTION OF ENCUMBERED PROPERTY
Published: January 23, 1984
SECTION 722. - -BASIS OF CONTRIBUTING PARTNER'S INTEREST, 26 CFR 1.722-1: Basis of contributing partner's interest
(Also Sections 705, 721, 723, 731, 752; 1.705-1, 1.721-1, 1.723-1, 1.752-1.)
Partnerships; basis of partner's interest; basis of partnership property; contribution of encumbered property. A partner who recognizes gain upon the contribution of encumbered property to a partnership, does not increase the basis of the partnership interest to reflect the gain and the partnership does not increase the adjusted basis of the contributed property to reflect such gain.
ISSUE
Is the basis of the partnership interest of a partner increased under section 722 of the Internal Revenue Code and is the basis of partnership property increased under section 723 if the partner contributes encumbered property to the partnership and the partner recognizes gain as a result of sections 731(a) and 752(b) of the Code?
FACTS
A, an individual, acquired a 20 percent interest in GP, a general partnership, by contributing land to GP. At the time of A's contribution, the property had a fair market value of 100x dollars, an adjusted basis to A of 40x dollars, and was subject to a mortgage of 60x dollars. Payment of the mortgage was assumed by GP, and there were no other outstanding partnership liabilities. GP is not a partnership that would be treated as an investment company (within the meaning of section 351 of the Internal Revenue Code) if GP were incorporated.
LAW AND ANALYSIS
Section 721(a) of the 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 721(b) of the Code provides that subsection (a) shall not apply to gain realized on a transfer of property to a partnership which would be treated as an investment company (within the meaning of section 351) if the partnership were incorporated.
Section 722 of the Code states 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 at the time of the contribution increased by the amount (if any) of gain recognized to the contributing partner at such time.
Section 723 of the Code provides that the basis of property contributed to a partnership by a partner shall be the adjusted basis of such property to the contributing partner at the time of the contribution increased by the amount (if any) of gain recognized to the contributing partner at such time.
Section 752(b) of the Code provides that any decrease in a partner's individual liabilities by reason of the assumption by the partnership of such individual liabilities shall be considered as a distribution of money to the partner by the partnership.
Section 731(a) of the Code provides that in the case of a distribution, gain shall not be recognized to a partner except to the extent that any money distributed exceeds the adjusted basis of the partner's interest in the partnership immediately before the distribution.
Section 705(a)(2) of the Code states that the adjusted basis of a partner's interest shall be decreased (but not below zero) by distributions by the partnership.
Under section 721(a) of the Code, when a person contributes property to a partnership in exchange for an interest therein, gain or loss is generally not recognized on the transfer. However, if the property is encumbered and the encumbrance becomes a liability of the partnership, under section 752(b), the contributing partner is deemed to receive a distribution of money from the partnership in an amount equal to the reduction in the share of such liability. As illustrated by example (2) of section 1.722-1 of the Income Tax Regulations, gain is recognized under section 731(a) by the contributing partner on the deemed distribution of money to the extent that such distribution exceeds the adjusted basis of such partner's interest.
Section 721(b) of the Code was added by section 2131(b) of the Tax Reform Act of 1976, 1976-3 (Vol. 1) C.B. 1, 400. It was
intended to provide an exception to the general rule of nonrecognition of gain or loss on the contribution of property to a partnership where investors transfer appreciated stock or securities (or other property) to an exchange fund operated as a partnership. S.Rep. No. 94-938 (Part 2), 94th Cong., 2d Sess. 43 (1976), 1976-3 (Vol. 3) C.B. 643, 685. Section 2131(c) of the Act made conforming amendments to sections 722 and 723 of the Code providing for the adjustment of the basis of the partner's interest and the basis of the contributed property to the partnership if gain is recognized under section 721(b).
The amendments to sections 722 and 723 of the Code do not apply to the recognition of gain that results under sections 731(a) and 752(b) from the contribution of encumbered property, since such gain arises immediately after the contribution, not "... at the time of the contribution." Basis is increased under sections 722 and 723 only by the amount of gain recognized at the time of contribution due to the inapplicability of section 721(a). See S.Rep. No. 94-938 (Part 2) at 43 n. 2, 1976-3 (Vol. 3) C.B. at 685.
In this case, section 721(a) of the Code applies to A's contribution of encumbered property to the partnership in exchange for the 20 percent partnership interest. Section 721(b) does not apply to the transaction. However, A must recognize a gain of 8x dollars under section 731(a), determined as follows:
Portion of mortgage assumed by other partners treated as a 48 x dollars
distribution under section 752(b)(80% of 60x dollars):
Less adjusted basis to A of property contributed: 40 x dollars
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Gain recognized: 8 x dollars
The adjusted basis of A's partnership interest is reduced to zero (section 705(a)(2)), and is not increased under section 722 by the 8x dollars of gain recognized by A. Similarly, the basis of partnership property is not increased under section 723 by the 8x dollars of gain recognized by A.
HOLDING
The adjusted basis of a partnership interest is not increased under section 722 of the Code and the adjusted basis of partnership property is not increased under section 723 if the partner contributes encumbered property to a partnership and the partner recognizes gain under section 731(a) of the Code.
Rev. Rul. 84-15, 1984-1 C.B. 158.