In a recently issued Private Letter Ruling (PLR 201608001), the IRS determined that a taxpayer-partnership’s obligation to perform work and incur costs under a long-term construction contract constituted a partnership liability under section 752 of the Code.
The taxpayer was a construction company that provided fabrication, construction, commissioning, performance testing, and other services in connection with the construction of industrial facilities. The taxpayer entered into long-term contracts with the owner of the industrial facilities. Under the terms of the contracts, the owner of the facilities was required to make progress payments to the taxpayer in accordance with a payment milestone schedule. The owner also was required to make certain payments before the work was completed or the related costs were incurred. The taxpayer provided to the owner certain guarantees and standby letters of credit securing the taxpayer’s obligations under the contracts and covering the owner’s damages in the event of default by the taxpayer.
A partner’s basis in a partnership is increased by the amount of money that a partner contributes to the partnership. If a partner shares in the liabilities of the partnership, this is treated as if the partner contributed money to the partnership to satisfy the liabilities. Accordingly, a partner’s share of liabilities of a partnership increases such partner’s basis. To increase basis, the subject liability must be a liability as defined in section 752 of the Code. In a prior ruling, the IRS determined that a section 752 liability existed where a partnership was required to deliver securities in a short-sale transaction because (1) the partnership was required to return the borrowed securities; and (2) the partnership’s asset basis was increased by the cash received from the sale of the securities.
The IRS determined that the taxpayer’s obligation to proceed with performing work and incurring costs, and the corresponding obligations to cover the owner’s damages in the event of default by the taxpayer, constituted liabilities under Section 752 of the Code. Accordingly, the partners could distribute additional proceeds tax-free or take additional deductions, in both instances due to this basis increase.
Partnerships engaged in construction activities under long-term contracts should be aware of the IRS’s position in this ruling. Consequently, the partners may be entitled to additional tax deferral. Partnerships engaged in such activities should consult tax counsel to determine whether any additional tax deferral is possible given the facts and circumstances of such partnership’s activities.
Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.
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