REVENUE RULE 95-24

1995-13 I.R.B. 4,

TREATMENT OF A DISTRIBUTION OF A BOND IN LIQUIDATION OF A PARTNERSHIP INTEREST

March 9, 1995

26 CFR 1.171-2: Determination of Bond Premium.

(Also §§732; 1.732-1)

Treatment of a distribution of a bond in liquidation of a partnership interest. For purposes of determining the amount of amortizable bond premiums, a distribution of a bond in liquidation of a partnership interest is an exchange for purposes of section 171(b)(4) of the Code.

ISSUE

Is a distribution in liquidation of a partnership interest an exchange for purposes of s 171(b)(4) of the Internal Revenue Code?

FACTS

PR is a partner in partnership PRS. PRS does not have any unrealized receivables or substantially appreciated inventory items as defined in s 751. On Date y, PRS distributes to PR a taxable bond, issued by an unrelated corporation, in liquidation of PR's partnership interest. At that time, the fair market value of PR's partnership interest is $40x and the basis is $100x. The fair market value of the bond is $40x.

LAW AND ANALYSIS

Section 171(a) provides that, in the case of a taxable bond, the amount of amortizable bond premium for the taxable year is allowed as a deduction. Under s 171(b), the amount of bond premium is determined by reference to the basis of the bond and, generally, by reference to the amount payable on maturity.

Section 171(b)(4)(A) provides that if a bond is acquired by any person in exchange for other property and the basis of the bond is determined (in whole or in part) by reference to the basis of the other property, then for purposes of determining the amount of amortizable bond premium, the basis of the bond may not exceed its fair market value immediately after the exchange. Section 171(b)(4)(B) provides an exception to this rule for a bond acquired in exchange for another bond as part of a reorganization under s 368.

Section 732(b) provides that the basis of property (other than money) distributed by a partnership to a partner in liquidation of the partner's interest is an amount equal to the adjusted basis of the partner's interest in the partnership reduced by any money distributed in the same transaction.

Section 731(a) provides that any gain or loss recognized by a partner on a distribution by a partnership to the partner is considered gain or loss from the sale or exchange of the partnership interest of the distributee partner.

Section 741 provides that gain or loss from the sale or exchange of a partnership interest is considered gain or loss from the sale or exchange of a capital asset, except as provided in s 751 (relating to unrealized receivables and inventory items that have appreciated substantially in value).

In certain circumstances a distribution in liquidation of a partnership interest is treated as a sale or exchange, and in other circumstances it is not. For example, s 1.708-1(b)(1)(ii), which determines when a sale or exchange of a partnership interest causes a partnership to terminate, states that the liquidation of a partnership interest is not a sale or exchange for purposes of this determination.

By contrast, s 1.1272-2(b)(6) treats a distribution of a debt instrument in liquidation of a partnership interest as an exchange in determining the amount of acquisition premium on a debt instrument. Acquisition premium, pursuant to s 1272(a)(7), reduces the amount of original issue discount (OID) a holder must recognize on a debt instrument. Section 1.1272-2(b)(6) generally provides that, when the basis of a debt instrument acquired in exchange for other property is determined by reference to the basis of that other property, the basis of the debt instrument may not exceed its fair market value immediately after the exchange. By treating a distribution of a debt instrument in liquidation of a partnership interest as an exchange, s 1.1272-2(b)(6) prevents a taxpayer from using any built-in capital loss on the partnership interest to offset interest income accruing on the debt instrument.

Congress intended for the treatment of bond premium generally to conform to the treatment of OID under §§1271 through 1275. See S. Rep. No. 313, 99th Cong., 2d Sess. 904 (1986), 1986-3 C.B. (Vol. 3) 904. Section 171(b)(4)(A) ensures an accurate measurement of amortizable bond premium on a debt instrument acquired by a taxpayer in exchange for other property when the basis of the debt instrument is determined by reference to the basis of the other property. It prevents a taxpayer from inappropriately converting unrecognized capital losses into amortizable bond premium. Thus, s 171(b)(4)(A) limits amortizable bond premium in the same manner as s 1.1272- 2(b)(6) limits acquisition premium. Absent exchange treatment, the built-in capital loss on the partnership interest would be converted to amortizable bond premium and the purpose of s 171(b)(4) would be circumvented.

In this case, PRS distributed the bond to PR in liquidation of PR's partnership interest. PR's basis in the bond is determined by reference to PR's basis in the partnership interest ($100), and the liquidating distribution is treated as an exchange for purposes of s 171(b)(4). Therefore, for purposes of computing amortizable bond premium, PR's basis in the bond is its fair market value ($40).

HOLDING

A distribution in liquidation of a partnership interest is treated as an exchange for purposes of s 171(b)(4). Therefore, s 171(b)(4) applies to the receipt of a bond in exchange for a partnership interest and, for purposes of s 171(b), the partner's basis in the bond is limited to the bond's fair market value immediately after the exchange. The partner's basis in the bond for other purposes is determined under s 732.

DRAFTING INFORMATION

For further information regarding this revenue ruling contact Carol A. Schwartz of the Office of the Assistant Chief Counsel, Financial Institutions & Products, on (202) 622-3920 (not a toll-free call).

Rev. Rul. 95-24, 1995-13 I.R.B. 4.