The IRS on November 15 issued final regulations on the application of Sec. 108(e)(8) to partners and partnerships (T.D. 9557). The regulations provide rules for determining a partnership’s discharge of indebtedness (DOI) income when it transfers a partnership interest to a creditor to satisfy a partnership debt.
The regulations also discuss how Sec. 721 applies when a partnership’s debt is contributed to the partnership in exchange for a capital profits interest in the partnership. The regulations also cover how partnership DOI income is allocated as a minimum gain chargeback under Sec. 704.
The American Jobs Creation Act of 2004, P.L. 108-357, expanded the scope of Sec. 108(e)(8) to include partnership discharges of indebtedness. Under Sec. 108(e)(8), if a debtor partnership transfers a capital or profits interest in the partnership to a creditor in satisfaction of its debt (recourse or nonrecourse), the partnership is treated as having satisfied the debt with an amount of money equal to the fair market value (FMV) of the partnership interest. If the debt exceeds the FMV of the transferred interest, the excess is DOI income that must be included in the distributive shares of the partners who were partners immediately before the debt discharge.
The regulations provide that the FMV of a partnership interest is its liquidation value—that is, the amount of cash or property that the creditor would receive for the equity interest if, immediately after the transfer, the partnership sold all its assets for cash equal to the FMV of those assets and then liquidated (Regs. Sec. 1.108-8(b)(2)(iii)). However, this liquidation value can be used to determine the FMV of a partnership interest only if four conditions are met (Regs. Secs. 1.108-8(b)(2)(i)(A)–(D)). If the conditions are not satisfied, the FMV of the transferred partnership interest is based on all the facts and circumstances.
The regulations are effective November 17, 2011.