[Federal Register Volume 64, Number 152 (Monday, August 9, 1999)]
[Proposed Rules]
[Pages 43117-43123]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-20368]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-106527-98]
RIN 1545-AW22
Capital Gains, Partnership, Subchapter S, and Trust Provisions
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations relating to sales
or exchanges of interests in partnerships, S corporations, and trusts.
The proposed regulations interpret the look-through provisions of
section 1(h), added by section 311 of the Taxpayer Relief Act of 1997
and amended by sections 5001 and 6005(d) of the Internal Revenue
Service Restructuring and Reform Act of 1998, and explain the rules
relating to the division of the holding period of a
[[Page 43118]]
partnership interest. The proposed regulations affect partnerships,
partners, S corporations, S corporation shareholders, trusts, and trust
beneficiaries.
DATES: Written comments must be received by November 8, 1999. Requests
to speak and outlines of topics to be discussed at the public hearing
scheduled for November 18, 1999, must be received by October 28, 1999.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-106527-98), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-
106527-98), 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/tax__regs/
regslist.html. The public hearing will be held in room 3411, Internal
Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Jeanne Sullivan (202) 622-3050; concerning submissions of comments, the
hearing, and/or to be placed on the building access list to attend the
hearing, LaNita VanDyke (202) 622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION
Paperwork Reduction Act
The collections of information contained in this notice of proposed
rulemaking have 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 collections 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 IRS, Attn: IRS Reports
Clearance Officer, OP:FS:FP, Washington, DC 20224. Comments on the
collections of information should be received by October 8, 1999.
Comments are specifically requested concerning:
Whether the proposed collections of information are necessary for
the proper performance of the functions of the IRS, including whether
the collections will have a practical utility;
The accuracy of the estimated burden associated with the proposed
collections 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 collections of
information may be minimized, including through application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
The collections of information in these proposed regulations are in
Sec. 1.1(h)-1(e). This information is required by the IRS to implement
section 311 of the Taxpayer Relief Act of 1997, as amended by the
Internal Revenue Service Restructuring and Reform Act of 1998. The
collections of information are required to provide information to the
IRS regarding the capital gain attributable to collectibles and section
1250 property held by a partnership when a partner sells or exchanges
an interest in that partnership and the capital gain attributable to
collectibles when a shareholder sells or exchanges an interest in an S
corporation or a trust beneficiary sells or exchanges an interest in a
trust. This information will be used to verify compliance with section
1(h) and to determine that the tax on capital gains has been computed
correctly. The collection of information is mandatory. The likely
respondents are individuals and businesses.
Respondent taxpayers provide information by attaching a statement
to the appropriate tax return. The burden for this requirement is
reflected in the burden estimates for: Form 1040, U.S. Individual
Income Tax Return; Form 1065, U.S. Partnership Return of Income; Form
1041, U.S. Income Tax Return for Estates and Trusts; and Form 1120S,
U.S. Income Tax Return for an S Corporation. The estimated burden of
information collection for the statement required is 10 minutes.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
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 contains proposed amendments to the Income Tax
Regulations (26 CFR Part 1) relating to taxation of capital gains in
the case of sales or exchanges of interests in partnerships, S
corporations, and trusts. The Taxpayer Relief Act of 1997, Public Law
105-34, 111 Stat. 788, 831 (1997 Act), amended section 1(h) of the
Internal Revenue Code to reduce the maximum statutory tax rates for
long-term capital gains of individuals in general. Certain technical
corrections and other amendments to section 1(h) were enacted as part
of the Internal Revenue Service Restructuring and Reform Act of 1998,
Public Law 105-206, 112 Stat. 685, 787, 800 (1998 Act).
Section 1(h) provides that intermediate level rates apply to long-
term capital gains from certain transactions, such as sales or
exchanges of collectibles, section 1202 stock (with respect to a
portion of the gain), and section 1250 property with gain attributable
to straight-line depreciation. Section 1(h)(11) provides authority to
the Secretary to issue such regulations as are appropriate to apply
these rules in the case of sales or exchanges by pass-thru entities and
of interests in pass-thru entities. This document provides rules for
sales or exchanges of interests in partnerships, S corporations, and
trusts. This document also provides rules relating to dividing the
holding period of a partnership interest.
Explanation of Provisions
In general, prior to the 1997 Act, individuals were taxed on
capital gains at the same rate as ordinary income, except that the rate
for net capital gain was capped at 28 percent. The 1997 Act provided
for lower maximum rates of taxation on gain from the sale or exchange
of certain types of property. As amended by the 1998 Act, section 1(h)
currently provides for maximum capital gains rates on the sale or
exchange of certain types of property in three categories: 20-percent
rate gain, 25-percent rate gain, and 28-percent rate gain. Twenty
percent rate gain is net capital gain from the sale or exchange of
capital assets held for more than one year, reduced by the sum of 25-
percent rate gain and 28-percent rate gain. Twenty-five percent rate
gain is limited to unrecaptured section 1250 gain. Unrecaptured section
1250 gain is the amount of long-term capital gain (not otherwise
treated as ordinary income) which would be treated as ordinary income
if section 1250(b)(1) included all depreciation and the applicable
percentage under section 1250(a) were
[[Page 43119]]
100 percent, reduced by any net loss in the 28-percent rate gain
category.Twenty-eight percent rate gain is capital gains and losses
from the sale or exchange of collectibles (as defined in section 408(m)
without regard to section 408(m)(3)) held for more than one year, a
portion of the gain attributable to the sale of section 1202 stock, and
capital gains and losses determined under the rules of section
1(h)(13), reduced by net short-term capital loss for the taxable year
and any long-term capital loss carryover under section 1212(b)(1)(B).
Collectibles Gain and Unrecaptured Section 1250 Gain
The sale or exchange of an interest in a partnership with a long-
term holding period generally will result in capital gain in the 20-
percent rate gain category to the extent that section 751(a) is not
applicable. Section 751(a) generally provides that an amount received
in exchange for a partnership interest, to the extent attributable to
unrealized receivables and inventory, shall be considered as an amount
realized from the sale or exchange of property other than a capital
asset. Section 1250 property is treated as an unrealized receivable for
purposes of section 751 to the extent of the amount that would be
treated as gain to which section 1250(a) would apply.
The sale or exchange of stock in an S corporation with a long-term
holding period generally will result in gain or loss in the 20-percent
rate gain category, unless an exception to capital gain treatment
applies. Certain of those exceptions are provided in sections 304, 306,
341, and 1254.
The sale or exchange of an interest in a trust with a long-term
holding period generally will result in gain or loss in the 20-percent
rate gain category. However, if the transferor is treated as the owner
of the portion of the trust attributable to an interest under sections
673 through 679, the transferor is treated as transferring an undivided
interest in the assets of the trust rather than an interest in the
trust itself.
Effective for taxable years ending after May 6, 1997, when an
interest in a partnership, an S corporation, or a trust held for more
than one year (or more than 18 months during certain periods in 1997)
is sold or exchanged, section 1(h) provides special treatment for
``collectibles gain'' in property held by a partnership, S corporation,
or trust and for ``section 1250 capital gain'' in property held by a
partnership. Specifically, section 1(h)(6)(B) provides that any gain
from the sale of an interest in a partnership, S corporation, or trust
which is attributable to unrealized appreciation in the value of
collectibles shall be treated as gain from the sale or exchange of a
collectible, applying rules similar to section 751(a) to determine the
amount of the gain. In addition, under section 1(h)(7)(A) (in
conjunction with sections 751(a) and (c)), the amount of long-term
capital gain (not otherwise treated as ordinary income under section
751(a)) that would be treated as ordinary income under section 751(a)
if section 1250 applied to all depreciation (section 1250 capital gain)
must be taken into account in computing unrecaptured section 1250 gain
when an interest in a partnership (with a holding period of more than
one year, or more than 18 months during certain periods in 1997) is
sold or exchanged. See H. Rep. No. 105-356, 105th Cong. 1st Sess.
(1997), at 16, fn. 11; S. Rep. No. 105-174, 105th Cong. 2d Sess.
(1998), at 149, fn. 65.
The proposed regulations provide guidance with respect to the
application of these rules to a sale or exchange of an interest in a
partnership, S corporation, or trust holding assets with collectibles
gain and a partnership holding assets with section 1250 capital gain.
Generally, the amount of such gain is determined by reference to the
gain that would be allocated to the selling partner, shareholder, or
beneficiary (to the extent attributable to the portion of the
transferred interest that is subject to long-term capital gain) if the
partnership, S corporation, or trust had sold all of its collectibles
or if the partnership had sold all of its section 1250 property in a
fully taxable transaction immediately before the transfer of the
partnership, S corporation, or trust interest. Special rules are
provided where the partner, S corporation shareholder, or trust
beneficiary recognizes less than all of the gain upon the sale or
exchange of its interest.
In addition, for purposes of applying section 1(h)(7)(B), which
provides that a taxpayer's unrecaptured section 1250 gain cannot exceed
the taxpayer's net section 1231 gain, gain from the sale of a
partnership interest that results in section 1250 capital gain is not
treated as section 1231 gain even if section 1231 could apply to the
disposition of the underlying partnership property. Although section
1(h)(7) (in combination with section 751) applies a limited look-thru
rule for purposes of determining the capital gain rate applicable to
the sale of a partnership interest, no similar look-thru rule applies
for purposes of applying section 1231. Anomalous results would follow
if section 1250 capital gain derived from the sale of a partnership
interest were treated as section 1231 gain for purposes of applying the
limitation in section 1(h)(7)(B) but not for purposes of actually
applying section 1231.
Determination of Holding Period in a Partnership
In view of the long-established principle that a partner has a
single basis in a partnership interest (see Rev. Rul. 84-53 (1984-1
C.B. 159)), there is some confusion under current law as to how the
principles of section 1223 apply to the sale of an interest, or a
portion of an interest, in a partnership. The proposed regulations
provide rules relating to the allocation of a divided holding period
with respect to an interest in a partnership. These rules generally
provide that the holding period of a partnership interest will be
divided if a partner acquires portions of an interest at different
times or if an interest is acquired in a single transaction that gives
rise to different holding periods under section 1223. The holding
period of a portion of a partnership interest shall be determined based
on a fraction that is equal to the fair market value of the portion of
the partnership interest to which the holding period relates
(determined immediately after the acquisition) over the fair market
value of the entire partnership interest. A selling partner may use the
actual holding period of the portion of a partnership interest sold if
the partnership is a ``publicly traded partnership'' (as defined under
section 7704(b)), the partnership interest is divided into identifiable
units with ascertainable holding periods, and the selling partner can
identify the portion of the interest transferred. Otherwise, the
holding period(s) of the transferred interest must be divided in the
same ratio as the holding period(s) of the partner's entire partnership
interest.
These proposed regulations do not contain a specific anti-abuse
rule regarding holding periods. However, there may be situations where
taxpayers will attempt to undertake abusive transactions using the
rules in these regulations. For instance, taxpayers may attempt to
shift gain from property with a short-term holding period to property
with a long-term holding period by contributing the short-term property
to a partnership and selling the partnership interest. Because the
basis of a partnership interest cannot be segregated to a portion of an
interest, basis in the portion of a partnership interest with a long-
term holding period could reduce gain attributable to the portion of a
partnership interest with a short-term holding period in situations
[[Page 43120]]
where such interest was recently received in exchange for contributed
short-term capital gain property. In appropriate situations, the IRS
may attack such abusive transactions under a variety of judicial
doctrines, including substance over form or step transaction, or under
Sec. 1.701-2 of the regulations.
Proposed Effective Date
The amendments are proposed to be effective for all transfers of
interests in a partnership, S corporation, or trust and for all
distributions from a partnership 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 Executive Order
12866. Therefore, a regulatory assessment is not required. Pursuant to
section 7805(f), 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. It is hereby certified
that the collection of information in these regulations will not have a
significant economic impact on a substantial number of small entities.
This certification is based on the facts that: (1) the time required to
prepare and file the statement is minimal (currently estimated at 10
minutes per statement); and (2) it is anticipated that, as a result of
these regulations, small entities will file no more than one statement
per year. Furthermore, taxpayers will have to respond to the requests
for information contained in Sec. 1.1(h)-1(e) only if there is a sale
or exchange of an interest in a partnership, an S corporation, or a
trust that holds certain property. Therefore, a Regulatory Flexibility
Analysis under the Regulatory Flexibility Act (5 U.S.C. Chapter 6) is
not required.
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 submitted timely to the IRS. The IRS and
Treasury request comments on the clarity of the proposed rule and how
it may be made easier to understand. All comments will be available for
public inspection and copying.
A public hearing has been scheduled for November 18, 1999,
beginning at 1 p.m. in room 3411 of the Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10th Street entrance, located
between Constitution and Pennsylvania Avenues, NW. In addition, all
visitors must present photo identification to enter the building.
Because of access restrictions, visitors will not be admitted beyond
the immediate entrance area more than 15 minutes before the hearing
starts. For information about having your name placed on the building
access list to attend the hearing, see the FOR FURTHER INFORMATION
CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who
wish to present oral comments at the hearing must request to speak and
submit written comments and an outline of the topics to be discussed
and the time to be devoted to each topic (signed original and eight (8)
copies) by October 28, 1999. 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 author of these proposed
regulations is Jeanne Sullivan, Office of the Assistant Chief Counsel
(Passthroughs and Special Industries). 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.
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 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.1(h)-1 is added to read as follows:
Sec. 1.1(h)-1 Capital gains look-through rule for sales or exchanges
of interests in a partnership, S corporation, or trust.
(a) In general. When an interest in a partnership held for more
than one year is sold or exchanged, the transferor may recognize
ordinary income (e.g., section 751(a)), collectibles gain, section 1250
capital gain, and residual long-term capital gain or loss. When stock
in an S corporation held for more than one year is sold or exchanged,
the transferor may recognize ordinary income (e.g., sections 304, 306,
341, 1254), collectibles gain, and residual long-term capital gain or
loss. When an interest in a trust held for more than one year is sold
or exchanged, a transferor who is not treated as the owner of the
portion of the trust attributable to the interest sold or exchanged
(sections 673 through 679) (a non-grantor transferor) may recognize
collectibles gain and residual long-term capital gain or loss.
(b) Look-through capital gain--(1) In general. Look-through capital
gain is the share of collectibles gain allocable to an interest in a
partnership, S corporation, or trust, plus the share of section 1250
capital gain allocable to an interest in a partnership, determined
under paragraphs (b)(2) and (3) of this section.
(2) Collectibles gain and collectibles loss--(i) Definitions. For
purposes of this section, collectibles gain and collectibles loss mean
gain or loss, respectively, from the sale or exchange of a collectible
(as defined in section 408(m) without regard to section 408(m)(3)) that
is a capital asset held for more than 1 year, but only to the extent
such gain is taken into account in computing gross income, and such
loss is taken into account in computing taxable income.
(ii) Share of collectibles gain allocable to an interest in a
partnership, S corporation, or trust. When an interest in a
partnership, S corporation, or trust held for more than one year is
sold or exchanged in a transaction in which all realized gain is
recognized, the transferor shall recognize as collectibles gain the
amount of net collectibles gain (but not net collectibles loss) that
would be allocated to that partner (taking into account any remedial
allocation under Sec. 1.704-3(d)), shareholder, or beneficiary (to the
extent attributable to the portion of the partnership interest, S
corporation stock, or trust interest transferred that was held for more
than one year) if the partnership, S corporation, or trust transferred
all of its collectibles in a fully taxable transaction immediately
before the transfer of the interest in the partnership, S corporation,
or trust. If less than all of the realized gain is recognized upon the
sale or exchange of an interest in a partnership, S corporation, or
trust, the same methodology shall apply to determine the collectibles
gain recognized by the transferor, except that the partnership, S
corporation, or trust shall be treated as transferring only a
proportionate amount of each of its collectibles determined as a
fraction that is the amount of gain recognized in the sale or exchange
over the amount of
[[Page 43121]]
gain realized in the sale or exchange. With respect to the transfer of
an interest in a trust, this paragraph applies only to transfers by
non-grantor transferors (as defined in paragraph (a) of this section).
(3) Section 1250 capital gain--(i) Definition. For purposes of this
section, section 1250 capital gain means the long-term capital gain
(not otherwise treated as ordinary income) that would be treated as
ordinary income if section 1250(b)(1) included all depreciation and the
applicable percentage under section 1250(a) were 100 percent.
(ii) Share of section 1250 capital gain allocable to interest in
partnership. When an interest in a partnership held for more than one
year is sold or exchanged in a transaction in which all realized gain
is recognized, there shall be taken into account under section
1(h)(7)(A)(i) in determining the partner's unrecaptured section 1250
gain the amount of section 1250 capital gain that would be allocated
(taking into account any remedial allocation under Sec. 1.704-3(d)) to
that partner (to the extent attributable to the portion of the
partnership interest transferred that was held for more than one year)
if the partnership transferred all of its section 1250 property in a
fully taxable transaction immediately before the transfer of the
interest in the partnership. If less than all of the realized gain is
recognized upon the sale or exchange of an interest in a partnership,
the same methodology shall apply to determine the section 1250 gain
recognized by the transferor, except that the partnership shall be
treated as transferring only a proportionate amount of each section
1250 property determined as a fraction that is the amount of gain
recognized in the sale or exchange over the amount of gain realized in
the sale or exchange.
(iii) Limitation with respect to net section 1231 gain. In
determining a transferor partner's net section 1231 gain (as defined in
section 1231(c)(3)) for purposes of section 1(h)(7)(B), the transferor
partner's allocable share of section 1250 capital gain in partnership
property shall not be treated as section 1231 gain, regardless of
whether the partnership property is used in the trade or business (as
defined in section 1231(b)).
(c) Residual long-term capital gain or loss. The amount of residual
long-term capital gain or loss recognized by a partner, shareholder of
an S corporation, or beneficiary of a trust on account of the sale or
exchange of an interest in a partnership, S corporation, or trust shall
equal the amount of long-term capital gain or loss that the partner
would recognize under section 741, that the shareholder would recognize
upon the sale or exchange of stock of an S corporation, or that the
beneficiary would recognize upon the sale or exchange of an interest in
a trust (pre-look-through long-term capital gain or loss) minus the
amount of long-term capital gain determined under paragraph (b) of this
section (look-through capital gain).
(d) Special rule for tiered entities. In determining whether a
partnership, S corporation, or trust has collectibles gain and whether
a partnership has section 1250 capital gain, such partnership, S
corporation, or trust shall be treated as owning its proportionate
share of the property of any partnership, S corporation, or trust in
which it owns an interest, either directly or indirectly through a
chain comprised exclusively of such entities.
(e) Notification requirements. Rules similar to those that apply to
the partners and the partnership under section 751(a) shall apply in
the case of sales or exchanges of interests in a partnership, S
corporation, or trust that holds property with collectibles gain and in
the case of sales or exchanges of interests in a partnership that holds
property with section 1250 capital gain. See Sec. 1.751-1(a)(3).
(f) Examples. The following examples illustrate the requirements of
this section:
Example 1. Collectibles gain. (i) A and B are equal partners in
a personal service partnership (PRS). B transfers B's 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 owed to partnership......................... 10,000 10,000
Collectibles.................................... 1,000 3,000
Other capital assets............................ 6,000 2,000
---------------------
Capital assets.................................... 7,000 5,000
Unrealized receivables............................ 0 14,000
---------------------
Total......................................... $20,000 $32,000
---------------------
Liabilities and
capital
---------------------
Liabilities....................................... $2,000 $2,000
Capital:
A............................................... 9,000 15,000
B............................................... 9,000 15,000
---------------------
Total......................................... $20,000 $32,000
------------------------------------------------------------------------
(ii) At the time of the transfer, B has held the interest in PRS
for more than one year, and none of the property 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 basis
for the partnership interest is $10,000 ($9,000 plus $1,000, B's
share of partnership liabilities). B's undivided one-half interest
in PRS includes a one-half interest in the partnership's unrealized
receivables and a one-half interest in the partnership's
collectibles.
(iii) If PRS were to sell 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 be 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 Sec. 1.751-1(a)(2) ($7,000) is the partner's
capital gain or loss on the sale of the partnership interest under
section 741. In this case, the transferor has a $1,000 pre-look-
through long-term capital loss.
(iv) If PRS were to sell all of its collectibles in a fully
taxable transaction immediately prior to the transfer of B's
partnership interest to T, B would be allocated $1,000 of
collectibles gain from the sale of the collectibles. Therefore, B
will recognize $1,000 of collectibles gain on account of the
collectibles held by PRS.
(v) The difference between the transferor's pre-look-through
long-term capital gain or loss (-$1,000) and the look-through
capital gain determined under this section ($1,000) is the
transferor's residual long-term capital gain or loss on the sale of
the partnership interest. Under these facts, B will recognize a
$2,000 residual long-term capital loss on account of the sale or
exchange of the interest in PRS.
Example 2. Special allocations. Assume the same facts as in
Example 1, except that under the partnership agreement, all gain
from the sale of the collectibles is specially allocated to B, and B
transfers B's interest to T for $16,000. All items of income, gain,
loss, or deduction of PRS, other than the collectibles gain, are
divided equally between A and B. Under these facts, B's pre-look-
through long-term capital gain would be $0. If PRS were to sell all
of its collectibles in a fully taxable transaction immediately prior
to the transfer of B's partnership interest to T, B would be
allocated $2,000 of collectibles gain from the sale of the
collectibles. Therefore, B will recognize $2,000 of collectibles
gain on account of the collectibles held by PRS. B also will
recognize $7,000 of ordinary income (determined under Sec. 1.751-
1(a)(2)) and a $2,000 long-term capital loss on account of the sale
of B's interest in PRS.
Example 3. Net collectibles loss ignored. Assume the same facts
as in Example 1, except that the collectibles held by PRS have an
adjusted basis of $3,000 and a fair market
[[Page 43122]]
value of $1,000, and the other capital assets have an adjusted basis
of $4,000 and a fair market value of $4,000. If PRS were to sell all
of its collectibles in a fully taxable transaction immediately prior
to the transfer of B's partnership interest to T, B would be
allocated $1,000 of collectibles loss. Because none of the gain from
the sale of the interest in PRS is attributable to unrealized
appreciation in the value of collectibles held by PRS, the net loss
in collectibles held by PRS is not recognized at the time B
transfers the interest in PRS. B will recognize $7,000 of ordinary
income (determined under Sec. 1.751-1(a)(2)) and a $1,000 long-term
capital loss on account of the sale of B's interest in PRS.
Example 4. Collectibles gain in an S corporation. (i) A
corporation (X) has always been an S corporation and is owned by
individuals A, B, and C. In 1996, X invested in antiques. Subsequent
to their purchase, the antiques appreciated in value by $300. A owns
one-third of the shares of X stock and has held that stock for more
than one year. A's adjusted basis in the X stock is $100. If A were
to sell all of the X stock to T for $150, A would realize $50 of
pre-look-through long-term capital gain.
(ii) If X were to sell its antiques in a fully taxable
transaction immediately before the transfer to T, A would be
allocated $100 of collectibles gain on account of the sale.
Therefore, A will recognize $100 of collectibles gain (look-through
capital gain) on account of the collectibles held by X.
(iii) The difference between the transferor's pre-look-through
long-term capital gain or loss ($50) and the look-through capital
gain determined under this section ($100) is the transferor's
residual long-term capital gain or loss on the sale of the S
corporation stock. Under these facts, A will recognize $100 of
collectibles gain and a $50 residual long-term capital loss on
account of the sale of A's interest in X.
(g) Effective date. This section applies to transfers of interests
in partnerships, S corporations, and trusts that occur on or after the
date these regulations are published as final regulations in the
Federal Register.
Par. 3. Section 1.1223-3 is added to read as follows:
Sec. 1.1223-3 Rules relating to the holding periods of partnership
interests.
(a) In general. A partner shall have a divided holding period in an
interest in a partnership if:
(1) The partner acquired portions of an interest at different
times; or
(2) The partner acquired portions of the partnership interest in
exchange for property transferred at the same time but resulting in
different holding periods determined under section 1223.
(b) Accounting for holding periods of an interest in a partnership.
The portion of a partnership interest to which a holding period relates
shall be determined by reference to a fraction that is the fair market
value of the portion of the partnership interest received in the
transaction to which the holding period relates over the fair market
value of the entire partnership interest (determined immediately after
the transaction).
(c) Sale or exchange of all or a portion of an interest in a
partnership--(1) Sale or exchange of entire interest in a partnership.
If a partner sells or exchanges the partner's entire interest in a
partnership, any capital gain or loss recognized shall be divided
between long-term and short-term capital gain or loss in the same
proportions as the holding period of the interest in the partnership is
divided between the portion of the interest held for more than one year
and the portion of the interest held for one year or less.
(2) Sale or exchange of a portion of an interest in a partnership.
(i) If the ownership interest in a publicly traded partnership (as
defined under section 7704(b)) is divided into identifiable units with
ascertainable holding periods, and the selling partner can identify the
portion of the partnership interest transferred, the selling partner
may use the actual holding period of the portion transferred.
(ii) If a partner has a divided holding period in a partnership
interest, and paragraph (c)(2)(i) of this section does not apply, then
the holding period of the transferred interest shall be divided between
long-term and short-term capital gain or loss in the same proportions
as the long-term and short-term capital gain or loss that the
transferor partner would realize if the entire interest in the
partnership were transferred in a fully taxable transaction immediately
before the actual transfer.
(d) Distributions--(1) In general. A partner's holding period in a
partnership interest is not affected by distributions from the
partnership.
(2) Character of capital gain or loss recognized as a result of a
distribution from a partnership. If a partner is required to recognize
capital gain or loss as a result of a distribution from a partnership,
then the capital gain or loss recognized shall be divided between long-
term and short-term capital gain or loss in the same proportions as the
long-term and short-term capital gain or loss that the distributee
partner would realize if such partner's entire interest in the
partnership were transferred in a fully taxable transaction immediately
before the distribution.
(e) Examples. The provisions of this section are illustrated by
the following examples:
Example 1. Division of holding period--contribution of money and
a capital asset. (i) A contributes $5,000 of cash and a
nondepreciable capital asset A has held for two years to a
partnership (PRS) for a 50% interest in PRS. A's basis in the
capital asset is $5,000, and the fair market value of the asset is
$10,000. After the exchange, A's basis in A's interest in PRS is
$10,000, and the fair market value of the interest is $15,000. A
received one-third of the interest in PRS for a cash payment of
$5,000 ($5,000/$15,000). Therefore, A's holding period in one-third
of the interest received (attributable to the contribution of money
to the partnership) begins on the day after the contribution. A
received two-thirds of the interest in PRS in exchange for the
capital asset ($10,000/$15,000). Accordingly, pursuant to section
1223(1), A has a two-year holding period in two-thirds of the
interest received in PRS.
(ii) Six months later, when A's basis in PRS is $12,000 (due to
a $2,000 allocation of partnership income to A), A sells the
interest in PRS for $15,000. Assuming PRS holds no inventory or
unrealized receivables (as defined under section 751(c)) and no
collectibles or section 1250 property, a will realize $3,000 of
capital gain. As determined above, one-third of A's interest in PRS
has a holding period of one year or less, and two-thirds of A's
interest in PRS has a holding period equal to two years and six
months. Therefore, one-third of the capital gain will be short-term
capital gain, and two-thirds of the capital gain will be long-term
capital gain.
Example 2. Division of holding period--contribution of money,
section 1231 property, and other property. In exchange for a 30%
interest in a partnership (ABC), A contributes to ABC $50,000 cash
and equipment used in a trade or business and held for more than one
year with a fair market value of $100,000 and an adjusted basis of
$40,000. The equipment has a recomputed basis under section 1245 of
$60,000. Accordingly, a portion of the equipment equal in value to
$20,000 is section 1245 property that is not section 1231 property.
See Sec. 1.1245-6(a). A's partnership interest has a fair market
value of $150,000, a basis of $90,000, and a divided holding period.
A received 46.67% ($70,000/$150,000) of the interest in ABC in
exchange for property that is neither a capital asset nor section
1231 property (that is, cash of $50,000 and a portion of the
equipment attributable to section 1245 recapture in an amount equal
to $20,000). Therefore, A's holding period for 46.67% of A's
interest begins on the day after the exchange of the property for
the partnership interest. A received 53.33% ($80,000/$150,000) of
A's interest in ABC in exchange for section 1231 property.
Accordingly, A's holding period for 53.33% of A's interest
includes A's holding period for the section 1231 property.
Example 3. Division of holding period when capital account is
increased by contribution. A, B, C, and D are equal partners in a
partnership (PRS), and the fair market value of a 25% interest in
PRS is $90x. A, B, C, and D each contribute an additional $10x to
partnership capital, thereby increasing the fair market value of
each partner's interest to $100x. As a result of the contribution,
each partner has a new holding period in the portion of the
partner's
[[Page 43123]]
interest in PRS that is attributable to the contribution. That
portion equals 10% ($10x/$100x) of each partner's interest in PRS.
Example 4. Sale or exchange of a portion of an interest in a
partnership. (i) A contributes $5,000 in cash and a capital asset
with a fair market value of $5,000 and a basis of $2,000 to a
partnership (PRS) in exchange for an interest in PRS. At the time of
the contribution, A had held the contributed property for two years.
Six months later, when A'S basis in PRS is $7,000, A transfers one-
half of A'S interest in PRS to T for $6,000 at a time when PRS's
balance sheet (reflecting a cash receipts and disbursements method
of accounting) is as follows:
------------------------------------------------------------------------
Assets
----------- Market
Adjusted value
basis
------------------------------------------------------------------------
Cash.............................................. $5,000 $5,000
Unrealized Receivables............................ 0 6,000
Capital Asset 1................................. 3,000 8,000
Capital Asset 2................................. 2,000 5,000
---------------------
Capital Assets.................................... 5,000 13,000
---------------------
Total......................................... $10,000 $24,000
------------------------------------------------------------------------
(ii) Although at the time of the transfer A has not held A's
interest in PRS for more than one year, 50% of the fair market value
of A'S interest in PRS was received in exchange for property with a
long-term holding period. Therefore, 50% of A'S interest in PRS has
a long-term holding period.
(iii) If PRS were to sell all of its section 751 property in a
fully taxable transaction immediately before A'S transfer of the
partnership interest, A would be allocated $3,000 of ordinary
income. One-half of that amount ($1,500) is attributable to the
portion of A'S interest in PRS transferred to T. Accordingly, A will
recognize $1,500 ordinary income and $1,000 ($2,500 -$1,500) of
capital gain on account of the transfer to T of one-half of A'S
interest in PRS. Fifty percent ($500) of that gain is long-term
capital gain and 50% ($500) is short-term capital gain.
Example 5. Sale or exchange of a portion of an interest in a
partnership. (i) The facts are the same as in Example 4, except that
capital asset 1 is a collectible that was purchased by PRS more than
one year earlier. If capital asset 1 were sold or exchanged in a
fully taxable transaction immediately before A's transfer of the
partnership interest, A would be allocated $2,500 of collectibles
gain. Fifty percent of that amount ($1,250) is attributable to the
portion of A's interest in PRS sold to T. The collectibles gain
allocable to the portion of the transferred interest in PRS with a
long-term holding period is $625 (50% of $1,250). Accordingly, A
will recognize $625 of collectibles gain on account of the transfer
of one-half of the interest in PRS.
(ii) The difference between the amount of pre-look-through long-
term capital gain or loss ($500) and the look-through capital gain
($625) is the amount of residual long-term capital gain or loss that
A will recognize on account of the transfer of one-half of the
interest in PRS. Under these facts, A will recognize a residual
long-term capital loss of $125 and a short-term capital gain of
$500.
Example 6. Sale of units of interests in partnership. A publicly
traded partnership (PRS) has ownership interests that are segregated
into identifiable units of interest. A owns 10 limited partnership
units in PRS for which A paid $10,000 three years ago. Later, A
purchases five additional units for $10,000 at a time when the fair
market value of each unit has increased to $2,000. A's holding
period for one-third ($10,000/$30,000) of the interest in PRS begins
on the day after the purchase of the five additional units. Less
than one year later, A sells five units of ownership in PRS for
$11,000. At the time, A's basis in the 15 units of PRS is $20,000,
and A's capital gain on the sale of 5 units is $4,333 (amount
realized of $11,000--one-third of the adjusted basis or $6,667). For
purposes of determining the holding period, A can designate the
specific units of PRS sold. If A properly identifies the five units
sold as five of the ten units for which A has a long-term holding
period, the capital gain realized will be long-term capital gain.
Example 7. Disproportionate distribution. In 1997, A and B each
contribute cash of $50,000 to form and become equal partners in a
partnership (PRS). Sometime later, A receives a distribution worth
$22,000 from PRS, which reduces A's interest in PRS to 36%. After
the distribution, B owns 64% of PRS. The holding periods of A and B
in their interests in PRS are not affected by the distribution.
Example 8. Gain or loss as a result of a distribution. In 1996,
A contributes property with a basis of $10 and a fair market value
of $10,000 in exchange for an interest in a partnership (ABC). In
1999, when A's interest in ABC is worth $12,000, A contributes
$6,000 cash in exchange for an additional interest in ABC, bringing
the fair market value of A's interest to $18,000. The holding period
of A's interest in ABC is determined immediately after that
exchange. A's holding period in one-third of A's interest in ABC
($6,000 cash contributed over the $18,000 value of the entire
interest) begins on the day after the cash contribution. (ABC holds
no inventory or unrealized receivables.) Later in 1999, ABC makes a
cash distribution to A of $10,000. A's basis in ABC immediately
before the distribution is $6,010. Accordingly, A must recognize
$3990 of capital gain as a result of the distribution. See section
731(a)(1). One-third of the capital gain recognized as a result of
the distribution is short-term capital gain, and two-thirds of the
capital gain is long-term capital gain. After the distribution, A's
basis in the interest in PRS is $0, and the holding period for the
interest in PRS continues to be divided in the same proportions as
before the distribution.
(f) 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. 4. Section 1.741-1 is amended by adding paragraphs (e) and (f)
to read as follows:
Sec. 1.741-1 Recognition and character of gain or loss on sale or
exchange.
* * * * *
(e) For rules relating to the capital gain or loss recognized when
a partner sells or exchanges an interest in a partnership that holds
appreciated collectibles or section 1250 property with section 1250
capital gain, see Sec. 1.1(h)-1.
(f) For rules relating to dividing the holding period of an
interest in a partnership, see Sec. 1.1223-3.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 99-20368 Filed 8-6-99; 8:45 am]
BILLING CODE 4830-01-U
