REVENUE RULE 95-5

1995-2 I.R.B. 5.

Internal Revenue Service
Revenue Ruling

PASSIVE ACTIVITY LOSSES; S CORPORATIONS AND PARTNERSHIPS

Publish December 21, 1994

Section 469. - Passive Activity Losses and Credits Limited, 26 CFR 1.469-2T: Passive activity loss (temporary).

(Also §§ 301, 731, 1368.)

Passive activity losses; S corporations and partnerships. The Service provides guidance regarding the characterization of gain for purposes of the passive activity loss rules of section 469 of the Code where the gain results from a distribution of money by an S corporation or partnership.

ISSUES

(1) If a partner receives a distribution of money in excess of the adjusted basis of the partner's interest in the partnership and recognizes gain under s 731(a) of the Internal Revenue Code, how is that gain characterized for purposes of the passive activity loss rules of s 469?

(2) If an S corporation shareholder receives a distribution of money in excess of the adjusted basis of the shareholder's stock in the corporation and recognizes gain under s 1368(b)(2), how is that gain characterized for purposes of the passive activity loss rules of s 469?

FACTS

Situation 1. Individual A is a partner in partnership PRS. During the tax year, A receives a distribution of cash from PRS in excess of the adjusted basis of A's partnership interest.

Situation 2. Individual B is a shareholder of S corporation X. X has no accumulated earnings and profits. During the tax year, B receives a distribution of cash from X in excess of the adjusted basis of B's stock.

LAW AND ANALYSIS

Section 731(a) provides that a distribution by a partnership to a partner in excess of the adjusted basis of the partner's interest in the partnership is treated as a gain from the sale or exchange of that interest.

Section 1368(a) provides that a distribution of property made by an S corporation with respect to its stock to which (but for s 1368(a)) s 301(c) would apply is treated as provided in s 1368(b) or (c), whichever applies. For a distribution described in s 1368(a) by an S corporation that has no accumulated earnings and profits, s 1368(b)(2) provides that any amount of the distribution exceeding the adjusted basis of the stock is treated as gain from the sale or exchange of property.

Section 469(a) disallows the passive activity loss for the tax year of individuals, estates, trusts, and certain corporations.

Section 1.469-2T(e) of the temporary Income Tax Regulations provides special rules for partners and S corporation shareholders for purposes of s 469.

Section 1.469-2T(e)(3) provides that, in the case of a sale, exchange, or other disposition of an interest in a passthrough entity (a partnership or an S corporation), the amount of the seller's gain from each activity in which such entity has an interest is determined under that section for purposes of section 469.

Section 1.469-2T(e)(3)(ii)(A) provides generally that, if a holder of an interest in a passthrough entity disposes of the interest, a ratable portion of any gain or loss from the disposition is treated as gain or loss from the disposition of an interest in each trade or business, rental, or investment activity in which the passthrough entity owns an interest.

Section 731(a) treats the amount of PRS' distribution in excess of the adjusted basis of A's partnership interest as gain from the sale or exchange of that interest. A's gain is therefore treated as gain from a disposition of A's interest in PRS for purposes of s 1.469-2T(e)(3). Therefore, s 1.469-2T(e)(3) applies and A's gain will generally be treated as gain from the disposition of an interest in each of PRS' activities.

Section 1368(b)(2) treats the amount of X's distribution in excess of B's adjusted stock basis as gain from the sale or exchange of property. "Property" in this context refers to the shareholder's stock in the S corporation. See s 301(c)(3)(A) (providing that the portion of a distribution that is not a dividend and is in excess of the adjusted basis of the stock is treated as "gain from the sale or exchange of property"). B's gain is therefore treated as gain from a disposition of B's interest in X for purposes of s 1.469-2T(e)(3). Therefore, s 1.469-2T(e)(3) applies and B's gain will generally be treated as gain from the disposition of an interest in each of X's activities. Thus, the regulations under s 469 characterize a s 1368(b)(2) distribution in the same way as a s 731(a) distribution.

HOLDINGS

(1) If a partner receives a distribution of money in excess of the adjusted basis of the partner's interest in the partnership and recognizes gain under s 731(a), for purposes of characterizing the gain under s 469, the gain is treated as gain from the sale or exchange of a partnership interest under s 1.469-2T(e)(3).

(2) If an S corporation shareholder receives a distribution of money in excess of the adjusted basis of the shareholder's stock in the corporation and recognizes gain under s 1368(b)(2), for purposes of characterizing the gain under s 469, the gain is treated as gain from the sale or exchange of the S corporation stock under s 1.469-2T(e)(3).

DRAFTING INFORMATION

The principal author of this revenue ruling is Martin L. Schaffer of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this ruling contact Mr. Schaffer at (202) 622- 3080 (not a toll-free call).

Rev. Rul. 95-5, 1995-2 I.R.B. 5.