[Federal Register Volume 61, Number 240 (Thursday, December 12, 1996)]
[Proposed Rules]
[Pages 65371-65373]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-31364]
[[Page 65371]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-209762-95]
RIN 1545-AT32
Allocations of Depreciation Recapture Among Partners in a
Partnership
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
allocation of depreciation recapture among partners in a partnership.
The proposed regulations amend existing regulations to require that any
gain characterized as depreciation recapture must be allocated to each
partner in an amount equal to the lesser of the partner's share of
total gain from the sale of the property or the partner's share of
depreciation from the property. The proposed regulations affect
partnerships and their partners. This document also contains a notice
of public hearing on the proposed regulations.
DATES: Written comments must be received by March 6, 1997. Outlines of
oral comments and requests to speak at the public hearing scheduled for
March 27, 1997, at 10 a.m., must be received by March 6, 1997.
ADDRESSES: Send submissions to CC:DOM:CORP:R [REG-209762-95], room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered between the
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R [REG-209762-95], Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue, NW.,
Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Internet by selecting the ``Tax Regs'' option on
the IRS Home Page, or by submitting comments directly to the IRS
Internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The public hearing will be held in room 3313, Internal
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Daniel
J. Coburn or Deborah Harrington, (202) 622-3050 (not a toll-free
number); concerning submissions and the hearing, Evangelista Lee,
(202) 622-7190 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document proposes to change the current Income Tax Regulations
(26 CFR part 1) relating to the characterization and allocation of
depreciation recapture among partners in a partnership.
Section 1245 of the Internal Revenue Code requires taxpayers to
recharacterize as ordinary income some or all of the gain on the
disposition of certain types of business properties. The amount
recharacterized as ordinary income (recapture gain) is the lesser of:
(a) the gain realized on disposition, or (b) the total deductions
allowed or allowable for depreciation or amortization from the
property. Section 1.1245-1(e)(2) of the Income Tax Regulations
currently provides that each partner's share of recapture gain will
generally be determined in accordance with the provisions of section
704. The regulations also provide that, if the partnership agreement
provides for the allocation of total gain from the property but does
not provide for the allocation of recapture gain, recapture gain is
allocated in the same manner as total gain.
The current regulations create some uncertainty because it is
unclear how recapture gain is allocated under section 704. The
allocation of recapture gain cannot have substantial economic effect
because classifying a portion of the gain as recapture gain merely
changes the tax character of the gain. In addition, by allowing the
partnership to allocate recapture gain in the same manner as total
gain, the current regulations increase the possibility that a partner
may receive an allocation of recapture gain in excess of the partner's
share of depreciation from the property. For example, if a partner
acquires an interest in a partnership that has fully depreciated the
property and the property is subsequently sold at a gain, the partner
may be allocated a portion of the total gain and a portion of the
recapture gain, even though the partner did not receive any
depreciation deductions from the property. This mismatch between
depreciation allocations and recapture allocations should be minimized
because recapture gain is intended to offset the earlier depreciation
deductions taken from the property and should therefore be allocated to
the extent possible to the partner that received those depreciation
deductions. Finally, the current regulations do not provide guidance on
the allocation of recapture gain from contributed property subject to
section 704(c). In the legislative history of the 1984 amendment to
section 704(c), Congress suggested that Treasury and the Service issue
regulations governing the allocation of recapture gain inherent in
property contributed to a partnership. See H.R. Rep. No. 861, 98th
Cong., 2d Sess. 857 (1984); see also Staff of the Joint Comm. on
Taxation, 98th Cong., 2d Sess., General Explanation of the Revenue
Provisions of the Deficit Reduction Act of 1984 214 (Comm. Print 1984).
In the 1994 preamble to the section 704(c) final regulations, Treasury
and the Service indicated that this issue would be considered in a
separate regulations project. 59 FR 66,726 (1994).
Explanation of Provisions
The proposed regulations provide guidance on allocating recapture
gain among partners, including recapture gain attributable to
contributed property. The proposed regulations provide that a partner's
share of recapture gain is equal to the lesser of (1) the partner's
share of total gain arising from the disposition of the property, or
(2) the partner's share of depreciation or amortization from the
property. This rule seeks to insure, to the extent possible, that a
partner recognizes recapture on the disposition of property in an
amount equal to the depreciation or amortization deductions previously
taken by the partner on the property. If recapture gain remains
unallocated under the general rule, the remaining unallocated gain is
allocated among those partners whose shares of total gain on the
disposition of the property exceed their shares of depreciation or
amortization with respect to the property. Recapture gain may be
unallocated under the general rule if, for example, the total gain
allocated to a partner on the sale of the property is less than the
amount of depreciation previously allocated to that partner.
The proposed regulations provide special rules for determining a
partner's share of depreciation or amortization from contributed
property subject to section 704(c). The proposed regulations provide
that a contributing partner's share of depreciation or amortization
includes depreciation or amortization allowed or allowable prior to
contribution. In addition, the proposed regulations provide that
curative and
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remedial allocations generally reduce the contributing partner's share
of depreciation or amortization and increase the noncontributing
partners' shares of depreciation or amortization.
Treasury and the Service request comments on whether these special
rules can be incorporated into accounting systems that track section
704(c) allocations for partnerships with multiple section 704(c)
properties.
Proposed Effective Date
These amendments are proposed to apply to properties acquired by a
partnership on or after the date the 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 also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations, and, because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. 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 March 27, 1997, at 10:00
a.m. in room 3313 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 March 6, 1997, 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 March 6, 1997.
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 authors of these regulations
are Daniel J. Coburn and Deborah Harrington, 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 * * *
Par. 2. Section 1.704-3 is amended as follows:
1. Paragraphs (a)(9) and (a)(10) are redesignated as paragraphs
(a)(10) and (a)(11), respectively.
2. New paragraph (a)(9) is added.
The addition reads as follows:
Sec. 1.704-3 Contributed property.
(a) * * *
(9) Contributing and noncontributing partners' recapture shares.
For special rules applicable to the allocation of recapture gain with
respect to property contributed by a partner to a partnership, see
Secs. 1.1245-1(e)(2) and 1.1250-1(f).
* * * * *
Par. 3. Section 1.1245-1 is amended by revising paragraph (e)(2) to
read as follows:
Sec. 1.1245-1 General rule for treatment of gain from dispositions of
certain depreciable property.
* * * * *
(e) * * *
(2)(i) Unless paragraph (e)(3) of this section applies, a partner's
distributive share of gain recognized under section 1245(a)(1) by the
partnership is equal to the lesser of the partner's share of the total
gain from the disposition of the property or the partner's share of the
depreciation or amortization with respect to the property. Any gain
recognized under section 1245(a)(1) by the partnership that is not
allocated under the first sentence of this paragraph is allocated among
the partners whose shares of total gain exceed their shares of
depreciation or amortization with respect to the property and is
allocated to those partners in proportion to (but not in excess of)
their shares of the total gain (including gain recognized under section
1245(a)(1)) from the disposition of the property.
(ii) A partner's share of depreciation or amortization with respect
to property equals the total amount of allowed or allowable
depreciation or amortization previously allocated to that partner with
respect to the property. If a partner transfers a partnership interest,
a share of depreciation or amortization must be allocated to the
transferee partner as it would have been allocated to the transferor
partner. If the partner transfers a portion of the partnership
interest, a share of depreciation or amortization proportionate to the
interest transferred must be allocated to the transferee partner.
(iii)(A) A partner's share of depreciation or amortization with
respect to property contributed by the partner includes the amount of
depreciation or amortization allowed or allowable to the partner for
the period prior to the property's contribution.
(B) The partners' shares of depreciation or amortization with
respect to property contributed by a partner must be adjusted to
account for any curative allocations. (See Sec. 1.704-3(c) for a
description of the curative allocation method). The contributing
partner's share of depreciation or amortization with respect to the
contributed property is decreased (but not below zero) by the amount of
any curative allocation of ordinary income to the contributing partner
with respect to the contributed property and by the amount of any
curative allocation of deduction or loss (other than capital loss)
allocated to the noncontributing partners with respect to the
contributed property. A noncontributing partner's share of depreciation
or amortization with respect to the contributed property is increased
by the noncontributing partner's share of any curative allocation of
ordinary income to the contributing partner with respect to the
contributed property and by the amount of any curative allocation of
deduction or loss (other than capital loss) allocated to the
noncontributing partner with respect to the contributed property. The
partners' shares of depreciation or amortization with respect to
property from which curative allocations of depreciation or
amortization are taken is determined without regard to those curative
allocations.
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(C) The partners' shares of depreciation or amortization with
respect to property contributed by a partner must be adjusted to
account for any remedial allocations. (See Sec. 1.704-3(d) for a
description of the remedial allocation method.) The contributing
partner's share of depreciation or amortization with respect to the
contributed property is decreased (but not below zero) by the amount of
any remedial allocation of ordinary income to the contributing partner
with respect to the contributed property. A noncontributing partner's
share of depreciation or amortization with respect to the contributed
property is increased by the amount of any remedial allocation of
depreciation or amortization to the noncontributing partner with
respect to the contributed property.
(D) The principles of this paragraph (e)(2)(iii) apply in
determining the effect of remedial or curative allocations on a
partner's share of depreciation or amortization with respect to
property for which differences between book value and adjusted tax
basis are created when a partnership revalues partnership property
pursuant to Sec. 1.704-1(b)(2)(iv)(f).
(iv) Examples. The application of this paragraph (e)(2) may be
illustrated by the following examples:
Example 1. Recapture allocations. (i) Facts. A and B each
contribute $5,000 cash to form AB, a general partnership. The
partnership agreement provides that depreciation deductions will be
allocated 90 percent to A and 10 percent to B, and, on the sale of
depreciable property, A will first be allocated gain to the extent
necessary to equalize A's and B's capital accounts. Any remaining
gain will be allocated 50 percent to A and 50 percent to B. In its
first year of operations, AB purchases depreciable equipment for
$5,000. AB depreciates the equipment over its 5-year recovery period
and elects to use the straight-line method. In its first year of
operations, AB's operating income equals its expenses (other than
depreciation).
(ii) Year 1. In its first year of operations, AB has $1,000 of
depreciation from the partnership equipment. (To simplify this
example, the partnership's depreciation deductions are determined
without regard to any first-year depreciation conventions.) In
accordance with the partnership agreement, AB allocates 90 percent
($900) of the depreciation to A and 10 percent ($100) of the
depreciation to B. At the end of the year, AB sells the equipment
for $5,200, recognizing $1,200 of gain ($5,200 amount realized less
$4,000 adjusted tax basis). In accordance with the partnership
agreement, the first $800 of gain is allocated to A to equalize the
partners' capital accounts, and the remaining $400 of gain is
allocated $200 to A and $200 to B.
(iii) Recapture allocations. $1,000 of the gain from the sale of
the equipment is treated as gain recognized under section
1245(a)(1). Under paragraph (e)(2)(i) of this section, each
partner's share of this section 1245 gain is the lesser of the
partner's share of total gain recognized on the sale of the
equipment or the partner's share of total depreciation with respect
to the equipment. Thus, A's share of the section 1245 gain is $900
(the lesser of A's share of total gain ($1,000) and A's share of
depreciation ($900)) and B's share of the section 1245 gain is $100
(the lesser of B's share of total gain ($200) and B's share of
depreciation ($100)). Accordingly, $900 of the $1,000 of total gain
allocated to A will be treated as ordinary income and $100 of the
$200 of total gain allocated to B will be treated as ordinary
income.
Example 2. Recapture allocation limited by gain share. Assume
the same facts as in Example 1, except that the partnership
agreement provides that gains and losses from the sale of
depreciable property will be allocated equally between the partners.
On the sale of the equipment, the partnership's total gain of $1,200
is allocated $600 to A and $600 to B. Under paragraph (e)(2)(i) of
this section, A's share of the section 1245 gain is limited to $600
(the amount of total gain allocated to A) even though A's share of
the total depreciation from the equipment was $900. The remaining
$400 of section 1245 gain must be allocated to B. Accordingly, all
$600 of total gain allocated to A is treated as ordinary income and
$400 of the $600 of total gain allocated to B is treated as ordinary
income.
Example 3. Determination of partners' shares of depreciation
with respect to contributed property. (i) Facts. C and D form
partnership CD as equal partners. C contributes depreciable personal
property C1 with an adjusted tax basis of $800 and a fair market
value of $2,800. D contributes $2,800 cash. Prior to contributing
C1, C claimed $200 of depreciation from C1. At the time of
contribution, C1 has four years remaining on its 5-year recovery
period and is depreciable under the straight-line method. At the
time CD is formed, it purchases depreciable personal property D1 for
$2,800, which is depreciable over seven years under the straight-
line method. (To simplify the example, all depreciation is
determined without regard to any first-year depreciation
conventions).
(ii) Traditional method. C and D will each be allocated $350 of
the total of $700 of book depreciation from C1 in year 1. Under the
traditional method of making section 704(c) allocations, C will not
be allocated any tax depreciation from C1 and D will be allocated
the entire $200 of tax depreciation from C1. C and D will each be
allocated $200 of book and tax depreciation from D1. As a result,
after the first year of partnership operations, C's share of
depreciation with respect to C1 is $200 (the depreciation taken by C
prior to contribution) and D's share of depreciation with respect to
C1 is $200 (the amount of tax depreciation allocated to D). C and D
each have a $200 share of depreciation with respect to D1.
(iii) Effect of curative allocations. If the partnership elects
to make curative allocations under Sec. 1.704-3(c) using
depreciation from D1, the results in year 1 will be the same as
under the traditional method, except that $150 of the $200 of tax
depreciation from D1 that would have been allocated to C under the
traditional method will be allocated to D as additional depreciation
with respect to C1. As a result, after the first year of partnership
operations, C's share of depreciation with respect to C1 will be
reduced to $50 (the total depreciation taken by C prior to
contribution ($200) decreased by the amount of the curative
allocation to D ($150)). C's share of depreciation with respect to
D1 will still be $200 and D's share of depreciation with respect to
C1 will be $350 (the depreciation allocated to D under the
traditional method ($200) increased by the amount of the curative
allocation to D ($150)). D's share of depreciation with respect to
D1 will still be $200.
(iv) Effect of remedial allocations. If the partnership elects
the remedial allocation method for making section 704(c) allocations
under Sec. 1.704-3(d), there will be $600 of total book depreciation
from C1 in year 1. (Under the remedial allocation method, the amount
by which C1's book basis ($2,800) exceeds its tax basis ($800) is
depreciated over a 5-year life, rather than a 4-year life). C and D
will each be allocated one-half ($300) of the total book
depreciation. As under the traditional method, C will be allocated
$0 of tax depreciation from C1 and D will be allocated $200 of tax
depreciation from C1. Because the ceiling rule would cause a
disparity of $100 between D's book and tax allocations of
depreciation, D will also receive a $100 remedial allocation of
depreciation with respect to C1, and C will receive a $100 remedial
allocation of income with respect to C1. As a result, after the
first year of partnership operations, D's share of depreciation with
respect to C1 is $300 (the depreciation allocated to D under the
traditional method ($200) increased by the amount of the remedial
allocation ($100)). C's share of depreciation with respect to C1 is
$100 (the total depreciation taken by C prior to contribution ($200)
decreased by the amount of the remedial allocation of income
($100)). As under the traditional method, C and D each have a $200
share of depreciation with respect to D1.
(v) Effective date. This paragraph (e)(2) is effective for
properties acquired by the partnership on or after [the date the
regulations are published as final regulations in the Federal
Register].
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-31364 Filed 12-11-96; 8:45 am]
BILLING CODE 4830-01-U