CONVERSION OF GENERAL PARTNERSHIP INTEREST INTO LIMITED PARTNERSHIP INTEREST.

Rev. Rul. 84-52

ISSUE

What are the federal income tax consequences of the conversion of a general partnership interest into a limited partnership interest in the same partnership?

FACTS

In 1975, X was formed as a general partnership under the Uniform Partnership Act of state M, X is engaged in the business of farming. The partners of X are A, B, C, and D. The partners have equal interest in the partnership.

The partners propose to amend the partnership agreement to convert the general partnership into a limited partnership under the Uniform Limited Partnership Act of State M, a statute that corresponds in all material respects to the Uniform Limited Partnership Act. Under the certificate of limited partnership, A and B will be limited partners, and both C and D will be general partners and limited partners. Each partner's total percent interest in the partnership's profits, losses, and capital will remain the same when the general partnership is converted into a limited partnership. The business of the general partnership will continue to be carried on after the conversion.

LAW AND ANALYSIS

Section 741 of the Internal Revenue Code provides that in the case of a sale or exchange of an interest in a partnership, gain or loss shall be recognized by the transferor partner.

Under section 1001 of the Code, if there is a sale or other disposition of property, the entire amount of the gain or loss realized thereunder will be recognized, unless another section of subtitle A provides for nonrecognition.

Under section 721 of the Code, no gain or loss is recognized by a partnership or any of its partners upon the contribution of property to the partnership in exchange for an interest therein.

Section 708 of the Code provides that a partnership is considered to be continuing if it is not terminated. A partnership is terminated if (1) no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership, or (2) within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.

Section 1.708-1(b)(1)(ii) of the Income Tax Regulations provides that a contribution of property to a partnership does not constitute a sale or exchange for purposes of section 708 of the Code.

Section 722 of the Code generally provides that the basis of an interest in a partnership acquired by a contribution of property equals the transferor partner's adjusted basis in the contributed property.

Section 1223(1) of the Code provides that the holding period of property received in exchange for other property includes the holding period of the property exchanged, if the property received has the same basis (in whole or in part) as the property exchanged.

Under section 731 of the Code, if a partnership distributes money to a partner, then that partner will generally recognize gain only to the extent that the amount of money distributed (or deemed distributed) exceeds the adjusted basis of the partner's interest in the partnership immediately before the distribution.

Under section 733 of the Code, if there is a distribution by a partnership to a partner and if there is no liquidation of that partner's interest, then the adjusted basis of that partner's interest in the partnership must be reduced (but not below zero) by the amount of money distributed to the partner.

Section 752(a) of the Code states, in part, that any increase in a partner's share of the partnership's liabilities is considered to be a contribution of money by the partner to the partnership.

Section 752(b) of the Code states in part, that any decrease in a partner's share of a partnership's liabilities is considered to be a distribution of money by the partnership to the partner.

Section 1.752-1(e) of the regulations provides rules for determining a partner's share of partnership liabilities with respect to both limited partnerships and general partnerships.

Under the facts of this revenue ruling, A, B, C, and D, will remain partners in X after X is converted to a limited partnership. Although the partners have exchanged their interests in the general partnership X for interests in the limited partnership X, under section 721 of the Code, gain or loss will not be recognized by any of the partners of X except as provided in section 731 of the Code.

HOLDINGS

(1) Except as provided below, pursuant to section 721 of the Code, no gain or loss will be recognized by A, B, C, or D under section 741 or section 1001 of the Code as a result of the conversion of a general partnership interest in X into a limited partnership in X.

(2) Because the business of X will continue after the conversion and because, under section 1.708-1(b)(1)(ii) of the regulations, a transaction governed by section 721 of the Code is not treated as a sale or exchange for purposes of section 708 of the Code, X will not be terminated under section 708 of the Code.

(3) If, as a result of the conversion, there is no change in the partners' shares of X's liabilities under section 1.752-1(e) of the regulations, there will be no change to the adjusted basis of any partner's interest in X, and C and D will each have a single adjusted basis with respect to each partner's interest in X (both as limited partner and general partner) equal to the adjusted basis of each partner's respective general partner interest in X prior to the conversion. See Rev. Rul. 84-53, this page, this Bulletin.

(4) If, as a result of the conversion, there is a change in the partners' shares of X's liabilities under section 1.752-1(e) of the regulations, and such change causes a deemed contribution of money to X by a partner under section 752(a) of the Code, then the adjusted basis of that partner's interest shall, under section 722 of the Code, be increased by the amount of such deemed contribution. If the change in the partners' shares of X's liabilities causes a deemed distribution of money by X to a partner under section 752(b) of the Code, then the basis of that partner's interest shall, under section 733 of the Code, be reduced (but not below zero) by the amount of such deemed distribution, and gain will be recognized by that partner under section 731 of the Code to the extent the deemed distribution exceeds the adjusted basis of that partner's interest in X.

(5) Pursuant to section 1223(1) of the Code, there will be no change to the holding period of any partner's total interest in X.

The holdings contained herein would apply with equal force if the conversion had been of a limited partnership to a general partnership.