[Federal Register Volume 68, Number 226 (Monday, November 24, 2003)]
[Proposed Rules]
[Pages 65864-65866]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-29323]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-160330-02]
RIN 1545-BB65


Section 704(c), Installment Obligations and Contributed Contracts

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to the 
tax treatment of installment obligations and property acquired pursuant 
to a contract under sections 704(c) and 737. The proposed regulations 
affect partners and partnerships and provide guidance necessary to 
comply with the law.

DATES: Written and electronic comments and requests for a public 
hearing must be received no later than February 23, 2004.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-160330-02), room 
5203, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may also be hand delivered Monday 
through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR 
(REG-160330-02), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue NW., Washington, DC. Alternatively, taxpayers may 
submit electronic comments directly to the IRS Internet site at: 
www.irs.gov/regs.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, 
Christopher L. Trump, 202-622-3070; concerning submissions and the 
hearing, Robin Jones, 202-622-3521 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 704(c)(1)(A) provides that income, gain, loss or deduction 
with respect to property contributed to a partnership by a partner 
shall be shared among the partners so as to take into account the 
variation between the basis of the property to the partnership and its 
fair market value at the time of the contribution.
    Under section 704(c)(1)(B) and the regulations thereunder, any 
partner that contributes section 704(c) property to a partnership must 
recognize gain or loss on the distribution of such property to another 
partner within 7 years of its contribution. The amount of gain or loss 
recognized is the amount of gain or loss that would have been allocated 
to such partner under section 704(c)(1)(A) if the property had been 
sold by the partnership to the distributee partner for its fair market 
value at the time of the distribution.
    Under section 737(a) and the regulations thereunder, any partner 
that contributes section 704(c) property to a partnership may recognize 
gain on a distribution of property (other than money) by the 
partnership to that partner. The amount of gain recognized is the 
lesser of: (1) The amount by which the fair market value of the 
distributed property exceeds the distributee partner's adjusted tax 
basis in the partner's partnership interest, or (2) the net 
precontribution gain of the partner. Section 737(b) defines the net 
precontribution gain of the partner as the net gain (if any) that would 
have been recognized by the distributee partner under section 
704(c)(1)(B) if all property that (1) had been contributed to the 
partnership by the distributee partner within 7 years of the 
distribution and (2) is held by such partnership immediately before the 
distribution, had been distributed by such partnership to another 
partner.
    For purposes of section 704(c)(1)(A) and (B) and section 737, if a 
partnership disposes of section 704(c) property in a nonrecognition 
transaction in which no gain or loss is recognized, the substituted 
basis property (within the meaning of section 7701(a)(42)) is treated 
as section 704(c) property with the same amount of built-in gain or 
loss as the section 704(c) property disposed of by the partnership. See 
Sec. Sec.  1.704-3(a)(8), 1.704-4(d)(1), and 1.737-2(d)(3).
    If a partnership disposes of property in an installment sale, 
income is taken into account under the installment method unless the 
partnership elects otherwise. See section 453. Upon the satisfaction of 
an installment obligation at other than its face value or the 
distribution, transmission, sale, or other disposition of an 
installment obligation, a taxpayer is generally required, under section 
453B, to recognize gain or loss. Section 453B does not apply, however, 
on the disposition of an installment obligation in certain situations 
where the Internal Revenue Code (Code) otherwise provides for 
nonrecognition of gain or loss. For example, Sec.  1.453-9(c)(2) 
provides that no gain or loss results under section 453(d) (now section 
453B) in the case of a contribution to or distribution from a 
partnership under sections 721 or 731.
    In addition, if a partnership acquires property pursuant to a 
contract such as an option, a forward contract, or a futures contract, 
the partnership may recognize no gain or loss on the acquisition of the 
property.

Explanation of Provisions

    The proposed regulations amend Sec.  1.704-3(a)(8) to clarify that, 
if a partnership disposes of section 704(c) property in exchange for an 
installment obligation, the installment obligation is treated as the 
section 704(c) property. The proposed regulations also clarify that, if 
a partner contributes a contract that is section 704(c) property to a 
partnership, and the partnership subsequently acquires property 
pursuant to that contract in a transaction in which less than all of 
the gain or loss is recognized, the acquired property is treated as the 
section 704(c) property for purposes of sections 704(c) and 737. For 
this purpose the term contract includes, but is not limited to, 
options, forward contracts, and futures contracts.
    The proposed regulations amend Sec.  1.704-4(d)(1) to provide that 
an installment obligation received by a partnership and property 
acquired pursuant to a contributed contract are treated as section 
704(c) property for purposes of section 704(c)(1)(B) to the extent that 
the installment obligation or the acquired property is section 704(c) 
property under Sec.  1.704-3(a)(8). As a result, if the installment 
obligation or property acquired pursuant to a contributed contract is 
distributed by a partnership to a partner other than the contributing 
partner within 7 years of the contribution, the contributing partner 
may recognize gain or loss under section 704(c)(1)(B). The proposed 
regulations include a similar rule under Sec.  1.737-2(d)(3).
    No inference is intended as to the treatment of these transactions 
under prior law.

Proposed Effective Date

    These regulations are proposed to apply to installment obligations 
received by a partnership on or after November 24, 2003 in exchange for 
section 704(c) property and to property acquired on or after November 
24, 2003 by a partnership pursuant to a contract that is section 704(c) 
property.

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 
these regulations do not impose a collection

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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 business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and 8 
copies) or electronic comments that are submitted timely to the IRS. 
The IRS and Treasury Department request comments on the clarity of the 
proposed rules, how they can be made easier to understand and the 
administrability of the rules in the proposed regulations. All comments 
will be available for public inspection and copying. A public hearing 
may 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 of the public hearing will be published in 
the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Christopher 
L. Trump of the Office of Associate Chief Counsel (Passthroughs and 
Special Industries). Other personnel from Treasury and the IRS 
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 continues to read in 
part as follows:

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

    Par. 2. Section 1.704-3 is amended as follows:
    1. The paragraph heading for (a)(8) is revised.
    2. The text of paragraph (a)(8) is redesignated as paragraph 
(a)(8)(i).
    3. A paragraph heading for newly designated paragraph (a)(8)(i) is 
added.
    4. The first sentence of newly designated paragraph (a)(8)(i) is 
amended by removing the language ``in which no gain or loss is 
recognized''.
    5. Paragraphs (a)(8)(ii) and (a)(8)(iii) are added.
    6. Paragraph (f) is amended by:
    a. Amending the first sentence of paragraph (f) by removing the 
language ``of paragraph (a)(11)'' and adding ``of paragraphs 
(a)(8)(ii), (a)(8)(ii) and (a)(11)'' in its place.
    b. Adding two sentences at the end of paragraph (f).
    The revisions and additions read as follows:


Sec.  1.704-3  Contributed property.

    (a) * * *
    (8) Special rules--(i) Disposition in a nonrecognition transaction. 
* * *
    (ii) Disposition in an installment sale. If a partnership disposes 
of section 704(c) property in an installment sale as defined in section 
453(b), the installment obligation received by the partnership is 
treated as the section 704(c) property with the same amount of built-in 
gain as the section 704(c) property disposed of by the partnership 
(with appropriate adjustments for any gain recognized on the 
installment sale). The allocation method for the installment obligation 
must be consistent with the allocation method chosen for the original 
property.
    (iii) Contributed contracts. If a partner contributes to a 
partnership a contract that is section 704(c) property, and the 
partnership subsequently acquires property pursuant to that contract in 
a transaction in which less than all of the gain or loss is recognized, 
then the acquired property is treated as the section 704(c) property 
with the same amount of built-in gain or loss as the contract (with 
appropriate adjustments for any gain or loss recognized on the 
acquisition). For this purpose, the term contract includes, but is not 
limited to, options, forward contracts, and futures contracts. The 
allocation method for the acquired property must be consistent with the 
allocation method chosen for the contributed contract.
* * * * *
    (f) Effective date. * * * Paragraph (a)(8)(ii) applies to 
installment obligations received by a partnership in exchange for 
section 704(c) property on or after November 24, 2003. Paragraph 
(a)(8)(iii) is effective for property acquired on or after November 24, 
2003 by a partnership pursuant to a contract that is section 704(c) 
property.
    Par. 3. Section 1.704-4 is amended as follows:
    1. The paragraph heading for (d)(1) is revised.
    2. The text of paragraph (d)(1) is redesignated as paragraph 
(d)(1)(i).
    3. A paragraph heading for newly designated paragraph (d)(1)(i) is 
added.
    4. Paragraphs (d)(1)(ii) and (d)(1)(iii) are added.
    5. Revising paragraph (g).
    The revisions and additions read as follows:


Sec.  1.704-4  Distribution of contributed property.

* * * * *
    (d) Special rules--(1) Nonrecognition transactions, installment 
obligations and contributed contracts-- (i) Nonrecognition 
transactions. * * *
    (ii) Installment obligations. An installment obligation received by 
the partnership in an installment sale (as defined in section 453(b)) 
of section 704(c) property is treated as the section 704(c) property 
for purposes of section 704(c)(1)(B) and this section to the extent 
that the installment obligation received is treated as section 704(c) 
property under Sec.  1.704-3(a)(8). See Sec.  1.737-2(d)(3) for a 
similar rule in the context of section 737.
    (iii) Contributed contracts. Property acquired by the partnership 
pursuant to a contract that is section 704(c) property is treated as 
the section 704(c) property for purposes of section 704(c)(1)(B) and 
this section, to the extent that the acquired property is treated as 
section 704(c) property under Sec.  1.704-3(a)(8). See Sec.  1.737-
2(d)(3) for a similar rule in the context of section 737.
* * * * *
    (g) Effective date. This section applies to distributions by a 
partnership to a partner on or after January 9, 1995, except that 
paragraphs (d)(1)(i) and (ii) apply to distributions by a partnership 
to a partner on or after November 24, 2003.
    Par. 4. Section 1.737-2 is amended as follows:
    1. The paragraph heading for (d)(3) is revised.
    2. The text of paragraph (d)(3) is redesignated (d)(3)(i).
    3. A paragraph heading for newly designated (d)(3)(i) is added.
    4. Paragraphs (d)(3)(ii) and (d)(3)(iii) are added.


Sec.  1.737-2  Exceptions and special rules.

* * * * *
    (d) * * *
    (3) Nonrecognition transactions, installment sales and contributed 
contracts--(i) Nonrecognition transactions. * * *
    (ii) Installment sales. An installment obligation received by the 
partnership in an installment sale (as defined in section 453(b)) of 
section 704(c) property is treated as the contributed property with 
regard to the contributing partner for purposes of section 737 to the 
extent that the installment

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obligation received is treated as section 704(c) property under Sec.  
1.704-3(a)(8). See Sec.  1.704-4(d)(1) for a similar rule in the 
context of section 704(c)(1)(B).
    (iii) Contributed contracts. Property acquired by a partnership 
pursuant to a contract that is section 704(c) property is treated as 
the contributed property with regard to the contributing partner for 
purposes of section 737 to the extent that the acquired property is 
treated as section 704(c) property under Sec.  1.704-3(a)(8). See Sec.  
1.704-4(d)(1) for a similar rule in the context of section 
704(c)(1)(B).
* * * * *
    Par. 5. Section 1.737-5 is revised to read as follows:


Sec.  1.737-5  Effective dates.

    Sections 1.737-1, 1.737-2, 1.737-3, and 1.737-4 apply to 
distributions by a partnership to a partner on or after January 9, 
1995, except that Sec.  1.737-2(d)(3)(ii) and (ii) apply to 
distributions by a partnership to a partner on or after November 24, 
2003.

Mark E. Matthews,
Deputy Commissioner of Services and Enforcement.
[FR Doc. 03-29323 Filed 11-21-03; 8:45 am]
BILLING CODE 4830-01-P