[Federal Register Volume 83, Number 247 (Thursday, December 27, 2018)]
[Proposed Rules]
[Pages 66647-66655]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-28167]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-113604-18]
RIN 1545-BO86


Gain or Loss of Foreign Persons From Sale or Exchange of Certain 
Partnership Interests

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations implementing 
section 864(c)(8) of the Internal Revenue Code. The proposed 
regulations affect certain foreign persons that recognize gain or loss 
from the sale or exchange of an interest in a partnership that is 
engaged in a trade or business within the United States. The proposed 
regulations also affect partnerships that, directly or indirectly, have 
foreign persons as partners.

DATES: Written or electronic comments and requests for a public hearing 
must be received by February 25, 2019.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-113604-18), Internal 
Revenue Service, Room 5203, 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-
113604-18), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW, Washington, DC 20224, or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov (IRS REG-113604-18).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Ronald M. Gootzeit or Chadwick Rowland, (202) 317-6937; concerning 
submissions of comments or requests for a public hearing, Regina L. 
Johnson, (202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    A foreign partner in a partnership that is engaged in the conduct 
of a trade or business within the United States is itself considered to 
be so engaged. See section 875. Under a 1991 revenue ruling, in 
determining the tax consequences of the sale or exchange of a foreign 
partner's interest in a partnership engaged in the conduct of a trade 
or business within the United States, the IRS held that the 
partnership's property located in the United States that is used or 
held for use in the partnership's trade or business within the United 
States is used to determine the extent to which income derived from the 
sale or exchange of the partnership interest is effectively connected 
with the conduct of the partner's trade or business within the United 
States. Rev. Rul. 91-32, 1991-1 C.B. 107. Under the ruling, if there is 
unrealized gain or loss in partnership assets that would be treated as 
effectively connected with the conduct of the partnership's trade or 
business within the United States if those assets were sold by the 
partnership, some or all of the foreign person's gain or loss from the 
sale or exchange of a partnership interest may be treated as 
effectively connected with the partner's conduct of a trade or business 
within the United States. However, a 2017 Tax Court case held instead 
that, generally, gain or loss on the sale or exchange by a foreign 
person of an interest in such a partnership is foreign source gain or 
loss based on the residence of the selling partner because gain on the 
sale of the partnership interest is not attributable to the 
partnership's assets and activities. As a result, such gain or loss 
generally would not be treated as effectively connected with the 
conduct of a trade or business. Grecian Magnesite Mining v. 
Commissioner, 149 T.C. No. 3 (2017), appeal argued, No. 17-1268 (D.C. 
Cir. Oct. 9, 2018).
    Section 864(c)(8), which was added to the Internal Revenue Code 
(the ``Code'') by section 13501 of the Tax Cuts and Jobs Act, Public 
Law 115-97 (2017) (the ``Act''), generally overturns the result of 
Grecian Magnesite Mining v. Commissioner by providing that gain or loss 
of a nonresident alien individual or foreign corporation (a ``foreign 
transferor'') from the sale, exchange, or other disposition 
(``transfer'') of a partnership interest is treated as effectively 
connected with the conduct of a trade or business within the United 
States (``effectively connected gain'' or ``effectively connected 
loss'') to the extent that the transferor would have had effectively 
connected gain or loss if the partnership had sold all of its assets at 
fair market value as of the date of the sale or exchange (``deemed 
sale'').
    Section 864(c)(8)(E) generally provides that the Secretary shall 
prescribe such regulations or other guidance as the Secretary 
determines appropriate for the application of section 864(c)(8). 
Section 864(c)(8) is effective for sales, exchanges, and dispositions 
on or after November 27, 2017.
    New section 1446(f) was also added to the Code by section 13501 of 
the Act. Section 1446(f)(1) requires that the transferee of a 
partnership interest withhold 10 percent of the amount realized on the 
transferor's disposition of the partnership interest (if any portion of 
the gain would be treated as effectively connected gain) unless the 
transferor certifies that the transferor is not a foreign person. 
Section 1446(f) is effective for sales, exchanges, and dispositions 
after December 31, 2017.
    On December 29, 2017, the Department of the Treasury (the 
``Treasury Department'') and the IRS released Notice 2018-08, 2018-7 
I.R.B. 352 (the ``PTP Notice''). The PTP Notice temporarily suspends 
the requirement to withhold on amounts realized in connection with the 
sale, exchange, or disposition of certain interests in publicly traded 
partnerships (``PTPs'') in response to stakeholder concerns that 
applying section 1446(f) to dispositions of interests in PTPs without 
guidance presented significant practical problems. On April 2, 2018, 
the Treasury Department and the IRS released Notice 2018-29, 2018-16 
I.R.B. 495, which announced an intent to issue proposed regulations 
under section 1446(f) that apply in the case of a disposition of a 
partnership interest that is not publicly traded and provided temporary 
guidance.

Explanation of Provisions

I. Gain or Loss on the Transfer of a Partnership Interest

    Section 864(c)(8)(A) provides that gain or loss of a foreign 
transferor from the transfer of an interest, owned directly or 
indirectly, in a partnership that is engaged in any trade or business 
within the United States is treated as effectively connected gain or 
loss to the extent such gain or loss does not exceed the amount 
determined under section 864(c)(8)(B). In general, section 864(c)(8)(B) 
limits the amount of effectively connected gain or loss to the portion 
of the foreign transferor's distributive share of gain or loss that 
would have been effectively connected gain or loss if the partnership 
had sold all of its assets at fair market value. The proposed 
regulations set forth rules for determining gain or loss described in 
section 864(c)(8)(A) and the limitation described in section 
864(c)(8)(B), each

[[Page 66648]]

of which is discussed in this section I of this Explanation of 
Provisions.
A. Determination of Gain or Loss Described in Section 864(c)(8)(A)
    To determine the amount of gain or loss described in section 
864(c)(8)(A), generally, the proposed regulations require that a 
foreign transferor first determine its gain or loss on the transfer of 
a partnership interest (``outside gain'' and ``outside loss''). For 
this purpose, the proposed regulations provide that outside gain or 
loss is determined under all relevant provisions of the Code and the 
regulations thereunder. As described in section I.A.1 of this 
Explanation of Provisions, a foreign transferor may recognize capital 
gain or loss (``outside capital gain'' or ``outside capital loss'') and 
ordinary gain or loss (``outside ordinary gain'' or ``outside ordinary 
loss'') on the transfer of its partnership interest and must separately 
apply section 864(c)(8) with respect to its capital gain or loss and 
its ordinary gain or loss.
1. Interaction With Sections 741 and 751
    Section 864(c)(8) provides rules regarding the treatment of gain or 
loss on the transfer of a partnership interest as effectively connected 
gain or loss, but it does not address the computation of the amount of 
gain or loss to a partner upon the transfer. Rather, applicable tax 
law, including subchapter K, determines the amount and character of 
outside gain or loss on the transfer of a partnership interest. For 
example, the reduction in a transferor's share of partnership 
liabilities is treated as an amount realized on the transfer of the 
partnership interest under section 1001 and the regulations thereunder. 
See section 752(d) and Sec.  1.752-1(h).
    Section 741 provides that on a sale or exchange of an interest in a 
partnership, gain or loss is recognized by the transferor, and shall be 
considered capital gain or loss except as otherwise provided in section 
751. Section 751 provides that an amount received by a transferor of a 
partnership interest that is attributable to unrealized receivables or 
inventory items of the partnership (``section 751 property'') is 
considered ordinary income or loss. As a result of sections 741 and 751 
and the regulations thereunder, gain or loss on a sale or exchange of a 
partnership interest can comprise capital gain, capital loss, ordinary 
income, or ordinary loss (or a combination thereof). See Sec. Sec.  
1.741-1(a) and 1.751-1(a).
    In general, the proposed regulations provide that a foreign 
transferor must determine the portion of its capital gain or loss, and 
the portion of its ordinary income or loss from section 751 property, 
that must each be characterized as effectively connected gain or loss 
under section 864(c)(8). See proposed Sec.  1.864(c)(8)-1(b). As 
provided in section 864(c)(8)(A) and further described in section I.B 
of this Explanation of Provisions, the proposed regulations provide 
that a foreign partner's effectively connected gain or loss will not 
exceed its outside gain or loss on the sale of the interest as 
determined under sections 741 and 751 and the regulations thereunder. 
Thus, the amount of gain or loss determined under section 741 (before 
application of section 751) is not a limitation on the amount of gain 
or loss characterized as effectively connected with the conduct of a 
trade or business within the United States under the proposed 
regulations.
2. Nonrecognition Transactions
    The proposed regulations provide that the gain or loss on the 
transfer of a partnership interest that is subject to tax as 
effectively connected gain or loss is limited to gain or loss otherwise 
recognized under the Code. See proposed Sec.  1.864(c)(8)-1(b)(2)(ii). 
When a nonrecognition provision results in a foreign transferor 
recognizing only a portion of its gain or loss on the transfer of an 
interest in a partnership, section 864(c)(8) may apply with respect to 
the portion of the gain or loss recognized.
    Although section 864(c)(8)(E) authorizes regulations or other 
guidance with respect to the application of section 864(c)(8) to 
nonrecognition transactions, the proposed regulations do not contain 
special rules applicable to nonrecognition transactions. The Treasury 
Department and the IRS recognize, however, that certain nonrecognition 
transactions may have the effect of reducing gain or loss that would be 
taken into account for U.S. federal income tax purposes. For example, 
if a partnership that conducts a trade or business within the United 
States owns property not subject to tax under section 871(b) or 882(a) 
in the hands of a foreign partner, the partnership may distribute that 
property to the foreign partner rather than a U.S. partner. The 
Treasury Department and the IRS continue to consider, and comments are 
requested regarding, whether other Code provisions adequately address 
transactions that rely on section 731 distributions to reduce the scope 
of assets subject to U.S. federal income taxation, and may propose 
rules addressing these types of transactions.
B. Determination of Deemed Sale Gain or Loss
1. In General
    After outside gain and loss are determined under proposed Sec.  
1.864(c)(8)-1(b), the proposed regulations set forth three amounts that 
a foreign transferor must determine to derive the limitation in section 
864(c)(8)(B) against which the outside gain or loss is compared: (1) 
With respect to each asset held by the partnership, the amount of gain 
or loss that the partnership would recognize in connection with a 
deemed sale to an unrelated party in a fully taxable transaction for 
cash equal to the asset's fair market value immediately before the 
partner's transfer of its partnership interest; (2) the amount of that 
gain or loss that would be treated as effectively connected gain or 
loss (``deemed sale EC gain'' and ``deemed sale EC loss''); and (3) the 
foreign transferor's distributive share of the ordinary and capital 
components of any deemed sale EC gain and deemed sale EC loss. The 
proposed regulations refer to the separate sums of the foreign 
transferor's distributive shares of the ordinary and capital components 
of deemed sale EC gain and deemed sale EC loss items for all assets, 
determined at the level of the foreign transferor, as ``aggregate 
deemed sale EC capital gain,'' ``aggregate deemed sale EC capital 
loss,'' ``aggregate deemed sale EC ordinary gain,'' and ``aggregate 
deemed sale EC ordinary loss.''
    After each of these aggregate amounts is determined, the proposed 
regulations implement the limitation described in section 864(c)(8)(B), 
generally, by comparing the foreign transferor's outside gain or loss 
amounts with the relevant aggregate deemed sale EC gain or loss. This 
determination is made separately with respect to capital gain or 
capital loss and gain or loss treated as ordinary income or ordinary 
loss. Thus, for example, a foreign transferor would compare its outside 
capital gain to its aggregate deemed sale EC capital gain, treating the 
former as effectively connected gain only to the extent it does not 
exceed the latter. See proposed Sec.  1.864(c)(8)-1(b)(3).
2. Treatment of Deemed Sale Gain or Loss as Effectively Connected Gain 
or Loss
    As described in Part I.B.1 of this Explanation of Provisions, the 
proposed regulations require a foreign transferor to determine the 
amount of gain or loss that would arise in a deemed asset sale that 
would be treated as effectively connected gain or loss. In general, 
gain or loss on the sale of personal property

[[Page 66649]]

is effectively connected with the conduct of a trade or business within 
the United States if the gain is from sources within the United States 
and it satisfies the requirements of section 864(c) and the regulations 
thereunder. Accordingly, the proposed regulations provide that section 
864 and the regulations thereunder apply for purposes of determining 
whether gain or loss that would arise in a deemed asset sale would be 
treated as effectively connected gain or loss. See proposed Sec.  
1.864(c)(8)-1(c)(2)(i).
    The determination as to whether gain or loss from a deemed asset 
sale by the partnership would be from sources within or without the 
United States, and whether that income would be treated as effectively 
connected gain or loss, is based on certain factual determinations, 
including whether the gain or loss results from a sale that is 
attributable to an office or other fixed place of business in the 
United States. The proposed regulations provide that, for purposes of 
determining whether gain or loss recognized in connection with a deemed 
asset sale by the partnership would be from sources within or without 
the United States, and thus whether that income would be treated as 
effectively connected gain or loss, the deemed asset sale is treated as 
attributable to an office or fixed place of business in the United 
States maintained by the partnership. As a result, deemed sale gain or 
loss generally would be treated as from sources within the United 
States. To prevent this rule from potentially converting gain or loss 
from assets with no connection to the partnership's trade or business 
within the United States into effectively connected gain or loss, the 
proposed regulations provide that gain or loss from the deemed sale of 
a partnership asset is not treated as effectively connected gain or 
loss if (1) no income or gain previously produced by the asset was 
taxable as effectively connected with the conduct of a trade or 
business within the United States by the partnership (or a predecessor 
of the partnership) during the ten-year period ending on the date of 
the transfer, and (2) the asset was not used, or held for use, in the 
conduct of a trade or business within the United States by the 
partnership (or a predecessor of the partnership) during the ten-year 
period ending on the date of transfer. See proposed Sec.  1.864(c)(8)-
1(c)(2)(ii). Comments are requested as to whether additional guidance 
is needed regarding the source of gain or loss resulting from a deemed 
sale by the partnership, including rules coordinating this rule with 
section 865(e)(2)(B).
3. Determining Distributive Share of Deemed Sale EC Gain and Deemed 
Sale EC Loss
    The flush language of section 864(c)(8)(B) provides that a 
transferor partner's distributive share of gain or loss on the deemed 
sale is determined in the same manner as the transferor partner's 
distributive share of the non-separately stated taxable income or loss 
of the partnership. The term ``non-separately stated taxable income or 
loss of the partnership'' is not defined in the Code or regulations. 
The proposed regulations provide that a partner's distributive share of 
gain or loss from the deemed sale is determined under all applicable 
Code sections (including section 704), taking into account allocations 
of tax items applying the principles of section 704(c), including any 
remedial allocations under Sec.  1.704-3(d), and any section 743 basis 
adjustment pursuant to Sec.  1.743-1(j)(3). The Treasury Department and 
IRS propose this approach because applying section 704 more closely 
ties the results of the deemed sale with regard to the selling foreign 
partner to the economic results of an actual sale, as compared (for 
example) to an approach that did not consider special allocations or 
considered only a partner's share of ordinary business income, which 
would distort the economic agreement among the partners. See proposed 
Sec.  1.864(c)(8)-1(c)(3)(i).
    The Treasury Department and the IRS are considering whether section 
704 and the regulations thereunder adequately prevent the avoidance of 
the purposes of section 864(c)(8) through allocations of effectively 
connected gain or loss to specific partners. For example, immediately 
before a foreign transferor sells its interest in a partnership, 
adjustments could be made to partnership allocations that would result 
in the foreign transferor recognizing less effectively connected gain 
from the deemed sale by the partnership. While statutory and regulatory 
provisions, as well as judicial doctrines, may limit the extent to 
which inappropriate results may be obtained in that transaction or 
similar transactions, the Treasury Department and the IRS are 
considering whether additional guidance is necessary to prevent abuse. 
Comments are requested as to whether there are specific situations in 
which the purposes of section 864(c)(8) may be avoided and specific 
suggestions for additional guidance to address those situations.
C. Source
    Neither section 864(c)(8) nor the proposed regulations address the 
source of gain or loss from the transfer of a partnership interest. 
Section 864(c)(4) provides that, except as enumerated in section 
864(c)(4)(B) and (C), no income, gain, or loss from sources without the 
United States is treated as effectively connected gain or loss. Section 
864(c)(8)(A) and the proposed regulations, however, apply 
``[n]otwithstanding any other provision of [subtitle A of the Code],'' 
such that gain or loss recognized on the transfer of an interest in a 
partnership that is engaged in a trade or business within the United 
States may be treated as effectively connected gain or loss even if it 
is from sources without the United States. Comments are requested as to 
whether, and what, additional guidance is necessary regarding the 
source of gain or loss subject to section 864(c)(8).
D. Provision Is Non-Exclusive
    The proposed regulations clarify that they do not apply to prevent 
any portion of gain or loss recognized on the transfer of a partnership 
interest from being treated as effectively connected gain or loss under 
other provisions of the Code (subject to a special rule coordinating 
the application of section 864(c)(8) and section 897). Thus, if a 
foreign transferor maintains an office or fixed place of business in 
the United States, and sells a partnership interest in a transaction 
that generates gain or loss attributable to that office, gain or loss 
recognized in connection with that transfer may be United States source 
income under section 865(e)(2), and may be treated as effectively 
connected income under section 864(c)(2). If the amount of gain or loss 
recognized that would be treated as effectively connected gain or loss 
under section 864(c)(2) exceeds the amount of gain that would be 
treated as effectively connected gain under section 864(c)(8), then the 
larger amount would be treated as effectively connected gain. See 
proposed Sec.  1.864(c)(8)-1(b)(1).

II. Coordination With Section 897

    Section 897(g) generally provides that, under regulations 
prescribed by the Secretary, the amount realized by a nonresident alien 
individual or foreign corporation in exchange for all or part of its 
interest in a partnership is, to the extent attributable to United 
States real property interests (as defined in section 897(c)), 
considered as an amount received from the sale or exchange in the 
United States of such property. Accordingly, section 897(g) generally 
provides the same result for United

[[Page 66650]]

States real property interests as Revenue Ruling 91-32 provides for 
property used, or held for use, in a trade or business in the United 
States. In general, section 864(c)(8)(C) provides that if a partnership 
described in section 864(c)(8)(A) holds any United States real property 
interest at the time of the transfer of the partnership interest, then 
the gain or loss treated as effectively connected gain or loss under 
section 864(c)(8)(A) is reduced by the amount treated as effectively 
connected gain or loss with respect to that United States real property 
interest under section 897. The effect of section 864(c)(8)(C) is to 
prevent gain or loss from a United States real property interest that 
is taxed under section 897 from being taken into account a second time 
under section 864(c)(8).
    In the proposed regulations, the limitation on effectively 
connected gain or loss in section 864(c)(8)(B) is based on a deemed 
sale by the partnership of all of its assets, including all United 
States real property interests held by the partnership, which are 
treated as effectively connected assets under section 897. See proposed 
Sec.  1.864(c)(8)-1(c)(2)(i). To coordinate the taxation of United 
States real property interests under sections 897(g) and 864(c)(8), the 
proposed regulations provide that when a partnership holds United 
States real property interests and is also subject to section 864(c)(8) 
because it is engaged in the conduct of a trade or business within the 
United States without regard to section 897, the amount of the foreign 
transferor's effectively connected gain or loss will be determined 
under section 864(c)(8) and not under section 897(g). Therefore, the 
reduction called for by section 864(c)(8)(C) is not necessary. See 
proposed Sec.  1.864(c)(8)-1(d).
    The regulations include a proposed rule in regulations under 
section 897, which serves as a cross-reference to this coordination 
rule. See section V of this Explanation of Provisions for a discussion 
of a proposed anti-stuffing rule that also applies in the context of 
section 897. Further, comments are requested as to the interaction of 
this rule with other rules in the regulations under section 897, 
including the special rule for publicly traded partnerships in Sec.  
1.897-1(c)(2)(iv).

III. Tiered Partnerships

    Section 864(c)(8) applies to a foreign nonresident alien individual 
or foreign corporation that owns an interest in a partnership directly 
or indirectly. Consistent with section 12 of Notice 2018-29, the 
proposed regulations provide that if a foreign transferor transfers an 
interest in an upper-tier partnership that owns, directly or 
indirectly, an interest in one or more lower-tier partnerships that are 
engaged in the conduct of a trade or business within the United States, 
then the deemed sale gain or loss must be computed with respect to each 
lower-tier partnership, the amount of effectively connected gain or 
loss that would be allocated to the upper-tier partnership must be 
determined, and the amount of gain or loss recognized by a foreign 
transferor that is treated as effectively connected gain or loss under 
proposed Sec.  1.864(c)(8)-1(c) must be determined by reference to the 
transferor's distributive share of effectively connected gain or loss 
arising from each lower-tier partnership. See proposed Sec.  
1.864(c)(8)-1(e)(1).
    The proposed regulations also clarify that when a foreign 
transferor is a partner in an upper-tier partnership and the upper-tier 
partnership transfers an interest in a lower-tier partnership that is 
engaged in the conduct of a trade or business within the United States, 
the upper-tier partnership must determine its effectively connected 
gain or loss by applying the principles of the proposed regulations, 
including the tiered partnership rules described in proposed Sec.  
1.864(c)(8)-1(e)(1).

IV. Treaties

    The business profits articles of many U.S. income tax treaties 
limit the taxation of income that is otherwise treated as effectively 
connected with the conduct of a trade or business within the United 
States under the Code to income and gain attributable to a permanent 
establishment in the United States. The applicable gains articles of 
many U.S. income tax treaties allow the country in which a permanent 
establishment is located to tax gains from the alienation of movable 
property forming part of the business property of a permanent 
establishment, including gains from the alienation of a permanent 
establishment, alone or with the whole enterprise of which it is a 
part. In general, the permanent establishment of a partnership in the 
United States is considered a permanent establishment of the partners 
of the partnership. See Donroy, Ltd. v. United States, 196 F.Supp. 54 
(N.D. Cal. 1961), aff'd 301 F.2d 200 (9th Cir. 1962), and Unger v. 
Comm'r, T.C. Memo. 1990-15, 58 TCM 1157, aff'd 936 F.2d 1316 (DC Cir. 
1991).
    The proposed regulations provide that the disposition of a foreign 
partner's interest in a partnership, in whole or in part, is a 
disposition of all or part of a partner's permanent establishment. 
Thus, to the extent the partnership's assets form part of a foreign 
partner's permanent establishment in the United States, the permanent 
establishment paragraph of the gains article would generally preserve 
the United States' taxing jurisdiction over the gain on the transfer of 
a partnership interest that is subject to tax under section 864(c)(8). 
In addition, if an income tax treaty has a gains article that permits 
the United States to apply its domestic laws to tax gains or does not 
have a gains article, the treaty does not prevent the application of 
section 864(c)(8).
    Gains articles of treaties also frequently have special provisions 
covering certain assets, regardless of whether the assets form part of 
a permanent establishment, such as gains from dispositions of United 
States real property interests and ships and aircraft used in 
international traffic. If a gains article of an income tax treaty 
prohibits taxation of the gain from the disposition of any asset, such 
as ships or aircraft used in international traffic, the gains and 
losses from those assets will not be considered assets that form part 
of the permanent establishment, nor will they be taken into account in 
determining deemed sale EC gain or deemed sale EC loss, for purposes of 
computing the section 864(c)(8)(B) limitation. If the gains article of 
an applicable income tax treaty allows the taxation of gain from the 
disposition of a United States real property interest, the transfer of 
an interest in a partnership that holds a United States real property 
interest remains subject to section 897(g) even if the transfer is not 
subject to section 864(c)(8) (because the partnership's assets are not 
treated as forming part of a permanent establishment in the United 
States). See proposed Sec.  1.864(c)(8)-1(d).

V. Anti-Stuffing Rule

    The proposed regulations include an anti-stuffing rule applicable 
to both these regulations and section 897. This rule is included to 
prevent inappropriate reductions in amounts characterized as 
effectively connected with the conduct of a trade or business within 
the United States under section 864(c)(8) or section 897. A cross-
reference to this rule is also included in the proposed regulation 
under section 897.

VI. Section 1446(f) Guidance

    The proposed regulations do not provide guidance under section 
1446(f). The Treasury Department and the IRS intend to issue guidance 
under section 1446(f) expeditiously.

[[Page 66651]]

Applicability Dates

    The proposed regulations apply to transfers occurring on or after 
November 27, 2017, the effective date of section 864(c)(8). See section 
7805(b)(2). If any provision is finalized after June 22, 2019, the 
Treasury Department and the IRS expect that such provision will apply 
only to transfers occurring on or after December 26, 2018. See section 
7805(b)(1)(B).

Special Analyses

    Executive Orders 13771, 13563, and 12866 direct agencies to assess 
costs and benefits of available regulatory alternatives and, if 
regulation is necessary, to select regulatory approaches that maximize 
net benefits, including potential economic, environmental, public 
health and safety effects, distributive impacts, and equity. Executive 
Order 13563 emphasizes the importance of quantifying both costs and 
benefits, reducing costs, harmonizing rules, and promoting flexibility.
    These proposed regulations have been designated by the Office of 
Management and Budget's Office of Information and Regulatory Affairs 
(OIRA) as subject to review under Executive Order 12866 pursuant to the 
Memorandum of Agreement (April 11, 2018) between the Treasury 
Department and the Office of Management and Budget regarding review of 
tax regulations. OIRA has determined that the proposed rulemaking is 
significant and subject to review under E.O. 12866 and section 1(b) of 
the Memorandum of Agreement. Accordingly, the proposed regulations have 
been reviewed by the Office of Management and Budget.
    The Treasury Department and the IRS have assessed the benefits and 
costs of the proposed regulations relative to a no-action baseline 
reflecting anticipated tax-related behavior and other economic behavior 
in the absence of these proposed regulations. Because the proposed 
regulations generally provide taxpayers with additional certainty on 
the amount and character of gain or loss treated as effectively 
connected income as a result of section 864(c)(8) and concurrently 
coordinate section 864(c)(8) with other provisions in the Code, the 
Treasury Department and the IRS anticipate only minimal economic or 
revenue effects from the proposed regulations. The Treasury Department 
and the IRS estimate that between 5,000 and 10,000 taxpayers are 
potentially affected by section 864(c)(8), with only a fraction of 
these taxpayers having gain or loss from disposition of a partnership 
in any one year. The Treasury Department and the IRS estimate that the 
affected taxpayers would see a minimal difference in treatment between 
these proposed regulations and Revenue Ruling 91-32. Comments are 
requested regarding these assessments. The Treasury Department and the 
IRS have assessed that the proposed regulations do not establish a new 
collection of information nor modify an existing collection that 
requires the approval of the Office of Management and Budget under the 
Paperwork Reduction Act (44 U.S.C. chapter 35). The Treasury Department 
and the IRS seek comments on this assessment.
    Section 864(c)(8) and the proposed regulations generally apply to 
nonresident alien individuals and foreign corporations on the transfer 
of an interest in a partnership that is engaged in a trade or business 
within the United States, and not directly to the trade or business the 
partnership conducts in the United States. Under section 605 of the 
Regulatory Flexibility Act (5 U.S.C. chapter 6), the Treasury 
Department and the IRS certify that the proposed regulations will not 
have a significant economic impact on a substantial number of small 
entities. The reason is that the proposed regulations generally apply 
to nonresident alien individuals and foreign corporations on the 
transfer of an interest in a partnership and not directly to a domestic 
small business. Pursuant to section 7805(f), this notice of proposed 
rulemaking has been submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on their impact on small 
business.

Comments and Requests for Public Hearing

    Before the proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ADDRESSES heading. 
The Treasury Department and the IRS request comments on all aspects of 
the proposed regulations, and specifically on the issues identified in 
sections I.A.2, I.B, and I.C of the Explanations of Provisions. All 
comments will be available at www.regulations.gov or upon request. A 
public hearing will be scheduled if requested in writing by any person 
that timely submits written comments. If a public hearing is scheduled, 
then notice of the date, time, and place for the public hearing will be 
published in the Federal Register.

Drafting Information

    The principal authors of the proposed regulations are Ronald M. 
Gootzeit and Chadwick Rowland, Office of Associate Chief Counsel 
(International). However, other personnel from the Treasury Department 
and the IRS participated in their development.

Statement of Availability of IRS Documents

    IRS Revenue Procedures, Revenue Rulings, notices, and other 
guidance cited in this document are published in the Internal Revenue 
Bulletin (or Cumulative Bulletin) and are available from the 
Superintendent of Documents, U.S. Government Printing Office, 
Washington, DC 20402, or by visiting the IRS website at http://www.irs.gov.

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 is amended by adding 
entries in numerical order to read in part as follows:

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

    Section 1.864(c)(8)-1 also issued under 26 U.S.C. 864(c)(8) and 
897(g).
* * * * *
    Section 1.897-7 also issued under 26 U.S.C. 897(g).
* * * * *
0
Par. 2. Section 1.864(c)(8)-1 is added to read as follows:


Sec.  1.864(c)(8)-1  Gain or loss by foreign persons on the disposition 
of certain partnership interests.

    (a) Overview. This section provides rules and definitions under 
section 864(c)(8). Paragraph (b) of this section provides the general 
rule treating gain or loss recognized by a nonresident alien individual 
or foreign corporation from the sale or exchange of a partnership 
interest as effectively connected gain or effectively connected loss. 
Paragraph (c) of this section provides rules for determining the 
limitation on the amount of effectively connected gain or effectively 
connected loss under section 864(c)(8) and paragraph (b) of this 
section. Paragraph (d) of this section provides rules regarding 
coordination with section 897. Paragraph (e) of this section provides 
rules regarding certain tiered partnerships. Paragraph (f) of this 
section provides rules regarding U.S.

[[Page 66652]]

income tax treaties. Paragraph (g) of this section provides 
definitions. Paragraph (h) of this section provides a rule regarding 
certain contributions of property to a partnership. Paragraph (i) of 
this section contains examples illustrating the rules set forth in this 
section. Paragraph (j) of this section provides the applicability date.
    (b) Gain or loss treated as effectively connected gain or loss--(1) 
In general. Notwithstanding any other provision of subtitle A of the 
Internal Revenue Code, if a foreign transferor owns, directly or 
indirectly, an interest in a partnership that is engaged in the conduct 
of a trade or business within the United States, outside capital gain, 
outside capital loss, outside ordinary gain, or outside ordinary loss 
(each as defined in paragraph (b)(2) of this section) recognized by the 
foreign transferor on the transfer of all (or any portion) of the 
interest is treated as effectively connected gain or effectively 
connected loss, subject to the limit described in paragraph (b)(3) of 
this section. Except as provided in paragraph (d) of this section, this 
section does not apply to prevent any portion of the gain or loss that 
is otherwise treated as effectively connected gain or effectively 
connected loss under provisions of the Internal Revenue Code other than 
section 864(c)(8) from being so treated.
    (2) Determination of outside gain and loss--(i) In general. The 
amount of gain or loss recognized by the foreign transferor in 
connection with the transfer of its partnership interest is determined 
under all relevant provisions of the Internal Revenue Code and the 
regulations thereunder. See, e.g., Sec. Sec.  1.741-1(a) and 1.751-
1(a)(2). For purposes of this section, the amount of gain or loss that 
is treated as capital gain or capital loss under sections 741 and 751 
is referred to as outside capital gain or outside capital loss, 
respectively. The amount of gain or loss that is treated as ordinary 
gain or ordinary loss under sections 741 and 751 is referred to as 
outside ordinary gain or outside ordinary loss, respectively.
    (ii) Nonrecognition provisions. A foreign transferor's gain or loss 
recognized in connection with the transfer of its partnership interest 
does not include gain or loss to the extent that the gain or loss is 
not recognized by reason of one or more nonrecognition provisions of 
the Internal Revenue Code.
    (3) Limitations. This paragraph (b)(3) limits the amount of gain or 
loss recognized by a foreign transferor that may be treated as 
effectively connected gain or effectively connected loss.
    (i) Capital gain limitation. Outside capital gain recognized by a 
foreign transferor is treated as effectively connected gain to the 
extent it does not exceed aggregate deemed sale EC capital gain 
determined under paragraph (c)(3)(ii)(B) of this section.
    (ii) Capital loss limitation. Outside capital loss recognized by a 
foreign transferor is treated as effectively connected loss to the 
extent it does not exceed aggregate deemed sale EC capital loss 
determined under paragraph (c)(3)(ii)(B) of this section.
    (iii) Ordinary gain limitation. Outside ordinary gain recognized by 
a foreign transferor is treated as effectively connected gain to the 
extent it does not exceed aggregate deemed sale EC ordinary gain 
determined under paragraph (c)(3)(ii)(A) of this section.
    (iv) Ordinary loss limitation. Outside ordinary loss recognized by 
a foreign transferor is treated as effectively connected loss to the 
extent it does not exceed aggregate deemed sale EC ordinary loss 
determined under paragraph (c)(3)(ii)(A) of this section.
    (c) Amount treated as effectively connected with the conduct of a 
trade or business within the United States. This paragraph (c) 
describes the steps to be followed in computing the limitations 
described in paragraph (b)(3) of this section.
    (1) Step 1: Determine deemed sale gain and loss. Determine the 
amount of gain or loss that the partnership would recognize with 
respect to each of its assets (other than interests in partnerships 
described in paragraph (e) of this section) upon a deemed sale of all 
of the partnership's assets on the date of the transfer of the 
partnership interest described in paragraph (b)(1) of this section 
(deemed sale). For this purpose, a deemed sale is a hypothetical sale 
by the partnership to an unrelated person of each of its assets 
(tangible and intangible) in a fully taxable transaction for cash in an 
amount equal to the fair market value of each asset (taking into 
account section 7701(g)) immediately before the partner's transfer of 
the interest in the partnership. For rules concerning the deemed sale 
of certain partnership interests, see paragraph (e) of this section.
    (2) Step 2: Determine deemed sale EC gain and loss--(i) In general. 
With respect to each asset deemed sold in paragraph (c)(1) of this 
section, determine the amount of gain or loss from the deemed sale that 
would be treated as effectively connected gain or effectively connected 
loss (including by reason of section 897, taking into account any 
exceptions thereto, such as section 897(k) or section 897(l)). Gain 
described in this paragraph (c)(2) is referred to as deemed sale EC 
gain, and loss described in this paragraph (c)(2) is referred to as 
deemed sale EC loss. Section 864 and the regulations thereunder apply 
for purposes of determining whether gain or loss that would arise in a 
deemed asset sale would be treated as effectively connected gain or 
loss. For purposes of this paragraph (c)(2)(i), gain or loss from the 
deemed sale of an asset is treated as attributable to an office or 
other fixed place of business maintained by the partnership in the 
United States, and is not treated as sold for use, disposition, or 
consumption outside the United States in a sale in which an office or 
other fixed place of business maintained by the partnership in a 
foreign country materially participated in the sale.
    (ii) Exception. Gain or loss from the deemed sale of an asset 
described in paragraph (c)(2)(i) of this section (other than a United 
States real property interest) is not treated as deemed sale EC gain or 
deemed sale EC loss if--
    (A) No income or gain produced by the asset was taxable as income 
that was effectively connected with the conduct of a trade or business 
within the United States by the partnership (or a predecessor of the 
partnership) during the ten-year period ending on the date of the 
transfer; and
    (B) The asset has not been used, or held for use, in the conduct of 
a trade or business within the United States by the partnership (or a 
predecessor of the partnership) during the ten-year period ending on 
the date of the transfer.
    (3) Step 3: Determine the foreign transferor's distributive share 
of deemed sale EC gain or deemed sale EC loss--(i) In general. 
Determine the foreign transferor's distributive share of deemed sale EC 
gain and deemed sale EC loss. A foreign transferor's distributive share 
of deemed sale EC gain or deemed sale EC loss with respect to each 
asset is the amount of the deemed sale EC gain and deemed sale EC loss 
determined under paragraph (c)(2) of this section that would have been 
allocated to the foreign transferor by the partnership under all 
applicable Code sections (including section 704) upon the deemed sale 
described in paragraph (c)(1) of this section, taking into account 
allocations of tax items applying the principles of section 704(c), 
including any remedial allocations under Sec.  1.704-3(d), and any 
section 743 basis adjustment pursuant to Sec.  1.743-1(j)(3)).
    (ii) Aggregate deemed sale EC items--(A) Ordinary gain or loss. A 
foreign transferor's aggregate deemed sale EC ordinary gain (if the 
aggregate results in a gain) or aggregate deemed sale EC

[[Page 66653]]

ordinary loss (if the aggregate results in a loss) is the sum of--
    (1) The portion of the foreign transferor's distributive share of 
deemed sale EC gain and deemed sale EC loss that is attributable to the 
deemed sale of the partnership's assets that are section 751(a) 
property; and
    (2) Deemed sale EC gain and deemed sale EC loss from the sale of 
assets that are section 751(a) property that would be allocated to the 
foreign transferor with respect to interests in partnerships that are 
engaged in the conduct of a trade or business within the United States 
under paragraph (e)(1)(ii) of this section upon the deemed asset sales 
described in paragraph (e)(1)(i) of this section.
    (B) Capital gain or loss. A foreign transferor's aggregate deemed 
sale EC capital gain (if the aggregate of the foreign transferor's 
distributive share of the deemed sale EC capital gain and loss results 
in a gain) or aggregate deemed sale EC capital loss (if the aggregate 
of the foreign transferor's distributive share of the deemed sale EC 
capital gain and loss results in a loss) is the sum of--
    (1) The portion of the foreign transferor's distributive share of 
deemed sale EC gain and deemed sale EC loss that is attributable to the 
deemed sale of assets that are not section 751(a) property; and
    (2) Deemed sale EC gain and deemed sale EC loss from the sale of 
assets that are not section 751(a) property and that would be allocated 
to the foreign transferor with respect to all interests in partnerships 
that are engaged in the conduct of a trade or business within the 
United States under paragraph (e)(1)(ii) of this section upon the 
deemed asset sales described in paragraph (e)(1)(i) of this section.
    (iii) Partial transfers. If a foreign transferor transfers less 
than all of its interest in a partnership, then for purposes of 
paragraph (c)(3)(i) of this section, the foreign transferor's 
distributive share of deemed sale EC gain and deemed sale EC loss is 
determined by reference to the amount of deemed sale EC gain or deemed 
sale EC loss determined under paragraph (c)(3)(i) of this section that 
is attributable to the portion of the foreign transferor's partnership 
interest that was transferred.
    (d) Coordination with section 897. If a foreign transferor 
transfers an interest in a partnership in a transfer that is subject to 
section 864(c)(8), and the partnership owns one or more United States 
real property interests (as defined in section 897(c)), then the 
foreign transferor determines its effectively connected gain and 
effectively connected loss under this section, and not pursuant to 
section 897(g). Accordingly, with respect to a transfer described in 
the preceding sentence, section 864(c)(8)(C) does not reduce the amount 
of gain or loss treated as effectively connected gain or loss under 
this section. For rules regarding a transfer not subject to section 
864(c)(8) of an interest in a partnership that owns one or more United 
States real property interests, see section 897(g) and the regulations 
thereunder.
    (e) Tiered partnerships--(1) Transfers of upper-tier partnerships. 
Assets sold in a deemed sale described in paragraph (c)(1) of this 
section do not include interests in partnerships that are engaged in 
the conduct of a trade or business within the United States or 
interests in partnerships that hold, directly or indirectly, 
partnerships that are engaged in the conduct of a trade or business 
within the United States. Rather, if a foreign transferor transfers an 
interest in a partnership (upper-tier partnership) that owns, directly 
or indirectly, an interest in one or more partnerships that are engaged 
in the conduct of a trade or business within the United States, then--
    (i) Beginning with the lowest-tier partnership that is engaged in 
the conduct of a trade or business within the United States in a chain 
of partnerships and going up the chain, each partnership that is 
engaged in the conduct of a trade or business within the United States 
is treated as selling its assets in a deemed sale in accordance with 
the principles of paragraph (c)(1) of this section; and
    (ii) Each partnership must determine its deemed sale EC gain and 
deemed sale EC loss in accordance with the principles of paragraph 
(c)(2) of this section, and determine the distributive share of deemed 
sale EC gain and deemed sale EC loss for each partner that is either a 
partnership (in which the foreign transferor is a direct or indirect 
partner) or a foreign transferor, in accordance with the principles of 
paragraph (c)(3)(i) of this section.
    (2) Transfers by upper-tier partnerships. If a foreign transferor 
is a direct or indirect partner in an upper-tier partnership and the 
upper-tier partnership transfers an interest in a partnership that is 
engaged in the conduct of a trade or business within the United States 
(including a partnership held indirectly through one or more 
partnerships), then the principles of this section (including paragraph 
(e)(1) of this section) apply with respect to the gain or loss on the 
transfer that is allocated to the foreign transferor by the upper-tier 
partnership.
    (3) Coordination with section 897. For purposes of this paragraph 
(e), a lower-tier partnership that holds one or more United States real 
property interests is treated as engaged in the conduct of a trade or 
business within the United States.
    (f) Income tax treaties--(1) In general. This paragraph (f) 
describes how the provisions of a U.S. income tax treaty apply to the 
transfer by a foreign transferor that is eligible for benefits under 
the treaty of an interest in a partnership that is engaged in the 
conduct of a trade or business within the United States.
    (2) Application of gains article. Treaty provisions applicable to 
gains from the alienation of property forming part of a permanent 
establishment, including gains from the alienation of a permanent 
establishment in the United States, apply to the transfer by a foreign 
transferor of an interest in a partnership with a permanent 
establishment in the United States.
    (3) Coordination rule. For purposes of applying paragraph (c) of 
this section to gains described in paragraph (f)(2) of this section, a 
foreign transferor's distributive share of deemed sale EC gain and 
deemed sale EC loss are determined with respect to the assets of the 
partnership that form part of the partnership's permanent establishment 
in the United States and that are not otherwise exempt from U.S. 
taxation under the treaty.
    (g) Definitions. The following definitions apply for purposes of 
this section.
    (1) Effectively connected gain. The term effectively connected gain 
means gain that is treated as effectively connected with the conduct of 
a trade or business within the United States.
    (2) Effectively connected loss. The term effectively connected loss 
means loss treated as effectively connected with the conduct of a trade 
or business within the United States.
    (3) Foreign transferor. The term foreign transferor means a 
nonresident alien individual or foreign corporation.
    (4) Section 751(a) property. The term section 751(a) property means 
unrealized receivables described in section 751(c) and inventory items 
described in section 751(d).
    (5) Transfer. The term transfer means a sale, exchange, or other 
disposition, and includes a distribution from a partnership to a 
partner to the extent that gain or loss is recognized on the 
distribution, as well as a transfer treated as a sale or exchange under 
section 707(a)(2)(B).
    (h) Anti-stuffing rule. If a foreign transferor (or a person that 
is related to

[[Page 66654]]

a foreign transferor within the meaning of section 267(b) or 707(b)) 
transfers property (including another partnership interest) to a 
partnership in a transaction with a principal purpose of reducing the 
amount of gain treated as effectively connected gain, or increasing the 
amount of loss treated as effectively connected loss, under section 
864(c)(8) or section 897, the transfer is disregarded for purposes of 
section 864(c)(8) or section 897, as appropriate, or otherwise 
recharacterized in accordance with its substance.
    (i) Examples. This paragraph provides examples that illustrate the 
rules of this section. For purposes of this paragraph, unless otherwise 
provided, the following facts are presumed. FP is a foreign 
corporation. USP is a domestic corporation. PRS is a partnership that 
was formed on January 1, 2018, when FP and USP each contributed $100x 
in cash. PRS has made no distributions and received no contributions 
other than those described in paragraph (i)(1)(iii) of this section. 
FP's adjusted basis in its interest in PRS is $100x. X is a foreign 
corporation that is unrelated to FP, USP, or PRS. Upon the formation of 
PRS, FP and USP entered into an agreement providing that all income, 
gain, loss, and deduction of PRS will be allocated equally between FP 
and USP. PRS is engaged in the conduct of a trade or business within 
the United States (the U.S. Business) and an unrelated business in 
Country A (the Country A Business). In a deemed sale described in 
paragraph (c)(1) of this section, gain or loss on assets of the U.S. 
Business would be treated as effectively connected gain or effectively 
connected loss, and gain or loss on assets of the Country A Business 
would not be so treated (including by reason of paragraph (c)(2)(ii) of 
this section). PRS has no liabilities. FP does not qualify for the 
benefits of an income tax treaty between the United States and another 
country.
     (1) Example 1. Deemed sale limitation--(i) Facts. On January 1, 
2019, FP sells its entire interest in PRS to X for $105x. 
Immediately before the sale, PRS's balance sheet appears as follows:

------------------------------------------------------------------------
                                                            Fair market
                                          Adjusted basis       value
------------------------------------------------------------------------
U.S. Business capital asset.............           $100x           $104x
Country A Business capital asset........            100x            106x
                                         -------------------------------
    Total...............................            200x            210x
------------------------------------------------------------------------

    (ii) Analysis--(A) Outside gain or loss. FP is a foreign 
transferor (within the meaning of paragraph (g)(3) of this section) 
and transfers (within the meaning of paragraph (g)(5) of this 
section) its interest in PRS to X. FP recognizes a $5x capital gain 
under section 741, which is an outside capital gain within the 
meaning of paragraph (b)(2)(i) of this section. Under paragraph 
(b)(1) of this section, FP's $5x capital gain is treated as 
effectively connected gain to the extent that it does not exceed the 
limitation described in paragraph (b)(3)(i) of this section, which 
is FP's aggregate deemed sale EC capital gain.
    (B) Deemed sale. FP's aggregate deemed sale EC capital gain is 
determined according to the three-step process set forth in 
paragraph (c) of this section. First, the amount of gain or loss 
that PRS would recognize with respect to each of its assets upon a 
deemed sale described in paragraph (c)(1) of this section is a $4x 
gain with respect to the U.S. Business capital asset and a $6x gain 
with respect to the Country A Business capital asset. Second, under 
paragraph (c)(2) of this section, PRS's deemed sale EC gain is $4x. 
PRS recognizes no deemed sale EC gain or loss with respect to the 
Country A Business capital asset under section 864 and paragraph 
(c)(2)(ii) of this section. Third, under paragraph (c)(3)(ii)(B) of 
this section, FP's aggregate deemed sale EC capital gain is $2x 
(that is, the aggregate of its distributive share of deemed sale EC 
gain attributable to the deemed sale of assets that are not section 
751(a) property, which is 50% of $4x).
    (C) Limitation. Under paragraph (b)(3)(i) of this section, the 
$5x outside capital gain recognized by FP is treated as effectively 
connected gain to the extent that it does not exceed FP's $2x 
aggregate deemed sale EC capital gain. Accordingly, FP recognizes 
$2x of capital gain that is treated as effectively connected gain.
     (2) Example 2. Outside gain limitation--(i) Facts. On January 
1, 2019, FP sells its entire interest in PRS to X for $110x. 
Immediately before the sale, PRS's balance sheet appears as follows:

------------------------------------------------------------------------
                                                            Fair market
                                          Adjusted basis       value
------------------------------------------------------------------------
U.S. Business capital asset.............           $100x           $150x
Country A Business capital asset........            100x             70x
                                         -------------------------------
    Total...............................            200x            220x
------------------------------------------------------------------------

    (ii) Analysis--(A) Outside gain or loss. FP is a foreign 
transferor (within the meaning of paragraph (g)(3) of this section) 
and transfers (within the meaning of paragraph (g)(5) of this 
section) its interest in PRS to X. FP recognizes a $10x capital gain 
under section 741, which is an outside capital gain within the 
meaning of paragraph (b)(2)(i) of this section. Under paragraph 
(b)(1) of this section, FP's $10x capital gain is treated as 
effectively connected gain to the extent that it does not exceed the 
limitation described in paragraph (b)(3)(i) of this section, which 
is FP's aggregate deemed sale EC capital gain.
    (B) Deemed sale. FP's aggregate deemed sale EC capital gain is 
determined according to the three-step process set forth in 
paragraph (c) of this section. First, the amount of gain or loss 
that PRS would recognize with respect to each of its assets upon a 
deemed sale described in paragraph (c)(1) of this section is a $50x 
gain with respect to the U.S. Business capital asset and a $30x loss 
with respect to the Country A Business capital asset. Second, under 
paragraph (c)(2) of this section, PRS's deemed sale EC gain is $50x. 
PRS recognizes no deemed sale EC gain or loss with respect to the 
Country A Business capital asset under section 864 and paragraph 
(c)(2)(ii) of this section. Third, under paragraph (c)(3) of this 
section, FP's aggregate deemed sale EC capital gain is $25x (that 
is, the aggregate of its distributive share of deemed sale EC gain 
attributable to the deemed sale of assets that are not section 
751(a) property, which is 50% of $50x).
    (C) Limitation. Under paragraph (b)(3)(i) of this section, the 
$10x outside capital gain recognized by FP is treated as effectively 
connected gain to the extent that it does not exceed FP's $25x 
aggregate deemed sale EC capital gain. Accordingly, FP recognizes 
$10x of capital gain that is treated as effectively connected gain.
     (3) Example 3. Interaction with section 751(a)--(i) Facts. On 
January 1, 2019, FP sells its entire interest in PRS to X for $95x. 
Through both its U.S. Business and its Country A Business, PRS holds 
inventory items that are section 751 property (as

[[Page 66655]]

defined in Sec.  1.751-1(a)). Immediately before the sale, PRS's 
balance sheet appears as follows:

------------------------------------------------------------------------
                                                            Fair market
                                          Adjusted basis       value
------------------------------------------------------------------------
U.S. Business capital asset.............            $20x            $50x
U.S. Business inventory.................             30x             50x
Country A Business capital asset........            100x             80x
Country A Business inventory............             50x             10x
                                         -------------------------------
    Total...............................            200x            190x
------------------------------------------------------------------------

    (ii) Analysis--(A) Outside gain or loss. FP is a foreign 
transferor (within the meaning of paragraph (g)(3) of this section) 
and transfers (within the meaning of paragraph (g)(5) of this 
section) its interest in PRS to X. Under sections 741 and 751, FP 
recognizes a $10x ordinary loss and a $5x capital gain. See Sec.  
1.751-1(a). Under paragraph (b)(2)(i) of this section, FP has 
outside ordinary loss equal to $10x and outside capital gain equal 
to $5x. Under paragraph (b)(1) of this section, FP's outside 
ordinary loss and outside capital gain are treated as effectively 
connected loss and effectively connected gain to the extent that 
each does not exceed the applicable limitation described in 
paragraph (b)(3) of this section. In the case of FP's outside 
ordinary loss, the applicable limitation is FP's aggregate deemed 
sale EC ordinary loss. In the case of FP's outside capital gain, the 
applicable limitation is FP's aggregate deemed sale EC capital gain.
    (B) Deemed sale. FP's aggregate deemed sale EC ordinary loss and 
aggregate deemed sale EC capital gain are determined according to 
the three-step process set forth in paragraph (c) of this section.
    (1) Step 1. The amount of gain or loss that PRS would recognize 
with respect to each of its assets upon a deemed sale described in 
paragraph (c)(1) of this section is as follows:

------------------------------------------------------------------------
                          Asset                             Gain/(loss)
------------------------------------------------------------------------
U.S. Business capital asset.............................            $30x
U.S. Business inventory.................................             20x
Country A Business capital asset........................           (20x)
Country A Business inventory............................           (40x)
------------------------------------------------------------------------

    (2) Step 2. Under paragraph (c)(2) of this section, PRS's deemed 
sale EC gain and deemed sale EC loss must be determined with respect 
to each asset. The amounts determined under paragraph (c)(2) of this 
section are as follows:

------------------------------------------------------------------------
                                                          Deemed sale EC
                          Asset                             gain/(loss)
------------------------------------------------------------------------
U.S. Business capital asset.............................            $30x
U.S. Business inventory.................................             20x
Country A Business capital asset........................               0
Country A Business inventory............................               0
------------------------------------------------------------------------

    (3) Step 3. Under paragraph (c)(3) of this section, FP's 
aggregate deemed sale EC capital gain is $15x (that is, the 
aggregate of its distributive share of deemed sale EC gain that is 
attributable to the deemed sale of assets that are not section 
751(a) property, which is 50% of $30x) and FP's aggregate deemed 
sale EC ordinary loss is $0 (that is, the aggregate of its 
distributive share of deemed sale EC loss that is attributable to 
the deemed sale of assets that are section 751(a) property).
    (C) Limitation--(i) Capital gain. Under paragraph (b)(3)(i) of 
this section, the $5x outside capital gain recognized by FP is 
treated as effectively connected gain to the extent that it does not 
exceed FP's $15x aggregate deemed sale EC capital gain. Accordingly, 
the amount of FP's capital gain that is treated as effectively 
connected gain is $5x.
    (ii) Ordinary loss. Under paragraph (b)(3)(iv) of this section, 
the $10x outside ordinary loss recognized by FP is treated as 
effectively connected loss to the extent that it does not exceed 
FP's $0 aggregate deemed sale EC ordinary loss. Accordingly, the 
amount of FP's ordinary loss that is treated as effectively 
connected loss is $0.
    (j) Applicability date. This section applies to transfers 
occurring on or after November 27, 2017.

0
Par. 3. Section 1.897-7 is added to read as follows:


Sec.  1.897-7  Treatment of certain partnership interests, trusts and 
estates under section 897(g).

    (a) through (b) [Reserved]. For further guidance, see Sec.  
[thinsp]1.897-7T(a) through (b).
    (c) Coordination with section 864(c)(8). Except as provided in 
Sec.  1.864(c)(8)-1, the amount of any money, and the fair market value 
of any property, received by a nonresident alien individual or foreign 
corporation in exchange for all or part of its interest in a 
partnership, trust, or estate shall, to the extent attributable to 
United States real property interests, be considered as an amount 
received from the sale or exchange in the United States of such 
property. See also Sec.  1.864(c)(8)-1(h) for an anti-stuffing rule 
that may apply to transactions subject to section 897. This paragraph 
applies to transfers occurring on or after November 27, 2017.
0
Par. 4. Section 1.897-7T is amended by adding paragraph (c) to read as 
follows:


Sec.  1.897-7T   Treatment of certain partnership interests as entirely 
U.S. real property interests under sections 897(g) and 1445(e) 
(temporary).

* * * * *
    (c) Coordination with section 864(c)(8). [Reserved]. For further 
guidance, see Sec.  1.897-7(c).

Kirsten Wielobob,
 Deputy Commissioner for Services and Enforcement.
[FR Doc. 2018-28167 Filed 12-26-18; 8:45 am]
 BILLING CODE 4830-01-P