Current Developments in Partners and Partnerships

By Hughlene A. Burton, Ph.D., CPA

Current Developments in Partners and Partnerships
Photo by sharky1/iStock


  • Legislation in 2015 changed the due date for partnership returns in tax years beginning after Dec. 31, 2015, to the 15th day of the third month after the close of the partnership's tax year.
  • Congress also enacted legislation that repeals the TEFRA audit procedures and streamlines the partnership audit process, effective for partnership tax years beginning after Dec. 31, 2017.
  • The IRS issued final regulations that govern the allocation of income when interests vary during the year.
  • Proposed regulations were issued in an attempt to modernize guidance under Sec. 751(b), which overrides the nonrecognition provisions of Sec. 731 with respect to a partner's interest in partnership unrealized receivables and substantially appreciated inventory.
  • Proposed regulations were issued relating to disguised payments for services that target management fee waivers.
  • Disguised sales and disguised payments for services to partners were the subject of proposed regulations issued during the update period.

This article reviews and analyzes recent law changes as well as rulings and decisions involving partnerships. The discussion covers developments in income allocations, disguised sales, partnership distributions, terminations, and basis adjustments. During the period of this update (Nov. 1, 2014-Oct. 31, 2015), Treasury and the IRS worked to provide guidance for taxpayers on numerous changes that had been made to subchapter K over the past few years. The courts and the IRS also issued various rulings and regulations addressing partnership operations and allocations.

Audit Issues

Through 2017, there are three regimes for auditing partnerships. For partnerships with 10 or fewer partners, the IRS generally applies the same audit procedures as for individual taxpayers, while auditing both the partnership and the partner separately. For partnerships with more than 10 partners, the IRS uses the rules under TEFRA1 to audit partnership returns. TEFRA requires determining the treatment of all partnership items at the partnership level. The third regime relates to partnerships with 100 or more partners that elect to be treated as electing large partnerships.

Effective for partnership tax years beginning after Dec. 31, 2017, Section 1101 of the Bipartisan Budget Act of 20152 replaces the TEFRA partnership audit rules3 with new rules to streamline the audit process for large partnerships as well as smaller partnerships that do not elect out of application of the new rules. New Sec. 6221(a) requires that:

Any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership taxable year (and any partner's distributive share thereof) shall be determined, any tax attributable thereto shall be assessed and collected, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to any such item or share shall be determined, at the partnership level.

Under the new provisions, any adjustments determined in an IRS audit will be taken into account by the partnership in the year the adjustment request is made. A key part of the new law is that the additional tax will be paid by the partnership at the highest individual or corporate rate in effect for the reviewed year.

Partnerships will have the option to lower their tax liability if they can prove that the total tax liability would be lower if the adjustments were based on certain partner-level information. In addition, a partnership with 100 or fewer partners can elect out of application of the new rules if each of its partners is either an individual, a C corporation, any foreign entity that would be treated as a C corporation were it domestic, an S corporation, or an estate of a ­deceased partner.

Congress enacted TEFRA in part to improve the auditing and adjustment of income items attributable to partnerships. In a generic legal advice memorandum4 in the past year concerning TEFRA audits, the IRS Office of Chief Counsel addressed who is authorized to sign a power of attorney (POA) appointing a representative for a partnership or limited liability company (LLC) being examined in a TEFRA partnership-level examination.

The IRS determined that a general partner (GP) or, in the case of an LLC, a member-manager, may sign a POA for purposes of a TEFRA partnership-level examination or for other tax purposes of the partnership. A POA can also be secured from a limited partner or LLC member for the purposes of securing partnership item information and disclosing partnership information to the POA. In the case of an LLC that has no member who is also a manager, the nonmember manager may sign the POA for purposes of establishing that it would be appropriate and helpful to secure partnership item information, including securing documents and discussing the information with the designated individual.

A question that continues to come up in TEFRA audits is whether an item is a partnership item. This question is important because a partnership item must be settled at the partnership level and will apply to all partners, while a nonpartnership item must be settled at the individual partner level. In 2015, several cases addressed this issue. Russian Recovery Fund Ltd.,5 a TEFRA case, looked at a readjustment of partnership items involving what is known as a distressed asset-debt, or DAD, transaction, in which a tax-exempt entity transfers its losses to a partnership in exchange for an interest in that partnership. After the transfer, the tax-exempt entity sells its partnership interest to another entity that subsequently claims the loss. In this case, a foreign hedge fund transferred distressed Russian sovereign debt to the taxpayer, an LLC taxed as a partnership, in exchange for shares in the taxpayer. The hedge fund then sold the shares to another fund that was a shareholder in the taxpayer. The IRS disallowed approximately $50 million of the losses the taxpayer claimed on its return.6

The taxpayer alleged that the IRS had erred in its disallowance of the loss. The IRS contended that the original acquisition of shares in the taxpayer by the foreign hedge fund had no business purpose, that the hedge fund was never a real partner in the taxpayer, and that the swap of assets for the shares should be ignored, as the transfer was a disguised sale.

The Court of Federal Claims had to decide whether the final partnership administrative adjustment (FPAA) adjusting the taxpayer's return correctly concluded that the loss claim was inappropriate, or whether, stated differently, the built-in loss vanished immediately because the transaction was a disguised sale. The court sided with the IRS and found the taxpayer had reason to know that the hedge fund had no real intention of becoming a partner in it. Based on the evidence, the hedge fund was not a partner, and the transaction was a sham lacking economic substance. Thus, the court held, the contribution to the taxpayer should be ignored and the transaction characterized as a sale.

In another case,7 the Tax Court rejected the taxpayer's contentions that the FPAA issued to it was an improper second FPAA and therefore invalid. The taxpayer argued that the FPAA was a reproduction of a previous FPAA for a partnership in which the taxpayer was a partner and therefore violated the prohibition under Sec. 6223(f) of the IRS's issuing a second FPAA. Alternatively, the taxpayer contended that the court lacked jurisdiction over the current FPAA because all its adjustments were only computational adjustments from the lower-tier partnership's FPAA, and there were no affected items requiring factual determinations at the upper-tier partnership level.

The court found that the second FPAA was not a reproduction of the first, noting that none of the adjustments in the second FPAA were identical to those in the first, and the two FPAAs were issued to different entities. It found that the adjustments in the second FPAA (which involved the basis of assets the taxpayer received from the partnership) were not computational adjustments flowing from the first FPAA because the adjustments required specific factual findings about actions by the taxpayer.

Definition of Partnership and Partner

In the period covered by this update, the IRS addressed whether an entity should be treated as a partnership and who should report partnership income. In Letter Ruling 201515015, the taxpayer, a foreign business entity whose owners included three U.S. persons, terminated when it merged into another foreign entity, of which the three U.S. persons became owners. By default classification, the taxpayer had been an association for federal tax purposes. The taxpayer had intended to be taxed as a partnership; however, it failed to timely file an election to be classified as a partnership.

In the ruling, the IRS granted the taxpayer's request for a 120-day extension to make an election to be treated as a partnership for federal tax purposes, because the taxpayer had satisfied the requirements of Regs. Sec. 301.7701-3. The IRS required the taxpayer and the U.S. owners to file all required federal income tax and information returns. The U.S. owners also had to properly determine the adjusted bases of their respective partnership interests in the taxpayer (or its successor) as required under Sec. 705.

Formation of a Partnership

Under Sec. 721(a), no gain or loss is recognized to a partnership or any of its partners for a contribution of property to the partnership in exchange for an interest in the partnership. Sec. 721(c) allows the IRS to provide by regulations that Sec. 721(a) shall not apply to gain realized on the transfer of property to a partnership if the gain, when recognized, will be includible in the gross income of a non-U.S. person. The IRS issued Notice 2015-54 announcing its intention to issue regulations under Sec. 721(c). The forthcoming regulations will provide that Sec. 721(a) will not apply when a U.S. transferor contributes Sec. 721(c) property to a Sec. 721(c) partnership, unless the gain deferral method described in the notice is applied with respect to the Sec. 721(c) property. A Sec. 721(c) partnership is a domestic or foreign partnership in which, immediately after a contribution by a U.S. transferor of Sec. 721(c) property and any related transactions, one or more foreign persons related to the U.S. transferor is a direct or indirect partner, and the U.S. transferor and any related persons own more than 50% of the interests in partnership capital, profits, deductions, or losses. Sec. 721(c) property is built-in gain (BIG) property, subject to certain exclusions.

The gain deferral method in the notice requires the partnership to adopt the remedial allocation method8 with respect to all Sec. 721(c) property contributed by U.S. transferors. For each tax year in which there is remaining built-in gain on the Sec. 721(c) property, the partnership must allocate proportionately all items of Sec. 704(b) income, gain, loss, and deduction with respect to the BIG property.

Recognition of the built-in gain by the U.S. transferor with respect to any item of Sec. 721(c) property may be accelerated if a transaction occurs that either (1) would reduce the amount of remaining built-in gain that a U.S. transferor would recognize under the gain deferral method, or (2) could defer the recognition of the built-in gain. The notice also requires the gain deferral method to be applied to all subsequent contributions until the earlier of (1) the date no built-in gain remains on any Sec. 721(c) property to which the gain deferral method first applied, or (2) 60 months after the initial contribution to which the gain deferral method applied.

Partnership Return Due Date

The short-term highway funding bill9 passed by Congress in July 2015 included a provision changing the due date of a partnership tax return to the 15th day of the third month following the close of tax years beginning after Dec. 31, 2015. Calendar-year partnership returns thus will be due on March 15. The new law also allows a six-month extension (until Sept. 15 for calendar-year partnerships).

Partnership Operations

Sec. 701 provides that a partnership is not subject to tax but instead calculates its income or loss and allocates the amounts to the partners. Sec. 702(a) specifies the items a partner must take into account separately; Sec. 703(b) provides that the partnership must make any election affecting its taxable income computation. Under Sec. 704(a), partnership items are allocated based on the partnership agreement; however, there are several exceptions to this general allocation rule. Sec. 704(c) requires a partner's basis adjustment to be taken into account in determining the impact on that partner's income, gain, loss, or deduction when property is contributed that has a built-in gain or loss.

In two private letter rulings,10 four partners owned an LLC. Partner A contributed common stock to the LLC. Subsequently, the LLC distributed to A some of the contributed shares. Later, when the LLC determined that it no longer had a business use for the remaining stock, the LLC proposed to distribute back to A some of the remaining shares, all of which had the same income tax basis and holding period. The IRS determined that the distribution would be deemed a distribution of property that had been previously contributed by A for purposes of Secs. 704(c)(1)(B), 731(c)(3)(A)(i), and 737(d)(1). The partner would not have income on the distribution in this case.


A partner calculates basis in its partnership interest based on Sec. 705, which requires partners to increase their basis by contributions to the partnership and taxable and tax-exempt income and to decrease basis by distributions, nondeductible expenses, and deductible losses. Under Sec. 752, partners are allowed to increase their partnership basis by their share of partnership liabilities.

In Chief Counsel Advice 201534010, the IRS determined what were partnership items when a partner determined its outside basis, which is a partner's basis in its partnership interest. Outside basis is relevant when:

  • A partnership distributes to a partner that partner's share of the partnership's loss;
  • The partnership distributes cash or property to a partner; or
  • A partner sells its partnership interest.

Most, but not all, of the component items of outside basis are partnership items, including:

  • The basis of contributions to the partnership;
  • Distributions from the partnership;
  • The partner's share of nontaxable income, taxable income, losses, and deductions; and
  • The partner's share of partnership liabilities.

Partner-level determinations include, in the absence of a Sec. 754 election by the partnership, the cost to purchase the partnership interest or the transferor's basis in the partnership at the time of acquisition by gift, bequest, transfer, or exchange. The reason outside basis is a partnership item when a partnership makes a Sec. 754 election is that a partnership itself needs to determine its partners' outside bases to redetermine the partnership's own inside basis for the partnership's tax year. This information could be helpful for partnerships in a TEFRA audit.

Sec. 706: Varying Interests

Under Sec. 706(d), if during a partnership's tax year, any partner's interest in it changes, each partner's distributive share of any item of income, gain, loss, deduction, or credit of the partnership for the tax year shall be determined by any method prescribed by the IRS by regulations. The method must take into account the varying interests of the partners in the partnership during the tax year. Treasury issued final regulations11 governing the allocation of income when interests vary during the year. Under the new regulations, which reorganize Regs. Sec. 1.706-4, any partnership for which capital is not a material income-producing factor is now eligible to rely on the service partnership safe harbor (as opposed to only partnerships that meet the narrower definition of service partnership in the 2009 proposed regulations).

Partnerships are now allowed to use different methods for different ownership changes, such as closing the books for one change and prorations for another change, provided that the overall combination of methods is reasonable, based on the overall facts and circumstances. In addition, partnerships are now permitted to perform regular monthly or semimonthly interim closings and to prorate items within each month or semimonthly, as applicable. The final regulations added more extraordinary items that must be taken into account by persons that were partners when the item was incurred (rather than being eligible for proration). Tax advisers should continue to monitor this area, as the IRS may add more items in the future. The new regulations are generally applicable to partnership tax years that began on or after Aug. 3, 2015, with some exceptions.

Sec. 707(a) Transactions

Sec. 707 covers transactions between a partner and a partnership. Under the general rule, if a partner engages in a transaction with a partnership other than in the partner's capacity as a member of the partnership, the transaction shall, except as otherwise provided in Sec. 707, be considered as occurring between the partnership and one who is not a partner.

In SWF Real Estate LLC,12an entity became a partner in the taxpayer partnership and transferred money to the partnership in exchange for Virginia tax credits. The partnership treated the transaction as a contribution of cash to the partnership in exchange for a partnership interest and a subsequent allocation of the Virginia tax credits. The IRS argued that the partnership engaged in a disguised sale under Sec. 707(a). The Tax Court ruled in favor of the IRS because the facts were on point with those in a Fourth Circuit case.13 The Tax Court applied the holdings of that case, pursuant to the Golsen rule.14

Sec. 707(a)(2)(A) grants Treasury authority to issue regulations under which a purported allocation and distribution to a service partner is recharacterized as a disguised payment for services and consequently treated as ordinary compensation income. This grant of authority was intended to prevent partners from receiving a de facto deduction for capital expenditures and from converting ordinary income into capital gains.

During the past year, Treasury issued proposed regulations15 relating to disguised payments for services under Sec. 707(a)(2)(A). The proposed regulations target management fee waivers. In a common management fee waiver arrangement, the GP of an investment fund is permitted to satisfy its capital commitment to the fund with deemed capital contributions, and likewise, the fund managers are deemed to satisfy their capital contribution obligations to the GP. In connection with the deemed contribution, there is a reduction in the management fee payable by the fund. The GP is entitled to a priority allocation of subsequent net profits of the fund, if and when they occur, equal to the amount of its deemed capital contributions to the fund.

If the priority allocation includes net long-term capital gain or qualified dividend income, the fund's GP (and its partners) would be subject to tax at the capital gains rate rather than the ordinary income tax rate that otherwise would have applied to the waived management fee. The priority allocation may also result in deferral of the tax that would have been due if management fees had not been waived.

The proposed regulations recharacterize certain allocation and distribution agreements such as the one described above as disguised payments for services. The proposed regulations provide that the analysis of the recharacterization is based upon the facts and circumstances. The proposed regulations include six factors that may indicate a disguised payment for services: (1) that an allocation and distribution are not subject to significant entrepreneurial risk; (2) that the timing of the allocation and distribution to the service provider compares with that of payments to a nonpartner service provider; (3) that the service provider holds only a transitory partnership interest; (4) that the service provider became a partner primarily to obtain tax benefits not otherwise available; (5) that the value of the service provider's partnership interest is small in relation to the allocation and distribution; and (6) that different allocations and distributions exist, with significantly differing levels of entrepreneurial risk for different services.

The lack of significant entrepreneurial risk is the most important factor and is therefore accorded more weight. Whether an arrangement lacks significant entrepreneurial risk is based on the service provider's entrepreneurial risk relative to the overall entrepreneurial risk of the partnership. The proposed regulations list five arrangements that are presumed to lack significant entrepreneurial risk and therefore constitute a disguised payment for services unless facts and circumstances establish otherwise by clear and convincing evidence.

The proposed regulations are effective on the date final regulations are published. However, they could be applied to some arrangements entered into before then, as the IRS and Treasury believe that the proposed regulations reflect congressional intent as to which arrangements are appropriately treated as disguised payments for services. Such language indicates that the IRS believes it could apply the principles of the proposed regulations to arrangements not subject to the final regulations. Accordingly, taxpayers under IRS audit should expect the government to argue for the application of the principles included in the proposed regulations, even before they are finalized.

The proposed regulations also modify Rev. Proc. 93-27, narrowing its scope so that the safe harbor will not apply to arrangements in which an investment manager that provides services for a fee waives that fee in exchange for the issuance to an affiliate of the manager an interest in future partnership profits that is calculated by reference to the waived management fees. The safe harbor will not apply in the instance above because those transactions do not satisfy the requirement that receipt of a profits interest must be for the provision of services to or for the benefit of the partnership in a partner capacity or in anticipation of being a partner, and the service provider would effectively have disposed of the partnership interest within two years of receipt.

Based on the narrowed scope of Rev. Proc. 93-27, it may be possible for the IRS to contend that even if a fee waiver arrangement by the investment manager has significant entrepreneurial risk, the receipt of an additional carried interest by a GP that was not the actual service provider is a taxable event. Furthermore, the proposed regulations exclude from the Rev. Proc. 93-27 safe harbor the issuance of a partnership profits interest in conjunction with a partner's waiving payment of a substantially fixed amount for the performance of services, including a fee based on a percentage of partner capital commitments

Sec. 707(c): Guaranteed Payments

The proposed regulations also address minimum payment arrangements. Sec. 707(c) states that to the extent determined without regard to the income of the partnership, payments to a partner for services or the use of capital shall be considered as made to one who is not a member of the partnership, but only for the purposes of Sec. 61(a) (relating to gross income) and, subject to Sec. 263, for purposes of Sec. 162(a) (relating to trade or business expenses).

Currently, if a partner that is entitled to an allocation equal to the greater of a percentage of income or a minimum payment and the percentage of income is less than the minimum payment amount, the partner will treat only the difference between the minimum amount and the partner's allocated share of partnership income as a guaranteed payment. If the percentage of income is greater than the minimum payment, the partner treats the entire amount as a distributive share. An example in the proposed regulations16 would modify the current rules to require the partner to treat the entire minimum amount as a guaranteed payment because the minimum amount is not subject to significant entrepreneurial risk.

Partnership Terminations

Sec. 708 provides that an existing partnership shall be considered as continuing if it is not terminated. In Letter Ruling 201528007, the common parent of an affiliated group of corporations owned 100% of a holding company. The holding company owned the sole membership in a disregarded entity and an interest in a partnership. The disregarded entity owned a subsidiary, and the subsidiary owned the remaining interest in the partnership. As part of the group's restructuring, interests in the partnership (currently held by the holding company) were distributed by group members in intercompany transactions, and some gains were realized under Sec. 311(b). The taxpayer proposed to have the subsidiary distribute its interest in the partnership to the disregarded entity with respect to its stock, followed by the disregarded entity's distributing the same interest in the partnership to the holding company with respect to its membership interest.

The taxpayer sought a ruling to determine whether the distributions would terminate the partnership under Sec. 708. The IRS held that the partnership would terminate as a result of the distribution, as the partnership would then have a single owner, the holding company. Also, the partnership would be deemed to have made a liquidating distribution of all assets to the holding company and the subsidiary. Thereafter, the holding company would be treated as acquiring, in a distribution from the subsidiary, the assets deemed to be distributed by the partnership to the subsidiary in liquidation of the subsidiary's interest in the partnership. The holding company's basis in the assets deemed acquired from the subsidiary would be the assets' fair market value (FMV).

Sec. 732

Sec. 731 provides that a partner will not recognize a gain or loss on the distribution of property other than cash in a nonliquidating distribution. Under Sec. 732, the basis of property (other than money) distributed by a partnership to a partner other than in liquidation of the partner's interest is its adjusted basis to the partnership immediately before the distribution. The basis to the distributee partner of the property distributed will not exceed the adjusted basis of the partner's interest in the partnership, reduced by any money distributed in the same transaction. During the past year, Treasury issued final and temporary regulations17 that prevent a corporate partner from avoiding corporate-level gains through transactions with a partnership.

The regulations are intended to prevent corporate taxpayers from using a partnership to circumvent gain required to be recognized under Sec. 311(b) or 336(a). Taxpayers must apply these regulations, including the rules governing the amount and timing of recognized gain, in a manner consistent with, and that reasonably carries out, this purpose.

These regulations apply when a partnership, either directly or indirectly, owns, acquires, or distributes stock of a corporate partner. Under these regulations, a corporate partner may recognize gain when it is treated as acquiring or increasing its interest in stock of the corporate partner held by a partnership in exchange for appreciated property in a manner that avoids gain recognition under Sec. 311(b) or 336(a). The regulations also provide exceptions under which a corporate partner is not required to recognize gain.

In addition, Treasury issued proposed regulations18 that in certain situations would allow members of a consolidated group that are partners in the same partnership to aggregate their bases in stock distributed by the partnership for the purpose of limiting the application of rules that might otherwise cause basis reduction or gain recognition. The proposed regulations would also require certain corporations that engage in gain elimination transactions to reduce the basis of corporate assets or to recognize gain.

Sec. 736: Retiring Partners

Sec. 736 governs the tax treatment of payments "made in liquidation of the interest of a retiring partner."19 Liquidating payments are those that terminate "a partner's entire interest in a partnership by means of a distribution, or a series of distributions, to the partner by the partnership."20 They are taxed "as a distributive share to the recipient,"21 until "the final distribution has been made."22

In Brennan,23 the taxpayer agreed to relinquish his interest in an LLC and withdraw from the company. He received in return rights to about 45% of the proceeds of a sale of capital assets that was arranged as part of his withdrawal. The sale and restructuring occurred in 2002, although the LLC received the proceeds from the sale and reported long-term capital gains from them on returns for 2003 and 2004, on which it showed the taxpayer as a partner. However, the LLC did not distribute any portion of the sale proceeds to the taxpayer, who did not report the capital gains on his returns, contending that his status as a partner terminated for tax purposes in 2002.

The Tax Court concluded that the taxpayer was required to include items of partnership income from the LLC for 2003 and 2004. The LLC had elected to file tax returns as a partnership. Therefore, federal partnership tax law determined the tax consequences of the taxpayer's departure from the LLC. The taxpayer appealed the Tax Court's decision. The Ninth Circuit found that the Tax Court had properly concluded that, for federal tax purposes, the taxpayer remained a partner in the LLC during 2003 and 2004 because the final distribution had not been made. Therefore, the taxpayer owed taxes on his distributive share of the sale proceeds.

Sec. 751

Sec. 751 prevents the use of a partnership to convert potential ordinary income into capital gain. To that end, Sec. 751(a) mandates that the amount of any money or the FMV of any property received by a transferor partner in exchange for all or a part of the partner's interest in the partnership attributable to its unrealized receivables or inventory items is considered realized from the sale or exchange of property other than a capital asset.

In Mingo,24 married taxpayers reported the sale of a partnership interest, including the portion of the proceeds attributable to the partnership's unrealized receivables, through the installment method of accounting. The Tax Court held that the taxpayers were not entitled to use the installment method to report the unrealized receivables. The Tax Court further held that the IRS appropriately applied Sec. 481(a) to adjust the taxpayers' income tax return to account for the unrealized receivables income that should have been reported in the year the partnership interest was sold. The taxpayers could not use the installment method for the gain related to the accounts receivable because Sec. 751 required the gain to be reported as from an ordinary asset. During the period covered by this update, the taxpayers appealed the Tax Court decision based on the argument that the IRS erred in determining that the installment sale reporting of the unrealized receivables did not clearly reflect the taxpayer's income. The Fifth Circuit affirmed the Tax Court's decision.

Sec. 751(b) overrides the nonrecognition provisions of Sec. 731 to the extent a partner receives a distribution from the partnership that causes a shift between the partner's interest in the partnership's unrealized receivables or substantially appreciated inventory items (collectively, the partnership's Sec. 751 property) and the partner's interest in the partnership's other property. Whether Sec. 751(b) applies depends on the partner's interest in the partnership's Sec. 751 property before and after a distribution. The current Treasury regulations under Sec. 751(b) fail to provide an accurate determination of each partner's share of ordinary income because they do not take into account current allocation rules.

During the period covered by this article, Treasury issued proposed regulations25 that establish an approach for measuring partners' interests in Sec. 751 property. The proposed regulations also provide new rules under Sec. 704(c) to help partnerships compute partner gain in Sec. 751 property more precisely and describe how basis adjustments under Secs. 734(b) and 743(b) affect the computation of partners' interests in Sec. 751 property. The proposed regulations prescribe how a partner should measure its interest in a partnership's unrealized receivables and inventory items and provide guidance regarding the tax consequences of a distribution that causes a reduction in that interest. The proposed regulations also take into account statutory changes that have occurred since the IRS issued the existing regulations.

Sec. 754 Election

When a partnership distributes property or a partner transfers its interest, the partnership can elect under Sec. 754 to adjust the basis of partnership property. A Sec. 754 election allows a step-up or step-down in basis under either Sec. 734(b) or Sec. 743(b) to reflect the FMV at the time of the exchange. This election has the advantage of not taxing the new partner on gains or losses already reflected in the purchase price of the partnership interest. The partnership must file the election by the due date of the return for the year the election is effective, normally, with the return. If a partnership inadvertently fails to file the election, it can ask for relief under Regs. Secs. 301.9100-1 and -3.

In several rulings during this period,26 the IRS granted an extension of time to make a Sec. 754 election. In each case, the partnership was eligible to make the election but inadvertently omitted the election when filing its return. The IRS reasoned that the partnership in each case acted reasonably and in good faith, and it granted an extension to file the election under Regs. Secs. 301.9100-1 and -3. In these rulings, each partnership had 120 days after the ruling to file the election. The IRS granted the partnerships the extension for making the Sec. 754 election in some of the preceding letter rulings as well as in others27 where the partnerships had relied on one or more professional tax advisers who did not advise them of the availability of the election.  


1Tax Equity and Fiscal Responsibility Act of 1982, P.L. 97-248.

2Bipartisan Budget Act of 2015, P.L. 114-74.

3Secs. 6221 through 6235.

4AM 2015-004.

5Russian Recovery Fund, Ltd., 122 Fed. Cl. 600 (2015).

6The same taxpayer also filed a petition with the Tax Court contesting IRS adjustments related to $170 million in similar claimed losses for another tax year (Russian Recovery Fund Ltd., No. 019405-08 (Tax Ct. 8/8/08) (petition filed).

7American Milling, LP, T.C. Memo. 2015-192.

8Described in Regs. Sec. 1.704-3(d).

9Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, P.L. 114-41.

10IRS Letter Rulings 201537002 and 201537003.

11T.D. 9728.

12SWF Real Estate LLC, T.C. Memo. 2015-63.

13Virginia Historic Tax Credit Fund 2001, LP, 639 F.3d 129 (4th Cir. 2011), rev'g and remanding T.C. Memo. 2009-295.

14Golsen, 54 T.C. 742 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971).


16Id., Prop. Regs. Sec. 1.707-1(c), Example (2).

17T.D. 9722.


19Sec. 736(a).

20Sec. 761(d).

21Sec. 736(a).

22Regs. Sec. 1.761-1(d).

23Brennan, T.C. Memo. 2012-209, aff'd, No. 13-72437 (9th Cir. 10/23/15).

24Mingo, T.C. Memo. 2013-149, aff'd, 773 F.3d 629 (5th Cir. 2014).


26E.g., IRS Letter Rulings 201514002, 201525008, 201528027, and 201532019.

27IRS Letter Rulings 201519023, 201523007, 201532014, and 201532001.



Hughlene Burton is chair of the Department of Accounting at the University of North Carolina–Charlotte in Charlotte, N.C. She is a past chair of the AICPA Partnership Taxation Technical Resource Panel and has served on the AICPA Tax Executive Committee. For more information about this column, contact Prof. Burton at


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