[Federal Register Volume 70, Number 101 (Thursday, May 26, 2005)]
[Rules and Regulations]
[Pages 30334-30358]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-10266]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9207]
RIN 1545-AX93


Assumption of Partner Liabilities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations; and removal of temporary 
regulations.

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SUMMARY: This document contains final regulations relating to the 
definition of liabilities under section 752 of the Internal Revenue 
Code (Code). These regulations provide rules regarding a partnership's 
assumption of certain fixed and contingent obligations in connection 
with the issuance of a partnership interest and provide conforming 
changes to certain regulations. These regulations also provide rules 
under section 358(h) for assumptions of liabilities by corporations 
from partners and partnerships. Finally, this document also contains 
temporary regulations relating to the assumption of certain liabilities 
under section 358(h). The text

[[Page 30335]]

of the temporary regulations also serves as the text of the proposed 
regulations set forth in the notice of proposed rulemaking on this 
subject in the proposed rules section in this issue of the Federal 
Register.

DATES: Effective Date: These regulations are effective May 26, 2005.
    Applicability Dates: The final Sec.  1.752-6 regulations apply to 
assumptions of liabilities by a partnership occurring after October 18, 
1999, and before June 24, 2003. All of the other final regulations in 
this Treasury Decision, as well as the temporary regulations under 
section 358, apply to liabilities assumed on or after June 24, 2003, 
except as otherwise noted.

FOR FURTHER INFORMATION CONTACT: Laura Fields at (202) 622-3050 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control number 1545-1843. Responses to these collections 
of information are mandatory and are required to obtain a benefit. The 
collections of information in this final regulation is in Sec.  1.752-
7(e), (f), (g), and (h). This information is required for a former or 
current partner of a partnership to take deductions, losses, or capital 
expenses attributable to the satisfaction of the Sec.  1.752-7 
liability. This information will be used by the partner in order to 
take a deduction, loss, or capital expense. An additional collection of 
information in this final regulation is in Sec.  1.752-7(k)(2). This 
information is required to inform the IRS of partnerships making the 
designated election and to report income appropriately. The collection 
of information is required to obtain a benefit, i.e., to elect to apply 
the provisions of Sec.  1.752-7 of the regulations in lieu of Sec.  
1.752-6. The likely respondents are business or other for-profit 
institutions and small businesses or organizations.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Estimated total annual reporting burden: 125 hours.
    The estimated annual burden per respondent varies from 20 to 40 
minutes, depending on individual circumstances, with an estimated 
average of 30 minutes.
    Estimated number of respondents: 250.
    Estimated annual frequency of responses: On occasion.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, 
SE:W:CAR:MP:T:T:SP Washington, DC 20224, and to the Office of 
Management and Budget, Attn: Desk Officer for the Department of the 
Treasury, Office of Information and Regulatory Affairs, Washington, DC 
20503.
    Books or records relating to this collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains amendments to 26 CFR part 1 under sections 
358, 704, 705, 737 and 752 of the Internal Revenue Code (Code).
    As part of the Community Renewal Tax Relief Act of 2000 (the 
Act)(114 Stat. 2763), Congress enacted, on December 15, 2000, section 
358(h), effective October 18, 1999, to address certain situations in 
which property is transferred to a corporation in exchange for both 
stock and the corporation's assumption of certain obligations of the 
transferor. In these situations, transferors took the position that the 
obligations were not liabilities within the meaning of section 357(c) 
or that they were described in section 357(c)(3), and, therefore, the 
obligations did not reduce the basis of the transferor's stock. These 
assumed obligations, however, did reduce the value of the stock. The 
transferors then sold the stock and claimed a loss. In this way, 
taxpayers attempted to duplicate a loss in corporate stock and to 
accelerate deductions that typically are allowed only on the economic 
performance of these types of obligations.
    Section 358(h) addresses these transactions by requiring that, 
after the application of section 358(d), the basis in stock received in 
an exchange to which section 351, 354, 355, 356, or 361 applies be 
reduced (but not below the fair market value of the stock) by the 
amount of any liability assumed in the exchange. Exceptions to section 
358(h) are provided where: (1) The trade or business with which the 
liability is associated is transferred to the person assuming the 
liability as part of the exchange; or (2) substantially all of the 
assets with which the liability is associated are transferred to the 
person assuming the liability as part of the exchange. The Secretary, 
however, has the authority to limit these exceptions. The term 
liability for purposes of section 358(h) includes any fixed or 
contingent obligation to make payment without regard to whether the 
obligation is otherwise taken into account for purposes of the Code.
    Congress recognized that taxpayers were attempting to use 
partnerships and S corporations to carry out the same types of abuses 
that section 358(h) was designed to deter. Therefore, in sections 
309(c) and (d)(2) of the Act, Congress directed the Secretary to 
prescribe rules to provide ``appropriate adjustments under subchapter K 
of chapter 1 of the Code to prevent the acceleration or duplication of 
losses through the assumption of (or transfer of assets subject to) 
liabilities described in section 358(h)(3) * * * in transactions 
involving partnerships.'' Under the statute, these rules are to ``apply 
to assumptions of liability after October 18, 1999, or such later date 
as may be prescribed in such rules.''
    In response to this directive, a notice of proposed rulemaking 
(REG-106736-00; 2003-28 I.R.B. 46) under sections 358, 704, 705, and 
752 was published in the Federal Register (68 FR 37434) on June 24, 
2003. In addition, temporary regulations (TD 9062) were published on 
that same day (68 FR 37414). The proposed and temporary regulations 
provide rules to prevent the duplication and acceleration of loss 
through the assumption by a partnership of certain liabilities from a 
partner. Section 1.752-6T of the temporary regulations (the temporary 
regulations) applies to liabilities assumed by a partnership after 
October 18, 1999, and before June 24, 2003. Section 1.752-7 of the 
proposed regulations (the proposed regulations) applies to liabilities 
assumed by a partnership on or after June 24, 2003. However, taxpayers 
may elect to apply the proposed regulations, instead of the temporary 
regulations, to liabilities assumed by a partnership after October 18, 
1999, and before June 24, 2003.
    The temporary regulations adopt the approach of section 358(h), 
with some modifications. For example, the exception for contributions 
of ``substantially all of the assets with which the liability is 
associated'' does not apply to certain abusive transactions described 
in Notice 2000-44, released to the public on August 11, 2000, and 
published on September 5, 2000 (2000-2 C.B. 255).

[[Page 30336]]

    The proposed regulations deviate somewhat from the rules of section 
358(h). In particular, the proposed regulations do not reduce the 
partner's basis in the partnership at the time of the assumption of a 
Sec.  1.752-7 liability by the partnership, but delay that reduction 
until an event occurs that separates the partner from the liability 
(triggering event). The triggering events are: (1) A disposition (or 
partial disposition) of the partnership interest by the partner; (2) a 
liquidation of the partner's interest in the partnership; and (3) the 
assumption of the liability by another partner. After a triggering 
event, the partnership's (or the assuming partner's) deduction on the 
economic performance of the Sec.  1.752-7 liability is limited. 
However, if the partnership (or the assuming partner) notifies the 
partner of the economic performance of the Sec.  1.752-7 liability, 
then the partner may take a loss or deduction in the amount of the 
prior basis reduction.
    The proposed regulations include an exception, similar to the 
exception in section 358(h)(2)(A), for transactions in which the 
partner contributes to the partnership the trade or business with which 
the liability is associated as part of the exchange (the trade or 
business exception), but do not include an exception, similar to the 
exception in section 358(h)(2)(B), for transactions in which the 
partner contributes to the partnership substantially all of the assets 
associated with the liability as part of the exchange. The proposed 
regulations also include an additional exception for situations in 
which, immediately before the triggering event, the amount of the 
remaining built-in loss with respect to all Sec.  1.752-7 liabilities 
assumed by the partnership (other than Sec.  1.752-7 liabilities 
assumed by the partnership with an associated trade or business) in one 
or more Sec.  1.752-7 liability transfers is less than the lesser of 
10% of the gross value of partnership assets or $1,000,000 (the de 
minimis exception).
    In addition, the proposed regulations provide detailed rules to 
address the treatment of the liability between the date of the 
assumption of that liability by the partnership and the date of a 
triggering event and to address tiered entity situations.
    The proposed regulations distinguish between a Sec.  1.752-1 
liability, for which a basis reduction is required when the liability 
is assumed by the partnership from a partner, and a Sec.  1.752-7 
liability, for which a basis reduction is not required until the 
occurrence of a triggering event. Under the proposed regulations, an 
obligation is a Sec.  1.752-1 liability to the extent the obligation 
creates or increases the basis of any of the obligor's assets 
(including cash), gives rise to an immediate deduction to the obligor, 
or gives rise to an expense that is not deductible in computing the 
obligor's taxable income and is not properly chargeable to capital. All 
remaining obligations are Sec.  1.752-7 liabilities. Under the proposed 
regulations, Sec.  1.752-7 liabilities are subject to the rules of 
section 704(c) and the regulations thereunder.
    The American Jobs Creation Act of 2004, Public Law 108-357 (118 
Stat. 1418) (the Act), was enacted on October 22, 2004. Section 833(a) 
of the Act amended section 704(c) of the Code by adding section 
704(c)(1)(C), effective for contributions of property to a partnership 
after October 22, 2004. Under new section 704(c)(1)(C), if ``built-in 
loss'' property is contributed to a partnership, the built-in loss 
shall be taken into account only in determining the items allocated to 
the contributing partner, and, except as provided in regulations, in 
determining the amount of items allocated to the other partners, the 
basis of the contributed property shall be treated as being equal to 
its fair market value at the time of contribution. For this purpose, a 
``built-in loss'' is defined to mean the excess of the adjusted basis 
of the property in the hands of the contributing partner over its fair 
market value at the time of its contribution to the partnership.
    Section 833(b) of the Act requires basis adjustments to be made 
following certain transfers of interests in partnerships for which no 
section 754 election is in effect. As amended by the Act, section 
743(a) and (b) of the Code requires a partnership to reduce the basis 
of partnership property upon the transfer of an interest in the 
partnership by sale or exchange or upon the death of a partner, if, at 
the time of the relevant transfer, the partnership has a ``substantial 
built-in loss.'' Section 743(d)(1) provides that, for purposes of 
section 743, a partnership has a substantial built-in loss with respect 
to a transfer of a partnership interest if the partnership's adjusted 
basis in the partnership's property exceeds by more than $250,000 the 
fair market value of such property. Exceptions are provided for 
electing investment partnerships and for securitization partnerships, 
as defined in the Act. See also sections 734(b) and (d), as amended by 
section 833(c) of the Act (requiring a basis adjustment to be made 
following a distribution from a partnership for which no section 754 
election is in effect in the case of a ``substantial basis 
reduction'').
    The IRS and the Treasury Department are aware of certain 
similarities between the treatment of Sec.  1.752-7 liabilities in 
these regulations and the treatment of built-in losses under sections 
704(c)(1)(C), 734, and 743 of the Code, as added by the Act. For 
example, it is possible to view the contribution of property with an 
adjusted tax basis equal to the fair market value of the property, 
determined without regard to any Sec.  1.752-7 liabilities, as ``built-
in loss'' property after the Sec.  1.752-7 liability is taken into 
account in those cases where the Sec.  1.752-7 liability is related to 
the contributed property. Although a partnership's assumption of a 
Sec.  1.752-7 liability as part of the contribution of property to the 
partnership can be analogized to a property with an adjusted tax basis 
greater than fair market value, the purposes of section 704(c)(1)(C) 
and Sec.  1.752-7 are different in certain respects. Section 
704(c)(1)(C) and the other changes in section 833 of the Act are 
directed toward loss duplication whereas Sec.  1.752-7 is directed at 
both loss duplication and loss acceleration. Therefore, to the extent 
of any built-in loss attributable to a Sec.  1.752-7 liability, Sec.  
1.752-7 shall be applied without regard to the amendments made by the 
Act, unless future guidance provides to the contrary. Any such guidance 
would be prospective in application.
    Written comments were received in response to the notice of 
proposed rulemaking, and a public hearing was held on October 14, 2003. 
Two commentators requested to speak at that hearing. After 
consideration of the comments, the proposed and temporary regulations 
are adopted as modified by this Treasury decision.

Explanation of Provisions

    These final regulations generally follow the proposed and temporary 
regulations with the changes described below.

1. Comments on Sec.  1.752-6T

    Several commentators suggested that the issuance of Sec.  1.752-6T 
exceeded the authority granted to the Secretary in section 309 of the 
Act. More specifically, some commentators suggested that Sec.  1.752-6T 
results in the inappropriate denial of a bona fide loss, that Sec.  
1.752-6T was issued to bootstrap the IRS's litigating position 
regarding transactions described in Notice 2000-44 (2000-2 C.B. 255), 
and that section 309 of the Act only granted the Secretary the 
authority to prescribe rules to address situations in which a 
partnership liability is assumed by a corporation. In addition, several

[[Page 30337]]

commentators argued that the Treasury Department and the IRS exceeded 
their authority in providing that Sec.  1.752-6T applies retroactively 
to assumptions of liabilities occurring after October 18, 1999, and 
before June 24, 2003, the date the regulations were issued.
    The Treasury Department and the IRS believe that Sec.  1.752-6T 
does not result in the inappropriate denial of a bona fide loss. The 
exceptions in Sec.  1.752-6T generally limit the application of the 
regulations to transactions that are abusive in nature and that lack a 
business purpose. In addition, the regulations allow taxpayers to elect 
into Sec.  1.752-7 so as to avoid the immediate basis reduction under 
Sec.  1.752-6T. Recognizing, however, that some taxpayers may not have 
expected the approach taken in Sec.  1.752-7 when engaging in 
transactions in prior years, Sec.  1.752-6T employs rules similar to 
section 358(h) for partnership transactions.
    Those commentators who suggested that the IRS issued Sec.  1.752-6T 
to ``bootstrap'' its litigating position in Notice 2000-44 pointed to 
the fact that Notice 2000-44 did not mention that regulations would be 
issued in the future to challenge the transactions described in that 
notice. As discussed earlier, the Act was enacted with a retroactive 
effective date and granted the Treasury Department and the IRS the 
authority to issue retroactive regulations. The Treasury Department and 
the IRS believe that they have appropriately exercised this grant of 
authority. Also, Notice 2000-44 was released on August 11, 2000. The 
Act was not enacted into law until December 15, 2000, after the release 
of Notice 2000-44. Therefore, the Treasury Department and the IRS could 
not reference regulations promulgated under the Act in Notice 2000-44.
    The Treasury Department and the IRS have concluded that the 
Secretary's authority under section 309(c) is not limited to addressing 
assumptions of liabilities by corporations from partnerships. The plain 
language of the legislative directive is not so limited and the 
legislative history does not support such a limitation.
    To the contrary, the Treasury Department and the IRS believe that 
the rules of Sec.  1.752-6T carry out the explicit directive of section 
309(c) of the Act by applying to partnership transactions rules that 
are analogous to the rules that apply to corporate transactions under 
section 358(h). For example, if the transactions described in Notice 
2000-44 were effected through a contribution to a corporation, rather 
than a contribution to a partnership, section 358(h) would generally 
apply to such a transaction, causing a basis reduction identical to 
that provided by Sec.  1.752-6T.
    Section 7805(b) addresses when a regulation (temporary, proposed, 
or final) may be effective retroactively. Section 7805(b)(1) generally 
provides that no temporary, proposed, or final regulations relating to 
the internal revenue laws shall apply to any taxable period ending 
before the earliest of the following dates: (A) The date on which such 
regulation is filed with the Federal Register; (B) in the case of any 
final regulation, the date on which any proposed or temporary 
regulation to which such final regulation relates was filed with the 
Federal Register; or (C) the date on which any notice substantially 
describing the expected contents of any temporary, proposed, or final 
regulation is issued to the public. However, section 7805(b) provides a 
list of exceptions to the general rule stated above. Included in that 
list, and relevant in this context, is section 7805(b)(6). Section 
7805(b)(6) provides that the limitation may be superseded ``by a 
legislative grant from Congress authorizing the Secretary to prescribe 
the effective date with respect to any regulation.'' Also included 
among the exceptions to the general rule in section 7805(b)(1) is 
section 7805(b)(3). Section 7805(b)(3) states that the ``Secretary may 
provide that any regulation may take effect or apply retroactively to 
prevent abuse.''
    The retroactive effective date of Sec.  1.752-6T is in accordance 
with the directive in section 309(c) and (d)(2) of the Act and section 
7805(b)(6). Furthermore, pursuant to section 7805(b)(3), the Secretary 
has determined that a retroactive effective date is appropriate to 
prevent abuse.
    For these reasons, the Treasury Department and the IRS have 
concluded that Sec.  1.752-6T is a valid exercise of the Secretary's 
regulatory authority under the Code and section 309 of the Act.

2. Extension of Time To Adopt the Provisions of Sec.  1.752-7 in Lieu 
of Sec.  1.752-6T

    Section 1.752-6T(d)(2) provides that partnerships may elect to 
apply the provisions of Sec.  1.752-7 of the proposed regulations to 
all assumptions of liabilities by the partnership occurring after 
October 18, 1999, and before June 24, 2003, in lieu of applying Sec.  
1.752-6T of the temporary regulations. The election must be filed with 
the first Federal income tax return filed by the partnership on or 
after September 24, 2003.
    Several commentators expressed a need for additional time to make 
this election. In response to these comments, the election period 
described in Sec.  1.752-6T(d)(2) has been extended. Under the 
extension, an election to apply the regulations under Sec.  1.752-7, 
rather than the regulations under Sec.  1.752-6, to all liabilities 
assumed by a partnership after October 18, 1999, and before June 24, 
2003, must be filed with a Federal income tax return filed by the 
partnership on or after September 24, 2003, and on or before December 
31, 2005.

3. Section 1.358-5T, Special Rules for Assumption of Liabilities

    The preamble to the proposed regulations advised taxpayers that, 
with respect to an exchange to which section 358(a)(1) applies, the 
Treasury Department and the IRS were considering exercising their 
authority under section 358(h)(2) to issue regulations that would limit 
the exceptions to section 358(h)(1) to follow the exceptions set forth 
in the proposed regulations under Sec.  1.752-7 (other than the de 
minimis exception). The preamble indicated that such regulations would 
be retroactive to the extent necessary to prevent abuse. No comments 
were received regarding the appropriate scope or substance of such 
regulations. The Treasury Department and the IRS have determined that 
removing the exception of section 358(h)(2)(B) (which applies where 
substantially all of the assets with which the liability is associated 
are transferred to the person assuming the liability as part of the 
exchange) is necessary to prevent the abuse that section 358(h) was 
designed to prevent. Therefore, with respect to an exchange to which 
section 358(a)(1) applies, this document contains temporary regulations 
providing that the exception contained in section 358(h)(2)(B) does not 
apply to exchanges under section 358(a)(1) in which liabilities are 
assumed on or after June 24, 2003.

4. Section 752-7 Liability

    Commentators have asked for clarification on whether an obligation 
could be a Sec.  1.752-1 liability in part and a Sec.  1.752-7 
liability in part. Certain obligations that create liabilities under 
Sec.  1.752-1 may also create Sec.  1.752-7 liabilities. For example, a 
fixed obligation that gives rise to basis can have a component portion 
that changes in value between the time the obligation is first incurred 
by the partner and the time that the partnership assumes the obligation 
due to changes in interest rates, stock price, or other similar 
factors. In these and other cases, the value of the obligation to the 
holder has

[[Page 30338]]

increased and, as a result, the cost to the obligor has increased by a 
like amount. The final regulations clarify that an obligation can be 
treated in part as a Sec.  1.752-7 liability and in part as a Sec.  
1.752-1 liability.

5. Satisfaction Other Than by Economic Performance

    The proposed regulations allow the Sec.  1.752-7 liability partner 
to claim a loss or deduction upon ``economic performance'' of the 
obligation. Certain Sec.  1.752-7 liabilities may be settled in cash or 
in kind, extinguished, satisfied or otherwise resolved under 
circumstances where there may not be an ``economic performance'' of the 
obligation within the meaning of that term. See section 461(h) and 
Sec.  1.461-4. In addition, economic performance only applies to 
``liabilities'' as defined in Sec.  1.446-1(c)(1)(ii)(B), and it is 
possible that some Sec.  1.752-7 liabilities may not come within the 
meaning of that term. As a result, the final regulations allow the 
Sec.  1.752-7 liability partner to claim a loss or deduction under 
Sec.  1.752-7 upon the ``satisfaction of the Sec.  1.752-7 liability''. 
A Sec.  1.752-7 liability is treated as satisfied on the date upon 
which, but for Sec.  1.752-7, the partnership, or the assuming partner, 
would have been allowed to take the Sec.  1.752-7 liability into 
account for federal tax purposes. The final regulations provide a 
nonexclusive list of examples of when the Sec.  1.752-7 liability would 
be taken into account for these purposes.

6. Application of Section 704(c)

    Under Sec.  1.752-7(c), any Sec.  1.752-7 liability assumed by a 
partnership in a Sec.  1.752-7 liability transfer is treated under 
section 704(c) principles as having a built-in loss equal to the amount 
of the Sec.  1.752-7 liability as of the date of the partnership's 
assumption of the Sec.  1.752-7 liability. The proposed regulations 
provide that, if a Sec.  1.752-7 liability is assumed from the 
partnership by a partner other than the Sec.  1.752-7 liability 
partner, and the trade or business or de minimis exceptions does not 
apply, then section 704(c)(1)(B) does not apply to the assumption and 
instead the rules of Sec.  1.752-7(g) apply. Commentators asked whether 
section 704(c)(1)(B) applies to the assumption of a Sec.  1.752-7 
liability by another partner if the trade or business or de minimis 
exceptions apply to that assumption. In addition, commentators 
questioned whether the successor partner rule of Sec.  1.704-3(a)(7) 
applies to the built-in loss amount of the Sec.  1.752-7 liability. The 
successor partner rule provides that, if a contributing partner 
transfers a partnership interest, built-in gain or loss must be 
allocated to the transferee partner as it would have been allocated to 
the transferor partner.
    The intent of the Treasury Department and the IRS was that all of 
the rules of section 704(c), Sec.  1.704-3, and Sec.  1.704-4, 
including section 704(c)(1)(B), apply to Sec.  1.752-7 liabilities 
unless otherwise specifically stated. The Sec.  1.752-7 regulations 
have been modified to make this clear. In addition, Sec.  1.704-3 has 
been amended to provide that Sec.  1.752-7 liabilities are section 
704(c) property and to provide that in general, the successor partner 
rule does not apply to Sec.  1.752-7 liabilities.
    Comments were also received regarding the application of section 
704(c) principles to the extent that a Sec.  1.752-7 liability has 
decreased after the partnership's assumption of the liability. 
Consistent with the principles of Sec.  1.704-3, the final regulations 
provide that, if there is a post-assumption change in the value of the 
Sec.  1.752-7 liability, resulting in an obligation amount that is 
either greater or less than the initial amount of the obligation, the 
change in the amount will be treated as a section 704(b) and not a 
section 704(c) item, thereby creating book income or loss to be 
allocated to the partners. The final regulations also provide that, if 
the value of the Sec.  1.752-7 liability decreases after the assumption 
of the obligation by the partnership, the ``ceiling rule'' applies, and 
the partnership and the partners are entitled to adopt one of the 
reasonable methods specified in Sec.  1.704-3 to correct any ceiling 
rule disparities.

7. Section 1.752-7 Liabilities That Are Capitalized and Not Deducted

    The proposed regulations make reference in several places to a 
``deduction or capital expense'', but no rules are provided as to how 
the capital expense is taken into account. For example, no rules are 
provided in the proposed regulations for situations where the 
contributing partner is still a partner in the partnership at the time 
that the obligation is recognized for federal tax purposes and 
capitalized into the tax basis of one or more assets of the 
partnership.
    The final regulations add a rule to Sec.  1.704-3 providing that, 
to the extent a partnership properly capitalizes all or a portion of an 
item as described in paragraph Sec.  1.704-3(a)(12), then the item or 
items to which such cost is properly capitalized is treated as section 
704(c) property with the same amount of built-in loss as corresponds to 
the amount capitalized. Similar rules are provided under Sec. Sec.  
1.704-4 and 1.737-2.
    In addition, the proposed regulations do not provide any guidance 
as to the appropriate tax treatment if a triggering event occurs after 
a Sec.  1.752-7 liability has been capitalized into the basis of one or 
more assets of the partnership. Under the final regulations, no 
reduction in the partner's basis in the partnership interest is 
required with respect to such a capitalized amount as a result of the 
triggering event, but, after the triggering event, neither the 
partnership nor the remaining partners may use the capitalized basis.

8. Exception for Trading and Investment Partnerships

    The proposed regulations contain an exception to Sec.  1.752-7(e), 
(f), and (g) for assumptions of liabilities in connection with the 
contribution of an associated trade or business, provided that the 
partnership continues to carry on that trade or business after the 
contribution. The proposed regulations provide that, for this purpose, 
a trade or business generally does not include the activity of 
acquiring, holding, or disposing of financial instruments, unless such 
activity is carried on by an entity registered with the Securities and 
Exchange Commission as a management company under the Investment 
Company Act of 1940, as amended (15 U.S.C. 80a).
    The exception for entities registered as management companies was 
intended to apply narrowly to master-feeder partnerships; however, it 
appears that the exception could apply to a broader range of entities, 
some of which could be carrying on the types of transactions that 
section 309 of the Act and these regulations were intended to address. 
Consequently, the Treasury Department and the IRS have removed the 
exception for entities registered as management companies.
    The Treasury Department and the IRS do not believe that eliminating 
the exception will create a substantial burden for master-feeder 
partnerships, because interests in these partnerships are not regularly 
sold, and because distributions by these partnerships typically take 
the form of nonliquidating distributions of cash. Accordingly, master-
feeder partnerships are unlikely to engage in triggering events that 
would implicate this regulation.
    Therefore, under the final regulations, the activity of acquiring, 
holding, dealing in, or disposing of financial instruments is not 
treated as a trade or business even if engaged in by an entity 
registered as a management company. For assumptions of liabilities on 
or after June 24, 2003, and before May 26, 2005, however, entities 
registered as

[[Page 30339]]

management companies may rely on the exception to the trade or business 
definition in the proposed regulations.

9. Technical Terminations, Mergers, and Divisions

    Section 1.708-1(b)(4) provides that if a partnership is terminated 
under section 708(b)(1)(B) by a sale or exchange of an interest, the 
partnership is deemed to contribute all of its assets and liabilities 
to a new partnership in exchange for an interest in the new 
partnership; and, immediately thereafter, the terminated partnership is 
deemed to distribute interests in the new partnership to the purchasing 
partner and the other remaining partners.
    A commentator asked whether the rules provided in Sec.  1.752-7 
apply to the contribution and distribution of partnership interests 
deemed to occur under Sec.  1.708-1(b)(4). Rules have been added to the 
final regulations to clarify how the regulations apply to technical 
terminations and partnership mergers and divisions. These rules are 
designed to ensure that, after a technical termination, merger, or 
division, the partners that were Sec.  1.752-7 liability partners of 
the prior partnership continue to be Sec.  1.752-7 liability partners 
of the new partnership, and that built-in loss associated with the 
Sec.  1.752-7 liability does not shift from one partner to another 
partner. In addition, these rules are designed to ensure that a deemed 
assumption of a liability as a result of a technical termination of a 
partnership does not create any new Sec.  1.752-7 liabilities that did 
not exist prior to the technical termination.
    Accordingly, Sec.  1.752-7(b)(6)(ii) of the final regulations 
provides that, in determining if a deemed contribution of assets and 
assumption of liability as a result of a technical termination is 
treated as a Sec.  1.752-7 liability transfer, only liabilities that 
were Sec.  1.752-7 liabilities of the terminating partnership are taken 
into account and, then, only to the extent of the amount of the 
liability that was subject to Sec.  1.752-7 prior to the technical 
termination.
    In addition, the definition of a Sec.  1.752-7 liability partner 
has been amended to clarify that, if, in a transaction described in 
Sec.  1.752-7(e)(3), a partnership (lower-tier partnership) assumes a 
Sec.  1.752-7 liability from another partnership (upper-tier 
partnership), then any partners that were Sec.  1.752-7 liability 
partners of the upper-tier partnership continue to be Sec.  1.752-7 
liability partners of the lower-tier partnership with respect to the 
remaining built-in loss associated with the Sec.  1.752-7 liability at 
the time of the assumption of the Sec.  1.752-7 liability by the lower-
tier partnership from the upper-tier partnership. Any new built-in loss 
associated with the Sec.  1.752-7 liability that is created on the 
assumption of the Sec.  1.752-7 liability from the upper-tier 
partnership by the lower-tier partnership is shared by all the partners 
of the upper-tier partnership in accordance with their interests in the 
upper-tier partnership, and each partner of the upper-tier partnership 
is treated as a Sec.  1.752-7 liability partner with respect to that 
new built-in loss.
    The definition of Sec.  1.752-7 liability partner has also been 
amended to provide that, if, in a transaction described in Sec.  1.752-
7(e)(3), an interest in a partnership (lower-tier partnership) that has 
assumed a Sec.  1.752-7 liability is distributed by a partnership 
(upper-tier partnership) that is the Sec.  1.752-7 liability partner 
with respect to that liability, then the persons receiving interests in 
the lower-tier partnership are Sec.  1.752-7 liability partners with 
respect to the lower-tier partnership to the same extent that they were 
prior to the distribution. In addition, Sec.  1.752-7(e)(3) has been 
amended to provide that a distribution of an interest in a lower-tier 
partnership is exempt from the application of Sec.  1.752-7(e) only if 
the partners that were Sec.  1.752-7 liability partners with respect to 
the lower-tier partnership prior to the distribution continue to be 
Sec.  1.752-7 liability partners with respect to the lower-tier 
partnership after the distribution.

10. Disguised Sale Rules

    Section 707(a)(2)(B) provides that where there is a direct or 
indirect transfer of money or other property by a partner to a 
partnership and a related direct or indirect transfer of money or 
property by the partnership to such partner and the transfers, when 
viewed together, are properly characterized as a sale or exchange, such 
transfers shall be treated either as a transaction between the 
partnership and one who is not a partner, or as a transaction between 
two or more partners acting other than in their capacity as members of 
the partnership. Section 1.752-7(a)(2) of the proposed regulations 
provides that the assumption of a Sec.  1.752-7 liability is not 
treated as an assumption of a liability or as a transfer of cash for 
purposes of section 707(a)(2)(B). One commentator noted that the 
language contained in the proposed regulations was not consistent with 
Sec.  1.707-5(a), which takes into account all liabilities, regardless 
of whether those liabilities are taken into account under section 752.
    The intent of the proposed regulations under section 752 was not to 
override the disguised sale rules under section 707, which may include 
Sec.  1.752-7 liabilities as consideration. Therefore, Sec.  1.752-
7(a)(2) has been removed.

11. Revisions to Sec.  1.704-1(b)(2)(iv)

    Under section 704(b), a partner's distributive share of income, 
gain, loss, deduction, or credit (or item thereof) is determined in 
accordance with the partnership agreement provided that those 
allocations have substantial economic effect. If the allocations under 
the partnership agreement do not have substantial economic effect or 
the partnership agreement does not provide as to a partner's 
distributive share of partnership items, then the partner's 
distributive share of such items is determined in accordance with the 
partner's interest in the partnership (determined by taking into 
account all facts and circumstances).
    Section 1.704-1(b) describes various requirements that must be met 
for partnership allocations to have substantial economic effect. Among 
these requirements is that (except as otherwise provided in Sec.  
1.704-1(b)) the partnership agreement must provide for the 
determination and maintenance of capital accounts in accordance with 
the rules of Sec.  1.704-1(b)(2)(iv).
    Section 1.704-1(b)(2)(iv)(b) generally requires that a partner's 
capital account be increased by the value of property contributed by 
the partner to the partnership net of liabilities secured by such 
contributed property that the partnership is considered to assume or 
take subject to under section 752, and be decreased by the value of 
property distributed by the partnership to the partner net of 
liabilities secured by such distributed property that the partner is 
considered to assume or take subject to under section 752. Section 
1.704-1(b)(2)(iv)(c) requires that a partner's capital account be 
increased by liabilities of the partnership that are assumed by such 
partner (other than liabilities described in Sec.  1.704-
1(b)(2)(iv)(b)(5)), and be decreased by liabilities of the partner that 
are assumed by the partnership (other than liabilities described in 
Sec.  1.704-1(b)(2)(iv)(b)(2)). The proposed regulations revised Sec.  
1.704-1(b)(2)(iv)(b) to take into account all liabilities to which the 
contributed or distributed property is subject, not just liabilities 
described in section 752. The proposed regulations did not revise Sec.  
1.704-1(b)(2)(iv)(c), because that section is not limited to 
assumptions of liabilities described in section 752.

[[Page 30340]]

    A commentator suggested that, if all liabilities are covered by 
Sec.  1.704-1(b)(2)(iv)(b), then Sec.  1.704-1(b)(2)(iv)(c) did not 
have any effect and should be removed. The final regulations do not 
adopt this comment, because the Treasury Department and the IRS believe 
that Sec.  1.704-1(b)(2)(iv)(c) has significance even though Sec.  
1.704-1(b)(2)(iv)(b) is no longer limited to liabilities described in 
section 752. Section 1.704-1(b)(2)(iv)(b) applies only to situations in 
which liabilities are assumed by the partnership or the partner in 
connection with the contribution or distribution of property, or 
contributed or distributed property is taken subject to liabilities. 
Section 1.704-1(b)(2)(iv)(b) does not apply if liabilities are assumed 
by the partnership or a partner other than in connection with a 
contribution or distribution; these assumptions are covered by Sec.  
1.704-1(b)(2)(iv)(c).

12. Notification Upon Satisfaction of the Sec.  1.752-7 Liability

    One commentator suggested that, to prevent the loss of a deduction 
to the Sec.  1.752-7 partner, the regulations should require the 
assuming partnership or partner to notify the Sec.  1.752-7 liability 
partner of the satisfaction of the Sec.  1.752-7 liability. The 
proposed regulations impose no penalty on the partnership for failure 
to notify the Sec.  1.752-7 liability partner. The commentator also 
suggested that the Sec.  1.752-7 liability partner be required to keep 
contact information current with the assuming partnership or partner.
    The Treasury Department and the IRS do not believe that imposing 
additional requirements is necessary in these circumstances. It is 
anticipated that the Sec.  1.752-7 liability partner, upon entering the 
partnership, will negotiate with the partnership for the necessary 
notification. Therefore, this comment was not adopted.

13. Treatment of Sec.  1.752-7 Liabilities

    Commentators have requested that the final regulations include 
guidance on the recourse or nonrecourse treatment of Sec.  1.752-7 
liabilities for all purposes of subchapter K. Under the proposed 
regulations, a Sec.  1.752-7 liability is treated as a nonrecourse 
liability solely for purposes of Sec.  1.704-2, dealing with the 
allocation of nonrecourse deductions among the partners. The only other 
provision that the Treasury Department and the IRS are aware of for 
which the characterization of a Sec.  1.752-7 liability as recourse or 
nonrecourse is Sec.  1.707-5 (addressing the treatment of liabilities 
for purposes of the disguised sale rules of section 707(a)(2)(B)), and 
Sec.  1.707-5 already provides adequate rules for determining if a 
Sec.  1.752-7 liability is recourse or nonrecourse. Because a Sec.  
1.752-7 liability is not, by definition, a Sec.  1.752-1 liability, the 
recourse or nonrecourse nature of a Sec.  1.752-7 liability is not 
relevant for purposes of Sec. Sec.  1.752-1 through 1.752-5. For this 
reason, this comment was not adopted.

14. Valuation of Sec.  1.752-7 Liabilities

    Comments were received requesting that the final regulations 
include guidance on acceptable methods for identifying and valuing 
Sec.  1.752-7 liabilities, as well as identifying the appropriate 
discount rate for determining the liability's present value.
    The Treasury Department and the IRS believe that such matters are 
best left to the negotiation of the financial arrangement among the 
parties and are beyond the scope of this regulation. In an arm's length 
transaction, the parties will take the potential occurrence of these 
obligations into account in arriving at the agreement among the parties 
that will govern their affairs, including the appropriate valuation 
methodology to apply to these obligations. Accordingly, the final 
regulations do not adopt this comment.
    However, the final regulations clarify that, if the obligation 
arose under a contract in exchange for rights granted to the obligor 
under that contract, and those contractual rights are contributed to 
the partnership in connection with the partnership's assumption of the 
contractual obligation, then the amount of the Sec.  1.752-7 liability 
is the amount of cash, if any, that a willing assignor would pay to a 
willing assignee to assume the entire contract.

Effective Date

    The final Sec.  1.752-6 regulations apply to assumptions of 
liabilities by a partnership occurring after October 18, 1999, and 
before June 24, 2003. All of the other final regulations in this 
Treasury decision apply to liabilities assumed on or after June 24, 
2003, except as otherwise noted.

Special Analyses

    These final and temporary regulations are necessary to prevent 
abusive transactions involving transfers to partnerships and 
corporations of the type Section 358(h) was enacted to prevent. 
Accordingly, good cause is found for dispensing with notice and public 
procedure pursuant to 5 U.S.C. 553(b)(B) with respect to the temporary 
regulations, and for dispensing with a delayed effective date pursuant 
to 5 U.S.C. 553(d)(1) and (3) with respect to the final and temporary 
regulations.
    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 is hereby 
certified that the final regulations in this document will not have a 
significant economic impact on a substantial number of small entities. 
This certification is based upon the fact that few partnerships engage 
in the type of transactions that are subject to these regulations 
(assumptions of liabilities not described in section 752(a) and (b) 
from a partner). In addition, available data indicates that most 
partnerships that engage in the type of transactions that are subject 
to these regulations are large partnerships. Certain broad exceptions 
to the application of these regulations (including a de minimis 
exception) further limit the economic impact of these regulations on 
small entities. Therefore, a Regulatory Flexibility Analysis under the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. For 
the applicability of the Regulatory Flexibility Act to the temporary 
regulations in this document (Sec.  1.358-5T), refer to the cross-
reference notice of proposed rulemaking published in the proposed rules 
section in this issue of the Federal Register. Pursuant to section 
7805(f) of the Code, the notice of proposed rulemaking that preceded 
these regulations was submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on its impact on small 
business.

Drafting Information

    The principal author of these regulations is Laura Nash, 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

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

[[Page 30341]]

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.358-5T also issued under 26 U.S.C. 358(h)(2). * * *
    Section 1.358-7 also issued under Public Law 106-554, 114 Stat. 
2763, 2763A-638 (2001). * * *
    Section 1.752-1(a) also issued under Public Law 106-554, 114 
Stat. 2763, 2763A-638 (2001).
    Section 1.752-6 also issued under Public Law 106-554, 114 Stat. 
2763, 2763A-638 (2001)
    Section 1.752-7 also issued under Public Law 106-554, 114 Stat. 
2763, 2763A-638 (2001). * * *


0
Par. 2. Section 1.358-5T is added to read as follows:


Sec.  1.358-5T  Special rules for assumption of liabilities 
(temporary).

    (a) In general. Section 358(h)(2)(B) does not apply to an exchange 
occurring on or after June 24, 2003.
    (b) Effective dates. This section applies to exchanges occurring on 
or after June 24, 2003.

0
Par. 3. Section 1.358-7 is added to read as follows:


Sec.  1.358-7  Transfers by partners and partnerships to corporations.

    (a) Transfers by partners of partnership interests. For purposes of 
section 358(h), a transfer of a partnership interest to a corporation 
is treated as a transfer of the partner's share of each of the 
partnership's assets and an assumption by the corporation of the 
partner's share of partnership liabilities (including section 358(h) 
liabilities, as defined in paragraph (d) of this section). See 
paragraph (e) Example 2 of this section.
    (b) Transfers by partnerships. If a corporation assumes a section 
358(h) liability from a partnership in an exchange to which section 
358(a) applies, then, for purposes of applying section 705 
(determination of basis of partner's interest) and Sec.  1.704-1(b), 
any reduction, under section 358(h)(1), in the partnership's basis in 
corporate stock received in the transaction is treated as an 
expenditure of the partnership described in section 705(a)(2)(B). See 
paragraph (e) Example 1 of this section. This expenditure must be 
allocated among the partners in accordance with section 704(b) and (c) 
and Sec.  1.752-7(c). If a partner's share of the reduction, under 
section 358(h)(1), in the partnership's basis in corporate stock 
exceeds the partner's basis in the partnership interest, then the 
partner recognizes gain equal to the excess, which is treated as gain 
from the sale or exchange of a partnership interest. This paragraph 
does not apply to the extent that Sec.  1.752-7(j)(4) applies to the 
assumption of the Sec.  1.752-7 liability by the corporation.
    (c) Assumption of section 358(h) liability by partnership followed 
by transfer of partnership interest or partnership property to a 
corporation--trade or business exception. Where a partnership assumes a 
section 358(h) liability from a partner and, subsequently, the partner 
transfers all or part of the partner's partnership interest to a 
corporation in an exchange to which section 358(a) applies, then, for 
purposes of applying section 358(h)(2), the section 358(h) liability is 
treated as associated only with the contribution made to the 
partnership by that partner. See paragraph (e) Example 2 of this 
section. Similar rules apply where a partnership assumes a section 
358(h) liability of a partner and a corporation subsequently assumes 
that section 358(h) liability from the partnership in an exchange to 
which section 358(a) applies.
    (d) Section 358(h) liabilities defined. For purposes of this 
section, section 358(h) liabilities are liabilities described in 
section 358(h)(3).
    (e) Examples. The following examples illustrate the provisions of 
this section. Assume, for purposes of these examples, that the 
obligation assumed by the corporation does not reduce the shareholder's 
basis in the corporate stock under section 358(d). The examples are as 
follows:

    Example 1. Transfer of partnership property to corporation. In 
2004, in an exchange to which section 351(a) applies, PRS, a cash 
basis taxpayer, transfers $2,000,000 cash to Corporation X, also a 
cash basis taxpayer, in exchange for Corporation X shares and the 
assumption by Corporation X of $1,000,000 of accounts payable 
incurred by PRS. At the time of the exchange, PRS has two partners, 
A, a 90% partner, who has a $2,000,000 basis in the PRS interest, 
and B, a 10% partner, who has a $50,000 basis in the PRS interest. 
Assume that, under section 358(h)(1), PRS's basis in the Corporation 
X stock is reduced by the accounts payable assumed by Corporation X 
($1,000,000). Under paragraph (b) of this section, A's and B's bases 
in PRS must be reduced, but not below zero, by their respective 
shares of the section 358(h)(1) basis reduction. If either partner's 
share of the section 358(h)(1) basis reduction exceeds the partner's 
basis in the partnership interest, then the partner recognizes gain 
equal to the excess. A's share of the section 358(h) basis reduction 
is $900,000 (90% of $1,000,000). Therefore, A's basis in the PRS 
interest is reduced to $1,100,000 ($2,000,000 - $900,000). B's share 
of the section 358(h) basis reduction is $100,000 (10% of 
$1,000,000). Because B's share of the section 358(h) basis reduction 
($100,000) exceeds B's basis in the PRS interest ($50,000), B's 
basis in the PRS interest is reduced to $0 and B recognizes $50,000 
of gain. This gain is treated as gain from the sale of the PRS 
interest.
    Example 2. Transfer of partnership interest to corporation. In 
2004, A contributes undeveloped land with a value and basis of 
$4,000,000 in exchange for a 50% interest in PRS and an assumption 
by PRS of $2,000,000 of pension liabilities from a separate business 
that A conducts. A's basis in the PRS interest immediately after the 
contribution is A's basis in the land, $4,000,000, unreduced by the 
amount of the pension liabilities. PRS develops the land as a 
landfill. Before PRS has economically performed with respect to the 
pension liabilities, A transfers A's interest in PRS to Corporation 
X, in an exchange to which section 351 applies. At the time of the 
exchange, the value of A's PRS interest is $2,000,000, A's basis in 
PRS is $4,000,000, and A has no share of partnership liabilities 
other than the pension liabilities. For purposes of applying section 
358(h), the transfer of the PRS interest to Corporation X is treated 
as a transfer to Corporation X of A's share of PRS assets and an 
assumption by Corporation X of A's share of the pension liabilities 
of PRS ($2,000,000). Because the pension liabilities were not 
assumed by PRS from A in an exchange in which the trade or business 
associated with the liability was transferred to PRS, the transfer 
of the PRS interest to Corporation X is not excepted from section 
358(h) under section 358(h)(2). See paragraph (c) of this section. 
Under section 358(h), A's basis in the Corporation X stock is 
reduced by the $2,000,000 of pension liabilities.

    (f) Effective date. This section applies to assumptions of 
liabilities by a corporation occurring on or after June 24, 2003.

0
Par. 4. Section 1.704-1 is amended as follows:
0
1. Paragraph (b)(1)(ii)(a) is amended by removing the language ``The'' 
at the beginning of the first sentence and adding ``Except as otherwise 
provided in this section, the'' in its place.
0
2. Paragraph (b)(2)(iv)(b) is amended by adding a sentence at the end 
of the paragraph.
0
3. Paragraph (b)(2)(iv)(b)(2) is amended by removing the language 
``secured by such contributed property'' in the parenthetical.
0
4. Paragraph (b)(2)(iv)(b)(2) is further amended by removing the 
language ``under section 752'' in the parenthetical.
0
5. Paragraph (b)(2)(iv)(b)(5) is amended by removing the language 
``secured by such distributed property'' in the parenthetical.
0
6. Paragraph (b)(2)(iv)(b)(5) is further amended by removing the 
language ``under section 752'' in the parenthetical.
    The addition reads as follows:

[[Page 30342]]

Sec.  1.704-1  Partner's distributive share.

* * * * *
    (b) * * *
    (2) * * *
    (iv) * * *
    (b) * * * For liabilities assumed before June 24, 2003, references 
to liabilities in this paragraph (b)(2)(iv)(b) shall include only 
liabilities secured by the contributed or distributed property that are 
taken into account under section 752(a) and (b).
* * * * *


Sec.  1.704-2  [Amended]

0
Par. 5. In Sec.  1.704-2, paragraph (b)(3) is amended by adding the 
language ``or a Sec.  1.752-7liability (as defined in Sec.  1.752-
7(b)(3)(i)) assumed by the partnership from a partner on or after June 
24, 2003'' at the end of the sentence.

0
Par. 6. Section 1.704-3 is amended as follows:
0
1. The paragraph heading for (a)(7) is revised.
0
2. Two sentences are added to the end of paragraph (a)(7).
0
3. Paragraphs (a)(8)(ii) and (iii) are removed and reserved and 
paragraph (a)(8)(iv) is added.
0
4. Paragraph (a)(12) is added.
0
5. Two additional sentences are added at the end of paragraph (f).
    The revisions and additions read as follows:


Sec.  1.704-3  Contributed property.

    (a) * * *
    (7) Transfer of a partnership interest. * * * This rule does not 
apply to any person who acquired a partnership interest from a Sec.  
1.752-7 liability partner in a transaction to which paragraph (e)(1) of 
Sec.  1.752-7 applies. See Sec.  1.752-7(c)(1).
    (8) * * * (i) * * *
    (ii) [Reserved]
    (iii) [Reserved]
    (iv) Capitalized amounts. To the extent that a partnership properly 
capitalizes all or a portion of an item as described in paragraph 
(a)(12) of this section, then the item or items to which such cost is 
properly capitalized is treated as section 704(c) property with the 
same amount of built-in loss as corresponds to the amount capitalized.
* * * * *
    (12) Sec.  1.752-7 liabilities. Except as otherwise provided in 
Sec.  1.752-7, Sec.  1.752-7 liabilities (within the meaning of Sec.  
1.752-7(b)(2)) are section 704(c) property (built-in loss property that 
at the time of contribution has a book value that differs from the 
contributing partner's adjusted tax basis) for purposes of applying the 
rules of this section. See Sec.  1.752-7(c). To the extent that the 
built-in loss associated with the Sec.  1.752-7 liability exceeds the 
cost of satisfying the Sec.  1.752-7 liability (as defined in Sec.  
1.752-7(b)(3)), the excess creates a ``ceiling rule'' limitation, 
within the meaning of Sec.  1.704-3(b)(1), subject to the methods of 
allocation set forth in Sec.  1.704-3(b), (c) and (d).
* * * * *
    (f) * * * Except as otherwise provided in Sec.  1.752-7(k), 
paragraphs (a)(8)(iv) and (a)(12) apply to Sec.  1.752-7 liability 
transfers, as defined in Sec.  1.752-7(b)(4), occurring on or after 
June 24, 2003. See Sec.  1.752-7(k).

0
Par. 7. Section 1.704-4 is amended as follows:
0
1. The paragraph heading for (d)(1) is revised.
0
2. Paragraphs (d)(1)(ii) and (iii) are removed and reserved and 
paragraph (d)(1)(iv) is added.
0
3. Paragraph (g) is revised.
    The additions and revisions read as follows:


Sec.  1.704-4  Distribution of contributed property.

    (d) Special rules--(1) Nonrecognition transactions, installment 
obligations, contributed contracts, and capitalized costs--(i) * * *
    (ii) [Reserved]
    (iii) [Reserved]
    (iv) Capitalized costs. Property to which the cost of section 
704(c) property is properly capitalized is treated as section 704(c) 
property for purposes of section 704(c)(1)(B) and this section to the 
extent that such property is treated as section 704(c) property under 
Sec.  1.704-3(a)(8)(iv). See Sec.  1.737-2(d)(3) for a similar rule in 
the context of section 737.
* * * * *
    (g) Effective dates. This section applies to distributions by a 
partnership to a partner on or after January 9, 1995, except that 
paragraph (d)(1)(iv) applies to distributions by a partnership to a 
partner on or after June 24, 2003.

0
Par. 8. Section 1.705-1 is amended by adding paragraph (a)(8) to read 
as follows:


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

    (a) * * *
    (8) For basis adjustments necessary to coordinate sections 705 and 
358(h), see Sec.  1.358-7(b). For certain basis adjustments with 
respect to a Sec.  1.752-7 liability assumed by a partnership from a 
partner, see Sec.  1.752-7.
* * * * *

0
Par. 9. Section 1.737-2 is amended as follows:
0
1. The paragraph heading for (d)(3) is revised.
0
2. Paragraphs (d)(3)(ii) and (iii) are removed and reserved and 
paragraph (d)(3)(iv) is added.
    The additions and revisions read as follows:


Sec.  1.737-2  Exceptions and special rules.

    (d) * * *
    (3) Nonrecognition transactions, installment sales, contributed 
contracts, and capitalized costs--(i) * * *
    (ii) [Reserved]
    (iii) [Reserved]
    (iv) Capitalized costs. Property to which the cost of section 
704(c) property is properly capitalized is treated as section 704(c) 
property for purposes of section 737 to the extent that such property 
is treated as section 704(c) property under Sec.  1.704-3(a)(8)(iv). 
See Sec.  1.704-4(d)(1) for a similar rule in the context of section 
704(c)(1)(B).
* * * * *

0
Par. 10. 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)(iv) applies to distributions by a 
partnership to a partner on or after June 24, 2003.

0
Par. 11. Section 1.752-0 is amended as follows:
0
1. The section heading and introductory text of Sec.  1.752-0 are 
revised.
0
2. An entry for Sec.  1.752-1(a)(4) is added.
0
3. Entries for Sec.  1.752-1(a)(4)(i), (ii), (iii), and (iv) are added.
0
4. Entries for Sec.  1.752-6 and Sec.  1.752-7 are added.
    The revision and additions read as follows:


Sec.  1.752-0  Table of contents.

    This section lists the major paragraphs that appear in Sec. Sec.  
1.752-1 through 1.752-7.


Sec.  1.752-1  Treatment of partnership liabilities.

    (a) * * *
    (4) Liability defined.
    (i) In general.
    (ii) Obligation.
    (iii) Other liabilities.
    (iv) Effective date.
* * * * *


Sec.  1.752-6  Partnership assumption of partner's section 358(h)(3) 
liability after October 18, 1999, and before June 24, 2003.

    (a) In general.
    (b) Exceptions.
    (1) In general.

[[Page 30343]]

    (2) Transactions described in Notice 2000-44.
    (c) Example.
    (d) Effective date.
    (1) In general.
    (2) Election to apply Sec.  1.752-7.


Sec.  1.752-7  Partnership assumption of partner's Sec.  1.752-7 
liability on or after June 24, 2003.

    (a) Purpose and structure.
    (b) Definitions.
    (1) Assumption.
    (2) Adjusted value.
    (3) Sec.  1.752-7 liability.
    (i) In general.
    (ii) Amount and share of Sec.  1.752-7 liability.
    (iii) Example.
    (4) Sec.  1.752-7 liability transfer.
    (i) In general.
    (ii) Terminations under section 708(b)(1)(B).
    (5) Sec.  1.752-7 liability partner.
    (i) In general.
    (ii) Tiered partnerships.
    (A) Assumption by a lower-tier partnership.
    (B) Distribution of partnership interest.
    (6) Remaining built-in loss associated with a Sec.  1.752-7 
liability.
    (i) In general.
    (ii) Partial dispositions and assumptions.
    (7) Sec.  1.752-7 liability reduction.
    (i) In general.
    (ii) Partial dispositions and assumptions.
    (8) Satisfaction of Sec.  1.752-7 liability.
    (9) Testing date.
    (10) Trade or business.
    (i) In general.
    (ii) Examples.
    (c) Application of section 704(b) and (c) to assumed Sec.  
1.752-7 liabilities.
    (1) In general.
    (i) Section 704(c).
    (ii) Section 704(b).
    (2) Example.
    (d) Special rules for transfers of partnership interests, 
distributions of partnership assets, and assumptions of the Sec.  
1.752-7 liability after a Sec.  1.752-7 liability transfer.
    (1) In general.
    (2) Exceptions.
    (i) In general.
    (ii) Examples.
    (e) Transfer of Sec.  1.752-7 liability partner's partnership 
interest.
    (1) In general.
    (2) Examples.
    (3) Exception for nonrecognition transactions.
    (i) In general.
    (ii) Examples.
    (f) Distribution in liquidation of Sec.  1.752-7 liability 
partner's partnership interest.
    (1) In general.
    (2) Example.
    (g) Assumption of Sec.  1.752-7 liability by a partner other 
than Sec.  1.752-7 liability partner.
    (1) In general.
    (2) Consequences to Sec.  1.752-7 liability partner.
    (3) Consequences to partnership.
    (4) Consequences to assuming partner.
    (5) Example.
    (h) Notification by the partnership (or successor) of the 
satisfaction of the Sec.  1.752-7 liability.
    (i) Special rule for amounts that are capitalized prior to the 
occurrence of an event described in paragraphs (e), (f), or (g).
    (1) In general.
    (2) Example.
    (j) Tiered partnerships.
    (1) Look-through treatment.
    (2) Trade or business exception.
    (3) Partnership as a Sec.  1.752-7 liability partner.
    (4) Transfer of Sec.  1.752-7 liability by partnership to 
another partnership or corporation after a transaction described in 
paragraphs (e),(f), or (g).
    (i) In general.
    (ii) Subsequent transfers.
    (5) Example.
    (k) Effective dates.
    (1) In general.
    (2) Election to apply this section to assumptions of liabilities 
occurring after October 18, 1999 and before June 24, 2003.
    (i) In general.
    (ii) Manner of making election.
    (iii) Filing of amended returns.
    (iv) Time for making election.

0
Par. 12. In Sec.  1.752-1, paragraph (a)(4) is added to read as 
follows:


Sec.  1.752-1  Treatment of partnership liabilities.

    (a) * * *
    (4) Liability defined--(i) In general. An obligation is a liability 
for purposes of section 752 and the regulations thereunder (Sec.  
1.752-1 liability), only if, when, and to the extent that incurring the 
obligation--
    (A) Creates or increases the basis of any of the obligor's assets 
(including cash);
    (B) Gives rise to an immediate deduction to the obligor; or
    (C) Gives rise to an expense that is not deductible in computing 
the obligor's taxable income and is not properly chargeable to capital.
    (ii) Obligation. For purposes of this paragraph and Sec.  1.752-7, 
an obligation is any fixed or contingent obligation to make payment 
without regard to whether the obligation is otherwise taken into 
account for purposes of the Internal Revenue Code. Obligations include, 
but are not limited to, debt obligations, environmental obligations, 
tort obligations, contract obligations, pension obligations, 
obligations under a short sale, and obligations under derivative 
financial instruments such as options, forward contracts, futures 
contracts, and swaps.
    (iii) Other liabilities. For obligations that are not Sec.  1.752-1 
liabilities, see Sec. Sec.  1.752-6 and 1.752-7.
    (iv) Effective date. Except as otherwise provided in Sec.  1.752-
7(k), this paragraph (a)(4) applies to liabilities that are incurred or 
assumed by a partnership on or after June 24, 2003.
* * * * *


Sec.  1.752-5(a)  [Amended]

0
Par. 13. In Sec.  1.752-5, paragraph (a) is amended by removing the 
language ``Unless'' at the beginning of the first sentence and adding 
``Except as otherwise provided in Sec. Sec.  1.752-1 through 1.752-4, 
unless'' in its place.

0
Par. 14. Section 1.752-6 is added to read as follows:


Sec.  1.752-6  Partnership assumption of partner's section 358(h)(3) 
liability after October 18, 1999, and before June 24, 2003.

    (a) In general. If, in a transaction described in section 721(a), a 
partnership assumes a liability (defined in section 358(h)(3)) of a 
partner (other than a liability to which section 752(a) and (b) apply), 
then, after application of section 752(a) and (b), the partner's basis 
in the partnership is reduced (but not below the adjusted value of such 
interest) by the amount (determined as of the date of the exchange) of 
the liability. For purposes of this section, the adjusted value of a 
partner's interest in a partnership is the fair market value of that 
interest increased by the partner's share of partnership liabilities 
under Sec. Sec.  1.752-1 through 1.752-5.
    (b) Exceptions--(1) In general. Except as provided in paragraph 
(b)(2) of this section, the exceptions contained in section 
358(h)(2)(A) and (B) apply to this section.
    (2) Transactions described in Notice 2000-44. The exception 
contained in section 358(h)(2)(B) does not apply to an assumption of a 
liability (defined in section 358(h)(3)) by a partnership as part of a 
transaction described in, or a transaction that is substantially 
similar to the transactions described in, Notice 2000-44 (2000-2 C.B. 
255). See Sec.  601.601(d)(2) of this chapter.
    (c) Example. The following example illustrates the principles of 
paragraph (a) of this section:

    Example. In 1999, A and B form partnership PRS. A contributes 
property with a value and basis of $200, subject to a nonrecourse 
debt obligation of $50 and a fixed or contingent obligation of $100 
that is not a liability to which section 752(a) and (b) applies, in 
exchange for a 50% interest in PRS. Assume that, after the 
contribution, A's share of partnership liabilities under Sec. Sec.  
1.752-1 through 1.752-5 is $25. Also assume that the $100 liability 
is not associated with a trade or business contributed by A to PRS 
or with assets contributed by A to PRS. After the contribution, A's 
basis in PRS is $175 (A's basis in the contributed land ($200) 
reduced by the nonrecourse debt assumed by PRS ($50), increased by 
A's share of partnership

[[Page 30344]]

liabilities under Sec. Sec.  1.752-1 through 1.752-5 ($25)). Because 
A's basis in the PRS interest is greater than the adjusted value of 
A's interest, $75 (the fair market value of A's interest ($50) 
increased by A's share of partnership liabilities ($25)), paragraph 
(a) of this section operates to reduce A's basis in the PRS interest 
(but not below the adjusted value of that interest) by the amount of 
liabilities described in section 358(h)(3) (other than liabilities 
to which section 752(a) and (b) apply) assumed by PRS. Therefore, 
A's basis in PRS is reduced to $75.

    (d) Effective date--(1) In general. This section applies to 
assumptions of liabilities occurring after October 18, 1999, and before 
June 24, 2003.
    (2) Election to apply Sec.  1.752-7. The partnership may elect, 
under Sec.  1.752-7(k)(2), to apply the provisions referenced in Sec.  
1.752-7(k)(2)(ii) to all assumptions of liabilities by the partnership 
occurring after October 18, 1999, and before June 24, 2003. Section 
1.752-7(k)(2) describes the manner in which the election is made.


Sec.  1.752-6T  [Removed]

0
Par. 15. Section 1.752-6T is removed.

0
Par. 16. Section 1.752-7 is added to read as follows:


Sec.  1.752-7  Partnership assumption of partner's Sec.  1.752-7 
liability on or after June 24, 2003.

    (a) Purpose and structure. The purpose of this section is to 
prevent the acceleration or duplication of loss through the assumption 
of obligations not described in Sec.  1.752-1(a)(4)(i) in transactions 
involving partnerships. Under paragraph (c) of this section, any such 
obligation that is assumed by a partnership from a partner in a 
transaction governed by section 721(a) is treated as section 704(c) 
property. Paragraphs (e), (f), and (g) of this section provide rules 
for situations where a partnership assumes such an obligation from a 
partner and, subsequently, that partner transfers all or part of the 
partnership interest, that partner receives a distribution in 
liquidation of the partnership interest, or another partner assumes 
part or all of that obligation from the partnership. These rules 
prevent the duplication of loss by prohibiting the partnership and any 
person other than the partner from whom the obligation was assumed from 
claiming a deduction, loss, or capital expense to the extent of the 
built-in loss associated with the obligation. These rules also prevent 
the acceleration of loss by deferring the partner's deduction or loss 
attributable to the obligation (if any) until the satisfaction of the 
Sec.  1.752-7 liability (within the meaning of paragraph (b)(8) of this 
section). Paragraph (d) of this section provides a number of exceptions 
to paragraphs (e), (f), and (g) of this section, including a de minimis 
exception. Paragraph (i) provides a special rule for situations in 
which an amount paid to satisfy a Sec.  1.752-7 liability is 
capitalized into other partnership property. Paragraph (j) of this 
section provides special rules for tiered partnership transactions.
    (b) Definitions. For purposes of this section, the following 
definitions apply:
    (1) Assumption. The principles of Sec.  1.752-1(d) and (e) apply in 
determining if a Sec.  1.752-7 liability has been assumed.
    (2) Adjusted value. The adjusted value of a partner's interest in a 
partnership is the fair market value of that interest increased by the 
partner's share of partnership liabilities under Sec. Sec.  1.752-1 
through 1.752-5.
    (3) Sec.  1.752-7 liability--(i) In general. A Sec.  1.752-7 
liability is an obligation described in Sec.  1.752-1(a)(4)(ii) to the 
extent that either--
    (A) The obligation is not described in Sec.  1.752-1(a)(4)(i); or
    (B) The amount of the obligation (under paragraph (b)(3)(ii) of 
this section) exceeds the amount taken into account under Sec.  1.752-
1(a)(4)(i).
    (ii) Amount and share of Sec.  1.752-7 liability. The amount of a 
Sec.  1.752-7 liability (or, for purposes of paragraph (b)(3)(i) of 
this section, the amount of an obligation) is the amount of cash that a 
willing assignor would pay to a willing assignee to assume the Sec.  
1.752-7 liability in an arm's-length transaction. If the obligation 
arose under a contract in exchange for rights granted to the obligor 
under that contract, and those contractual rights are contributed to 
the partnership in connection with the partnership's assumption of the 
contractual obligation, then the amount of the Sec.  1.752-7 liability 
or obligation is the amount of cash, if any, that a willing assignor 
would pay to a willing assignee to assume the entire contract. A 
partner's share of a partnership's Sec.  1.752-7 liability is the 
amount of deduction that would be allocated to the partner with respect 
to the Sec.  1.752-7 liability if the partnership disposed of all of 
its assets, satisfied all of its liabilities (other than Sec.  1.752-7 
liabilities), and paid an unrelated person to assume all of its Sec.  
1.752-7 liabilities in a fully taxable arm's-length transaction 
(assuming such payment would give rise to an immediate deduction to the 
partnership).

    (iii) Example. In 2005, A, B, and C form partnership PRS. A 
contributes $10,000,000 in exchange for a 25% interest in PRS and 
PRS's assumption of a debt obligation. The debt obligation was 
issued for cash and the issue price was equal to the stated 
redemption price at maturity ($5,000,000). The debt obligation bears 
interest, payable quarterly, at a fixed rate of interest, which was 
a market rate of interest when the debt obligation was issued. At 
the time of the assumption, all accrued interest has been paid. 
Prior to the partnership assuming the obligation, interest rates 
decrease, resulting in the debt obligation bearing an above-market 
interest rate. Assume that, as a result of the decline in interest 
rates, A would have had to pay a willing assignee $6,000,000 to 
assume the debt obligation. The assumption of the debt obligation by 
PRS from A is treated as an assumption of a Sec.  1.752-1(a)(4)(i) 
liability in the amount of $5,000,000 (the portion of the total 
amount of the debt obligation that has created basis in A's assets, 
that is, the $5,000,000 that was issued in exchange for the debt 
obligation ) and an assumption of a Sec.  1.752-7 liability in the 
amount of $1,000,000 (the difference between the total obligation, 
$6,000,000, and the Sec.  1.752-1(a)(4)(i)liability, $5,000,000).

    (4) Sec.  1.752-7 liability transfer--(i) In general. Except as 
provided in paragraph (b)(4)(ii) of this section, a Sec.  1.752-7 
liability transfer is any assumption of a Sec.  1.752-7 liability by a 
partnership from a partner in a transaction governed by section 721(a).
    (ii) Terminations under section 708(b)(1)(B). In determining if a 
deemed contribution of assets and assumption of liability as a result 
of a technical termination is treated as a Sec.  1.752-7 liability 
transfer, only Sec.  1.752-7 liabilities that were assumed by the 
terminating partnership as part of an earlier Sec.  1.752-7 liability 
transfer are taken into account and, then, only to the extent of the 
remaining built-in loss associated with that Sec.  1.752-7 liability.
    (5) Sec.  1.752-7 liability partner--(i) In general. A Sec.  1.752-
7 liability partner is a partner from whom a partnership assumes a 
Sec.  1.752-7 liability as part of a Sec.  1.752-7 liability transfer 
or any person who acquires a partnership interest from the Sec.  1.752-
7 liability partner in a transaction to which paragraph (e)(3) of this 
section applies.
    (ii) Tiered partnerships--(A) Assumption by a lower-tier 
partnership. If, in a Sec.  1.752-7 liability transfer, a partnership 
(lower-tier partnership) assumes a Sec.  1.752-7 liability from another 
partnership (upper-tier partnership), then both the upper-tier 
partnership and the partners of the upper-tier partnership are Sec.  
1.752-7 liability partners. Therefore, paragraphs (e) and (f) of this 
section apply on a sale or liquidation of any partner's interest in the 
upper-tier partnership and on a sale or liquidation of the upper-tier 
partnership's interest in the lower-tier partnership. See paragraph 
(j)(3) of this section. If, in a Sec.  1.752-7 liability transfer, the 
upper-tier partnership assumes a Sec.  1.752-7 liability from a

[[Page 30345]]

partner, and, subsequently, in another Sec.  1.752-7 liability 
transfer, a lower-tier partnership assumes that Sec.  1.752-7 liability 
from the upper-tier partnership, then the partner from whom the upper-
tier partnership assumed the Sec.  1.752-7 liability continues to be 
the Sec.  1.752-7 liability partner of the lower-tier partnership with 
respect to the remaining built-in loss associated with that Sec.  
1.752-7 liability. Any new built-in loss associated with the Sec.  
1.752-7 liability that is created on the assumption of the Sec.  1.752-
7 liability from the upper-tier partnership by the lower-tier 
partnership is shared by all the partners of the upper-tier partnership 
in accordance with their interests in the upper-tier partnership, and 
each partner of the upper-tier partnership is treated as a Sec.  1.752-
7 liability partner with respect to that new built-in loss. See 
paragraph (e)(3)(ii), Example 3 of this section.
    (B) Distribution of partnership interest. If, in a transaction 
described in Sec.  1.752-7(e)(3), an interest in a partnership (lower-
tier partnership) that has assumed a Sec.  1.752-7 liability is 
distributed by a partnership (upper-tier partnership) that is the Sec.  
1.752-7 liability partner with respect to that liability, then the 
persons receiving interests in the lower-tier partnership are Sec.  
1.752-7 liability partners with respect to the lower-tier partnership 
to the same extent that they were prior to the distribution.
    (6) Remaining built-in loss associated with a Sec.  1.752-7 
liability. (i) In general. The remaining built-in loss associated with 
a Sec.  1.752-7 liability equals the amount of the Sec.  1.752-7 
liability as of the time of the assumption of the Sec.  1.752-7 
liability by the partnership, reduced by the portion of the Sec.  
1.752-7 liability previously taken into account by the Sec.  1.752-7 
liability partner under paragraph (j)(3) of this section and adjusted 
as provided in paragraph (c) of this section and Sec.  1.704-3 for--
    (A) Any portion of that built-in loss associated with the Sec.  
1.752-7 liability that is satisfied by the partnership on or prior to 
the testing date (whether capitalized or deducted); and
    (B) Any assumption of all or part of the Sec.  1.752-7 liability by 
the Sec.  1.752-7 liability partner (including any assumption that 
occurs on the testing date).
    (ii) Partial dispositions and assumptions. In the case of a partial 
disposition of the Sec.  1.752-7 liability partner's partnership 
interest or a partial assumption of the Sec.  1.752-7 liability by 
another partner, the remaining built-in loss associated with Sec.  
1.752-7 liability is pro rated based on the portion of the interest 
sold or the portion of the Sec.  1.752-7 liability assumed.
    (7) Sec.  1.752-7 liability reduction--(i) In general. The Sec.  
1.752-7 liability reduction is the amount by which the Sec.  1.752-7 
liability partner is required to reduce the basis in the partner's 
partnership interest by operation of paragraphs (e), (f), and (g) of 
this section. The Sec.  1.752-7 liability reduction is the lesser of--
    (A) The excess of the Sec.  1.752-7 liability partner's basis in 
the partnership interest over the adjusted value of that interest (as 
defined in paragraph (b)(2) of this section); or
    (B) The remaining built-in loss associated with the Sec.  1.752-7 
liability (as defined in paragraph (b)(6) of this section without 
regard to paragraph (b)(6)(ii) of this section).
    (ii) Partial dispositions and assumptions. In the case of a partial 
disposition of the Sec.  1.752-7 liability partner's partnership 
interest or a partial assumption of the Sec.  1.752-7 liability by 
another partner, the Sec.  1.752-7 liability reduction is pro rated 
based on the portion of the interest sold or the portion of the Sec.  
1.752-7 liability assumed.
    (8) Satisfaction of Sec.  1.752-7 liability--In general. A Sec.  
1.752-7 liability is treated as satisfied (in whole or in part) on the 
date on which the partnership (or the assuming partner) would have been 
allowed to take the Sec.  1.752-7 liability into account for federal 
tax purposes but for this section. For example, a Sec.  1.752-7 
liability is treated as satisfied when, but for this section, the Sec.  
1.752-7 liability would give rise to--
    (i) An increase in the basis of the partnership's or the assuming 
partner's assets (including cash);
    (ii) An immediate deduction to the partnership or to the assuming 
partner;
    (iii) An expense that is not deductible in computing the 
partnership's or the assuming partner's taxable income and not properly 
chargeable to capital account; or
    (iv) An amount realized on the sale or other disposition of 
property subject to that liability if the property was disposed of by 
the partnership or the assuming partner at that time.
    (9) Testing date. The testing date is--
    (i) For purposes of paragraph (e) of this section, the date of the 
sale, exchange, or other disposition of part or all of the Sec.  1.752-
7 liability partner's partnership interest;
    (ii) For purposes of paragraph (f) of this section, the date of the 
partnership's distribution in liquidation of the Sec.  1.752-7 
liability partner's partnership interest; and
    (iii) For purposes of paragraph (g) of this section, the date of 
the assumption (or partial assumption) of the Sec.  1.752-7 liability 
by a partner other than the Sec.  1.752-7 liability partner.
    (10) Trade or business--(i) In general. A trade or business is a 
specific group of activities carried on by a person for the purpose of 
earning income or profit, other than a group of activities consisting 
of acquiring, holding, dealing in, or disposing of financial 
instruments, if the activities included in that group include every 
operation that forms a part of, or a step in, the process of earning 
income or profit. Such group of activities ordinarily includes the 
collection of income and the payment of expenses. The group of 
activities must constitute the carrying on of a trade or business under 
section 162(a) (determined as though the activities were conducted by 
an individual).
    (ii) Examples. The following examples illustrate the provisions of 
this paragraph (b)(10):

    Example 1. Corporation Y owns, manages, and derives rental 
income from an office building and also owns vacant land that may be 
subject to environmental liabilities. Corporation Y contributes the 
land subject to the environmental liabilities to PRS in a 
transaction governed by section 721(a). PRS plans to develop the 
land as a landfill. The contribution of the vacant land does not 
constitute the contribution of a trade or business because 
Corporation Y did not conduct any significant business or 
development activities with respect to the land prior to the 
contribution.
    Example 2. For the past 5 years, Corporation X has owned and 
operated gas stations in City A, City B, and City C. Corporation X 
transfers all of the assets associated with the operation of the gas 
station in City A to PRS for interests in PRS and the assumption by 
PRS of the Sec.  1.752-7 liabilities associated with that gas 
station. PRS continues to operate the gas station in City A after 
the contribution. The contribution of the gas station to PRS 
constitutes the contribution of a trade or business.
    Example 3. For the past 7 years, Corporation Z has engaged in 
the manufacture and sale of household products. Throughout this 
period, Corporation Z has maintained a research department for use 
in connection with its manufacturing activities. The research 
department has 10 employees actively engaged in the development of 
new products. Corporation Z contributes the research department to 
PRS in exchange for a PRS interest and the assumption by PRS of 
pension liabilities with respect to the employees of the research 
department. PRS continues the research operations on a contractual 
basis with several businesses, including Corporation Z. The 
contribution of the research operations to PRS constitutes a 
contribution of a trade or business.

    (c) Application of section 704(b) and (c) to assumed Sec.  1.752-7 
liabilities--(1)

[[Page 30346]]

In general--(i) Section 704(c). Except as otherwise provided in this 
section, sections 704(c)(1)(A) and (B), section 737, and the 
regulations thereunder, apply to Sec.  1.752-7 liabilities. See Sec.  
1.704-3(a)(12). However, Sec.  1.704-3(a)(7) does not apply to any 
person who acquired a partnership interest from a Sec.  1.752-7 
liability partner in a transaction to which paragraph (e)(1) of this 
section applies.
    (ii) Section 704(b). Section 704(b) and Sec.  1.704-1(b) apply to a 
post-contribution change in the value of a Sec.  1.752-7 liability. If 
there is a decrease in the value of a Sec.  1.752-7 liability that is 
reflected in the capital accounts of the partners under Sec.  1.704-
1(b)(2)(iv)(f), the amount of the decrease constitutes an item of 
income for purposes of section 704(b) and Sec.  1.704-1(b). Conversely, 
if there is an increase in the value of a Sec.  1.752-7 liability that 
is reflected in the capital accounts of the partners under Sec.  1.704-
1(b)(2)(iv)(f), the amount of the increase constitutes an item of loss 
for purposes of section 704(b) and Sec.  1.704-1(b).
    (2) Example. The following example illustrates the provisions of 
this paragraph (c):

    Example-- (i) Facts. In 2004, A, B, and C form partnership PRS. 
A contributes Property 1 with a fair market value and basis of 
$400X, subject to a Sec.  1.752-7 liability of $100X, for a 25% 
interest in PRS. B contributes $300X cash for a 25% interest in PRS, 
and C contributes $600X cash for a 50% interest in PRS. Assume that 
the partnership complies with the substantial economic effect safe 
harbor of Sec.  1.704-1(b)(2). Under Sec.  1.704-1(b)(2)(iv)(b), A's 
capital account is credited with $300X (the fair market value of 
Property 1, $400X, less the Sec.  1.752-7 liability assumed by PRS, 
$100X). In accordance with Sec. Sec.  1.752-7(c)(1)(i) and 1.704-3, 
the partnership can use any reasonable method for section 704(c) 
purposes. In this case, the partnership elects the traditional 
method under Sec.  1.704-3(b) and also elects to treat the 
deductions or losses attributable to the Sec.  1.752-7 liability as 
coming first from the built-in loss. In 2005, PRS earns $200X of 
income and uses it to satisfy the Sec.  1.752-7 liability which has 
increased in value to $200X. Assume that the cost to PRS of 
satisfying the Sec.  1.752-7 liability is deductible by PRS. The 
$200X of partnership income is allocated according to the 
partnership agreement, $50X to A, $50X to B, and $100X to C.
[GRAPHIC] [TIFF OMITTED] TR26MY05.000

    (ii) Analysis. Pursuant to paragraph (c) of this section, $100X 
of the deduction attributable to the satisfaction of the Sec.  
1.752-7 liability is specially allocated to A, the Sec.  1.752-7 
liability partner, under section 704(c)(1)(A) and Sec.  1.704-3. No 
book item corresponds to this tax allocation. The remaining $100X of 
deduction attributable to the satisfaction of the Sec.  1.752-7 
liability is allocated, for both book and tax purposes, according to 
the partnership agreement, $25X to A, $25X to B, and $50X to C. If 
the partnership, instead, satisfied the Sec.  1.752-7 liability over 
a number of years, the first $100X of deduction with respect to the 
Sec.  1.752-7 liability would be allocated to A, the Sec.  1.752-7 
liability partner, before any deduction with respect to the Sec.  
1.752-7 liability would be allocated to the other partners. For 
example, if PRS were to satisfy $50X of the Sec.  1.752-7 liability, 
the $50X deduction with respect to the Sec.  1.752-7 liability would 
be allocated to A for tax purposes only. No deduction would arise 
for book purposes. If PRS later paid a further $100X in satisfaction 
of the Sec.  1.752-7 liability, $50X of the deduction with respect 
to the Sec.  1.752-7 liability would be allocated, solely for tax 
purposes, to A and the remaining $50X would be allocated, for both 
book and tax purposes, according to the partnership agreement. Under 
these circumstances, the partnership's method of allocating the 
built-in loss associated with the Sec.  1.752-7 liability is 
reasonable.

    (d) Special rules for transfers of partnership interests, 
distributions of partnership assets, and assumptions of the Sec.  
1.752-7 liability after a Sec.  1.752-7 liability transfer--(1) In 
general. Except as provided in paragraphs (d)(2) and (i) of this 
section, paragraphs (e), (f), and (g) of this section apply to certain 
partnership transactions occurring after a Sec.  1.752-7 liability 
transfer.
    (2) Exceptions--(i) In general. Paragraphs (e), (f), and (g) of 
this section do not apply--
    (A) If the partnership assumes the Sec.  1.752-7 liability as part 
of a contribution to the partnership of the trade or business with 
which the liability is associated, and the partnership continues to 
carry on that trade or business after the contribution (for the 
definition of a trade or business, see paragraph (b)(10) of this 
section); or
    (B) If, immediately before the testing date, the amount of the 
remaining built-in loss with respect to all Sec.  1.752-7 liabilities 
assumed by the partnership (other than Sec.  1.752-7 liabilities 
assumed by the partnership with an associated trade or business) in one 
or more Sec.  1.752-7 liability transfers is less than the lesser of 
10% of the gross value of partnership assets or $1,000,000.
    (ii) Examples. The following examples illustrate the principles of 
this paragraph (d)(2):

    Example 1.  For the past 5 years, Corporation X, a C 
corporation, has been engaged in Business A and Business B. In 2004, 
Corporation X contributes Business A, in a transaction governed by 
section 721(a), to PRS in exchange for a PRS interest and the 
assumption by PRS of pension liabilities with respect to the 
employees engaged in Business A. PRS plans to carry on Business A 
after the contribution. Because PRS has assumed the pension 
liabilities as part of a contribution to PRS of the trade or 
business with which the liabilities are associated, the treatment of 
the pension liabilities is not affected by paragraphs (e), (f), and 
(g) of this section with respect to any transaction occurring after 
the Sec.  1.752-7 liability transfer of the pension liabilities.
    Example 2. (i) Facts. The facts are the same as in Example 1, 
except that PRS also assumes from Corporation X certain pension 
liabilities with respect to the employees of Business B. At the time 
of the assumption, the amount of the pension liabilities with 
respect to the employees of Business A is $3,000,000 (the A 
liabilities) and the amount of the pension liabilities associated 
with the employees of Business B (the B liabilities) is $2,000,000. 
Two years later, Corporation X sells its interest in PRS to Y for 
$9,000,000. At the time of the sale, the remaining built-in loss 
associated with the A liabilities is $2,100,000, the remaining 
built-in loss associated with the B liabilities is $900,000, and the 
gross value of PRS's assets (excluding Sec.  1.752-7 liabilities) is 
$20,000,000. Assume that PRS has no Sec.  1.752-7 liabilities other 
than those assumed from Corporation X.

[[Page 30347]]

[GRAPHIC] [TIFF OMITTED] TR26MY05.001

    (ii) Analysis. The only liabilities assumed by PRS from 
Corporation X that were not assumed as part of Corporation X's 
contribution of Business A were the B liabilities. Immediately 
before the testing date, the remaining built-in loss associated with 
the B liabilities ($900,000) was less than the lesser of 10% of the 
gross value of PRS's assets ($2,000,000) or $1,000,000. Therefore, 
paragraph (d)(2)(i)(B) of this section applies to exclude 
Corporation X's sale of the PRS interest to Y from the application 
of paragraph (e) of this section.

    (e) Transfer of Sec.  1.752-7 liability partner's partnership 
interest--(1) In general. Except as provided in paragraphs (d)(2), 
(e)(3), and (i) of this section, immediately before the sale, exchange, 
or other disposition of all or a part of a Sec.  1.752-7 liability 
partner's partnership interest, the Sec.  1.752-7 liability partner's 
basis in the partnership interest is reduced by the Sec.  1.752-7 
liability reduction (as defined in paragraph (b)(7) of this section). 
No deduction, loss, or capital expense is allowed to the partnership on 
the satisfaction of the Sec.  1.752-7 liability (within the meaning of 
paragraph (b)(8) of this section) to the extent of the remaining built-
in loss associated with the Sec.  1.752-7 liability (as defined in 
paragraph (b)(6) of this section). For purposes of section 705(a)(2)(B) 
and Sec.  1.704-1(b)(2)(ii)(b) only, the remaining built-in loss 
associated with the Sec.  1.752-7 liability is not treated as a 
nondeductible, noncapital expenditure of the partnership. Therefore, 
the remaining partners' capital accounts and bases in their partnership 
interests are not reduced by the remaining built-in loss associated 
with the Sec.  1.752-7 liability. If the partnership (or any successor) 
notifies the Sec.  1.752-7 liability partner of the satisfaction of the 
Sec.  1.752-7 liability, then the Sec.  1.752-7 liability partner is 
entitled to a loss or deduction. The amount of that deduction or loss 
is, in the case of a partial satisfaction of the Sec.  1.752-7 
liability, the amount that the partnership would, but for this section, 
take into account on the partial satisfaction of the Sec.  1.752-7 
liability (but not, in total, more than the Sec.  1.752-7 liability 
reduction) or, in the case of a complete satisfaction of the Sec.  
1.752-7 liability, the remaining Sec.  1.752-7 liability reduction. To 
the extent of the amount that the partnership would, but for this 
section, take into account on the satisfaction of the Sec.  1.752-7 
liability, the character of that deduction or loss is determined as if 
the Sec.  1.752-7 liability partner had satisfied the liability. To the 
extent that the Sec.  1.752-7 liability reduction exceeds the amount 
that the partnership would, but for this section, take into account on 
the satisfaction of the Sec.  1.752-7 liability, the character of the 
Sec.  1.752-7 liability partner's loss is capital.
    (2) Examples. The following examples illustrate the principles of 
paragraph (e)(1) of this section:

    Example 1.  (i) Facts. In 2004, A, B, and C form partnership 
PRS. A contributes Property 1 with a fair market value of $5,000,000 
and basis of $4,000,000 subject to a Sec.  1.752-7 liability of 
$2,000,000 in exchange for a 25% interest in PRS. B contributes 
$3,000,000 cash in exchange for a 25% interest in PRS, and C 
contributes $6,000,000 cash in exchange for a 50% interest in PRS. 
In 2006, when PRS has a section 754 election in effect, A sells A's 
interest in PRS to D for $3,000,000. At the time of the sale, the 
basis of A's PRS interest is $4,000,000, the remaining built-in loss 
associated with the Sec.  1.752-7 liability is $2,000,000, and PRS 
has no liabilities (as defined in Sec.  1.752-1(a)(4)). Assume that 
none of the exceptions of paragraph (d)(2) of this section apply and 
that the satisfaction of the Sec.  1.752-7 liability would have 
given rise to a deductible expense to A. In 2007, PRS pays 
$3,000,000 to satisfy the liability.
[GRAPHIC] [TIFF OMITTED] TR26MY05.002

    (ii) Sale of A's PRS interest. Immediately before the sale of 
the PRS interest to D, A's basis in the PRS interest is reduced (to 
$3,000,000) by the Sec.  1.752-7 liability reduction, i.e., the 
lesser of the excess of A's basis in the PRS interest ($4,000,000) 
over the adjusted value of that interest ($3,000,000), $1,000,000, 
or the remaining built-in loss associated with the Sec.  1.752-7 
liability, $2,000,000. Therefore, A neither realizes nor recognizes 
any gain or loss on the sale of the PRS interest to D. D's basis in 
the PRS interest is $3,000,000. D's share of the adjusted basis of 
partnership property, as determined under Sec.  1.743-1(d), equals 
D's interest in the partnership's previously taxed capital of 
$2,000,000 (the amount of cash that D would receive on a liquidation 
of the partnership, $3,000,000, increased by the amount of tax loss 
that would be allocated to D in the hypothetical transaction, $0, 
and reduced by the amount of tax gain that would be allocated to D 
in the hypothetical transaction, $1,000,000). Therefore, the 
positive basis adjustment under section 743(b) is $1,000,000.

[[Page 30348]]

[GRAPHIC] [TIFF OMITTED] TR26MY05.003

    (iii) Satisfaction of Sec.  1.752-7 liability. Neither PRS nor 
any of its partners is entitled to a deduction, loss, or capital 
expense upon the satisfaction of the Sec.  1.752-7 liability to the 
extent of the remaining built-in loss associated with the Sec.  
1.752-7 liability ($2,000,000). PRS is entitled to a deduction, 
however, for the amount by which the cost of satisfying the Sec.  
1.752-7 liability exceeds the remaining built-in loss associated 
with the Sec.  1.752-7 liability. Therefore, in 2007, PRS may deduct 
$1,000,000 (cost to satisfy the Sec.  1.752-7 liability, $3,000,000, 
less the remaining built-in loss associated with the Sec.  1.752-7 
liability, $2,000,000). If PRS notifies A of the satisfaction of the 
Sec.  1.752-7 liability, then A is entitled to an ordinary deduction 
in 2007 of $1,000,000 (the Sec.  1.752-7 liability reduction).
[GRAPHIC] [TIFF OMITTED] TR26MY05.004

    Example 2.  The facts are the same as in Example 1 except that, 
at the time of A's sale of the PRS interest to D, PRS has a 
nonrecourse liability of $4,000,000, of which A's share is 
$1,000,000. A's basis in PRS is $5,000,000. At the time of the sale 
of the PRS interest to D, the adjusted value of A's interest is 
$4,000,000 (the fair market value of the interest ($3,000,000), 
increased by A's share of partnership liabilities ($1,000,000)). The 
difference between the basis of A's interest ($5,000,000) and the 
adjusted value of that interest ($4,000,000) is $1,000,000. 
Therefore, the Sec.  1.752-7 liability reduction is $1,000,000 (the 
lesser of this difference or the remaining built-in loss associated 
with the Sec.  1.752-7 liability, $2,000,000). Immediately before 
the sale of the PRS interest to D, A's basis is reduced from 
$5,000,000 to $4,0000,000. A's amount realized on the sale of the 
PRS interest to D is $4,000,000 ($3,000,000 paid by D, increased 
under section 752(d) by A's share of partnership liabilities, or 
$1,000,000). Therefore, A neither realizes nor recognizes any gain 
or loss on the sale. D's basis in the PRS interest is $4,000,000. 
Because D's share of the adjusted basis of partnership property is 
$3,000,000 (D's share of the partnership's previously taxed capital, 
$2,000,000, plus D's share of partnership liabilities, $1,000,000), 
the basis adjustment under section 743(b) is $1,000,000.
[GRAPHIC] [TIFF OMITTED] TR26MY05.005


[[Page 30349]]


[GRAPHIC] [TIFF OMITTED] TR26MY05.006

    Example 3.  The facts are the same as in Example 1, except that 
the satisfaction of the Sec.  1.752-7 liability would have given 
rise to a capital expense to A or PRS. Neither PRS nor any of its 
partners are entitled to a capital expense upon the satisfaction of 
the Sec.  1.752-7 liability to the extent of the remaining built-in 
loss associated with the Sec.  1.752-7 liability ($2,000,000). PRS 
may, however, increase the basis of appropriate partnership assets 
by the amount by which the cost of satisfying the Sec.  1.752-7 
liability exceeds the remaining built-in loss associated with the 
Sec.  1.752-7 liability. Therefore, in 2007, PRS may capitalize 
$1,000,000 (cost to satisfy the Sec.  1.752-7 liability, $3,000,000, 
less the remaining built-in loss associated with the Sec.  1.752-7 
liability, $2,000,000) to the appropriate partnership assets. If A 
is notified by PRS that the Sec.  1.752-7 liability has been 
satisfied, then A is entitled to a capital loss in 2007 as provided 
in paragraph (e)(1) of this section, the year of the satisfaction of 
the Sec.  1.752-7 liability.

    (3) Exception for nonrecognition transactions--(i) In general. 
Paragraph (e)(1) of this section does not apply where a Sec.  1.752-7 
liability partner transfers all or part of the partner's partnership 
interest in a transaction in which the transferee's basis in the 
partnership interest is determined in whole or in part by reference to 
the transferor's basis in the partnership interest. In addition, 
paragraph (e)(1) of this section does not apply to a distribution of an 
interest in the partnership (lower-tier partnership) that has assumed 
the Sec.  1.752-7 liability by a partnership that is the Sec.  1.752-7 
liability partner (upper-tier partnership) if the partners of the 
upper-tier partnership that were Sec.  1.752-7 liability partners with 
respect to the lower-tier partnership prior to the distribution 
continue to be Sec.  1.752-7 liability partners with respect to the 
lower-tier partnership after the distribution. See paragraphs 
(b)(4)(ii) and (j)(3) of this section for rules on the application of 
this section to partners of the Sec.  1.752-7 liability partner.
    (ii) Examples. The following examples illustrate the provisions of 
this paragraph (e)(3):

    Example 1. Transfer of partnership interest to lower-tier 
partnership. (i) Facts. In 2004, X contributes undeveloped land with 
a value and basis of $2,000,000 and subject to environmental 
liabilities of $1,500,000 to partnership LTP in exchange for a 50% 
interest in LTP. LTP develops the land as a landfill. In 2005, in a 
transaction governed by section 721(a), X contributes the LTP 
interest to UTP in exchange for a 50% interest in UTP. In 2008, X 
sells the UTP interest to A for $500,000. At the time of the sale, 
X's basis in UTP is $2,000,000, the remaining built-in loss 
associated with the environmental liability is $1,500,000, and the 
gross value of UTP's assets is $2,500,000. The environmental 
liabilities were not assumed by LTP as part of a contribution by X 
to LTP of a trade or business with which the liabilities were 
associated. (See paragraph (b)(10)(ii), Example 1 of this section.)
    (ii) Analysis. Because UTP's basis in the LTP interest is 
determined by reference to X's basis in the LTP interest, X's 
contribution of the LTP interest to UTP is exempted from the rules 
of paragraph (e)(1) of this section. Under paragraph (j)(1) of this 
section, X's contribution of the LTP interest to UTP is treated as a 
contribution of X's share of the assets of LTP and UTP's assumption 
of X's share of the LTP liabilities (including Sec.  1.752-7 
liabilities). Therefore, X's transfer of the LTP interest to UTP is 
a Sec.  1.752-7 liability transfer. The Sec.  1.752-7 liabilities 
deemed transferred by X to UTP are not associated with a trade or 
business transferred to UTP for purposes of paragraph (d)(2)(i)(A) 
of this section, because they were not associated with a trade or 
business transferred by X to LTP as part of the original Sec.  
1.752-7 liability transfer. See paragraph (j)(2) of this section. 
Because none of the exceptions described in paragraph (d)(2) of this 
section apply to X's taxable sale of the UTP interest to A in 2008, 
paragraph (e)(1) of this section applies to that sale.
    Example 2. Transfer of partnership interest to corporation. The 
facts are the same as in Example 1, except that, rather than 
transferring the LTP interest to UTP in 2005, X contributes the LTP 
interest to Corporation Y in an exchange to which section 351 
applies. Because Corporation Y's basis in the LTP interest is 
determined by reference to X's basis in that interest, X's 
contribution of the LTP interest is exempted from the rules of 
paragraph (e)(1) of this section. But see section 358(h) and Sec.  
1.358-7 for appropriate basis adjustments.
    Example 3. Partnership merger. (i) Facts. In 2004, A, B, C, and 
D form equal partnership

[[Page 30350]]

PRS1. A contributes Blackacre with a value and basis of $2,000,000 
to PRS1 and PRS1 assumes from A $1,500,000 of pension liabilities 
unrelated to Blackacre. B, C, and D each contribute $500,000 cash to 
PRS1. PRS1 uses the cash contributed by B, C, and D ($1,500,000) to 
purchase Whiteacre. In 2006, PRS1 merges into PRS2 in an assets-over 
merger under Sec.  1.708-1(c)(3). Assume that, under Sec.  1.708-
1(c), PRS2 is the surviving partnership and PRS1 is the terminating 
partnership. At the time of the merger, the value of Blackacre is 
still $2,000,000, the remaining built-in loss with respect to the 
pension liabilities is still $1,500,000, but the value of Whiteacre 
has declined to $500,000.
    (ii) Deemed assumption by PRS2 of PRS1 liabilities. Under Sec.  
1.708-1(c)(3), the merger is treated as a contribution of the assets 
and liabilities of PRS1 to PRS2, followed by a distribution of the 
PRS2 interests by PRS1 in liquidation of PRS1. Because PRS2 assumes 
a Sec.  1.752-7 liability (the pension liabilities) of PRS1, PRS1 is 
a Sec.  1.752-7 liability partner of PRS2. Under paragraph 
(b)(5)(ii)(A) of this section, A is also Sec.  1.752-7 liability 
partner of PRS2 to the extent of the remaining $1,500,000 built-in 
loss associated with the pension liabilities. B, C, and D are not 
Sec.  1.752-7 liability partners with respect to PRS1. If the amount 
of the pension liabilities had increased between the date of PRS1's 
assumption of those liabilities from A and the date of the merger of 
PRS1 into PRS2, then B, C, and D would be Sec.  1.752-7 liability 
partners with respect to PRS2 to the extent of their respective 
shares of that increase. See paragraph (b)(5)(ii) of this section.
    (iii) Deemed distribution of PRS2 interests. Paragraph (e)(1) 
does not apply to PRS1's deemed distribution of the PRS2 interests, 
because, under paragraph (b)(5)(ii)(B) of this section, all of the 
partners that were Sec.  1.752-7 liability partners with respect to 
PRS2 before the distribution, i.e., A, continue to be Sec.  1.752-7 
liability partners after the distribution. After the distribution, 
A's share of the pension liabilities now held by PRS2 will continue 
to be $1,500,000.
    Example 4. Partnership division; no shifting of Sec.  1.752-7 
liability. The facts are the same as in Example 3, except that PRS1 
does not merge with PRS2, but instead contributes Blackacre to PRS2 
in exchange for PRS2 interests and the assumption by PRS2 of the 
pension liabilities. Immediately thereafter, PRS1 distributes the 
PRS2 interests to A and B in liquidation of their interests in PRS1. 
The analysis is the same as in Example 3. After the assumption of 
the pension liabilities by PRS2, A is a Sec.  1.752-7 liability 
partner with respect to PRS2. After the distribution of a PRS2 
interest to A, A continues to be a Sec.  1.752-7 liability partner 
with respect to PRS2, and the amount of A's built-in loss with 
respect to the Sec.  1.752-7 liabilities continues to be $1,500,000. 
Therefore, paragraph (e)(1) of this section does not apply to the 
distribution of the PRS2 interests to A and B.
    Example 5. Partnership division; shifting of Sec.  1.752-7 
liability. The facts are the same as in Example 4, except that PRS1 
distributes the PRS2 interests not to A and B, but to C and D, in 
liquidation of their interests in PRS1. After this distribution, A 
does not continue to be a Sec.  1.752-7 liability partner of PRS2, 
because A no longer has an interest in PRS2. Therefore, paragraph 
(e)(1) of this section applies to the distribution of the PRS2 
interests to C and D.

    (f) Distribution in liquidation of Sec.  1.752-7 liability 
partner's partnership interest--(1) In general. Except as provided in 
paragraphs (d)(2) and (i) of this section, immediately before a 
distribution in liquidation of a Sec.  1.752-7 liability partner's 
partnership interest, the Sec.  1.752-7 liability partner's basis in 
the partnership interest is reduced by the Sec.  1.752-7 liability 
reduction (as defined in paragraph (b)(7) of this section). This rule 
applies before section 737. No deduction, loss, or capital expense is 
allowed to the partnership on the satisfaction of the Sec.  1.752-7 
liability (within the meaning of paragraph (b)(8) of this section) to 
the extent of the remaining built-in loss associated with the Sec.  
1.752-7 liability (as defined in paragraph (b)(6) of this section). For 
purposes of section 705(a)(2)(B) and Sec.  1.704-1(b)(2)(ii)(b) only, 
the remaining built-in loss associated with the Sec.  1.752-7 liability 
is not treated as a nondeductible, noncapital expenditure of the 
partnership. Therefore, the remaining partners' capital accounts and 
bases in their partnership interests are not reduced by the remaining 
built-in loss associated with the Sec.  1.752-7 liability. If the 
partnership (or any successor) notifies the Sec.  1.752-7 liability 
partner of the satisfaction of the Sec.  1.752-7 liability, then the 
Sec.  1.752-7 liability partner is entitled to a loss or deduction. The 
amount of that deduction or loss is, in the case of a partial 
satisfaction of the Sec.  1.752-7 liability, the amount that the 
partnership would, but for this section, take into account on the 
partial satisfaction of the Sec.  1.752-7 liability (but not, in total, 
more than the Sec.  1.752-7 liability reduction) or, in the case of a 
complete satisfaction of the Sec.  1.752-7 liability, the remaining 
Sec.  1.752-7 liability reduction. To the extent of the amount that the 
partnership would, but for this section, take into account on 
satisfaction of the Sec.  1.752-7 liability, the character of that 
deduction or loss is determined as if the Sec.  1.752-7 liability 
partner had satisfied the liability. To the extent that the Sec.  
1.752-7 liability reduction exceeds the amount that the partnership 
would, but for this section, take into account on satisfaction of the 
Sec.  1.752-7 liability, the character of the Sec.  1.752-7 liability 
partner's loss is capital.
    (2) Example. The following example illustrates the provision of 
this paragraph (f):

    Example. (i) Facts. In 2004, A, B, and C form partnership PRS. A 
contributes Property 1 with a fair market value and basis of 
$5,000,000 subject to a Sec.  1.752-7 liability of $2,000,000 for a 
25% interest in PRS. B contributes $3,000,000 cash for a 25% 
interest in PRS, and C contributes $6,000,000 cash for a 50% 
interest in PRS. In 2012, when PRS has a section 754 election in 
effect, PRS distributes Property 2, which has a basis and fair 
market value of $3,000,000, to A in liquidation of A's PRS interest. 
At the time of the distribution, the fair market value of A's PRS 
interest is still $3,000,000, the basis of that interest is still 
$5,000,000, and the remaining built-in loss associated with the 
Sec.  1.752-7 liability is still $2,000,000. Assume that none of the 
exceptions of paragraph (d)(2) of this section apply to the 
distribution and that the satisfaction of the Sec.  1.752-7 
liability would have given rise to a deductible expense to A. In 
2013, PRS pays $1,000,000 to satisfy the entire Sec.  1.752-7 
liability.

[[Page 30351]]

[GRAPHIC] [TIFF OMITTED] TR26MY05.007

    (ii) Liquidation of A's PRS interest. Immediately before the 
distribution of Property 2 to A, A's basis in the PRS interest is 
reduced (to $3,000,000) by the Sec.  1.752-7 liability reduction, 
i.e., the lesser of the excess of A's basis in the PRS interest 
($5,000,000) over the adjusted value ($3,000,000) of that interest 
($2,000,000) or the remaining built-in loss associated with the 
Sec.  1.752-7 liability ($2,000,000). Therefore, A's basis in 
Property 2 under section 732(b) is $3,000,000. Because this is the 
same as the partnership's basis in Property 2 immediately before the 
distribution, the partnership's basis adjustment under section 
734(b) is $0.
[GRAPHIC] [TIFF OMITTED] TR26MY05.008

    (iii) Satisfaction of Sec.  1.752-7 liability. PRS is not 
entitled to a deduction, loss, or capital expense on the 
satisfaction of the Sec.  1.752-7 liability to the extent of the 
remaining built-in loss associated with the Sec.  1.752-7 liability 
($2,000,000). Because this amount exceeds the amount paid by PRS to 
satisfy the Sec.  1.752-7 liability ($1,000,000), PRS is not 
entitled to any deduction for the Sec.  1.752-7 liability in 2013. 
If, however, PRS notifies A of the satisfaction of the Sec.  1.752-7 
liability, A is entitled to an ordinary deduction in 2013 of 
$1,000,000 (the amount paid in satisfaction of the Sec.  1.752-7 
liability) and a capital loss of $1,000,000 (the remaining Sec.  
1.752-7 liability reduction).
[GRAPHIC] [TIFF OMITTED] TR26MY05.009

    (g) Assumption of Sec.  1.752-7 liability by a partner other than 
Sec.  1.752-7 liability partner--(1) In general. If this paragraph (g) 
applies, section 704(c)(1)(B) does not apply to an assumption of a 
Sec.  1.752-7 liability from a partnership by a partner other than the 
Sec.  1.752-7 liability partner. The rules of paragraph (g)(2) of this 
section apply only if the Sec.  1.752-7 liability partner is a partner 
in the partnership at the time of the assumption of the Sec.  1.752-7 
liability from the partnership. The rules of paragraphs (g)(3) and (4) 
of this section apply to any assumption of the Sec.  1.752-7 liability 
by a partner other than the Sec.  1.752-7 liability partner, whether or 
not the Sec.  1.752-7 liability partner is a partner in the partnership 
at the time of the assumption from the partnership.
    (2) Consequences to Sec.  1.752-7 liability partner. If, at the 
time of an assumption of a Sec.  1.752-7 liability from a partnership 
by a partner other than the Sec.  1.752-7 liability partner, the Sec.  
1.752-7 liability partner remains a partner in the partnership, then 
the Sec.  1.752-7 liability partner's basis in the partnership interest 
is reduced by the Sec.  1.752-7 liability reduction (as defined in 
paragraph (b)(7) of this section). If the assuming partner (or any 
successor) notifies the Sec.  1.752-7 liability partner of the 
satisfaction of the Sec.  1.752-7 liability (within the meaning of 
paragraph (b)(8) of this section), then the Sec.  1.752-7 liability 
partner is entitled to a deduction or loss. The amount of that 
deduction or loss is, in the case of a partial satisfaction of the 
Sec.  1.752-7 liability, the amount that the assuming partner would, 
but for this section, take into account on the satisfaction of the 
Sec.  1.752-7 liability (but not, in total,

[[Page 30352]]

more than the Sec.  1.752-7 liability reduction) or, in the case of a 
complete satisfaction of the Sec.  1.752-7 liability, the remaining 
Sec.  1.752-7 liability reduction. To the extent of the amount that the 
assuming partner would, but for this section, take into account on the 
satisfaction of the Sec.  1.752-7 liability, the character of that 
deduction or loss is determined as if the Sec.  1.752-7 liability 
partner had satisfied the liability. To the extent that the Sec.  
1.752-7 liability reduction exceeds the amount that the assuming 
partner would, but for this section, take into account on the 
satisfaction of the Sec.  1.752-7 liability, the character of the Sec.  
1.752-7 liability partner's loss is capital.
    (3) Consequences to partnership. Immediately after the assumption 
of the Sec.  1.752-7 liability from the partnership by a partner other 
than the Sec.  1.752-7 liability partner, the partnership must reduce 
the basis of partnership assets by the remaining built-in loss 
associated with the Sec.  1.752-7 liability (as defined in paragraph 
(b)(6) of this section). The reduction in the basis of partnership 
assets must be allocated among partnership assets as if that adjustment 
were a basis adjustment under section 734(b).
    (4) Consequences to assuming partner. No deduction, loss, or 
capital expense is allowed to an assuming partner (other than the Sec.  
1.752-7 liability partner) on the satisfaction of the Sec.  1.752-7 
liability assumed from a partnership to the extent of the remaining 
built-in loss associated with the Sec.  1.752-7 liability. Instead, 
upon the satisfaction of the Sec.  1.752-7 liability, the assuming 
partner must adjust the basis of the partnership interest, any assets 
(other than cash, accounts receivable, or inventory) distributed by the 
partnership to the partner, or gain or loss on the disposition of the 
partnership interest, as the case may be. These adjustments are 
determined as if the assuming partner's basis in the partnership 
interest at the time of the assumption were increased by the lesser of 
the amount paid (or to be paid) to satisfy the Sec.  1.752-7 liability 
or the remaining built-in loss associated with the Sec.  1.752-7 
liability. However, the assuming partner cannot take into account any 
adjustments to depreciable basis, reduction in gain, or increase in 
loss until the satisfaction of the Sec.  1.752-7 liability.
    (5) Example. The following example illustrates the provisions of 
this paragraph (g):

    Example. (i) Facts. In 2004, A, B, and C form partnership PRS. A 
contributes Property 1, a nondepreciable capital asset with a fair 
market value and basis of $5,000,000, in exchange for a 25% interest 
in PRS and assumption by PRS of a Sec.  1.752-7 liability of 
$2,000,000. B contributes $3,000,000 cash for a 25% interest in PRS, 
and C contributes $6,000,000 cash for a 50% interest in PRS. PRS 
uses the cash contributed to purchase Property 2. In 2007, PRS 
distributes Property 1, subject to the Sec.  1.752-7 liability to B 
in liquidation of B's interest in PRS. At the time of the 
distribution, A's interest in PRS still has a value of $3,000,000 
and a basis of $5,000,000, and B's interest in PRS still has a value 
and basis of $3,000,000. Also at that time, Property 1 still has a 
value and basis of $5,000,000, Property 2 still has a value and 
basis of $9,000,000, and the remaining built-in loss associated with 
the Sec.  1.752-7 liability still is $2,000,000. Assume that none of 
the exceptions of paragraph (d)(2)(i) of this section apply to the 
assumption of the Sec.  1.752-7 liability by B and that the 
satisfaction of the Sec.  1.752-7 liability by A would have given 
rise to a deductible expense to A. In 2010, B pays $1,000,000 to 
satisfy the entire Sec.  1.752-7 liability. At that time, B still 
owns Property 1, which has a basis of $3,000,000.
[GRAPHIC] [TIFF OMITTED] TR26MY05.010

    (ii) Assumption of Sec.  1.752-7 liability by B. Section 
704(c)(1)(B) does not apply to the assumption of the Sec.  1.752-7 
liability by B. Instead, A's basis in the PRS interest is reduced 
(to $3,000,000) by the Sec.  1.752-7 liability reduction, i.e., the 
lesser of the excess of A's basis in the PRS interest ($5,000,000) 
over the adjusted value ($3,000,000) of that interest ($2,000,000), 
or the remaining built-in loss associated with the Sec.  1.752-7 
liability as of the time of the assumption ($2,000,000). PRS's basis 
in Property 2 is reduced (to $7,000,000) by the $2,000,000 remaining 
built-in loss associated with the Sec.  1.752-7 liability. B's basis 
in Property 1 under section 732(b) is $3,000,000 (B's basis in the 
PRS interest). This is $2,000,000 less than PRS's basis in Property 
1 before the distribution of Property 1 to B. If PRS has a section 
754 election in effect for 2007, PRS may increase the basis of 
Property 2 under section 734(b) by $2,000,000.

[[Page 30353]]

[GRAPHIC] [TIFF OMITTED] TR26MY05.011

    (iii) Satisfaction of Sec.  1.752-7 liability. B is not entitled 
to a deduction on the satisfaction of the Sec.  1.752-7 liability in 
2010 to the extent of the remaining built-in loss associated with 
the Sec.  1.752-7 liability ($2,000,000). As this amount exceeds the 
amount paid by B to satisfy the Sec.  1.752-7 liability, B is not 
entitled to any deduction on the satisfaction of the Sec.  1.752-7 
liability in 2010. B may, however, increase the basis of Property 1 
by the lesser of the remaining built-in loss associated with the 
Sec.  1.752-7 liability ($2,000,000) or the amount paid to satisfy 
the Sec.  1.752-7 liability ($1,000,000). Therefore, B's basis in 
Property 1 is increased to $4,000,000. If B notifies A of the 
satisfaction of the Sec.  1.752-7 liability, then A is entitled to 
an ordinary deduction in 2010 of $1,000,000 (the amount paid in 
satisfaction of the Sec.  1.752-7 liability) and a capital loss of 
$1,000,000 (the remaining Sec.  1.752-7 liability reduction).
[GRAPHIC] [TIFF OMITTED] TR26MY05.012

    (h) Notification by the partnership (or successor) of the 
satisfaction of the Sec.  1.752-7 liability. For purposes of paragraphs 
(e), (f), and (g) of this section, notification by the partnership (or 
successor) of the satisfaction of the Sec.  1.752-7 liability must be 
attached to the Sec.  1.752-7 liability partner's return (whether an 
original or an amended return) for the year in which the loss is being 
claimed and must include--
    (1) The amount paid in satisfaction of the Sec.  1.752-7 liability, 
and whether the amounts paid were in partial or complete satisfaction 
of the Sec.  1.752-7 liability;
    (2) The name and address of the person satisfying the Sec.  1.752-7 
liability;
    (3) The date of the payment on the Sec.  1.752-7 liability; and
    (4) The character of the loss to the Sec.  1.752-7 liability 
partner with respect to the Sec.  1.752-7 liability.
    (i) Special rule for amounts that are capitalized prior to the 
occurrence of an event described in paragraphs (e), (f), or (g)--(1) In 
general. If all or a portion of a Sec.  1.752-7 liability is properly 
capitalized (capitalized basis) prior to an event described in 
paragraph (e), (f), or (g) of this section, then, before an event 
described in paragraph (e), (f), or (g) of this section, the 
partnership may take the capitalized basis into account for purposes of 
computing cost recovery and gain or loss on the sale of the asset to 
which the basis has been capitalized (and for any other purpose for 
which the basis of the asset is relevant), but after an event described 
in paragraph (e), (f), or (g) of this section, the partnership may not 
take any remaining capitalized basis into account for tax purposes.

[[Page 30354]]

    (2) Example. The following example illustrates the provisions of 
this paragraph (i):

    Example. (i) Facts. In 2004, A and B form partnership PRS. A 
contributes Property 1, a nondepreciable capital asset, with a fair 
market value and basis of 5,000,000, in exchange for a 25% interest 
in PRS and an assumption by PRS of a Sec.  1.752-7 liability of 
$2,000,000. B contributes $9,000,000 in cash in exchange for a 75% 
interest in PRS. PRS uses $7,000,000 of the cash to purchase 
Property 2, also a nondepreciable capital asset. In 2007, when PRS's 
assets have not changed, PRS satisfies the Sec.  1.752-7 liability 
by paying $2,000,000. Assume that PRS is required to capitalize the 
cost of satisfying the Sec.  1.752-7 liability. In 2008, A sells his 
interest in PRS to C for $3,000,000. At the time of the sale, the 
basis of A's interest is still $5,000,000.
    (ii) Analysis. On the sale of A's interest to C, A realizes a 
loss of $2,000,000 on the sale of the PRS interest (the excess of 
$5,000,000, the basis of the partnership interest, over $3,000,000, 
the amount realized on sale). The remaining built-in loss associated 
with the Sec.  1.752-7 liability at that time is zero because all of 
the Sec.  1.752-7 liability as of the time of the assumption of the 
Sec.  1.752-7 liability by the partnership was capitalized by the 
partnership. The partnership may not take any remaining capitalized 
basis into account for tax purposes.
[GRAPHIC] [TIFF OMITTED] TR26MY05.013

    (iii) Partial Satisfaction. Assume that, prior to the sale of 
A's interest in PRS to C, PRS had paid $1,500,000 to satisfy a 
portion of the Sec.  1.752-7 liability. Therefore, immediately 
before the sale of the PRS interest to C, A's basis in the PRS 
interest would be reduced (to $4,500,000) by the $500,000 remaining 
built-in loss associated with the Sec.  1.752-7 liability 
($2,000,000 less the 1,500,000 portion capitalized by the 
partnership as that time). On the sale of the PRS interest, A 
realizes a loss of $1,500,000 (the excess of $4,500,000, the basis 
of the PRS interest, over $3,000,000, the amount realized on the 
sale). Neither PRS nor any of its partners is entitled to a 
deduction, loss, or capital expense upon the satisfaction of the 
Sec.  1.752-7 liability to the extent of the remaining built-in loss 
associated with the Sec.  1.752-7 liability ($500,000). If PRS 
notifies A of the satisfaction of the remaining portion of the Sec.  
1.752-7 liability, then A is entitled to a deduction or loss of 
$500,000 (the remaining Sec.  1.752-7 liability reduction). The 
partnership may not take any remaining capitalized basis into 
account for tax purposes.
[GRAPHIC] [TIFF OMITTED] TR26MY05.014

    (j) Tiered partnerships--(1) Look-through treatment. For purposes 
of this section, a contribution by a partner of an interest in a 
partnership (lower-tier partnership) to another partnership (upper-tier 
partnership) is treated as a contribution by the partner of the 
partner's share of each of the lower-tier partnership's assets and an 
assumption by the upper-tier partnership of the partner's share of the 
lower-tier partnership's liabilities (including Sec.  1.752-7 
liabilities). See paragraph (e)(3)(ii) Example 1 of this section. In 
addition, a partnership is treated as having its share of any Sec.  
1.752-7 liabilities of the partnerships in which it has an interest.
    (2) Trade or business exception. If a partnership (upper-tier 
partnership) assumes a Sec.  1.752-7 liability of a partner, and, 
subsequently, another partnership (lower-tier partnership) assumes that 
Sec.  1.752-7 liability from the upper-tier partnership, then the Sec.  
1.752-7 liability is treated as associated only with any trade or 
business contributed to the upper-tier partnership by the Sec.  1.752-7 
liability partner. The same rule applies where a partnership assumes a 
Sec.  1.752-7 liability of a partner, and, subsequently, the Sec.  
1.752-7 liability partner transfers that partnership interest to 
another partnership. See paragraph (e)(3)(ii) Example 1 of this 
section.
    (3) Partnership as a Sec.  1.752-7 liability partner. If a 
transaction described in paragraph (e), (f), or (g) of this section 
occurs with respect to a partnership (upper-tier partnership) that is a 
Sec.  1.752-7 liability partner of another partnership (lower-tier 
partnership), then such transaction will also be treated as a 
transaction described in paragraph (e), (f), or (g) of this section, as 
appropriate, with respect to the partners of the upper-tier 
partnership, regardless of whether the upper-tier partnership assumed 
the Sec.  1.752-7 liability from those partners. (See paragraph (b)(5) 
of this section for rules relating to the treatment of transactions by 
the partners of the upper-tier partnership). In such a case, each 
partner's share of the Sec.  1.752-7 liability reduction in the upper-
tier partnership is equal to that partner's share of the Sec.  1.752-7 
liability. The partners of the upper-tier partnership at the time of 
the transaction described in paragraph (e), (f), or (g) of this 
section, and not the upper-tier partnership, are entitled to the 
deduction or loss on the satisfaction of the Sec.  1.752-7 liability. 
Similar principles apply where the upper-tier

[[Page 30355]]

partnership is itself owned by one or a series of partnerships. This 
paragraph does not apply to the extent that Sec.  1.752-7(j)(4) applied 
to the assumption of the Sec.  1.752-7 liability by the lower-tier 
partnership.
    (4) Transfer of Sec.  1.752-7 liability by partnership to another 
partnership or corporation after a transaction described in paragraph 
(e), (f), or (g)--(i) In general. If, after a transaction described in 
paragraph (e), (f), or (g) of this section with respect to a Sec.  
1.752-7 liability assumed by a partnership (the upper-tier 
partnership), another partnership or a corporation assumes the Sec.  
1.752-7 liability from the upper-tier partnership (or the assuming 
partner) in a transaction in which the basis of property is determined, 
in whole or in part, by reference to the basis of the property in the 
hands of the upper-tier partnership (or assuming partner), then--
    (A) The upper-tier partnership (or assuming partner) must reduce 
its basis in any corporate stock or partnership interest received by 
the remaining built-in loss associated with the Sec.  1.752-7 
liability, at the time of the transaction described in paragraph (e), 
(f), or (g) of this section (but the partners of the upper-tier 
partnership do not reduce their bases or capital accounts in the upper-
tier partnership); and
    (B) No deduction, loss, or capital expense is allowed to the 
assuming partnership or corporation on the satisfaction of the Sec.  
1.752-7 liability to the extent of the remaining built-in loss 
associated with the Sec.  1.752-7 liability.
    (ii) Subsequent transfers. Similar rules apply to subsequent 
assumptions of the Sec.  1.752-7 liability in transactions in which the 
basis of property is determined, in whole or in part, by reference to 
the basis of the property in the hands of the transferor. If, 
subsequent to an assumption of the Sec.  1.752-7 liability by a 
partnership in a transaction to which paragraph (j)(4)(i) of this 
section applies, the Sec.  1.752-7 liability is assumed from the 
partnership by a partner other than the partner from whom the 
partnership assumed the Sec.  1.752-7 liability, then the rules of 
paragraph (g) of this section apply.
    (5) Example. The following example illustrates the provisions of 
paragraphs (j)(3) and (4) of this section:
    Example. (i) Assumption of Sec.  1.752-7 liability by UTP and 
transfer of Sec.  1.752-7 liability partner's interest in UTP. In 
2004, A, B, and C form partnership UTP. A contributes Property 1 
with a fair market value and basis of $5,000,000 subject to a Sec.  
1.752-7 liability of $2,000,000 in exchange for a 25% interest in 
UTP. B contributes $3,000,000 cash in exchange for a 25% interest in 
UTP, and C contributes $6,000,000 cash in exchange for a 50% 
interest in UTP. UTP invests the $9,000,000 cash in Property 2. In 
2006, A sells A's interest in UTP to D for $3,000,000. At the time 
of the sale, the basis of A's UTP interest is $5,000,000, the 
remaining built-in loss associated with the Sec.  1.752-7 liability 
is $2,000,000, and UTP has no liabilities other than the Sec.  
1.752-7 liabilities assumed from A. Assume that none of the 
exceptions of paragraph (d)(2) of this section apply and that the 
satisfaction of the Sec.  1.752-7 liability would give rise to a 
deductible expense to A and to UTP. Under paragraph (e) of this 
section, immediately before the sale of the UTP interest to D, A's 
basis in UTP is reduced to $3,000,000 by the $2,000,000 Sec.  1.752-
7 liability reduction. Therefore, A neither realizes nor recognizes 
any gain or loss on the sale of the UTP interest to D. D's basis in 
the UTP interest is $3,000,000.
[GRAPHIC] [TIFF OMITTED] TR26MY05.015

    (ii) Assumption of Sec.  1.752-7 liability by LTP from UTP. In 
2008, at a time when the estimated amount of the Sec.  1.752-7 
liability has increased to $3,500,000, UTP contributes Property 1 
and Property 2, subject to the Sec.  1.752-7 liability, to LTP in 
exchange for a 50% interest in LTP. At the time of the contribution, 
Property 1 still has a value and basis of $5,000,000 and Property 2 
still has a value and basis of $9,000,000. UTP's basis in LTP under 
section 722 is $14,000,000. Under paragraph (j)(4)(i) of this 
section, UTP must reduce its basis in LTP by the $2,000,000 
remaining built-in loss associated with the Sec.  1.752-7 liability 
(as of the time of the sale of the UTP interest by A). The partners 
in UTP are not required to reduce their bases in UTP by this amount. 
UTP is a Sec.  1.752-7 liability partner of LTP with respect to the 
entire $3,500,000 Sec.  1.752-7 liability assumed by LTP. However, 
as A is no longer a partner of UTP, none of the partners of UTP (as 
of the time of the assumption of the Sec.  1.752-7 liability by LTP)

[[Page 30356]]

are Sec.  1.752-7 liability partners of LTP with respect to the 
$2,000,000 remaining built-in loss associated with the Sec.  1.752-7 
liability (as of the time of the sale of the UTP interest by A). The 
UTP partners (as of the time of the assumption of the Sec.  1.752-7 
liability by LTP) are Sec.  1.752-7 liability partners of LTP with 
respect to the $1,500,000 increase in the amount of the Sec.  1.752-
7 liability of UTP since the assumption of that Sec.  1.752-7 
liability by UTP from A.
[GRAPHIC] [TIFF OMITTED] TR26MY05.016

    (iii) Sale by UTP of LTP interest. In 2010, UTP sells its 
interest in LTP to E for $10,500,000. At the time of the sale, the 
LTP interest still has a value of $10,500,000 and a basis of 
$12,000,000, and the remaining built-in loss associated with the 
Sec.  1.752-7 liability is $3,500,000. Under paragraph (e) of this 
section, immediately before the sale, UTP must reduce its basis in 
the LTP interest by the Sec.  1.752-7 liability reduction. Under 
paragraph (a)(4) of this section, the remaining built-in loss 
associated with the Sec.  1.752-7 liability is $1,500,000 (remaining 
built-in loss associated with the Sec.  1.752-7 liability, 
$3,500,000, reduced by the amount of the Sec.  1.752-7 liability 
taken into account under paragraph (j)(4) of this section, 
$2,000,000). The difference between the basis of the LTP interest 
held by UTP ($12,000,000) and the adjusted value of that interest 
($10,500,000) is also $1,500,000. Therefore, the Sec.  1.752-7 
liability reduction is $1,500,000 and UTP's basis in the LTP 
interest must be reduced to $10,500,000. In addition, UTP's partners 
must reduce their bases in their UTP interests by their 
proportionate shares of the Sec.  1.752-7 liability reduction. Thus, 
the basis of each of B's and D's interest in UTP must be reduced by 
$375,000 and the basis of C's interest in UTP must be reduced by 
$750,000. In 2011, D sells the UTP interest to F.

[[Page 30357]]

[GRAPHIC] [TIFF OMITTED] TR26MY05.017

    (iv) Deduction, expense, or loss associated with the Sec.  
1.752-7 liability by LTP. In 2012, LTP pays $3,500,000 to satisfy 
the Sec.  1.752-7 liability. Under paragraphs (e) and (j)(4) of this 
section, LTP is not entitled to any deduction with respect to the 
Sec.  1.752-7 liability. Under paragraph (j)(3) of this section, UTP 
also is not entitled to any deduction with respect to the Sec.  
1.752-7 liability. If LTP notifies A, B, C and D of the satisfaction 
of the Sec.  1.752-7 liability, then A is entitled to a deduction in 
2012 of $2,000,000, B and D are each entitled to deductions in 2012 
of $375,000, and C is entitled to a deduction in 2012 of $750,000.

    (k) Effective dates--(1) In general. This section applies to Sec.  
1.752-7 liability transfers occurring on or after June 24, 2003. For 
assumptions occurring after October 18, 1999, and before June 24, 2003, 
see Sec.  1.752-6. For Sec.  1.752-7 liability transfers occurring on 
or after June 24, 2003 and before May 26, 2005, taxpayers may rely on 
the exception for trading and investment partnerships in paragraph 
(b)(8)(ii) of Sec.  1.752.7 (2003-28 I.R.B. 46; 68 FR 37434).
    (2) Election to apply this section to assumptions of liabilities 
occurring after October 18, 1999 and before June 24, 2003--(i) In 
general. A partnership may elect to apply this section to all 
assumptions of liabilities (including Sec.  1.752-7 liabilities) 
occurring after October 18, 1999, and before June 24, 2003. Such an 
election is binding on the partnership and all of its partners. A 
partnership making such an election must apply all of the provisions of 
Sec.  1.752-1 and Sec.  1.752-7, including Sec.  1.358-5T, Sec.  1.358-
7, Sec.  1.704-1(b)(1)(ii) and (b)(2)(iv)(b), Sec.  1.704-2(b)(3), 
Sec.  1.704-3(a)(7), (a)(8)(iv), and (a)(12), Sec.  1.704-4(d)(1)(iv), 
Sec.  1.705-1(a)(8), Sec.  1.732-2(d)(3)(iv), and Sec.  1.737-5.
    (ii) Manner of making election. A partnership makes an election 
under this paragraph (k)(2) by attaching the following statement to its 
timely filed return: [Insert name and employer identification number of 
electing partnership] elects under Sec.  1.752-7 of the Income Tax 
Regulations to be subject to the rules of Sec.  1.358-5T, Sec.  1.358-
7, Sec.  1.704-1(b)(1)(ii) and (b)(2)(iv)(b), Sec.  1.704-2(b)(3), 
Sec.  1.704-3(a)(7), (a)(8)(iv), and (a)(12), Sec.  1.704-4(d)(1)(iv), 
Sec.  1.705-1(a)(8), Sec.  1.732-2(d)(3)(iv), and Sec.  1.737-5 with 
respect to all liabilities (including Sec.  1.752-7 liabilities) 
assumed by the partnership after October 18, 1999 and before June 24, 
2003. In the statement, the partnership must list, with respect to each 
liability (including each Sec.  1.752-7 liability) assumed by the 
partnership after October 18, 1999 and before June 24, 2003--
    (A) The name, address, and taxpayer identification number of the 
partner from whom the liability was assumed;
    (B) The date on which the liability was assumed by the partnership;
    (C) The amount of the liability as of the time of its assumption; 
and
    (D) A description of the liability.
    (iii) Filing of amended returns. An election under this paragraph 
(k)(2) will be valid only if the partnership and its partners promptly 
amend any returns for open taxable years that would be affected by the 
election.
    (iv) Time for making election. An election under this paragraph 
(k)(2) must be filed with any timely filed Federal income tax return 
filed by the partnership on or after September 24, 2003 and on or 
before December 31, 2005.

[[Page 30358]]

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 17. The authority for part 602 continues to read as follows:

    Authority: 26 U.S.C.7805.

0
Par. 18. In Sec.  602.101, paragraph (b) is amended by adding an entry 
to the table in numerical order to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described        control
                                                                number
------------------------------------------------------------------------
 
                                * * * * *
1.752-7....................................................    1545-1843
 
                                * * * * *
------------------------------------------------------------------------


Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: May 16, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
[FR Doc. 05-10266 Filed 5-23-05; 11:17 am]
BILLING CODE 4830-01-P