[Federal Register Volume 61, Number 1 (Tuesday, January 2, 1996)]
[Proposed Rules]
[Pages 28-33]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-31457]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[PS-2-95]
RIN 1545-AT19
Distribution of Marketable Securities by a Partnership
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations relating to the
treatment of a distribution of marketable securities by a partnership
under section 731(c) of the Internal Revenue Code of 1986, as amended
(Code). These proposed regulations provide taxpayers with guidance
needed to comply with certain changes made by the Uruguay Round
Agreements Act of 1994 (Pub. L. No. 103-465). This document also
provides notice of a public hearing on these proposed regulations.
DATES: Written comments and requests to speak (with outlines of oral
comments) at a public hearing scheduled for 10 a.m. on Wednesday, April
3, 1996 must be received by Wednesday, March 13, 1996.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (PS-2-95), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be hand delivered between
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (PS-2-95), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC. The public hearing will be held in the IRS Auditorium.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Terri A.
Belanger or William M. Kostak, (202) 622-3080; concerning submissions
and the hearing, Christina Vasquez, (202) 622-7190 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Introduction
This document proposes to add Sec. 1.731-2 to the Income Tax
Regulations (26 CFR part 1) under section 731(c) of the Code. Section
731(c) was amended by section 741(a) of the Uruguay Round Agreements
Act of 1994 (Public Law 103-465).
Background
Section 731(a)(1) of the Code provides that a partner must
recognize gain on a distribution from a partnership to the extent that
any money distributed exceeds the adjusted basis of the partner's
interest in the partnership immediately before the distribution.
Section 737 provides that a partner must recognize gain on a
distribution of property other than money in an amount equal to the
lesser of (i) the partner's net precontribution gain or (ii) the excess
of the fair market value of the distributed property over the partner's
basis in the partnership interest.
Section 731(c) provides that the term money includes marketable
securities for purposes of section 731(a)(1) and section 737. As
discussed in the legislative history accompanying section 731(c),
treating marketable securities as money for this purpose is appropriate
because marketable securities are economically equivalent to money.
Section 731(c) affects only the tax consequences to the distributee
partner; section 731(c) does not require the partnership or any partner
other than the distributee partner to recognize gain on a distribution
of marketable securities.
Explanation of Provisions
Marketable Securities Treated as Money
Distributions of marketable securities are treated as distributions
of money under section 731(c) only for purposes of sections 731(a)(1)
and 737. For example, a distribution of marketable securities is not
treated as a distribution of money to the extent it is subject to
section 707 or section 751(b) because the distribution is not subject
to section 731(a)(1) or section 737. In addition, marketable securities
are not treated as money for purposes of section 731(a)(2), so that a
partner does not recognize a loss on a distribution of marketable
securities. Finally, marketable securities contributed by a partner are
treated as property other than money for purposes of determining the
partner's net precontribution gain under section 737(b).
Reduction of Amount Treated as Money
Under section 731(c)(3)(B), the amount of marketable securities
that is treated as money is reduced by the excess of (i) the partner's
share of the net gain of the partnership's securities of the same class
and issuer as the distributed securities immediately before the
distribution over (ii) the partner's share of such net gain immediately
after the distribution. This provision allows a partner to withdraw the
partner's share of appreciation in the partnership's marketable
securities without recognizing gain on the distribution. As a result,
section 731(c) generally applies only when a partner receives a
distribution of marketable securities in exchange for the partner's
share of appreciated assets other than marketable securities.
Under the authority of section 731(c)(3)(B), the proposed
regulations provide that all marketable securities held by a
partnership are treated as marketable securities of the same class and
issuer as the distributed securities. Treating all marketable
securities as a single asset for this purpose is consistent with the
basic rationale of section 731(c) that marketable securities are the
economic equivalent of money. As a result, the amount of the
distribution that is not treated as money will depend on the partner's
share of the net appreciation in all partnership securities, not on the
partner's share of the appreciation in the type of securities
distributed.
Definition of Marketable Securities
In general, the term marketable securities includes any financial
instruments--such as stocks, options, and derivatives--that are
actively traded within the meaning of section 1092(d)(1). In addition,
section 731(c)(2)(B)(v) provides that an interest in an entity is a
marketable security if substantially all of the assets of the entity
consist of marketable securities or money. The proposed regulations
provide that substantially all of the assets of an entity consist of
marketable securities or money only if 90 percent or more of the assets
of the entity at the time of the distribution consist of such assets.
Section 731(c)(2)(B)(vi) provides that, to the extent provided in
regulations, an interest in an entity not described in section
731(c)(2)(B)(v) is a marketable security to the extent that the value
of such interest is attributable to marketable securities or money. The
proposed regulations provide that an interest in an entity is a
marketable security to the extent that the value of the interest is
attributable to marketable securities or money that constitute less
than 90 percent but 20 percent or more of the assets of the entity. The
20 percent threshold means that an interest in an entity holding only a
small
[[Page 29]]
amount of marketable securities will not be treated as a marketable
security.
The proposed regulations also provide that a marketable security
will continue to be treated as a marketable security, even if the
partnership or its partners are restricted by agreement or otherwise
from selling or exchanging the security. This provision is intended to
prevent a partnership from avoiding section 731(c) by temporarily
restricting the transferability of the distributed security.
Exceptions
Consistent with the provisions of section 731(c)(3)(A), the
proposed regulations provide three exceptions to section 731(c). First,
the proposed regulations provide that if the marketable security was
contributed to the partnership by the distributee partner, section
731(c) does not apply to the distribution of that security.
Second, the proposed regulations provide that section 731(c) does
not apply to the distribution of a marketable security to the extent
that the security was acquired by the partnership in a nonrecognition
transaction in exchange for property other than marketable securities
or cash and (i) the security is actively traded as of the date of
distribution and (ii) the security is distributed by the partnership
within five years of either the date the security was acquired by the
partnership or, if later, the date the security became actively traded.
For example, if a partnership contributed substantially all of its
assets to a corporation in a transaction described in section 351 and
the stock of the corporation became marketable, the distribution of the
stock by the partnership within five years would not be subject to
section 731(c). This exception recognizes that the marketable security
in these situations is simply a substitute for the underlying assets
exchanged in the nonrecognition transaction.
The proposed regulations also provide that section 731(c) does not
apply to the distribution of a marketable security if (i) the security
was not actively traded on the date acquired by the partnership and the
entity to which the security relates had no outstanding actively traded
securities at the time the security was acquired by the partnership;
(ii) the security is actively traded as of the date of distribution;
and (iii) the security was held by the partnership for at least six
months before it became actively traded and the security was
distributed by the partnership within five years of the date on which
the security became actively traded.
In addition, the proposed regulations provide a successor security
rule that applies to these exceptions. This rule provides that the
exceptions continue to apply to a security acquired in a nonrecognition
transaction in exchange for a security that was already subject to an
exception.
Investment Partnerships
Section 731(c) does not apply to the distribution of marketable
securities by an investment partnership to an eligible partner. An
investment partnership is defined as a partnership that has never been
engaged in a trade or business and substantially all of the assets of
which consist of the investment assets described in section
731(c)(3)(C)(i). The proposed regulations provide that a partner can
qualify as an eligible partner even if the partner contributed services
to the partnership. In addition, the proposed regulations provide that
a partnership will not be treated as engaged in a trade or business if
the partnership provides reasonable and customary management services
to a lower-tier investment partnership. This exception allows an upper-
tier investment partnership to manage the investments and other
activities of a lower-tier investment partnership without disqualifying
the upper-tier partnership as an investment partnership. The exception
does not extend to management services provided to lower-tier
partnerships other than investment partnerships because, as discussed
below, the tiering rules of section 731(c)(3)(C)(iv) treat the upper-
tier management partnership as engaged in the trade or business of the
lower-tier partnership, thereby preventing the upper-tier partnership
from qualifying as an investment partnership.
The proposed regulations also provide that a partnership will not
be treated as engaged in a trade or business if the partnership
provides reasonable and customary services in assisting the formation,
capitalization, expansion, or offering of interests in an entity in
which the partnership holds a significant equity interest, provided
that the anticipated receipt of compensation for the services does not
represent a significant purpose for the partnership's investment in the
entity and is incidental to the investment in the entity.
Section 731(c)(3)(C)(iv) provides that, except as otherwise
provided in regulations, a partnership is treated as engaged in any
trade or business engaged in by (and as holding the assets of) any
partnership in which the partnership holds an interest. The proposed
regulations provide that this look-through rule does not apply if the
upper-tier partnership does not participate in the management of the
lower-tier partnership and the interest held by the upper-tier
partnership is less than 10 percent of the total profits and capital
interests in the lower-tier partnership.
Coordination With Other Sections
The proposed regulations provide rules for coordinating section
731(c) with section 704(c)(1)(B) and section 737. This coordination is
necessary because a distribution of marketable securities could occur
as part of a larger distribution in which property contributed by the
distributee partner is distributed to another partner (section
704(c)(1)(B)) or the distributee partner receives property in addition
to marketable securities (section 737).
Under the proposed regulations, the basis increase in the partner's
interest in the partnership as a result of any gain recognized by the
partner under section 704(c)(1)(B) is taken into account in determining
the distributee partner's gain under section 731(c) and the partner's
basis in the distributed securities. Taking the stepped-up basis into
account for purposes of section 731 reflects the fact that the general
effect of section 704(c)(1)(B) is to treat the contributing partner as
having contributed property with a full fair market value basis at the
time of contribution. The proposed regulations, however, provide that
the basis increase in the partner's interest as a result of any gain
recognized by the partner under section 737 is not taken into account
for these purposes. The proposed regulations are consistent with
section 737, which generally treats a distribution of money as
occurring before, and independent of, a distribution of other property.
Anti-Abuse Rule
The proposed regulations provide that the provisions of section
731(c) and this section must be applied in a manner that is consistent
with the purpose of section 731(c) and the substance of the
transaction.
Proposed Effective Date
This section is proposed to apply to distributions of marketable
securities by a partnership to a partner on or after December 29, 1995.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory
[[Page 30]]
assessment is not required. It also has been determined that section
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the
Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these
regulations, and, therefore, a Regulatory Flexibility Analysis is not
required. Pursuant to section 7805(f) of the Internal Revenue Code,
this notice of proposed rulemaking will be submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are timely submitted to the IRS. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for Wednesday, April 3, 1996 at
10:00 a.m. in the Auditorium of the Internal Revenue Building, 1111
Constitution Avenue NW., Washington, DC. Because of access
restrictions, visitors will not be admitted beyond the Internal Revenue
Building lobby more than 15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing must
submit written comments by Wednesday, March 13, 1996 and submit an
outline of the topics to be discussed and the time to be devoted to
each topic (signed original and eight (8) copies) by Wednesday, March
13, 1996.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal authors of these regulations are Terri A. Belanger
and William M. Kostak, Office of Assistant Chief Counsel (Passthroughs
and Special Industries), IRS. However, other personnel from the IRS and
Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805.* * *
Section 1.731-2 also issued under 26 U.S.C. 731(c).* * *
Par. 2. Section 1.731-2 is added to read as follows:
Sec. 1.731-2 Partnership distributions of marketable securities.
(a) Marketable securities treated as money. Except as otherwise
provided in section 731(c) and this section, for purposes of section
731(a)(1) and 737, the term money includes marketable securities and
such securities are taken into account at their fair market value as of
the date of the distribution.
(b) Reduction of amount treated as money--(1) Aggregation of
securities. For purposes of section 731(c)(3)(B) and this paragraph
(b), all marketable securities held by a partnership are treated as
marketable securities of the same class and issuer as the distributed
security.
(2) Amount of reduction. The amount of the distribution of
marketable securities that is treated as a distribution of money under
section 731(c) and paragraph (a) of this section is reduced (but not
below zero) by the excess, if any, of--
(i) The distributee partner's distributive share of the net gain,
if any, which would be recognized if all the marketable securities held
by the partnership were sold (immediately before the transaction to
which the distribution relates) by the partnership for fair market
value; over
(ii) The distributee partner's distributive share of the net gain,
if any, which is attributable to the marketable securities held by the
partnership immediately after the transaction, determined by using the
same fair market value as used under paragraph (b)(2)(i) of this
section.
(3) Distributee partner's share of net gain. For purposes of
section 731(c)(3)(B) and paragraph (b)(2) of this section, a partner's
distributive share of net gain is determined--
(i) By taking into account any basis adjustments under section
743(b) with respect to that partner; and
(ii) Without taking into account any special allocations adopted
with a principal purpose of avoiding the effect of section 731(c) and
this section.
(c) Marketable securities--(1) Actively traded. For purposes of
section 731(c) and this section, a financial instrument is actively
traded (and thus is a marketable security) if it is of a type that is,
as of the date of distribution, actively traded within the meaning of
section 1092(d)(1). Thus, for example, if XYZ common stock is listed on
a national securities exchange, particular shares of XYZ common stock
that are distributed by a partnership are marketable securities even if
those particular shares cannot be resold by the distributee partner for
a designated period of time.
(2) Interests in an entity--(i) Substantially all. For purposes of
section 731(c)(2)(B)(v) and this section, substantially all of the
assets of an entity consist (directly or indirectly) of marketable
securities, money, or both only if 90 percent or more of the assets of
the entity (by value) at the time of the distribution of an interest in
the entity consist (directly or indirectly) of marketable securities,
money, or both.
(ii) Less than substantially all. For purposes of section
731(c)(2)(B)(vi) and this section, an interest in an entity is a
marketable security to the extent that the value of the interest is
attributable (directly or indirectly) to marketable securities, money,
or both, if less than 90 percent but 20 percent or more of the assets
of the entity (by value) at the time of the distribution of an interest
in the entity consist (directly or indirectly) of marketable
securities, money, or both.
(d) Exceptions--(1) Previously contributed property. Section 731(c)
and this section do not apply to the distribution of a marketable
security if the security was contributed to the partnership by the
distributee partner, except to the extent that the value of the
distributed security is attributable to marketable securities or money
contributed (directly or indirectly) by the partnership to the entity
to which the distributed security relates.
(2) Security acquired in nonrecognition transaction. Section 731(c)
and this section do not apply to the distribution of a marketable
security to the extent that--
(i) The security was acquired by the partnership in a
nonrecognition transaction in exchange for any property except money or
marketable securities (including a security that would have been
treated as a marketable security under paragraph (c)(2) of this section
if distributed at the time of the exchange);
(ii) The distributed security is actively traded as of the date of
distribution; and
(iii) The security is distributed within five years of either the
date on which the security was acquired by the partnership or, if
later, the date on
[[Page 31]]
which the security became actively traded.
(3) Security not marketable when acquired. Section 731(c) and this
section do not apply to the distribution of a marketable security if--
(i) The security was not actively traded as of the date acquired by
the partnership and the entity to which the security relates had no
outstanding actively traded securities on that date;
(ii) The security is actively traded as of the date of
distribution; and
(iii) The security was held by the partnership for at least six
months before the date the security became actively traded and the
security was distributed within five years of the date on which the
security became actively traded.
(4) Successor security. Section 731(c) and this section do not
apply to the distribution of a marketable security to the extent that
the security was acquired by the partnership in a nonrecognition
transaction in exchange for a security the distribution of which
immediately prior to the exchange would have been excepted under this
paragraph (d).
(e) Investment partnerships--(1) In general. Section 731(c) and
this section do not apply to the distribution of marketable securities
by an investment partnership (as defined in section 731(c)(3)(C)(i)) to
an eligible partner (as defined in section 731(c)(3)(C)(iii)).
(2) Eligible partner. For purposes of section 731(c)(3)(C)(iii) and
this section, a partner is not treated as a partner other than an
eligible partner solely because the partner contributed services to the
partnership.
(3) Trade or business activities. For purposes of section
731(c)(3)(C) and this section, a partnership is not treated as engaged
in a trade or business by reason of--
(i) Any activity undertaken as an investor, trader, or dealer in
any asset described in section 731(c)(3)(C)(i), including the receipt
of commitment fees, break-up fees, guarantee fees, director's fees, or
similar fees that are customary in and incidental to any activities of
the partnership as an investor, trader, or dealer in such assets;
(ii) Reasonable and customary management services (including the
receipt of reasonable and customary fees in exchange for such
management services) provided to an investment partnership (within the
meaning of section 731(c)(3)(C)(i)) in which the partnership holds a
partnership interest; or
(iii) Reasonable and customary services provided by the partnership
in assisting the formation, capitalization, expansion, or offering of
interests in a corporation (or other entity) in which the partnership
holds or acquires a significant equity interest (including the
provision of advice or consulting services, bridge loans, guarantees of
obligations, or service on a company's board of directors), provided
that the anticipated receipt of compensation for the services, if any,
does not represent a significant purpose for the partnership's
investment in the entity and is incidental to the investment in the
entity.
(4) Partnership tiers. For purposes of section 731(c)(3)(C)(iv) and
this section, a partnership (upper-tier partnership) is not treated as
engaged in a trade or business engaged in by, or as holding (instead of
a partnership interest) a proportionate share of the assets of, a
partnership (lower-tier partnership) in which the partnership holds a
partnership interest if--
(i) The upper-tier partnership does not participate in the
management of the lower-tier partnership; and
(ii) The interest held by the upper-tier partnership is less than
10 percent of the total profits and capital interests in the lower-tier
partnership.
(f) Basis rules--(1) Partner's basis--(i) Partner's basis in
distributed securities. The distributee partner's basis in distributed
marketable securities with respect to which gain is recognized by
reason of section 731(c) and this section is the basis of the security
determined under section 732, increased by the amount of such gain. Any
increase in the basis of the marketable securities attributable to gain
recognized by reason of section 731(c) and this section is allocated to
marketable securities in proportion to their respective amounts of
unrealized appreciation in the hands of the partner before such
increase.
(ii) Partner's basis in partnership interest. The basis of the
distributee partner's interest in the partnership is determined under
section 733 as if no gain were recognized by the partner on the
distribution by reason of section 731(c) and this section.
(2) Basis of partnership property. No adjustment is made to the
basis of partnership property under section 734 as a result of any gain
recognized by a partner, or any step-up in the basis in the distributed
marketable securities in the hands of the distributee partner, by
reason of section 731(c) and this section.
(g) Coordination with other sections--(1) Section 704(c)(1)(B). The
basis of the distributee partner's interest in the partnership for
purposes of determining the amount of gain, if any, recognized by
reason of section 731(c) (and for determining the basis of the
marketable securities in the hands of the distributee partner) includes
the increase, if any, in the partner's basis that occurs under section
704(c)(1)(B)(iii) as a result of a distribution to another partner of
property contributed by the distributee partner in a distribution that
is part of the same distribution as the marketable securities.
(2) Section 737--(i) Marketable securities as other property. A
distribution of marketable securities is treated as a distribution of
property other than money for purposes of section 737 to the extent
that the marketable securities are not treated as money under section
731(c). In addition, marketable securities contributed to the
partnership are treated as property other than money in determining the
contributing partner's net precontribution gain under section 737(b).
(ii) Basis increase under section 737. The basis of the distributee
partner's interest in the partnership for purposes of determining the
amount of gain, if any, recognized by reason of section 731(c) (and for
determining the basis of the marketable securities in the hands of the
distributee partner) does not include the increase, if any, in the
partner's basis that occurs under section 737(c)(1) as a result of a
distribution of property to the distributee partner in a distribution
that is part of the same distribution as the marketable securities.
(h) Anti-abuse rule. The provisions of section 731(c) and this
section must be applied in a manner consistent with the purpose of
section 731(c) and the substance of the transaction. Accordingly, if a
principal purpose of a transaction is to achieve a tax result that is
inconsistent with the purpose of section 731(c) and this section, the
Commissioner can recast the transaction for federal tax purposes as
appropriate to achieve tax results that are consistent with the purpose
of section 731(c) and this section. Whether a tax result is
inconsistent with the purpose of section 731(c) and this section must
be determined based on all the facts and circumstances. For example,
under the provisions of this paragraph (h)--
(1) A change in partnership allocations or distribution rights with
respect to marketable securities may be treated as a distribution of
the marketable securities subject to section 731(c) if the change in
allocations or distribution rights is, in substance, a distribution of
the securities;
(2) A distribution of substantially all of the assets of the
partnership other than marketable securities and money to some partners
may also be treated as a distribution of marketable securities to the
remaining partners if the
[[Page 32]]
distribution of the other property and the withdrawal of the other
partners is, in substance, equivalent to a distribution of the
securities to the remaining partners; and
(3) The distribution of multiple properties to one or more partners
at different times may also be treated as part of a single distribution
if the distributions are part of a single plan of distribution.
(i) [Reserved]
(j) Examples. The following examples illustrate the rules of this
section. Unless otherwise specified, all securities held by a
partnership are marketable securities within the meaning of section
731(c); the partnership holds no marketable securities other than the
securities described in the example; all distributions by the
partnership are subject to section 731(a) and are not subject to
sections 704(c)(1)(B), 751(b), or 737; and no securities are eligible
for an exception to section 731(c).
Example 1. Recognition of gain. (i) A and B form partnership AB
as equal partners. A contributes property with a fair market value
of $1,000 and an adjusted tax basis of $250. B contributes $1,000
cash. AB subsequently purchases Security X for $500 and immediately
distributes the security to A in a current distribution. The basis
in A's interest in the partnership at the time of distribution is
$250.
(ii) The distribution of Security X is treated as a distribution
of money in an amount equal to the fair market value of Security X
on the date of distribution ($500). (The amount of the distribution
that is treated as money is not reduced under section 731(c)(3)(B)
and paragraph (b) of this section because, if Security X had been
sold immediately before the distribution, there would have been no
gain recognized by AB and A's distributive share of the gain would
therefore have been zero.) As a result, A recognizes $250 of gain
under section 731(a)(1) on the distribution ($500 distribution of
money less $250 adjusted tax basis in A's partnership interest).
Example 2. Reduction in amount treated as money--in general. (i)
A and B form partnership AB as equal partners. AB subsequently
distributes Security X to A in a current distribution. Immediately
before the distribution, AB held securities with the following fair
market values, adjusted tax bases, and unrecognized gain or loss:
------------------------------------------------------------------------
Gain
Value Basis (loss)
------------------------------------------------------------------------
Security X.................................. 100 70 30
Security Y.................................. 100 80 20
Security Z.................................. 100 110 (10)
------------------------------------------------------------------------
(ii) If AB had sold the securities for fair market value
immediately before the distribution to A, the partnership would have
recognized $40 of net gain ($30 gain on Security X plus $20 gain on
Security Y minus $10 loss on Security Z). A's distributive share of
this gain would have been $20 (one-half of $40 net gain). If AB had
sold the remaining securities immediately after the distribution of
Security X to A, the partnership would have $10 of net gain ($20 of
gain on Security Y minus $10 loss on Security Z). A's distributive
share of this gain would have been $5 (one-half of $10 net gain). As
a result, the distribution resulted in a decrease of $15 in A's
distributive share of the net gain in AB's securities ($20 net gain
before distribution minus $5 net gain after distribution).
(iii) Under paragraph (b) of this section, the amount of the
distribution of Security X that is treated as a distribution of
money is reduced by $15. The distribution of Security X is therefore
treated as a distribution of $85 of money to A ($100 fair market
value of Security X minus $15 reduction).
Example 3. Reduction in amount treated as money--carried
interest. (i) A and B form partnership AB. A contributes $1,000 and
provides substantial services to the partnership in exchange for a
60 percent interest in partnership profits. B contributes $1,000 in
exchange for a 40 percent interest in partnership profits. AB
subsequently distributes Security X to A in a current distribution.
Immediately before the distribution, AB held securities with the
following fair market values, adjusted tax bases, and unrecognized
gain:
------------------------------------------------------------------------
Value Basis Gain
------------------------------------------------------------------------
Security X................................... 100 80 20
Security Y................................... 100 90 10
------------------------------------------------------------------------
(ii) If AB had sold the securities for fair market value
immediately before the distribution to A, the partnership would have
recognized $30 of net gain ($20 gain on Security X plus $10 gain on
Security Y). A's distributive share of this gain would have been $18
(60 percent of $30 net gain). If AB had sold the remaining
securities immediately after the distribution of Security X to A,
the partnership would have $10 of net gain ($10 gain on Security Y).
A's distributive share of this gain would have been $6 (60 percent
of $10 net gain). As a result, the distribution resulted in a
decrease of $12 in A's distributive share of the net gain in AB's
securities ($18 net gain before distribution minus $6 net gain after
distribution).
(iii) Under paragraph (b) of this section, the amount of the
distribution of Security X that is treated as a distribution of
money is reduced by $12. The distribution of Security X is therefore
treated as a distribution of $88 of money to A ($100 fair market
value of Security X minus $12 reduction).
Example 4. Reduction in amount treated as money--change in
partnership allocations. (i) A is admitted to partnership ABC as a
partner with a 1 percent interest in partnership profits. At the
time of A's admission, ABC held no securities. ABC subsequently
acquires Security X. A's interest in partnership profits is
subsequently increased to 2 percent for securities acquired after
the increase. A retains a 1 percent interest in all securities
acquired before the increase. ABC then acquires Securities Y and Z
and later distributes Security X to A in a current distribution.
Immediately before the distribution, the securities held by ABC had
the following fair market values, adjusted tax bases, and
unrecognized gain or loss:
------------------------------------------------------------------------
Value Basis Gain (loss)
------------------------------------------------------------------------
Security X.................................. 1,000 500 500
Security Y.................................. 1,000 800 200
Security Z.................................. 1,000 1,100 (100)
------------------------------------------------------------------------
(ii) If ABC had sold the securities for fair market value
immediately before the distribution to A, the partnership would have
recognized $600 of net gain ($500 gain on Security X plus $200 gain
on Security Y minus $100 loss on Security Z). A's distributive share
of this gain would have been $7 (1 percent of $500 gain on Security
X plus 2 percent of $200 gain on Security Y minus 2 percent of $100
loss on Security Z).
(iii) If ABC had sold the remaining securities immediately after
the distribution of Security X to A, the partnership would have $100
of net gain ($200 gain on Security Y minus $100 loss on Security Z).
A's distributive share of this gain would have been $2 (2 percent of
$200 gain on Security Y minus 2 percent of $100 loss on Security Z).
As a result, the distribution resulted in a decrease of $5 in A's
distributive share of the net gain in ABC's securities ($7 net gain
before distribution minus $2 net gain after distribution).
(iv) Under paragraph (b) of this section, the amount of the
distribution of Security X that is treated as a distribution of
money is reduced by $5. The distribution of Security X is therefore
treated as a distribution of $95 of money to A ($100 fair market
value of Security X minus $5 reduction).
Example 5. Basis consequences--distribution of marketable
security. (i) A and B form partnership AB as equal partners. A
contributes nondepreciable real property with a fair market value
and adjusted tax basis of $100.
(ii) AB subsequently distributes Security X with a fair market
value of $120 and an adjusted tax basis of $90 to A in a current
distribution. At the time of distribution, the basis in A's interest
in the partnership is $100. The amount of the distribution that is
treated as money is reduced under section 731(c)(3)(B) and paragraph
(b)(2) of this section by $15 (one- half of $30 net gain in Security
X). As a result, A recognizes $5 of gain under section 731(a) on the
distribution (excess of $105 distribution of money over $100
adjusted tax basis in A's partnership interest).
(iii) A's adjusted tax basis in Security X is $95 ($90 adjusted
basis of Security X determined under section 732(a)(1) plus $5 of
gain recognized by A by reason of section 731(c)). The basis in A's
interest in the partnership is $10 as determined under section 733
($100 pre-distribution basis minus $90 basis allocated to Security X
under section 732).
Example 6. Basis consequences--distribution of marketable
security and other property. (i) A and B form partnership AB as
equal partners. A contributes nondepreciable
[[Page 33]]
real property, with a fair market value of $100 and an adjusted tax
basis of $10.
(ii) AB subsequently distributes Security X with a fair market
value and adjusted tax basis of $40 to A in a current distribution
and, as part of the same distribution, AB distributes Property Z to
A with an adjusted tax basis and fair market value of $40. At the
time of distribution, the basis in A's interest in the partnership
is $10. A recognizes $30 of gain under section 731(a) on the
distribution (excess of $40 distribution of money over $10 adjusted
tax basis in A's partnership interest).
(iii) A's adjusted tax basis in Security X is $35 ($5 adjusted
basis determined under section 732(a)(2) plus $30 of gain recognized
by A by reason of section 731(c)). A's basis in Property Z is $5, as
determined under section 732(a)(2). The basis in A's interest in the
partnership is $0 as determined under section 733 ($10 pre-
distribution basis minus $10 basis allocated between Security X and
Property Z under section 732).
(iv) AB's adjusted tax basis in the remaining partnership assets
is unchanged unless the partnership has a section 754 election in
effect. If AB made such an election, the aggregate basis of AB's
assets would be increased by $70 (the difference between the $80
combined basis of Security X and Property Z in the hands of the
partnership before the distribution and the $10 combined basis of
the distributed property in the hands of A under section 732 after
the distribution). Under section 731(c)(5), no adjustment is made to
partnership property under section 734 as a result of any gain
recognized by A by reason of section 731(c) or as a result of any
step-up in basis in the distributed marketable securities in the
hands of A by reason of section 731(c).
Example 7. Coordination with section 737. (i) A and B form
partnership AB. A contributes Property A, nondepreciable real
property with a fair market value of $200 and an adjusted basis of
$100 in exchange for a 25 percent interest in partnership capital
and profits. AB owns marketable Security X.
(ii) Within five years of the contribution of Property A, AB
subsequently distributes Security X, with a fair market value of
$120 and an adjusted tax basis of $100, to A in a current
distribution that is subject to section 737. As part of the same
distribution, AB distributes Property Y to A with a fair market
value of $20 and an adjusted tax basis of $0. At the time of
distribution, there has been no change in the fair market value of
Property A or the adjusted tax basis in A's interest in the
partnership.
(iii) If AB had sold Security X for fair market value
immediately before the distribution to A, the partnership would have
recognized $20 of gain. A's distributive share of this gain would
have been $5 (25 percent of $20 gain). Because AB has no other
marketable securities, A's distributive share of gain in partnership
securities after the distribution would have been $0. As a result,
the distribution resulted in a decrease of $5 in A's share of the
net gain in AB's securities ($5 net gain before distribution minus
$0 net gain after distribution). Under paragraph (b)(2) of this
section, the amount of the distribution of Security X that is
treated as a distribution of money is reduced by $5. The
distribution of Security X is therefore treated as a distribution of
$115 of money to A ($120 fair market value of Security X minus $5
reduction). The portion of the distribution of the marketable
security that is not treated as a distribution of money ($5) is
treated as other property for purposes of section 737.
(iv) A recognizes total gain of $40 on the distribution. A
recognizes $15 of gain under section 731(a)(1) on the distribution
of the portion of Security X treated as money ($115 distribution of
money less $100 adjusted tax basis in A's partnership interest). A
recognizes $25 of gain under section 737 on the distribution of
Property Y and the portion of Security X that is not treated as
money. A's section 737 gain is equal to the lesser of (i) A's
precontribution gain ($100) or (ii) the excess of the fair market
value of property received ($20 fair market value of Property Y plus
$5 portion of Security X not treated as money) over the adjusted
basis in A's interest in the partnership immediately before the
distribution ($100) reduced (but not below zero) by the amount of
money received in the distribution ($115).
(v) A's adjusted tax basis in Security X is $115 ($100 basis of
Security X determined under section 732(a) plus $15 of gain
recognized by reason of section 731(c)). A's adjusted tax basis in
Property Y is $0 under section 732(a). The basis in A's interest in
the partnership is $25 ($100 basis before distribution minus $100
basis allocated to Security X under section 732(a) plus $25 gain
recognized under section 737).
(k) Effective date. This section applies to distributions of
marketable securities made on or after December 29, 1995.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 95-31457 Filed 12-29-95; 8:45 am]
BILLING CODE 4830-01-U