Partnership Basis Rules Proposed

The IRS on Wednesday issued proposed regulations providing guidance on the application of Sec. 704(c)(1)(C) added by the American Jobs Creation Act of 2004, P.L. 108-357 (AJCA), and the amendments to the mandatory basis adjustment rules of Sec. 743 in the AJCA (REG-144468-05). The proposed regulations would also conform the regulations to account for the extended time periods in Secs. 704(c)(1)(B) and 737(b)(1) for taxing precontribution gain that were made by the Taxpayer Relief Act of 1997, P.L. 105-34. The proposed regulations would also modify the basis allocation rules to prevent certain unintended consequences of the current basis allocation rules for substituted basis transactions and provide additional guidance on allocations resulting from revaluations of partnership property. The rules also contain reporting requirements and the provisions for electing investment partnerships and securitization partnerships.

Sec. 704(c)(1)(C) provides that a partner’s built-in loss may only be taken into account in determining the contributing partner’s share of partnership items. The proposed regulations provide rules regarding: (1) the scope of Sec. 704(c)(1)(C); (2) the effect of the built-in loss; (3) distributions by partnerships holding Sec. 704(c)(1)(C) property; (4) transfers of a Sec. 704(c)(1)(C) partner’s partnership interest; (5) transfers of Sec. 704(c)(1)(C) property; and (6) reporting requirements.

Under the amendments to Sec. 743 in the AJCA, the mandatory basis adjustment rules were changed to require a partnership to adjust the basis of partnership property upon the sale or exchange of a partnership interest or upon the death of a partner if the partnership has a substantial built-in loss immediately after the transfer. The proposed regulations provide guidance regarding the transfers the rule applies to, whether there is a substantial built-in loss and the application of the rules to tiered partnerships.

One of the new proposed rules was aimed at preventing an abusive transaction that came to light in the Joint Committee on Taxation’s investigation of Enron Corp. According to the committee, taxpayers were taking advantage of the interaction of the partnership basis adjustment rules under Sec. 755 with the Sec. 1032 rule permitting corporations to not recognize gain or loss on contributions. To curtail this abuse, Sec. 755(c) was enacted to preclude an increase in an asset’s basis if the offsetting basis reduction would be allocated to the stock of a partner or a related party. The rules governing this provision are contained in Prop. Regs. Sec. 1.755-1(b)(5).

The regulations will be effective when they are published as final in the Federal Register. A public hearing will be held in Washington on April 30.