Rev. Rul. 89-11

1989-1 C.B. 179, 1989-4 I.R.B. 5.

                       Internal Revenue Service

                                 Revenue Ruling

                 PARTNERSHIPS; PARTNERSHIP SYNDICATION EXPENSES

                          Published: January 23, 1989

SECTION 709. - TREATMENT OF ORGANIZATION AND SYNDICATION FEES, 26 CFR 1.709-1: Treatment of organizations and syndication costs

(Also Section 165; 1.165-1.)

  Partnerships; partnership syndication expenses. Section 709 of the Code precludes a deduction under section 165 for an abandonment loss despite the fact that expenses were incurred in a syndication effort that failed and was abandoned. Rev. Rul. 79-2 distinguished.

  A corporation formed a limited partnership in 1985, becoming its general partner. An individual became a limited partner in the partnership. Following formation of the partnership, the corporation entered into an agreement with an underwriter for a best-efforts public offering of limited partnership interests in the partnership. The corporation paid certain costs toward the syndication of the partnership. However, the syndication efforts were unsuccessful and were abandoned.

  In 1986, the corporation entered into an agreement with a second underwriter to undertake a best-efforts public offering of limited partnership interests in the same partnership. The corporation incurred further costs in connection with the second offering, which was successful and resulted in numerous investors being admitted as limited partners in the partnership. Amounts expended in the first syndication effort had no value to the partnership or the corporation with regard to the second, successful syndication.

  ISSUE. At issue is whether expenses incurred in the syndication of a partnership, which ultimately is unsuccessful and abandoned, are deductible under section 165.

  HOLDING. The Service has held that section 709 precludes deductions for partnership syndication expenses, regardless of whether the syndication efforts are successful.

  ANALYSIS. The Service found that the partnership was required to capitalize the 1985 syndication expenses under regulation section 1.709-2(b). Moreover, Rev. Rul. 85-32, 1985-1 C.B. 186, holds that syndication costs are chargeable to capital accounts. The Service reasoned that the terms 'capitalize' and 'chargeable to capital account' indicate that the partnership is required to record the syndication expenditures as an intangible asset.

  The Service cited regulation section 1.709-1(b)(2), which provides that section 709 precludes the allowance of a loss deduction to the partnership under section 165 for capitalized syndication expenses upon the winding up or liquidation of a partnership. The Service concluded that to allow a loss deduction for capitalized syndication expenses, if those expenditures become worthless before the winding up of the partnership, would be inconsistent with the regulations. The Service distinguished Rev. Rul. 79-2, 1979-1 C.B. 98.

ISSUE

  Whether syndication expenses incurred in connection with the syndication of a partnership are deductible under section 165 of the Internal Revenue Code if the syndication effort to which the expenses relate fails and that effort is abandoned.

FACTS

  In 1985, corporation X formed a limited partnership, PRS, and became its general partner. A, an individual, became a limited partner. Shortly after the formation of PRS, corporation X entered into an agreement with underwriter Y to undertake a best-efforts public offering of limited partner interests in PRS. In connection with this syndication effort, corporation X paid certain costs toward the syndication of partnership PRS. The syndication effort, however, was unsuccessful and was abandoned.

  In 1986, corporation X entered into an agreement with underwriter Z to undertake a best-efforts public offering of limited partner interests in PRS. In connection with this second effort, corporation X incurred further syndication costs. This second syndication effort was successful and numerous investors were admitted as limited partners in PRS. The amounts expended in connection with the 1985 syndication effort had no value to PRS or corporation X in the 1986 syndication effort.

LAW AND ANALYSIS

  Section 165(a) provides that there shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.

  Section 1.165-1(b) of the Income Tax Regulations provides that to be allowable as a deduction under section 165(a), a loss must be evidenced by closed and completed transactions, fixed by identifiable events, and actually sustained during the taxable year.

  Section 1.165-2(a) of the regulations provides that a loss incurred in a business or a transaction entered into for profit and arising from the sudden termination of the usefulness in such business or transaction of any nondepreciable property, in a case where such business or transaction is discontinued or if such property is permanently discarded from use therein, shall be allowed as a deduction under section 165 for the taxable year in which the loss is actually sustained.

  Section 709(a) of the Code provides that, except as provided in section 709(b), no deduction shall be allowed under chapter 1 of subtitle A of the Code to a partnership or to any partner for any amount paid or incurred to organize a partnership or to promote the sale of an interest in such partnership. Section 709(b) allows a partnership to amortize its organizational expenses over a period of not less than 62 months. Syndication expenses are not subject to the election under section 709(b) of the Code and must be capitalized. Section 1.709-2(a) and (b) of the regulations. See also S. Rep. No. 938, 94th Cong., 2d Sess. 94 (1976), 1976-3 (Vol. 3) C.B. 132.

  Section 1.709-1(b)(2) of the regulations provides that if there is a winding up and complete liquidation of a partnership before the end of the amortization period described in section 709(b) of the Code, the unamortized amount of organizational expenses is deductible by the partnership under section 165 as a loss in the partnership's final taxable year. This section of the regulations provides, however, that no partnership deduction is allowed with respect to capitalized syndicate expenses.

  Rev. Rul. 85-32, 1985-1 C.B. 186, holds that syndication costs incurred in connection with the sale of partner interests are chargeable by the partnership to capital account and can not be amortized. In addition, that ruling states that '[N]o deduction is permitted at the partnership or partner level with respect to the partnership's . . . capitalized syndication expenses.'

  Syndication costs can be paid in a number of ways. For example, they can be paid directly by the partnership, indirectly by a general partner, or by investors paying a portion of costs, such as sales commissions, at the time those investors acquire their partner interests. Rev. Rul. 81-153, 1981-1 C.B. 387, stands for the principle that the cost of marketing partner interests are syndication costs regardless of who pays the costs. Rev. Rul. 81-153 considered two situations in which an investor paid sales commissions in connection with the investor's acquisition of a limited partner interest. The ruling holds that in both situations the sales commissions are considered to have been paid by the partnership. In effect, the amount of the sales commission is treated as a capital contribution by the investor to the partnership and a payment of a syndication expense by the partnership. In this case, the syndication costs paid by corporation X are viewed as amounts paid by PRS. The investor's basis in the limited partner interest includes the amount paid as sales commissions and not merely the net cash received by the partnership.

  In Rev. Rul. 79-2, 1979-1 C.B. 98, expenses incurred by shareholders in preparation for public offering of their shares of stock in a corporation were required to be capitalized as an intangible asset of the shareholders, separate from their stock. The ruling holds that the shareholders are allowed loss deductions with respect to the capitalized expenses for the year the offering was abandoned. The facts here are distinguishable from those in Rev. Rul. 79-2, because a partnership is involved.

  PRS was required to capitalize the syndication expenses incurred in connection with the 1985 syndication effort because section 1.709- 2(b) of the regulations directs that partnership syndication costs must be capitalized. Rev. Rul. 85-32 holds that syndication costs are chargeable to capital account. The terms 'capitalize' and 'chargeable to capital account' indicate that the partnership is to record the syndication expenditures as an intangible asset on its balance sheet. Because here, as in Rev. Rul. 79-2, the usefulness to PRS of the intangible asset created upon capitalization of the syndication costs terminated upon the abandonment of the effort, a question is presented as to whether PRS is allowed a loss deduction under section 165 of the Code and section 1.165-2(a) of the regulations.

  The 'no deduction shall be allowed' language in section 709 of the Code precludes the deduction of syndication costs under any circumstances. Rev. Rul. 85-32 states that, with respect to the deductibility of syndication costs, the provision of section 709 of the Code and the related regulations supersede any other section contained in chapter 1 of the Code. See also Egolf v. Commissioner, 87 T.C. 34, 46 (1986); Rev. Rul. 87-111, 1987-2 C.B. 160. Furthermore, section 1.709-1(b)(2) provides that section 709 precludes the allowance of a loss deduction to the partnership under section 165 for capitalized syndication expenses upon the winding up and liquidation of a partnership. Obviously, the intangible asset represented by capitalized syndication expenditures can have no value to a partnership upon its liquidation, but the regulations expressly deny a loss deduction to the partnership at that time. To allow a loss deduction with respect to capitalized syndication expenditures if those expenditures became worthless before the winding up of the partnership would, therefore, be inconsistent with the direction given in the regulations.

HOLDING

  Section 709 of the Code precludes the allowance of a deduction for partnership syndication expenses regardless of whether the syndication effort is successful.

EFFECT ON OTHER RULINGS

  Rev. Rul. 79-2 is distinguished.

DRAFTING INFORMATION

  The principal author of this revenue ruling is Tom Lyden of the Financial Institutions and Products Division. For further information regarding this revenue ruling contact Mr. Lyden on (202) 566-3458 (not a toll-free number).

Rev. Rul. 89-11, 1989-1 C.B. 179, 1989-4 I.R.B. 5.