[Federal Register Volume 63, Number 19 (Thursday, January 29, 1998)]
[Proposed Rules]
[Pages 4408-4426]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-1949]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-209682-94]
RIN 1545-AS39
Adjustments Following Sales of Partnership Interests
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Partial withdrawal of notice of proposed rulemaking, amendment
to notice of proposed rulemaking; notice of proposed rulemaking and
notice of public hearing.
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SUMMARY: This document withdraws a portion of the notice of proposed
rulemaking published in the Federal Register, February 16, 1984 (49 FR
5940); contains proposed 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, and 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, finally, amends
proposed regulations relating to the computation of a partner's
proportionate share of the adjusted basis of depreciable property (or
depreciable real property) under section 1017. The changes are
necessary to provide clearer guidance on the proper application of
these sections and will effect 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 proposed
regulations under section 732(c) reflect changes to the law made by the
Taxpayer Relief Act of 1997.
DATES: Written comments must be received by April 29, 1998. Outlines of
topics to be discussed at the public hearing scheduled for Wednesday,
July 8, 1998, at 10 a.m. must be received by Wednesday, June 24, 1998.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209682-94), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered between the
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-209682-94), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue, NW,
Washington, DC.
Alternatively, taxpayers may submit comments electronically via the
internet by selecting the ``Tax Regs'' option on the IRS Home Page, or
by submitting comments directly to the IRS internet site at http://
www.irs.ustreas.gov/prod/tax__regs/comments.html. The public hearing
will be held in the IRS Auditorium, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Terri A.
Belanger, (202) 622-3070; concerning submissions and the hearing,
LaNita VanDyke, (202) 622-7180 (not toll-free numbers).
[[Page 4409]]
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)). Comments on the collection of information should be
sent to the Office of Management and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, DC
20224. Comments on the collection of information should be received by
March 30, 1998. Comments are specifically requested concerning:
Whether the proposed collection of information is necessary for the
proper performance of the functions of the Internal Revenue Service,
including whether the information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collection of information (see below);
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collection of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up cost and costs of operation,
maintenance, and purchase of service to provide information.
The collection of information in this proposed regulation is in
Secs. 1.743-1(b), 1.743-1(k), and 1.755-1. This information is required
in order for partners to have adequate knowledge to comply with section
743 and for the IRS to verify compliance with section 743. This
information will be used to determine whether the amount of tax has
been computed correctly. Responses to this collection of information
are mandatory for partnerships that have made an election under section
754 and for which a section 743 transfer has been made. The likely
respondents are businesses or other for-profit institutions.
Estimated total annual recordkeeping burden under Sec. 1.743-1(b):
600,000 hours.
The estimated annual burden per recordkeeper varies from 1 hour to
300 hours, depending on the individual circumstances, with an estimated
average of 4 hours.
Estimated number of recordkeepers: 150,000.
Estimated total annual reporting burden under Sec. 1.743-1(k)(1):
225,000 hours.
The estimated annual burden per respondent is estimated at an
average of 3 hours.
Estimated number of respondents: 75,000.
Estimated frequency of responses: On occasion.
Estimated total annual reporting burden under Sec. 1.743-1(k)(2):
75,000 hours.
The estimated annual burden per respondent is estimated at an
average of 1 hour.
Estimated number of respondents: 75,000.
Estimated frequency of responses: On occasion.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid OMB control number.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
This document proposes to (a) revise Secs. 1.743-1 and 1.755-1 of
the Income Tax Regulations (26 CFR part 1), (b) withdraw Sec. 1.168-
2(n) of the proposed Income Tax Regulations published on February 16,
1984 (49 FR 5940), and (c) amend Secs. 1.732-1, 1.732-2, 1.734-1,
1.751-1 of the Income Tax Regulations, and Sec. 1.1017-1 of the
proposed Income Tax Regulations published January 7, 1997 (62 FR 955).
Section 743(b) provides for an optional adjustment to the basis of
partnership property following certain transfers of partnership
interests. The Code provides for basis adjustments in an attempt to
coordinate the transferee's tax consequences and economic consequences.
The amount of the basis adjustment is the difference between the
transferee's basis in the partnership interest (outside basis) and its
share of the partnership's basis in the partnership's assets (inside
basis). Once the amount of the basis adjustment is determined, it is
allocated among the partnership's various assets pursuant to section
755.
The proposed regulations coordinate sections 704(c), 743, 751, and
755, and reflect changes in the Code and Income Tax Regulations since
the adoption of the current regulations. The proposed regulations also
provide rules concerning adjustments to the basis of partnership
property made pursuant to section 1017(b)(3)(C). The proposed
regulations describe how to determine a partner's proportionate share
of the adjusted basis of depreciable property (or depreciable real
property) under section 1017, and clarify that an adjustment to the
basis of partnership property made under section 1017(b)(3)(C) is
treated in the same manner as an adjustment to the basis of partnership
property made under section 743.
Section 732(c) provides for the allocation of a partner's basis in
its partnership interest upon certain distributions of property to the
partner by the partnership. Section 732(c) was amended by the Taxpayer
Relief Act of 1997, Public Law 105-34, section 1061, 111 Stat. 788,
945-46 (1997). Under prior law, the allocation was made based on the
adjusted basis of the distributed property to the partnership
immediately before the distribution. Under the new law, the allocation
is made, in general, based on the fair market value of the distributed
property on the date of distribution. The proposed regulations amend
the existing regulations under section 732 to reflect this change.
Explanation of Provisions
A. Section 743
In General
If an election is in effect under section 754, section 743 requires
the partnership to adjust the basis of partnership property upon the
transfer of an interest in the partnership by sale or exchange or on
the death of a partner. The partnership is required to increase the
adjusted basis of partnership property by the excess of the
transferee's basis in the transferred partnership interest over the
transferee's share of the adjusted basis to the partnership of the
partnership's property. The partnership is also required to decrease
the adjusted basis of partnership property by the excess of the
transferee's share of the adjusted basis to the partnership of
partnership property over the transferee's basis in the transferred
partnership interest.
The proposed regulations address a number of issues raised in
connection with the calculation, treatment, and reporting of basis
adjustments under section 743. In particular, the proposed regulations
(i) Clarify the manner in which the partnership calculates a
transferee's income, gain, loss, or deduction when the transferee has a
[[Page 4410]]
basis adjustment under section 743 (including the recovery of negative
basis adjustments) and (ii) coordinate sections 743 and 704(c) when
partnerships elect the remedial allocation method under Sec. 1.704-
3(d). The proposed regulations also provide that partnerships (rather
than partners) are required to make and report the basis adjustments
under section 743(b). Partnerships are required to adjust the
transferee's distributive share of partnership tax items so that the
information reported on the transferee's Schedule K-1 reflects the
adjustments to the transferee's distributive share of the partnership
items affected by the basis adjustment.
Determining the Amount of the Basis Adjustment
The amount of the basis adjustment with respect to partnership
property under section 743 is the difference between the transferee's
share of the partnership's inside basis and the transferee's outside
basis. The current regulations provide that a partner's share of the
adjusted basis of partnership property is equal to the sum of the
partner's interest as a partner in partnership capital and surplus,
plus the partner's share of partnership liabilities. The current
regulations also provide that where section 704(c) applies to property
contributed to the partnership, section 704(c) is taken into account in
determining a partner's share of the adjusted basis of partnership
property.
The current regulations do not provide, other than by example,
specific guidance on how to determine a transferee partner's share of
the adjusted basis of partnership property. The proposed regulations
provide that 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.
The partner's share of the partnership's previously taxed capital is
determined by reference to a hypothetical transaction in which
(immediately after the transfer of the partnership interest) the
partnership is assumed to have sold all of its assets in a fully
taxable transaction for cash equal to the fair market value of the
assets. The partner's share of the partnership's previously taxed
capital is equal to: (i) The amount of cash that the transferee would
receive on liquidation of the partnership immediately following the
hypothetical transaction, increased by (ii) the amount of tax loss that
would be allocated to the transferee from the hypothetical transaction,
and decreased by (iii) the amount of tax gain that would be allocated
to the transferee from the hypothetical transaction.
Calculation of Income, Gain, or Loss
The basis adjustment under section 743, like any other basis
amount, is a reference used to calculate income, gain, loss, and
deduction. However, generally the basis adjustment under section 743 is
an adjustment with respect to the transferee. No adjustment is made to
the common basis of partnership property (i.e., the partnership's
adjusted basis for the property). Thus, for purposes of income,
deduction, gain, loss, and distribution, the transferee will have a
special basis for those partnership properties that are adjusted under
section 743(b). The proposed regulations clarify the rules contained in
the current regulations.
The basis adjustment under section 743 does not affect the
partnership's computation of any item under section 703, and does not
have any effect on the partners' capital accounts. Partnerships compute
their tax items at the partnership level under section 703 without
regard to the basis adjustments. Partnership level tax items (including
any remedial allocations under Sec. 1.704-3(d)) are then allocated
among the partners, including the transferee, in accordance with
section 704. Finally, the partnership adjusts the transferee's
distributive share of partnership tax items to reflect the transferee's
special basis in the properties that give rise to the tax items. A
transferee's income, gain, or loss from the sale of partnership
property in which the transferee has a basis adjustment is equal to the
transferee's distributive share of partnership income, gain, or loss
(including any remedial allocations under Sec. 1.704-3(d)) from the
sale of the property adjusted to account for the amount of the
transferee's basis adjustment with respect to the property.
Coordination of Section 743 With Section 704(c)
Section 704(c) is taken into account in determining a transferee's
share of the partnership's basis in the partnership's assets. As a
result, some or all of a transferee's basis adjustment may be
attributable to section 704(c) built-in gain or loss when a transferee
purchases a partnership interest from a partner that contributed
section 704(c) property to the partnership. For example, assume that A
contributes property with a fair market value of $100 and an adjusted
tax basis of $10 to a partnership for a fifty percent interest and B
contributes $100 of cash for the remaining fifty percent interest.
Immediately after the formation of the partnership, A's share of the
partnership's basis in the partnership property is $10, while B's share
is $100. The contributed asset then appreciates in value to $120, and A
transfers its entire interest to T for $110 while an election is in
effect under section 754. T will have a basis adjustment of $100. The
first $90 of the basis adjustment is attributable to the section 704(c)
built-in gain, while the remaining $10 of the basis adjustment is
attributable to T's fifty percent share of the $20 of post-contribution
appreciation in the contributed property.
Despite the fact that a portion of the basis adjustment may be
attributable to a property's section 704(c) built-in gain, section
704(c) and section 743 operate independently. Section 1.704-
1(b)(2)(iv)(g)(3) requires a partnership to recover the value of
section 704(c) property on the books of the partnership over the
property's remaining useful life, determined with reference to the
property's useful life in the hands of the contributing partner. At the
same time, Sec. 1.168-2(n)(1) of the proposed Income Tax Regulations
provides that the entire basis adjustment is recovered as though it is
new property. Cf. Sections 168(i)(7) and 197(f)(2). As a result, the
book and tax items representing the section 704(c) built-in gain are
recovered over different periods.
Although a portion of the basis adjustment may represent actual tax
basis equal to the amount of the section 704(c) built-in gain, the
deductions attributable to the basis adjustment cannot be allocated to
the noncontributing partner. The basis adjustment does not, therefore,
eliminate any book-tax disparities that result from ceiling rule
problems relating to the section 704(c) property. Because the basis
adjustment only affects the transferee, the Service and Treasury
believe that it is appropriate for sections 704(c) and 743(b) to
operate independently.
When a partnership adopts the remedial allocation method, however,
the partners may be viewed as agreeing to shift, over time, a portion
of the partnership's basis in its assets from the noncontributing
partner to the contributing partner. Partnership basis that was
considered part of the noncontributing partner's share of the
partnership's basis at the time the adjustment to basis was made will
be transferred to the contributing partner as the property is recovered
on the partnership's books. In addition, a partnership that adopts the
remedial allocation method with respect to contributed property must
depreciate or amortize the portion of the contributed
[[Page 4411]]
property's book basis that is attributable to section 704(c) built-in
gain as though it is new property at the time of contribution. As a
result, the Service and Treasury believe that it is appropriate to
coordinate the recovery periods of the section 704(c) built-in gain and
the built-in gain portion of the basis adjustment where the partnership
uses the remedial allocation method.
Where a partnership adopts the remedial allocation method, the
proposed regulations treat the portion of any basis adjustment that is
attributable to section 704(c) built-in gain differently from the rest
of the basis adjustment. Instead of treating the section 704(c) built-
in gain portion of the basis adjustment and the basis adjustment in
excess of such amount as newly acquired property, the section 704(c)
built-in gain portion of the basis adjustment is recovered over the
remaining cost recovery period for the section 704(c) built-in gain.
The recovery period for the partner's share of common basis continues
to be determined by reference to the property's useful life in the
hands of the contributing partner, and the remaining basis adjustment
in excess of the section 704(c) built-in gain portion of the basis
adjustment is recovered as if it were new property.
If a partnership receives remedial allocations of income under
Sec. 1.704-3(d) with respect to an item of adjusted partnership
property, the partner does not offset the cost recovery deductions from
the property against the remedial allocations of income. Rather, the
partner will receive an allocation of remedial income and a separate
cost recovery deduction. If a partner receives remedial allocations of
deductions under Sec. 1.704-3(d) with respect to an item of partnership
property that has a negative basis adjustment, the partner first adds
the amount of the remedial allocation of deduction to any common basis
deductions received from the property. The partner then reduces the
total amount of deductions from the property by the amount of the
negative basis adjustment recovered in that year.
One result of this proposal is that the interests in a partnership
will generally be fungible (i.e. the tax consequences that stem from
the purchase of a partnership interest do not vary with the identity of
the transferor), if: (i) Each partnership interest has an identical
right in capital and profits, and (ii) each item of the partnership's
section 704(c) property is subject to the remedial allocation method.
The Service and Treasury request comments on situations in which the
fungibility of partnership interests may otherwise be accommodated
without significantly adding to the complexity of subchapter K. In
addition, comments are 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 is
contributed to the partnership.
Recovery of Negative Basis Adjustments
Section 1.168-2(n)(2) of the proposed Income Tax Regulations
provides that a negative basis adjustment to depreciable property is
recovered over the property's remaining recovery period in the hands of
the partnership (i.e., the adjustment made to the common basis of the
partnership property). The portion of the adjustment that is recovered
in any year is equal to the product of (i) the amount of the decrease
to the item's adjusted basis (determined as of the date of the
transfer), multiplied by (ii) 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 transfer (determined prior to any basis
adjustments).
Because the basis adjustment under section 743 is personal to the
transferee, the primary method adopted by the proposed regulations for
recovering a negative basis adjustment provides that the basis
adjustment does not affect the common basis of partnership property and
does not affect the tax consequences of partners other than the
transferee. Under this method, the recovery of the negative basis
adjustment may generate ordinary income to the extent that it exceeds
the transferee's share of the depreciation deductions. The proposed
regulations provide that, unless the partnership elects to make a
common basis adjustment, as described below, the amount of the basis
adjustment recovered in any year first decreases the transferee's
distributive share of the partnership's deductions from the adjusted
item of property for that year. If, in any year, a partnership does not
allocate to a transferee sufficient deductions from the adjusted
property to offset the recovery of the negative basis adjustment, then
the transferee's distributive share of the deductions from other items
of partnership property is decreased. The transferee then recognizes
income equal to the excess of the amount of the negative basis
adjustment recovered in the year over the transferee's share of
deductions from the other items of property for the year.
As an alternative, the proposed regulations also allow partnerships
to elect to follow the approach of the old proposed regulations. If
this election is made, the partnership treats the amount of the
negative basis adjustment as an item of built-in gain, decreasing the
total amount of depreciation or amortization that the partnership may
allocate for tax purposes. This election would prevent the transferee
from ever recognizing income in situations where the partnership did
not allocate to the transferee sufficient depreciation to offset the
negative basis adjustment. It should be noted, however, that this
election has no effect on the partners' capital accounts, which
continue to be adjusted to reflect the depreciation or amortization of
the adjusted property as though there was no basis adjustment to the
property. Consequently, to the extent that the basis adjustment causes
the amount of the deductions allocated to the non-transferee partners
for book purposes to exceed the amount of tax depreciation available to
be allocated to them by the partnership, a book-tax disparity results
for the non-transferee partners.
The Service and Treasury request comments concerning the recovery
of negative basis adjustments under section 743. Specifically, the
Service and Treasury request comments regarding whether there are other
possible ways of accounting for the recovery of negative basis
adjustments that treat the basis adjustment as personal to the
transferee and, at the same time, do not interfere with the economic
agreement among the partners.
Reporting and Returns
The statutory language of section 743(b) indicates that
partnerships are responsible for making the basis adjustments. This
mandate is repeated in the language of the current regulations issued
under both sections 743 and 755. Notwithstanding that partnerships are
required to make and allocate basis adjustments under the current
regulations, transferees are required to report the basis adjustments.
Transferees accomplish this by attaching statements to their returns
that show how the section 743(b) adjustment was determined and how the
adjustment was allocated among the various partnership properties. No
existing guidance indicates when (i.e., before or after the Schedule K-
1) the effect of the basis adjustment to specific partnership items is
to be determined or who is required to make and report the adjustments
to the partnership items.
The proposed regulations clarify that partnerships are required to
make the basis adjustments. In addition, the
[[Page 4412]]
proposed regulations place the responsibility for reporting basis
adjustments on partnerships. Partnerships report basis adjustments by
attaching statements to their partnership returns when they acquire
knowledge of transfers subject to section 743. In addition,
partnerships are required to adjust specific partnership items in light
of the basis adjustments. Consequently, amounts reported on the
transferee's Schedule K-1 are adjusted amounts.
Transferees are subject to an affirmative obligation to notify
partnerships of their basis in acquired partnership interests. To
accommodate partnership concerns about the reliability of the
information provided, partnerships are entitled to rely on the written
representations of transferees concerning either the amount paid for
the partnership interest or the transferee's basis in the partnership
interest under section 1014 (unless clearly erroneous).
B. Section 751
Section 751(a) provides that to the extent an amount realized on
the sale or exchange of a partnership interest is attributable to the
transferor's interest in unrealized receivables or inventory items of
the partnership, the amount realized is considered to be an amount
realized from the sale or exchange of property other than a capital
asset. Thus, the transferor partner may recognize ordinary income or
loss on the sale or exchange of its partnership interest. Under the
current section 751 regulations, the amount of income or loss realized
by a partner on the sale or exchange of an interest in section 751
property is equal to the difference between: (i) The portion of the
total amount realized for the partnership interest allocated to section
751 property, and (ii) the portion of the transferor partner's basis in
its partnership interest allocated to the property. Generally, the
portion of the total amount realized allocated to section 751 property
is determined by the seller and purchaser in an arm's length agreement.
The portion of the partner's adjusted basis in the partnership interest
allocated to the section 751 property equals the basis that the
property would have had under section 732 if the transferor partner had
received its proportionate share of the property in a current
distribution immediately before the sale.
The proposed regulations amend these rules for determining the
transferor partner's gain or loss from the sale or exchange of its
interest in section 751 property. Rather than attempting to allocate a
portion of the transferor partner's amount realized and adjusted basis
to the section 751 property, the proposed regulations adopt a
hypothetical sale approach. Thus, the income or loss realized by a
partner from section 751 property upon the sale or exchange of its
interest is the amount of income or loss that would have been allocated
to the partner from section 751 property (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 fair market
value immediately prior to the partner's transfer of the partnership
interest.
C. Section 755
In General
The current regulations under section 755 contain a number of
problems that prevent partnerships from allocating the section 743(b)
basis adjustments to appropriate assets. The proposed regulations
resolve these problems and implement the purposes of section 743(b) by
focusing on the items that the transferee partner would receive upon a
fair market value sale of all of the partnership's assets.
At the same time, the proposed regulations recognize that
adjustments under section 734 differ significantly from adjustments
under section 743. Specifically, adjustments under section 743(b) are
intended to affect the transferee partner only. In contrast,
adjustments under section 734 affect all of the partners. As a result,
the proposed regulations under section 755 contain two separate
regimes--one that applies to adjustments under section 734, and another
that applies to adjustments under section 743. While the regime
allocating adjustments under section 743 focuses on the transferee, the
regime allocating adjustments under section 734 focuses on the
difference between value and basis at the partnership entity level.
Allocating Adjustments Under Section 743(b)
The proposed regulations provide that allocations of basis
adjustments under section 743 among partnership assets are made based
on the amount of income, gain, or loss (including remedial allocations
under Sec. 1.704-3(d)) that the transferee would be allocated if,
immediately after the section 743(b) transfer, all of the partnership's
assets were disposed of in a fully taxable transaction at fair market
value. By adopting this method, in some situations the proposed
regulations will require adjustments to be made that increase the basis
of some assets and decrease the basis of others.
Hypothetical Sale
The current regulations do not take each partner's interest in
specific assets into account. The amount of the section 743 adjustment
is allocated among partnership properties to reduce the difference
between the fair market value and the adjusted basis of partnership
properties at the partnership entity level rather than at the partner
level. This formulation of the rule fails to take into account special
allocations or the varying treatment of different partners by virtue of
the operation of section 704(c) or the minimum gain chargeback.
Therefore, basis adjustments will often be made to the wrong assets,
exposing the partners to tax consequences that may vary significantly
from the partners' economic consequences.
Rather than attempt to define a partner's share of the basis or
fair market value of a specific partnership asset, the proposed
regulations focus on the actual tax items that would be allocated to
the transferee in a fully taxable, fair market value sale. Under the
proposed regulations, partnerships are required to adjust the basis of
partnership assets in a manner that reflects the amount of income,
gain, or loss that the transferee would recognize if all of the
partnership's assets were sold in the hypothetical transaction.
Two-Way Adjustments
Under the current regulations, the partnership may not increase the
basis of assets that have a fair market value in excess of basis and,
at the same time, decrease the basis of assets that have a basis in
excess of fair market value. Thus, if the section 743(b) adjustment is
positive, the partnership may only increase the basis of assets that
have a basis that is less than their fair market value. This
restriction prevents the partnership from adjusting the basis of its
assets in a manner that coordinates a transferee's tax consequences
with its economic consequences.
The proposed regulations remove this restriction. Instead, the
amount of the section 743 adjustment is viewed as a net adjustment.
This net amount is then allocated between the partnership's two classes
of assets (capital gain property and ordinary income property). The
amount of the adjustment allocated to ordinary income property may be
an increase while the amount of the adjustment allocated to capital
gain property is a decrease. The amount of the adjustment allocated to
each class is then allocated among the assets within each class. The
amount of the
[[Page 4413]]
adjustment allocated to one item within the class may also be an
increase even if the amount allocated to another item is a decrease.
Allocation Between Classes
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 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 (i) the total amount of the basis adjustment under section
743, less (ii) the amount of the basis adjustment allocated to ordinary
income; provided, however, that in no event may the amount of any
decrease in basis allocated to capital gain property exceed the
partnership's basis in capital gain property.
In the event that a decrease in basis allocated to capital gain
property exceeds the partnership's basis in capital gain property, the
excess is applied to reduce the basis of ordinary income property.
Allocation Within Classes
The amount of the basis adjustment allocated to each item of
property within the class of ordinary income property equals:
(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 from the hypothetical sale of the item, minus
(b) The product of (1) any decrease to the amount of the basis
adjustment to ordinary income property required because the partnership
did not have enough basis in capital gain property to reduce,
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 items of the partnership's
ordinary income property.
The amount of the basis adjustment allocated to each item of
property within the class of capital gain property equals:
(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 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 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 all items of 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
total fair market value of all of the partnership's items of capital
gain property.
Allocating Adjustments Under Section 734
As under the current regulations, the proposed regulations provide
that allocations of section 734 adjustments among partnership assets
are made based on the difference between the value of the property and
the property's basis. 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. If there is an increase in basis to be
allocated within a class of property, 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. 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).
D. Section 1017
Section 1017 provides rules concerning basis reductions resulting
from a taxpayer's exclusion of cancellation of indebtedness income. In
general, under Sec. 1.1017-1(f) of the proposed Income Tax Regulations,
if a partner makes an election under section 108(b)(5) or section
108(c), the partner may treat a partnership interest as depreciable
property (or depreciable real property) to the extent the partnership
correspondingly reduces the partner's proportionate share of the
adjusted basis of depreciable property (or depreciable real property)
held by the partnership. These proposed regulations provide guidance
regarding the determination of a partner's proportionate share of the
partnership's basis in depreciable property (or depreciable real
property) and the consequences of the basis reductions required under
sections 108 and 1017.
In general, these proposed regulations provide that a partner's
share of the partnership's basis in depreciable property (or
depreciable real property) equals the sum of (a) the partner's section
743(b) basis adjustment, if any, in the partnership items of
depreciable property (or depreciable real property) and (b) the common
basis depreciation deductions (not including remedial allocations of
depreciation under Sec. 1.704-3(d)) that are reasonably expected to be
allocated to the partner over the partnership property's remaining
useful life. The amount of common basis depreciation deductions that a
partner may reasonably expect to be allocated over the partnership
property's useful life is based on all the facts and circumstances in
effect at the time of the basis reduction. It is per se unreasonable,
however, for the partnership to treat the same depreciation deductions
as ``reasonably expected'' by more than one partner. Thus, the amount
of the partners' total basis reductions under sections 108(b)(5) and
108(c) cannot exceed the partnership's basis in depreciable property
(or depreciable real property).
The proposed regulations further provide that any reduction to the
basis of depreciable property required under sections 108 and 1017
constitutes an adjustment to the basis of partnership property with
respect to the partner only. These adjustments, therefore, are similar
to the basis adjustments required under section 743(b). Accordingly,
the proposed regulations provide that these adjustments have the same
effect and are recovered in the same manner as basis adjustments
required under section 743(b); provided, however, that the election to
treat the negative basis adjustment as an item of built-in gain (which
decreases the amount of depreciation or amortization that the
partnership may allocate) is not applicable. Consequently, if a
partner's actual share of the partnership's common basis depreciation
deductions in any year is less than the amount that was included in
determining the partner's proportionate share of the partnership's
common basis depreciation deductions for that year, the partner will
recognize income.
[[Page 4414]]
E. Section 732
In General
With some exceptions, partners generally may receive distributions
of partnership property without recognition of gain or loss. Rules are
provided for determining the basis of the distributed property in the
hands of the distributee. In the event that multiple properties are
distributed by a partnership, section 732(c) provides allocation rules
for determining their bases in the distributee partner's hands.
Section 732(c) was amended by the Taxpayer Relief Act of 1997,
Public Law 105-34, Sec. 1061, 111 Stat. 788, 945-46 (1997). Under prior
law, a partner's basis in its partnership interest was allocated among
property distributed to the partner based on the distributed
properties' adjusted bases. The rules allocated the partner's basis in
its partnership interest first to unrealized receivables and inventory
items in an amount equal to the partnership's adjusted basis (or if the
basis to be allocated was less than the partnership's basis, then in
proportion to the partnership's basis). To the extent that there was
any basis remaining to be allocated among distributed properties, the
basis was allocated among the other properties in proportion to their
adjusted bases to the partnership.
Section 1061 of the Taxpayer Relief Act of 1997, Public Law 105-34,
section 1061, 111 Stat. 788, 945-46 (1997), revised the allocation
rules for determining basis in the distributee partner's hands. As
under prior law, basis is allocated first to any distributed unrealized
receivables and inventory items before it is allocated to any other
distributed property. Basis is then allocated among the other
distributed properties to the extent of each such property's adjusted
basis to the partnership. Any remaining basis adjustment, if an
increase, is allocated among properties with unrealized appreciation in
proportion to their respective amounts of unrealized appreciation (to
the extent of each property's appreciation), and then in proportion to
their respective fair market values. If the remaining basis adjustment
is a decrease, it is allocated among properties with unrealized
depreciation in proportion to their respective amounts of unrealized
depreciation (to the extent of each property's depreciation), and then
in proportion to their respective adjusted bases (taking into account
the adjustment already made). The proposed regulations amend the
current regulations to incorporate these changes to section 732(c).
Section 732(d)
Section 732(d) provides a special rule that applies to determine
the basis of property distributed to a transferee partner who acquired
any part of its partnership interest in a transfer when an election
under section 754 was not in effect. When the special rule applies, the
basis of distributed property is adjusted immediately before the
distribution to reflect the basis that the property would have had if
the partnership had a section 754 election in effect at the time the
transferee acquired the partnership interest. As a result, the basis of
the distributed property in the hands of the partnership immediately
before the distribution more closely approximates its fair market
value. Consequently, the transferee's basis in the distributed property
will also more closely approximate its fair market value.
Section 1.732-1(d)(4) of the current regulations requires
transferees to apply the special basis rule in certain cases.
Specifically, transferees are required to apply the special basis rule
if at the time of the acquisition of the partnership interest--
(i) The fair market value of all partnership property (other than
money) exceeded 110 percent of its adjusted basis to the partnership,
(ii) An allocation of basis under section 732(c) upon a liquidation
of the partnership interest immediately after the transfer of the
interest would have resulted in a shift of basis from property not
subject to an allowance for depreciation, depletion, or amortization,
to property subject to such an allowance, and
(iii) A basis adjustment under section 743(b) would change the
basis to the transferee partner of the property actually distributed.
The purpose of Sec. 1.732-1(d)(4) was to prevent distortions caused
by section 732(c) that might inflate the basis of depreciable,
depletable, or amortizable property above its fair market value. At the
time that the regulations were adopted, such distortions might occur
because section 732(c) allocated basis among distributed properties
based on their relative bases. The changes made to section 732(c) by
the Taxpayer Relief Act of 1997, Public Law 105-34, section 1061, 111
Stat. 788, 945-46 (1997), make the distortions targeted by the
regulations less likely to occur. As a result, the Service and Treasury
request comments on the proper scope of section 732(d), and
specifically, under what circumstances, if any, the Secretary should
exercise its authority to mandate the application of section 732(d) to
a transferee.
Proposed Effective Date
The regulations are proposed to be effective: (i) For all transfers
of partnership interests on and after the date the regulations are
published as final regulations in the Federal Register, (ii) for all
distributions from partnerships on and after the date the regulations
are published as final regulations in the Federal Register, and (iii)
for all elections under sections 108(b)(5) and 108(c) made on or after
the date the regulations are published as final regulations in the
Federal Register.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. An initial regulatory
flexibility analysis has been prepared for the collection of
information in this notice of proposed rulemaking under 5 U.S.C. 603. A
summary of the analysis is set forth below under the heading ``Summary
of Initial Regulatory Flexibility Analysis.'' Pursuant to section
7805(f) of the Internal Revenue Code, this notice of proposed
rulemaking will be submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
Summary of Initial Regulatory Flexibility Analysis
This initial analysis is prepared pursuant to the Regulatory
Flexibility Act (5 U.S.C. chapter 6). In general, the proposed
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
and 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 this
requirement is
[[Page 4415]]
contained in sections 743(b), 6001, 7805(a).
There were approximately 1,494,000 partnerships in 1994. However,
these proposed 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. The election also
cannot be revoked without the consent of the Secretary. Accordingly,
the Service and Treasury believe that most partnerships do not make the
election under section 754. Therefore, most partnerships will not be
affected by the proposed 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 Treasury Department are not aware of any federal rules
that may duplicate, overlap, or conflict with the proposed rule.
As an alternative to the disclosure described above, the Service
and Treasury considered, but rejected, a rule that would have required
the partners, and not the partnerships, to make the basis reductions
and to determine the effects of the basis adjustments on the partner's
distributive shares. This alternative was rejected because the Service
and Treasury believe that partnerships generally have better access to
the information necessary to report section 743 basis adjustments
properly. To 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. The Service and Treasury request comments
concerning possible alternatives.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are timely submitted to the IRS. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for Wednesday, July 8, 1998, at
10 a.m. in the IRS Auditorium of the Internal Revenue Building. Because
of access restrictions, visitors will not be admitted beyond the
Internal Revenue Building lobby more than 15 minutes before the hearing
starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons
that wish to present oral comments at the hearing must submit written
comments by April 29, 1998, and submit an outline of the topics to be
discussed and the time to be devoted to each topic (signed original and
eight (8) copies) by Wednesday, June 24, 1998.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal authors of these proposed regulations are Brian M.
Blum and Terri A. Belanger of the Office of the Assistant Chief Counsel
(Passthroughs and Special Industries). However, personnel from other
offices of the Internal Revenue Service and the Treasury Department
participated in their development.
Partial Withdrawal of Notice of Proposed Rulemaking
Accordingly, under the authority of 26 U.S.C. 7805, Sec. 1.168-2(n)
in the notice of proposed rulemaking published February 16, 1984 (49 FR
5940) is withdrawn.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.168-2 also issued under 26 U.S.C. 168. * * *
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 by revising paragraphs (c),
(d)(1)(vi), (d)(4)(iii) and the last sentence of paragraph (d)(1)(v)
and removing the undesignated text including the examples immediately
following paragraph (d)(4)(iii) to 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.
[[Page 4416]]
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
value of $400. Asset Y has an adjusted basis to the partnership and
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 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 the date final
regulations are published in the Federal Register.
(d) * * *
(1) * * *
(v) * * * (For a shift of transferee's basis adjustment 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 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 to Market
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 value of the inventory received by T was one-fourth of
the 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 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
[[Page 4417]]
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.
* * * * *
Par. 3. Section 1.732-2 is amended by adding a new 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 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 the date final
regulations are published in the Federal Register.
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. 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; 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, as defined in paragraph (d)(2) of this
section; 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, as defined in paragraph (d)(2) of this
section.
(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. For example, if the partnership properly maintains capital
accounts under the rules of Sec. 1.704-1(b)(2)(iv), the transferee's
interest as a partner in the partnership's previously taxed capital is
equal to--
(i) The transferee's capital account adjusted for the hypothetical
transaction; 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; 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.
(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
-------------------
Adjusted Market
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 Market
books value
------------------------------------------------------------------------
Liabilities......................................... $10,000 $10,000
Capital:
A................................................. 15,000 22,000
B................................................. 15,000 22,000
[[Page 4418]]
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 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 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 worth $1,000 (Asset 1) with 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 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) may be 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 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 value of the
partnership property). An election under section 754 is in effect;
therefore, T1 has a basis adjustment 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
value of the partnership property). T2 has a basis adjustment of
$200. This amount is determined without regard to any basis
adjustment 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. 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 pursuant
to 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 to 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
-------------------
Adjusted Market
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
------------------------------------------------------------------------
------------------------------------------------------------------------
Capital
-------------------
Adjusted
per 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
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:
[[Page 4419]]
------------------------------------------------------------------------
Assets
---------------------------------------
Adjusted Market Basis
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 4,000.00
------------------------------------------------------------------------
------------------------------------------------------------------------
Capital
--------------------------------------
Adjusted Market Special
per books value 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 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 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,
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 adjustment 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 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 special 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.
(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 income,
deduction, gain, loss, and distribution, 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 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
[[Page 4420]]
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 to the property that
is the source of the item of partnership income, deduction, gain, or
loss. 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 of gain or loss 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 that, under section 755, is allocated
to the nondepreciable property. PRS then sells the property for $60.
PRS recognizes a book gain of $10 and a tax loss of $40. T will
receive an allocation of $40 of tax loss under the principles of
section 704(c). 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 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
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). 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 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 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. 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 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 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) 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:
[[Page 4421]]
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)
------------------------------------------------------
Subtotal............................................. 470,000 110,000 470,000 470,000
Depreciation Year 2...................................... (30,000) ........... (30,000) (20,000)
Remedial................................................. ............ 10,000 ............ (10,000)
------------------------------------------------------
Total................................................ 440,000 120,000 440,000 440,000
----------------------------------------------------------------------------------------------------------------
(iii) 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.
(iv) 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) Effect on depreciation deductions--(1)--Reduced
deduction to transferee. Except as provided in paragraph
(j)(4)(ii)(A)(2) of this section, the amount of the basis adjustment 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.
(2) Election to reduce deduction of other partners by excess
adjustment. The partnership may elect to treat the amount of the basis
adjustment as an item of built-in gain, decreasing the amount of
depreciation or amortization that the partnership may allocate for tax
purposes. This election has no effect on the depreciation or
amortization of the property on the books of the partnership. The
partnership must make this election on the statement required to be
attached to its return pursuant to paragraph (k) of this section for
the year that the adjustment is made to the item 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 deducations from Asset 2 is
$1,000. Also assume that, under paragraph (j)(4)(ii)(B) of this
section, the amount of the basis adjustment that T recovers during
the year is $500. The total amount of depreciation 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 deducation
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
[[Page 4422]]
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.
Example 4. (i) A and B are equal partners in partnership PRS.
PRS has one depreciable asset that it purchased with cash. On the
first day of a year, A transfers its interest to T at a time when
the fair market value of the depreciable asset is $50 and its
adjusted tax basis is $200. The partnership has an election in
effect under section 754, resulting in a $75 decrease in the basis
of the depreciable asset to T under section 743.
(ii) The depreciable asset has a remaining useful life of two
years and is being recovered using the straight-line method. The
partnership elects, under paragraph (j)(4)(ii)(A)(2) of this
section, to treat the decrease in basis under section 743 as an item
of built-in gain, decreasing the amount of depreciation that the
partnership can allocate from $200 to $125. This reduces the amount
of depreciation available to be allocated to the partners in each
year from $100 to $62.50. This election has no effect on the
depreciation or amortization of the property on the books of the
partnership. Therefore, the partnership will recover $100 of
depreciation on its books in each year.
(iii) At the end of the year, the partnership allocates each
partner $50 of depreciation for book purposes. Under the principles
of section 704(c), the first $50 of tax depreciation is allocated to
B. The remaining $12.50 of tax depreciation is allocated to T.
(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).
(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 oil 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 for the oil
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 oil 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. A partnership that must
adjust the bases of partnership properties under section 743 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.
(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, must
notify the partnership, in writing, within 30 days of the sale or
exchange (or, if earlier, by January 15 of the calendar year following
the calendar year in which the sale or exchange occurred). The written
notice to the partnership must include the names and addresses of both
parties to the sale or exchange, the taxpayer identification numbers of
the transferee and (if known) of the transferor, the date of the
transfer, and the amount of any money and the fair market value of any
other property delivered or to be delivered for the transferred
interest in the partnership.
(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, must notify the partnership, in writing, within one year
of the death of the deceased partner. The written notice to the
partnership 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 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.
(3) Reliance. In making the adjustments under section 743 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 the tax matters partner (as defined under section
6231(a)(7)) or any other 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 until it has notice of the transfer. A partnership is not
required to make the adjustments under section 743 (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) The tax matters partner (as defined under section 6231(a)(7))
or any other 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 known) 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
[[Page 4423]]
transferee to amend its prior returns to properly reflect the
adjustment under section 743.
(l) Effective date. This section applies to transfers of
partnership interests that occur on or after the date final regulations
are published in the Federal Register.
Par. 6. Section 1.751-1 is amended by:
1. Revising paragraphs (a)(2) and (a)(3) and Example 1 of paragraph
(g).
2. Adding a sentence at the end of paragraph (f).
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 allocation 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 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.
* * * * *
(f) * * * The rules contained in paragraphs (a) (2) and (3) of this
section apply to transfers of partnership interests that occur on or
after the date final regulations are published in the Federal Register.
(g) * * *
Example 1. (i) 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:
------------------------------------------------------------------------
Assets
-------------------
Adjusted Market
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 Market
per books value
------------------------------------------------------------------------
Liabilities....................................... $2,000 $2,000
Capital:
A............................................. 9,000 15,000
B............................................. 9,000 15,000
---------------------
Total....................................... 20,000 32,000
------------------------------------------------------------------------
(ii) None of the assets owned by PRS is section 704(c) property.
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.
(iii) 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 1.755-1 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--
(1) Capital assets and section 1231(b) property (capital gain
property); and
(2) Any other property of the partnership (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. In general,
the allocation of the basis adjustment under section 743 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 assets were disposed of in a fully
taxable transaction for fair market value (the hypothetical
transaction). 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. 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.
(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;
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
[[Page 4424]]
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 example:
Example 1. (i) A and B form equal partnership PRS. A contributes
$50,000 and Asset 1, a 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
---------------------
Adjusted Market
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 is zero.
(ii) Immediately after the transfer of the partnership interest to
T, the adjusted basis and fair market value of PRS' assets are as
follows:
------------------------------------------------------------------------
Assets
-------------------
Adjusted Market
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, 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--
(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 total 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 example:
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 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
[[Page 4425]]
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. The amount of the
adjustment to Asset 1 is $33,604 (the sum of $37,500, less $3,896
($10,000 x $75,000/192,500)). The amount of the basis adjustment to
Asset 2 is $2,646 (the sum of $8,750, less $6,104 ($10,000 x
$117,500/192,500)).
(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) Goodwill. The application of the rules with respect to the
allocation of an adjustment in basis under this paragraph (c) requires
that a portion of the adjustment be allocated to partnership goodwill,
to the extent that goodwill exists and is reflected in the value of the
property distributed in accordance with the difference between such
value of the goodwill and its adjusted basis at the time of the
distribution.
(6) 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. None of the partnership's assets are section 751
property. The partnership has an election in effect under section
754. After five years, the adjusted basis and fair market value of
PRS's assets are as follows:
------------------------------------------------------------------------
Assets
-------------------
Adjusted Market
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
$37,500 in each of Assets 3 and 5. The distribution results in a
$12,500 increase in the basis of both capital gain property and
ordinary income property.
(iii) Allocation within classes--(A) Capital gain property. The
amount of the basis increase to capital gain property is $12,500,
and must be allocated among the remaining capital gain assets in
proportion to the difference between the 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 $9,260
($12,500, multiplied by $50,000, divided by $67,500), and the basis
of Asset 2 will be increased by $3,240 ($12,500 multiplied by
$17,500, divided by $67,500).
(B) Ordinary income property. The amount of the basis increase
to ordinary income property is $12,500, and must be allocated among
the remaining ordinary income assets in proportion to the difference
between the value and basis of each. Because the basis of Asset 6
exceeds its fair market value, no part of the basis adjustment will
be allocated to Asset 6. The fair market value of Asset 4, $45,000,
exceeds its basis, $40,000, by $5,000. Because the partnership owns
no other ordinary income property that has a value in excess of its
basis, the entire basis adjustment will be allocated to Asset 4,
increasing its basis from $40,000 to $52,500.
(d) Effective date. This section applies to transfers of
partnership interests and distributions of property from a partnership
that occur on or after the date final regulations are published in the
Federal Register.
Par. 8. Section 1.1017-1 as proposed to be revised at 62 FR 958,
January 7, 1997, is amended by:
1. Revising paragraph (f)(2)(iv).
2. Adding paragraph (f)(2)(v).
The addition and revision read as follows:
Sec. 1.1017-1 Basis reductions following a discharge of indebtedness.
* * * * *
[[Page 4426]]
(f) * * *
(2) * * *
(iv) Partner's share of partnership basis--(A) In general. For
purposes of this paragraph (f), 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, 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 (f)(2)(iv) applies to elections
made under sections 108(b)(5) and 108(c) on or after the date the
regulations are published as final regulations in the Federal Register.
(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, provided, however, that the election in
Sec. 1.743-1(j)(4)(ii)(A)(2) is not available. The following example
illustrates this paragraph (f)(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 (f)(2)(v) applies to elections
made under sections 108(b)(5) and 108(c) on or after the date the
regulations are published as final regulations in the Federal Register.
* * * * *
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
[FR Doc. 98-1949 Filed 1-28-98; 8:45 am]
BILLING CODE 4830-01-U
