The reporting rules for partnerships regarding basis adjustments under Sec. 743(b) have been in place for over 20 years, but, often, not all the pieces of the rules are stuck in the memory of a partnership's advisers. Thus, at compliance work time, as well as throughout the year, a review of the various pieces of the rules will help ensure that a partnership return is complete and that computations are accurate. Knowing the reporting rules is important; but, of course, there is no substitute for gathering complete information and understanding the Subchapter K rules to apply them properly. However, the reporting rules need to be more detailed to address certain common transactions.
If a partnership has an election under Sec. 754 in effect, a basis adjustment under Sec. 743(b) to partnership property is made upon a sale or exchange of a partnership interest or a transfer of a partnership interest on the death of a partner. Additionally, even if a partnership does not have an election under Sec. 754 in effect, if the partnership has a "substantial built-in loss," the partnership is required to make a Sec. 743(b) basis adjustment upon such a transfer.
A substantial built-in loss with regard to a transfer of an interest in a partnership is present if (1) the partnership's adjusted basis in the partnership property exceeds by more than $250,000 the fair market value (FMV) of the property, or (2) the transferee partner would be allocated a loss of more than $250,000 if the partnership assets were sold for cash equal to their FMV immediately after such transfer.
The definition of a substantial built-in loss was broadened in the law known as the Tax Cuts and Jobs Act, P.L. 115-97. Prior to the amendment in 2017, a substantial built-in loss was present only if the first part of the definition was met — i.e., the partnership's adjusted basis in the partnership property exceeded by more than $250,000 the FMV of the property. A Sec. 743(b) basis adjustment is made only with respect to the transferee; it differs from a basis adjustment under Sec. 734(b), which is a common basis adjustment that is not isolated to one partner. The substantive aspects of Sec. 743(b) adjustments are not the focus of this discussion. Rather, this discussion focuses on their reporting aspects.
The current reporting rules for partnerships with regard to Sec. 743(b) adjustments were promulgated in T.D. 8847, in which the Sec. 743(b) adjustment rules, along with other basis adjustment and allocation rules, were overhauled. At that time, the IRS and Treasury affirmatively moved to place the reporting responsibility concerning Sec. 743(b) adjustments onto partnerships, as opposed to partners. Prior to these 1999 amendments, notwithstanding that partnerships were required to make and allocate basis adjustments under the then-current regulations, transferees were required to report the basis adjustments. There was a perceived lack of clarity about when (i.e., before or after the Schedule K-1, Partner's Share of Income, Deductions, Credits, etc.) the effect of the basis adjustment to specific partnership items was to be determined or who was required to make and report the adjustments to the partnership items.
Thus, in the proposed regulations that preceded T.D. 8847, the IRS and Treasury explained that the proposed regulations "clarify that partnerships are required to make the basis adjustments" and that the proposed regulations "place the responsibility for reporting basis adjustments on partnerships" (preamble to REG-209682-94). The IRS and Treasury explained further their rationale for the reporting rules they were proposing, explaining that partnerships, rather than partners, are better equipped to report the Sec. 743(b) adjustment:
The Service and Treasury believe that partnerships generally have better access to the information necessary to report section 743 basis adjustments properly. To require the partners rather than the partnerships to bear the burden of reporting would require the partnerships to provide the partners with significant amounts of information not otherwise needed by the partners. [preamble, REG-209682-94]
The reporting rules under the Sec. 743(b) regulations
Generally, a partnership that must adjust the bases of partnership properties under Sec. 743(b) must attach a statement to the partnership return for the year of the transfer setting forth:
- The name and taxpayer identification number of the transferee;
- The computation of the adjustment; and
- The partnership properties to which the adjustment has been allocated.
There is a special rule regarding transfers of interests in oil and gas properties (Regs. Sec. 1.743-1(k)(1)).
The reporting of a Sec. 743(b) adjustment by a partnership generally hinges on the partnership's receiving written notice of a sale or exchange or of a transfer upon the death of the partner. Thus, transferees have a duty to report transfers promptly to their partnership. Upon receiving the notice of the transfer, or if any partner who has responsibility for federal income tax reporting for the partnership has "knowledge" of the transfer, the partnership is to take action to report the Sec. 743(b) adjustment. That is, the knowledge of such a partner is considered notice for this purpose (Regs. Sec. 1.743-1(k)(4)). The partnership may rely on the written notice unless any partner who has responsibility for federal income tax reporting by the partnership has knowledge of facts indicating that the statement is clearly erroneous (Regs. Sec. 1.743-1(k)(3)). In the absence of notice or of the requisite knowledge, the partnership is not required to make the adjustments under Sec. 743(b) (Regs. Sec. 1.743-1(k)(4)).
Regarding notice by the transferee, in the case of a transfer upon a sale or exchange of a partnership interest, the transferee must notify the partnership, in writing, within 30 days of the sale or exchange. Under Regs. Sec. 1.743-1(k)(2)(i), the written notice to the partnership must be signed under penalties of perjury and must include the following:
- The names and addresses of the transferee and (if ascertainable) of the transferor;
- The taxpayer identification numbers (TINs) of the transferee and (if ascertainable) of the transferor;
- The relationship (if any) between the transferee and the transferor, and the date of the transfer;
- Any liabilities assumed or taken subject to by the transferee;
- Any money and the FMV of any other property delivered or to be delivered for the transferred interest in the partnership; and
- Any other information necessary for the partnership to compute the transferee's basis.
In the case of a transfer upon the death of a partner, the timing of the notice is more relaxed: The transferee must notify the partnership, in writing, within one year of the partner's death. Under Regs. Sec. 1.743-1(k)(2)(ii), the written notice to the partnership must be signed under penalties of perjury and must include the following:
- The names and addresses of the deceased partner and the transferee;
- The TINs of the deceased partner and the transferee;
- The relationship (if any) between the transferee and the transferor;
- The deceased partner's date of death;
- The date on which the transferee became the owner of the partnership interest;
- The FMV of the partnership interest on the applicable date of valuation in Sec. 1014; and
- The manner in which the FMV of the partnership interest was determined.
There are special rules if the transferee is a nominee (Regs. Sec. 1.743-1(k)(2)(iii)).
If a transferee fails to provide the notice required, the partnership is to attach a statement to its return in the year that the partnership is otherwise notified of the transfer. The partnership's statement must set forth the following:
- The name and TIN (if ascertainable) of the transferee.
- On the front page of the partnership's return and on the first page of any schedule or information statement relating to such transferee's share of income, credits, deductions, etc., include the statement "Return filed pursuant to §1.743-1(k)(5)."
This mechanism entitles the partnership to report the transferee's share of partnership items without adjustment to reflect the transferee's basis adjustment in partnership property. The regulations further provide that if, following the filing of a return pursuant to this provision, the transferee provides the applicable written notice to the partnership, the partnership must make "such adjustments as are necessary to adjust the basis of partnership property (as of the date of the transfer) in any amended return otherwise to be filed by the partnership or in the next annual partnership return of income to be regularly filed by the partnership" (Regs. Sec. 1.743-1(k)(5)). Further, at such time, the partnership must also provide the transferee with such information as is necessary for the transferee to amend its prior returns to properly reflect the adjustment under Sec. 743(b).
The 1999 reporting regime with regard to Sec. 743(b) basis adjustments was promulgated prior to the enactment in 2004 of the mandatory basis adjustment rules for substantial built-in loss situations. However, proposed regulations published in 2014 would make the reporting regime for Sec. 743(b) adjustments apply to substantial built-in loss situations. The effect would be that the partnership would be required to attach a statement of adjustments to its partnership return as if an election under Sec. 754 were in effect at the time of the transfer solely with respect to the transfer for which there is a substantial built-in loss (REG-144468-05). These proposed regulations follow up on prior interim guidance in Notice 2005-32, stating that until further guidance is provided, partnerships that are required to reduce the bases of partnership properties under the substantial built-in loss provisions in Sec. 743 must comply with Regs. Secs. 1.743-1(k)(1) through (5) as if an election under Sec. 754 were in effect at the time of the relevant transfer. Corresponding transferees must comply with Regs. Sec. 1.743-1(k)(2) as if an election under Sec. 754 were in effect at the time of the relevant transfer.
Additionally, information concerning the Sec. 743(b) adjustment of a partner is to be included in the partnership return on Schedule K-1. For 2021, the draft instructions to Form 1065, U.S. Return of Partnership Income, for Schedule K-1 instruct taxpayers to provide:
- Line 11, code F: For partnerships other than publicly traded partnerships (PTPs), the partner's share of "net positive income resulting from all section 743(b) adjustments," which was described as "the excess of all section 743(b) adjustments allocated to the partner that increase the partner's taxable income over all section 743(b) adjustments that decrease the partner's taxable income."
- Line 13, code V: For partnerships other than PTPs, the partner's share of "net negative income resulting from all section 743(b) adjustments," which was described as "the excess of all section 743(b) adjustments allocated to the partner that decrease partner taxable income over all section 743(b) adjustments that increase partner taxable income."
- Line 20, code U: For each partner, the total Sec. 743(b) adjustment net of any cost recovery as a single amount for all asset categories; and a statement showing the amount of each remaining Sec. 743(b) basis adjustment, net of cost recovery by asset category. For this purpose, a "reasonable grouping by asset category may be used, but such grouping should not be less detailed than the asset categories listed on the Form 1065, Schedule L, balance sheet."
Basis adjustments are a major aspect of partnership taxation, and transactions are often undertaken with basis adjustment benefits in mind. In a nontiered setting, with regard to a particular transfer of a partnership interest, basis computations need to be done by just one partnership vis-à-vis one partner, and communications do not need to take place among multiple parties; so, the Sec. 743(b) adjustment stands a good chance of being reported within the framework of the regulations. Even in those situations, full compliance is not certain. For example, transfers of partnership interests among family members sometimes are not reported to partnerships, and the partnership may not know that the transfer has taken place. Another example is that sometimes valuations upon the death of a partner take more than a year, so the notice from the transferee to the partnership may be late.
However, once tiered partnerships are involved, challenges may steeply rise in how the notice process and information sharing work and, ultimately, in the transferee's receiving information needed to report correctly. For example, in a tiered partnership situation where both the upper-tier partnership (UTP) and lower-tier partnership (LTP) have a Sec. 754 election in place and there is a sale of a partnership interest in the UTP, both the UTP and the LTP will need to compute basis adjustments under Sec. 743(b), per Rev. Rul. 87-115. That ruling concludes that it is appropriate to treat the sale of a partnership interest in a UTP as a deemed sale of an interest in an LTP and to adjust the inside basis of LTP assets accordingly only where both the UTP and the LTP have an election under Sec. 754 in effect, based on the rationale that such elections indicate an intent to be treated as an aggregate for purposes of Secs. 754 and 743. Similarly, Rev. Rul. 92-15 analyzes the basis consequences of a distribution by a UTP of an interest in an LTP.
Proposed regulations published in 2014 are directed at being consistent with both Rev. Rul. 87-115 and Rev. Rul. 92-15 (REG-144468-05). Those proposed regulations address tiered partnership situations where there is a mandatory basis adjustment at the UTP. They would require that, if an event with respect to a UTP causes a mandatory adjustment under either Sec. 734(a) or Sec. 743(a), each LTP must also be treated as though it had made a Sec. 754 election (but only with respect to that specific event) (Prop. Regs. Secs. 1.734-1(f)(1) and 1.743-1(l)(1)). The reporting provisions in those proposed regulations make LTPs that are required to make basis adjustments under Secs. 743 and 734 under the substantial built-in loss and substantial basis reduction provisions, respectively, subject to reporting such basis adjustments.
One commenter has noted that the proposed regulations do not include a clear mechanism for a UTP to provide the necessary information to provide notice of an event at the UTP and information to enable an LTP to compute basis adjustments in its properties. The commenter explains that often, in tiered partnership situations, it is difficult for an LTP to know about the events that occur at the UTP. Thus, under the proposed regulations, it would be difficult for LTPs to make the necessary computations and to comply with reporting any basis adjustment under the tiered partnership provisions relating to substantial built-in losses and substantial basis reductions. The commenter recommends that, if final regulations require basis adjustments for properties held by an LTP, as a result of an event at a UTP, the final regulations should include clear mechanisms for the UTP to provide information to the LTP, furnish notice of UTP triggering events, and of computational information that the LTP would need to make its computations (see American Bar Association Section of Taxation, Comments on Proposed Regulations on Certain Partnership Provisions of the American Jobs Creation Act of 2004 (May 7, 2015)).
An example is that the basic question of who is the transferee to be named by an LTP that falls under Rev. Rul. 87-115 needs clarification. Is the "transferee" the person who is the ultimate transferee at the UTP? Is it the UTP?
Review the regulations
In conclusion, in reporting Sec. 743(b) adjustments, reviewing the current regulations is a good start. However, parts of those rules may not be sufficiently detailed to address common transactions, particularly in tiered partnership situations. Additional guidance would be welcome. In the meantime, until the government issues additional guidance, partnerships and their partners need to work closely to maintain strong communications to overcome challenges to information sharing and, ultimately, to computational matters and information reporting.
Greg A. Fairbanks, J.D., LL.M., is a tax managing director with Grant Thornton LLP in Washington, D.C.
For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or firstname.lastname@example.org.
Contributors are members of or associated with Grant Thornton LLP.