Notice Contains Rules on Gain Recognition for Property Transferred to Foreign Partnerships

By Sally P. Schreiber, J.D.

The IRS intends to issue regulations under Sec. 721(c) to ensure that a U.S. person recognizes gain either immediately or periodically when it transfers certain property to a partnership that has foreign partners related to the transferor (Notice 2015-54). The IRS also intends to issue regulations under Secs. 482 and 6662 that will apply to controlled transactions involving partnerships to ensure those transactions are appropriately valued. And when the regulations are issued, the IRS intends for them to generally apply to transfers occurring on or after Aug. 6, 2015.

The IRS wants to issue these rules because it is aware that certain taxpayers purport to be able to contribute, consistently with Secs. 704(b) (which requires partnership allocations to have substantial economic effect), 704(c) (which provides rules for allocation of gain or loss for property contributed to a partnership), and 482 (which permits the IRS to allocate amounts reported by related taxpayers), property to a partnership that allocates the income or gain from the contributed property to related foreign partners that are not subject to U.S. tax. Many of these taxpayers choose a Sec. 704(c) method other than the remedial allocation method, or use valuation techniques that are inconsistent with the Sec. 482 arm’s-length standard.

In the notice, the IRS explained that no regulation currently requires a U.S. person that transfers appreciated property to a foreign partnership to recognize gain, as is the case with transfers to foreign corporations. So the notice contains rules that will be issued as regulations. Under the new rules, Sec. 721(a), which provides nonrecognition treatment for transfers to a partnership will not apply unless the partnership adopts the gain deferral method. That method requires the partnership to adopt the Regs. Sec. 1.704-3(d) remedial allocation method for any built-in gain for all Sec. 721(c) property contributed to the partnership by a U.S. transferor and all related U.S. transferors.

The rules also require, during any tax year in which there is remaining built-in gain for this property, the partnership to allocate all Sec. 704(b) items of income, gain, loss, and deduction for that property in the same proportion. In addition, the partnership must satisfy the reporting requirements in the notice. The U.S. transferor must recognize built-in gain on the property if an acceleration event, as described in the notice, occurs. The gain deferral method must be adopted for all Sec. 721(c) property later contributed to the partnership by the U.S. transferor and all related persons until the earlier of the dates described in the notice.

In addition, the IRS is addressing a practice that certain taxpayers may be using to value property contributed to partnerships, or the property or services involved in related controlled transactions, contrary to Sec. 482, resulting in partnership interests or consideration received in related controlled transactions being incorrectly valued. This reduces the amount of income or gain allocated to U.S. partners. For example, a partnership agreement might provide a domestic partner with a fixed preferred interest in exchange for the contribution of an intangible that is assigned a value that is inappropriately low, while specially allocating a greater share of the income from the intangible to a related foreign partner.

Because the IRS faces administrative challenges when it must make adjustments years after a transaction occurred and taxpayers have better access to this information, the IRS intends to amend the Sec. 482 rules so they apply to controlled transactions involving partnerships.

The rules in the notice, except for the reporting requirements and the Sec. 482 rules, will apply to transfers occurring on or after Aug. 6, 2015, and to certain transfers before then resulting from entity-classification elections. The reporting requirements and Sec. 482 regulations will apply to transfers and transactions occurring after those regulations are published. 

Sally P. Schreiber ( is a Tax Adviser senior editor.

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