Startup and Organizational Costs in a Partnership Technical Termination

By Randy A. Schwartzman, CPA, MST, and Patricia Brandstetter, J.D., LL.M., Melville, N.Y.

Editor: Kevin D. Anderson, CPA, J.D.

Partners & Partnerships

The Treasury Department issued Prop. Regs. Sec. 1.708-1 (REG-126285-12) to clarify that no immediate deduction of unamortized startup and organizational expenses is available when partnerships undergo a "technical termination" under Sec. 708(b)(1)(B), as opposed to an actual termination under Sec. 708(b)(1)(A). Once the proposed regulations are finalized, they will be effective retroactively for technical terminations that occur on or after Dec. 9, 2013.

Technical Termination

A technical termination occurs when there is a sale or exchange of 50% or more of a partnership's capital and profit interests within a 12-month period. The technical termination rules are not implicated, however, when a 50%-or-more change occurs as a result of contribution or redemption transactions. Also, these rules do not apply under Sec. 708(b)(1)(A) when a business actually terminates, either by ceasing operations (i.e., winding down and shutting its doors for business) or when an interest in a multimember limited liability company (LLC) is sold, exchanged, or otherwise converted to a single-member LLC (as provided for in Rev. Rul. 99-6).

Under Regs. Sec. 1.708-1(b)(4), if a partnership is terminated by a sale or exchange of an interest, the "old" partnership is deemed to have contributed all of its assets and liabilities to a "new" partnership in exchange for an interest in the new partnership. Immediately after the contribution, while still in existence for legal and other nontax purposes, the "old" partnership is deemed to have terminated. The terminated partnership is then deemed to have distributed interests in the "new" partnership to the partners in proportion to their respective interests in the terminated partnership in its liquidation.

If the technical termination occurs on a date other than the end of the tax year, the partnership that technically terminates is required to file two short-period returns. The first return, for the "old" partnership, runs from the beginning of the tax year to the end of the day of the transaction that triggered the technical termination. The second return, for the "new" partnership, begins on the day following the technical termination and runs until the end of the partnership tax year. Inasmuch as the partnership is deemed to be new for tax purposes, it must select new accounting methods and make new elections (e.g., the recurring-item exception for the "all events" test under Sec. 461(h)(3) or the election to ratably accrue property taxes under Sec. 461(c)).

Election to Deduct Startup and Organizational Expenses

In general, a partnership must capitalize startup expenses for a trade or business and organizational expenses for the partnership. However, under Sec. 195(b)(1)(A), a partnership may elect to deduct startup expenses in the year in which the partnership begins an active trade or business, up to the lesser of (1) the amount of startup expenditures with respect to the active trade or business or (2) $5,000, reduced (but not below zero) by the amount by which the startup expenditures exceed $50,000. Under Sec. 709(b)(1)(A), a partnership can elect to deduct organizational expenses in the year in which the partnership begins business. The amount that may be deducted in that year is the lesser of (1) the amount of the organizational expenses of the partnership or (2) $5,000, reduced (but not below zero) by the amount by which the organizational expenses exceed $50,000.

Under Secs. 195(b)(1)(B) and 709(b)(1)(B), if the partnership makes the election, any costs in excess of these thresholds are amortized ratably over 180 months, starting in the month in which the active trade or business begins for startup expenditures and with the month in which the partnership begins business for organizational expenses. If the partnership completely disposes of the trade or business for which the costs are incurred (in the case of startup expenses) or liquidates (in the case of organizational expenses) before the 180-month period ends, any unamortized costs are deductible at the time of the disposition or liquidation.

What Are Startup Expenses and Organizational Expenses?

Startup costs commonly include costs incurred in investigating the creation or acquisition of an active trade or business, creating a new active trade or business, or conducting any preopening activity in anticipation of the commencement of a trade or business. Sec. 195 startup cost treatment does not apply to interest and taxes that are deductible under Secs. 163 and 164, respectively, or to research and development expenses, which are deductible under Sec. 174. However, those otherwise deductible costs could be capitalized under other provisions of the Code. Under Sec. 709(b)(3), organizational expenses are expenditures that are incident to the creation of the partnership, chargeable to capital account, and of a character such that they would be amortizable in the case of a partnership with an ascertainable life.

Depreciation and Amortization of Assets After Technical Termination

When a technical termination occurs, depreciation for the assets of the partnership that are not fully depreciated restarts with a new recovery period.Under the Sec. 721 general rules for property contributions, a partnership acquiring property by contribution from a partner "steps into the shoes" of the contributing partner with respect to depreciable lives and methods. However, Sec. 168(i)(7) specifically disallows this treatment in the case of a Sec. 708(b)(1)(B) technical termination.

Therefore, any depreciable property retained by the "new" partnership is considered new property placed in service by that partnership. As a result, the clock is restarted with respect to depreciation recovery periods, methods, and conventions for the remaining basis of the new partnership's property. This provision generally serves to lengthen the depreciable lives of property after a partnership termination, which is usually unfavorable to most taxpayers and not truly reflective of the underlying economics or useful life of the asset.

Sec. 197 intangibles, which are amortized over a 15-year period, are not treated in the same way as depreciable assets after a technical termination. Under Regs. Secs. 1.197-2(g)(2)(ii)(B) and (iv)(B), a technical termination does not cause amortization of Sec. 197 intangibles to restart. Instead, the new partnership amortizes Sec. 197 intangibles using the same amortization period adopted by the old partnership.

Proposed Regulations

In the preamble to the proposed regulations, the IRS noted that some taxpayers were taking the position that the partnership could deduct any remaining unamortized balance of its startup costs and organizational expenses to the extent provided under Sec. 165. The IRS stated that this treatment of startup costs and organizational expenses is contrary to the congressional intent underlying Secs. 195, 708, and 709. The IRS explained:

The legislative purpose of sections 195 and 709 was to allow expenses incurred in the formation of a partnership to be deducted ratably over the period during which the partnership benefits from those initial expenses. Section[s] 195 and 709 provide that this period begins with the commencement of business (which must be an active trade or business in the case of section 195) and closes after 180 months, or when the business ceases, if earlier.

According to the IRS, a technical termination should not constitute the cessation of a trade or business, and therefore it is not the type of disposition or liquidation that should trigger deduction of such deferred capitalized expenditures. In support of this contention, the IRS pointed to the legislative history of the American Jobs Creation Act of 2004, P.L. 108-357. In the legislative history, Sec. 195 startup expenses and Sec. 179 organizational expenses are treated as analogous to other Sec. 197 intangible business assets, which after a technical termination are amortized by the new partnership over the same amortization period used by the old partnership.

Thus, Prop. Regs. Secs. 1.195-2(a) and 1.709-1(b)(3) provide that a technical termination is not considered to be a "disposition" of the active trade or business for purposes of Sec. 195(b)(2) or a liquidation of the partnership for purposes of Sec. 709(b)(2). In addition, Prop. Regs. Sec. 1.708-1(b)(6) clarifies that a technical termination of a partnership does not trigger a current deduction of any remaining unamortized startup or organizational costs under Secs. 195 and 709 and that, like Sec. 197 intangibles, the remaining unamortized startup and/or organizational expenses should be amortized using the same amortization period adopted by the terminating partnership.

Example: At the time Old Partnership technically terminates, it has an unamortized balance of $10 in qualified startup costs. The costs have been amortized over seven years of their original 15-year period. Under the proposed regulations, Old Partnership cannot deduct the $10 of unamortized expenses, even though Old Partnership is treated as having been terminated under Sec. 708. Instead, the balance is transferred to the newly formed partnership. New Partnership then can deduct the remaining $10 over the remaining eight years of the original 15 years.


The proposed regulations clarify that a technical termination should not be considered a "disposition" of the trade or business and, as a result, taxpayers should continue to amortize startup and organizational costs in the "new" partnership. This is consistent with the legislative intent that the deduction be granted at the point at which the business ends and not the point at which the partnership ends through the technical termination provisions.

Moreover, the proposed regulations bring the tax treatment of startup costs in conformity with the tax rules for amortizing intangible assets under Sec. 197 since those rules do not allow accelerated deductions upon a technical termination but do allow the new partnership to "step into the shoes" of the old partnership's amortization period. While no immediate deduction is available for any unamortized startup and organization costs, the taxpayer would not be required to restart the 15-year amortization period. Therefore, Treasury has reached an acceptable middle ground in promulgating these proposed rules.

Taxpayers and practitioners now have more definitive guidance on the tax treatment of unamortized startup and organizational costs in the context of a technical termination.


Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Bethesda, Md.

For additional information about these items, contact Mr. Anderson at 301-634-0222 or

Unless otherwise noted, contributors are members of or associated with BDO USA LLP.


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