[Federal Register Volume 61, Number 93 (Monday, May 13, 1996)]
[Proposed Rules]
[Pages 21985-21988]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-11779]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[PS-5-96]
RIN 1545-AU14


Termination of a Partnership under Section 708(b)(1)(B)

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 
termination of a partnership upon the sale or exchange of 50 percent or 
more of the total interest in partnership capital and profits. The 
proposed regulations affect all partners and partnerships that 
terminate under section 708(b)(1)(B).

DATES: Written comments and requests to speak (with outlines of oral 
comments) at a public hearing scheduled for September 5, 1996, must be 
received by August 15, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (PS-5-96), 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-5-96), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., 
Washington, DC. The public hearing will be held in the IRS Auditorium, 
Seventh Floor, 7400 Corridor, Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Steven R. Schneider, (202) 622-3060; concerning submissions and the 
hearing, Christina Vasquez, (202) 622-7190; (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Introduction

    This document proposes to revise section 1.708-1(b)(1)(iv) of the 
Income

[[Page 21986]]

Tax Regulations (26 CFR Part 1) under section 708(b)(1)(B) of the 
Internal Revenue Code (Code). This document also proposes revisions to 
other sections of the Income Tax Regulations to reflect the proposed 
revision to Sec. 1.708- 1(b)(1)(iv).

Background

    Section 708(b)(1)(B) provides that, for purposes of section 708(a), 
a partnership shall be considered terminated if within a 12-month 
period there is a sale or exchange of 50 percent or more of the total 
interest in partnership capital and profits. The Code and the 
legislative history to section 708(b)(1)(B) do not specify the tax 
consequences of that termination or the steps by which such a 
termination occurs.
    However, Sec. 1.708-1(b)(1)(iv) of the Income Tax Regulations 
provides that, if a partnership is terminated by a sale or exchange of 
an interest, the following is deemed to occur: the partnership 
distributes its properties to the purchaser and the other remaining 
partners in proportion to their respective interests in the partnership 
properties; and, immediately thereafter, the purchaser and the other 
remaining partners contribute the properties to a new partnership, 
either for the continuation of the business or for its dissolution and 
winding up.
    The distribution of property that is deemed to occur upon a 
termination under section 708(b)(1)(B) is treated like an actual 
distribution for federal tax purposes. As a result, a continuing 
partner may recognize gain under section 731(a) if the amount of money 
deemed distributed to the partner (including any money deemed 
distributed upon a shift in liabilities under section 752) exceeds the 
partner's basis in the partnership interest. In addition, the 
distribution may affect the basis of the partnership's assets because 
the basis of the distributed property in the hands of the partners (and 
thus in the hands of the reconstituted partnership) is determined under 
section 732(b) by reference to the partners' bases in their partnership 
interests. Another possible consequence of the deemed distribution is a 
change in the holding periods of the partners' interests in the 
partnership.
    The deemed distribution of partnership property that occurs on a 
termination raises particular concerns with respect to the interaction 
of sections 708(b)(1)(B), 704(c), and 737. Section 704(c)(1)(A) 
requires that gain or loss with respect to property contributed to a 
partnership by a partner be shared among the partners so as to take 
into account any built-in gain or loss in the property at the time of 
the contribution. Section 704(c)(1)(B) provides that, if property 
contributed by a partner is distributed to another partner within five 
years, the contributing partner must recognize gain or loss in an 
amount equal to the gain or loss the partner would have been allocated 
under section 704(c)(1)(A) on a sale of the property by the 
partnership. Section 737 provides that, if property is distributed to a 
partner that had contributed other property to the partnership within 
five years, the distributee partner must recognize gain equal to the 
lesser of (i) the net precontribution gain on property contributed by 
the partner, or (ii) the excess of the value of the distributed 
property over the adjusted basis of the partner's interest in the 
partnership. Net precontribution gain is the net gain, if any, that 
would have been recognized by the distributee partner under section 
704(c)(1)(B) if all partnership property contributed by the distributee 
partner within five years of the distribution had been distributed to 
another partner.
    The legislative history of sections 704(c)(1)(B) and 737 indicates 
that Congress intended these sections to be coordinated with the rules 
governing partnership terminations under section 708(b)(1)(B). The 
legislative history states that such coordination will provide that (1) 
no gain is recognized under sections 704(c)(1)(B) and 737 as a result 
of a deemed distribution on termination; (2) the deemed distribution 
will not change the application of the sharing requirements of section 
704(c) to precontribution gain or loss with respect to property 
contributed to the partnership before the termination; and (3) the 
constructive contribution of partnership property to a new partnership 
is treated as beginning a new five-year period for all contributed 
property to the extent that the pretermination appreciation in the 
value of property was not already required to be allocated to the 
original contributor (if any) of the property. H.R. Rep. No. 247, 101st 
Cong., 1st Sess. 1355 (1989); H.R. Conf. Rep. No. 1018, 102d Cong., 2d 
Sess. 428 (1992). These results are difficult to integrate with the 
current regulations under section 708(b)(1)(B). The difficulty arises 
primarily because the section 708(b)(1)(B) regulations provide for a 
pro rata distribution of property to the partners, while the 
legislative history seems to contemplate that partnership property 
previously contributed to the partnership by a partner will be 
distributed to that partner, at least to the extent of the remaining 
built-in gain or loss in the property.
    The IRS and Treasury Department recently issued final regulations 
under sections 704(c)(1)(B) and 737. Commentators, however, noted that 
the approach taken in the legislative history and the final regulations 
would not be required if the section 708(b)(1)(B) regulations did not 
create a deemed distribution of partnership property to the partners as 
part of a section 708(b)(1)(B) termination. The preamble to the final 
regulations indicated that the IRS and Treasury would consider issuing 
separate guidance on the interaction of sections 704(c) and 
708(b)(1)(B) and invited additional comments and suggestions regarding 
the project.

Explanation of Provisions

    The proposed regulations under section 708(b)(1)(B) provide that, 
if a partnership is terminated by a sale or exchange of an interest, 
the following is deemed to occur: the partnership transfers all of its 
assets and liabilities to a new partnership in exchange for an interest 
in the new partnership; immediately thereafter, the terminated 
partnership distributes interests in the new partnership to the 
purchasing partner and the other remaining partners in liquidation of 
the terminated partnership, either for the continuation of the business 
or for its dissolution and winding up.
    Under the proposed regulations, a termination under section 
708(b)(1)(B) will no longer result in a deemed distribution of the 
terminated partnership's assets to the purchasing and remaining 
partners. As a result, the federal tax consequences of a termination 
that result from the deemed distribution of assets will no longer occur 
on a section 708(b)(1)(B) termination. Such consequences include the 
possibility of gain under section 731(a), a change in the partnership's 
basis in partnership property, and the commencement of a new five-year 
period for purposes of sections 704(c)(1)(B) and 737. In addition, the 
interaction between section 704(c) and section 708(b)(1)(B) is greatly 
simplified under the proposed regulation. The section 704(c) property 
held by the terminated partnership (and deemed contributed to a new 
partnership) will continue to be treated as section 704(c) property in 
the hands of the new partnership under Sec. 1.704-3(a)(9). A 
distribution of property by the new partnership will have the same 
effect for purposes of section 704(c)(1)(B) and section 737 as a 
distribution from the terminated partnership. See Secs. 1.704-

[[Page 21987]]

4(c)(4) and 1.737-2(b)(1) as proposed to be amended by this document.
    The proposed regulations do not change the federal tax consequences 
of a termination under section 708(b)(1)(B) to the extent that the 
consequences were not dependent on the deemed distribution. Such 
consequences will continue under the proposed regulations. For example, 
the tax year of the terminated partnership will still close as a result 
of the termination, the elections of the terminated partnership will be 
invalidated, and a termination will continue to be treated as a 
liquidation under the section 704(b) regulations.
    In addition, the proposed regulations will not change the effect of 
a termination on the depreciation of partnership property by the new 
partnership. Property deemed contributed to the new partnership will 
continue to be subject to the anti- churning provisions of section 
168(f)(5), which generally require the new partnership to depreciate 
the property as if it were newly acquired property under the same 
depreciation system used by the terminated partnership. This result is 
required by statute and is not affected by the specific mechanics of a 
termination under section 708(b)(1)(B). See Code sections 168(f)(5); 
168(i)(7); 168(e)(4) and (f)(10) (repealed 1986).
    This document also contains proposed regulations under sections 
704(b), 704(c)(1)(B), 743(b), 737, and 761(e). These proposed 
regulations relate to the elimination of a deemed distribution of 
partnership assets as part of a section 708(b)(1)(B) termination. The 
proposed regulations under section 704(b) will eliminate the reference 
to a deemed contribution of partnership property by the partners of the 
continuing partnership. The proposed regulations under sections 
704(c)(1)(B) and 737 provide that a termination under section 
708(b)(1)(B) does not commence a new five-year period for partnership 
property and that a distribution of property by the new partnership 
will be treated in the same manner as a distribution by the terminated 
partnership would have been treated. Although the legislative history 
suggests the beginning of a new five year period for built in gain or 
loss in the property deemed contributed to the new partnership, that 
legislative history was commenting on a deemed contribution of property 
by the partners to the new partnership, as then required by the section 
708 regulations. Under the approach proposed in this regulation, a new 
five year period is no longer appropriate.
    The proposed regulations under section 743(b) provide that any 
special basis adjustment a partner has in assets of the terminated 
partnership as a result of a section 754 election will carry over to 
the new partnership. The proposed regulations under section 761(e) 
provide that the distribution of interests in the new partnership by 
the terminated partnership is not treated as a sale or exchange of the 
interests in the new partnership. This provision is necessary to 
prevent the distribution of interests in the new partnership from 
causing a termination of the new partnership.

Proposed Effective Date

    This section is proposed to apply to terminations of partnerships 
under section 708(b)(1)(B) occurring on or after the date on which 
these regulations are published as final regulations in the Federal 
Register.

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 assessment is not required. It has also 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 September 5, 1996, at 10 
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 August 15, 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 August 15, 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 author of these regulations is Steven R. Schneider of 
the 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 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805. * * *
    Section 1.704-4 also issued under 26 U.S.C. 704(c). * * *

    Par. 2. Section 1.704-1 is amended as follows:
    1. Paragraph (b)(2)(iv)(l) is amended by removing the fourth 
sentence.
    2. Paragraph (b)(5) Example 13(v) is amended by removing sentences 
five to the end and adding five new sentences in their place.
    The revisions and addition read as follows:


Sec. 1.704-1  Partner's distributive share.

* * * * *
    (b) * * *
    (5) * * *

    Example 13. * * *
    (v) * * * In accordance with paragraph (b)(2)(iv)(e) of this 
section, the partnership agreement provides that the partners' 
capital accounts are adjusted to reflect how unrealized taxable gain 
would have been allocated if the property distributed to the 
partners in liquidation of the partnership (i.e., the interest in 
the new partnership constructively received by the terminated 
partnership under Sec. 1.708-1(b)(1)(iv)) had been sold for its fair 
market value of $40,000. Accordingly, the $18,000 of unrealized gain 
($40,000 less $22,000 adjusted tax basis) is credited to the 
partners' capital accounts as follows:

[[Page 21988]]



                                                        Z          LK   
Capital account following sale....................    $11,000    $11,000
Deemed sale adjustment............................      9,000      9,000
                                                   ---------------------
Capital account before constructive liquidation...     20,000     20,000
                                                                        

Constructive liquidating distributions of the interests in the new 
partnership are made with reference to its $40,000 fair market 
value. Under section 732(b), the adjusted tax basis of the 50 
percent interest in the new partnership constructively distributed 
to Z is equal to the $11,000 adjusted tax basis of Z's partnership 
interest before the constructive liquidation, and the adjusted tax 
basis of the 50 percent interest in the new partnership 
constructively distributed to LK is equal to the $20,000 adjusted 
tax basis of LK's partnership interest before the constructive 
liquidation. Under paragraph (b)(2)(iv)(d) of this section, the 
capital account of the terminated partnership with respect to the 
new partnership would be $40,000 (i.e., the fair market value of the 
property constructively contributed to the new partnership by the 
terminated partnership). The capital accounts of Z and LK with 
respect to the constructively distributed interests in the new 
partnership are stated at $20,000 (i.e., one-half of the $40,000 
capital account of the terminated partnership). This Example 13(v) 
applies to terminations of partnerships under section 708(b)(1)(B) 
occurring on or after the date on which these regulations are 
published as final regulations in the Federal Register.
* * * * *

    Par. 3. Section 1.704-4 is amended by revising paragraphs 
(a)(4)(ii) and (c)(3) to read as follows:


Sec. 1.704-4   Distribution of contributed property.

    (a) * * *
    (4) * * *
    (ii) Section 708(b)(1)(B) terminations. A termination of the 
partnership under section 708(b)(1)(B) does not begin a new five-year 
period for each partner with respect to the built-in gain and built-in 
loss property that the terminated partnership is deemed to contribute 
to a new partnership following the termination. See Sec. 1.704-
3(a)(3)(ii) for the definitions of built-in gain and built-in loss on 
section 704(c) property. This paragraph (a)(4)(ii) applies to 
terminations of partnerships under section 708(b)(1)(B) occurring on or 
after the date on which these regulations are published as final 
regulations in the Federal Register.
* * * * *
    (c) * * *
    (3) Section 708(b)(1)(B) terminations. Section 704(c)(1)(B) and 
this section do not apply to a deemed distribution of interests in a 
new partnership caused by a termination of a partnership under section 
708(b)(1)(B). A subsequent distribution of section 704(c) property by 
the new partnership to a partner of the new partnership is subject to 
section 704(c)(1)(B) to the same extent that a distribution by the 
terminated partnership would have been subject to section 704(c)(1)(B). 
See also Sec. 1.737-2(a) for a similar rule in the context of section 
737. This paragraph (c)(3) applies to terminations of partnerships 
under section 708(b)(1)(B) occurring on or after the date on which 
these regulations are published as final regulations in the Federal 
Register.
* * * * *
    Par. 4. In Sec. 1.708-1, paragraph (b)(1)(iv) is amended by 
removing the first sentence and adding two new sentences in its place 
to read as follows:


Sec. 1.708-1   Continuation of Partnership.

* * * * *
    (b) * * *
    (1) * * *
    (iv) If a partnership is terminated by a sale or exchange of an 
interest, the following is deemed to occur: The partnership transfers 
all of its assets and liabilities to a new partnership in exchange for 
an interest in the new partnership; and, immediately thereafter, the 
terminated partnership distributes an interest in the new partnership 
to the purchasing partner and the other remaining partners in 
liquidation of the terminated partnership, either for the continuation 
of the business of the new partnership or for its dissolution and 
winding up. The first sentence of this paragraph (b)(1)(iv) applies to 
terminations of partnerships under section 708(b)(1)(B) occurring on or 
after the date on which these regulations are published as final 
regulations in the Federal Register. * * *
* * * * *
    Par. 5. Section 1.743-1 is amended by adding paragraph (d) as 
follows:


Sec. 1.743-1  Optional adjustment to basis of partnership property.

* * * * *
    (d) Section 708(b)(1)(B) terminations. A partner with a special 
basis adjustment in property held by a partnership that terminates 
under section 708(b)(1)(B) will continue to have the same special basis 
adjustment with respect to property contributed by the terminated 
partnership to the new partnership under Sec. 1.708-1(b)(1)(iv). This 
paragraph (d) applies to terminations of partnerships under section 
708(b)(1)(B) occurring on or after the date on which these regulations 
are published as final regulations in the Federal Register.
    Par. 6. In Sec. 1.737-2, paragraph (a) is revised to read as 
follows:


Sec. 1.737-2  Exceptions and special rules.

    (a) Section 708(b)(1)(B) terminations. Section 737 and this section 
do not apply to a deemed distribution of interests in a new partnership 
caused by a termination of a partnership under section 708(b)(1)(B). A 
subsequent distribution of section 704(c) property by the new 
partnership to a partner of the new partnership is subject to section 
737 to the same extent that a distribution by the terminated 
partnership would have been subject to section 737. See also 
Sec. 1.704-4(c)(3) for a similar rule in the context of section 
704(c)(1)(B). This paragraph (a) applies to terminations of 
partnerships under section 708(b)(1)(B) occurring on or after the date 
on which these regulations are published as final regulations in the 
Federal Register.
* * * * *
    Par 7. In Sec. 1.761-1, paragraph (e) is added to read as follows:


Sec. 1.761-1  Terms defined.

* * * * *
    (e) Distribution of partnership interest. For purposes of section 
708(b)(1)(B) and Sec. 1.708-1(b)(1)(iv), the distribution of an 
interest in a new partnership by a partnership that terminates under 
section 708(b)(1)(B) is not a sale or exchange of an interest in the 
new partnership. This paragraph (e) applies to terminations of 
partnerships under section 708(b)(1)(B) occurring on or after the date 
on which these regulations are published as final regulations in the 
Federal Register.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-11779 Filed 5-9-96; 8:45 am]
BILLING CODE 4830-01-U