BASIS ADJUSTMENTS RELATING TO TRANSFER OF PARTNERSHIP
INTERESTS/DISTRIBUTIONS
I.
Section 754.
A.
Introduction. Code §754 is an important, but optional provision which permits a
partnership to file an election which will allow it to adjust the basis of partnership property in the
event of certain distributions (in accordance with Section §734) or allow a partner to adjust the
basis of his share of partnership assets in the event of a transfer of a partnership interest (in
accordance with Section 743). Absent a §754 election, there is no authority to adjust the basis of
partnership assets directly as a result of distributions and transfers.
B.
The Election. The election is made for the first year that it is desired on the return
for that year. Once made, the election applies with respect to all distributions of property by the
partnership, and to all transfers of interests in the partnership, during the taxable year with
respect to which such election was filed and all subsequent taxable years. Although a §754
election may be revoked by the partnership, the revocation is subject to strict regulatory limits.
II.
Section 743.
A.
Transfers of Interests: The Section 743(b) Adjustment. IN THE CASE OF A
TRANSFER OF A PARTNERSHIP INTEREST, THE §754 ELECTION GIVES RISE TO
A §743(B) ADJUSTMENT IF THE OUTSIDE BASIS OF THE TRANSFEREE
PARTNER IS MORE OR LESS THAN THE INSIDE BASIS OF THE PARTNERSHIP.
This may result in a positive or negative 743(b) adjustment. Under §743(b), the effect of
the inside basis adjustment is solely for the benefit (or detriment) of the transferee partner and
not the partnership or the other partners.
EXAMPLE #1
Assume that Partnership ABC has the following balance sheet. The partnership has a
§754 election in effect when X agrees to buy A’s interest for $100,000 cash.
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Partnership ABC
Cash
Stock
Total Assets
A
B
C
Total Capital
Tax Basis
$110,000
160,000
270,000
90,000
90,000
90,000
$270,000
Book Value
$110,000
190,000
300,000
100,000
100,000
100,000
$300,000
Since the §754 election is in effect, a §743(b) adjustment of $10,000 will be
made. As provided in §755, the adjustment will result in a increase to the
partnership’s basis in the stock of $10,000, but only for the benefit of X. This
adjustment is normally kept as a memo account for the benefit of X and not on the
partnership's balance sheet. Note that the election/adjustment has no impact on
X’s capital account, which is "inherited" from A. Nor does the election impact B
or C. The adjustment for X should be kept in a memo account for X and should
not be reflected on the partnership’s books. The balance sheet for the partnership
remains the same.
EXAMPLE #2
Assume that same facts as in Week 11, Example 1, except that 1 month after X’s
admission, the partnership sells the stock for $220,000. Since the partnership has
$60,000 gain without regard to the §743(b) adjustment ($220,000 - $160,000), it
will allocate $20,000 gain to each of the partners. As to X only, his $20,000 gain
allocation will be reduced by the $10,000 §743(b) adjustment to basis, so that X
reports only $10,000 gain.
EXAMPLE #3
Assume that same facts as Example 1, except that the partnership never made a
§754 election. In this situation, no basis adjustment is permitted to reflect X’s
purchase of A’s interest, and if the stock is subsequently sold for $220,000, X will
be allocated and must report his full 1/3 share of the $60,000 gain, that is $20,000.
The only time X will recover the additional $10,000 of "outside basis" will be on
liquidation of the partnership.
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III.
Determination of Amount of Adjustments Under § 743.
A.
General Rule. The §743 regs provide:
A transferee’s share of the adjusted basis of partnership property is equal to the
sum of the transferee’s interest as a partner in the partnership’s previously taxed
capital, plus the transferee’s share of partnership liabilities. Generally, a
transferee’s interest as a partner in the partnership’s previously taxed capital is
equal to-(i) The amount of cash that the transferee would receive on a liquidation of the
partnership following the "Hypothetical Transaction," (to the extent attributable to
the acquired partnership interest); increased by
(ii) The amount of tax loss (including any remedial allocations under §1.7043(d)), that would be allocated to the transferee from the Hypothetical Transaction
(to the extent attributable to the acquired partnership interest); and decreased by
(iii) The amount of tax gain (including any remedial allocations under §1.7043(d)), that would be allocated to the transferee from the Hypothetical Transaction
(to the extent attributable to the acquired partnership interest).
B.
Hypothetical Transaction Defined. The Hypothetical Transaction is defined as an
imaginary disposition by the partnership of all of the partnership’s assets, immediately after the
transfer of the partnership interest, in a fully taxable transaction for cash equal to the fair market
value of the assets. (§1.743-1(d)(2))
EXAMPLE #4
A is a member of partnership PRS in which the partners have equal interests in
capital and profits. The partnership has made an election under section 754,
relating to the optional adjustment to the basis of partnership property. A sells its
interest to T for $22,000. The balance sheet of the partnership at the date of sale
shows the following:
Assets
Cash
Accounts Receivable
Inventory
Depreciable Assets
Total
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Adjusted Basis
$5,000
10,000
20,000
20,000
$55,000
3
Fair Market Value
$5,000
10,000
21,000
40,000
$76,000
Liabilities and
Capital
Liabilities
Capital:
A
B
C
Total
Adjusted Per Books
$10,000
15,000
15,000
15,000
$55,000
Fair Market Value
$10,000
22,000
22,000
22,000
$76,000
The amount of the basis adjustment under section 743(b) is the difference
between the basis of T’s interest in the partnership and T’s share of the adjusted
basis to the partnership of the partnership’s property. Under section 742, the basis
of T’s interest is $25,333 (the cash paid for A’s interest, $22,000, plus $3,333, T’s
share of partnership liabilities). T’s interest in the partnership’s previously taxed
capital is $15,000 ($22,000, the amount of cash T would receive if PRS liquidated
immediately after the hypothetical transaction, decreased by $7,000, the amount
of tax gain allocated to T from the hypothetical transaction). T’s share of the
adjusted basis to the partnership of the partnership’s property is $18,333 ($15,000
share of previously taxed capital, plus $3,333 share of the partnership’s
liabilities). The amount of the basis adjustment under section 743(b) to
partnership property therefore, is $7,000, the difference between $25,333 and
$18,333.
Professor Hint: This is a funny way of saying the adjustment is equal to the
difference between the Book Value (restated as of the date of the transfer) of the
selling partner's capital account and the tax basis capital account of the selling
partner subject to 704c adjustments. In this example, $22,000 - $15,000 = $7,000.
EXAMPLE #5
A, B, and C form partnership PRS, to which A contributes land (Asset 1) with a
fair market value of $1,000 and an adjusted basis to A of $400, and B and C each
contribute $1,000 cash. Each partner has $1,000 credited to it on the books of the
partnership as its capital contribution. The partners share in profits equally.
During the partnership’s first taxable year, Asset 1 appreciates in value to $1,300.
A sells its one-third interest in the partnership to T for $1,100, when an election
under section 754 is in effect. The amount of tax gain that would be allocated to T
from the hypothetical transaction is $700 ($600 section 704(c) built-in gain, plus
one-third of the additional gain). Thus, T’s interest in the partnership’s previously
taxed capital is $400 ($1,100, the amount of cash T would receive if PRS
liquidated immediately after the hypothetical transaction, decreased by $700, T’s
share of gain from the hypothetical transaction). The amount of T’s basis
adjustment under section 743(b) to partnership property is $700 (the excess of
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$1,100, T’s cost basis for its interest, over $400, T’s share of the adjusted basis to
the partnership of partnership property).
At the time of T’s entry, the PRS balance sheet was:
PRS Assets
Cash
Land
Total
Liabilities and
Capital
Liabilities
Capital:
A
B
C
Total
Adjusted Basis
$2,000
400
$2,400
Fair Market Value
$2,000
1,300
$3,300
Adjusted Per Books
$ -0-
Fair Market Value
$ -0-
400
1,000
1,000
$2,400
1,100
1,100
1,100
$3,300
If you simply assume T is a 1/3 partner upon entrance, then his underlying share
of partnership basis would appear to be $2,400/3, or $800, resulting in a $300
743(b) adjustment, since T paid $1,100 for his interest. But, because of the way
that the 704(b) requires 704( c) gains to be allocated arising from A’s original
contribution of property with $600 built in gain potential, T’s immediate potential
tax gain is $700 (the $600 704(b)/704( c) gain "acquired" from A, plus 1/3 of the
$300 additional gain arising from the land’s appreciation while held by the
partnership.
IV.
Special Situations Under § 743.
A.
What happens if a transferee’s special basis adjustment property is distributed to
the transferee? If a partnership distributes property to a transferee and the transferee has a basis
adjustment for the property, the basis adjustment is taken into account for purposes of the
property distribution basis rules of section 732. See §1.732-2(b).
B.
What happens if a transferee’s special basis adjustment property is distributed to
another partner? A transferee with a basis adjustment in property that is distributed to another
partner reallocates the basis adjustment among the remaining items of partnership property under
§1.755-1(c).
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C.
What happens if a transferee receives liquidating property distributions? If a
transferee receives a distribution of property (whether or not the transferee has a basis adjustment
in such property) in liquidation of its interest in the partnership, the adjusted basis to the
partnership of the distributed property immediately before the distribution includes the
transferee’s basis adjustment for the property in which the transferee relinquished an interest
(either because it remained in the partnership or was distributed to another partner). Any basis
adjustment for property in which the transferee is deemed to relinquish its interest is reallocated
among the properties distributed to the transferee under §1.755-1(c).
V.
Section 734.
A.
NO
ADJUSTMENT
RULE.
DISTRIBUTIONS
OF
PARTNERSHIP
PROPERTY TO PARTNERS, LIKE CORPORATE DISTRIBUTIONS OF PROPERTY TO
SHAREHOLDERS, GENERALLY DO NOT AFFECT THE BASIS OF UNDISTRIBUTED
PROPERTY.
EXAMPLE #6
Assume the balance sheet of the equal ABC partnership is as follows:
Assets
Cash
Blackacre
Total Assets
Capital
A
B
C
Total Capital
Adjusted Basis
$2,000
1,000
$3,000
$1,000
1,000
1,000
$3,000
Fair Market Value
$2,000
4,000
$6,000
$2,000
2,000
2,000
$6,000
Assume that A receives cash of $2,000 in complete liquidation of his interest,
recognizing gain of $1,000. Under the general rule of §734(a), the basis of the
partnership property is not adjusted to reflect the recognition of this gain by A,
and on a subsequent sale of Blackacre for $4,000, an additional gain of $3,000 is
realized and taxed to partners B and C, causing each to recognize taxable income
of $1,500 instead of $1,000. This will result in an outside basis adjustment to B
and C which will be reconciled on liquidation of the Partnership.
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VI.
Optional Adjustment Rule of §734(b)
A.
Election. If the partnership makes a valid § 754 election it may adjust the basis of
its assets to reflect gain or loss to a partner arising from partnership distributions. This is a
partnership basis adjustment, not a partner basis adjustment.
B.
METHOD OF ADJUSTING BASIS. THE AMOUNT OF THE § 734(B)
ADJUSTMENT IS DETERMINED AS FOLLOWS:
1.
IF AN AMOUNT OF MONEY IS DISTRIBUTED WHICH EXCEEDS
THE DISTRIBUTEE'S PREDISTRIBUTION BASIS IN HIS PARTNERSHIP INTEREST,
THE DISTRIBUTEE RECOGNIZES GAIN IN THE AMOUNT OF THE EXCESS UNDER
§731(A)(1), AND THE PARTNERSHIP IS ENTITLED TO INCREASE THE BASIS OF ITS
REMAINING ASSETS BY A LIKE AMOUNT UNDER §734(B)(1)(A).
2.
IF A PARTNERSHIP INTEREST IS COMPLETELY LIQUIDATED
SOLELY IN EXCHANGE FOR CASH, UNREALIZED RECEIVABLES (§751(C))) AND
INVENTORY (§751(D)(2)), THE DISTRIBUTEE RECOGNIZES A LOSS UNDER
§731(A)(2) IF THE PREDISTRIBUTION BASIS OF HIS PARTNERSHIP INTEREST
EXCEEDS THE AMOUNT OF CASH AND THE PARTNERSHIP’S ADJUSTED BASIS OF
THE
UNREALIZED
RECEIVABLES
AND
INVENTORY
DISTRIBUTED,
THEN
§734(B)(2)(A) REQUIRES THE PARTNERSHIP TO DECREASE THE BASIS OF ITS
REMAINING ASSETS BY THE AMOUNT OF THE LOSS.
3.
PARTNER
IF THE PARTNERSHIP'S BASIS IN ASSETS DISTRIBUTED TO A
EXCEEDS
THE
DISTRIBUTEE'S
BASIS
IN
HIS
INTEREST,
THE
DISTRIBUTEE'S AGGREGATE BASIS IN THE DISTRIBUTED ASSETS IS LIMITED TO
HIS PREDISTRIBUTION BASIS IN HIS PARTNERSHIP INTEREST UNDER §§732(A)(2)
AND 732(B), THEN §734(B)(1)(B) ALLOWS THE PARTNERSHIP TO INCREASE THE
BASIS OF ITS REMAINING ASSETS BY AN AMOUNT EQUAL TO THE EXCESS OF
THE PARTNERSHIP'S ADJUSTED BASIS IN ITS ASSETS OVER THE DISTRIBUTEE'S
ADJUSTED BASIS IN THEM.
4.
IF A PARTNER'S INTEREST IS COMPLETELY LIQUIDATED AND
THE AGGREGATE BASIS OF DISTRIBUTED ASSETS IN HIS HANDS IS GREATER
THAN THE PARTNERSHIP'S PREDISTRIBUTION BASIS IN THE ASSETS, THEN THE
PARTNERSHIP'S BASIS IN ITS REMAINING ASSETS IS DECREASED UNDER
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§734(B)(2)(B) BY THE EXCESS OF THE DISTRIBUTEE'S BASIS IN THE DISTRIBUTED
ASSETS OVER THE PARTNERSHIP'S PREDISTRIBUTION BASIS IN THEM.
EXAMPLE #7
Assume the same facts as in Week 11, Example 6.
If a §754 election had been in effect with respect to the cash distribution to A in
the example set forth above, the partnership's basis in asset X would have been
increased under §734(b)(1)(A) by the $1,000 gain recognized by A. A subsequent
sale of assets by X would have generated gain taxable to B and C of $1,000 each.
C.
Distributions of Property. The basis of property distributed in a current
distribution is generally the same in the hands of the distributee as it was in the hands of the
partners (§732(a)(1)), and §734(b) has no impact on the basis of the remaining partnership assets
in connection with such distributions except under§732(a)(2) which limits the basis of property
received in a current distribution to the distributee’s outside basis. Similarly, in the case of a
liquidating distribution, the basis of distributed property may be increased or decreased under
§732(b) to equate to the distributee’s outside basis. TO THE EXTENT THE BASIS OF
DISTRIBUTED ASSETS IS DECREASED UNDER EITHER OF THESE EXCEPTIONS TO
THE
GENERAL
CARRYOVER—BASIS
RULE,
THE
BASIS
OF
REMAINING
PARTNERSHIP ASSETS IS INCREASED UNDER §734(B)(1)(B); TO THE EXTENT THE
BASIS OF THE DISTRIBUTED ASSETS IS INCREASED, THE BASIS OF THE RETAINED
ASSETS IS DECREASED UNDER §734(B)(2)(B).
EXAMPLE #8
Assume the balance sheet of partnership DEF is as follows:
Assets
Cash
Capital Asset X
Capital Asset Y
Total Assets
Capital
D
E
F
Total Capital
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Adjusted Basis
$ 4,000
11,000
15,000
$30,000
$10,000
10,000
10,000
$30,000
8
Fair Market Value
$ 4,000
11,000
18,000
$33,000
$11,000
11,000
11,000
$33,000
If D receives asset X in complete liquidation of his partnership interest, his basis
in X is $10,000 under §732(b), or $1,000 less than the partnership's basis.
Consequently, if the partnership makes a §754 election, it is entitled to increase
the basis of its remaining assets by $1,000 under §734(b)(1)(B). This increase is
allocated to Capital Asset Y under §755, and the partnership's post-distribution
balance sheet is as follows:
Assets
Cash
Capital Asset Y
Total Assets
Capital
E
F
Total Capital
VII.
Adjusted Basis
$ 4,000
16,000
$20,000
10,000
10,000
$20,000
Fair Market Value
$4,000
18,000
$22,000
11,000
11,000
$22,000
Section 755.
A.
Introduction. IRC § 755 provides for two different methods of allocation of basis
adjustments depending on whether the transaction falls under § 734 or § 743. As mentioned
above, § 743 applies to transfers of partnership interest, whereas § 734 applies to distributions
from a partnership to a partner.
B.
Capital Assets vs. Ordinary Income Assets. To make the allocation under § 755
and without regard to whether § 743 or § 734 is involved, a division first must be made on the
partnership books between Capital Assets and § 1231 Assets (collectively "Capital Gain
Property") and any other partnership property ("Ordinary Income Property"). In the case of a
transaction under IRC § 743, the gain or loss on a sale of a partnership interest is then allocated
proportionately between the classes based on the net gain or net loss within each class. In the
case of a transaction under § 734, the character of the property distributed is first identified as
Capital Gain Property or Ordinary Income Property. The basis adjustment to the partnership
assets occurring from the distribution is generally restricted to the same class of property (Capital
or Ordinary) as was distributed by the partnership.
C.
Hypothetical Transaction. Under § 755, the regulations use what is called a
"Hypothetical Transaction." Pursuant to the regulations, the Hypothetical Transaction is the
amount of income, gain, or loss (including remedial allocations under § 1.704-3(d) that the
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transferee partner would receive (to the extent attributable to the acquired partnership interest) if,
immediately after the transfer of the partnership interest, all of the partnership’s property were
disposed of in a fully taxable transaction for cash in an amount equal to the fair market value of
such property. By this the regulations mean that the amount of gain or loss for each class of
Capital Gain Property or Ordinary Income Property based on an ASSUMED SALE by the
partnership of all the properties for fair market value. To determine the amount of gain or loss
allocable to each partner, the provisions of IRC § 704 control.
D.
Section 743 - Allocation of Basis Adjustment Between Capital Gain Property and
Ordinary Income Property.
EXAMPLE #9
A and B form equal partnership AB. A contributes $50,000 in cash and Asset 1, a
nondepreciable capital asset with a fair market value of $50,000 and an adjusted
tax basis of $25,000. B contributes $100,000. AB uses the cash to purchase Assets
2, 3, and 4. After a year, A sells its interest in AB to T for $120,000. At the time
of the transfer, A’s share of the partnership’s basis in partnership assets is
$75,000. Therefore, T receives a $45,000 basis adjustment.
Immediately after the transfer of the partnership interest to T, the adjusted basis
and fair market value of AB’s assets are as follows:
Assets
Capital Gain Property:
Asset 1
Asset 2
Ordinary Income Property:
Asset 3
Asset 4
Total
Adjusted Basis
Fair Market Value
$25,000
100,000
75,000
117,500
40,000
10,000
$175,000
45,000
2,500
$240,000
If AB sold all of its assets in a fully taxable transaction at fair market value
immediately after the transfer of the partnership interest, the total amount of
capital gain that would be allocated to T is equal to $46,250 ($25,000 § 704(c)
built-in gain from Asset 1, plus 50 percent of the $42,500 appreciation in Capital
Gain Property). T would also be allocated a $1,250 ordinary loss from the sale of
the Ordinary Income Property.
The amount of the basis adjustment that is allocated to Ordinary Income Property
is equal to ($1,250) (the amount of the loss allocated to T from the hypothetical
sale of the Ordinary Income Property).
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The amount of the basis adjustment that is allocated to Capital Gain Property is
equal to $46,250. This is computed by taking the total basis adjustment of
$45,000 increased by the $1,250 ordinary loss attributable to the hypothetical sale
of the Ordinary Income Property.
VIII. Section 743 - Specific Rules for the Allocations Within the Items Comprising each
Class of Property.
The regulations provide as follows:
A.
Allocation Within the Class.
(1) Ordinary Income Property. The amount of the basis adjustment to
each item of property within the class of Ordinary Income Property is equal to:
(a) The amount of income, gain or loss (including any remedial
allocations under § 1.704-3(d)) that would be allocated to the transferee (to the
extent attributable to the acquired partnership interest) from the hypothetical sale
of the item; reduced by
(b) The product of:
(i) Any decrease to the amount of the basis adjustment to
Ordinary Income Property required pursuant to the last sentence of Reg. § 1.7552(b)(i); multiplied by
(ii) A fraction, the numerator of which is the fair market
value of the item of property to the partnership and the denominator of which is
the total fair market value of all of the partnership’s items of Ordinary Income
Property.
(2) Capital Gain Property. The amount of the basis adjustment to each
item of property within the class of Capital Gain Property is equal to:
(a) The amount of income, gain, or loss (including any remedial
allocations under § 1.704-3(d)) that would be allocated to the transferee (to the
extent attributable to the acquired partnership interest) from the hypothetical sale
of the item: minus
(b) The product of:
(i) The total amount of gain or loss (including any
remedial allocations under § 1.704-3(d)) that would be allocated to the transferee
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(to the extent attributable to the acquired partnership interest) from the
hypothetical sale of all items of Capital Gain Property, minus the amount of the
positive basis adjustment to all items of Capital Gain Property or plus the amount
of the negative basis adjustment to Capital Gain Property; multiplied by
(ii) A fraction, the numerator of which is the fair market
value of the item of property to the partnership, and the denominator of which is
the fair market value of all of the partnership’s items of Capital Gain Property.
EXAMPLE #10
(i) Assume the same facts as Example 9. Of the $45,000 basis adjustment,
$46,250 was allocated to Capital Gain Property. The amount allocated to
Ordinary Income Property was ($1,250).
(ii) Asset 1 is a capital gain asset, and T would be allocated $37,500 from
the sale of Asset 1 in the Hypothetical Transaction. Therefore, the amount of the
adjustment to Asset 1 is $37,000.
(iii) Asset 2 is a capital gain asset, and T would be allocated $8,750 from
the sale of Asset 2 in the Hypothetical Transaction. Therefore, the amount of the
adjustment to Asset 2 is $8,750.
(iv) Asset 3 is Ordinary Income Property, and T would be allocated
$2,500 from the sale of Asset 3 in the Hypothetical Transaction. Therefore, the
amount of the adjustment to Asset 3 is $2,500.
(v) Asset 4 is Ordinary Income Property, and T would be allocated
($3,750) from the sale of Asset 4 in the Hypothetical Transaction. Therefore, the
amount of the adjustment to Asset 4 is ($3,750).
EXAMPLE #11
(i) Assume the same facts as Example 10 of this section, except that A
sold its interest in AB to T for $110,000 rather than $120,000. T, therefore,
receives a basis adjustment under § 743(b) of $35,000. Of the $35,000 basis
adjustment, ($1,250) is allocated to Ordinary Income Property, and $36,250 is
allocated to Capital Gain Property.
(ii) Asset 3 is ordinary income property, and T would be allocated $2,500
from the sale of Asset 3 in the hypothetical transaction. Therefore, the amount of
the adjustment to Asset 3 is $2,500.
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(iii) Asset 4 is ordinary income property, and T would be allocated
($3,750) from the sale of Asset 4 in the Hypothetical Transaction. Therefore, the
amount of the adjustment to Asset 4 is ($3,750).
(iv) Asset 1 is a capital gain asset, and T would be allocated $37,500 from
the sale of Asset 1 in the hypothetical transaction. Asset 2 is a capital gain asset,
and T would be allocated $8,750 from the sale of Asset 2 in the Hypothetical
Transaction. The total amount of gain that would be allocated to T from the sale
of the capital gain assets in the Hypothetical Transaction if $46,250, which
exceeds the amount of the basis adjustment allocated to Capital Gain Property by
$10,000. The amount of the adjustment to Asset 1 is $33,604 ($37,500 minus
$3,896 ($10,000 x $75,000/192,500)).
IX.
Allocations of Section 734(b) Adjustments to Partnership Assets: Section 755.
A.
The Allocation Rules. Three steps are involved in the allocation of §734(b) basis
adjustments to specific partnership assets:
STEP 1: THE PARTNERSHIP'S ASSETS ARE FIRST DIVIDED INTO TWO
CLASSES UNDER §755(B) — "CAPITAL GAIN ASSETS" (CAPITAL
ASSETS AND §1231(B) PROPERTY) AND "ORDINARY INCOME ASSETS"
(ALL OTHER PARTNERSHIP ASSETS).
STEP 2: A DETERMINATION IS MADE AS TO THE CLASS OF ASSETS TO
WHICH THE §734(B) ADJUSTMENT IS ALLOCATED.
STEP 3: THE §734(B) ADJUSTMENT IS ALLOCATED TO SPECIFIC
ASSETS IN THE APPROPRIATE CLASS.
B.
Determination of Class of Assets (Step 2).
1.
If the §734(b) adjustment is the result of an increase (or decrease) in the
basis of distributed assets of a certain class, the basis of retained partnership assets of the same
class is decreased (or increased) by a like amount.
2.
If the §734(b) adjustment is a consequence of the recognition of gain by
the distributee upon receipt of a distribution of cash in excess of his basis in the partnership, or
the recognition of loss upon the complete liquidation of his partnership interest solely in
exchange for money, unrealized receivables and inventory, the adjustment is allocated entirely to
capital gain assets of the partnership.
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EXAMPLE #12
A, B, and C form equal partnership AB. A contributes $50,000 and Asset 1,
Capital Gain Property with a fair market value of $50,000 and an adjusted tax
basis of $25,000. B and C each contribute $100,000. AB uses the cash to purchase
Assets 2, 3, 4, 5, and 6. Assets 4, 5, and 6 are the only assets held by the
partnership which are subject to § 751. The partnership has an election in effect
under § 754. After seven years, the adjusted basis and fair market value of AB’s
assets are as follows
Assets
Capital Gain Property:
Asset 1
Asset 2
Asset 3
Ordinary Income Property:
Asset 4
Asset 5
Asset 6
Total
Adjusted Basis
Fair Market Value
$25,000
100,000
50,000
75,000
117,500
60,000
40,000
50,000
10,000
$275,000
45,000
60,000
2,500
$360,000
Allocation Between Classes. Assume that AB distributes Assets 3 and 5 to A in
complete liquidation of A’s interest in the partnership. A’s basis in the partnership
interest was $75,000. The partnership’s basis in Assets 3 and 5 was $50,000 each.
A’s $75,000 basis in its partnership interest is allocated between Assets 3 and 5
under §§ 732(b) and (c). A will, therefore, have a basis of $25,000 in Asset 3
(Capital Gain Property), and a basis of $50,000 in Asset 5 (§ 751 property). The
distribution results in a $25,000 increase in the basis of Capital Gain Property.
There is no change in the basis of Ordinary Income Property.
C.
Allocations Under Step 3. The adjustment attributable to a class of partnership
assets to specific assets in the class is allocated "in a manner which has the effect of reducing the
difference between the fair market value of the adjusted basis of partnership properties." The
adjustment is, therefore, allocated so as to reduce proportionately the difference between the fair
market value and the adjusted basis of each asset in the class. If the adjustment increases the
basis of assets in the class, any loss assets (those which have bases in excess of their market
values) are excluded from the allocation. Conversely, if the adjustment decreases asset bases,
gain assets (those with market values in excess of their bases) are excluded.
{09000.BKW / 00932053.DOC.1 }
14
IN APPLYING THESE ALLOCATION RULES, THE BASIS OF AN ASSET CANNOT BE
REDUCED BELOW ZERO. IF AN ADJUSTMENT IS ALLOCATED TO A CLASS IN
WHICH THE PARTNERSHIP DOES NOT HAVE RETAINED PROPERTY, OR IF A
NEGATIVE ADJUSTMENT IS NOT FULLY ABSORBED BY THE BASIS OF PROPERTY
IN THE CLASS, THE ADJUSTMENT (OR THE PORTION REMAINING AFTER THE
BASIS OF APPLICABLE PROPERTY IS REDUCED TO ZERO) IS APPLIED TO
SUBSEQUENTLY ACQUIRED PROPERTY IN THE CLASS.
EXAMPLE #13
Assume the same facts as in Example 12.
Allocation Within Class. The amount of the basis increase to Capital Gain
Property is $25,000 and must be allocated among the remaining capital gain
assets in proportion to the difference between the fair market value and basis of
each. The fair market value of Asset 1 exceeds its basis by $50,000. The fair
market value of Asset 2 exceeds its basis by $17,500. Therefore, the basis of
Asset 1 will be increased by $18,519 ($25,000, multiplied by $50,000, divided by
$67,500), and the basis of Asset 2 will be increased by $6,481 ($25,000
multiplied by $17,500 divided by $67,500).
D.
Application of Section 755(b) to Adjustments Caused by the Recognition of Gain
or Loss.
1.
Gain. To the extent a §734(b) adjustment is a consequence of the
recognition of gain by a distributee under §731(a) upon the receipt of cash in excess of his basis,
Regulation §1.755-1(b)(1)(ii) requires the resultant basis increase to be allocated entirely to
capital gain assets.
2.
Loss. Section 1.755-1(b)(1)(ii) of the Regulations also allocates solely to
capital gain assets any negative §734(b) adjustment resulting from the recognition of loss by the
distributee under §731(a)(2).
E.
The Negative--Basis Prohibition and the Carryover of Unused Basis Adjustments.
1.
Zero Limit. Section 755(b) provides that the allocation of any adjustment
to like-kind property shall not cause the basis of property to be reduced below zero.
2.
Carryover. Section 755(b) also provides that if full application of a basis
adjustment with respect to a class of property is prevented by an absence of property in the class,
the unused adjustment is applied to subsequently acquired property of a like kind.
{09000.BKW / 00932053.DOC.1 }
15
X.
Section 732(d).
A.
General Rule. If a partnership interest is acquired by sale or exchange or upon the
death of a partner in a transaction which is not subject to §743(b), §732(d) provides two special
rules which require that distributed assets are treated as having adjusted partnership bases equal
to the bases they would have had if §743(b) had been applicable to the distributee's acquisition of
his interest. The two special rules are as follows:
1.
Elective. At the option of the distributee, with respect to any property
distributions within two (2) years of the acquisition of the partnership interest.
2.
Mandatory.
a.
The fair market value of all partnership property (other than
money) exceeded 110 percent of its adjusted basis to the partnership,
b.
An allocation of basis under § 732(c) upon a liquidation of his
interest immediately after the transfer of the interest would have resulted in a shift of basis from
property not subject to an allowance for depreciation, depletion, or amortization, to property
subject to such an allowance, and
c.
A basis adjustment under § 743(b) would change the basis to the
transferee partner of the property actually distributed.
EXAMPLE #14
Transferee partner, T, purchased a one-fourth interest in partnership AB for
$17,000. At the time T purchased the partnership interest, the election under § 754
was not in effect and the partnership inventory had a basis to the partnership of
$14,000 and a fair market value of $16,000. T’s purchase price reflected $500 of
this difference. Thus, $4,000 of the $17,000 paid by T for the partnership interest
was attributable to T’s share of partnership inventory with a basis of $3,500.
Within 2 years after T acquired the partnership interest, T retired from the
partnership and received in liquidation of its entire partnership interest the
following property:
Assets
Cash
Inventory
Asset X
Asset Y
{09000.BKW / 00932053.DOC.1 }
Adjusted Basis to AB
$1,500
3,500
2,000
4,000
16
Fair Market Value
$1,500
4,000
4,000
5,000
The fair market value of the inventory received by T was one-fourth of the fair
market value of all partnership inventory and was T’s share of such property. It is
immaterial whether the inventory T received was on hand when T acquired the
interest. In accordance with T’s election under § 732(d), the amount of T’s share
of partnership basis that is attributable to partnership inventory is increased by
$500 (one-fourth of the $2,000 difference between the fair market value of the
property, $16,000, and its $14,000 basis to the partnership at the time T purchased
its interest). This adjustment under § 732(d) applies only for purposes of
distributions to T, and not for purposes of partnership depreciation, depletion, or
gain or loss on disposition. Thus, the amount to be allocated among the properties
received by T in the liquidating distribution of $15,500 ($17,000, T’s basis for the
partnership interest, reduced by the amount of cash received, $1,500). This
amount is allocated as follows: The basis of the inventory items received is
$4,000 consisting of the $3,500 common partnership basis, plus the basis
adjustment of $500 which T would have had under § 743(b). The remaining basis
of $11,500 ($15,500 minus $4,000) is allocated among the remaining property
distributed to T by assigning to each property the adjusted basis to the partnership
of such property and adjusting that basis by any required increase or decrease.
Thus, the adjusted basis to T of Asset X is $5,111 ($2,000, the adjusted basis of
Asset X to the partnership, plus $2,000, the amount of unrealized appreciation in
Asset X, plus $1,111 ($4,000/$9,000 multiplied by $2,500)). Similarly, the
adjusted basis of Asset Y to T is $6,389 ($4,000, the adjusted basis of Asset Y to
the partnership, plus $1,000, the amount of unrealized appreciation in Asset Y,
plus, $1,389 ($5,000/$9,000 multiplied by $2,500)).
{09000.BKW / 00932053.DOC.1 }
17