Rev. Rul. 79-51

ISSUE

What are the federal income tax consequences to a partner of a sale of the partner's entire interest in a partnership using the completed contract method of accounting for its long-term contracts and having an uncompleted long-term contract?

FACTS

In 1976 a partner sold the partner's entire 30 percent interest in the capital and profits in a partnership. The sale did not terminate the partnership. After the sale the remaining partners and the new partners continued to operate the business. The partnership used the completed contract method of accounting for its long-term construction contracts and at the time of the sale of the partnership interests had an uncompleted long-term contract. In accordance with the completed contract method of accounting the partnership did not report any income or loss from the uncompleted long-term contract prior to the date the partner sold the interests in the partnership.

LAW AND ANALYSIS

Under section 741 of the Internal Revenue Code of 1954, gain or loss from the sale or exchange of a partnership interest is considered as gain or loss from the sale or exchange of a capital asset, except as otherwise provided in section 751 (relating to unrealized receivables and inventory items which have appreciated substantially in value).

Section 751(a) of the Code provides that the amount of any money, or the fair market value of any property, received by a transferor partner in exchange for all or any part of the partner's interest in the partnership attributable to unrealized receivables of the partnership, or inventory items of the partnership that have appreciated substantially in value, shall be considered as an amount realized from the sale or exchange of property other than a capital asset.

Under section 1.751-1(a)(1) of the Income Tax Regulations, to the extent that money or property received by a partner in exchange for all or a part of the partner's partnership interest is attributable to the partner's share of the value of partnership unrealized receivables or substantially appreciated inventory items, the money or fair market value of the property received shall be considered as an amount realized from the sale or exchange of property other than a capital asset. The remainder of the amount realized is considered to be realized from the sale or exchange of a capital asset under section 741 of the Code.

Section 751(c) of the Code provides that the term "unrealized receivables" includes, to the extent not previously includible in income under the method of accounting used by the partnership, any rights (contractual or otherwise) to payment for (1) goods delivered, or to be delivered, to the extent the proceeds therefrom would be treated as amounts received from the sale or exchange of property other than a capital asset; or (2) services rendered, or to be rendered.

Under section 1.751-1(a)(2) of the regulations, the income or loss realized by a partner upon the sale or exchange of the partner's interest in section 751 property is the difference between the portion of the total amount realized for the partnership interest allocated to the section 751 property and the portion of the selling partner's basis for the entire interest allocated to such property. The portion of the partner's adjusted basis for the partner's partnership interest to be allocated to section 751 property is an amount equal to the basis such property would have had under section 732 of the Code if the selling partner had received that partner's share of such properties in a current distribution made immediately before the sale. Any gain or loss recognized that it attributable to section 751 property will be ordinary gain or loss. The difference between the remainder, if any, of the partner's adjusted basis for the partnership interest and the balance, if any, of the amount realized is the selling partner's capital gain or loss on the sale of the partnership interest.

Rev. Rul. 73-301, 1973-2 C.B. 215, provides, in part, that progress payments received by a partnership on account of a long-term contract together with the right to additional payment for work performed are "unrealized receivables" within the meaning of section 751(c) of the Code. In addition, pursuant to section 751(c)(2), the right to payment for work to be performed is an "unrealized receivable" within the meaning of section 751(c). See Wolcott v. Commissioner, 39 T.C. 538 (1962).

HOLDING

Since the amounts earned or to be earned under the long-term construction contract in the instant case are unrealized receivables within the meaning of section 751(c) of the Code, any money and the fair market value of any property received from the incoming partner by the selling partner in exchange for that partner's interest in the partnership attributable to the value at the time of sale of such unrealized receivables are considered as amounts realized from the sale or exchange of property other than a capital asset. The amount of the selling partner's ordinary gain or loss is measured by the difference between the partner's adjusted basis under section 732 for the unrealized receivables relinquished and the amount considered to have been realized as described above. Any remaining gain or loss on the transaction is treated as a capital gain or loss under section 741.