Rev. Rul. 89-7

1989-1 C.B. 178, 1989-3 I.R.B. 6.

                       Internal Revenue Service

                                 Revenue Ruling

           PARTNERSHIPS; BASIS OF PARTNER'S INTEREST IN A PARTNERSHIP

                          Published: January 17, 1989

SECTION 705. - DETERMINATION OF BASIS OF PARTNER'S INTEREST, 26 CFR 1.705-1: Determination of basis of partner's interest

(Also Sections 179, 702, 703, 1.179-1, 1.702-1.)

  Partnerships; basis of partner's interest in a partnership. A partner's distributive share of section 179 expenses will be reflected in the adjusted basis ofthe partner's interest through the basis adjustments required by section 705(a) whether or not the partner is allowed a deduction for such expense.

  An individual holds a three-fifths interest in two separate partnerships. During 1988, each partnership made section 179(a) elections to expense the entire cost of qualifying property purchased and placed in service during that year. The partnerships separately stated each partner's distributive share of section 179 expenses. The sum of the individual's section 179 expenses from the two partnerships exceeded the section 179(b)(1) ceiling of $10,000. Each partnership reduced the basis of the specific property to which the elections applied by the total amount of section 179 expenses allocated to the partners under regulation section 1.179-1(f)(2).

  ISSUE. At issue is whether the individual partner, who has section 179 expenses that exceed the $10,000 statutory maximum, may reduce his basis in the partnership interests by his full distributive share of the partnership's section 179 expenses, including the partnership's section 179 expenses that the partner cannot deduct.

  HOLDING. The Service has held that the partner's basis in the two partnerships must be reduced under section 705 by his distributive share of the section 179 expenses, even though the partner may be prohibited from deducting all or a portion of the expenses under section 179(b)(1).

  ANALYSIS. The Service, after reviewing the conditions attaching to a section 179 deduction, noted that section 703(a) provides for the computation of partnership taxable income in the same manner as that used to compute an individual's taxable income. An exception is provided in regulation section 1.702-1(a)(8)(ii) for items that, if taken into account by any partner, would result in an income tax liability different from that which would result from not taking the item into account separately.

  Finding that the section 179 expenses are of a type covered by the exception to section 703, the Service concluded that the partner's distributive share of section 179 expenses 'will be reflected in the adjusted basis of [the partner's] interest in each partnership through the basis adjustments required by section 705(a), whether or not [the partner] is allowed a deduction for such expenses.'

ISSUE

  If a partner's distributive share of the partnership's expenses under section 179 of the Internal Revenue Code is not fully deductible by the partner because, when combined with the partner's section 179 expenses from other sources, the partner's section 179 expenses from all sources exceed the maximum amount allowable to the partner under section 179(b)(1), is the partner's basis in the partnership interest reduced by the partner's full distributive share of the partnership's section 179 expenses, including the partnership's section 179 expenses that the partner cannot deduct?

FACTS

  In 1988, AB, a partnership, elected under section 179(a) of the Code to expense the entire cost of certain qualifying property that it purchased and placed in service during that year. A similar election was made by another partnership, AC. With respect to each of the partnerships, A had a three-fifths interest in each item of partnership income, gain, deduction, loss, and credit. The partnerships separately stated each partner's distributive share of section 179 expenses for that year. The sum of A's distributive share of section 179 expenses from AB and AC exceeded $10,000. AB and AC reduced the basis of the specific property to which the section 179 election applied by the total amount of section 179 expenses allocated to the partners as required by section 1.179- 1(f)(2) of the Income Tax Regulations. The partnerships are both calendar year partnerships. But for the limitation contained in section 179(b)(1), A, AB, and AC each meet all the other limitations and restrictions of section 179.

LAW AND ANALYSIS

  Section 179(a) of the Code provides that a taxpayer may elect to treat the cost of any section 179 property as an expense that is not chargeable to capital account. Any cost so treated shall be allowed as a deduction for the taxable year in which the section 179 property is placed in service. Under section 1.179-1(a) of the regulations, taxpayers may elect to treat as an expense all or a portion of the cost of section 179 property.

  Section 179(b)(1) of the Code provides that the aggregate cost of property that may be taken into account under section 179(a) shall not exceed $10,000.

  Section 179(d)(1) of the Code provides that the term 'section 179 property' means any recovery property that is section 38 property and that is acquired by purchase for use in the active conduct of a trade or business.

  Section 179(d)(8) of the Code and section 1.179-2(c) of the regulations provide that, in the case of a partnership, the dollar limitation contained in section 179(b)(1) shall apply with respect to the partnership and with respect to each partner.

  Section 1.179-1(f)(2) of the regulations provides that, generally, the basis of a partnership's section 179 property must be reduced to reflect the amount of the section 179 expense elected by the partnership. This reduction must be made even if the section 179(b) dollar limitation prevents a partner from deducting all or a portion of the amount allocated by the partnership.

  Section 1.179-1(h) of the regulations provides that the election to expense the cost of section 179 property is made by the partnership.

  Section 702(a)(7) of the Code provides that in determining a partner's income tax, each partner shall take into account separately the partner's distributive share of the partnership's items of income, gain, loss, deduction, and credit (in addition to those items specifically listed in section 702(a)(1) through 702(a)(6)) to the extent provided by regulations prescribed by the Secretary. Section 1.702-1(a)(8)(ii) of the regulations provides that each partner must take into account separately the distributive share of any partnership item that if separately taken into account by any partner would result in an income tax liability for the partner different from that which would result if that partner did not take the item into account separately.

  Section 703(a) of the Code provides that the taxable income of a partnership is computed in the same manner as in the case of an individual, except that the items described in section 702(a) must be separately stated and certain deductions specified in section 703(a)(2) are not allowed to the partnership. The deduction allowable under section 179 is not among the deductions disallowed under section 703(a)(2).

  Section 705(a) of the Code provides, in part, that the adjusted basis of a partner's interest in a partnership shall be the basis of such interest determined under section 722 (relating to contributions to a partnership) or section 742 (relating to transfers of partnership interests) increased by the partner's distributive share for the taxable year and prior taxable years of taxable income of the partnership as determined under section 703(a) and decreased (but not below zero) by distributions by the partnership as provided in section 733 and by the sum of the partner's distributive share for the taxable year and prior taxable years of losses of the partnership and expenditures of the partnership not deductible in computing its taxable income and not properly chargeable to capital account.

  The deduction allowable under section 179 of the Code must be separately stated under section 702(a)(7) because a partner's income tax liability may differ depending on whether or not this deduction is separately stated by the partnership. In compliance with section 179(d)(8) of the Code and section 1.179-2(c) of the regulations, A deducted only $10,000 of the total section 179 expenses separately stated and allocated to A by the partnerships.

  Under section 703(a) of the Code, the deductible section 179 expenses of a partnership for a taxable year reduce the taxable income or increase the taxable loss of the partnership for the year. In addition, the section 179 expenses of a partnership that are not deductible in computing the partnership's taxable income or loss for a taxable year by reason of the application of the section 179(b) limitations to the partnership constitute expenditures of the partnership that are not properly chargeable to capital account. Accordingly, A's distributive share of the section 179 expenses of the partnerships will be reflected in the adjusted basis of A's interest in each partnership through the basis adjustments required by section 705(a), whether or not A is allowed a deduction for such expenses.

HOLDING

  The adjusted basis of A's interest in AB and AC must be reduced under section 705 by A's distributive share of the section 179 expenses of the partnerships even though A may be prohibited from deducting all or a portion of such expenses under section 179(b)(1).

DRAFTING INFORMATION

  The principal author of this revenue ruling is Mary A. Munday of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this ruling, contact Ms. Munday on (202) 343-8459 (not a toll-free call).

Rev. Rul. 89-7, 1989-1 C.B. 178, 1989-3 I.R.B. 6.