Regulations Determine Partnership Distributive Shares When Ownership Changes

By Sally P. Schreiber, J.D.

The IRS issued final regulations (T.D. 9728) on determining partners’ distributive shares of partnership items when a partner’s interest varies during the partnership’s tax year. The rules apply in any year in which there is a change in a partner’s interest in the partnership, whether because the partner disposed of its entire interest (or less than its entire interest) or because a partner’s interest in the partnership was reduced as a result of the entry of a new partner or partners. The final regulations adopt proposed regulations issued in 2009 (REG-144689-04) with some changes in response to comments.

The regulations provide two exceptions for certain allocations that would otherwise be subject to the final regulations: first, the “contemporaneous partner exception” and second, an exception for certain service partnerships.

Contemporaneous partner exception

The final regulations provide an exception for dispositions of less than a partner’s entire interest in the partnership, if the variation in the partner’s interest is not attributable to a capital contribution or a partnership distribution to a partner that is a return of capital, and the allocations resulting from the modification otherwise comply with Sec. 704(b) (requiring partners’ distributive shares to have substantial economic effect and meet other requirements) and its regulations. In response to comments, the version of this exception in the final regulations expands the scope of the contemporaneous partner exception to include allocations of items attributable solely to a particular segment of a partnership’s year.

The IRS noted that commenters on the proposed rules asked for guidance on determining when changes in the allocations among partners are attributable to capital contributions to, and distributions from, the partnership, and which requirements of Sec. 704(b) must be met, but the final rules do not address these issues because these are beyond the scope of this regulation project. The IRS may address these issues in future guidance.

Partnerships for which capital is not a material income-producing factor

The proposed regulations contained a second exception that applied to service partnerships. In response to comments, the IRS modified this exception to apply to partnerships for which capital is not a material income-producing factor. The second exception provides that with respect to any tax year in which there is a change in any partner’s interest in a partnership for which capital is not a material income-producing factor, the partnership and the partner may choose to determine the partners’ distributive shares of partnership income, gain, loss, deduction, and credit using any reasonable method, provided that the allocations are valid under Sec. 704(b).

Interim closing and proration methods

One major change made to the proposed regulation was to the method used by partnerships subject to these rules to determine distributive shares.

Under the proposed regulations, a partnership was required to take into account any variation in the partners’ interests in the partnership during the tax year in determining the distributive share of partnership items using either the interim closing method or the proration method. Unless the partners agreed to use the proration method, the partnership was required to use the interim closing method and allocate its items among the partners in accordance with their respective partnership interests during each segment of the tax year.

If the partners agreed to use the proration method, the partnership was required to allocate the distributive share of partnership items among the partners in accordance with their pro rata shares of the items for the entire tax year. (There was also no provision for certain “extraordinary items” to be prorated, but instead those items had to be allocated using special rules.)

In response to comments, the final rules allow partnerships to use different methods for different variations in the partnership’s tax year, but the regulations also permit the IRS to restrict the use of the two methods in future guidance.

Effective date

The new rules apply to partnership tax years beginning on or after Aug. 3, 2015, the date they will be published as final in the Federal Register, except for some grandfathered partnerships.   

Other regulations

At the same time the IRS published the final rules discussed above, it also issued proposed rules on determining a partner’s distributive share of certain allocable cash-basis items and items attributable to an interest in a lower-tier partnership during a partnership tax year in which a partner’s interest changes (REG-109370-10). Those rules also partially withdrew 2005 proposed regulations.

Sally P. Schreiber ( is a JofA senior editor.

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