Partial Sale of a Partnership Interest: Flexibility in Controlling Gain?

A sale of a partial partnership interest and an allocation of adjusted basis between the interest sold and the interest retained is rather complicated, particularly in situations involving the discharge of partnership liabilities. The IRS issued Rev. Rul. 84-53 to clarify this issue, based, in part, on the Sec. 752 regulations then in effect. However, the subsequent issuance of final Sec. 752 regulations may result in substantially different allocations of nonrecourse debt (and basis) than occurred under the previous Sec. 752 regulations and Sec. 1001 rules used in formulating Rev. Rul. 84-53. Therefore, it is difficult to predict how Rev. Rul. 84-53 applies in certain circumstances.

General Rule of Rev. Rul. 84-53

Under Rev. Rul. 84-53, a partner has a single basis in his partnership interest. When calculating basis if he sells only a portion of his partnership interest, the partner first excludes from the adjusted basis of his entire interest an amount equal to his share of all partnership liabilities. Next, he allocates part of the remaining adjusted basis (the residual basis) to the portion of the interest sold based on the ratio of the fair market value (FMV) of the portion sold to the entire interest's FMV. Finally, he adds the amount of residual basis allocated to the interest sold to the amount of his share of liabilities considered discharged on the disposition of the transferred interest. The result represents the basis in the portion of the interest sold.

Special Rule

The general rule does not apply when the partner's share of partnership liabilities exceeds the total adjusted basis in his interest (e.g., when allocated tax losses exceed capital contributions, and cash distributions exceed capital contributions and taxable income inclusions). If the partner's share of partnership debt exceeds his basis in his entire partnership interest (including basis attributable to liabilities), the basis of the portion sold would bear the same relationship to his entire basis that his share of partnership debt discharged on the sale bears to his total share of partnership debt.

Example 1: A is a 50% general partner in AB Partnership and also owns a 25% limited interest. A's basis in his combined interest is $90, which includes $96 of recourse partnership liabilities allocated to him as a general partner under Sec. 752. A sells half of his general-partner interest to C for $6. In calculating his gain or loss on the sale, A uses Rev. Rul. 84-53, which compares the debt deemed transferred to C ($48, one half of $96) to the total debt allocated to A ($96) and multiplies that fraction by A's total basis in his partnership interest ($90). Therefore, A's interest sold with a basis of $45 (($48/$96) x $90) and he realizes $54 ($6 + $48, basis plus liabilities considered discharged), resulting in a $9 gain.

Final Sec. 752 Regs., Sec. 1001 and Rev. Rul. 84-53

Rev. Rul. 84-53 cites the Sec. 1001 regulations for including liabilities in the amount realized, and those under Sec. 752 for determining a partner's share of partnership liabilities. Under Regs. Sec. 1.1001-2(a)(4)(i), an amount realized from a property sale that secures a nonrecourse liability includes the nonrecourse liability. According to Regs. Sec. 1.1001-2(a)(4)(ii), an amount realized from a property sale that secures a recourse liability would include the recourse liability only if the purchaser agrees to pay the liability. The Sec. 752 regulations in effect when the ruling was issued essentially mirrored the Sec. 1001 provisions. For recourse liabilities, the final Sec. 752 regulations published in 1991 employ the concept of "economic risk of loss," consistent with the previous Sec. 752 regulations and the Sec. 1001 rules. For nonrecourse debt, however, the final Sec. 752 regulations differ substantially from the previous Sec. 752 regulations and the Sec. 1001 rules.

A significant modification was the introduction of "partner nonrecourse debt," which differs from a nonrecourse liability. A "nonrecourse liability" is one for which no partner or related person bears the economic risk of loss. In essence, no partner is personally liable. By contrast, a partner nonrecourse liability is one for which a partner or related person does bear the economic risk of loss (e.g., when a partner personally guarantees a loan or lends money to a partnership). The partner allocates partner nonrecourse debt solely to himself and includes it in his partnership basis.

Under the final Sec. 752 regulations, debt that is nonrecourse for Sec. 1001 purposes may be considered recourse for Sec. 752 purposes. Therefore, if a partner guarantees an otherwise nonrecourse partnership loan, the debt would be recharacterized as a recourse liability under Sec. 752, and allocated solely to the guaranteeing partner for purposes of calculating his basis in the partnership interest.

Reconciling Final Sec. 752 Regs. and Rev. Rul. 84-53

The critical issue is how to reconcile the final Sec. 752 regulations with the analysis contained in Rev. Rul. 84-53.

Under Regs. Sec. 1.1001-2(a), an amount realized from a sale of a partnership interest includes liabilities discharged from the transferor as a result of the sale. The final Sec. 752 regulations effectively operate to recharacterize nonrecourse debt as recourse debt allocated to the partner who has the economic risk of loss. Therefore, if a partner guarantees partnership debt and subsequently sells a portion of his interest, but does not discharge any debt in connection with the sale (as a result of the guarantee), he should not include any liabilities in the amount he realizes, given that he is not relieved of any liability related to the sale. As a result of the guarantee, it is possible the partner may have to satisfy the liability at a later date; therefore, he should not include the liability in the amount realized on the sale of his partnership interest. In the event the partnership subsequently satisfies the liability so that the partner is relieved of the potential obligation associated with the guarantee, the partner will be deemed to have received a cash distribution due to the reduction in his share of liabilities. This treatment is consistent with the true economics of the transaction. Absent further guidance from the IRS, final Sec. 752 regulations appear to apply in conjunction with Rev. Rul. 84-53 in determining the basis of a partial partnership interest sold.

Surprisingly, this issue seems to have drawn very little attention in the years since the Service finalized the regulations. (For additional reading on the topic, see Carman and O'Neil, "Accounting Issues: Basis of a Transferred Partnership Interest: A Will-O'-the Wisp Created by the New Debt Allocation Regulations," 9 J. Partnership Tax'n 253 (1992).)

Planning Opportunity: Liabilities in Excess of Basis

 Example 2: The facts are the same as in Example 1, except A's $96 in recourse liabilities is a nonrecourse liability that he guarantees both before and after the transfer to C. In this case, A's proceeds include the $6 received, plus the amount of the reduction in A's share of partnership liabilities (zero), resulting in total proceeds of $6. A's $90 basis is multiplied by the ratio of the amount of debt transferred to C (zero), divided by the total partnership debt allocated to A ($96). This calculation results in zero basis allocated to the interest sold. Therefore, it appears that A has $6 gain.

 

Conclusion

The interaction of the final Sec. 752 regulations and Rev. Rul. 84-53 may give rise to substantially different basis allocations on a sale of a partial partnership interest than occurred under the old Sec. 752 regulations and Rev. Rul. 84-53. Consequently, with proper planning, a partner may control the amount of gain or loss he recognizes on the sale of a partial partnership interest under the final Sec. 752 regulations. Careful planning is crucial, as the final Sec. 752 regulations contain pitfalls (e.g., the de minimis exception applies when a partner holds a 10%-or-less interest and the indebtedness constitutes qualified nonrecourse financing).

From Allison M. McSweeney, CPA, and Robert C. Pedersen, CPA, J.D., LL.M., New York, NY