Is the federal gain a nonresident partner recognizes under IRC sections 731 and 752, when a New York investment partnership pays down its liabilities, treated as New York source income?

Plain-English summary

A New York resident taxpayer invested in four partnerships that leased equipment to third parties. When the leases matured around 1979-1980, the partnerships' managers stopped leasing, sold the old equipment, bought U.S. Treasury obligations, and used margin debt (a loan against the value of those obligations) to pay off the partnerships' equipment loans. In 1982, the taxpayer moved out of New York and became a nonresident.

In 2003, the partnerships paid down a portion of that margin debt. Under IRC sections 731 and 752, a decrease in a partner's share of partnership liabilities is treated as a deemed distribution of money to the partner. Because the taxpayer's basis in the partnership interests had already been reduced (in part by years of prior losses), the deemed distribution exceeded the taxpayer's remaining adjusted basis, triggering recognition of gain for federal income tax purposes. Keith R. Bookbinder, CPA, asked the Department whether that federal gain counted as New York source income for the now-nonresident taxpayer.

The Department explained that gain recognized under IRC § 731(a)(1) is treated, by the terms of that section, as gain from the sale or exchange of the partner's partnership interest. Citing its own prior guidance (TSB-M-92(2)I), the Department reasoned that gain from selling an interest in a New York partnership generally is not derived from or connected with New York sources and is not includible in a nonresident's New York source income, except in situations not present here. Applying that rule, the Department concluded the gain from the partnerships' 2003 margin-debt paydown was not New York source income and should not be included in the numerator of the nonresident partner's New York source income fraction under Tax Law § 601(e).

What this means for you

Nonresident partners in New York partnerships

If you are a nonresident partner in a New York partnership and the partnership pays down its liabilities, IRC sections 731 and 752 may force you to recognize federal gain even though you received no cash. This ruling confirms that such gain - because it is treated as gain from the sale or exchange of your partnership interest - is generally not New York source income and does not get pulled into your New York source income fraction under Tax Law § 631 and § 632.

Accountants and tax professionals

When a client's basis has been drawn down by years of partnership losses and the partnership later reduces its debt (including margin debt secured by investments the partnership holds), check whether the resulting IRC § 731/§ 752 gain is properly excluded from the nonresident partner's New York return. The key authority is the partnership-interest-sale rule described in TSB-M-92(2)I, not the ordinary sourcing rules for a nonresident partner's distributive share of partnership operating income under Tax Law § 632 and 20 NYCRR 137.1.

Common questions

Q: Why did the taxpayer recognize gain at all if no cash changed hands?
A: Under IRC § 752(b), a decrease in a partner's share of partnership liabilities is treated as if the partnership distributed money to the partner. Under IRC § 733, that deemed distribution reduces the partner's basis, and once basis is exhausted, IRC § 731(a)(1) requires recognition of gain on the excess.

Q: Does that gain get taxed as New York source income to a nonresident?
A: No. IRC § 731(a) treats the gain as gain from the sale or exchange of the partnership interest, and gain from selling an interest in a New York partnership is generally not New York source income for a nonresident (per TSB-M-92(2)I), so it is not included in the New York source income fraction under Tax Law § 601(e).

Q: Would the answer differ if the debt paydown involved regular partnership operating liabilities instead of margin debt on investments?
A: The ruling addresses margin debt used to finance Treasury obligations after the partnerships exited the leasing business, but the legal analysis turns on IRC §§ 731, 733, and 752 characterizing the gain as gain from sale of the partnership interest - the same characterization would apply regardless of what generated the underlying liability decrease.

Q: Are there exceptions where gain from selling a New York partnership interest would still be New York source income?
A: The opinion notes there are "certain situations not present here" where such gain could still be treated as New York source income, referencing TSB-M-92(2)I, but it does not identify what those situations are since they didn't apply to this taxpayer.

Citations and references

• Tax Law § 601(e) - imposes personal income tax on nonresidents' New York source income via the New York source fraction
• Tax Law § 631(a) and (b)(1) - defines a nonresident's New York source income, including income from a business, trade, profession, or occupation carried on in New York
• Tax Law § 632(a) - sourcing rules for a nonresident partner's distributive share of partnership income
• 20 NYCRR 137.1 - New York source income of a nonresident partner attributable to partnership real property, tangible property, or business activity in New York
• IRC § 705(a) - computation of a partner's adjusted basis in a partnership interest
• IRC § 731(a)(1) - gain recognized when a distribution of money exceeds the partner's adjusted basis; treated as gain from sale or exchange of the partnership interest
• IRC § 733 - reduction of a distributee partner's basis by money distributed
• IRC § 752(b) - decrease in a partner's share of partnership liabilities treated as a distribution of money
• TSB-M-92(2)I (August 21, 1992) - New York treatment of gains and losses from a nonresident's sale of an interest in a New York partnership

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2006.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a06_1i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-06(1)I
Income Tax
March 3, 2006

Office of Tax Policy Analysis
Technical Services Division
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I050209A

On February 9, 2005, a Petition for Advisory Opinion was received from Keith R.
Bookbinder, CPA, 300 Corporate Parkway, Suite 200N, Amherst, New York 14226.
The issue raised by Petitioner, Keith R. Bookbinder, CPA, is whether income recognized
for federal income tax purposes resulting from a decrease in a nonresident partner’s share of
liabilities of a New York investment partnership is New York source income for New York State
personal income tax purposes.
Petitioner submits the following facts as the basis for this Advisory Opinion.
A taxpayer, as a resident of New York State, invested in four partnerships that leased
equipment to third parties. The partnerships generated significant operating losses. The
taxpayer’s capital contribution and share of partnership recourse debt was generally sufficient to
provide the taxpayer with adequate basis in the partnership for federal income tax purposes to
deduct these partnership losses.
In 1979 and 1980, many of the equipment leases held by the partnerships reached
maturity and the partnerships’ managers decided to discontinue the leasing business. The
managers sold off the old equipment, purchased various U.S. Treasury obligations and used
margin debt (i.e., a loan against the value of the obligations) to pay off the partnership’s
outstanding equipment loans. These investments and their accompanying debt have generated
interest income and investment interest expense for the entities.
In 1982, the taxpayer moved out of New York State.
In 2003, the partnerships’ management decided to pay down a portion of the
partnerships’ liabilities. Pursuant to sections 731 and 752 of the Internal Revenue Code (IRC),
the taxpayer recognized a gain to the extent the amount of the pay down of the partnership
liabilities exceeded the adjusted basis of the taxpayer’s interest in the partnership.
Applicable law and regulations
Section 705(a) of the IRC provides, in part:
General Rule. The adjusted basis of a partner’s interest in a partnership shall,
except as provided in subdivision (b), be the basis of such interest determined under

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March 3, 2006

section 722 (relating to contributions to a partnership) or section 742 (relating to transfers
of partnership interests)
(1) increased by the sum of his distributive share for the taxable year and prior
taxable years of
(A) taxable income of the partnership as determined under section 703(a),
(B) income of the partnership exempt from tax under this title, and
(C) the excess of the deductions for depletion over the basis of the property
subject to depletion;
(2) decreased (but not below zero) by distributions by the partnership as provided
in section 733 and by the sum of his distributive share for the taxable year and prior
taxable years of
(A) losses of the partnership, and
(B) expenditures of the partnership not deductible in computing its taxable
income and not properly chargeable to capital account; and
(3) decreased (but not below zero) by the amount of the partner’s deduction for
depletion for any partnership oil and gas property to the extent such deduction does not
exceed the proportionate share of the adjusted basis of such property allocated to such
partner under section 613A(c)(7)(D).
Section 731(a) of the IRC provides:
Partners. In the case of a distribution by a partnership to a partner
(1) gain shall not be recognized to such partner, except to the extent that any
money distributed exceeds the adjusted basis of such partner’s interest in the partnership
immediately before the distribution, and
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Any gain or loss recognized under this subsection shall be considered as gain or loss from
the sale or exchange of the partnership interest of the distributee partner.
Section 733 of the IRC provides:
Basis of distributee partner’s interest

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In the case of a distribution by a partnership to a partner other than in liquidation
of a partner’s interest, the adjusted basis to such partner of his interest in the partnership
shall be reduced (but not below zero) by –
(1) the amount of any money distributed to such partner, and
(2) the amount of the basis to such partner of distributed property other than
money, as determined under section 732.
Section 752(b) of the IRC provides:
Decrease in partner’s liabilities. Any decrease in a partner’s share of the
liabilities of a partnership, or any decrease in a partner’s individual liabilities by reason of
the assumption by the partnership of such individual liabilities, shall be considered as a
distribution of money to the partner by the partnership.
Section 601(e) of the New York State Tax Law imposes a personal income tax on
nonresidents of New York State who have New York source income and provides, in part:
Nonresidents and part-year residents. (1) General. There is hereby imposed for
each taxable year on the taxable income which is derived from sources in this state of
every nonresident and part-year resident individual . . . a tax which shall be equal to the
tax base multiplied by the New York source fraction.
(2) Tax base. The tax base is the tax computed under subsections (a) through (d)
of this section, as the case may be, reduced by the credits permitted under subsections (b),
(c), (d) and (m) of section six hundred six, as if such nonresident or part-year resident
individual . . . were a resident subject to the provisions of part II of this article.
(3) New York source fraction. The New York source fraction is a fraction the
numerator of which is such individual's . . . New York source income determined in
accordance with part III of this article and the denominator of which is such individual's
New York adjusted gross income determined in accordance with part II of this article. . . .
Section 631 of the Tax Law provides, in part:
(a) General. The New York source income of a nonresident individual shall be the
sum of the following: (1) The net amount of items of income, gain, loss and deduction
entering into his federal adjusted gross income, as defined in the laws of the United States
for the taxable year, derived from or connected with New York sources, including: (A)
his distributive share of partnership income, gain, loss and deduction, determined under
section six hundred thirty-two, and
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(2) The portion of the modifications described in subsections (b) and (c) of
section six hundred twelve which relate to income derived from New York sources
(including any modifications attributable to him as a partner. . .).
(b) Income and deductions from New York sources.
(1) Items of income, gain, loss and deduction derived from or connected with
New York sources shall be those items attributable to:
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(B) a business, trade, profession or occupation carried on in this state; or
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(2) Income from intangible personal property, including annuities, dividends,
interest, and gains from the disposition of intangible personal property, shall constitute
income derived from New York sources only to the extent that such income is from
property employed in a business, trade, profession, or occupation carried on in this
state. . . .
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(d) Purchase and sale for own account. A nonresident, other than a dealer holding
property primarily for sale to customers in the ordinary course of his trade or business,
shall not be deemed to carry on a business, trade, profession or occupation in this state
solely by reason of the purchase and sale of property or the purchase, sale or writing of
stock option contracts, or both, for his own account.
Section 632 of the Tax Law pertains, in part, to nonresident partners and provides, in
part:
(a) Portion derived from New York sources.
(1) In determining New York source income of a nonresident partner of any
partnership, there shall be included only the portion derived from or connected with
New York sources of such partner's distributive share of items of partnership income,
gain, loss and deduction entering into his federal adjusted gross income, as such portion
shall be determined under regulations of the [Commissioner of Taxation and Finance]
consistent with the applicable rules of section six hundred thirty-one.
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(e) Application of rules for resident partners . . . to nonresident partners. . . .
(1) A nonresident partner's distributive share . . . of items shall be determined
under subsection (a) of section six hundred seventeen.
(2) The character of partnership . . . items for a nonresident partner . . . shall be
determined under subsection (b) of section six hundred seventeen. . . .
Section 137.1 of the New York State Personal Income Tax Regulations (Regulations)
provides:
Partnership income and deductions of nonresident partner derived from New York
State sources.
The New York source income of a nonresident partner includes the partner’s
distributive share of all items of partnership income, gain, loss and deduction entering
into such partner’s Federal adjusted gross income to the extent such items are derived
from or connected with New York State sources, i.e., attributable to the ownership by the
partnership of any interest in real or tangible personal property in New York State or to a
business, trade, profession or occupation carried on in New York State by the partnership
as determined under sections 132.3, 132.4(a), 132.6, 132.9, 132.12-132.16, 132.21 and
132.22 of this article and 137.2 of this Part.
Opinion
As a result of the decrease of the partner’s share of liabilities of the partnership, the
partner recognized income pursuant to sections 731 and 752 of the IRC. Section 752 of the IRC
provides that a decrease in a partner’s share of the partnership liabilities is treated as a
distribution of money to the partner by the partnership. These deemed distributions of money
cause a decrease in the partner’s basis of his interest in each of the partnerships. See section 733
of the IRC. When such basis is exhausted, such deemed distributions of money result in the
recognition of gain under section 731(a)(1) of the IRC. (See Internal Revenue Service Revenue
Ruling 94-4, 1994-1 CB 195.) Any gain recognized under section 731(a)(1) of the IRC is
considered a gain from the sale or exchange of the partnership interest of the distributee partner.
A gain (whether treated as capital or ordinary for federal income tax purposes) from the
sale of an interest in a New York partnership, except in certain situations not present here, does
not constitute gain or loss derived from or connected with New York sources and is not
includible as New York source income. (See Technical Services Bureau Memorandum entitled
New York Treatment of Gains and Losses from the Sale by a Nonresident or Part-Year Resident
of an Interest in a New York Partnership, August 21, 1992, TSB-M-92-(2)I.)
In this case, therefore, the recognition of a gain by the nonresident partner for federal
income tax purposes as a result of the pay down of the margin debt by the partnerships does not

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constitute income, gain, loss or deduction derived from or connected with New York sources for
New York State personal income tax purposes.
Accordingly, in determining the numerator of the New York source fraction of the
nonresident partner, New York source income does not include any income from the gain
recognized from the partnerships’ pay down of their margin debt.

DATED: March 3, 2006

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.