Withdrawal from a partnership after Rev. Rul. 93-80.

Rev. Rul. 93-80 clarified the treatment of a loss incurred on a partnership interest's abandonment or worthlessness. Generally, the loss is treated as capital if it qualifies for sale or exchange treatment. Conversely, if sale or exchange treatment does not apply, the loss generally is ordinary.

Before Rev. Rul. 93-80, there were two revenue rulings that dealt with the character of gain or loss to a partner when no money or property was distributed on a partnership's liquidation: Rev. Rul. 70-355 concluded that the loss was ordinary, but Rev. Rul. 76-189 concluded that the loss was capital. Rev. Rul. 93-80 revoked Rev. Rul. 76-189 and clarified and superseded Rev. Rul. 70-355.

Rev. Rul. 93-80 considered the partnership rules as they relate to a partnership interest's abandonment or worthlessness. The starting point was Sec. 752(b), which provides that any decrease in a partner's share of partnership liabilities is treated as a distribution of money to the partner by the partnership. Under Sec. 731(a), any gain or loss recognized on a distribution is treated as gain or loss from the sale or exchange of the partnership interest's character of that gain or loss is prescribed by Sec. 741, which provides that, except to the extent that Sec. 751(b) applies, any gain or loss recognized on the sale or exchange of a partnership interest is treated as arising from the sale or exchange of a capital asset.

However, if a partner does not receive any deemed or actual distributions, the abandonment or worthlessness loss would be ordinary and fully deductible under Sec. 165.

Acts of abandonment

To substantiate that an asset was abandoned, a taxpayer must demonstrate that he intended to abandon the asset coupled with an affirmative act of abandonment. Rev. Rul. 93-80 stated that each partner in the ruling took all steps necessary to effect a proper abandonment, including written notification to their respective partnerships. However, because abandonment of an intangible asset (such as a partnership interest) is not a physical act, it may be difficult to substantiate that an abandonment occurred. Nevertheless, based on the case law available, it appears that notification of abandonment by a partner to a general partner might be sufficient to constitute an overt act of abandonment.

In O'Brien, 77 TC 113 (1981), the IRS accepted a letter sent to the general partner as sufficient evidence of abandonment. Further, in Echols, 950 F2d 209 (5th Cir. 1991), per curiam, motion for rehearing denied, 935 F2d 703 (5th Cir. 1991), rev'g and rem'g 93 TC 553 (1989), and Citron, 97 TC 200 (1991), a taxpayer's announcement that he would no longer contribute additional monies or be involved in future endeavors of the partnership was sufficient evidence of abandonment. (See Kramer and Kramer, "Withdrawal From a Partnership After Citron and Echols," TTA, June 1993, at 386.)

Tax planning opportunity

If a partner with potential "recapture" in his capital account abandons his partnership interest when sale or exchange treatment applies, he generally will recognize capital gain to the extent of that recapture. This transaction should qualify as a complete termination of his partnership interest and, therefore, trigger the full use of passive losses, as ordinary losses, if they had been suspended under Sec. 469.

In light of the current tax differential between the maximum 28% long-term capital gain tax rate and the maximum 39.6% ordinary income tax rate, the tax savings could be substantial. Moreover, there is a potentially greater benefit to be achieved if the taxpayer has a capital loss carry-over. The capital gain would be sheltered and an ordinary loss generated.