[Federal Register Volume 65, Number 66 (Wednesday, April 5, 2000)]
[Proposed Rules]
[Pages 17829-17835]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-8276]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-107872-99]
RIN 1545-AXI8


Coordination of Sections 755 and 1060 Relating to Allocation of 
Basis Adjustments Among Partnership Assets

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 
allocation of basis adjustments among partnership assets under section 
755. The proposed regulations are necessary to implement section 
1060(d), which applies the residual method to certain partnership 
transactions. This document also provides notice of a public hearing on 
these proposed regulations.

DATES: Written comments must be received by July 5, 2000.
    Outlines of topics to be discussed at the public hearing scheduled 
for July 12, 2000, must be received by June 21, 2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-107872-99), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-
107872-99), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit 
comments electronically via the internet by selecting the ``Tax Regs'' 
option on the IRS Home Page, or by submitting comments directly to the 
IRS internet site at http://www.irs.ustreas.gov/tax__regs/reglist.html. 
The public hearing will be held in room 2716, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Matthew 
Lay or Craig Gerson, (202) 622-3050; concerning submissions, the 
hearing, and/or to be placed on the building access list to attend the 
hearing, LaNita VanDyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    As part of the Tax Reform Act of 1986, Congress enacted section 
1060, which generally requires the use of the residual method in order 
to allocate the purchase price of ``applicable asset acquisitions'' 
among individual assets purchased. An applicable asset acquisition is 
defined as any transfer of assets that constitute a trade or business 
where the transferee's basis is determined wholly by reference to the 
consideration paid for the assets. Both direct and indirect transfers 
of a business were intended to be covered by the provision, including 
``the sale of a partnership interest in which the basis of the 
purchasing partner's proportionate share of the partnership's assets is 
adjusted to reflect the purchase price.'' See section 1060(c) and S. 
Rep. No. 99-313, 1986-3 C.B. Vol. 3 at 254-255.
    In July of 1988, the IRS and the Treasury Department issued 
temporary and proposed regulations, which, among other things, provided 
guidance concerning the application of section 1060 and coordinated the 
application of sections 755 and 1060. TD 8215 (1988-2 C.B. 305).

[[Page 17830]]

    In 1988, shortly after the IRS and the Treasury Department issued 
its temporary and proposed regulations, Congress enacted section 
1060(d), which expressly addresses the extent to which section 1060 
should apply to transactions involving partnerships. As amended in 
1993, section 1060(d)(1) applies the section 1060 residual method in 
the case of a distribution of partnership property or a transfer of an 
interest in a partnership, but only in determining the value of section 
197 intangibles for purposes of applying section 755. Section 
1060(d)(2) provides that if section 755 applies, such distribution or 
transfer (as the case may be) shall be treated as an applicable asset 
acquisition for purposes of section 1060(b) (which imposes certain 
reporting requirements for applicable asset acquisitions).
    Section 755 governs the allocation of certain adjustments to the 
basis of partnership property among partnership assets. Section 1.755-
2T applies the residual method to transfers and distributions which 
trigger basis adjustments under section 743(b) (involving certain 
transfers of partnership interests) or section 732(d) (involving 
certain distributions within two years of a partnership interest 
transfer) if the assets of the partnership constitute a trade or 
business for purposes of section 1060(c). Section 1.755-2T(c) contains 
a cross reference to the reporting requirements applicable to such 
transfers and distributions.

Explanation of Provisions

1. Application of Proposed Regulations

    The temporary regulations under section 755 apply only if the 
assets of the partnership comprise a trade or business within the 
meaning of section 1060(c), and the basis adjustments are made under 
section 743(b) or section 732(d). They do not apply the residual method 
in valuing partnership property for the purpose of allocating basis 
adjustments under section 734(b). However, the temporary regulations 
were issued prior to the enactment of section 1060(d)(1), which 
expressly refers to basis adjustments triggered by partnership 
distributions, and does not reference a trade or business requirement.
    The IRS and the Treasury Department anticipate that the regulations 
under Sec. 1.755-2, when finalized, will apply to all transfers of 
partnership interests and partnership distributions to which section 
755 applies, and not just to transfers and distributions relating to 
partnerships conducting a trade or business. This approach is 
consistent with the language of section 1060(d) and is supported by 
language contained in the legislative history. See H.R. Rep. No. 100-
795, at 70 n.34 (1988) (the IRS is not precluded from applying the 
residual method under other provisions of the Code).
    Proposed Sec. 1.755-2(d) contains a cross reference to the 
reporting requirements applicable to such transfers and distributions.

2. Basis Adjustments Under Section 743(b) or 732(d)

    In the case of a basis adjustment under section 743(b) or section 
732(d), the proposed regulations determine the fair market value of 
partnership assets in two steps. In most situations, it first is 
necessary to determine partnership gross value. Second, partnership 
gross value must be allocated among partnership property.
    (a) Partnership gross value. In general, partnership gross value 
equals the amount that, if assigned to all partnership property, would 
result in a liquidating distribution to the partner equal to the 
transferee's basis in the transferred partnership interest immediately 
following the relevant transfer (reduced by the amount, if any, of such 
basis that is attributable to partnership liabilities). Here, the 
amount paid for the partnership interest provides the frame of 
reference for valuing the entire partnership.
    In the case of basis adjustments which are triggered by an exchange 
of a partnership interest in which the transferee's basis in the 
interest is determined in whole or in part by reference to the 
transferor's basis in the interest (transferred basis exchange), the 
transferee's basis does not necessarily have any connection to the 
value of partnership assets. Accordingly, a transferred basis exchange 
provides no frame of reference for valuing partnership assets. 
Furthermore, if the valuation rules which apply to other transfers were 
applied to transferred basis exchanges, then partners could use these 
exchanges to shift basis from capital gain assets to ordinary income 
assets, or vice versa. The proposed regulations do not provide a rule 
addressing transferred basis exchanges. Comments are requested as to 
how the residual method should apply if basis adjustments under section 
743(b) are triggered by transferred basis exchanges, or if basis 
adjustments under section 732(d) relate to prior transferred basis 
exchanges.
    (b) Allocating partnership gross value among partnership property. 
Once determined, partnership gross value is allocated among five 
classes of property, as follows: first among cash and general deposit 
accounts (including savings and checking accounts) other than 
certificates of deposit held in banks, savings and loan associations, 
and other depository institutions (referred to hereafter as cash); then 
among partnership assets other than cash, capital assets, section 
1231(b) property, and section 197 intangibles (referred to hereafter as 
ordinary income property); then among capital assets and section 
1231(b) property other than section 197 intangibles; then among section 
197 intangibles other than goodwill and going concern value; and 
finally to goodwill and going concern value (referred to hereafter as 
goodwill).
    In determining the values to be assigned to assets in the third, 
fourth, and fifth classes, properties or potential gain within these 
classes that are treated as unrealized receivables under the flush 
language in section 751(c) are not counted as assets in the second 
class. To provide otherwise would be inconsistent with the residual 
method, because the residual method is justified, at least in part, by 
the fact that goodwill is not readily subject to valuation. Where 
goodwill is subject to amortization under section 197, the portion of 
the intangible that is subject to recapture under section 1245 will be 
treated as an unrealized receivable under the flush language of section 
751(c). To assign value to this portion of the asset in the second 
class would require a determination that the goodwill has a value equal 
to at least the amount of the recapture. If these assets are not 
readily subject to valuation, this determination presumably could not 
be made. Accordingly, in allocating value among the five classes under 
the residual method, it is appropriate to include properties or 
potential gain treated as unrealized receivables under the flush 
language of section 751(c) within the overall class to which the 
underlying property belongs rather than treating the section 751(c) 
portion of such property as a separate asset included in the second 
class.
    Although properties or potential gain treated as unrealized 
receivables under the flush language of section 751(c) are not included 
in the second class of assets under these proposed regulations for 
purposes of allocating value, they are treated as separate assets that 
are ordinary income property for purposes of allocating basis 
adjustments among such assets under Sec. 1.755-1.
    With respect to allocating value within the asset classes, in 
general, if the value assigned to a class is less than the sum of the 
fair market values of the assets in that class (determined without

[[Page 17831]]

regard to the residual method), then the assigned value must be 
allocated among the individual assets in proportion to their fair 
market values. Although, as discussed above, it is not appropriate to 
treat properties or potential gain treated as unrealized receivables 
under the flush language of section 751(c) as separate ordinary income 
assets, it is appropriate to allocate value within each class by giving 
priority to the portions of the assets that will be taxed at higher 
rates as ordinary income. Such treatment better equates the basis 
adjustments of the transferee with the higher taxed income recognized 
by the transferor, thereby avoiding duplicative recognition of ordinary 
income on subsequent transfers with respect to the same asset. 
Accordingly, once values have been assigned generally to the third, 
fourth, and fifth classes of assets, such values will be assigned 
within each of these classes first to properties or potential gain 
treated as unrealized receivables under the flush language in section 
751(c), if any, in proportion to the income that would be recognized if 
the underlying assets were sold for their fair market values 
(determined without regard to the residual method), but only to the 
extent of the income attributable to the unrealized receivables. Any 
remaining value in each class will be allocated among the remaining 
portions of the assets in that class in proportion to the fair market 
values of such portions (determined without regard to the residual 
method).
    In general, the value assigned to an asset (other than goodwill) 
cannot exceed the fair market value (determined without regard to the 
residual method) of that asset on the date of the relevant transfer. 
Therefore, if partnership gross value exceeds the aggregate value of 
the partnership's individual assets, the excess must be allocated 
entirely to the value of goodwill. However, an exception is provided if 
partnership gross value exceeds the aggregate value of the 
partnership's individual assets, and goodwill could not under any 
circumstances attach to the assets. Under this exception, the excess 
partnership gross value must be allocated among all partnership assets 
other than cash in proportion to their fair market values (determined 
without regard to the residual method).
    (c) Special situations. In general, partnership gross value may be 
determined without reference to the value of individual partnership 
assets. In calculating partnership gross value, it is only necessary to 
determine the relevant partner's share of book value in partnership 
assets and how much book gain or loss must be recognized by the 
partnership on the disposition of all such assets to cause the partner 
to receive the appropriate liquidating distribution. The manner in 
which the book gain or loss is allocated among the partnership's assets 
generally will not affect the amount of the liquidating distribution to 
the partner.
    In certain circumstances, however, such as where book income or 
loss with respect to particular partnership properties is allocated 
differently among partners, partnership gross value may vary depending 
on the value of particular partnership assets. In these situations, it 
is not possible to first determine the total value of the partnership 
(i.e., partnership gross value) and then apply the residual method to 
allocate that value to the partnership's individual assets. Instead, it 
is necessary first to determine the fair market value of the 
partnership's individual assets (determined taking into account all 
relevant facts and circumstances), and then to assign such value among 
the asset tiers described in the residual method such that the combined 
value of all partnership assets would cause the appropriate 
distribution to the relevant partner. The proposed regulations include 
a rule to address these special situations. In addition, under this 
rule, if the value determined for assets in the first four asset 
classes is not sufficient to cause the appropriate liquidating 
distribution, then, so long as goodwill could attach to the assets of 
the partnership, the value of goodwill is presumed to be an amount 
that, if assigned to such property, would cause the appropriate 
liquidating distribution.

3. Basis Adjustments Under Section 734(b)

    The proposed regulations do not provide a rule for valuing 
partnership assets in the case of distributions that result in a basis 
adjustment under section 734(b). The IRS and the Treasury Department 
have considered several alternative approaches, described below. Two of 
these approaches utilize a method similar to the one provided for basis 
adjustments under sections 743(b) and 732(d); that is, first determine 
partnership gross value and then allocate such amount among the 
partnership property applying the residual method. The third approach 
does not rely on the concept of partnership gross value. The IRS and 
the Treasury Department request comments as to which, if any, of these 
approaches should be utilized in applying the residual method in the 
context of basis adjustments under section 734(b). In addition, 
comments are requested concerning whether the second or third approach 
should be adopted in the context of basis adjustments under sections 
743(b) and 732(d) involving transferred basis transactions.
    Under the first approach, in the case of a distribution which 
results in a basis adjustment under section 734(b) and which causes the 
distributee partner's interest in the partnership to decrease, 
partnership gross value would be deemed to equal the amount that, if 
assigned to all partnership property, would result in a liquidating 
distribution to the partner (attributable to the reduction in interest) 
equal to the value of the consideration received by the distributee 
partner in the distribution. Under this approach, the amount 
distributed in exchange for the relinquished interest would provide the 
frame of reference for valuing the entire partnership. The reduction in 
a partner's interest could be measured as the difference between the 
partner's interest in the partnership immediately before the 
distribution and the partner's interest in the partnership immediately 
after the distribution. However, the IRS and the Treasury Department 
recognize that measuring the reduction in a partner's interest in the 
partnership in connection with a distribution can be difficult in some 
situations (for example, situations in which partners do not share 
profits or other items in proportion to their relative capital account 
balances). Moreover, in the case of a distribution that results in a 
basis adjustment under section 734(b) and does not reduce the 
distributee partner's interest in the partnership (such as in a pro 
rata distribution of cash), the transaction provides no frame of 
reference to value the partnership.
    A second approach would be to determine partnership gross value as 
the value of the entire partnership as a going concern, and to apply 
the residual method by reference to that overall value. This method has 
the disadvantage of divorcing the valuation of partnership property 
from the transaction that gives rise to the adjustment. However, there 
would be no need to measure the reduction in the distributee partner's 
interest or even to have a reduction in the distributee partner's 
interest to apply this method. The method would work equally well for 
distributions where the partner's interest in the partnership is 
reduced and for distributions where it is not.
    Under a third possible approach, the concept of partnership gross 
value would be disregarded, and, instead, value would be allocated to 
goodwill for

[[Page 17832]]

section 755 purposes only if the amount of a positive basis adjustment 
under section 734(b) exceeds the appreciation in all assets of the 
character required to be adjusted which are not goodwill. This approach 
avoids the problems relating to the measurement or presence of a 
reduction in the distributee partner's interest and has the added 
benefit of avoiding a valuation of the partnership's overall 
operations. In contrast with the second approach, however, the value 
that is assigned to goodwill under this approach would not necessarily 
bear any relation to the actual value of goodwill in the hands of the 
partnership. In addition, this rule arguably would be inconsistent with 
the rule in Sec. 1.755-1(c), which requires that positive basis 
adjustments must be allocated to undistributed property of like 
character to the distributed property (or capital gain property in the 
case of adjustments attributable to gain recognized by the distributee 
partner) first in proportion to unrealized appreciation with respect to 
such property and then in proportion to fair market value. Under the 
third approach, a basis adjustment under section 734(b) to the class of 
assets composed of capital assets and property described in section 
1231(b) could not exceed the unrealized appreciation with respect to 
any such partnership property other than goodwill. Accordingly, a 
section 734(b) basis adjustment never would be made in proportion to 
the fair market value of the property in the class of capital assets 
and property described in section 1231(b).

4. Effect on Sec. 1.755-1

    Section 1.755-1(b)(3)(ii)(B) of the Income Tax Regulations 
published on December 15, 1999 (64 FR 69903) contains a rule allocating 
discounts among capital assets following the transfer of a partnership 
interest that results in a basis adjustment under section 743(b). 
Because proposed Sec. 1.755-2 takes discounts and premiums into account 
when assigning values to partnership property for purposes of section 
755 in such cases, the rule in Sec. 1.755-1(b)(3)(ii)(B) would become 
unnecessary.

5. Possible Expansion of Regulations

    With respect to transfers of partnership interests, the IRS and the 
Treasury Department are considering applying the rules contained in 
these proposed regulations not just for valuing partnership assets for 
purposes of applying section 755, but also to determine the value of 
assets for purposes of applying section 1(h)(6)(B) (collectibles gain 
or loss) with respect to partnerships, section 1(h)(7) (section 1250 
capital gain), and section 751(a) (ordinary income treatment upon sale 
or exchange of an interest in a partnership). Applying the rules in 
these proposed regulations in connection with these provisions is 
consistent with the legislative history to section 1060(d) and would 
provide greater uniformity with respect to the amount and character of 
income recognized upon the transfer of a partnership interest and the 
basis adjustments to partnership assets to which the different income 
character is attributable. However, this application of the rules could 
cause an increase in complexity, particularly if a section 754 election 
is not in effect for a year in which the transfer of a partnership 
interest occurs (so that application of the residual method otherwise 
would not be required). The IRS and the Treasury Department request 
comments on whether partnerships should value partnership assets using 
the residual method for purposes of sections 1(h)(6)(B), 1(h)(7), and 
751(a).

Proposed Effective Date

    The regulations are proposed to be effective for any basis 
adjustment resulting from any distribution of partnership property or 
transfer of a partnership interest that occurs on or after the date 
final regulations are published 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 Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
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 regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. 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 businesses.

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. The IRS and 
the Treasury Department request comments on the clarity of the proposed 
rule and how it may be made easier to understand. All comments will be 
available for public inspection and copying.
    A public hearing has been scheduled for July 12, 2000, beginning at 
10 a.m., in room 2716 of the Internal Revenue Building. Due to building 
security procedures, visitors must enter at the 10th Street entrance, 
located between Constitution and Pennsylvania Avenues, NW. In addition, 
all visitors must present photo identification to enter the building. 
Because of access restrictions, visitors will not be admitted beyond 
the immediate entrance area more than 15 minutes before the hearing 
starts. For information about having your name placed on the building 
access list to attend the hearing, see the FOR FURTHER INFORMATION 
CONTACT section of the preamble.
    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 and an outline of the topics to be discussed and the time to 
be devoted to each topic (signed original and eight (8) copies) by June 
21, 2000.
    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 proposed regulations is Matthew Lay 
of the Office of the Assistant Chief Counsel (Passthroughs and Special 
Industries). However, personnel from other offices of the IRS and the 
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 
a new entry in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.755-2 also issued under 26 U.S.C. 755 and 26 U.S.C. 
1060. * * *

    Par. 2. Section 1.755-2 is added to read as follows:

[[Page 17833]]

Sec. 1.755-2  Coordination of sections 755 and 1060.

    (a) Coordination with section 1060--(1) In general. If there is a 
basis adjustment to which this section applies, the partnership must 
determine the fair market value of each item of partnership property 
under the residual method, as described in paragraph (b) of this 
section, and the rules of Sec. 1.755-1 must be applied using the values 
so determined.
    (2) Application of this section. This section applies to any basis 
adjustment made under section 743(b) (relating to certain transfers of 
interests in a partnership) or section 732(d) or section 734(b) 
(relating to certain partnership distributions).
    (b) Residual method--(1) In general--(i) Five classes. (A) Except 
as provided in paragraph (b)(3) of this section, partnership gross 
value (as defined in paragraph (c) of this section) is allocated among 
five asset classes in the following order--
    (1) Among cash and general deposit accounts (including savings and 
checking accounts) other than certificates of deposit held in banks, 
savings and loan associations, and other depository institutions 
(referred to hereafter as cash);
    (2) Among partnership assets other than cash, capital assets, 
section 1231(b) property, and section 197 intangibles (referred to 
hereafter as ordinary income property);
    (3) Among capital assets and section 1231(b) property other than 
section 197 intangibles;
    (4) Among section 197 intangibles other than goodwill and going 
concern value; and
    (5) To goodwill and going concern value (referred to hereafter as 
goodwill).
    (B) In determining the values to be assigned to each class, 
properties or potential gain treated as unrealized receivables under 
the flush language in section 751(c) are not counted as assets in the 
second class. For example, any portion of goodwill that would result in 
ordinary income under section 1245 if the goodwill were sold would be 
included in the residual class for goodwill.
    (ii) Impaired classes. If the value assigned to a class is less 
than the sum of the fair market values (determined under paragraph 
(b)(2)(i) of this section) of the assets in that class, then the 
assigned value generally must be allocated among the individual assets 
in proportion to such fair market values. However, in the third, 
fourth, and fifth classes, values must be assigned first to properties 
or potential gain treated as unrealized receivables under the flush 
language in section 751(c), if any, in proportion to the income that 
would be recognized if the underlying assets were sold for their fair 
market values (determined under paragraph (b)(2)(i) of this section), 
but only to the extent of the income attributable to the unrealized 
receivables. Any remaining value in each class will be allocated among 
the remaining portions of the assets in that class in proportion to the 
fair market values of such portions (determined under paragraph 
(b)(2)(i) of this section).
    (2) Special rules. For purposes of this section:
    (i) Except as otherwise provided in this section, the fair market 
value of each item of partnership property (other than goodwill) shall 
be determined on the basis of all the facts and circumstances, taking 
into account section 7701(g).
    (ii) If goodwill could not under any circumstances attach to the 
assets of a partnership, then the value of goodwill is zero. This might 
occur, for example, if a partnership's only asset is a vacant parcel of 
real estate that does not produce current income.
    (iii) (A) The value assigned to an asset (other than goodwill) 
shall not exceed the fair market value (determined under paragraph 
(b)(2)(i)) of that asset on the date of the relevant transfer, unless--
    (1) Partnership gross value (as defined in paragraph (c) of this 
section) exceeds the aggregate value of the partnership's individual 
assets; and
    (2) Goodwill could not under any circumstances attach to the 
assets.
    (B) If both of these conditions are satisfied, the excess must be 
allocated among all partnership assets other than cash in proportion to 
such fair market values.
    (3) Special situations. In certain circumstances, such as where 
book income or loss with respect to particular partnership properties 
is allocated differently among partners, partnership gross value may 
vary depending on the value of particular partnership assets. In these 
special situations, the fair market value of each item of partnership 
property (other than goodwill) first shall be determined on the basis 
of all the facts and circumstances, taking into account section 
7701(g). Such value then shall be assigned within the first four asset 
classes under the residual method described in paragraph (b)(1) of this 
section in a manner that is consistent with the ordering rule used in 
paragraph (b)(1) of this section (together with the special rules in 
paragraph (b)(2) of this section) so that the amount of the liquidating 
distribution described in paragraph (c)(1) of this section would equal 
the transferee's basis in the transferred partnership interest. If the 
value so determined for the assets in the first four asset classes is 
not sufficient to cause the appropriate liquidating distribution, then, 
so long as goodwill may attach to the assets of the partnership, the 
fair market value of goodwill shall be presumed to equal an amount that 
if assigned to goodwill would cause the appropriate liquidating 
distribution.
    (c) Partnership gross value--(1) Basis adjustments under section 
743(b) and section 732(d)--(i) In general. In the case of a basis 
adjustment under section 743(b) or 732(d), partnership gross value 
generally is equal to the amount that, if assigned to all partnership 
property, would result in a liquidating distribution to the partner 
equal to the transferee's basis in the transferred partnership interest 
immediately following the relevant transfer (reduced by the amount, if 
any, of such basis that is attributable to partnership liabilities) 
pursuant to the hypothetical transaction (as defined in paragraph 
(c)(3) of this section). Solely for the purpose of determining 
partnership gross value under the preceding sentence, where a 
partnership interest is transferred as a result of the death of a 
partner, the transferee's basis in its partnership interest is 
determined without regard to section 1014(c), and is deemed to be 
adjusted for that portion of the interest, if any, which is 
attributable to items representing income in respect of a decedent 
under section 691.
    (ii) Transferred basis transactions. [Reserved]
    (2) Basis adjustments under section 734(b). [Reserved]
    (3) Hypothetical transaction. For purposes of this paragraph (c), 
the hypothetical transaction means the disposition by the partnership 
of all partnership property in a fully taxable transaction for cash, 
followed by the payment of all partnership liabilities (within the 
meaning of section 752 and the regulations thereunder), and the 
distribution of all remaining proceeds to the partners.
    (d) Required statements. See Sec. 1.743-1(k)(2) for provisions 
requiring the transferee of a partnership interest to provide 
information to the partnership relating to the transfer of an interest 
in the partnership. See Sec. 1.743-1(k)(1) for a provision requiring 
the partnership to attach a statement to the partnership return showing 
the computation of a basis adjustment under section 743(b) and the 
partnership properties to which the adjustment is allocated under 
section 755. See Sec. 1.732-1(d)(3) for a

[[Page 17834]]

provision requiring a transferee partner to attach a statement to its 
return showing the computation of a basis adjustment under section 
732(d) and the partnership properties to which the adjustment is 
allocated under section 755. See Sec. 1.732-1(d)(5) for a provision 
requiring the partnership to provide information to a transferee 
partner reporting a basis adjustment under section 732(d).
    (e) Examples. The provisions of this section are illustrated by the 
following examples, which assume that the partnerships have an election 
in effect under section 754 at the time of the transfer. Except as 
provided, no partnership asset (other than inventory) is property 
described in section 751(a). The examples are as follows:

    Example 1. (i) A is the sole general partner in ABC, a limited 
partnership. ABC has goodwill and three other assets with fair 
market values (determined under paragraph (b)(2)(i) of this section) 
as follows: inventory worth $1,000,000, a building (a capital asset) 
worth $2,000,000, and section 197 intangibles (other than goodwill) 
worth $800,000. ABC has one liability of $1,000,000, for which A 
bears the entire risk of loss under section 752 and the regulations 
thereunder. Each partner has a one-third interest in partnership 
capital and profits. D purchases A's partnership interest for 
$1,000,000.
    (ii) D's basis in the transferred partnership interest (reduced 
by the amount of such basis that is attributable to partnership 
liabilities) is $1,000,000 ($2,000,000-$1,000,000). Under paragraph 
(c) of this section, partnership gross value is $4,000,000 (the 
amount that, if assigned to all partnership property, would result 
in a liquidating distribution to D equal to $1,000,000).
    (iii) Under paragraph (b) of this section, partnership gross 
value is allocated first to the inventory ($1,000,000), then to the 
building ($2,000,000), and third to section 197 intangibles 
$800,000. The partnership must allocate the remainder of partnership 
gross value, $200,000, to goodwill ($4,000,000-$3,800,000). D's 
section 743(b) adjustment must be allocated under Sec. 1.755-1 using 
these fair market value calculations for the partnership's assets.
    Example 2. (i) D is the sole general partner in DEF, a limited 
partnership. DEF has goodwill and three other assets with fair 
market values (determined under paragraph (b)(2)(i) of this section) 
as follows: inventory worth $1,000,000, a building (a capital asset) 
worth $2,000,000, and equipment (section 1231(b) property) worth 
$750,000. DEF has one liability of $1,000,000, for which D bears the 
entire risk of loss under section 752 and the regulations 
thereunder. Each partner has a one-third interest in partnership 
capital and profits. If the equipment were sold for $750,000, 
$250,000 would be depreciation recapture treated as an unrealized 
receivable under the flush language in section 751(c). G purchases 
E's limited partnership interest for $750,000.
    (ii) Under paragraph (c) of this section, partnership gross 
value is $3,250,000 (the amount that, if assigned to all partnership 
property, would result in a liquidating distribution to G equal to 
$750,000).
    (iii) Under paragraph (b) of this section, partnership gross 
value is allocated first to inventory ($1,000,000), and then to the 
class containing capital assets and section 1231(b) property 
($2,250,000). Within that class, value must be assigned first to the 
$250,000 ordinary gain portion of the equipment (properties or 
potential gain treated as unrealized receivables under the flush 
language in section 751(c)). The remaining value in the class 
($2,250,000 minus $250,000, which is $2,000,000) must be allocated 
among the remaining portions of the assets in that class in 
proportion to the fair market values of such portions (determined 
under paragraph (b)(2)(i) of this section). The remaining portion of 
the building is $2,000,000. The remaining portion of the equipment 
is $500,000 ($750,000, its fair market value, minus $250,000, the 
section 751(c) portion). Thus, the remaining portion of the building 
will be allocated $1,600,000 ($2,000,000 multiplied by $2,000,000/
$2,500,000) and the remaining portion of the equipment will be 
allocated $400,000 ($2,000,000 multiplied by $500,000/$2,500,000). 
Nothing is allocated to goodwill. G's section 743(b) adjustment must 
be allocated under Sec. 1.755-1 using these fair market value 
calculations for the partnership's assets.
    Example 3. (i) G and H are partners in partnership GH. GH has 
goodwill and three other assets with fair market values (determined 
under paragraph (b)(2)(i) of this section) as follows: inventory 
worth $1,000,000 and two buildings (capital assets), each worth 
$500,000. GH has no liabilities. The GH partnership agreement 
provides that the partners will allocate all income, gain, loss, and 
deductions equally, except with respect to depreciation, loss, and 
gain from the buildings. With respect to the buildings, depreciation 
and loss are allocated two-thirds to G and one-third to H. Gain from 
the disposition of the buildings is charged back two-thirds to G and 
one-third to H to the extent of accrued depreciation, and then is 
allocated equally between G and H. G transfers one-half of its 
interest in GH to I for $450,000. At the time of the transfer, the 
book value of the inventory is $900,000, the book value of each 
building is $300,000, and $150,000 of book depreciation has accrued 
with respect to each building. The capital account attributable to 
the partnership interest purchased by I from G is equal to $350,000. 
H's capital account is equal to $800,000, and the capital account 
attributable to G's retained partnership interest is equal to 
$350,000.
    (ii) Because gain with respect to the inventory and buildings 
are shared in different ratios as between H, and G and I, a 
partnership gross value cannot be determined without assuming values 
for the individual assets of the partnership. Accordingly, the rule 
for special situations in paragraph (b)(3) of this section must be 
used to compute the value of the partnership's assets.
    (iii) Applying paragraph (b)(2)(i) of this section, the fair 
market value of the inventory is $1,000,000 and the fair market 
value of each building is $500,000. These values would result in a 
liquidating distribution to I under paragraph (c)(1) of this section 
equal to $500,000, determined as follows. The book gain from the 
sale of the inventory would equal $100,000 ($1,000,000-$900,000) and 
the book gain from the sale of each building would equal $200,000 
($500,000-$300,000). Book gain from the inventory equal to $25,000 
($100,000  x  \1/4\) and book gain from each building equal to 
$62,500 (($150,000  x  \1/3\) + ($50,000  x  \1/4\)) would be 
allocated to I. The sum of this book gain ($25,000 + $62,500 + 
$62,500 = $150,000) and I's capital account inherited from G 
($350,000) would equal $500,000.
    (iv) Because I's basis in the transferred partnership interest 
is only $450,000, under paragraph (b)(2)(ii) of this section, the 
value with respect to the buildings must be reduced in proportion to 
the fair market values of such assets to an amount that would cause 
a liquidating distribution to I equal to $450,000. This calculation 
is accomplished as follows. In order for I to receive a liquidating 
distribution of $450,000, the book gain attributable to the 
buildings that is allocated to I must equal $75,000 ($350,000 
inherited capital account + $25,000 book gain from inventory + 
$75,000 book gain from buildings). Each building has the same book 
value and fair market value, and the allocations with respect to 
each building are the same as between G, H, and I. Accordingly, I's 
share of book gain should be allocated equally between the two 
buildings, $37,500 to each. In order for I to be allocated $37,500 
of book gain with respect to each building, the total amount of book 
gain with respect to each building would have to be $112,500 
($112,500  x  \1/3 \ = $37,500). Adding this book gain to the 
current book value of each building results in a value for each 
building of $412,500 ($300,000 + $112,500). Nothing is allocated to 
goodwill. I's section 743(b) adjustment must be allocated under 
Sec. 1.755-1 using these fair market value calculations for the 
partnership's assets.
    Example 4. The facts are the same as Example 3, except that I 
purchases one-half of G's partnership interest for $550,000. Because 
the fair market value of the partnership's assets (as determined 
under paragraph (b)(2)(i) of this section) in the first four asset 
classes under the residual method is not sufficient to cause a 
liquidating distribution to I equal to its basis in the purchased 
interest (i.e., $550,000), the additional value necessary to cause 
such a distribution must be allocated to goodwill.

[[Page 17835]]

Accordingly, under paragraph (b)(3) of this section, the value of 
the partnership's assets is as follows: inventory $1,000,000, each 
building $500,000, and goodwill $200,000. I's section 743(b) 
adjustment must be allocated under Sec. 1.755-1 using these fair 
market value calculations for the partnership's assets.

    (f) Effective date. This section applies to any basis adjustment 
resulting from any distribution of partnership property or transfer of 
a partnership interest that occurs on or after the date final 
regulations are published in the Federal Register.


Sec. 1.755-2T  [Removed]

    Par. 3. Section 1.755-2T is removed.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 00-8276 Filed 4-4-00; 8:45 am]
BILLING CODE 4830-01-P