Editor: Christine M. Turgeon, CPA
Sec. 708(b)(2)(B) and Regs. Sec. 1.708-1(d) govern the tax treatment of partnership divisions. This item provides an overview of the division rules and touches on some key issues to consider when a transaction involves a partnership division.
Definitions
Regs. Sec. 1.708-1(d)(4) introduces four definitions specific to partnership divisions: (1) divided partnership, (2) recipient partnership, (3) prior partnership, and (4) resulting partnership.
The divided partnership is the continuing partnership, which is treated as transferring the assets and liabilities to the recipient partnership. A recipient partnership, in turn, is a partnership that is treated as receiving assets and liabilities from a divided partnership.
The prior partnership is the partnership subject to division. A resulting partnership is a partnership resulting from the division that has at least two partners who were partners in the prior partnership.
The divided partnership and a recipient partnership are U.S. federal income tax concepts, while the prior partnership and a resulting partnership are the legal entities under applicable law.
Any resulting partnership is considered a continuation of the prior partnership if the members of the resulting partnership had an interest of more than 50% in the capital and profits of the prior partnership. Any other resulting partnership will not be considered a continuation of the prior partnership but will be considered a new partnership.
If the resulting partnership that, in form, transferred the assets and liabilities in connection with the division is a continuation of the prior partnership, then such resulting partnership will be treated as the divided partnership. Contrast this treatment with the partnership merger rules, in which the regulations determine which entity is the surviving partnership based on relative value (Regs. Sec. 1.708-1(c)(1)).
Form of a division
Regs. Sec. 1.708-1(d)(3) provides two choices of form: assets-over and assets-up. The assets-over form is the default method if no form of a division is specified. The assets-over form is more common because the assets-up form requires the partners to be treated, under the laws of the applicable jurisdiction, as the owner of the assets (i.e., it requires the legal transfer and retitling of assets).
Assets-over form:
- If at least one resulting partnership is a continuation of the prior partnership, the divided partnership will be treated as contributing certain assets and liabilities to a recipient partnership in exchange for interests in the recipient partnership. Immediately thereafter, the divided partnership is treated as distributing the interests in the recipient partnership to some or all of its partners in partial or complete liquidation of the partners' interests in the divided partnership.
- If none of the resulting partnerships is a continuation of the prior partnership, the prior partnership is treated as contributing all of its assets and liabilities to new resulting partnerships in exchange for interests in the resulting partnerships. Immediately thereafter, the prior partnership is treated as liquidating by distributing the interests in the new resulting partnerships to the prior partnership's partners.
Assets-up form:
- If the partnership distributing assets is a continuation of the prior partnership, the divided partnership will be treated as distributing certain assets to some or all of its partners in partial or complete liquidation of the partners' interests in the divided partnership. Immediately thereafter, the partners are treated as contributing the distributed assets to a recipient partnership in exchange for interests in the recipient partnership.
- If none of the resulting partnerships is a continuation of the prior partnership, the prior partnership is treated as distributing certain assets to some or all of its partners in partial or complete liquidation of the partners' interests in the prior partnership. Immediately thereafter, the partners are treated as contributing the distributed assets to a resulting partnership in exchange for interests in the resulting partnership.
Partnership division checklist — nonrecognition exceptions
Under either the assets-over or assets-up form, every partnership division contains a contribution into a partnership and a distribution out of a partnership. While partnership contributions and distributions generally are nonrecognition transactions, numerous exceptions could result in a taxable transaction.
Below is a checklist to help consider the U.S. federal income tax consequences of some of these exceptions.
Secs. 721(b) and 721(c): Contributions into a partnership are not tax-deferred if the investment company or related foreign partner exceptions apply.
- Is a recipient or resulting partnership an "investment company" under Secs. 721(b) and 351?
- Does a recipient or resulting partnership have any related foreign partners under Sec. 721(c)?
Sec. 751(b) — disproportionate distributions: Distributions that result in a shift in any partner's share of "hot" or "cold" assets are treated as a sale or exchange of the property between the distributee and the partnership.
- Are any of the distributions from the divided or prior partnership made disproportionately to the partner's interests?
If disproportionate distributions are made, consider whether Prop. Regs. Sec. 1.751-1(b) may help address this concern.
Secs. 731(a) and 752(b) — deemed distributions from liability shifts: The decrease in a partner's share of liabilities, or any decrease in a partner's individual liabilities by reason of the assumption by the partnership of the individual liabilities, is considered a distribution of money to the partner by the partnership. In addition, a partner recognizes gain to the extent that any money distributed exceeds the adjusted basis of the partner's interest in the partnership.
- Does the allocation of liabilities shift in the divided, recipient, or resulting partnership such that a partner may recognize a distribution in excess of basis?
Secs. 704(c)(1)(B) and 737 — the "mixing-bowl rules": The mixing-bowl rules are intended to prevent partners from using a partnership to swap property in a nonrecognition transaction. If a partner has contributed property within the past seven years and either (1) that property is distributed to a different partner, or (2) different property is distributed to the contributing partner, then tax-deferred treatment is turned off and gain may be recognized.
- Will any partner that contributed property to the divided or prior partnership within the past seven years receive a distribution of either assets or partnership interests?
Note that the partnership division will restart the seven-year clock for any mixing-bowl applicable transactions on a go-forward basis for a recipient or resulting partnership. Consider also the application of the successor rules under Regs. Secs. 1.704-4(d)(2) and 1.737-1(c)(2)(iii) on the deemed contribution of assets under the assets-over form.
Sec. 707(a)(2)(B) — the "disguised-sale rules": If a transfer of property by a partner to a partnership and one or more transfers of money or other consideration by the partnership to that partner are made, the transfers may be treated as a sale of property between the partner and partnership. Transfers made within two years are presumed to be a sale unless the facts and circumstances clearly establish that the transfers do not constitute a sale, and ordering does not matter.
- Did any partner contribute money or property to the divided or prior partnership within the past two years?
- Do any of the contributions to a recipient or resulting partnership involve nonqualified liabilities?
Like the mixing-bowl rules, the contribution of property into a new partnership will restart a two-year clock to monitor disguised sales on a go-forward basis for a recipient or resulting partnership.
EditorNotes
Christine M. Turgeon, CPA, is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in New York City.
For additional information about these items, contact Ms. Turgeon at 973-202-6615 or christine.turgeon@pwc.com.
Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.
