[Federal Register Volume 64, Number 240 (Wednesday, December 15, 1999)]
[Rules and Regulations]
[Pages 69903-69922]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-32400]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8847]
RIN 1545-AS39
Adjustments Following Sales of Partnership Interests
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document finalizes regulations relating to the optional
adjustments to the basis of partnership property following certain
transfers of partnership interests under section 743, the calculation
of gain or loss under section 751(a) following the sale or exchange of
a partnership interest, the allocation of basis adjustments among
partnership assets under section 755, the allocation of a partner's
basis in its partnership interest to properties distributed to the
partner by the partnership under section 732(c), and the computation of
a partner's proportionate share of the adjusted basis of depreciable
property (or depreciable real property) under section 1017. The changes
will affect partnerships and partners where there are transfers of
partnership interests, distributions of property, or elections under
sections 108(b)(5) or (c). In addition, the final regulations under
section 732(c) reflect changes to the law made by the Taxpayer Relief
Act of 1997.
DATES: Effective Dates: These regulations are effective December 15,
1999.
Applicability Date: These regulations apply to transfers of
partnership interests and distributions occurring on or after December
15, 1999.
FOR FURTHER INFORMATION CONTACT: Matthew Lay, (202) 622-3050.
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information in these final regulations have been
reviewed and approved by the Office of Management and Budget in
accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545-1588. Responses to these collections of information
are mandatory for partnerships that have made an election under section
754 and for which a section 743 transfer has been made, and for
partnerships which distribute property in a transaction subject to
section 732(d).
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number assigned by the Office of
Management and Budget.
The estimated annual burden per respondent varies from 1 hour to
300 hours, depending on the individual circumstances, with an estimated
average of 4 hours.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224, and to the Office of Management and Budget, Attn:
Desk Officer for the Department of the Treasury, Office of Information
and Regulatory Affairs, Washington, DC 20503.
Books or records relating to these collections of information must
be retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
This document (a) revises Secs. 1.743-1 and 1.755-1 of the Income
Tax Regulations (26 CFR part 1), and (b) amends Secs. 1.732-1, 1.732-2,
1.734-1, 1.751-1, 1.754-1, and Sec. 1.1017-1 of the Income Tax
Regulations.
On January 29, 1998, proposed regulations (REG 209682-94) were
published in the Federal Register (63 FR 4408). Written comments were
received in response to the notice of proposed rulemaking. One speaker
provided testimony at a public hearing held on September 10, 1998.
After consideration of all the comments, the proposed regulations
under sections 732, 734, 743, 751, 755, and 1017 are adopted, as
revised by this Treasury Decision.
Explanation of Revisions and Summary of Contents
1. Basis in Distributed Property
(a) Mandatory application of section 732(d). Section 1.732-1(d)(4)
of the current regulations requires transferees to apply the special
basis rule in certain
[[Page 69904]]
cases. In the preamble to the proposed regulations, the IRS and the
Treasury Department requested comments on the proper scope of section
732(d), and specifically, under what circumstances, if any, the
Secretary should continue to exercise his authority to mandate the
application of section 732(d) to a transferee. Several commentators
suggested that the mandatory application of section 732(d) no longer
should be required, because the changes made to section 732(c) by the
Taxpayer Relief Act of 1997, Public Law 105-34, 111 Stat. 788, 945-46
(1997), make the distortions targeted by the regulations less likely to
occur. However, other commentators noted that distortions caused by
section 732(c) still may occur. Accordingly, the rule contained in
Sec. 1.732-1(d)(4), which requires the mandatory application of section
732(d) in certain cases, remains in effect.
(b) Statement required by partnership. Because partners, rather
than partnerships, are required to report basis adjustments under
section 732(d), the final regulations require partnerships to provide
transferees with such information as is necessary for the transferees
properly to compute basis adjustments made under section 732(d). This
information must be provided if a transferee notifies a partnership
that it plans to make the election under section 732(d) or if a
partnership makes a distribution subject to the mandatory application
of section 732(d).
(c) Effective date. One commentator asked for clarification
regarding the application of the final regulations to section 732(d)
adjustments. If section 732(d) applies to a distribution, it is
necessary to calculate the basis adjustments which would have been
required under section 743(b) if a section 754 election were in effect
for the partnership in the taxable year in which the partnership
interest was transferred to the partner. In calculating these basis
adjustments, the partnership should apply the final regulations under
section 743 and 755 if the distribution to which section 732(d) applies
occurs after December 15, 1999.
2. Basis Adjustments Under Section 743(b)
(a) Coordination with section 704(c). Where a partnership adopts
the remedial allocation method, the proposed regulations provide that
the section 704(c) built-in gain portion of a basis adjustment under
section 743(b) shall be recovered over the remaining cost recovery
period for the section 704(c) built-in gain. Some commentators
suggested that the final regulations should provide this treatment for
the section 704(c) built-in gain portion of the adjustment regardless
of the method elected by the partnership for allocating section 704(c)
built-in gain and loss. The IRS and the Treasury Department continue to
believe that, except for partnerships which adopt the remedial
allocation method, it is appropriate for sections 704(c) and 743(b) to
operate independently. Accordingly, this change has not been adopted.
In the preamble to the proposed regulations, comments were
requested concerning the application of the remedial allocation method
to contributed property where there are no distortions caused by the
ceiling rule at the time the property was contributed to the
partnership. Even if it is not clear that the ceiling rule will apply
at the time the property is contributed because the adjusted basis of
the contributed property is sufficient so that the non-contributing
partners will be allocated their appropriate share of depreciation or
amortization attributable to the property, the partnership's adoption
of the remedial method still may be relevant due to allocations
resulting from a subsequent disposition of the property. For instance,
suppose that partners A and B form a partnership and agree that each
partner will be allocated a 50 percent share of all partnership items,
and that the partnership will make allocations under section 704(c)
using the traditional method. A contributes depreciable property with
an adjusted tax basis of $40 and a book value of $50, and B contributes
$50 in cash. At the time of the contribution, it is not readily
apparent that the ceiling rule will have any application. However, if,
before any federal income tax depreciation accrues with respect to the
contributed property, the property's value declines to $40, and the
property is sold for that amount, there will be no tax gain or loss.
The book loss of $10 would be shared equally between A and B. In this
situation, the ceiling rule would prevent B from being allocated the $5
tax loss to which it otherwise would be entitled. However, if the
partnership elected to use the remedial method with respect to the
contributed property, B would be allocated a $5 tax loss, and A would
be allocated a corresponding $5 tax gain. In addition, if a
contributing partner transfers its interest in a partnership during a
period when a section 754 election is in effect, the section 704(c)
method adopted by the partnership will determine the recovery period
for the built-in gain portion of the transferee's section 743(b)
adjustment. The IRS and the Treasury Department believe that under the
current regulations under section 704(c), a partnership may use the
remedial method under Sec. 1.704-3, even where it is not readily
apparent at the time the property is contributed that the ceiling rule
will be applicable.
(b) Previously taxed capital. One commentator suggested that the
second sentence in proposed Sec. 1.743-1(d)(2), relating to the
correlation between a partner's interest in previously taxed capital
and the partnership's capital accounts, is redundant and should be
deleted. This suggestion has been adopted; however, no substantive
change is intended by the deletion.
(c) Common basis election. Some commentators suggested that the
provision in the proposed regulations that permitted the partners to
elect to apply negative basis adjustments under section 743(b) to the
partnership's common basis should be deleted. The commentators argued
that the provision was contrary to the purpose of section 743(b),
because it permitted basis adjustments under section 743(b) to affect
nontransferring partners. The commentators also argued that the
provision would be used by a small number of partnerships and would add
unnecessary complexity to the regulations. In response to these
suggestions, the provision that permitted the partners to elect to
apply negative basis adjustments under section 743(b) to the
partnership's common basis has been deleted.
(d) Statements by partners. Some commentators suggested modifying
the statements which partners are required to provide to the
partnership in the case of transfers which result in basis adjustments
under section 743(b). Many of these suggestions have been adopted. For
example, the regulations specify that the transferee of a partnership
interest is required to provide the name, address, and taxpayer
identification number of the transferor only if that information is
ascertainable by the transferee. The regulations also specify that if a
partnership interest is transferred to a nominee which is required to
furnish the statement under Sec. 1.6031(c)-1T to the partnership, the
nominee may satisfy the notice requirements of both the section 743 and
6031 regulations by providing a single statement with respect to that
transfer, but only if the statement satisfies all requirements of both
regulations.
The regulations require the transferee to sign the statement under
penalties of perjury, and require the transferee to provide the amount
of any liabilities assumed or taken subject to by the transferee, and
any other information
[[Page 69905]]
necessary for the partnership to compute the transferee's basis in the
partnership interest. In order to assist the partnership in properly
calculating depreciation and amortization deductions which may be
subject to anti-churning provisions, the regulations require the
transferee to describe its relationship, if any, to the transferor.
Finally, the statement required by a transferee that acquires an
interest by death must include the date of the decedent's death.
One commentator suggested that the statement required by a
transferee that acquires a partnership interest by sale or exchange
should be provided within 30 days of the sale or exchange, regardless
of whether or not the transfer occurs at the end of the calendar year.
This change has been adopted.
One commentator suggested that references to the tax matters
partner in Sec. 1.743-1(k) of the proposed regulations (regarding the
partnership's obligations where a partner's statement is clearly
erroneous, or a partner fails to notify the partnership that an
interest has been transferred and the partnership has actual knowledge
of the transfer) should be changed. This commentator emphasized that
while the tax matters partner has a specialized role with respect to
consolidated administrative and judicial proceedings to determine the
tax treatment of partnership items at the partnership level, the tax
matters partner does not have any special responsibilities with respect
to federal income tax reporting. The final regulations adopt this
comment. Section 1.743-1(k) now refers to partners who are responsible
for federal income tax reporting by the partnership.
(e) Oil and gas. One commentator suggested that the example
described in Sec. 1.743-1(j)(6) should be changed to describe a non-oil
and gas property. This change has been made. The commentator also
suggested that in the case of domestic oil and gas properties that are
depleted at the partner level, the transferee partner (rather than the
partnership) should be required to make and allocate basis adjustments
among such properties. The final regulations adopt this comment.
The same commentator suggested that the regulations should specify
a method for adjusting the basis of section 613A(c)(7)(D) properties in
order to account for percentage depletion made by a partner with
respect to such properties. Under the principles of Sec. 1.743-1(j),
percentage depletion should reduce first any carryover basis under
Sec. 1.613A-3(e)(6)(iv). After the carryover basis has been recovered,
any further percentage depletion should reduce the section 743
adjustment for the property.
3. Sales of Partnership Interests
One commentator suggested that references to fair market value
should specify whether fair market value is determined taking into
account section 7701(g), which generally provides that fair market
value shall be treated as being not less than the amount of any
nonrecourse indebtedness to which the property is subject. The
regulations specify that for purposes of the hypothetical sale employed
to determine the income or loss realized by a partner upon the sale or
exchange of its interest in section 751 property, fair market value is
determined taking into account section 7701(g). Basis adjustments under
section 743(b) also are allocated by reference to a hypothetical
transaction. The IRS and the Treasury Department intend to issue
guidance in the near future which will provide rules for determining
the fair market value of partnership assets in certain situations,
including for purposes of allocating section 743(b) basis adjustments
upon the transfer of a partnership interest. The IRS and the Treasury
Department anticipate that the guidance will provide that section
7701(g) will apply in determining the fair market value of partnership
assets for purposes of allocating section 743(b) basis adjustments.
One commentator suggested that where a partnership interest is sold
or exchanged, the transferor and the transferee of a partnership
interest should be permitted jointly to assign values to partnership
assets in a written agreement. Because this approach is inconsistent
with the hypothetical sale approach of the regulations, this suggestion
has not been adopted.
4. Elections Under Section 754
One commentator requested that partnerships be granted a one-time
right to revoke section 754 elections in effect for such partnerships.
Given the significant changes to the rules made by these final
regulations as compared to the regulations that were in effect at the
time that section 754 elections previously were made, the IRS and
Treasury believe that it is appropriate to provide for a one-time
revocation of such elections. Accordingly, a partnership having an
election in effect under section 754 for its taxable year that includes
December 15, 1999 may revoke such election by attaching a statement to
the partnership's return for that year. The return must be filed on or
before the due date (including extensions) for the return for that
year.
5. Allocation of Basis Adjustments Among Partnership Assets
(a) Income in respect of a decedent. One commentator requested that
the final regulations illustrate the allocation of basis adjustments
among partnership assets where one or more of such assets represents
income in respect of a decedent. Where a partnership interest is
transferred as a result of the death of a partner, under section
1014(c) the transferee's basis in its partnership interest is not
adjusted for that portion of the interest, if any, which is
attributable to items representing income in respect of a decedent
under section 691. Because the transferee's basis in its partnership
interest does not include the value of assets which represent income in
respect of a decedent, the section 743(b) adjustment likewise does not
reflect the value of such assets. George Edward Quick's Trust, 54 TC
1336 (1970) (acq.), aff'd per curiam, 444 F.2d 90 (8th Cir. 1971);
Chrissie H. Woodhall, 28 T.C.M. 1438 (1969), aff'd, 454 F.2d 226 (9th
Cir. 1972); Rev. Rul. 66-325, 1966-2 C.B. 249. Where a partnership
holds assets that represent income in respect of a decedent, the
section 743(b) adjustment should be allocated solely to other assets.
Accordingly, the final regulations provide that if a partnership
interest is transferred as a result of the death of a partner, and the
partnership holds assets representing income in respect of a decedent,
no part of the basis adjustment under section 743(b) is allocated to
these assets.
(b) Transferred basis transactions. One commentator called for a
revised system for allocating basis adjustments under section 743(b)
which are triggered by exchanges in which the transferee's basis in the
interest is determined in whole or in part by reference to the
transferor's basis in the interest. In many such cases, the net section
743(b) adjustment will be zero. However, a positive or negative section
743(b) adjustment may result, because the transferee's basis in the
interest may not be equal to the transferee's share of the
partnership's bases in its assets.
The IRS and the Treasury Department believe that, although these
transferred basis transactions involve transfers which are subject to
section 743(b), the new, comprehensive basis allocation rules in the
proposed regulations should not be available. For example, where a
partnership interest is contributed to a corporation in a transaction
to which section 351 applies, or to a partnership in a transaction to
which section 721(a) applies, the transferor merely has changed the
form of its investment. If
[[Page 69906]]
the allocation rules which apply to other section 743(b) transfers were
applied to these exchanges, then partners could use these exchanges to
shift basis from capital gain assets to ordinary income assets, or vice
versa.
Therefore, the final regulations contain special basis allocation
rules for transferred basis exchanges. The special rules generally are
modeled on the rules for allocating basis adjustments under section
734(b). The final regulations do not contain a specific anti-abuse rule
regarding the special basis allocation rules which are applicable to
such transfers. However, there may be situations where taxpayers will
attempt to undertake abusive transactions using these special rules.
For instance, a partner could acquire a partnership interest during a
year in which no section 754 election is in effect, and then (in a
related transaction) contribute the property to a wholly-owned
corporation in order to take advantage of the basis allocation rules
applicable to transferred basis exchanges. In appropriate situations,
the IRS may attack such abusive transactions under a variety of
judicial doctrines, including substance over form or step transaction,
or under Sec. 1.701-2 of the regulations.
(c) Unrealized receivables under section 751(c). One commentator
requested that the final regulations illustrate the effect of
depreciation recapture on the allocation of basis adjustments among
partnership assets under section 755. For purposes of this section, the
final regulations treat depreciation recapture, and any other
properties or potential gain treated as unrealized receivables under
section 751(c) and the regulations thereunder, as separate assets that
are ordinary income property.
(d) Special rules for securities partnerships and tiered
partnerships. One commentator suggested that the regulations permit
securities partnerships to allocate basis adjustments among partnership
assets using an aggregation method. Another commentator requested that
the regulations clarify how the regulations would apply to tiered
partnerships. The IRS and the Treasury Department believe that a method
for allocating basis adjustments among partnership assets on an
aggregate basis is not consistent with the hypothetical sale of
individual assets, which is required by the regulations. In addition,
the IRS and Treasury Department believe that special rules for tiered
partnerships would make the regulations more complex. Therefore, these
changes have not been adopted.
6. Other Comments
One commentator suggested that for purposes of allocating basis
adjustments among partnership assets, the values of all partnership
assets should be determined by reference to the basis of the transferee
or distributee partner in its partnership interest. This suggestion is
being considered in connection with a separate project currently under
review by the IRS and the Treasury Department.
One commentator suggested that the language of section 743 does not
authorize regulations that permit both positive and negative
adjustments as part of the same transaction. The IRS and the Treasury
Department continue to believe that this aspect of the regulations is
within the IRS's authority to administer sections 743 and 755.
Special Analyses
It has been determined that these final regulations are not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has been
determined that a final regulatory flexibility analysis is required for
the collection of information in this Treasury decision under 5 U.S.C.
604. A summary of the analysis is set forth below under the heading
``Summary of Final Regulatory Flexibility Act Analysis.'' Pursuant to
section 7805(f) of the Internal Revenue Code, these final regulations
have been submitted to the Chief Counsel for Advocacy of the Small
Business Administration for comment on their impact on small business.
Summary of Final Regulatory Flexibility Act Analysis
This analysis is required under the Regulatory Flexibility Act (5
U.S.C. chapter 6). In general, the regulations require a transferee
that acquires an interest in a partnership with an election under
section 754 in effect to notify the partnership of the transfer. This
notification must include the name and taxpayer identification number
of the transferee and the transferee's basis in the acquired
partnership interest. The partnership is required to include a
statement with its Form 1065, U.S. Partnership Return of Income, for
the taxable year in which the partnership acquires knowledge of the
transfer. This statement must identify the name and taxpayer
identification number of the transferee, the computation of the basis
adjustment, and the allocation of that adjustment to partnership
properties. These requirements will ensure that the partnership has
notice that a transfer has occurred and that the proper basis
adjustments are computed. The legal basis for these requirements is
contained in sections 743(b), 6001, and 7805(a).
If an interest is transferred in a partnership holding domestic oil
and gas properties that are depleted at the partner level under
613A(c)(7)(D), the regulations require the transferee partner (rather
than the partnership) to make and allocate basis adjustments under
section 743(b) among such properties.
There were approximately 1,494,000 partnerships in 1994. However,
these regulations apply only to partnerships that have made an election
under section 754. The election under section 754 is generally not made
unless there has been a transfer of a partnership interest or a
distribution by the partnership. Moreover, the effects of the election
attach to specific items of partnership property and may provide only
temporary benefits for the partners. Except for the one-time revocation
which is allowed in connection with the promulgation of these final
regulations, the election cannot be revoked without the consent of the
Secretary. The IRS and the Treasury Department believe that most
partnerships do not make the election under section 754. Therefore,
most partnerships will not be affected by the regulations in any given
year.
After a partner conveys information to the partnership concerning a
transfer of a partnership interest, the partnership must adjust the
partner's interest in the basis of partnership property. Because these
basis adjustments will affect the partner's share of depreciation or
amortization deductions and amounts of gain or loss on the disposition
of certain items of partnership property, the partnership must prepare
and maintain special entries on its books. However, in many cases,
partnership returns are prepared using computer software that can
prepare and maintain these special entries after the initial year.
The IRS and the Treasury Department are not aware of any federal
rules that may duplicate, overlap, or conflict with the rule.
As an alternative to the disclosure described above, the IRS and
the Treasury Department considered, but rejected, a rule that would
have required the partners, and not the partnerships, to make the basis
adjustments and to determine the effects of the basis adjustments on
the partners' distributive shares. This alternative was rejected
because the IRS and the Treasury Department believe that partnerships
generally have better access to the information necessary to report
section 743 basis adjustments properly. To
[[Page 69907]]
require the partners rather than the partnerships to bear the burden of
reporting would require the partnerships to provide the partners with
significant amounts of information not otherwise needed by the
partners. There are no known alternative rules that are less burdensome
to the partnerships and their partners but that accomplish the purpose
of the statute.
Finally, because partners, rather than partnerships, are required
to report basis adjustments under section 732(d), the final regulations
require partnerships to provide transferees with such information as is
necessary for the transferees properly to compute basis adjustments
made under section 732(d). This information must be provided if a
transferee notifies a partnership that it plans to make the election
under section 732(d) or if a partnership makes a distribution subject
to the mandatory application of section 732(d). The IRS and the
Treasury Department believe that this requirement will apply under
limited circumstances to a small percentage of partnerships.
Drafting Information
The principal author of these regulations is Matthew Lay of the
Office of the Assistant Chief Counsel (Passthroughs and Special
Industries). However, other personnel from the IRS and the Treasury
Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.732-1 also issued under 26 U.S.C. 732.
Section 1.732-2 also issued under 26 U.S.C. 732.
Section 1.734-1 also issued under 26 U.S.C. 734.
Section 1.743-1 also issued under 26 U.S.C. 743.
Section 1.751-1 also issued under 26 U.S.C. 751.
Section 1.755-1 also issued under 26 U.S.C. 755. * * *
Section 1.1017-1 also issued under 26 U.S.C. 1017. * * *
Par. 2. Section 1.732-1 is amended as follows:
1. Revise paragraph (c).
2. Revise paragraph (d)(1)(ii).
3. Revise the last sentence of paragraph (d)(1)(v).
4. Revise paragraph (d)(1)(vi).
5. Revise paragraph (d)(4)(iii).
6. Remove the flush text and Examples 1 and 2 following paragraph
(d)(4)(iii).
7. Add paragraph (d)(5).
The additions and revisions read as follows:
Sec. 1.732-1 Basis of distributed property other than money.
* * * * *
(c) Allocation of basis among properties distributed to a partner--
(1) General rule--(i) Unrealized receivables and inventory items. The
basis to be allocated to properties distributed to a partner under
section 732(a)(2) or (b) is allocated first to any unrealized
receivables (as defined in section 751(c)) and inventory items (as
defined in section 751(d)(2)) in an amount equal to the adjusted basis
of each such property to the partnership immediately before the
distribution. If the basis to be allocated is less than the sum of the
adjusted bases to the partnership of the distributed unrealized
receivables and inventory items, the adjusted basis of the distributed
property must be decreased in the manner provided in paragraph
(c)(2)(i) of this section.
(ii) Other distributed property. Any basis not allocated to
unrealized receivables or inventory items under paragraph (c)(1)(i) of
this section is allocated to any other property distributed to the
partner in the same transaction by assigning to each distributed
property an amount equal to the adjusted basis of the property to the
partnership immediately before the distribution. However, if the sum of
the adjusted bases to the partnership of such other distributed
property does not equal the basis to be allocated among the distributed
property, any increase or decrease required to make the amounts equal
is allocated among the distributed property as provided in paragraph
(c)(2) of this section.
(2) Adjustment to basis allocation--(i) Decrease in basis. Any
decrease to the basis of distributed property required under paragraph
(c)(1) of this section is allocated first to distributed property with
unrealized depreciation in proportion to each property's respective
amount of unrealized depreciation before any decrease (but only to the
extent of each property's unrealized depreciation). If the required
decrease exceeds the amount of unrealized depreciation in the
distributed property, the excess is allocated to the distributed
property in proportion to the adjusted bases of the distributed
property, as adjusted pursuant to the immediately preceding sentence.
(ii) Increase in basis. Any increase to the basis of distributed
property required under paragraph (c)(1)(ii) of this section is
allocated first to distributed property (other than unrealized
receivables and inventory items) with unrealized appreciation in
proportion to each property's respective amount of unrealized
appreciation before any increase (but only to the extent of each
property's unrealized appreciation). If the required increase exceeds
the amount of unrealized appreciation in the distributed property, the
excess is allocated to the distributed property (other than unrealized
receivables or inventory items) in proportion to the fair market value
of the distributed property.
(3) Unrealized receivables and inventory items. If the basis to be
allocated upon a distribution in liquidation of the partner's entire
interest in the partnership is greater than the adjusted basis to the
partnership of the unrealized receivables and inventory items
distributed to the partner, and if there is no other property
distributed to which the excess can be allocated, the distributee
partner sustains a capital loss under section 731(a)(2) to the extent
of the unallocated basis of the partnership interest.
(4) Examples. The provisions of this paragraph (c) are illustrated
by the following examples:
Example 1. A is a one-fourth partner in partnership PRS and has
an adjusted basis in its partnership interest of $650. PRS
distributes inventory items and Assets X and Y to A in liquidation
of A's entire partnership interest. The distributed inventory items
have a basis to the partnership of $100 and a fair market value of
$200. Asset X has an adjusted basis to the partnership of $50 and a
fair market value of $400. Asset Y has an adjusted basis to the
partnership and a fair market value of $100. Neither Asset X nor
Asset Y consists of inventory items or unrealized receivables. Under
this paragraph (c), A's basis in its partnership interest is
allocated first to the inventory items in an amount equal to their
adjusted basis to the partnership. A, therefore, has an adjusted
basis in the inventory items of $100. The remaining basis, $550, is
allocated to the distributed property first in an amount equal to
the property's adjusted basis to the partnership. Thus, Asset X is
allocated $50 and Asset Y is allocated $100. Asset X is then
allocated $350, the amount of unrealized appreciation in Asset
[[Page 69908]]
X. Finally, the remaining basis, $50, is allocated to Assets X and Y
in proportion to their fair market values: $40 to Asset X (400/500
x $50), and $10 to Asset Y (100/500 x $50). Therefore, after the
distribution, A has an adjusted basis of $440 in Asset X and $110 in
Asset Y.
Example 2. B is a one-fourth partner in partnership PRS and has
an adjusted basis in its partnership interest of $200. PRS
distributes Asset X and Asset Y to B in liquidation of its entire
partnership interest. Asset X has an adjusted basis to the
partnership and fair market value of $150. Asset Y has an adjusted
basis to the partnership of $150 and a fair market value of $50.
Neither of the assets consists of inventory items or unrealized
receivables. Under this paragraph (c), B's basis is first assigned
to the distributed property to the extent of the partnership's basis
in each distributed property. Thus, Asset X and Asset Y are each
assigned $150. Because the aggregate adjusted basis of the
distributed property, $300, exceeds the basis to be allocated, $200,
a decrease of $100 in the basis of the distributed property is
required. Assets X and Y have unrealized depreciation of zero and
$100, respectively. Thus, the entire decrease is allocated to Asset
Y. After the distribution, B has an adjusted basis of $150 in Asset
X and $50 in Asset Y.
Example 3. C, a partner in partnership PRS, receives a
distribution in liquidation of its entire partnership interest of
$6,000 cash, inventory items having an adjusted basis to the
partnership of $6,000, and real property having an adjusted basis to
the partnership of $4,000. C's basis in its partnership interest is
$9,000. The cash distribution reduces C's basis to $3,000, which is
allocated entirely to the inventory items. The real property has a
zero basis in C's hands. The partnership bases not carried over to C
for the distributed properties are lost unless an election under
section 754 is in effect requiring the partnership to adjust the
bases of remaining partnership properties under section 734(b).
Example 4. Assume the same facts as in Example 3 of this
paragraph except C receives a distribution in liquidation of its
entire partnership interest of $1,000 cash and inventory items
having a basis to the partnership of $6,000. The cash distribution
reduces C's basis to $8,000, which can be allocated only to the
extent of $6,000 to the inventory items. The remaining $2,000 basis,
not allocable to the distributed property, constitutes a capital
loss to partner C under section 731(a)(2). If the election under
section 754 is in effect, see section 734(b) for adjustment of the
basis of undistributed partnership property.
(5) Effective date. This paragraph (c) applies to distributions of
property from a partnership that occur on or after December 15, 1999.
(d) * * *
(1) * * *
(ii) Where an election under section 754 is in effect, see section
743(b) and Secs. 1.743-1 and 1.732-2.
* * * * *
(v) * * * (For a shift of transferee's basis adjustment under
section 743(b) to like property, see Sec. 1.743-1(g).)
(vi) The provisions of this paragraph (d)(1) may be illustrated by
the following example:
Example. (i) Transferee partner, T, purchased a one-fourth
interest in partnership PRS for $17,000. At the time T purchased the
partnership interest, the election under section 754 was not in
effect and the partnership inventory had a basis to the partnership
of $14,000 and a fair market value of $16,000. T's purchase price
reflected $500 of this difference. Thus, $4,000 of the $17,000 paid
by T for the partnership interest was attributable to T's share of
partnership inventory with a basis of $3,500. Within 2 years after T
acquired the partnership interest, T retired from the partnership
and received in liquidation of its entire partnership interest the
following property:
------------------------------------------------------------------------
Assets
-------------------------------
Adjusted basis Fair market
to PRS value
------------------------------------------------------------------------
Cash.................................... $1,500 $1,500
Inventory............................... 3,500 4,000
Asset X................................. 2,000 4,000
Asset Y................................. 4,000 5,000
------------------------------------------------------------------------
(ii) The fair market value of the inventory received by T was
one-fourth of the fair market value of all partnership inventory and
was T's share of such property. It is immaterial whether the
inventory T received was on hand when T acquired the interest. In
accordance with T's election under section 732(d), the amount of T's
share of partnership basis that is attributable to partnership
inventory is increased by $500 (one-fourth of the $2,000 difference
between the fair market value of the property, $16,000, and its
$14,000 basis to the partnership at the time T purchased its
interest). This adjustment under section 732(d) applies only for
purposes of distributions to T, and not for purposes of partnership
depreciation, depletion, or gain or loss on disposition. Thus, the
amount to be allocated among the properties received by T in the
liquidating distribution is $15,500 ($17,000, T's basis for the
partnership interest, reduced by the amount of cash received,
$1,500). This amount is allocated as follows: The basis of the
inventory items received is $4,000, consisting of the $3,500 common
partnership basis, plus the basis adjustment of $500 which T would
have had under section 743(b). The remaining basis of $11,500
($15,500 minus $4,000) is allocated among the remaining property
distributed to T by assigning to each property the adjusted basis to
the partnership of such property and adjusting that basis by any
required increase or decrease. Thus, the adjusted basis to T of
Asset X is $5,111 ($2,000, the adjusted basis of Asset X to the
partnership, plus $2,000, the amount of unrealized appreciation in
Asset X, plus $1,111 ($4,000/$9,000 multiplied by $2,500)).
Similarly, the adjusted basis of Asset Y to T is $6,389 ($4,000, the
adjusted basis of Asset Y to the partnership, plus $1,000, the
amount of unrealized appreciation in Asset Y, plus, $1,389 ($5,000/
$9,000 multiplied by $2,500)).
* * * * *
(4) * * *
(iii) A basis adjustment under section 743(b) would change the
basis to the transferee partner of the property actually distributed.
(5) Required statements. If a transferee partner notifies a
partnership that it plans to make the election under section 732(d)
under paragraph (d)(3) of this section, or if a partnership makes a
distribution to which paragraph (d)(4) of this section applies, the
partnership must provide the transferee with such information as is
necessary for the transferee properly to compute the transferee's basis
adjustments under section 732(d).
* * * * *
Par. 3. Section 1.732-2 is amended by revising the sentence at the
end of the Example in paragraph (b) to read as follows:
Sec. 1.732-2 Special partnership basis of distributed property.
* * * * *
(b) * * *
Example. * * * See Sec. 1.743-1(g).
* * * * *
Par. 4. In Sec. 1.734-1, paragraph (e) is added to read as follows:
Sec. 1.734-1 Optional adjustment to basis of undistributed partnership
property.
* * * * *
(e) Recovery of adjustments to basis of partnership property--(1)
Increases in basis. For purposes of section 168, if the basis of a
partnership's recovery property is increased as a result of the
distribution of property to a partner, then the increased portion of
the basis
[[Page 69909]]
must be taken into account as if it were newly-purchased recovery
property placed in service when the distribution occurs. Consequently,
any applicable recovery period and method may be used to determine the
recovery allowance with respect to the increased portion of the basis.
However, no change is made for purposes of determining the recovery
allowance under section 168 for the portion of the basis for which
there is no increase.
(2) Decreases in basis. For purposes of section 168, if the basis
of a partnership's recovery property is decreased as a result of the
distribution of property to a partner, then the decrease in basis must
be accounted for over the remaining recovery period of the property
beginning with the recovery period in which the basis is decreased.
(3) Effective date. This paragraph (e) applies to distributions of
property from a partnership that occur on or after December 15, 1999.
Par. 5. Section 1.743-1 is revised to read as follows:
Sec. 1.743-1 Optional adjustment to basis of partnership property.
(a) Generally. 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 only 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.
Whether or not the election provided in section 754 is in effect, the
basis of partnership property is not adjusted as the result of a
contribution of property, including money, to the partnership.
(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--
(1) Increases the adjusted basis of partnership property by the
excess of the transferee's basis for the transferred partnership
interest over the transferee's share of the adjusted basis to the
partnership of the partnership's property; or
(2) Decreases the adjusted basis of partnership property by the
excess of the transferee's share of the adjusted basis to the
partnership of the partnership's property over the transferee's basis
for the transferred partnership interest.
(c) Determination of transferee's basis in the transferred
partnership interest. In the case of the transfer of a partnership
interest by sale or exchange or as a result of the death of a partner,
the transferee's basis in the transferred partnership interest is
determined under section 742 and Sec. 1.742-1. See also section 752 and
Secs. 1.752-1 through 1.752-5.
(d) Determination of transferee's share of the adjusted basis to
the partnership of the partnership's property--(1) Generally. A
transferee's share of the adjusted basis to the partnership of
partnership property is equal to the sum of the transferee's interest
as a partner in the partnership's previously taxed capital, plus the
transferee's share of partnership liabilities. Generally, a
transferee's interest as a partner in the partnership's previously
taxed capital is equal to--
(i) The amount of cash that the transferee would receive on a
liquidation of the partnership following the hypothetical transaction,
as defined in paragraph (d)(2) of this section (to the extent
attributable to the acquired partnership interest); increased by
(ii) The amount of tax loss (including any remedial allocations
under Sec. 1.704-3(d)), that would be allocated to the transferee from
the hypothetical transaction (to the extent attributable to the
acquired partnership interest); and decreased by
(iii) The amount of tax gain (including any remedial allocations
under Sec. 1.704-3(d)), that would be allocated to the transferee from
the hypothetical transaction (to the extent attributable to the
acquired partnership interest).
(2) Hypothetical transaction defined. For purposes of paragraph
(d)(1) of this section, the hypothetical transaction means the
disposition by the partnership of all of the partnership's assets,
immediately after the transfer of the partnership interest, in a fully
taxable transaction for cash equal to the fair market value of the
assets.
(3) Examples. The provisions of this paragraph (d) are illustrated
by the following examples:
Example 1. (i) A is a member of partnership PRS in which the
partners have equal interests in capital and profits. The
partnership has made an election under section 754, relating to the
optional adjustment to the basis of partnership property. A sells
its interest to T for $22,000. The balance sheet of the partnership
at the date of sale shows the following:
------------------------------------------------------------------------
Assets
-------------------------------
Fair market
Adjusted basis value
------------------------------------------------------------------------
Cash.................................... $5,000 $5,000
Accounts receivable..................... 10,000 10,000
Inventory............................... 20,000 21,000
Depreciable assets...................... 20,000 40,000
-------------------------------
Total............................... 55,000 76,000
------------------------------------------------------------------------
------------------------------------------------------------------------
Liabilities and Capital
-------------------------------
Adjusted per Fair market
books value
------------------------------------------------------------------------
Liabilities............................. $10,000 $10,000
Capital:
A................................... 15,000 22,000
B................................... 15,000 22,000
C................................... 15,000 22,000
-------------------------------
Total........................... 55,000 76,000
------------------------------------------------------------------------
[[Page 69910]]
(ii) The amount of the basis adjustment under section 743(b) is
the difference between the basis of T's interest in the partnership
and T's share of the adjusted basis to the partnership of the
partnership's property. Under section 742, the basis of T's interest
is $25,333 (the cash paid for A's interest, $22,000, plus $3,333,
T's share of partnership liabilities). T's interest in the
partnership's previously taxed capital is $15,000 ($22,000, the
amount of cash T would receive if PRS liquidated immediately after
the hypothetical transaction, decreased by $7,000, the amount of tax
gain allocated to T from the hypothetical transaction). T's share of
the adjusted basis to the partnership of the partnership's property
is $18,333 ($15,000 share of previously taxed capital, plus $3,333
share of the partnership's liabilities). The amount of the basis
adjustment under section 743(b) to partnership property therefore,
is $7,000, the difference between $25,333 and $18,333.
Example 2. A, B, and C form partnership PRS, to which A
contributes land (Asset 1) with a fair market value of $1,000 and an
adjusted basis to A of $400, and B and C each contribute $1,000
cash. Each partner has $1,000 credited to it on the books of the
partnership as its capital contribution. The partners share in
profits equally. During the partnership's first taxable year, Asset
1 appreciates in value to $1,300. A sells its one-third interest in
the partnership to T for $1,100, when an election under section 754
is in effect. The amount of tax gain that would be allocated to T
from the hypothetical transaction is $700 ($600 section 704(c)
built-in gain, plus one-third of the additional gain). Thus, T's
interest in the partnership's previously taxed capital is $400
($1,100, the amount of cash T would receive if PRS liquidated
immediately after the hypothetical transaction, decreased by $700,
T's share of gain from the hypothetical transaction). The amount of
T's basis adjustment under section 743(b) to partnership property is
$700 (the excess of $1,100, T's cost basis for its interest, over
$400, T's share of the adjusted basis to the partnership of
partnership property).
(e) Allocation of basis adjustment. For the allocation of the basis
adjustment under this section among the individual items of partnership
property, see section 755 and the regulations thereunder.
(f) Subsequent transfers. 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 provisions of this paragraph (f) are illustrated by the following
example:
Example. (i) A, B, and C form partnership PRS. A and B each
contribute $1,000 cash, and C contributes land with a basis and fair
market value of $1,000. When the land has appreciated in value to
$1,300, A sells its interest to T1 for $1,100 (one-third of $3,300,
the fair market value of the partnership property). An election
under section 754 is in effect; therefore, T1 has a basis adjustment
under section 743(b) of $100.
(ii) After the land has further appreciated in value to $1,600,
T1 sells its interest to T2 for $1,200 (one-third of $3,600, the
fair market value of the partnership property). T2 has a basis
adjustment under section 743(b) of $200. This amount is determined
without regard to any basis adjustment under section 743(b) that T1
may have had in the partnership assets.
(iii) During the following year, T2 makes a gift to T3 of fifty
percent of T2's interest in PRS. At the time of the transfer, T2 has
a $200 basis adjustment under section 743(b). T2 is treated as
transferring $100 of the basis adjustment to T3 with the gift of the
partnership interest.
(g) Distributions--(1) Distribution of adjusted property to the
transferee--(i) Coordination with section 732. If a partnership
distributes property to a transferee and the transferee has a basis
adjustment for the property, the basis adjustment is taken into account
under section 732. See Sec. 1.732-2(b).
(ii) Coordination with section 734. For certain adjustments to the
common basis of remaining partnership property after the distribution
of adjusted property to a transferee, see Sec. 1.734-2(b).
(2) Distribution of adjusted property to another partner--(i)
Coordination with section 732. If a partner receives a distribution of
property with respect to which another partner has a basis adjustment,
the distributee does not take the basis adjustment into account under
section 732.
(ii) Reallocation of basis. A transferee with a basis adjustment in
property that is distributed to another partner reallocates the basis
adjustment among the remaining items of partnership property under
Sec. 1.755-1(c).
(3) Distributions in complete liquidation of a partner's interest.
If a transferee receives a distribution of property (whether or not the
transferee has a basis adjustment in such 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 transferee's basis adjustment for the property in which
the transferee relinquished an interest (either because it remained in
the partnership or was distributed to another partner). Any basis
adjustment for property in which the transferee is deemed to relinquish
its interest is reallocated among the properties distributed to the
transferee under Sec. 1.755-1(c).
(4) Coordination with other provisions. The rules of sections
704(c)(1)(B), 731, 737, and 751 apply before the rules of this
paragraph (g).
(5) Example. The provisions of this paragraph (g) are illustrated
by the following example:
Example. (i) A, B, and C are equal partners in partnership PRS.
Each partner originally contributed $10,000 in cash, and PRS used
the contributions to purchase five nondepreciable capital assets.
PRS has no liabilities. After five years, PRS's balance sheet
appears as follows:
------------------------------------------------------------------------
Assets
-------------------------------
Fair market
Adjusted basis value
------------------------------------------------------------------------
Asset 1................................. $10,000 $10,000
Asset 2................................. 4,000 6,000
Asset 3................................. 6,000 6,000
Asset 4................................. 7,000 4,000
Asset 5................................. 3,000 13,000
-------------------------------
Total............................... 30,000 39,000
------------------------------------------------------------------------
[[Page 69911]]
------------------------------------------------------------------------
Capital
-------------------------------
Adjusted per Fair market
books value
------------------------------------------------------------------------
Partner A............................... $10,000 $13,000
Partner B............................... 10,000 13,000
Partner C............................... 10,000 13,000
-------------------------------
Total............................... 30,000 39,000
------------------------------------------------------------------------
(ii) A sells its interest to T for $13,000 when PRS has an
election in effect under section 754. T receives a basis adjustment
under section 743(b) in the partnership property that is equal to
$3,000 (the excess of T's basis in the partnership interest,
$13,000, over T's share of the adjusted basis to the partnership of
partnership property, $10,000). The basis adjustment is allocated
under section 755, and the partnership's balance sheet appears as
follows:
----------------------------------------------------------------------------------------------------------------
Assets
-----------------------------------------------
Fair market Basis
Adjusted basis value adjustment
----------------------------------------------------------------------------------------------------------------
Asset 1......................................................... $10,000 $10,000 $0.00
Asset 2......................................................... 4,000 6,000 666.67
Asset 3......................................................... 6,000 6,000 0.00
Asset 4......................................................... 7,000 4,000 (1,000.00)
Asset 5......................................................... 3,000 13,000 3,333.33
-----------------------------------------------
Total....................................................... 30,000 39,000 3,000.00
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Capital
-----------------------------------------------
Adjusted per Fair market
books value Special basis
----------------------------------------------------------------------------------------------------------------
Partner T....................................................... $10,000 $13,000 $3,000
Partner B....................................................... 10,000 13,000 0
Partner C....................................................... 10,000 13,000 0
-----------------------------------------------
Total....................................................... 30,000 39,000 3,000
----------------------------------------------------------------------------------------------------------------
(iii) Assume that PRS distributes Asset 2 to T in partial
liquidation of T's interest in the partnership. T has a basis
adjustment under section 743(b) of $666.67 in Asset 2. Under
paragraph (g)(1)(i) of this section, T takes the basis adjustment
into account under section 732. Therefore, T will have a basis in
Asset 2 of $4,666.67 following the distribution.
(iv) Assume instead that PRS distributes Asset 5 to C in
complete liquidation of C's interest in PRS. T has a basis
adjustment under section 743(b) of $3,333.33 in Asset 5. Under
paragraph (g)(2)(i) of this section, C does not take T's basis
adjustment into account under section 732. Therefore, the
partnership's basis for purposes of sections 732 and 734 is $3,000.
Under paragraph (g)(2)(ii) of this section, T's $3,333.33 basis
adjustment is reallocated among the remaining partnership assets
under Sec. 1.755-1(c).
(v) Assume instead that PRS distributes Asset 5 to T in complete
liquidation of its interest in PRS. Under paragraph (g)(3) of this
section, immediately prior to the distribution of Asset 5 to T, PRS
must adjust the basis of Asset 5. Therefore, immediately prior to
the distribution, PRS's basis in Asset 5 is equal to $6,000, which
is the sum of (A) $3,000, PRS's common basis in Asset 5, plus (B)
$3,333.33, T's basis adjustment to Asset 5, plus (C) ($333.33), the
sum of T's basis adjustments in Assets 2 and 4. For purposes of
sections 732 and 734, therefore, PRS will be treated as having a
basis in Asset 5 equal to $6,000.
(h) Contributions of adjusted property--(1) Section 721(a)
transactions. If, in a transaction described in section 721(a), a
partnership (the upper tier) contributes to another partnership (the
lower tier) property with respect to which a basis adjustment has been
made, the basis adjustment is treated as contributed to the lower-tier
partnership, regardless of whether the lower-tier partnership makes a
section 754 election. The lower tier's basis in the contributed assets
and the upper tier's basis in the partnership interest received in the
transaction are determined with reference to the basis adjustment.
However, that portion of the basis of the upper tier's interest in the
lower tier attributable to the basis adjustment must be segregated and
allocated solely to the transferee partner for whom the basis
adjustment was made. Similarly, that portion of the lower tier's basis
in its assets attributable to the basis adjustment must be segregated
and allocated solely to the upper tier and the transferee. A partner
with a basis adjustment in property held by a partnership that
terminates under section 708(b)(1)(B) will continue to have the same
basis adjustment with respect to property deemed contributed by the
terminated partnership to the new partnership under Sec. 1.708-
1(b)(1)(iv), regardless of whether the new partnership makes a section
754 election.
(2) Section 351 transactions--(i) Basis in transferred property. A
corporation's adjusted tax basis in property transferred to the
corporation by a partnership in a transaction described in section 351
is determined with reference to any basis adjustments to the property
under section 743(b) (other than any basis adjustment that reduces a
partner's gain under paragraph (h)(2)(ii) of this section).
(ii) Partnership gain. The amount of gain, if any, recognized by
the partnership on a transfer of property by the partnership to a
corporation in a transfer described in section 351 is determined
without reference to any basis adjustment to the transferred property
under section 743(b). The amount of gain, if any, recognized by the
partnership on the transfer that is allocated to a partner with a basis
adjustment in the transferred property is
[[Page 69912]]
adjusted to reflect the partner's basis adjustment in the transferred
property.
(iii) Basis in stock. The partnership's adjusted tax basis in stock
received from a corporation in a transfer described in section 351 is
determined without reference to the basis adjustment in property
transferred to the corporation in the section 351 exchange. A partner
with a 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 basis adjustment in the transferred property, reduced by any
basis adjustment that reduced the partner's gain under paragraph
(h)(2)(ii) of this section.
(iv) Example. The following example illustrates the principles of
this paragraph (h):
Example. (i) A, B, and C are equal partners in partnership PRS.
The partnership's only asset, Asset 1, has an adjusted tax basis of
$60 and a fair market value of $120. Asset 1 is a nondepreciable
capital asset and is not section 704(c) property. A has a basis in
its partnership interest of $40, and a positive section 743(b)
adjustment of $20 in Asset 1. In a transaction to which section 351
applies, PRS contributes Asset 1 to X, a corporation, in exchange
for $15 in cash and X stock with a fair market value of $105.
(ii) Under paragraph (h)(2)(ii) of this section, PRS realizes
$60 of gain on the transfer of Asset 1 to X ($120, its amount
realized, minus $60, its adjusted basis), but recognizes only $15 of
that gain under section 351(b)(1). Of this amount, $5 is allocated
to each partner. A must use $5 of its basis adjustment in Asset 1 to
offset A's share of PRS's gain. Under paragraph (h)(2)(iii) of this
section, PRS's basis in the stock received from X is $60. However, A
has a basis adjustment in the stock received by PRS equal to $15
(its basis adjustment in Asset 1, $20, reduced by the portion of the
adjustment which reduced A's gain, $5). Under paragraph (h)(2)(i) of
this section, X's basis in Asset 1 equals $75 (PRS's common basis in
the asset, $60, plus A's basis adjustment under section 743(b), $20,
less the portion of the adjustment which reduced A's gain, $5).
(i) [Reserved].
(j) Effect of basis adjustment--(1) In general. The basis
adjustment constitutes an adjustment to the basis of partnership
property with respect to the transferee only. No adjustment is made to
the common basis of partnership property. Thus, for purposes of
calculating income, deduction, gain, and loss, the transferee will have
a special basis for those partnership properties the bases of which are
adjusted under section 743(b) and this section. The adjustment to the
basis of partnership property under section 743(b) has no effect on the
partnership's computation of any item under section 703.
(2) Computation of 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 transferee, in accordance with section 704, and adjusts
the partners' capital accounts accordingly. The partnership then
adjusts the transferee's distributive share of the items of partnership
income, deduction, gain, or loss, in accordance with paragraphs (j)(3)
and (4) of this section, to reflect the effects of the transferee's
basis adjustment under section 743(b). These adjustments to the
transferee's distributive shares must be reflected on Schedules K and
K-1 of the partnership's return (Form 1065). These adjustments to the
transferee's distributive shares do not affect the transferee's capital
account.
(3) Effect of basis adjustment in determining items of income,
gain, or loss--(i) In general. The amount of a transferee's income,
gain, or loss from the sale or exchange of a partnership asset in which
the transferee has a basis adjustment is equal to the transferee's
share of the partnership's gain or loss from the sale of the asset
(including any remedial allocations under Sec. 1.704-3(d)), minus the
amount of the transferee's positive basis adjustment for the
partnership asset (determined by taking into account the recovery of
the basis adjustment under paragraph (j)(4)(i)(B) of this section) or
plus the amount of the transferee's negative basis adjustment for the
partnership asset (determined by taking into the account the recovery
of the basis adjustment under paragraph (j)(4)(ii)(B) of this section).
(ii) Examples. The following examples illustrate the principles of
this paragraph (j)(3):
Example 1. A and B form equal partnership PRS. A contributes
nondepreciable property with a fair market value of $50 and an
adjusted tax basis of $100. PRS will use the traditional allocation
method under Sec. 1.704-3(b). B contributes $50 cash. A sells its
interest to T for $50. PRS has an election in effect to adjust the
basis of partnership property 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 then
sells the property for $60. PRS recognizes a book gain of $10
(allocated equally between T and B) and a tax loss of $40. 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 2. A and B form equal partnership PRS. A contributes
nondepreciable property with a fair market value of $100 and an
adjusted tax basis of $50. B contributes $100 cash. PRS will use the
traditional allocation method under Sec. 1.704-3(b). A sells its
interest to T for $100. PRS has an election in effect to adjust the
basis of partnership property under section 754. Therefore, T
receives a $50 basis adjustment under section 743(b) that, under
section 755, is allocated to the nondepreciable property. PRS then
sells the nondepreciable property for $90. PRS recognizes a book
loss of $10 (allocated equally between T and B) and a tax gain of
$40. T will receive an allocation of the entire $40 of tax gain
under the principles of section 704(c). However, because T has a $50
basis adjustment in the property, T recognizes a $10 loss from the
partnership's sale of the property.
Example 3. A and B form equal partnership PRS. PRS will make
allocations under section 704(c) using the remedial allocation
method described in Sec. 1.704-3(d). A contributes nondepreciable
property with a fair market value of $100 and an adjusted tax basis
of $150. B contributes $100 cash. A sells its partnership interest
to T for $100. PRS has an election in effect to adjust the basis of
partnership property under section 754. T receives a negative $50
basis adjustment under section 743(b) that, under section 755, is
allocated to the property. The partnership then sells the property
for $120. The partnership recognizes a $20 book gain and a $30 tax
loss. The book gain will be allocated equally between the partners.
The entire $30 tax loss will be allocated to T under the principles
of section 704(c). To match its $10 share of book gain, B will be
allocated $10 of remedial gain, and T will be allocated an
offsetting $10 of remedial loss. T was allocated a total of $40 of
tax loss with respect to the property. However, because T has a
negative $50 basis adjustment to the property, T recognizes a $10
gain from the partnership's sale of the property.
(4) Effect of basis adjustment in determining items of deduction--
(i) Increases--(A) Additional deduction. The amount of any positive
basis adjustment that is recovered by the transferee in any year is
added to the transferee'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 basis adjustment.
(B) Recovery period--(1) In general. Except as provided in
paragraph (j)(4)(i)(B)(2) of this section, for purposes of section 168,
if the basis of a partnership's recovery property is increased as a
result of the transfer of a partnership interest, then the increased
portion of the basis is taken into account as if it were newly-
purchased recovery
[[Page 69913]]
property placed in service when the transfer occurs. Consequently, any
applicable recovery period and method may be used to determine the
recovery allowance with respect to the increased portion of the basis.
However, no change is made for purposes of determining the recovery
allowance under section 168 for the portion of the basis for which
there is no increase.
(2) Remedial allocation method. If a partnership elects to use the
remedial allocation method described in Sec. 1.704-3(d) with respect to
an item of the partnership's recovery property, then the portion of any
increase in the basis of the item of the partnership's recovery
property under section 743(b) that is attributable to section 704(c)
built-in gain is recovered over the remaining recovery period for the
partnership's excess book basis in the property as determined in the
final sentence of Sec. 1.704-3(d)(2). Any remaining portion of the
basis increase is recovered under paragraph (j)(4)(i)(B)(1) of this
section.
(C) Examples. The provisions of this paragraph (j)(4)(i) are
illustrated by the following examples:
Example 1. (i) A, B, and C are equal partners in partnership
PRS, which owns Asset 1, an item of depreciable property that has a
fair market value in excess of its adjusted tax basis. C sells its
interest in PRS to T while PRS has an election in effect under
section 754. PRS, therefore, increases the basis of Asset 1 with
respect to T.
(ii) Assume that in the year following the transfer of the
partnership interest to T, T's distributive share of the
partnership's common basis depreciation deductions from Asset 1 is
$1,000. Also assume that, under paragraph (j)(4)(i)(B) of this
section, the amount of the basis adjustment under section 743(b)
that T recovers during the year is $500. The total amount of
depreciation deductions from Asset 1 reported by T is equal to
$1,500.
Example 2. (i) A and B form equal partnership PRS. A contributes
property with an adjusted basis of $100,000 and a fair market value
of $500,000. B contributes $500,000 cash. When PRS is formed, the
property has five years remaining in its recovery period. The
partnership's adjusted basis of $100,000 will, therefore, be
recovered over the five years remaining in the property's recovery
period. PRS elects to use the remedial allocation method under
Sec. 1.704-3(d) with respect to the property. If PRS had purchased
the property at the time of the partnership's formation, the basis
of the property would have been recovered over a 10-year period. The
$400,000 of section 704(c) built-in gain will, therefore, be
amortized under Sec. 1.704-3(d) over a 10-year period beginning at
the time of the partnership's formation.
(ii)(A) Except for the depreciation deductions, PRS's expenses
equal its income in each year of the first two years commencing with
the year the partnership is formed. After two years, A's share of
the adjusted basis of partnership property is $120,000, while B's is
$440,000:
----------------------------------------------------------------------------------------------------------------
Capital accounts
---------------------------------------------------------------
A B
---------------------------------------------------------------
Book Tax Book Tax
----------------------------------------------------------------------------------------------------------------
Initial Contribution............................ $500,000 $100,000 $500,000 $500,000
Depreciation Year 1............................. (30,000) .............. (30,000) (20,000)
Remedial........................................ .............. 10,000 .............. (10,000)
---------------------------------------------------------------
470,000 110,000 470,000 470,000
Depreciation Year 2............................. (30,000) .............. (30,000) (20,000)
Remedial........................................ .............. 10,000 .............. (10,000)
---------------------------------------------------------------
440,000 120,000 440,000 440,000
----------------------------------------------------------------------------------------------------------------
(B) A sells its interest in PRS to T for its fair market value
of $440,000. A valid election under section 754 is in effect with
respect to the sale of the partnership interest. Accordingly, PRS
makes an adjustment, pursuant to section 743(b), to increase the
basis of partnership property. Under section 743(b), the amount of
the basis adjustment is equal to $320,000. Under section 755, the
entire basis adjustment is allocated to the property.
(iii) At the time of the transfer, $320,000 of section 704(c)
built-in gain from the property was still reflected on the
partnership's books, and all of the basis adjustment is attributable
to section 704(c) built-in gain. Therefore, the basis adjustment
will be recovered over the remaining recovery period for the section
704(c) built-in gain under Sec. 1.704-3(d).
(ii) Decreases--(A) Reduced deduction. The amount of any negative
basis adjustment allocated to an item of depreciable or amortizable
property that is recovered in any year first decreases the transferee's
distributive share of the partnership's depreciation or amortization
deductions from that item of property for the year. If the amount of
the basis adjustment recovered in any year exceeds the transferee's
distributive share of the partnership's depreciation or amortization
deductions from the item of property, then the transferee's
distributive share of the partnership's depreciation or amortization
deductions from other items of partnership property is decreased. The
transferee then recognizes ordinary income to the extent of the excess,
if any, of the amount of the basis adjustment recovered in any year
over the transferee's distributive share of the partnership's
depreciation or amortization deductions from all items of property.
(B) Recovery period. For purposes of section 168, if the basis of
an item of a partnership's recovery property is decreased as the result
of the transfer of an interest in the partnership, then the decrease is
recovered over the remaining useful life of the item of the
partnership's recovery property. The portion of the decrease that is
recovered in any year during the recovery period is equal to the
product of--
(1) The amount of the decrease to the item's adjusted basis
(determined as of the date of the transfer); multiplied by
(2) A fraction, the numerator of which is the portion of the
adjusted basis of the item recovered by the partnership in that year,
and the denominator of which is the adjusted basis of the item on the
date of the transfer (determined prior to any basis adjustments).
(C) Examples. The provisions of this paragraph (j)(4)(ii) are
illustrated by the following examples:
Example 1. (i) A, B, and C are equal partners in partnership
PRS, which owns Asset 2, an item of depreciable property that has a
fair market value that is less than its adjusted tax basis. C sells
its interest in PRS to T while PRS has an election in effect under
section 754. PRS, therefore, decreases the basis of Asset 2 with
respect to T.
(ii) Assume that in the year following the transfer of the
partnership interest to T, T's distributive share of the
partnership's common basis depreciation deductions from Asset 2 is
$1,000. Also assume that, under paragraph (j)(4)(ii)(B) of this
section, the amount of the basis adjustment under section 743(b)
that T recovers during the year is $500. The total amount of
depreciation
[[Page 69914]]
deductions from Asset 2 reported by T is equal to $500.
Example 2. (i) A and B form equal partnership PRS. A contributes
property with an adjusted basis of $100,000 and a fair market value
of $50,000. B contributes $50,000 cash. When PRS is formed, the
property has five years remaining in its recovery period. The
partnership's adjusted basis of $100,000 will, therefore, be
recovered over the five years remaining in the property's recovery
period. PRS uses the traditional allocation method under Sec. 1.704-
3(b) with respect to the property. As a result, B will receive
$5,000 of depreciation deductions from the property in each of years
1-5, and A, as the contributing partner, will receive $15,000 of
depreciation deductions in each of these years.
(ii) Except for the depreciation deductions, PRS's expenses
equal its income in each of the first two years commencing with the
year the partnership is formed. After two years, A's share of the
adjusted basis of partnership property is $70,000, while B's is
$40,000. A sells its interest in PRS to T for its fair market value
of $40,000. A valid election under section 754 is in effect with
respect to the sale of the partnership interest. Accordingly, PRS
makes an adjustment, pursuant to section 743(b), to decrease the
basis of partnership property. Under section 743(b), the amount of
the adjustment is equal to ($30,000). Under section 755, the entire
adjustment is allocated to the property.
(iii) The basis of the property at the time of the transfer of
the partnership interest was $60,000. In each of years 3 through 5,
the partnership will realize depreciation deductions of $20,000 from
the property. Thus, one third of the negative basis adjustment
($10,000) will be recovered in each of years 3 through 5.
Consequently, T will be allocated, for tax purposes, depreciation of
$15,000 each year from the partnership and will recover $10,000 of
its negative basis adjustment. Thus, T's net depreciation deduction
from the partnership in each year is $5,000.
Example 3. (i) A, B, and C are equal partners in partnership
PRS, which owns Asset 2, an item of depreciable property that has a
fair market value that is less than its adjusted tax basis. C sells
its interest in PRS to T while PRS has an election in effect under
section 754. PRS, therefore, decreases the basis of Asset 2 with
respect to T.
(ii) Assume that in the year following the transfer of the
partnership interest to T, T's distributive share of the
partnership's common basis depreciation deductions from Asset 2 is
$500. PRS allocates no other depreciation to T. Also assume that,
under paragraph (j)(4)(ii)(B) of this section, the amount of the
negative basis adjustment that T recovers during the year is $1,000.
T will report $500 of ordinary income because the amount of the
negative basis adjustment recovered during the year exceeds T's
distributive share of the partnership's common basis depreciation
deductions from Asset 2.
(5) Depletion. Where an adjustment is made under section 743(b) to
the basis of partnership property subject to depletion, any depletion
allowance is determined separately for each partner, including the
transferee partner, based on the partner's interest in such property.
See Sec. 1.702-1(a)(8). For partnerships that hold oil and gas
properties that are depleted at the partner level under section
613A(c)(7)(D), the transferee partner (and not the partnership) must
make the basis adjustments, if any, required under section 743(b) with
respect to such properties. See Sec. 1.613A-3(e)(6)(iv).
(6) Example. The provisions of paragraph (j)(5) of this section are
illustrated by the following example:
Example. A, B, and C each contributes $5,000 cash to form
partnership PRS, which purchases a coal property for $15,000. A, B,
and C have equal interests in capital and profits. C subsequently
sells its partnership interest to T for $100,000 when the election
under section 754 is in effect. T has a basis adjustment under
section 743(b) for the coal property of $95,000 (the difference
between T's basis, $100,000, and its share of the basis of
partnership property, $5,000). Assume that the depletion allowance
computed under the percentage method would be $21,000 for the
taxable year so that each partner would be entitled to $7,000 as its
share of the deduction for depletion. However, under the cost
depletion method, at an assumed rate of 10 percent, the allowance
with respect to T's one-third interest which has a basis to him of
$100,000 ($5,000, plus its basis adjustment of $95,000) is $10,000,
although the cost depletion allowance with respect to the one-third
interest of A and B in the coal property, each of which has a basis
of $5,000, is only $500. For partners A and B, the percentage
depletion is greater than cost depletion and each will deduct $7,000
based on the percentage depletion method. However, as to T, the
transferee partner, the cost depletion method results in a greater
allowance and T will, therefore, deduct $10,000 based on cost
depletion. See section 613(a).
(k) Returns--(1) Statement of adjustments--(i) In general. A
partnership that must adjust the bases of partnership properties under
section 743(b) must attach a statement to the partnership return for
the year of the transfer setting forth the name and taxpayer
identification number of the transferee as well as the computation of
the adjustment and the partnership properties to which the adjustment
has been allocated.
(ii) Special rule. Where an interest is transferred in a
partnership which holds oil and gas properties that are depleted at the
partner level under section 613A(c)(7)(D), the transferee must attach a
statement to the transferee's return for the year of the transfer,
setting forth the computation of the basis adjustment under section
743(b) which is allocable to such properties and the specific
properties to which the adjustment has been allocated.
(iii) Example. The provisions of paragraph (k)(1)(ii) of this
section are illustrated by the following example:
Example. (i) Partnership XYZ owns a single section 613A(c)(7)(D)
domestic oil and gas property (Property) and other non-depletable
assets. A, a partner in XYZ with an adjusted tax basis in Property
of $100 (excluding any prior adjustments under section 743(b)),
sells its partnership interest to B for $800 cash. Under
Sec. 1.613A-3(e)(6)(iv), A's adjusted basis of $100 in Property
carries over to B.
(ii) Under section 755, XYZ determines that Property accounts
for 50% of the fair market value of all partnership assets. The
remaining 50% of B's purchase price ($400) is attributable to non-
depletable property. XYZ must provide a statement to B containing
the portion of B's adjusted basis attributable to non-depletable
property ($400). Under this paragraph (k)(1), XYZ must report basis
adjustments under section 743(b) to non-depletable property. B must
report basis adjustments under section 743(b) to Property.
(2) Requirement that transferee notify partnership--(i) Sale or
exchange. A transferee that acquires, by sale or exchange, an interest
in a partnership with an election under section 754 in effect for the
taxable year of the transfer, must notify the partnership, in writing,
within 30 days of the sale or exchange. The written notice to the
partnership must be signed under penalties of perjury and must include
the names and addresses of the transferee and (if ascertainable) of the
transferor, the taxpayer identification numbers of the transferee and
(if ascertainable) of the transferor, the relationship (if any) between
the transferee and the transferor, the date of the transfer, the amount
of any liabilities assumed or taken subject to by the transferee, and
the amount of any money, the fair market value of any other property
delivered or to be delivered for the transferred interest in the
partnership, and any other information necessary for the partnership to
compute the transferee's basis.
(ii) Transfer on death. A transferee that acquires, on the death of
a partner, an interest in a partnership with an election under section
754 in effect for the taxable year of the transfer, must notify the
partnership, in writing, within one year of the death of the deceased
partner. The written notice to the partnership must be signed under
penalties of perjury and must include the names and addresses of the
deceased partner and the transferee, the taxpayer identification
numbers of the deceased partner and the transferee, the relationship
(if any) between the
[[Page 69915]]
transferee and the transferor, the deceased partner's date of death,
the date on which the transferee became the owner of the partnership
interest, the fair market value of the partnership interest on the
applicable date of valuation set forth in section 1014, and the manner
in which the fair market value of the partnership interest was
determined.
(iii) Nominee reporting. If a partnership interest is transferred
to a nominee which is required to furnish the statement under section
6031(c)(1) to the partnership, the nominee may satisfy the notice
requirement contained in this paragraph (k)(2) by providing the
statement required under Sec. 1.6031(c)-1T, provided that the statement
satisfies all requirements of Sec. 1.6031(c)-1T and this paragraph
(k)(2).
(3) Reliance. In making the adjustments under section 743(b) and
any statement or return relating to such adjustments under this
section, a partnership may rely on the written notice provided by a
transferee pursuant to paragraph (k)(2) of this section to determine
the transferee's basis in a partnership interest. The previous sentence
shall not apply if any partner who has responsibility for federal
income tax reporting by the partnership has knowledge of facts
indicating that the statement is clearly erroneous.
(4) Partnership not required to make or report adjustments under
section 743(b) until it has notice of the transfer. A partnership is
not required to make the adjustments under section 743(b) (or any
statement or return relating to those adjustments) with respect to any
transfer until it has been notified of the transfer. For purposes of
this section, a partnership is notified of a transfer when either--
(i) The partnership receives the written notice from the transferee
required under paragraph (k)(2) of this section; or
(ii) Any partner who has responsibility for federal income tax
reporting by the partnership has knowledge that there has been a
transfer of a partnership interest.
(5) Effect on partnership of the failure of the transferee to
comply. If the transferee fails to provide the partnership with the
written notice required by paragraph (k)(2) of this section, the
partnership must attach a statement to its return in the year that the
partnership is otherwise notified of the transfer. This statement must
set forth the name and taxpayer identification number (if
ascertainable) of the transferee. In addition, the following statement
must be prominently displayed in capital letters on the first page of
the partnership's return for such year, and on the first page of any
schedule or information statement relating to such transferee's share
of income, credits, deductions, etc.: ``RETURN FILED PURSUANT TO
Sec. 1.743-1(k)(5).'' The partnership will then be entitled to report
the transferee's share of partnership items without adjustment to
reflect the transferee's basis adjustment in partnership property. If,
following the filing of a return pursuant to this paragraph (k)(5), the
transferee provides the applicable written notice to the partnership,
the partnership must make such adjustments as are necessary to adjust
the basis of partnership property (as of the date of the transfer) in
any amended return otherwise to be filed by the partnership or in the
next annual partnership return of income to be regularly filed by the
partnership. At such time, the partnership must also provide the
transferee with such information as is necessary for the transferee to
amend its prior returns to properly reflect the adjustment under
section 743(b).
(l) Effective date. This section applies to transfers of
partnership interests that occur on or after December 15, 1999.
Par. 6. Section 1.751-1 is amended by:
1. Revising paragraphs (a)(2) and (a)(3).
2. Revising paragraph (c)(3).
3. Removing paragraph (c)(4)(x).
4. Adding a sentence at the end of paragraph (f).
5. Revising Example 1 of paragraph (g).
The addition and revisions read as follows:
Sec. 1.751-1 Unrealized receivables and inventory items.
* * * * *
(a) * * *
(2) Determination of gain or loss. The income or loss realized by a
partner upon the sale or exchange of its interest in section 751
property is the amount of income or loss from section 751 property
(including any remedial allocations under Sec. 1.704-3(d)) that would
have been allocated to the partner (to the extent attributable to the
partnership interest sold or exchanged) if the partnership had sold all
of its property in a fully taxable transaction for cash in an amount
equal to the fair market value of such property (taking into account
section 7701(g)) immediately prior to the partner's transfer of the
interest in the partnership. Any gain or loss recognized that is
attributable to section 751 property will be ordinary gain or loss. The
difference between the amount of capital gain or loss that the partner
would realize in the absence of section 751 and the amount of ordinary
income or loss determined under this paragraph (a)(2) is the
transferor's capital gain or loss on the sale of its partnership
interest.
(3) Statement required. A partner selling or exchanging any part of
an interest in a partnership that has any section 751 property at the
time of sale or exchange must submit with its income tax return for the
taxable year in which the sale or exchange occurs a statement setting
forth separately the following information--
(i) The date of the sale or exchange;
(ii) The amount of any gain or loss attributable to the section 751
property; and
(iii) The amount of any gain or loss attributable to capital gain
or loss on the sale of the partnership interest.
* * * * *
(c) Unrealized receivables. * * *
(3) In determining the amount of the sale price attributable to
such unrealized receivables, or their value in a distribution treated
as a sale or exchange, full account shall be taken not only of the
estimated cost of completing performance of the contract or agreement,
but also of the time between the sale or distribution and the time of
payment.
* * * * *
(f) * * * The rules contained in paragraphs (a)(2) and (a)(3) of
this section apply to transfers of partnership interests that occur on
or after December 15, 1999.
(g) * * *
Example 1. (i)(A) A and B are equal partners in personal service
partnership PRS. B transfers its interest in PRS to T for $15,000
when PRS's balance sheet (reflecting a cash receipts and
disbursements method of accounting) is as follows:
[[Page 69916]]
------------------------------------------------------------------------
Assets
-------------------------------
Fair market
Adjusted basis value
------------------------------------------------------------------------
Cash.................................... $3,000 $3,000
Loans Receivable........................ 10,000 10,000
Capital Assets.......................... 7,000 5,000
Unrealized Receivables.................. 0 14,000
-------------------------------
Total............................... 20,000 32,000
------------------------------------------------------------------------
------------------------------------------------------------------------
Liabilities and Capital
-------------------------------
Adjusted per Fair market
books value
------------------------------------------------------------------------
Liabilities............................. $2,000 $2,000
Capital:
A................................... 9,000 15,000
B................................... 9,000 15,000
-------------------------------
Total........................... 20,000 32,000
------------------------------------------------------------------------
(B) None of the assets owned by PRS is section 704(c) property,
and the capital assets are nondepreciable. The total amount realized
by B is $16,000, consisting of the cash received, $15,000, plus
$1,000, B's share of the partnership liabilities assumed by T. See
section 752. B's undivided half-interest in the partnership property
includes a half-interest in the partnership's unrealized receivables
items. B's basis for its partnership interest is $10,000 ($9,000,
plus $1,000, B's share of partnership liabilities). If section
751(a) did not apply to the sale, B would recognize $6,000 of
capital gain from the sale of the interest in PRS. However, section
751(a) does apply to the sale.
(ii) If PRS sold all of its section 751 property in a fully
taxable transaction immediately prior to the transfer of B's
partnership interest to T, B would have been allocated $7,000 of
ordinary income from the sale of PRS's unrealized receivables.
Therefore, B will recognize $7,000 of ordinary income with respect
to the unrealized receivables. The difference between the amount of
capital gain or loss that the partner would realize in the absence
of section 751 ($6,000) and the amount of ordinary income or loss
determined under paragraph (a)(2) of this section ($7,000) is the
transferor's capital gain or loss on the sale of its partnership
interest. In this case, B will recognize a $1,000 capital loss.
* * * * *
Par. 7. Section 1.754-1 is amended as follows:
1. Designate the text following the heading of paragraph (c) as
paragraph (c)(1).
2. Add a heading to newly designated paragraph (c)(1).
3. Add paragraph (c)(2).
The additions read as follows:
Sec. 1.754-1 Time and manner of making election to adjust basis of
partnership property.
* * * * *
(c) Revocation of election--(1) In general. * * *
(2) Revocations made for first taxable year ending after December
15, 1999. Notwithstanding paragraph (c)(1) of this section, any
partnership having an election in effect under this section for its
taxable year that includes December 15, 1999 may revoke such election
by attaching a statement to the partnership's return for such year. For
the revocation to be valid, the statement must be filed not later than
the time prescribed by Sec. 1.6031(a)-1(e) (including extensions
thereof) for filing the return for such taxable year, and must set
forth the name and address of the partnership revoking the election, be
signed by any one of the partners who is authorized to sign the
partnership's federal income tax return, and contain a declaration that
the partnership revokes its election under section 754 to apply the
provisions of section 734(b) and 743(b). In addition, the following
statement must be prominently displayed in capital letters on the first
page of the partnership's return for such year: ``RETURN FILED PURSUANT
TO 1.754-1(c)(2).''
Par. 8. Section 1.755-1 is revised to read as follows:
Sec. 1.755-1 Rules for allocation of basis.
(a) Generally. A partnership that has an election in effect under
section 754 must adjust the basis of partnership property under the
provisions of section 734(b) and section 743(b) pursuant to the
provisions of this section. The basis adjustment is first allocated
between the two classes of property described in section 755(b). These
classes of property consist of capital assets and section 1231(b)
property (capital gain property), and any other property of the
partnership (ordinary income property). For purposes of this section,
properties and potential gain treated as unrealized receivables under
section 751(c) and the regulations thereunder shall be treated as
separate assets that are ordinary income property. The portion of the
basis adjustment allocated to each class is then allocated among the
items within the class. Adjustments under section 743(b) are allocated
under paragraph (b) of this section. Adjustments under section 734(b)
are allocated under paragraph (c) of this section.
(b) Adjustments under section 743(b)--(1) Generally. (i) For
exchanges in which the transferee's basis in the interest is determined
in whole or in part by reference to the transferor's basis in the
interest, paragraph (b)(5) of this section shall apply. For all other
transfers which result in a basis adjustment under section 743(b),
paragraphs (b)(2) through (b)(4) of this section shall apply. Except as
provided in paragraph (b)(5) of this section, the portion of the basis
adjustment allocated to one class of property may be an increase while
the portion allocated to the other class is a decrease. This would be
the case even though the total amount of the basis adjustment is zero.
Except as provided in paragraph (b)(5) of this section, the portion of
the basis adjustment allocated to one item of property within a class
may be an increase while the portion allocated to another is a
decrease. This would be the case even though the basis adjustment
allocated to the class is zero.
(ii) Hypothetical transaction. For purposes of paragraphs (b)(2)
through (b)(4) of this section, the allocation of
[[Page 69917]]
the basis adjustment under section 743(b) between the classes of
property and among the items of property within each class are made
based on the allocations of income, gain, or loss (including remedial
allocations under Sec. 1.704-3(d)) that the transferee partner would
receive (to the extent attributable to the acquired partnership
interest) if, immediately after the transfer of the partnership
interest, all of the partnership's property were disposed of in a fully
taxable transaction for cash in an amount equal to the fair market
value of such property (the hypothetical transaction).
(2) Allocations between classes of property--(i) In general. The
amount of the basis adjustment allocated to the class of ordinary
income property is equal to the total amount of income, 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 sale of all ordinary income
property in the hypothetical transaction. The amount of the basis
adjustment to capital gain property is equal to--
(A) The total amount of the basis adjustment under section 743(b);
less
(B) The amount of the basis adjustment allocated to ordinary income
property under the preceding sentence; provided, however, that in no
event may the amount of any decrease in basis allocated to capital gain
property exceed the partnership's basis (or in the case of property
subject to the remedial allocation method, the transferee's share of
any remedial loss under Sec. 1.704-3(d) from the hypothetical
transaction) in capital gain property. In the event that a decrease in
basis allocated to capital gain property would otherwise exceed the
partnership's basis in capital gain property, the excess must be
applied to reduce the basis of ordinary income property.
(ii) Examples. The provisions of this paragraph (b)(2) are
illustrated by the following examples:
Example 1. (i) A and B form equal partnership PRS. A contributes
$50,000 and Asset 1, a nondepreciable capital asset with a fair
market value of $50,000 and an adjusted tax basis of $25,000. B
contributes $100,000. PRS uses the cash to purchase Assets 2, 3, and
4. After a year, A sells its interest in PRS to T for $120,000. At
the time of the transfer, A's share of the partnership's basis in
partnership assets is $75,000. Therefore, T receives a $45,000 basis
adjustment.
(ii) Immediately after the transfer of the partnership interest
to T, the adjusted basis and fair market value of PRS's assets are
as follows:
------------------------------------------------------------------------
Assets
-------------------------------
Fair market
Adjusted basis value
------------------------------------------------------------------------
Capital Gain Property:
Asset 1............................. $25,000 $75,000
Asset 2............................. 100,000 117,500
Ordinary Income Property:
Asset 3............................. 40,000 45,000
Asset 4............................. 10,000 2,500
-------------------------------
Total........................... 175,000 240,000
------------------------------------------------------------------------
(iii) If PRS sold all of its assets in a fully taxable
transaction at fair market value immediately after the transfer of
the partnership interest to T, the total amount of capital gain that
would be allocated to T is equal to $46,250 ($25,000 section 704(c)
built-in gain from Asset 1, plus fifty percent of the $42,500
appreciation in capital gain property). T would also be allocated a
$1,250 ordinary loss from the sale of the ordinary income property.
(iv) The amount of the basis adjustment that is allocated to
ordinary income property is equal to ($1,250) (the amount of the
loss allocated to T from the hypothetical sale of the ordinary
income property).
(v) The amount of the basis adjustment that is allocated to
capital gain property is equal to $46,250 (the amount of the basis
adjustment, $45,000, less ($1,250), the amount of loss allocated to
T from the hypothetical sale of the ordinary income property).
Example 2. (i) A and B form equal partnership PRS. A and B each
contribute $1,000 cash which the partnership uses to purchase Assets
1, 2, 3, and 4. After a year, A sells its partnership interest to T
for $1,000. T's basis adjustment under section 743(b) is zero.
(ii) Immediately after the transfer of the partnership interest
to T, the adjusted basis and fair market value of PRS's assets are
as follows:
------------------------------------------------------------------------
Assets
-------------------------------
Fair market
Adjusted basis value
------------------------------------------------------------------------
Capital Gain Property:
Asset 1............................. $500 $750
Asset 2............................. 500 500
Ordinary Income Property:
Asset 3............................. 500 250
Asset 4............................. 500 500
-------------------------------
Total........................... 2,000 2,000
------------------------------------------------------------------------
(iii) If, immediately after the transfer of the partnership
interest to T, PRS sold all of its assets in a fully taxable
transaction at fair market value, T would be allocated a loss of
$125 from the sale of the ordinary income property. Thus, the amount
of the basis adjustment to ordinary income property is ($125). The
amount of the basis adjustment to capital gain property is $125
(zero, the amount of the basis adjustment under section 743(b), less
($125), amount of the basis adjustment allocated to ordinary income
property).
(3) Allocation within the class--(i) Ordinary income property. The
amount of the basis adjustment to each item of property within the
class of ordinary income property is equal to--
[[Page 69918]]
(A) The amount of income, 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 the item; reduced by
(B) The product of--
(1) Any decrease to the amount of the basis adjustment to ordinary
income property required pursuant to the last sentence of paragraph
(b)(2)(i) of this section; multiplied by
(2) A fraction, the numerator of which is the fair market value of
the item of property to the partnership and the denominator of which is
the total fair market value of all of the partnership's items of
ordinary income property.
(ii) Capital gain property. The amount of the basis adjustment to
each item of property within the class of capital gain property is
equal to--
(A) The amount of income, 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 the item; minus
(B) The product of--
(1) 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 items of capital gain
property, minus the amount of the positive basis adjustment to all
items of capital gain property or plus the amount of the negative basis
adjustment to capital gain property; multiplied by
(2) A fraction, the numerator of which is the fair market value of
the item of property to the partnership, and the denominator of which
is the fair market value of all of the partnership's items of capital
gain property.
(iii) Examples. The provisions of this paragraph (b)(3) are
illustrated by the following examples:
Example 1. (i) Assume the same facts as Example 1 in paragraph
(b)(2)(ii) of this section. Of the $45,000 basis adjustment, $46,250
was allocated to capital gain property. The amount allocated to
ordinary income property was ($1,250).
(ii) Asset 1 is a capital gain asset, and T would be allocated
$37,500 from the sale of Asset 1 in the hypothetical transaction.
Therefore, the amount of the adjustment to Asset 1 is $37,500.
(iii) Asset 2 is a capital gain asset, and T would be allocated
$8,750 from the sale of Asset 2 in the hypothetical transaction.
Therefore, the amount of the adjustment to Asset 2 is $8,750.
(iv) Asset 3 is ordinary income property, and T would be
allocated $2,500 from the sale of Asset 3 in the hypothetical
transaction. Therefore, the amount of the adjustment to Asset 3 is
$2,500.
(v) Asset 4 is ordinary income property, and T would be
allocated ($3,750) from the sale of Asset 4 in the hypothetical
transaction. Therefore, the amount of the adjustment to Asset 4 is
($3,750).
Example 2. (i) Assume the same facts as Example 1 in paragraph
(b)(2)(ii) of this section, except that A sold its interest in PRS
to T for $110,000 rather than $120,000. T, therefore, receives a
basis adjustment under section 743(b) of $35,000. Of the $35,000
basis adjustment, ($1,250) is allocated to ordinary income property,
and $36,250 is allocated to capital gain property.
(ii) Asset 3 is ordinary income property, and T would be
allocated $2,500 from the sale of Asset 3 in the hypothetical
transaction. Therefore, the amount of the adjustment to Asset 3 is
$2,500.
(iii) Asset 4 is ordinary income property, and T would be
allocated ($3,750) from the sale of Asset 4 in the hypothetical
transaction. Therefore, the amount of the adjustment to Asset 4 is
($3,750).
(iv) Asset 1 is a capital gain asset, and T would be allocated
$37,500 from the sale of Asset 1 in the hypothetical transaction.
Asset 2 is a capital gain asset, and T would be allocated $8,750
from the sale of Asset 2 in the hypothetical transaction. The total
amount of gain that would be allocated to T from the sale of the
capital gain assets in the hypothetical transaction is $46,250,
which exceeds the amount of the basis adjustment allocated to
capital gain property by $10,000. The amount of the adjustment to
Asset 1 is $33,604 ($37,500 minus $3,896 ($10,000 x $75,000/
192,500)). The amount of the basis adjustment to Asset 2 is $2,646
($8,750 minus $6,104 ($10,000 x $117,500/192,500)).
(4) Income in respect of a decedent--(i) In general. Where a
partnership interest is transferred as a result of the death of a
partner, under section 1014(c) the transferee's basis in its
partnership interest is not adjusted for that portion of the interest,
if any, which is attributable to items representing income in respect
of a decedent under section 691. See Sec. 1.742-1. Accordingly, if a
partnership interest is transferred as a result of the death of a
partner, and the partnership holds assets representing income in
respect of a decedent, no part of the basis adjustment under section
743(b) is allocated to these assets. See Sec. 1.743-1(b).
(ii) The provisions of this paragraph (b)(4) are illustrated by the
following example:
Example. (i) A and B are equal partners in personal service
partnership PRS. As a result of B's death, B's partnership interest
is transferred to T when PRS's balance sheet (reflecting a cash
receipts and disbursements method of accounting) is as follows:
------------------------------------------------------------------------
Assets
-------------------------------
Fair market
Adjusted basis value
------------------------------------------------------------------------
Capital Asset........................... $2,000 $5,000
Unrealized Receivables.................. 0 15,000
-------------------------------
Total............................... 2,000 20,000
------------------------------------------------------------------------
------------------------------------------------------------------------
Liabilities and Capital
-------------------------------
Adjusted per Fair market
books value
------------------------------------------------------------------------
Capital:
A................................... 1,000 10,000
B................................... 1,000 10,000
-------------------------------
Total........................... 2,000 20,000
------------------------------------------------------------------------
(ii) None of the assets owned by PRS is section 704(c) property,
and the capital asset is nondepreciable. The fair market value of
T's partnership interest on the applicable date of valuation set
forth in section 1014 is $10,000. Of this amount, $2,500 is
[[Page 69919]]
attributable to T's share of the partnership's capital asset, and
$7,500 is attributable to T's 50% share of the partnership's
unrealized receivables. The partnership's unrealized receivables
represent income in respect of a decedent. Accordingly, under
section 1014(c), T's basis in its partnership interest is not
adjusted for that portion of the interest which is attributable to
the unrealized receivables. Therefore, T's basis in its partnership
interest is $2,500.
(iii) At the time of the transfer, B's share of the
partnership's basis in partnership assets is $1,000. Accordingly, T
receives a $1,500 basis adjustment under section 743(b). Under this
paragraph (b)(4), the entire basis adjustment is allocated to the
partnership's capital asset.
(5) Transferred basis exchanges--(i) In general. This paragraph
(b)(5) applies to basis adjustments under section 743(b) which result
from exchanges in which the transferee's basis in the interest is
determined in whole or in part by reference to the transferor's basis
in the interest. For example, this paragraph applies if a partnership
interest is contributed to a corporation in a transaction to which
section 351 applies or to a partnership in a transaction to which
section 721(a) applies.
(ii) Allocations between classes of property. 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). If there is an increase in basis to be allocated to
partnership assets, such increase 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 gain or
net income, as the case may be, to the transferee. Where, under the
preceding sentence, an increase in basis may be allocated to both
capital gain assets and ordinary income assets, the increase shall be
allocated to each class in proportion to the net gain or net income,
respectively, which would be allocated to the transferee from the sale
of all assets in each class. If there is a decrease in basis to be
allocated to partnership assets, such 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. Where, under the preceding sentence, a decrease in
basis may be allocated to both capital gain assets and ordinary income
assets, the decrease shall be allocated to each class in proportion to
the net loss which would be allocated to the transferee from the sale
of all assets in each class.
(iii) Allocations within the classes--(A) Increases. If 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 before such 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 the transferee's share of the amount that would
be realized by the partnership upon the hypothetical sale of each asset
in the class.
(B) Decreases. If 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 before such 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 the 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 depreciated assets in that class, the
transferee's negative basis adjustment is limited to the transferee's
share of the partnership's adjusted basis in all depreciated assets in
that class.
(D) Carryover adjustment. Where a transferee's negative basis
adjustment under section 743(b) cannot be allocated to any asset,
because the adjustment exceeds the transferee's share of the adjusted
basis to the partnership of all depreciated assets in a particular
class, 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. A is a member of partnership LTP, which has made an
election under section 754. The three partners in LTP have equal
interests in capital and profits. Solely in exchange for a
partnership interest in UTP, 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 partnership interest ($5,000) equals its
share of inside basis (also $5,000). Under section 723, UTP's basis
in its interest in LTP is $5,000. LTP's only two assets on the date
of contribution are inventory with a basis of $5,000 and a fair
market value of $7,500, and a nondepreciable capital asset with a
basis of $10,000 and a fair market value of $7,500. The amount of
the basis adjustment under section 743(b) to partnership property is
$0 ($5,000, UTP's basis in its interest in LTP, minus $5,000, UTP's
share of LTP's basis in partnership assets). Because UTP acquired
its interest in LTP in a transferred basis exchange, and the total
amount of the basis adjustment under section 743(b) is zero, UTP
receives no special basis adjustments under section 743(b) with
respect to the partnership property of LTP.
Example 2. (i) A purchases a partnership interest in LTP at a
time when an election under section 754 is not in effect. The three
partners in LTP have equal interests in capital and profits. During
a later year for which LTP has an election under section 754 in
effect, and in a transaction that is unrelated to A's purchase of
the LTP interest, A contributes its interest in LTP to UTP in a
transaction described in section 721 (solely in exchange for a
partnership interest in UTP). At the time of the transfer, A's
adjusted basis in its interest in LTP is $20,433. Under section 721,
A recognizes no gain or loss as a result of the contribution of its
partnership interest to UTP. Under section 723, UTP's basis in its
partnership interest in LTP is $20,433. The balance sheet of LTP on
the date of the contribution shows the following:
------------------------------------------------------------------------
Assets
-------------------------------
Fair market
Adjusted basis value
------------------------------------------------------------------------
Cash.................................... $5,000 $5,000
Accounts receivable..................... 10,000 10,000
Inventory............................... 20,000 21,000
[[Page 69920]]
Nondepreciable capital asset............ 20,000 40,000
-------------------------------
Total............................... 55,000 76,000
------------------------------------------------------------------------
------------------------------------------------------------------------
Liabilities and Capital
-------------------------------
Adjusted per Fair market
books value
------------------------------------------------------------------------
Liabilities............................. $10,000 $10,000
Capital:
A................................... 15,000 22,000
B................................... 15,000 22,000
C................................... 15,000 22,000
-------------------------------
Total........................... 55,000 76,000
------------------------------------------------------------------------
(ii) The amount of the basis adjustment under section 743(b) is
the difference between the basis of UTP's interest in LTP and UTP's
share of the adjusted basis to LTP of partnership property. UTP's
interest in the previously taxed capital of LTP is $15,000 ($22,000,
the amount of cash UTP would receive if LTP liquidated immediately
after the hypothetical transaction, decreased by $7,000, the amount
of tax gain allocated to UTP from the hypothetical transaction).
UTP's share of the adjusted basis to LTP of partnership property is
$18,333 ($15,000 share of previously taxed capital, plus $3,333
share of LTP's liabilities). The amount of the basis adjustment
under section 743(b) to partnership property therefore, is $2,100
($20,433 minus $18,333).
(iii) The total amount of gain that would be allocated to UTP
from the hypothetical sale of capital gain property is $6,666.67
(one-third of the excess of the fair market value of LTP's
nondepreciable capital asset, $40,000, over its basis, $20,000). The
total amount of gain that would be allocated to UTP from the
hypothetical sale of ordinary income property is $333.33 (one-third
of the excess of the fair market value of LTP's inventory, $21,000,
over its basis, $20,000). Under paragraph (b)(5), LTP must allocate
$2,000 ($6,666.67 divided by $7,000 times $2,100) of UTP's basis
adjustment to the nondepreciable capital asset. LTP must allocate
$100 ($333.33 divided by $7,000 times $2,100) of UTP's basis
adjustment to the inventory.
(c) Adjustments under section 734(b)--(1) Allocations between
classes of property--(i) General rule. Where there is a distribution of
partnership property resulting in an adjustment to the basis of
undistributed partnership property under section 734(b)(1)(B) or
(b)(2)(B), the adjustment must be allocated to remaining partnership
property of a character similar to that of the distributed property
with respect to which the adjustment arose. Thus, when the
partnership's adjusted basis of distributed capital gain property
immediately prior to distribution exceeds the basis of the property to
the distributee partner (as determined under section 732), the basis of
the undistributed capital gain property remaining in the partnership is
increased by an amount equal to the excess. Conversely, when the basis
to the distributee partner (as determined under section 732) of
distributed capital gain property exceeds the partnership's adjusted
basis of such property immediately prior to the distribution, the basis
of the undistributed capital gain property remaining in the partnership
is decreased by an amount equal to such excess. Similarly, where there
is a distribution of ordinary income property, and the basis of the
property to the distributee partner (as determined under section 732)
is not the same as the partnership's adjusted basis of the property
immediately prior to distribution, the adjustment is made only to
undistributed property of the same class remaining in the partnership.
(ii) Special rule. Where there is a distribution resulting in an
adjustment under section 734(b)(1)(A) or (b)(2)(A) to the basis of
undistributed partnership property, the adjustment is allocated only to
capital gain property.
(2) Allocations within the classes--(i) Increases. If 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 their respective amounts of unrealized appreciation
before such increase (but only to the extent 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.
(ii) Decreases. If 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 their respective amounts of
unrealized depreciation before such decrease (but only to the extent of
each property's unrealized depreciation). Any remaining decrease must
be allocated among the properties within the class in proportion to
their adjusted bases (as adjusted under the preceding sentence).
(3) Limitation in decrease of basis. Where a decrease in the basis
of partnership assets is required under section 734(b)(2) and the
amount of the decrease exceeds the adjusted basis to the partnership of
property of the required character, the basis of such property is
reduced to zero (but not below zero).
(4) Carryover adjustment. Where, in the case of a distribution, an
increase or a decrease in the basis of undistributed property cannot be
made because the partnership owns no property of the character required
to be adjusted, or because the basis of all the property of a like
character has been reduced to zero, the adjustment is made when the
partnership subsequently acquires property of a like character to which
an adjustment can be made.
(5) Example. The following example illustrates this paragraph (c):
Example. (i) A, B, and C form equal partnership PRS. A
contributes $50,000 and Asset 1, capital gain property with a fair
market value of $50,000 and an adjusted tax basis of $25,000. B and
C each contributes $100,000. PRS uses the cash to purchase Assets 2,
3, 4, 5, and 6. Assets 4, 5, and 6 are the only assets held by the
partnership which are subject to section 751. The partnership has an
election in effect under section 754. After seven years, the
adjusted basis and fair market value of PRS's assets are as follows:
[[Page 69921]]
------------------------------------------------------------------------
Assets
-------------------------------
Fair market
Adjusted basis value
------------------------------------------------------------------------
Capital Gain Property:
Asset 1............................. $ 25,000 $ 75,000
Asset 2............................. 100,000 117,500
Asset 3............................. 50,000 60,000
Ordinary Income Property:
Asset 4............................. $ 40,000 $ 45,000
Asset 5............................. 50,000 60,000
Asset 6............................. 10,000 2,500
-------------------------------
Total............................. 275,000 360,000
------------------------------------------------------------------------
(ii) Allocation between classes. Assume that PRS distributes
Assets 3 and 5 to A in complete liquidation of A's interest in the
partnership. A's basis in the partnership interest was $75,000. The
partnership's basis in Assets 3 and 5 was $50,000 each. A's $75,000
basis in its partnership interest is allocated between Assets 3 and
5 under sections 732(b) and (c). A will, therefore, have a basis of
$25,000 in Asset 3 (capital gain property), and a basis of $50,000
in Asset 5 (section 751 property). The distribution results in a
$25,000 increase in the basis of capital gain property. There is no
change in the basis of ordinary income property.
(iii) Allocation within class. The amount of the basis increase
to capital gain property is $25,000 and must be allocated among the
remaining capital gain assets in proportion to the difference
between the fair market value and basis of each. The fair market
value of Asset 1 exceeds its basis by $50,000. The fair market value
of Asset 2 exceeds its basis by $17,500. Therefore, the basis of
Asset 1 will be increased by $18,519 ($25,000, multiplied by
$50,000, divided by $67,500), and the basis of Asset 2 will be
increased by $6,481 ($25,000 multiplied by $17,500, divided by
$67,500).
(d) Effective date. This section applies to transfers of
partnership interests and distributions of property from a partnership
that occur on or after December 15, 1999.
Par. 9. Section 1.1017-1 is amended by:
1. Revising paragraph (g)(2)(iv).
2. Adding paragraph (g)(2)(v).
The addition and revision read as follows:
Sec. 1.1017-1 Basis reductions following a discharge of indebtedness.
* * * * *
(g) * * *
(2) * * *
(iv) Partner's share of partnership basis--(A) In general. For
purposes of this paragraph (g), a partner's proportionate share of the
partnership's basis in depreciable property (or depreciable real
property) is equal to the sum of--
(1) The partner's section 743(b) basis adjustments to items of
partnership depreciable property (or depreciable real property); and
(2) The common basis depreciation deductions (but not including
remedial allocations of depreciation deductions under Sec. 1.704-3(d))
that, under the terms of the partnership agreement effective for the
taxable year in which the discharge of indebtedness occurs, are
reasonably expected to be allocated to the partner over the property's
remaining useful life. The assumptions made by a partnership in
determining the reasonably expected allocation of depreciation
deductions must be consistent for each partner. For example, a
partnership may not treat the same depreciation deductions as being
reasonably expected by more than one partner.
(B) Effective date. This paragraph (g)(2)(iv) applies to elections
made under sections 108(b)(5) and 108(c) on or after December 15, 1999.
(v) Treatment of basis reduction--(A) Basis adjustment. The amount
of the reduction to the basis of depreciable partnership property
constitutes an adjustment to the basis of partnership property with
respect to the partner only. No adjustment is made to the common basis
of partnership property. Thus, for purposes of income, deduction, gain,
loss, and distribution, the partner will have a special basis for those
partnership properties the bases of which are adjusted under section
1017 and this section.
(B) Recovery of adjustments to basis of partnership property.
Adjustments to the basis of partnership property under this section are
recovered in the manner described in Sec. 1.743-1.
(C) Effect of basis reduction. Adjustments to the basis of
partnership property under this section are treated in the same manner
and have the same effect as an adjustment to the basis of partnership
property under section 743(b). The following example illustrates this
paragraph (g)(2)(v):
Example. (i) A, B, and C are equal partners in partnership PRS,
which owns (among other things) Asset 1, an item of depreciable
property with a basis of $30,000. A's basis in its partnership
interest is $20,000. Under the terms of the partnership agreement,
A's share of the depreciation deductions from Asset 1 over its
remaining useful life will be $10,000. Under section 1017, A
requests, and PRS agrees, to decrease the basis of Asset 1 with
respect to A by $10,000.
(ii) In the year following the reduction of basis under section
1017, PRS amends its partnership agreement to provide that items of
depreciation and loss from Asset 1 will be allocated equally between
B and C. In that year, A's distributive share of the partnership's
common basis depreciation deductions from Asset 1 is now $0. Under
Sec. 1.743-1(j)(4)(ii)(B), the amount of the section 1017 basis
adjustment that A recovers during the year is $1,000. A will report
$1,000 of ordinary income because A's distributive share of the
partnership's common basis depreciation deductions from Asset 1 ($0)
is insufficient to offset the amount of the section 1017 basis
adjustment recovered by A during the year ($1,000).
(iii) In the following year, PRS sells Asset 1 for $15,000 and
recognizes a $12,000 loss. This loss is allocated equally between B
and C, and A's share of the loss is $0. Upon the sale of Asset 1, A
recovers its entire remaining section 1017 basis adjustment
($9,000). A will report $9,000 of ordinary income.
(D) Effective date. This paragraph (g)(2)(v) applies to elections
made under sections 108(b)(5) and 108(c) on or after December 15, 1999.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 10. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 11. In Sec. 602.101, paragraph (b) is amended by revising the
entries for 1.732-1 and 1.743-1 in the table to read as follows:
Sec. 602.101 OMB Control numbers.
* * * * *
(b) * * *
[[Page 69922]]
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control No.
------------------------------------------------------------------------
* * * * *
1.732-1.................................................... 1545-0099
1545-1588
* * * * *
1.743-1.................................................... 1545-0074
1545-1588
* * * * *
------------------------------------------------------------------------
David A. Mader,
Acting Deputy Commissioner of Internal Revenue.
Approved November 29, 1999.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury.
[FR Doc. 99-32400 Filed 12-14-99; 8:45 am]
BILLING CODE 4830-01-U
