[Federal Register Volume 61, Number 249 (Thursday, December 26, 1996)]
[Rules and Regulations]
[Pages 67936-67942]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-32854]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8707]
RIN 1545-AT19
Distribution of Marketable Securities by a Partnership
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations providing rules for
partnership distributions of marketable securities under section 731(c)
of the
[[Page 67937]]
Internal Revenue Code of 1986, as amended, and for determining when
those distributions are taxable to the distributee partner. The
regulations reflect changes to the law made by the Uruguay Round
Agreements Act enacted on December 8, 1994.
DATES: These regulations are effective on December 26, 1996.
FOR FURTHER INFORMATION CONTACT: Terri A. Belanger or William M. Kostak
at (202) 622-3080 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document amends 26 CFR part 1 to provide rules relating to the
treatment of partnership distributions of marketable securities under
section 731(c). Under section 731(a), in the case of a distribution by
a partnership to a partner, gain is recognized to the partner only to
the extent that any money distributed exceeds the adjusted basis of the
partner's interest in the partnership. Prior to the enactment of
section 731(c), marketable securities were not considered money and,
therefore, the distribution of marketable securities by a partnership
to a partner was not a taxable event. Section 731(c) now treats a
partnership distribution of marketable securities as a distribution of
money and as a taxable event if the value of the distributed securities
exceeds the adjusted basis of the partner's interest in the
partnership. Section 731(c) also provides several exceptions to the
general rule that a distribution of marketable securities will be
treated as a distribution of money.
On January 2, 1996, the IRS published in the Federal Register (61
FR 28) a notice of proposed rulemaking (PS-2-95) to provide guidance
regarding section 731(c). A number of public comments were received
concerning the proposed regulations. However, the public hearing
scheduled for April 3, 1996, was cancelled because no one requested to
speak. After consideration of the written comments received, the
proposed regulations are adopted as revised by this Treasury decision.
Explanation of Provisions
I. General Background
The proposed regulations provide rules for determining when and the
extent to which a distribution of marketable securities by a
partnership to a partner will be treated as a distribution of money for
purposes of section 731(a). Although modified in response to comments,
the final regulations generally adopt the rules contained in the
proposed regulations.
II. Public Comments
Several comments requested that the IRS reconsider the requirement
in Sec. 1.731-2(d) (2)(ii) of the proposed regulations that a
marketable security must be actively traded on the date of distribution
to qualify for the ``nonrecognition transaction'' exception to section
731(c). Because of this rule, financial instruments (securities) that
are treated as marketable securities under section 731(c)(2)(B) on the
date of distribution, but that are not actively traded, would not
qualify for this exception. Commentators suggested that the final
regulations should not include this requirement or should include a
more narrowly drafted provision. In response to these comments, the
final regulations provide that a security that falls within the
definition of marketable security may qualify for the exceptions under
Sec. 1.731-2(d) of the final regulations even if the security is not
actively traded on the date of distribution. An anti-stuffing rule has
been added to address the concern to which the actively-traded
requirement of the proposed regulations was directed.
Several comments also suggested that Sec. 1.731-2(d)(2) of the
proposed regulations should allow a de minimis amount of cash and
marketable securities to be transferred in a nonrecognition
transaction. The final regulations provide that if the value of money
and marketable securities transferred in a nonrecognition transaction
is less than 20 percent of the total amount of all property transferred
in exchange for the distributed security, the entire value of the
distributed security will qualify for the nonrecognition transaction
exception under Sec. 1.731-2(d)(1)(ii) of the final regulations.
Several commentators also suggested that the five-year rules of
Sec. 1.731-2(d)(2) and (3) of the proposed regulations be eliminated.
Section 1.731-2(d)(2) of the proposed regulations provided that a
marketable security that was acquired in a nonrecognition transaction
in exchange for other property and distributed within five years by the
partnership would not be subject to section 731(c). Section 1.731-
2(d)(3) of the proposed regulations provided that a marketable security
that was acquired by the partnership before it became actively traded
would also not be subject to section 731(c) if it was distributed by
the partnership within five years of becoming actively traded. One
commentator, for example, argued that a security is no less a
substitute for the underlying assets in a nonrecognition transaction
after five years than before five years. These five-year rules were
included in the proposed regulations because of administrative
concerns. For example, it may be difficult, after the passage of many
years, for taxpayers or the IRS to determine the circumstances in which
a partnership acquired a particular security. Moreover, it is not clear
whether certain exceptions should apply to a distribution of securities
if those securities were acquired by a partnership many years ago and
are now distributed to a partner who was not a partner at the time the
securities were acquired. These administrative concerns remain valid,
and a five year time limitation provides a reasonable and simple
solution to such problems. Therefore, the final regulations retain both
five-year rules.
One comment requested clarification regarding whether a section
708(b)(1)(B) termination affects a partnership's qualification for the
exceptions under Sec. 1.731-2 (d) and (e) of the regulations. Another
commentator suggested that the regulations be modified to provide that
marketable securities will not be treated as money when there is a
deemed distribution of marketable securities by the terminating
partnership as the result of a section 708(b)(1)(B) termination. In
response to these comments, the final regulations provide that a
section 708(b)(1)(B) termination does not have any effect on a
partnership's qualification for the exceptions under section 731(c). In
addition, a deemed distribution occurring as a result of a section
708(b)(1)(B) termination will not be subject to section 731(c).
Several comments suggested that the 10-percent test in the
investment partnership look-through rule under Sec. 1.731-2(e)(4) of
the proposed regulations should be modified or eliminated. A
partnership can qualify for the investment partnership exception only
if it has never been engaged in a trade or business and substantially
all of its assets are investment assets. Under the proposed
regulations, a partnership is treated as engaged in a trade or business
engaged in by, or as holding a proportionate share of the assets of, a
lower-tier partnership in which the partnership holds a partnership
interest unless the upper-tier partnership does not participate in the
management of the lower-tier partnership and the interest held by the
upper-tier partnership is less than 10 percent of the total profits and
capital interests in the lower-tier partnership. According to the
comments, the requirement that the upper-tier partnership not
participate in
[[Page 67938]]
the management of the lower-tier partnership should be sufficient to
ensure passive ownership of the interest in the lower-tier partnership.
The commentators further argued that ownership of more than 10 percent
of the capital and profits interest in a lower-tier partnership may
still be consistent with passive ownership. After consideration of
these comments, the final regulations modify the rule in the proposed
regulations to increase the threshold ownership percentage amount from
10 to 20 percent.
In response to a comment, the final regulations clarify that an
interest in a lower-tier partnership that qualifies for the exception
to the investment partnership ``look-through'' rule is treated as
eligible property for purposes of determining whether the partner who
contributed the lower-tier partnership interest is an eligible partner
of the upper-tier investment partnership.
One commentator recommended that the regulations include an example
that illustrates the section 732(a)(2) ordering rules for distributions
that include money, marketable securities and other property, and to
clarify whether marketable securities are treated as money for purposes
of section 732(a)(2). Because the statute and the regulations provide
that marketable securities are treated as money only for purposes of
sections 731(a)(1) and 737, no additional examples are necessary.
One comment suggested that the effective date of the regulations
should be the same as the effective date of section 731(c) because the
regulations contain guidance for the various exceptions provided for by
the Internal Revenue Code. In response to this comment, the final
regulations provide that, for the period between the effective date of
the statutory provision and the effective date of these regulations,
taxpayers may apply the rules contained in these regulations. Another
comment suggested that the final regulations should make clear that the
rules in the investment partnership exception apply with respect to all
property contributed to, or held by, a partnership at any time
(including any period prior to the enactment of section 731(c)). The
IRS and Treasury believe that this is sufficiently clear from the
statutory language, and an explicit statement to this effect in these
regulations is not necessary and may be confusing.
One comment requested that the regulations provide several examples
illustrating abusive transactions intended to be covered by the anti-
abuse rules of Sec. 1.731-2(h), and that these rules be coordinated
with the general anti-abuse rules of Sec. 1.701-2. After consideration
of this comment, it has been determined that the text of the
regulations adequately describes several situations that would be
considered abusive under these rules, and that additional examples are
unnecessary.
In response to several comments, the final regulations clarify that
the 90 percent test of Sec. 1.731-2(c)(2)(i) and the 20 percent test of
Sec. 1.731-2(c)(2)(ii) are determined using the gross value of the
entity's assets, disregarding any debt that may encumber or otherwise
be allocable to those assets, other than debt that is incurred to
acquire property with a principal purpose of avoiding or reducing the
effect of section 731(c).
Finally, the regulations clarify the interaction of the limitation
on gain rule in section 731(c)(3)(B) and the various exceptions listed
in paragraph (d). The regulations provide that any gain or loss on a
distributed security that qualifies for an exception is not taken into
account in determining the distributee partner's limitation on gain.
III. Effective Dates
In general, section 731(c) applies to distributions made after
December 8, 1994. These regulations are effective for distributions
made on or after December 26, 1996. However, taxpayers may apply the
rules of this section to distributions made after December 8, 1994, and
before December 26, 1996.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the notice of proposed
rulemaking preceding the regulations was issued prior to March 29,
1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding these regulations was submitted
to the Small Business Administration for comment on its impact on small
business.
Drafting Information
The principal authors of these regulations are Terri A. Belanger
and William M. Kostak, Office of Assistant Chief Counsel (Passthroughs
and Special Industries), IRS. However, other personnel from the IRS and
Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.731-2 also issued under 26 U.S.C. 731(c). * * *
Par. 2. Section 1.731-2 is added to read as follows:
Sec. 1.731-2 Partnership distributions of marketable securities.
(a) Marketable securities treated as money. Except as otherwise
provided in section 731(c) and this section, for purposes of sections
731(a)(1) and 737, the term money includes marketable securities and
such securities are taken into account at their fair market value as of
the date of the distribution.
(b) Reduction of amount treated as money--(1) Aggregation of
securities. For purposes of section 731(c)(3)(B) and this paragraph
(b), all marketable securities held by a partnership are treated as
marketable securities of the same class and issuer as the distributed
security.
(2) Amount of reduction. The amount of the distribution of
marketable securities that is treated as a distribution of money under
section 731(c) and paragraph (a) of this section is reduced (but not
below zero) by the excess, if any, of--
(i) The distributee partner's distributive share of the net gain,
if any, which would be recognized if all the marketable securities held
by the partnership were sold (immediately before the transaction to
which the distribution relates) by the partnership for fair market
value; over
(ii) The distributee partner's distributive share of the net gain,
if any, which is attributable to the marketable securities held by the
partnership immediately after the transaction, determined by using the
same fair market value as used under paragraph (b)(2)(i) of this
section.
(3) Distributee partner's share of net gain. For purposes of
section 731(c)(3)(B) and paragraph (b)(2) of this section, a partner's
distributive share of net gain is determined--
(i) By taking into account any basis adjustments under section
743(b) with respect to that partner;
[[Page 67939]]
(ii) Without taking into account any special allocations adopted
with a principal purpose of avoiding the effect of section 731(c) and
this section; and
(iii) Without taking into account any gain or loss attributable to
a distributed security to which paragraph (d)(1) of this section
applies.
(c) Marketable securities--(1) In general. For purposes of section
731(c) and this section, the term marketable securities is defined in
section 731(c)(2).
(2) Actively traded. For purposes of section 731(c) and this
section, a financial instrument is actively traded (and thus is a
marketable security) if it is of a type that is, as of the date of
distribution, actively traded within the meaning of section 1092(d)(1).
Thus, for example, if XYZ common stock is listed on a national
securities exchange, particular shares of XYZ common stock that are
distributed by a partnership are marketable securities even if those
particular shares cannot be resold by the distributee partner for a
designated period of time.
(3) Interests in an entity--(i) Substantially all. For purposes of
section 731(c)(2)(B)(v) and this section, substantially all of the
assets of an entity consist (directly or indirectly) of marketable
securities, money, or both only if 90 percent or more of the assets of
the entity (by value) at the time of the distribution of an interest in
the entity consist (directly or indirectly) of marketable securities,
money, or both.
(ii) Less than substantially all. For purposes of section
731(c)(2)(B)(vi) and this section, an interest in an entity is a
marketable security to the extent that the value of the interest is
attributable (directly or indirectly) to marketable securities, money,
or both, if less than 90 percent but 20 percent or more of the assets
of the entity (by value) at the time of the distribution of an interest
in the entity consist (directly or indirectly) of marketable
securities, money, or both.
(4) Value of assets. For purposes of section 731(c) and this
section, the value of the assets of an entity is determined without
regard to any debt that may encumber or otherwise be allocable to those
assets, other than debt that is incurred to acquire an asset with a
principal purpose of avoiding or reducing the effect of section 731(c)
and this section.
(d) Exceptions--(1) In general. Except as otherwise provided in
paragraph (d)(2) of this section, section 731(c) and this section do
not apply to the distribution of a marketable security if--
(i) The security was contributed to the partnership by the
distributee partner;
(ii) The security was acquired by the partnership in a
nonrecognition transaction, and the following conditions are
satisfied--
(A) The value of any marketable securities and money exchanged by
the partnership in the nonrecognition transaction is less than 20
percent of the value of all the assets exchanged by the partnership in
the nonrecognition transaction; and
(B) The partnership distributed the security within five years of
either the date the security was acquired by the partnership or, if
later, the date the security became marketable; or
(iii) The security was not a marketable security on the date
acquired by the partnership, and the following conditions are
satisfied--
(A) The entity that issued the security had no outstanding
marketable securities at the time the security was acquired by the
partnership;
(B) The security was held by the partnership for at least six
months before the date the security became marketable; and
(C) The partnership distributed the security within five years of
the date the security became marketable.
(2) Anti-stuffing rule. Paragraph (d)(1) of this section does not
apply to the extent that 20 percent or more of the value of the
distributed security is attributable to marketable securities or money
contributed (directly or indirectly) by the partnership to the entity
to which the distributed security relates after the security was
acquired by the partnership (other than marketable securities
contributed by the partnership that were originally contributed to the
partnership by the distributee partner). For purposes of this paragraph
(d)(2), money contributed by the distributing partnership does not
include any money deemed contributed by the partnership as a result of
section 752.
(3) Successor security. Section 731(c) and this section apply to
the distribution of a marketable security acquired by the partnership
in a nonrecognition transaction in exchange for a security the
distribution of which immediately prior to the exchange would have been
excepted under this paragraph (d) only to the extent that section
731(c) and this section otherwise would have applied to the exchanged
security.
(e) Investment partnerships--(1) In general. Section 731(c) and
this section do not apply to the distribution of marketable securities
by an investment partnership (as defined in section 731(c)(3)(C)(i)) to
an eligible partner (as defined in section 731(c)(3)(C)(iii)).
(2) Eligible partner--(i) Contributed services. For purposes of
section 731(c)(3)(C)(iii) and this section, a partner is not treated as
a partner other than an eligible partner solely because the partner
contributed services to the partnership.
(ii) Contributed partnership interests. For purposes of determining
whether a partner is an eligible partner under section 731(c)(3)(C), if
the partner has contributed to the investment partnership an interest
in another partnership that meets the requirements of paragraph
(e)(4)(i) of this section after the contribution, the contributed
interest is treated as property specified in section 731(c)(3)(C)(i).
(3) Trade or business activities. For purposes of section
731(c)(3)(C) and this section, a partnership is not treated as engaged
in a trade or business by reason of----
(i) Any activity undertaken as an investor, trader, or dealer in
any asset described in section 731(c)(3)(C)(i), including the receipt
of commitment fees, break-up fees, guarantee fees, director's fees, or
similar fees that are customary in and incidental to any activities of
the partnership as an investor, trader, or dealer in such assets;
(ii) Reasonable and customary management services (including the
receipt of reasonable and customary fees in exchange for such
management services) provided to an investment partnership (within the
meaning of section 731(c)(3)(C)(i)) in which the partnership holds a
partnership interest; or
(iii) Reasonable and customary services provided by the partnership
in assisting the formation, capitalization, expansion, or offering of
interests in a corporation (or other entity) in which the partnership
holds or acquires a significant equity interest (including the
provision of advice or consulting services, bridge loans, guarantees of
obligations, or service on a company's board of directors), provided
that the anticipated receipt of compensation for the services, if any,
does not represent a significant purpose for the partnership's
investment in the entity and is incidental to the investment in the
entity.
(4) Partnership tiers. For purposes of section 731(c)(3)(C)(iv) and
this section, a partnership (upper-tier partnership) is not treated as
engaged in a trade or business engaged in by, or as holding (instead of
a partnership interest) a proportionate share of the assets of, a
partnership (lower-tier partnership) in which the partnership holds a
partnership interest if----
(i) The upper-tier partnership does not actively and substantially
[[Page 67940]]
participate in the management of the lower-tier partnership; and
(ii) The interest held by the upper-tier partnership is less than
20 percent of the total profits and capital interests in the lower-tier
partnership.
(f) Basis rules--(1) Partner's basis--(i) Partner's basis in
distributed securities. The distributee partner's basis in distributed
marketable securities with respect to which gain is recognized by
reason of section 731(c) and this section is the basis of the security
determined under section 732, increased by the amount of such gain. Any
increase in the basis of the marketable securities attributable to gain
recognized by reason of section 731(c) and this section is allocated to
marketable securities in proportion to their respective amounts of
unrealized appreciation in the hands of the partner before such
increase.
(ii) Partner's basis in partnership interest. The basis of the
distributee partner's interest in the partnership is determined under
section 733 as if no gain were recognized by the partner on the
distribution by reason of section 731(c) and this section.
(2) Basis of partnership property. No adjustment is made to the
basis of partnership property under section 734 as a result of any gain
recognized by a partner, or any step-up in the basis in the distributed
marketable securities in the hands of the distributee partner, by
reason of section 731(c) and this section.
(g) Coordination with other sections--(1) Sections 704(c)(1)(B) and
737--(i) In general. If a distribution results in the application of
sections 731(c) and one or both of sections 704(c)(1)(B) and 737, the
effect of the distribution is determined by applying section
704(c)(1)(B) first, section 731(c) second, and finally section 737.
(ii) Section 704(c)(1)(B). The basis of the distributee partner's
interest in the partnership for purposes of determining the amount of
gain, if any, recognized by reason of section 731(c) (and for
determining the basis of the marketable securities in the hands of the
distributee partner) includes the increase or decrease, if any, in the
partner's basis that occurs under section 704(c)(1)(B)(iii) as a result
of a distribution to another partner of property contributed by the
distributee partner in a distribution that is part of the same
distribution as the marketable securities.
(iii) Section 737--(A) Marketable securities as other property. A
distribution of marketable securities is treated as a distribution of
property other than money for purposes of section 737 to the extent
that the marketable securities are not treated as money under section
731(c). In addition, marketable securities contributed to the
partnership are treated as property other than money in determining the
contributing partner's net precontribution gain under section 737(b).
(B) Basis increase under section 737. The basis of the distributee
partner's interest in the partnership for purposes of determining the
amount of gain, if any, recognized by reason of section 731(c) (and for
determining the basis of the marketable securities in the hands of the
distributee partner) does not include the increase, if any, in the
partner's basis that occurs under section 737(c)(1) as a result of a
distribution of property to the distributee partner in a distribution
that is part of the same distribution as the marketable securities.
(2) Section 708(b)(1)(B). If a partnership termination occurs under
section 708(b)(1)(B), the successor partnership will be treated as if
there had been no termination for purposes of section 731(c) and this
section. Accordingly, a section 708(b)(1)(B) termination will not
affect whether a partnership qualifies for any of the exceptions in
paragraphs (d) and (e) of this section. In addition, a deemed
distribution that may occur as a result of a section 708(b)(1)(B)
termination will not be subject to section 731(c) and this section.
(h) Anti-abuse rule. The provisions of section 731(c) and this
section must be applied in a manner consistent with the purpose of
section 731(c) and the substance of the transaction. Accordingly, if a
principal purpose of a transaction is to achieve a tax result that is
inconsistent with the purpose of section 731(c) and this section, the
Commissioner can recast the transaction for Federal tax purposes as
appropriate to achieve tax results that are consistent with the purpose
of section 731(c) and this section. Whether a tax result is
inconsistent with the purpose of section 731(c) and this section must
be determined based on all the facts and circumstances. For example,
under the provisions of this paragraph (h)--
(1) A change in partnership allocations or distribution rights with
respect to marketable securities may be treated as a distribution of
the marketable securities subject to section 731(c) if the change in
allocations or distribution rights is, in substance, a distribution of
the securities;
(2) A distribution of substantially all of the assets of the
partnership other than marketable securities and money to some partners
may also be treated as a distribution of marketable securities to the
remaining partners if the distribution of the other property and the
withdrawal of the other partners is, in substance, equivalent to a
distribution of the securities to the remaining partners; and
(3) The distribution of multiple properties to one or more partners
at different times may also be treated as part of a single distribution
if the distributions are part of a single plan of distribution.
(i) [Reserved]
(j) Examples. The following examples illustrate the rules of this
section. Unless otherwise specified, all securities held by a
partnership are marketable securities within the meaning of section
731(c); the partnership holds no marketable securities other than the
securities described in the example; all distributions by the
partnership are subject to section 731(a) and are not subject to
sections 704(c)(1)(B), 707(a)(2)(B), 751(b), or 737; and no securities
are eligible for an exception to section 731(c). The examples are as
follows:
Example 1. Recognition of gain. (i) A and B form partnership AB
as equal partners. A contributes property with a fair market value
of $1,000 and an adjusted tax basis of $250. B contributes $1,000
cash. AB subsequently purchases Security X for $500 and immediately
distributes the security to A in a current distribution. The basis
in A's interest in the partnership at the time of distribution is
$250.
(ii) The distribution of Security X is treated as a distribution
of money in an amount equal to the fair market value of Security X
on the date of distribution ($500). (The amount of the distribution
that is treated as money is not reduced under section 731(c)(3)(B)
and paragraph (b) of this section because, if Security X had been
sold immediately before the distribution, there would have been no
gain recognized by AB and A's distributive share of the gain would
therefore have been zero.) As a result, A recognizes $250 of gain
under section 731(a)(1) on the distribution ($500 distribution of
money less $250 adjusted tax basis in A's partnership interest).
Example 2. Reduction in amount treated as money--in general. (i)
A and B form partnership AB as equal partners. AB subsequently
distributes Security X to A in a current distribution. Immediately
before the distribution, AB held securities with the following fair
market values, adjusted tax bases, and unrecognized gain or loss:
------------------------------------------------------------------------
Gain
Value Basis (Loss)
------------------------------------------------------------------------
Security X................................... 100 70 30
Security Y................................... 100 80 20
Security Z................................... 100 110 (10)
------------------------------------------------------------------------
(ii) If AB had sold the securities for fair market value
immediately before the distribution to A, the partnership would have
[[Page 67941]]
recognized $40 of net gain ($30 gain on Security X plus $20 gain on
Security Y minus $10 loss on Security Z). A's distributive share of
this gain would have been $20 (one-half of $40 net gain). If AB had
sold the remaining securities immediately after the distribution of
Security X to A, the partnership would have $10 of net gain ($20 of
gain on Security Y minus $10 loss on Security Z). A's distributive
share of this gain would have been $5 (one-half of $10 net gain). As
a result, the distribution resulted in a decrease of $15 in A's
distributive share of the net gain in AB's securities ($20 net gain
before distribution minus $5 net gain after distribution).
(iii) Under paragraph (b) of this section, the amount of the
distribution of Security X that is treated as a distribution of
money is reduced by $15. The distribution of Security X is therefore
treated as a distribution of $85 of money to A ($100 fair market
value of Security X minus $15 reduction).
Example 3. Reduction in amount treated as money--carried
interest. (i) A and B form partnership AB. A contributes $1,000 and
provides substantial services to the partnership in exchange for a
60 percent interest in partnership profits. B contributes $1,000 in
exchange for a 40 percent interest in partnership profits. AB
subsequently distributes Security X to A in a current distribution.
Immediately before the distribution, AB held securities with the
following fair market values, adjusted tax bases, and unrecognized
gain:
------------------------------------------------------------------------
Value Basis Gain
------------------------------------------------------------------------
Security X................................... 100 80 20
Security Y................................... 100 90 10
------------------------------------------------------------------------
(ii) If AB had sold the securities for fair market value
immediately before the distribution to A, the partnership would have
recognized $30 of net gain ($20 gain on Security X plus $10 gain on
Security Y). A's distributive share of this gain would have been $18
(60 percent of $30 net gain). If AB had sold the remaining
securities immediately after the distribution of Security X to A,
the partnership would have $10 of net gain ($10 gain on Security Y).
A's distributive share of this gain would have been $6 (60 percent
of $10 net gain). As a result, the distribution resulted in a
decrease of $12 in A's distributive share of the net gain in AB's
securities ($18 net gain before distribution minus $6 net gain after
distribution).
(iii) Under paragraph (b) of this section, the amount of the
distribution of Security X that is treated as a distribution of
money is reduced by $12. The distribution of Security X is therefore
treated as a distribution of $88 of money to A ($100 fair market
value of Security X minus $12 reduction).
Example 4. Reduction in amount treated as money--change in
partnership allocations.
(i) A is admitted to partnership ABC as a partner with a 1
percent interest in partnership profits. At the time of A's
admission, ABC held no securities. ABC subsequently acquires
Security X. A's interest in partnership profits is subsequently
increased to 2 percent for securities acquired after the increase. A
retains a 1 percent interest in all securities acquired before the
increase. ABC then acquires Securities Y and Z and later distributes
Security X to A in a current distribution. Immediately before the
distribution, the securities held by ABC had the following fair
market values, adjusted tax bases, and unrecognized gain or loss:
------------------------------------------------------------------------
Gain
Value Basis (Loss)
------------------------------------------------------------------------
Security X................................... 1,000 500 500
Security Y................................... 1,000 800 200
Security Z .................................. 11,000 1,100 (100)
------------------------------------------------------------------------
(ii) If ABC had sold the securities for fair market value
immediately before the distribution to A, the partnership would have
recognized $600 of net gain ($500 gain on Security X plus $200 gain
on Security Y minus $100 loss on Security Z). A's distributive share
of this gain would have been $7 (1 percent of $500 gain on Security
X plus 2 percent of $200 gain on Security Y minus 2 percent of $100
loss on Security Z).
(iii) If ABC had sold the remaining securities immediately after
the distribution of Security X to A, the partnership would have $100
of net gain ($200 gain on Security Y minus $100 loss on Security Z).
A's distributive share of this gain would have been $2 (2 percent of
$200 gain on Security Y minus 2 percent of $100 loss on Security Z).
As a result, the distribution resulted in a decrease of $5 in A's
distributive share of the net gain in ABC's securities ($7 net gain
before distribution minus $2 net gain after distribution).
(iv) Under paragraph (b) of this section, the amount of the
distribution of Security X that is treated as a distribution of
money is reduced by $5. The distribution of Security X is therefore
treated as a distribution of $995 of money to A ($1000 fair market
value of Security X minus $5 reduction).
Example 5. Basis consequences--distribution of marketable
security. (i) A and B form partnership AB as equal partners. A
contributes nondepreciable real property with a fair market value
and adjusted tax basis of $100.
(ii) AB subsequently distributes Security X with a fair market
value of $120 and an adjusted tax basis of $90 to A in a current
distribution. At the time of distribution, the basis in A's interest
in the partnership is $100. The amount of the distribution that is
treated as money is reduced under section 731(c)(3)(B) and paragraph
(b)(2) of this section by $15 (one-half of $30 net gain in Security
X). As a result, A recognizes $5 of gain under section 731(a) on the
distribution (excess of $105 distribution of money over $100
adjusted tax basis in A's partnership interest).
(iii) A's adjusted tax basis in Security X is $95 ($90 adjusted
basis of Security X determined under section 732(a)(1) plus $5 of
gain recognized by A by reason of section 731(c)). The basis in A's
interest in the partnership is $10 as determined under section 733
($100 pre-distribution basis minus $90 basis allocated to Security X
under section 732).
Example 6. Basis consequences--distribution of marketable
security and other property. (i) A and B form partnership AB as
equal partners. A contributes nondepreciable real property, with a
fair market value of $100 and an adjusted tax basis of $10.
(ii) AB subsequently distributes Security X with a fair market
value and adjusted tax basis of $40 to A in a current distribution
and, as part of the same distribution, AB distributes Property Z to
A with an adjusted tax basis and fair market value of $40. At the
time of distribution, the basis in A's interest in the partnership
is $10. A recognizes $30 of gain under section 731(a) on the
distribution (excess of $40 distribution of money over $10 adjusted
tax basis in A's partnership interest).
(iii) A's adjusted tax basis in Security X is $35 ($5 adjusted
basis determined under section 732(a)(2) plus $30 of gain recognized
by A by reason of section 731(c)). A's basis in Property Z is $5, as
determined under section 732(a)(2). The basis in A's interest in the
partnership is $0 as determined under section 733 ($10 pre-
distribution basis minus $10 basis allocated between Security X and
Property Z under section 732).
(iv) AB's adjusted tax basis in the remaining partnership assets
is unchanged unless the partnership has a section 754 election in
effect. If AB made such an election, the aggregate basis of AB's
assets would be increased by $70 (the difference between the $80
combined basis of Security X and Property Z in the hands of the
partnership before the distribution and the $10 combined basis of
the distributed property in the hands of A under section 732 after
the distribution). Under section 731(c)(5), no adjustment is made to
partnership property under section 734 as a result of any gain
recognized by A by reason of section 731(c) or as a result of any
step-up in basis in the distributed marketable securities in the
hands of A by reason of section 731(c).
Example 7. Coordination with section 737. (i) A and B form
partnership AB. A contributes Property A, nondepreciable real
property with a fair market value of $200 and an adjusted basis of
$100 in exchange for a 25 percent interest in partnership capital
and profits. AB owns marketable Security X.
(ii) Within five years of the contribution of Property A, AB
subsequently distributes Security X, with a fair market value of
$120 and an adjusted tax basis of $100, to A in a current
distribution that is subject to section 737. As part of the same
distribution, AB distributes Property Y to A with a fair market
value of $20 and an adjusted tax basis of $0. At the time of
distribution, there has been no change in the fair market value of
Property A or the adjusted tax basis in A's interest in the
partnership.
(iii) If AB had sold Security X for fair market value
immediately before the distribution to A, the partnership would have
recognized $20 of gain. A's distributive share of this gain would
have been $5 (25 percent of $20 gain). Because AB has no other
marketable securities, A's distributive share of gain in partnership
securities after the distribution would have been $0. As a result,
the distribution resulted in a decrease of $5 in A's share of the
net gain in AB's securities ($5 net gain before distribution minus
$0 net
[[Page 67942]]
gain after distribution). Under paragraph (b)(2) of this section,
the amount of the distribution of Security X that is treated as a
distribution of money is reduced by $5. The distribution of Security
X is therefore treated as a distribution of $115 of money to A ($120
fair market value of Security X minus $5 reduction). The portion of
the distribution of the marketable security that is not treated as a
distribution of money ($5) is treated as other property for purposes
of section 737.
(iv) A recognizes total gain of $40 on the distribution. A
recognizes $15 of gain under section 731(a)(1) on the distribution
of the portion of Security X treated as money ($115 distribution of
money less $100 adjusted tax basis in A's partnership interest). A
recognizes $25 of gain under section 737 on the distribution of
Property Y and the portion of Security X that is not treated as
money. A's section 737 gain is equal to the lesser of (i) A's
precontribution gain ($100) or (ii) the excess of the fair market
value of property received ($20 fair market value of Property Y plus
$5 portion of Security X not treated as money) over the adjusted
basis in A's interest in the partnership immediately before the
distribution ($100) reduced (but not below zero) by the amount of
money received in the distribution ($115).
(v) A's adjusted tax basis in Security X is $115 ($100 basis of
Security X determined under section 732(a) plus $15 of gain
recognized by reason of section 731(c)). A's adjusted tax basis in
Property Y is $0 under section 732(a). The basis in A's interest in
the partnership is $25 ($100 basis before distribution minus $100
basis allocated to Security X under section 732(a) plus $25 gain
recognized under section 737).
(k) Effective date. This section applies to distributions made on
or after December 26, 1996. However, taxpayers may apply the rules of
this section to distributions made after December 8, 1994, and before
December 26, 1996.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: November 27, 1996.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 96-32854 Filed 12-24-96; 8:45 am]
BILLING CODE 4830-01-U
