[Federal Register Volume 66, Number 2 (Wednesday, January 3, 2001)]
[Proposed Rules]
[Pages 315-319]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-32189]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-106702-00]
RIN 1545-AX94


Determination of Basis of Partner's Interest; Special Rules

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 
special rules on determination of basis of partner's interest under 
section 705 of the Internal Revenue Code. The proposed regulations are 
necessary to coordinate sections 705 and 1032. This document also 
provides a notice of public hearing on these proposed regulations.

DATES: Written comments must be received by April 3, 2001. Outlines of 
topics to be discussed at the public hearing scheduled for May 3, 2001, 
also must be received by April 3, 2001.

ADDRESSES: Send submissions to: CC:M&SP:RU (REG-106702-00), 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:M&SP:RU (REG-106702-00), 
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.gov/tax_regs/reglist.html. The public 
hearing will be held in room 6718, Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Barbara 
MacMillan, (202) 622-3050; concerning submissions, the hearing, and/or 
to be placed on the building access list to attend the hearing, Sonya 
Cruse, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    In Rev. Rul. 99-57 (1999-51 I.R.B. 678), the IRS issued guidance 
with respect to the tax consequences for a partnership and a corporate 
partner where the corporate partner contributes its own stock to the 
partnership, and the partnership later exchanges the stock with a third 
party in a taxable transaction. Under that ruling, section 1032 will 
protect a corporate partner from recognizing gain or loss (to the 
extent allocated to such partner) when the partnership exchanges stock 
of the corporate partner in a taxable transaction. The ruling also 
concludes that, under section 705, the corporate partner increases its 
basis in its partnership interest by an amount equal to its share of 
the gain resulting from the partnership's sale or exchange of the 
stock.
    In situations where a corporation acquires an interest in a 
partnership that holds stock in that corporation, a section 754 
election is not in effect with respect to the partnership for the 
taxable year in which the corporation acquires the interest, and the 
partnership later sells or exchanges the stock, it may be inconsistent 
with the intent of section 705 to increase the basis of the 
corporation's partnership interest by the full amount of the gain that 
is not recognized.
    For instance, assume that a corporation (A) purchases a 50 percent 
interest in a partnership for $100,000. The partnership's only asset is 
A stock with a basis of $100,000 and a value of $200,000. If the 
partnership had not made a section 754 election, then when the 
partnership disposes of the property for $200,000, A would be allocated 
$50,000 of gain. Under section 1032, the gain allocated to A would not 
be subject to tax. If A's basis in the partnership interest were 
increased to $150,000 under section 705(a)(1), A would recognize a 
corresponding $50,000 loss (or reduced gain) upon a subsequent sale of 
the partnership interest. In this situation, it would be inconsistent 
with the intent of section 705 to increase the basis of A's partnership 
interest for the gain that is not recognized. To do so would create a 
recognizable loss (or reduced gain) in a situation where no economic 
loss was incurred and no offsetting gain had previously been 
recognized.
    Accordingly, in Notice 99-57 (1999-51 I.R.B. 692), the IRS 
announced that it intended to promulgate regulations under section 705 
to address certain situations where a corporation acquires an interest 
in a partnership that holds stock in that corporation, and a section 
754 election is not in effect with respect to the partnership for the 
taxable year in which the corporation acquired the interest. The IRS 
announced that rules regarding tiered-entity structures also would be 
included in the regulations. The IRS requested comments as to the

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appropriate scope of the regulations regarding other situations where 
the price paid for a partnership interest reflects built-in gain or 
accrued income items that will not be subject to tax, or built-in loss 
or accrued deductions that will be permanently denied, when allocated 
to the transferee partner, and the partnership has not made an election 
under section 754. No formal comments were received.

Explanation of Provisions

    As discussed in Notice 99-57, these proposed regulations are being 
issued in order to prevent inappropriate increases or decreases in the 
adjusted basis of a corporate partner's interest in a partnership 
resulting from the partnership's disposition of the corporate partner's 
stock.
    The proposed regulations set forth a detailed statement of the 
purpose for these regulations which is consistent with the discussion 
in Notice 99-57. The proposed regulations then provide a specific rule 
implementing this purpose in situations where a corporate partner holds 
a direct interest in a partnership that owns stock of the corporate 
partner. This rule applies where a corporation acquires an interest in 
a partnership that holds stock in that corporation (or the partnership 
subsequently acquires stock in that corporation in an exchanged basis 
transaction), the partnership does not have an election under section 
754 in effect for the year in which the corporation acquires the 
interest, and the partnership later sells or exchanges the stock. In 
these situations, the increase (or decrease) in the corporation's 
adjusted basis in its partnership interest resulting from the sale or 
exchange of the stock equals the amount of gain (or loss) that the 
corporate partner would have recognized (absent the application of 
section 1032) if, for the taxable year in which the corporation 
acquired the interest, a section 754 election had been in effect.
    The purpose of these proposed regulations cannot be avoided through 
the use of tiered partnerships or other arrangements. For example, the 
proposed regulations provide that if a corporation acquires an indirect 
interest in its own stock through a chain of two or more partnerships 
(either where the corporation acquires a direct interest in a 
partnership or where one of the partnerships in the chain acquires an 
interest in another partnership), and gain or loss from the sale or 
exchange of the stock is subsequently allocated to the corporation, 
then the bases of the interests in the partnerships included in the 
chain shall be adjusted in a manner that is consistent with the purpose 
of the proposed regulations. As stated above, the proposed regulations 
include a statement describing the purpose of these regulations which 
is intended to guide taxpayers in making basis adjustments in the 
tiered partnership context. In addition, the proposed regulations 
include two examples illustrating the basis adjustments that are 
required by the proposed regulations where a corporation acquires an 
indirect interest in its own stock through a chain of two or more 
partnerships.

Proposed Effective Date

    The regulations shall apply to gain or loss allocated with respect 
to sales or exchanges of stock occurring after December 6, 1999.

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 May 3, 2001, beginning at 
10 a.m., in room 6718 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 
April 3, 2001.
    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 Associate 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 
an entry in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * * Section 1.705-2 also issued 
under 26 U.S.C. 705. * * *
    Par. 2. Section 1.705-1 is amended by adding paragraph (a)(7) to 
read as follows:


Sec. 1.705-1  Determination of basis of partner's interest.

    (a) * * *
    (7) For basis adjustments necessary to coordinate sections 705 and 
1032 in certain situations in which a corporation directly or 
indirectly acquires an interest in a partnership that holds stock in 
that corporation, see Sec. 1.705-2.
* * * * *
    Par. 3. Section 1.705-2 is added to read as follows:

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Sec. 1.705-2  Basis adjustments coordinating sections 705 and 1032.

    (a) Purpose. This section is intended to prevent inappropriate 
increases or decreases in the adjusted basis of a corporate partner's 
interest in a partnership resulting from the partnership's disposition 
of the corporate partner's stock. The rules under section 705 generally 
are intended to preserve equality between the adjusted basis of a 
partner's interest in a partnership (outside basis) and such partner's 
share of the adjusted basis in partnership assets (inside basis). In 
the situation where a section 754 election was not in effect for the 
year in which the partner acquired its interest, however, a partner's 
inside basis and outside basis may not be equal. In this situation, 
gain or loss allocated to the partner upon disposition of the 
partnership assets that is attributable to the difference between the 
adjusted basis of the partnership assets absent the section 754 
election and the adjusted basis of the partnership assets had a section 
754 election been in effect generally will result in an adjustment to 
the basis of the partner's interest in the partnership under section 
705(a). Such gain (or loss) therefore generally will be offset by a 
corresponding decrease in the gain or increase in the loss (or increase 
in the gain or decrease in the loss) upon the subsequent disposition by 
the partner of its interest in the partnership.
    Where such a difference exists with respect to stock of a corporate 
partner that is held by the partnership, gain or loss from the 
disposition of corporate partner stock attributable to the difference 
is not recognized by the corporate partner under section 1032. To 
adjust the basis of the corporate partner's interest in the partnership 
for this unrecognized gain or loss would not be appropriate because it 
would create an opportunity for the recognition of taxable gain or loss 
on a subsequent disposition of the partnership interest where no 
economic gain or loss has been incurred by the corporate partner and no 
corresponding taxable gain or loss had previously been allocated to the 
corporate partner by the partnership.
    (b) Single partnership--(1) Required adjustments. This paragraph 
(b) applies in situations where a corporation acquires an interest in a 
partnership that holds stock in that corporation (or the partnership 
subsequently acquires stock in that corporation in an exchanged basis 
transaction), the partnership does not have an election under section 
754 in effect for the year in which the corporation acquires the 
interest, and the partnership later sells or exchanges the stock. In 
these situations, the increase (or decrease) in the corporation's 
adjusted basis in its partnership interest resulting from the sale or 
exchange of the stock equals the amount of gain (or loss) that the 
corporate partner would have recognized (absent the application of 
section 1032) if, for the year in which the corporation acquired the 
interest, a section 754 election had been in effect.
    (2) Example. The provisions of this paragraph (b) are illustrated 
by the following example:

    Example. (i) A, B, and C form equal partnership PRS. Each 
partner contributes $30,000 in exchange for its partnership 
interest. PRS has no liabilities. PRS purchases stock in corporation 
X for $30,000, which appreciates in value to $120,000. PRS also 
purchases inventory for $60,000, which appreciates in value to 
$150,000. A sells its interest in PRS to X for $90,000 in a year for 
which an election under section 754 is not in effect. PRS later 
sells the X stock for $150,000. PRS realizes a gain of $120,000 on 
the sale of the X stock. X's share of the gain is $40,000. Under 
section 1032, X does not recognize its share of the gain.
    (ii) Normally, X would be entitled to a $40 increase in the 
basis of its PRS interest for its allocable share of PRS's gain from 
the sale of the X stock, but a special rule applies in this 
situation. If a section 754 election had been in effect for the year 
in which X acquired its interest in PRS, X would have been entitled 
to a basis adjustment under section 743(b) of $60,000 (the excess of 
X's basis for the transferred partnership interest over X's share of 
the adjusted basis to PRS of PRS's property). See Sec. 1.743-1(b). 
Under Sec. 1.755-1(b), the basis adjustment under section 743(b) 
would have been allocated $30,000 to the X stock (the amount of the 
gain that would have been allocated to X from the hypothetical sale 
of the stock), and $30,000 to the inventory (the amount of the gain 
that would have been allocated to X from the hypothetical sale of 
the inventory).
    (iii) If a section 754 election had been in effect for the year 
in which X acquired its interest in PRS, the amount of gain that X 
would have recognized upon PRS's disposition of X stock (absent the 
application of section 1032) would be $10,000 (X's share of PRS's 
gain from the stock sale, $40,000, minus the amount of X's basis 
adjustment under section 743(b), $30,000). See Sec. 1.743-1(j). 
Accordingly, the increase in the basis of X's interest in PRS is 
$10,000.

    (c) Tiered partnerships and other arrangements--(1) Required 
adjustments. The purpose of these proposed regulations as set forth in 
paragraph (a) of this section cannot be avoided through the use of 
tiered partnerships or other arrangements. For example, if a 
corporation acquires an indirect interest in its own stock through a 
chain of two or more partnerships (either where the corporation 
acquires a direct interest in a partnership or where one of the 
partnerships in the chain acquires an interest in another partnership), 
and gain or loss from the sale or exchange of the stock is subsequently 
allocated to the corporation, then the bases of the interests in the 
partnerships included in the chain shall be adjusted in a manner that 
is consistent with the purpose of this section.
    (2) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples:

    Example 1. Acquisition of upper-tier partnership interest by 
corporation. (i) A, B, and C form a partnership (UTP), with each 
partner contributing $25,000. UTP and D form a partnership (LTP). 
UTP contributes $75,000 in exchange for its interest in LTP, and D 
contributes $25,000 in exchange for D's interest in LTP. Neither UTP 
nor LTP has any liabilities. LTP purchases stock in corporation E 
for $100,000, which appreciates in value to $1,000,000. C sells its 
interest in UTP to E for $250,000 in a year for which an election 
under section 754 is not in effect for UTP or LTP. LTP later sells 
the E stock for $2,000,000. LTP realizes a $1,900,000 gain on the 
sale of the E stock. UTP's share of the gain is $1,425,000, and E's 
share of the gain is $475,000. Under section 1032, E does not 
recognize its share of the gain.
    (ii) With respect to the basis of UTP's interest in LTP, if all 
of the gain from the sale of the E stock (including E's share) were 
to increase the basis of UTP's interest in LTP, UTP's basis in such 
interest would be $1,500,000 ($75,000 + $1,425,000). The fair market 
value of UTP's interest in LTP is $1,500,000. Because UTP did not 
have a section 754 election in effect for the taxable year in which 
E acquired its interest in UTP, UTP's basis in the LTP interest does 
not reflect the purchase price paid by E for its interest. 
Increasing the basis of UTP's interest in LTP by the full amount of 
the gain that would be recognized (in the absence of section 1032) 
on the sale of the E stock preserves the conformity between UTP's 
inside basis and outside basis with respect to LTP (i.e., UTP's 
share of LTP's cash is equal to $1,500,000, and UTP's basis in the 
LTP interest is $1,500,000) and appropriately would cause UTP to 
recognize no gain or loss on the sale of UTP's interest in LTP 
immediately after the sale of the E stock. Accordingly, increasing 
the basis of UTP's interest in LTP by the entire amount of gain 
allocated to UTP (including E's share) from LTP's sale of the E 
stock is consistent with the purpose of this section. The $1,425,000 
of gain allocated by LTP to UTP will increase the adjusted basis of 
UTP's interest in LTP under section 705(a)(1). The basis of UTP's 
interest in LTP immediately after the sale of the E stock is 
$1,500,000.
    (iii) With respect to the basis of E's interest in UTP, if E's 
share of the gain allocated to UTP and then to E were to increase 
the basis of E's interest in UTP, E's basis in such interest would 
be $725,000 ($250,000 + $475,000) and the fair market value of such 
interest would be $500,000, so that E would

[[Page 318]]

recognize a loss of $225,000 if E sold its interest in UTP 
immediately after LTP's disposition of the E stock. It would be 
inappropriate for E to recognize a taxable loss of $225,000 upon a 
disposition of its interest in UTP because E would not incur an 
economic loss in the transaction, and E did not recognize a taxable 
gain upon LTP's disposition of the E stock that appropriately would 
be offset by a taxable loss on the disposition of its interest in 
UTP. Accordingly, increasing E's basis in its UTP interest by the 
entire amount of gain allocated to E from the sale of the E stock is 
not consistent with the purpose of this section. (Conversely, 
because A and B were allocated taxable gain on the disposition of 
the E stock, it would be appropriate to increase A's and B's bases 
in their respective interests in UTP by the full amount of the gain 
allocated to them.)
    (iv) The appropriate basis adjustment for E's interest in UTP 
upon the disposition of the E stock by LTP can be determined as the 
amount of gain that E would have recognized (in the absence of 
section 1032) upon the sale by LTP of the E stock if both UTP and 
LTP had made section 754 elections for the taxable year in which E 
acquired the interest in UTP. If section 754 elections had been in 
effect for UTP and LTP for the year in which E acquired E's interest 
in UTP, the following would occur. E would be entitled to a $225,000 
positive basis adjustment under section 743(b) with respect to the 
property of UTP. The entire basis adjustment would be allocated to 
UTP's only asset, its interest in LTP. In addition, the sale of C's 
interest in UTP would be treated as a deemed sale of E's share of 
UTP's interest in LTP for purposes of sections 754 and 743. The 
deemed selling price of E's share of UTP's interest in LTP would be 
$250,000 (E's share of UTP's adjusted basis in LTP, $25,000, plus 
E's basis adjustment under section 743(b) with respect to the assets 
of UTP, $225,000). The deemed sale of E's share of UTP's interest in 
LTP would trigger a basis adjustment under section 743(b) of 
$225,000 with respect to the assets of LTP (the excess of E's share 
of UTP's adjusted basis in LTP, including E's basis adjustment 
($225,000), $250,000, over E's share of the adjusted basis of LTP's 
property, $25,000). This $225,000 adjustment by LTP would be 
allocated to LTP's only asset, the E stock, and would be segregated 
and allocated solely to E. The amount of LTP's gain from the sale of 
the E stock (before considering section 743(b)) would be $1,900,000. 
E's share of this gain, $475,000, would be offset in part by the 
$225,000 basis adjustment under section 743(b), so that E would 
recognize gain equal to $250,000 in the absence of section 1032.
    (v) If the basis of E's interest in UTP were increased by 
$250,000, the total basis of E's interest would equal $500,000. This 
would conform to E's share of UTP's basis in the LTP interest 
($1,500,000  x  \1/3\ = $500,000) as well as E's indirect share of 
the cash held by LTP ((\1/3\  x  \3/4\)  x  $2,000,000 = $500,000). 
Such a basis adjustment does not create the opportunity for the 
recognition of an inappropriate loss by E on a subsequent 
disposition of E's interest in UTP and is consistent with the 
purpose of this section. Accordingly, under paragraph (c) of this 
section, of the $475,000 gain allocated to E, only $250,000 will 
apply to increase the adjusted basis of E in UTP under section 
705(a)(1). E's adjusted basis in its UTP interest following the sale 
of the E stock is $500,000.
    Example 2. Acquisition of lower-tier partnership interest by 
upper-tier partnership. (i) A, B, and C form an equal partnership 
(UTP), with each partner contributing $100,000. D, E, and F also 
form an equal partnership (LTP), with each partner contributing 
$30,000. LTP purchases stock in corporation B for $90,000, which 
appreciates in value to $900,000. LTP has no liabilities. UTP 
purchases D's interest in LTP for $300,000. LTP does not have an 
election under section 754 in effect for the taxable year of UTP's 
purchase. LTP later sells the B stock for $900,000. UTP's share of 
the gain is $270,000, and B's share of that gain is $90,000. Under 
section 1032, B does not recognize its share of the gain.
    (ii) With respect to the basis of UTP's interest in LTP, if all 
of the gain from the sale of the B stock (including B's share) were 
to increase the basis of UTP's interest in LTP, UTP's basis in the 
LTP interest would be $570,000 ($300,000 + $270,000), and the fair 
market value of such interest would be $300,000, so that B would be 
allocated a loss of $90,000 (($570,000-$300,000)  x  \1/3\) if UTP 
sold its interest in LTP immediately after LTP's disposition of the 
B stock. It would be inappropriate for B to recognize a taxable loss 
of $90,000 upon a disposition of UTP's interest in LTP. B would not 
incur an economic loss in the transaction, and B was not allocated a 
taxable gain upon LTP's disposition of the B stock that 
appropriately would be offset by a taxable loss on the disposition 
of UTP's interest in LTP. Accordingly, increasing UTP's basis in its 
LTP interest by the gain allocated to B from the sale of the B stock 
is not consistent with the purpose of this section. (Conversely, 
because E and F were allocated taxable gain on the disposition of 
the B stock, it would be appropriate to increase E's and F's bases 
in their respective interests in LTP by the full amount of such 
gain.)
    (iii) The appropriate basis adjustment for UTP's interest in LTP 
upon the disposition of the B stock by LTP can be determined as the 
amount of gain that UTP would have recognized (in the absence of 
section 1032) upon the sale by LTP of the B stock if the portion of 
the gain allocated to UTP that subsequently is allocated to B were 
determined as if LTP had made an election under section 754 for the 
taxable year in which UTP acquired its interest in LTP. If a section 
754 election had been in effect for LTP for the year in which UTP 
acquired its interest in LTP, then with respect to B, the following 
would occur. UTP would be entitled to a $90,000 positive basis 
adjustment under section 743(b), allocable to B, in the property of 
LTP. The entire basis adjustment would be allocated to LTP's only 
asset, its B stock. The amount of LTP's gain from the sale of the B 
stock (before considering section 743(b)) would be $810,000. UTP's 
share of this gain, $270,000, would be offset, in part, by the 
$90,000 basis adjustment under section 743(b), so that UTP would 
recognize gain equal to $180,000.
    (iv) If the basis of UTP's interest in LTP were increased by 
$180,000, the total basis of UTP's partnership interest would equal 
$480,000. This would conform to the sum of UTP's share of the cash 
held by LTP (\1/3\  x  $900,000 = $300,000) and the taxable gain 
recognized by A and C on the disposition of the B stock that 
appropriately may be offset on the disposition of their interests in 
UTP ($90,000 + $90,000 = $180,000). Such a basis adjustment does not 
inappropriately create the opportunity for the allocation of a loss 
to B on a subsequent disposition of UTP's interest in LTP and is 
consistent with the purpose of this section. Accordingly, of the 
$270,000 gain allocated to UTP, only $180,000 will apply to increase 
the adjusted basis of UTP in LTP under section 705(a)(1). UTP's 
adjusted basis in its LTP interest following the sale of the B stock 
is $480,000.
    (v) With respect to B's interest in UTP, if B's share of the 
gain allocated to UTP and then to B were to increase the basis of 
B's interest in UTP, B would have a UTP partnership interest with an 
adjusted basis of $190,000 ($100,000 + $90,000) and a value of 
$100,000, so that B would recognize a loss of $90,000 if B sold its 
interest in UTP immediately after LTP's disposition of the B stock. 
It would be inappropriate for B to recognize a taxable loss of 
$90,000 upon a disposition of its interest in UTP because B would 
not incur an economic loss in the transaction, and B did not 
recognize a taxable gain upon LTP's disposition of the B stock that 
appropriately would be offset by a taxable loss on the disposition 
of its interest in UTP. Accordingly, increasing B's basis in its UTP 
interest by the gain allocated to B from the sale of the B stock is 
not consistent with the purpose of this section. (Conversely, 
because A and C were allocated taxable gain on the disposition of 
the B stock that is a result of LTP not having a section 754 
election in effect, it would be appropriate for A and C to recognize 
an offsetting taxable loss on the disposition of A's and C's 
interests in UTP. Accordingly, it would be appropriate to increase 
A's and C's bases in their respective interests in UTP by the amount 
of gain recognized by A and C.)
    (vi) The appropriate basis adjustment for B's interest in UTP 
upon the disposition of the B stock by LTP can be determined as the 
amount of gain that B would have recognized (in the absence of 
section 1032) upon the sale by LTP of the B stock if the portion of 
the gain allocated to UTP that is subsequently allocated to B were 
determined as if LTP had made an election under section 754 for the 
taxable year in which UTP acquired its interest in LTP. If a section 
754 election had been in effect for LTP for the year in which UTP 
acquired its interest in LTP, then with respect to B, the following 
would occur. UTP would be entitled to a basis adjustment under 
section 743(b) in the property of LTP of $90,000. The entire basis 
adjustment would be allocated to LTP's only asset, its B stock. The 
amount of UTP's gain from the sale of the B stock (before 
considering section 743(b)) would be $810,000. UTP's share of this 
gain, $270,000, would be offset, in part, by the $90,000 basis 
adjustment under

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section 743(b), so that UTP would recognize gain equal to $180,000. 
The $90,000 basis adjustment would completely offset the gain that 
otherwise would be allocated to B.
    (vii) If no gain were allocated to B so that the basis of B's 
interest in UTP was not increased, the total basis of B's interest 
would equal $100,000. This would conform to B's share of UTP's basis 
in the LTP interest (($480,000--$180,000 (i.e., A's and C's share of 
the basis that should offset taxable gain recognized as a result of 
LTP's failure to have a section 754 election))  x  \1/3\ = $100,000) 
as well as B's indirect share of the cash held by LTP ((\1/3\  x  
\1/3\)  x  $900,000 = $100,000). Such a basis adjustment does not 
create the opportunity for the recognition of an inappropriate loss 
by B on a subsequent disposition of B's interest in UTP and is 
consistent with the purpose of this section. Accordingly, under 
paragraph (c) of this section, of the $90,000 gain allocated to B, 
none will apply to increase the adjusted basis of B in UTP under 
section 705(a)(1). B's adjusted basis in its UTP interest following 
the sale of the B stock is $100,000.

    (d) Effective date. This section applies to gain or loss allocated 
with respect to sales or exchanges of stock occurring after December 6, 
1999.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 00-32189 Filed 12-29-00; 8:45 am]
BILLING CODE 4830-01-U