[Federal Register Volume 72, Number 162 (Wednesday, August 22, 2007)]
[Proposed Rules]
[Pages 46932-46939]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-16189]


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DEPARTMENT OF THE TREASURY

26 CFR Part 1

[REG-143397-05]
RIN 1545-BE99


Partner's Distributive Share

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed regulations and notice of public hearing.

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SUMMARY: This document contains regulations that provide rules 
concerning the application of sections 704(c)(1)(B) and 737 to 
distributions of property after two partnerships engage in an assets-
over merger. The proposed regulations affect partnerships and their 
partners. This document also provides a notice of public hearing on 
these proposed regulations.

DATES: Written or electronic comments must be received by November 20, 
2007. Outlines of the topic to be discussed at the public hearing 
scheduled for December 5, 2007 at 10 a.m. must be received by November 
21, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-143397-05), room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday, between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
143397-05), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov (IRS REG-143397-05). 
The public hearing will be held in the Auditorium, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Jason Smyczek or Laura Fields (202) 622-3050, concerning submissions of 
comments, the hearing, and/or to be placed on the building access list 
to attend the hearing, Richard Hurst, 
[email protected], (202) 622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 704(c)(1)(B) provides that a partner that contributes 
section 704(c) property to a partnership must recognize gain or loss on 
the distribution of such property to another partner within seven years 
of its contribution to the partnership in an amount equal to the gain 
or loss that would have been allocated to such partner under section 
704(c) if the distributed property had been sold by the partnership to 
the distributee partner for its fair market value at the time of the 
distribution.
    Section 737(a) provides that a partner that contributes section 
704(c) property to the partnership and then receives a distribution of 
property (other than money) within seven years of its contribution must 
recognize gain in an amount equal to the lesser of (1) The excess (if 
any) of (A) the fair market value of property (other than money) 
received in the distribution over (B) the adjusted basis of the 
partner's interest in the partnership immediately before the 
distribution reduced (but not below zero) by the amount of money 
received in the distribution, or (2) the net precontribution gain of 
the partner.
    Section 737(b) provides that for purposes of section 737, the term 
``net precontribution gain'' means the net gain (if any) which would 
have been recognized by the distributee partner under section 
704(c)(1)(B) if all property which (1) Had been contributed to the 
partnership by the distributee partner within seven years of the 
distribution, and (2) is held by the partnership immediately before the 
distribution, had been distributed by the partnership to another 
partner.
    Rev. Rul. 2004-43, 2004-1 CB 842, (see Sec.  601.601(d)(2) of this 
chapter) issued on April 12, 2004, addressed the application of 
sections 704(c)(1)(B) and 737 in an assets-over partnership merger 
described in Sec.  1.708-1(c)(3). Rev. Rul. 2004-43 held that section 
704(c)(1)(B) applies to newly created section 704(c) gain or loss in 
property contributed by the transferor partnership to the transferee 
partnership in an assets-over partnership merger. The revenue ruling 
also held that for purposes of section 737(b), net precontribution gain 
includes newly created section 704(c) gain or loss in property 
contributed by the transferor partnership to the transferee partnership 
in an assets-over partnership merger. In addition, the revenue ruling 
held that section 704(c)(1)(B) will not apply to, and, for purposes of 
section 737, net precontribution gain will not include, reverse section 
704(c) gain or loss resulting from a revaluation of property of the 
transferee partnership.
    Some commentators argued that Rev. Rul. 2004-43 was not consistent 
with the existing regulations under sections 704(c)(1)(B) and 737, and 
that the conclusions contained in the ruling should not be applied 
retroactively. In response to these comments, the Treasury Department 
and the IRS issued Notice 2005-15, 2005-7 IRB 527, (see Sec.  
601.601(d)(2) of this chapter) indicating their intent to issue 
regulations under sections 704(c)(1)(B) and 737 implementing the 
principles of the ruling, and issued Rev. Rul. 2005-10, 2005-7 IRB 492 
(see Sec.  601.601(d)(2) of this chapter) officially revoking Rev. Rul. 
2004-43. The Notice provided that any such regulations would be 
effective for distributions made after January 19, 2005.

Explanation of Provisions

A. Assets-Over Partnership Mergers

    These proposed regulations implement the principles articulated in 
Rev. Rul. 2004-43. The proposed regulations under Sec.  1.704-4(c)(4) 
and Sec.  1.737-2(b) provide that in an assets-over merger, sections 
704(c)(1)(B) and 737 do not apply to the transfer by a partnership (the 
transferor partnership) of all of its assets and liabilities to another 
partnership (the transferee partnership), followed by a distribution of 
the interests in the transferee

[[Page 46933]]

partnership in liquidation of the transferor partnership as part of the 
same plan or arrangement.
    The proposed regulations, however, provide that section 
704(c)(1)(B) applies to a subsequent distribution by the transferee 
partnership of section 704(c) property contributed in the assets-over 
merger by the transferor partnership to the transferee partnership. The 
proposed regulations also provide that section 737 applies when a 
partner of the transferor partnership receives a subsequent 
distribution of property (other than money) from the transferee 
partnership.
    The proposed regulations provide that for property contributed to 
the transferor partnership (original contribution), the amount of 
original section 704(c) gain or loss is the difference between the 
property's fair market value and the contributing partner's adjusted 
basis at the time of contribution to the extent such difference has not 
been eliminated by section 704(c) allocations, prior revaluations, or 
in connection with the merger. In the case of property contributed with 
original section 704(c) loss, section 704(c)(1)(C) which was added by 
the American Jobs Creation Act of 2004 provides special rules for 
determining the basis of the property contributed. The Treasury 
Department and IRS are currently developing guidance that will 
implement the provisions of section 704(c)(1)(C). Thus, the proposed 
regulations do not address the impact of section 704(c)(1)(C) in 
applying these rules. However, when finalized, these regulations will 
clarify the application of section 704(c)(1)(C) to these rules.
    The proposed regulations provide that the seven year period will 
not restart with respect to the original section 704(c) gain or loss as 
a result of the merger. Accordingly, a subsequent distribution by the 
transferee partnership of property with original section 704(c) gain or 
loss is subject to sections 704(c)(1)(B) and 737 if the distribution 
occurs within seven years of the contribution of the property to the 
transferor partnership (original contribution). However, with respect 
to new section 704(c) gain or loss, the regulations provide that the 
seven-year period in sections 704(c)(1)(B) and 737 begins on the date 
of merger. Thus, a subsequent distribution by the transferee 
partnership of property with new section 704(c) gain or loss is subject 
to sections 704(c)(1)(B) and 737 if the distribution occurs within 
seven years of the merger.
    The regulations further provide that no original section 704(c) 
gain or loss will be recognized under section 704(c)(1)(B) or section 
737 if property that was originally contributed to the transferor 
partnership is distributed to the original contributor. If property has 
new section 704(c) gain or loss, then a subsequent distribution of such 
property within seven years of the merger to one of the former partners 
of the transferor partnership (former partner) is subject to section 
704(c)(1)(B) only to the extent of the other former partners' shares of 
such gain or loss.
    New section 704(c) gain or loss shall be allocated among the 
partners of the transferor partnership in a manner consistent with the 
principles of Sec. Sec.  1.704-3(a)(7) and newly designated 1.704-
3(a)(10) (previously Sec.  1.704-3(a)(9)). In addition, the partners of 
the transferor partnership are deemed to have contributed an undivided 
interest in the assets of the partnership. The proposed regulations 
provide that the determination of the partners' undivided interest for 
this purpose shall be made by the transferor partnership using any 
reasonable method. The Treasury Department and the IRS request comments 
on methods that should be considered reasonable for this purpose.
    The proposed regulations also provide that if less than all of a 
section 704(c) property is distributed, then a proportionate amount of 
original and new section 704(c) gain or loss must be recognized under 
section 704(c)(1)(B). Similarly, if gain is required to be recognized 
under section 737, a proportionate amount of original and new section 
704(c) gain must be recognized under section 737. Each partner must 
recognize its respective proportionate share of gain or loss required 
to be recognized.
    The proposed regulations further provide a subsequent merger rule. 
This rule provides that if the transferee partnership is subsequently 
merged (a subsequent merger) the new section 704(c) gain or loss that 
resulted from the original merger shall be subject to section 
704(c)(1)(B) for seven years from the time of the original merger and 
the new section 704(c) gain or loss that resulted from the subsequent 
merger will be subject to section 704(c)(1)(B) for seven years from the 
time of the subsequent merger.
    In addition, the proposed regulations provide an identical 
ownership and a de minimis change in ownership exception to sections 
704(c)(1)(B) and 737 with regard to assets-over partnership mergers. 
Under the identical ownership exception, section 704(c)(1)(B) will not 
apply to, and section 737 net precontribution gain will not include, 
new section 704(c) gain or loss in any property contributed in an 
assets-over partnership merger where the ownership of both partnerships 
is identical. In order for merging partnerships to qualify for the 
identical ownership exception, each partner must own identical 
interests in book capital and in each item of income, gain, loss, 
deductions and credit, and identical shares of distributions and 
liabilities in each of the transferor and transferee partnerships. 
Where ownership of both partnerships is identical, the merger more 
accurately represents a change in form, and should have no substantive 
tax consequences. The same principles apply where the change in 
ownership is de minimis. For purposes of the de minimis exception, a 
difference in ownership is de minimis if ninety seven percent of the 
interests in book capital, items of income, gain, loss, deduction and 
credit and share of distributions and liabilities of the transferor 
partnership and transferee partnership are owned by the same owners in 
the same proportions.
    Proposed regulations under Sec.  1.704-3(c)(4)(iii) provide that 
taxpayers may distinguish between the original and new portions of 
section 704(c) gain or loss. The proposed regulations provide that the 
transferee partnership may continue to use the section 704(c) 
allocation method adopted by the transferor partnership with respect to 
original section 704(c) property, or it may adopt another reasonable 
section 704(c) method. In addition, the transferee partnership may 
adopt any reasonable section 704(c) method with respect to new section 
704(c) gain or loss. With respect to both the original and the new 
section 704(c) gain or loss, the transferee partnership must use a 
reasonable method that is consistent with the purpose of sections 
704(b) and 704(c).

B. Miscellaneous Provisions

    As part of this proposed regulation, the Treasury Department and 
the IRS are also making certain regulatory changes to reflect statutory 
changes that occurred as part of the Taxpayer Relief Act of 1997 
(Public Law 105-34). Effective June 8, 1997, Congress lengthened the 
period of time from five years to seven for accounting for section 
704(c) gain or loss with respect to distributions. Consistent with the 
statutory changes, various provisions in Sec.  1.704-4 and Sec.  1.737-
1 have been amended.

Effective Dates

    Except as otherwise provided, these proposed regulations will be 
effective

[[Page 46934]]

for any distributions of property after January 19, 2005, if such 
property was contributed in an assets-over merger after May 3, 2004. 
Provisions relating to the change in the regulations in Sec.  1.704-4 
and Sec.  1.737-1 from the previous five-year rule to the seven-year 
rule will be effective August 22, 2007.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
the regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. The Treasury Department and IRS request comments on the 
clarity of the proposed rules and how they may be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for December 5, 2007, 10 a.m. 
in the Auditorium, Internal Revenue Building, 1111 Constitution Avenue, 
NW., Washington, DC. Due to building security procedures, visitors must 
enter at the Constitution Avenue entrance. In addition, all visitors 
must present photo identification to enter the building. Because of 
access restrictions, visitors will not be admitted beyond the immediate 
entrance area more than 15 minutes before the hearing starts. For 
information about having your name placed on the building access list 
to attend the hearing, see the FOR FURTHER INFORMATION CONTACT section 
of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit written or 
electronic comments by November 20, 2007 and an outline of the topics 
to be discussed and time to be devoted to each topic (a signed original 
and eight (8) copies) by November 21, 2007. A period of 10 minutes will 
be allotted to each person for making comments. An agenda showing the 
scheduling of the speakers will be prepared after the deadline for 
receiving outlines has passed. Copies of the agenda will be available 
free of charge at the hearing.

Drafting Information

    The principal authors of these proposed regulations are Jason 
Smyczek and Laura Fields, Office of the Associate Chief Counsel 
(Passthroughs and Special Industries), IRS. However, other personnel 
from the IRS and the Treasury Department participated in their 
development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

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

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

    Section 1.704-3 also issued under 26 U.S.C. 704. * * *
    Par. 2. Section 1.704-3 is amended as follows:
    1. Paragraphs (a)(9) through (a)(12) are redesignated as paragraphs 
(a)(10) through (a)(13) respectively.
    2. New paragraph (a)(9) is added.
    3. Paragraph (f) is amended by revising the paragraph heading and 
adding one additional sentence at the end of the paragraph.
    The revisions and additions read as follows:


Sec.  1.704-3  Contributed Property.

    (a) * * *
    (9) Section 704(c) property transferred in an assets-over merger. 
Assets transferred to a transferee partnership from the transferor 
partnership in an assets-over merger as defined in Sec.  1.708-1(c)(3) 
(the transferor partnership being the partnership considered to have 
been terminated under Sec.  1.708-1(c)(1) and the transferee 
partnership being the partnership considered to be the resulting 
partnership under Sec.  1.708-(1)(c)(1)) may have both original section 
704(c) gain or loss (see Sec.  1.704-4(c)(4)(ii)(A) for the definition 
of original section 704(c) gain or loss) and new section 704(c) gain or 
loss. The transferee partnership may continue to use the section 704(c) 
allocation method adopted by the transferor partnership with respect to 
section 704(c) property originally contributed to the transferor 
partnership or it may adopt another reasonable section 704(c) method. 
Also, the transferee partnership may continue to use the section 704(c) 
allocation method adopted by the transferor partnership with respect to 
new section 704(c) gain or loss to account for differences between book 
value and adjusted tax basis as a result of a prior revaluation. In 
addition, the transferee partnership may adopt any reasonable section 
704(c) method with respect to new section 704(c) gain or loss in excess 
of the amount of new section 704(c) gain or loss described in the prior 
sentence. With respect to both original and new section 704(c) gain or 
loss, the transferee partnership must use a reasonable method that is 
consistent with the purpose of sections 704(b) and 704(c).
* * * * *
    (f) Effective/applicability date. * * * Paragraph (a)(9) is 
effective for any distribution of property after January 19, 2005, if 
such property was contributed in a merger using the assets-over form 
after May 3, 2004.
    Par. 3. Section 1.704-4 is amended as follows:
    1. Paragraph (a)(1) is amended by removing the phrase ``five 
years'' and adding in its place the phrase ``seven years.''
    2. Paragraph (a)(4)(i) is amended by removing the phrase ``five-
year'' and adding in its place ``seven-year.''
    3. Paragraph (a)(4)(ii) is amended by removing the phrase ``five-
year'' and adding in its place the phrase ``seven-year.''
    4. Paragraphs (c)(4)(i) and (c)(4)(ii) are added.
    5. Paragraph (c)(7) is redesignated as paragraph (c)(8).
    6. A new paragraph (c)(7) is added.
    7. Paragraphs (f)(2), Examples (1) and (2) are amended by removing 
the language ``five-year'' and replacing it with the language ``seven-
year'' wherever it appears throughout both examples.
    8. Paragraph (g) is amended by revising the paragraph heading and 
adding two sentences at the end of the paragraph.
    The revisions and additions read as follows:


Sec.  1.704-4  Distribution of contributed property.

* * * * *
    (c) * * *
    (4) Complete transfer to another partnership (Assets-Over 
Merger).-- (i) In general. Section 704(c)(1)(B) and this

[[Page 46935]]

section do not apply to the transfer in an assets-over merger as 
defined in Sec.  1.708-1(c)(3) by a partnership (the transferor 
partnership, which is considered to be the terminated partnership as a 
result of the merger) of all of its assets and liabilities to another 
partnership (the transferee partnership, which is considered to be the 
resulting partnership after the merger), followed by a distribution of 
the interest in the transferee partnership in liquidation of the 
transferor partnership as part of the same plan or arrangement.
    (ii) Subsequent distributions. Except as provided in paragraph 
(c)(4)(E) below, section 704(c)(1)(B) and this section apply to the 
subsequent distribution by the transferee partnership of section 704(c) 
property contributed by the transferor partnership to the transferee 
partnership in an assets-over merger, as provided in paragraphs 
(c)(4)(ii)(A) through (D) of this section.
    (A) Original section 704(c) gain or loss. The seven-year period in 
section 704(c)(1)(B) does not restart with respect to original section 
704(c) gain or loss as a result of the transfer of the section 704(c) 
property to the transferee partnership. For purposes of this paragraph 
(c)(4)(ii)(A), the amount of original section 704(c) gain or loss is 
the difference between the property's fair market value and the 
contributing partner's adjusted tax basis, at the time of contribution, 
to the extent such difference has not been eliminated by section 704(c) 
allocations, prior revaluations, or in connection with the merger. See 
Sec. Sec.  1.704-4(a) and (b) for post-merger distributions of property 
contributed to the transferee partnership prior to the merger. A 
subsequent distribution by the transferee partnership of property with 
original section 704(c) gain or loss to a partner other than the 
partner that contributed such property to the transferor partnership is 
subject to section 704(c)(1)(B) if the distribution occurs within seven 
years of the contribution of the property to the transferor 
partnership. See Sec.  1.704-4(c)(4)(ii)(B) for rules relating to the 
distribution of property with new section 704(c) gain or loss. See 
Sec.  1.737-2(b)(1)(ii)(A) for a similar rule in the context of section 
737.
    (B) New section 704(c) gain or loss. A subsequent distribution of 
property with new section 704(c) gain or loss by the transferee 
partnership to a partner other than the contributing partner is subject 
to section 704(c)(1)(B) if the distribution occurs within seven years 
of the contribution of the property to the transferee partnership by 
the transferor partnership. For these purposes, a partner of the 
transferor partnership is deemed to have contributed to the transferee 
partnership an undivided interest in the property of the transferor 
partnership. The determination of the partners' undivided interest for 
this purpose shall be determined by the transferor partnership using 
any reasonable method. New section 704(c) gain or loss shall be 
allocated among the partners of the transferor partnership in a manner 
consistent with the principles of Sec. Sec.  1.704-3(a)(7) and 1.704-
3(a)(10). See Sec.  1.737-2(d)(4) for a similar rule in the context of 
section 737.
    (C) Ordering Rule.-- (1) Post-merger partial recognition. For 
purposes of this section, if less than all of a section 704(c) property 
is distributed, then a proportionate amount of original and new section 
704(c) gain or loss must be recognized.
    (2) Post-merger revaluation. Revaluations after a merger that 
reflect a reduction in the amount of built-in gain or loss inherent in 
property will reduce new section 704(c) gain or loss prior to reducing 
original section 704(c) gain or loss.
    (D) Subsequent Mergers. If the transferee partnership (first 
transferee partnership) is subsequently merged into another partnership 
(new transferee partnership) the new section 704(c) gain or loss that 
resulted from the merger of the transferor partnership into the first 
transferee partnership shall be subject to section 704(c)(1)(B) for 
seven years from the time of the contribution by the transferor 
partnership to the first transferee partnership (original merger) and 
new section 704(c) gain or loss that resulted from the merger of the 
first transferee into the new transferee (subsequent merger) shall be 
subject to section 704(c)(1)(B) for seven years from the time of the 
subsequent merger. See Sec.  1.737-2(b)(1)(ii)(D) for a similar rule in 
the context of section 737.
    (E) Identical Ownership or De Minimis Change in Ownership 
Exception. Section 704(c)(1)(B) and this section do not apply to new 
section 704(c) gain or loss in property transferred by the transferor 
partnership to the transferee partnership if both the transferor 
partnership and the transferee partnership are owned by the same owners 
in the same proportions or the difference in ownership is de minimis. 
The transferor partnership and the transferee partnership are owned by 
the same owners in the same proportions if each partner owns identical 
interests in book capital and in each item of income, gain, loss, 
deduction, and credit, and identical shares of distributions and 
liabilities in each of the transferor and transferee partnerships. A 
difference in ownership is de minimis if ninety seven percent of the 
interests in book capital and in each item of income, gain, loss, 
deduction and credit and shares of distributions, and liabilities of 
the transferor partnership and transferee partnership are owned by the 
same owners in the same proportions.
    (F) Examples. The following examples illustrate the rules of 
paragraph (c)(4)(ii) of this section.
    Example (1). New section 704(c) gain. (i) Facts. On January 1, 
2005, A contributes Asset 1, with a basis of $200x and a fair market 
value of $300x, to partnership PRS1 in exchange for a 50 percent 
interest. On the same date, B contributes $300x of cash to PRS1 in 
exchange for a 50 percent interest. Also on January 1, 2005, C 
contributes Asset 2, with a basis of $100x and a fair market value 
of $200x, to partnership PRS2 in exchange for a 50 percent interest. 
D contributes $200x of cash to PRS2 in exchange for a 50 percent 
interest. On January 1, 2008, PRS1 and PRS2 undertake an assets-over 
partnership merger in which PRS1 is the continuing partnership and 
PRS2 is the terminating partnership for both state law and federal 
tax purposes. At the time of the merger, PRS1's only assets are 
Asset 1, with a fair market value of $900x, and $300x in cash. 
PRS2's only assets are Asset 2, with a fair market value of $600x, 
and $200x in cash. After the merger, the partners have book capital 
and profits interests in PRS1 as follows: A, 30 percent; B, 30 
percent; C, 20 percent; and D, 20 percent. PRS1 and PRS2 both have 
provisions in their respective partnership agreements requiring the 
revaluation of partnership property upon entry of a new partner. 
PRS1 would not be treated as an investment company (within the 
meaning of section 351) if it were incorporated. Neither partnership 
holds any unrealized receivables or inventory for purposes of 
section 751. In addition, neither partnership has a section 754 
election in place. Asset 1 and Asset 2 are nondepreciable capital 
assets. On January 1, 2013, PRS1 has the same assets that it had 
after the merger. Each asset has the same value that it had at the 
time of the merger. On this date, PRS1 distributes Asset 2 to A in 
liquidation of A's interest.
    (ii) Analysis. On the date of the merger of PRS2 into PRS1, the 
fair market value of Asset 2 ($600x) exceeded its adjusted tax basis 
($100x). Thus, pursuant to Sec.  1.704-4(c)(4)(ii)(A), when Asset 2 
was contributed to PRS1 in the merger, it was section 704(c) gain 
property. The total amount of the section 704(c) gain was $500x 
($600x (fair market value)-$100x (adjusted basis)). The amount of 
original section 704(c) gain attributable to Asset 2 equals $100x, 
the difference between its fair market value ($200x) and adjusted 
tax basis ($100x) upon contribution to PRS2 by C. The amount of new 
section 704(c) gain attributable to Asset 2 equals $400x, the total 
amount of section 704(c) gain ($500x) less the amount of the 
original section 704(c) gain ($100x). The distribution of Asset 2 to 
A occurs more than seven years after the contribution by C of

[[Page 46936]]

Asset 2 to PRS2. Therefore, pursuant to Sec.  1.704-4(c)(4)(ii)(A), 
section 704(c)(1)(B) does not apply to the $100x of original section 
704(c) gain. The distribution of Asset 2 to A, however, occurs 
within seven years of the contribution in the merger of Asset 2 to 
PRS1 by PRS2. Pursuant to Sec.  1.704-4(c)(4)(ii)(B), section 
704(c)(1)(B) applies to the new section 704(c) gain. As the 
transferees of PRS2's partnership interest in PRS1, C and D succeed 
to one-half of the $400x of the new section 704(c) gain created by 
the merger. Thus, as a result of the distribution of Asset 2 to A 
within seven years of the merger, C and D are required to recognize 
$200x of gain each. See Sec.  1.737-2(b)(1)(ii)(F), Example (1) for 
analysis of a similar example under section 737.
    Example (2). Revaluation gain and merger gain. (i) Facts. The 
facts are the same as Example (1), except that during 2005, PRS2 
admitted E as a new partner in PRS2 at a time when the fair market 
value of Asset 2 was $300x and PRS2's only other asset was cash of 
$200X. In exchange for a contribution of cash of $250x, E was 
admitted as a one-third partner in PRS2. In accordance with the 
terms of PRS2's partnership agreement, the partnership revalued its 
assets pursuant to Sec.  1.704-1(b)(2)(iv)(f) upon admission of E so 
that the unrealized gain of $100X attributable to Asset 2 was 
allocated equally between C and D, or $50X each. On January 1, 2008, 
PRS2 merges into PRS1. At the time of the merger, PRS1's only assets 
are Asset 1, with a fair market value of $550x, and $300x in cash. 
PRS2's only assets are Asset 2, with a fair market value of $400x, 
and $450x in cash. After the merger, the partners have book capital 
and profits and loss interests in PRS1 as follows: A, 25%; B, 25%; 
C, 16.67%; D, 16.67% and E, 16.67%. On January 1, 2011, Asset 2 is 
distributed to A when its value is still $400x.
    (ii) Analysis. On the date of the merger of PRS2 into PRS1, the 
fair market value of Asset 2 ($400x) exceeded its adjusted tax basis 
($100x). Thus, when Asset 2 was contributed to PRS1 in the merger, 
it was section 704(c) gain property. The total amount of the section 
704(c) gain was $300x ($400x (fair market value)-$100x (adjusted 
basis)). The amount of the original section 704(c) gain attributable 
to Asset 2 equals $100x, the difference between its fair market 
value of $200x and adjusted tax basis $100x upon contribution to 
PRS2 by C. The amount of the new section 704(c) gain attributable to 
Asset 2 equals $200x, the total section 704(c) gain ($300x) less the 
amount of the original section 704(c) gain ($100x). The distribution 
of Asset 2 to A occurs within seven years after the contribution by 
C to PRS2. Therefore, pursuant to Sec.  1.704-4(c)(4)(ii)(A), 
section 704(c)(1)(B) applies to the original section 704(c) gain. 
The distribution of Asset 2 to A also occurs within seven years of 
the contribution of Asset 2 to PRS1 by PRS2. Pursuant to Sec.  
1.704-4(c)(4)(ii)(B), section 704(c)(1)(B) applies to the new 
section 704(c) gain. As the transferees of PRS2's partnership 
interest in PRS1, C and D each succeed to $50x of new section 704(c) 
gain as a result of the revaluation of Asset 2 upon admission of E 
as a partner. Moreover, C, D and E each succeed to $33.33x of new 
section 704(c) gain as a result of the merger. C also has $100 of 
original section 704(c) gain as a result of the original 
contribution of Asset 2 to PRS2. Thus, as a result of the 
distribution of Asset 2 to A within seven years of the merger, C, D 
and E are each required to recognize gain. C will recognize a total 
of $183.33x of gain ($100x of original section 704(c) gain and 
$83.33x of new section 704(c) gain). D will recognize a total of 
$83.33x of gain (all new section 704(c) gain) and E will recognize 
$33.33x of gain (all new section 704(c) gain). See Sec.  1.737-
2(b)(1)(ii)(F), Example (2) for a similar example under section 737.
    Example (3). Revaluation loss and merger gain. (i) Facts. The 
facts are the same as Example (1) except that during 2005, PRS2 
admitted E as a new partner in PRS2 at a time when the fair market 
value of Asset 2 was $150x and PRS2's only other asset was cash of 
$200x. In exchange for a contribution of cash of $175x, E was 
admitted as a one-third partner in PRS2. In accordance with the 
terms of PRS2's partnership agreement, the partnership revalued its 
assets upon admission of E so that the unrealized loss of $50x 
attributable to Asset 2 was allocated equally between C and D, or 
$25x each. On January 1, 2008, PRS2 merges into PRS1. At the time of 
the merger, PRS1's only assets are Asset 1, with a fair market value 
of $900x, and $300x in cash. PRS2's only assets are Asset 2, with a 
fair market value of $600x, and $375x in cash. After the merger, the 
partners have book capital and profits and loss interests in PRS1 as 
follows: A, 27.5%; B, 27.5%; C, 15%; D, 15% and E, 15%. On January 
1, 2013, Asset 2 is distributed to A when its value is still $600.
    (ii) Analysis. On the date of the merger of PRS2 into PRS1, the 
fair market value of Asset 2 ($600x) exceeded its adjusted tax basis 
($100x). Thus, when Asset 2 was contributed to PRS1 in the merger, 
it was section 704(c) gain property. The total amount of the section 
704(c) gain was $500x ($600x (fair market value)-100x (adjusted 
basis)). The amount of the original section 704(c) gain attributable 
to Asset 2 equals $50x, the difference between its fair market value 
($200x) and adjusted tax basis ($100x) upon contribution to PRS2 by 
C, less the unrealized loss ($50X) attributable to the revaluation 
of PRS2 on the admission of E as a partner in PRS2. The amount of 
the new section 704(c) gain attributable to Asset 2 equals $450x, 
the total section 704(c) gain ($500x) less the amount of the 
original section 704(c) gain ($50x). The distribution of Asset 2 to 
A occurs more than seven years after the contribution by C to PRS2. 
Therefore, pursuant to Sec.  1.704-4(c)(4)(ii)(A), section 
704(c)(1)(B) does not apply to the original section 704(c) gain. The 
distribution of Asset 2 to A, however, occurs within seven years of 
the contribution of Asset 2 to PRS1 and PRS2. Pursuant to Sec.  
1.704-4(c)(4)(ii)(B), section 704(c)(1)(B) applies to the new 
section 704(c) gain. As the transferees of PRS2's partnership 
interest in PRS1, C, D and E each succeed to $150 of new section 
704(c) gain. Thus, as a result of the distribution of Asset 2 to A 
within seven years of the merger, C, D and E are each required to 
recognize $150 of gain.
    Example (4). Reverse section 704(c) gain. (i) Facts. The facts 
are the same as Example (1), except that on January 1, 2013, PRS1 
distributes Asset 1 to C in liquidation of C's interest in PRS1.
    (ii) Analysis. The distribution of Asset 1 to C occurs more than 
seven years after the contribution of Asset 1 to PRS1. Thus, 
pursuant to Sec.  1.704-4(c)(4)(ii)(A), section 704(c)(1)(B) does 
not apply to the original section 704(c) gain. Pursuant to Sec.  
1.704-4(c)(7), section 704(c)(1)(B) does not apply to reverse 
section 704(c) gain in Asset 1 resulting from a revaluation of 
PRS1's partnership property at the time of the merger. Accordingly, 
neither A nor B will recognize gain under section 704(c)(1)(B) as a 
result of the distribution of Asset 1 to C. See Sec.  1.737-
2(b)(1)(ii)(F), Example (4) for a similar example under section 737.
    Example (5). Identical ownership exception. (i) Facts. In 1990, 
A, an individual, and B, a subchapter C corporation, formed PRS1, a 
partnership. A owned 75 percent of the interests in the book capital 
(as determined for purposes of Sec.  1.704-1(b)(2)(iv)), profits, 
losses, distributions, and liabilities (under section 752) of PRS1. 
B owned the remaining 25 percent interest in the book capital, 
profits, losses, distributions, and liabilities of PRS1. In the same 
year, A and B also formed another partnership, PRS2, with A owning 
75 percent of the interests in the book capital, profits, losses, 
distributions, and liabilities of PRS2 and B owning the remaining 25 
percent of the book capital, profits, losses, distributions, and 
liabilities. Upon formation of the partnerships, A contributed the 
Asset X to PRS1 and Asset Y to PRS2 and B contributed cash. Both 
Assets X and Y had section 704(c) built-in gain at the time of 
contribution to the partnerships.
    (ii) In January 2005, PRS1 is merged into PRS2 in an assets-over 
merger in which PRS1 is the terminating partnership and PRS2 as the 
continuing partnership for both state law and federal income tax 
purposes. At the time of the merger, both Asset X and Y had 
increased in value from the time they were contributed to PRS1 and 
PRS2, respectively. As a result, a new layer of section 704(c) gain 
was created with respect to Asset X in PRS1, and reverse section 
704(c) gain was created with respect to Asset Y in PRS2. After the 
merger, A had a 75 percent interest in PRS2's capital, profits, 
losses, distributions, liabilities, and all other items. B held the 
remaining 25 percent interest in PRS2's capital, profits, losses, 
distributions, liabilities, and all other items. In 2006, PRS2 
distributes all of Asset X to A.
    (iii) Analysis. The 2006 distribution of Asset X occurs more 
than seven years after the formation of the partnerships and the 
original contribution of both Assets X and Y to the partnerships. 
Therefore, the original layer of built-in gain created on the 
original contribution of Asset X to PRS1 is not taken into account 
in applying section 704(c)(1)(B) to the proposed distribution. In 
addition, paragraph (c)(4)(ii)(E) of this section provides that 
section 704(c)(1)(B) and paragraph (c)(4)(ii)(B) of this section do 
not apply to new section 704(c) gain or loss in property transferred 
by the transferor partnership to the transferee partnership if both 
the transferor partnership and the transferee

[[Page 46937]]

partnership are owned by the same owners in the same proportions. 
The transferor partnership and the transferee partnership are owned 
by the same owners in the same proportions if each partner's 
percentage interest in the transferor partnership's book capital, 
profits, losses, distributions, and liabilities, is the same as the 
partner's percentage interest in those items of the transferee 
partnership. In this case, A owned 75 percent and B owned 25 percent 
of the interests in the book capital, and in each item of income, 
gain, loss and credit, and share of distributions and liabilities of 
PRS1 and PRS2 prior to the merger and 75 percent and 25 percent, 
respectively, of PRS2 after the merger. As a result, the 
requirements of the identical ownership exception of paragraph 
(c)(4)(ii)(E) of this section are satisfied. Thus, the new built-in 
gain created upon contribution of Asset X in connection with the 
partnership merger will not be taken into account in applying 
section 704(c)(1)(B) to the proposed distribution. See Sec.  1.737-
2(b)(1)(ii)(F), Example (5) for a similar example under section 737.
* * * * *
    (7) Reverse section 704(c) gain or loss. Section 704(c)(1)(B) and 
this section do not apply to reverse section 704(c) gain or loss as 
described in Sec.  1.704-3(a)(6)(i).
* * * * *
    (g) Effective/applicability date. * * * Paragraphs (a)(1), 
(a)(4)(i), (a)(4)(ii), and (f)(2), Examples (1) and (2) are effective 
August 22, 2007. Paragraphs (c)(4)(i), (c)(4)(ii), (c)(4)(ii)(A), 
(c)(4)(ii)(B), (c)(4)(ii)(C), (c)(4)(ii)(D), (c)(4)(ii)(E), 
(c)(4)(ii)(F), and (c)(7) are effective for any distributions of 
property after January 19, 2005, if such property was contributed in a 
merger using the assets-over form after May 3, 2004.
    Par. 4. Section 1.737-1(c)(1) is amended by removing the phrase 
``five years'' and adding in its place the phrase ``seven years''.
    Par. 5. Section 1.737-2 is amended as follows:
    1. Paragraph (b) is revised.
    2. Paragraph (f) is added.
    The additions and revisions read as follows:


Sec.  1.737-2  Exceptions and special rules.

* * * * *
    (b) Transfers to another partnership.--(1) Complete transfer to 
another partnership (Assets-over merger).--(i) In General. Section 737 
and this section do not apply to a transfer in an assets-over merger as 
defined in Sec.  1.708-1(c)(3) by a partnership (the transferor 
partnership, which is considered to be the terminated partnership as a 
result of the merger) of all of its assets and liabilities to another 
partnership (the transferee partnership, which is considered to be the 
resulting partnership after the merger) followed by a distribution of 
the interest in the transferee partnership in liquidation of the 
transferor partnership as part of the same plan or arrangement.
    (ii) Subsequent distributions.--(A) Original section 704(c) gain. 
If, immediately before the assets-over merger, the transferor 
partnership holds property that has original built-in gain (as defined 
in Sec.  1.704-4(c)(4)(ii)(A)), the seven year period in section 737(b) 
does not restart with respect to such gain as a result of the transfer 
of such section 704(c) property to the transferee partnership. A 
subsequent distribution of other property by the transferee partnership 
to the partner who contributed the original section 704(c) gain 
property to the transferor partnership is only subject to section 737 
with respect to the original section 704(c) gain if the distribution 
occurs within seven years of the time such property was contributed to 
the transferor partnership. See Sec.  1.704-4(c)(4)(ii)(A) for a 
similar provision in the context of section 704. See Sec.  1.737-1 for 
post-merger distribution of property contributed to the transferee 
partnership prior to the merger.
    (B) New section 704(c) gain. Except as provided in paragraph 
(b)(1)(ii)(E) of this section, if new built-in gain is created upon the 
contribution of assets by the transferor partnership to the transferee 
partnership, a subsequent distribution by the transferee partnership of 
property to a partner of the transferee partnership (other than 
property deemed contributed by such partner) is subject to section 737, 
if such distribution occurs within seven years of the contribution by 
the transferor partnership to the transferee partnership. For these 
purposes, a partner of the transferor partnership is deemed to have 
contributed to the transferee partnership an undivided interest in the 
property of the transferor partnership. The determination of the 
partner's undivided interest for this purpose shall be determined by 
the transferor partnership using any reasonable method. See Sec.  
1.704-4(c)(4)(ii)(B) for a similar provision in the context of section 
704.
    (C) Ordering Rule. For purposes of this section, if a partner is 
required to recognize gain under this section, the partner shall 
recognize a proportionate amount of original and new section 704(c) 
gain.
    (D) Subsequent Mergers. If the transferee partnership (first 
transferee partnership) is subsequently merged into another partnership 
(new transferee partnership) the section 704(c) gain that resulted from 
the merger of the transferor partnership into the first transferee 
partnership shall be subject to section 737 for seven years from the 
time of the contribution by the transferor partnership to the first 
transferee partnership (original merger) and section 704(c) gain that 
resulted from the merger of the first transferee partnership into the 
new transferee partnership shall be subject to section 737 for seven 
years from the time of the contribution by the first transferee 
partnership to the new transferee partnership (subsequent merger). See 
Sec.  1.704-4(c)(4)(ii)(D) for a similar rule in the context of section 
704.
    (E) Identical Ownership or De Minimis Change in Ownership.
    For purposes of section 737(b) and this section, net 
precontribution gain does not include new section 704(c) gain in 
property transferred by the transferor partnership to the transferee 
partnership if both the transferor partnership and the transferee 
partnership are owned by the same owners in the same proportions or if 
the difference in ownership is de minimis. The transferor partnership 
and the transferee partnership are owned by the same owners in the same 
proportions if each partner owns identical interests in book capital 
and each item of income, gain, loss, deduction, and credit, and 
identical shares of distributions and liabilities in each of the 
transferor and transferee partnerships. A difference in ownership is de 
minimis if ninety-seven percent of interests in book capital and each 
item of income, gain, loss, deduction and credit and shares in 
distributions and liabilities of the transferor partnership and 
transferee partnership are owned by the same owners in the same 
proportions. See Sec.  1.704-4(c)(4)(ii)(E) for a similar provision in 
the context of section 704.
    (F) Examples. The following examples illustrate the rules of 
paragraph (b)(3) of this section.

    Example (1). No net precontribution gain. (i) Facts. On January 
1, 2005, A contributes Asset 1, with a basis of $200x and a fair 
market value of $300x, to partnership PRS1 in exchange for a 50 
percent interest. On the same date, B contributes $300x of cash to 
PRS1 in exchange for a 50 percent interest. Also on January 1, 2005, 
C contributes Asset 2, with a basis of $100x and a fair market value 
of $200x, to partnership PRS2 in exchange for a 50 percent interest. 
D contributes $200x of cash to PRS2 in exchange for a 50 percent 
interest. On January 1, 2008, PRS1 and PRS2 undertake an assets-over 
partnership merger in which PRS1 is the continuing partnership and 
PRS2 is the terminating partnership for both state law and federal 
tax purposes. At the time of the merger, PRS1's only assets are 
Asset 1, with a fair market value of $900x, and $300x in cash. 
PRS2's only assets are Asset 2, with a fair market value of $600x 
and $200x in

[[Page 46938]]

cash. After the merger, the partners have capital and profits 
interests in PRS1 as follows: A, 30 percent; B, 30 percent; C, 20 
percent; and D, 20 percent. PRS1 and PRS2 both have provisions in 
their respective partnership agreements requiring the revaluation of 
partnership property upon entry of a new partner. PRS1 would not be 
treated as an investment company (within the meaning of section 351) 
if it were incorporated. Neither partnership holds any unrealized 
receivables or inventory for purposes of section 751. In addition, 
neither partnership has a section 754 election in place. Asset 1 and 
Asset 2 are nondepreciable capital assets. On January 1, 2013, PRS1 
has the same assets that it had after the merger. Each asset has the 
same value that it had at the time of the merger. On this date, PRS1 
distributes Asset 2 to A in liquidation of A's interest.
    (ii) Analysis. Section 737(a) requires A to recognize gain when 
it receives a distribution of property in an amount equal to the 
lesser of the excess distribution or the partner's net 
precontribution gain. The distribution of Asset 2 to A results in an 
excess distribution of $400x ($600x fair market value of Asset 2-
$200x adjusted basis in A's partnership interest). However, the 
distribution of Asset 2 to A occurs more than seven years after the 
contribution by A of Asset 1 to PRS1 and A made no subsequent 
contributions to PRS1. Therefore, A's net precontribution gain for 
purposes of section 737(b) at the time of the distribution is zero. 
The $600x of reverse section 704(c) gain in Asset 1, resulting from 
a revaluation of PRS1's partnership property at the time of the 
merger, is not net precontribution gain (see Sec.  1.737-2(e)). 
Accordingly, A will not recognize gain under section 737 as a result 
of the distribution of Asset 2. See Sec.  1.704-4(c)(4)(ii)(F), 
Example (1) for a similar example under section 704.
    Example (2). Revaluation gain and merger gain. (i) Facts. The 
facts are the same as Example (1), except that on January 1, 2007, E 
joins PRS2 as a one-third partner for $250x in cash. At the time E 
joins the partnership, Asset 2 has a fair market value of $300x. On 
January 1, 2008, PRS2 merges into PRS1. At the time of the merger, 
Asset 1 and Asset 2 both have a fair market value of $400x. On 
January 1, 2011, Asset 1 is distributed to C when its value is 
$275x.
    (ii) Analysis. Section 737(a) requires A to recognize gain when 
it receives a distribution of property in an amount equal to the 
lesser of the excess distribution or the partner's net 
precontribution gain. The distribution of Asset 1 to C results in an 
excess distribution of $175x ($275x fair market value of Asset 1-
$100x adjusted basis in C's partnership interest). The distribution 
of Asset 1 to C occurs within seven years of the original 
contribution of Asset 2 by C to PRS2. Therefore, C's net 
precontribution gain at the time of the distribution is $183.33x, 
which includes C's original section 704(c) gain from the 
contribution of Asset 2 to PRS2 of $100x plus C's share of new 
section 704(c) gain of $83.33x ($50x of reverse section 704(c) gain 
upon the admission of E, plus $33.33x of additional section 704(c) 
gain upon merger). C's excess distribution is less than C's net 
precontribution gain. Thus, C will recognize $175x of gain upon 
receipt of Asset 1 in accordance with section 737(a). See Sec.  
1.704-4(c)(4)(ii)(F), Example (2) for a similar example under 
section 704.
    Example (3). Fluctuations in the value of an asset. (i) Facts. 
The facts are the same as Example (1), except that on January 1, 
2011, Asset 1 is distributed to C when its fair market value is 
$300x. Immediately prior to the distribution, PRS1 revalues its 
property in accordance with Sec.  1.704-1(b)(2)(iv)(f).
    (ii) Analysis. The distribution of Asset 1 to C occurs within 
seven years of the original contribution of Asset 2 by C to PRS2 and 
within seven years of the date of the merger. Therefore, C's net 
precontribution gain at the time of the distribution equals $300x 
($100x of original section 704(c) gain from the contribution of 
Asset 2 to PRS2 and $200x of new section 704(c) gain). The 
distribution of Asset 1 to C results in an excess distribution of 
$200x ($300x fair market value of Asset 1-$100x adjusted basis in 
C's partnership interest). Accordingly, in accordance with section 
737(a), C will recognize gain of $200x upon receipt of Asset 1.
    Example (4). Reverse section 704(c) gain. (i) Facts. The facts 
are the same as Example (1), except that on January 1, 2011, PRS1 
distributes Asset 2 to A in liquidation of A's interest in PRS1. At 
the time of the distribution, Asset 2 has a value of $600x.
    (ii) Analysis. Section 737(a) requires A to recognize gain when 
it receives a distribution of property in an amount equal to the 
lesser of the excess distribution or the partner's net 
precontribution gain. The distribution of Asset 2 to A results in an 
excess distribution of $400x ($600x fair market value - $200x 
adjusted basis in A's partnership interest). The distribution of 
Asset 2 to A occurs within seven years after the contribution of 
Asset 1 to PRS1 by A. Thus, A's net precontribution gain for 
purposes of section 737(b) at the time of the distribution is $100x 
(A's original section 704(c) gain from the contribution of Asset 1 
to PRS1). Under Sec.  1.737-2(e), A's net precontribution gain does 
not include A's reverse section 704(c) gain upon the revaluation of 
the Assets of PRS1 prior to the merger. Accordingly, A will 
recognize $100x of gain (the lesser of the excess distribution or 
net precontribution gain) under section 737 as a result of the 
distribution of Asset 2. See Sec.  1.704-4(c)(4)(ii)(F), Example (4) 
for a similar example under section 704.
    Example (5). Identical ownership exception. (i) Facts. In 1990, 
A, an individual, and B, a subchapter C corporation, formed PRS1, a 
partnership. A owned 75 percent of the interests in the book 
capital, profits, losses, distributions, and liabilities of PRS1. B 
owned the remaining 25 percent interest in the book capital, 
profits, losses, distributions, and liabilities of PRS1. In the same 
year, A and B also formed another partnership, PRS2, with A owning 
75 percent of the interests in PRS2 and B owning the remaining 25 
percent. Upon formation of the partnerships, A contributed Asset X 
to PRS1 and Asset Y to PRS2 and B contributed cash. Both Assets X 
and Y had section 704(c) built-in gain at the time of contribution 
to the partnerships.
    (ii) In January 2005, PRS1 is merged into PRS2 in an assets-over 
merger in which PRS1 is the terminating partnership and PRS2 is the 
continuing partnership for both state law and federal income tax 
purposes. At the time of the merger, both Assets X and Y had 
increased in value from the time they were contributed to PRS1 and 
PRS2, respectively. As a result, a new layer of section 704(c) gain 
was created with respect to Asset X in PRS1. After the merger, A had 
a 75 percent interest in PRS2's book capital, profits, losses, 
distributions, and liabilities. B held the remaining 25 percent 
interest in PRS2's book capital, profits, losses, distributions, and 
liabilities. In 2006, PRS2 distributes all of Asset X to A.
    (iii) Analysis. The 2006 distribution by PRS2 occurs more than 
seven years after the formation of the partnerships and the original 
contribution of Asset X to the partnerships. Therefore, the original 
layer of built-in gain created on the original contribution of Asset 
X to the partnerships should not be taken into account in applying 
section 737 to the proposed liquidation. In addition, paragraph 
(b)(1)(ii)(E) of this section provides that section 737(a) does not 
apply to newly created section 704(c) gain in property transferred 
by the transferor partnership to the transferee partnership if both 
the transferor partnership and the transferee partnership are owned 
by the same owners in the same proportions. The transferor 
partnership and the transferee partnership are owned by the same 
owners in the same proportions if each partner's percentage interest 
in the transferor partnership's book capital, profits, losses, 
distributions, and liabilities is the same as the partner's 
percentage interest in those items of the transferee partnership. In 
this case, A owned 75 percent and B owned 25 percent of the 
interests in the book capital, profits, losses, distributions, and 
liabilities of PRS1 and PRS2 prior to the merger and 75 percent and 
25 percent, respectively, of PRS2 after the merger. As a result, the 
requirements of the identical ownership exception of paragraph 
(b)(1)(ii)(E) of this section are satisfied. Thus, the new built-in 
gain created upon contribution of Asset X in connection with the 
partnership merger will not be taken into account in applying 
section 737 to the proposed distribution. See Sec.  1.704-
4(c)(4)(ii)(F), Example (5) for a similar example under section 704.

    (2) Certain divisive transactions.--(i) In general. Section 737 and 
this section do not apply to a transfer by a partnership (transferor 
partnership) of all of the section 704(c) property contributed by a 
partner to a second partnership (transferee partnership) in an exchange 
described in section 721, followed by a distribution as part of the 
same plan or arrangement of an interest in the transferee partnership 
(and no other property) in complete liquidation of the interest of the 
partner that originally contributed the section 704(c) property to the 
transferor partnership (divisive transactions).
    (ii) Subsequent distributions. After a divisive transaction 
referred to in paragraph (b)(2)(i) of this section, a

[[Page 46939]]

subsequent distribution of property by the transferee partnership to a 
partner of the transferee partnership that was formerly a partner of 
the transferor partnership is subject to section 737 to the same extent 
that a distribution from the transferor partnership would have been 
subject to section 737.
* * * * *
    (f) Reverse section 704(c) gain. For purposes of section 737(b), 
net precontribution gain does not include reverse section 704(c) gain 
as described in Sec.  1.704-3(a)(6)(i).
    Par. 6. Section 1.737-5 is amended by revising the section heading 
and adding two additional sentences at the end of the paragraph to read 
as follows:


Sec.  1.737-5  Effective/applicability date.

    * * * Section 1.737-1(c) is effective as of August 22, 2007. 
Section 1.737-2(b)(1) is effective for any distribution of property 
after January 19, 2005, if such property was contributed in a merger 
using the assets-over form after May 3, 2004.

Kevin M. Brown,
Deputy Commissioner for Service and Enforcement.
[FR Doc. E7-16189 Filed 8-21-07; 8:45 am]
BILLING CODE 4830-01-P