[4830-01-u]
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[PS-5-96]
RIN 1545-AU14
Termination of a Partnership under Section 708(b)(1)(B)
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
SUMMARY: This document contains proposed regulations relating to the
termination of a partnership upon the sale or exchange of 50 percent or more
of the total interest in partnership capital and profits. The proposed
regulations affect all partners and partnerships that terminate under section
708(b)(1)(B).
DATES: Written comments and requests to speak (with outlines of oral
comments) at a public hearing scheduled for September 5, 1996, must be
received by August 15, 1996.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (PS-5-96), room 5228, Internal
Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. In the
alternative, submissions may be hand delivered between the hours of 8 a.m. and
5 p.m. to: CC:DOM:CORP:R (PS-5-96), Courier's Desk, Internal Revenue Service,
1111 Constitution Avenue, NW., Washington, DC. The public hearing will be
held in the IRS Auditorium, Seventh Floor, 7400 Corridor, Internal Revenue
Building, 1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Steven
R. Schneider, (202) 622-3060; concerning submissions and the hearing,
Christina Vasquez, (202) 622-7190; (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Introduction
This document proposes to revise 1.708-1(b)(1)(iv) of the Income Tax
Regulations (26 CFR Part 1) under section 708(b)(1)(B) of the Internal Revenue
Code (Code). This document also proposes revisions to other sections of the
Income Tax Regulations to reflect the proposed revision to 1.708-1(b)(1)(iv).
Background
Section 708(b)(1)(B) provides that, for purposes of section 708(a), a
partnership shall be considered terminated if within a 12-month period there
is a sale or exchange of 50 percent or more of the total interest in
partnership capital and profits. The Code and the legislative history to
section 708(b)(1)(B) do not specify the tax consequences of that termination
or the steps by which such a termination occurs.
However, 1.708-1(b)(1)(iv) of the Income Tax Regulations provides that,
if a partnership is terminated by a sale or exchange of an interest, the
following is deemed to occur: the partnership distributes its properties to
the purchaser and the other remaining partners in proportion to their
respective interests in the partnership properties; and, immediately
thereafter, the purchaser and the other remaining partners contribute the
properties to a new partnership, either for the continuation of the business
or for its dissolution and winding up.
The distribution of property that is deemed to occur upon a termination
under section 708(b)(1)(B) is treated like an actual distribution for federal
tax purposes. As a result, a continuing partner may recognize gain under
section 731(a) if the amount of money deemed distributed to the partner
(including any money deemed distributed upon a shift in liabilities under
section 752) exceeds the partner's basis in the partnership interest. In
addition, the distribution may affect the basis of the partnership's assets
because the basis of the distributed property in the hands of the partners
(and thus in the hands of the reconstituted partnership) is determined under
section 732(b) by reference to the partners' bases in their partnership
interests. Another possible consequence of the deemed distribution is a
change in the holding periods of the partners' interests in the partnership.
The deemed distribution of partnership property that occurs on a
termination raises particular concerns with respect to the interaction of
sections 708(b)(1)(B), 704(c), and 737. Section 704(c)(1)(A) requires that
gain or loss with respect to property contributed to a partnership by a
partner be shared among the partners so as to take into account any built-in
gain or loss in the property at the time of the contribution. Section
704(c)(1)(B) provides that, if property contributed by a partner is
distributed to another partner within five years, the contributing partner
must recognize gain or loss in an amount equal to the gain or loss the partner
would have been allocated under section 704(c)(1)(A) on a sale of the property
by the partnership. Section 737 provides that, if property is distributed to
a partner that had contributed other property to the partnership within five
years, the distributee partner must recognize gain equal to the lesser of (i)
the net precontribution gain on property contributed by the partner, or (ii)
the excess of the value of the distributed property over the adjusted basis of
the partner's interest in the partnership. Net precontribution gain is the
net gain, if any, that would have been recognized by the distributee partner
under section 704(c)(1)(B) if all partnership property contributed by the
distributee partner within five years of the distribution had been distributed
to another partner.
The legislative history of sections 704(c)(1)(B) and 737 indicates that
Congress intended these sections to be coordinated with the rules governing
partnership terminations under section 708(b)(1)(B). The legislative history
states that such coordination will provide that (1) no gain is recognized
under sections 704(c)(1)(B) and 737 as a result of a deemed distribution on
termination; (2) the deemed distribution will not change the application of
the sharing requirements of section 704(c) to precontribution gain or loss
with respect to property contributed to the partnership before the
termination; and (3) the constructive contribution of partnership property to
a new partnership is treated as beginning a new five-year period for all
contributed property to the extent that the pretermination appreciation in the
value of property was not already required to be allocated to the original
contributor (if any) of the property. H.R. Rep. No. 247, 101st Cong., 1st
Sess. 1355 (1989); H.R. Conf. Rep. No. 1018, 102d Cong., 2d Sess. 428 (1992).
These results are difficult to integrate with the current regulations under
section 708(b)(1)(B). The difficulty arises primarily because the section
708(b)(1)(B) regulations provide for a pro rata distribution of property to
the partners, while the legislative history seems to contemplate that
partnership property previously contributed to the partnership by a partner
will be distributed to that partner, at least to the extent of the remaining
built-in gain or loss in the property.
The IRS and Treasury Department recently issued final regulations under
sections 704(c)(1)(B) and 737. Commentators, however, noted that the approach
taken in the legislative history and the final regulations would not be
required if the section 708(b)(1)(B) regulations did not create a deemed
distribution of partnership property to the partners as part of a section
708(b)(1)(B) termination. The preamble to the final regulations indicated
that the IRS and Treasury would consider issuing separate guidance on the
interaction of sections 704(c) and 708(b)(1)(B) and invited additional
comments and suggestions regarding the project.
Explanation of Provisions
The proposed regulations under section 708(b)(1)(B) provide that, if a
partnership is terminated by a sale or exchange of an interest, the following
is deemed to occur: the partnership transfers all of its assets and
liabilities to a new partnership in exchange for an interest in the new
partnership; immediately thereafter, the terminated partnership distributes
interests in the new partnership to the purchasing partner and the other
remaining partners in liquidation of the terminated partnership, either for
the continuation of the business or for its dissolution and winding up.
Under the proposed regulations, a termination under section 708(b)(1)(B)
will no longer result in a deemed distribution of the terminated partnership's
assets to the purchasing and remaining partners. As a result, the federal tax
consequences of a termination that result from the deemed distribution of
assets will no longer occur on a section 708(b)(1)(B) termination. Such
consequences include the possibility of gain under section 731(a), a change in
the partnership's basis in partnership property, and the commencement of a new
five-year period for purposes of sections 704(c)(1)(B) and 737. In addition,
the interaction between section 704(c) and section 708(b)(1)(B) is greatly
simplified under the proposed regulation. The section 704(c) property held by
the terminated partnership (and deemed contributed to a new partnership) will
continue to be treated as section 704(c) property in the hands of the new
partnership under 1.704-3(a)(9). A distribution of property by the new
partnership will have the same effect for purposes of section 704(c)(1)(B) and
section 737 as a distribution from the terminated partnership. See 1.704-
4(c)(4) and 1.737-2(b)(1) as proposed to be amended by this document.
The proposed regulations do not change the federal tax consequences of a
termination under section 708(b)(1)(B) to the extent that the consequences
were not dependent on the deemed distribution. Such consequences will
continue under the proposed regulations. For example, the tax year of the
terminated partnership will still close as a result of the termination, the
elections of the terminated partnership will be invalidated, and a termination
will continue to be treated as a liquidation under the section 704(b)
regulations.
In addition, the proposed regulations will not change the effect of a
termination on the depreciation of partnership property by the new
partnership. Property deemed contributed to the new partnership will continue
to be subject to the anti-churning provisions of section 168(f)(5), which
generally require the new partnership to depreciate the property as if it were
newly-acquired property under the same depreciation system used by the
terminated partnership. This result is required by statute and is not
affected by the specific mechanics of a termination under section
708(b)(1)(B). See Code sections 168(f)(5); 168(i)(7); 168(e)(4) and (f)(10)
(repealed 1986).
This document also contains proposed regulations under sections 704(b),
704(c)(1)(B), 743(b), 737, and 761(e). These proposed regulations relate to
the elimination of a deemed distribution of partnership assets as part of a
section 708(b)(1)(B) termination. The proposed regulations under section
704(b) will eliminate the reference to a deemed contribution of partnership
property by the partners of the continuing partnership. The proposed
regulations under sections 704(c)(1)(B) and 737 provide that a termination
under section 708(b)(1)(B) does not commence a new five-year period for
partnership property and that a distribution of property by the new
partnership will be treated in the same manner as a distribution by the
terminated partnership would have been treated. Although the legislative
history suggests the beginning of a new five year period for built in gain or
loss in the property deemed contributed to the new partnership, that
legislative history was commenting on a deemed contribution of property by the
partners to the new partnership, as then required by the section 708
regulations. Under the approach proposed in this regulation, a new five year
period is no longer appropriate.
The proposed regulations under section 743(b) provide that any special
basis adjustment a partner has in assets of the terminated partnership as a
result of a section 754 election will carry over to the new partnership. The
proposed regulations under section 761(e) provide that the distribution of
interests in the new partnership by the terminated partnership is not treated
as a sale or exchange of the interests in the new partnership. This provision
is necessary to prevent the distribution of interests in the new partnership
from causing a termination of the new partnership.
Proposed Effective Date
This section is proposed to apply to terminations of partnerships under
section 708(b)(1)(B) occurring on or after the date on which these regulations
are published as final regulations in the Federal Register.
Special Analyses
It has been determined that this notice of proposed rulemaking is not a
significant regulatory action as defined in EO 12866. Therefore, a regulatory
assessment is not required. It has also been determined that section 553(b)
of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory
Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and,
therefore, a Regulatory Flexibility Analysis is not required. Pursuant to
section 7805(f) of the Internal Revenue Code, this notice of proposed
rulemaking will be submitted to the Chief Counsel for Advocacy of the Small
Business Administration for comment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original and
eight (8) copies) that are timely submitted to the IRS. All comments will be
available for public inspection and copying.
A public hearing has been scheduled for September 5, 1996, at 10 a.m. in
the Auditorium of the Internal Revenue Building, 1111 Constitution Avenue NW.,
Washington, DC. Because of access restrictions, visitors will not be admitted
beyond the Internal Revenue Building lobby more than 15 minutes before the
hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing must submit
written comments by August 15, 1996, and submit an outline of the topics to be
discussed and the time to be devoted to each topic (signed original and eight
(8) copies) by August 15, 1996.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared after
the deadline for receiving outlines has passed. Copies of the agenda will be
available free of charge at the hearing.
Drafting Information
The principal author of these regulations is Steven R. Schneider of the
Office of Assistant Chief Counsel (Passthroughs and Special Industries), IRS.
However, other personnel from the IRS and Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART I--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.704-4 also issued under 26 U.S.C. 704(c). * * *
Par. 2. Section 1.704-1 is amended as follows:
1. Paragraph (b)(2)(iv)(l) is amended by removing the fourth sentence.
2. Paragraph (b)(5) Example 13(v) is amended by removing sentences five
to the end and adding five new sentences in their place.
The revisions and addition read as follows:
1.704-1 Partner's distributive share.
* * * * *
(b) * * *
(5) * * *
Example 13. * * *
(v) * * * In accordance with paragraph (b)(2)(iv)(e) of this section,
the partnership agreement provides that the partners' capital accounts are
adjusted to reflect how unrealized taxable gain would have been allocated if
the property distributed to the partners in liquidation of the partnership
(i.e., the interest in the new partnership constructively received by the
terminated partnership under 1.708-1(b)(1)(iv)) had been sold for its fair
market value of $40,000. Accordingly, the $18,000 of unrealized gain ($40,000
less $22,000 adjusted tax basis) is credited to the partners' capital accounts
as follows:
Z LK
Capital account following sale................ $11,000 $11,000
Deemed sale adjustment........................ 9,000 9,000
Capital account before constructive liquidation $20,000 $20,000
Constructive liquidating distributions of the interests in the new partnership
are made with reference to its $40,000 fair market value. Under section
732(b), the adjusted tax basis of the 50 percent interest in the new
partnership constructively distributed to Z is equal to the $11,000 adjusted
tax basis of Z's partnership interest before the constructive liquidation, and
the adjusted tax basis of the 50 percent interest in the new partnership
constructively distributed to LK is equal to the $20,000 adjusted tax basis of
LK's partnership interest before the constructive liquidation. Under
paragraph (b)(2)(iv)(d) of this section, the capital account of the terminated
partnership with respect to the new partnership would be $40,000 (i.e., the
fair market value of the property constructively contributed to the new
partnership by the terminated partnership). The capital accounts of Z and LK
with respect to the constructively distributed interests in the new
partnership are stated at $20,000 (i.e., one-half of the $40,000 capital
account of the terminated partnership). This Example 13(v) applies to
terminations of partnerships under section 708(b)(1)(B) occurring on or after
the date on which these regulations are published as final regulations in the
Federal Register.
* * * * *
Par. 3. Section 1.704-4 is amended by revising paragraphs (a)(4)(ii)
and (c)(3) to read as follows:
1.704-4 Distribution of contributed property.
(a) * * *
(4) * * *
(ii) Section 708(b)(1)(B) terminations. A termination of the
partnership under section 708(b)(1)(B) does not begin a new five-year period
for each partner with respect to the built-in gain and built-in loss property
that the terminated partnership is deemed to contribute to a new partnership
following the termination. See 1.704-3(a)(3)(ii) for the definitions of
built-in gain and built-in loss on section 704(c) property. This paragraph
(a)(4)(ii) applies to terminations of partnerships under section 708(b)(1)(B)
occurring on or after the date on which these regulations are published as
final regulations in the Federal Register.
* * * * *
(c) * * *
(3) Section 708(b)(1)(B) terminations. Section 704(c)(1)(B) and this
section do not apply to a deemed distribution of interests in a new
partnership caused by a termination of a partnership under section
708(b)(1)(B). A subsequent distribution of section 704(c) property by the new
partnership to a partner of the new partnership is subject to section
704(c)(1)(B) to the same extent that a distribution by the terminated
partnership would have been subject to section 704(c)(1)(B). See also 1.737-
2(a) for a similar rule in the context of section 737. This paragraph (c)(3)
applies to terminations of partnerships under section 708(b)(1)(B) occurring
on or after the date on which these regulations are published as final
regulations in the Federal Register.
* * * * *
Par. 4. In 1.708-1, paragraph (b)(1)(iv) is amended by removing the
first sentence and adding two new sentences in its place to read as follows:
1.708-1 Continuation of Partnership.
* * * * *
(b) * * *
(1) * * *
(iv) If a partnership is terminated by a sale or exchange of an
interest, the following is deemed to occur: The partnership transfers all of
its assets and liabilities to a new partnership in exchange for an interest in
the new partnership; and, immediately thereafter, the terminated partnership
distributes an interest in the new partnership to the purchasing partner and
the other remaining partners in liquidation of the terminated partnership,
either for the continuation of the business of the new partnership or for its
dissolution and winding up. The first sentence of this paragraph (b)(1)(iv)
applies to terminations of partnerships under section 708(b)(1)(B) occurring
on or after the date on which these regulations are published as final
regulations in the Federal Register. * * *
* * * * *
Par. 5. Section 1.743-1 is amended by adding paragraph (d) as follows:
1.743-1 Optional adjustment to basis of partnership property.
* * * * *
(d) Section 708(b)(1)(B) terminations. A partner with a special basis
adjustment in property held by a partnership that terminates under section
708(b)(1)(B) will continue to have the same special basis adjustment with
respect to property contributed by the terminated partnership to the new
partnership under 1.708-1(b)(1)(iv). This paragraph (d) applies to
terminations of partnerships under section 708(b)(1)(B) occurring on or after
the date on which these regulations are published as final regulations in the
Federal Register.
Par. 6. In 1.737-2, paragraph (a) is revised to read as follows:
1.737-2 Exceptions and special rules.
(a) Section 708(b)(1)(B) terminations. Section 737 and this section do
not apply to a deemed distribution of interests in a new partnership caused by
a termination of a partnership under section 708(b)(1)(B). A subsequent
distribution of section 704(c) property by the new partnership to a partner of
the new partnership is subject to section 737 to the same extent that a
distribution by the terminated partnership would have been subject to section
737. See also 1.704-4(c)(3) for a similar rule in the context of section
704(c)(1)(B). This paragraph (a) applies to terminations of partnerships
under section 708(b)(1)(B) occurring on or after the date on which these
regulations are published as final regulations in the Federal Register.
* * * * *
Par 7. In 1.761-1, paragraph (e) is added to read as follows:
1.761-1 Terms defined.
* * * * * (e) Distribution of partnership interest. For purposes of section
708(b)(1)(B) and 1.708-1(b)(1)(iv), the distribution of an interest in a new
partnership by a partnership that terminates under section 708(b)(1)(B) is not
a sale or exchange of an interest in the new partnership. This paragraph (e)
applies to terminations of partnerships under section 708(b)(1)(B) occurring
on or after the date on which these regulations are published as final
regulations in the Federal Register.
Margaret Milner Richardson
Commissioner of Internal Revenue