IRS Disallows Write-Off of Startup and Organizational Costs in a Technical Termination

By James M. Greenwell, CPA, MST, Bartlesville, Okla. (not affiliated with Deloitte Tax LLP)

Editor: Jon Almeras, J.D., LL.M.

Partners & Partnerships

On Dec. 6, the IRS released Prop. Regs. Sec. 1.195-2 and proposed amendments to Regs. Secs. 1.708-1 and 1.709-1 (REG-126285-12). These proposals require new partnerships formed from Sec. 708(b)(1)(B) technical terminations to step into the shoes of the terminated partnership and continue to amortize Sec. 195 startup expenditures and Sec. 709 organization fees using the same amortization period the terminated partnership used. When the proposed regulations and amendments are finalized, they will be applied to technical terminations occurring after Dec. 8, 2013.

Sec. 195 and Sec. 709 Expenditures

Sec. 195, a general provision that applies to all trades and businesses, denies a deduction for startup expenditures unless the taxpayer elects otherwise. An electing taxpayer may immediately deduct up to $5,000 of qualifying startup expenditures once the taxpayer begins its active trade or business. This amount is reduced dollar for dollar by the amount of startup expenditures exceeding $50,000 (Sec. 195(b)(1)(A)(ii)). The residual amount is deducted ratably over 180 months beginning with the month the active trade or business begins (Sec. 195(b)(1)(B)). Sec. 709, which is analogous to the election under Sec. 248 for corporate entities to deduct organizational expenditures, generally applies the same rules found in Sec. 195 to organization fees partnerships incurred.

An election to deduct Sec. 195 or Sec. 709 costs is irrevocable and applies to all startup or organizational costs incurred in connection with the trade, business, or partnership. An election under Sec. 195 or Sec. 709 is deemed to be made when the tax return is filed (Regs. Secs. 1.195-1(b) and 1.709-1(b)(2)). However, a taxpayer may choose to forgo either deemed election by affirmatively electing to capitalize its startup or organizational expenditures on its timely filed tax return, including extensions.

Sec. 708(b)(1)(B) Technical Terminations

A partnership can terminate in two ways:

  1. A true liquidation where no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners.
  2. When there is a cumulative sale or exchange of 50% of more of the total capital and profits interests of the partnership within a consecutive 12-month period (Sec. 708(b)). This is often referred to as a “technical termination.”

When a partnership technically terminates, the regulations deem the following to occur (Regs. Sec. 1.708-1(b)(4)):

  1. The terminated partnership contributes all of its assets and liabilities to a new partnership in exchange for all the interests in the new partnership; and
  2. Immediately afterward, the terminated partnership distributes all of the interests in the new partnership to its partners in proportion to their interests in the terminated partnership, in full liquidation of the terminated partnership.
Reasoning for the New Regulations

Sec. 195(b)(2) and Sec. 709(b)(2) provide that when a trade or business is completely disposed of or when a partnership liquidates before the end of the amortization period of the Sec. 195 or Sec. 709 expenditures, the unamortized expenses may be deducted under Sec. 165 as a loss. The IRS and Treasury became aware that some taxpayers interpreted this to include technical terminations. The IRS claims the legislative intent of Sec. 195 and Sec. 709 was to allow partnerships to ratably recognize these expenses over the period in which the partnership benefited from them. Its position, as supported by Sec. 195 and Sec. 709, is that this period starts with the commencement of business and ends the earlier of (1) 180 months later or (2) when the business ceases. It states that a technical termination does not “constitute a cessation of a trade or business to which section 195 or section 709 expenses relate, nor does it otherwise constitute the type of disposition or liquidation that should trigger deduction of deferred section 195 or section 709 expenses” (preamble to REG-126285-12).

The IRS also recognized that the Conference Report of the American Jobs Creation Act of 2004 (AJCA), P.L. 108-357, saw that Sec. 195 and Sec. 709 expenditures are similar to Sec. 197 intangible business assets, which provide a 15-year (180-month) amortization period as well. When there is a transfer of Sec. 197 intangibles in a Sec. 721 transaction, the transferee partnership continues to amortize the adjusted basis of the Sec. 197 costs using the transferor’s remaining amortization period. In this case, the terminated partnership is treated as the transferor, and the new partnership is treated as the transferee (Regs. Sec. 1.197-2(g)(2)(ii)(B)).

The IRS argues that Congress intended to align the amortization of Sec. 195 and Sec. 709 costs with the rules of Sec. 197 intangible assets, and, as such, there should be a step-in-the-shoes treatment of Sec. 195 and Sec. 709 unamortized costs as well. Nonetheless, it is important to note that this similar treatment is in contrast to the treatment of depreciable property subject to Sec. 168, which provides a step-in-the-shoes treatment for Sec. 332, Sec. 351, Sec. 361, Sec. 721, and Sec. 731 transactions, but specifically excludes technical terminations from this treatment. Instead, the rules require the partnership to restart the depreciation of the assets as though they were newly acquired (Sec. 168(i)(7)).

Although these provisions will not apply to technical terminations that occurred before Dec. 9, 2013, it may be advisable for taxpayers that have technically terminated before this date to review whether they followed the provisions of the new proposed regulations, especially if these years are under audit. The IRS has requested comments by March 10 on the proposed regulations before they are made final, especially on how to clarify them and make them easier to understand.


Jon Almeras is a tax manager with Deloitte Tax LLP in Washington, D.C.

For additional information about these items, contact Mr. Almeras at 202-758-1437 or

Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP.

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