partnership taxation: an application approach (2d … partnership taxation 2e...$12,000 and fair...
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Partnership Taxation:
An Application Approach (2d Ed.)
Update
Spring – 2015
Joni Larson
Copyright © Joni Larson. All rights reserved.
Chapter 5. Receipt of Partnership Interest for Services
The Services has issued proposed regulations addresing the treatment of providing
services in exchange for a capital interest or for a profits interests. The proposed
regulations as summarized below.
Services in exchange for a capital interest. Because services are not considered
property for purposes of the non-recognition provision,1 a transaction in which a partner
receives a capital interest in a partnership in exchange for services does not come within
the non-recognition provision. However, there has been disagreement over whether a
capital interest received by the service partner is property for purposes of Section 83. If
applicable, Section 83 determines when property received for services must be included
in income.2 When property is transferred in connection with services, the person who
performs the services includes the fair market value of the property (less any amount paid
for the property) in income in the year the property becomes transferable or not subject to
a substantial risk of forfeiture.3 “Property” is defined as “real and personal property other
than either money or an unfunded and unsecured promise to pay money or property in the
future.”4
Under proposed regulations, when the interest is a substantially vested interest,
the service partner must include the liquidation value of the capital interest (less any
amount paid for the interest) in income upon receipt.5 The partner’s capital account
includes the amount included as compensation under Section 83(a).6 In addition, the
transfer of a capital interest to a service partner is not a taxable event to the partnership.7
Under Section 83, the partnership is entitled to a deduction equal to the amount included
as compensation by the service partner.8 Under a safe harbor provision, the deduction is
allowed based on the partnership’s method of accounting.9
Services in exchange for a profits interest. Regulations under Section 721 provide
that the transfer of a partnership interest in connection with the performance of services is
1 Treas. Reg. § 1.721-1(b).
2 Code Sec. 83(a).
3 Id.
4 Treas. Reg. § 1.83-3(e).
5 Sec. 5.01, Notice 2005-43.
6 Prop. Reg. § 1.704-1(b)(2)(iv)(b)(l). The proposed regulation applies to compensatory partnership
interests and defines a compensatory partnership interest as an interest in the transferring partnership that is
transferred in connection with the performance of services for that partnership. Prop. Reg. § 1.721-1(b)(3). 7 Prop. Reg. § 1.721-1(b)(2)(i). The proposed regulations provide that capital accounts be booked to fair
market value just prior to the transaction. Prop. Reg. § 1.704-1(b)(2)(iv)(f)(5)(iii). 8 Code Sec. 83(a), (h). To be deductible, the amount otherwise must meet the requirements of Section 162.
9 Sec. 5.02, Notice 2005-43. The proposed regulations provide the transfer of the partnership capital interest
in exchange for services rendered to the partnership is treated as a guaranteed payment. Prop. Reg. § 1.721-
1(b)(4)(i). As a guaranteed payment, the partner must include the amount in income in the year in which
the partnership takes the deduction. Under Section 83(h), the partnership would take the deduction in the
taxable year in which or with which ends the taxable year in which the partner included the amount in
income. If there is an inconsistency between the timing rules of Section 707(c) and those of Section 83,
those of Section 83 take precedence. Prop. Reg. § 1.707-1(c).
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a transfer of property governed by Section 83.10
Moreover, proposed regulations under
Section 83 provide that property includes a partnership interest (making no distinction
between a capital interest and a profits interest).11
The proposed regulations and Notice
2005-43, which includes a proposed Revenue Procedure,12
also provide a safe harbor
under which the value of the partnership interest is equal to the liquidation value of the
interest.13
Because a profits interest partner has no interest in the underlying assets, the
profits interest generally will have no value. Thus, the partner has no income upon receipt
of the interest and the partnership is not entitled to a deduction.14
10
Prop. Reg. § 1.721-1(b)(1). 11
Prop. Reg. § 1.83-3(e). 12
Notice 2005-43, 2005-1 C.B. 1221. If the Revenue Procedure contained in this notice becomes final, it
will obsolete Rev. Proc. 93-27 and Rev. Proc. 2001-43. 13
Prop. Reg. § 1.83-3(l)(1), Sec. 4.02, Notice 2005-43, 2005-1 C.B. 1221. The partnership and all its
partners must elect the safe harbor. In addition, certain requirements must be met. See Prop. Reg. § 1.83-
3(1); Sec. 3.03, Notice 2005-43. 14
Code Sec. 83(a), (h).
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Chapter 7. Non-Recourse Liabilities
In this chapter, allocation of non-recourse debt is made under the “third tier” of
allocations. In general, such an allocation is based on how the partners share profits.
Proposed regulations would alter this third tier allocation, often referred to as the
allocation of excess non-recourse deductions.
Under the proposed regulations, issued January 30, 2014, the partnership agreement may
specify the partners’ interest in partnership profits for purposes of allocating excess
nonrecourse liabilities, provided the interests specified are in accordance with the
partners’ liquidation value percentages.15
In general, a partner’s liquidation value
percentage is the ratio of the liquidation value of the partner’s interest in the partnership,
divided by the aggregate liquidation value of all the partners’ interest in the partnership.16
15
Prop. Reg. § 1.752-3(a)(3). 16
Id.
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Chapter 15. Allocation of Recourse Deductions
Replace Problem 1(b)(3)(a), (b), and (c) (page 165) with the following:
(3) The partnership makes no distribution to Ben in the third year. In its third year, the
partnership has $20,000 of income, $20,000 of expenses, and $50,000 of depreciation
from the building.
(a) What is the impact of the allocation of deprecation on capital accounts in year
three?
(b) Alternatively, in the third year Ben contributed a promissory note for $75,000
to the partnership. What is the impact on the allocation of depreciation on capital
accounts?
(c) Alternatively, the partnership distributed $30,000 to Ben at the beginning of
year three. What is the impact of the distribution and the allocation of
depreciation and other partnership items on capital accounts?
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Chapter 17. Allocations of Depreciation from Property Contributed to the
Partnership by a Partner
Treasury has issued proposed regulations to address Section 704(c)(1)(C). Under the
proposed regulations, if a partner contributes property with a built in loss to a partnership,
the built in loss is taken into account only in determining the amount of items allocated to
the contributing partner.17
For purposes of determining allocations to the non-
contributing partners, the initial basis of the built in loss property is equal to its fair
market value at the time of contribution.18
The contributing partner has a “basis
adjustment” amount equal to the amount of built in loss.19
The basis adjustment amount
is subsequently adjusted for the recovery of the basis adjustment. This adjustment
impacts only the contributing partner.20
Thus, for purposes of calculating income,
deduction, gain, and loss, the contributing partner will have a special basis for the
property. However, the basis adjustment does not impact the partnership’s computation
under Section 703.21
The adjustments to the contributing partner’s distributive shares do
not affect the partner’s capital account.22
If the contributed built in loss property is depreciable, the basis adjustment amount is
recovered through depreciation and included with the contributing partner’s other
depreciation for the year. The basis of the basis adjustment amount is reduced to reflect
the depreciation recovery.23
Example. Alex contributes depreciable property with an adjusted basis of
$12,000 and fair market value of $5,000. The property has a life of 10
years, with 7.5 years remaining at the time of contribution, and is
recovered using the straightline method, half-year convention. Ben
contributes $5,000.
Because the property is contributed with a built in loss, Alex’s basis
adjustment amount is $7,000 (amount of the built in loss). The partnership
takes a $5,000 basis in the property (basis equal to fair market value). The
partnership is entitled to $667 of depreciation each year ($5,000, divided
by 7.5 years remaining), which is allocated between Alex and Ben. Alex
also is entitled to $933 of depreciation with respect to his basis adjustment
amount ($7,000 basis adjustment amount, divided by 7.5 remaining
years).24
17
Prop. Reg. § 1.704-3(f)(1)(i). 18
Prop. Reg. § 1.704-3(f)(1)(ii). 19
Prop. Reg. § 1.704-3(f)(2)(iii). 20
Prop. Reg. § 1.704-3(f)(3)(ii)(A). 21
Id. 22
Prop. Reg. § 1.704-3(f)(3)(ii)(B). 23
Prop. Reg. § 1.704-3(f)(3)(ii)(D)(1). 24
Prop. Reg. § 1.704-3(f)(3)(ii)(D)(2).
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Chapter 18. Allocations Related to the Sale of Contributed Property
Treasury has issued proposed regulations to address Section 704(c)(1)(C). Under the
proposed regulations, if a partner contributes property with a built in loss to a partnership,
the built in loss is taken into account only in determining the amount of items allocated to
the contributing partner.25
For purposes of determining allocations to the non-
contributing partners, the initial basis of the built in loss property is equal to its fair
market value at the time of contribution.26
The contributing partner has a “basis
adjustment” amount equal to the amount of built in loss.27
The basis adjustment amount
is subsequently adjusted for the recovery of the basis adjustment. This adjustment
impacts only the contributing partner.28
Thus, for purposes of calculating income,
deduction, gain, and loss, the contributing partner will have a special basis for the
property. However, the basis adjustment does not impact the partnership’s computation
under Section 703.29
The adjustments to the contributing partner’s distributive shares do
not affect the partner’s capital account.30
The contributing partner’s gain or loss from the sale of the contributed built in loss
property is equal to the contributing partner’s share of the partnership’s gain or loss from
the sale of the property, less the basis adjustment.31
25
Prop. Reg. § 1.704-3(f)(1)(i). 26
Prop. Reg. § 1.704-3(f)(1)(ii). 27
Prop. Reg. § 1.704-3(f)(2)(iii). 28
Prop. Reg. § 1.704-3(f)(3)(ii)(A). 29
Id. 30
Prop. Reg. § 1.704-3(f)(3)(ii)(B). 31
Prop. Reg. § 1.704-3(f)(3)(ii)(C).
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Chapter 20. Non-Recourse Liabilities
On pages 240-242, there is a discussion of third tier allocations. Proposed regulations,
issued January 30, 2014, would alter the allocation of excess non-recourse deductions.
Under the proposed regulations, the partnership agreement may specify the partners’
interest in partnership profits for purposes of allocating excess nonrecourse liabilities,
provided the interests specified are in accordance with the partners’ liquidation value
percentages.32
In general, a partner’s liquidation value percentage is the ratio of the
liquidation value of the partner’s interest in the partnership, divided by the aggregate
liquidation value of all the partners’ interest in the partnership.33
32
Prop. Reg. § 1.752-3(a)(3). 33
Id.
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Chapter 21. Tax Consequences to Transferring Partner
The tax rates applicable to long-term capital gains have changed. Accordingly, replace
Section 2. c Preferential Capital Gain Rates (pages 256-57) with the following.
The tax rate applicable to net long-term capital gains depends on the nature of the
asset sold and the taxpayer’s tax bracket. The rate will be one of the following:
28 percent;
25 percent;
20 percent
15 percent
0 percent; or
The tax rate applied to the taxpayer’s ordinary income.
If the taxpayer is in a tax bracket higher than 28 percent and the item sold is either
“collectibles” or “Section 1202 gain,” the maximum tax rate will be 28 percent. If the
taxpayer would otherwise be in a lower tax bracket, the taxpayer’s lower rate will
apply.34
Collectibles gain is gain from the sale or exchange of any rug, antique, metal,
gem, stamp, coin, or other collectible that has been held as a capital asset for more than
one year.35
“Section 1202” gain generally is 50 percent of the gain from the sale or
exchange of certain stock described in Section 1202.36
If the taxpayer is in a tax bracket higher than 28 percent and the item sold is either
“collectibles” or “Section 1202 gain,” the maximum tax rate will be 28 percent. If the
taxpayer would otherwise be in a lower tax bracket, the taxpayer’s lower rate will
apply.37
Example. Jamaal, who was in the 35 percent tax bracket, sold an antique
rug he had purchased three years earlier for investment purposes. He
recognized a long-term capital gain of $30,000. Because the gain was
from a collectible and Jamaal would otherwise have been in a higher tax
bracket, the gain from the rug will be taxed at the 28 percent rate. His
remaining income will be taxed at the 35 percent rate.
Alternatively, assume Jamaal had been in the 15 percent tax bracket when
he sold the antique rug. He still recognized a long-term capital gain of
$30,000. Because he was not in a tax bracket higher than 28 percent, the
gain will be taxed at the 15 percent rate, the same as his other income.
34
Section 1(h)(1)(E). 35
Section 1(h)(5)(A). 36
Section 1(h)(7). 37
Section 1(h)(1)(E).
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In general, unrecaptured Section 1250 gain is long-term capital gain attributable
to depreciation allowed with respect to real estate held for more than one year.38
If the
gain is “unrecaptured Section 1250 gain,” it is taxed at a maximum rate of 25 percent.39
Example. Brian sold a building that he had used in his business for two
years for $100,000. At the time of the sale, the adjusted basis in the
building was $75,000 and he had claimed $25,000 of depreciation; he
recognized $25,000 of gain. Because the gain from the sale was
attributable to the depreciation taken by Brian prior to sale, the gain is
characterized as unrecaptured Section 1250 gain and is taxed at a rate not
higher than 25 percent.
Adjusted net capital gain is the gain remaining after considering the previous two
categories of gain, i.e., the net capital gain reduced by the amount of gain from
collectibles, Section 1202 gain, and unrecaptured Section 1250 gain.40
Adjusted net
capital gain is taxed at a maximum rate of 20 percent. If the gain otherwise would have
been taxed at the 10 or 15 percent marginal rate, it will be taxed at zero percent; if the
gain otherwise would have been taxed at the 25, 28, 33, or 35 percent marginal rate, it
will be taxed at 15 percent; if the gain otherwise would have been taxed at the 39.6
percent marginal rate, it will be taxed at 20 percent.41
Example. Erik is in the 35 percent tax bracket. He sold stock in GainCo
and recognized a long-term capital gain of $20,000. Erik sold no other
assets during the year. Because he had no collectibles, Section 1202, or
unrecaptured Section 1250 gain, the adjusted net capital gain is $20,000. It
will be taxed at the 15 percent rate. All other income will be taxed at the
35 percent rate. Alternatively, if Erik had been in the 10 percent tax
bracket, the $20,000 of gain would not be subject to tax.
__________________________________________________________________
Treasury has issued proposed regulations to address Section 704(c)(1)(C). Under the
proposed regulations, if a partner contributes property with a built in loss to a partnership,
the built in loss is taken into account only in determining the amount of items allocated to
the contributing partner.42
For purposes of determining allocations to the non-
contributing partners, the initial basis of the built in loss property is equal to its fair
market value at the time of contribution.43
The contributing partner has a “basis
adjustment” amount equal to the amount of built in loss.44
The basis adjustment amount
is subsequently adjusted for the recovery of the basis adjustment. This adjustment
38
Section 1(h)(6). 39
Section 1(h)(1)(D). 40
Section 1(h)(3). 41
Section 1(h)(1)(B), (C). 42
Prop. Reg. § 1.704-3(f)(1)(i). 43
Prop. Reg. § 1.704-3(f)(1)(ii). 44
Prop. Reg. § 1.704-3(f)(2)(iii).
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impacts only the contributing partner.45
Thus, for purposes of calculating income,
deduction, gain, and loss, the contributing partner will have a special basis for the
property. However, the basis adjustment does not impact the partnership’s computation
under Section 703.46
The adjustments to the contributing partner’s distributive shares do
not affect the partner’s capital account.47
In general, if the partner who contributed the built in loss property transfers the
partnership interest, the portion of the basis adjustment amount is eliminated. The
transferee partner is not treated as the contributing partner was with respect to the
interest. The transferor partner continues to have any remaining basis adjustment
amount.48
Example. Andy contributed land with a basis of $11,000 and fair market
value of $5,000. Bob and Cindy each contributed $5,000. Because Andy’s
property was contributed with a built in loss, Andy’s basis adjustment is
$6,000 (amount of the built in loss). The partnership takes a $5,000 basis
in the property (basis equal to fair market value). In the third year, when
the fair market value of the land is still $5,000, Andy sells his interest to
David for $5,000. Andy has a loss from the sale equal to the excess of his
outside basis, $11,000, over the amount realized, $5,000. David does not
succeed to any of the basis adjustment amount; it is eliminated upon
sale.49
45
Prop. Reg. § 1.704-3(f)(3)(ii)(A). 46
Prop. Reg. § 1.704-3(f)(3)(ii)(A). 47
Prop. Reg. § 1.704-3(f)(3)(ii)(B). 48
Prop. Reg. § 1.704-3(f)(3)(iii)(A). 49
Prop. Reg. § 1.704-3(f)(3)(iii)(C), Example 1.
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Chapter 23. Non-Liquidating Distributions
Treasury has issued proposed regulations to address Section 704(c)(1)(C). Under the
proposed regulations, if a partner contributes property with a built in loss to a partnership,
the built in loss is taken into account only in determining the amount of items allocated to
the contributing partner.50
For purposes of determining allocations to the non-
contributing partners, the initial basis of the built in loss property is equal to its fair
market value at the time of contribution.51
The contributing partner has a “basis
adjustment” amount equal to the amount of built in loss.52
The basis adjustment amount
is subsequently adjusted for the recovery of the basis adjustment. This adjustment
impacts only the contributing partner.53
Thus, for purposes of calculating income,
deduction, gain, and loss, the contributing partner will have a special basis for the
property. However, the basis adjustment does not impact the partnership’s computation
under Section 703.54
The adjustments to the contributing partner’s distributive shares do
not affect the partner’s capital account.55
If a partnership distributes property to a partner and the partner has a basis adjustment
amount for the property, the basis adjustment amount is taken into consideration under
Section 732.56
Example. Beth contributed Blackacre with a basis of $15,000 and fair
market value of $10,000 and Whiteacre with a basis of $5,000 and fair
market value of $20,000. Carl contributed $30,000. Because Blackacre is
contributed with a built in loss, Beth’s basis adjustment amount is $5,000
(amount of the built in loss). The partnership takes a $10,000 basis in
Blackacre (basis equal to fair market value).
In Year 3, the partnership distributes Blackacre to Beth. At the time of the
distribution, the fair market value of Blackacre is $12,000 and Beth’s basis
in her partnership interest is still $20,000. For purposes of Section
732(a)(1), the basis of Blackacre immediately before the distribution is
$15,000, the partnership’s $10,000 basis, increased by Beth’s $5,000 basis
adjustment amount. Thus, upon distribution her basis in Blackacre is
$15,000.57
50
Prop. Reg. § 1.704-3(f)(1)(i). 51
Prop. Reg. § 1.704-3(f)(1)(ii). 52
Prop. Reg. § 1.704-3(f)(2)(iii). 53
Prop. Reg. § 1.704-3(f)(3)(ii)(A). 54
Id. 55
Prop. Reg. § 1.704-3(f)(3)(ii)(B). 56
Prop. Reg. § 1.704-3(f)(3)(v)(A). 57
Prop. Reg. § 1.704-3(f)(3)(v)(D), Example 1.
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Chapter 25. Disproportionate Distributions
Page 329, Step Seven. In the first sentence, change “accounts receivable” to “inventory.”
________________________________________________________________________
The IRS has published proposed regulations under Section 751(b) on how a partner
should measure its interest in a partnership's unrealized receivables and inventory items
and on the tax consequences of a distribution that causes a reduction in that interest. The
regulations would allow use of the hypothetical sale approach only to determine whether
there is a hot asset shift, but then allow use of any reasonable method to determine the
amount of gain triggered. The regulations would affect partners in partnerships that own
unrealized receivables and inventory items and that make a distribution to one or more
partners.
The proposed regulations follow many of the principles of Notice 2006-14, first
describing the rules for determining partners' interests in Section 751 property. They then
outline a test to determine whether Section 751(b) applies to a partnership distribution
and provide an antiabuse rule that may apply when the test would not otherwise be
satisfied. Further, the regulations explain the tax consequences of a distribution covered
by Section 751(b) and describe miscellaneous issues, including a clarification to the
scope of Reg. § 1.751-1(a).
The regulations adopt the hypothetical sale approach as the method by which the partners
must measure their respective interests in Section 751 property for determining whether a
distribution reduces a partner's interest in the partnership's Section 751 property. Because
the hypothetical sale approach relies on the principles of Section 704(c) to preserve a
partner's share of the unrealized gain and loss in the partnership's Section 751 property,
the regulations make several changes to the regulations on Section 704(c) and
revaluations.
The IRS determined that a deemed gain approach produces an appropriate outcome in the
greatest number of circumstances and that the hot asset sale approach also produced an
appropriate outcome in most circumstances. However, no one approach produced an
appropriate outcome in all circumstances. Therefore, the proposed regulations would
withdraw the asset exchange approach of the current regulations but would not require
the use of a particular approach for determining the tax consequences of a Section 751(b)
distribution. Instead, the regulations provide that, if under the hypothetical sale approach
a distribution reduces a partner's interest in the partnership's Section 751 property, giving
rise to a Section 751(b) amount, the partnership must use a reasonable approach that is
consistent with the purpose of Section 751(b) to determine the tax consequences of the
reduction. Except in limited situations, a partnership will be required to continue using
the same approach, once chosen, including after a termination of the partnership.
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Chapter 26. Mixing Bowl Transaction—Distribution of Previously Contributed
Property
In problem 1 (page 338), in addition to determining the tax consequences to the
partnership and Jeb, determine the tax consequences to Kayla.
___________________________________________________________________
Treasury has issued proposed regulations to address Section 704(c)(1)(C). Under the
proposed regulations, if a partner contributes property with a built in loss to a partnership,
the built in loss is taken into account only in determining the amount of items allocated to
the contributing partner.58
For purposes of determining allocations to the non-
contributing partners, the initial basis of the built in loss property is equal to its fair
market value at the time of contribution.59
The contributing partner has a “basis
adjustment” amount equal to the amount of built in loss.60
The basis adjustment amount
is subsequently adjusted for the recovery of the basis adjustment. This adjustment
impacts only the contributing partner.61
Thus, for purposes of calculating income,
deduction, gain, and loss, the contributing partner will have a special basis for the
property. However, the basis adjustment does not impact the partnership’s computation
under Section 703.62
The adjustments to the contributing partner’s distributive shares do
not affect the partner’s capital account.63
If the partnership distributes the property with the built in loss to the contributing partner,
the basis adjustment amount is taken into account under Section 732.64
If a partnership
distributes the property with the built in loss to a partner other than the contributing
partner, the distribute partner does not take the basis adjustment amount into
consideration. If Section 704(c)(1)(B) applies to treat the partner who contributed the
built in loss property as recognizing a loss on the sale of the property, the basis
adjustment amount is taken into consideration in determining the amount of the loss.65
Example. Beth contributed Blackacre with a basis of $15,000 and fair
market value of $10,000 and Whiteacre with a basis of $5,000 and fair
market value of $20,000. Carl contributed $30,000. Because Blackacre is
contributed with a built in loss, Beth’s basis adjustment amount is $5,000
(amount of the built in loss). The partnership takes a $10,000 basis in
Blackacre (basis equal to fair market value).
In Year 10, the partnership distributes Blackacre to Carl. Carl does not
take any portion of Beth’s basis adjustment amount into account. For
58
Prop. Reg. § 1.704-3(f)(1)(i). 59
Prop. Reg. § 1.704-3(f)(1)(ii). 60
Prop. Reg. § 1.704-3(f)(2)(iii). 61
Prop. Reg. § 1.704-3(f)(3)(ii)(A). 62
Id. 63
Prop. Reg. § 1.704-3(f)(3)(ii)(B). 64
Prop. Reg. § 1.704-3(f)(3)(v)(A). 65
Prop. Reg. § 1.704-3(f)(3)(v)(B).
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purposes of Section 732(a)(1), the basis of Blackacre immediately before
the distribution is $10,000 (the partnership’s $10,000 basis). Thus, upon
distribution his basis in Blackacre is $10,000. Beth’s basis adjustment in
Blackacre is reallocated to Whiteacre.66
66
Prop. Reg. § 1.704-3(f)(3)(v)(D), Example 2.
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Chapter 28. Liquidating Distributions
Treasury has issued proposed regulations to address Section 704(c)(1)(C). Under the
proposed regulations, if a partner contributes property with a built in loss to a partnership,
the built in loss is taken into account only in determining the amount of items allocated to
the contributing partner.67
For purposes of determining allocations to the non-
contributing partners, the initial basis of the built in loss property is equal to its fair
market value at the time of contribution.68
The contributing partner has a “basis
adjustment” amount equal to the amount of built in loss.69
The basis adjustment amount
is subsequently adjusted for the recovery of the basis adjustment. This adjustment
impacts only the contributing partner.70
Thus, for purposes of calculating income,
deduction, gain, and loss, the contributing partner will have a special basis for the
property. However, the basis adjustment does not impact the partnership’s computation
under Section 703.71
The adjustments to the contributing partner’s distributive shares do
not affect the partner’s capital account.72
If a partner who had contributed property with a built in loss receives a liquidating
distribution of property (irrespective of whether he has a basis adjustment amount in the
property), the adjusted basis of the distributed property immediately before the
distribution includes the basis adjustment amount for the property in which the partner
relinquishes an interest.73
For purposes of determining the partner’s basis in the
distributed property, the partnership reallocates any basis adjustment amount from built
in loss property retained by the partnership to distributed properties of like character as
provided under Reg. § 1.755-1(c)(i), after applying Sections 704(c)(1)(B) and 737. If the
built in loss property is retained by the partnership and no property of a like character is
distributed, the basis adjustment amount is not reallocated to the distributed property for
purposes of Section 732, and Reg. § 1.734-2(c)(2) applies for any basis adjustment
amount not fully utilized by the partner.74
Example. Beth contributed Blackacre with a basis of $15,000 and fair
market value of $10,000 and Whiteacre with a basis of $5,000 and fair
market value of $20,000. (Both Blackacre and Whiteacre are capital
assets.) Carl and Dennis each contributed $30,000. Because Blackacre is
contributed with a built in loss, Beth’s basis adjustment amount is $5,000
(amount of the built in loss). The partnership takes a $10,000 basis in
Blackacre (basis equal to fair market value). The partnership makes a
Section 754 election.
67
Prop. Reg. § 1.704-3(f)(1)(i). 68
Prop. Reg. § 1.704-3(f)(1)(ii). 69
Prop. Reg. § 1.704-3(f)(2)(iii). 70
Prop. Reg. § 1.704-3(f)(3)(ii)(A). 71
Id. 72
Prop. Reg. § 1.704-3(f)(3)(ii)(B). 73
Prop. Reg. § 1.704-3(f)(3)(v)(C). 74
Id.
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In Year 10, the partnership distributes Whiteacre and $10,000 to Beth in
complete liquidation of her interest. At the time of distribution, the fair
market value of Whiteacre is still $20,000, and Beth, Carl, and Dennis’s
basis are unchanged. For purposes of Section 732(a)(1), the basis of
Whiteacre immediately before the distribution is $10,000 (the
partnership’s $5,000 basis, plus Beth’s $5,000 basis adjustment amount).
Thus, upon distribution Beth’s basis in Whiteacre is $10,000. No
adjustment is required to be made under Section 73475
75
Prop. Reg. § 1.704-3(f)(3)(v)(D), Example 3.
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Chapter 29. Transaction in Capacity Other Than as Partner
In problem 2(c) (page 387), replace “distributed” with “allocated”.
Copyright © Joni Larson. All rights reserved.