[Federal Register Volume 68, Number 52 (Tuesday, March 18, 2003)]
[Rules and Regulations]
[Pages 12815-12817]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-6345]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9049]
RIN 1545-BA50


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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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

DATES: Effective Date: These regulations are effective March 18, 2003.
    Applicability Date: For dates of applicability, see Sec.  1.705-
2(e).

FOR FURTHER INFORMATION CONTACT: Barbara (MacMillan) Campbell or 
Rebekah A. Myers (202) 622-3050 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On March 29, 2002, the Treasury Department and the IRS published 
final regulations (TD 8986; 2002-16 I.R.B. 780) under section 705 of 
the Internal Revenue Code (Code) in the Federal Register (67 FR 15112). 
Those final regulations provide 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. During the 
development of those final regulations, the Treasury Department and the 
IRS considered other issues related to the coordination of sections 705 
and 1032. Accordingly, also on March 29, 2002, the Treasury Department 
and the IRS published proposed regulations (REG-167648-01; 2002-16 
I.R.B. 790) to revise the final regulations contained in Sec.  1.705-2 
of 26 CFR part 1 in the Federal Register (67 FR 15132). No written 
comments were received in response to the notice of proposed 
rulemaking, and no public hearing was requested or held. The proposed 
regulations are adopted as revised by this Treasury decision.

Explanation of Provisions

1. Overview of Proposed Regulations

    The proposed regulations apply to situations where 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. As stated in the preamble to the proposed 
regulations, in these 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.

2. Revisions in Final Regulations

    These final regulations follow the proposed regulations but extend 
the rules of the proposed regulations to situations where a corporation 
owns a direct or indirect interest in a

[[Page 12816]]

partnership that owns stock in that corporation, the partnership 
distributes money or other property to another partner and that partner 
recognizes loss on the distribution or the basis of the property 
distributed to that partner is adjusted 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. The 
revisions provide a more consistent approach, and better conform these 
final regulations to the final regulations issued on March 29, 2002 
under section 705 (TD 8986; 2002-16 I.R.B. 780).

3. Effective Date

    The final regulations apply with respect to sales or exchanges of 
stock occurring on or after March 18, 2003, except that paragraph (d) 
applies with respect to sales or exchanges of stock occurring on or 
after March 29, 2002.

Special Analyses

    It has been determined that this Treasury decision 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, the 
notice of proposed rulemaking preceding these regulations was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small businesses.

Drafting Information

    The principal author of these regulations is Barbara (MacMillan) 
Campbell 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 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 1.705-1 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.
* * * * *

    Par. 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)(2) is added.
    3. Paragraph (c)(1) is amended by adding a sentence at the end of 
the paragraph.
    4. Paragraph (d) is added.
    5. Paragraph (e) is revised.
    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 or 
loss on the distribution or the basis of the property distributed to 
that partner is adjusted, 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 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 or loss on the 
distribution or the basis of the property distributed to that partner 
is adjusted 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 or loss on the 
distribution or the basis of the property distributed to that partner 
is adjusted 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

[[Page 12817]]

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) Effective date. This section applies to gain or loss allocated 
with respect to sales or exchanges of stock occurring after December 6, 
1999, except that paragraph (d) of this section is applicable with 
respect to sales or exchanges of stock occurring on or after March 29, 
2002, and 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 
18, 2003.

David A. Mader,
Assistant Deputy Commissioner of Internal Revenue.

    Approved: March 6, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-6345 Filed 3-17-03; 8:45 am]
BILLING CODE 4830-01-P