PORTFOLIO

Partnerships — Allocation of Liabilities; Basis Rules (Portfolio 714)

Tax Management Portfolio, No. 714-3rd, Partnerships — Allocation of Liabilities; Basis Rules, analyzes the tax considerations relating to the determination of a partner's adjusted basis in his partnership interest, a partner's adjusted basis in distributed property and a partnership's adjusted basis in partnership property. These basis determinations are essential to the computation of the amount and timing of each partner's taxable income or loss.

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DESCRIPTION

Tax Management Portfolio, No. 714-3rd, Partnerships — Allocation of Liabilities; Basis Rules, analyzes the tax considerations relating to the determination of a partner's adjusted basis in his partnership interest, a partner's adjusted basis in distributed property and a partnership's adjusted basis in partnership property. These basis determinations are essential to the computation of the amount and timing of each partner's taxable income or loss.
Under the general rule of §722, a partner's initial basis in his partnership interest is equal to the amount of money contributed plus the adjusted basis of any contributed property in the hands of the contributing partner, increased by the amount of gain, if any, recognized by the contributing partner under §721(b). If the contributed property is subject to an encumbrance, §752 provides rules governing the effect of such encumbrances on the partner's adjusted basis. The rules in §752 and the regulations thereunder, governing allocation of partnership liabilities and other obligations, are discussed in detail in this portfolio.


Under §742, the determination of the basis of a partnership interest acquired other than by contribution is generally governed by the general basis rules set forth in §§1011, et seq.


Under §723, the partnership's initial basis in property contributed to it is equal to the adjusted basis of the property in the hands of the contributing partner, increased by the amount of gain, if any, recognized by the contributing partner under §721(b).


When property is distributed to a partner, basis adjustments can occur at both the partnership level, with respect to the remaining assets, and at the partner level, with respect to both the distributed property and any remaining partnership interest. The partner's basis in the distributed property depends on several factors, principally whether the distribution is in liquidation of the partner's entire partnership interest.


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AUTHORS

LISA MARIE STARCZEWSKI
Lisa Marie Starczewski, Smith College, B.A. (magna cum laude, 1985); Villanova University School of Law, J.D. (summa cum laude, 1988); Editor-in-Chief, Villanova Law Review (1987-88); member of adjunct faculty, Villanova University School of Law; former associate, Morgan, Lewis & Bockius; Schnader, Harrison, Segal & Lewis; Author, 550 T.M., At-Risk Rules; 565 T.M., Installment Sales; 752 T.M., Corporate Alternative Minimum Tax; 587 T.M., Noncorporate Alternative Minimum Tax; 621 T.M., IRS National Office Procedures — Rulings, Closing Agreements; Co-Author, 517 T.M., Scholarships and Educational Expenses; 504 T.M., Deduction Limitations: General; 503 T.M., Deductions: Overview and Conceptual Aspects; BNA Tax and Accounting Portfolio 5100, Revenue Recognition: Fundamental Principles; BNA Tax and Accounting Portfolio 5101, Revenue Recognition: Product Sales and Services; BNA Tax and Accounting Portfolio 5114, Accounting for Leases: Fundamental Principles; BNA Tax and Accounting Portfolio 5117, Leases: Lessee Perspective; BNA Tax and Accounting Portfolio 5118, Leases: Lessee Perspective — Selected Topics; Author of several chapters in the Tax Practice Series and contributor to various tax publications; recipient of Distinguished Author award; Member, Tax Management U.S. Income Advisory Board.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

A. Aggregate vs. Entity Approach to Partnership Taxation

B. Two Concepts of Basis

C. Relationship Between Basis and Capital Account

D. Subchapter K Anti-Abuse Regulations

II. Determination of Partner's Initial Basis in Partnership Interest

A. Partnership Interest Acquired by Contribution to Partnership: § § 721 and 722

1. Contribution of Money or Property

a. General Rule

b. Contribution of Property Encumbered by Recourse Liabilities

c. Contribution of Property Encumbered by Nonrecourse Liabilities

d. Contribution of Recapture Property

e. Loans to Partnership

f. Contribution of Partner Indebtedness

g. Contributions Involving Long-Term Contracts

(1) Contributions of Long-Term Contracts

(2) Contributions of Other Property to Partnerships Holding Long-Term Contracts

2. Contribution of Services

a. Section 721

b. 2005 Proposed Regulations

c. Rev. Proc. 93-27 and Rev. Proc. 2001-43

d. The Diamond Decision

e. Post-Diamond Decisions

(1) GCM 36346

(2) The Liquidation Approach

(3) The Campbell Case

3. Contribution to an “Investment Company”

4. Noncompensatory Options

5. Obligations to Make Future Contributions

6. Deferred Compensation: § 409A

B. Partnership Interest Acquired Other Than by Contribution

1. General Rule: Cost Basis

2. Acquisition of Partnership Interest from a Decedent

3. Acquisition of Partnership Interest by Gift

C. Alternative Rule for Determination of Partner's Basis

D. Multiple Interests in a Single Partnership

III. Inclusion of Partnership Liabilities in Partner's Basis: Section 752

A. In General

B. Prior Law - The 1956 Regulations

1. General Rules

2. Recourse and Nonrecourse Liabilities

3. Application of Sharing Rules to General Partnerships

4. Application of Sharing Rules to Limited Partnerships

C. Prior Law - The 1988 Regulations

1. Background: The Raphan Case and § 79 of the 1984 Deficit Reduction Act

2. General Overview of the 1988 Regulations

3. Effective Date

D. Current Law - The 1991 Regulations and Amendments

1. Effective Date and Transition Rules

2. Treatment of Partnership Liabilities

a. Definition of “Liability”

(1) Section 752 Liabilities

(2) Regs. § 1.752-7 Liabilities

b. Definition of “Recourse Liability”

c. Definition of “Nonrecourse Liability”

d. Increase in Partner's Share of Partnership Liabilities

e. Decrease in Partner's Share of Partnership Liabilities

f. Assumption of Liabilities

g. Contributions and Distributions of Property Subject to a Liability

h. Netting of Increases and Decreases of Liabilities Resulting from Same Transaction

i. Sale or Exchange of Partnership Interest

j. Bifurcation of Partnership Liabilities

k. Timing of Determination

3. Determining Partner's Share of Recourse Liabilities

a. Economic Risk of Loss and Constructive Liquidation

b. Obligations to Make a Payment or a Contribution

(1) In General

(2) “Related Person” Defined

(a) In General

(b) Person Related to More than One Partner

(i) In General

(ii) Natural Persons

(iii) Related Partner Exception

(iv) Special Rules Where Entity Structured to Avoid Related Person Status

(3) Contingent Obligations

(4) Reimbursement Rights

(5) Assumption of Full Performance

(6) Obligations of Disregarded Entities

c. Partner or Related Person as Lender

(1) In General

(2) Wrapped Debt

d. Guarantee of Interest on Partnership Nonrecourse Liability

(1) In General

(2) Computation of Present Value

(3) Safe Harbor

(4) De Minimis Exception

e. Partner Providing Property as Security for Partnership Liability

(1) Direct Pledge

(2) Indirect Pledge

f. Valuation of Payment or Contribution Obligations

g. Application of Recourse Liability Sharing Rules to Tiered Partnerships

h. Anti-Abuse Rules

(1) In General

(2) Arrangements Tantamount to a Guarantee

(3) Plan to Circumvent or Avoid the Regulations

4. Partner's Share of Nonrecourse Liabilities

a. In General

b. Non-contributed Property

c. Contributed Property: No Ceiling Rule Problem

d. Contributed Property: Ceiling Rule Issues/Traditional Method in Effect

e. Contributed Property: Ceiling Rule Issues/Curative Method in Effect

f. Contributed Property: Ceiling Rule Issues/Remedial Method in Effect

g. Allocating a Single Nonrecourse Liability Among Multiple Partnership Properties

E. Assumptions of Regs. § 1.752-7 Liabilities

IV. Adjustments to Partner's Initial Basis

A. Annual Basis Adjustments

1. General Rules: § § 705 and 733

2. Section 179 Expense

3. Partnership Interest Acquired from Decedent

4. Discharge of Partnership Indebtedness

5. Purpose of Adjustments

6. Tax-Exempt Income

a. General Rule

b. Tax-Deferred Income: The Helmer Case

7. Nondeductible Expenditures

8. Effect of § 465 on Adjusted Basis

9. Effect of § 469 on Adjusted Basis

10. Effect of Gain/Loss Not Recognized Under § 707

11. Effect of § 1032 on Corporate Partners

B. Adjustments Arising from the Operation of the § 752 Liability Rules

1. Changes in Partner's Share of Partnership Liabilities

2. Distributions of Encumbered Property

a. Current Distributions

b. Liquidating Distributions

C. Adjustments Arising from the Operation of the Regs. § 1.752-7 Liability Rules

1. Triggering Events

a. In General

b. Application of Triggering Event Rules to Tiered Partnerships

c. Exceptions to the Basis Reduction Rule

2. Satisfaction of Regs. § 1.752-7 Liabilities

V. Partner's Basis in Distributed Property Other Than Money: § 732

A. Distributions Other Than in Liquidation of a Partner's Interest

B. Distributions in Liquidation of a Partner's Interest

C. Allocation of Basis Among Distributed Properties

1. Overview and Conceptual Aspects

2. Current Law

a. Nonliquidating Distributions - Basis Shortfall

(1) Distribution of Only Category One Assets

(2) Distribution of Only Category Two Assets

(3) Distribution of Both Types of Assets - Partnership's Basis in Distributed Category One Assets Exceeds Partner's Basis in Partnership Interest

(4) Distribution of Both Types of Assets - Partner's Basis in Partnership Interest Exceeds Partnership's Basis in Distributed Category One Assets

b. Liquidating Distributions - Basis Shortfall

c. Liquidating Distributions - Excess Basis

(1) Distribution of Only Category One Assets

(2) Distribution of Only Category Two Assets

(3) Distribution of Both Types of Assets

3. Distributions Before August 5, 1997

D. Special Basis Adjustment Available to Transferee Partner: § 732(d)

1. In General

2. Mandatory Application of the Adjustment

3. Election to Make Adjustment

4. Allocation of the Adjustment

E. Relationship Between § § 732 and 751(b)

F. Relationship Between § § 732 and 751(a)

G. Distributions of Partner Debt

H. Relationship Between § § 732 and 734(b)

I. Relationship Between § § 732 and 743(b)

J. Distributions of Marketable Securities Under § 731(c)

K. Adjustments to Contributing Partner's Basis in the Partnership Interest: § § 704(c) and 737

L. Basis Reduction in Distributed Corporations

M. Basis Increases in Amortizable Intangibles

1. Section 732(b) Basis Increases

2. Section 732(d) Basis Increases

N. Distributions Involving Long-Term Contracts

1. Partnership's Distribution of Long-Term Contract to Partner

2. Partnership's Distribution of Interest in Lower-Tier Partnership Holding Long-Term Contract

3. Deemed Distribution on Termination of Partnership Holding Long-Term Contract

VI. Determination of Partnership's Initial Basis in Its Assets

A. Partnership's Basis in Contributed Property: § 723

B. Partnership's Basis in Property Other Than Contributed Property

1. In General - Cost Basis

2. Property Purchased from a Partner

VII. Special Basis Adjustment Applicable to Transfer of Partnership Interest - Section 743(b)

A. Application of the Adjustment

1. In General

2. Exception to Mandatory Adjustment - Electing Investment Partnerships

3. § 351/§ 721 Contributions

4. Distributions of Partnership Interests

5. Transfers of Partnership Property to a Foreign Corporation - § 367

6. Partnership Interests Held as Community Property

7. Application of the Adjustment to a Terminated Partnership

B. Computation of the Adjustment

1. In General

2. Determination of Partner's “Proportionate Share” of Partnership's Bases in Its Assets

a. In General

b. Examples

3. Computation of an Estate's § 743(b) Adjustment

4. Computation of Adjustment When Partnership Holds Long-Term Contract

C. Allocation of the Adjustment - § 755

1. In General

2. Transactions Other Than Substituted Basis Transactions - Purchase and Death Transfers

a. Valuation of Partnership Assets

(1) In General

(2) Final Regulations

(3) Former Temporary Regulations

b. Allocation Between Classes of Partnership Property

(1) In General

(2) Upward § 743(b) Adjustment

(3) Downward § 743(b) Adjustment

(4) Allocation of “Zero” § 743(b) Adjustment

c. Allocation Within Each Class of Partnership Property

3. Substituted Basis Exchanges

a. Valuation of Partnership Assets

b. Allocations Between Classes of Property

c. Allocations Within the Classes

d. Transfers Before December 15, 1999

D. Effect of § 743(b) Adjustment on Calculation of Income, Gain, or Loss and on Transferee Partner's Distributive Share of Partnership Items

E. Reporting and Returns

1. In General

2. Special Reporting Requirements Applicable to Electing Investment Partnerships

F. Application of § 743(b) Adjustment to Tiered Partnerships

G. Effect of § 743(b) Adjustment on Subsequent Distributions of Partnership Property

1. Current Distributions of Special Basis Property to a Transferee Partner

2. Current Distributions of Special Basis Property to a Non-transferee Partner

3. Liquidating Distributions to a Transferee Partner

H. Effect of § 743(b) Adjustment on Subsequent Transfers of Partnership Interests

I. Effect of § 743(b) Adjustment on Subsequent Contributions of Partnership Interests

1. Contributions of Property by an Upper-Tier Partnership to a Lower-Tier Partnership Under § 721

2. Effect of Termination on § 743(b) Adjustment

3. Contributions of Property by a Partnership to a Corporation Under § 351

J. Effect of § 743(b) Adjustment on Depletion

K. Effect of § 743(b) Adjustment on Depreciation

1. Upward Adjustments

2. Downward Adjustments

L. Section 743(b) Basis Increases in Amortizable Intangibles

M. Relationship Between § 743(b) Adjustment and the Consolidated Return Rules

N. Applicability of the § 743(b) Adjustment to Oil and Gas Properties

VIII. Special Basis Adjustment Applicable to Distributions of Partnership Property - § 734(b)

A. Application and Computation of the Adjustment

B. Allocation of the § 734(b) Adjustment - § 755

1. In General

2. Current Law

a. Allocation Between the Classes

b. Allocation Within the Classes

3. Prior Law

a. Allocation to One Class of Property

b. Allocation Within a Class

C. Reporting Requirements

D. Basis Adjustments for Distributions Under § § 704(c) and 737

E. Effect of § 734(b) Adjustment on Depletion

F. Effect of § 734(b) Adjustment on Depreciation

1. Upward Adjustment to Partnership Recovery Property

2. Downward Adjustment to Partnership Recovery Property

3. Upward Adjustment to Partnership Property Depreciated Under Pre-1981 § 167 Rules

4. Downward Adjustment to Partnership Property Depreciated Under Pre-1981 § 167 Rules

G. Amortization of § 734(b) Increases in Bases of Intangible Assets

H. Timing of § 734(b) Adjustment in Context of Complete Liquidation

I. Relationship Between § 734(b) Adjustment and § 751(b)

1. Section 751(b) - In General

2. Interaction Between § 734(b) and § 751(b)

J. Application of § 734(b) to Distribution Preceded by § 743(b) Transfer

K. Relationship Between § 734(b) Adjustment and § 732(d) Adjustment

L. Application of § 734(b) to Tiered Partnerships

M. Application of § 734(b) to Partnerships Holding Long-Term Contracts

IX. Election to Make Adjustment-§ 754

A. In General

B. Tiered Partnerships

C. Revocation of the Election

D. Partnership Terminations

E. Election by Foreign Partnership

F. Relationship Between § 754 Election and § 197 Retroactive Transition Election


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 IRS Publication 541, “Tax Information on Partnerships” (including Form 1065)

Worksheet 2 Notice 2005-32, 2005-16 I.R.B. 895

Worksheet 3 Sample § 754 Election, Computation, and Revocation Statements and Partnership Agreement Provision

Worksheet 4 Sample Partnership's Basis Adjustment Computation Statement per Regs. § 1.734-1(d)

Worksheet 5 Sample Election Under § 732(d) to Adjust the Basis of Distributed Property (Regs. § 1.732-1(d))

Worksheet 6 Partnership's Basis Adjustment Computation Statement (Regs. § 1.743-1(k)(1))

Worksheet 7 Allocation of Recourse Debt: 1991 Final Regulations and 1988 Temporary Regulations

Worksheet 8 Allocation of Nonrecourse Debt: 1991 Final Regulations and 1988 Temporary Regulations

Worksheet 9 Section 752 Regulations Effective Date and Transition Rules

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Committee Reports:

Public Laws:

Revenue Rulings and Revenue Procedures:

Cases:

UNOFFICIAL

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