Rev Rul 93-80: Partnership Interest Gain and Loss
Understand Rev Rul 93-80's framework for characterizing gain or loss on a partnership interest by analyzing the distinct tax impact of liability relief.
An Internal Revenue Service (IRS) Revenue Ruling provides official interpretation of tax law to ensure it is applied uniformly. Revenue Ruling 93-80 addresses the tax consequences when a partner leaves a partnership, either by selling their interest or by abandonment. It establishes a framework for calculating the resulting gain or loss, particularly when the partnership has outstanding liabilities.
The Core Principle of the Ruling
Revenue Ruling 93-80 establishes that the disposition of a partnership interest is not treated as a single event when liabilities are involved. Instead, the transaction is bifurcated, or split, into two distinct parts for tax analysis. The ruling interprets how different sections of the Internal Revenue Code (IRC) interact in these situations.
The first part of the transaction relates to the change in the partner’s share of partnership liabilities. Under IRC Section 752, any decrease in a partner’s share of liabilities is considered a deemed distribution of money to that partner. The ruling clarifies that this relief from debt is treated as part of a sale or exchange, which has implications for the character of the resulting gain or loss.
The second part of the transaction involves the actual sale or abandonment of the partnership interest itself. The tax consequences of this part are determined by comparing any cash or property received with the partner’s remaining basis in the partnership. The character of this gain or loss is governed by IRC Section 741, which treats the sale of a partnership interest as the sale of a capital asset.
Determining Gain and Loss
The calculation of gain or loss begins with determining the partner’s adjusted basis in their partnership interest, often called “outside basis.” This basis starts with the partner’s contributions of cash or property, is increased by their share of partnership income and their share of partnership liabilities, and is decreased by distributions and their share of partnership losses.
When a partner disposes of their interest, the first step under the ruling’s framework is to address the liability relief. The amount of liabilities the partner is relieved from is treated as an amount realized from a sale or exchange. If the liability relief exceeds the partner’s entire basis, a gain is recognized. This gain is capital in nature due to the sale or exchange treatment mandated by the interaction of Sections 752 and 731.
If the partner receives actual cash or property in addition to being relieved of liabilities, that amount is also part of the total amount realized. The total amount realized is compared to the partner’s total outside basis to determine the overall gain or loss. An exception exists under Section 751, which can recharacterize a portion of the capital gain into ordinary income if the partnership holds certain assets like unrealized receivables or inventory, often referred to as “hot assets.”
If a partner abandons their interest, the tax outcome depends on the presence of partnership liabilities. If the abandoning partner is relieved of any partnership debt, the transaction is treated as a sale or exchange, resulting in a capital gain or loss. Only when a partner abandons their interest and is not relieved of any liabilities can the loss be characterized as an ordinary loss under IRC Section 165.
Illustrative Scenarios from the Ruling
Revenue Ruling 93-80 provides specific examples to demonstrate its principles. These scenarios are fundamental to understanding the practical application of the law. They show how different facts can lead to vastly different tax outcomes for a departing partner.
In the first situation, a partner sells their interest for $1,000 in cash. The partner has an adjusted basis of $20,000 in the interest, which includes a $12,000 share of partnership liabilities. The partner is relieved of this $12,000 liability as part of the sale. The total amount realized is $13,000 ($1,000 cash + $12,000 liability relief). When compared to the $20,000 basis, the partner has a total loss of $7,000. The ruling treats this as a capital loss.
The second scenario involves a partner abandoning their interest in a partnership that has become insolvent. The partner has an adjusted basis of $18,000, which includes a $10,000 share of partnership liabilities. Upon abandonment, the partner is relieved of their share of the liabilities. This $10,000 relief is treated as a deemed distribution of money under Section 752. Because there is a deemed distribution, the transaction is treated as a sale or exchange, resulting in a capital loss of $8,000 ($18,000 basis – $10,000 deemed distribution).
The final situation presents a partner abandoning an interest with an adjusted basis of $20,000. In this case, the partnership has no liabilities, and the partner receives no cash or property upon abandonment. Because there is no relief from liabilities, there is no deemed distribution and therefore no sale or exchange. The ruling concludes that the partner can recognize an ordinary loss of $20,000 under the rules of IRC Section 165, which governs losses from abandonment.