[Federal Register Volume 62, Number 90 (Friday, May 9, 1997)]
[Rules and Regulations]
[Pages 25498-25502]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-12061]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 301
[TD 8717]
RIN 1545-AU14
Termination of a Partnership Under Section 708(b)(1)(B)
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to the
termination of a partnership upon the sale or exchange of 50 percent or
more of the total interest in partnership capital and profits within a
12-month period. The final regulations affect all partnerships that
terminate under section 708(b)(1)(B).
DATES: These regulations are effective May 9, 1997.
For applicability dates, see Effective Dates under Supplementary
Information.
FOR FURTHER INFORMATION CONTACT: Steven R. Schneider, (202) 622-3060
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On May 13, 1996, a notice of proposed rulemaking (PS-5-96) was
published in the Federal Register (61 FR 21985) containing proposed
amendments to the Income Tax Regulations (26 CFR part 1) under section
708 of the Internal Revenue Code (Code). The notice of proposed
rulemaking also contained proposed amendments to other sections of the
Income Tax Regulations to reflect the amendments to the regulations
under section 708. Written comments responding to this notice were
received. A public hearing was held on September 5, 1996, pursuant to
the notice published in the Federal Register on May 13, 1996. After
consideration of all comments received, the proposed amendments are
adopted as revised by this Treasury decision.
Explanation of Provisions
Section 708(b)(1)(B) provides that, for purposes of section 708(a),
a partnership shall be considered terminated if within a 12-month
period there is a sale or exchange of 50 percent or more of the total
interest in partnership capital and profits. The existing regulations
under Sec. 1.708-1(b)(1)(iv) provide that, if a partnership is
terminated by a sale or exchange of an interest, the following is
deemed to occur: The partnership distributes its properties to the
purchaser and the other remaining partners in proportion to their
respective interests in the partnership properties; and, immediately
thereafter, the purchaser and the other remaining partners contribute
the properties to a new partnership, either for the continuation of the
business or for its dissolution and winding up. The final regulations
adopt the proposed regulations and change the mechanics of a
termination under section 708(b)(1)(B) so that the following is deemed
to occur on a termination: The partnership contributes all of its
assets and liabilities to a new partnership in exchange for an interest
in the new partnership; and, immediately thereafter, the partnership
liquidates by distributing interests in the new partnership to the
purchaser and the other remaining partners, followed by the
continuation of the business by the new partnership or its dissolution
and winding up. The final regulations also clarify certain aspects of
the proposed regulations in response to comments received.
One commentator requested clarification of the section 704(c)
consequences of a termination. The proposed regulations provide for a
section 704(b) capital account ``book up'' upon the deemed contribution
of assets by the terminated partnership to
[[Page 25499]]
the new partnership and also upon the deemed distribution in
liquidation of the terminated partnership. This would have resulted in
a new layer of section 704(c) property. The final regulations amend the
regulations under section 704(b) to provide that the deemed
contribution of assets to a new partnership and the distribution of the
new partnership interests to the partners of the terminated partnership
are disregarded for purposes of maintaining capital accounts. As a
result, the termination of a partnership does not change the capital
accounts of the partners or the books of the partnership and the deemed
contribution of assets to a new partnership does not create additional
section 704(c) property. The final regulations also provide that the
new partnership is not bound by the section 704(c) method used by the
terminated partnership.
A commentator requested clarification of whether a termination
under the new section 708(b)(1)(B) construct will trigger recapture of
investment tax credit under section 47.
Although not specifically addressed in the regulations, a section
708(b)(1)(B) termination no longer triggers recapture of the investment
tax credit under the ``mere change in form'' exception in Sec. 1.47-
3(f) of the regulations.
Commentators also requested guidance on whether a section 1491
excise tax may be triggered upon a section 708(b)(1)(B) termination of
a foreign partnership with U.S. partners. This issue is currently under
study and the IRS and Treasury welcome comments from interested
taxpayers and practitioners.
One commentator requested clarification of whether the distribution
of the interests in the new partnership will be subject to section
731(c). The section 731(c) final regulations, December 26, 1996 (61 FR
67936), provide that the deemed distribution of partnership interests
under Sec. 1.708-1(b)(1)(iv) does not trigger the application of
section 731(c).
Several commentators suggested that partnerships should be allowed
to apply the final regulations to terminations under section
708(b)(1)(B) occurring on or after the date the proposed regulations
were filed with the Federal Register. In response, the final
regulations provide that the regulations may be applied to terminations
occurring on or after May 9, 1996, provided that the partnership and
its partners apply the regulations to the termination in a consistent
manner.
The final regulations also provide an example illustrating the
mechanics of a termination under section 708(b)(1)(B). In addition, the
final regulations provide that the new partnership retains the TIN of
the terminated partnership. However, if the new partnership has already
applied for a new TIN, the partnership should continue to use the new
TIN.
Finally, the regulations make several revenue rulings obsolete. The
holdings of revenue rulings 87-50 and 87-51 (dealing with the effect of
terminations under section 708(b)(1)(B) on lower-tier partnerships) and
revenue rulings 86-73 and 88-42 (dealing with the effect of a Sec. 754
election made by the terminating partnership) are now incorporated,
without substantive change, into the regulations under Sec. 1.708-1.
Additionally, the final regulations make revenue ruling 93-90 (dealing
with minimum gain chargeback in a section 708(b)(1)(B) termination)
obsolete because the Sec. 704(b) capital account ``book up'' that is
the subject of the revenue ruling is eliminated.
Effective Date
These regulations apply to terminations of partnerships under
section 708(b)(1)(B) occurring on or after May 9, 1997; however, these
regulations may be applied to terminations occurring on or after May 9,
1996, provided that the partnership and its partners apply these
regulations to the termination in a consistent manner.
Effect on Other Documents
The following publications are obsolete as of May 9, 1997:
Rev. Rul. 86-73, 1986-1 C.B. 282
Rev. Rul. 87-50, 1987-1 C.B. 157
Rev. Rul. 87-51, 1987-1 C.B. 158
Rev. Rul. 88-42, 1988-1 C.B. 265
Rev. Rul. 93-90, 1993-2 C.B. 238
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 has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the regulation does
not impose a collection of information on small entities, the
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Therefore, a Regulatory Flexibility Analysis is not required. 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 author of these regulations is Steven R. Schneider of
the 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
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income
taxes, Penalties, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 301 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.704-1 is amended as follows:
1. Paragraph (b)(2)(iv)(d)(1) is amended by revising the second
sentence.
2. Paragraph (b)(2)(iv)(l) is amended by removing the last three
sentences and adding four sentences in their place.
3. Paragraph (b)(5) Example 13(v) is amended by removing all the
text following the third sentence and adding four sentences in its
place.
The revisions and additions read as follows:
Sec. 1.704-1 Partner's distributive share.
* * * * *
(b) * * *
(2) * * *
(iv) * * *
(d) * * *
(1) * * * See Example 13(i) of paragraph (b)(5) of this section. *
* *
* * * * *
(l) * * * If the transfer of an interest in a partnership causes a
termination of the partnership under section 708(b)(1)(B), the capital
account of the transferee partner and the capital accounts of the other
partners of the terminated partnership carry over to the new
partnership that is formed as a result of the termination of the
partnership under Sec. 1.708-1(b)(1)(iv). Moreover, the deemed
contribution of assets and liabilities by the terminated partnership to
a new partnership and
[[Page 25500]]
the deemed liquidation of the terminated partnership that occur under
Sec. 1.708-1(b)(1)(iv) are disregarded for purposes of this paragraph
(b)(2)(iv). See Example 13 of paragraph (b)(5) of this section and the
example in Sec. 1.708-1(b)(1)(iv). The previous three sentences apply
to terminations of partnerships under section 708(b)(1)(B) occurring on
or after May 9, 1997; however, the sentences may be applied to
terminations occurring on or after May 9, 1996, provided that the
partnership and its partners apply the sentences to the termination in
a consistent manner.
* * * * *
(5) * * *
Example 13. * * *
(v) * * * Immediately preceding the constructive liquidation,
the capital accounts of Z and LK equal $11,000 each (LK having
inherited Y's $11,000 capital account) and the book value of the G
Corp. securities is $22,000 (original purchase price of securities).
Under paragraph (b)(2)(iv)(l) of this section, the deemed
contribution of assets and liabilities by the terminated partnership
to the new partnership and the deemed liquidation of the terminated
partnership that occur under Sec. 1.708-1(b)(1)(iv) in connection
with the constructive liquidation of the terminated partnership are
disregarded in the maintenance and computation of the partners'
capital accounts. As a result, the capital accounts of Z and LK in
the new partnership equal $11,000 each (their capital accounts in
the terminated partnership immediately prior to the termination),
and the book value of the G Corp. securities remains $22,000 (its
book value immediately prior to the termination). This Example 13(v)
applies to terminations of partnerships under section 708(b)(1)(B)
occurring on or after May 9, 1997; however, this Example 13(v) may
be applied to terminations occurring on or after May 9, 1996,
provided that the partnership and its partners apply this Example
13(v) to the termination in a consistent manner.
* * * * *
Par. 3. Section 1.704-3 is amended as follows:
1. Paragraph (a)(2) is amended by adding two sentences at the end
of the paragraph.
2. Paragraph (a)(3)(i) is amended by adding three sentences at the
end of the paragraph.
The additions read as follows:
Sec. 1.704-3 Contributed property.
(a) * * *
(2) * * * A new partnership formed as the result of the termination
of a partnership under section 708(b)(1)(B) is not required to use the
same method as the terminated partnership with respect to section
704(c) property deemed contributed to the new partnership by the
terminated partnership under Sec. 1.708-1(b)(1)(iv). The previous
sentence applies to terminations of partnerships under section
708(b)(1)(B) occurring on or after May 9, 1997; however, the sentence
may be applied to terminations occurring on or after May 9, 1996,
provided that the partnership and its partners apply the sentence to
the termination in a consistent manner.
(3) * * *
(i) * * * Property deemed contributed to a new partnership as the
result of the termination of a partnership under section 708(b)(1)(B)
is treated as section 704(c) property in the hands of the new
partnership only to the extent that the property was section 704(c)
property in the hands of the terminated partnership immediately prior
to the termination. See Sec. 1.708-1(b)(1)(iv) for an example of the
application of this rule. The previous two sentences apply to
terminations of partnerships under section 708(b)(1)(B) occurring on or
after May 9, 1997; however, the sentences may be applied to
terminations occurring on or after May 9, 1996, provided that the
partnership and its partners apply the sentences to the termination in
a consistent manner.
* * * * *
Par. 4. Section 1.704-4 is amended by revising paragraphs
(a)(4)(ii) and (c)(3) to read as follows:
Sec. 1.704-4 Distribution of contributed property.
(a) * * *
(4) * * *
(ii) Section 708(b)(1)(B) terminations. A termination of the
partnership under section 708(b)(1)(B) does not begin a new five-year
period for each partner with respect to the built-in gain and built-in
loss property that the terminated partnership is deemed to contribute
to the new partnership under Sec. 1.708-1(b)(1)(iv). See Sec. 1.704-
3(a)(3)(ii) for the definitions of built-in gain and built-in loss on
section 704(c) property. This paragraph (a)(4)(ii) applies to
terminations of partnerships under section 708(b)(1)(B) occurring on or
after May 9, 1997; however, this paragraph (a)(4)(ii) may be applied to
terminations occurring on or after May 9, 1996, provided that the
partnership and its partners apply this paragraph (a)(4)(ii) to the
termination in a consistent manner.
* * * * *
(c) * * *
(3) Section 708(b)(1)(B) terminations. Section 704(c)(1)(B) and
this section do not apply to the deemed distribution of interests in a
new partnership caused by the termination of a partnership under
section 708(b)(1)(B). A subsequent distribution of section 704(c)
property by the new partnership to a partner of the new partnership is
subject to section 704(c)(1)(B) to the same extent that a distribution
by the terminated partnership would have been subject to section
704(c)(1)(B). See also Sec. 1.737-2(a) for a similar rule in the
context of section 737. This paragraph (c)(3) applies to terminations
of partnerships under section 708(b)(1)(B) occurring on or after May 9,
1997; however, this paragraph (c)(3) may be applied to terminations
occurring on or after May 9, 1996, provided that the partnership and
its partners apply this paragraph (c)(3) to the termination in a
consistent manner.
* * * * *
Par. 5. Section 1.708-1 is amended as follows:
1. Paragraph (b)(1)(ii) is amended by adding three sentences after
the third sentence.
2. Paragraph (b)(1)(iv) is revised.
3. Paragraph (b)(1)(v) is added.
The additions and revisions read as follows:
1.708-1 Continuation of partnership.
* * * * *
(b) * * *
(1) * * *
(ii) * * * Moreover, if the sale or exchange of an interest in a
partnership (upper-tier partnership) that holds an interest in another
partnership (lower-tier partnership) results in a termination of the
upper-tier partnership, the upper-tier partnership is treated as
exchanging its entire interest in the capital and profits of the lower-
tier partnership. If the sale or exchange of an interest in an upper-
tier partnership does not terminate the upper-tier partnership, the
sale or exchange of an interest in the upper-tier partnership is not
treated as a sale or exchange of a proportionate share of the upper-
tier partnership's interest in the capital and profits of the lower-
tier partnership. The previous two sentences apply to terminations of
partnerships under section 708(b)(1)(B) occurring on or after May 9,
1997; however, the sentences may be applied to terminations occurring
on or after May 9, 1996, provided that the partnership and its partners
apply the sentences to the termination in a consistent manner. * * *
* * * * *
(iv) If a partnership is terminated by a sale or exchange of an
interest, the following is deemed to occur: The partnership contributes
all of its assets and liabilities to a new partnership in exchange for
an interest in the new partnership; and, immediately
[[Page 25501]]
thereafter, the terminated partnership distributes interests in the new
partnership to the purchasing partner and the other remaining partners
in proportion to their respective interests in the terminated
partnership in liquidation of the terminated partnership, either for
the continuation of the business by the new partnership or for its
dissolution and winding up. In the latter case, the new partnership
terminates in accordance with (b)(1)(i) of this section. This paragraph
(b)(1)(iv) applies to terminations of partnerships under section
708(b)(1)(B) occurring on or after May 9, 1997; however, this paragraph
(b)(1)(iv) may be applied to terminations occurring on or after May 9,
1996, provided that the partnership and its partners apply this
paragraph (b)(1)(iv) to the termination in a consistent manner. The
provisions of this paragraph (b)(1)(iv) are illustrated by the
following example:
Example. (i) A and B each contribute $10,000 cash to form AB, a
general partnership, as equal partners. AB purchases depreciable
Property X for $20,000. Property X increases in value to $30,000, at
which time A sells its entire 50 percent interest to C for $15,000
in a transfer that terminates the partnership under section
708(b)(1)(B). At the time of the sale, Property X had an adjusted
tax basis of $16,000 and a book value of $16,000 (original $20,000
tax basis and book value reduced by $4,000 of depreciation). In
addition, A and B each had a capital account balance of $8,000
(original $10,000 capital account reduced by $2,000 of depreciation
allocations with respect to Property X).
(ii) Following the deemed contribution of assets and liabilities
by the terminated AB partnership to a new partnership (new AB) and
the liquidation of the terminated AB partnership, the adjusted tax
basis of Property X in the hands of new AB is $16,000. See Section
723. The book value of Property X in the hands of new partnership AB
is also $16,000 (the book value of Property X immediately before the
termination) and B and C each have a capital account of $8,000 in
new AB (the balance of their capital accounts in AB prior to the
termination). See Sec. 1.704-1(b)(2)(iv)(l) (providing that the
deemed contribution and liquidation with regard to the terminated
partnership are disregarded in determining the capital accounts of
the partners and the books of the new partnership). Additionally,
under Sec. 301.6109-1(d)(2)(iii) of this chapter, new AB retains the
taxpayer identification number of the terminated AB partnership.
(iii) Property X was not section 704(c) property in the hands of
terminated AB and is therefore not treated as section 704(c)
property in the hands of new AB, even though Property X is deemed
contributed to new AB at a time when the fair market value of
Property X ($30,000) was different from its adjusted tax basis
($16,000). See Sec. 1.704-3(a)(3)(i) (providing that property
contributed to a new partnership under Sec. 1.708-1(b)(1)(iv) is
treated as section 704(c) property only to the extent that the
property was section 704(c) property in the hands of the terminated
partnership immediately prior to the termination).
(v) If a partnership is terminated by a sale or exchange of an
interest in the partnership, a section 754 election (including a
section 754 election made by the terminated partnership on its final
return) that is in effect for the taxable year of the terminated
partnership in which the sale occurs, applies with respect to the
incoming partner. Therefore, the bases of partnership assets are
adjusted pursuant to sections 743 and 755 prior to their deemed
contribution to the new partnership. This paragraph (b)(1)(v) applies
to terminations of partnerships under section 708(b)(1)(B) occurring on
or after May 9, 1997; however, this paragraph (b)(1)(v) may be applied
to terminations occurring on or after May 9, 1996, provided that the
partnership and its partners apply this paragraph (b)(1)(v) to the
termination in a consistent manner.
* * * * *
Par. 6. Section 1.737-2 is amended as follows:
1. Paragraph (a) is revised.
2. In paragraph (d)(1), the first sentence is revised and one
sentence is added after the first sentence.
The additions and revisions read as follows:
Sec. 1.737-2 Exceptions and special rules.
(a) Section 708(b)(1)(B) terminations. Section 737 and this section
do not apply to the deemed distribution of interests in a new
partnership caused by the termination of a partnership under section
708(b)(1)(B). A subsequent distribution of property by the new
partnership to a partner of the new partnership that was formerly a
partner of the terminated partnership is subject to section 737 to the
same extent that a distribution from the terminated partnership would
have been subject to section 737.
See also Sec. 1.704-4(c)(3) for a similar rule in the context of
section 704(c)(1)(B). This paragraph (a) applies to terminations of
partnerships under section 708(b)(1)(B) occurring on or after May 9,
1997; however, this paragraph (a) may be applied to terminations
occurring on or after May 9, 1996, provided that the partnership and
its partners apply this paragraph (a) to the termination in a
consistent manner.
* * * * *
(d) * * * (1) * * * Any portion of the distributed property that
consists of property previously contributed by the distributee partner
(previously contributed property) is not taken into account in
determining the amount of the excess distribution or the partner's net
precontribution gain. The previous sentence applies on or after May 9,
1997. * * *
* * * * *
Par. 7. In section 1.743-1, paragraph (d) is added to read as
follows:
Sec. 1.743-1 Optional adjustment to basis of partnership property.
* * * * *
(d) Section 708(b)(1)(B) terminations. A partner with a special
basis adjustment in property held by a partnership that terminates
under section 708(b)(1)(B) will continue to have the same special 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. This paragraph (d) applies to terminations of
partnerships under section 708(b)(1)(B) occurring on or after May 9,
1997; however, this paragraph (d) may be applied to terminations
occurring on or after May 9, 1996, provided that the partnership and
its partners apply this paragraph (d) to the termination in a
consistent manner.
Par. 8. In Sec. 1.761-1, paragraph (e) is added to read as follows:
Sec. 1.761-1 Terms defined.
* * * * *
(e) Distribution of partnership interest. For purposes of section
708(b)(1)(B) and Sec. 1.708-1(b)(1)(iv), the deemed distribution of an
interest in a new partnership by a partnership that terminates under
section 708(b)(1)(B) is not a sale or exchange of an interest in the
new partnership. However, the deemed distribution of an interest in a
new partnership by a partnership that terminates under section
708(b)(1)(B) is treated as an exchange of the interest in the new
partnership for purposes of section 743. This paragraph (e) applies to
terminations of partnerships under section 708(b)(1)(B) occurring on or
after May 9, 1997; however, this paragraph (e) may be applied to
terminations occurring on or after May 9, 1996, provided that the
partnership and its partners apply this paragraph (e) to the
termination in a consistent manner.
PART 301--PROCEDURE AND ADMINISTRATION
Par. 9. The authority citation for part 301 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
[[Page 25502]]
Par. 10. Section 301.6109-1 is amended by adding paragraph
(d)(2)(iii) as follows:
Sec. 301.6109-1 Identifying numbers.
* * * * *
(d) * * *
(2) * * *
(iii) Special rule for Section 708(b)(1)(B) terminations. A new
partnership that is formed as a result of the termination of a
partnership under section 708(b)(1)(B) will retain the employer
identification number of the terminated partnership. This paragraph
(d)(2)(iii) applies to terminations of partnerships under section
708(b)(1)(B) occurring on or after May 9, 1997; however, this paragraph
(d)(2)(iii) may be applied to terminations occurring on or after May 9,
1996, provided that the partnership and its partners apply this
paragraph (d)(2)(iii) to the termination in a consistent manner.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: May 1, 1997.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 97-12061 Filed 5-8-97; 8:45 am]
BILLING CODE 4830-01-U
