[Federal Register Volume 68, Number 127 (Wednesday, July 2, 2003)]
[Proposed Rules]
[Pages 39498-39500]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-16788]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[REG-139796-02]
RIN 1545-BB10


Section 704(b) and Capital Account Revaluations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to the 
capital account maintenance rules under section 704 of the Internal 
Revenue Code. These regulations expand the rules regarding a 
partnership's right to adjust capital accounts to reflect unrealized 
appreciation and depreciation in the value of partnership assets.

DATES: Written or electronic comments and requests for a public hearing 
must be received by September 30, 2003.

[[Page 39499]]


ADDRESSES: Send submissions to: CC:PA:RU (REG-139796-02), 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:PA:RU (REG-139796-02), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, 
NW., Washington, DC.
    Alternatively, taxpayers may submit comments electronically via the 
Internet by submitting comments directly to the IRS Internet site at 
www.irs.gov/regs.

FOR FURTHER INFORMATION CONTACT: Craig Gerson at (202) 622-3050; 
concerning submissions, the hearing, and/or placement on the building 
access list to attend the hearing, Sonya Cruse, (202) 622-7180 (not 
toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 704(b) of the Internal Revenue Code provides that a 
partner's distributive share of income, gain, loss, deduction, or 
credit is determined in accordance with the partner's interest in the 
partnership if the partnership agreement does not provide as to the 
partner's distributive shares of these items, or the allocation to a 
partner of these items under the agreement does not have substantial 
economic effect. Regulations under section 704 provide extensive rules 
for determining whether allocations under an agreement have substantial 
economic effect. One requirement for finding substantial economic 
effect is that the partnership maintains partners' capital accounts in 
accordance with certain rules. Compliance with these capital account 
maintenance rules, and other related rules, provides taxpayers a safe 
harbor under which the IRS will respect a partnership agreement's 
allocations.
    Under the capital account maintenance rules of Sec.  1.704-
1(b)(2)(iv), partnership property is generally reflected on the 
partnership's books at historic cost, rather than at fair market value. 
However, newly contributed property is reflected in the capital 
accounts of the partners at fair market value, rather than the 
contributing partner's cost; that is, the contributed property is 
essentially revalued at the time of contribution. Sec.  1.704-
1(b)(2)(iv)(d)(1). In addition, under Sec.  1.704-1(b)(2)(iv)(f), a 
partnership is permitted to, and generally does, revalue its assets to 
their current fair market values if there is a contribution to the 
partnership by a new or existing partner as consideration for an 
interest in the partnership or a distribution from the partnership to a 
retiring or continuing partner as consideration for an interest in the 
partnership. Also, a revaluation is permitted under generally accepted 
industry accounting practices if substantially all of a partnership's 
property (excluding money) consists of stock, securities, commodities, 
options, warrants, futures, or similar instruments that are readily 
tradable on an established securities market.
    Commentators have suggested that there are additional situations 
beyond those described in Sec.  1.704-1(b)(2)(iv)(f) where revaluations 
are useful to properly reflect a partnership's economic arrangements. 
In particular, several commentators have noted that the section 704 
regulations do not specifically permit a revaluation of partnership 
property in connection with the admission of a service partner because 
the service partner does not contribute property. Those commentators 
argue that a revaluation upon the admission of a service partner allows 
a partnership to allocate the existing partnership capital to the other 
partners. In this manner, the partnership keeps its capital accounts 
consistent with an intent to provide the service partner with only a 
profits interest. See Rev. Proc. 93-27 (1993-2 C.B. 343) and Rev. Proc. 
2001-43 (2001-2 C.B. 191).

Explanation of Provisions

1. Revaluations of Property Under Section 704 on Provision of Services

    The proposed regulations expand the circumstances under which a 
partnership is specifically permitted to increase or decrease the 
capital accounts of the partners to reflect a revaluation of 
partnership property on the partnership's books. Specifically, the 
proposed regulations allow revaluations in connection with the grant of 
an interest in the partnership (other than a de minimis interest) on or 
after the date final regulations are published in the Federal Register 
as consideration for the provision of services to or for the benefit of 
the partnership by an existing partner acting in a partner capacity, or 
by a new partner acting in a partner capacity or in anticipation of 
being a partner.

2. Possible Expansion of Regulations

    The IRS and the Treasury Department are considering further 
increasing the number of situations in which revaluations of 
partnership property are permitted. One approach under consideration 
would allow revaluations any time there is more than a de minimis bona 
fide change in the manner in which partners agree to share profits or 
losses. Comments are requested concerning whether the regulations 
should adopt this standard or another standard for revaluations.

3. Other Future Guidance

    The IRS recently issued proposed regulations on the taxation of 
noncompensatory partnership options and is currently studying the 
taxation of compensatory partnership options. This notice of proposed 
rulemaking concerning revaluations is not intended to provide guidance 
regarding when a partnership interest is considered to be granted.

Effective Date

    The regulations are proposed to apply to the grant of an interest 
in a partnership (other than a de minimis interest) on or after the 
date final regulations are published in the Federal Register as 
consideration for the provision of services to or for the benefit of 
the partnership by an existing partner acting in a partner capacity, or 
by a new partner acting in a partner capacity or in anticipation of 
being a partner.

Special Analysis

    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 proper scope of the 
rule allowing revaluations. 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.

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Drafting Information

    The principal author of these regulations is Craig Gerson, Office 
of Associate Chief Counsel (Passthroughs and Special Industries), IRS. 
However, other personnel from the IRS and 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 in part 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 1.704-1 is amended as follows:
    1. Paragraph (b)(2)(iv)(f)(5)(iii) is redesignated as paragraph 
(b)(2)(iv)(f)(5)(iv).
    2. New paragraph (b)(2)(iv)(f)(5)(iii) is added.


Sec.  1.704-1  Partner's distributive share.

* * * * *
    (b) * * *
    (2) * * *
    (iv) * * *
    (f) * * *
    (5) * * *
    (iii) In connection with the grant of an interest in the 
partnership (other than a de minimis interest) on or after the date 
final regulations are published in the Federal Register as 
consideration for the provision of services to or for the benefit of 
the partnership by an existing partner acting in a partner capacity, or 
by a new partner acting in a partner capacity or in anticipation of 
being a partner.
* * * * *

Judith B. Tomaso,
Acting Deputy Commissioner of Internal Revenue.
[FR Doc. 03-16788 Filed 7-1-03; 8:45 am]
BILLING CODE 4830-01-U