[Federal Register Volume 61, Number 93 (Monday, May 13, 1996)]
[Proposed Rules]
[Pages 21985-21988]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-11779]
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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.
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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 section 1.708-1(b)(1)(iv) of the
Income
[[Page 21986]]
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 Sec. 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, Sec. 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 Sec. 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 Secs. 1.704-
[[Page 21987]]
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 1--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:
Sec. 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 Sec. 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:
[[Page 21988]]
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:
Sec. 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 Sec. 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 Sec. 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 Sec. 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:
Sec. 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:
Sec. 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 Sec. 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 Sec. 1.737-2, paragraph (a) is revised to read as
follows:
Sec. 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
Sec. 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 Sec. 1.761-1, paragraph (e) is added to read as follows:
Sec. 1.761-1 Terms defined.
* * * * *
(e) Distribution of partnership interest. For purposes of section
708(b)(1)(B) and Sec. 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.
[FR Doc. 96-11779 Filed 5-9-96; 8:45 am]
BILLING CODE 4830-01-U