[Federal Register Volume 62, Number 90 (Friday, May 9, 1997)]
[Rules and Regulations]
[Pages 25498-25502]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-12061]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[TD 8717]
RIN 1545-AU14


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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final 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 within a 
12-month period. The final regulations affect all partnerships that 
terminate under section 708(b)(1)(B).

DATES: These regulations are effective May 9, 1997.
    For applicability dates, see Effective Dates under Supplementary 
Information.

FOR FURTHER INFORMATION CONTACT: Steven R. Schneider, (202) 622-3060 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On May 13, 1996, a notice of proposed rulemaking (PS-5-96) was 
published in the Federal Register (61 FR 21985) containing proposed 
amendments to the Income Tax Regulations (26 CFR part 1) under section 
708 of the Internal Revenue Code (Code). The notice of proposed 
rulemaking also contained proposed amendments to other sections of the 
Income Tax Regulations to reflect the amendments to the regulations 
under section 708. Written comments responding to this notice were 
received. A public hearing was held on September 5, 1996, pursuant to 
the notice published in the Federal Register on May 13, 1996. After 
consideration of all comments received, the proposed amendments are 
adopted as revised by this Treasury decision.

Explanation of Provisions

    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 existing regulations 
under Sec. 1.708-1(b)(1)(iv) provide 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 final regulations 
adopt the proposed regulations and change the mechanics of a 
termination under section 708(b)(1)(B) so that the following is deemed 
to occur on a termination: The partnership contributes all of its 
assets and liabilities to a new partnership in exchange for an interest 
in the new partnership; and, immediately thereafter, the partnership 
liquidates by distributing interests in the new partnership to the 
purchaser and the other remaining partners, followed by the 
continuation of the business by the new partnership or its dissolution 
and winding up. The final regulations also clarify certain aspects of 
the proposed regulations in response to comments received.
    One commentator requested clarification of the section 704(c) 
consequences of a termination. The proposed regulations provide for a 
section 704(b) capital account ``book up'' upon the deemed contribution 
of assets by the terminated partnership to

[[Page 25499]]

the new partnership and also upon the deemed distribution in 
liquidation of the terminated partnership. This would have resulted in 
a new layer of section 704(c) property. The final regulations amend the 
regulations under section 704(b) to provide that the deemed 
contribution of assets to a new partnership and the distribution of the 
new partnership interests to the partners of the terminated partnership 
are disregarded for purposes of maintaining capital accounts. As a 
result, the termination of a partnership does not change the capital 
accounts of the partners or the books of the partnership and the deemed 
contribution of assets to a new partnership does not create additional 
section 704(c) property. The final regulations also provide that the 
new partnership is not bound by the section 704(c) method used by the 
terminated partnership.
    A commentator requested clarification of whether a termination 
under the new section 708(b)(1)(B) construct will trigger recapture of 
investment tax credit under section 47.
    Although not specifically addressed in the regulations, a section 
708(b)(1)(B) termination no longer triggers recapture of the investment 
tax credit under the ``mere change in form'' exception in Sec. 1.47-
3(f) of the regulations.
    Commentators also requested guidance on whether a section 1491 
excise tax may be triggered upon a section 708(b)(1)(B) termination of 
a foreign partnership with U.S. partners. This issue is currently under 
study and the IRS and Treasury welcome comments from interested 
taxpayers and practitioners.
    One commentator requested clarification of whether the distribution 
of the interests in the new partnership will be subject to section 
731(c). The section 731(c) final regulations, December 26, 1996 (61 FR 
67936), provide that the deemed distribution of partnership interests 
under Sec. 1.708-1(b)(1)(iv) does not trigger the application of 
section 731(c).
    Several commentators suggested that partnerships should be allowed 
to apply the final regulations to terminations under section 
708(b)(1)(B) occurring on or after the date the proposed regulations 
were filed with the Federal Register. In response, the final 
regulations provide that the regulations may be applied to terminations 
occurring on or after May 9, 1996, provided that the partnership and 
its partners apply the regulations to the termination in a consistent 
manner.
    The final regulations also provide an example illustrating the 
mechanics of a termination under section 708(b)(1)(B). In addition, the 
final regulations provide that the new partnership retains the TIN of 
the terminated partnership. However, if the new partnership has already 
applied for a new TIN, the partnership should continue to use the new 
TIN.
    Finally, the regulations make several revenue rulings obsolete. The 
holdings of revenue rulings 87-50 and 87-51 (dealing with the effect of 
terminations under section 708(b)(1)(B) on lower-tier partnerships) and 
revenue rulings 86-73 and 88-42 (dealing with the effect of a Sec. 754 
election made by the terminating partnership) are now incorporated, 
without substantive change, into the regulations under Sec. 1.708-1. 
Additionally, the final regulations make revenue ruling 93-90 (dealing 
with minimum gain chargeback in a section 708(b)(1)(B) termination) 
obsolete because the Sec. 704(b) capital account ``book up'' that is 
the subject of the revenue ruling is eliminated.

Effective Date

    These regulations apply to terminations of partnerships under 
section 708(b)(1)(B) occurring on or after May 9, 1997; however, these 
regulations may be applied to terminations occurring on or after May 9, 
1996, provided that the partnership and its partners apply these 
regulations to the termination in a consistent manner.

Effect on Other Documents

    The following publications are obsolete as of May 9, 1997:

Rev. Rul. 86-73, 1986-1 C.B. 282
Rev. Rul. 87-50, 1987-1 C.B. 157
Rev. Rul. 87-51, 1987-1 C.B. 158
Rev. Rul. 88-42, 1988-1 C.B. 265
Rev. Rul. 93-90, 1993-2 C.B. 238

Special Analyses

    It has been determined that this Treasury decision 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) 
does not apply to these regulations, and because the regulation does 
not impose a collection of information on small entities, the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. 
Therefore, a Regulatory Flexibility Analysis is not required. Pursuant 
to section 7805(f) of the Internal Revenue Code, the notice of proposed 
rulemaking preceding these regulations was submitted to the Small 
Business Administration for comment on its impact on small business.

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

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 301 are 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 * * *

    Par. 2. Section 1.704-1 is amended as follows:
    1. Paragraph (b)(2)(iv)(d)(1) is amended by revising the second 
sentence.
    2. Paragraph (b)(2)(iv)(l) is amended by removing the last three 
sentences and adding four sentences in their place.
    3. Paragraph (b)(5) Example 13(v) is amended by removing all the 
text following the third sentence and adding four sentences in its 
place.
    The revisions and additions read as follows:


Sec. 1.704-1  Partner's distributive share.

* * * * *
    (b) * * *
    (2) * * *
    (iv) * * *
    (d) * * *
    (1) * * * See Example 13(i) of paragraph (b)(5) of this section. * 
* *
* * * * *
    (l) * * * If the transfer of an interest in a partnership causes a 
termination of the partnership under section 708(b)(1)(B), the capital 
account of the transferee partner and the capital accounts of the other 
partners of the terminated partnership carry over to the new 
partnership that is formed as a result of the termination of the 
partnership under Sec. 1.708-1(b)(1)(iv). Moreover, the deemed 
contribution of assets and liabilities by the terminated partnership to 
a new partnership and

[[Page 25500]]

the deemed liquidation of the terminated partnership that occur under 
Sec. 1.708-1(b)(1)(iv) are disregarded for purposes of this paragraph 
(b)(2)(iv). See Example 13 of paragraph (b)(5) of this section and the 
example in Sec. 1.708-1(b)(1)(iv). The previous three sentences apply 
to terminations of partnerships under section 708(b)(1)(B) occurring on 
or after May 9, 1997; however, the sentences may be applied to 
terminations occurring on or after May 9, 1996, provided that the 
partnership and its partners apply the sentences to the termination in 
a consistent manner.
* * * * *
    (5) * * *

    Example 13. * * *
    (v) * * * Immediately preceding the constructive liquidation, 
the capital accounts of Z and LK equal $11,000 each (LK having 
inherited Y's $11,000 capital account) and the book value of the G 
Corp. securities is $22,000 (original purchase price of securities). 
Under paragraph (b)(2)(iv)(l) of this section, the deemed 
contribution of assets and liabilities by the terminated partnership 
to the new partnership and the deemed liquidation of the terminated 
partnership that occur under Sec. 1.708-1(b)(1)(iv) in connection 
with the constructive liquidation of the terminated partnership are 
disregarded in the maintenance and computation of the partners' 
capital accounts. As a result, the capital accounts of Z and LK in 
the new partnership equal $11,000 each (their capital accounts in 
the terminated partnership immediately prior to the termination), 
and the book value of the G Corp. securities remains $22,000 (its 
book value immediately prior to the termination). This Example 13(v) 
applies to terminations of partnerships under section 708(b)(1)(B) 
occurring on or after May 9, 1997; however, this Example 13(v) may 
be applied to terminations occurring on or after May 9, 1996, 
provided that the partnership and its partners apply this Example 
13(v) to the termination in a consistent manner.
* * * * *
    Par. 3. Section 1.704-3 is amended as follows:
    1. Paragraph (a)(2) is amended by adding two sentences at the end 
of the paragraph.
    2. Paragraph (a)(3)(i) is amended by adding three sentences at the 
end of the paragraph.
    The additions read as follows:


Sec. 1.704-3  Contributed property.

    (a) * * *
    (2) * * * A new partnership formed as the result of the termination 
of a partnership under section 708(b)(1)(B) is not required to use the 
same method as the terminated partnership with respect to section 
704(c) property deemed contributed to the new partnership by the 
terminated partnership under Sec. 1.708-1(b)(1)(iv). The previous 
sentence applies to terminations of partnerships under section 
708(b)(1)(B) occurring on or after May 9, 1997; however, the sentence 
may be applied to terminations occurring on or after May 9, 1996, 
provided that the partnership and its partners apply the sentence to 
the termination in a consistent manner.
    (3) * * *
    (i) * * * Property deemed contributed to a new partnership as the 
result of the termination of a partnership under section 708(b)(1)(B) 
is treated as section 704(c) property in the hands of the new 
partnership only to the extent that the property was section 704(c) 
property in the hands of the terminated partnership immediately prior 
to the termination. See Sec. 1.708-1(b)(1)(iv) for an example of the 
application of this rule. The previous two sentences apply to 
terminations of partnerships under section 708(b)(1)(B) occurring on or 
after May 9, 1997; however, the sentences may be applied to 
terminations occurring on or after May 9, 1996, provided that the 
partnership and its partners apply the sentences to the termination in 
a consistent manner.
* * * * *
    Par. 4. 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 the new partnership under Sec. 1.708-1(b)(1)(iv). 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 May 9, 1997; however, this paragraph (a)(4)(ii) may be applied to 
terminations occurring on or after May 9, 1996, provided that the 
partnership and its partners apply this paragraph (a)(4)(ii) to the 
termination in a consistent manner.
* * * * *
    (c) * * *
    (3) Section 708(b)(1)(B) terminations. Section 704(c)(1)(B) and 
this section do not apply to the deemed distribution of interests in a 
new partnership caused by the 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 May 9, 
1997; however, this paragraph (c)(3) may be applied to terminations 
occurring on or after May 9, 1996, provided that the partnership and 
its partners apply this paragraph (c)(3) to the termination in a 
consistent manner.
* * * * *
    Par. 5. Section 1.708-1 is amended as follows:
    1. Paragraph (b)(1)(ii) is amended by adding three sentences after 
the third sentence.
    2. Paragraph (b)(1)(iv) is revised.
    3. Paragraph (b)(1)(v) is added.
    The additions and revisions read as follows:


1.708-1  Continuation of partnership.

* * * * *
    (b) * * *
    (1) * * *
    (ii) * * * Moreover, if the sale or exchange of an interest in a 
partnership (upper-tier partnership) that holds an interest in another 
partnership (lower-tier partnership) results in a termination of the 
upper-tier partnership, the upper-tier partnership is treated as 
exchanging its entire interest in the capital and profits of the lower-
tier partnership. If the sale or exchange of an interest in an upper-
tier partnership does not terminate the upper-tier partnership, the 
sale or exchange of an interest in the upper-tier partnership is not 
treated as a sale or exchange of a proportionate share of the upper-
tier partnership's interest in the capital and profits of the lower-
tier partnership. The previous two sentences apply to terminations of 
partnerships under section 708(b)(1)(B) occurring on or after May 9, 
1997; however, the sentences may be applied to terminations occurring 
on or after May 9, 1996, provided that the partnership and its partners 
apply the sentences to the termination in a consistent manner. * * *
* * * * *
    (iv) If a partnership is terminated by a sale or exchange of an 
interest, the following is deemed to occur: The partnership contributes 
all of its assets and liabilities to a new partnership in exchange for 
an interest in the new partnership; and, immediately

[[Page 25501]]

thereafter, the terminated partnership distributes interests in the new 
partnership to the purchasing partner and the other remaining partners 
in proportion to their respective interests in the terminated 
partnership in liquidation of the terminated partnership, either for 
the continuation of the business by the new partnership or for its 
dissolution and winding up. In the latter case, the new partnership 
terminates in accordance with (b)(1)(i) of this section. This paragraph 
(b)(1)(iv) applies to terminations of partnerships under section 
708(b)(1)(B) occurring on or after May 9, 1997; however, this paragraph 
(b)(1)(iv) may be applied to terminations occurring on or after May 9, 
1996, provided that the partnership and its partners apply this 
paragraph (b)(1)(iv) to the termination in a consistent manner. The 
provisions of this paragraph (b)(1)(iv) are illustrated by the 
following example:

    Example. (i) A and B each contribute $10,000 cash to form AB, a 
general partnership, as equal partners. AB purchases depreciable 
Property X for $20,000. Property X increases in value to $30,000, at 
which time A sells its entire 50 percent interest to C for $15,000 
in a transfer that terminates the partnership under section 
708(b)(1)(B). At the time of the sale, Property X had an adjusted 
tax basis of $16,000 and a book value of $16,000 (original $20,000 
tax basis and book value reduced by $4,000 of depreciation). In 
addition, A and B each had a capital account balance of $8,000 
(original $10,000 capital account reduced by $2,000 of depreciation 
allocations with respect to Property X).
    (ii) Following the deemed contribution of assets and liabilities 
by the terminated AB partnership to a new partnership (new AB) and 
the liquidation of the terminated AB partnership, the adjusted tax 
basis of Property X in the hands of new AB is $16,000. See Section 
723. The book value of Property X in the hands of new partnership AB 
is also $16,000 (the book value of Property X immediately before the 
termination) and B and C each have a capital account of $8,000 in 
new AB (the balance of their capital accounts in AB prior to the 
termination). See Sec. 1.704-1(b)(2)(iv)(l) (providing that the 
deemed contribution and liquidation with regard to the terminated 
partnership are disregarded in determining the capital accounts of 
the partners and the books of the new partnership). Additionally, 
under Sec. 301.6109-1(d)(2)(iii) of this chapter, new AB retains the 
taxpayer identification number of the terminated AB partnership.
    (iii) Property X was not section 704(c) property in the hands of 
terminated AB and is therefore not treated as section 704(c) 
property in the hands of new AB, even though Property X is deemed 
contributed to new AB at a time when the fair market value of 
Property X ($30,000) was different from its adjusted tax basis 
($16,000). See Sec. 1.704-3(a)(3)(i) (providing that property 
contributed to a new partnership under Sec. 1.708-1(b)(1)(iv) is 
treated as section 704(c) property only to the extent that the 
property was section 704(c) property in the hands of the terminated 
partnership immediately prior to the termination).

    (v) If a partnership is terminated by a sale or exchange of an 
interest in the partnership, a section 754 election (including a 
section 754 election made by the terminated partnership on its final 
return) that is in effect for the taxable year of the terminated 
partnership in which the sale occurs, applies with respect to the 
incoming partner. Therefore, the bases of partnership assets are 
adjusted pursuant to sections 743 and 755 prior to their deemed 
contribution to the new partnership. This paragraph (b)(1)(v) applies 
to terminations of partnerships under section 708(b)(1)(B) occurring on 
or after May 9, 1997; however, this paragraph (b)(1)(v) may be applied 
to terminations occurring on or after May 9, 1996, provided that the 
partnership and its partners apply this paragraph (b)(1)(v) to the 
termination in a consistent manner.
* * * * *
    Par. 6. Section 1.737-2 is amended as follows:
    1. Paragraph (a) is revised.
    2. In paragraph (d)(1), the first sentence is revised and one 
sentence is added after the first sentence.
    The additions and revisions 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 the deemed distribution of interests in a new 
partnership caused by the termination of a partnership under section 
708(b)(1)(B). A subsequent distribution of property by the new 
partnership to a partner of the new partnership that was formerly a 
partner of the terminated partnership is subject to section 737 to the 
same extent that a distribution from 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 May 9, 
1997; however, this paragraph (a) may be applied to terminations 
occurring on or after May 9, 1996, provided that the partnership and 
its partners apply this paragraph (a) to the termination in a 
consistent manner.
* * * * *
    (d) * * * (1) * * * Any portion of the distributed property that 
consists of property previously contributed by the distributee partner 
(previously contributed property) is not taken into account in 
determining the amount of the excess distribution or the partner's net 
precontribution gain. The previous sentence applies on or after May 9, 
1997. * * *
* * * * *
    Par. 7. In section 1.743-1, paragraph (d) is added to read 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 deemed contributed by the 
terminated partnership to the new partnership under Sec. 1.708-
1(b)(1)(iv), regardless of whether the new partnership makes a section 
754 election. This paragraph (d) applies to terminations of 
partnerships under section 708(b)(1)(B) occurring on or after May 9, 
1997; however, this paragraph (d) may be applied to terminations 
occurring on or after May 9, 1996, provided that the partnership and 
its partners apply this paragraph (d) to the termination in a 
consistent manner.
    Par. 8. 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 deemed 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. However, the deemed distribution of an interest in a 
new partnership by a partnership that terminates under section 
708(b)(1)(B) is treated as an exchange of the interest in the new 
partnership for purposes of section 743. This paragraph (e) applies to 
terminations of partnerships under section 708(b)(1)(B) occurring on or 
after May 9, 1997; however, this paragraph (e) may be applied to 
terminations occurring on or after May 9, 1996, provided that the 
partnership and its partners apply this paragraph (e) to the 
termination in a consistent manner.

PART 301--PROCEDURE AND ADMINISTRATION

    Par. 9. The authority citation for part 301 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


[[Page 25502]]


    Par. 10. Section 301.6109-1 is amended by adding paragraph 
(d)(2)(iii) as follows:


Sec. 301.6109-1  Identifying numbers.

* * * * *
    (d) * * *
    (2) * * *
    (iii) Special rule for Section 708(b)(1)(B) terminations. A new 
partnership that is formed as a result of the termination of a 
partnership under section 708(b)(1)(B) will retain the employer 
identification number of the terminated partnership. This paragraph 
(d)(2)(iii) applies to terminations of partnerships under section 
708(b)(1)(B) occurring on or after May 9, 1997; however, this paragraph 
(d)(2)(iii) may be applied to terminations occurring on or after May 9, 
1996, provided that the partnership and its partners apply this 
paragraph (d)(2)(iii) to the termination in a consistent manner.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.

    Approved: May 1, 1997.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 97-12061 Filed 5-8-97; 8:45 am]
BILLING CODE 4830-01-U