[Federal Register Volume 79, Number 11 (Thursday, January 16, 2014)]
[Proposed Rules]
[Pages 3042-3069]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-00649]
[[Page 3041]]
Vol. 79
Thursday,
No. 11
January 16, 2014
Part III
Department of the Treasury
-----------------------------------------------------------------------
Internal Revenue Service
26 CFR Part 1
Disallowance of Partnership Loss Transfers, Mandatory Basis
Adjustments, Basis Reduction in Stock of a Corporate Partner,
Modification of Basis Allocation Rules for Substituted Basis
Transactions, Miscellaneous Provisions; Proposed Rule
Federal Register / Vol. 79 , No. 11 / Thursday, January 16, 2014 /
Proposed Rules
[[Page 3042]]
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-144468-05]
RIN 1545-BE98
Disallowance of Partnership Loss Transfers, Mandatory Basis
Adjustments, Basis Reduction in Stock of a Corporate Partner,
Modification of Basis Allocation Rules for Substituted Basis
Transactions, Miscellaneous Provisions
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
-----------------------------------------------------------------------
SUMMARY: The proposed regulations provide guidance on certain
provisions of the American Jobs Creation Act of 2004 and conform the
regulations to statutory changes in the Taxpayer Relief Act of 1997.
The proposed regulations also modify the basis allocation rules to
prevent certain unintended consequences of the current basis allocation
rules for substituted basis transactions. Finally, the proposed
regulations provide additional guidance on allocations resulting from
revaluations of partnership property. The proposed regulations affect
partnerships and their partners. This document also contains a notice
of a public hearing on these proposed regulations.
DATES: Comments must be received by April 16, 2014. Requests to speak
and outlines of the topics to be discussed at the public hearing
scheduled for April 30, 2014, at 10 a.m., must be received by April 16,
2014.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-144468-05), room
5203, Internal Revenue Service, P.O. 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-
144468-05), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the Federal eRulemaking Portal at
www.regulations.gov (IRS REG-144468-05).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Wendy Kribell or Benjamin Weaver at (202) 317-6850; concerning
submissions of comments, the hearing, and/or to be placed on the
building access list to attend the hearing, Oluwafunmilayo (Funmi)
Taylor, (202) 317-6901 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)). Comments on the collection of information should be
sent 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, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP,
Washington, DC 20224. Comments on the collection of information should
be received by March 17, 2014. Comments are specifically requested
concerning:
Whether the proposed collection of information is necessary for the
proper performance of the functions of the IRS, including whether the
information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collection of information; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
The collections of information in the proposed regulations are in
proposed Sec. Sec. 1.704-3(f), 1.734-1(d), 1.743-1(k), and 1.743-1(n).
This information will be used by the IRS to assure compliance with
certain provisions of the American Jobs Creation Act of 2004. The
collections of information are either required to obtain a benefit or
are mandatory. The likely respondents are individuals and partnerships.
The burden for the collection of information in Sec. 1.704-3(f) is
as follows:
Estimated total annual reporting burden: 324,850 hours.
Estimated average annual burden per respondent: 2 hours.
Estimated number of respondents: 162,425.
Estimated annual frequency of responses: On occasion.
The burden for the collection of information in Sec. 1.734-1(d) is
as follows:
Estimated total annual reporting burden: 1,650 hours.
Estimated average annual burden per respondent: 3 hours.
Estimated number of respondents: 550.
Estimated annual frequency of responses: On occasion.
The burden for the collection of information in Sec. 1.743-1(k)(1)
is as follows:
Estimated total annual reporting burden: 1,650 hours.
Estimated average annual burden per respondent: 3 hours.
Estimated number of respondents: 550.
Estimated annual frequency of responses: On occasion.
The burden for the collection of information in Sec. 1.743-1(k)(2)
is as follows:
Estimated total annual reporting burden: 550 hours.
Estimated average annual burden per respondent: 1 hour.
Estimated number of respondents: 550.
Estimated annual frequency of responses: On occasion.
The burden for the collection of information in Sec. 1.743-
1(n)(10) is as follows:
Estimated total annual reporting burden: 3,600.
Estimated average annual burden per respondent: 1 hour.
Estimated number of respondents: 3,600.
Estimated annual frequency of responses: Various.
The burden for the collection of information in Sec. 1.743-
1(n)(11) is as follows:
Estimated total annual reporting burden: 2,700.
Estimated average annual burden per respondent: 1.5 hours.
Estimated number of respondents: 1,800.
Estimated annual frequency of responses: On occasion
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.
Books or records relating to a 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 section 6103.
Background
1. Contributions of Built-in Loss Property
Under section 721(a) of the Internal Revenue Code (the Code), if a
partner contributes property in exchange for a partnership interest,
neither the partners
[[Page 3043]]
nor the partnership recognize gain or loss. Section 722 provides that
when a partner contributes property to a partnership, the basis in the
partnership interest received equals the adjusted basis of the
contributed property. Similarly, under section 723, the partnership's
adjusted basis in the contributed property equals the contributing
partner's adjusted basis in the property. Section 704(c)(1)(A) requires
the partnership to allocate items of partnership income, gain, loss,
and deduction with respect to contributed property among the partners
so as to take into account any built-in gain or built-in loss in the
contributed property. This rule is intended to prevent the transfer of
built-in gain or built-in loss from the contributing partner to other
partners. If a partner contributes built-in gain or built-in loss
property to a partnership and later transfers the interest in the
partnership, Sec. 1.704-3(a)(7) provides that the built-in gain or
built-in loss must be allocated to the transferee as it would have been
allocated to the transferor.
Section 833(a) of the American Jobs Creation Act of 2004, Public
Law 108-357, 118 Stat. 1418 (the AJCA) added section 704(c)(1)(C) to
the Code for contributions of built-in loss property to partnerships
after October 22, 2004. In general, section 704(c)(1)(C) provides that
a partner's built-in loss may only be taken into account in determining
the contributing partner's share of partnership items. Prior to the
AJCA, a contributing partner could transfer losses to a transferee
partner or other partners when the contributing partner was no longer a
partner in the partnership. See H. R. Rep. 108-548 at 282 (2004) (House
Committee Report) and H.R. Rep. 108-755 at 622 (2004) (Conference
Report). Thus, Congress enacted section 704(c)(1)(C) to prevent the
inappropriate transfer of built-in losses to partners other than the
contributing partner. See House Committee Report, at 283. More
specifically, Congress enacted section 704(c)(1)(C) to prevent a
transferee partner from receiving an allocation of the transferor
partner's share of losses relating to the transferor's contribution of
built-in loss property and to prevent remaining partners from receiving
an allocation of a distributee partner's share of losses relating to
the distributee's contribution of built-in loss property when the
distributee receives a liquidating distribution. See House Committee
Report, at 282 and Conference Report, at 621-622. To that end, section
704(c)(1)(C) provides that if property contributed to a partnership has
a built-in loss, (i) such built-in loss shall be taken into account
only in determining the amount of items allocated to the contributing
partner; and (ii) except as provided by regulations, in determining the
amount of items allocated to other partners, the basis of the
contributed property in the hands of the partnership is equal to its
fair market value at the time of the contribution. For purposes of
section 704(c)(1)(C), the term built-in loss means the excess of the
adjusted basis of the property (determined without regard to section
704(c)(1)(C)(ii)) over its fair market value at the time of
contribution.
2. Mandatory Basis Adjustment Provisions
a. Overview
The mandatory basis adjustment provisions in section 833(b) and (c)
of the AJCA reflect Congress' belief that the ``electivity of
partnership basis adjustments upon transfers and distributions leads to
anomalous tax results, causes inaccurate income measurement, and gives
rise to opportunities for tax sheltering.'' See S. Rep. 108-192 at 189
(2003) (Grassley Report). Specifically, Congress was concerned that the
optional basis adjustment regime permitted partners to duplicate losses
and inappropriately transfer losses among partners. Id. According to
the legislative history, Congress intended these amendments to prevent
the inappropriate transfer of losses among partners, while preserving
the simplification aspects of the existing partnership rules for
transactions involving smaller amounts (as described in this preamble,
a $250,000 threshold). See House Committee Report, at 283. Thus,
section 743 and section 734 were amended as described in sections 2.b.
and 2.c. of the background section of this preamble.
b. Section 743 Substantial Built-In Loss Provisions
i. In General
Before the enactment of the AJCA, under section 743(a), upon the
transfer of a partnership interest by sale or exchange or upon the
death of a partner, a partnership was not required to adjust the basis
of partnership property unless the partnership had a section 754
election in effect. If the partnership had a section 754 election in
effect at the time of a transfer, section 743(b) required the
partnership to increase or decrease the adjusted basis of the
partnership property to take into account the difference between the
transferee's proportionate share of the adjusted basis of the
partnership property and the transferee's basis in its partnership
interest.
As amended by the AJCA, section 743(a) and (b) require a
partnership to adjust the basis of partnership property upon a sale or
exchange of an interest in the partnership or upon the death of a
partner if there is a section 754 election in effect, or, for transfers
after October 22, 2004, if the partnership has a substantial built-in
loss immediately after the transfer (regardless of whether the
partnership has a section 754 election in effect). Section 743(d)(1)
provides that, for purposes of section 743, a partnership has a
substantial built-in loss if the partnership's adjusted basis in the
partnership property exceeds the fair market value of the property by
more than $250,000. Section 743(d)(2) provides that the Secretary shall
prescribe such regulations as may be appropriate to carry out the
purposes of section 743(d)(1), including regulations aggregating
related partnerships and disregarding property acquired by the
partnership in an attempt to avoid such purposes.
ii. Electing Investment Partnerships
Section 833(b) of the AJCA also added section 743(e) to the Code,
which provides alternative rules for electing investment partnerships
(EIPs). According to the legislative history, Congress was aware that
mandating section 743(b) adjustments would impose administrative
difficulties on certain types of investment partnerships that are
engaged in investment activities and that typically did not make
section 754 elections prior to the AJCA, even when the adjustments to
the bases of partnership property would be upward adjustments. See
House Committee Report, at 283. Accordingly, for partnerships that meet
the requirements of an EIP in section 743(e)(6) and that elect to apply
the provisions of section 743(e), section 743(e)(1) provides that for
purposes of section 743, an EIP shall not be treated as having a
substantial built-in loss with respect to any transfer occurring while
the EIP election is in effect. Instead, section 743(e)(2) provides
that, in the case of a transfer of an interest in an EIP, the
transferee's distributive share of losses (without regard to gains)
from the sale or exchange of partnership property shall not be allowed
except to the extent that it is established that such losses exceed the
loss (if any) recognized by the transferor (or any prior transferor to
the extent not fully offset by a prior disallowance under section
743(e)(2)) on the transfer of the partnership
[[Page 3044]]
interest. Section 743(e)(3) further provides that losses disallowed
under section 743(e)(2) shall not decrease the transferee's basis in
the partnership interest. In the case of partnership property that has
a built-in loss at the time of the transfer, the loss disallowance
rules in section 743(e)(2) and (e)(3) approximate the effect of a basis
adjustment and prevent the transferee from taking into account an
allocation of the preexisting built-in loss (and the corresponding
basis reduction) without requiring the partnership to adjust the bases
of all partnership property. In addition, section 743(e)(5) provides
that in the case of a transferee whose basis in distributed partnership
property is reduced under section 732(a)(2), the amount of the loss
recognized by the transferor on the transfer that is taken into account
under section 743(e)(2) shall be reduced by the amount of such basis
reduction.
Section 743(e)(6) defines an electing investment partnership as any
partnership if (A) the partnership makes an election to have section
743(e) apply; (B) the partnership would be an investment company under
section 3(a)(1)(A) of the Investment Company Act of 1940 but for an
exemption under paragraph (1) or (7) of section 3(c) of the Act; (C)
the partnership has never been engaged in a trade or business; (D)
substantially all of the assets of the partnership are held for
investment; (E) at least 95 percent of the assets contributed to the
partnership consist of money; (F) no assets contributed to the
partnership had an adjusted basis in excess of fair market value at the
time of contribution; (G) all partnership interests are issued pursuant
to a private offering before the date that is 24 months after the date
of the first capital contribution to the partnership; (H) the
partnership agreement has substantive restrictions on each partner's
ability to cause a redemption of the partner's interest; and (I) the
partnership agreement provides for a term that is not in excess of 15
years. The flush language of section 743(e)(6) provides that the EIP
election, once made, shall be irrevocable except with the consent of
the Secretary. Section 833(d) of the AJCA provides a transition rule
with respect to section 743(e)(6)(H) and (I) for partnerships eligible
to make an election to be an EIP that were in existence on June 4,
2004. For those partnerships, section 743(e)(6)(H) does not apply and
the term in section 743(e)(6)(I) is 20 years.
According to the legislative history, Congress expected EIPs to
include venture capital funds, buyout funds, and funds of funds. See
Conference Report, at 626. The legislative history further indicates
that, with respect to the requirement in section 743(e)(6)(G), Congress
intended that ``dry'' closings in which partnership interests are
issued without the contribution of capital not start the running of the
24-month period. Id. Furthermore, with respect to the requirement in
section 743(e)(6)(H), Congress provided illustrative examples of
substantive restrictions: a violation of Federal or State law (such as
ERISA or the Bank Holding Company Act) or an imposition of the Federal
excise tax on, or a change in the Federal tax-exempt status of, a tax-
exempt partner. Id.
Section 743(e)(4) also provides that section 743(e) shall be
applied without regard to any termination of a partnership under
section 708(b)(1)(B). Finally, section 743(e)(7) provides that the
Secretary shall prescribe such regulations as may be appropriate to
carry out the purposes of section 743(e), including regulations for
applying section 743(e) to tiered partnerships.
Section 833(b) of the AJCA prescribed certain reporting
requirements for EIPs by adding section 6031(f) to the Code. Section
6031(f) provides that in the case of an EIP, the information required
under section 6031(b) (relating to furnishing copies of returns of
partnership income to partners) to be furnished to a partner to whom
section 743(e)(2) applies shall include information as is necessary to
enable the partner to compute the amount of losses disallowed under
section 743(e).
On April 1, 2005, the Treasury Department and the IRS issued Notice
2005-32 (2005-1 CB 895), which provides, in part, interim procedures
and reporting requirements for EIPs; interim procedures for transferors
of EIP interests; and guidance regarding whether a partnership is
engaged in a trade or business for purposes of section 743(e)(6)(C).
Public comments on Notice 2005-32 are discussed in Parts 2.a.i and
2.a.ii of the Explanation of Provisions section of this preamble. See
Sec. 601.601(d)(2)(ii)(b).
iii. Securitization Partnerships
Finally, section 833 of the AJCA added section 743(f) to the Code,
which provides an exception from the mandatory basis adjustment
provisions in section 743(a) and (b) for securitization partnerships.
Section 743(f)(1) states that for purposes of section 743, a
securitization partnership shall not be treated as having a substantial
built-in loss with respect to any transfer. Section 743(f)(2) provides
that the term securitization partnership means a partnership the sole
business activity of which is to issue securities that provide for a
fixed principal (or similar) amount and that are primarily serviced by
the cash flows of a discrete pool (either fixed or revolving) of
receivables or other financial assets that by their terms convert into
cash in a finite period, but only if the sponsor of the pool reasonably
believes that the receivables and other financial assets comprising the
pool are not acquired so as to be disposed of. For purposes of the
``reasonable belief'' standard, the legislative history indicates that
Congress intended rules similar to the rules in Sec. 1.860G-2(a)(3)
(relating to a reasonable belief safe harbor for obligations
principally secured by an interest in real property) to apply. See
Conference Report, at 627. Furthermore, Congress did not intend for the
mandatory basis adjustment rules to be avoided by securitization
partnerships through dispositions of pool assets. Id. Finally, the
legislative history states that if a partnership ceases to meet the
qualifications of a securitization partnership, the mandatory basis
adjustment provisions apply to the first transfer thereafter and to
each subsequent transfer. Id.
c. Section 734 Substantial Basis Reduction Provisions
Section 734(b) requires a partnership to increase or decrease the
adjusted basis of partnership property to take into account any gain or
loss recognized to the distributee and the difference between the
partnership's and the distributee's bases in distributed property.
Similar to section 743, prior to the AJCA, section 734(a) did not
require a partnership to adjust the basis of partnership property upon
a distribution of partnership property to a partner unless the
partnership had a section 754 election in effect.
Consistent with the amendments to section 743, section 833(c) of
the AJCA amended section 734(a) and (b) to require a partnership to
adjust the basis of partnership property upon a distribution of
partnership property to a partner if there is a section 754 election in
effect or, for distributions occurring after October 22, 2004, if there
is a substantial basis reduction with respect to the distribution.
Section 734(d)(1) provides that for purposes of section 734, there is a
substantial basis reduction with respect to a distribution if the sum
of the amounts described in section 734(b)(2)(A) and 734(b)(2)(B)
exceeds $250,000. The amount described in section 734(b)(2)(A) is the
amount of loss recognized to the distributee partner with respect to
the distribution under section 731(a)(2). The amount described in
section
[[Page 3045]]
734(b)(2)(B) is, in the case of distributed property to which section
732(b) applies, the excess of the basis of the distributed property to
the distributee, as determined under section 732, over the adjusted
basis of the distributed property to the partnership immediately before
the distribution (as adjusted by section 732(d)). Section 734(d)(2)
provides regulatory authority for the Secretary to carry out the
purposes of section 734(d) by cross-reference to section 743(d)(2).
Section 743(d)(2) is discussed in Part 2.b.i of the Background section
of this preamble.
As with section 743(b) adjustments, section 734(e) provides an
exception to the mandatory basis adjustment provisions in section 734
for securitization partnerships. A securitization partnership (which is
defined by reference to section 743(f)) is not treated as having a
substantial basis reduction with respect to any distribution of
property to a partner. See Part 2.b.iii of the Background section of
this preamble for the definition of securitization partnership in
section 743(f). Like the rules under section 743, the mandatory basis
adjustment provisions under section 734 will apply with respect to the
first distribution that occurs after the partnership ceases to meet the
definition of a securitization partnership and to each subsequent
distribution.
d. Interim Reporting Requirements for Mandatory Basis Adjustments
The Treasury Department and the IRS issued general interim
procedures for mandatory basis adjustments under sections 734 and 743.
These interim procedures, which are described in Notice 2005-32, state
that until further guidance is provided, partnerships required to
reduce the bases of partnership properties under the substantial basis
reduction provisions in section 734 must comply with Sec. 1.734-1(d)
as if an election under section 754 were in effect at the time of the
relevant distribution. Similarly, partnerships that are required to
reduce the bases of partnership properties under the substantial built-
in loss provisions in section 743 must comply with Sec. 1.743-1(k)(1),
(3), (4), and (5) as if an election under section 754 were in effect at
the time of the relevant transfer. Furthermore, a transferee of an
interest in a partnership that is required to reduce the bases of
partnership properties under the substantial built-in loss provisions
must comply with Sec. 1.743-1(k)(2) as if an election under section
754 were in effect at the time of the relevant transfer.
3. Section 755 Rules for Allocation of Basis
a. Section 755(c)
If section 734(a) requires a basis adjustment (either because the
partnership has a section 754 election in effect or because there is a
substantial basis reduction with respect to the distribution), section
734(b) provides that the partnership increases or decreases the basis
of partnership property by any gain or loss recognized by the
distributee and the difference (if any) between the partnership's and
the distributee's adjusted bases in the distributed property. Section
755(a) generally provides that any increase or decrease in the adjusted
basis of partnership property under section 734(b) shall be allocated
in a manner that: (1) reduces the difference between the fair market
value and the adjusted basis of partnership properties, or (2) in any
other manner permitted by regulations. Generally, section 755(b)
requires a partnership to allocate increases or decreases in the
adjusted basis of partnership property arising from the distribution of
property to property of a like character to the property distributed
(either to (1) capital assets and property described in section
1231(b), or (2) any other property).
According to the Joint Committee on Taxation's (the JCT's)
investigative report of Enron Corporation (See Joint Committee on
Taxation, Report of Investigation of Enron Corporation and Related
Entities Regarding Federal Tax and Compensation Issues, and Policy
Recommendations, JCS-3-03 (February 2003) (JCT Enron Report)),
taxpayers were engaging in transactions to achieve unintended tax
results through the interaction of these partnership basis adjustment
rules and the rules in section 1032 protecting a corporation from
recognizing gain on its stock. Section 1032(a) provides that no gain or
loss is recognized to a corporation on the receipt of money or other
property in exchange for stock of the corporation. In particular, the
JCT Enron Report describes Enron Corporation's Project Condor as
structured to take advantage of the interaction between sections 754
and 1032 by increasing the basis of depreciable assets under section
732 while decreasing the basis under section 734(b) of preferred stock
of a corporate partner held by the partnership. The step down in the
basis of the corporate partner's preferred stock had no ultimate tax
effect because the corporate partner could avoid recognizing the gain
in the stock through section 1032, which prevents a corporation from
recognizing gain on the sale of its stock. The transaction thus
duplicated tax deductions at no economic cost. See Grassley Report, at
127 and House Committee Report, at 287. The JCT expressed specific
concern about the exclusion of gain under section 1032 following a
negative basis adjustment under section 734(b) to stock of a corporate
partner. JCT Enron Report, at 220-21. Therefore, the JCT recommended
that the partnership basis rules preclude an increase in basis to an
asset if the offsetting basis reduction would be allocated to stock of
a partner (or related party). Id. at 221.
In response to these recommendations, section 834(a) of the AJCA
enacted section 755(c), which provides that in making an allocation
under section 755(a) of any decrease in the adjusted basis of
partnership property under section 734(b)--(1) no allocation may be
made to stock in a corporation (or any person related (within the
meaning of sections 267(b) and 707(b)(1)) to such corporation) that is
a partner in the partnership, and (2) any amount not allocable to stock
by reason of section 755(c)(1) shall be allocated under section 755(a)
to other partnership property. The flush language of section 755(c)
further provides that a partnership recognizes gain to the extent that
the amount required to be allocated under section 755(c)(2) to other
partnership property exceeds the aggregate adjusted basis of such other
property immediately before the required allocation.
b. Basis Adjustment Allocation Rules for Substituted Basis Transactions
A basis adjustment under section 743(a) is determined in accordance
with section 743(b). The partnership must allocate any increase or
decrease in the adjusted basis of partnership property required under
section 743(b) under the rules of section 755. Section 1.755-1(b)(5)
provides additional guidance on how to allocate basis adjustments under
section 743(b) that result from substituted basis transactions, which
are defined as exchanges 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 that interest. For exchanges on or after June
9, 2003, Sec. 1.755-1(b)(5) also applies to basis adjustments that
result from exchanges in which the transferee's basis in the
partnership interest is determined by reference to other property held
at any time by the transferee.
Generally, Sec. 1.755-1(b)(5)(ii) provides that if there is an
increase in basis to be allocated to partnership assets, the increase
must be allocated to capital
[[Page 3046]]
gain property or ordinary income property, respectively, only if the
total amount of gain or loss (including any remedial allocations under
Sec. 1.704-3(d)) that would be allocated to the transferee (to the
extent attributable to the acquired partnership interest) from the
hypothetical sale of all such property would result in a net gain or
net income, as the case may be, to the transferee. Similarly, if there
is a decrease in basis to be allocated to partnership assets, Sec.
1.755-1(b)(5)(ii) generally provides that the decrease must be
allocated to capital gain property or ordinary income property,
respectively, only if the total amount of gain or loss (including any
remedial allocations under Sec. 1.704-3(d)) that would be allocated to
the transferee (to the extent attributable to the acquired partnership
interest) from the hypothetical sale of all such property would result
in a net loss to the transferee. Thus, whether or not a basis
adjustment resulting from a substituted basis transaction can be
allocated to partnership property depends on whether the transferee
partner would be allocated a net gain or net income, in the case of a
positive basis adjustment, or net loss, in the case of a negative basis
adjustment.
Section 1.755-1(b)(5)(iii) provides rules for allocating increases
or decreases in basis within the classes of property. Of note, in the
case of a decrease, Sec. 1.755-1(b)(5)(iii)(B) states that the
decrease must be allocated first to properties with unrealized
depreciation in proportion to the transferee's shares of the respective
amounts of unrealized depreciation before the decrease (but only to the
extent of the transferee's share of each property's unrealized
depreciation). Any remaining decrease must be allocated among the
properties within the class in proportion to the transferee's shares of
their adjusted bases (as adjusted under the preceding sentence)
(subject to a limitation in decrease of basis in Sec. 1.755-
1(b)(5)(iii)(C) and a carryover rule in Sec. 1.755-1(b)(5)(iii)(D)).
In addition, Sec. 1.743-1(f) provides that, when there has been
more than one transfer of a partnership interest, a partnership
determines a transferee's basis adjustment without regard to any prior
transferee's basis adjustment. Accordingly, if a partner acquires its
partnership interest in a transaction other than a substituted basis
transaction and then subsequently transfers its interest in a
substituted basis transaction, the transferee's basis adjustment may
shift among partnership assets.
4. Miscellaneous Provisions
a. Section 704(c) Allocations
Property contributed to a partnership by a partner is section
704(c) property if, at the time of contribution, the property has a
built-in gain or built-in loss (``forward section 704(c) gain or
loss''). Section 704(c)(1)(A) requires a partnership to allocate
income, gain, loss, and deduction so as to take into account the built-
in gain or built-in loss. For this purpose, Sec. 1.704-3(a)(3)(ii)
provides that a built-in gain or built-in loss is generally the
difference between the property's book value and the contributing
partner's adjusted tax basis upon contribution (reduced by decreases in
the difference between the property's book value and adjusted tax
basis). Section 1.704-3(a)(6)(i) provides that the principles of
section 704(c) also apply to allocations with respect to property for
which differences between book value and adjusted tax basis are created
when a partnership revalues property pursuant to Sec. 1.704-
1(b)(2)(iv)(f) (``reverse section 704(c) allocations''). Partnerships
are not required to use the same allocation method for forward and
reverse section 704(c) allocations, but the allocation method (or
combination of methods) must be reasonable. See Sec. Sec. 1.704-
3(a)(6)(i) and 1.704-3(a)(10)(i). Section 1.704-3(a)(10)(i) provides
that an allocation method is not reasonable if the contribution or
revaluation event and the corresponding allocation are made with a view
to shifting the tax consequences of built-in gain or built-in loss
among the partners in a manner that substantially reduces the present
value of the partners' aggregate tax liability.
On August 12, 2009, the Treasury Department and the IRS published
Notice 2009-70, 2009-2 CB 255, which requested comments on the proper
application of the rules relating to the creation and maintenance of
forward and multiple reverse section 704(c) allocations (referred to as
``section 704(c) layers'' in this preamble). Specifically, Notice 2009-
70 requested comments on, among other things, whether taxpayers should
net reverse section 704(c) allocations against existing section 704(c)
layers or maintain separate section 704(c) layers if the section 704(c)
layers offset one another; how partnerships should allocate tax
depreciation, depletion, amortization, and gain or loss between
multiple section 704(c) layers (including any offsetting section 704(c)
layers); and whether there are other issues relating to section 704(c)
layers. Public comments on Notice 2009-70 are discussed in Part 4.a of
the Explanation of Provisions section of this preamble. See Sec.
601.601(d)(2)(ii)(b).
b. Extension of Time Period for Taxing Precontribution Gain
The Taxpayer Relief Act of 1997 (Pub. Law 105-34, 111 Stat. 788)
extended the time period in sections 704(c)(1)(B) and 737(b)(1) for
taxing precontribution gain for property contributed to a partnership
after June 8, 1997, from five years to seven years (the rule does not,
however, apply to any property contributed pursuant to a written
binding contract in effect on June 8, 1997, and at all times thereafter
before such contribution if such contract provides for the contribution
of a fixed amount of property). The regulations under sections 704,
737, and 1502 have not been revised to reflect this statutory change.
Explanation of Provisions
1. Contributions of Built-in Loss Property
a. Overview
Section 704(c)(1)(C)(i) provides that if property contributed to a
partnership has a built-in loss (``section 704(c)(1)(C) property''),
such built-in loss shall be taken into account only in determining the
amount of items allocated to the contributing partner (``section
704(c)(1)(C) partner''). Section 704(c)(1)(C)(ii) further provides
that, except as provided by regulations, in determining the amount of
items allocated to other partners, the basis of the contributed
property in the hands of the partnership is equal to its fair market
value at the time of the contribution. For purposes of section
704(c)(1)(C), the term built-in loss means the excess of the adjusted
basis of the section 704(c)(1)(C) property (determined without regard
to section 704(c)(1)(C)(ii)) over its fair market value at the time of
contribution.
The Treasury Department and the IRS believe additional guidance is
needed with respect to the application of section 704(c)(1)(C).
Accordingly, the proposed regulations provide rules regarding: (1) the
scope of section 704(c)(1)(C); (2) the effect of the built-in loss; (3)
distributions by partnerships holding section 704(c)(1)(C) property;
(4) transfers of a section 704(c)(1)(C) partner's partnership interest;
(5) transfers of section 704(c)(1)(C) property; and (6) reporting
requirements.
b. Scope of Section 704(c)(1)(C)
The proposed regulations define section 704(c)(1)(C) property as
section
[[Page 3047]]
704(c) property with a built-in loss at the time of contribution. Thus,
in addition to the rules in the proposed regulations, section
704(c)(1)(C) property is subject to the existing rules and regulations
applicable to section 704(c) property generally (see, for example,
Sec. 1.704-3(a)(9), which provides special rules for tiered
partnerships), except as provided in the proposed regulations.
The Treasury Department and the IRS considered whether the
principles of section 704(c)(1)(C) should apply to reverse section
704(c) allocations (within the meaning of Sec. 1.704-3(a)(6)(i)). The
Treasury Department and the IRS concluded that applying the proposed
regulations to reverse section 704(c) allocations would be difficult
for taxpayers to comply with and for the IRS to administer. Therefore,
the proposed regulations do not apply to reverse section 704(c)
allocations.
The Treasury Department and the IRS also considered whether section
704(c)(1)(C) should apply to Sec. 1.752-7 liabilities. Under Sec.
1.752-7(b)(3)(i), a Sec. 1.752-7 liability is an obligation described
in Sec. 1.752-1(a)(4)(ii) (generally any fixed or contingent
obligation to make payment without regard to whether the obligation is
otherwise taken into account for purposes of Code) to the extent that
the obligation either is not described in Sec. 1.752-1(a)(4)(i) or the
amount of the obligation exceeds the amount taken into account under
Sec. 1.752-1(a)(4)(i). The preamble to the final regulations under
Sec. 1.752-7, published on May 26, 2005, acknowledges that the rules
in section 704(c)(1)(C) and the rules under Sec. 1.752-7 are similar.
See TD 9207, 70 FR 30334. The preamble explains that 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 (when the Sec. 1.752-7
liability is related to the contributed property). However, the
preamble further provides that Sec. 1.752-7 shall be applied without
regard to the amendments made by the AJCA, unless future guidance
provides to the contrary. The Treasury Department and the IRS believe
the rules regarding Sec. 1.752-7 liabilities adequately address the
issues posed by Sec. 1.752-7 liabilities and, thus, the proposed
regulations provide that section 704(c)(1)(C) property does not include
a Sec. 1.752-7 liability.
c. Effect of Section 704(c)(1)(C) Basis Adjustment
The legislative history indicates that Congress intended the built-
in loss attributable to section 704(c)(1)(C) property to be for the
benefit of the contributing partner only. Conceptually, the built-in
loss is similar to a section 743(b) adjustment, which is an adjustment
to the basis of partnership property solely with respect to the
transferee partner. The current regulations under section 743 provide
detailed rules regarding accounting for, maintenance of, recovery of,
and transfers of assets with, section 743(b) adjustments. The Treasury
Department and the IRS believe it is appropriate that the proposed
regulations provide rules similar to those applicable to positive basis
adjustments under section 743(b). The Treasury Department and the IRS
believe that this approach simplifies the application and
administration of section 704(c)(1)(C) and provides a framework of
rules familiar to partners, partnerships, and the IRS. Even though the
proposed regulations generally adopt the approach taken with respect to
section 743(b) adjustments, the Treasury Department and the IRS believe
that some of the rules governing section 743(b) adjustments should not
apply with respect to a built-in loss and that additional rules are
necessary for section 704(c)(1)(C). Thus, the proposed regulations
import and specifically apply certain concepts contained in the section
743 regulations to section 704(c)(1)(C), as opposed to simply providing
that principles similar to those contained in the regulations under
section 743 apply to section 704(c)(1)(C) by cross-reference. The
following discussion describes both the substantive rules applied under
section 704(c)(1)(C) and, where applicable, how those rules differ from
their counterparts under section 743(b).
The proposed regulations create the concept of a section
704(c)(1)(C) basis adjustment. The section 704(c)(1)(C) basis
adjustment is initially equal to the built-in loss associated with the
section 704(c)(1)(C) property at the contribution and then is adjusted
in accordance with the proposed regulations. For example, if A
contributes, in a section 721 transaction, property with a fair market
value of $6,000 and an adjusted basis of $11,000 to a partnership, the
partnership's basis in the property is $6,000, A's basis in its
partnership interest is $11,000, and A has a section 704(c)(1)(C) basis
adjustment of $5,000. Similar to basis adjustments under section
743(b), a section 704(c)(1)(C) basis adjustment is unique to the
section 704(c)(1)(C) partner and does not affect the basis of
partnership property or the partnership's computation of any item under
section 703. The rules regarding the effect of the section 704(c)(1)(C)
basis adjustment are similar to the rules for section 743(b)
adjustments in Sec. Sec. 1.743-1(j)(1) through (j)(3), including: (1)
the effect of the section 704(c)(1)(C) basis adjustment on the basis of
partnership property; (2) the computation and allocation of the
partnership's items of income, deduction, gain, or loss; (3)
adjustments to the partners' capital accounts; (4) adjustments to the
section 704(c)(1)(C) partner's distributive share; and (5) the
determination of a section 704(c)(1)(C) partner's income, gain, or loss
from the sale or exchange of section 704(c)(1)(C) property. The
Treasury Department and the IRS believe the rule regarding recovery of
the section 704(c)(1)(C) basis adjustment should be consistent with the
rule regarding recovery of the adjusted tax basis in the property that
is not subject to section 704(c)(1)(C). Thus, for property eligible for
cost recovery, the proposed regulations provide that, regarding the
effect of the basis adjustment in determining items of deduction, if
section 704(c)(1)(C) property is subject to amortization under section
197, depreciation under section 168, or other cost recovery in the
hands of the section 704(c)(1)(C) partner, the section 704(c)(1)(C)
basis adjustment associated with the property is recovered in
accordance with section 197(f)(2), section 168(i)(7), or other
applicable Code sections. Similar to section 743, the proposed
regulations further provide that the amount of any section 704(c)(1)(C)
basis adjustment that is recovered by the section 704(c)(1)(C) partner
in any year is added to the section 704(c)(1)(C) partner's distributive
share of the partnership's depreciation or amortization deductions for
the year. The section 704(c)(1)(C) basis adjustment is adjusted under
section 1016(a)(2) to reflect the recovery of the section 704(c)(1)(C)
basis adjustment.
d. Distribution by Partnership Holding Section 704(c)(1)(C) Property
The proposed regulations provide guidance on current distributions
of section 704(c)(1)(C) property to the section 704(c)(1)(C) partner;
distributions of section 704(c)(1)(C) property to another partner; and
liquidating distributions to a section 704(c)(1)(C) partner. The
Treasury Department and the IRS believe it is appropriate to apply
principles similar to section 743 to simplify the administration of
section 704(c)(1)(C)
[[Page 3048]]
for partners, partnerships, and the IRS. Thus, the proposed regulations
generally provide rules similar to those for section 743(b)
adjustments.
i. Current Distribution of Section 704(c)(1)(C) Property to Section
704(c)(1)(C) Partner
Under the proposed regulations, the adjusted partnership basis of
section 704(c)(1)(C) property distributed to the section 704(c)(1)(C)
partner includes the section 704(c)(1)(C) basis adjustment for purposes
of determining the amount of any adjustment under section 734. However,
the proposed regulations provide that section 704(c)(1)(C) basis
adjustments are not taken into account in making allocations under
Sec. 1.755-1(c).
ii. Distribution of Section 704(c)(1)(C) Property to Another Partner
Under the proposed regulations, if a partner receives a
distribution of property in which another partner has a section
704(c)(1)(C) basis adjustment, the distributee partner does not take
the section 704(c)(1)(C) basis adjustment into account under section
732. However, the Treasury Department and the IRS request comments on
whether a section 704(c)(1)(C) adjustment to distributed stock should
be taken into account for purposes of section 732(f) notwithstanding
the general rule that section 704(c)(1)(C) adjustments are not taken
into account under section 732.
Upon the distribution of section 704(c)(1)(C) property to another
partner, the section 704(c)(1)(C) partner reallocates its section
704(c)(1)(C) basis adjustment relating to the distributed property
among the remaining items of partnership property under Sec. 1.755-
1(c), which is similar to the rule in Sec. 1.743-1(g)(2)(ii) for
reallocating section 743(b) adjustments. This rule allocates the basis
adjustment to partnership property without regard to the section
704(c)(1)(C) partner's allocable share of income, gain, or loss in each
partnership asset. The Treasury Department and the IRS request comments
on whether the reallocations of section 704(c)(1)(C) basis adjustments
and section 743(b) basis adjustments should instead be made under the
principles of Sec. 1.755-1(b)(5)(iii) to take into account the
partner's allocable share of income, gain, or loss from each
partnership asset.
The proposed regulations further provide that if section
704(c)(1)(B) applies to treat the section 704(c)(1)(C) partner as
recognizing loss on the sale of the distributed property, the section
704(c)(1)(C) basis adjustment is taken into account in determining the
amount of loss. Accordingly, when the section 704(c)(1)(C) property is
distributed to a partner other than the contributing partner within
seven years of its contribution to the partnership, the loss will be
taken into account by the contributing partner. The Treasury Department
and the IRS considered extending the seven-year period so that the loss
will be taken into account by the contributing partner on any
distribution of section 704(c)(1)(C) property to a partner other than
the contributing partner. The Treasury Department and the IRS do not
adopt this approach in the proposed regulations because it would be
inconsistent with section 704(c)(1)(B) generally and would be more
difficult to administer.
iii. Distribution in Complete Liquidation of a Section 704(c)(1)(C)
Partner's Interest
The proposed regulations provide that if a section 704(c)(1)(C)
partner receives a distribution of property (whether or not the
property is section 704(c)(1)(C) property) in liquidation of its
interest in the partnership, the adjusted basis to the partnership of
the distributed property immediately before the distribution includes
the section 704(c)(1)(C) partner's section 704(c)(1)(C) basis
adjustment for the property in which the section 704(c)(1)(C) partner
relinquished an interest (if any) by reason of the liquidation. For
purposes of determining the redeemed section 704(c)(1)(C) partner's
basis in distributed property under section 732, the partnership
reallocates any section 704(c)(1)(C) basis adjustment from section
704(c)(1)(C) property retained by the partnership to distributed
properties of like character under the principles of Sec. 1.755-
1(c)(i), after applying sections 704(c)(1)(B) and 737. If section
704(c)(1)(C) property is retained by the partnership, and no property
of like character is distributed, then that property's section
704(c)(1)(C) basis adjustment is not reallocated to the distributed
property for purposes of applying section 732.
If any section 704(c)(1)(C) basis adjustment is not reallocated to
the distributed property in connection with the distribution, then that
remaining section 704(c)(1)(C) basis adjustment shall be treated as a
positive section 734(b) adjustment. If the distribution also gives rise
to a negative section 734(b) adjustment, then the negative section
734(b) adjustment and the section 704(c)(1)(C) basis adjustment
reallocation are netted together, and the net amount is allocated under
Sec. 1.755-1(c). If the partnership does not have a section 754
election in effect at the time of the liquidating distribution, the
partnership shall be treated as having made a section 754 election
solely for purposes of computing any negative section 734(b) adjustment
that would arise from the distribution.
e. Transfer of Section 704(c)(1)(C) Partner's Partnership Interest
i. In General
Under section 722, a section 704(c)(1)(C) partner's basis in its
partnership interest fully reflects the built-in loss portion of the
basis of the contributed property and the built-in loss generally is
taken into account by the section 704(c)(1)(C) partner upon disposition
of the partnership interest. Therefore, in accordance with section
704(c)(1)(C)'s overall policy objective of preventing the inappropriate
transfer of built-in losses through partnerships, the proposed
regulations provide that the transferee of a section 704(c)(1)(C)
partner's partnership interest generally does not succeed to the
section 704(c)(1)(C) partner's section 704(c)(1)(C) basis adjustment.
Instead, the share of the section 704(c)(1)(C) basis adjustment
attributable to the interest transferred is eliminated. For example, if
a section 704(c)(1)(C) partner sells 20 percent of its interest in a
partnership, the partner recognizes its outside loss with respect to
that 20 percent but 20 percent of the partner's section 704(c)(1)(C)
basis adjustment for each section 704(c)(1)(C) property contributed by
the partner is eliminated. The transferor remains a section
704(c)(1)(C) partner with respect to any remaining section 704(c)(1)(C)
basis adjustments. The proposed regulations provide exceptions to this
general rule for nonrecognition transactions, which are discussed in
Part 1.e.ii of the Explanation of Provisions section of this preamble.
ii. Nonrecognition Transactions
Under the proposed regulations, the general rule that a section
704(c)(1)(C) basis adjustment is not transferred with the related
partnership interest does not apply to the extent a section
704(c)(1)(C) partner transfers its partnership interest in a
nonrecognition transaction, with certain exceptions. The legislative
history notes that Congress intended to treat a corporation succeeding
to the attributes of a contributing corporate partner under section 381
in the same manner as the contributing partner. See Conference Report,
at 623 n. 546. The Treasury Department and the IRS considered whether
similar successor rules should apply in other
[[Page 3049]]
nonrecognition transactions. Some of the considerations included: (1)
providing consistent results regardless of the order in which a
transaction occurs; (2) ensuring that built-in losses are not
duplicated; (3) preventing the shifting of basis to other assets; (4)
recognizing that other provisions in subchapter K (for example, section
743(b)) already apply to prevent many of the potential abuses; and (5)
providing administrable rules for partners, partnerships, and the IRS.
The Treasury Department and the IRS concluded that these considerations
and the policy rationale underlying the successor rule for section 381
transactions in the legislative history weigh in favor of applying
similar successor rules to other nonrecognition transactions, including
section 721 transactions, section 351 transactions, and distributions
governed by section 731. Thus, when the partnership interest is
transferred in one of these nonrecognition transactions, the transferee
generally succeeds to the transferor's section 704(c)(1)(C) basis
adjustments attributable to the interest transferred and is treated as
the section 704(c)(1)(C) partner with respect to such interest. If the
nonrecognition transaction is described in section 168(i)(7)(B), then
the rules in section 168(i)(7)(A) apply with respect to the
transferor's cost recovery deductions under section 168 with respect to
the section 704(c)(1)(C) basis adjustment. The proposed regulations
further provide that if gain or loss is recognized in the transaction,
appropriate adjustments must be made to the section 704(c)(1)(C) basis
adjustment.
The Treasury Department and the IRS believe that a section 743(b)
adjustment generally will prevent inappropriate duplication of loss
when a partnership has a section 754 election in effect or a
substantial built-in loss with respect to the transfer. (See Part
2.a.i. of the Explanation of Provisions section of this preamble for
rules regarding substantial built-in loss transactions). To the extent
that the transferee partner's basis in the transferred partnership
interest does not reflect a built-in loss, a section 743(b) adjustment
should require the partnership to reduce the basis of its properties to
reflect the elimination of the built-in loss. The Treasury Department
and the IRS believe that the amount of the section 704(c)(1)(C)
adjustment and any negative 743(b) adjustment should be netted for this
purpose. The Treasury Department and the IRS believe that similar
treatment is appropriate when a partnership does not have a section 754
election in effect at the time of transfer to prevent duplication of
the built-in loss. Therefore, regardless of whether a section 754
election is in effect or a substantial built-in loss exists with
respect to a transfer, the proposed regulations provide that the
transferee partner succeeds to the transferor's section 704(c)(1)(C)
basis adjustment, as reduced by the amount of any negative section
743(b) adjustment that would be allocated to the section 704(c)(1)(C)
property if the partnership had a section 754 election in effect at the
time of the transfer.
The proposed regulations also provide that the general rule
regarding nonrecognition transactions does not apply to the transfer of
all or a portion of a section 704(c)(1)(C) partner's partnership
interest by gift because the gift recipient does not fit within
Congress's notion of a successor as described in the legislative
history. See Conference Report, at 623 n. 546. Thus, the general
transfer rule applies instead, and the section 704(c)(1)(C) basis
adjustment is eliminated.
f. Transfers of Section 704(c)(1)(C) Property
The proposed regulations also provide guidance on the treatment of
the section 704(c)(1)(C) partner and the section 704(c)(1)(C) basis
adjustment when the partnership transfers section 704(c)(1)(C)
property. Consistent with the rules under section 743, a section
704(c)(1)(C) partner's section 704(c)(1)(C) basis adjustment is
generally taken into account in determining the section 704(c)(1)(C)
partner's income, gain, loss, or deduction from the sale or exchange of
section 704(c)(1)(C) property.
With certain exceptions, if section 704(c)(1)(C) property is
transferred in a nonrecognition transaction, the proposed regulations
provide that the section 704(c)(1)(C) partner retains the section
704(c)(1)(C) basis adjustment in the replacement property (in the case
of a section 1031 transaction), in stock (in the case of a section 351
transaction), in a lower-tier partnership interest (in the case of a
section 721 transaction), or in the same property held by a new
partnership (in the case of a section 708(b)(1)(B) technical
termination). The proposed regulations also provide additional rules
for section 721 and section 351 transactions, which are described in
the following sections.
i. Contribution of Section 704(c)(1)(C) Property Under Section 721
The proposed regulations provide rules for when, after a section
704(c)(1)(C) partner contributes section 704(c)(1)(C) property to an
upper-tier partnership, the upper-tier partnership contributes the
property to a lower-tier partnership in a transaction described in
section 721(a). The proposed regulations ensure that the section
704(c)(1)(C) adjustment amount is ultimately tracked back to the
initial contributing partner, similar to the rules for section 721
contributions of property in which a partner has a section 743(b)
adjustment.
In particular, the proposed regulations provide that the interest
in the lower-tier partnership received by the upper-tier partnership is
treated as the section 704(c)(1)(C) property with the same section
704(c)(1)(C) basis adjustment as the contributed property. The lower-
tier partnership determines its basis in the contributed property by
excluding the existing section 704(c)(1)(C) basis adjustment. However,
the lower-tier partnership also succeeds to the upper-tier
partnership's section 704(c)(1)(C) basis adjustment. The portion of the
upper-tier partnership's basis in its interest in the lower-tier
partnership attributable to the section 704(c)(1)(C) basis adjustment
must be segregated and allocated solely to the section 704(c)(1)(C)
partner for whom the initial section 704(c)(1)(C) basis adjustment was
made. Similarly, the section 704(c)(1)(C) basis adjustment to which the
lower-tier partnership succeeds must be segregated and allocated solely
to the upper-tier partnership, and the section 704(c)(1)(C) partner for
whom the initial section 704(c)(1)(C) basis adjustment was made. If
gain or loss is recognized on the transaction, appropriate adjustments
must be made to the section 704(c)(1)(C) basis adjustment.
The proposed regulations provide that to the extent that any
section 704(c)(1)(C) basis adjustment in a tiered partnership is
recovered (for example, by sale or depreciation of the property), or is
otherwise reduced, upper or lower partnerships in the tiered structure
must make conforming reductions to related section 704(c)(1)(C) basis
adjustments to prevent duplication of loss.
The proposed regulations recognize that the contribution from the
upper-tier partnership to the lower-tier partnership will give rise to
an additional section 704(c)(1)(C) basis adjustment if the value of the
property has fallen below its common basis to the upper-tier
partnership; this additional section 704(c)(1)(C) adjustment will be
allocated among the partners of the upper-tier partnership in a manner
that reflects their relative shares of that loss.
[[Page 3050]]
ii. Transfer of Section 704(c)(1)(C) Property in a Section 351
Transaction
The transfer of the section 704(c)(1)(C) property by a partnership
to a corporation in a section 351 transaction severs the contributing
partner's connection with the section 704(c)(1)(C) property at the
partnership level. The section 704(c)(1)(C) partner, now an indirect
shareholder of the corporation, no longer has a section 704(c)(1)(C)
basis adjustment with respect to the property. The proposed regulations
provide that if, in an exchange described in section 351, a partnership
transfers section 704(c)(1)(C) property to a corporation, the stock the
partnership receives in the exchange is treated, solely with respect to
the section 704(c)(1)(C) partner, as section 704(c)(1)(C) property that
generally has the same section 704(c)(1)(C) basis adjustment as the
section 704(c)(1)(C) property transferred to the corporation (reduced
by any portion of the section 704(c)(1)(C) basis adjustment that
reduced the partner's share of any gain on the transaction). The
transferee corporation's adjusted basis in the transferred property is
determined under section 362 (including by applying section 362(e)),
taking into account any section 704(c)(1)(C) basis adjustments in the
transferred property. However, the proposed regulations provide that,
if a partnership recognizes gain on the transfer, the partnership's
gain is determined without regard to any section 704(c)(1)(C) basis
adjustment, but the section 704(c)(1)(C) partner's gain does take into
account the section 704(c)(1)(C) basis adjustment. See Sec. 1.362-
4(e)(1) for additional rules regarding the application of section
362(e) to transfers by partnerships.
iii. Partnership Technical Terminations
The proposed regulations provide that a partner with a section
704(c)(1)(C) basis adjustment in section 704(c)(1)(C) property held by
a partnership that terminates under section 708(b)(1)(B) will continue
to have the same section 704(c)(1)(C) basis adjustment with respect to
section 704(c)(1)(C) property deemed contributed by the terminated
partnership to the new partnership under Sec. 1.708-1(b)(4). In
addition, the deemed contribution of property by a terminated
partnership to a new partnership is not subject to the proposed
regulations and does not create a section 704(c)(1)(C) basis
adjustment.
iv. Miscellaneous Provisions
The proposed regulations also provide additional rules for like-
kind exchanges of section 704(c)(1)(C) property, dispositions of
section 704(c)(1)(C) property in installment sales, and contributed
contracts.
g. Reporting Requirements Under Section 704(c)(1)(C)
The proposed regulations prescribe certain reporting requirements
for section 704(c)(1)(C) basis adjustments that are similar to the
requirements for section 743(b) adjustments. Specifically, the proposed
regulations provide that a partnership that owns property for which
there is a section 704(c)(1)(C) basis adjustment must attach a
statement to the partnership return for the year of the contribution of
the section 704(c)(1)(C) property setting forth the name and taxpayer
identification number of the section 704(c)(1)(C) partner as well as
the section 704(c)(1)(C) basis adjustment and the section 704(c)(1)(C)
property to which the adjustment relates.
2. Mandatory Basis Adjustment Provisions
a. Section 743 Substantial Built-In Loss Provisions
i. General Provisions
The proposed regulations generally restate the statutory language
in section 743(a) and (b) regarding substantial built-in losses, but
provide additional guidance in several areas. The proposed regulations
clarify that, if a partnership has a substantial built-in loss
immediately after the transfer of a partnership interest, the
partnership is treated as having a section 754 election in effect for
the taxable year in which the transfer occurs, but only with respect to
that transfer (unless another transaction is also subject to the
mandatory basis adjustment provisions of sections 734 or 743).
The proposed regulations also provide that in determining whether
there is a substantial built-in loss, section 743(b) adjustments and
section 704(c)(1)(C) basis adjustments (except the transferee's section
743(b) adjustments and section 704(c)(1)(C) basis adjustments, if any)
are disregarded.
The proposed regulations also provide special rules for determining
fair market value in the case of a tiered partnership. The Treasury
Department and the IRS are aware that there is some uncertainty as to
how to determine the fair market value of a lower-tier partnership
interest for purposes of determining whether the partnership has a
substantial built-in loss in its assets when the upper-tier partnership
is allocated a share of the lower-tier partnership's liabilities under
section 752. The Treasury Department and the IRS believe it is
appropriate for this purpose to gross up the fair market value of the
lower-tier partnership interest by the upper-tier partnership's
allocated share of liabilities; otherwise, the regulations could
inappropriately treat a lower-tier partnership interest as a loss
asset. Thus, under the proposed regulations, the fair market value of a
lower-tier partnership interest (solely for purposes of computing the
upper-tier partnership's basis adjustment under section 743(b)) is
equal to the sum of: (i) the amount of cash that the upper-tier
partnership would receive if the lower-tier partnership sold all of its
property for cash to an unrelated person for an amount equal to the
fair market value of such property, satisfied all of its liabilities,
and liquidated; and (ii) the upper-tier partnership's share of the
lower-tier partnership's liabilities (as determined under section 752
and the regulations).
In addition, the proposed regulations provide special rules for
basis adjustments with respect to tiered partnerships. Under the
authority granted by section 743(d)(2), the proposed regulations
provide that if a partner transfers an interest in an upper-tier
partnership that holds a direct or indirect interest in a lower-tier
partnership, and the upper-tier partnership has a substantial built-in
loss with respect to the transfer, each lower-tier partnership is
treated, solely with respect to the transfer, as if it had made a
section 754 election for the taxable year of the transfer. The Treasury
Department and the IRS are aware of the practical and administrative
difficulties associated with requiring a lower-tier partnership that
has not elected under section 754 to adjust the basis of its assets in
connection with the transfer of an interest in an upper-tier
partnership. Comments are requested on the scope of this rule and on
measures to ease administrative burdens while still accomplishing the
objective of the statute.
These proposed regulations also provide guidance on the application
of section 743(b) adjustments in tiered partnership situations
generally. Consistent with Rev. Rul. 87-115, 1987-2 CB 163, the
proposed regulations provide that if an interest in an upper-tier
partnership that holds an interest in a lower-tier partnership is
transferred by sale or exchange or upon the death of a partner, and the
upper-tier partnership and the lower-tier partnership both have
elections in effect under section 754, then an interest in the lower-
tier partnership will be deemed to have been transferred by sale or
exchange or
[[Page 3051]]
upon the death of a partner, as the case may be. The amount of the
interest in the lower-tier partnership deemed to have been transferred
is the portion of the upper-tier partnership's interest in the lower-
tier partnership that is attributable to the interest in the upper-tier
partnership being transferred. Accordingly, to the extent the adjusted
basis of the upper-tier partnership's interest in a lower-tier
partnership is adjusted, the lower-tier partnership must adjust the
basis of its properties.
Section 743(e)(7) provides that the Secretary may prescribe
regulations for applying the EIP rules to tiered partnerships, and the
legislative history makes clear that Congress did not intend for EIPs
to avoid the mandatory basis adjustment provisions through the use of
tiered partnerships. See Conference Report, at 627. The Treasury
Department and the IRS believe that the same concerns exist for tiered
EIPs as exist for all other partnerships subject to the mandatory basis
adjustment provisions. Accordingly, the proposed regulations do not
include specific rules for tiered EIPs beyond the rules governing all
tiered partnerships.
The proposed regulations provide anti-abuse rules. The purpose of
the amendments to section 743 is to prevent a partner that purchases an
interest in a partnership with an existing built-in loss and no
election under section 754 in effect from being allocated a share of
the loss when the partnership disposes of the property or takes cost
recovery deductions with respect to the property. Accordingly,
consistent with the purpose of the amendments and the specific grant of
regulatory authority in section 743(d)(2), the proposed regulations
provide that the provisions of section 743 and the regulations
thereunder regarding substantial built-in loss transactions must be
applied in a manner consistent with the purpose of such provisions and
the substance of the transaction. Thus, if a principal purpose of a
transaction is to avoid the application of the substantial built-in
loss rules with respect to a transfer, the Commissioner can recast the
transaction for Federal income tax purposes as appropriate to achieve
tax results that are consistent with the purpose of the provisions.
Whether a tax result is inconsistent with the purpose of the
substantial built-in loss provisions is determined based on all the
facts and circumstances. For example, under the proposed regulations,
property held by related partnerships may be aggregated and a
contribution of property to a partnership may be disregarded in
applying the substantial built-in loss provisions in section 743 and
the regulations thereunder if the property was transferred with a
principal purpose of avoiding the application of such provisions.
Finally, the proposed regulations clarify that a partnership that
has a substantial built-in loss immediately following the transfer of a
partnership interest must comply with certain provisions of Sec.
1.743-1(k). In this case, the partnership must attach a statement of
adjustments to its partnership return as if an election under section
754 were in effect at the time of the transfer solely with respect to
the transfer for which there is a substantial built-in loss.
One commenter on the Notice requested that the Treasury Department
and the IRS provide a de minimis exception for the substantial built-in
loss provisions for transfers of small interests (subject to an annual
limit on aggregate transfers during a taxable year). The substantial
built-in loss provisions are intended to prevent the inappropriate
shifting of losses among partners, and neither the legislative history
nor the statute suggests that Congress intended to limit the scope of
the rule to the transfer of large interests. Accordingly, the Treasury
Department and the IRS decline to provide an exception to the
substantial built-in loss rules based on the size of the interest
transferred. The Treasury Department and the IRS will continue to
study, and request comments on, whether a rule is warranted that
excludes de minimis basis adjustments from the mandatory adjustment
provisions.
ii. EIPs
The proposed regulations generally adopt the statutory language in
section 743(e) and the provisions in the Notice. The Notice requested
comments on certain aspects of the interim procedures for EIPs, and the
Treasury Department and the IRS received comments in response to that
request, which are described in this section.
The Notice detailed reporting requirements for transferors of EIP
interests so that transferees could comply with the loss limitation
rule in section 743(e)(2). The proposed regulations clarify that the
reporting requirements with respect to transferors of an interest in an
EIP described in the Notice do not apply if the transferor recognizes
gain on the transfer and no prior transferor recognized a loss on any
transfer. The Treasury Department and the IRS do not believe reporting
is necessary in this limited circumstance because the transferee should
not be subject to the loss limitation rule of section 743(e)(2).
In regard to the requirement in section 743(e)(6)(I) that the
partnership agreement provide for a term that is not in excess of 15
years, one commenter requested that regulations provide that a
partnership may still qualify as an EIP even if the partnership's
initial term is greater than 15 years, particularly in cases in which
the amount of the partnership's equity investment in the remaining
assets is small (for example, 25 percent of the total committed
capital). However, Congress considered the circumstances in which it
would be appropriate to provide an extension of the term and
specifically provided an exception to the 15-year requirement for EIPs
in existence on June 4, 2004. Accordingly, the Treasury Department and
the IRS decline to adopt this comment in the proposed regulations.
The Notice also provides guidance on whether a partnership has ever
been engaged in a trade or business for purposes of section
743(e)(6)(C). The Notice provides that until further guidance is
issued, an upper-tier partnership will not be treated as engaged in the
trade or business of a lower-tier partnership if, at all times during
the period in which the upper-tier partnership owns an interest in the
lower-tier partnership, the adjusted basis of its interest in the
lower-tier partnership is less than 25 percent of the total capital
that is required to be contributed to the upper-tier partnership by its
partners during the entire term of the upper-tier partnership (the
``25% Rule''). The Notice specifically requests comments on rules that
would be appropriate for future guidance in determining whether an
upper-tier partnership is treated as engaged in a trade or business
that is conducted by a lower-tier partnership. One commenter requested
that the Treasury Department and the IRS confirm whether the 25% Rule
is a safe harbor or whether a violation of the 25% Rule disqualifies a
partnership from being an EIP. This commenter also requested that the
Treasury Department and the IRS clarify the 25% Rule in the case of
borrowing. The commenter noted that lower-tier partnership interests
are often acquired with capital contributions and the proceeds of
borrowing. Therefore, the commenter requested that any safe harbor take
into account leverage. This commenter further suggested that rules
similar to the rules in Sec. 1.731-2(e)(3) (providing circumstances in
which a partnership would not be treated as engaged in a trade or
business for purposes of section 731(c)(3)(C)) should apply for
purposes of section 743(e)(6)(C). Finally, the
[[Page 3052]]
commenter requested that the Treasury Department and the IRS provide
additional safe harbors (for example, where the upper-tier partnership
is organized for investment services and the partners and managers of
the upper-tier partnership do not engage in the day-to-day operations
of the lower-tier partnership's trade or business activity, but
partners and/or managers are on the board of directors of the lower-
tier partnership).
The Treasury Department and the IRS view the 25% Rule as a bright-
line rule. Therefore, a failure to meet the 25% Rule will mean that the
partnership fails to qualify as an EIP. The Treasury Department and the
IRS agree that the rules in Sec. 1.731-2(e)(3) should apply for
purposes of section 743(e)(6)(C). Therefore, the proposed regulations
provide a safe harbor by cross-referencing those rules. Under the
proposed regulations, if a partnership would not be treated as engaged
in a trade or business under Sec. 1.731-2(e)(3) for purposes of
section 731(c)(3)(C), the partnership also will not be treated as
engaged in a trade or business for purposes of section 743(e)(6)(C).
The Treasury Department and the IRS believe the 25% Rule and the cross-
reference to Sec. 1.731-2(e)(3) provide appropriate guidance under
section 743(e)(6)(C) and therefore the proposed regulations do not
provide any additional safe harbors. The Treasury Department and the
IRS are continuing to study the extent to which borrowing should be
taken into account in applying the 25% Rule and therefore request
comments on appropriate rules.
A commenter also requested additional guidance regarding section
743(e)(6)(H), which provides that one of the eligibility requirements
for an EIP is that the partnership agreement have substantive
restrictions on each partner's ability to cause a redemption of the
partner's interest. The proposed regulations follow the examples in the
legislative history and provide that substantive restrictions for
purposes of section 743(e)(7)(H) include cases in which a redemption is
permitted under a partnership agreement only if the redemption is
necessary to avoid a violation of state, federal, or local laws (such
as ERISA or the Bank Holding Company Act) or the imposition of a
federal excise tax on, or a change in the federal tax-exempt status of,
a tax-exempt partner. See Conference Report at 626. The Treasury
Department and the IRS request comments on other restrictions that
could be considered substantive restrictions on a partner's ability to
cause a redemption of the partner's interest for purposes of section
743(e)(6)(H).
The proposed regulations provide that the EIP election must be made
on a timely filed original return, including extensions. One commenter
requested relief for certain instances in which the partnership fails
to make a valid EIP election. The commenter requested relief when: (1)
A partnership makes an EIP election, but did not qualify to make the
election; (2) the partnership attempts to make an EIP election, but it
is defective; or (3) the partnership makes an EIP election, but fails
to continue to qualify. In each case, the commenter believes that the
Treasury Department and the IRS should treat the partnership as an EIP
if: (a) Its failure to qualify or the defect was inadvertent; (b) the
partners and the partnership consistently treated the partnership as an
EIP; (c) steps were taken to cure the defect in a reasonable period of
time; and (d) the partners and the EIP agree to make any necessary
adjustments. The Treasury Department and the IRS do not adopt this
comment in the proposed regulations because there are existing
procedures for situations in which a regulatory election is defective.
The Treasury Department and the IRS request comments on appropriate
rules for situations in which a partnership that has elected to be an
EIP fails to qualify in a particular year, but then qualifies again in
a future year. The Treasury Department and the IRS also request
comments on the circumstances in which a qualifying partnership that
has revoked an EIP election should be permitted to reelect and the
rules and procedures that should apply to the reelection.
iii. Securitization Partnerships
The proposed regulations generally restate the statutory provisions
relating to the exception from the substantial built-in loss provisions
for securitization partnerships.
b. Section 734 Substantial Basis Reduction Provisions
i. General Provisions
The proposed regulations generally follow the statutory provisions
regarding substantial basis reductions. Questions have been raised
whether the $250,000 threshold in section 734(d)(1) applies to a
partnership's aggregate distributions for a taxable year. The Treasury
Department and the IRS believe that the better interpretation of
section 734(a), (b), and (d) is that the threshold applies separately
with respect to each distributee because: (1) Both section 734(a) and
(b) refer to a distribution of property to ``a partner;'' and (2)
section 734(b)(2)(A) and (B), referenced in section 734(d), refer to
the ``distributee partner'' or the ``distributee.'' These references
indicate that the substantial built-in loss provisions apply to each
partner-distributee separately, but with respect to the entire
distribution made to the distributee. That is, where multiple
properties are distributed to a partner-distributee, the $250,000
threshold is determined by reference to all properties distributed to
the partner-distributee as part of the same distribution.
The proposed regulations also provide additional guidance in
several areas. The proposed regulations provide that if there is a
substantial basis reduction, the partnership is treated as having an
election under section 754 in effect for the taxable year in which the
distribution occurs, but solely for the distribution to which the
substantial basis reduction relates (unless another transaction is
subject to the mandatory basis adjustment provisions of sections 734 or
743). For example, if a partnership without a section 754 election in
effect has a substantial basis reduction with respect to a
distribution, and a partner in the partnership in that same year
transfers a partnership interest (and the partnership does not have a
substantial built-in loss immediately after the transfer), the
partnership will be treated as having a section 754 election in effect
for the distribution but not the transfer.
The same issues exist in the context of section 734(b) adjustments
and tiered partnerships as exist with respect to section 743(b)
adjustments and tiered partnerships. Thus, the proposed regulations
also provide guidance for substantial basis reductions in tiered
partnership arrangements. Under the proposed regulations, if there is a
substantial basis reduction with respect to a distribution by an upper-
tier partnership that (either directly or indirectly through one or
more partnerships) holds an interest in a lower-tier partnership, each
lower-tier partnership is treated, solely with respect to the
distribution, as if it had made an election under section 754 for the
taxable year in which the distribution occurs.
These proposed regulations also provide guidance on the application
of section 734(b) adjustments in tiered partnership situations
generally. Consistent with Rev. Rul. 92-15, 1992-1 CB 215, if an upper-
tier partnership makes an adjustment under section 734(b) to the basis
of an interest it holds in a lower-tier partnership that has an
[[Page 3053]]
election under section 754 in effect, the lower-tier partnership must
make adjustments to the upper-tier partnership's share of the lower-
tier partnership's assets. The amount of the lower-tier partnership's
adjustment is equal to the adjustment made by the upper-tier
partnership to the basis of its interest in the lower-tier partnership.
The lower-tier partnership's adjustment to the upper-tier partnership's
share of its assets is for the upper-tier partnership only and does not
affect the basis in the lower-tier partnership's property for the other
partners of the lower-tier partnership.
The Treasury Department and the IRS are aware of the practical and
administrative difficulties associated with the requirement that a
lower-tier partnership adjust the basis of its assets with respect to
adjustments under both section 734 and section 743 and request comments
on the scope of this rule and measures to ease the administrative
burden while still accomplishing the objective of the statute.
The proposed regulations also update Sec. 1.734-1(d) to clarify
that its reporting requirements apply if there is a substantial basis
reduction with respect to a distribution. In this case, the provisions
of Sec. 1.734-1(d) apply solely with respect to the distribution to
which the substantial basis reduction relates as if an election under
section 754 were in effect at the time of the transfer.
ii. Securitization Partnerships
The proposed regulations generally restate the statutory provisions
relating to the exception from the substantial basis reduction
provisions for securitization partnerships.
3. Section 755 Basis Allocation Rules
a. Section 755(c)
The proposed regulations generally restate the statutory provisions
of section 755(c) and provide rules applicable to an allocation of a
downward adjustment in the basis of partnership property under sections
734(b) and 755(a). As discussed in Part 3 of the Background section of
this preamble, Congress enacted section 755(c) in response to the JCT's
investigation of Enron Corporation. In addressing transactions among
related parties, the JCT Enron Report specifically provides that:
Partnership allocations between members of the same affiliated
group (and, in general, related parties) may not have the same
economic consequences as allocations between unrelated partners. As
a result, related partners can use the partnership allocation rules
inappropriately to shift basis among assets . . . The Joint
Committee staff recommends that . . . the partnership basis rules
should be altered to preclude an increase in basis to an asset if
the offsetting basis reduction would be allocated to stock of a
partner (or related party).
JCT Enron Report, at 29-30. The proposed regulations provide that
in making an allocation under section 755(a) of any decrease in the
adjusted basis of partnership property under section 734(b), no
allocation may be made to stock in a corporation (or any person related
(within the meaning of sections 267(b) or 707(b)(1)) to such
corporation) that is a partner in the partnership. Given Congress's
intent to prevent taxpayers from shifting tax gain to stock of a
corporate partner or corporation related to a corporate partner, the
Treasury Department and the IRS believe it is appropriate to interpret
section 755(c) to apply broadly to related persons under either section
267(b) or section 707(b)(1). See Grassley Report, at 127 and House
Committee Report, at 287. If section 755(c) only applied to persons
treated as related within the meaning of both section 267(b) and
section 707(b)(1), then the provision would apply in very limited
circumstances, significantly restricting the scope of section 755(c).
b. Modification of Basis Allocation Rules for Substituted Basis
Transactions
The Treasury Department and the IRS are aware that the current
basis allocation rules for substituted basis transactions can result in
unintended consequences, particularly with regard to the ``net gain''
and ``net loss'' requirement in Sec. 1.755-1(b)(5)(ii). The net gain
or net loss requirement in Sec. 1.755-1(b)(5)(ii) may, in certain
situations, cause a partnership to be unable to properly adjust the
basis of partnership property with respect to a transferee partner. For
example, when there is an increase in basis to be allocated to
partnership assets and the property of the partnership does not have
overall unrealized net gain or net income, the basis increase cannot be
allocated under Sec. 1.755-1(b)(5). Conversely, if there is a decrease
in basis to be allocated to partnership assets and the property of the
partnership does not have overall unrealized net loss, the basis
decrease cannot be allocated under Sec. 1.755-1(b)(5). The Treasury
Department and the IRS believe this result is inappropriate.
Accordingly, the Treasury Department and the IRS propose to amend the
current regulations as described in this preamble.
i. Allocations Between Classes of Property
The proposed regulations provide that if there is an increase in
basis to be allocated to partnership assets under Sec. 1.755-1(b)(5),
the increase must be allocated between capital gain property and
ordinary income property in proportion to, and to the extent of, gross
gain or gross income (including any remedial allocations under Sec.
1.704-3(d)) that would be allocated to the transferee (to the extent
attributable to the acquired partnership interest) from the
hypothetical sale of all property in each class. The proposed
regulations further provide that any remaining increase must be
allocated between the classes in proportion to the fair market value of
all property in each class.
If there is a decrease in basis to be allocated to partnership
assets under Sec. 1.755-1(b)(5), the proposed regulations provide that
the decrease must be allocated between capital gain property and
ordinary income property in proportion to, and to the extent of, the
gross loss (including any remedial allocations under Sec. 1.704-3(d))
that would be allocated to the transferee (to the extent attributable
to the acquired partnership interest) from the hypothetical sale of all
property in each class. Any remaining decrease must be allocated
between the classes in proportion to the transferee's shares of the
adjusted bases of all property in each class (as adjusted under the
preceding sentence). Thus, the proposed regulations remove the
requirements that (1) there be an overall net gain or net income in
partnership property for an increase in basis to be allocated to a
particular class of property; and (2) there be an overall net loss in
partnership property for a decrease in basis to be allocated to a
particular class of property.
ii. Allocations Within Classes of Property
The Treasury Department and the IRS are aware that there is
uncertainty regarding whether the transferee's shares of unrealized
appreciation and depreciation described in Sec. 1.755-1(b)(5)(iii)(A)
and (B) include only amounts attributable to the acquired partnership
interest. The proposed regulations clarify that the transferee's shares
of the items are limited to the amounts attributable to the acquired
partnership interest.
In addition, Sec. 1.755-1(b)(5)(iii)(C) has a limitation that
provides that a transferee's negative basis adjustment is limited to
the transferee's share of the partnership's adjusted basis in all
[[Page 3054]]
depreciated assets in that class. By focusing on the transferee's share
of adjusted basis with respect to only depreciated assets in the class,
as opposed to all assets in the class, this rule subjects more of the
negative basis adjustment to the carryover rules in Sec. 1.755-
1(b)(5)(iii)(D). The Treasury Department and the IRS believe this
result is inappropriate. Accordingly, the proposed regulations provide
that if a decrease in basis must be allocated to partnership property
and the amount of the decrease otherwise allocable to a particular
class exceeds the transferee's share of the adjusted basis to the
partnership of all assets in that class, the basis of the property is
reduced to zero (but not below zero). Therefore, under the proposed
regulations, the negative basis adjustment is no longer limited to the
transferee's share of the partnership's adjusted basis in all
depreciated assets in a class.
c. Succeeding to Transferor's Basis Adjustment
The proposed regulations amend the regulations under section 743 to
provide an exception to the rule that a transferee's basis adjustment
is determined without regard to any prior transferee's basis
adjustment. The Treasury Department and the IRS believe that this rule
can lead to inappropriate results when the transferor transfers its
partnership interest in a substituted basis transaction (within the
meaning of Sec. 1.755-1(b)(5)) and the transferor had a basis
adjustment under section 743(b) attributable to the transferred
interest that was allocated pursuant to Sec. 1.755-1(b)(2) through
(b)(4). Under the current regulations, the transferee does not succeed
to the transferor's section 743(b) adjustment but, rather, is entitled
to a new section 743(b) adjustment that is allocated under a different
set of rules, which may result in the inappropriate shifting of basis
among the partnership's assets. The proposed regulations provide that
the transferee in a substituted basis transaction succeeds to that
portion of the transferor's basis adjustment attributable to the
transferred partnership interest and that the adjustment is taken into
account in determining the transferee's share of the adjusted basis to
the partnership for purposes of Sec. Sec. 1.743-1(b) and 1.755-
1(b)(5).
4. Miscellaneous Provisions
a. Special Rules for Forward and Reverse Section 704(c) Allocations
One commenter on Notice 2009-70 noted that the definitions of the
terms ``built-in gain'' and ``built-in loss'' in Sec. 1.704-
3(a)(3)(ii) imply that section 704(c) layers with ``different signs''
should be netted against each other because the regulations provide
that built-in gain or built-in loss is reduced by differences in the
property's adjusted tax basis and book value.
In response to this comment, the proposed regulations provide that
built-in gain and built-in loss do not take into account any decreases
or increases, as the case may be, to the property's book value pursuant
to a revaluation of partnership property under Sec. 1.704-
1(b)(2)(iv)(f). Thus, for example, under the proposed regulations,
reverse section 704(c) allocations do not reduce forward section 704(c)
gain or loss.
The Treasury Department and the IRS also received several comments
regarding the proper treatment of section 704(c) layers, suggesting one
of two approaches. Under the layering approach, a partnership would
create and maintain multiple section 704(c) layers for the property.
Under the netting approach, a partnership would net multiple section
704(c) layers for the property and therefore each section 704(c)
property would have one section 704(c) layer. One commenter recommended
that the layering approach be the default rule, but that certain
partnerships should be permitted to adopt a netting approach depending
on the value of the partnership's assets. This commenter believed that
the layering approach is more appropriate because the netting approach
can result in distortions when partnerships use the traditional method
of allocating section 704(c) amounts and the ceiling rule is
implicated. The commenter also argued that the layering approach better
maintains the economic expectations of the partners and is generally
more consistent with the policy underlying section 704(c). However,
this commenter also acknowledged that the netting approach is simpler
to apply, and that in many cases both approaches will reach the same
result. Another commenter suggested that partnerships be given the
option of using either the layering approach or the netting approach.
According to the commenter, this would allow partnerships to avoid the
burden and expense of maintaining section 704(c) layers, particularly
when maintaining section 704(c) layers is unnecessary.
The proposed regulations do not permit taxpayers to use a netting
approach because a netting approach could lead to distortions. The
Treasury Department and the IRS understand, however, that maintaining
section 704(c) layers may result in additional administrative burdens
and, therefore, request comments on when it is appropriate for
partnerships to use a netting approach (for example, small
partnerships).
One commenter noted that guidance was necessary with respect to how
to allocate tax items among multiple section 704(c) layers. This
commenter suggested three methods for allocating tax items: (1)
Allocate tax items to the oldest layer first; (2) allocate tax items to
the newest section 704(c) layers first; and (3) allocate tax items
among the section 704(c) layers pro rata based on the amount of each
layer. The commenter suggested that the Treasury Department and the IRS
provide a default rule that would allocate to the oldest section 704(c)
layers first, but permit partnerships to elect any reasonable method
(such as the three methods described).
The Treasury Department and the IRS agree that partnerships should
be permitted to use any reasonable method in allocating tax items. The
Treasury Department and the IRS decline to adopt a default rule for
allocating tax items because no single method is more appropriate than
other methods. Therefore, the proposed regulations provide that a
partnership may use any reasonable method to allocate items of income,
gain, loss, and deduction associated with an item of property among the
property's forward and reverse section 704(c) layers subject to the
anti-abuse rule in Sec. 1.704-3(a)(10). The partnership's choice of
method is also subject to Sec. 1.704-3(a)(2), which provides that a
partnership may use different methods with respect to different items
of contributed property, provided that the partnership and the partners
consistently apply a single reasonable method for each item of
contributed property and that the overall method or combination of
methods is reasonable based on the facts and circumstances and
consistent with the purpose of section 704(c). The Treasury Department
and the IRS are considering providing examples of reasonable methods in
future guidance and therefore request comments on these and other
methods for allocating tax items.
b. Extension of Time Period for Taxing Precontribution Gain
The proposed regulations amend various provisions in Sec. Sec.
1.704-4, 1.737-1, and 1.1502-13 to reflect the amendments to sections
704(c)(1)(B) and 737(b)(1) that lengthen the period of time for taxing
precontribution gain from five years to seven years. The
[[Page 3055]]
proposed regulations also clarify how partners determine the seven-year
period. Specifically, the proposed regulations provide that the seven-
year period begins on, and includes, the date of contribution, and ends
on, and includes, the last date that is within seven years of the
contribution.
Proposed Effective Date
These regulations are generally proposed to apply to partnership
contributions and transactions occurring on or after the date final
regulations are published in the Federal Register. The proposed
regulations under Sec. 1.755-1(b)(5) will apply to transfers of
partnership interests occurring on or after January 16, 2014. No
inference is intended as to the tax consequences of transactions
occurring before the effective date of these regulations.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866, as supplemented by Executive Order 13563. 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. It is hereby certified that the
collection of information in this notice of proposed rulemaking will
not have a significant economic impact on a substantial number of small
entities within the meaning of section 601(6) of the Regulatory
Flexibility Act (5 U.S.C. chapter 6). The Treasury Department and the
IRS believe that the economic impact on small entities as a result of
the collection of information in this notice of proposed rulemaking
will not be significant. The small entities subject to the collection
are business entities formed as partnerships that: (1) Receive a
contribution of built-in loss property; (2) are required to make a
mandatory basis adjustment under section 734 or section 743; and/or (3)
are eligible for, and elect to apply, the electing investment
partnership provisions in section 743(e). In the case of the
contribution of built-in loss property, the partnership is required to
provide a statement in the year of contribution setting forth basic
information that the partnership will need in order to properly apply
the rules. Similarly, in the case of the mandatory basis adjustment
provisions, the partnership will already have the information subject
to the collection in order to comply with the rules. In the case of
EIPs, the collections are either one-time (election) or annual (annual
statement). The collection only applies if the partnership elects to be
an EIP. Furthermore, the proposed regulations provide the specific
language for the annual statement. Finally, the collection regarding
the mandatory basis adjustment provisions and the EIP rules have been
in effect since 2005, as required by Notice 2005-32, and the Treasury
Department and the IRS have not received comments that the collections
have a significant economic impact. For these reasons, the Treasury
Department and the IRS do not believe that the collection of
information in this notice of proposed rulemaking has a significant
economic impact. 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 the proposed regulations are adopted as final regulations,
consideration will be given to any written (a signed original and eight
(8) copies) or electronic comments that are submitted timely to the
IRS. The Treasury Department and the IRS request comments on all
aspects of the proposed rules. All comments will be available for
public inspection and copying.
A public hearing has been scheduled for April 30, 2014 beginning at
10:00 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 30 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. April 16, 2014.
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 electronic or
written comments by April 16, 2014, and an outline of the topics to be
discussed and the time to be devoted to each topic (signed original and
eight (8) copies) by April 16, 2014. 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 regulations are Wendy L. Kribell and
Benjamin H. Weaver, Office of the Associate Chief Counsel (Passthroughs
& Special Industries). However, other personnel from the Treasury
Department and the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR Part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.704-3 is amended by:
0
1. Revising paragraph (a)(3)(ii).
0
2. Adding paragraph (a)(3)(iii).
0
3. Revising paragraph (a)(6)(i).
0
4. Adding paragraph (a)(6)(iii).
0
5. Adding paragraph (a)(6)(iv).
0
6. Revising paragraph (a)(7).
0
7. Revising the first sentence in paragraph (a)(10) by removing the
word ``allocation'' before the word ``method''.
0
8. Redesignating paragraph (f) as paragraph (g).
0
9. Adding a new paragraph (f).
0
10. Adding a sentence at the end of newly redesignated paragraph (g).
The revisions and additions read as follows.
Sec. 1.704-3 Contributed property.
(a) * * *
(3) * * *
(ii) Built-in gain and built-in loss. The built-in gain on section
704(c) property is the excess of the property's book value over the
contributing partner's adjusted tax basis upon contribution. The built-
in gain is thereafter reduced by decreases in the difference between
the property's book value and adjusted tax basis (other than decreases
to the property's book value pursuant to Sec. 1.704-1(b)(2)(iv)(f)).
The built-in loss on section 704(c) property is the excess of the
contributing partner's adjusted tax basis over the property's book
value upon contribution. The built-in loss is thereafter reduced by
decreases in the difference between the property's adjusted tax basis
and book value (other than increases to the property's book
[[Page 3056]]
value pursuant to Sec. 1.704-1(b)(2)(iv)(f)). For purposes of
paragraph (a)(6)(iii) and (iv) of this section, a built-in gain or
built-in loss referred to in this paragraph shall be referred to as a
forward section 704(c) allocation. See Sec. 1.460-4(k)(3)(v)(A) for a
rule relating to the amount of built-in income or built-in loss
attributable to a contract accounted for under a long-term contract
method of accounting.
(iii) Effective/applicability date. The provisions of paragraph
(a)(3)(ii) of this section apply to partnership contributions and
transactions occurring on or after the date of publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register. * * *
* * * * *
(6) (i) Revaluations under section 704(b). The principles of this
section apply with respect to property for which differences between
book value and adjusted tax basis are created when a partnership
revalues partnership property pursuant to section 1.704-1(b)(2)(iv)(f)
(reverse section 704(c) allocations). Each such revaluation creates a
separate amount of built-in gain or built-in loss, as the case may be
(a section 704(c) layer), that must be tracked separately from built-in
gain or built-in loss arising from contribution (a forward section
704(c) layer) and any other revaluation (a reverse section 704(c)
layer). For instance, one section 704(c) layer with respect to a
particular property may be of built-in gain, and another section 704(c)
layer with respect to the same property may be of built-in loss.
* * * * *
(iii) Allocation method. A partnership may use any reasonable
method to allocate the items of income, gain, loss, and deduction
associated with an item of property among the property's forward and
reverse section 704(c) layers.
(iv) Effective/applicability date. The provisions of paragraph
(a)(6)(iii) of this section apply to partnership contributions and
transactions occurring on or after the date of publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register.
* * * * *
(7) Transfers of a partnership interest. If a contributing partner
transfers a partnership interest, built-in gain must be allocated to
the transferee partner as it would have been allocated to the
transferor partner. If the contributing partner transfers a portion of
the partnership interest, the share of built-in gain proportionate to
the interest transferred must be allocated to the transferee partner.
Rules for the allocation of built-in loss are provided in paragraph (f)
of this section.
* * * * *
(f) Special rules for built-in loss property--(1) General
principles--(i) Contributing partner. If a partner contributes section
704(c)(1)(C) property (as defined in paragraph (f)(2)(i) of this
section) to a partnership, the excess of the adjusted basis of the
section 704(c)(1)(C) property (determined without regard to paragraph
(f)(1)(ii) of this section) over its fair market value immediately
before the contribution will be taken into account only in determining
the amount of items allocated to the section 704(c)(1)(C) partner (as
defined in paragraph (f)(2)(ii) of this section) that contributed such
section 704(c)(1)(C) property.
(ii) Non-contributing partners. In determining the amount of items
allocated to partners other than the section 704(c)(1)(C) partner, the
initial basis of section 704(c)(1)(C) property in the hands of the
partnership is equal to the property's fair market value at the time of
contribution.
(2) Definitions. For purposes of this section--
(i) Section 704(c)(1)(C) property. The term section 704(c)(1)(C)
property means section 704(c) property (as defined in paragraph
(a)(3)(i) of this section) with a built-in loss at the time of
contribution. Section 704(c)(1)(C) property does not include a Sec.
1.752-7 liability (within the meaning of Sec. 1.752-7(b)(3)) or
property for which differences between book value and adjusted tax
basis are created when a partnership revalues property pursuant to
Sec. 1.704-1(b)(2)(iv)(f).
(ii) Section 704(c)(1)(C) partner. The term section 704(c)(1)(C)
partner means a partner that contributes section 704(c)(1)(C) property
to a partnership.
(iii) Section 704(c)(1)(C) basis adjustment. A property's section
704(c)(1)(C) basis adjustment is initially equal to the excess of the
adjusted basis of section 704(c)(1)(C) property (determined without
regard to paragraph (f)(1)(ii) of this section) over its fair market
value immediately before the contribution, and is subsequently adjusted
for the recovery of the section 704(c)(1)(C) basis adjustment under
paragraph (f)(3)(ii)(D) of this section.
(3) Operational rules--(i) In general. Except as provided in this
section, section 704(c)(1)(C) property is subject to the rules and
regulations applicable to section 704(c) property. See, for example,
Sec. 1.704-3(a)(9).
(ii) Effect of section 704(c)(1)(C) basis adjustment--(A) In
general. The section 704(c)(1)(C) basis adjustment is an adjustment to
the basis of partnership property with respect to the section
704(c)(1)(C) partner only. A section 704(c)(1)(C) basis adjustment
amount is excluded from the partnership's basis of section 704(c)(1)(C)
property. Thus, for purposes of calculating income, deduction, gain,
and loss, the section 704(c)(1)(C) partner will have a special basis
for section 704(c)(1)(C) property in which the partner has a section
704(c)(1)(C) basis adjustment. The section 704(c)(1)(C) basis
adjustment has no effect on the partnership's computation of any item
under section 703.
(B) Computation of section 704(c)(1)(C) partner's distributive
share of partnership items. The partnership first computes its items of
income, deduction, gain, or loss at the partnership level under section
703. The partnership then allocates the partnership items among the
partners, including the section 704(c)(1)(C) partner, in accordance
with section 704, and adjusts the partners' capital accounts
accordingly. The partnership then adjusts the section 704(c)(1)(C)
partner's distributive share of the items of partnership income,
deduction, gain, or loss in accordance with paragraphs (f)(3)(ii)(C)
and (D) of this section, to reflect the effects of the section
704(c)(1)(C) partner's section 704(c)(1)(C) basis adjustment. These
adjustments to the section 704(c)(1)(C) partner's distributive share
must be reflected on Schedules K and K-1 of the partnership's return
(Form 1065). The adjustments to the section 704(c)(1)(C) partner's
distributive shares do not affect the section 704(c)(1)(C) partner's
capital account.
(C) Effect of section 704(c)(1)(C) basis adjustment in determining
items of income, gain, or loss. The amount of a section 704(c)(1)(C)
partner's income, gain, or loss from the sale or exchange of
partnership property in which the section 704(c)(1)(C) partner has a
section 704(c)(1)(C) basis adjustment is equal to the section
704(c)(1)(C) partner's share of the partnership's gain or loss from the
sale of the property (including any remedial allocations under Sec.
1.704-3(d)), minus the section 704(c)(1)(C) partner's section
704(c)(1)(C) basis adjustment for the partnership property.
(D) Effect of section 704(c)(1)(C) basis adjustment in determining
items of deduction--(1) In general. If section 704(c)(1)(C) property is
subject to amortization under section 197, depreciation under section
168, or other cost recovery in the hands of the section 704(c)(1)(C)
partner, the section
[[Page 3057]]
704(c)(1)(C) basis adjustment associated with the property is recovered
in accordance with section 197(f)(2), section 168(i)(7), or another
applicable Internal Revenue Code section. The amount of any section
704(c)(1)(C) basis adjustment that is recovered by the section
704(c)(1)(C) partner in any year is added to the section 704(c)(1)(C)
partner's distributive share of the partnership's depreciation or
amortization deductions for the year. The basis adjustment is adjusted
under section 1016(a)(2) to reflect the recovery of the section
704(c)(1)(C) basis adjustment.
(2) Example. A contributes Property, with an adjusted basis of
$12,000 and a fair market value of $5,000 on January 1 of the year
of contribution, and B contributes $5,000 to PRS, a partnership.
Prior to the contribution, A depreciates Property under section 168
over 10 years using the straight-line method and the half-year
convention. On the contribution date, Property has 7.5 years
remaining in its recovery period. Property is section 704(c)(1)(C)
property, and A's section 704(c)(1)(C) basis adjustment is $7,000.
PRS's basis in Property is $5,000 (fair market value) and, in
accordance with section 168(i)(7), the depreciation is $667 per year
($5,000 divided by 7.5 years), which is shared equally between A and
B. A's $7,000 section 704(c)(1)(C) basis adjustment is subject to
depreciation of $933 per year in accordance with section 168(i)(7)
($7,000 divided by 7.5 years), which is taken into account by A.
(iii) Transfer of section 704(c)(1)(C) partner's partnership
interest--(A) General rule. Except as provided in paragraph
(f)(3)(iii)(B) of this section, if a section 704(c)(1)(C) partner
transfers its partnership interest, the portion of the section
704(c)(1)(C) basis adjustment attributable to the interest transferred
is eliminated and the transferee is not treated as the section
704(c)(1)(C) partner with respect to the interest transferred. The
transferor remains the section 704(c)(1)(C) partner with respect to any
remaining section 704(c)(1)(C) basis adjustment.
(B) Special rules--(1) General rule for transfer of partnership
interest in nonrecognition transaction. Except as provided in paragraph
(f)(3)(iii)(B)(2) of this section, paragraph (f)(3)(iii)(A) of this
section does not apply to the extent a section 704(c)(1)(C) partner
transfers its partnership interest in a nonrecognition transaction.
Instead, the transferee of all or a portion of a section 704(c)(1)(C)
partner's partnership interest succeeds to the transferor's section
704(c)(1)(C) basis adjustments in an amount attributable to the
interest transferred and the transferee will be treated as the section
704(c)(1)(C) partner with respect to the transferred interest.
Regardless of whether a section 754 election is in effect or a
substantial built-in loss exists with respect to the transfer, the
amount of any section 704(c)(1)(C) basis adjustment with respect to
section 704(c)(1)(C) property to which the transferee succeeds shall be
decreased by the amount of the negative section 743(b) adjustment that
would be allocated to the section 704(c)(1)(C) property pursuant to the
provisions of Sec. 1.755-1 if the partnership had a section 754
election in effect upon the transfer. If the nonrecognition transaction
is described in section 168(i)(7)(B), then the rules in section
168(i)(7)(A) apply with respect to transferor's cost recovery
deductions under section 168. If gain or loss is recognized on the
transaction, appropriate adjustments must be made to the section
704(c)(1)(C) basis adjustment.
(2) Exception for gifts. Paragraph (f)(3)(iii)(B)(1) of this
section does not apply to the transfer of all or a portion of a section
704(c)(1)(C) partner's partnership interest by gift.
(C) Examples. The following examples illustrate the principles of
this paragraph (f)(3)(iii)--
Example 1. Sale of entire partnership interest. In Year 1, A
contributes non-depreciable Property, with an adjusted basis of
$11,000 and a fair market value of $5,000, and B and C each
contribute $5,000 cash to PRS, a partnership. PRS's basis in
Property is $5,000, and A's section 704(c)(1)(C) basis adjustment in
Property is $6,000. In Year 3, Property's fair market value is
unchanged and A's section 704(c)(1)(C) basis adjustment remains
$6,000. D purchases A's interest in PRS for its fair market value of
$5,000. PRS does not have a section 754 election in effect in Year
3. A recognizes a loss of $6,000 on the sale, which equals the
excess of its basis in PRS ($11,000) over the amount realized on the
sale ($5,000). Pursuant to paragraph (f)(3)(iii)(A) of this section,
D does not succeed to A's section 704(c)(1)(C) basis adjustment,
which is eliminated upon the sale.
Example 2. Sale of portion of partnership interest. Assume the
same facts as Example 1 except that D purchases 50 percent of A's
interest in PRS for its fair market value of $2,500. A recognizes a
loss of $3,000 on the sale, which equals the excess of its basis in
the 50 percent interest in PRS ($5,500) over the amount realized on
the sale ($2,500). Pursuant to paragraph (f)(3)(iii)(A) of this
section, D does not succeed to A's section 704(c)(1)(C) basis
adjustment, and A's section 704(c)(1)(C) basis adjustment is reduced
to $3,000 upon the sale.
Example 3. Section 721 transaction--(i) Assume the same facts as
Example 1 except that instead of selling its interest in PRS to D in
Year 3, A contributes its interest in PRS to UTP, a partnership, in
exchange for a 50 percent interest in UTP. Following the
contribution, UTP's basis in PRS is $5,000 plus a $6,000 section
704(c)(1)(C) basis adjustment solely allocable to A. Under the facts
of this example, UTP's share of basis in PRS property is the same.
(ii) Under paragraph (f)(3)(iii)(B)(1) of this section, UTP
succeeds to A's $6,000 section 704(c)(1)(C) basis adjustment in
Property. PRS does not have a section 754 election in effect and
does not have a substantial built-in loss (within the meaning of
Sec. 1.743-1(a)(2)(i)) with respect to the transfer. Paragraph
(f)(3)(iii)(B)(1) of this section requires PRS to reduce the amount
of the section 704(c)(1)(C) basis adjustment by the amount of the
negative section 743(b) adjustment that would be allocated to
Property if PRS had an election under section 754 in effect. Because
UTP's basis in PRS equals UTP's share of basis in PRS property, no
negative section 743(b) adjustment would result from the transfer.
Accordingly, UTP's section 704(c)(1)(C) basis adjustment in Property
is $6,000. Pursuant to paragraph (a)(9) of this section, UTP must
allocate its distributive share of PRS's items with respect to the
section 704(c)(1)(C) basis adjustment solely to A.
(iii) In Year 3, PRS sells Property for its fair market value of
$5,000. PRS realizes no gain or loss on the sale. Pursuant to
paragraph (f)(3)(ii)(C) of this section, PRS reduces UTP's allocable
gain from the sale of Property ($0) by the amount of UTP's section
704(c)(1)(C) basis adjustment for Property ($6,000). Thus, UTP is
allocated a $6,000 loss. Pursuant to paragraph (a)(9) of this
section, UTP must allocate the $6,000 loss with respect to the
section 704(c)(1)(C) basis adjustment to A. A's basis in UTP
decreases from $11,000 to $5,000 and its section 704(c)(1)(C) basis
adjustment in UTP is eliminated.
Example 4. Interaction with section 362(e)(2)(A)--(i) Assume the
same facts as Example 1 except that instead of selling its interest
in PRS to D in Year 3, A contributes its interest in PRS to Y Corp,
a corporation, in a transfer described in section 351. PRS has a
section 754 election in effect. A's basis in its Y Corp stock is
$11,000 under section 358.
(ii) A and Y Corp do not elect to apply the provisions of
section 362(e)(2)(C). Therefore, section 362(e)(2)(A) will apply
because Y Corp's basis in PRS ($11,000) would exceed the fair market
value of PRS ($5,000) immediately after the transaction. Thus,
pursuant to section 362(e)(2)(B), Y Corp's basis in PRS will be
$5,000. Y Corp succeeds to A's $6,000 section 704(c)(1)(C) basis
adjustment in Property pursuant to paragraph (f)(3)(iii)(B)(1) of
this section. Pursuant to Sec. 1.743-1, Y Corp's section 743(b)
adjustment is ($6,000), or the difference between Y Corp's basis in
PRS of $5,000 and Y Corp's share of the adjusted basis of PRS's
property of $11,000 (which is Y Corp's cash on liquidation of
$5,000, increased by the $6,000 tax loss that would be allocated to
Y Corp upon a hypothetical transaction). The ($6,000) section 743(b)
adjustment will be allocated to PRS's property in accordance with
section 755 and the regulations thereunder.
Example 5. Gift of partnership interest. Assume the same facts
as Example 1 except that instead of selling its PRS interest to D in
Year 3, A makes a gift of its PRS interest
[[Page 3058]]
to D. Pursuant to paragraph (f)(3)(iii)(B)(2) of this section, D
does not succeed to any of A's section 704(c)(1)(C) basis adjustment
in Property. The $6,000 section 704(c)(1)(C) basis adjustment is
eliminated upon the gift.
(iv) Transfer of section 704(c)(1)(C) property by partnership--(A)
Like-kind exchange--(1) General rule. If a partnership disposes of
section 704(c)(1)(C) property in a like-kind exchange described in
section 1031 and the regulations thereunder, the substituted basis
property (as defined in section 7701(a)(42)) received by the
partnership is treated, solely with respect to the section 704(c)(1)(C)
partner, as section 704(c)(1)(C) property with the same section
704(c)(1)(C) basis adjustment as the section 704(c)(1)(C) property
disposed of by the partnership (with appropriate adjustments for any
portion of the section 704(c)(1)(C) basis adjustment taken into account
in determining the section 704(c)(1)(C) partner's gain or loss
recognized on the transfer).
(2) Example. A contributes Property 1 with an adjusted basis of
$12,000 and a fair market value of $10,000 and B contributes $10,000
cash to PRS, a partnership. A has a $2,000 section 704(c)(1)(C)
basis adjustment in Property 1, and PRS has an adjusted basis in
Property 1 of $10,000, or its fair market value. PRS subsequently
engages in a like-kind exchange under section 1031 of Property 1
when the fair market value of Property 1 is $13,000 and receives
Property 2 with a fair market value of $12,000 and $1,000 cash in
exchange. PRS's gain on the transaction is $3,000 ($13,000 minus
PRS's $10,000 adjusted basis) but is recognized only to the extent
of the cash received of $1,000, of which $500 is allocable to A. As
provided in paragraph (f)(3)(iv)(A)(1) of this section, Property 2
is treated as section 704(c)(1)(C) property with respect to A and
has the same section 704(c)(1)(C) basis adjustment as Property 1.
Because PRS recognized gain on the transaction, A must use $500 of
its section 704(c)(1)(C) basis adjustment to reduce A's gain to $0.
Therefore, A's $2,000 section 704(c)(1)(C) basis adjustment is
reduced to $1,500.
(B) Contribution of 704(c)(1)(C) property in section 721
transaction--(1) In general. The rules set forth in this paragraph
(f)(3)(iv)(B) apply if a section 704(c)(1)(C) partner contributes
section 704(c)(1)(C) property to an upper-tier partnership, and that
upper-tier partnership subsequently contributes the section
704(c)(1)(C) property to a lower-tier partnership in a transaction
described in section 721(a) (whether as part of a single transaction or
as separate transactions). The interest in the lower-tier partnership
received by the upper-tier partnership is treated as the section
704(c)(1)(C) property with the same section 704(c)(1)(C) basis
adjustment as the contributed property. The lower-tier partnership
determines its basis in the contributed property by excluding the
existing section 704(c)(1)(C) basis adjustment under the principles of
paragraph (f)(3)(ii)(A) of this section. However, the lower-tier
partnership also succeeds to the upper-tier partnership's section
704(c)(1)(C) basis adjustment. The portion of the upper-tier
partnership's basis in its interest in the lower-tier partnership
attributable to the section 704(c)(1)(C) basis adjustment must be
segregated and allocated solely to the section 704(c)(1)(C) partner for
whom the initial section 704(c)(1)(C) basis adjustment was made.
Similarly, the section 704(c)(1)(C) basis adjustment to which the
lower-tier partnership succeeds must be segregated and allocated solely
to the upper-tier partnership, and the section 704(c)(1)(C) partner for
whom the initial section 704(c)(1)(C) basis adjustment was made. If
gain or loss is recognized on the transaction, appropriate adjustments
must be made to the section 704(c)(1)(C) basis adjustment.
(2) Special rules. (a) To the extent that any section 704(c)(1)(C)
basis adjustment in a tiered partnership is recovered under paragraphs
(f)(3)(ii)(C) or (D) of this section, or is otherwise reduced, upper-
or lower-tier partnerships in the tiered structure must make conforming
reductions to related section 704(c)(1)(C) basis adjustments to prevent
duplication of loss.
(b) Section 704(c)(1)(C) property that is contributed by an upper-
tier partnership to a lower-tier partnership will have an additional
section 704(c)(1)(C) basis adjustment if the value of the section
704(c)(1)(C) property is less than its tax basis (as adjusted under
paragraph (f)(3)(ii) of this section) at the time of the transfer to
the lower-tier partnership. Any additional section 704(c)(1)(C) basis
adjustment determined under this paragraph will be allocated among the
partners of the upper-tier partnership in a manner that reflects their
relative shares of that loss.
(3) Example 1-- (i) In Year 1, A contributes Property with an
adjusted basis of $11,000 and a fair market value of $5,000, and B
contributes $5,000 cash to UTP, a partnership. Later in Year 1, when
Property's basis has not changed, and Property is worth at least
$5,000, UTP contributes Property to LTP in a section 721 transaction
for a 50-percent interest in LTP. In Year 2, LTP sells Property for
its fair market value of $29,000.
(ii) A has a $6,000 section 704(c)(1)(C) basis adjustment in
Property. After the section 721 transaction, A's section
704(c)(1)(C) basis adjustment in Property becomes A's section
704(c)(1)(C) adjustment in UTP's interest in LTP. UTP has a section
704(c)(1)(C) adjustment in Property in the amount of A's section
704(c)(1)(C) adjustment in Property. This section 704(c)(1)(C)
adjustment must be segregated and allocated solely to A. UTP's basis
in its interest in LTP is determined without reference to the
section 704(c)(1)(C) adjustment. Thus, UTP's basis in LTP is $5,000.
LTP's basis in Property is determined without reference to the
section 704(c)(1)(C) basis adjustment; therefore, LTP's basis in
Property is $5,000.
(iii) Upon the sale of Property, LTP realizes a gain of $24,000
($29,000 fair market value minus $5,000 adjusted basis). UTP's
allocable share of the $24,000 gain from the sale of Property by LTP
is $12,000, reduced by UTP's $6,000 section 704(c)(1)(C) basis
adjustment in Property. Because UTP's section 704(c)(1)(C) basis
adjustment must be segregated and allocated solely to A, UTP
allocates the $12,000 of gain equally between A and B, but allocates
the recovery of the $6,000 section 704(c)(1)(C) basis adjustment to
A. Therefore, pursuant to paragraph (f)(3)(ii)(C) of this section, A
recognizes no gain or loss on the sale (A's $6,000 share of UTP's
gain minus the $6,000 section 704(c)(1)(C) basis adjustment).
Because UTP's section 704(c)(1)(C) adjustment in Property is used,
A's section 704(c)(1)(C) basis adjustment in UTP's interest in LTP
is reduced to $0 to prevent duplication of loss pursuant to
paragraph (f)(3)(iv)(B)(2)(a) of this section.
Example 2-- Assume the same facts as Example 1, except that in
Year 2, UTP sells its entire interest in LTP to D for its fair
market value of $17,000. UTP recognizes a $12,000 gain on the sale,
which equals the excess of UTP's amount realized on the sale
($17,000) over UTP's basis in LTP ($5,000). UTP allocates the
$12,000 gain equally to A and B. However, A's $6,000 section
704(c)(1)(C) adjustment in UTP's interest in LTP offsets A's share
of the gain. Therefore, A recognizes no gain or loss on the sale. D
does not receive any of UTP's section 704(c)(1)(C) basis adjustment
in Property, which is eliminated upon the sale.
Example 3-- (i) Assume the same facts as Example 1, except that
at the time UTP contributes Property to LTP, the fair market value
of Property has fallen to $2,000. In Year 2, LTP sells Property for
its fair market value of $2,000.
(ii) A has a $6,000 section 704(c)(1)(C) basis adjustment in
Property. After the section 721 transaction, pursuant to paragraph
(f)(3)(iv)(B)(1) of this section, A's section 704(c)(1)(C) basis
adjustment in Property becomes A's section 704(c)(1)(C) adjustment
in UTP's interest in LTP. Pursuant to paragraph (f)(3)(iv)(B)(1) of
this section, UTP has a section 704(c)(1)(C) adjustment in Property
in the amount of A's section 704(c)(1)(C) adjustment in Property.
This section 704(c)(1)(C) adjustment must be segregated and
allocated solely to A. Because UTP's basis in Property ($5,000)
exceeds the fair market value of Property ($2,000) by $3,000 at the
time of UTP's contribution to LTP, UTP has an additional section
704(c)(1)(C) adjustment of $3,000 in Property pursuant to paragraph
(f)(3)(iv)(B)(2)(b) of this section. Partners A and B share equally
in this $3,000 section 704(c)(1)(C)
[[Page 3059]]
adjustment. UTP's basis in its interest in LTP is determined without
reference to A's section 704(c)(1)(C) adjustment. Thus, UTP's basis
in LTP is $5,000. Pursuant to paragraph (f)(3)(iv)(B)(1) of this
section, LTP's basis in Property is determined without reference to
either section 704(c)(1)(C) basis adjustment; therefore, LTP's basis
in Property is $2,000.
(iii) Upon the sale of Property, LTP recognizes no gain or loss
($2,000 sales price minus $2,000 adjusted basis). However, the sale
of Property triggers UTP's two separate section 704(c)(1)(C) basis
adjustments. First, UTP applies the $3,000 section 704(c)(1)(C)
adjustment attributable to the built-in loss in Property arising
after A contributed Property to UTP. This results in an allocation
of ($1,500) of loss to each of A and B. Next, UTP applies the $6,000
section 704(c)(1)(C) basis adjustment attributable to A's initial
contribution of Property to UTP, resulting in an additional ($6,000)
of loss allocated to A. Thus, the sale of Property by LTP results in
A recognizing ($7,500) of loss, and B recognizing ($1,500) of loss.
Pursuant to paragraph (f)(3)(iv)(B)(2)(a) of this section, because
UTP's section 704(c)(1)(C) adjustment in Property is used, A's
section 704(c)(1)(C) basis adjustment in UTP's interest in LTP is
reduced to $0 to prevent duplication of loss.
(C) Section 351 transactions--(1) Basis in transferred property. A
corporation's adjusted basis in property transferred to the corporation
by a partnership in a transaction described in section 351 is
determined under section 362 (including for purposes of applying
section 362(e)) by taking into account any section 704(c)(1)(C) basis
adjustment for the property (other than any portion of a section
704(c)(1)(C) basis adjustment that reduces a partner's gain under
paragraph (f)(3)(iv)(C)(2) of this section).
(2) Partnership gain. The amount of gain, if any, recognized by the
partnership on the transfer of property by the partnership to a
corporation in a transfer described in section 351 is determined
without regard to any section 704(c)(1)(C) basis adjustment for the
transferred property. The amount of gain, if any, recognized by the
partnership on the transfer that is allocated to the section
704(c)(1)(C) partner is adjusted to reflect the partner's section
704(c)(1)(C) basis adjustment in the transferred property.
(3) Basis in stock. The partnership's adjusted basis in stock
received from a corporation in a transfer described in section 351 is
determined without regard to the section 704(c)(1)(C) basis adjustment
in property transferred to the corporation in the section 351 exchange.
A partner with a section 704(c)(1)(C) basis adjustment in property
transferred to the corporation, however, has a basis adjustment in the
stock received by the partnership in the section 351 exchange in an
amount equal to the partner's section 704(c)(1)(C) basis adjustment in
the transferred property, reduced by any portion of the section
704(c)(1)(C) basis adjustment that reduced the partner's gain under
paragraph (f)(3)(iv)(C)(2) of this section.
(4) Example. The following example illustrates the provisions of
this paragraph (f)(3)(iv)(C).
Example. Section 351 transaction --(i) In Year 1, A contributes
$10,000 cash and B contributes Property with an adjusted basis of
$18,000 and a fair market value of $10,000 to PRS, a partnership.
PRS takes Property with a basis of $10,000. B's section 704(c)(1)(C)
basis adjustment for Property is $8,000. PRS contributes Property to
Y Corp in a section 351 transaction. Under section 362(e)(2)(A), Y
Corp takes a $10,000 basis in Property. PRS's basis in its Y Corp
stock is $10,000 under section 358. Pursuant to paragraph
(f)(3)(iv)(C)(3) of this section, B has a section 704(c)(1)(C) basis
adjustment of $8,000 in the Y Corp stock received by PRS in the
section 351 exchange.
(ii) In Year 2, Y Corp sells Property for its fair market value
of $10,000. Y Corp recognizes no gain or loss on the sale of
Property. Pursuant to paragraph (f)(3)(iv)(C)(1) of this section, B
does not take into account its section 704(c)(1)(C) basis adjustment
upon the sale by Y Corp of Property. Instead, B will take the
section 704(c)(1)(C) basis adjustment into account when PRS disposes
of the Y Corp stock.
(D) Section 708(b)(1)(B) transactions--(1) In general. A partner
with a section 704(c)(1)(C) basis adjustment in section 704(c)(1)(C)
property held by a partnership that terminates under section
708(b)(1)(B) will continue to have the same section 704(c)(1)(C) basis
adjustment for section 704(c)(1)(C) property deemed contributed by the
terminated partnership to the new partnership under Sec. 1.708-
1(b)(4). In addition, the deemed contribution of property by a
terminated partnership to a new partnership is not subject to this
section and does not create a section 704(c)(1)(C) basis adjustment.
(2) Example. A contributes Property with an adjusted basis of
$11,000 and a fair market value of $5,000 and B contributes $5,000
cash to PRS, a partnership. B sells its entire interest in PRS to C
for its fair market value of $5,000, which terminates PRS under
section 708(b)(1)(B). Under Sec. 1.708-1(b)(4), PRS is deemed to
contribute all of its assets and liabilities to a new partnership
(New PRS) in exchange for an interest in New PRS. Immediately
thereafter, PRS is deemed to distribute its interest in New PRS
equally to A and C in complete liquidation of PRS. New PRS takes
Property with a basis of $5,000 and A retains its $6,000 section
704(c)(1)(C) basis adjustment related to Property inside New PRS.
(E) Disposition in an installment sale. If a partnership disposes
of section 704(c)(1)(C) property in an installment sale (as defined in
section 453(b)), the installment obligation received by the partnership
is treated as the section 704(c)(1)(C) property with the same section
704(c)(1)(C) basis adjustment as the section 704(c)(1)(C) property
disposed of by the partnership (with appropriate adjustments for any
gain recognized on the installment sale).
(F) Contributed contracts. If a partner contributes to a
partnership a contract that is section 704(c)(1)(C) property, and the
partnership subsequently acquires property pursuant to the contract in
a transaction in which less than all of the loss is recognized, then
the acquired property is treated as section 704(c)(1)(C) property with
the same section 704(c)(1)(C) basis adjustment as the contract (with
appropriate adjustments for any gain or loss recognized on the
acquisition). For this purpose, the term contract includes, but is not
limited to, options, forward contracts, and futures contracts.
(v) Distributions--(A) Current distribution of section 704(c)(1)(C)
property to section 704(c)(1)(C) partner. If a partnership distributes
property to a partner and the partner has a section 704(c)(1)(C) basis
adjustment for the property, the section 704(c)(1)(C) basis adjustment
is taken into account under section 732. See Sec. 1.732-2(a). For
certain adjustments to the basis of remaining partnership property
after the distribution of section 704(c)(1)(C) property to the section
704(c)(1)(C) partner, see Sec. 1.734-2(c).
(B) Distribution of section 704(c)(1)(C) property to another
partner. If a partner receives a distribution of property in which
another partner has a section 704(c)(1)(C) basis adjustment, the
distributee does not take the section 704(c)(1)(C) basis adjustment
into account under section 732. If section 704(c)(1)(B) applies to
treat the section 704(c)(1)(C) partner as recognizing loss on the sale
of the distributed property, the section 704(c)(1)(C) basis adjustment
is taken into account in determining the amount of the loss. A section
704(c)(1)(C) partner with a section 704(c)(1)(C) basis adjustment in
the distributed property that is not taken into account as described in
the prior sentence reallocates the section 704(c)(1)(C) basis
adjustment among the remaining items of partnership property under
Sec. 1.755-1(c).
(C) Distributions in complete liquidation of a section 704(c)(1)(C)
partner's interest. If a section 704(c)(1)(C) partner receives a
distribution of property (whether or not
[[Page 3060]]
the partner has a section 704(c)(1)(C) basis adjustment in the
property) in liquidation of its interest in the partnership, the
adjusted basis to the partnership of the distributed property
immediately before the distribution includes the section 704(c)(1)(C)
partner's section 704(c)(1)(C) basis adjustment for the property in
which the section 704(c)(1)(C) partner relinquished an interest. For
purposes of determining the section 704(c)(1)(C) partner's basis in
distributed property under section 732, the partnership reallocates any
section 704(c)(1)(C) basis adjustment from section 704(c)(1)(C)
property retained by the partnership to distributed properties of like
character under the principles of Sec. 1.755-1(c)(i), after applying
sections 704(c)(1)(B) and 737. If section 704(c)(1)(C) property is
retained by the partnership, and no property of like character is
distributed, then that property's section 704(c)(1)(C) basis adjustment
is not reallocated to the distributed property for purposes of applying
section 732. See Sec. 1.734-2(c)(2) for rules regarding the treatment
of any section 704(c)(1)(C) adjustment that is not fully utilized by
the section 704(c)(1)(C) partner.
(D) Examples. The following examples illustrate the principles of
this paragraph (f)(3)(v).
Example 1. Current distribution of section 704(c)(1)(C) property
to section 704(c)(1)(C) partner--(i) A contributes Property 1 with
an adjusted basis of $15,000 and a fair market value of $10,000 and
Property 2 with an adjusted basis of $5,000 and a fair market value
of $20,000 and B contributes $30,000 cash to PRS, a partnership.
Property 1 and Property 2 are both capital assets. When Property 1
has a fair market value of $12,000, and neither A nor B's basis in
PRS has changed, PRS distributes Property 1 to A in a current
distribution.
(ii) Property 1 has an adjusted basis to PRS of $10,000, and A
has a section 704(c)(1)(C) basis adjustment of $5,000 in Property 1.
Pursuant to Sec. 1.732-2(c) and paragraph (f)(3)(v)(A) of this
section, for purposes of section 732(a)(1), the adjusted basis of
Property 1 to PRS immediately before the distribution is $15,000
(PRS's $10,000 adjusted basis increased by A's $5,000 section
704(c)(1)(C) basis adjustment for Property 1) and, therefore. A
takes a $15,000 adjusted basis in Property 1 upon the distribution.
Accordingly, no adjustment is required to PRS's property under
section 734.
Example 2. Current distribution of section 704(c)(1)(C) property
to another partner. Assume the same facts as Example 1 except PRS
distributes Property 1 to B in a distribution to which section
704(c)(1)(B) does not apply. B does not take any portion of A's
section 704(c)(1)(C) basis adjustment into account. Accordingly,
pursuant to Sec. 1.732-1(a) and paragraph (f)(3)(v)(B) of this
section, for purposes of section 732(a)(1), the adjusted basis of
Property 1 to PRS immediately before the distribution is $10,000
and, therefore, B takes a $10,000 adjusted basis in Property 1 upon
the distribution. Accordingly, no adjustment is required to PRS's
property under section 734. A's section 704(c)(1)(C) basis
adjustment in Property 1 is reallocated to Property 2 in accordance
with Sec. 1.755-1(c).
Example 3. (i) Liquidating distribution to section 704(c)(1)(C)
partner. In Year 1, A contributes Property 1 with an adjusted basis
of $15,000 and a fair market value of $10,000 and Property 2 with an
adjusted basis of $5,000 and a fair market value of $20,000 and B
and C each contribute $30,000 cash to PRS, a partnership. Property 1
and Property 2 are both capital assets. In a later year, when the
fair market value of Property 2 is still $20,000, and no partner's
basis in PRS has changed, PRS distributes Property 2 and $10,000 to
A in complete liquidation of A's partnership interest in a
distribution to which section 737 does not apply. PRS has a section
754 election in effect for the year of the distribution.
(ii) Property 2 has an adjusted basis to PRS of $5,000, and A
has a section 704(c)(1)(C) basis adjustment of $5,000 in Property 1.
Pursuant to Sec. 1.732-2(c) and paragraph (f)(3)(v)(C) of this
section, for purposes of section 732(b), the adjusted basis of
Property 2 to PRS immediately before the distribution is $10,000
(PRS's $5,000 adjusted basis in Property 2 increased by A's $5,000
section 704(c)(1)(C) basis adjustment for Property 1), and A's
adjusted basis in Property 2 upon the distribution is $10,000 (A's
$20,000 basis in PRS minus the $10,000 cash distributed). Therefore,
no adjustment is required to PRS's property under section 734.
(vi) Returns. A partnership that owns property with a section
704(c)(1)(C) basis adjustment must attach a statement to the
partnership return for the year of the contribution setting forth the
name and taxpayer identification number of the section 704(c)(1)(C)
partner as well as the section 704(c)(1)(C) basis adjustment and the
section 704(c)(1)(C) property to which the adjustment relates.
(g) * * *. The provisions of paragraph (f) of this section apply to
partnership contributions occurring on or after the date of publication
of the Treasury decision adopting these rules as final regulations in
the Federal Register.
0
Par. 3. Section 1.704-4 is amended as follows:
0
1. In paragraph (a)(1), by removing ``five years'' and adding in its
place ``seven years''.
0
2. In paragraph (a)(4) by removing ``five-year'' and adding in its
place ``seven-year'' each time it appears.
0
3. By revising paragraph (a)(4)(i).
0
4. In paragraph (f)(2), Examples 1 and 2, by removing the phrase
``five-year'' and adding in its place ``seven-year'' each time it
appears and removing ``2000'' and adding in its place ``2002'' each
time it appears.
0
5. By adding a sentence to the end of paragraph (g).
The revision and addition read as follows:
Sec. 1.704-4 Distribution of contributed property.
(a) * * *
(4) Determination of seven-year period--(i) General rule. The
seven-year period specified in paragraph (a)(1) of this section begins
on, and includes, the date of contribution and ends on, and includes,
the last date that is within seven years of the contribution. For
example, if a partner contributes section 704(c) property to a
partnership on May 15, 2016, the seven-year period with respect to the
section 704(c) property ends on, and includes, May 14, 2023.
* * * * *
(g) * * * The provisions of this section relating to the seven-year
period for determining the applicability of section 704(c)(1)(B) are
applicable for partnership contributions occurring on or after the date
of publication of the Treasury decision adopting these rules as final
regulations in the Federal Register.
0
Par. 4. Section 1.732-2 is amended by:
0
1. Redesignating paragraph (b) introductory text as (b)(1) introductory
text and revising it.
0
2. Adding paragraph (b)(2.
0
3. Redesignating paragraph (c) as paragraph (d).
0
4. Adding a new paragraph (c).
The revisions and addition reads as follows:
Sec. 1.732-2 Special partnership basis of distributed property.
* * * * *
(b) Adjustments under section 743(b)--(1) In general. In the case
of a distribution of property to a partner who acquired any part of its
interest in a transfer, if there was an election under section 754 in
effect with respect to the transfer, or if the partnership had a
substantial built-in loss (as defined in Sec. 1.743-1(a)(2)(i))
immediately after the transfer, then, for purposes of section 732
(other than subsection (d) thereof), the adjusted partnership basis of
the distributed property shall take into account, in addition to any
adjustments under section 734(b), the transferee's special basis
adjustment for the distributed property under section 743(b). The
application of this paragraph may be illustrated by the following
example:
* * * * *
(2) Effective/applicability date. Paragraph (b)(1) of this section
relating to substantial built-in losses is
[[Page 3061]]
applicable for partnership distributions occurring on or after the date
of publication of the Treasury decision adopting these rules as final
regulations in the Federal Register.
(c) Adjustments under section 704(c)(1)(C)--(1) In general. In the
case of a distribution of property to a section 704(c)(1)(C) partner
(as defined in Sec. 1.704-3(f)(2)(ii)), for purposes of section 732
(other than subsection (d) thereof), the adjusted partnership basis of
the distributed property shall take into account, in addition to any
adjustments under section 734(b), the distributee's section
704(c)(1)(C) basis adjustment (if any) for the distributed property.
(2) Effective/applicability date. Paragraph (c)(1) of this section
is applicable for partnership distributions occurring on or after the
date of publication of the Treasury decision adopting these rules as
final regulations in the Federal Register.
* * * * *
0
Par. 5. Section 1.734-1 is amended by:
0
1. Revising the section heading.
0
2. Revising paragraph (a).
0
3. Revising paragraph (b)(2)(i).
0
4. Adding Example 3 following paragraph (b)(2)(ii).
0
5. Adding a sentence at the end of paragraph (d).
0
6. Adding paragraphs (f), (g), and (h).
The revisions and additions read as follows:
Sec. 1.734-1 Adjustment to basis of undistributed partnership
property where partnership has a section 754 election or there is a
substantial basis reduction with respect to a distribution.
(a) General rule--(1) Adjustments to basis. A partnership shall not
adjust the basis of partnership property as the result of a
distribution of property to a partner unless the election provided in
section 754 (relating to optional adjustment to basis of partnership
property) is in effect or there is a substantial basis reduction
(within the meaning of paragraph (a)(2)(i) of this section) with
respect to the distribution.
(2) Substantial basis reduction--(i) In general. For purposes of
this section, there is a substantial basis reduction with respect to a
distribution of property or properties to a partner if the sum of the
amounts described in section 734(b)(2)(A) and (b)(2)(B) exceeds
$250,000. If there is a substantial basis reduction under this section,
the partnership is treated as having an election under section 754 in
effect solely for the distribution to which the substantial basis
reduction relates.
(ii) Special rules for tiered partnerships. See paragraph (f) of
this section for special rules regarding tiered partnerships.
(iii) Special rules for securitization partnerships. See paragraph
(g) of this section for special rules regarding securitization
partnerships.
(b) * * *
(2) Decrease in basis. (i) When a partnership with a section 754
election in effect makes a distribution in liquidation of a partner's
entire interest in the partnership, or when there is a substantial
basis reduction (within the meaning of paragraph (a)(2)(i) of this
section), the partnership shall decrease the adjusted basis of the
remaining partnership property by--
(ii) * * *
Example 3 --(i) A, B, and C each contribute $2 million to PRS, a
partnership. PRS purchases Property 1 and Property 2, both of which
are capital assets, for $1 million and $5 million respectively. In
Year 2, the fair market value of Property 1 increases to $3 million
and the fair market value of Property 2 increases to $6 million.
Also in Year 2, PRS distributes Property 1 to C in liquidation of
C's interest in PRS at a time when C's basis in its PRS interest is
still $2 million. PRS does not have an election under section 754 in
effect.
(ii) Under section 732, the basis of Property 1 in the hands of
C is $2 million. Because the excess of C's adjusted basis in
Property 1 ($2 million) over PRS's adjusted basis in Property 1 ($1
million) is $1 million, the amount described in section 734(b)(2)(B)
($1 million) exceeds $250,000, and therefore, there is a substantial
basis reduction with respect to the distribution. Accordingly,
pursuant to paragraph (a)(2)(i) of this section, PRS is treated as
having a section 754 election in effect in Year 2 and must reduce
its basis in Property 2 in accordance with paragraph (b)(2)(i) of
this section.
* * * * *
(d) * * * A partnership required to adjust the basis of partnership
property following the distribution of property because there is a
substantial basis reduction (within the meaning of paragraph (a)(2)(i)
of this section) with respect to the distribution is subject to, and
required to comply with, the provisions of this paragraph (d) solely
with respect to the distribution to which the substantial basis
reduction relates.
* * * * *
(f) Adjustments with respect to tiered partnerships--(1) In
general. If an upper-tier partnership makes an adjustment under
paragraph (b) of this section to the basis of an interest it holds in a
lower-tier partnership that has an election under section 754 in
effect, the lower-tier partnership must make adjustments under
paragraph (b) of this section to the upper-tier partnership's share of
the lower-tier partnership's assets. The amount of the lower-tier
partnership's adjustment is equal to the adjustment made by the upper-
tier partnership to the basis of its interest in the lower-tier
partnership. The lower-tier partnership's adjustment to the upper-tier
partnership's share of its assets is for the upper-tier partnership
only and does not affect the basis in the lower-tier partnership's
property for the other partners of the lower-tier partnership.
Additionally, if there is a substantial basis reduction (within the
meaning of paragraph (a)(2)(i) of this section) with respect to a
distribution by an upper-tier partnership that (either directly or
indirectly through one or more partnerships) holds an interest in a
lower-tier partnership, each lower-tier partnership is treated, solely
with respect to the distribution, as if it had made an election under
section 754 for the taxable year in which the distribution occurs. For
additional examples of the application of the principles of this
paragraph (f)(1), see Revenue Ruling 92-15, 1992-1 CB 215. See Sec.
601.601(d)(2)(ii)(b)
(2) Example --(i) Facts. A, B, and C are equal partners in UTP,
a partnership. Each partner's interest in UTP has an adjusted basis
and fair market value of $3 million. UTP owns two capital assets
with the following adjusted bases and fair market values:
Adjusted basis Fair market value
Property 1............. $2.2 million........... $3 million.
Property 2............. $2.8 million........... $3 million.
UTP also owns a 50 percent interest in LTP, a partnership. UTP's
interest in LTP has an adjusted basis of $4 million and a fair
market value of $3 million. LTP owns one asset, Property 3, a
capital asset, which has an adjusted basis of $8 million and a fair
market value of $6 million. Neither UTP nor LTP has an election
under section 754 in effect.
(ii) Liquidating distribution to A of Property 1. UTP
distributes Property 1 to A in complete liquidation of A's interest
in UTP. Under section 732(b), the adjusted basis of Property 1 to A
is $3 million. Therefore, there is a substantial basis reduction
with respect to the distribution to A because the sum of the amounts
described in section 734(b)(2)(A) ($0) and section 734(b)(2)(B) (the
excess of $3 million over $2.2 million, or $800,000) exceeds
$250,000. Therefore, pursuant to paragraph (b)(2) of this section,
UTP must decrease the basis of its property by $800,000. Under Sec.
1.755-1(c), UTP must decrease the adjusted basis of its 50 percent
interest in LTP by $800,000. Likewise, pursuant to paragraph (f)(1)
of this section, LTP must decrease its basis in UTP's share of
Property 3 by $800,000 in accordance with Sec. 1.755-1(c).
(g) Securitization partnerships. A securitization partnership (as
defined in Sec. 1.743-1(o)(2)) shall not be treated as
[[Page 3062]]
having a substantial basis reduction with respect to any distribution
of property to a partner.
(h) Effective/applicability date. The rules relating to substantial
basis reductions in paragraphs (a) and (b) of this section and
paragraphs (f) and (g) of this section apply to partnership
distributions occurring on or after the date of publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register.
0
Par. 6. Section 1.734-2 is amended by revising the section heading and
adding paragraph (c) to read as follows:
Sec. 1.734-2 Adjustment after distribution to transferee partner or
section 704(c)(1)(C) partner.
* * * * *
(c)(1) Section 704(c)(1)(C) basis adjustments will be taken into
account in determining the basis adjustment under section 734(b).
However, section 704(c)(1)(C) basis adjustments, other than a section
704(c)(1)(C) basis adjustment applied as an adjustment to the basis of
partnership property pursuant to paragraph (c)(2) of this section, will
not be taken into account in making allocations under Sec. 1.755-1(c).
(2) Liquidating distributions. If a section 704(c)(1)(C) partner
receives a distribution of property (including money) in liquidation of
its entire partnership interest, the section 704(c)(1)(C) partner's
section 704(c)(1)(C) basis adjustments that are treated as basis in the
distributed property pursuant to section 732 will be taken into account
in determining the basis adjustment under section 734(b), regardless of
whether the distributed property is section 704(c)(1)(C) property. If
any section 704(c)(1)(C) basis adjustment cannot be reallocated to
distributed property in connection with the distribution, then that
remaining section 704(c)(1)(C) basis adjustment shall be treated as a
positive section 734(b) adjustment. If the distribution also gives rise
to a negative section 734(b) adjustment without regard to the section
704(c)(1)(C) basis adjustment reallocation, then the negative section
734(b) adjustment and the section 704(c)(1)(C) basis adjustment
reallocation are netted together, and the net amount is allocated under
Sec. 1.755-1(c). If the partnership does not have a section 754
election in effect at the time of the liquidating distribution, the
partnership shall be treated as having made a section 754 election
solely for purposes of computing any negative section 734(b) adjustment
that would arise from the distribution.
(3) The following examples illustrate the provisions of this
paragraph (c).
Example 1 --(i) In Year 1, A contributes $5,000 cash and
Property A, a capital asset, with an adjusted basis of $7,000 and a
fair market value of $5,000; B contributes $8,000 cash and Property
B, a capital asset, with an adjusted basis and fair market value of
$2,000; and C contributes $7,000 cash and Property C, a capital
asset, with an adjusted basis and fair market value of $3,000 to
PRS, a partnership. In Year 3, Property B has appreciated in value
to $8,000. PRS distributes Property B and $4,000 to C in complete
liquidation of C's interest in PRS at a time when no partner's basis
in PRS has changed. PRS revalues its property under Sec. 1.704-
1(b)(2)(iv)(f) in connection with the distribution, and makes an
election under section 754. C recognizes no gain or loss on the
distribution.
(ii) C receives Property B with a basis of $6,000 (C's adjusted
basis in PRS of $10,000 minus the $4,000 cash distributed). Because
PRS has an election under section 754 in effect, PRS must reduce its
basis in remaining partnership property under Sec. 1.734-
1(b)(2)(ii) by $4,000 (C's $6,000 basis in Property B minus PRS's
$2,000 adjusted basis in Property B prior to the distribution. Under
Sec. 1.755-1(c)(2)(ii), that basis reduction must be allocated
within a class first to properties with unrealized depreciation in
proportion to their respective amounts of unrealized depreciation.
Any remaining decrease must be allocated in proportion to the
properties' adjusted bases. Because there is no unrealized
depreciation in either Property A (disregarding A's section
704(c)(1)(C) basis adjustment) or Property C, the decrease must be
allocated between the two properties in proportion to their adjusted
bases, $2,500 ($4,000 multiplied by $5,000 divided by $8,000) to
Property A and $1,500 ($4,000 multiplied by $3,000 divided by
$8,000) to Property C.
(iii) In a subsequent year, PRS sells Property A for its fair
market value of $7,500 and recognizes $5,000 of gain ($7,500 amount
realized minus adjusted basis of $2,500). Pursuant to Sec. 1.704-
3(f)(3)(ii)(B), A's $2,500 distributive share of the $5,000 gain
from the sale of Property A is reduced by A's $2,000 section
704(c)(1)(C) basis adjustment. Therefore, A recognizes a gain of
$500 on the sale.
Example 2 --(i) A contributes Property 1 with an adjusted basis
of $15,000 and a fair market value of $10,000 and Property 2 with an
adjusted basis of $15,000 and a fair market value of $20,000, and B
and C each contribute $30,000 cash to PRS, a partnership. A has a
section 704(c)(1)(C) basis adjustment of $5,000 with respect to
Property 1. PRS's adjusted bases in Property 1 and Property 2 are
$10,000 and $15,000, respectively. When the fair market value of A's
interest in PRS is still $30,000, and no partner's basis in its PRS
interest has changed, PRS makes a liquidating distribution to A of
$30,000 cash, which results in A realizing no gain or loss. PRS has
an election under section 754 in effect.
(ii) A is unable to take into account A's section 704(c)(1)(C)
basis adjustment in Property 1 upon the distribution of the cash as
described in paragraph (c)(2) of this section because A cannot
increase the basis of cash under Sec. 1.704-3(f)(v)(C). Thus, A's
$5,000 section 704(c)(1)(C) basis adjustment is treated as a
positive section 734(b) adjustment to the partnership's assets
retained. PRS's $5,000 section 734(b) adjustment will be allocated
to Property 2, increasing its basis from $15,000 to $20,000 under
Sec. 1.755-1(c).
Example 3 --(i) A contributes Property 1 with an adjusted basis
of $35,000 and a fair market value of $30,000, B contributes
Property 2 with an adjusted basis and fair market value of $30,000,
and C contributes $30,000 cash to PRS, a partnership. Property 1 is
a capital asset, and Property 2 is inventory (as defined in section
751(d)). PRS's adjusted basis in Property 1 is $30,000 under section
704(c)(1)(C)(ii), and A has a section 704(c)(1)(C) basis adjustment
of $5,000 with respect to Property 1. Later, at a time when the
value and bases of the properties have not changed, PRS distributes
$30,000 cash to A in complete liquidation of A's interest. A
recognizes a ($5,000) loss under section 731(a)(2) on the
distribution. PRS has an election under section 754 in effect.
(ii) The distribution results in a negative section 734(b)
adjustment to capital gain property of ($5,000) (the amount of loss
A recognizes under section 731(a)(2)). Additionally, because A is
unable to take into account A's section 704(c)(1)(C) basis
adjustment in Property 1 upon the distribution of the cash, A's
$5,000 section 704(c)(1)(C) basis adjustment is treated as a
positive section 734(b) adjustment. Pursuant to paragraph (c)(2) of
this section, these two adjustments are netted together, resulting
in no adjustment under section 734(b). Therefore, the partnership's
basis in Property 1 and Property 2 remains $30,000.
Example 4 --(i) Assume the same facts as in Example 3 except
that PRS distributes Property 2 to A in complete liquidation of A's
interest in a transaction to which section 704(c)(1)(B) and section
737 do not apply.
(ii) Pursuant to Sec. 1.704-3(f)(v)(C), A cannot include A's
section 704(c)(1)(C) basis adjustment in the basis of the
distributed property, because the section 704(c)(1)(C) property and
the distributed property are not of like character. Accordingly, the
basis to A of Property 2 is $30,000. A also recognizes a $5,000
capital loss under section 731(a)(2), resulting in a ($5,000) basis
adjustment under section 734(b). Because the section 704(c)(1)(C)
basis adjustment to Property 1 was not reallocated in connection
with the distribution, that remaining $5,000 section 704(c)(1)(C)
basis adjustment is treated as a positive section 734(b) adjustment.
Pursuant to paragraph (c)(2) of this section, these two adjustments
are netted together, resulting in no adjustment under section
734(b). Therefore, the basis of Property 1 remains $30,000.
(4) Effective/applicability date. This paragraph (c) applies to
partnership distributions occurring on or after the date of publication
of the Treasury decision adopting these rules as final regulations in
the Federal Register.
[[Page 3063]]
0
Par. 7. Section 1.737-1 is amended by revising paragraph (c)(1) and
adding paragraphs (c)(3) and (4) to read as follows:
Sec. 1.737-1 Recognition of precontribution gain.
* * * * *
(c) Net precontribution gain--(1) General rule. The distributee
partner's net precontribution gain is the net gain (if any) that would
have been recognized by the distributee partner under section
704(c)(1)(B) and Sec. 1.704-4 if all property that had been
contributed to the partnership by the distributee partner within seven
years of the distribution and is held by the partnership immediately
before the distribution had been distributed by the partnership to
another partner other than the partner who owns, directly or
indirectly, more than 50 percent of the capital or profits interest in
the partnership.
* * * * *
(3) Determination of seven-year period--(i) General rule. The
seven-year period specified in paragraph (c)(1) of this section begins
on, and includes, the date of contribution and ends on, and includes,
the last date that is within seven years of the contribution. For
example, if a partner contributes 704(c) property to a partnership on
May 15, 2016, the seven-year period with respect to the section 704(c)
property ends on, and includes, May 14, 2023.
(ii) Section 708(b)(1)(B) terminations. A termination of the
partnership under section 708(b)(1)(B) does not begin a new seven-year
period for each partner with respect to built-in gain and built-in loss
property that the terminated partnership is deemed to contribute to the
new partnership under Sec. 1.708-1(b)(4). See Sec. 1.704-3(a)(3)(ii)
for the definitions of built-in gain and built-in loss on section
704(c) property.
(4) Effective/applicability date. The provisions of paragraph
(c)(1) and (3) of this section relating to the seven-year period for
determining the applicability of section 737(b) apply for partnership
contributions occurring on or after the date of publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register.
* * * * *
0
Par. 8. Section 1.743-1 is amended by:
0
1. Revising the section heading.
0
2. Revising paragraph (a).
0
3. Revising paragraph (b).
0
4. Redesignating paragraph (f) introductory text as paragraph (f)(1)
introductory text and revising it.
0
5. Adding paragraph (f)(2).
0
6. In paragraph (h)(1), removing ``Sec. 1.708-1(b)(1)(iv)'' and adding
in its place ``Sec. 1.708-1(b)(4)''.
0
7. Revising paragraph (j)(3)(ii) Example 1.
0
8. Revising paragraph (j)(3)(ii) Example 3.
0
9. Revising paragraph (k)(1)(iii).
0
10. Adding paragraph (k)(2)(iv).
0
11. Redesignating paragraph (l) as paragraph (p).
0
12. Adding a new paragraph (l).
0
13. Adding paragraphs (m), (n), and (o).
0
14. Revising newly redesignated paragraph (p).
The revisions and additions read as follows:
Sec. 1.743-1 Special rules where partnership has a section 754
election in effect or has a substantial built-in loss immediately after
transfer of partnership interest.
(a) Generally--(1) Adjustment to basis. The basis of partnership
property is adjusted as a result of the transfer of an interest in a
partnership by sale or exchange or on the death of a partner if the
election provided by section 754 (relating to optional adjustments to
the basis of partnership property) is in effect with respect to the
partnership, or if the partnership has a substantial built-in loss
(within the meaning of paragraph (a)(2)(i) of this section) immediately
after the transfer.
(2) Substantial built-in loss--(i) In general. A partnership has a
substantial built-in loss with respect to a transfer of an interest in
a partnership if the partnership's adjusted basis in partnership
property exceeds the fair market value of the property (as determined
in paragraph (a)(2)(iii) of this section) by more than $250,000
immediately after the transfer.
(ii) Impact of section 743 basis adjustments and section
704(c)(1)(C) basis adjustments. For purposes of paragraph (a)(2)(i) of
this section, any section 743 or section 704(c)(1)(C) basis adjustments
(as defined in Sec. 1.704-3(f)(2)(iii)) (other than the transferee's
section 743(b) basis adjustments or section 704(c)(1)(C) basis
adjustments) to partnership property are disregarded.
(iii) Determination of fair market value in tiered situation. For
purposes of paragraph (a)(2)(i) of this section, an upper-tier
partnership's fair market value in a lower-tier partnership is equal to
the sum of--
(A) The amount of cash that the upper-tier partnership would
receive if the lower-tier partnership sold all of its property for cash
to an unrelated person for an amount equal to the fair market value of
such property, satisfied all of its liabilities (other than Sec.
1.752-7 liabilities), paid an unrelated person to assume all of its
Sec. 1.752-7 liabilities in a fully taxable, arm's-length transaction,
and liquidated; and
(B) The upper-tier partnership's share of the lower-tier
partnership's liabilities as determined under section 752 and the
regulations.
(iv) Example. A and B are equal partners in PRS, a partnership.
PRS owns Property 1, with an adjusted basis of $3 million and a fair
market value of $2 million, and Property 2, with an adjusted basis
of $1 million and a fair market value of $1 million. In Year 2, A
sells 50 percent of its interest in PRS to C for its fair market
value of $750,000. PRS does not have section 754 election in effect.
Under paragraph (a)(2)(i) of this section, PRS has a substantial
built-in loss because, immediately after the transfer, the adjusted
basis of PRS's property ($4 million) exceeds the fair market value
of the property ($3 million) by more than $250,000. Thus, pursuant
to paragraph (a)(1) of this section, PRS must adjust the bases of
its properties as if PRS had made a section 754 election for Year 2.
(b) Determination of adjustment. In the case of the transfer of an
interest in a partnership, either by sale or exchange or as a result of
the death of a partner, a partnership that has an election under
section 754 in effect or that has a substantial built-in loss (within
the meaning of paragraph (a)(2)(i) of this section) --
* * * * *
(f) Subsequent transfers--(1) In general. Where there has been more
than one transfer of a partnership interest, a transferee's basis
adjustment is determined without regard to any prior transferee's basis
adjustment. In the case of a gift of an interest in a partnership, the
donor is treated as transferring, and the donee as receiving, that
portion of the basis adjustment attributable to the gifted partnership
interest. The following example illustrates the provisions of this
paragraph (f)(1):
* * * * *
(2) Special rules for substituted basis transactions. Where a
partner had a basis adjustment under section 743(b) allocated pursuant
to Sec. 1.755-1(b)(2) through (b)(4) that is attributable to an
interest that is subsequently transferred in a substituted basis
transaction (within the meaning of Sec. 1.755-1(b)(5)), the provisions
of paragraph (f)(1) of this section do not apply. Instead, the
transferee succeeds to that portion of the transferor's basis
adjustment attributable to the transferred partnership interest. The
basis adjustment to which the transferee succeeds is taken into account
for purposes of determining the transferee's share of the adjusted
basis
[[Page 3064]]
to the partnership of the partnership's property for purposes of
paragraph (b) of this section and Sec. 1.755-1(b)(5). To the extent a
transferee would be required to decrease the adjusted basis of an item
of partnership property pursuant to Sec. Sec. 1.743-1(b)(2) and 1.755-
1(b)(5), the decrease first reduces the positive section 743(b)
adjustment, if any, that the transferee succeeds to. The following
example illustrates the provisions of this paragraph (f)(2):
Example --(i) A and B are partners in LTP, a partnership. A owns
a 60 percent interest, and B owns a 40 percent interest, in LTP. B
owns the LTP interest with an adjusted basis of $50 and a fair
market value of $70. LTP owns two assets: Capital Asset 1 with an
adjusted basis of $25 and a fair market value of $100, and Capital
Asset 2 with an adjusted basis of $100 and a fair market value of
$75. B sells its interest in LTP to UTP. Both LTP and UTP have a
section 754 election in effect. Pursuant to Sec. 1.755-1(b)(3),
UTP's $20 section 743(b) adjustment is allocated $30 to Capital
Asset 1 and ($10) to Capital Asset 2.
(ii) UTP distributes its LTP interest to C, a partner in UTP,
when the adjusted bases and fair market values of the LTP interest
and LTP's assets have not changed. C's adjusted basis in its UTP
interest at the time of the distribution is $40. Pursuant to
paragraph (f)(2) of this section, C succeeds to UTP's section 743(b)
adjustment. Also pursuant to paragraph (f)(2) of this section, the
section 743(b) adjustment is taken into account in determining C's
share of the adjusted basis of LTP property. Thus, C also has a $30
negative section 743(b) adjustment that must be allocated pursuant
to Sec. 1.755-1(b)(5). That is, C's interest in the partnership's
previously taxed capital is $70 (C would be entitled to $70 cash on
liquidation and there is no increase or decrease for tax gain or tax
loss from the hypothetical transaction, taking into account UTP's
section 743(b) adjustment to which C succeeds). Pursuant to Sec.
1.755-1(b)(5)(iii)(B), the $30 negative section 743(b) adjustment
must be allocated within the capital class first to properties with
unrealized depreciation in proportion to C's share of the respective
amounts of unrealized depreciation before the decrease. Taking into
account UTP's section 743(b) adjustment to which C succeeds, C has
no share of LTP's unrealized depreciation. Pursuant to Sec. 1.755-
1(b)(5)(iii)(B), any remaining decrease must be allocated among
Capital Asset 1 and Capital Asset 2 in proportion to C's share of
their adjusted bases. Taking into account UTP's section 743(b)
adjustment to which C succeeds, C's share of the adjusted basis in
Capital Asset 1 is $40 ($10 share of LTP's basis and $30 of UTP's
section 743(b) adjustment to which C succeeded) and in Capital Asset
2 is $30 ($40 share of LTP's basis and ($10) of UTP's section 743(b)
adjustment). Thus, 40/70 of the $30 adjustment, $17.14, is allocated
to Capital Asset 1 and 30/70 of the $30 adjustment, $12.86, is
allocated to Capital Asset 2. The decrease allocated to Capital
Asset 1 first reduces UTP's section 743(b) adjustment to which C
succeeds. Thus, C has a net section 743(b) adjustment in Capital
Asset 1 of $12.86 ($30 minus $17.14) and in Capital Asset 2 of
($22.86) (($10) plus ($12.86)). If Capital Asset 1 is subject to the
allowance for depreciation or amortization, C's net $12.86 positive
basis adjustment is recovered pursuant to paragraph (j)(4)(i)(B).
(iii) If C later transfers its LTP interest to D in a
transaction that is not a substituted basis transaction within the
meaning of Sec. 1.755-1(b)(5), under paragraph (f)(1) of this
section, D does not succeed to any of C's section 743(b) adjustment.
* * * * *
(j) * * *
(3) * * *
(ii) * * *
Example 1. A and B form equal partnership PRS. A and B each
contribute $100 cash, and PRS purchases nondepreciable property for
$200. Later, at a time when the property value has decreased to
$100, C contributes $50 cash for a 1/3 interest in PRS. Under Sec.
1.704-1(b)(2)(iv)(f)(5), PRS revalues its property in connection
with the admission of C, allocating the $100 unrealized loss in the
property equally between A and B under the partnership agreement,
which provides for the use of the traditional method under Sec.
1.704-3(b). A subsequently sells its interest in PRS to T for $50.
PRS has an election in effect under section 754. T receives a
negative $50 basis adjustment under section 743(b) that, under
section 755, is allocated to the nondepreciable property. PRS later
sells the property for $120. PRS recognizes a book gain of $20
(allocated equally between T, B, and C), and a tax loss of $80. T
will receive an allocation of $40 of tax loss under the principles
of section 704(c). However, because T has a negative $50 basis
adjustment in the nondepreciable property, T recognizes a $10 gain
from the partnership's sale of the property.
* * * * *
Example 3. A and B form equal partnership PRS. A and B each
contribute $75 cash. PRS purchases nondepreciable property for $150.
Later, at a time when the property value has decreased to $100, C
contributes $50 cash for a 1/3 interest in PRS. Under Sec. 1.704-
1(b)(2)(iv)(f)(5), PRS revalues its property in connection with the
admission of C. The $50 unrealized loss in the property is allocated
equally to A and B under the partnership agreement, which provides
for the use of the remedial allocation method described in Sec.
1.704-3(d). A subsequently sells its interest in PRS to T for $50.
PRS has an election in effect under section 754. T receives a
negative $25 basis adjustment under section 743(b) that, under
section 755, is allocated to the nondepreciable property. PRS later
sells the property for $112. PRS recognizes a book gain of $12
(allocated equally between T, B, and C), and a tax loss of $38
(allocated equally between T and B). To match its share of book
gain, C will be allocated $4 of remedial gain, and T and B will each
be allocated an offsetting $2 remedial loss. T was allocated a total
of $21 of tax loss with respect to the property. However, because T
has a negative $25 basis adjustment in the nondepreciable property,
T recognizes a $4 gain from the partnership's sale of the property.
* * * * *
(k) * * *
(1) * * *
(iii) Rules for substantial built-in loss transactions. A
partnership required to adjust the basis of partnership property
following the transfer of an interest in a partnership by sale or
exchange or on the death of a partner as the result of the partnership
having a substantial built-in loss (as defined in paragraph (a)(2)(i)
of this section) immediately after such transfer is subject to, and
required to comply with, this paragraph (k)(1), and may rely on, and
must comply with, paragraphs (k)(3), (k)(4), and (k)(5) of this section
solely with respect to the transfer to which the substantial built-in
loss relates as if an election under section 754 were in effect at the
time of the transfer. See paragraph (k)(2) of this section for
additional rules for transferees and paragraph (n) of this section for
special reporting rules relating to electing investment partnerships.
(2) * * *
(iv) Special rules for transferees subject to the substantial
built-in loss provisions. The transferee of an interest in a
partnership that is required to reduce the bases of partnership
property in accordance with the rules in paragraph (a)(2) of this
section must comply with this paragraph (k)(2) as if an election under
section 754 were in effect at the time of the transfer.
(l) Basis adjustments with respect to tiered partnerships--(1)
General rule. If an interest in an upper-tier partnership that holds an
interest in a lower-tier partnership is transferred by sale or exchange
or upon the death of a partner, and the upper-tier partnership and the
lower-tier partnership both have elections in effect under section 754,
then for purposes of section 743(b) and section 754, an interest in the
lower-tier partnership will be deemed similarly transferred in an
amount equal to the portion of the upper-tier partnership's interest in
the lower-tier partnership that is attributable to the interest in the
upper-tier partnership being transferred. Additionally, if an interest
in an upper-tier partnership that holds (directly or indirectly through
one or more partnerships) an interest in a lower-tier partnership is
transferred by sale or exchange or on the death of a partner, and the
upper-tier partnership has a substantial built-in loss (within the
meaning of paragraph (a)(2)(i) of this section) with respect to the
transfer, each lower-tier partnership is treated, solely with respect
to the transfer, as if it had made a section 754 election for
[[Page 3065]]
the taxable year of the transfer. For additional examples of the
application of the principles of this paragraph (l), see Revenue Ruling
87-115, 1987-2 CB 163. See Sec. 601.601(d)(2)(ii)(b).
(2) Example. The following example illustrates the principles of
this paragraph (l).
Example. A and B are equal partners in UTP, a partnership. UTP
has no liabilities and owns a 25 percent interest in LTP, a
partnership. UTP's interest in LTP has a fair market value of
$100,000 and an adjusted basis of $500,000. LTP has no liabilities
and owns Land, which has a fair market value of $400,000 and an
adjusted basis of $2 million. In Year 3, when UTP and LTP do not
have section 754 elections in effect, B sells 50 percent of its
interest in UTP to C for its fair market value of $25,000. Because
the adjusted basis of UTP's interest in LTP ($500,000) exceeds the
fair market value of UTP's interest in LTP ($100,000) by more than
$250,000 immediately after the transfer, UTP has a substantial
built-in loss with respect to the transfer. Thus, pursuant to
paragraph (l) of this section, UTP must adjust the basis of its
interest in LTP, and LTP must adjust the basis of Land, as if it had
made a section 754 election for Year 3.
(m) Anti-abuse rule for substantial built-in loss transactions.
Provisions relating to substantial built-in loss transactions in
paragraph (a) and paragraphs (k), (l), (n), and (o) of this section
must be applied in a manner consistent with the purposes of these
paragraphs and the substance of the transaction. Accordingly, if a
principal purpose of a transaction is to achieve a tax result that is
inconsistent with the purpose of one or more of these paragraphs, the
Commissioner may recast the transaction for Federal income tax
purposes, as appropriate, to achieve tax results that are consistent
with the purpose of these paragraphs. Whether a tax result is
inconsistent with the purposes of the provisions is determined based on
all the facts and circumstances. For example, under the provisions of
this paragraph (m)--
(1) Property held by related partnerships may be aggregated if the
properties were transferred to the related partnerships with a
principal purpose of avoiding the application of the substantial built-
in loss provisions in section 743 and the regulations; and
(2) A contribution of property to a partnership may be disregarded
if the transfer of the property was made with a principal purpose of
avoiding the application of the substantial built-in loss provisions in
section 743 and the regulations thereunder.
(n) Electing investment partnerships--(1) No adjustment of
partnership basis. For purposes of this section, an electing investment
partnership (as defined in paragraph (n)(6) of this section) shall not
be treated as having a substantial built-in loss (within the meaning of
paragraph (a)(2)(i) of this section) with respect to any transfer
occurring while the election in paragraph (n)(6)(i) of this section is
in effect.
(2) Loss deferral for transferee partner. In the case of a transfer
of an interest in an electing investment partnership, the transferee
partner's distributive share of losses (without regard to gains) from
the sale or exchange of partnership property shall not be allowed
except to the extent that it is established that such losses exceed the
loss (if any) recognized by the transferor partner (or by any prior
transferor to the extent not fully offset by a prior disallowance under
this paragraph (n)(2)) on the transfer of the partnership interest. If
an electing investment partnership allocates losses with a different
character from the sale or exchange of property to the transferee (such
as ordinary or section 1231 losses and capital losses) and the losses
allocated to that partner are limited by this paragraph (n)(2), then a
proportionate amount of the losses disallowed under this paragraph
(n)(2) shall consist of each loss of a separate character that is
allocated to the transferee partner.
(3) No reduction in partnership basis. Losses disallowed under
paragraph (n)(2) of this section shall not decrease the transferee
partner's basis in the partnership interest.
(4) Effect of termination of partnership. This paragraph (n) shall
be applied without regard to any termination of a partnership under
section 708(b)(1)(B).
(5) Certain basis reductions treated as losses. In the case of a
transferee partner whose basis in property distributed by the
partnership is reduced under section 732(a)(2), the amount of the loss
recognized by the transferor on the transfer of the partnership
interest that is taken into account under paragraph (n)(2) of this
section shall be reduced by the amount of such basis reduction.
(6) Electing investment partnership. For purposes of this section,
the term electing investment partnership means any partnership if--
(i) The partnership makes an election under paragraph (n)(10) of
this section to have this paragraph (n) apply;
(ii) The partnership would be an investment company under section
3(a)(1)(A) of the Investment Company Act of 1940 but for an exemption
under paragraph (1) or (7) of section 3(c) of such Act;
(iii) The partnership has never been engaged in a trade or business
(see paragraph (n)(7) of this section for additional rules regarding
this paragraph (n)(6)(iii));
(iv) Substantially all of the assets of the partnership are held
for investment;
(v) At least 95 percent of the assets contributed to the
partnership consist of money;
(vi) No assets contributed to the partnership had an adjusted basis
in excess of fair market value at the time of contribution;
(vii) All partnership interests of the partnership are issued by
the partnership pursuant to a private offering before the date that is
24 months after the date of the first capital contribution to the
partnership;
(viii) The partnership agreement of the partnership has substantive
restrictions on each partner's ability to cause a redemption of the
partner's interest (see paragraphs (n)(8) and (n)(9) of this section
for additional rules regarding this paragraph (n)(6)(viii)); and
(ix) The partnership agreement of the partnership provides for a
term that is not in excess of 15 years (see paragraph (n)(9) of this
section for additional rules regarding this paragraph (n)(6)(ix)).
(7) Trade or business. For purposes of paragraph (n)(6)(iii) of
this section, whether a partnership is engaged in a trade or business
is based on the all the facts and circumstances. Notwithstanding the
prior sentence--
(i) A partnership will not be treated as engaged in a trade or
business if, based on all the facts and circumstances, the partnership
is not engaged in a trade or business under the rules in Sec. 1.731-
2(e)(3).
(ii) In the case of a tiered partnership arrangement, a partnership
(upper-tier partnership) will not be treated as engaged in a trade or
business of a partnership in which it owns an interest (lower-tier
partnership) if the upper-tier partnership can establish that, at all
times during the period in which the upper-tier partnership owns an
interest in the lower-tier partnership, the adjusted basis of its
interest in the lower-tier partnership is less than 25 percent of the
total capital that is required to be contributed to the upper-tier
partnership by its partners during the entire term of the upper-tier
partnership. Otherwise, the upper-tier partnership will be treated as
engaged in the trade or business of the lower-tier partnership.
(8) Substantive restrictions. For purposes of paragraph
(n)(6)(viii) of this section, substantive restrictions include cases in
which a redemption is permitted under a partnership agreement only if
the redemption is
[[Page 3066]]
necessary to avoid a violation of state, federal, or local laws (such
as ERISA or the Bank Holding Company Act) or the imposition of a
federal excise tax on, or a change in the federal tax-exempt status of,
a tax-exempt partner.
(9) Special rules for partnerships in existence on June 4, 2004. In
the case of a partnership in existence on June 4, 2004, paragraph
(n)(6)(viii) of this section will not apply to the partnership and
paragraph (n)(6)(ix) of this section is applied by substituting ``20
years'' for ``15 years.''
(10) Election--(i) Eligibility. A partnership is eligible to make
the election described in paragraph (n)(6)(i) of this section if the
partnership meets the definition of an electing investment partnership
in paragraph (n)(6) of this section and does not have an election under
section 754 in effect.
(ii) Manner of making election. A partnership must make the
election by attaching a written statement to an original return for the
taxable year for which the election is effective. The original return
must be filed not later than the time prescribed by Sec. 1.6031(a)-
1(e) of the Procedure and Administration Regulations (including
extensions) for filing the return for the taxable year for which the
election is effective. If the partnership is not otherwise required to
file a partnership return, the election shall be made in accordance
with the rules in Sec. 1.6031(a)-1(b)(5) of the Procedure and
Administration Regulations. The statement must--
(A) Set forth the name, address, and tax identification number of
the partnership making the election;
(B) Contain a representation that the partnership is eligible to
make the election; and
(C) Contain a declaration that the partnership elects to be treated
as an electing investment partnership.
(iii) Effect and duration of election. Once the election is made,
the election is effective for all transfers during the partnership's
taxable year for which the election is effective and all succeeding
taxable years, except as provided in paragraphs (n)(10)(iv) and
(n)(10)(v) of this section.
(iv) Termination of election--(A) In general. The election
terminates if the partnership fails to meet the definition of an
electing investment partnership. The electing investment partnership's
election also terminates if the partnership files an election under
section 754.
(B) Effect of termination. If the election terminates, the
partnership will be subject to the substantial built-in loss provisions
in this section with respect to the first transfer of a partnership
interest that occurs after the partnership ceases to meet the
definition of an electing investment partnership (or the first transfer
that occurs after the effective date of the section 754 election) and
to each subsequent transfer. In addition, any losses that are
subsequently allocated to a partner to whom a partnership interest was
transferred while the election was in effect shall remain subject to
the rules in paragraph (n)(2) of this section.
(v) Revocation of election--(A) In general. The election, once
made, shall be irrevocable except with the consent of the Commissioner.
The application for consent to revoke the election must be submitted to
the Internal Revenue Service in the form of a letter ruling request.
(B) Effect of revocation. If the election is properly revoked, the
partnership will be subject to the substantial built-in loss provisions
in this section with respect to the first transfer of a partnership
interest that occurs after the effective date of the revocation and to
each subsequent transfer. In addition, any losses that are subsequently
allocated to a partner to whom a partnership interest was transferred
while the election was in effect shall remain subject to the rules in
paragraph (n)(2) of this section.
(11) Transferor partner required to provide information to
transferee partner and partnership--(i) In general. Except as provided
in paragraph (n)(11)(ii) of this section, if an electing investment
partnership interest is transferred in a sale or exchange or upon the
death of a partner, the transferor (or, in the case of a partner who
dies, the partner's executor, personal representative, or other
successor in interest) must notify the transferee and the partnership
in writing. If the transferor is a nominee (within the meaning of Sec.
1.6031(c)-1T), then the nominee, and not the beneficial owner of the
transferred interest, must supply the information to the transferee and
the partnership. The notice must be provided within 30 days after the
date on which the transferor partner (or the executor, personal
representative, or other successor in interest) receives a Schedule K-1
from the partnership for the partnership's taxable year in which the
transfer occurred. The notice must be signed under penalties of
perjury, must be retained by the transferee and the partnership as long
as the contents thereof may be material in the administration of any
internal revenue law, and must include--
(A) The name, address, and tax identification number of the
transferor;
(B) The name, address, and tax identification number of the
transferee (if ascertainable);
(C) The name of the electing investment partnership;
(D) The date of the transfer (and, in the case of the death of a
partner, the date of the death of the partner);
(E) The amount of loss, if any, recognized by the transferor on the
transfer of the interest, together with the computation of the loss;
(F) The amount of losses, if any, recognized by any prior
transferors to the extent the losses were subject to disallowance under
paragraph (n)(2) of this section in the hands of a prior transferee and
have not been offset by prior loss disallowances under paragraph (n)(2)
of this section; and
(G) Any other information necessary for the transferee to compute
the amount of loss disallowed under paragraph (n)(2) of this section.
(ii) Exception. The rules of paragraph (n)(11)(i) of this section
do not apply if the transferor recognizes a gain on the transfer and no
prior transferor recognized a loss on any transfer.
(iii) Effect of failure to notify transferee partner. If the
transferor partner, its legal representative in the case of a transfer
by death, or the nominee (if the transferor is a nominee) fails to
provide the transferee partner with the statement, the transferee
partner must treat all losses allocated from the electing investment
partnership as disallowed under paragraph (n)(2) of this section unless
the transferee partner obtains, from the partnership or otherwise, the
information necessary to determine the proper amount of losses
disallowed under paragraph (n)(2) of this section. If the transferee
does not have the information necessary to determine the proper amount
of losses disallowed under paragraph (n)(2) of this section, but does
have information sufficient to determine the maximum amount of losses
that could be disallowed, then the transferee may treat the amount of
losses disallowed under paragraph (n)(2) of this section as being equal
to that maximum amount. For example, if the transferee is able to
ascertain the adjusted basis that a prior transferor had in its
partnership interest, but is not able to ascertain the amount realized
by that transferor, the transferee may assume, for purposes of
calculating the amount of losses disallowed under paragraph (n)(2) of
this section, that the sales price when the prior transferor sold its
interest was zero. If, following the filing of a return pursuant to the
previous sentence, the transferor partner or the partnership provides
the required
[[Page 3067]]
information to the transferee partner, the transferee partner should
make appropriate adjustments in an amended return for the year of the
loss allocation from the partnership in accordance with section 6511 or
other applicable rules.
(iv) Additional rules. See paragraph (n)(12)(i) of this section for
additional reporting requirements when the electing investment
partnership is not required to file a partnership return.
(12) Electing investment partnership required to provide
information to partners--(i) Distributive shares of partnership items.
An electing investment partnership is required to separately state on
Schedule K and K-1 of the partnership's return (Form 1065) all
allocations of losses to all of its partners under Sec. 1.702-
1(a)(8)(ii), including losses that, in the absence of section 743(e),
could be netted against gains at the partnership level. If a
partnership's election to be treated as an electing investment
partnership is terminated or revoked under paragraphs (n)(10)(iv) or
(n)(10)(v) of this section, the partnership must continue to state such
gains and losses separately in future returns relating to any period
during which the partnership has one or more transferee partners that
are subject to section paragraph (n)(2) of this section. If an electing
investment partnership is not required to file a partnership return,
the transferee of a partnership interest may be required to provide the
Commissioner similar information regarding the partner's distributive
share of gross gains and losses of the partnership under Sec.
1.6031(a)-1(b)(4).
(ii) Annual statement. An electing investment partnership must
provide an annual statement to all of its partners. The statement must
be attached to every statement provided to a partner or nominee under
section 6031(b) that is issued with respect to any taxable year for
which an election to be treated as an electing investment partnership
is in effect (whether or not the election is in effect for the entire
taxable year). The statement must include the following--
(A) A statement that the partnership has elected to be treated as
an electing investment partnership;
(B) A statement that, unless the transferor partner recognizes a
gain on the transfer and no prior transferor recognized a loss on any
transfer, if a partner transfers an interest in the partnership to
another person, the transferor partner must, within 30 days after
receiving a Schedule K-1 from the partnership for the taxable year that
includes the date of the transfer, provide the transferee with certain
information, including the amount, if any, of loss that the transferor
recognized on the transfer of the partnership interest, and the amount
of losses, if any, recognized by prior transferors with respect to the
same interest; and
(C) A statement that if an interest in the partnership is
transferred to a transferee partner, the transferee is required to
reduce its distributive share of losses from the partnership,
determined without regard to gains from the partnership, to the extent
of any losses recognized by the transferor partner when that partner
transferred the partnership interest to the transferee (and to the
extent of other losses recognized on prior transfers of the same
partnership interest that have not been offset by prior loss
disallowances). The statement must also notify the transferee that it
is required to reduce its share of losses as reported to the transferee
by the partnership each year by the amount of any loss recognized by
the transferor partner (or any prior transferor to the extent not
already offset by prior loss disallowances) until the transferee has
reduced its share of partnership losses by the total amount of losses
required to be disallowed. Finally, the statement must state that if
the transferor partner (or its nominee), or its legal representative in
the case of a transfer by death, fails to provide the transferee with
the required statement, the transferee must treat all losses allocated
from the partnership as disallowed unless the transferee obtains, from
the partnership or otherwise, the information necessary to determine
the proper amount of losses disallowed.
(o) Securitization partnerships--(1) General rule. A securitization
partnership (as defined in paragraph (o)(2) of this section) shall not
be treated as having a substantial built-in loss with respect to any
transfer.
(2) Definition of securitization partnership. A securitization
partnership means any partnership the sole business activity of which
is to issue securities that provide for a fixed principal (or similar)
amount and that are primarily serviced by the cash flows of a discrete
pool (either fixed or revolving) of receivables or other financial
assets that by their terms convert into cash in a finite period, but
only if the sponsor of the pool reasonably believes that the
receivables and other financial assets comprising the pool are not
acquired for the purpose of being disposed of.
(p) Effective/applicability date. * * * Paragraph (f)(2) of this
section and the provisions relating to substantial built-in losses in
paragraph (a) and paragraphs (k), (l), (m), (n), and (o) of this
section are effective for transfers of partnership interests occurring
on or after the date of publication of the Treasury decision adopting
these rules as final regulations in the Federal Register.
0
Par. 9. Section 1.755-1 is amended by:
0
1. Revising paragraph (b)(5).
0
2. Redesignating paragraph (e) as paragraph (f).
0
3. Adding a new paragraph (e).
0
4. Revising newly redesignated paragraph (f).
The revisions and addition read as follows:
Sec. 1.755-1 Rules for allocation of basis.
* * * * *
(b) * * *
* * * * *
(5) Substituted basis transactions--(i) In general. This paragraph
(b)(5) applies to basis adjustments under section 743(b) that result
from exchanges 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 that interest and from exchanges in which the
transferee's basis in the partnership interest is determined by
reference to other property held at any time by the transferee. For
example, this paragraph (b)(5) applies if a partnership interest is
contributed to a corporation in a transaction to which section 351
applies, if a partnership interest is contributed to a partnership in a
transaction to which section 721(a) applies, or if a partnership
interest is distributed by a partnership in a transaction to which
section 731(a) applies.
(ii) Allocations between classes of property--(A) No adjustment. If
the total amount of the basis adjustment under section 743(b) is zero,
then no adjustment to the basis of partnership property will be made
under this paragraph (b)(5).
(B) Increases. If there is an increase in basis to be allocated to
partnership assets, the increase must be allocated between capital gain
property and ordinary income property in proportion to, and to the
extent of, the gross gain or gross income (including any remedial
allocations under Sec. 1.704-3(d)) that would be allocated to the
transferee (to the extent attributable to the acquired partnership
interest) from the hypothetical sale of all property in each class. Any
remaining increase must be allocated between the classes in proportion
to the fair market value of all property in each class.
(C) Decreases. If there is a decrease in basis to be allocated to
partnership assets, the decrease must be allocated
[[Page 3068]]
between capital gain property and ordinary income property in
proportion to, and to the extent of, the gross loss (including any
remedial allocations under Sec. 1.704-3(d)) that would be allocated to
the transferee (to the extent attributable to the acquired partnership
interest) from the hypothetical sale of all property in each class. Any
remaining decrease must be allocated between the classes in proportion
to the transferee's shares of the adjusted bases of all property in
each class (as adjusted under the preceding sentence).
(iii) Allocations within the classes--(A) Increases. If, under
paragraph (b)(5)(ii) of this section, there is an increase in basis to
be allocated within a class, the increase must be allocated first to
properties with unrealized appreciation in proportion to the
transferee's share of the respective amounts of unrealized appreciation
(to the extent attributable to the acquired partnership interest)
before the increase (but only to the extent of the transferee's share
of each property's unrealized appreciation). Any remaining increase
must be allocated among the properties within the class in proportion
to their fair market values.
(B) Decreases. If, under paragraph (b)(5)(ii) of this section,
there is a decrease in basis to be allocated within a class, the
decrease must be allocated first to properties with unrealized
depreciation in proportion to the transferee's shares of the respective
amounts of unrealized depreciation (to the extent attributable to the
acquired partnership interest) before the decrease (but only to the
extent of the transferee's share of each property's unrealized
depreciation). Any remaining decrease must be allocated among the
properties within the class in proportion to the transferee's shares of
their adjusted bases (as adjusted under the preceding sentence).
(C) Limitation in decrease of basis. Where, as a result of a
transaction to which this paragraph (b)(5) applies, a decrease in basis
must be allocated to capital gain assets, ordinary income assets, or
both, and the amount of the decrease otherwise allocable to a
particular class exceeds the transferee's share of the adjusted basis
to the partnership of all assets in that class, the basis of the
property is reduced to zero (but not below zero).
(D) Carryover adjustment. Where a transferee's negative basis
adjustment under section 743(b) cannot be allocated to any asset, the
adjustment is made when the partnership subsequently acquires property
of a like character to which an adjustment can be made.
(iv) Examples. The provisions of this paragraph (b)(5) are
illustrated by the following examples--
Example 1. * * *
Example 2. * * *
Example 3 --(i) A is a one-third partner in UTP, a partnership,
which has a valid election in effect under section 754. The three
partners in UTP have equal interests in the capital and profits of
UTP. UTP has three assets with the following adjusted bases and fair
market values:
Fair market
Assets Adjusted basis value
Intangible 1............................ $30 $200
Land.................................... 200 200
50% interest in LTP..................... 190 200
LTP, a partnership, has a section 754 election in effect for the
year of the distribution. LTP owns three assets with the following
adjusted bases and fair market values:
Fair market
Assets Adjusted basis value
Intangible 2............................ $340 $100
Intangible 3............................ 20 280
Inventory............................... 20 20
UTP distributes its interest in LTP in redemption of A's
interest in UTP. At the time of the distribution, A's adjusted basis
in its UTP interest is $140. A recognizes no gain or loss on the
distribution. Under section 732(b), A's basis in the distributed LTP
interest is $140. Under sections 734(b) and 755, UTP increases its
adjusted basis in Intangible 1 by $50, the amount of the basis
adjustment to the LTP interest in the hands of A.
(ii) The amount of the basis adjustment with respect to LTP
under section 743(b) is the difference between A's basis in LTP of
$140 and A's share of the adjusted basis to LTP of partnership
property. A's share of the adjusted basis to LTP of partnership
property is equal to the sum of A's share of LTP's liabilities of $0
plus A's interest in the previously taxed capital of LTP of $190
($200, A's cash on liquidation, increased by $120, the amount of tax
loss allocated to A from the sale of Intangible 2 in the
hypothetical transaction, decreased by $130, the amount of tax gain
allocated to A from the sale of Intangible 3 in the hypothetical
transaction). Therefore, the amount of the negative basis adjustment
under section 743(b) to partnership property is $50.
(iii) Under this paragraph (b)(5), LTP must allocate $50 of A's
negative basis adjustment between capital gain property and ordinary
income property in proportion to, and to the extent of, the gross
loss (including any remedial allocations under Sec. 1.704-3(d))
that would be allocated to A from the hypothetical sale of all
property in each class. If LTP disposed of its assets in a
hypothetical sale, A would be allocated $120 of gross loss from
Intangible 2 only. Accordingly, the $50 negative adjustment must be
allocated to capital assets. Under paragraph (b)(5)(iii)(B) of this
section, the $50 negative adjustment must be allocated to the assets
in the capital class first to properties with unrealized
depreciation in proportion to the transferee's shares of the
respective amounts of unrealized depreciation. Thus, the $50
negative adjustment must be allocated entirely to Intangible 2.
Example 4 --(i) A is a one-third partner in LTP, a partnership
that has made an election under section 754. The three partners in
LTP have equal interests in the capital and profits of LTP. LTP has
two assets: accounts receivable with an adjusted basis of $300 and a
fair market value of $240 and a nondepreciable capital asset with an
adjusted basis of $60 and a fair market value of $240. A contributes
its interest in LTP to UTP in a transaction described in section
721. At the time of the transfer, A's basis in its LTP interest is
$150. Under section 723, UTP's basis in its interest in LTP is $150.
(ii) The amount of the basis adjustment under section 743(b) is
the difference between UTP's $150 basis in its LTP interest and
UTP's share of the adjusted basis to LTP of LTP's property. UTP's
share of the adjusted basis to LTP of LTP's property is equal to the
sum of UTP's share of LTP's liabilities of $0 plus UTP's interest in
the previously taxed capital of LTP of $120 ($160, the amount of
cash on liquidation, increased by $20, the amount of tax loss
allocated to UTP from the hypothetical transaction, and decreased by
$60, the amount of tax gain allocated to UTP from the hypothetical
transaction). Therefore, the amount of the negative basis adjustment
under section 743(b) to partnership property is $30.
(iii) The total amount of gross loss that would be allocated to
UTP from the hypothetical sale of LTP's ordinary income property is
$20 (one third of the excess of the basis of the accounts receivable
($300) over their fair market value ($240)). The hypothetical sale
of LTP's capital gain property would result in a net gain.
Therefore, under this paragraph (b)(5), $20 of the $30 basis
adjustment must be allocated to ordinary income property. Because
LTP holds only one ordinary income property, the $20 decrease must
be allocated entirely to the accounts receivable. Pursuant to
paragraph (b)(5)(ii)(C) of this section, the remaining $10 basis
adjustment must be allocated between ordinary income property and
capital gain property according to UTP's share of the adjusted bases
of such properties. Therefore, $8 ($10 multiplied by $80 divided by
$100) would be allocated to the accounts receivable and $2 ($10
multiplied by $20 divided by $100) would be allocated to the
nondepreciable capital asset. * * *
* * * * *
(e) No allocation of basis decrease to stock of corporate partner--
(1) In general. In making an allocation under section 755(a) of any
decrease in the adjusted basis of partnership property under section
734(b)--
(A) No allocation may be made to stock in a corporation (or any
person related (within the meaning of sections
[[Page 3069]]
267(b) or 707(b)(1)) to such corporation) that is a partner in the
partnership; and
(B) Any amount not allocable to stock by reason of paragraph (c)(1)
of this section shall be allocated under section 755(a) to other
partnership property.
(2) Recognition of gain. Gain shall be recognized to the
partnership to the extent that the amount required to be allocated
under paragraph (e)(1)(B) of this section to other partnership property
exceeds the aggregate adjusted basis of such other property immediately
before the allocation required by paragraph (e)(1)(B) of this section.
(3) Example. A, B, and C are equal partners in PRS, a
partnership. C is a corporation. The adjusted basis and fair market
value for each of their interests in PRS are $100. PRS owns Capital
Asset 1 with an adjusted basis of $0 and a fair market value of
$100, Capital Asset 2 with an adjusted basis of $150 and a fair
market value of $50, and stock in Corp, a corporation that is
related to C under section 267(b), with an adjusted basis and fair
market value of $150. PRS has a section 754 election in effect. PRS
distributes Capital Asset 1 to A in liquidation of A's interest in
PRS. PRS will reduce the basis of its remaining assets under section
734(b) by $100, to be allocated under section 755. The entire
adjustment is allocated to Capital Asset 2, reducing its basis by
$100 to $50. Pursuant to the general rule of paragraph (c) of this
section, PRS would reduce the basis of Capital Asset 2 by $50 and
the stock of Corp by $50. However, Pursuant to paragraph (e)(1)(A)
of this section, the basis of the Corp stock is not adjusted. Thus,
the basis of Capital Asset 2 is reduced by $100 from $150 to $50.
(f) Effective date--(1) Generally. Except as provided in paragraph
(f)(2) of this section, this section applies to transfers of
partnership interests and distributions of property from a partnership
that occur on or after December 15, 1999.
(2) Special rules. Paragraphs (a) and (b)(3)(iii) of this section
apply to transfers of partnership interests and distributions of
property from a partnership that occur on or after June 9, 2003.
Paragraph (b)(5) of this section applies to transfers of partnership
interests occurring on or after January 16, 2014. Paragraph (e) of this
section applies to transfers of partnership interests occurring on or
after the date of publication of the Treasury decision adopting these
rules as final regulations in the Federal Register.
* * * * *
Sec. 1.1502-13 [Amended]
0
Par. 10. Section 1.1502-13 is amended by:
0
1. Amending paragraph (h)(2), Example 4, by removing ``Five years'' and
adding in its place ``Seven years''.
Beth Tucker,
Deputy Commissioner for Operations Support.
[FR Doc. 2014-00649 Filed 1-15-14; 8:45 am]
BILLING CODE 4830-01-P