Presenting a live 110‐minute teleconference with interactive Q&A
Section 754 and Basis Adjustments for Partnership and LLC Interests
Navigating Complexities in Federal Tax Treatment of Distributions and Sales of Interests
TUESDAY, SEPTEMBER 13, 2011
1pm Eastern
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12pm Central | 11am Mountain
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Today’s faculty features:
Janice Eiseman,
Eiseman Principal
Principal, Cummings & Lockwood,
Lockwood Stamford,
Stamford Conn
Conn.
Craig Taylor, Director, Carruthers & Roth, Greensboro, N.C.
Craig Gerson, Principal, National Tax Services, PricewaterhouseCoopers, Washington, D.C.
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Section 754 and Basis Adjustments for S
ti d B i Adj t
t f Partnership and LLC Interests Seminar
Sept. 13, 2011
Janice Eiseman, Cummings & Lockwood
jeisem@cl-law.com
Craig Gerson, PricewaterhouseCoopers
craig.a.gerson@us.pwc.com
Craig Taylor, Carruthers & Roth
cat@crlaw.com
Today’s Program
Introduction To Key Concepts
[Janice Eiseman]
Slide 7 – Slide 11
Sect. 754 Elections
[Craig Taylor]
Slide 12 – Slide 19
Sect. 743(b) Adjustments On Transfer Of Partnership Interests
[Janice Eiseman]
Slide 20 – Slide 37
Sect. 734(b) Adjustments On Distributions From Partnerships
[Craig Taylor]
Slide 38 – Slide 50
Collected Issues And Nuances Of Partnership Basis Adjustments
[Craig Gerson]
Slide 51 – Slide 70
Janice Eiseman, Cummings & Lockwood
INTRODUCTION TO KEY CONCEPTS
PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
O
Overview
i
A.
Subchapter K: In parts of Subchapter K, the subchapter governing the taxation of
partnerships
hi andd partners, a partnership
hi is
i treatedd as a separate entity,
i which
hi h is
i distinct
di i
from its partners. In other parts of Subchapter K, a partnership is treated as an aggregate
of individuals, each of whom owns an undivided interest in partnership assets.
B.
Outside basis: “Outside basis” refers to a partner’s tax basis in the partnership interest
itself. The partnership is treated as an entity separate from its partners and the
partnership interest as an intangible asset that is separate and distinct from partnership
assets. This is similar to a shareholder’s tax basis in a share of stock.
C.
Inside basis: “Inside basis” refers to the partner’s share of the basis in the assets held by
the partnership. Because the partnership is not a separate taxable entity, its income is
allocated and taxed to its partners,
partners treating them like owners of undivided interests in the
assets and business of the partnership, i.e., as an aggregate of individuals. This does not
have a direct analog in the Subchapter C or Subchapter S world, because corporations
are treated as separate entities.
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
Overview (Cont.)
(Cont )
D.
Sect. 754 election: Purpose of making a Sect. 754 election is to equalize the “outside basis” and the
“inside basis,” to the extent allowed. A Sect. 754 election activates both Sect. 743(b), which applies to
certain transfers of partnership interests, and Sect. 734(b), which applies to certain distributions of
property by the partnership to a partner.
1.
If a Sect. 754 election is not made, there is no change to the inside basis of partnership assets; that
is, there is no adjustment to a transferee’s “inside basis” no adjustment to the tax basis of
partnership assets because of a distribution of property by the partnership to a partner.
•
For example, Sect.743(a), which treats the partnership as an entity, provides that the basis of
partnership property is not adjusted as a result of a sale, or exchange, or the death of a
partner unless an election has been made under Sect. 754 or unless the partnership has a
“substantial built-in loss.”
•
If a Sect.
S t 754 election
l ti is
i made,
d then
th Sect.
S t 743(b) is
i operative.
ti A Sect.
S t 743(b) adjustment
dj t
t
implements an aggregate approach by adjusting the tax consequences allocable to a
transferee partner so as to provide the transferee with an approximation of a cost basis in an
undivided interest in the partnership property. The legislative history of the 1954 Code states
that the p
purpose
p
of Sect. 743(b)
( ) is to ensure that a transferee’s distributive share of income,,
gain, loss, deduction or credit is the same “as though the partnership had dissolved and been
reformed, with the transferee of the interest a member of the partnership.” H.R. Rep. No.
1337, 83rd Cong., 2d Sess. 70 (1954). In other words, the function of a Sect. 743(b)
adjustment is to offset gain or loss that accrued prior to the transferee becoming a partner.
2
2.
A
Assuming
i that
h there
h is
i a basis
b i adjustment,
dj
the
h amount off the
h adjustment
dj
is
i determined
d
i d under
d Sect.
S
743(b) in the case of a transfer and Sect. 734(b) in the case of a distribution.
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
O
Overview
i
(Cont.)
(C t )
E.
Sect. 755: How the adjustment determined under Sect. 743(b) or Sect.
734(b) is allocated to partnership assets is determined under Sect. 755.
F.
Mandatory adjustment under Sect. 743: If there is a transfer of a
partnership interest, and immediately after such transfer the adjusted
tax basis of all of the partnership assets exceeds the fair market value of
the partnership assets by more than $250,000 (“substantial built-in
loss”), then the partnership must make a Sect. 743(b) adjustment as if
an election under Sect. 754 were in effect. I.R.C. § 743(d).
E
Exceptions
i
for
f electing
l i investment
i
partnerships
hi (e.g.,
(
buyout
b
funds,
f d
venture capital funds and fund of funds) and securitization
partnerships. I.R.C. §§ 743(e) & (f)
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
O
Overview
i
(Cont.)
(C t )
G.
Mandatory adjustment under Sect. 734: If there is a distribution of
partnership
t
hi property
t in
i liquidation
li id ti off a partner’s
t ’ interest,
i t
t andd the
th difference
diff
between the sum of (i) the basis of the distributed property to the partner,
which equals the value of his partnership interest in the partnership under Sect.
732(b), and the tax basis of the distributed property to the partnership; and (ii)
the loss recognized by the liquidating partner exceeds $250,000, then the tax
basis of partnership property must be decreased as if a Sect. 754 election were
in effect. I.R.C. § 734(d). There is an exception for securitization partnerships.
I R C § 734(e).
I.R.C.
734(e)
H.
Summary: Under sections 734(a) and 743(a), the partnership is treated as an
entity, ii.e.,
e , no adjustments to basis of partnership property unless mandatory
adjustments are required. If a Sect. 754 election is made, then adjustments can
be made to the basis of partnership property (the “inside basis”) under sections
734(b) and 743(b). How the amount of the adjustment is allocated among
partnership
hi assets is
i determined
d
i d under
d Sect.
S
755.
755
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Craig Taylor, Carruthers & Roth
SECT 754 ELECTIONS
SECT. 754 ELECTIONS
M ki Th S
Making The Sect. 754 Election
El i
• Partnership may make the Sect. 754 election at any time – does
not require the occurrence of a triggering event. Election must be
signed by a partner.
• Election
El ti is
i filed
fil d with
ith a timely
ti l fil
filed
d partnership
t
hi return
t
(including
(i l di
extensions).
• Once made, the Sect. 754 election is:
•
In effect for the tax year of the partnership return
containing the election; and
•
In effect for all future tax years of the partnership,
partnership unless
revoked.
• Revocation requires a special application to the IRS and will be
granted
d only
l iff there
h
are substantial
b
l changes
h
to the
h b
business or
assets of the partners. Sect. 1.754-1(c).
13
When To Consider The Sect. 754 Election
• Distributions of property other than cash,
cash especially where tax
basis of property is different from fair market value (whether
appreciated or depreciated)
• Any distributions of cash or property that are disproportionate to
partnership interests
p
to recognize
g
• Distributions of cash that will cause the recipient
gain
• Liquidating distributions of cash or property
• Sales
S l or exchanges
h
off interests
i t
t iin th
the partnership
t
hi
• Death of a partner
y , “good”
g
for all
• Sect. 754 elections are often,, but not always,
partners and all partnerships. Each situation should be evaluated
carefully.
14
Eff
Effects Of The Sect. 754 Election
Of Th S
El i
EXAMPLE 1: Purchase of a partnership interest
A and B form a 50/50 partnership. Each contributes $150,000 in cash. The AB
Partnership buys Asset for $300,000.
$300 000 Asset appreciates to $400,000.
$400 000
C buys a 50% interest in the AB Partnership for $200,000, and the ABC Partnership
sells Asset for $400,000 – a gain of $100,000. If no Sect. 754 election is in place:
Partner C’s outside basis:
C’s 50% share of gain:
C’ss share of cash distributed:
C
$200,000
$ 50,000
( $200,000)
Partner C’s remaining basis:
$50,000
15
Effects Of The Sect. 754 Election (Cont.)
EXAMPLE 1: Purchase of a partnership interest (Cont.)
• Partner C cannot use the $50,000 in remaining basis until it sells the
interest (unlikely)
( l k l ) or the
h partnership
h is lliquidated.
d d
• If Partner C recognizes a loss, it will be a capital loss.
• If Asset is a non-capital asset, the $50,000 income allocated to Partner C
will
ill be
b ordinary
di
iincome, but
b tP
Partner
t
C’s
C’ lloss will
ill be
b a “mismatched”
“ i
t h d”
capital loss.
• If Asset is sold in 2011, but ABC Partnership doesn’t liquidate until 2012,
Partner C
C’ss loss will be delayed and “mismatched”
mismatched to the 2011 income
income.
• If a Sect. 754 election is made for the year of the sale, or is already in
place, both of these bad outcomes are avoided.
16
Effects Of The Sect. 754 Election (Cont.)
EXAMPLE 2: Non-liquidating distributions to partners property
Partner D has an outside basis of $40,000 in the DEF Partnership.
Partner D receives a distribution of land that has a fair market
value (FMV) of $75,000 and an inside basis of $50,000.
• If no Sect. 754 election is in place, Partner D will hold the land
with a basis of $40
$40,000.
000 The remaining $10
$10,000
000 of basis is “lost”
lost .
• If a Sect. 754 election is in place, the DEF Partnership would
increase its basis in its remaining assets by $10,000
$10 000 under Sect.
Sect
734(b).
17
Effects Of The Sect. 754 Election (Cont.)
EXAMPLE 3: Non-liquidating distributions to partners – cash and
property
Partner D has an outside basis of $40,000 in the DEF Partnership. Partner
D receives a distribution
d
b
off cash
h off $$50,000 and
d a distribution
d
b
off lland
d that
h
has a fair market value (FMV) of $75,000 and an inside basis of $50,000.
• Partner D recognizes a gain of $10,000 from the distribution of cash (Sect.
731) and
d its
it outside
t id basis
b i is
i reduced
d
d to
t $0.
$0 If no Sect.
S t 754 election
l ti is
i in
i
place, Partner D will hold the land with a basis of $0. $50,000 of basis is
“lost.”
• If a Sect
Sect. 754 election is in place
place, the DEF Partnership would increase its
basis in its remaining assets by $60,000 under Sect. 734(b) – the sum of
$10,000 in gain recognized by Partner D and $50,000 of “lost basis.”
18
Effects Of The Sect. 754 Election (Cont.)
EXAMPLE 4: Liquidating distributions to partners
Partner D has an outside basis of $40,000 in the DEF Partnership. Partner
D receives a liquidating
l
d
distribution
d
b
off land
l d that
h has
h a fair
f market
k value
l
(FMV) of $75,000 and an inside basis of $25,000.
• If no Sect.
S t 754 election
l ti is
i in
i place,
l
P
Partner
t
A will
ill hold
h ld th
the land
l d with
ith a
basis of $40,000, and there will be no impact on Partnership DEF’s other
assets.
• If a Sect. 754 election is in place, Partner A will hold the land with a basis
of $40,000, but the DEF Partnership would be required to decrease its
basis in its remaining assets by $15,000 under Sect. 734(b).
19
Janice Eiseman, Cummings & Lockwood
SECT. 743(B) ADJUSTMENTS ON SECT
743(B) ADJUSTMENTS ON TRANSFER OF PARTNERSHIP INTERESTS
PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
Abilit To
Ability
T Make
M k A Sect.
S t 754 El
Election
ti
Due To A Transfer
A.
Sect. 743(b): Election may be made when there is a sale or
exchange of a partnership interest or upon the death of a partner.
If a triggering event has not occurred, no Sect. 754 election can be
made, and, therefore there will be no change to the tax basis of
partnership assets with regard to the transferee unless the
mandatory rule for basis adjustment applies.
1. Sales or exchanges: This includes a carryover basis exchange,
such as under Sect. 351. Transfers by gift do not trigger a
Sect. 754 election, because transfers by gift are not sales or
exchanges under Sect. 743(b).
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© Cummings & Lockwood LLC 2011
PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
Ability To
Abilit
T Make
M k A Sect.
S t 754 El
Election
ti
Due To A Transfer (Cont.)
2.
Distribution of partnership interest: Note that Sect. 761(e)(2) provides
that for purposes of Sect. 743, any distribution of an interest in a
partnership (not otherwise treated as an exchange) shall be treated as an
exchange. Thus, if there is a “constructive termination” under Sect.
708(b)(1)(B), i.e. sale or exchange of 50% or more of the total interest
in partnership capital and profits within a period of 12 consecutive
months, then the deemed distribution of an interest in the new
partnership by a terminating partnership is treated as an exchange of the
interest in the new partnership for interest in the terminating
partnership,
t
hi for
f purposes off Sect.743.
S t 743 This
Thi allows
ll
the
th new partnership
t
hi
to make a Sect. 754 election because the exchange requirement of Sect.
743(b) is satisfied.
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
What Happens Under Sect.
Sect 743(b) When A
Sect. 754 Election Is Made?
A
A.
The actual amount of the Sect.
Sect 743(b) adjustment: Sect.
Sect 743(b) states that the
adjustment to the basis of partnership property to the transferee equals the difference
between the (i) transferee’s tax basis in his partnership interest (i.e., the purchase price of
the interest or its fair market value at date of death plus his share of partnership
liabilities) and (ii) the transferee
liabilities),
transferee’ss “proportionate
proportionate share of the adjusted basis of
partnership property.” Treasury Reg. §1.743-1 flushes out how to determine the
transferee’s “proportionate share of the adjusted basis of partnership property.” To
understand the regulations, it is important to always remember what the Sect. 743(b)
adjustment is designed to do; namely,
namely to prevent the transferee from recognizing gain or
loss already accounted for in the purchase price of the partnership interest.
1.
Treasury Reg. §1.743-1(d) provides that the transferee’s “share of the adjusted
b i to the
basis
h partnership
hi off partnership
hi property”” is
i equall to the
h sum off the
h
transferee’s interest as a partner in the partnership’s “previously taxed capital” plus
his share of partnership liabilities. The transferee’s share of “previously taxed
capital” is defined to be the amount of cash the transferee would receive if the
partnership
t
hi were liquidated
li id t d by
b selling
lli its
it assets
t att fair
f i market
k t value.
l
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
What Happens Under Sect.
Sect 743(b) When A
Sect. 754 Election Is Made? (Cont.)
andd (i) increasing
i
i the
th amountt off cashh by
b the
th tax
t loss
l
(including
(i l di any remedial
di l
allocations under Treasury Reg. §1.704-3(d)) that would be allocated to the
transferee to the extent attributable to the transferred interest, or (ii) decreasing the
amount by the amount of tax gain (including any remedial allocations under
T
Treasury
Reg.
R §1.704-3(d))
§1 704 3(d)) th
thatt would
ld bbe allocated
ll t d tto th
the ttransferee
f
tto th
the extent
t t
attributable to the transferred interest. (Note that non-contingent liabilities do not
affect the amount of the adjustment because they are included in the transferee’s
tax basis and the computation of the transferee’s share of the adjusted basis of
partnership
t
hi property.)
t )
2.
In essence, the tax capital account that the transferee inherits from his transferor
determines the transferee’s share of the partnership basis in its assets. By using
transferor’s tax capital account as a measure of inside basis, the Treasury
regulations generally ensure that a transferee receives a basis adjustment that takes
into account both pre-contribution gain or loss and post-contribution changes in
value.
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
What Happens Under Sect. 743(b) When A
Sect. 754 Election Is Made?
3.
Example 2 of Treasury Reg. §1.743-1(d)(3) illustrates the
computation of the Sect. 743(b) adjustment. See Exhibit A.
4.
As this example shows, if the partnership sells the land for
$1,300, the gain from the sale equals $900. Transferee will have
$700 of the gain allocated to him, and the other two partners will
each have $100 allocated to them. Because the transferee has a tax
basis of $700 in the land, he will recognize no gain.
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
What Happens Under Sect.
Sect 743(b) When A
Sect. 754 Election Is Made?
B.
Note the following with regard to a Sect. 743(b) adjustment:
1. The adjustment applies only to the transferee partner. There is no adjustment
to common basis of partnership property. The adjustment essentially operates
outside the partnership. Treas. Reg. § 1.743-1(j)(1)
2
2.
The adjustment
Th
dj t
t hhas no effect
ff t on the
th computation
t ti off the
th partnership’s
t
hi ’ income
i
or loss. Treas. Reg. § 1.743-1(j)(1)
3.
The adjustment has no effect on the transferee’s capital account. The
transferee steps into the capital account of the transferor.
transferor Treas.
Treas Reg.
Reg § 1.7431 743
1(j)(2)
4.
The adjustments to the transferee’s distributive share of income or loss must
be shown on the Form K-1
K 1 issued to the transferee.
transferee Treas
Treas. Reg
Reg.
§ 1.743-1(j)(2)
5.
Where there has been more than one transfer of a partnership interest, a
transferee’ss basis adjustment is determined without regard to any prior
transferee
transferee’s basis adjustment. Treas. Reg. § 1.743-1(f)
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
S t 755 B
Sect.
Basis
i Adj
Adjustments
t
t
A.
Three sets of rules
1
1.
Transfer of partnership interest when assets of partnership do not constitute a trade or business.
business
Treas. Reg. § 1.755-1(b)(1)-(b)(4)
2.
Transfer of partnership interest involving “substituted basis exchanges” (e.g., Sect. 351 and
721 exchanges). Treas. Reg. §1.755-1(b)(5). Also, Treasury Reg. §1.755-1(b)(5) applies to
basis adjustments that result from exchanges in which the transferee’s
transferee s basis in the partnership
interest is determined by reference to other property held at any time by the transferee e.g. a
constructive termination under Sect. 708(b)(1)(B) in which the terminated partnership is
deemed to contribute its assets to a new partnership in exchange for an interest in the new
partnership and the terminated partnership is deemed to distribute interests in the new
partnership in liquidation of the partner’s interest in the terminated partnership. Sect. 761(e)
provides the “exchange,” meaning the distribution of partnership interests in the new
partnership is an “exchange” for purposes of Sect. 743(b). Because the distribute-partner of the
terminated partnership receives its interest in the new partnership in a liquidating distribution,
the distributee takes a substituted basis in the new partnership under Sect
Sect.732(b).
732(b) A Sect
Sect. 754
election by the new partnership will bring into play Treasury Reg. §1.755-1(b)(5).
3.
Transfer of a partnership interest when the assets of the partnership constitute a trade or
business, as described in Reg. §1.1060-1(b)(2)
Treas Reg.
Treas.
Reg §1.755-1(a)(2)-(a)(6)
§1 755 1(a)(2) (a)(6)
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
S t 755 B
Sect.
Basis
i Adj
Adjustments
t
t (C
(Cont.)
t)
B.
Transfer of partnership interest when assets of partnership do not constitute a
“trade
trade or business”
business
1.
First, determine the adjusted basis and the fair market value of the partnership
assets immediately after the transfer and determine how much income, gain or
loss (including remedial allocations under Treasury Reg. §1.704-3(d)) would be
allocated to the transferee-partner, if the partnership were to sell all of its assets
for cash in a hypothetical sale for an amount equal to their fair market values. If,
in fact, the purchase price for the partnership interest equals the fair market value
of the assets, then the adjustment to the basis of partnership property with respect
to the transferee-partner is done.
Treas. Reg. §1.755-1(b)(1)(ii); Example 1, Treas. Reg. 1.755-1(b)(2)(ii)
2.
The portion of the transferee-partner’s basis adjustment allocated to ordinary
income property is equal to the total income gain or loss (including remedial
allocations) that would be allocated to the transferee with respect to the
hypothetical
yp
sale of ordinaryy income property.
p p y Treas. Reg.
g §§1.755-1(b)(2)
( )( )
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
S t 755 B
Sect.
Basis
i Adj
Adjustments
t
t (C
(Cont.)
t)
3.
The portion of the transferee-partner’s basis adjustment allocated to capital gain
property is equal to the Sect. 743(b) adjustment reduced by the amount allocated
to ordinary income property. If the purchase price of the partnership interest is
less than the purchase price based upon fair market value, and there has to be a
decrease in capital gain property, the decrease cannot be greater than the
“partnership’s basis” in the property or the transferee’s share of any remedial loss
under Treasury Reg. §1.704-3(d). Any excess is applied to reduce the basis of
ordinary income property. Treas. Reg. §1.755-1(b)(2)
•
4
4.
Note that this approach allocates any overpayment or underpayment for
the partnership interest to the basis of capital gain property.
Adjustments
Adj
t
t can be
b made
d to
t individual
i di id l assets
t even though
th
h the
th total
t t l amountt off
basis adjustment is zero. Treas. Reg. §1.755-1(b)(1)(i)
•
Note that in a substituted basis transaction, no adjustment can be made if
the total amount of the Sect. 743(b) adjustment is zero.
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PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
S t 755 B
Sect.
Basis
i Adj
Adjustments
t
t (C
(Cont.)
t)
5.
Allocations have to be made within the class of ordinaryy income property
p p y and within
the class of capital gain property.
a.
Within the class of ordinary income property, the basis of each property is
generally adjusted by an amount equal to the income, gain or loss (including
remedial allocations) that would be allocated to the transferee upon a sale of
the property in the hypothetical transaction.
b.
Within the class of capital gain property, the basis of such property is
generally adjusted by (1) the amount of income, gain or loss that would be
allocated to the transferee in the hypothetical transaction,
transaction minus (2) a portion
(based on the market value of a particular property) compared to the
aggregate market value of all capital gain property. Treas. Reg. §1.7551(b)(3)
c.
N t that
Note
th t there
th mustt be
b an adjustment
dj t
t whenever
h
the
th actual
t l Sect.
S t 743(b)
adjustment is either more or less than what it would be if the transferee had
paid fair market value for each partnership asset.
6.
See subsequent exhibits B and C for examples of Sect. 755 allocations
30
30
© Cummings & Lockwood LLC 2011
PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
Sect 755 Basis Adjustments (Cont.)
Sect.
(Cont )
C.
Substituted basis exchanges
1.
The rules for “substituted basis exchanges” are set forth in Treasury Reg. §1.755-1(b)(5). If the
basis adjustment is positive,
positive an adjustment can be made only if the hypothetical sale of the
partnership’s assets results in a net gain to the transferee.
a.
The increase is allocated between classes of assets (ordinary and capital) in proportion to the
net income or gain of each class allocable to the transferee.
b
b.
Within each class,
class increases are first allocated to properties with unrealized appreciation in
proportion to the transferee’s share of such unrealized appreciation until the transferee’s
share of the appreciation is eliminated. Any remaining amount is allocated among assets in
the class according to the transferee’s share of the amount realized from the hypothetical sale
of each asset in the class.
2.
Likewise, if the basis adjustment is negative, an adjustment can only be made if the
hypothetical sale results in the allocation of a net loss to the transferee.
a.
The decrease is allocated between asset classes in proportion to the net loss allocable to the
transferee from the hypothetical sale of all assets in each class.
b
b.
Within
i hi eachh class,
l
the
h decrease
d
is
i allocated
ll
d to properties
i with
i h unrealized
li d depreciation
d
i i in
i
proportion to the transferee’s shares of such unrealized depreciation until they are eliminated.
Remaining decreases are allocated in proportion to the transferee’s shares of the adjusted
bases of all assets in the class until these shares of adjusted bases are reduced to zero, with
any
y remaining
g downward adjustment
j
suspended
p
until the partnership
p
p acquires
q
additional
property in that class.
31
31
© Cummings & Lockwood LLC 2011
PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
Sect 755 Basis Adjustments (Cont
Sect.
(Cont.))
D.
Sale of business
1.
2.
If the assets of the partnership constitute a trade or business (as described in Treasury Reg.
§1.1060-1(b)(2)),
§
( )( )), the partnership
p
p must use the residual method to assign
g values to the
partnership’s Sect. 197 intangibles. Treas. Reg. §1.755-1(a)(2)
Residual method involves the following steps:
a.
b.
c.
d.
e.
First, the partnership must determine the value of its assets other than Sect. 197.
Second, the partnership must determine “partnership gross value” under Treasury Reg.
§1.755-1(a)(4).
Third, the partnership gross value is then compared to the aggregate value of all partnership
property other than Sect. 197 intangibles. If there is no residual value, then the value of all Sect.
197 intangibles is deemed to be zero. If there is a residual value, then the amount must be
Sect. 197 intangibles
g
in order to assign
g a value to them under the rules of Treasury
y
allocated to S
Reg. §1.755-1(a)(5).
“Partnership gross value” generally is equal to the amount that, if assigned to all partnership
property, would result in a liquidating distribution to the partner equal to the transferee’s basis
in the transferred partnership interest immediately following the relevant transfer (reduced by
the amount
amount, if any
any, of such basis that is attributable to partnership liabilities)
liabilities). Treas
Treas. Reg
Reg.
§1.755-1(a)(4)(i)(A).
Treasury Reg. §1.755-1(a)(5)(i) requires that the residual value be allocated first among Sect.
197 intangibles other than goodwill and going concern value, but the value assigned to a Sect.
197 intangible (other than goodwill and going concern value) is limited to its actual fair market
value
l on the
h date
d off the
h relevant
l
transfer.
f Any
A remaining
i i residual
id l value
l is
i then
h allocated
ll
d to
goodwill and going concern value.
32
32
© Cummings & Lockwood LLC 2011
PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
Exhibit A
Example 2 of Treasury Reg. Sect. 1.743-1(d)(3)
Tax
Land
Cash
Total
A
B
C
Fair market value on contribution date
Sale of partnership interest for fair market value by A
$$400
$2,000
$2,400
$$1,000
$2,000
$3,000
$$1,300
$2,000
$3,300
$400
$
$1,000
$1,000
$1,000
$
$1,000
$1,000
$1,100
$
$1,100
$1,100
Transferee's share of previously taxed capital:
Cash received on sale of assets for fair market value
Less: Gain allocated to transferee
Share of previously taxed capital
$1,100
$700 (Pre-contribution gain & post-contribution gain)
$400
Section 743(b) adjustment:
Outside basis of price paid for partnership interest
Less: Share of previous taxed capital
Amount of Section 743(b) adjustment to the basis of the land
$1,100
$400
$700
33
33
© Cummings & Lockwood LLC 2011
PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
Exhibit B
Example 2 of Treasury Reg. §1.755-1(b)(3)(iv): T buys A’s partnership interest for $110,000.
Capital gain property
Assett 1
A
Asset 2
Ordinary Income property
Asset 3
Asset 4
Adjusted
Basis
Fair Market Value
at time of contribution
$25 000
$25,000
$100,000
$50 000
$50,000
$100,000
$75 000
$75,000
$117,500
$192,500
$33,604
$33
604
$2,646
$36,250
$40,000
$10,000
$175 000
$175,000
$40,000
$10,000
$200 000
$200,000
$45,000
$2,500
$47 500
$47,500
$2,500
($3,750)
($1 250)
($1,250)
$240,000
$35,000
Total
Book Capital Accounts
A
B
$100,000
$100 000
$100,000
Fair Market
Value at time of sale
Basis
Adjustment
$120,000
$120 000
$120,000
Section 743(b) adjustment:
T's partnership basis
$110,000
Less: T's share of adjusted basis ($75,000)
partnership
pp
property
p y
in p
Adjustment
$35,000
Ordinary income adjustment
($1,250)
Capital gain adjustment
$36,250
Total capital gain
Asset 1
Asset 2
Total capital gain/Adjustment
$37,500
$
$8,750
$46,250
Adjustment
$33,604 ($37,500 -($10,000*$75,000/$192,500))
$
$2,646
($8,750-($10,000*$117,500/$192,500))
$
$
$
$
$36,250
34
34
© Cummings & Lockwood LLC 2011
PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
Exhibit C
Page C-1
Example of
complicated
adjustment for
an interest held
by a Grantor
Trust upon
death of
Grantor; value
of membership
interest
determined for
estate tax
purposes
purposes.
I.
Calculation of Section 743(b)
( ) Adjustment
j
to Trust
Step-up in basis of Company assets based on fair market value at date of death
Proportionate Share of Tax
Basis in Company's Assets
Gain recognized upon liquidation
Real Estate
Accrued Dividend
Sysco
Johnson & Johnson
Schering Plough
United Health Care
Cisco
Dover
Emerson
Bershire Hathaway A
Berkshire Hathaway B
$173,500
$173
500
$17,826,500
$17
826 500
0
$578
0
$37,129
0
$15,242
0
$10,379
0
$6,226
0
$18,306
0
$13,729
0
$11,295
0
$46,525
0
$30,462
$173,500
$18,016,371
(Stock contributed by children of grantor of Trust)
II. Trust
Trust'ss previously taxed capital:
Liquidation proceeds based on fair market value:
$19,100,813 *
Less: Gain recognized on liquidation
$18,016,371
Previously Taxed Capital
$1,084,442
III.
IV.
Code Section 743(b) Adjustment based on Fair Market Value:
Fair Market Value less IRD
Less: Previously Taxed Capital
Section 743(b) Adjustment
$19,100,235
$1 084 442
$1,084,442
$18,015,793
Code Section 743(b) Adjustment based on Estate Tax Audit:
Value of Membership Interest
Less: Income in respect of a Decedent
Tax basis of Membership Interest
Less: Trust's previously taxed capital
Section 743(b) Adjustment
$17,815,000
$578
$17,814,422
$1,084,442
$16,729,980
Code § 743(b) Basis Adjustment & Code § 755 Allocation
$17,826,500
$17
826 500
0
$37,129
$15,242
$10,379
$6,226
$18,306
$13,729
$11,295
$46,525
$30,462
$18,015,793
($19,100,813 -$578)
(Treas. Reg. Section 1.755-1(b)(4).)
* $19,100,813 (liquidating proceeds) = $20,609,423 (Fair Market Value of Company at date of death)*92.68% (Trust Percentage Interest)
35
35
© Cummings & Lockwood LLC 2011
PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
Exhibit C
Page C-2
Calculation of Section 743(b) basis adjustments to capital gain assets based on Fair Market Value must
must be reduced pro rata by $1,285,813 under Treasury Regulation Section 1.755-1(b)(3)(ii).
§ 743(b) adjustment based on FMV
Less: § 743(b) adjustment based on Estate
Tax Valuation
Amount to be allocated among assets
$18,015,793
$16 729 980
$16,729,980
$1,285,813
Code Section 743(b)
Adjustment based on FMV
Fair Market Value
Real Estate
Sysco
Johnson & Johnson
Schering Plough
United Health Care
Cisco
Dover
Emerson
Berkshire Hathaway A
Berkshire Hathaway B
$18,000,000
$188,564
$276,334
$65,400
$60,000
$326 250
$326,250
$98,063
$54,750
$227,800
$153,384
$19,450,545
$17,826,500
$37,129
$15,242
$10,379
$6,226
$18 306
$18,306
$13,729
$11,295
$46,525
$30,462
$18,015,793
Decrease*
Tentative
Section 755
Allocation
$1,189,922
$12,465
$18,268
$4,323
$3,966
$21 567
$21,567
$6,483
$3,619
$15,059
$10,140
$1,285,813
$16,636,577.87
$24,663.64
-$3,025.55
$6,055.62
$2,259.59
-$3
$3,261.34
261 34
$7,246.37
$7,675.65
$31,465.87
$20,322.28
$16,729,980.00
*Decrease to each asset is calculated as follows:
$1,285,813 x (Fair Market Value of each asset/$19,450,545 (Total Fair Market Value))
Note: Assets with respect to which transferee has no interest in income, gain, losses or deductions are not taken into account in
applying adjustment to basis under Code Section 755. Treas. Reg. Section 1.755-1(b)(3)(iii).
1.755 1(b)(3)(iii).
36
36
© Cummings & Lockwood LLC 2011
PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASIS
Exhibit C
Page C-3
Calculation of Section 755 Basis Adjustments Based On Code Section 743(b) Adjustment of $16,729,980
(A)
Proportionate Share of
Tax Basis in Sasco's Assets
Real Estate
Sysco
Johnson & Johnson
Schering Plough
United Health Care
Cisco
Dover
Emerson
Berkshire Hathaway A
Berkshire Hathaway B
(B)
Tentative
§ 755 Allocation
$173,500.00
0
0
0
0
0
0
0
0
0
$16,636,577.87
$24 663 64
$24,663.64
($3,025.55)
$6,055.62
$2,259.59
($3,261.34)
$$7,246.37
,
$7,675.65
$31,465.87
$20,322.28
$16,729,980.00
(C)
Adjustment for
Negative Decrease*
($6,249.83)
($9 17)
($9.17)
$3,025.55
($2.25)
($0.84)
$3,261.34
($2.69))
($
($2.85)
($11.70)
($7.56)
$0.00
(D)
§ 755 Allocation
((B)-(C))
$16,630,328.04
$24 654 47
$24,654.47
$0.00
$6,053.37
$2,258.75
$0.00
$$7,243.68
,
$7,672.80
$31,454.17
$20,314.72
$16,729,980.00
Column C: Treas. Reg. §1.755-1(b)(3)(iii)(B)
(Column B Positive Adjustment)
x
$6,289.89 (Total Value of Negative Adjustments)
(Total Column B Positive Adjustments
off $16,909,766.89)
$16 909 766 89)
37
37
© Cummings & Lockwood LLC 2011
Craig Taylor, Carruthers & Roth
SECT. 734(B) ADJUSTMENTS SECT
734(B) ADJUSTMENTS ON DISTRIBUTIONS FROM PARTNERSHIPS
Transactions Causing 734(b) Adjustments
• If a Sect. 754 election is in place, all of the following may give rise
to adjustments under Sect. 734(b):
39
•
Any distribution of cash when recipient recognizes gain
•
Any distribution of property where there is “lost basis”
•
Liquidating distributions when recipient recognizes loss
•
Liquidating distributions where there is “acquired basis”
M d
Mandatory 734(b) Adjustments
(b) Adj
• Even if a Sect. 754 election is NOT in place, under Sect. 732(d), the
following may require mandatory 734(b) adjustments:
40
•
A partner acquires a partnership interest by transfer when
no Sect. 754 election is in place, AND
•
That partner receives a distribution of property within two
years; OR
•
That partner receives a distribution of property at any
time, if at the time of the original transfer the FMV of noncash partnership property exceeded 110% of its inside basis
in the hands of the partnership.
Sect. 755 Allocation Of 734(b) Adjustments
To allocate basis adjustments required by Sect. 734(b), refer to Sect. 755 and Regulations
Sections 1.755-1(a) and (c):
41
•
p
p must determine the value of each of its assets,, using
g the
First,, the partnership
rules in Regulations Sect. 1.755-1(a). Note the specific rules for treatment of
Sect. 197 intangibles in Regulations Sect. 1.755-1(a)(5)
•
Second,, in g
general,, basis adjustments
j
arising
g ((i)) from distributions of capital
p
gain property are allocated to capital assets and Sect. 1231(b) property; and (ii)
from distributions of ordinary income property to any other property of the
partnership (ordinary income property). Properties and potential gain treated
as unrealized receivables under Sect. 751(c) are treated as separate assets that
are ordinary income property.
•
Third, allocate basis adjustments within each class using the rules in
Regulations Sect. 1.755-1(c)
Sect. 755 Allocation Of 734(b) Adjustments (Cont.)
• Sect. 755 and Regulations Sect. 1.755-1(a) and (c) contain certain special rules, including
the following:
42
•
A basis adjustment resulting from the recognition of gain on a cash distribution
or from a loss from the distribution of cash
cash, unrealized
unreali ed recei
receivables
ables or inventory,
in entor
must be allocated to the partnership capital gain property. Regulations Sect.
1.755-1(c)(1)(ii)
•
Within a class,
class basis increases due to “lost basis“
basis are allocated first to properties
with unrealized appreciation up to and in proportion with their respective
unrealized appreciation. Any excess is allocated among all properties in the class
in proportion to FMV. Regulations Sect. 1.755-1(c)(2)
•
Within a class, basis decreases due to “acquired basis” are allocated first to
properties with unrealized depreciation up to and in proportion with their
respective amounts of unrealized depreciation. Any excess is allocated among
all the properties within the class in proportion to their adjusted basis (after
taking into account the first allocation). Regulations Sect. 1.755-1(c)(2)
Sect. 755 Allocation Of 734(b) Adjustments (Cont.)
• 734(b) basis adjustment special rules (Cont.)
43
•
If a decrease in basis is required and the basis adjustment exceeds
the remaining basis in the assets in a class,
class the assets are reduced
to zero, but not below zero. The unused basis is carried forward
until such time as the partnership acquires new property in the
class. This is contrary to the Sect. 755 rules for death, sales or
exchanges
h
that
h require
i excess capital
i l gain
i decreases
d
to be
b applied
li d
against ordinary income assets. Sect. 755(b)
•
When an increase or decrease in the basis of undistributed
property cannot be made because the partnership owns no
property of the character required to be adjusted, the adjustment is
made when the partnership acquires property of a like character to
which
hi h an adjustment
dj t
t can be
b made.
d Regulations
R
l ti
S
Sect.
t 11.755-1(c)(4)
755 1( )(4)
Calculation Of 734(b) Basis Adjustment
EXAMPLE 1: Distribution of cash
Partner D has an outside basis of $25,000 in the DEF Partnership. Partner D receives
a distribution of $40
$40,000.
000 This is the balance sheet of DEF Partnership:
Cash
Inventory
Investments
44
Adjusted Basis
$ 60,000
$ 27,000
$ 13,000
$100,000
FMV
$ 60,000
$ 30,000
$ 70,000
$160,000
Calculation Of 734(b) Basis Adjustment (Cont.)
EXAMPLE 1: Distribution of cash result
Partner D realizes a gain of $15,000 = $40,000 cash distribution less $25,000 basis
Under Sect. 734(b), DEF Partnership is entitled to increase its inside basis in its
assets by $15,000.
Under Sect. 755, the basis adjustment is allocated to the same property class as that
in which the distributed property is included. Under the special rule of Regulations
Sect. 1.755-1(c)(1)(ii), inside basis adjustments due to distributions of cash in excess
of basis must be allocated to capital gain property.
Therefore, DEF Partnership must allocate the $15,000 increase in inside basis to the
investments.
45
Calculation Of 734(b) Basis Adjustment (Cont.)
EXAMPLE 2: Liquidating distribution of real estate
Partner A owns a 40% interest in ABC Partnership with an outside basis of $28,000.
ABC Partnership liquidates Partner A
A’ss interest by distributing land (Tract 2) with
an adjusted basis of $30,000 and FMV of $40,000. ABC Partnership’s balance sheet is
as follows:
Cash
A/R
Land – Tract 1
Land – Tract 2
Land – Tract 3
46
Adjusted Basis
$ 10,000
$ 5,000
$ 5,000
$ 30,000
$ 20,000
$ 70,000
FMV
$ 10,000
$ 5,000
$ 25,000
$ 40,000
$ 20,000
$100,000
Calculation Of 734(b) Basis Adjustment (Cont.)
EXAMPLE 2 : Liquidating distribution of real estate result
g $2,000 in “lost
Partner A would have a basis in Tract 2 of $28,000, causing
basis.”
If a Sect. 754 election is place, ABC Partnership must increase its basis in
its assets by $2,000. The property distributed was capital gain property
(real estate). Accordingly, the $2,000 upward basis adjustment is allocated
to capital
p
g
gain p
property
p y – Tracts 1 and 3. Sect. 755(b)
( )
Tract 1 is the only asset with unrealized appreciation, so all $2,000 must be
allocated to Tract 1. Sect. 755(a)(1)
47
Calculation Of 734(b) Basis Adjustment (Cont.)
EXAMPLE 3: Liquidating distribution of real estate
Partner D purchases Partner A’s 40% interest in ABC Partnership for $40,000. Then,
ABC Partnership liquidates Partner D
D’ss interest by distributing land (Tract 2) with
an adjusted basis of $30,000 and FMV of $40,000. ABC Partnership’s balance sheet is
as follows:
Adjusted Basis
FMV
Cash
$ 10,000
$ 10,000
A/R
$ 5,000
$ 5,000
Land – Tract 1
$ 5,000
$ 25,000
Land – Tract 2
$ 30,000
$ 40,000
$ 20,000
Land – Tract 3
$ 25,000
$ 75,000
$100,000
N t FMV off partnership
Note:
t
hi assets
t iis greater
t than
th 110% off b
basis
i att ti
time off ttransfer.
f
48
Calculation Of 734(b) Basis Adjustment (Cont.)
EXAMPLE 3: Liquidating
q
g distribution of real estate result
Partner A would have a basis in Tract 2 of $40,000, causing $10,000 in “acquired
basis.”
Because FMV exceeded basis by
y more than 110% at time of transfer, Sect. 732(d)
( )
requires a Sect. 734(b) adjustment, even if no Sect. 754 election is in place.
ABC Partnership must decrease its basis in its assets by $10,000. The property
distributed was capital
p
g
gain p
property
p y ((real estate).
) Accordingly,
g y the $10,000
downward basis adjustment is allocated to capital gain property – Tracts 1 and 3.
Sect. 755(b)
Tract 3 is the only
y asset with unrealized depreciation,
p
so the adjustment
j
is first
allocated to Tract 3 to the extent of the unrealized depreciation ($5,000).
Regulations Sect. 1.755-1(c)(2)(ii)
g $5,000 decrease is allocated between Tract 1 and Tract 3 in
The remaining
proportion to their inside basis, taking into account the first allocation to Tract 3.
Regulations Sect. 1.755-1(c)(2)(ii) (see next slide)
49
Calculation Of 734(b) Basis Adjustment (Cont.)
EXAMPLE 3 result (Cont.)
The remaining $5,000 decrease is allocated between Tract 1 and Tract 3 in proportion to their
inside basis, taking into account the first allocation to Tract 3. Regulations Sect. 1.755-1(c)(2)(ii)
Tract 1:
Tract 3:
Total
50
Starting
Basis
$ 5,000
$20,000
$
$25,000
Percentage
Adjustment
$5,000/$25,000 = 20% $5,000*20% = $1,000
$20,000/$5,000 = 80% $5,000*80% = $4,000
Final Basis
$ 4,000
$16,000
$
$20,000
Craig Gerson, PricewaterhouseCoopers
COLLECTED ISSUES AND NUANCES OF PARTNERSHIP BASIS ADJUSTMENTS
Collected Issues Involving Basis Adjustments
Agenda for this section
•
Basis adjustments and partnership technical terminations
•
Adjustments to the basis of stock of a corporate partner
•
Contingent liabilities and allocations of basis adjustments
Section 754 and Basis Adjustments
PwC
52
Basis Adjustments And Technical Terminations
Technical terminations generally:
•
•
•
•
Partnership technical termination occurs when partners sell or
exchange 50% or more of interests in partnership profits and
capital within a 12-month period.
Limited federal income tax consequences
Partnership elections reset
New partner gets basis adjustment if original partnership has
Sect. 754 election or if the new partnership makes an election.
Section 754 and Basis Adjustments
PwC
53
Basis Adjustments And Technical
Terminations (Cont.)
C
Deemed steps:
• Contribution of
assets/liabilities to new
partnership
•
Distribution of new
partnership interests to
continuing partners in
liquidation of old partnership
Sale
A
50%
50%
B
Old
Assets &
Liabilities
New
Section 754 and Basis Adjustments
PwC
54
Basis
as s Adjustments
djust e ts And
d Technical
ec
ca
Terminations (Cont.)
Basis adjustment allocation
in taxable transaction
Basis adjustment allocation in
non recognition transaction
non-recognition
•
Bi-directional adjustments permitted
(increasing basis of some assets and
(decreasing basis of other assets)
•
Single directional adjustments okay
•
Adjustments permitted when net
allocation is zero
•
No adjustments permitted when net
allocation is zero
Section 754 and Basis Adjustments
PwC
55
Basis Adjustments And Technical
Terminations (Cont.)
Taxable exchange
g
C
Sale
A
50%
50%
B
Old
Non-recognition
g
exchange
g
Assets &
Liabilities
i bili i
New
Section 754 and Basis Adjustments
PwC
56
Basis Adjustments And Technical
Terminations (Cont.)
•
Arguably, purchasing partners can elect which basis adjustment
allocation scheme to apply by choosing whether to elect under
Sect. 754 for the new partnership.
•
By purchasing an interest and subsequently transferring the
interest in a non-recognition transaction (e.g., a Sect. 351
transaction), the partner might avoid a decrease to the basis of
assets if the partnership is allocating a positive basis adjustment.
Section 754 and Basis Adjustments
PwC
57
Basis Adjustments And Technical
Terminations (Cont.)
Example
• C purchases A’s partnership interest and receives a basis
adjustment of $100. The partnership has two assets: Asset #1
partnership
p would
and Asset #2. On a sale of these assets, the p
allocate
ll
gain off $140 to C ffrom Asset #1 and
d lloss off $40 to C
from Assets #2.
Asset #1
Asset #2
Section 754 and Basis Adjustments
PwC
Allocation
All
i
on sale
Allocation
All
i on
_distribution_
$140
($ 40)
$100
-
58
Adjustments To Basis Of Stock
Of Corporate Partner
•
Prior to 2004, partners could duplicate losses by disposing of
partnership interest in a loss transaction and stepping down the
partnership
p
p basis of p
partner stock.
•
Loss transaction examples:
• Sale of interest for loss
• Redemption of interest for cash for loss
• Redemption of interest for property, increasing basis in
distributed property
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Adjustments To Basis Of Stock Of
Corporate Partner (Cont.)
•
After reducing the basis of stock, partnership could distribute
stock to corporate partner,
partner which could liquidate distributed
company while retaining high basis in underlying assets.
•
To prevent this result,
result Congress enacted Sect.
Sect 755(c) in 2004
2004.
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Adjustments To Basis Of Stock Of
Corporate Partner (Cont.)
•
•
•
•
Sect. 755(c) limits the ability of partnership to reduce basis of
stock in “corporate partner.”
• Corporate partner is defined broadly to include any related
person under sections 267(b) or 707(b)(1).
Basis reductions that would be applied against stock basis must
instead reduce basis of other partnership assets.
Partnership recognizes a gain if it does not hold other assets
with sufficient basis.
Partnership with gain under Sect. 755(c) should consider
whether
h th b
better
tt results
lt can b
be achieved
hi d under
d S
Sect.
t 732(f).
(f)
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Adjustments To Basis Of Stock Of
Corporate Partner (Cont.)
Example:
• Asset 1 distributed to Sub 2
in redemption of its interest.
PY
S b1
Sub
S b2
Sub
49%
AB = 100
• Reduction to CFC stock is
disallowed under Sect. 755(c).
• Partnership has no other assets, so it
must recognize a $100 gain.
gain
Section 754 and Basis Adjustments
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LLC
CFC
Asset 1
AB = $100
AB = $0
FMV = $100
FMV = $100
62
Basis Adjustments And Contingent Liabilities
Contingent liabilities generally:
•
•
Partnership “contingent” liabilities are obligations that have not
yet given rise to basis or a deduction for tax purposes.
purposes
Examples:
• Employee benefits
• Commercial
C
i l or ttortt claims
l i
• Environmental remediation
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Basis Adjustments And Contingent
Liabilities (Cont.)
Liabilities and Sect
Sect. 743(b) basis adjustments
•
•
Ordinary partnership tax liabilities do not affect partnership
basis adjustments under Sect
Sect. 743(b)
Sect. 743(b) adjustment equals:
• Outside basis (inclusive of allocated liabilities),
less
• Previously taxed capital plus allocated liabilities.
• Sect. 752 liabilities cancel each other out in this equation.
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Basis Adjustments And Contingent
Liabilities (Cont.)
Liabilities and Sect. 743(b) basis adjustments (Cont.)
•
•
•
The effect
Th
ff
off contingent
i
obligations
bli i
on partnership
hi b
basis
i
adjustments under Sect. 743(b) is less clear.
Contingent obligations are not treated as “liabilities,” for
purposes of calculating Sect.
Sect 743(b) adjustment
adjustment.
However, a contingent obligation may function as a “negative
asset,” which would reduce the basis adjustment amount.
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Basis Adjustments And Contingent
Liabilities (Cont.)
Is a contingent obligation a “partnership asset”?
•
TR 1.752-7(b)(3)
(b)( ) provides
id that
h a contingent
i
li
liability
bili iis one that
h
has not given rise to tax basis or a deduction.
•
TR 1.752-7(c)
( ) provides
id th
thatt sections
ti
704(b)
(b) and
d 704(c)
( ) apply
l tto
contingent liabilities.
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Basis Adjustments And Contingent
Liabilities (Cont.)
If the contingent obligation is a partnership asset
asset, it affects the
calculation of the step up:
Example: Assume $100 purchase of partnership interest; purchaser’s
g
liability.
y
share of asset has $120 value, $60 basis, $20 contingent
Treated as Asset
Not Treated as Asset
Outside Basis
Less sum of:
Cash on liquidation
l
less
gain
i iin assets
t
plus loss in assets
Sect. 743(b) adjustment
Section 754 and Basis Adjustments
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$100
$100
$80
($60)
$20
($40)
$60
$80
($60)
-__
($20)
$80
67
Basis Adjustments And Contingent
Liabilities (Cont.)
•
The treatment of the contingent obligation also affects the
allocation of the adjustment in the partnership.
•
The regulations under Sect. 755 describe allocations of basis
adjustments to “partnership
partnership property.
property.”
•
A contingent liability functions like a negative built-in loss
asset.
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Basis Adjustments And Technical Terminations
Example
• C receives a basis adjustment of $100 on the purchase of a
partnership interest. The partnership has one asset, Asset #1. On a
sale of this asset, the partnership would allocate gain of $140 to C. In
addition, the partnership has a contingent liability which, when paid,
will generate a $40 deduction to C.
C
Treated as Property
Not Treated as Property
Asset #1
Contingent liability
$140
($ 40)
$100
-_
Total adjustment
$100
$100
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Basis Adjustments And Contingent
Liabilities (Cont.)
Should the contingent liability be treated as partnership “property”?
property ?
Yes?
• Treating contingent liability as
property is most consistent
with purpose of basis
adjustment and allocation
rules.
No?
• Sect. 755 applies to “property”,
and Sect. 743(b) applies to
assets; neither applies
pp
to
partnership obligations.
• TR 11.752-7
752-7 treats contingent
liability as built-in loss
property.
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