[Federal Register Volume 67, Number 61 (Friday, March 29, 2002)]
[Proposed Rules]
[Pages 15132-15134]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-7650]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-167648-01]
RIN 1545-BA50


Amendments to Rules for Determination of Basis of Partner's 
Interest; Special Rules

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to 
special rules on determination of basis of a partner's interest under 
section 705. The proposed regulations are necessary to coordinate 
sections 705 and 1032.

DATES: Written or electronic comments and requests for a public hearing 
must be received by June 27, 2002.

ADDRESSES: Send submissions to: CC:ITA:RU (REG-167648-01), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered Monday through Friday

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between the hours of 8 a.m. and 5 p.m. to: CC:ITA:RU (REG-167648-01), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, 
NW., Washington, DC. Alternatively, taxpayers may submit comments 
electronically directly to the IRS internet site at www.irs.gov/regs.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Barbara 
MacMillan or Rebekah A. Myers, (202) 622-3050; concerning submissions 
of comments or requests for a hearing, LaNita VanDyke at (202) 622-7180 
(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    On January 3, 2001, the Treasury Department and the IRS published a 
notice of proposed rulemaking (REG-106702-00, 2001-4 I.R.B. 424) under 
section 705 of the Internal Revenue Code (Code) in the Federal Register 
(66 FR 315). Those proposed regulations provided guidance on the 
coordination of sections 705 and 1032 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. 
Final regulations for the issues addressed in those proposed 
regulations are being published elsewhere in this issue of the Federal 
Register. These proposed regulations propose to revise the final 
regulations contained in Sec. 1.705-2 of 26 CFR part 1 to address 
remaining issues that Treasury and the IRS considered during the 
development of the final regulations.

Explanation of Provisions

    These proposed regulations provide guidance in situations in which 
a corporation owns a direct or indirect interest in a partnership that 
owns stock in that corporation, the partnership distributes money or 
other property to another partner and that partner recognizes gain on 
the distribution during a year in which the partnership does not have 
an election under section 754 in effect, and the partnership 
subsequently sells or exchanges the stock. For reasons similar to those 
explained in the preamble of the final regulations, in those situations 
it may be inconsistent with the intent of sections 705 and 1032 to 
increase the basis of the corporation's partnership interest by the 
full amount of any gain resulting from the partnership's sale or 
exchange of the stock which is not recognized by the corporation under 
section 1032.
    Accordingly, the proposed regulations revise the purpose statement 
of Sec. 1.705-2(a) to take into account situations involving such 
partnership distributions. The proposed regulations provide a specific 
rule implementing the revised purpose in single partnership cases. The 
proposed regulations also revise Sec. 1.705-2(c) to clarify that the 
tiered partnerships rule applies to situations involving such 
partnership distributions.
    In addition, the proposed regulations clarify that references in 
the regulations to stock of a corporate partner include any position in 
stock of a corporate partner to which section 1032 applies.

Proposed Effective Date

    The regulations are proposed to apply to sales or exchanges of 
stock occurring after March 29, 2002.

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 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 will be 
scheduled if requested in writing by any person that timely submits 
written comments. If a public hearing is scheduled, notice of the date, 
time, and place for the public hearing will be published in the Federal 
Register.

Drafting Information

    The principal author of these proposed regulations is Barbara 
MacMillan 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

    1. The authority citation for part 1 continues to read in part as 
follows:

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

    2. Section 1.705-1 is amended by revising 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 partnership disposes of stock or 
any position in stock to which section 1032 applies of a corporation 
that holds a direct or indirect interest in the partnership, see 
Sec. 1.705-2.
* * * * *
    3. Section 1.705-2 is amended as follows:
    1. Paragraph (a) is amended by adding a new sentence after the 
third sentence.
    2. Paragraph (b) is amended by adding paragraph (b)(2).
    3. Paragraph (c)(1) is amended by adding a new sentence after the 
second sentence.
    4. Paragraph (d) is added.
    5. Paragraph (e) is amended by removing the period at the end of 
the paragraph and adding a new phrase at the end of the paragraph.
    The additions and revision read as follows:


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

    (a) * * * Similarly, in situations where a section 754 election was 
not in effect for the year in which a partnership distributes money or 
other property to another partner and that partner recognizes gain on 
the distribution, the remaining partners' inside basis and outside 
basis may not be equal. * * *
* * * * *
    (b) * * *
    (2) Required adjustments relating to distributions. (i) This 
paragraph (b)(2) applies in situations where a corporation owns a 
direct or indirect

[[Page 15134]]

interest in a partnership that owns stock in that corporation, the 
partnership distributes money or other property to another partner and 
that partner recognizes gain on the distribution during a year in which 
the partnership does not have an election under section 754 in effect, 
and the partnership subsequently 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 partnership made the distribution, a 
section 754 election had been in effect.
    (ii) The provisions of this paragraph (b)(2) are illustrated by the 
following example:

    Example. (i) A, B, and corporation C form partnership PRS. A and 
B each contribute $10,000 and C contributes $20,000 in exchange for 
a partnership interest. PRS has no liabilities. PRS purchases stock 
in corporation C for $10,000, which appreciates in value to $70,000. 
PRS distributes $25,000 to A in complete liquidation of A's interest 
in PRS in a year for which an election under section 754 is not in 
effect. PRS later sells the C stock for $70,000. PRS realizes a gain 
of $60,000 on the sale of the C stock. C's share of the gain is 
$40,000. Under section 1032, C does not recognize its share of the 
gain.
    (ii) Normally, C would be entitled to a $40,000 increase in the 
basis of its PRS interest for its allocable share of PRS's gain from 
the sale of the C stock, but a special rule applies in this 
situation. If a section 754 election had been in effect for the year 
in which PRS made the distribution to A, PRS would have been 
entitled to adjust the basis of partnership property under section 
734(b)(1)(A) by $15,000 (the amount of gain recognized by A with 
respect to the distribution to A under section 731(a)(1)). See 
Sec. 1.734-1(b). Under Sec. 1.755-1(c)(1)(ii), the basis adjustment 
under section 734(b) would have been allocated to the C stock, 
increasing its basis to $25,000. (where there is a distribution 
resulting in an adjustment under section 734(b)(1)(A) to the basis 
of undistributed partnership property, the adjustment is allocated 
only to capital gain property.)
    (iii) If a section 754 election had been in effect for the year 
in which PRS made the distribution to A, the amount of gain that PRS 
would have recognized upon PRS's disposition of C stock would be 
$45,000 ($70,000 minus $25,000 basis in the C stock), and the amount 
of gain C would have recognized upon PRS's disposition of the C 
stock (absent the application of section 1032) would be $30,000 (C's 
share of PRS's gain of $45,000 from the stock sale). Accordingly, 
upon PRS's sale of the C stock, the increase in the basis of C's 
interest in PRS is $30,000.
* * * * *
    (c)(1) * * * Similarly, if a corporation owns an indirect interest 
in its own stock through a chain of two or more partnerships, and a 
partnership in the chain distributes money or other property to another 
partner and that partner recognizes gain on the distribution during a 
year in which the partnership does not have an election under section 
754 in effect, then upon any subsequent sale or exchange of the stock, 
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.
* * * * *
    (d) Positions in Stock. For purposes of this section, stock 
includes any position in stock to which section 1032 applies.
    (e) * * * , except that the fourth sentence of paragraph (a), 
paragraph (b)(2), and the third sentence of paragraph (c)(1) of this 
section are applicable with respect to sales or exchanges of stock 
occurring on or after March 29, 2002.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 02-7650 Filed 3-28-02; 8:45 am]
BILLING CODE 4830-01-P