rr-99-6.pdf

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# Part I

# Section 708 .-- Continuation of Partnership

## 26 CFR 1.708-1: Continuation of partnership. (Also §§ 731, 732, 735, 741, 751, 1012; 1.741-1; 301.7701-2, 301.7701-3.)

Rev. Rul. 99-6

ISSUE

What are the federal income tax consequences if one person purchases all of
the ownership interests in a domestic limited liability company (LLC) that is classified
as a partnership under § 301.7701-3 of the Procedure and Administration Regulations,
causing the LLC's status as a partnership to terminate under § 708(b)(1)(A) of the
Internal Revenue Code?

### FACTS

In each of the following situations, an LLC is formed and operates in a state
which permits an LLC to have a single owner. Each LLC is classified as a partnership
under § 301.7701-3. Neither of the LLCs holds any unrealized receivables or
substantially appreciated inventory for purposes of § 751(b). For the sake of simplicity,
it is assumed that neither LLC is liable for any indebtedness, nor are the assets of the
LLCs subject to any indebtedness.

Situation 1. A and B are equal partners in AB, an LLC. A sells A's entire
interest in AB to B for $10,000. After the sale, the business is continued by the LLC,
which is owned solely by B.

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Situation 2. C and D are equal partners in CD, an LLC. C and D sell their entire
interests in CD to E, an unrelated person, in exchange for $10,000 each. After the
sale, the business is continued by the LLC, which is owned solely by E.

After the sale, in both situations, no entity classification election is made under §
301.7701-3(c) to treat the LLC as an association for federal tax purposes.
LAW

Section 708(b)(1)(A) and § 1.708-1(b)(1) of the Income Tax Regulations provide
that a partnership shall terminate when the operations of the partnership are
discontinued and 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.

Section 731(a)(1) provides that, in the case of a distribution by a partnership to a
partner, gain is not recognized to the partner except to the extent that any money
distributed exceeds the adjusted basis of the partner's interest in the partnership
immediately before the distribution.

Section 731(a)(2) provides that, in the case of a distribution by a partnership in
liquidation of a partner's interest in a partnership where no property other than money,
unrealized receivables (as defined in § 751(c)), and inventory (as defined in
§ 751(d)(2)) is distributed to the partner, loss is recognized to the extent of the excess
of the adjusted basis of the partner's interest in the partnership over the sum of (A) any
money distributed, and (B) the basis to the distributee, as determined under § 732, of
any unrealized receivables and inventory.

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Section 732(b) provides that the basis of property (other than money) distributed
by a partnership to a partner in liquidation of the partner's interest shall be an amount
equal to the adjusted basis of the partner's interest in the partnership, reduced by any
money distributed in the same transaction.

Section 735(b) provides that, in determining the period for which a partner has
held property received in a distribution from a partnership (other than for purposes of §
735(a)(2)), there shall be included the holding period of the partnership, as determined
under § 1223, with respect to the property.

Section 741 provides that gain or loss resulting from the sale or exchange of an
interest in a partnership shall be recognized by the transferor partner, and that the gain
or loss shall be considered as gain or loss from a capital asset, except as provided in
§ 751 (relating to unrealized receivables and inventory items).

Section 1.741-1(b) provides that § 741 applies to the transferor partner in a two-
person partnership when one partner sells a partnership interest to the other partner,
and to all the members of a partnership when they sell their interests to one or more
persons outside the partnership.

Section 301.7701-2(c)(1) provides that, for federal tax purposes, the term
"partnership" means a business entity (as the term is defined in § 301.7701-2(a)) that is
not a corporation and that has at least two members.

In Edwin E. McCauslen v. Commissioner, 45 T.C. 588 (1966), one partner in an
equal, two-person partnership died, and his partnership interest was purchased from
his estate by the remaining partner. The purchase caused a termination of the

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partnership under § 708(b)(1)(A). The Tax Court held that the surviving partner did not
purchase the deceased partner's interest in the partnership, but that the surviving
partner purchased the partnership assets attributable to the interest. As a result, the
surviving partner was not permitted to succeed to the partnership's holding period with
respect to these assets.

Rev. Rul. 67-65, 1967-1 C.B. 168, also considered the purchase of a deceased
partner's interest by the other partner in a two-person partnership. The Service ruled
that, for the purpose of determining the purchaser's holding period in the assets
attributable to the deceased partner's interest, the purchaser should treat the
transaction as a purchase of the assets attributable to the interest. Accordingly, the
purchaser was not permitted to succeed to the partnership's holding period with respect
to these assets. See also Rev. Rul. 55-68, 1955-1 C.B. 372.

ANALYSIS AND HOLDINGS

Situation 1. The AB partnership terminates under § 708(b)(1)(A) when B
purchases A's entire interest in AB. Accordingly, A must treat the transaction as the
sale of a partnership interest. Reg. § 1.741-1(b). A must report gain or loss, if any,
resulting from the sale of A's partnership interest in accordance with § 741.

Under the analysis of McCauslen and Rev. Rul. 67-65, for purposes of
determining the tax treatment of B, the AB partnership is deemed to make a liquidating
distribution of all of its assets to A and B, and following this distribution, B is treated as
acquiring the assets deemed to have been distributed to A in liquidation of A's
partnership interest.

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B's basis in the assets attributable to A's one-half interest in the partnership is
$10,000, the purchase price for A's partnership interest. Section 1012. Section 735(b)
does not apply with respect to the assets B is deemed to have purchased from A.
Therefore, B's holding period for these assets begins on the day immediately following
the date of the sale. See Rev. Rul. 66-7, 1966-1 C.B. 188, which provides that the
holding period of an asset is computed by excluding the date on which the asset is
acquired.

Upon the termination of AB, B is considered to receive a distribution of those
assets attributable to B's former interest in AB. B must recognize gain or loss, if any,
on the deemed distribution of the assets to the extent required by § 731(a). B's basis in
the assets received in the deemed liquidation of B's partnership interest is determined
under § 732(b). Under § 735(b), B's holding period for the assets attributable to B's
one-half interest in AB includes the partnership's holding period for such assets (except
for purposes of § 735(a)(2)).

Situation 2. The CD partnership terminates under § 708(b)(1)(A) when E
purchases the entire interests of C and D in CD. C and D must report gain or loss, if
any, resulting from the sale of their partnership interests in accordance with § 741.

For purposes of classifying the acquisition by E, the CD partnership is deemed
to make a liquidating distribution of its assets to C and D. Immediately following this
distribution, E is deemed to acquire, by purchase, all of the former partnership's assets.
Compare Rev. Rul. 84-111, 1984-2 C.B. 88 (Situation 3), which determines the tax
consequences to a corporate transferee of all interests in a partnership in a manner

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consistent with McCauslen, and holds that the transferee's basis in the assets received
equals the basis of the partnership interests, allocated among the assets in accordance
with § 732(c).

E's basis in the assets is $20,000 under § 1012. E's holding period for the
assets begins on the day immediately following the date of sale.

# DRAFTING INFORMATION

The principal author of this revenue ruling is Matthew Lay of the Office of
Assistant Chief Counsel (Passthroughs and Special Industries). For further information
regarding this revenue ruling contact Mr. Lay at (202) 622-3050 (not a toll-free call).