5452 Federal Register / Vol. 86, No. 11 / Tuesday, January 19, 2021 / Rules and Regulations 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[TD 9945] 

RIN 1545–BO81 

Guidance Under Section 1061 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final regulations. 

SUMMARY: This document contains final 

regulations that provide guidance under 

section 1061 of the Internal Revenue 

Code (Code). Section 1061 

recharacterizes certain net long-term 

capital gains of a partner that holds one 

or more applicable partnership interests 

as short-term capital gains. An 

applicable partnership interest is an 

interest in a partnership that is 

transferred to or held by a taxpayer, 

directly or indirectly, in connection 

with the performance of substantial 

services by the taxpayer, or any other 

related person, in any applicable trade 

or business. These final regulations also 

amend existing regulations on holding 

periods to clarify the holding period of 

a partner’s interest in a partnership that 

includes in whole or in part an 

applicable partnership interest and/or a 

profits interest. These regulations affect 

taxpayers who directly or indirectly 

hold applicable partnership interests in 

partnerships and the passthrough 

entities through which the applicable 

partnership interest is held. 

DATES: 

Effective date: These regulations are 

effective on January 13, 2021. 

Applicability date: For dates of 

applicability, see §§ 1.702–1(g), 1.704– 

3(f), 1.1061–1(b), 1.1061–2(c), 1.1061– 

3(f), 1.1061–4(d), 1.1061–5(g), 1.1061– 

6(e), and 1.1223–3(g). 

FOR FURTHER INFORMATION CONTACT: Kara 

K. Altman or Sonia K. Kothari at (202) 

317–6850 or Wendy L. Kribell at (202) 

317–5279 (not toll-free numbers). 

SUPPLEMENTARY INFORMATION: 

Background 

This document contains final 

regulations under section 1061 of the 

Code to amend the Income Tax 

Regulations (26 CFR part 1). Section 

1061 was added to the Code on 

December 22, 2017, by section 13309 of 

Public Law 115–97, 131 Stat. 2054 

(2017), commonly referred to as the Tax 

Cuts and Jobs Act (TCJA). Section 1061 

applies to taxable years beginning after 

December 31, 2017. Section 1061 

recharacterizes certain net long-term 

capital gain with respect to applicable 

partnership interests (APIs) as shortterm capital gain. 

On August 14, 2020, the Department 

of the Treasury (Treasury Department) 

and the IRS published a notice of 

proposed rulemaking (REG–107213–18) 

in the Federal Register (85 FR 49754) 

containing proposed regulations under 

sections 702, 704, 1061, and 1223 of the 

Code (proposed regulations). The 

Treasury Department and the IRS 

received written and electronic 

comments responding to the proposed 

regulations. No public hearing was 

requested or held. All comments are 

available at www.regulations.gov or 

upon request. After full consideration of 

all comments timely received, this 

Treasury decision adopts the proposed 

regulations with modifications in 

response to the comments as described 

in the Summary of Comments and 

Explanation of Revisions section of this 

preamble. 

Summary of Comments and 

Explanation of Revisions 

Most of the comments addressing the 

proposed regulations are summarized in 

this Summary of Comments and 

Explanation of Revisions. However, 

non-substantive comments or comments 

merely summarizing or interpreting the 

proposed regulations, recommending 

statutory revisions, or addressing 

provisions outside the scope of these 

final regulations are not discussed in 

this preamble. 

The final regulations retain the 

structure of the proposed regulations, 

with certain revisions. Section 1.1061– 

1 provides definitions of the terms used 

in §§ 1.1061–1 through 1.1061–6 of 

these final regulations (Section 1061 

Regulations or final regulations). 

Section 1.1061–2 provides rules and 

examples regarding APIs and applicable 

trades or businesses (ATBs). Section 

1.1061–3 provides guidance on the 

exceptions to the definition of an API, 

including the capital interest exception. 

Section 1.1061–4 provides guidance on 

the computation of the 

Recharacterization Amount and gives 

computation examples. Section 1.1061– 

5 provides guidance regarding the 

application of section 1061(d) to 

transfers to certain related parties. 

Section 1.1061–6 provides reporting 

rules. Because the application of section 

1061 requires a clear determination of 

the holding period of a partnership 

interest that is, in whole or in part, an 

API, the final regulations also provide 

clarifying amendments to § 1.1223–3. 

Additional clarifying amendments to 

§§ 1.702–1(a)(2) and 1.704–3(e) are also 

provided. 

Part I of this Summary of Comments 

and Explanation of Revisions provides 

an overview of the statutory provisions 

and defined terms used in the proposed 

and final regulations. Part II describes 

the comments received and revisions 

made in response to those comments 

with respect to the following four areas 

of the proposed regulations: (1) The 

capital interest exception; (2) the 

treatment of capital interests acquired 

with loan proceeds; (3) the Lookthrough 

Rule for certain API dispositions; and 

(4) transfers of APIs to Section 1061(d) 

Related Persons. Part III discusses 

additional comments received and 

revisions made in other areas of the 

proposed regulations. Part IV 

summarizes comments received on 

issues related to section 1061 that are 

beyond the scope of the regulations and 

are under study. Part V discusses 

applicability dates for the final 

regulations. In addition to the revisions 

made in response to comments, 

clarifying changes have been made 

throughout the final regulations. 

I. Overview and Defined Terms 

A. Section 1061(a): Recharacterization 

Amount, Owner Taxpayer, and Related 

Concepts 

1. Recharacterization Amount 

Section 1061(a) recharacterizes as 

short-term capital gain the difference 

between a taxpayer’s net long-term 

capital gain with respect to one or more 

APIs and the taxpayer’s net long-term 

capital gain with respect to these APIs 

if paragraphs (3) and (4) of section 1222, 

which define the terms long-term 

capital gain and long-term capital loss, 

respectively, for purposes of subtitle A 

of the Code, are applied using a threeyear holding period instead of a oneyear holding period. The regulations 

refer to this difference as the 

Recharacterization Amount. This 

recharacterization is made regardless of 

any election in effect under section 

83(b). 

2. Owner Taxpayers and Passthrough 

Entities 

The regulations provide that the 

person who is subject to Federal income 

tax on the Recharacterization Amount is 

required to calculate such amounts and 

refer to this person as the Owner 

Taxpayer. Although an API can be held 

directly by an Owner Taxpayer, it also 

may be held indirectly through one or 

more passthrough entities (Passthrough 

Entities). A Passthrough Entity may be 

a partnership, trust, estate, S 

corporation, or a passive foreign 

investment company (PFIC) with 

respect to which the shareholder has a 


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qualified electing fund (QEF) election in 

effect. An API Holder is any person who 

holds an API. The regulations provide a 

framework for determining the 

Recharacterization Amount when an 

API is held through one or more tiers of 

Passthrough Entities (tiered structure). 

3. Gains and Losses Subject to Section 

1061 

Section 1061(a) applies to a taxpayer’s 

net long-term capital gain with respect 

to one or more APIs held during the 

taxable year. The regulations provide 

that the determination of a taxpayer’s 

net long-term capital gain with respect 

to the taxpayer’s APIs held during the 

taxable year includes the taxpayer’s 

combined net distributive share of longterm capital gain or loss from all APIs 

held during the taxable year and the 

Owner Taxpayer’s long-term capital 

gain and loss from the disposition of 

any APIs during the taxable year. The 

regulations generally refer to long-term 

capital gains and losses recognized with 

respect to an API as API Gains and 

Losses. However, API Gains and Losses 

do not include long-term capital gain 

determined under sections 1231 and 

1256, qualified dividends described in 

section 1(h)(11)(B), and any other 

capital gain that is characterized as 

long-term or short-term without regard 

to the holding period rules in section 

1222, such as capital gain characterized 

under the identified mixed straddle 

rules described in section 1092(b). 

Unrealized API Gains and Losses 

means, with respect to a Passthrough 

Entity’s assets, all unrealized capital 

gains and losses that would be realized 

if those assets were disposed of for fair 

market value in a taxable transaction 

and allocated to an API Holder with 

respect to its API, taking into account 

the principles of section 704(c). In a 

tiered structure, API Gains and Losses 

and Unrealized API Gains and Losses 

retain their character as API Gains and 

Losses as they are allocated through the 

tiers. 

B. Section 1061(c)(1): Definition of an 

Applicable Partnership Interest 

Section 1061(c)(1) provides that an 

API is a partnership interest held by, or 

transferred to, a taxpayer, directly or 

indirectly, in connection with the 

performance of substantial services by 

the taxpayer, or by any other related 

person, in any ATB. For this purpose, 

the regulations define a Related Person 

as a person or entity who is treated as 

related to another person or entity under 

section 707(b) or 267(b). Both section 

1061(c)(1) and the regulations provide 

that an API does not include certain 

partnership interests held by employees 

of entities that are not engaged in an 

ATB. 

The regulations provide that an API 

means any interest in a partnership 

which, directly or indirectly, is 

transferred to (or is held by) an Owner 

Taxpayer or Passthrough Taxpayer in 

connection with the performance of 

substantial services by the Owner 

Taxpayer or by a Passthrough Taxpayer, 

or by a Related Person, including 

services performed as an employee, in 

any ATB unless an exception applies. 

There may be one or more Passthrough 

Entities between the partnership that 

originally issued the API and the 

Passthrough Entity in which the Owner 

Taxpayer holds its indirect interest in 

the API. Each Passthrough Entity in the 

tiered structure is treated as holding an 

API under the regulations, that is, each 

Passthrough Entity is an API Holder as 

is the Owner Taxpayer. An API Holder 

may be an individual, partnership, trust, 

estate, S corporation (as defined in 

section 1361(a)(1)), or a PFIC with 

respect to which the shareholder has a 

QEF election in effect under section 

1295. 

Section 1061(c)(1), similar to section 

1061(a), uses the term ‘‘taxpayer.’’ The 

proposed regulations provide that an 

Owner Taxpayer is the taxpayer for 

purposes of section 1061(a). The 

regulations further provide that the 

reference to ‘‘taxpayer’’ in section 

1061(c)(1) also includes a Passthrough 

Taxpayer. A Passthrough Taxpayer is a 

Passthrough Entity that is treated as a 

taxpayer for the purpose of determining 

the existence of an API, regardless of 

whether such Passthrough Taxpayer 

itself is subject to Federal income tax. 

Generally, if an interest in a partnership 

is transferred to a Passthrough Taxpayer 

in connection with the performance of 

its own services, the services of its 

owners, or the services of persons 

related to either such Passthrough 

Taxpayer or its owners, the interest is an 

API as to the Passthrough Taxpayer. The 

Passthrough Taxpayer’s ultimate owners 

will be treated as Owner Taxpayers, 

unless otherwise excepted. 

A partnership interest is an API if it 

was transferred in connection with the 

performance of substantial services. The 

regulations presume that services are 

substantial with respect to a partnership 

interest transferred in connection with 

services. This presumption is based on 

the assumption, for purposes of section 

1061, that the parties have economically 

equated the services performed or to be 

performed with the potential value of 

the partnership interest transferred. The 

regulations provide that, subject to 

certain exceptions, once a partnership 

interest is an API, it remains an API and 

never loses its API character. 

C. Section 1061(c)(2): Definition of an 

Applicable Trade or Business 

Under section 1061, for an interest in 

a partnership to be an API, the interest 

must be held or transferred in 

connection with the performance of 

substantial services in an ATB. An ATB 

is defined in section 1061(c)(2) as any 

activity conducted on a regular, 

continuous, and substantial basis 

consisting, in whole or in part, of raising 

or returning capital, and either (i) 

investing in (or disposing of) specified 

assets (or identifying specified assets for 

such investing or disposition), or (ii) 

developing specified assets. The 

regulations refer to these actions, 

respectively, as Raising or Returning 

Capital Actions and Investing or 

Developing Actions (collectively, 

Specified Actions). The regulations 

provide that an activity is conducted on 

a regular, continuous, and substantial 

basis if it meets the ATB Activity Test. 

The ATB Activity Test is met if the total 

level of activity (conducted in one or 

more entities) meets the level of activity 

required to establish a trade or business 

for purposes of section 162. 

In applying the ATB Activity Test, the 

regulations provide that it is not 

necessary for both Raising or Returning 

Capital Actions and Investing or 

Developing Actions to occur in a single 

taxable year. In that regard, the 

combined Specified Actions are 

considered together to determine if the 

ATB Activity Test is met. 

Section 1061(c)(3) provides that 

specified assets (Specified Assets) are 

securities, as defined in section 

475(c)(2) (without regard to the last 

sentence thereof), commodities, as 

defined in section 475(e)(2), real estate 

held for rental or investment, cash or 

cash equivalents, options or derivative 

contracts with respect to any of the 

foregoing, and an interest in a 

partnership to the extent of the 

partnership’s proportionate interest in 

any of the foregoing. The definition of 

Specified Assets in the regulations 

generally tracks the statutory language. 

It also includes an option or derivative 

contract on a partnership interest to the 

extent that the partnership interest 

represents an interest in other Specified 

Assets. 

D. Section 1061(c)(4) and Other 

Exceptions to API Treatment 

Section 1061 includes four exceptions 

to the treatment of a profits interest as 

an API and the regulations add an 

additional exception. 


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First, the statutory definition of an 

API in section 1061(c)(1) excludes an 

interest held by a person who is 

employed by another entity that is 

conducting a trade or business (other 

than an ATB) and provides services 

only to such other entity. 

Second, section 1061(c)(4)(A) 

provides that an API does not include 

any interest in a partnership directly or 

indirectly held by a corporation. The 

regulations provide that the term 

‘‘corporation’’ for purposes of section 

1061(c)(4)(A) does not include an S 

corporation for which an election under 

section 1362(a) is in effect or a PFIC 

with respect to which the shareholder 

has a QEF election under section 1295 

in effect. 

Third, section 1061(c)(4)(B) provides 

that an API does not include a capital 

interest which provides a right to share 

in partnership capital commensurate 

with (i) the amount of capital 

contributed (determined at the time of 

receipt of such partnership interest), or 

(ii) the value of such interest subject to 

tax under section 83 upon the receipt or 

vesting of such interest (the capital 

interest exception). The regulations 

provide that long-term capital gains and 

losses with respect to an API Holder’s 

capital investment in a Passthrough 

Entity, referred to as Capital Interest 

Gains and Losses (which can include 

allocations and disposition amounts 

meeting the requirements), are not 

subject to recharacterization under 

section 1061. As explained in more 

detail in Part II.A. of this Summary of 

Comments and Explanation of 

Revisions, to meet this exception to API 

treatment, the proposed regulations 

require allocations to API Holders (or 

Passthrough Entities that hold an API in 

a lower-tier Passthrough Entity) to be 

made in the same manner as to certain 

other partners. The final regulations 

provide a revised and simplified rule 

that looks to whether allocations are 

commensurate with capital contributed. 

Fourth, section 1061(b) provides that 

to the extent provided by the Secretary, 

section 1061 will not apply to income 

or gain attributable to any asset not held 

for portfolio investment on behalf of 

third party investors. 

Finally, the regulations provide that 

an interest in a partnership that was an 

API in the hands of the seller will not 

be treated as an API in the hands of the 

purchaser if the interest is acquired by 

a bona fide purchaser who (i) does not 

provide services in the Relevant ATB to 

which the acquired interest relates, (ii) 

is unrelated to any service provider, and 

(iii) acquired the interest for fair market 

value. 

E. Section 1061(d): Transfer of API to a 

Section 1061(d) Related Person 

Section 1061(d)(1) provides that if a 

taxpayer transfers an API, directly or 

indirectly, to a related person described 

in section 1061(d)(2), the taxpayer must 

include in gross income (as short term 

capital gain) the excess of so much of 

the taxpayer’s long term capital gains 

with respect to such interest for the 

taxable year attributable to the sale or 

exchange of any asset held for not more 

than 3 years as is allocable to such 

interest over any amount treated as 

short term capital gain under section 

1061(a). 

A related person for purposes of 

section 1061(d)(2) (a Section 1061(d) 

Related Person) is defined more 

narrowly than a related person for 

purposes of section 1061(c)(1) and 

includes only members of the taxpayer’s 

family within the meaning of section 

318(a)(1), the taxpayer’s colleagues 

(those who provided services in the 

ATB during certain time periods) and, 

under the regulations, a Passthrough 

Entity to the extent that a member of the 

taxpayer’s family or a colleague is an 

owner. 

F. Section 1061(e): Reporting 

Section 1061(e) provides that the 

Secretary ‘‘shall require such reporting 

(at the time and in the manner 

prescribed by the Secretary) as is 

necessary to carry out the purposes of 

[section 1061].’’ The regulations set 

forth the reporting requirements and 

include rules for providing information 

required to compute the 

Recharacterization Amount when there 

is a tiered structure. 

G. Regulatory Authority 

Section 1061(f) provides that the 

Secretary ‘‘shall issue such regulations 

or other guidance as is necessary or 

appropriate to carry out the purposes of 

[section 1061].’’ The legislative history 

indicates that such guidance is to 

address the prevention of abuse of the 

purposes of the provision. See H.R. 

Conf. Rep. No. 115–466 at 422 (2017) 

(Conference Report); see also Joint 

Committee on Taxation, General 

Explanation of Public Law 115–97, JCS– 

1–18, at 203 (2017) (Blue Book). The 

Conference Report and the Blue Book 

also state that the guidance is to address 

the application of the provision to tiered 

structures of entities. See id. 

II. Primary Changes to the Proposed 

Regulations 

The majority of comments received on 

the proposed regulations relate to four 

areas: (1) The capital interest exception; 

(2) the treatment of capital interests 

acquired with loan proceeds; (3) the 

Lookthrough Rule for certain API 

dispositions; and (4) transfers of APIs to 

Section 1061(d) Related Persons. After 

considering these comments, the 

Treasury Department and the IRS have 

determined that changes in approach 

are required for each of these sections of 

the final regulations. The remainder of 

this section generally describes the 

comments received in these areas and 

the changes made in response. While all 

comments timely received were 

considered, comments are not described 

in detail to the extent that the ancillary 

concerns raised by the commenter were 

resolved by the changes made to the 

final regulations. 

A. Capital Interest Exception 

Section 1061(c)(4)(B) provides that an 

API does not include certain capital 

interests. The proposed regulations 

implement the capital interest exception 

by excepting from recharacterization 

long-term capital gains and losses that 

represent a return on an API Holder’s 

capital invested in a Passthrough Entity. 

The proposed regulations refer to these 

amounts as Capital Interest Gains and 

Losses, and include in that definition 

Capital Interest Allocations, 

Passthrough Interest Capital 

Allocations, and Capital Interest 

Disposition Amounts that meet the 

requirements of proposed § 1.1061– 

3(c)(3) through (6). 

The majority of comments received 

regarding the capital interest exception 

suggested that the rules in the proposed 

regulations are too rigid and do not 

reflect many common business 

arrangements, resulting in many capital 

interest holders being denied eligibility 

for the exception. Commenters 

described a variety of concerns, detailed 

in this Part II.A. 

The final regulations provide a 

revised and simplified rule that looks to 

whether allocations are commensurate 

with capital contributed. An allocation 

will be considered a Capital Interest 

Allocation if the allocation to the API 

Holder with respect to its capital 

interest is determined and calculated in 

a similar manner to the allocations with 

respect to capital interests held by 

similarly situated Unrelated NonService Partners who have made 

significant aggregate capital 

contributions. 

1. Capital Interest Allocations, in 

General 

Proposed § 1.1061–3(c)(3) provides 

that for an allocation to be treated as a 

Capital Interest Allocation or a 

Passthrough Interest Capital Allocation, 

the allocation must be one made in the 


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same manner to all partners. As 

described further in part II.A.2. of this 

Summary of Comments and Explanation 

of Provisions, proposed § 1.1061–3(c)(4) 

further provides, in part, that Capital 

Interest Allocations are allocations of 

long-term capital gain or loss make to an 

API Holder and to Unrelated NonService Partners based on their 

respective capital account balances 

where the Unrelated Non-Service 

Partners have a significant aggregate 

capital account balance equal to five 

percent or more of the aggregate capital 

account balance of the partnership are 

the time the allocations are made. The 

proposed regulations also indicate that 

in general, an allocation will be deemed 

to satisfy the ‘‘same manner’’ 

requirement if, under the partnership 

agreement, the allocation is based on the 

relative capital accounts of the partners 

(or Passthrough Entity owners) who are 

receiving the allocation in question and 

the terms, priority, type and level of 

risk, rate of return, and rights to cash or 

property distributions during the 

partnership’s operations and on 

liquidation are the same. Allocations to 

an API Holder may be subordinated to 

allocations to Unrelated Non-Service 

Partners or reduced by the cost of 

services provided by such API Holder or 

a Related Person. Under proposed 

§ 1.1061–3(c)(3)(ii), in the case of a 

partnership that maintains capital 

accounts under § 1.704–1(b)(2)(iv), the 

allocation must be tested based on that 

partner’s capital account. In the case of 

a Passthrough Entity that is not a 

partnership (or a partnership that does 

not maintain capital accounts under 

§ 1.704–1(b)(2)(iv)), if the Passthrough 

Entity maintains and determines 

accounts for its owners using principles 

similar to those provided under § 1.704– 

1(b)(2)(iv), those accounts will be 

treated as a capital account for purposes 

of the proposed regulations. 

Several commenters noted that 

requiring allocations be made in 

accordance with partners’ overall 

section 704(b) capital accounts in a fund 

does not comport with the commercial 

reality of how most venture capital, 

private equity funds, and hedge funds 

make their allocations, and would 

preclude API Holders from ever 

utilizing the capital interest exception. 

One commenter noted that many bona 

fide partnerships use targeted 

allocations and questioned whether it is 

fair to exclude partnerships that do not 

maintain section 704(b) capital or 

similar accounts from the capital 

interest exception when those capital 

accounts lack economic significance in 

the business arrangement. The 

commenter asked the same question 

about partnerships that maintain capital 

accounts using generally accepted 

accounting principles (GAAP). 

Several commenters objected to the 

‘‘same manner’’ requirement on the 

grounds that it did not properly 

implement section 1061(c)(4)(B), which 

provides, in part, that an API ‘‘shall not 

include any capital interest in the 

partnership which provides the 

taxpayer with a right to share in 

partnership capital commensurate with 

. . . the amount of capital contributed’’ 

by such partner. Commenters explained 

that while fund managers may earn an 

economic return on both their capital 

investment and their APIs, they 

generally do not have the same 

economic rights with respect to their 

capital investment that the limited 

partners in the fund have with respect 

to their capital investment. For example, 

commenters indicated that an API 

Holder may be entitled to tax 

distributions, may have different 

allocations of expenses, may be subject 

to regulatory allocations (for example, 

minimum gain chargeback, as described 

in § 1.704–2), and may have different 

withdrawal or liquidity rights, which 

might be more or less favorable than 

those provided to Unrelated NonService Partners. Commenters indicated 

there could be varying liquidity rights 

between Unrelated Non-Service Partners 

and noted that API Holders’ capital may 

be subject to more risk than Unrelated 

Non-Service Partners’ capital in that API 

Holders may bear the first risk of loss. 

In the case of hedge funds, commenters 

noted that limited partners may invest 

at different times and, as such, earn a 

return that may not be comparable to 

other limited partners’ returns. 

In addition, several commenters 

explained that economic rights and 

allocations in private equity and venture 

capital funds are frequently determined 

and made on a deal-by-deal basis, 

including allocations made in a tiered 

structure by an API Holder that is a 

Passthrough Entity, and that funds may 

have multiple classes of interests with 

different rights and obligations, meaning 

that economic rights and allocations are 

rarely, if ever, aligned with respect to all 

partners based on the partners’ section 

704(b) capital accounts. 

For the aforementioned reasons, 

several commenters recommended that 

the ‘‘same manner’’ requirement be 

eliminated and replaced with a rule that 

permits distributions and allocations to 

an API Holder, who contributes capital 

to a fund, to be ‘‘commensurate’’ with 

capital contributed by Unrelated NonService partners. Similarly, one 

commenter suggested that the only 

requirement be that an allocation to an 

API Holder be calculated and 

determined in a similar manner as the 

allocations to similarly situated 

Unrelated Non-Service Partners. Several 

commenters suggested that funds 

should be able to establish that they 

satisfied the ‘‘commensurate’’ standard 

using any reasonable method. 

Commenters also recommended that 

the scope of the term ‘‘cost of services’’ 

as used in the proposed regulations be 

further explained, noting that situations 

where API Holders’ capital investments 

are not subject to management fees, 

while other investors’ interests are 

subject to management fees, should not 

prevent the API Holders’ capital 

interests from qualifying for the capital 

interest exception. Commenters 

recommended that the final regulations 

clarify the meaning of the term ‘‘cost of 

services’’ and specify that an API 

Holder’s capital investment that is not 

subject to incentive payments or to 

management fees may still be eligible 

for the capital interest exception. 

Because private equity and hedge 

funds operate differently, commenters 

suggested that there should be separate 

rules, tailored to each structure, with 

respect to the capital interest exception. 

The commenters alluded to the notion 

that, although private equity and hedge 

funds each operate within a certain 

blueprint, there are many variations. 

The Treasury Department and the IRS 

generally agree with commenters that 

under the test in the proposed 

regulations, it might be difficult for 

some common business arrangements to 

meet the capital interest exception and 

that a partner comparison, based on 

capital contributed rather than the 

partners’ section 704(b) capital 

accounts, would be more accurate in 

determining whether an interest 

qualifies for the capital interest 

exception. Accordingly, the final 

regulations provide that Capital Interest 

Allocations must be commensurate with 

capital contributed in order to qualify 

for the capital interest exception. The 

final regulations replace the 

requirement that allocations be made to 

all partners in the same manner with a 

requirement that an allocation to an API 

Holder with respect to its capital 

interest must be determined and 

calculated in a similar manner as the 

allocations with respect to capital 

interests held by similarly situated 

Unrelated Non-Service Partners who 

have made significant aggregate capital 

contributions. In this regard, the 

allocations and distribution rights with 

respect to API Holders’ capital interests 

and the capital interests of Unrelated 

Non-Service Partners who have made 


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significant aggregate capital 

contributions must be reasonably 

consistent. The similar manner test may 

be applied on an investment-byinvestment basis or on the basis of 

allocations made to a particular class of 

interests. The final regulations retain the 

factors used in the proposed regulations 

to determine whether allocations and 

distribution rights are made in a similar 

manner among partners: The amount 

and timing of capital contributed, the 

rate of return on capital contributed, the 

terms, priority, the type and level of risk 

associated with capital contributed, and 

the rights to cash or property 

distributions during the partnership’s 

operations and on liquidation. The final 

regulations maintain the rule that an 

allocation to an API Holder will not fail 

to qualify solely because the allocation 

is subordinated to allocations made to 

Unrelated Non-Service Partners or 

because an allocation to an API Holder 

is not reduced by the cost of services 

provided by the API Holder or a Related 

Person to the partnership. The final 

regulations also clarify the meaning of 

cost of services for this purpose. The 

fact that API Holders are not charged 

management fees on their capital or that 

their capital is not subject to allocations 

of API items will not prevent the API 

Holder’s capital interest from being 

eligible for the capital interest 

exception. Similarly, an allocation to an 

API Holder will not fail if an API Holder 

has a right to receive tax distributions 

while Unrelated Non-Service Partners 

do not have such a right, where such 

distributions are treated as advances 

against future distributions. 

The final regulations extend these 

concepts to allocations made through 

tiered structures. The final regulations 

remove the terms Passthrough Capital 

Allocation, Passthrough Interest Capital 

Allocation, and Passthrough Interest 

Direct Investment Allocation, and 

instead provide that an allocation made 

to a Passthrough Entity that holds an 

API in a lower-tier Passthrough Entity 

will be considered a Capital Interest 

Allocation if made in accordance with 

the principles applicable in determining 

Capital Interest Allocations. Under the 

final regulations, Capital Interest 

Allocations retain their character when 

allocated to an upper-tier partnership so 

long as they are allocated among the 

partners in the upper-tier partnership 

with respect to such partners’ capital 

interests in a manner that is respected 

under section 704(b) (taking the 

principles of section 704(c) into 

account). 

Because the revised rules provide 

sufficient flexibility for all structures, 

the final regulations do not adopt the 

suggestion to provide a separate set of 

rules for private equity and hedge funds. 

The Treasury Department and the IRS 

continue to study other issues raised by 

the commenters, including the 

application of the similar manner 

requirement to S corporations and the 

application of the capital interest 

exception to co-invest vehicles. 

The Treasury Department and the IRS 

request any additional comments on the 

application of the capital interest 

exception in the final regulations. 

2. Unrelated Non-Service Partner 

Requirement 

As discussed in the prior section, 

proposed § 1.1061–3(c)(4) provides 

additional guidance on Capital Interest 

Allocations. Under the proposed 

regulations, Capital Interest Allocations 

are allocations of long-term capital gain 

or loss made under the partnership 

agreement to an API Holder and to 

Unrelated Non-Service Partners based 

on their respective capital accounts and 

which meet other requirements. 

Unrelated Non-Service Partners are 

defined in proposed § 1.1061–1(a) as 

partners who have not provided services 

to the Relevant ATB and who are not, 

and have never been, related to any API 

Holder in the partnership or any person 

who provides, or has provided, services 

in the Relevant ATB. Proposed 

§ 1.1061–3(c)(4) specifies that Capital 

Interest Allocations must be made in the 

same manner to API Holders and to 

Unrelated Non-Service Partners with a 

significant aggregate capital account 

balance (defined as five percent or more 

of the aggregate capital account balance 

of the partnership at the time the 

allocations are made). Proposed 

§ 1.1061–3(c)(4)(iii) provides that the 

allocations to the API Holder and the 

Unrelated Non-Service Partners must be 

clearly identified both under the 

partnership agreement and on the 

partnership’s books and records as 

separate and apart from allocations 

made to the API Holder with respect to 

its API. The partnership agreement and 

the partnership books and records must 

also clearly demonstrate that the 

requirements for an allocation to be 

considered a Capital Interest Allocation 

have been met. 

For allocations made on a deal-bydeal or class-by-class basis, commenters 

noted that it is unclear if the 

requirement that allocations be made in 

the same manner to API Holders and 

Unrelated Non-Service Partners with a 

significant aggregate capital account 

balance applies to each deal or class, or 

if it applies only to a fund generally. 

One commenter suggested that as an 

alternative to a strict percentage test, 

funds should also be able to satisfy the 

test by establishing that the return on a 

class of equity was determined at arm’s 

length. Another commenter noted that a 

specific number or percentage of 

Unrelated Non-Service Partners must 

comprise the test group to prevent easy 

avoidance of the statute but questioned 

whether the five percent threshold for 

the test group is the appropriate 

threshold. The commenter also asked 

for clarification on the effect of the rule 

in proposed § 1.1061–3(c)(3)(ii)(C) that a 

capital account, for these purposes, does 

not include the contribution of amounts 

attributable to loans made by other 

partners or the partnership when 

comparing the allocations made to API 

Holders and Unrelated Non-Service 

Partners. 

One commenter stated that many 

funds would be unable to meet the 

requirement that allocations to the API 

Holder and the Unrelated Non-Service 

Partners be clearly identified in the 

partnership agreement because their 

agreements use liquidating distributions 

to govern an API Holder’s rights with 

respect to its API rather than 

allocations. The commenter 

recommended that the requirement be 

considered satisfied if the distribution 

provision clearly identified capital 

interest distributions separate and apart 

from distributions with respect to APIs. 

Several other commenters suggested 

that the rule requiring the allocations to 

be clearly identified both under the 

partnership agreement and on the 

partnership’s books and records be 

disjunctive, that is, that the allocations 

be clearly demarcated in either the 

partnership agreement or on the 

partnership’s books and records. 

Commenters noted that in order to meet 

the partnership agreement reporting 

requirement, a fund would have to 

update its partnership agreements, 

which could be done only by 

negotiating with the Unrelated NonService Partners. Initiating those 

negotiations could cause partners to 

want to negotiate other partnership 

items, which could take time and alter 

the agreements. These commenters thus 

suggested grandfathering existing 

partnership agreements or providing a 

transition period for funds to update 

their agreements to comply with this 

requirement. 

The final regulations retain the 

requirement that Capital Interest 

Allocations to an API Holder be 

compared to Capital Interest Allocations 

made to Unrelated Non-Service 

Partners, as well as the requirement that 

Capital Interest Allocations be made to 

Unrelated Non-Service Partners with a 

significant capital account balance, 


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including the five percent threshold. 

The Treasury Department and the IRS 

considered a number of alternatives and 

determined that the five percent 

threshold adequately insures that there 

is a significant comparison to meet the 

statutory exception that an API does not 

include a capital interest which 

provides the API Holder with a right to 

share in partnership capital 

commensurate with the amount of 

capital contributed. In accordance with 

the provision that the similar manner 

test in the final regulations may be 

applied on an investment-by-investment 

or class-by-class basis, the final 

regulations specify that the Unrelated 

Non-Service Partner requirement can 

also be applied on an investment-byinvestment basis, or on a class-by-class 

basis. The final regulations move the 

definition of Capital Interest Allocations 

to the definition section of the final 

regulations but retain the requirement 

that allocations with respect to, and 

corresponding to, contributed capital be 

clearly identified under both the 

partnership agreement and in the 

partnership’s books and records as 

separate and apart from allocations 

made to the API Holder with respect to 

its API, and specify that the books and 

records must be contemporaneous. 

Documenting the allocations in the 

partnership agreement and in 

contemporaneous books and records is 

a necessary corollary to the rule 

requiring Capital Interest Allocations to 

be made in a similar manner between 

API Holders and Unrelated Non-Service 

Partners with a significant interest, 

because it shows that the partnership’s 

Unrelated Non-Service Partners 

considered these allocations a valid 

return on their contributed capital. 

The final regulations do not include a 

rule that would grandfather existing 

partnership agreements or provide a 

transition period for partnerships to 

update their agreements. Because the 

final regulations more closely align the 

capital interest exception to standard 

industry practice, the number of 

partnership agreements that will need to 

be amended is reduced. Allocations 

made to an API Holder that do not meet 

the requirements of these final 

regulations will not be considered 

Capital Interest Allocations. Finally, due 

to the revisions made to the capital 

interest exception in these final 

regulations, the Treasury and the IRS 

have determined that it is not necessary 

to clarify the effect that the rule 

disregarding contributions made with 

the proceeds of loans by other partners 

or by the partnership has on the 

comparison of the allocation made to 

API Holders and Unrelated Non-Service 

Partners. 

3. Capital Interest Disposition Amounts 

If an owner disposes of an interest in 

a Passthrough Entity that is composed of 

a capital interest and an API, proposed 

§ 1.1061–3(c)(6) provides a mechanism 

for the owner to determine the portion 

of long-term capital gain or loss 

recognized on the disposition that is 

treated as a Capital Interest Disposition 

Amount and thus, a Capital Interest 

Gain or Loss. 

The final regulations clarify the 

determination of an API Holder’s 

Capital Interest Disposition Amount 

when the API Holder transfers a 

Passthrough Entity interest that is 

comprised of both an API and a capital 

interest at a gain and would be allocated 

only capital loss as a Capital Interest 

Allocation if all of the assets of the 

Passthrough Entity had been sold for 

their fair market value in a fully taxable 

transaction immediately before the 

interest transfer. In such an instance, the 

final regulations provide that all of the 

long-term capital gain attributable to the 

interest transfer is API Gain. Conversely, 

if such API Holder recognizes long-term 

capital loss on the transfer of a 

Passthrough Entity interest and would 

be allocated only capital gain as a 

Capital Interest Allocation if all of the 

assets of the Passthrough Entity had 

been sold for their fair market value in 

a fully taxable transaction immediately 

before the interest transfer, the final 

regulations provide that all of the longterm capital loss attributable to the 

interest transfer is API Loss. The final 

regulations provide additional rules 

where a transferred Passthrough Entity 

interest results in a gain and the 

transferor would have been allocated 

both Capital Interest Gain and API Gain 

as well as where a transferred 

Passthrough Entity interest results in a 

loss and the transferor would have been 

allocated both Capital Interest Loss and 

API Loss. In such instances, a fraction 

is used to determine the portion of the 

transferred interest gain or loss 

characterized as a Capital Interest 

Disposition Amount. 

Commenters noted a concern that 

Example 5 in proposed regulation 

§ 1.1061–3(c)(7)(v), did not adequately 

address basis proration upon a partial 

interest sale where a partner holds a 

partnership interest comprised of both 

an API and a capital interest. 

Specifically, one commenter noted that 

Example 5’s reliance on the equitable 

apportionment approach of § 1.61–6(a) 

could lead to a situation where the 

characterization of the gain or loss 

attributable to the sale of a portion of 

the partner’s partnership interest differs 

from the characterization of that 

partner’s distributive share of asset gain 

or loss if all of the assets of the 

Passthrough Entity were sold for their 

fair market value in a fully taxable 

transaction. Another commenter 

suggested applying the specific 

identification rules in § 1.1223–3 

applicable to publicly traded 

partnership units to transfers of private 

interests. These commenters noted that 

because the issue illustrated in Example 

5 has ramifications beyond section 

1061, further study should occur before 

proceeding with the position stated in 

Example 5. 

The Treasury Department and the IRS 

continue to study the issue noted with 

respect to Example 5 and have removed 

the example in the interim as many of 

the concerns raised on the sale of a 

partial partnership interest extend 

beyond section 1061. 

4. Unrealized API Gains and Losses 

Proposed § 1.1061–1(a) defines 

Unrealized API Gains and Losses as all 

unrealized capital gains and losses, 

including both short-term and longterm, that would be allocated to an API 

Holder with respect to its API if all 

relevant assets were disposed of for fair 

market value in a taxable transaction on 

the relevant date. Proposed § 1.1061– 

2(a)(1)(ii) provides rules for the 

treatment of Unrealized API Gains and 

Losses, including the requirement to 

determine Unrealized API Gains and 

Losses in tiered structures. Proposed 

§ 1.1061–3(c)(3)(iii) provides that 

Capital Interest Allocations and 

Passthrough Interest Capital Allocations 

do not include amounts treated as API 

Gains and Losses or Unrealized API 

Gains and Losses. 

A commenter stated that the 

requirement to determine Unrealized 

API Gains and Losses in tiered 

structures is not reasonable because an 

upper-tier Passthrough Entity would not 

be able to require every uncontrolled 

lower-tier Passthrough Entity in the 

chain to revalue its assets under the 

principles of § 1.704–1(b)(2)(iv)(f). The 

commenter recommended that the 

mandatory section 1061 revaluation 

rules be eliminated. The commenter 

requested instead that the existing rules 

for revaluations under the section 704(b) 

and 704(c) regulations govern 

Unrealized API Gains and Losses. 

Alternatively, the commenter suggested 

that anti-abuse regulations be written to 

address revaluations in chains of 

controlled tiered partnerships. 

The final regulations remove the 

mandatory revaluation rules and adopt 

the commenter’s suggestion that 


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Unrealized API Gains and Losses be 

determined according to the existing 

rules governing unrealized gains and 

losses, including section 704(c) 

principles. Accordingly, the final 

regulations provide that the term 

Unrealized API Gains and Losses 

means, with respect to a Passthrough 

Entity’s assets, all unrealized capital 

gains and losses that would be (i) 

realized if those assets were disposed of 

for fair market value in a taxable 

transaction on the relevant date, and (ii) 

allocated to an API Holder with respect 

to its API, taking into account the 

principles of section 704(c). 

Because the proposed regulations 

provide that Capital Interest Allocations 

are made based on partners’ relative 

section 704(b) capital accounts, several 

commenters questioned whether 

Unrealized API Gains and Losses that 

are reflected in an API Holder’s capital 

account could generate Capital Interest 

Allocations, including book Capital 

Interest Allocations, before these 

amounts are recognized. Commenters 

explained that these issues are 

particularly relevant for hedge funds 

and described their operations and 

incentive structure. When an API 

Holder in a hedge fund receives 

incentive allocations with respect to the 

API, its capital account is increased by 

the amount of the incentive allocation, 

and Unrelated Non-Service Partners’ 

capital accounts are decreased. This 

increase is coupled with allocations of 

taxable income and gain and also 

allocations of unrealized gain (reverse 

section 704(c) allocations). Commenters 

also requested additional guidance on 

the treatment of realized and unrealized 

gains from an API which are contributed 

to, or reinvested in, a partnership. 

The final regulations continue to 

provide that Unrealized API Gains and 

Losses are not included in Capital 

Interest Gains and Losses. In response to 

comments, the final regulations clarify 

that if an API Holder is allocated API 

Gain by a Passthrough Entity, to the 

extent that an amount equal to the API 

Gain is reinvested in Passthrough Entity 

by the API Holder (either as the result 

of an actual distribution and 

recontribution of the API Gain amount 

or the retention of the API Gain amount 

by the Passthrough Entity), the amount 

will be treated as a contribution to the 

Passthrough Entity for a capital interest 

that may produce Capital Interest 

Allocations for the API Holder, 

provided such allocations otherwise 

meet the requirements to be a Capital 

Interest Allocation. 

B. Capital Contributions Made With the 

Proceeds of Partnership or Partner 

Loans 

Proposed § 1.1061–3(c)(3)(ii)(C) 

provides that for purposes of proposed 

§§ 1.1061–1 through 1.1061–6, a capital 

account does not include the 

contribution of amounts directly or 

indirectly attributable to any loan or 

other advance made or guaranteed, 

directly or indirectly, by any other 

partner, the partnership, or a Related 

Person with respect to any other partner 

or the partnership. Repayments on the 

loan are included in capital accounts as 

those amounts are paid by the partner, 

provided that the loan is not repaid with 

the proceeds of another similarly 

sourced loan. Id. 

Several commenters criticized this 

treatment, suggesting that the exclusion 

of these amounts from the partner’s 

capital account inhibits common and 

reasonable business practices, and 

creates barriers to entry for service 

partners, particularly those who are less 

represented based on age, gender, or 

race or do not have ready access to 

capital. One commenter noted that it is 

typical for fund managers to either 

extend loans to their employees, or to 

guarantee loans issued to such 

employees by third parties, so that 

employees may invest in the manager’s 

own investment funds. Similarly, 

another commenter stated that the 

proposed regulations would introduce a 

substantial impediment to raising 

capital for commercial real estate 

investment by creating a disincentive 

for general partners to finance or 

support the financing of the 

participation of its employees in its 

commercial real estate investments. The 

commenter claimed that contributions 

made in this manner are a significant 

source of capital available for real estate 

investment and also an important factor 

in attracting third party capital because 

they create an alignment of interest 

between the limited partners and the 

general partner and its employees. 

Commenters noted that neither the 

statute nor the legislative history 

indicates that the use of loan proceeds 

to make a capital contribution precludes 

the interest from being included in a 

partner’s capital account and contended 

that adding such a rule is not justified 

by the commensurate with capital 

statutory language of the capital interest 

exception. To the contrary, commenters 

argued that the authors of the TCJA 

were familiar with prior proposals 

regarding profits interests that contained 

exceptions for loaned capital and their 

decision not to include such an 

exception in section 1061 is an 

indication that the choice was 

intentional. Instead, one commenter 

maintained that Congress addressed any 

concerns through the rule that a service 

provider’s rights with respect to its 

contributed capital must match the 

rights of other non-service partners with 

respect to their shares of contributed 

capital. 

Some commenters recognized that the 

exclusion from capital accounts of 

contributions attributable to partner or 

partnership loans is an attempt to 

control the perceived abuse of limited 

partners loaning the general partner of 

the partnership an amount of capital 

that entitles the general partner to a 

portion of the partnership’s profits in 

order to avoid the application of section 

1061 and fit within the capital interest 

exception. Commenters noted that 

section 1061(f) provides the Secretary 

with authority to issue guidance as is 

necessary or appropriate to carry out the 

purposes of section 1061 and that the 

legislative history indicates that such 

guidance is to address the prevention of 

abuse of the purposes of the provision. 

Other commenters, suggesting that the 

policy behind the capital interest 

exception is to ensure a partner has 

capital at risk to qualify for the 

exception, acknowledged that there are 

fact patterns in which a partner might 

be considered less at risk. One 

commenter pointed to the at-risk 

limitation on losses under section 465, 

noting that a service provider would not 

be considered at-risk with respect to 

contributed capital that is financed 

through a loan from another partner, 

even if the loan were fully recourse to 

the service provider. By contrast, a 

partner is considered at-risk when an 

investment is funded by a third-party 

loan for which the partner has personal 

liability. Another commenter noted that 

the proposed regulations’ treatment of a 

capital interest funded through a loan 

from the issuing partnership is 

consistent with the treatment of 

partnership loans under other areas of 

Subchapter K. The commenter pointed 

out that the contribution of a partner’s 

own promissory note generally does not 

increase the partner’s basis in its 

partnership interest under section 722. 

Similarly, pursuant to § 1.704– 

1(b)(2)(iv)(d)(2), the partner’s capital 

account will be increased with respect 

to the promissory note only when there 

is a taxable disposition of the note by 

the partnership or when the partner 

makes principal payments on such note, 

provided that the note is not readily 

tradable on an established securities 

market. 

Despite recognizing these concerns 

regarding abuse, commenters 


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maintained that the loan proceeds 

exclusion should be eliminated because 

general income tax principles, such as 

those in sections 83 and 7872, are 

sufficient to determine whether a loanfinanced arrangement should not 

qualify for the capital interest exception. 

Other commenters suggested that if 

limitations must be imposed, the rule 

should be narrowly tailored, 

recommending that only loans that are 

nonrecourse or lack substantial security 

be excluded from the capital interest 

exception. Commenters also suggested 

that guarantees should not be treated in 

the same manner as a loan, particularly 

in the context of a recourse loan or a 

loan from a third-party bank. Another 

commenter suggested that if the loan or 

guarantee operates under normal armslength standards, it should be eligible to 

support a capital contribution. Another 

commenter noted that the proposed 

regulations are silent on loans that are 

fully secured with partnership assets. 

The Treasury Department and the IRS 

remain concerned that capital 

contributions made with the proceeds of 

loans made or guaranteed by another 

partner, the partnership, or a Related 

Person with respect to such partner or 

partnership could lead to abuse of the 

capital interest exception. Therefore, the 

final regulations do not adopt the 

suggestions to remove the rule. 

However, the Treasury Department and 

the IRS agree with commenters that the 

potential for abuse is reduced when a 

loan or advance is made by another 

partner (or Related Person with respect 

to such other partner, other than the 

partnership) to an individual service 

provider if the individual service 

provider is personally liable for the 

repayment of such loan or advance. 

Accordingly, the final regulations 

provide that an allocation will be 

treated as a Capital Interest Allocation if 

the allocation is attributable to a 

contribution made by an individual 

service provider that, directly or 

indirectly, results from, or is attributable 

to, a loan or advance from another 

partner in the partnership (or any 

Related Person with respect to such 

lending or advancing partner, other than 

the partnership) to such individual 

service provider if the individual 

service provider is personally liable for 

the repayment of such loan or advance 

as described in the final regulations. 

The final regulations apply a similar 

approach with respect to loans or 

advances made by a partner in the 

partnership (or a Related Person to such 

partner, other than the partnership) to a 

wholly owned entity that is disregarded 

as separate from an individual service 

provider where the individual service 

provider that owns such disregarded 

entity is personally liable for the 

repayment of any borrowed amounts 

that are not repaid by the disregarded 

entity. The final regulations provide that 

an individual service provider is 

personally liable for the repayment of a 

loan or advance made by a partner (or 

any Related Person, other than the 

partnership) if (i) the loan or advance is 

fully recourse to the individual service 

provider; (ii) the individual service 

provider has no right to reimbursement 

from any other person; and (iii) the loan 

or advance is not guaranteed by any 

other person. The Treasury Department 

and the IRS continue to study the 

treatment of guarantees generally in 

light of questions about who the 

borrower is for Federal tax purposes. 

A commenter noted that the proposed 

regulations’ treatment of loans, together 

with the section 704(b) capital account 

approach being taken with respect to the 

capital interest exception, could mean 

that a partner who borrows from a 

related person to make even a small 

portion of his or her capital contribution 

might be denied the capital interest 

exception with respect to his or her 

entire capital interest. A few 

commenters recommended that if the 

treatment of related party loans is 

retained in the final regulations, 

adjustments should be made to ensure 

that partners are able to receive 

appropriate credit for capital 

contributions they make that are not 

attributable to loans. Another 

commenter stated that the proposed 

regulations did not provide a tracing 

regime to connect loan proceeds with 

capital contributions. One commenter 

suggested that final regulations clarify 

how to treat a partner that fully funded 

a capital contribution with loan 

proceeds but repaid such amounts 

before there was a capital interest 

allocation, including whether a 

revaluation would change the answer. 

The commenter recommended that it 

would be appropriate to treat the 

partner’s capital account as funded at 

the time of actual contribution. Finally, 

the commenter recommended that final 

regulations include a transition rule 

related to related party loans made, 

advanced, guaranteed, or repaid before 

final regulations are issued. The 

Treasury Department and the IRS 

considered these comments and believe 

that the concerns raised in them are 

resolved by the commensurate with 

capital approach to the capital interest 

exception taken in the final regulations 

because this approach does not rely on 

a comparison of allocations based on the 

partners’ overall section 704(b) capital 

accounts. 

C. Lookthrough Rule for Certain API 

Dispositions 

Proposed § 1.1061–4(b)(9) provides a 

limited Lookthrough Rule that may 

apply to the sale of an API where capital 

gain is recognized and the holding 

period of the API is more than three 

years. In the case of a disposition of a 

directly held API with a holding period 

of more than three years, the proposed 

Lookthrough Rule applies if the assets of 

the partnership in which the API is held 

meet the Substantially All Test. The 

Substantially All Test is met if 80 

percent or more of the assets of the 

partnership in which the API is held, 

based on fair market value, are assets 

that would produce capital gain or loss 

that is not described in proposed 

§ 1.1061–4(b)(6) if disposed of by the 

partnership, and that have a holding 

period of three years or less. In the case 

of a tiered structure in which an API 

Holder holds its API through one or 

more Passthrough Entities, the 

Lookthrough Rule applies if the API 

Holder disposes of a Passthrough 

Interest held for more than three years 

and recognizes capital gain, and either: 

(i) The Passthrough Entity through 

which the API is directly or indirectly 

held has a holding period in the API 

that is three years or less, or (ii) the 

Passthrough Entity through which the 

API is held has a holding period in the 

API of more than three years and the 

assets of the partnership in which the 

API is held meet the Substantially All 

Test. 

The Treasury Department and the IRS 

received several comments stating that, 

although the application of the 

Lookthrough Rule for directly-held APIs 

is reasonable, the application of the 

Lookthrough Rule for indirectly-held 

APIs is punitive and imposes an 

unreasonable and significant 

administrative burden. The commenters 

recommended that the scope of the 

Lookthrough Rule for indirectly-held 

APIs be limited, particularly in the case 

of indirectly-held APIs where the 

relevant taxpayer does not control a 

partnership that issued the API. Another 

commenter questioned the authority for 

the Lookthrough Rule but noted that it 

is consistent with partnership tax 

principles and that the proposed 

regulation would be easily manipulated 

without the rule. 

Commenters suggested that the 

proposed regulations be amended in one 

or more of the following ways: (i) Limit 

the Lookthrough Rule to situations in 

which a Passthrough Entity controls all 

of the relevant lower-tier Passthrough 


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Entities (or only applying it to lower-tier 

Passthrough Entities that it controls); (ii) 

limit the Lookthrough Rule for 

indirectly held APIs to situations in 

which the API is held by a lower-tier 

Passthrough Entity for three years or 

less; (iii) limit the application of the 

Lookthrough Rule to situations in which 

assets that produce capital gain or loss 

of a type taken into account under 

section 1061 are a material amount 

(greater than 50 percent) of the value of 

the underlying assets of the partnership; 

(iv) eliminate the Substantially All Test 

in the context of tiered structures (that 

is, determine the applicability of the 

Substantially All Test with respect to 

the assets held by the partnership whose 

interest was sold); (v) amend the 

Substantially All Test so that a 

transferring taxpayer who has held its 

interest for more than three years will be 

required to look through to the 

underlying assets’ character only if 80 

percent or more of the assets held 

directly or indirectly by the Passthrough 

Entity have a holding period of three 

years or less; (vi) make information 

reporting related to the Lookthrough 

Rule mandatory for partnerships and S 

corporations and for required PFIC 

annual information statements 

regardless of whether a Passthrough 

Entity has issued or holds an API; (vii) 

provide a de minimis rule by which an 

upper-tier partnership holding a five 

percent or less interest in the lower-tier 

partnership would be allowed to use its 

holding period in the lower-tier 

partnership; and (viii) as a part of the de 

minimis rule, not require revaluations of 

lower-tier partnerships when an Owner 

Taxpayer disposes of an upper-tier 

interest that holds five percent or less of 

a lower-tier partnership. A commenter 

recommended that the Lookthrough 

Rule approach calculations in tiered 

structures from the lower-tier entities 

up, aligning with the approach to tiered 

structures elsewhere in the proposed 

regulations, and allowing the rule to 

appropriately accommodate lower-tier 

gains from assets whose sale proceeds 

are treated as capital gains without 

regard to section 1222(3) and (4). 

After considering the comments, the 

Treasury Department and the IRS agree 

that the Lookthrough Rule as proposed 

could be difficult for Owner Taxpayers 

and Passthrough Entities to apply, 

particularly in the context of tiered 

structures. However, the Treasury 

Department and the IRS remain 

concerned that taxpayers could avoid 

section 1061 by transferring assets to, 

and issuing APIs from, existing 

partnerships. Accordingly, the final 

regulations retain the Lookthrough Rule, 

but instead of applying the Lookthrough 

Rule to the disposition of an API held 

for more than three years and where the 

Substantially All Test is met, the final 

regulations limit the application of the 

Lookthrough Rule to situations where, 

at the time of disposition of an API held 

for more than three years, (1) the API 

would have a holding period of three 

years or less if the holding period of 

such API were determined by not 

including any period prior to the date 

that an Unrelated Non-Service Partner is 

legally obligated to contribute 

substantial money or property directly 

or indirectly to the Passthrough Entity 

to which the API relates (this rule does 

not apply to the disposition of an API 

to the extent that the gain recognized 

upon the disposition of the API is 

attributable to any asset not held for 

portfolio investment on behalf of third 

party investors); or (2) a transaction or 

series of transactions has taken place 

with a principal purpose of avoiding 

potential gain recharacterization under 

section 1061(a). The Lookthrough Rule 

similarly applies with respect to a 

Passthrough Interest issued by an S 

corporation or a PFIC to the extent the 

Passthrough Interest is treated as an 

API. The final regulations also simplify 

the method for applying the 

Lookthrough Rule. 

Commenters also stated that the 

Lookthrough Rule raises a concern that 

going concern value in a lower-tier 

entity might be subject to ordinary 

income rates if an upper-tier partnership 

interest is sold, the Lookthrough Rule 

applies, and the upper-tier partnership 

owns a lower-tier partnership interest. 

These commenters recommended that 

gain associated with goodwill or 

enterprise value retain the holding 

period of the partnership interest itself, 

as opposed to the underlying assets, and 

that the Lookthrough Rule apply only to 

the gain associated with the 

hypothetical liquidation of the 

underlying assets. The Treasury 

Department and the IRS continue to 

study this issue and may address it in 

future guidance. 

One commenter requested 

clarification that the phrase ‘‘total net 

capital gain’’ in proposed § 1.1061– 

4(b)(9)(ii)(C)(1) refers to ‘‘net long-term 

capital gain’’ and that short- and longterm capital gains and losses cannot be 

netted against each other. The final 

regulations do not include this 

language. The Treasury Department and 

the IRS believe that the concerns raised 

by the commenter are alleviated by the 

simplified Lookthrough Rule adjustment 

in the final regulations. 

D. Section 1.1061–5: Transfers to 

Related Parties 

Proposed § 1.1061–5(a) provides that 

if an Owner Taxpayer transfers any API, 

or any Distributed API Property, directly 

or indirectly, to a Section 1061(d) 

Related Person, or if a Passthrough 

Entity in which an Owner Taxpayer 

holds an interest, directly or indirectly, 

transfers an API to a Section 1061(d) 

Related Person, regardless of whether 

gain is otherwise recognized on the 

transfer under the Code, the Owner 

Taxpayer must include in gross income 

as short-term capital gain, the excess of: 

(1) The Owner Taxpayer’s net long-term 

capital gain with respect to such interest 

for such taxable year determined as 

provided in proposed § 1.1061–5(c), 

over (2) any amount treated as shortterm capital gain under proposed 

§ 1.1061–4 with respect to the transfer of 

such interest (that is, any amount 

included in the Owner Taxpayer’s API 

One Year Disposition Gain Amount and 

not in the Owner Taxpayer’s Three Year 

Disposition Gain Amount with respect 

to the transferred interest). Proposed 

§ 1.1061–5(b) provides that for purposes 

of section 1061(d), the term transfer 

includes contributions, distributions, 

sales and exchanges, and gifts. 

Several commenters addressed 

whether section 1061(d) should be 

interpreted as an acceleration provision 

or merely a recharacterization provision. 

With certain exceptions, the proposed 

regulations require that gain be 

accelerated on the transfer of an API to 

a Section 1061(d) Related Person, 

regardless of whether the transfer is 

otherwise a taxable transaction for 

Federal income taxes or whether gain is 

otherwise realized or recognized under 

the Code on the transfer. One 

commenter supported this treatment, 

noting that section 1061(d)(1) is literally 

worded as an income acceleration 

provision while acknowledging that 

others have viewed the language as a 

recharacterization provision, such as 

section 751(a). Another commenter 

noted that neither the text nor the 

legislative history shed any light on its 

purpose and stated that the provision’s 

language is susceptible to numerous 

different readings. The commenter 

noted that section 1061(d) could be read 

as a narrow recharacterization 

lookthrough provision similar to section 

751, a recharacterization and 

assignment of income provision that 

provides for nonrecognition transfers 

and requires the transferor rather than 

the transferee to include API Gain when 

ultimately realized, a recharacterization 

and acceleration provision, or a 

proration provision. The commenter did 


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not provide a recommendation, but 

noted that the proposed regulations 

create many traps for the unwary. The 

commenter stated that the broad 

definition of transfer in the proposed 

regulations combined with the 

overriding of nonrecognition treatment 

could lead to significant, adverse tax 

impacts on transferors as well as 

otherwise uninvolved, passive interest 

holders in a variety of transactions. The 

commenter suggested that the Treasury 

Department and the IRS carefully 

consider whether the effect of the 

proposed regulations is appropriate and 

aligns with section 1061(d)’s language, 

function, and origins. 

Other commenters argued that 

applying section 1061(d) to transactions 

where gain is not otherwise recognized 

is inconsistent with the statutory 

language. One commenter stated that 

section 1061(d) itself does not refer to 

any nonrecognition provisions, nor does 

it contain any express statement of 

intent to override nonrecognition 

treatment. This commenter and others 

noted that section 1061(d) operates by 

reference to the taxpayer’s long-term 

capital gains, which as defined in 

section 1223(3) include only gains that 

are recognized for U.S. Federal income 

tax purposes. Consequently, these 

commenters argued that the statute by 

its terms does not apply to situations in 

which the taxpayer has no actual longterm capital gain with respect to such 

interest. Commenters also noted that the 

legislative history does not provide 

support for treating section 1061(d) as 

an acceleration provision. Previous 

carried interest provisions included 

language that explicitly overrode nonrecognition; section 1061 as enacted 

contains no such language. 

One commenter stated that it is not 

necessary to accelerate gain on the 

transfer of an API to a Section 1061(d) 

Related Person, noting that the API in 

the hands of the transferee is still 

subject to section 1061(a) because an 

API includes interests held by or 

transferred to the taxpayer in 

connection with the performance of a 

substantial service by the taxpayer or a 

related person. 

Commenters also raised a variety of 

concerns about the proposed 

regulation’s definition of transfer. 

Commenters recommended that the 

term transfer be further defined to 

address potential cases involving 

indirect transfers of an API, such as the 

admission of new partners into the 

partnership, the withdrawal of old 

partners from the partnership, the 

transfer of an employee between teams, 

or an award to a high performer. One 

commenter explained that, in these 

circumstances, because there is no 

change in the relative economic position 

between fund managers and third-party 

investors, there should be no 

requirement for the fund manager or 

employees of the fund manager to 

recognize unrealized built-in gain. 

Commenters also recommended that the 

final regulations consider whether a 

forfeiture of an API is a transfer for 

purposes of section 1061(d) but stated 

that such an interpretation would be 

overbroad. One commenter noted that 

forfeiture and reallocations involve 

circumstances in which the partners’ 

legal and economic interests in the 

partnership’s Unrealized API Gains are 

contingent rather than fixed. Where a 

partner’s interest in Unrealized API 

Gains is contingent, the commenter 

argued that it is not appropriate to tax 

a partner on a reduction in that interest 

under section 1061(d). 

Another commenter asked for 

clarification that the distribution of an 

API by a direct API Holder to an Owner 

Taxpayer (indirect API Holder) would 

be exempt from the application of 

section 1061(d). The commenter noted 

that section 1061(a) would continue to 

apply to the distributed API and that 

this treatment would be consistent with 

the rules related to Distributed API 

Property in § 1.1061–4. Under those 

rules, a distribution of property by a 

Passthrough Entity to an API Holder is 

not subject to recharacterization under 

section 1061 but the Distributed API 

Property continues to be subject to 

section 1061. The commenter argued 

that this rule would also treat similarly 

situated taxpayers the same, rather than 

treating distributees of Distributed API 

Property differently from Owner 

Taxpayers who receive a distribution of 

an API from a partnership. 

Another commenter asked for 

clarification that the definition of gift 

refers to transfers which are gifts for 

income tax purposes (rather than for gift 

tax purposes). The commenter noted 

that many common estate planning 

techniques involve transfers of assets to 

grantor trusts with the transferor as the 

grantor and the grantor’s family 

members as beneficiaries of the trust, 

and that these types of transfers often 

result in a completed gift for gift tax 

purposes but do not constitute a transfer 

of ownership for income tax purposes. 

Commenters also recommended that 

the final regulations exclude specific 

nonrecognition transactions, including 

(i) transfers resulting from the death of 

an Owner Taxpayer; (ii) gifts to a nongrantor trust by an Owner Taxpayer; and 

(iii) transfers resulting from a change in 

tax status of a grantor trust. One 

commenter noted that, in light of 

section 1061(d)’s specific reference to 

section 318(a)(1), and not to section 

318(a)(2), a gift to a non-grantor trust for 

the benefit of a taxpayer’s spouse, 

children, grandchildren or parents 

should not be considered an ‘‘indirect 

transfer’’ that would trigger the 

application of section 1061(d). The 

commenter noted that Congress’s use of 

the phrase ‘‘directly or indirectly’’ does 

not warrant disturbing the conclusion 

that a transfer to a non-grantor trust 

does not constitute an acceleration 

event for purposes of section 1061(d). 

This commenter suggested in the 

alternative that if a transfer to a nongrantor trust is an acceleration event for 

purposes of section 1061(d), only upon 

a subsequent distribution of the API out 

of the non-grantor trust should the 

acceleration event occur. 

After considering the comments, the 

Treasury Department and the IRS have 

determined that while section 1061(d) 

can reasonably be interpreted as an 

acceleration provision, in the absence of 

clear language to the contrary, it is more 

appropriate to apply section 1061(d) 

only to transfers in which long-term 

capital gain is recognized under chapter 

1 of the Code. Interpreting section 

1061(d) as only a recharacterization 

provision is consistent with the 

statutory language that looks to so much 

of the taxpayer’s long-term capital gain 

with respect to such interest for such 

taxable year as is attributable to the sale 

or exchange of any asset held. This 

treatment also prevents the acceleration 

of gain in the many non-abusive 

nonrecognition transactions described 

by commenters. Furthermore, it is not 

necessary to accelerate gain on the 

transfers of an API to a Section 1061(d) 

Related Person in a non-taxable 

transaction because the API will remain 

an API in the hands of the transferee 

under § 1.1061–2(a). Accordingly, the 

final regulations provide that the 

Section 1061(d) Recharacterization 

Amount includes only long-term capital 

gain that the Owner Taxpayer 

recognizes under chapter 1 of the Code 

upon a transfer through a sale or 

exchange of an API to a Section 1061(d) 

Related Person. 

Proposed § 1.1061–5(c) provides a 

formula for calculating the Owner 

Taxpayer’s short-term capital gain upon 

a transfer of an API to a Section 1061(d) 

Related Person based upon a 

hypothetical sale of all of the 

partnership’s property in a fully taxable 

transaction. A commenter noted that 

because the calculation is not based on 

the Recharacterization Amount under a 

hypothetical liquidation, it includes 

amounts excluded from the 

Recharacterization Amount, such as 


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capital interest gains and losses. The 

commenter recommended that the 

formula be amended so that it is based 

upon the Recharacterization Amount in 

a hypothetical partnership liquidation, 

and that the final regulations contain an 

exception from taxation for transactions 

in which the Owner Taxpayer’s deemed 

distributions with respect to the Owner 

Taxpayer’s API on a hypothetical 

liquidation basis are the same 

immediately before and after the 

transaction (not including any deemed 

distributions due to changes in debt 

allocations). Another commenter 

suggested that, in order to avoid doublecounting in a tiered structure, there 

should be a cap on the amount that 

would be taxed equal to the gain that 

would be realized if the directly 

transferred API were sold for its fair 

market value by the Owner Taxpayer. 

Another commenter noted that the 

proposed regulations provide that 

section 1061(d) applies to transfers of 

APIs by Passthrough Entities and to 

transfers of Distributed API Property by 

Owner Taxpayers, but that the rules do 

not provide guidance on how to 

calculate the amount to be included. 

The commenter suggested that, in the 

case of a transfer of an API by a 

Passthrough Entity, the inclusion 

amount should be the amount that 

would be allocated to each of the 

Passthrough Entity’s direct or indirect 

Owner Taxpayers in a deemed taxable 

sale of assets by the lower-tier entity in 

which the Passthrough Entity holds its 

API, and that the amounts that such 

Passthrough Entity includes in the API 

One Year Distributive Share Amount, 

but not in the API Three Year 

Distributive Share Amount, for each 

Owner Taxpayer should be subtracted 

from the aforementioned amounts to 

calculate an Owner Taxpayer’s 

recharacterization amount under section 

1061(d). In the case of a transfer of 

Distributed API Property by an Owner 

Taxpayer, the commenter suggested that 

the inclusion amount should be the 

amount of long-term capital gain that 

the Owner Taxpayer would have 

recognized on a taxable sale for cash at 

the Distributed API Property’s fair 

market value. 

The Treasury Department and the IRS 

appreciate these thoughtful suggestions. 

The final regulations have revised and 

simplified the computation of the 

inclusion amount in § 1.1061–5(c) and 

have added the term Section 1061(d) 

Recharacterization Amount. The final 

regulations provide that, if section 

1061(d) applies, an Owner Taxpayer’s 

Section 1061(d) Recharacterization 

Amount is the Owner Taxpayer’s share 

of the amount of net long-term capital 

gain from assets held for three years or 

less that would have been allocated to 

the Owner Taxpayer with respect to the 

transferred API if the partnership had 

sold all of its property in a fully taxable 

transaction for cash in an amount equal 

to the fair market value of such property 

immediately prior to the Owner 

Taxpayer’s transfer of the API (or a 

portion of such gain if only a portion of 

the API is transferred). 

A commenter requested clarification 

as to whether ‘‘capital gain recognized’’ 

on an otherwise taxable transfer in 

proposed § 1.1061–5(c)(2) means that 

the amount recharacterized under 

section 1061(d) includes only gain that 

would otherwise be treated as long-term 

gain or whether it sets the total amount 

of short-term gain on the transfer. The 

final regulations provide that the longterm gain that is recharacterized to 

short-term under section 1061(d) is the 

lesser of (i) the amount of net long-term 

capital gain recognized by the Owner 

Taxpayer upon the transfer of such 

interest, or (ii) the Section 1061(d) 

Recharacterization Amount as 

computed under § 1.1061–5(c). Thus, 

only gain that would otherwise be 

treated as long-term gain is 

recharacterized under section 1061(d). 

Proposed § 1.1061–5(d) provides that 

the basis of a transferred API or 

transferred Passthrough Interest (in the 

case of a transferred Indirect API) is 

increased by the additional gain 

recognized. A commenter requested that 

the rule be revised to explicitly 

coordinate with section 743 so that the 

basis adjustments will be allocated to 

the assets that result in the gain 

recognition. The concerns raised in this 

comment are resolved because the final 

regulations limit the application of 

section 1061(d) to transactions in which 

gain is recognized. 

Another commenter recommended 

that the final regulations explicitly 

exclude amounts that would be subject 

to the Capital Interest Exception. The 

final regulations do not adopt this 

comment because the Capital Interest 

Exception is an exception to the 

definition of an API. Therefore, such a 

rule is not needed. Commenters also 

recommended that the final regulations 

explicitly exclude amounts specified in 

proposed § 1.1061–4(b)(6) (designated as 

§ 1.1061–4(b)(7) in the final regulations) 

from the calculation of the Section 

1061(d) Recharacterization Amount. 

One commenter noted that the scope of 

section 1061(d)(1) is broader than the 

tax result that would occur if the 

partnership had actually sold all its 

property, noting that neither the statute 

nor the proposed regulations exclude 

section 1231 gains (and other excluded 

gains such as those under section 1256) 

from the Section 1061(d) 

Recharacterization Amount. Another 

commenter argued that section 1061(d) 

should not recharacterize section 1231 

gain, stating that while the statutory 

language in section 1061(d) provides 

arguable authority for including section 

1231 gains in the computation of the 

Section 1061(d) Recharacterization 

Amount, the approach is hard to justify 

from a policy perspective. The 

commenter argued that because section 

1061(d) is aimed at preventing an API 

Holder from circumventing section 

1061(a), the regulations should not 

impose on taxpayers a result under 

section 1061(d) that is worse than if 

section 1061(a) had applied to assets 

sold by the partnership. The commenter 

recommended that ‘‘long-term capital 

gains’’ should be interpreted 

consistently for purposes of section 

1061(a) and section 1061(d), and that 

long-term capital gain recognized with 

respect to section 1231 assets should not 

be recharacterized under either 

paragraph. 

The final regulations adopt these 

comments and provide that the Section 

1061(d) Recharacterization Amount 

does not include amounts not taken into 

account for purposes of section 1061 

under § 1.1061–4(b)(7). 

Proposed § 1.1061–5(c)(1) provides 

that if an Owner Taxpayer transfers an 

Indirect API and is subject to section 

1061(d), the computation of the Section 

1061(d) Recharacterization Amount 

must be applied at the level of any 

lower-tier Passthrough Entities. One 

commenter recommended that this rule 

be aligned with the rules for tiered 

partnerships elsewhere in the proposed 

regulations, such as the Lookthrough 

Rule, which explicitly states that it 

applies only to the ‘‘assets of the 

partnership in which the API is held.’’ 

A commenter recommended that the 

final regulations clarify whether the 

transfer of a distributed asset held, or 

deemed to be held, by the partnership 

for three years or less is subject to 

section 1061(d). Another commenter 

noted that there is no principled reason 

for not applying section 1061(d) in 

tiered partnerships to transfers of 

Distributed API Property by Passthrough 

Entities to Section 1061(d) Related 

Persons of the ultimate Owner 

Taxpayer. 

Under the final regulations, the 

Section 1061(d) Recharacterization 

Amount is computed by the Owner 

Taxpayer. The transfer of a distributed 

asset held, or deemed to be held, by a 

Passthrough Entity for three years or 

less is subject to section 1061(d). The 

final regulations clarify that for 


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purposes of section 1061(d), an Owner 

Taxpayer will be treated as transferring 

the Owner Taxpayer’s share of any 

Indirect API or Distributed API Property 

if the Indirect API or Distributed API 

Property is transferred by the API 

Holder to a person that is a Section 

1061(d) Related Person with respect to 

the Owner Taxpayer. The final 

regulations also provide that the rules 

for determining the Section 1061(d) 

Recharacterization Amount also apply 

to the transfer of a Passthrough Interest 

issued by an S corporation or PFIC to 

the extent the Passthrough Interest is 

treated as an API. 

Proposed § 1.1061–5(e) defines a 

Section 1061(d) Related Person as: (i) A 

person that is a member of the 

taxpayer’s family within the meaning of 

section 318(a)(1); (ii) a person that 

performed a service within the current 

calendar year or the preceding three 

calendar years in a Relevant ATB to the 

API transferred by taxpayer; or (iii) a 

Passthrough Entity to the extent that a 

person described in paragraph (e)(1)(i) 

or (ii) owns an interest, directly or 

indirectly. One commenter 

recommended that the definition of 

Section 1061(d) Related Person be 

amended to exclude a Passthrough 

Entity to the extent that a member of the 

taxpayer’s family or colleague is an 

owner, noting that language is not in the 

statute and is not discussed in the 

legislative history. The final regulations 

do not adopt this comment. Section 

1061(d)(1) provides that the inclusion 

required by section 1061(d) applies if a 

taxpayer transfers any API, directly or 

indirectly, to a person related to the 

taxpayer. 

III. Additional Comments Received and 

Revisions Made 

A. Sections 1.1061–1 and 1.1061–2: 

Definitions, Operational Rules, and 

Examples 

1. Definitions, In General 

A commenter expressed the view that 

the interrelated new terms and 

definitions make the proposed 

regulations difficult to read and 

comprehend in some places. The final 

regulations largely retain the terms and 

definitions provided in § 1.1061–1(a) 

but simplify many of the computational 

rules and concepts used to determine 

the Recharacterization Amount and the 

Section 1061(d) Recharacterization 

Amount. The terms and definitions 

provide a helpful roadmap to the 

regulations and are also needed to 

provide Owner Taxpayers, Passthrough 

Entities, and the IRS with a common 

vocabulary that can be used to describe 

the necessary computations and 

reporting requirements. The final 

regulations make clarifying changes 

throughout the definitions, including 

providing that a Passthrough Entity can 

also be a trust or estate. Terms have also 

been added and removed in accordance 

with the revisions discussed elsewhere 

in this Summary of Comments and 

Explanation of Revisions. 

A commenter noted that the preamble 

to the proposed regulations provides 

that ‘‘taxpayer’’ means Owner Taxpayer 

in sections 1061(a) and (d), and both 

Owner Taxpayer and Passthrough 

Taxpayer in section 1061(c)(1). The 

commenter further noted that the 

proposed regulations use the definition 

of ‘‘person’’ as that term is generally 

used under section 7701(a)(1). The 

commenter requested that the final 

regulations provide explicit definitions 

of ‘‘taxpayer’’ and ‘‘person’’ in each 

relevant part because the terms have 

different meanings in different contexts. 

The final regulations do not adopt this 

comment because defining taxpayer and 

person in different ways in each 

relevant section would introduce 

unnecessary complexity. However, the 

use of these terms has been modified in 

certain places in the final regulations to 

alleviate confusion. 

2. Operational Rules 

a. Definition of API; An API Remains an 

API 

Proposed § 1.1061–1(a) provides that 

API means any interest in a partnership 

which, directly or indirectly, is 

transferred to (or is held by) an Owner 

Taxpayer or Passthrough Taxpayer in 

connection with the performance of 

substantial services by the Owner 

Taxpayer or by a Passthrough Taxpayer, 

or by any Related Person, including 

services performed as an employee, in 

any ATB unless an exception applies, 

and that for purposes of this definition, 

an interest in a partnership also 

includes any financial instrument or 

contract, the value of which is 

determined in whole or in part by 

reference to the partnership (including 

the amount of partnership distributions, 

the value of partnership assets, or the 

results of partnership operations.) 

A commenter expressed concern that 

defining an interest in a partnership to 

include a financial instrument or 

contract, the value of which is 

determined in whole or in part by 

reference to the partnership, could 

include investment management 

contracts that provide for a fee based on 

the assets of a fund partnership and not 

a carried interest or other performance 

allocation, creating a risk that the sale 

of a management company or indirect 

sale of a management contract could be 

subject to section 1061. This in turn 

could cause the enterprise value of the 

management company to be taxed at 

ordinary income rates. The commenter 

recommended that the definition of API 

be modified to exclude financial 

instruments or contracts that merely 

reference the value of partnership assets 

or that provide for fee income that is 

subject to ordinary income tax 

treatment. 

Because financial instruments can 

replicate the performance of a 

partnership interest, the inclusion of 

such items in the definition of an API 

is necessary for purposes of 

implementing section 1061. 

Accordingly, the final regulations do not 

adopt this comment. As stated in Part IV 

of this Summary of Comments and 

Explanation of Revisions, the Treasury 

Department and the IRS continue to 

study the impact of section 1061 on the 

taxation of enterprise value related to 

the transfer or exchange of partnership 

interests and management contracts. 

Proposed § 1.1061–2(a)(1)(i) provides 

that once a partnership interest qualifies 

an API, the partnership interest remains 

an API unless and until the 

requirements of one of the exceptions to 

qualification of a partnership interest as 

an API are satisfied. A commenter 

questioned whether this provision is 

valid given that it is not explicit in the 

statute, but reasoned that the rule is 

implicit in the statutory scheme and is 

necessary to prevent avoidance of the 

statute. 

The Treasury Department and the IRS 

agree with the commenter that this rule 

is implicit in the statutory scheme. 

Neither the statute nor the legislative 

history provide a time limit or other 

means of ending API treatment beyond 

the exceptions to qualification as an 

API. Consequently, no modifications 

have been made to § 1.1061–2(a)(1)(i). 

b. Presumption That Services are 

Substantial 

Proposed § 1.1061–2(a)(1)(iv) provides 

that if a partnership interest is 

transferred to or held by an Owner 

Taxpayer, Passthrough Taxpayer, or any 

Related Person in connection with the 

performance of services, the Owner 

Taxpayer, the Passthrough Taxpayer, or 

the Related Person is presumed to have 

provided substantial services for 

purposes of section 1061. Commenters 

suggested that presuming all services to 

be substantial is overbroad and 

recommended that the presumption be 

removed. In addition, one commenter 

recommended the inclusion of nonexclusive safe harbors that service 

partners could rely on to determine that 


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partnership interests they hold or that 

have been transferred to them are not in 

connection with the performance of 

substantial services. Another 

commenter recommended adding a 

means to rebut the presumption that the 

services are substantial. 

The final regulations retain the 

proposed rule’s presumption that all 

services provided for a partnership 

interest are substantial services for 

purposes of section 1061. However, the 

Treasury Department and the IRS will 

continue to study and consider possible 

circumstances under which the 

presumption might be rebutted as well 

as the possibility of providing safe 

harbors for circumstances under which 

the presumption will not apply. These 

considerations may be addressed in 

future guidance. 

c. Application of the ATB Activity Test 

i. In General, ATB 

Proposed § 1.1061–1(a) provides that 

applicable trade or business (ATB) 

means any activity for which the ATB 

Activity Test with respect to Specified 

Actions is met, and includes all 

Specified Actions taken by Related 

Persons, including combining activities 

occurring in separate partnership tiers 

or entities as one ATB. Proposed 

§ 1.1061–1(a) defines an Owner 

Taxpayer as the person subject to 

Federal income tax on net gain with 

respect to an API or an Indirect API 

during the taxable year, including an 

owner of a Passthrough Taxpayer unless 

the owner of the Passthrough Taxpayer 

is a Passthrough Entity itself or is 

excepted under proposed § 1.1061–3(a), 

(b), or (d). 

ii. ATB Activity Test 

Proposed § 1.1061–2(b)(1) provides 

that the ATB Activity Test is satisfied if 

Specified Actions are conducted by one 

or more Related Persons and the total 

level of activity, including the combined 

activities of all Related Persons, satisfies 

the level of activity that would be 

required to establish a trade or business 

under section 162. Proposed § 1.1061– 

1(a) provides that Specified Actions 

means Raising or Returning Capital 

Actions and Investing or Developing 

Actions. Raising or Returning Capital 

Actions means actions involving raising 

or returning capital but does not include 

Investing or Developing Actions. 

Investing or Developing Actions means 

actions involving either (i) investing in 

(or disposing of) Specified Assets (or 

identifying Specified Assets for such 

investing or disposition), or (ii) 

developing Specified Assets. 

Commenters requested clarification 

that joint ventures of a real estate 

developer involving a single stand-alone 

project at a single location will not 

satisfy the ATB Activity Test. One of 

these commenters recommended that 

the definition of Raising or Returning 

Capital should be refined so that it 

includes only raising or returning 

capital activities in which the business 

earns compensation based on either 

capital committed, capital contributed, 

or capital invested. Another commenter 

noted that additional guidance may be 

needed to make the statute more 

administrable because real estate held 

for rental or investment is a Specified 

Asset but holding the property may not 

constitute a trade or business under 

section 162. 

The final regulations do not adopt 

these comments. Whether a single 

project or raising of capital involves the 

level of activity needed to constitute a 

trade or business under section 162 is 

dependent on the facts and 

circumstances unique to the project or 

raising of capital. Furthermore, 

guidance under section 162 is beyond 

the scope of these regulations. 

Example 6 of proposed § 1.1061– 

2(b)(2)(vi) describes a situation in which 

A manages a hardware store that 

Partnership owns. A is issued a profits 

interest in Partnership in connection 

with A’s services. Partnership owns the 

building in which the hardware store 

operates. The example notes that the 

building is held by Partnership not for 

rental or investment, but to conduct 

Partnership’s hardware business and, 

thus, the building is not a Specified 

Asset. The example provides that the 

partnership maintains and manages a 

certain amount of working capital for its 

business, but notes that working capital 

is not taken into account for the purpose 

of determining whether the ATB 

Activity Test is met. A commenter 

suggested that another example should 

be added to analyze how to apply the 

ATB Activity Test where the facts are 

changed so that the business is held in 

a C corporation, the partnership only 

holds the C corporation stock, and the 

holding partnership is held by an 

investment partnership. The commenter 

stated that the ATB Activity Test should 

not be met by the holding partnership 

and the manager should not be an API 

Holder. 

The final regulations do not adopt this 

comment. Depending on the specific 

facts and circumstances of the situation, 

the Treasury and the IRS believe that 

the ATB Activity Test could be met by 

such a holding partnership and the 

manager might be an API Holder. 

A commenter requested clarification 

regarding what activities occurring in 

separate partnership tiers or entities will 

be considered combined and treated as 

one ATB, and recommended that the 

regulations be amended to include an 

example illustrating how the ATB and 

API rules work in this situation. The 

commenter recommended that the 

application of section 1061 be limited to 

an Owner Taxpayer solely with respect 

to partnership interests that serve as 

compensation for services relating to 

Specified Assets. Another commenter 

requested simplifying safe harbors for 

activities conducted in multiple entities 

either in the same chain or in a brothersister chain. 

The Treasury Department and the IRS 

continue to study these issues and may 

consider providing future guidance on 

these matters. However, the Treasury 

Department and the IRS note the 

definition of ATB includes any and all 

activities, no matter how minimal, 

conducted by entities that are Related 

Persons to each other, for purposes of 

determining whether the ATB Activity 

Test is met, and if that test is met, then 

each such participating entity is 

considered to be engaged in an ATB. 

Another commenter requested 

clarification that businesses that do not 

both raise or return capital and engage 

in either investment or development 

activities do not satisfy the ATB 

Activity Test, and that the regular, 

continuous, and substantial standard 

applies independently to each prong of 

the ATB Activity Test. The commenter 

suggested that because the proposed 

regulations aggregate activities of one or 

more entities and related parties, the 

final regulations should not include the 

statement that the fact that either 

Raising or Returning Capital Actions or 

Investing or Developing Actions are 

only infrequently taken does not 

preclude the test from being satisfied if 

the combined Specified Actions meet 

the test. The commenter expressed 

concern that this language combined 

with the rule that Raising or Returning 

Capital Actions and Investing or 

Developing Actions are not required to 

be taken in each taxable year could 

cause the activities of a fund sponsor’s 

affiliates to satisfy the raising or 

returning capital prong with respect to 

any of the sponsored funds. 

The final regulations do not adopt this 

comment. It is necessary for both the 

Raising or Returning Capital Actions 

and Investing or Developing Actions to 

be present for the ATB Activity Test to 

be satisfied. The aggregation rule and 

the language regarding infrequent 

actions are necessary to prevent abuse of 

section 1061. Without these rules, 


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activities could be spread among 

multiple related entities with the intent 

of not satisfying the ATB Activity Test. 

iii. Definition of Specified Assets 

Proposed § 1.1061–1(a) defines 

Specified Assets as: (i) Securities, 

including interests in partnerships 

qualifying as securities (as defined in 

section 475(c)(2) without regard to the 

last sentence thereof); (ii) commodities 

(as defined in section 475(e)(2)); (iii) 

real estate held for rental or investment; 

(iv) cash or cash equivalents; (v) an 

interest in a partnership to the extent 

that the partnership holds Specified 

Assets; and, (vi) options or derivative 

contracts with respect to any of the 

foregoing. 

Commenters requested additional 

guidance on the treatment of 

partnerships that engage in the 

production, storage, transportation, 

processing, or marketing of physical 

commodities in the ordinary course of 

business (including hedges with respect 

to the commodities). The commenters 

requested that such partnerships not be 

treated as engaged in Investing and 

Developing Actions as a result of such 

activities, and that Specified Assets only 

include commodities that are 

themselves actually actively traded on 

an established financial market, not 

merely commodities of the same type as 

commodities that are or can be actively 

traded on an established financial 

market. 

The final regulations do not adopt this 

comment; however, the Treasury 

Department and the IRS continue to 

study this issue and may address it in 

future guidance. 

Another commenter noted that it is 

unclear whether the rule treating a 

derivative contract with respect to a 

partnership interest as a partnership 

interest for purposes of applying section 

1061 is needed to appropriately 

administer section 1061. The 

commenter noted that the proposed 

regulation’s position regarding such a 

derivative injects unnecessary 

complexity into the tax system, and 

stated that because payments made 

before termination of a swap are almost 

always ordinary income, it may not 

make economic or tax sense to use such 

a financial instrument in lieu of a 

partnership interest in an attempt to 

avoid section 1061. 

The final regulations do not adopt this 

comment. While the use of a derivative 

contract in this circumstance may be 

rare, the Treasury and the IRS are 

concerned that the potential for abuse 

exists. Consequently, the treatment of a 

derivative contract as a partnership 

interest for purposes of applying section 

1061 is necessary to prevent the 

circumvention of, and compliance with, 

section 1061. 

B. Section 1.1061–3: Exceptions to the 

Definition of API 

1. Corporate Exception 

Section 1061(c)(4)(A) provides that an 

API ‘‘shall not include any interest in a 

partnership directly or indirectly held 

by a corporation.’’ In implementing this 

exception, proposed § 1.1061–3(b)(2) 

provides that a corporation does not 

include an entity for which an election 

was made to treat the entity as a 

Passthrough Entity, and that therefore, 

an S corporation for which an election 

under 1362(a) is in effect and a PFIC 

with respect to which the shareholder 

has a QEF election under section 1295 

in effect (such entity is a QEF with 

respect to the shareholder), are not 

treated as corporations for purposes of 

section 1061. One commenter approved 

of this decision, noting that section 

1061(f) provides ample authority for 

excluding S corporations and PFICs 

from the term corporation. The 

commenter noted that allowing such 

structures to benefit from the corporate 

exception would allow section 1061 to 

be entirely circumvented. Another 

commenter, discussing PFICs subject to 

QEF elections, noted that the exclusion 

of QEFs from the definition of 

corporation for purposes of section 1061 

is consistent with section 1(h)(9) and 

(h)(10). 

One commenter disagreed regarding 

authority, noting that the ability to treat 

QEFs and S corporations as subject to 

section 1061 is subject to substantial 

doubt and contrary to the plain text of 

the statute. The commenter also noted 

that Notice 2018–18, 2018–2 I.R.B. 443, 

and the provision’s legislative history 

offer no reason why S corporations 

should, or should not, qualify for the 

exception. Another commenter said that 

a legislative clarification should be 

sought prior to including a rule in the 

final regulations providing that S 

corporations are subject to section 1061. 

The Treasury Department and the IRS 

agree with commenters that the 

exclusion of S corporations and QEFs 

from the corporate exception is 

necessary to avoid circumvention of 

section 1061. Accordingly, no change 

has been made to this section of the 

final regulations. As explained in the 

preamble to the proposed regulations, 

section 1061(f) provides that the 

Secretary has authority to issue 

regulations or other guidance as is 

necessary or appropriate to carry out the 

purposes of section 1061. Both the 

Conference Report and the Blue Book 

further direct the Treasury Department 

and the IRS to issue regulations to 

address the prevention of abuse of the 

purposes of the provision. The grant of 

authority in section 1061(f) is sufficient 

to issue regulations providing that the 

exception in section 1061(c)(4)(A) does 

not include S corporations and PFICs 

with respect to which shareholders have 

QEF elections in effect. See also section 

1(h)(9) and (10). 

2. Unrelated Purchaser Exception 

Proposed § 1.1061–3(d) provides that 

if a taxpayer acquires an interest in a 

partnership (target partnership) by 

taxable purchase for fair market value 

that, but for the exception in § 1.1061– 

3(d), would be an API, the taxpayer will 

not be treated as acquiring an API if, 

immediately before the purchase (1) the 

taxpayer is not related within the 

meaning of section 267(b) or 707(b) to 

any person who provides services in the 

Relevant ATB, or any service providers 

who provide services to or for the 

benefit of the target partnership or a 

lower-tier partnership in which the 

target partnership holds a direct or 

indirect interest; (2) section 1061(d) 

does not apply to the transaction (as 

provided in § 1.1061–5); and (3) the 

taxpayer has not provided in the past, 

does not then provide, and does not 

anticipate providing services in the 

future to, or for the benefit of, the target 

partnership, directly or indirectly, or 

any lower-tier partnership in which the 

target partnership holds a direct or 

indirect interest. 

A few commenters stated that the 

proposed regulations are unclear as to 

whether the exception applies only to 

an API that is directly acquired or 

whether it also applies to an API in 

which the buyer acquired an indirect 

interest through an upper-tier 

partnership. One commenter 

recommended that final regulations 

provide that the exception applies to 

both APIs purchased directly as well as 

an APIs purchased indirectly, noting 

that the unrelated purchaser might not 

be able to rely on Rev. Rul. 87–115, 

1987–2 C.B. 163, to adjust the basis of 

the underlying fund assets to prevent 

the recognition of built-in gain, as fund 

sponsors generally do not make section 

754 elections at the fund level. Further, 

the commenter suggested that the final 

regulations provide that the exception 

applies regardless of whether the lowertier partnership interest is acquired after 

the third-party purchases the interest in 

the upper-tier partnership or acquires 

the upper-tier partnership interest by 

contribution. Another commenter 

suggested that the exception be 


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extended to interests in other 

Passthrough Entities. 

The final regulations do not adopt 

these comments because of the 

complexity of administering the 

unrelated purchaser exception through 

tiers of Passthrough Entities. The final 

regulations make non-substantive 

clarifying changes to the rule. 

The preamble to the proposed 

regulations provides that the exception 

does not apply to an Unrelated NonService Partner who becomes a partner 

by making a contribution to a 

Passthrough Entity that holds an API 

and in exchange receives an interest in 

the Passthrough Entity’s API, stating 

that, in this case, allocations to the 

Unrelated Non-Service Partner with 

respect to the API are API Gains and 

Losses and retain their character as API 

Gains and Losses. One commenter noted 

that this exception to the unrelated 

purchaser exception is not explained in 

the proposed regulations’ preamble and 

suggested that the exception to the 

exception is most likely intended to 

refer to a situation in which an investor 

makes a contribution in form to an 

upper-tier partnership, which then 

distributes an API with respect to a 

lower-tier partnership to the 

contributing upper-tier partner. The 

commenter notes that these transfers 

might be a purchase of the API by the 

investor from the upper-tier partnership. 

The Treasury Department and the IRS 

intend that the third-party purchaser 

exception be limited to API purchases 

and not apply when a third party 

contributes cash or property to a 

Passthrough Entity holding an API in a 

transaction qualifying for 

nonrecognition under section 721(a), or 

any similar provision, resulting in the 

contributor receiving allocations 

attributable to the transferee 

Passthrough Entity’s API. 

C. Section 1.1061–4: Computing the 

Recharacterization Amount 

1. Computation of the 

Recharacterization Amount 

Proposed § 1.1061–4(a)(1) provides 

that the Recharacterization Amount 

equals the Owner Taxpayer’s One Year 

Gain Amount less the Owner Taxpayer’s 

Three Year Gain Amount. The Owner 

Taxpayer’s One Year Gain Amount is 

the sum of the Owner Taxpayer’s 

combined net API One Year Distributive 

Share Amount from all APIs held during 

the taxable year and the Owner 

Taxpayer’s API One Year Disposition 

Amount. An Owner’s Taxpayer’s Three 

Year Gain Amount is equal to the 

Owner Taxpayer’s combined net API 

Three Year Distributive Share Amount 

from all APIs held during the taxable 

year and the Owner Taxpayer’s API 

Three Year Disposition Amount. The 

API One Year and Three Year 

Distributive Share Amounts exclude 

Capital Interest Gains and Losses. 

Capital Interest Disposition Amounts 

are not included in the computation of 

the API One Year and Three Year 

Disposition Amounts because they 

relate to the disposition of a Capital 

Interest rather than an API. 

Proposed § 1.1061–4(a)(3)(i) provides 

that the API One Year Distributive Share 

Amount equals the API Holder’s 

distributive share of net long-term 

capital gain from the partnership for the 

taxable year, including capital gain or 

loss on the disposition of all or a part 

of an API, with respect to the 

partnership interest held by the API 

Holder calculated without the 

application of section 1061 less, to the 

extent included in the amount 

determined under proposed § 1.1061– 

4(a)(3)(i)(A), the aggregate of amounts 

that are excluded from section 1061 

under proposed § 1.1061–4(b)(6), the 

API Holder’s Transition Amount for the 

taxable year; and Capital Interest Gains 

and Losses as determined under 

proposed § 1.1061–3(c)(2). 

One commenter stated that the 

definition of API One Year Distributive 

Share Amount does not allow for this 

amount to be a loss. For example, if an 

Owner Taxpayer holds two APIs and 

one partnership allocates the taxpayer a 

loss and the other a gain, the loss does 

not offset the gain because the API One 

Year Distributive Share Amount for the 

partnership that allocated the taxpayer a 

loss will be zero. The commenter 

recommended allowing the API One 

Year Distributive Share Amount to be 

less than zero. The final regulations 

adopt this suggestion by revising the 

computation for the API One Year 

Distributive Share Amount to include 

both capital gain and loss. In addition, 

the commenter suggested that the final 

regulations provide that if each of the 

API One Year Distributive Share 

Amount and the API Three Year 

Distributive Share Amount is greater 

than zero but the API One Year 

Distributive Share Amount is less than 

the API Three Year Distributive Share 

Amount, no portion of the API One Year 

Distributive Share Amount is 

recharacterized as short-term capital 

gain. The final regulations adopt this 

suggestion by providing that if the One 

Year Gain Amount and the Three Year 

Gain Amount are both greater than zero 

but the One Year Gain Amount is less 

than the Three Year Gain Amount, none 

of the One Year Gain Amount is 

included in the Recharacterization 

Amount for the taxable year. In addition 

to adopting this comment, the final 

regulations make minor clarifying 

changes to the computation rules. 

Commenters raised several additional 

concerns related to the computation 

rules. One commenter recommended 

that regulations provide guidance on 

how losses limited by section 1211 

affect the Recharacterization Amount. 

Another commenter noted that the 

proposed regulations do not address 

how net capital gain is computed or the 

order of steps in doing so under section 

1(h)(1). The commenter stated that 

because section 1061(a) recharacterizes 

what would have been long-term capital 

gain as short-term capital gain, it is 

apparent that section 1061(a) must be 

applied somewhere in the process 

before the application of section 1(h). 

Further, the proposed regulations do not 

address § 1.1(h)–1, which provides a 

look-through rule when a partnership 

interest is sold, to determine what 

portion of the gain on sale will be 

treated as collectibles gain or section 

1250 capital gain. The commenter also 

noted that, although section 1231 and 

section 1256 gains are excluded from 

section 1061 by the proposed 

regulations, a sale of a partnership 

interest holding such assets is not 

excluded, and all the gain is subject to 

section 1061(a) unless section 751(a) 

applies. Finally, the commenter stated 

that there is no provision in the 

proposed regulations addressing 

suspension of the holding period of an 

API when an API owner seeks to obtain 

a more-than-three-year holding period 

without undertaking additional risk— 

that is, the hedging of the API. The 

commenter recommended that an 

express rule be provided, such as the 

rule provided in § 1.1400Z2(a)–1(b) for 

interests in partnerships self-certified as 

qualified opportunity funds. 

The Treasury Department and the IRS 

continue to study the issues raised by 

these comments in regard to the 

computation rules and may address 

them in future guidance. 

2. Distributed API Property 

Proposed § 1.1061–1(a) provides that 

Distributed API Property means 

property distributed by a Passthrough 

Entity to an API Holder with respect to 

the API if the holding period, as 

determined under sections 735 and 

1223, in the API Holder’s hands is three 

years or less at the time of disposition 

of the property by the API Holder. 

A commenter questioned whether the 

Treasury Department and the IRS have 

the authority to treat Distributed API 

Property as subject to section 1061(a). 

The commenter further stated that in 


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order for the rule to be a valid exercise 

of regulatory authority, distributed 

property for this purpose should 

exclude property that, if sold by the 

partnership, would be excluded from 

section 1061, such as property that 

would generate 1231 and 1256 gains. 

The final regulations continue to treat 

Distributed API Property as subject to 

section 1061(a) under the authority of 

section 1061(f). However, the Treasury 

Department and the IRS agree with the 

commenter that long-term capital gain 

from the disposition of Distributed API 

Property that, if sold by the partnership, 

would be excluded from section 1061, 

such as 1231 and 1256 gain, qualified 

dividends described in section 

1(h)(11)(B), and any other capital gain 

that is characterized as long-term or 

short-term without regard to the holding 

period rules in section 1222, should not 

be recharacterized under section 

1061(a). The final regulations clarify 

this point by excluding these items from 

the calculation of the API One Year 

Disposition Amount. Additionally, 

because a Passthrough Entity does not 

calculate an API One Year Disposition 

Amount, the final regulations clarify 

that for purposes of calculating the API 

One Year Distributive Share Amount, an 

API Holder’s distributive share of net 

long-term capital gain from the 

partnership includes capital gain or loss 

on the disposition of Distributed API 

Property or all or part of an API by an 

API Holder that is a Passthrough Entity. 

Another commenter suggested that 

the final regulations explicitly provide 

rules for the treatment of Distributed 

API Property when the Distributed API 

Property is distributed from one 

Passthrough Entity to another and the 

upper-tier entity disposes of the 

Distributed API Property. The 

commenter also requested confirmation 

in the final regulations that partnerships 

should subtract capital gain or loss from 

property that had been Distributed API 

Property but no longer is at the time of 

disposition when calculating the API 

One Year Distributive Share Amount 

because such gain is excluded from the 

calculation of the Recharacterization 

Amount. 

The final regulations partially adopt 

this comment by revising the 

computation of the One Year 

Distributive Share Amount to explicitly 

include dispositions of API Distributed 

Property by a partnership or other 

Passthrough Entity. The final 

regulations do not adopt the suggestion 

to explicitly provide that partnerships 

should subtract capital gain or loss from 

property that had been Distributed API 

Property but no longer is at the time of 

disposition when calculating the API 

One Year Distributive Share Amount. 

The definition of Distributed API 

Property provides that it only applies to 

property with a holding period of three 

years or less on the date of disposition 

by an API Holder. Any property with a 

greater than three-year holding period is 

therefore not Distributed API Property. 

A special rule for Distributed API 

Property distributed to an upper-tier 

entity by a lower-tier entity is 

unnecessary because the definition of 

API Holder includes a Passthrough 

Entity. 

Commenters noted that the proposed 

regulations are unclear as to how the 

Distributed API Property rules apply 

where an API Holder owns both a 

profits interest and a capital interest in 

a partnership, and recommended that 

the final regulations clarify that a 

distribution to a partner is not 

Distributed API Property to the extent 

that it is distributed with respect to the 

portion of the partner’s interest 

qualifying for the Capital Interest 

Exception. One commenter suggested 

that such guidance should also address 

how to apply the recommended rule in 

the context of tiered structures. 

The Treasury Department and the IRS 

continue to study this issue and may 

address it in future guidance. 

3. Special Rules for Capital Gain 

Dividends From Regulated Investment 

Companies (RICs) and Real Estate 

Investment Trusts (REITs) 

The preamble to the proposed 

regulations recognizes that long-term 

capital gain treatment should be 

available for a capital gain dividend 

paid by a RIC or REIT to the extent that 

the capital gain dividend is attributable 

to assets held for more than three years 

or is attributable to assets that are not 

subject to section 1061. Proposed 

§ 1.1061–4(b)(4) facilitates this 

treatment by allowing a RIC or REIT to 

disclose two additional amounts based 

on modified computations of the RIC’s 

or REIT’s net capital gain. First, the RIC 

or REIT may disclose the amount of the 

capital gain dividend that is attributable 

to the RIC’s or REIT’s net capital gain 

excluding any amounts not taken into 

account for purposes of section 1061 

under proposed § 1.1061–4(b)(6) from 

the computation. Second, the RIC or 

REIT may disclose the amount of the 

capital gain dividend that is attributable 

to the RIC’s or REIT’s net capital gain 

both (1) excluding any amounts not 

taken into account for purposes of 

section 1061 under proposed § 1.1061– 

4(b)(6) from the computation, and (2) 

substituting three years for one year in 

applying section 1222. The proposed 

regulations allow a RIC or REIT to 

disclose these two additional amounts 

in writing to its shareholders with its 

section 852(b)(3)(C)(i) capital gain 

dividend statement or section 

857(b)(3)(B) capital gain dividend 

notice. 

One commenter suggested that it 

would be extremely rare for a RIC to 

have shareholders for whom this 

provision is relevant and stated that 

requiring this additional reporting 

would be unnecessarily burdensome as 

it creates a third type of capital gain that 

RICs would need to track and report. 

Consequently, the commenter requested 

that final regulations continue to permit, 

but not require, RICs to report this 

information if they have a shareholder 

for whom such amounts are relevant. In 

addition, the commenter noted that 

most funds will not calculate this 

information at the time capital gain 

dividends are reported on Forms 1099– 

DIV. The commenter requested that 

final regulations allow reporting on a 

written statement furnished to the 

applicable shareholder on request, 

without tying the reporting of such 

amounts to the reporting of capital gain 

dividends. 

Another commenter suggested that 

RICs and REITs should be permitted to 

disclose these additional amounts, upon 

request by a shareholder, and report the 

One Year Amounts Disclosure and 

Three Year Amounts Disclosure (as 

those terms are defined in proposed 

§ 1.1061–6(c)) until the extended due 

date of their returns. 

The final regulations retain the rules 

as proposed but designate them as 

§ 1.1061–4(b)(5). As suggested by these 

commenters, the final regulations retain 

the option to disclose to shareholders 

the two additional amounts (that is the 

final regulations do not make disclosure 

mandatory). The final regulations do not 

adopt the suggestion to allow RICs and 

REITs to disclose these additional 

amounts only upon the request of a 

shareholder because such treatment may 

allow a RIC or REIT to choose to provide 

information only to certain shareholders 

but not to other shareholders. The 

Treasury Department and the IRS 

continue to study comments suggesting 

that the disclosure of this information 

be separated from the reporting of 

capital gain dividends and may issue 

guidance in the future. In the interim, 

the final regulations retain the rule that 

the disclosures are to be provided with 

the section 852(b)(3)(C)(i) capital gain 

dividend statement or section 

857(b)(3)(B) capital gain dividend 

notice. 


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4. Computation of the 

Recharacterization Amount for Owner 

Taxpayers With Interests in QEFs 

The proposed regulations provide 

special rules for Owner Taxpayers that 

hold their APIs indirectly through PFICs 

for which they have made a QEF 

election. Specifically, under proposed 

§ 1.1061–4(b)(5), the API One and Three 

Year Distributive Share Amounts 

include an Owner Taxpayer’s section 

1293(a)(1) inclusions from QEFs, 

reduced by amounts that are excluded 

from section 1061(a) if the QEF 

complies with the reporting rules under 

§ 1.1061–6(d). These reporting rules 

provide that QEFs may provide 

information to allow Owner Taxpayers 

to compute their Recharacterization 

Amount. If a QEF fails to provide such 

information, an Owner Taxpayer 

includes its entire pro rata share of the 

QEF’s net capital gain in its API One 

Year Distributive Share Amount and no 

portion of its pro rata share of the QEF’s 

net capital gain is ultimately included 

in its API Three Year Distributive Share 

Amount. One commenter made several 

suggestions regarding the computation 

of an Owner Taxpayer’s API One Year 

Distributive Share Amount and API 

Three Year Distributive Share Amount 

with respect to a QEF’s net capital gain. 

Broadly, the commenter expressed a 

concern that the corporate-level capital 

gain netting rules applicable to QEFs are 

not consonant with the requirement that 

the Recharacterization Amount be 

computed at the Owner Taxpayer level. 

A QEF determines its net capital gain at 

the corporate level, and may do so in 

one of three ways: First, the QEF may 

calculate and report the amount of each 

category of long-term capital gain 

described in section 1(h) of the Code; 

second, the QEF may report its net 

capital gain for the year and state that 

it is subject it to the highest capital gain 

rate of tax applicable to the shareholder; 

or third, the QEF may determine its 

current earnings and profits (E&P) and 

report the entire amount as ordinary 

earnings. Section 1.1293–1(a)(2). A 

QEF’s net capital gain is limited to its 

current E&P, regardless of how it 

computes such amount under § 1.1293– 

1(a)(2) (QEF E&P limitation). Section 

1293(e)(2). The commenter had several 

suggestions on how to clarify or 

improve the rules under section 1061 

applicable to QEFs. 

First, the commenter suggested that 

the three year QEF net capital gain 

provision was not entirely clear, 

particularly in regard to the API Three 

Year Distributive Share Amount. The 

commenter recommended that the final 

regulations clarify that an Owner 

Taxpayer includes in its API Three Year 

Distributive Share Amount the same 

base amount as determined for the API 

One Year Distributive Share Amount (as 

adjusted to reflect only net long-term 

capital gains and losses calculated by 

substituting a greater-than-three-year 

holding period for a greater-than-oneyear holding period). 

The Treasury Department and the IRS 

confirm that an Owner Taxpayer’s API 

Three Year Distributive Share Amount 

is based on the amount computed for its 

API One Year Distributive Share 

Amount and adjusted to include only 

items that would be treated as a longterm gain or loss if three years were 

substituted for one year in paragraphs 

(3) and (4) of section 1222 if the QEF 

satisfies certain reporting obligations. 

See § 1.1061–6(d). However, the final 

regulations revise proposed § 1.1061– 

4(b)(5) (designated as § 1.1061–4(b)(6) in 

the final regulations) to more precisely 

identify the inputs for computing an 

Owner Taxpayer’s API One and Three 

Year Distributive Share Amounts and 

illustrate an Owner Taxpayer’s API 

Three Year Distributive Share Amount 

computation with respect to a QEF. 

Specifically, § 1.1061–4(b)(6)(i) provides 

that an Owner Taxpayer’s inclusion 

under section 1293(a)(1)(B) that is taken 

into account in determining the API 

One Year Distributive Share Amount 

with respect to a QEF is limited to the 

QEF’s E&P by section 1293(e)(2) and 

that the section 1293(a)(1)(B) inclusion 

may be reduced by the Owner 

Taxpayer’s share of the excess (if any) 

of the Capital Interest Gain over Capital 

Interest Loss with respect to the QEF as 

well as amounts not taken into account 

for purposes of section 1061 pursuant to 

§ 1.1061–4(b)(7). In either case, 

however, § 1.1061–4(b)(6)(i) permits 

such reductions only if a QEF has 

provided an Owner Taxpayer with the 

relevant information necessary for the 

Owner Taxpayer to determine those 

amounts. 

Additionally, § 1.1061–4(b)(6)(ii) of 

the final regulations provides that the 

minuend of an Owner Taxpayer’s API 

Three Year Distributive Share Amount 

computation (under § 1.1061–4(a)(3)(ii)) 

includes its entire amount determined 

under § 1.1061–4(b)(6)(i) (one year QEF 

net capital gain). The final regulations 

further provide that if the QEF does not 

provide the Owner Taxpayer with 

information necessary under § 1.1061– 

6(d) to determine the amount of its 

section 1293(a)(1)(B) inclusion (less any 

allowed reductions) with respect to the 

QEF that would be included in its API 

One and Three Year Distributive Share 

Amounts, then the entire amount of the 

Owner Taxpayer’s one year QEF net 

capital gain (less any allowed 

reductions) is also included in the 

subtrahend of its API Three Year 

Distributive Share Amount formula 

(under § 1.1061–4(a)(3)(ii)(A)). This 

results in an Owner Taxpayer’s entire 

section 1293(a)(1)(B) inclusion (less any 

allowed reductions) being treated as 

short-term capital gain. However, if the 

QEF provides the Owner Taxpayer with 

the additional necessary information, 

then the Owner Taxpayer includes only 

the amount of its one year QEF net 

capital gain amount that would not be 

treated as long-term capital gain 

substituting a greater-than-three-year 

holding period in applying paragraphs 

(3) and (4) of section 1222 in the 

subtrahend of this formula (under 

§ 1.1061–4(a)(3)(ii)(A)). This can result 

in a portion of an Owner Taxpayer’s 

section 1293(a)(1)(B) inclusion being 

characterized as long-term capital gain 

with the balance being treated as shortterm capital gain. 

To illustrate, assume an Owner 

Taxpayer owns an interest in a QEF that 

holds an API; the Owner Taxpayer owns 

no other API directly or indirectly. The 

QEF generates both long- and short-term 

capital gain in its taxable year, none of 

which are amounts described in 

§ 1.1061–4(b)(7) or Capital Interest 

Gains; the Owner Taxpayer’s pro rata 

share of the QEF’s long-term capital gain 

is $100, $70 of which would not be 

long-term capital gain if a greater-thanthree-year holding period were used in 

applying paragraphs (3) and (4) of 

section 1222, and its share of the QEF’s 

short-term capital gain (determined 

without regard to section 1061) is $15. 

Before applying section 1061, under 

§ 1.1293–1(a)(2), the Owner Taxpayer’s 

pro rata share of the QEF’s net capital 

gain is $100. Under § 1.1061–4(b)(6)(i), 

with respect to the QEF, the Owner 

Taxpayer’s one year QEF net capital 

gain amount, and thus its API One Year 

Distributive Share Amount, is $100. In 

its API Three Year Distributive Share 

Amount computation with respect to 

the QEF, this $100 is the minuend 

(under § 1.1061–4(a)(3)(ii)). If the QEF 

does not provide the Owner Taxpayer 

with information to determine how 

much of its pro rata share of the QEF’s 

net capital gain would constitute longterm capital gain if a greater-than-threeyear holding period were used in 

applying paragraphs (3) and (4) of 

section 1222, the Owner Taxpayer 

would include all $100 under § 1.1061– 

4(a)(3)(ii)(A) in the subtrahend of its 

computation. This results in an API 

Three Year Distributive Share Amount 

of $0 with respect to the QEF (that is: 

$100 under § 1.1061–4(a)(3)(ii) 


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introductory text, minus $100 under 

§ 1.1061–4(a)(3)(ii)(A)) and a 

Recharacterization Amount of $100 (that 

is, $100 API One Year Distributive 

Share Amount minus $0 API Three Year 

Distributive Share Amount). However, if 

the QEF does provide the Owner 

Taxpayer with this information, the 

Owner Taxpayer includes $70 in the 

subtrahend of its API Three Year 

Distributive Share Amount computation 

with respect to the QEF under § 1.1061– 

4(a)(3)(ii)(A). This results in an API 

Three Year Distributive Share Amount 

of $30 (that is: $100 under § 1.1061– 

4(a)(3)(ii) introductory text, minus $70 

under § 1.1061–4(a)(3)(ii)(A)) and a $70 

Recharacterization Amount (that is: 

$100 API One Year Distributive Share 

Amount minus $30 API Three Year 

Distributive Share Amount). 

Additionally, the commenter asked 

that the final regulations harmonize the 

QEF reporting rules with the reporting 

rules applicable to other Passthrough 

Entities. Specifically, the commenter 

requested that if a QEF does not report 

relevant information, then QEF 

shareholders that are Owner Taxpayers 

should be able to substantiate amounts 

included in the API One Year 

Distributive Share Amount and Three 

Year Distributive Share Amount, as well 

as items excluded from section 1061(a), 

through alternative means. 

The Treasury Department and the IRS 

have concluded that, when coupled 

with § 1.1061–6(d), the QEF reporting 

rules in § 1.1295–1(g) provide a 

sufficiently comprehensive framework 

for information reporting and no 

additional rule for section 1061 is 

necessary. Under § 1.1295–1(g)(1), for a 

PFIC to be treated as a QEF by its 

shareholders it must provide either an 

annual statement including the 

shareholder’s pro rata share of the QEF’s 

net capital gain for the year or a 

statement that it has granted its 

shareholders access to its books and 

records (or other documents) for the 

purpose of determining those amounts; 

under § 1.1295–1(g)(3), the same 

information must be reported to indirect 

PFIC shareholders on an intermediary 

statement. Under § 1.1295–1(g)(2), in 

‘‘rare and unusual circumstances,’’ a 

PFIC can provide alternative 

documentation if it obtains a private 

letter ruling from, and enters into a 

closing agreement with, the IRS. In 

addition to these reporting 

requirements, § 1.1061–6(d) permits (but 

does not require) a QEF to provide its 

shareholders that are Owner Taxpayers 

with additional information for the 

purpose of determining the Owner 

Taxpayer’s API One Year Distributive 

Share Amount and Three Year 

Distributive Share Amount. 

The Treasury Department and the IRS 

have determined that the reporting 

mechanisms under §§ 1.1295–1(g) and 

1.1061–6(d) provide sufficient avenues 

for an Owner Taxpayer to obtain 

information from a QEF to determine its 

API One Year Distributive Share 

Amount and Three Year Distributive 

Share Amount. A special rule allowing 

Owner Taxpayers to substantiate QEF 

information through alternative means 

for purposes of section 1061 would also 

run counter to § 1.1295–1(g), which 

generally requires a QEF, and not its 

shareholders, to report information for 

purposes of section 1293. As a result, to 

reconcile the optional nature of QEF 

reporting as compared with reporting 

requirements of other Passthrough 

Entities, the final regulations revise 

§ 1.1061–6(b)(2)(ii) to provide that a 

Passthrough Entity from which 

information is requested must provide 

such information, but only to the extent 

the information is necessary for the 

requesting Passthrough Entity to meet 

its reporting and filing requirements 

under § 1.1061–6. The final regulations 

also revise § 1.1061–6(d) to provide that 

Owner Taxpayers are not permitted to 

separately substantiate amounts with 

respect to a QEF under § 1.1061–6(a)(2). 

Accordingly, the comments suggesting 

changes to the QEF reporting rules 

under section 1061 are not adopted. 

The commenter also suggested that 

the final regulations should provide 

guidance on how to apportion the QEF 

E&P limitation for purposes of section 

1061. Specifically, the commenter 

suggested that the QEF E&P limitation 

should be apportioned according to the 

shareholder’s relative share of the API 

One Year Distributive Share Amount 

and the API Three Year Distributive 

Share Amount with respect to the QEF. 

The commenter also suggested that 

consideration be given to bypassing 

netting at the PFIC level, with guidance 

to be provided on how to allocate the 

QEF E&P limitation at the Owner 

Taxpayer level. 

The QEF E&P limitation is imposed 

by section 1293(e)(2) and is taken into 

account in determining a shareholder’s 

pro rata share of the net capital gains of 

a QEF that is required to be included in 

a shareholder’s income pursuant to 

section 1293(a)(1). Netting of losses 

must therefore be carried out before 

determining the net capital gain of a 

QEF that is required to be included by 

a shareholder. The Treasury Department 

and the IRS recognize the complexity 

regarding apportioning the QEF E&P 

limitation for purposes of section 1061. 

This issue is particularly acute in light 

of the different types of capital gain and 

loss relevant for purposes of section 

1061 that may be included in a QEF’s 

net capital gain, including one- and 

three-year capital gains and losses, and 

amounts excluded from section 1061 

under § 1.1061–4(b)(7) or under the 

capital interest exception. Further 

complication arises from the fact that a 

loss may arise either from a QEF’s 

ordinary business operations, or from 

one or more of the four categories listed 

in the prior sentence. 

In this regard, the Treasury 

Department and the IRS considered 

several possible ways of apportioning 

the QEF E&P limitation. One possibility 

would be to adopt an approach that 

apportions the QEF E&P limitation 

between the relevant types of capital 

gains for purposes of section 1061 on a 

pro rata basis, which the Treasury 

Department and the IRS determined 

would be appropriate in many 

circumstances, though not all. For 

example, if a loss arises from a QEF’s 

ordinary business operations while its 

capital gain income is derived from an 

API, there may be no direct link 

between the ordinary loss and the APIderived capital gain. In such a case a pro 

rata approach may be appropriate. 

Alternatively, for other circumstances, 

the Treasury Department and the IRS 

considered apportioning a QEF’s E&P 

limitation based on more specific 

ordering rules. For example, if a loss 

were related to one or more categories 

of capital gain, allocation first to those 

categories might be appropriate. 

Another possible approach would be to 

allocate the loss giving rise to the E&P 

limitation in the manner that most 

closely approximates how an Owner 

Taxpayer would be permitted to allocate 

the loss if the QEF’s gains and losses 

were derived directly by the Owner 

Taxpayer and the Owner Taxpayer’s 

income was limited to otherwise-longterm capital gain income. In light of the 

complexity regarding the different 

scenarios under which a pro rata 

approach or an alternative approach 

would be more appropriate, the 

Treasury Department and the IRS have 

determined that this issue warrants 

further study and welcome comments in 

this regard. Until the Treasury 

Department and the IRS issue further 

guidance on this issue, taxpayers may 

adopt any reasonable method for 

apportioning the QEF E&P limitation for 

purposes of section 1061 taking into 

account these considerations. 

Finally, the commenter requested that 

the Treasury Department and the IRS 

provide a rule that would identify an 

Owner Taxpayer’s distributive share of 

a QEF’s net capital gain from a 


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Passthrough Entity attributable to the 

Owner Taxpayer’s qualifying capital 

interest and API. The Treasury 

Department and the IRS continue to 

study this issue and may address it in 

future guidance. 

5. Items Not Taken Into Account for 

Purposes of Section 1061 

Proposed § 1.1061–4(b)(6) provides 

that certain items of long-term capital 

gain and loss are excluded from the 

calculation of the API One Year 

Distributive Share Amount and the API 

Three Year Distributive Share Amount. 

Specifically, long-term capital gain and 

long-term capital loss determined under 

section 1231 or 1256, qualified 

dividends included in net capital gain 

for purposes of section 1(h)(11)(B), and 

capital gains or losses that are 

characterized as long-term or short-term 

without regard to the holding period 

rules in section 1222 are excluded from 

these calculations. 

Two commenters questioned the 

exclusion of long-term capital gain 

determined under section 1231 from 

recharacterization under section 1061. 

Those commenters discussed the 

discrepancies in language between 

section 1061(a)(1) and 1061(a)(2), noting 

that only section 1061(a)(2) refers to 

section 1222. Both commenters 

suggested that the treatment of section 

1231 gains in the proposed regulations 

is contrary to the statutory text of 

section 1061. The first commenter stated 

that section 1061(a)(1) applies to net 

long-term capital gain and noted that 

other portions of section 1061 indicate 

that it is supposed to apply to gains that 

are taxed at favorable rates for 

disposition of investment assets. This 

commenter argued that the reference to 

section 1222 in section 1061(a)(2) can be 

read as excluding certain section 1222 

gains from the reach of section 1061(a), 

rather than limiting section 1061(a) to 

such gains by implication. The 

commenter noted that if a determination 

is made that section 1061(a) does apply 

to section 1231, then regulations need to 

address the holding periods of section 

1231 and how the netting rules of 

section 1231 interact with section 1061. 

The second commenter suggested 

that, under the proposed regulations, 

the portion of any net section 1231 gains 

attributable to APIs could arguably be 

included in the amount described in 

section 1061(a)(1). The commenter 

stated that this would lead to 

nonsensical results if net section 1231 

gains are included in the amount 

described in section 1061(a)(1) but 

excluded from the amount described in 

section 1061(a)(2). Because of the 

conflicting statutory language in 

sections 1061(a)(1) and 1061(a)(2), the 

commenter recommended that the 

treatment of section 1231 gains be 

reconsidered, suggesting that one 

approach would be to include the net 

1231 gain attributable to APIs in the 

section 1061(a) computation after 

recomputing this amount by 

substituting 3 years for 1 year. 

In contrast, several commenters 

supported the proposed regulation’s 

treatment of qualified dividends and 

long-term capital gains determined 

under section 1231 and 1256 as not 

subject to recharacterization under 

section 1061 and recommended these 

provisions be finalized as proposed. 

Commenters noted that this treatment 

aligns with the clear language of the 

statute and is consistent with 

Congressional intent. One commenter 

stated that section 1256 amounts should 

not be subject to section 1061(a) because 

they are not gains that are taxed at 

favorable rates that arise from the 

disposition of assets. Another 

commenter noted that the statutory 

references to section 1223(3) and (4) 

raise the question of section 1061’s 

potential effect on other Code 

provisions without regard to section 

1222. The commenter indicated that 

some provisions have their own holding 

period, such as section 1231, while 

others, such as section 1256, just 

mandate tax treatment. The commenter 

stated that this results in a haphazard 

inclusion or exclusion of items from 

section 1061 and noted that because the 

section 1061 legislative history is 

devoid of guidance on this issue, the 

approach taken in the proposed 

regulations is reasonable but a technical 

correction from Congress would be 

welcome. 

The final regulations do not adopt 

suggestions that section 1231 gain 

should be subject to recharacterization 

under section 1061(a) and maintain the 

rules in proposed § 1.1061–4(b)(6), 

which is designated as 1.1061–4(b)(7) in 

the final regulations. As stated in the 

preamble to the proposed regulations, 

section 1231 gains and losses are treated 

as long-term based on the operation of 

section 1231, and not by reference to 

paragraphs (3) and (4) of section 1222. 

Similarly, section 1256 provides for 

specific character treatment and does 

not calculate gain by reference to 

section 1222. Accordingly, the Treasury 

Department and the IRS have 

determined that it is appropriate to 

exclude these amounts from both the 

One Year and Three Year Gain 

Amounts. In contrast, because section 

1061(d)(1) looks to the excess of longterm capital gains with respect to the 

transferred interest to the sale or 

exchange of any asset held for not more 

than three years as is allocable to such 

interest over what is otherwise shortterm capital gain under section 1061(a), 

and does not reference section 1222, 

these amounts are captured in 

transactions to which section 1061(d) 

applies. The final regulations do not 

adopt the suggestion to provide 

guidance on section 1231 holding 

periods or netting rules because such 

guidance would be beyond the scope of 

these final regulations. 

One commenter suggested that 

proposed § 1.1061–4(b), which excludes 

certain items from the calculation of the 

API One Year and Three Year 

Distributive Share Amounts, should be 

modified to explicitly reference both 

One Year Disposition Gains and One 

Year Distributive Share Amounts in 

providing for an exclusion of section 

1231 property from the scope of section 

1061. The commenter suggested that the 

Treasury Department and the IRS 

should also determine whether a similar 

modification is appropriate for the 

exclusion for section 1256 property. 

The final regulations do not adopt this 

comment. The API One Year 

Disposition Amount includes long-term 

capital gains and losses recognized by 

an Owner Taxpayer on the disposition 

of all or a portion of an API. Pursuant 

to section 741, the sale or exchange of 

a partnership interest, including an API, 

is the sale or exchange of a capital asset. 

Accordingly, the character of the gain is 

determined with reference to section 

1222. The items listed in § 1.1061– 

4(b)(7), including section 1231 gain, are 

excluded from the calculation of the API 

One Year and Three Year Distributive 

Share Amounts because they are not 

determined without regard to section 

1222. Furthermore, asymmetrical tax 

treatment occasionally is a result of the 

difference between the sale of a 

partnership interest and the sale of 

assets by a partnership. 

One commenter noted that under 

section 197(f), acquired goodwill is 

treated as depreciable property, thereby 

causing gain recognized on the sale of 

acquired goodwill to be treated as 

section 1231 gain. By contrast, selfcreated goodwill does not qualify as an 

amortizable intangible under section 

197; therefore, any gain recognized on 

the sale of the self-created goodwill is 

not section 1231 gain. Instead, it is 

treated as a capital asset giving rise to 

capital gain upon a sale or exchange. 

Consequently, under the proposed 

regulations, gain on the sale of acquired 

goodwill is excluded from the 

Recharacterization Amount while gain 

on the sale of self-created goodwill is 

not excluded. The commenter 


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recommended that in addition to the 

exclusion for section 1231 gain, the 

regulations should provide that any gain 

recognized on the sale of goodwill held 

in connection with the conduct of a 

trade or business (whether or not 

determined under section 1231) is also 

excluded from the Recharacterization 

Amount because there is no evidence 

Congress intended to subject selfcreated goodwill held in connection 

with a trade or business to section 1061. 

The final regulations do not adopt this 

comment. The disparate treatment of 

purchased and self-created goodwill is 

prescribed by section 197 and nothing 

in section 1061 changes this treatment. 

6. Holding Periods 

Proposed § 1.1061–4(b)(8) clarifies 

that the relevant holding period of 

either an asset or an API is determined 

under all provisions of the Code or 

regulations that are relevant to 

determining whether the asset or the 

API has been held for the long-term 

capital gain holding period by applying 

those provisions as if the holding period 

were three years instead of one year. For 

this purpose, the relevant holding 

period is the direct owner’s holding 

period in the asset sold. 

The final regulations maintain this 

rule as proposed. One commenter 

requested clarification that the 

modification of a partnership agreement 

does not itself create a new holding 

period for the API. The final regulations 

do not adopt this comment as section 

1061 does not generally change the 

holding period of an asset. 

7. API Holder Transition Amounts and 

Partnership Transition Amounts 

The proposed regulations provide that 

a partnership that was in existence as of 

January 1, 2018, could irrevocably elect 

to treat all long-term capital gains and 

losses recognized from the disposition 

of all assets held by the partnership for 

more than three years as of January 1, 

2018, as Partnership Transition 

Amounts. An amount of long-term gain 

or loss treated as a Partnership 

Transition Amount and included in the 

allocation of long-term capital gains and 

losses under sections 702 and 704 to an 

API Holder with respect to its interest 

in a Passthrough Entity was treated as 

an API Holder Transition Amount. API 

Holder Transition Amounts were not 

taken into account for purposes of 

determining the Recharacterization 

Amount. The preamble to the proposed 

regulations also requests comments on 

whether a transition rule is needed and 

whether the Partnership Transition 

Amount rules are useful or whether 

another approach would be more 

helpful in easing transition difficulties. 

Several commenters questioned the 

need for an elective transition rule. One 

commenter noted that while they 

appreciated the Treasury Department 

and the IRS seeking to minimize the 

burdens associated with the change in 

law, they did not believe the transition 

rules would measurably lessen the 

recordkeeping burden on funds. The 

commenter also noted that whether and 

for whom the transition rules would be 

beneficial is unpredictable. Another 

commenter recommended that final 

regulations include an example 

illustrating, or otherwise better 

explaining, the importance of the API 

Holder Transition Amount rules, that is, 

what benefits the API Holder Transition 

Amount rules are intended to confer on 

taxpayers. No commenter provided an 

example of the potential applicability of 

the API Holder Transition Amount 

rules. After considering the comments, 

the Treasury Department and the IRS 

have determined that the Partnership 

Transition Amount rules are 

unnecessary. Accordingly, the final 

regulations do not include these rules. 

D. Section 1.1061–6: Reporting 

Requirements 

Proposed § 1.1061–6(a) provides filing 

and reporting requirements for Owner 

Taxpayers and Passthrough Entities. 

Proposed § 1.1061–6(a)(1) provides that 

an Owner Taxpayer must file such 

information with the IRS as the 

Commissioner may require in forms, 

instructions, or other guidance as is 

necessary for the Commissioner to 

determine that the Owner Taxpayer is in 

compliance with section 1061 and the 

regulations. Proposed § 1.1061–6(b)(1) 

provides that a Passthrough Entity must 

file such information with the IRS as the 

Commissioner may require in forms, 

instructions, or other guidance as is 

necessary for the Commissioner to 

determine that the Passthrough Entity 

and its partners have complied with 

section 1061 and the regulations and 

that a Passthrough Entity that has issued 

an API must furnish to the API Holder, 

including an Owner Taxpayer, such 

information at such time and in such 

manner as is necessary to determine the 

One Year Gain Amount and the Three 

Year Gain Amount with respect to the 

Owner Taxpayer that directly or 

indirectly holds the API. 

Proposed § 1.1061–6(a)(2) provides 

that if a Passthrough Entity does not 

furnish the information that an Owner 

Taxpayer needs to determine its 

Recharacterization Amount and meet its 

reporting requirements, and the Owner 

Taxpayer is not able to otherwise 

substantiate all or a part of those 

amounts to the satisfaction of the 

Secretary, then (i) the negative 

adjustments under proposed § 1.1061– 

4(a)(3)(i)(B) necessary to calculate the 

API One Year Distributive Share 

Amount will be deemed to equal zero, 

and (ii) the negative adjustment to the 

API One Year Distributive Share 

Amount for purposes of determining the 

API Three Year Distribution Amount 

under proposed § 1.1061–4(a)(3)(ii)(B) 

will be deemed to equal zero. 

Proposed § 1.1061–6(b)(2) provides 

that a Passthrough Entity that holds an 

interest in a lower-tier entity and needs 

information from the lower-tier entity to 

meet its reporting obligations under the 

proposed regulations must request such 

information from that entity by the later 

of the 30th day after the close of the 

taxable year to which the information 

request relates or within 14 days after 

the date of a request for information 

from an upper-tier Passthrough Entity 

and the lower-tier entity must respond 

by the due date (including extensions) 

of the Schedule K–1 for the taxable year. 

Proposed § 1.1061–6(b)(2)(vii) provides 

that a Passthrough Entity that fails to 

comply with the reporting rules in the 

proposed regulations or as further 

required in forms, instructions, or other 

guidance will be subject to penalties. 

One commenter stated that the 

reporting rules are based on the 

assumption that there will be a limited 

number of individuals who are in 

control and who have access to all 

relevant factual information. 

Consequently, the rules are extensive 

and smaller partnerships and noncontrolled partnerships may have 

difficulty complying without significant 

cost and expense. The commenter 

suggested this argued in favor of 

exempting small partnerships from 

these rules. 

A few commenters stated that lowertier passthrough entities are not 

required to furnish information until the 

due date of their returns and that this 

deadline does not permit upper-tier 

entities sufficient time to incorporate 

lower-tier passthrough entity 

information into their reporting. 

Further, the commenter noted that the 

regulations appear to prevent Owner 

Taxpayers from excluding anything 

from the API One Year Distributive 

Share Amount even if only part of the 

information cannot be substantiated. 

The commenter recommended that for 

groups of non-controlled entities, the 

requestor should be allowed any 

reasonable approach to substantiate the 

information and suggested that issues 

from non-compliant tiers should be 

resolved by having the IRS impose 


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failure to furnish penalties on those 

tiers. Finally, the commenter 

recommended guidance on how to 

substantiate unreported amounts. 

Several commenters suggested that 

the information reporting requirements 

are onerous and that denying exclusions 

from recharacterization for noncompliance is too harsh a penalty for 

Owner Taxpayers and upper-tier 

partnerships who are unable to secure 

the necessary information from lowertier partnerships, particularly where an 

Owner Taxpayer or upper-tier 

partnership has no control over whether 

the reporting requirements are met by 

the lower-tier partnership. One 

commenter argued that there is no 

indication in the statute or legislative 

history that this is what Congress 

intended. The commenter noted that the 

TCJA conference report indicates that 

Congress intended section 6031(b) 

penalties to apply to a failure to report 

to partners and those penalties are 

sufficient to deter non-compliance 

while not acting to change the character 

of distributive share items. 

A few commenters noted that the 

reporting requirements will require 

significant amendments to partnership 

agreements and reporting systems. 

These commenters requested that the 

effective date for the reporting 

requirements and associated penalties 

be delayed until at least 12 months after 

the year end in which the regulations 

are finalized to give funds and API 

Holders time to amend their operations 

and establish proper information 

reporting systems, particularly in light 

of the increased reporting requirements 

resulting from partner tax capital 

account reporting, Forms K–2 and K–3, 

the section 163(j) limitation, and other 

recent guidance. 

One commenter suggested that the 

regulations should provide a de minimis 

exception to the reporting requirements, 

especially in tiered partnership 

arrangements. The commenter suggested 

that if a limited partner owns less than 

five percent of a fund, there should be 

limitations on reporting requirements to 

those partners, arguing that information 

reporting is costly in a tiered fund 

context and the lower-tiered funds may 

not want to dedicate the resources to 

provide the proper reporting for such 

small fund interests. 

The final regulations do not adopt 

these comments. The reporting rules, 

including the zero presumptions, are 

necessary to effectively administer 

section 1061 and the regulations. The 

Treasury Department and the IRS note 

that the amounts required to be reported 

under the reporting rules may be 

substantiated by any reasonable means 

if a Passthrough Entity fails to report the 

necessary information to the Owner 

Taxpayer. Similarly, a de minimis rule 

or an exception for small partnerships 

would frustrate Owner Taxpayers’ 

ability to correctly determine the 

Recharacterization Amount and the 

IRS’s ability to administer the statute. 

For these reasons, the Treasury 

Department and the IRS also decline to 

provide a delay in the applicability date 

for the reporting rules. 

The final regulations retain the 

reporting rules as proposed with minor 

clarifying changes, including the 

changes discussed in paragraph III.C.4 

of this preamble with respect to QEF 

reporting. In addition, the final 

regulations provide that if an Owner 

Taxpayer requires information from a 

Passthrough Entity to determine the 

Section 1061(d) Recharacterization 

Amount, the Owner Taxpayer should 

request such information from that 

entity. The Passthrough Entity is 

required to provide the information to 

the extent requested by an API Holder 

and necessary to determine the Owner 

Taxpayer’s Section 1061(d) 

Recharacterization Amount. Finally, the 

final regulations substitute 

‘‘Commissioner’’ for ‘‘Secretary of the 

Treasury’’ in § 1.1061–6(a)(2) to avoid 

any misperception that any office or 

bureau within the Treasury Department 

other than the IRS is responsible for 

examining taxpayers’ returns. 

E. Securities Partnerships 

The proposed regulations include an 

amendment to § 1.704–3(e), which 

provides that a method for aggregating 

gains and losses by a securities 

partnership will not be considered 

reasonable unless it takes into account 

the application of section 1061. 

Specifically, the proposed regulations 

require partnerships that use the partial 

or full netting approaches described in 

§ 1.704–3(e) to establish accounts to 

track API Holders’ Capital Interest Gains 

and Losses, Unrealized API Gains and 

Losses, and API Gains and Losses. A 

commenter questioned whether these 

rules were necessary, given the 

likelihood of hedge fund managers to 

leave a fund before the three-year 

holding period expires. Another 

commenter noted that funds would 

need to implement sophisticated 

tracking mechanisms to distinguish 

between Capital Interest Gains and 

Losses and API Gains and Losses. The 

commenter thought that such tracing 

conflicted with the principles of 

aggregation provided by § 1.704–3(e). 

Another commenter recommended 

that the final regulations confirm that 

partnerships can change their section 

704(c) aggregation method in order to 

address section 1061 in a manner 

consistent with the regulations and that 

any such change would not violate the 

requirement to use the same aggregation 

approach once an approach is adopted. 

The commenter requested that the final 

regulations provide examples 

illustrating the intended application of 

the creation of separate accounts for 

APIs and capital interests. 

The final regulations provide a 

simplified rule in § 1.704–3(e) that 

states that section 1061 must be taken 

into account in applying the aggregation 

rule for securities partnerships, but does 

not provide a specific method for doing 

so. The Treasury Department and the 

IRS continue to study the comments 

received on this issue and may provide 

additional guidance in the future. 

IV. Additional Areas Under Study 

A. Section 1061(b) Exception 

Section 1061(b) provides that ‘‘[t]o the 

extent provided by the Secretary, 

[section 1061(a)] shall not apply to 

income or gain attributable to any asset 

not held for portfolio investment on 

behalf of third party investors.’’ The 

proposed regulations reserve with 

respect to the application of section 

1061(b). The preamble to the proposed 

regulations states that the Treasury 

Department and the IRS generally 

believe that the section 1061(b) 

exception is effectively implemented in 

the proposed regulations with the 

exception to section 1061 for 

Passthrough Interest Direct Investment 

Allocations. The preamble further 

requested comments on the application 

of section 1061(b) and whether the 

proposed regulations’ exclusion for 

Passthrough Interest Direct Investment 

Allocations properly implements the 

exception. 

One commenter suggested that the 

Passthrough Interest Direct Investment 

Allocations would exempt certain 

family offices from section 1061(a) but 

stated that the exception is too narrow 

to account for all types of family offices. 

The commenter noted that section 

1061(b) is not intended to cover family 

offices managed by a professional 

investment manager who is not a family 

member and who receives an API 

because the family members are thirdparty investors with respect to the 

professional investment manager. 

Several commenters suggested that 

additional guidance under section 

1061(b) is needed for family offices, 

management companies, and other 

partnerships that do not hold assets for 

portfolio investment on behalf of thirdparty investors. One commenter argued 


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that the Treasury Department and the 

IRS should not reserve on section 

1061(b) because carried interests as used 

in asset management businesses were 

the particular focus of Congress as it 

contemplated carried interest proposals. 

One commenter noted that it had 

recommended prior to the issuance of 

the proposed regulations that the 

authority under section 1061(b) should 

be exercised to confirm that section 

1061(a) does not apply to recharacterize 

income or gain attributable to the value 

of intangibles, including goodwill, 

created or used in an ATB. The 

commenter recognized that the 

Passthrough Interest Direct Investment 

Allocation rules in the proposed 

regulations operate in part to implement 

an exception for enterprise value, but 

recommended that final regulations 

should provide specifically that section 

1061(a) does not apply to recharacterize 

income or gain attributable to enterprise 

value. Furthermore, the commenter 

argued that the enterprise value 

exception should apply to allocations 

through tiers and should not require 

allocations in accordance with partner 

capital accounts if the intangible asset it 

not held for portfolio investment on 

behalf of third-party investors. 

As discussed in Part II.A. of this 

Summary of Comments and Explanation 

of Revisions, the final regulations 

modify the rules related to the capital 

interest exception, including removing 

the Passthrough Interest Direct 

Investment Allocation rules. As 

discussed in Part II.C. of this Summary 

of Comments and Explanation of 

Revisions, the final regulations provide 

that the delayed holding period prong of 

the Lookthrough Rule does not apply to 

the disposition of an API to the extent 

that the gain recognized upon the 

disposition is attributable to any asset 

not held for portfolio investment on 

behalf of third party investors. The 

Treasury Department and the IRS 

continue to study the comments 

regarding section 1061(b) and may 

address the application of the provision 

in future guidance, including whether 

section 1061(a) applies to recharacterize 

income or gain attributable to enterprise 

value. The Treasury Department and the 

IRS request additional comments related 

to section 1061(b). 

B. Small Partnerships 

In the preamble to the proposed 

regulations, the Treasury Department 

and the IRS requested comments and 

suggestions on whether a simplified 

method for determining and calculating 

the API Gain or Loss should be provided 

for small partnerships and if so, the 

criteria that should be used to determine 

which partnerships should be eligible to 

use the simplified method. One 

commenter stated that a small 

partnership exception is critically 

important to the integrity of the entire 

section 1061 regulatory regime. The 

commenter also noted that given the 

burdensome nature of the reporting 

requirements that could apply to small 

business taxpayers, a modification of 

these requirements for either ‘‘small 

partnerships’’ or ‘‘small partners’’ 

would appear to be justified. As 

discussed in the section on reporting 

requirements, a commenter also 

recommended a de minimis exception 

to the reporting requirements for 

passthrough entities in which a limited 

partner owns five percent, or less, of a 

fund. The Treasury Department and the 

IRS continue to study this issue and 

may address this in future guidance. 

The Treasury Department and the IRS 

request additional comments and 

suggestions on whether a simplified 

method for determining and calculating 

the API Gain or Loss should be provided 

for small partnerships and if so, the 

criteria that should be used to determine 

which partnerships should be eligible to 

use the simplified method. 

V. Applicability Dates 

The final regulations retain the 

applicability dates as proposed. 

Accordingly, the final regulations 

generally apply to taxable years of 

Owner Taxpayers and Passthrough 

Entities beginning on or after January 

19, 2021. Section 1.1061–3(b)(2)(i) 

applies to taxable years beginning after 

December 31, 2017. Section 1.1061– 

3(b)(2)(ii) applies to taxable years 

beginning after August 14, 2020. An 

Owner Taxpayer or Passthrough Entity 

may choose to apply the final 

regulations in their entirety to a taxable 

year beginning after December 31, 2017, 

provided that they consistently apply 

the final regulations in their entirety to 

that year and all subsequent years. 

With respect to an API in a 

partnership with a fiscal year ending 

after December 31, 2017, section 706 

determines the capital gains and losses 

the Owner Taxpayer includes in income 

with respect to an API after December 

31, 2017. Section 706 provides that the 

taxable income of a partner for a taxable 

year includes amounts required by 

sections 702 and 707(c) with respect to 

a partnership based on the income, gain, 

loss, deduction, or credit of a 

partnership for any taxable year ending 

within or with the taxable year of the 

partner. Accordingly, if a calendar year 

Owner Taxpayer has an API in a fiscal 

year partnership whose taxable year 

ends after December 31, 2017, section 

1061 applies to the Owner Taxpayer’s 

distributive share of long-term capital 

gain or loss with respect to the API in 

calendar year 2018 regardless of 

whether the partnership disposed of the 

property giving rise to the gains and 

losses in the period prior to January 1, 

2018. See § 1.706–1(a). 

Special Analyses 

I. Regulatory Planning and Review— 

Economic Analysis 

Executive Orders 12866, 13563, and 

13771 direct agencies to assess costs and 

benefits of available regulatory 

alternatives and, if regulation is 

necessary, to select regulatory 

approaches that maximize net benefits 

(including potential economic, 

environmental, public health and safety 

effects, distributive impacts, and 

equity). Executive Order 13563 

emphasizes the importance of 

quantifying both costs and benefits, of 

reducing costs, of harmonizing rules, 

and of promoting flexibility. 

These regulations have been 

designated as economically significant 

under Executive Order 12866 pursuant 

to the Memorandum of Agreement 

(April 11, 2018) between the Treasury 

Department and the Office of 

Management and Budget (OMB) 

regarding review of tax regulations. 

A. Need for Final Regulations 

These final regulations provide 

certainty and clarity to taxpayers 

affected by statutory changes introduced 

in section 1061 by TCJA. The Treasury 

Department and the IRS have received 

questions and comments regarding the 

meaning of various provisions in section 

1061 and issues not explicitly addressed 

in the statute. The Treasury Department 

and the IRS have determined that such 

comments warrant the issuance of 

further guidance. 

B. Background 

Section 1061 of the Internal Revenue 

Code (Code), enacted by TCJA, 

characterizes certain long-term capital 

gains recognized with respect to an API 

as short-term capital gains. Short-term 

capital gains are generally taxed at a 

higher rate than long-term capital gains. 

Section 1061 defines an API as an 

interest in a partnership transferred to 

or held by the taxpayer in connection 

with the performance of substantial 

services by the taxpayer, or any other 

related person, in any ‘‘applicable trade 

or business’’ (ATB). Under section 1061 

the term ATB encompasses a range of 

financial service activities. Specifically, 

an ATB is any activity conducted on a 

regular, continuous, and substantial 

basis which consists, in whole or in 


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part, of raising or returning capital, and 

either (i) investing in (or disposing of) 

‘‘specified assets’’ (or identifying 

specified assets for such investing or 

disposition), or (ii) developing specified 

assets. ‘‘Specified assets’’ are certain 

securities, certain commodities, real 

estate held for rental or investment, cash 

or cash equivalents, options or 

derivative contracts with respect to any 

of the foregoing, and an interest in a 

partnership to the extent of the 

partnership’s proportionate interest in 

any of the foregoing. 

Prior to the TCJA, the Internal 

Revenue Code made no distinction 

between capital gains allocated to APIs 

versus other partnership interests and 

partnership assets. Generally, the 

required holding period to obtain the 

lower long-term capital gains tax rate 

was one year for all partnership 

interests and partnership capital assets. 

Under the new provision, the required 

holding period for an API must be 

greater than three years to obtain longterm capital gains treatment. 

The Treasury Department and the IRS 

previously published proposed 

regulations under section 1061 

(‘‘proposed regulations’’). 

C. Overview of the Final Regulations 

The final regulations provide 

taxpayers with definitional and 

computational guidance regarding the 

application of section 1061. In 

particular, the final regulations provide 

a number of definitions, including the 

term ‘taxpayer’ for the purpose of 

determining the existence of an API. 

Additionally, the regulations clarify the 

rules for certain exceptions to section 

1061, including the exception for capital 

interests, and provide for an additional 

exception for bona fide purchases of 

APIs by an unrelated party who is not 

a service provider. The final regulations 

also provide rules for calculating the 

recharacterized gain amount. 

D. Economic Analysis 

1. Baseline 

In this analysis, the Treasury 

Department and the IRS assess the 

benefits and costs of the final 

regulations relative to a no-action 

baseline reflecting anticipated Federal 

income tax-related behavior in the 

absence of these final regulations. 

2. Summary of Economic Effects 

The final regulations provide 

certainty and consistency in the 

application of section 1061 by providing 

definitions and clarifications regarding 

the statute’s terms and rules. An 

economically efficient tax system 

generally aims to treat income and 

expense derived from similar economic 

decisions consistently across taxpayers 

and activities in order to reduce 

incentives for individuals and 

businesses to make choices based on tax 

rather than market incentives. In the 

absence of the guidance provided in 

these final regulations, taxpayers would 

bear the burden of interpreting the 

statute and the chances that different 

taxpayers might interpret the statute 

differently would be exacerbated. For 

example, two similarly situated 

taxpayers might interpret the statutory 

provisions pertaining to the definition 

of taxpayer or the capital interest 

exception differently, causing one to 

enter into a partnership that another 

comparable taxpayer might decline 

because of a different interpretation of 

how the income will be treated under 

section 1061. If this opportunity did not 

go to the more productive taxpayer, this 

lack of clarity results in an economically 

inefficient pattern of activity. An 

economic loss may also arise if all 

taxpayers have identical interpretations 

of the tax treatment of particular income 

streams under the statute but which 

differ slightly from the interpretation 

that Congress intended for these income 

streams. In this case, guidance provides 

value by bringing economic decisions 

closer in line with the intent and 

purpose of the statute. 

The final regulations include multiple 

substantive changes compared to the 

proposed regulations. The Treasury 

Department and the IRS view these 

changes as favorable to taxpayers, 

providing more flexibility and reducing 

burden and complexity. In particular, 

the final rules governing the capital 

interest exception are more flexible to 

better accommodate common business 

practices, which vary considerably 

across industries. Compared to the 

proposed regulations, the final 

regulations considerably narrow the 

range of related party transactions 

triggering 1061 recharacterization, and 

the associated compliance burden. 

Finally, compared to the proposed 

regulations, the Lookthrough Rule on 

the sale of APIs included in the final 

regulations is a more narrowly targeted 

anti-abuse rule, only imposing a 

compliance burden on taxpayers that 

appear to have engaged in abusive 

practices with the primary aim of 

avoiding section 1061(a) 

recharacterization. 

The proposed regulations solicited 

comments on the economic analysis of 

the proposed regulations. No such 

comments were received. 

3. Economic Analysis of Specific 

Provisions 

a. Provisions Not Substantially Revised 

From the Proposed Regulations 

i. Definition of Taxpayer 

The statute requires taxpayers to make 

a number of determinations, including 

the determination of the existence of an 

API, and the calculation of the section 

1061 amount, or amount of long-term 

gain recharacterized under section 1061. 

However, the term ‘‘taxpayer’’ is not 

defined in either section 1061 or in the 

Conference Report. Comments received 

by the Treasury Department and IRS 

highlight the importance of the 

definition of the term taxpayer for 

purposes of section 1061. Without 

guidance, taxpayers could use different 

approaches to define ‘‘taxpayer,’’ 

leading otherwise similar taxpayers to 

experience different degrees of 

complexity, and to report different 

recharacterized amounts. 

The final regulations include two 

definitions of taxpayer to address the 

level at which the determination of the 

existence of an API is made and the 

level at which the calculation of the 

section 1061 amount is made. The final 

regulations define the Owner Taxpayer 

as the person generally required to pay 

tax on the gain or loss with respect to 

the API. Under the final regulations, the 

section 1061 calculation is only 

performed by the person (the Owner 

Taxpayer) who must pay tax on the 

gains and losses recognized with respect 

to the API. The final regulations also 

introduce the term Passthrough 

Taxpayer. A Passthrough Taxpayer is an 

entity that does not itself generally pay 

tax on capital gains but must determine 

when an API exists and allocate income, 

gain, deduction and loss to its owners. 

Both the Owner Taxpayer and the 

Passthrough Taxpayer are treated as 

taxpayers for the purpose of 

determining whether an API exists. 

The Treasury Department and the IRS 

considered and rejected two alternative 

approaches to the definition of taxpayer 

outlined in received comments, the 

‘‘aggregate approach’’ and the ‘‘full 

entity approach’’. Under the aggregate 

approach, a partnership is not treated as 

a taxpayer for purposes of section 1061. 

Instead, section 1061 is applied solely to 

the partners that are ultimately subject 

to tax on the partnership’s items of 

capital gain and loss. A concern with 

using this approach for the purpose of 

determining whether an API exists is 

that it could incentivize partners to use 

tiered ownership structures to avoid 

section 1061 recharacterization. For 

example, an upper tier partnership may 


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receive an interest in a lower-tier fund 

in connection with the upper-tier 

partnership’s performance of services in 

an ATB. Partners of the upper-tier 

partnership may contend that they did 

not receive their interest in the uppertier partnership in connection with the 

services performed by the upper-tier 

partnership. Stopping such avoidance 

strategies would require complex rules 

and potentially burdensome reporting 

requirements when tiered ownership 

structures are involved. 

Under the ‘‘full entity approach’’, the 

partnership is treated as a taxpayer for 

purposes of both determining the 

existence of an API and calculating the 

section 1061 recharacterization amount. 

Treating the partnership as a taxpayer 

for purposes of calculating the section 

1061 recharacterization amount was 

found to be more burdensome than the 

approach taken in the final regulations 

for three reasons. First, using the full 

entity approach for determining the 

section 1061 recharacterization amount 

may lead to increased recharacterization 

of gains under section 1061 because 

individuals would not be able to net 

gains and losses across multiple APIs. 

Second, the administrative burden on 

both the taxpayer and the IRS would be 

increased in cases of tiered ownership. 

Under the full entity approach, a 

separate section 1061 calculation would 

be required at each level at which an 

API is held in a tiered partnership 

structure. Finally, the full entity 

approach may add complexity and 

burden in cases in which an exception 

to section 1061 applies, such as if a 

corporation is a direct or indirect 

partner. Because corporations are 

excluded from section 1061, any 

amount recharacterized at the 

partnership level would need to be 

tracked as it is allocated to partners to 

ensure that corporate or other excepted 

partners are not subject to the three-year 

holding period under section 1061. 

The Treasury and the IRS have 

concluded that the chosen alternative, 

incorporating the concepts of Owner 

Taxpayer and Passthrough Taxpayer, is 

less burdensome than other alternatives 

and provides helpful certainty to 

taxpayers. 

ii. Clarification of the Treatment of an 

API Purchased by an Unrelated Party 

The statute states that capital gain or 

loss recognized by a taxpayer on the sale 

of an API held for more than one year 

is subject to section 1061. The statute 

also provides guidance for ongoing 

treatment under section 1061 when the 

API is purchased by, or transferred to, 

a related party or another service 

provider. However, the statute does not 

provide guidance for the taxpayer who 

purchases an API and is neither a 

service provider to the relevant ATB, 

nor related to the seller of the API. The 

final regulations add an exception to 

section 1061 and provide that the term 

API does not include an interest in a 

partnership that would be treated as an 

API but is held by a bona fide purchaser 

of the interest who does not currently 

and has never provided services in the 

relevant ATB and who is not related to 

a person who provides services 

currently or has provided services in the 

past. By clarifying the treatment of an 

API that is sold at arm’s length, the final 

regulations reduce uncertainty and 

compliance burdens for taxpayers 

entering into these transactions. The 

Treasury Department and the IRS have 

determined that this exception is 

consistent with the purpose of section 

1061, which applies to service providers 

and persons related to service providers 

and which is not meant to apply to bona 

fide purchasers of a partnership interest 

who do not provide services. 

The Treasury Department and the IRS 

considered not providing this exception. 

However, it was determined that failure 

to provide this exception would treat 

unrelated purchasers of an API in an 

inequitable fashion, and that continued 

treatment of the partnership interest as 

an API would be inconsistent with the 

purpose of section 1061 because 

unrelated purchasers did not receive 

their interest in connection with the 

performance of substantial services. 

b. Provisions Substantially Revised 

From the Proposed Regulations 

i. Capital Interest Exception 

Section 1061(c)(4)(B) provides that 

the definition of an API does not 

include ‘‘any capital interest in the 

partnership which provides the 

taxpayer with a right to share in 

partnership capital commensurate 

with—(i) the amount of capital 

contributed (determined at the time of 

receipt of such partnership interest) or 

(ii) the value of the interest included in 

income under section 83 upon the 

receipt or vesting of such interest.’’ 

However, the statute does not provide 

guidance on what it means for a right to 

share in partnership capital to be 

‘‘commensurate’’ with the amount of 

capital contributed. 

The final regulations clarify that 

allocations are deemed commensurate 

with capital contributed if, under the 

partnership agreement, the allocation to 

an API Holder is calculated in a similar 

manner as the allocations to similarly 

situated Unrelated Non-Service 

Partners. This may be determined on an 

investment-by-investment or class-byclass basis. To qualify as a benchmark 

for comparison, the Unrelated NonService Partners must hold a significant 

investment, defined as at least five 

percent of the partnership. In the 

absence of these regulations, taxpayers 

might face confusion, along with 

substantial compliance cost, in 

calculating their qualifying capital 

interest. Further, partners with realized 

gains would be incentivized to engage 

in a series of inefficient transactions in 

order to minimize tax. 

The Treasury Department and the IRS 

considered alternative interpretations of 

‘‘commensurate with capital 

contributed.’’ In particular, the 

proposed regulations provide that an 

allocation is ‘‘commensurate with 

capital’’ if the allocation is based on the 

relative section 704(b) capital accounts 

of the partners under the partnership 

agreement. The proposed regulations 

then provide multiple rules for 

calculating an API holder’s capital 

account, including a rule disallowing 

unrealized API capital gains in 

calculating the API holder’s capital 

account, and a rule for determining the 

capital account when an API is held 

through another partnership. In light of 

numerous comments, the Treasury 

Department and the IRS have 

determined that the proposed 

regulations were too rigid and were not 

well suited to the wide variety of 

common business practices regarding 

ownership structure, accounting 

conventions, and compensation 

arrangements. Specifically, many 

partnerships subject to section 1061 do 

not maintain section 704(b) capital 

accounts. For many other partnerships, 

the capital account of one partner may 

relate to economic rights associated 

with multiple separate investments held 

by a partnership, while the capital 

account of another partner may relate to 

economic rights associated with a 

separate set of investments held by a 

partnership. For these reasons, the 

Treasury Department and the IRS have 

determined that the section 704(b) 

capital accounts of partners provide a 

poor means of measuring commensurate 

economic capital interest rights. 

The proposed regulations also 

prohibited use of the capital interest 

exception if a capital contribution was 

funded with related party loan 

proceeds. Commenters noted that it is a 

common business practice in industries 

subject to Section 1061 for employees to 

require new partners to make 

substantial capital contributions, which 

are often acquired through a loan. This 

arrangement, designed not to avoid tax 

but to align the incentives of general 


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partners and limited partners, would be 

unduly penalized under the proposed 

regulations, incentivizing firms to 

choose a less efficient ownership and 

governance structure. The final 

regulations amend the rule to allow an 

individual service provider’s capital 

contributions to be funded with loan 

proceeds from partners and persons 

related to partners if the individual 

service provider is personally liable for 

the loan, meaning the loan is fully 

recourse to the individual service 

provider, the individual service 

provider has no right to be reimbursed 

by any person, and no person has 

guaranteed the individual service’s 

provider’s loan. The Treasury 

Department and the IRS believe the final 

rules address abusive avoidance 

strategies, while imposing less burden 

on taxpayers engaged in standard 

business practices relative to not 

allowing any contributions from 

proceeds from related part loans to be 

eligible for the capital interest 

exception. 

ii. Lookthrough Rule on Sale of APIs 

Section 1061(a) provides that if one or 

more APIs are held by a taxpayer at any 

time during the taxable year, the excess 

(if any) of (1) the taxpayer’s net longterm capital gain with respect to such 

interests for such taxable year, over (2) 

the taxpayer’s net long-term capital gain 

with respect to such interests for that 

taxable year computed by applying 

paragraphs (3) and (4) of sections 1222 

by substituting ‘‘3 years’’ for ‘‘1 year,’’ 

must be treated as short-term capital 

gain, notwithstanding section 83 or any 

election in effect under section 83(b). 

The House Report explains that section 

1061 ‘‘imposes a three-year holding 

period (not the generally applicable oneyear holding period) in the case of longterm capital gain from applicable 

partnership interests.’’ Neither section 

1061 nor the Reports, however, 

explicitly provides what the relevant 

holding period is for purposes of section 

1061(a) for the sale of an API with assets 

of different holding periods. 

The final regulations include a 

Lookthrough Rule that is triggered if a 

transaction or series of transactions has 

taken place with a principal purpose of 

avoiding potential gain 

recharacterization under section 

1061(a). Under this Lookthrough Rule, 

all gain not attributable to assets held 

for more than three years is subject to 

recharacterization under section 

1061(a). Additionally, the Lookthrough 

Rule applies if the API disposition 

would be subject to Section 1061(a) 

recharacterization using a holding 

period not beginning until the date that 

Unrelated Non-Service Partners legally 

commit to contribute substantial capital 

to the applicable partnership. Without 

this rule, fund managers might attempt 

to avoid the recharacterization of gains 

by establishing partnerships and leaving 

them inactive for three years before 

attracting investment from limited 

partners, thereby circumventing Section 

1061. 

The Treasury Department and the IRS 

considered and rejected alternative 

approaches, including applying a 

simple interest approach, an alternative 

lookthrough rule (as provided in the 

proposed regulations), and an 

underlying assets approach. The simple 

interest approach looks solely to the 

holding period in the API, regardless of 

the length of time the partnership has 

engaged in substantive investment. This 

approach might allow taxpayers to 

avoid section 1061 characterization for 

long-term capital gains on assets that are 

not held for the more than three years 

by the partnership. This result would 

encourage distortive behavior in 

investment funds, which might look to 

create partnerships for different 

investors solely for tax purposes, 

relative to the approach adopted in the 

final regulations. That is, the partners of 

that investment partnership would not 

be subject to section 1061 if they had 

owned their APIs for more than three 

years, irrespective of how long the 

investment partnership had been active 

and attracting capital from outside 

investors. 

Alternatively, the underlying asset, or 

full lookthrough, approach looks solely 

to the holding period in the underlying 

asset (or assets) of the partnership, 

regardless of whether the underlying 

asset is sold by the partnership or the 

API is sold by its owner. The underlying 

asset approach would be more difficult 

(and burdensome) for taxpayers to apply 

(relative to the provision provided in 

the final regulations) as it would require 

a determination of the unrealized gain 

for each asset held by the partnership, 

even in cases in which a relatively small 

share of assets by value have a holding 

period of three years or less. 

The proposed regulations included an 

alternative lookthrough rule applied to 

the sale of an API if 80% or more of the 

value of the assets held by the 

partnership at the time of the API 

disposition were assets held for three 

years or less that would produce capital 

gain or loss subject to section 1061 if 

disposed of by the partnership. If the 

lookthrough rule in the proposed 

regulations applied, a portion of the 

capital gain on the disposition of the 

API attributable partnership assets held 

for three or fewer years would be 

recharacterized as short-term capital 

gain. This alternative was rejected in the 

final regulations because the 

calculations required by the proposed 

lookthrough rule would impose 

unnecessary compliance burden on 

individual taxpayers selling an API 

without any accompanying general 

economic benefit. The rules requiring 

partnerships to furnish taxpayers with 

the relevant information to perform the 

calculations would also impose undue 

additional burden on the relevant 

partnerships. The lookthrough rule 

provided in the final regulations applies 

in more limited circumstances, 

narrowly targeting taxpayers that appear 

to be engaged in abusive practices to 

avoid section 1061(a) recharacterization. 

Therefore, the final regulations provide 

helpful guidance and certainty for 

taxpayers, while imposing minimal 

compliance burden relative to the noaction baseline or alternative regulatory 

approaches. 

iii. Treatment of API Transfers to 

Related Parties 

Section 1061(d) recharacterizes 

certain long-term capital gain as shortterm capital gain when a taxpayer 

transfers an API to a related person. 

While the statute provides a definition 

of a related person and a general 

description of the recharacterization 

amount, numerous commenters 

expressed uncertainty regarding the 

scope of transfers subject to section 

1061(d), pointing out that although the 

statutory language of section 1061(d) 

refers to the transfer of an API, it refers 

to income inclusion associated with an 

API transfer that is related to the sale or 

exchange of partnership assets held for 

three years of less. Based on the 

statutory language, commenters 

expressed the view that section 1061(d) 

transfers should be limited to taxable 

transfers. 

Although one read of the text of 

section 1061(d) suggests that the 

provision can be broadly applied to 

capture all API transfers, including gifts 

and other nonrecognition transfer, the 

Treasury Department and the IRS 

considered and rejected applying 

section 1061(d) to nontaxable transfers. 

Applying section 1061(d) to nontaxable 

transfers would impose income 

recognition on gifts including an API, 

where no income recognition is 

imposed on otherwise similar gifts, 

creating a tax disadvantage for gifts 

including an API. Instead, the Treasury 

and the IRS have determined that the 

section 1061(d) statute is better read as 

a recharacterization provision that looks 

to how much of the taxpayer’s long-term 

capital gain upon the sale of an API is 


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attributable to the sale or exchange of 

any asset held for three years or less and 

that the provision’s use of the word 

‘‘transfer’’ does not supersede 

application of the sale or exchange 

requirement in the statute. 

II. Paperwork Reduction Act 

A. Collection of Information in § 1.1061– 

6(a) on the Owner Taxpayer is on 

Existing Forms 

The collection of information in 

§ 1.1061–6(a) requires an Owner 

Taxpayer to file such information with 

the IRS as the Commissioner may 

require in forms, instructions and other 

published guidance as is necessary for 

the IRS to determine that the taxpayer 

has properly complied with section 

1061 and the Section 1061 Regulations. 

This information is necessary for the 

IRS to determine that the Owner 

Taxpayer has properly complied with 

section 1061. In general, the Owner 

Taxpayer is an individual and the 

Owner Taxpayer’s Recharacterization 

Amount and Section 1061(d) 

Recharacterization Amount will be 

required to be reported to the IRS as 

short-term capital gain on Schedule D, 

‘‘Capital Gains and Losses,’’ of the Form 

1040, ‘‘U.S. Individual Income Tax 

Return.’’ Less frequently, the Owner 

Taxpayer is a trust and the Owner 

Taxpayer’s Recharacterization Amount 

and Section 1061(d) Recharacterization 

Amount will be required to be reported 

to the IRS as short-term capital gain on 

Schedule D, ‘‘Capital Gains and Losses,’’ 

of the Form 1041, ‘‘U.S. Income Tax 

Return for Estates and Trusts.’’ 

The current status of the Paperwork 

Reduction Action submission related to 

§ 1.1061–6(a) is provided in the 

following table. The burdens associated 

with the collection of information from 

the Owner Taxpayer to comply with 

section 1061 are included in the 

aggregate burden estimates for Form 

1040 under OMB control number 1545– 

0074 and Form 1041 under OMB control 

number 1545–0092. The overall burden 

estimates provided in OMB Control 

Number 1545–0074 represents a total 

estimated burden time, including all 

other related forms and schedules for 

individuals, of 1.784 billion hours and 

total estimated monetized costs of 

$31.74 billion (in 2017 dollars). The 

overall burden estimates provided in 

OMB Control Number 1545–0092 

represents a total estimated burden 

time, including all other forms and 

schedules for trusts and estates of 307.8 

million hours and total estimated 

monetized costs of $9.95 billion (in 

2016 dollars). These amounts are 

aggregate amounts that relate to all 

information collections associated with 

the applicable OMB control numbers, 

and will in the future include, but not 

isolate, the estimated burden of Owner 

Taxpayers as a result of the information 

collections in the regulations. No 

burden estimates specific to the final 

regulations are currently available. The 

Treasury Department and IRS have not 

estimated the burden, including that of 

any new information collections, related 

to the requirements under the final 

regulations. Those estimates would 

capture both changes made by the TCJA 

and those that arise out of discretionary 

authority exercised in the regulations. 

The Treasury Department and the IRS 

request comments on all aspects of 

information collection burdens related 

to the collection of information 

applicable to the Owner Taxpayer in 

these regulations. In addition, when 

available, drafts of IRS forms are posted 

for comment at www.irs.gov/draftforms. 

Form Type of filer OMB No.(s) Status 

Form 1040 (Including Schedule D).Individual (NEW Model) .......... 1545–0074 Published in the Federal Register on 9/30/19. Comment period closed on 11/29/19. 84 FR 51712. Thirty-day notice 

published on 12/18/19. 84 FR 69458. Approved by the Office of Information and Regulatory Affairs (OIRA) on 1/30/ 

20. 

Form 1041 (Including Schedule D).Trusts and Estates (Legacy 

Model).

1545–0092 Published in the Federal Register on 4/4/2018. 83 FR 

14552. Public comment period closed 6/4/2018. Thirty-day 

notice published on 9/27/18. 83 FR 48894. Approved by 

OIRA on 5/8/19. 

B. Collection of Information on 

Passthrough Entities in § 1.1061–6(b) 

and (c) on Existing Forms 

1. Passthrough Entities 

The collection of information in 

§ 1.1061–6(b) requires a Passthrough 

Entity that has issued an API to furnish 

to the API Holder, including the Owner 

Taxpayer, such information at such time 

and in such manner as the 

Commissioner may require in forms, 

instructions, and other published 

guidance as is necessary to determine 

the One Year Gain amount and the 

Three Year Gain Amount with respect to 

an Owner Taxpayer. This includes: (i) 

The API One Year Distributive Share 

Amount and the API Three Year 

Distributive Share Amount (as 

determined under § 1.1061–4); (ii) 

Capital gains and losses allocated to the 

API Holder that are excluded from 

section 1061 under § 1.1061–4(b)(7); (iii) 

Capital Interest Gains and Losses 

allocated to the API Holder (as 

determined under § 1.1061–3(c)); (iv) In 

the case of a disposition by the API 

Holder of an interest in the Passthrough 

Entity during the taxable year, any 

information required by the API Holder 

to properly take the disposition into 

account under section 1061, including 

information necessary to apply the 

Lookthrough Rule and to determine its 

Capital Interest Disposition Amount and 

any information necessary to determine 

an Owner Taxpayer’s Section 1061(d) 

Recharacterization Amount. The 

regulations seek to minimize the 

information that a Passthrough Entity is 

required to automatically furnish 

annually. In some cases, an upper-tier 

Passthrough Entity may be an API 

Holder in a lower-tier Passthrough 

Entity, and the information furnished by 

the lower-tier Passthrough Entity to the 

upper-tier Passthrough Entity may not 

be sufficient for the upper-tier 

Passthrough Entity to meet its reporting 

obligations under the regulations. In this 

case, the regulations require the lowertier Passthrough Entity to furnish 

information to the upper-tier 

Passthrough Entity if requested. Thus, if 

an upper-tier Passthrough Entity in a 

tiered entity structure holds an interest 

in a lower-tier Passthrough Entity and it 

needs information from the lower-tier 

Passthrough Entity to comply with its 

obligation to furnish information under 

the regulations, it must request 

information from the lower-tier entity 

and the lower-tier entity must furnish 

the requested information. This passing 

of information upon request between 

the tiers of entities is necessary to 

minimize the quantity of information 

required to be annually furnished by a 

Passthrough Entity and because each 

Passthrough Entity in a tiered entity 

arrangement is the only entity that has 


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5478 Federal Register / Vol. 86, No. 11 / Tuesday, January 19, 2021 / Rules and Regulations 

access to the information that is 

required to be furnished. The collection 

of information in the regulations is 

necessary to ensure that the Owner 

Taxpayer receives information sufficient 

to correctly calculate its 

Recharacterization Amount under 

section 1061. 

2. RICs and REITs 

Section 1.1061–6(c) permits a RIC or 

a REIT that reports or designates all or 

a part of a dividend as a capital gain 

dividend, to disclose additional 

information to their shareholders for 

purposes of section 1061. The 

furnishing of this information may 

allow a Passthrough Entity to include a 

portion of the capital gain dividend in 

the API Three Year Distributive Share 

amount furnished to API Holders and 

may ultimately enable an Owner 

Taxpayer to reduce its 

Recharacterization Amount under the 

regulations. 

3. Table for Collections of Information 

in § 1.1061–6(b) and (c) 

The collection of information with 

respect to § 1.1061–6(b) and (c) is 

provided in the following table. In the 

case of a Passthrough Entity that is a 

partnership, the information will be 

required to be furnished as an 

attachment to the Schedule K–1, 

‘‘Partner’s Share of Income, Deduction, 

Credit, Etc.’’ of Form 1065, ‘‘U.S. Return 

of Partnership Income.’’ In the case of a 

Passthrough Entity that is an S 

corporation, the information will be 

required to be furnished as an 

attachment to the Schedule K–1, 

‘‘Shareholder’s Share of Income, 

Deductions, Credit, Etc.,’’ of Form 1120– 

S, ‘‘U.S. Income Tax Return for an S 

Corporation.’’ The burdens associated 

with the collection of information from 

the Passthrough Entities will be 

included in the aggregate burden 

estimates for the Form 1065 and the 

Form 1120S under OMB control number 

1545–0123. The overall burden 

estimates provided in OMB Control 

Number 1545–0123 represents a total 

estimated burden time, including all 

others related forms and schedules, of 

3.344 billion hours and total estimated 

monetized costs of $61.558 billion (in 

2019 dollars). The burden estimates 

provided in OMB Control Number 

1545–0123 are aggregate amounts that 

relate to all information collections 

associated with the applicable OMB 

control number, and will in the future 

include, but not isolate, the Passthrough 

Entities’ estimated burden as a result of 

the information collections in the 

proposed regulations. 

In the case of a Passthrough Entity 

that is a trust or estate, the information 

will be required to be furnished as an 

attachment to the Schedule K–1, 

‘‘Beneficiary’s Share of Income, 

Deductions, Credit, Etc.,’’ of Form 1041, 

‘‘U.S. Income Tax Return for Estates and 

Trusts.’’ The burdens associated with 

the collection of information from a 

Passthrough Entity that is a trust or 

estate will be included in the aggregate 

burden estimates for the Form 1041 

OMB control number 1545–0092. The 

overall burden estimates provided in 

OMB Control Number 1545–0092 

represents a total estimated burden 

time, including all other forms and 

schedules for trusts and estates of 307.8 

million hours and total estimated 

monetized costs of $9.95 billion (in 

2016 dollars). The burden estimates 

provided in OMB Control Number 

1545–0092 are aggregate amounts that 

relate to all information collections 

associated with the applicable OMB 

control number, and will in the future 

include, but not isolate, the Passthrough 

Entities’ estimated burden as a result of 

the information collections in the 

regulations. 

In the case of RICs and REITs the 

information will be furnished in 

connection with the Form 1099–DIV, 

‘‘Dividends and Distributions.’’ The 

burden estimates associated with the 

collection of information from RICs and 

REITs will be included in the aggregate 

burden estimated for the Form 1099– 

DIV under OMB Control Number 1545– 

0110. The overall burden estimates 

provided in OMB Control Number 

1545–0110 represents a total estimated 

burden time of 32,119,195 hours and 

total estimated monetized costs of $ 1.64 

billion (in 2016 dollars). The burden 

estimates provided in OMB Control 

Number 1545–0110 relate to all 

information collections associated with 

the applicable OMB Control Number, 

and will in the future include, but not 

isolate, the RIC and REIT estimated 

burden as a result of the information 

collections in the regulations. 

The Treasury Department and IRS 

have not estimated the burden, 

including that of any new information 

collections, related to the requirements 

under the regulations. Those estimates 

would capture both changes made by 

the TCJA and those that arise out of the 

discretionary authority exercised in the 

regulations. The Treasury Department 

and the IRS request comments on all 

aspects of information collection 

burdens related to the collection of 

information applicable to the 

Passthrough Entities in the regulations. 

In addition, when available, drafts of 

IRS Forms and the applicable 

instructions are posted for comment at 

https://www.irs.gov/pub/irs-dft/. 

Form Type of filer OMB No.(s) Status 

Form 1041 (including Schedule K–1).Trusts and Estates (Legacy 

Model).

1545–0092 Published in the Federal Register on 4/4/2018. 83 FR 

14552. Public comment period closed 6/4/2018. Thirty-day 

notice published on 9/27/18. 83 FR 48894. Approved by 

OIRA on 5/8/19. 

Form 1065 (including Schedule K–1).Business (NEW Model) .......... 1545–0123 Sixty-day notice published in the Federal Register on 9/30/ 

19. Public Comment period closed on 11/29/19. 84 FR 

51718. Thirty-day notice published in the Federal Register 

on 12/19/19. Public Comment period closed on 1/21/20. 84 

FR 69825. Approved by OIRA on 1/30/20. 

Form 1120S (Including Schedule K–1).Business (New Model) ............ 1545–0123 Sixty-day notice published in the Federal Register on 9/30/ 

19. Public Comment period closed on 11/29/19. 84 FR 

51718. Thirty-day notice published in the Federal Register 

on 12/19/19. Public Comment period closed on 1/21/20. 84 

FR 69825. Approved by OIRA on 1/30/20. 

Form 1099–DIV ....................... (Legacy Model) ....................... 1545–0110 Sixty-day notice published in the Federal Register on 9/19/ 

19. Public comment period closed 11/18/19. 84 FR 49379. 

Thirty-day notice published in the Federal Register on 12/ 

20/19. 84 FR 70269. 


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Form Type of filer OMB No.(s) Status 

Link: https://www.federal register.gov/documents/2018/05/23/2018-10981/proposed-collection-comment-requestfor-form-1099-div. 

C. Chart Showing Number of 

Respondents Regarding Existing Forms 

The following chart shows the 

estimated number of returns that are 

expected to have attachments providing 

additional information with respect to 

section 1061. As noted previously, 

Owner Taxpayers will be required to 

provide section 1061 information on an 

attachment to Schedules D for Forms 

1040 and 1041. Passthrough Taxpayers 

will be required to report section 1061 

on Forms 1041, 1065, and 1120S to the 

IRS and to furnish information to their 

API Holders on attachments to the 

respective K–1s. RICs and REITs may 

voluntarily report additional 

information at an attachment to Form 

1099–DIV. 

Schedule D Form 1040 ........ 20,475 

Schedule D Form 1041 ........ 2,275 

Schedule K Form 1065 ........ 28,500 

Schedule K–1s Form 1065 ... 57,000 

Schedule K Form 1120S ...... 1,500 

Schedule K–1s Form 1120 ... 1,000 

Form 1099–DIV filed by 

REITs ................................ 836 

Form 1099–DIV filed by 

RICs .................................. 3,880 

D. Voluntary Collection of Information 

in § 1.1061–6(d) on PFIC Shareholder 

Will Be Added to Existing OMB Control 

Number for PFIC Information Retention 

Section 1.1061–6(d) permits a PFIC 

with respect to which the shareholder is 

an API Holder who has a QEF election 

is in effect for the taxable year to 

provide additional information to the 

shareholder to determine the amount of 

the shareholder’s inclusion that would 

be included in the API One Year 

Distributive Share Amount and the API 

Three Year Distributive Share Amount. 

If the PFIC furnishes this information to 

the shareholder, the shareholder must 

retain a copy of this information along 

with the other information required to 

be retained under § 1.1295–1(f)(2)(ii). 

The burden associated with retaining 

this additional information will be 

included in the aggregate burden 

estimates for § 1.1295–1(f) under OMB 

Control Number 1545–1555. An agency 

may not conduct or sponsor, and a 

person is not required to respond to, a 

collection of information unless it 

displays a valid control number 

assigned by the Office of Management 

and Budget. 

Books and records related to the 

collection of information must be 

retained as long as their contents may 

become material in the administration 

of any internal revenue law. Generally, 

tax returns and tax return information 

are confidential, as required by 26 

U.S.C. 6103. 

III. Regulatory Flexibility Act 

Pursuant to the Regulatory Flexibility 

Act (5 U.S.C. chapter 6), it is hereby 

certified that these final regulations will 

not have a significant economic impact 

on a substantial number of small entities 

within the meaning of section 601(6) of 

the Regulatory Flexibility Act. These 

regulations generally only impact 

investment funds that have capital gains 

and losses that derive from the 

disposition of assets that have a holding 

period of more than one year but not 

more than three years. Investment funds 

are considered small business if they 

have annual average receipts of $41.5 

million or less (13 CFR part 121). The 

rule may affect a substantial number of 

small entities, but data are not readily 

available to assess how many entities 

will be affected. 

The Treasury Department and the IRS 

received no actionable comments on the 

impact that the proposed regulations 

would have on small entities. Although 

certain commenters requested that 

partnerships with an unspecified 

amount of limited assets be excepted 

from the application of the statutory 

rules of section 1061, these commenters 

did not provide any data to demonstrate 

that any burden would be significant. 

Similarly, a commenter requested an 

exception to the reporting requirements 

for passthrough entities in which a 

limited partner owns 5 percent or less 

of a fund but did not quantify the 

burden. In addition, the final 

regulations adopt other comments that 

limit the general burden of the 

regulations to all entities, including 

small entities. 

Even if a substantial number of small 

entities are affected, the economic 

impact of these regulations on small 

entities is not significant. The 

regulations provide taxpayers with 

definitional and computational 

guidance regarding the application of 

section 1061. The impact of the 

regulations is to impose an additional 

reporting obligation that applies only 

with respect to the sale of assets held for 

more than one year but not more than 

three years. The Treasury Department 

and the IRS recognize that this reporting 

obligation may increase, at least to some 

extent, the tax preparation burden for 

affected taxpayers beyond that imposed 

by the statute. This reporting obligation 

generally will only apply to a minority 

of the asset dispositions by an entity. 

The entity will also have a reporting 

obligation in certain circumstances 

regarding the disposition of an API, but 

the extent of the reporting obligation 

depends on the number of assets 

disposed by the entity and their holding 

periods. The information reported is 

readily available to taxpayers and 

reported on forms already in use 

beginning with the 2019 taxable year 

such as Schedule D to IRS Form 1065. 

Finally, some taxpayers may find they 

need an initial investment of time to 

read and understand these regulations at 

an approximate cost of $95/hour and an 

estimated time of ten hours. 

Accordingly, the Secretary certifies that 

these regulations will not have a 

significant economic impact on a 

substantial number of small entities. 

Pursuant to section 7805(f), the notice 

of proposed rulemaking preceding this 

regulation was submitted to the Chief 

Counsel for the Office of Advocacy of 

the Small Business Administration for 

comment on its impact on small 

businesses. No comments were received 

from the Chief Counsel for the Office of 

Advocacy of the Small Business 

Administration. 

IV. Unfunded Mandates Reform Act 

Section 202 of the Unfunded 

Mandates Reform Act of 1995 requires 

that agencies assess anticipated costs 

and benefits and take certain other 

actions before issuing a final rule that 

includes any Federal mandate that may 

result in expenditures in any one year 

by a state, local, or tribal government, in 

the aggregate, or by the private sector, of 

$100 million in 1995 dollars, updated 

annually for inflation. This rule does 

not include any Federal mandate that 

may result in expenditures by state, 

local, or tribal governments, or by the 

private sector in excess of that 

threshold. 

V. Executive Order 13132: Federalism 

Executive Order 13132 (entitled 

‘‘Federalism’’) prohibits an agency from 

publishing any rule that has federalism 

implications if the rule either imposes 

substantial, direct compliance costs on 


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state and local governments, and is not 

required by statute, or preempts state 

law, unless the agency meets the 

consultation and funding requirements 

of section 6 of the Executive order. This 

rule does not have federalism 

implications and does not impose 

substantial direct compliance costs on 

state and local governments or preempt 

state law within the meaning of the 

Executive order. 

VI. Congressional Review Act 

The Administrator of the Office of 

Information and Regulatory Affairs of 

the Office of Management and Budget 

has determined that this Treasury 

decision is a major rule for purposes of 

the Congressional Review Act (5 U.S.C. 

801 et seq.). Under 5 U.S.C. 801(a)(3), a 

major rule takes effect 60 days after the 

rule is published in the Federal 

Register. 

Notwithstanding this requirement, 5 

U.S.C. 808(2) allows agencies to 

dispense with the requirements of 5 

U.S.C. 801 when the agency for good 

cause finds that such procedure would 

be impracticable, unnecessary, or 

contrary to the public interest and the 

rule shall take effect at such time as the 

agency promulgating the rule 

determines. Pursuant to 5 U.S.C. 808(2), 

the Treasury Department and the IRS 

find, for good cause, that a 60-day delay 

in the effective date is contrary to the 

public interest. 

Following the enactment of section 

1061 by the TCJA, the Treasury 

Department and the IRS published the 

proposed regulations to provide 

certainty to taxpayers. In particular, as 

demonstrated by the wide variety of 

public comments in response to the 

proposed regulations received, 

taxpayers continue to express 

uncertainty regarding the proper 

application of the statutory rules under 

section 1061. This is especially the case 

for taxpayers in the trade or business of 

operating investment funds, which may 

be unwilling to engage in certain 

commercial transactions without the 

additional clarity provided by these 

final regulations. Additionally, various 

rules contained within these regulations 

attempt to curb certain abusive 

transactions designed to avoid the 

application of section 1061 and an 

earlier effective date is necessary to 

address these abusive transactions. 

Accordingly, the Treasury Department 

and the IRS have determined that the 

rules in this Treasury decision will take 

effect on the date of filing for public 

inspection in the Federal Register. 

Statement of Availability of IRS 

Documents 

Notice 2018–18, 2018–2 I.R.B. 443 (in 

addition to any other revenue 

procedures or revenue rulings, etc. cited 

in this preamble) is published in the 

Internal Revenue Bulletin (or 

Cumulative Bulletin) and is available 

from the Superintendent of Documents, 

U.S. Government Publishing Office, 

Washington, DC 20402, or by visiting 

the IRS website at http://www.irs.gov. 

Drafting Information 

The principal authors of these 

regulations are Kara K. Altman, Sonia K. 

Kothari, and Wendy L. Kribell of the 

Office of Associate Chief Counsel 

(Passthroughs and Special Industries). 

However, other personnel from the 

Treasury Department and the IRS 

participated in their development. 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Amendment to the Regulations 

Accordingly, 26 CFR part 1 is 

amended as follows: 

PART 1—INCOME TAXES 

■ Paragraph 1. The authority citation 

for part 1 is amended by adding entries 

for §§ 1.1061–0, 1.1061–1, 1.1061–2, 

1.1061–3, 1.1061–4, 1.1061–5, and 

1.1061–6 in numerical order to read in 

part as follows: 

Authority: 26 U.S.C. 7805 * * * 

Section 1.1061–0 added under 26 U.S.C. 

1061(f). 

Section 1.1061–1 added under 26 U.S.C. 

1061(f). 

Section 1.1061–2 added under 26 U.S.C. 

1061(f). 

Section 1.1061–3 added under 26 U.S.C. 

1(h)(9) and 1061(f). 

Section 1.1061–4 added under 26 U.S.C. 

1061(f). 

Section 1.1061–5 added under 26 U.S.C. 

1061(f). 

Section 1.1061–6 added under 26 U.S.C. 

1061(f). 

* * * * * 

■ Par. 2. Section 1.702–1 is amended by 

adding a sentence at the end of 

paragraph (a)(2) and adding paragraph 

(g) to read as follows. 

§ 1.702–1 Income and credits of partner. 

(a) * * * 

(2) * * * Each partner subject to 

section 1061 must take into account 

gains and losses from sales of capital 

assets held for more than one year as 

provided in section 1061 and §§ 1.1061– 

1 through 1.1061–6. 

* * * * * 

(g) Applicability date. The last 

sentence of paragraph (a)(2) of this 

section applies for the taxable years 

beginning on or after January 19, 2021. 

■ Par. 3. Section 1.704–3 is amended 

by: 

■ 1. In paragraph (e)(3)(vi)(B), remove 

the word ‘‘and’’ at the end of the 

paragraph; 

■ 2. Redesignating paragraph 

(e)(3)(vi)(C) as paragraph (e)(3)(vi)(D); 

■ 3. Adding new paragraph (e)(3)(vi)(C); 

and 

■ 4. Revising the heading and first 

sentence of paragraph (f) and adding a 

sentence to the end of paragraph (f). 

The additions and revisions read as 

follows: 

§ 1.704–3 Contributed property. 

* * * * * 

(e) * * * 

(3) * * * 

(vi) * * * 

(C) With respect to any person who 

directly or indirectly holds an 

Applicable Partnership Interest, as 

defined in § 1.1061–1(a)(1), take into 

account the application of section 1061 

with respect to such interest in an 

appropriate manner; and 

* * * * * 

(f) Applicability dates. With the 

exception of paragraphs (a)(1), (a)(8)(ii) 

and (iii), (a)(10) and (11), and 

(e)(3)(vi)(C) of this section, and of the 

last sentence of paragraph (d)(2) of this 

section, this section applies to 

properties contributed to a partnership 

and to revaluations pursuant to § 1.704– 

1(b)(2)(iv)(f) or (s) on or after December 

21, 1993. 

* * * Paragraph (e)(3)(vi)(C) of this 

section applies to taxable years 

beginning on or after January 19, 2021. 

* * * * * 

■ Par. 4. Sections 1.1061–0 through 

1.1061–6 are added before the 

undesignated center heading ‘‘Changes 

to Effectuate F.C.C. Policy’’ to read as 

follows: 

Sec. 

* * * * * 

1.1061–0 Table of contents. 

1.1061–1 Section 1061 definitions. 

1.1061–2 Applicable partnership interests 

and applicable trades or businesses. 

1.1061–3 Exceptions to the definition of an 

API. 

1.1061–4 Section 1061 computations. 

1.1061–5 Section 1061(d) transfers to 

related persons. 

1.1061–6 Reporting rules. 

* * * * * 

§ 1.1061–0 Table of contents. 

This section lists the captions that 

appear in §§ 1.1061–1 through 1.1061– 

6. 


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§ 1.1061–1 Section 1061 definitions. 

(a) Definitions. 

(b) Applicability date. 

§ 1.1061–2 Applicable partnership interests 

and applicable trades or businesses. 

(a) API rules and examples. 

(1) Rules. 

(i) An API remains an API. 

(ii) Application of section 1061 to 

Unrealized API Gains and Losses. 

(iii) API Gains and Losses retain their 

character. 

(iv) Substantial services by the Owner 

Taxpayer, Passthrough Taxpayer or any 

Related Person. 

(v) Grantor trusts and entities disregarded 

as separate from their owners. 

(2) Examples. 

(b) Application of the ATB Activity Test. 

(1) In general. 

(i) Rules for applying the ATB Activity 

Test. 

(A) Aggregate Specified Actions taken into 

account. 

(B) Raising or Returning Capital Actions 

and Investing or Developing Actions are not 

both required to be taken in each taxable 

year. 

(C) Combined conduct by multiple related 

entities taken into account. 

(ii) Developing Specified Assets. 

(iii) Partnerships. 

(2) Examples. 

(c) Applicability date. 

§ 1.1061–3 Exceptions to the definition of 

an API. 

(a) A partnership interest held by an 

employee of another entity not conducting an 

ATB. 

(b) Partnership interest held by a 

corporation. 

(1) In general. 

(2) Treatment of interests held by an S 

corporation or a qualified electing fund. 

(c) Capital Interest Gains and Losses. 

(1) In general. 

(2) Capital Interest Gains and Losses 

defined. 

(3) General rules for determining Capital 

Interest Allocations. 

(i) Commensurate with capital contributed. 

(ii) In a similar manner. 

(A) Relevant factors. 

(B) Clear identification requirement. 

(iii) Reinvestment of API Gain. 

(iv) Unrelated Non-Service Partner 

requirement. 

(v) Proceeds of certain loans not taken into 

account for Capital Interest Allocation 

purposes. 

(A) General rule. 

(B) Recourse liability. 

(vi) Items that are not included in Capital 

Interest Allocations. 

(4) Capital Interest Disposition Amounts. 

(i) In general. 

(ii) Determination of the Capital Interest 

Disposition Amount. 

(5) Capital Interest Allocations made by a 

Passthrough Entity that is an API Holder. 

(6) Examples. 

(d) Partnership interest acquired by 

purchase by an unrelated person. 

(1) Acquirer not a Related Person. 

(2) Section 1061(d) not applicable. 

(3) Acquirer not a service provider. 

(e) [Reserved] 

(f) Applicability date. 

(1) General rule. 

(2) Partnership interest held by an S 

corporation. 

(3) Partnership interest held by a PFIC with 

respect to which the shareholder has a QEF 

election in effect. 

§ 1.1061–4 Section 1061 computations. 

(a) Computations. 

(1) Recharacterization Amount. 

(2) One Year Gain Amount and Three Year 

Gain Amount. 

(i) One Year Gain Amount. 

(ii) Three Year Gain Amount. 

(3) API One Year Distributive Share 

Amount and API Three Year Distributive 

Share Amount. 

(i) API One Year Distributive Share 

Amount. 

(ii) API Three Year Distributive Share 

Amount. 

(4) API One Year Disposition Amount and 

API Three Year Disposition Amount. 

(i) API One Year Disposition Amount. 

(ii) API Three Year Disposition Amount. 

(b) Special rules for calculating the One 

Year Gain Amount and the Three Year Gain 

Amount. 

(1) One Year Gain Amount equals zero or 

less. 

(2) Three Year Gain Amount equals zero or 

less. 

(3) One Year Gain Amount less than Three 

Year Gain Amount. 

(4) Installment sale gain. 

(5) Special rules for capital gain dividends 

from regulated investment companies (RICs) 

and real estate investment trusts (REITs). 

(i) API One Year Distributive Share 

Amount. 

(ii) API Three Year Distributive Share 

Amount. 

(iii) Loss on sale or exchange of stock. 

(6) Pro rata share of qualified electing fund 

(QEF) net capital gain. 

(i) One year QEF net capital gain. 

(ii) Three year QEF net capital gain 

adjustment. 

(7) Items not taken into account for 

purposes of section 1061. 

(8) Holding period determination. 

(i) Determination of holding period for 

purposes of the Three Year Gain Amount. 

(ii) Relevant holding period. 

(9) Lookthrough Rule for certain API 

dispositions. 

(i) Determination that the Lookthrough 

Rule applies. 

(A) In general. 

(B) Determination that the Lookthrough 

Rule applies to the disposition of a 

Passthrough Interest. 

(ii) Application of the Lookthrough Rule. 

(10) Section 83. 

(c) Examples. 

(1) Recharacterization rules. 

(2) Special rules examples. 

(d) Applicability date. 

§ 1.1061–5 Section 1061(d) transfers to 

related persons. 

(a) In general. 

(b) Transfer. 

(c) Section 1061(d) Recharacterization 

Amount. 

(d) Special rules. 

(e) Section 1061(d) Related Person. 

(f) Examples. 

(g) Applicability date. 

§ 1.1061–6 Reporting rules. 

(a) Owner Taxpayer filing requirements. 

(1) In general. 

(2) Failure to obtain information. 

(b) Passthrough Entity filing requirements 

and reporting. 

(1) Requirement to file information with 

the IRS and to furnish information to API 

Holder. 

(2) Requirement to request, furnish, and 

file information in tiered structures. 

(i) Requirement to request information. 

(ii) Requirement to furnish and file 

information. 

(iii) Timing of requesting and furnishing 

information. 

(A) Requesting information. 

(B) Furnishing information. 

(iv) Manner of requesting information. 

(v) Recordkeeping requirement. 

(vi) Passthrough Entity is not furnished 

information to meet its reporting obligations 

under paragraph (b)(1) of this section. 

(vii) Filing requirements. 

(viii) Penalties. 

(c) Regulated investment company (RIC) 

and real estate investment trust (REIT) 

reporting. 

(1) Section 1061 disclosures. 

(i) One Year Amounts Disclosure. 

(ii) Three Year Amounts Disclosure. 

(2) Pro rata disclosures. 

(3) Report to shareholders. 

(d) Qualified electing fund (QEF) reporting. 

(e) Applicability date. 

§ 1.1061–1 Section 1061 definitions. 

(a) Definitions. The following 

definitions apply solely for purposes of 

this section and §§ 1.1061–2 through 

1.1061–6. 

API Gains and Losses are any longterm capital gains and capital losses 

with respect to an API and include: 

(i) The API One Year Distributive 

Share Amount as defined in § 1.1061– 

4(a)(3)(i); 

(ii) The API Three Year Distributive 

Share Amount as defined in § 1.1061– 

4(a)(3)(ii); 

(iii) The API One Year Disposition 

Amount as defined in § 1.1061– 

4(a)(4)(i); 

(iv) The API Three Year Disposition 

Amount as defined in § 1.1061– 

4(a)(4)(ii); and 

(v) Capital gains or losses from the 

disposition of Distributed API Property. 

API Holder is a person who holds an 

API. 

Applicable Partnership Interest (API) 

means any interest in a partnership 

which, directly or indirectly, is 

transferred to (or is held by) an Owner 

Taxpayer or Passthrough Taxpayer in 

connection with the performance of 

substantial services by the Owner 

Taxpayer or by a Passthrough Taxpayer, 


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or by any Related Person, including 

services performed as an employee, in 

any ATB unless an exception in 

§ 1.1061–3 applies. For purposes of 

defining an API under this section and 

section 1061 of the Internal Revenue 

Code (Code), an interest in a partnership 

also includes any financial instrument 

or contract, the value of which is 

determined in whole or in part by 

reference to the partnership (including 

the amount of partnership distributions, 

the value of partnership assets, or the 

results of partnership operations). An 

Owner Taxpayer and a Passthrough 

Taxpayer can hold an API directly or 

indirectly through one or more 

Passthrough Entities. 

Applicable Trade or Business (ATB) 

means any activity for which the ATB 

Activity Test with respect to Specified 

Actions is met, and includes all 

Specified Actions taken by Related 

Persons, including combining activities 

occurring in separate partnership tiers 

or entities as one ATB. 

ATB Activity Test has the meaning 

provided in § 1.1061–2(b)(1). 

Capital account means a capital 

account maintained under § 1.704– 

1(b)(2)(iv) or similar principles. 

Capital Interest Allocations means, 

with respect to a partnership, 

allocations of long-term capital gain or 

loss made under the partnership 

agreement to an API Holder and to 

Unrelated Non-Service Partners based 

on such partners’ capital contributed 

with respect to the partnership to the 

extent such allocations otherwise meet 

the requirements of § 1.1061–3(c). With 

respect to other Passthrough Entities, 

the principles of this definition apply. 

Capital Interest Disposition Amount 

has the meaning provided in § 1.1061– 

3(c)(4). 

Capital Interest Gains and Losses has 

the meaning provided in § 1.1061– 

3(c)(2). 

Distributed API Property means 

property distributed by a Passthrough 

Entity to an API Holder with respect to 

an API if the holding period, as 

determined under sections 735 and 

1223, in the API Holder’s hands is three 

years or less at the time of disposition 

of the property by the API Holder. 

Indirect API means an API that is held 

through one or more Passthrough 

Entities. 

Investing or Developing Actions 

means actions involving either— 

(i) Investing in (or disposing of) 

Specified Assets (or identifying 

Specified Assets for such investing or 

disposition); or 

(ii) Developing Specified Assets (see 

§ 1.1061–2(b)(1)(ii)). 

Lookthrough Rule means the 

recharacterization rule described in 

§ 1.1061–4(b)(9). 

One Year Gain Amount has the 

meaning provided in § 1.1061–4(a)(2)(i). 

Owner Taxpayer means the person 

subject to Federal income tax on net 

gain with respect to an API or an 

Indirect API during the taxable year, 

including an owner of a Passthrough 

Taxpayer unless the owner of the 

Passthrough Taxpayer is a Passthrough 

Entity itself or is excepted under 

§ 1.1061–3(a), (b), or (d). 

Passthrough Entity means a 

partnership, trust, estate, S corporation 

described in § 1.1061–3(b)(2)(i), or 

passive foreign investment company 

described in § 1.1061–3(b)(2)(ii). 

Passthrough Interest means an 

interest in a Passthrough Entity that 

represents in whole or in part an API. 

Passthrough Taxpayer means a 

Passthrough Entity that is treated as a 

taxpayer for the purpose of determining 

the existence of an API. 

Raising or Returning Capital Actions 

means actions involving raising or 

returning capital but does not include 

Investing or Developing Actions. 

Recharacterization Amount has the 

meaning provided in § 1.1061–4(a)(1). 

Related Person means a person or 

entity who is treated as related to 

another person or entity under sections 

707(b) or 267(b). 

Relevant ATB means the ATB in 

which services were provided and in 

connection with which an API is held 

or was transferred. 

Section 1061(d) Recharacterization 

Amount has the meaning provided in 

§ 1.1061–5(c). 

Section 1061(d) Related Person has 

the meaning provided in § 1.1061–5(e). 

Section 1061 Regulations means the 

provisions of this section and 

§§ 1.1061–2 through 1.1061–6. 

Specified Actions means the 

combination of Raising or Returning 

Capital Actions and Investing or 

Developing Actions. 

Specified Assets means— 

(i) Securities, including interests in 

partnerships qualifying as securities (as 

defined in section 475(c)(2) without 

regard to the last sentence thereof); 

(ii) Commodities (as defined in 

section 475(e)(2)); 

(iii) Real estate held for rental or 

investment; 

(iv) Cash or cash equivalents; and 

(v) An interest in a partnership to the 

extent that the partnership holds 

Specified Assets. See § 1.1061– 

2(b)(1)(iii). 

(vi) Specified Assets include options 

or derivative contracts with respect to 

any of the items provided in paragraphs 

(i) through (v) of this definition. 

Three Year Gain Amount has the 

meaning provided in § 1.1061– 

4(a)(2)(ii). 

Unrealized API Gains and Losses 

means, with respect to a Passthrough 

Entity’s assets, all unrealized capital 

gains and losses that would be: 

(i) Realized if those assets were 

disposed of for fair market value in a 

taxable transaction on the relevant date; 

and 

(ii) Allocated to an API Holder with 

respect to its API, taking into account 

the principles of section 704(c). 

Unrelated Non-Service Partners 

means partners who do not (and did 

not) provide services in the Relevant 

ATB and who are not (and were not) 

Related Persons with respect to any API 

Holder in the partnership or any person 

who provides or has provided services 

in the Relevant ATB. 

(b) Applicability date. The provisions 

of this section apply to taxable years of 

Owner Taxpayers and Passthrough 

Entities beginning on or after January 

19, 2021. An Owner Taxpayer or 

Passthrough Entity may choose to apply 

this section to a taxable year beginning 

after December 31, 2017, provided that 

they consistently apply the Section 1061 

Regulations in their entirety to that year 

and all subsequent years. 

§ 1.1061–2 Applicable partnership 

interests and applicable trades or 

businesses. 

(a) API rules and examples—(1) 

Rules—(i) An API remains an API. Once 

a partnership interest qualifies as an 

API, the partnership interest remains an 

API unless and until the requirements of 

one of the exceptions to qualification of 

a partnership interest as an API, set 

forth in § 1.1061–3, are satisfied. 

(ii) Application of section 1061 to 

Unrealized API Gains and Losses. 

Unrealized API Gains and Losses are 

API Gains and Losses subject to section 

1061 when the gains and losses are 

realized and recognized. Unrealized API 

Gains and Losses do not lose their 

character as such until they are 

recognized. 

(iii) API Gains and Losses retain their 

character. API Gains and Losses retain 

their character as API Gains and Losses 

as they are allocated from one 

Passthrough Entity to another 

Passthrough Entity and then to the 

Owner Taxpayer. 

(iv) Substantial services by an Owner 

Taxpayer, Passthrough Taxpayer, or any 

Related Person. If an interest in a 

partnership is transferred to or held by 

an Owner Taxpayer, Passthrough 

Taxpayer, or any Related Person in 

connection with the performance of 

services, the Owner Taxpayer, the 


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Passthrough Taxpayer, or the Related 

Person is presumed to have provided 

substantial services for purposes of 

section 1061. 

(v) Grantor trusts and entities 

disregarded as separate from their 

owners. A trust wholly described in 

subpart E, part I, subchapter J, chapter 

1 of the Internal Revenue Code (that is, 

a grantor trust), a qualified subchapter S 

subsidiary described in section 

1361(b)(3), and an entity with a single 

owner that is treated as disregarded as 

an entity separate from its owner under 

any provision of the Internal Revenue 

Code or any part of 26 CFR (including 

§ 301.7701–3 of this chapter) are 

disregarded for purposes of the Section 

1061 Regulations. 

(2) Examples. The following examples 

illustrate the provisions of this 

paragraph (a). 

(i) Example 1: API. (A) A is the 

general partner of PRS, a partnership, 

and provides services to PRS. A is 

engaged in an ATB as defined in 

§ 1.1061–1(a). PRS transfers a PRS 

profits interest to A in connection with 

A’s performance of substantial services 

with respect to PRS’s ATB. A’s interest 

in PRS is an API. 

(B) After 6 years, A retires and is no 

longer engaged in an ATB and does not 

perform any services with respect to its 

ATB and with respect to PRS. However, 

A retains the API in PRS. PRS continues 

to acquire new capital assets and to 

allocate gain to A from the disposition 

of those assets. Under paragraph (a)(1)(i) 

of this section, A’s interest in PRS 

remains an API after A retires. 

(ii) Example 2: Contribution of an API 

to a partnership. Individuals A, B, and 

C each directly hold APIs in PRS, a 

partnership. A and B form a new 

partnership, GP, and contribute their 

APIs in PRS to GP. Following the 

contribution, each of A and B holds an 

Indirect API because each of A and B 

now indirectly holds an API in PRS 

through GP, a Passthrough Entity. Each 

of A’s and B’s interests in GP is a 

Passthrough Interest because each of A’s 

and B’s interest in GP represents an 

Indirect API. 

(iii) Example 3: Passthrough Interest, 

Indirect API, Passthrough Taxpayer. 

Each of A, B, and C provides services to, 

and is an equal partner in, GP. GP is 

engaged in an ATB as defined in 

§ 1.1061–1(a), is the general partner of 

PRS, and provides substantial 

management services to PRS. In 

connection with GP’s performance of 

substantial services in an ATB, PRS 

issues a profits interest to GP. Because 

GP’s PRS interest was received in 

connection with GP’s providing services 

in an ATB, GP is a Passthrough 

Taxpayer and GP’s interest in PRS is an 

API. Because A, B, and C are partners 

in GP, they each hold a Passthrough 

Interest in GP and an Indirect API in 

PRS. Each of A, B, and C is treated as 

an Owner Taxpayer because each is a 

partner in GP and because each holds an 

Indirect API in PRS in connection with 

the performance of its services to GP’s 

ATB. 

(iv) Example 4: S corporation, 

Passthrough Interest, Indirect API, and 

Passthrough Taxpayer. A owns all of the 

stock of S Corp, an S corporation. S 

Corp is engaged in an ATB, as defined 

in § 1.1061–1(a). S Corp is the general 

partner of PRS, a partnership, and 

provides substantial management 

services to PRS. A provides substantial 

services in S Corp’s ATB. In connection 

with S Corp providing substantial 

services to PRS, PRS issues a profits 

interest to S Corp. S Corp’s interest in 

PRS is its only asset. Because S Corp’s 

profits interest in PRS was issued to S 

Corp in connection with substantial 

services in an ATB, S Corp is a 

Passthrough Taxpayer and its interest in 

PRS is an API. Because A is a 

shareholder in S Corp, A holds a 

Passthrough Interest in S Corp and an 

Indirect API in PRS as a result of S 

Corp’s API in PRS. A is treated as an 

Owner Taxpayer because A holds an 

interest in S Corp, a Passthrough 

Taxpayer, and also indirectly holds an 

API in PRS in connection with A’s 

services in S Corp’s ATB. 

(v) Example 5: Indirect API, Related 

Person, and Passthrough Taxpayer. 

Each of A, B, and C is an equal partner 

in partnership GP, the general partner of 

PRS. GP’s Specified Actions do not 

satisfy the ATB Activity Test under 

§ 1.1061–1(a) and as a result, GP’s 

actions do not establish an ATB. 

Management Company is a Related 

Person with respect to GP within the 

meaning of sections 267(b) and 707(b), 

is engaged in an ATB, and provides 

substantial management services to PRS 

that are sufficient to satisfy the ATB 

Activity Test. Management Company’s 

actions are attributed to GP under 

paragraphs (a)(1)(iv) and (b)(1)(i)(C) of 

this section because Management 

Company is a Related Person to GP. In 

connection with Management 

Company’s services to PRS, PRS issues 

a profits interest to GP. Because its PRS 

profits interest is issued to GP in 

connection with services provided by 

Management Company, a Related 

Person, GP is a Passthrough Taxpayer 

and its interest in PRS is an API. Unless 

an exception described in § 1.1061–3 

applies, because A, B, and C are 

partners in GP, they each hold a 

Passthrough Interest in GP and an 

Indirect API in PRS. A, B, and C are 

treated as Owner Taxpayers because 

they hold an interest in GP, a 

Passthrough Taxpayer. 

(b) Application of the ATB Activity 

Test—(1) In general. The ATB Activity 

Test is satisfied if both Raising and 

Returning Actions and Investing or 

Developing Actions are conducted by an 

Owner Taxpayer, Passthrough Taxpayer, 

or one or more Related Persons with 

respect to an Owner Taxpayer or 

Passthrough Taxpayer, and the total 

level of activity, including the combined 

activities of all Related Persons, satisfies 

the level of activity that would be 

required to establish a trade or business 

under section 162. 

(i) Rules for applying the ATB Activity 

Test—(A) Aggregate Specified Actions 

taken into account. The determination 

of whether the ATB Activity Test is 

satisfied is based on the combined 

activities conducted that qualify as 

either Raising or Returning Capital 

Actions and Investing or Developing 

Actions. The fact that either Raising or 

Returning Capital Actions or Investing 

or Developing Actions are only 

infrequently taken does not preclude the 

test from being satisfied if the combined 

Specified Actions meet the test. 

(B) Raising or Returning Capital 

Actions and Investing or Developing 

Actions are not both required to be 

taken in each taxable year. Raising or 

Returning Capital Actions and Investing 

or Developing Actions are not both 

required to be taken in each taxable year 

in order to satisfy the ATB Activity Test. 

For example, the ATB Activity Test will 

be satisfied if Investing or Developing 

Actions are not taken in the current 

taxable year, but sufficient Raising or 

Returning Capital Actions are taken in 

anticipation of future Investing or 

Developing Actions. Additionally, the 

ATB Activity Test will be satisfied if no 

Raising or Returning Capital Actions are 

taken in the current taxable year, but 

have been taken in a prior taxable year 

(regardless of whether the ATB Activity 

Test was met in the prior year), and 

sufficient Investing or Developing 

Actions are undertaken by the taxpayer 

in the current taxable year. 

(C) Combined conduct by multiple 

related entities taken into account—(1) 

Related Entities. If a Related Person(s) 

(within the meaning of § 1.1061–1(a)) 

solely or primarily performs Raising or 

Returning Capital Actions and one or 

more other Related Person(s) solely or 

primarily performs Investing or 

Developing Actions, the combination of 

the activities performed by these 

Related Persons will be taken into 

account in determining whether the 

ATB Activity Test is satisfied. 


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(2) Actions taken by an agent or 

delegate. Specified Actions taken by an 

agent or a delegate in its capacity as an 

agent or a delegate of a principal will be 

taken into account by the principal in 

determining whether the ATB Activity 

Test is satisfied with respect to the 

principal. These Specified Actions are 

also taken into account in determining 

whether the ATB Activity test is 

satisfied with respect to the agent or the 

delegate. 

(ii) Developing Specified Assets. 

Developing Specified Assets takes place 

if it is represented to investors, lenders, 

regulators, or other interested parties 

that the value, price, or yield of a 

portfolio business may be enhanced or 

increased in connection with choices or 

actions of a service provider. Merely 

exercising voting rights with respect to 

shares owned or similar activities do not 

amount to developing Specified Assets. 

(iii) Partnerships. Investing or 

Developing Actions directly conducted 

with respect to Specified Assets held by 

a partnership are counted towards the 

ATB Activity Test. Additionally, a 

portion of the Investing or Developing 

Actions conducted with respect to the 

interests in a partnership that holds 

Specified Assets is counted towards the 

ATB Activity Test. This portion is the 

value of the partnership’s Specified 

Assets over the value of all of the 

partnership’s assets. Actions taken to 

manage a partnership’s working capital 

will not be taken into account in 

determining the portion of Investing or 

Developing Actions conducted with 

respect to the interests in the 

partnership. 

(2) Examples. The following examples 

illustrate the application of the ATB 

Activity Test described in paragraph 

(b)(1) of this section. 

(i) Example 1: Combined activities of 

Raising or Returning Capital Actions 

and Investing or Developing Actions. 

During the taxable year, B takes a small 

number of actions to raise capital for 

new investments. B takes numerous 

actions to develop Specified Assets. B’s 

actions with respect to raising capital 

and B’s actions with respect to 

developing Specified Assets are 

combined for the purpose of 

determining whether the ATB Activity 

Test is satisfied. These actions 

cumulatively rise to the level required 

to establish a trade or business under 

section 162. Thus, B satisfies the ATB 

Activity Test. 

(ii) Example 2: Combining Specified 

Actions in multiple entities. GP, a 

partnership, conducts Raising or 

Returning Capital Actions. Management 

Company, a partnership that is a Related 

Person to GP, conducts Investing or 

Developing Actions. When GP’s and 

Management Company’s activities are 

combined, the ATB Activity Test is 

satisfied. Accordingly, both GP and 

Management Company are engaged in 

an ATB, and services performed by 

either GP or Management Company are 

performed in an ATB under paragraph 

(b)(1) of this section. 

(iii) Example 3: Investing or 

Developing Actions taken after Raising 

or Returning Capital Actions that do not 

meet the ATB Activity Test. In year 1, 

PRS engaged in Raising or Returning 

Capital Actions to fund PRS’s 

investment in Specified Assets. 

However, PRS’ Specified Actions during 

year 1 did not satisfy the ATB Activity 

Test because they did not satisfy the 

level of activity required to establish a 

trade or business under section 162. 

Therefore, PRS was not engaged in an 

ATB in year 1. In year 2, PRS engaged 

in significant Investing or Developing 

Actions but did not engage in any 

Raising or Returning Capital Actions. In 

year 2, PRS’s Investing or Developing 

Actions rise to the level required to 

establish a trade or business under 

section 162. Because PRS has 

cumulatively engaged in both Investing 

or Developing Actions and Raising or 

Returning Capital Actions and because 

the Specified Actions rise to the level of 

activity required to establish a trade or 

business under section 162, PRS is 

engaged in an ATB in year 2. 

(iv) Example 4: Raising or Returning 

Capital Actions taken in anticipation of 

Investing or Developing Actions. In year 

1, A only conducted Raising or 

Returning Capital Actions. A’s Raising 

or Returning Capital Actions were 

undertaken to raise capital to invest in 

Specified Assets with the goal of 

increasing their value through Investing 

or Developing Actions and rise to the 

level of activity required to establish a 

trade or business under section 162. A 

did not take Investing or Developing 

Actions during the taxable year. A’s 

Raising or Returning Capital Actions 

satisfy the ATB Activity Test because 

they were undertaken in anticipation of 

also engaging in Investing or Developing 

Actions. Therefore, the ATB Activity 

Test is satisfied, and A is engaged in an 

ATB in year 1. 

(v) Example 5: Attribution of 

delegate’s actions. GP is the general 

partner of PRS. GP is responsible for 

providing management services to PRS. 

GP contracts with Management 

Company to provide management 

services on GP’s behalf to PRS. GP and 

Management Company are not Related 

Persons. The Specified Actions taken by 

Management Company on behalf of GP 

are attributed to GP for purposes of the 

ATB Activity Test because the 

Management Company is operating as a 

delegate of GP. Additionally, those 

Specified Actions are taken into account 

by Management Company for purposes 

of the ATB Activity Test and whether it 

is engaged in an ATB. 

(vi) Example 6: ATB Activity Test not 

satisfied. A is the manager of a hardware 

store. Partnership owns the hardware 

store, including the building in which 

the hardware business is conducted. In 

connection with A’s services as the 

manager of the hardware store, a profits 

interest in Partnership is transferred to 

A. Partnership’s business involves 

buying hardware from wholesale 

suppliers and selling it to customers. 

The hardware is not a Specified Asset. 

Although real estate is a Specified Asset 

if it is held for rental or investment 

purposes, Partnership holds the 

building for the purpose of conducting 

its hardware business and not for rental 

or investment purposes. Therefore, the 

building is not a Specified Asset as to 

Partnership. Partnership also maintains 

and manages a certain amount of 

working capital for its business, but 

actions with respect to working capital 

are not taken into account for the 

purpose of determining whether the 

ATB Activity Test is met. Partnership is 

not a Related Person with respect to any 

person who takes Specified Actions. 

Partnership is not engaged in an ATB 

because the ATB Activity Test is not 

satisfied. Although Partnership raises 

capital, its Raising or Returning Capital 

Actions alone do not satisfy the ATB 

Activity Test. Further, Partnership takes 

no Investing or Developing Actions 

because it holds no Specified Assets 

other than working capital. Partnership 

is not in an ATB and the profits interest 

transferred to A is not an API. 

(c) Applicability date. The provisions 

of this section apply to taxable years of 

Owner Taxpayers and Passthrough 

Entities beginning on or after January 

19, 2021. An Owner Taxpayer or 

Passthrough Entity may choose to apply 

this section to a taxable year beginning 

after December 31, 2017, provided that 

they apply the Section 1061 Regulations 

in their entirety to that year and all 

subsequent years. 

§ 1.1061–3 Exceptions to the definition of 

an API. 

(a) A partnership interest held by an 

employee of another entity not 

conducting an ATB. An API does not 

include any interest transferred to a 

person in connection with the 

performance of substantial services by 

that person as an employee of another 

entity that is conducting a trade or 

business (other than an ATB) and the 


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person provides services only to such 

other entity. 

(b) Partnership interest held by a 

corporation—(1) In general. An API 

does not include any interest directly or 

indirectly held by a corporation. 

(2) Treatment of interests held by an 

S corporation or a qualified electing 

fund. For purposes of this section, a 

corporation does not include an entity 

for which an election was made to treat 

the entity as a Passthrough Entity. Thus, 

the following entities are not treated as 

corporations for purposes of section 

1061— 

(i) An S corporation for which an 

election under section 1362(a) is in 

effect; and 

(ii) A passive foreign investment 

company (PFIC) with respect to which 

the shareholder has a qualified electing 

fund (QEF) election under section 1295 

in effect. 

(c) Capital Interest Gains and 

Losses—(1) In general. Capital Interest 

Gains and Losses are not subject to 

section 1061 and, therefore, are not 

included in calculating an Owner 

Taxpayer’s Recharacterization Amount. 

(2) Capital Interest Gains and Losses 

defined. For purposes of paragraph 

(c)(1) of this section, Capital Interest 

Gains and Losses are Capital Interest 

Allocations that meet the requirements 

of paragraph (c)(3) of this section and 

Capital Interest Disposition Amounts 

that meet the requirements of paragraph 

(c)(4) of this section. 

(3) General rules for determining 

Capital Interest Allocations—(i) 

Commensurate with capital contributed. 

An allocation will be considered a 

Capital Interest Allocation if the 

allocation to the API Holder with 

respect to its capital interest is 

determined and calculated in a similar 

manner as the allocations with respect 

to capital interests held by similarly 

situated Unrelated Non-Service Partners 

who have made significant aggregate 

capital contributions as described in 

paragraph (c)(3)(iv) of this section. For 

purposes of this paragraph (c)(3), a 

capital interest is an interest that would 

give the holder a share of the proceeds 

if the partnership’s assets were sold at 

fair market value at the time the interest 

was received and the proceeds were 

then distributed in a complete 

liquidation of the partnership. 

(ii) In a similar manner. For purposes 

of paragraph (c)(3)(i) of this section, a 

Capital Interest Allocation to an API 

Holder will be treated as made in a 

similar manner if allocations and 

distribution rights with respect to the 

capital contributed by an API Holder to 

which the API Holder’s Capital Interest 

Allocation relates are reasonably 

consistent with allocation and 

distribution rights with respect to 

capital contributed by Unrelated NonService Partners where the Unrelated 

Non-Service Partner requirement is met. 

For purposes of this paragraph (c)(3)(ii), 

allocation and distribution rights for an 

API Holder that are limited to a 

particular class of partnership capital 

interests or that are determined with 

respect to capital contributions invested 

in a particular partnership investment 

will be considered as made in a similar 

manner to allocations and distribution 

rights of Unrelated Non-Service Partners 

where the Unrelated Non-Service 

Partner requirement is met for the 

applicable interest class or partnership 

investment. 

(A) Relevant factors. For purposes of 

this paragraph (c)(3)(ii), the following 

factors are not exclusive, but are 

relevant factors in determining whether 

allocation and distribution rights with 

respect to capital contributed by an API 

Holder are reasonably consistent with 

allocation and distribution rights of 

persons meeting the Unrelated NonService Partner requirement: The 

amount and timing of capital 

contributed, the rate of return on capital 

contributed, the terms, priority, type 

and level of risk associated with capital 

contributed, and the rights to cash or 

property distributions during the 

partnership’s operations and on 

liquidation. Accordingly, an allocation 

to an API Holder will not fail to qualify 

solely because the allocation is 

subordinated to allocations made to 

Unrelated Non-Service Partners, 

because an allocation to an API Holder 

is not reduced by the cost of services 

provided by the API Holder or a Related 

Person to the partnership, where the 

cost of services provided includes 

management fees or API allocations, or 

because an API Holder has a right to 

receive tax distributions while 

Unrelated Non-Service Partners do not, 

where such distributions are treated as 

advances against future distributions. 

(B) Clear identification requirement. 

For purposes of this paragraph (c)(3)(ii), 

allocations will be considered made in 

a similar manner only if the allocations 

to the API Holder and the Unrelated 

Non-Service Partners are allocations 

with respect to, and corresponding to, 

such partners’ contributed capital that 

are separate and apart from allocations 

made to the API Holder with respect to 

its API and where both the partnership 

agreement and the partnership’s 

contemporaneous books and records 

clearly demonstrate that the 

requirements of paragraph (c)(3) of this 

section have been met. 

(iii) Reinvestment of API Gain. If an 

API Holder is allocated API Gain by a 

Passthrough Entity, to the extent that an 

amount equal to the API Gain is 

reinvested in the Passthrough Entity by 

the API Holder (either as the result of an 

actual distribution and recontribution of 

the API Gain amount or the retention of 

the API Gain amount by the Passthrough 

Entity), the amount will be treated as a 

contribution to the Passthrough Entity 

for a capital interest that may produce 

Capital Interest Allocations for the API 

Holder, provided such allocations meet 

the requirements of this paragraph 

(c)(3). 

(iv) Unrelated Non-Service Partner 

requirement. For purposes of paragraph 

(c)(3) of this section, the Unrelated NonService Partner requirement means that 

Unrelated Non-Service Partners must 

have made significant aggregate capital 

contributions in relation to total capital 

contributions of all partners. Unrelated 

Non-Service Partners will be treated as 

having made significant aggregate 

capital contributions provided such 

partners possess five percent or more of 

the aggregate capital contributed to the 

partnership at the time the allocations 

are made. With respect to an API Holder 

with allocation and distribution rights 

that are attributable to a particular 

interest class or partnership investment, 

the Unrelated Non-Service requirement 

must be met with respect to that 

particular interest class or partnership 

investment. 

(v) Proceeds of certain loans not taken 

into account for Capital Interest 

Allocation purposes—(A) General rule. 

For purposes of the Section 1061 

Regulations, an allocation is not a 

Capital Interest Allocation to the extent 

the allocation is attributable to the 

contribution of an amount of capital to 

a partnership that, directly or indirectly, 

results from, or is attributable to, any 

loan or other advance made or 

guaranteed, directly or indirectly, by the 

partnership, a partner in the 

partnership, or any Related Person with 

respect to such persons, except to the 

extent a loan or advance is described in 

paragraph (c)(3)(v)(B) of this section. 

However, the repayments on a loan 

described in the preceding sentence are 

taken into account as capital 

contributed (and may therefore generate 

Capital Interest Allocations) as those 

amounts are paid by the partner, 

provided that the loan is not repaid with 

the proceeds of another loan described 

in the preceding sentence. 

(B) Recourse liability. Paragraph 

(c)(3)(v)(A) of this section does not 

apply with respect to an allocation 

attributable to a contribution made by 

an individual service provider that, 


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directly or indirectly, results from, or is 

attributable to, a loan or advance from 

another partner in the partnership (or 

any Related Person with respect to such 

lending or advancing partner, other than 

the partnership) to such individual 

service provider if the individual 

service provider is personally liable for 

the repayment of such loan or advance. 

A contribution made by an individual 

service provider includes a contribution 

made by an entity that is wholly owned 

by, and disregarded as separate from, 

the individual service provider as 

described in § 1.1061–2(a)(1)(v), 

including a contribution attributable to 

a loan or advance made to the 

disregarded entity by another partner in 

the partnership (or any Related Person 

with respect to such lending or 

advancing partner, other that the 

partnership) if the individual service 

provider is personally liable for the 

repayment of any and all borrowed 

amounts that are not repaid by the 

disregarded entity. For purposes of this 

paragraph (c)(3)(v)(B), an individual 

service provider is personally liable for 

the repayment of a loan or advance 

made by a partner (or any Related 

Person, other than the partnership) if— 

(1) The loan or advance is fully 

recourse to the individual service 

provider; 

(2) The individual service provider 

has no right to reimbursement from any 

other person; and 

(3) The loan or advance is not 

guaranteed by any other person. 

(vi) Items that are not included in 

Capital Interest Allocations. Capital 

Interest Allocations do not include— 

(A) Amounts that are treated as API 

Gains and Losses and Unrealized API 

Gains and Losses; or 

(B) Items that are not taken into 

account for purposes of section 1061 

under § 1.1061–4(b)(7). 

(4) Capital Interest Disposition 

Amounts—(i) In general. The term 

Capital Interest Disposition Amount 

means the amount of long-term capital 

gain or loss recognized on the sale or 

disposition of all or a portion of a 

Passthrough Interest that is treated as 

Capital Interest Gain or Loss. In general, 

long-term capital gain or loss recognized 

on the sale or disposition of a 

Passthrough Interest is deemed to be 

API Gain or Loss unless it is determined 

under paragraph (c)(4)(ii) of this section 

to be a Capital Interest Disposition 

Amount. 

(ii) Determination of the Capital 

Interest Disposition Amount. If a 

Passthrough Interest that includes a 

right to allocations of Capital Interest 

Gains and Losses is disposed of, the 

amount of long-term capital gain or loss 

that is treated as a Capital Interest 

Disposition Amount is determined 

under the rules provided in this 

paragraph (c)(4)(ii). 

(A) First, determine the amount of 

long-term capital gain or loss that would 

be allocated to the Passthrough Interest 

(or the portion of the Passthrough 

Interest sold) if all the assets of the 

Passthrough Entity (including gain or 

loss with respect to assets described in 

§ 1.1061–4(b)(7)) were sold for their fair 

market value in a fully taxable 

transaction immediately before the 

disposition of the Passthrough Interest 

(hypothetical asset sale). For purposes 

of this paragraph (c)(4)(ii), the assets of 

the Passthrough Entity include any 

assets held by a lower-tier Passthrough 

Entity in which the Passthrough Entity 

has a direct or indirect interest. 

(B) Second, determine the amount 

from the hypothetical asset sale that 

would be allocated to the Passthrough 

Interest (or the portion of the 

Passthrough Interest sold) as Capital 

Interest Allocations under paragraph 

(c)(3) of this section. 

(C) Third, if the transferor recognized 

long-term capital gain upon disposition 

of the Passthrough Interest and only net 

short-term capital losses, net long-term 

capital losses, or both, are allocated to 

the Passthrough Interest under 

paragraph (c)(4)(ii)(B) of this section 

from the hypothetical asset sale, all of 

the long-term capital gain is API Gain. 

If the transferor recognized long-term 

capital loss on the disposition of the 

Passthrough Interest and only net shortterm capital gains, net long-term capital 

gains, or both, are allocated to the 

Passthrough Interest under paragraph 

(c)(4)(ii)(B) of this section, then all the 

long-term capital loss is API Loss. 

(D) If paragraph (c)(4)(ii)(C) of this 

section does not apply and long-term 

capital gain is recognized on the 

disposition of the Passthrough Interest, 

the amount of long-term capital gain 

that the transferor of the Passthrough 

Interest recognizes that is treated as a 

Capital Interest Disposition Amount is 

determined by multiplying long-term 

capital gain recognized on the 

disposition of the Passthrough Interest 

by a fraction, the numerator of which is 

the amount of long-term capital gain 

determined under paragraph (c)(4)(ii)(B) 

of this section, and the denominator of 

which is the amount of long-term 

capital gain determined under 

paragraph (c)(4)(ii)(A) of this section, 

with the percentage represented by the 

fraction limited to 100 percent. 

Alternatively, if paragraph (c)(4)(ii)(C) of 

this section does not apply and longterm capital loss is recognized on the 

disposition of the Passthrough Interest, 

the amount of long-term capital loss 

treated as a Capital Interest Disposition 

Amount is determined by multiplying 

the transferor’s capital loss by a fraction, 

the numerator of which is the amount 

of long-term capital loss determined 

under paragraph (c)(4)(ii)(B) of this 

section, and the denominator of which 

is the amount of long-term capital loss 

determined under paragraph (c)(4)(ii)(A) 

of this section, with the percentage 

represented by the fraction limited to 

100 percent. 

(E) In applying this paragraph 

(c)(4)(ii), allocations of amounts that are 

not included in determining the amount 

of long-term capital gain or loss 

recognized on the sale or disposition of 

the Passthrough Interest are not 

included. See, for example, section 

751(a). 

(5) Capital Interest Allocations made 

by a Passthrough Entity that is an API 

Holder. An allocation made to a 

Passthrough Entity that holds an API in 

a lower-tier Passthrough Entity will be 

considered a Capital Interest Allocation 

if it meets the principles set forth in 

paragraphs (c)(3) and (4) of this section 

(other than paragraph (c)(3)(iv) of this 

section). For purposes of applying the 

Capital Interest Allocation rules in this 

paragraph (c)(5) to a tiered partnership 

structure, to the extent that a Capital 

Interest Allocation that is made by a 

lower-tier partnership to an upper-tier 

partnership is properly allocated to the 

upper-tier partnership’s partners with 

respect to their capital interests in the 

upper-tier partnership in a manner that 

is respected under 704(b) (taking into 

account the principles of section 

704(c)), such allocation is a Capital 

Interest Allocation. 

(6) Examples. The rules of this 

paragraph (c) are illustrated by the 

following examples. 

(i) Example 1: Capital Interest 

Allocations—(A) Facts. Each of A, B, 

and C contributes $100 to GP and is an 

equal partner in GP, a partnership that 

is the general partner of PRS, a 

partnership. The contributions are not 

attributable to loans or advances 

described in paragraph (c)(3)(v)(A) of 

this section. PRS’s other partners are 

Unrelated Non-Service Partners. Each of 

GP and PRS makes allocations to its 

partners in accordance with its partners’ 

interests in that partnership, as 

described in § 1.704–1(b)(3). GP holds a 

20% profits interest in PRS that is an 

API that GP received in exchange for 

providing substantial services to PRS in 

an ATB. GP’s API is an Indirect API to 

each of A, B, and C. GP contributes the 

$300 of capital contributed by A, B and 

C to PRS. GP’s $300 contribution equals 

2% of the contributed capital made by 


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all of PRS’s partners ($15,000). PRS’s 

partnership agreement describes its 

partners’ economic distribution rights 

with respect to its liquidating proceeds 

as follows: First, liquidating proceeds 

are proportionately distributed to each 

of GP and the Unrelated Non-Service 

Partners equal to the amount necessary 

to return each of those partners’ 

unreturned capital; second, liquidating 

proceeds are distributed to GP with 

respect to its API in PRS; and, finally, 

any residual liquidating proceeds are 

distributed, proportionately, 98% to the 

Unrelated Non-Service Partners and 2% 

to GP. During its initial taxable year, 

PRS has $10,000 of net capital gain, 

causing an increase in PRS’s 

distributable proceeds of $10,000. In 

accordance with the partners’ economic 

rights as described in PRS’s partnership 

agreement, PRS allocates $2,160 of net 

capital gain to GP (a $2,000 API 

allocation plus $160 ($8,000 

($10,000¥$2,000) × 2%), with respect 

to GP’s contributed capital) and $7,840 

of net capital gain to the Unrelated NonService Partners with respect to their 

contributed capital. GP allocates $720 

($2,160/3) of this net capital gain to 

each of A, B, and C in accordance with 

their interests in GP. 

(B) PRS’s Capital Interest Allocation 

Analysis. Because PRS’s partnership 

agreement provides for no differences as 

to the amount and timing of capital 

contributed, the rate of return on capital 

contributed, the type and level of risk 

associated with capital contributed, or 

the rights to cash or property 

distributions during the PRS’s 

operations and on liquidation, the 

allocations and distribution rights with 

respect the capital contributed by GP are 

reasonably consistent with the 

allocation and distribution rights with 

respect to capital contributed by 

Unrelated Non-Service Partners. 

Accordingly, GP’s allocation of $160 is 

a Capital Interest Allocation that is 

treated as made in a similar manner as 

the allocations made to the Unrelated 

Non-Service Partners. 

(C) GP Capital Interest Allocation 

Analysis. GP is allocated $2,160 from 

PRS, consisting of a $2,000 API 

allocation and a $160 Capital Interest 

Allocation. The $160 Capital Interest 

Allocation is allocated equally to A, B, 

and C based on their capital 

contributions to GP. Therefore, they 

qualify as Capital Interest Allocations by 

GP. See paragraph (c)(5) of this section. 

The $2,000 of gain allocated by PRS’s to 

GP with respect to GP’s API cannot be 

treated as a Capital Interest Allocation 

by GP and therefore is subject to section 

1061. In summary, A, B, and C are each 

allocated $720 of capital gain from PRS 

($2,160/3). Of this amount, $667 is API 

Gain ($2,000/3) and $53 is a Capital 

Interest Allocation ($160/3). 

(ii) Example 2: Sale of a Passthrough 

Interest—(A) Facts. In Year 1, A, B, and 

C form GP, a partnership. Each of A, B, 

and C contributes $100 to GP and is an 

equal partner in GP. The contributions 

are not attributable to loans or advances 

described in paragraph (c)(3)(v)(A) of 

this section. GP invests the $300 in 

Asset X in Year 1. GP is also the general 

partner of PRS, a partnership. PRS’s 

other partners are Unrelated NonService Partners. GP holds a 20% profits 

interest in PRS that is an API that GP 

received in exchange for providing 

substantial services to PRS in an ATB. 

GP’s API is an Indirect API to each of 

A, B, and C. Each of GP and PRS makes 

allocations to its partners in accordance 

with its partners’ interests in that 

partnership, as described in § 1.704– 

1(b)(3). In Year 3, A sells A’s interest in 

GP to an unrelated third party for $800 

and recognizes $700 of capital gain on 

the sale. If PRS had sold its assets in a 

hypothetical asset sale as required by 

paragraph (c)(4)(ii)(A) of this section 

and liquidated immediately before A 

sold its interest in GP, GP would have 

been allocated $1,800 of long-term 

capital gain with respect to GP’s API in 

PRS, and GP would have allocated $600 

of this $1,800 to A. If GP sold Asset X 

for its fair market value and liquidated 

immediately before A sold its interest in 

GP, A would have been allocated $100 

of long-term capital gain. 

(B) Analysis. GP does not have a 

capital interest in PRS. Therefore, its 

allocations from PRS are allocations 

with respect to its API which are subject 

to section 1061. The total gain allocable 

to A as a result of the hypothetical 

liquidations would be $700. Under 

paragraph (c)(4)(ii)(D) of this section, 

$100 of the $700 of A’s interest sale gain 

is A’s Capital Interest Disposition 

Amount, and is not subject to section 

1061. 

(iii) Example 3: Reinvestment of 

Realized API Gain. A, B, and C are 

partners in PRS, a partnership. At the 

beginning of Year 1, A is issued an API 

in PRS in exchange for providing 

substantial services to PRS in an ATB. 

A has no capital interest in PRS. During 

Year 1, PRS’s assets appreciate by $100. 

At the end of Year 1, under the terms 

of its partnership agreement, if PRS 

were to sell all of its assets at their fair 

market value and distribute the 

proceeds in a complete liquidation, A 

would receive $20 with respect to its 

API. Thus, at the end of Year 1, A has 

$20 of Unrealized API Gain. In Year 2, 

PRS sells Asset X, an asset that PRS 

owned in Year 1, and allocates $8 of the 

long-term capital gain to A as API Gain. 

As a result, $8 of A’s $20 of Unrealized 

API Gain becomes API Gain that is 

subject to section 1061. A reinvests A’s 

share of the proceeds from the Asset X 

sale in PRS. As a result, under 

paragraph (c)(3)(iii) of this section, A 

has an $8 capital interest in PRS and, 

provided the requirements of paragraph 

(c)(3) of this section are met, A may 

receive future Capital Interest 

Allocations with respect to the capital 

interest. 

(d) Partnership interest acquired by 

purchase by an unrelated person. If a 

person (acquirer) acquires an interest in 

a partnership (target partnership) by 

taxable purchase for fair market value 

that, but for the exception set forth in 

this paragraph (d), would be an API, the 

transferor of the interest will be treated 

as selling an API but the acquirer will 

not be treated as acquiring an API if— 

(1) Acquirer not a Related Person. 

Immediately before the purchase, the 

acquirer is not a Related Person with 

respect to— 

(i) Any person who provides services 

in the Relevant ATB; or 

(ii) Any service providers who 

provide services to, or for the benefit of, 

the target partnership or a lower-tier 

partnership in which the target 

partnership holds an interest, directly or 

indirectly. 

(2) Section 1061(d) not applicable. 

Section 1061(d) does not apply to the 

transaction (as provided in § 1.1061–5). 

(3) Acquirer not a service provider. At 

the time of the purchase, the acquirer 

has not provided, does not provide, and 

does not anticipate providing, services 

in the future, to, or for the benefit of, the 

target partnership, directly or indirectly, 

or any lower-tier partnership in which 

the target partnership directly or 

indirectly holds an interest. 

(e) [Reserved] 

(f) Applicability date—(1) General 

rule. Except as provided in paragraphs 

(f)(2) and (3) of this section, the 

provisions of this section apply to 

taxable years of Owner Taxpayers and 

Passthrough Entities beginning on or 

after January 19, 2021. An Owner 

Taxpayer or Passthrough Entity may 

choose to apply this section to a taxable 

year beginning after December 31, 2017, 

provided that they apply the Section 

1061 Regulations in their entirety to that 

year and all subsequent years. 

(2) Partnership interest held by an S 

corporation. Paragraph (b)(2)(i) of this 

section, which provides that the 

exception under section 1061(c)(1) to 

the definition of an API does not apply 

to a partnership interest held by an S 

corporation with an election under 

section 1362(a) in effect, applies to 


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taxable years beginning after December 

31, 2017. 

(3) Partnership interest held by a PFIC 

with respect to which the shareholder 

has a QEF election in effect. Paragraph 

(b)(2)(ii) of this section, which provides 

that the exception under section 

1061(c)(1) to the definition of an API 

does not apply to a partnership interest 

held by a PFIC with respect to which 

the shareholder has a QEF election in 

effect under section 1295, applies to 

taxable years of an Owner Taxpayer and 

Passthrough Entity beginning after 

August 14, 2020. 

§ 1.1061–4 Section 1061 computations. 

(a) Computations—(1) 

Recharacterization Amount. The 

Recharacterization Amount is the 

amount that an Owner Taxpayer must 

treat as short-term capital gain under 

section 1061(a). The Recharacterization 

Amount equals— 

(i) The Owner Taxpayer’s One Year 

Gain Amount; less 

(ii) The Owner Taxpayer’s Three Year 

Gain Amount. 

(2) One Year Gain Amount and Three 

Year Gain Amount—(i) One Year Gain 

Amount. The Owner Taxpayer’s One 

Year Gain Amount is the sum of— 

(A) The Owner Taxpayer’s combined 

net API One Year Distributive Share 

Amount from all APIs held during the 

taxable year; and 

(B) The Owner Taxpayer’s API One 

Year Disposition Amount. 

(ii) Three Year Gain Amount. The 

Owner Taxpayer’s Three Year Gain 

Amount is the sum of— 

(A) The Owner Taxpayer’s combined 

net API Three Year Distributive Share 

Amount from all APIs held during the 

taxable year; and 

(B) The Owner Taxpayer’s API Three 

Year Disposition Amount. 

(3) API One Year Distributive Share 

Amount and API Three Year 

Distributive Share Amount—(i) API One 

Year Distributive Share Amount. The 

API One Year Distributive Share 

Amount equals— 

(A) The API Holder’s distributive 

share of net long-term capital gain or 

loss from the partnership for the taxable 

year (including capital gain or loss on 

the disposition of Distributed API 

Property by an API Holder that is a 

Passthrough Entity or the disposition of 

all or a part of an API by an API Holder 

that is a Passthrough Entity), with 

respect to the partnership interest held 

by the API Holder calculated without 

the application of section 1061; less 

(B) To the extent included in the 

amount determined under paragraph 

(a)(3)(i)(A) of this section, the aggregate 

of— 

(1) Amounts that are not taken into 

account for purposes of section 1061 

under paragraph (b)(7) of this section; 

and 

(2) Capital Interest Gains and Losses 

as determined under § 1.1061–3(c)(2). 

(ii) API Three Year Distributive Share 

Amount. The API Three Year 

Distributive Share Amount equals the 

API One Year Distributive Share 

Amount, less— 

(A) Items included in the API One 

Year Distributive Share Amount that 

would not be treated as a long-term gain 

or loss if three years is substituted for 

one year in paragraphs (3) and (4) of 

section 1222; and 

(B) Any adjustments resulting from 

the application of the Lookthrough Rule 

under paragraph (b)(9)(ii) of this section 

when an API is disposed of by an API 

Holder that is a Passthrough Entity. 

(4) API One Year Disposition Amount 

and API Three Year Disposition 

Amount—(i) API One Year Disposition 

Amount. The API One Year Disposition 

Amount is the combined net amount 

of— 

(A) Long-term capital gains and losses 

recognized during the taxable year by an 

Owner Taxpayer, including long-term 

capital gain computed under the 

installment method that is taken into 

account for the taxable year, on the 

disposition of all or a portion of an API 

that has been held for more than one 

year, including a disposition to which 

the Lookthrough Rule applies; 

(B) Long-term capital gain and loss 

recognized by an Owner Taxpayer due 

to a distribution with respect to an API 

during the taxable year that is treated 

under section 731(a) as gain or loss from 

the sale or exchange of a partnership 

interest held for more than one year; 

and, 

(C) Long-term capital gains and losses 

recognized by an Owner Taxpayer on 

the disposition of Distributed API 

Property (taking into account deemed 

exchanges under section 751(b)) during 

the taxable year that has a holding 

period of more than one year but not 

more than three years to the distributee 

Owner Taxpayer on the date of 

disposition, excluding items described 

in paragraph (b)(7) of this section. 

(ii) API Three Year Disposition 

Amount. The API Three Year 

Disposition Amount is the combined net 

amount of— 

(A) Long-term capital gains and losses 

recognized during the taxable year by an 

Owner Taxpayer, including long-term 

capital gain computed under the 

installment method that is taken into 

account for the taxable year, on the 

disposition of all or a portion of an API 

that has been held for more than three 

years and to which the Lookthrough 

Rule does not apply; 

(B) Long-term capital gains and losses 

recognized by an Owner Taxpayer on 

the disposition during the taxable year 

of all or a portion of an API that has 

been held for more than three years in 

a transaction to which the Lookthrough 

Rule in paragraph (b)(9) of this section 

applies, less any adjustments required 

under the Lookthrough Rule in 

paragraph (b)(9)(ii) of this section; and 

(C) Long-term capital gains and losses 

recognized on a distribution with 

respect to an API during the taxable year 

that is treated under sections 731(a) as 

gain or loss from the sale or exchange 

of a partnership interest held for more 

than three years. 

(b) Special rules for calculating the 

One Year Gain Amount and the Three 

Year Gain Amount—(1) One Year Gain 

Amount equals zero or less. If an Owner 

Taxpayer’s One Year Gain Amount is 

zero or results in a loss, the 

Recharacterization Amount for the 

taxable year is zero and section 1061(a) 

does not apply. 

(2) Three Year Gain Amount equals 

zero or less. If an Owner Taxpayer’s 

Three Year Gain Amount is less than or 

equal to $0, the Three Year Gain 

Amount is zero for purposes of 

calculating the Recharacterization 

Amount. 

(3) One Year Gain Amount less than 

Three Year Gain Amount. If the One 

Year Gain Amount and the Three Year 

Gain Amount are both greater than zero 

but the One Year Gain Amount is less 

than the Three Year Gain Amount, none 

of the One Year Gain Amount is 

included in the Recharacterization 

Amount for the taxable year. 

(4) Installment sale gain. The One 

Year Gain Amount under paragraph 

(a)(2)(i) of this section and the Three 

Year Gain Amount, as determined under 

paragraph (a)(2)(ii) of this section 

include long-term capital gains from 

installment sales. This includes longterm capital gain or loss recognized with 

respect to an API after December 31, 

2017, with respect to an installment sale 

that occurred on or before December 31, 

2017. The holding period of the asset 

upon the date of disposition is used for 

purposes of determining whether capital 

gain is included in the taxpayer’s One 

Year Gain Amount or the Three Year 

Gain Amount. 

(5) Special rules for capital gain 

dividends from regulated investment 

companies (RICs) and real estate 

investment trusts (REITs)—(i) API One 

Year Distributive Share Amount. If a 

RIC or REIT reports or designates a 

dividend as a capital gain dividend and 

provides the One Year Amounts 


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Disclosure as defined in § 1.1061– 

6(c)(1)(i), the amount provided in the 

One Year Amounts Disclosure is 

included in the calculation of an API 

One Year Distributive Share Amount. If 

the RIC or REIT does not provide the 

One Year Amounts Disclosure, the full 

amount of the RIC’s or REIT’s capital 

gain dividend must be included in the 

calculation of an API One Year 

Distributive Share Amount. 

(ii) API Three Year Distributive Share 

Amount. If a RIC or REIT reports or 

designates a dividend as a capital gain 

dividend and provides the Three Year 

Amounts Disclosure as defined in 

§ 1.1061–6(c)(1)(ii), the amount 

provided in the Three Year Amounts 

Disclosure is used for the calculation of 

an API Three Year Distributive Share 

amount. If the RIC or REIT does not 

provide the Three Year Amounts 

Disclosure, no amount of the RIC’s or 

REIT’s capital gain dividend may be 

used for the calculation of an API Three 

Year Distributive Share Amount. 

(iii) Loss on sale or exchange of stock. 

If a RIC or REIT provides the Three Year 

Amounts Disclosure as provided in 

paragraph (b)(5)(ii) of this section, any 

loss on the sale or exchange of shares of 

a RIC or REIT held for six months or less 

is treated as a capital loss on an asset 

held for more than three years, to the 

extent of the amount of the Three Year 

Amounts Disclosure from that RIC or 

REIT. 

(6) Pro rata share of qualified electing 

fund (QEF) net capital gain—(i) One 

year QEF net capital gain. The 

calculation of an API One Year 

Distributive Share Amount includes an 

Owner Taxpayer’s inclusion under 

section 1293(a)(1)(B) as limited by 

section 1293(e)(2) with respect to a 

passive foreign investment company (as 

defined in section 1297(a)) for which a 

QEF election (as described in section 

1295(a)) is in effect for the taxable year. 

The amount of the inclusion may be 

reduced by the amount of long-term 

capital gain that is not taken into 

account for purposes of section 1061 as 

provided in paragraph (b)(7) of this 

section and may be reduced by the 

Owner Taxpayer’s share of the excess, if 

any, of the Capital Interest Gain over 

Capital Interest Loss with respect to the 

QEF, provided in each case that the 

relevant information is provided by the 

QEF. See § 1.1061–6 for reporting rules. 

(ii) Three year QEF net capital gain 

adjustment. For purposes of calculating 

an Owner Taxpayer’s API Three Year 

Distributive Share Amount, the entire 

amount determined under paragraph 

(b)(6)(i) of this section, after any allowed 

reduction, is included as an item in 

paragraph (a)(3)(ii)(A) of this section 

unless the QEF provides information to 

determine the amount of the inclusion 

that would constitute net capital gain 

(as defined in § 1.1293–1(a)(2), as 

limited by section 1293(e)(2)) if the 

QEF’s net capital gain for the taxable 

year were calculated under section 

1222(11) applying paragraphs (3) and (4) 

of section 1222 by substituting three 

years for one year. If such information 

is provided, the amount included as an 

item in paragraph (a)(3)(ii)(A) of this 

section is the amount determined under 

paragraph (b)(6)(i) of this section that 

would not be treated as long-term gain 

if three years were substituted for one 

year in paragraphs (3) and (4) of section 

1222. See § 1.1061–6 for reporting rules. 

(7) Items not taken into account for 

purposes of section 1061. The following 

items of long-term capital gain and loss 

are excluded from the calculation of the 

API One Year Distributive Share 

Amount in paragraph (a)(3)(i) of this 

section and the API Three Year 

Distributive Share Amount in paragraph 

(a)(3)(ii) of this section— 

(i) Long-term capital gain and longterm capital loss determined under 

section 1231; 

(ii) Long-term capital gain and longterm capital loss determined under 

section 1256; 

(iii) Qualified dividends included in 

net capital gain for purposes of section 

1(h)(11)(B); and 

(iv) Capital gains and losses that are 

characterized as long-term or short-term 

without regard to the holding period 

rules in section 1222, such as certain 

capital gains and losses characterized 

under the mixed straddle rules 

described in section 1092(b) and 

§§ 1.1092(b)–3T, 1.1092(b)–4T, and 

1.1092(b)–6. 

(8) Holding period determination—(i) 

Determination of holding period for 

purposes of the Three Year Gain 

Amount. For purposes of computing the 

Three Year Gain Amount, the relevant 

holding period of either an asset or an 

API is determined under all provisions 

of the Code or regulations that are 

relevant to determining whether the 

asset or the API has been held for the 

long-term capital gain holding period by 

applying those provisions as if the 

holding period were three years instead 

of one year. 

(ii) Relevant holding period. The 

relevant holding period is the direct 

owner’s holding period in the asset sold. 

Accordingly, for purposes of 

determining an API Holder’s Taxpayer’s 

API One Year Distributive Share 

Amount and API Three Year 

Distributive Share Amount for the 

taxable year under paragraph (a)(3) of 

this section, the partnership’s holding 

period in the asset being sold or 

disposed of (whether a directly held 

asset or a partnership interest) is the 

relevant holding period for purposes of 

section 1061. 

(9) Lookthrough Rule for certain API 

dispositions—(i) Determination that the 

Lookthrough Rule applies—(A) In 

general. The Lookthrough Rule will 

apply if, at the time of disposition of an 

API held for more than three years— 

(1) The API would have a holding 

period of three years or less if the 

holding period of such API were 

determined by not including any period 

before the date that an Unrelated NonService Partner is legally obligated to 

contribute substantial money or 

property directly or indirectly to the 

Passthrough Entity to which the API 

relates. This paragraph (b)(9)(i)(A) does 

not apply to the disposition of an API 

to the extent that the gain recognized 

upon the disposition of the API is 

attributable to any asset not held for 

portfolio investment on behalf of third 

party investors (as defined in section 

1061(c)(5)). Solely for the purpose of 

this paragraph (b)(9)(i)(A), a substantial 

legal obligation to contribute money or 

property is an obligation to contribute a 

value that is at least 5 percent of the 

partnership’s total capital contributions 

as of the time of the API disposition; or 

(2) A transaction or series of 

transactions has taken place with a 

principal purpose of avoiding potential 

gain recharacterization under section 

1061(a). 

(B) Determination that the 

Lookthrough Rule applies to the 

disposition of a Passthrough Interest. 

Paragraph (b)(9)(i)(A) of this section 

similarly applies with respect to a 

Passthrough Interest issued by an S 

corporation or a PFIC to the extent the 

Passthrough Interest is treated as an 

API. 

(ii) Application of the Lookthrough 

Rule. If the Lookthrough Rule applies, 

for purposes of applying an Owner 

Taxpayer’s Recharacterization Amount, 

as described in paragraph (a) of this 

section— 

(A) The Owner Taxpayer must 

include the entire amount of capital 

gain recognized on the disposition of an 

API by the Owner Taxpayer in the 

Owner Taxpayer’s API One Year 

Disposition Amount; and 

(B) The Owner Taxpayer must include 

in its Three Year Disposition Amount an 

amount equal its One Year Disposition 

Amount (determined under paragraph 

(b)(9)(ii)(A) of this section) reduced by 

the Owner Taxpayer’s share of the 

amount of any gain, directly or 

indirectly, from assets held for three 

years or less that would have been 


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allocated to the Owner Taxpayer (to the 

extent attributable to the transferred 

API) by the partnership if the 

partnership had sold all of its property 

in a fully taxable transaction for cash in 

an amount equal to the fair market value 

of such property (taking into account 

section 7701(g)) immediately prior to 

the Owner Taxpayer’s transfer of the 

API. 

(C) In the case of an API disposition 

by an API Holder that is a Passthrough 

Entity and not an Owner Taxpayer, the 

principles set forth in paragraph 

(b)(9)(ii)(A) of this section must be 

applied to determine the amount to 

include in the Owner Taxpayer’s One 

Year Distributive Amount and in 

paragraph (b)(9)(ii)(B) of this section to 

determine the amounts included in the 

Owner Taxpayer’s Three Year 

Distributive Share Amount. 

(10) Section 83. Except with respect to 

any portion of the interest that is a 

capital interest under § 1.1061–3(c), this 

section applies regardless of whether an 

Owner Taxpayer or Passthrough Entity 

has made an election under section 

83(b) or included amounts in gross 

income under section 83. 

(c) Examples—(1) Recharacterization 

rules. The rules of paragraph (a) of this 

section are illustrated by the following 

examples. Unless otherwise stated, all 

gains and losses are long-term capital 

gains and losses, none of the long-term 

capital gain or loss in this section is 

capital gain or loss not taken into 

account for purposes of section 1061 

under paragraph (b)(7) of this section, 

and neither the Lookthrough Rule nor 

section 751 is applicable. 

(i) Example 1: Determination of API 

One Year and Three Year Distributive 

Share Amounts—(A) Facts. A holds an 

API in PRS but has no capital interest 

in PRS and is not entitled to a Capital 

Interest Allocation with respect to PRS. 

During the taxable year, PRS allocates to 

A $20 of long-term capital gain from the 

sale of capital asset X (which had been 

held by PRS for two years) and $40 of 

long-term capital gain from the sale of 

capital asset Y (which had held by PRS 

for five years). A has no other items of 

long-term capital gain or loss with 

respect to its interest in PRS during the 

taxable year. A has no other long-term 

capital gains or losses with respect to 

any other API during the taxable year. 

(B) Determination of A’s API One 

Year Distributive Share Amount. Under 

paragraph (a)(3)(i) of this section, A has 

an API One Year Distributive Share 

Amount of $60. This amount is the sum 

of the $20 of the long-term capital gain 

allocated to A from PRS’s sale of capital 

asset X and the $40 of long-term capital 

gain allocated to A from PRS’s sale of 

capital asset Y. 

(C) Determination of A’s API Three 

Year Distributive Share Amount. (1) 

Under paragraph (a)(3)(ii) of this 

section, A’s API Three Year Distributive 

Share Amount is equal to A’s API One 

Year Distributive Amount, $60, less the 

sum of: 

(i) The items included in the API One 

Year Distributive Share Amount that 

would not be treated as a long-term gain 

or loss if three years is substituted for 

one year in paragraphs (3) and (4) of 

section 1222, $20; and 

(ii) Adjustments resulting from the 

application of the Lookthrough Rule 

under paragraph (b)(9)(ii) of this section, 

which under the facts in paragraph 

(c)(1)(i)(A) of this section, is 

inapplicable. 

(2) Thus, A’s Three Year API 

Distributive Share Amount is $40. 

(D) Determination of A’s 

Recharacterization Amount. Under 

paragraph (a)(2)(i) of this section, A’s 

One Year Gain amount is equal to A’s 

API One Year Distributive Share 

Amount, $60. A’s Three Year Gain 

Amount is equal to A’s API Three Year 

Distributive Share Amount, $40. Under 

paragraph (a)(1) of this section, A’s 

Recharacterization Amount is A’s One 

Year Gain Amount, minus A’s Three 

Year Gain Amount, or $20. 

(ii) Example 2: API One Year and 

Three Year Disposition Amounts—(A) 

Facts. During the taxable year, A 

disposes of an API that A has held for 

four years for a $100 gain. Additionally, 

A sells Distributed API Property for a 

$300 gain at a time when A has a twoyear holding period in such property. A 

has no other items of long-term capital 

gain or loss with respect to any API in 

the year. 

(B) Determination of A’s API One 

Year and Three Year Disposition 

Amounts. Under paragraph (a)(4)(i) of 

this section, A’s API One Year 

Disposition Amount is $400. This 

amount is the sum of A’s $300 of longterm capital gain on A’s disposition of 

the Distributed API Property and A’s 

$100 of long-term capital gain on the 

disposition of the API. Under paragraph 

(a)(4)(ii) of this section, A’s Three Year 

Disposition Amount is $100, which is 

the amount of long-term capital gain 

that A recognized upon disposition of 

the API held for more than three years. 

Under paragraph (a)(2) of this section, 

A’s One Year Gain Amount is $400 and 

A’s Three Year Gain Amount is $100. 

(C) Determination of A’s 

Recharacterization Amount. Under 

paragraph (a)(1) of this section, A’s 

Recharacterization Amount is $300, 

which is the difference between A’s One 

Year Gain Amount and Three Year Gain 

Amount. 

(iii) Example 3: Determination of One 

Year Gain Amount, Three Year Gain 

Amount, and Recharacterization 

Amount—(A) Facts. A holds an API in 

each of PRS1 and PRS2. With respect to 

PRS1, A’s API One Year Distributive 

Share Amount is $100 and A’s API 

Three Year Distributive Share Amount 

is ($200). With respect to PRS2, A’s API 

One Year Distributive Share Amount is 

$600 and A’s API Three Year 

Distributive Share Amount is $300. 

During the taxable year, A also has an 

API One Year Disposition Amount of 

$200 of gain. A has no other items of 

long-term capital gain or loss with 

respect to an API for the taxable year. 

(B) Determination of A’s One Year 

Gain Amount. Under paragraph (a)(2) of 

this section, A’s One Year Gain Amount 

is $900, which is an amount equal to A’s 

$100 API One Year Distributive Share 

Gain from PRS1 and A’s $600 API One 

Year Distributive Share from PRS2 (a 

combined net API One Year Distributive 

Share Amount of $700) plus A’s $200 

API One Year Disposition Amount. 

(C) Determination of A’s Three Year 

Gain Amount. Under paragraph (a)(2) of 

this section, A’s Three Year Gain 

Amount is $100, which is equal to A’s 

combined net API Three Year 

Distributive Share Amount for the 

taxable year (A’s $200 API Three Year 

Distributive Share Amount loss from 

PRS1 plus A’s API Three Year 

Distributive Share Amount Gain of $300 

from PRS2). A does not have an API 

Three Year Disposition Amount. 

(D) Determination of A’s 

Recharacterization Amount. Under 

paragraph (a)(1) of this section, A’s 

Recharacterization Amount is $800. (A’s 

One Year Gain Amount of $900 less A’s 

Three Year Gain Amount of $100.) 

(2) Special rules examples. The 

principles of paragraph (b) of this 

section are illustrated by the following 

examples. 

(i) Example 1: Lookthrough Rule. On 

July 1, 2021, A and B form partnership 

PRS. At the time of PRS’s formation, A 

agrees to provide substantial services to 

PRS in exchange for a 20% profits 

interest in PRS, and B, a partner that is 

an Unrelated Non-Service Partner, 

contributes $1 million in exchange for 

an interest in PRS and PRS immediately 

uses the capital to purchase marketable 

securities. On July 1, 2023, C, another 

Unrelated Non-Service Partner becomes 

legally obligated to contribute capital to 

PRS ($75 million) for the purposes of 

investing in and developing Specified 

Assets and is admitted into PRS. On 

July 3, 2023, and after C makes a 

contribution of $75 million, PRS uses 


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this capital to acquire stock in portfolio 

company Z. On July 1, 2025, when Z 

has a value of $500 million and the 

value of the marketable securities is $2 

million, A sells its API in PRS for $85.2 

million. As a result of this sale, the 

Lookthrough Rule applies because B’s 

contribution was non-substantial under 

paragraph (b)(9)(i)(A)(1) of this section. 

Therefore, A includes $85.2 million in 

its API One Year Disposition Amount 

and under paragraph (b)(9)(ii)(B) of this 

section, $200,000 (20% share of $1 

million gain in marketable securities) in 

its API Three Year Disposition Amount. 

Accordingly, under paragraph (a)(1) of 

this section, A’s Recharacterization 

Amount is $85 million. 

(ii) Example 2: Installment sale gain. 

On December 22, 2021, A disposed of 

A’s API in an installment sale. At the 

time of the disposition, A had held its 

API for two years. A received a payment 

with respect to the installment sale 

during A’s 2022 taxable year causing A 

to recognize $200 of long-term capital 

gain. The $200 long-term capital gain 

recognized in 2022 is subject to section 

1061 because it is recognized after 

December 31, 2017. Accordingly, the 

$200 of long-term capital gain 

recognized by A in 2022 is included in 

A’s API One Year Disposition Amount. 

The $200 of long-term capital gain is not 

in A’s API Three Year Disposition 

Amount because the API was not held 

for more than three years at the time of 

its disposition. 

(iii) Example 3: REIT capital gain 

dividend. During the taxable year, A 

holds an API in PRS. PRS holds an 

interest in REIT. During the taxable 

year, REIT distributes a $1,000 capital 

gain dividend to PRS of which 50% is 

allocable to A’s API. Part of the capital 

gain dividend for the year results from 

section 1231 gain. In accordance with 

§ 1.1061–6(c)(1)(i), REIT discloses to 

PRS the One Year Amounts Disclosure 

of $400, which is the $1000 capital gain 

dividend reduced by the $600 of section 

1231 capital gain dividend included in 

that amount. Part of the One Year 

Amounts Disclosure for the year results 

from gain from property held for three 

years or less. In accordance with 

§ 1.1061–6(c)(1)(ii), REIT also discloses 

the Three Year Amounts Disclosure of 

$150, which is the $400 One Year 

Amounts Disclosure reduced by the 

$250 of gain attributable to property 

held for three years or less. PRS 

includes a $200 gain in determining A’s 

API One Year Distributive Share 

Amount and a $75 gain in determining 

A’s API Three Year Distributive Share 

Amount. See paragraphs (b)(5)(i) and (ii) 

of this section. 

(d) Applicability date. The provisions 

of this section apply to taxable years of 

Owner Taxpayers and Passthrough 

Entities beginning on or after January 

19, 2021. An Owner Taxpayer or 

Passthrough Entity may choose to apply 

this section to a taxable year beginning 

after December 31, 2017, provided that 

they apply the Section 1061 Regulations 

in their entirety to that year and all 

subsequent years. 

§ 1.1061–5 Section 1061(d) transfers to 

related persons. 

(a) In general. If an Owner Taxpayer 

transfers any API or Distributed API 

Property, directly or indirectly, to a 

Section 1061(d) Related Person (as 

defined in paragraph (e) of this section), 

the Owner Taxpayer must include in 

gross income as short-term capital gain, 

an amount equal to— 

(1) The short-term capital gain 

recognized upon the API transfer 

without regard to this paragraph (a); and 

(2) The lesser of— 

(i) The amount of net long-term 

capital gain recognized by the Owner 

Taxpayer upon the transfer of such 

interest; or 

(ii) The amount treated as short-term 

capital gain under paragraph (c) of this 

section (Section 1061(d) 

Recharacterization Amount). 

(b) Transfer. For purposes of this 

section, the term transfer means a sale 

or exchange in which gain is recognized 

by the Owner Taxpayer under chapter 1 

of the Internal Revenue Code. 

(c) Section 1061(d) Recharacterization 

Amount. To the extent an Owner 

Taxpayer recognizes long-term capital 

gain upon a transfer of an API to a 

Section 1061(d) Related Person, the 

Owner Taxpayer’s Section 1061(d) 

Recharacterization Amount is the 

amount of net long-term capital gain 

(excluding amounts not taken into 

account for purposes of section 1061 

under § 1.1061–4(b)(7)) from assets held 

for three years or less that would have 

been allocated to the Owner Taxpayer 

(to the extent attributable to the 

transferred API) by the partnership if 

the partnership had sold all of its 

property in a fully taxable transaction 

for cash in an amount equal to the fair 

market value of such property (taking 

into account section 7701(g)) 

immediately prior to the Owner 

Taxpayer’s transfer of the API. If only a 

portion of an Owner Taxpayer’s API is 

transferred, this paragraph (c) shall 

apply with respect to the portion of gain 

attributable to the transferred interest. 

(d) Special rules. For purposes of this 

section, the following rules are 

applicable. 

(1) An Owner Taxpayer will be 

treated as transferring the Owner 

Taxpayer’s share of any Indirect API or 

Distributed API Property if the Indirect 

API or Distributed API Property is 

transferred by the API Holder to a 

person that is a Section 1061(d) Related 

Person with respect to the Owner 

Taxpayer. 

(2) The rules set forth in paragraphs 

(a), (b), and (c) of this section apply 

upon the transfer of a Passthrough 

Interest issued by an S corporation or 

PFIC to the extent the Passthrough 

Interest is treated as an API. 

(e) Section 1061(d) Related Person. 

For purposes of this section, the term 

Section 1061(d) Related Person means— 

(1) A person that is a member of the 

taxpayer’s family within the meaning of 

section 318(a)(1); 

(2) A person that performed a service 

within the current calendar year or the 

preceding three calendar years in a 

Relevant ATB to the API transferred by 

taxpayer; or 

(3) A Passthrough Entity to the extent 

that a person described in paragraph 

(e)(1) or (2) of this section owns an 

interest, directly or indirectly. 

(f) Examples. The following examples 

illustrate the rules of this section. 

(1) Example 1: Transfer to child by 

gift. A, an individual, performs services 

in an ATB and has held an API in 

connection with those services for 10 

years. The API has a fair market value 

of $1,000 and a tax basis of $0, and no 

debt is associated with the API. A 

transfers all of the API to A’s daughter 

as a gift. A’s daughter is a section 

1061(d) Related Person but A’s gift is 

not a transfer as described in paragraph 

(b) of this section thus section 1061(d) 

does not apply to A’s gift. However, the 

API remains an API in the hands of A’s 

daughter under § 1.1061–2(a)(1)(i). 

(2) Example 2: Transfer of an API to 

a partnership owned by Section 1061(d) 

Related Persons—(i) Facts. A, B, and C 

are equal partners in GP, a partnership. 

GP holds only one asset, an API in PRS1 

which is an Indirect API as to each A, 

B, and C. A, B, and C each provides 

services in the ATB in connection with 

which GP was transferred its API in 

PRS1. A and B contribute their interests 

in GP to PRS2 in a Section 721(a) 

exchange for interests in PRS2. 

(ii) Application of section 1061(d). 

Because the contribution by A and B of 

their interest in GP to PRS2 is an 

exchange in which no gain is recognized 

by either A or B, the contribution is not 

a transfer as described in paragraph (b) 

of this section thus section 1061(d) does 

not apply to A and B’s contribution. 

However, the API remains an API in the 

hands of PRS2 under § 1.1061–2(a)(1)(i). 


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(3) Example 3: Transfer of an API to 

a Section 1061(d) Related Person. A 

holds an API in GP, a partnership which 

A has owned for four years. A transfers 

the API to a Section 1061(d) Related 

Person described in paragraph (e) of this 

section in exchange for $100 of cash, 

resulting in A recognizing long-term 

capital gain of $100. Because this is a 

transfer described in paragraph (b) of 

this section, section 1061(d) applies to 

the transfer of A’s API and A must 

determine its Section 1061(d) 

Recharacterization Amount under 

paragraph (c) of this section. If, 

immediately prior to A’s transfer of the 

API, the partnership had sold all of its 

assets in a fully taxable transaction for 

cash equal of the fair market value of the 

assets, A’s share of the net long-term 

capital gain (excluding amounts not 

taken into account for purposes of 

section 1061 under § 1.1061–4(b)(7)) 

from assets held for three years or less 

would have been $120. Thus, A’s 

Section 1061(d) Recharacterization 

Amount is $120. As a result, A’s $100 

long-term capital gain is recharacterized 

as short-term capital gain under 

paragraph (a) of this section. The API 

remains an API in the hands of the 

Section 1061(d) Related Person under 

§ 1.1061–2(a)(1)(i). 

(g) Applicability date. The provisions 

of this section apply to taxable years of 

Owner Taxpayers and Passthrough 

Entities beginning on or after January 

19, 2021. An Owner Taxpayer or 

Passthrough Entity may choose to apply 

this section to a taxable year beginning 

after December 31, 2017, provided that 

they apply the Section 1061 Regulations 

in their entirety to that year and all 

subsequent years. 

§ 1.1061–6 Reporting rules. 

(a) Owner Taxpayer filing 

requirements–(1) In general. An Owner 

Taxpayer must file such information 

with the IRS as the Commissioner of 

Internal Revenue or the Commissioner’s 

delegate (Commissioner) may require in 

forms, instructions, or other guidance as 

is necessary for the Commissioner to 

determine that the Owner Taxpayer has 

properly complied with section 1061 

and the Section 1061 Regulations. If an 

Owner Taxpayer requires information 

from a Passthrough Entity to determine 

the Capital Interest Disposition Amount 

or the Section 1061(d) 

Recharacterization Amount, the Owner 

Taxpayer must request such information 

from that entity. 

(2) Failure to obtain information. 

Paragraph (b)(1) of this section requires 

certain Passthrough Entities to furnish 

an Owner Taxpayer with certain 

amounts necessary to determine its 

Recharacterization Amount and meet its 

reporting requirements under paragraph 

(a)(1) of this section. To the extent that 

an Owner Taxpayer is not furnished the 

information required to be furnished 

under paragraph (b)(1) of this section in 

such time and in such manner as 

required by the Commissioner and the 

Owner Taxpayer is not otherwise able to 

substantiate all or a part of these 

amounts to the satisfaction of the 

Commissioner, then if the information 

with respect to the determination of 

the— 

(i) API One Year Distributive Share 

Amount under § 1.1061–4(a)(3)(i) is not 

furnished, the API One Year 

Distributive Share Amount will not be 

reduced by— 

(A) Amounts not taken into account 

for purposes of section 1061 under 

§ 1.1061–4(b)(7); or 

(B) Capital Interest Gains and Losses 

as determined under § 1.1061–3(c)(2). 

(ii) API Three Year Distributive Share 

Amount determined under § 1.1061– 

4(a)(3)(ii) is not furnished, all items 

included in the API One Year 

Distributive Share Amount are treated 

as items that would not be treated as 

long-term capital gain or loss, if three 

years is substituted for one year in 

paragraphs (3) and (4) of section 1222. 

(b) Passthrough Entity filing 

requirements and reporting—(1) 

Requirement to file information with the 

IRS and to furnish information to API 

Holder. A Passthrough Entity must file 

such information with the IRS as the 

Commissioner may require in forms, 

instructions, or other guidance as is 

necessary for the Commissioner to 

determine that it and its partners have 

complied with section 1061 and the 

Section 1061 Regulations. A 

Passthrough Entity that has issued an 

API must furnish to the API Holder, 

including an Owner Taxpayer, such 

information at such time and in such 

manner as the Commissioner may 

require in forms, instructions, or other 

guidance as is necessary to determine 

the One Year Gain Amount and the 

Three Year Gain Amount with respect to 

an Owner Taxpayer that directly or 

indirectly holds the API. A Passthrough 

Entity that has furnished information to 

the API Holder must file such 

information with the IRS, at such time 

and in such manner as the 

Commissioner may require in forms, 

instructions, or other guidance. This 

information includes: 

(i) The API One Year Distributive 

Share Amount and the API Three Year 

Distributive Share Amount (as 

determined under § 1.1061–4); 

(ii) Capital gains and losses allocated 

to the API Holder that are excluded 

from section 1061 under § 1.1061– 

4(b)(7); 

(iii) Capital Interest Gains and Losses 

allocated to the API Holder (as 

determined under § 1.1061–3(c)); and 

(iv) In the case of a disposition by an 

API Holder of an interest in the 

Passthrough Entity during the taxable 

year, upon the request of an API Holder, 

any information required by the API 

Holder to properly take the disposition 

into account under section 1061, 

including— 

(A) Information necessary to apply the 

Lookthrough Rule and to determine the 

API Holder’s Capital Interest 

Disposition Amount; and 

(B) Information necessary to 

determine an Owner Taxpayer’s Section 

1061(d) Recharacterization Amount. 

(2) Requirement to request, furnish, 

and file information in tiered 

structures—(i) Requirement to request 

information. If a Passthrough Entity 

requires information to meet its 

reporting and filing requirements under 

this section (in addition to any 

information required to be furnished to 

the Passthrough Entity under paragraph 

(b)(1) of this section) from a lower-tier 

entity in which it holds an interest, the 

Passthrough Entity must request such 

information from that entity. 

(ii) Requirement to furnish and file 

information. If information is requested 

of a Passthrough Entity under paragraph 

(b)(2)(i) of this section, the Passthrough 

Entity must furnish the requested 

information to the person making the 

request but only to the extent the 

information is necessary for the 

requesting Passthrough Entity to meet 

its reporting and filing requirements 

under this section or is required by the 

Commissioner in forms, instructions, or 

other guidance. If the person requesting 

the information is an API Holder in the 

Passthrough Entity, the information is 

furnished under paragraph (b)(1) of this 

section. If the Passthrough Entity 

requesting the information is not an API 

Holder, the Passthrough Entity must 

furnish the information to the 

requesting Passthrough Entity as 

required by the Commissioner in forms, 

instructions, or other guidance. 

(iii) Timing of requesting and 

furnishing information—(A) Requesting 

information. A Passthrough Entity 

described in paragraph (b)(2)(i) of this 

section must request information under 

paragraph (b)(2)(i) of this section by the 

later of the 30th day after the close of 

the taxable year to which the 

information request relates or 14 days 

after the date of a request for 

information from an upper-tier 

Passthrough Entity. 


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(B) Furnishing information—(1) In 

general. Except as provided in 

paragraph (b)(2)(iii)(B)(2) of this section, 

requested information must be 

furnished by the date on which the 

entity is required to furnish information 

under section 6031(b) or under section 

6037(b), as applicable. 

(2) Late requests. Information with 

respect to a taxable year that is 

requested by an upper-tier Passthrough 

Entity after the date that is 14 days prior 

to the due date for a lower-tier 

Passthrough Entity to furnish and file 

information under section 6031(b) or 

section 6037(b), as applicable, must be 

furnished and filed in the time and 

manner prescribed by forms, 

instructions and other guidance. 

(iv) Manner of requesting information. 

Information may be requested 

electronically or in any manner that is 

agreed to by the parties. 

(v) Recordkeeping requirement. Any 

Passthrough Entity receiving a request 

for information must retain a copy of the 

request and the date received in its 

books and records. 

(vi) Passthrough Entity is not 

furnished information to meet its 

reporting obligations under paragraph 

(b)(1) of this section. If an upper-tier 

Passthrough Entity holds an interest in 

a lower-tier Passthrough Entity and it is 

not furnished the information described 

in paragraph (b)(1) of this section, or, 

alternatively, if it has not been 

furnished information after having 

properly requested the information 

under this paragraph (b)(2), the uppertier Passthrough Entity must take 

actions to otherwise determine and 

substantiate the missing information. To 

the extent that the upper-tier 

Passthrough Entity is not able to 

otherwise substantiate and determine 

the missing information to the 

satisfaction of the Commissioner, the 

upper-tier Passthrough Entity must treat 

these amounts as provided under 

paragraph (a)(2) of this section. The 

upper-tier Passthrough Entity must 

provide notice to the API Holder and 

the IRS regarding the application of this 

paragraph (b)(2) to the information 

being reported as required in forms, 

instructions, and other guidance. 

(vii) Filing requirements. Both the 

Passthrough Entity requesting the 

information and the Passthrough Entity 

furnishing the information must file all 

information with the IRS as the 

Commissioner may require in forms, 

instructions, or other guidance. 

(viii) Penalties. In addition to the 

requirement in section 1061(e) that the 

Secretary shall require reporting (at the 

time and in the manner prescribed by 

the Secretary) as is necessary to carry 

out the purposes of this section, the 

information required to be furnished 

under this paragraph (b) is also required 

to be furnished under sections 6031(b) 

and 6037(b). Failure to report as 

required under this paragraph (b) will 

be subject to penalties under section 

6722. 

(c) Regulated investment company 

(RIC) and real estate investment trust 

(REIT) reporting—(1) Section 1061 

disclosures. A RIC or REIT that reports 

or designates a dividend, or part thereof, 

as a capital gain dividend, may, in 

addition to the information otherwise 

required to be furnished to a 

shareholder, disclose two amounts for 

purposes of section 1061— 

(i) One Year Amounts Disclosure. The 

One Year Amounts Disclosure of a RIC 

or REIT is a disclosure by the RIC or 

REIT of an amount that is attributable to 

a computation of the RIC’s or REIT’s net 

capital gain excluding capital gain and 

capital loss not taken into account for 

purposes of section 1061 under 

§ 1.1061–4(b)(7). The aggregate amounts 

provided in the One Year Amounts 

Disclosures with respect to a taxable 

year of a RIC or REIT must equal the 

lesser of the RIC’s or REIT’s net capital 

gain, excluding any capital gains and 

capital losses not taken into account for 

purposes of section 1061 under 

§ 1.1061–4(b)(7), for the taxable year or 

the RIC’s or REIT’s aggregate capital 

gain dividends for the taxable year. 

(ii) Three Year Amounts Disclosure. 

The Three Year Amounts Disclosure of 

a RIC or REIT is a disclosure by the RIC 

or REIT of an amount that is attributable 

to a computation of the RIC’s or REIT’s 

One Year Amounts Disclosure 

substituting ‘‘three years’’ for ‘‘one year’’ 

in applying section 1222. The aggregate 

amounts provided in the Three Year 

Amounts Disclosures with respect to a 

taxable year of a RIC or REIT must equal 

the lesser of the aggregate amounts 

provided in the RIC’s or REIT’s One 

Year Amounts Disclosures substituting 

‘‘three years’’ for ‘‘one year’’ in applying 

section 1222 for the taxable year or the 

RIC’s or REIT’s aggregate capital gain 

dividends for the taxable year. 

(2) Pro rata disclosures. The One Year 

Amounts Disclosure and Three Year 

Amounts Disclosure made to each 

shareholder of a RIC or REIT must be 

proportionate to the share of capital gain 

dividends reported or designated to that 

shareholder for the taxable year. 

(3) Report to shareholders. A RIC or 

REIT that provides the section 1061 

disclosures described in paragraphs 

(c)(1)(i) and (ii) of this section must 

provide those section 1061 disclosures 

in writing to its shareholders with the 

statement described in section 

852(b)(3)(C)(i) or the notice described in 

section 857(b)(3)(B) in which the capital 

gain dividend is reported or designated. 

(d) Qualified electing fund (QEF) 

reporting. A passive foreign investment 

company with respect to which the 

shareholder has a QEF election (as 

described in section 1295(a)) in effect 

for the taxable year that determines net 

capital gain as provided in § 1.1293– 

1(a)(2)(i)(A), as limited by section 

1293(e)(2), may provide some or all of 

the information listed in paragraph 

(b)(1) of this section (and any other 

relevant information) to its shareholders 

to enable API Holders to determine the 

amount of their inclusion under section 

1293(a)(1) that would be included in the 

API One Year Distributive Share 

Amounts and API Three Year 

Distributive Share Amounts. To the 

extent that such information is not 

provided, paragraph (a)(2) of this 

section will apply except that Owner 

Taxpayers are not permitted to 

separately substantiate the information. 

An API Holder who receives the 

additional information described in this 

paragraph (d) must retain such 

information as required by § 1.1295– 

1(f)(2)(ii). 

(e) Applicability date. The provisions 

of this section apply to taxable years of 

Owner Taxpayers and Passthrough 

Entities beginning on or after January 

19, 2021. An Owner Taxpayer or 

Passthrough Entity may choose to apply 

this section to a taxable year beginning 

after December 31, 2017, provided that 

they apply the Section 1061 Regulations 

in their entirety to that year and all 

subsequent years. 

■ Par. 5. Section 1.1223–3 is amended 

by: 

■ 1. Redesignating paragraph (b)(5) as 

paragraph (b)(6); 

■ 2. Adding a new paragraph (b)(5); 

■ 3. Designating Examples 1 through 8 

of paragraph (f) as paragraphs (f)(1) 

through (8); 

■ 4. Adding paragraphs (f)(9) and (10); 

and 

■ 5. Revising the heading and adding a 

sentence at the end of paragraph (g). 

The additions and revision read as 

follows: 

§ 1.1223–3 Rules relating to the holding 

periods of partnership interests. 

* * * * * 

(b) * * * 

(5) Divided holding period if 

partnership interest comprises in whole 

or in part one or more profits interests— 

(i) In general. If a partnership interest is 

comprised in whole or in part of one or 

more profits interests (as defined in 

paragraph (b)(5)(ii) of this section), then, 

for purposes of applying paragraph 


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(b)(1) of this section, the portion of the 

holding period to which a profits 

interest relates is determined based on 

the fair market value of the profits 

interest upon the disposition of all, or 

part, of the interest (and not at the time 

that the profits interest is acquired). 

Paragraph (b)(1) of this section 

continues to apply to the extent that a 

partner acquires portions of a 

partnership interest that are not 

comprised of a profits interest and the 

value of the profits interest is not 

included for purposes of determining 

the value of the entire partnership 

interest under paragraph (b)(1). 

(ii) Definition of capital interest and 

profits interest. For purposes of this 

paragraph (b)(5), a profits interest is a 

partnership interest other than a capital 

interest. A capital interest is an interest 

that would give the holder a share of the 

proceeds if the partnership’s assets were 

sold at fair market value at the time the 

interest was received and then the 

proceeds were distributed in a complete 

liquidation of the partnership. A profits 

interest, for purposes of this paragraph 

(b)(5), is received in connection with the 

performance of services to or for the 

benefit of a partnership in a partner 

capacity or in anticipation of being a 

partner, and the receipt of the interest 

is not treated as a taxable event for the 

partner or the partnership under 

applicable Federal income tax guidance. 

* * * * * 

(f) * * * 

(9) Example 9. On June 1, 2020, GP 

contributes $10,000 to PRS for a 

partnership interest in PRS. On June 30, 

2023, GP receives a 20% interest in the 

profits of PRS that is an Applicable 

Partnership Interest (API) as defined in 

§ 1.1061–1(a). On June 30, 2025, GP 

sells its interest in PRS for $30,000. At 

the time of GP’s sale of its interest, the 

API has a fair market value of $15,000. 

GP has a divided holding period in its 

interest in PRS; 50% of the partnership 

interest has a holding period beginning 

on June 1, 2020, and 50% has a holding 

period that begins on June 30, 2023. 

(10) Example 10. Assume the same 

facts as in paragraph (f)(9) of this section 

(Example 9), except that on June 30, 

2024, GP contributes an additional 

$5,000 cash to GP prior to GP’s sale of 

its interest in 2025. Immediately after 

the contribution of the $5,000 on June 

30, 2024, GP’s interest in PRS has a 

value of $15,000, not taking into 

account the value of GP’s profits interest 

in PRS. GP calculates its holding period 

in the portions not comprised by the 

profits interest and two-thirds of its 

holding period runs from June 30, 2020, 

and one-third runs from June 30, 2024. 

On June 30, 2025, GP sells its interest 

for $30,000 and the API has a fair 

market value of $15,000. Accordingly, 

on the date of disposition, one-third of 

GP’s interest has a five year holding 

period from its interest received in 2020 

for its $10,000 contribution, one-half of 

GP’s interest has a two year holding 

period from the profits interest issued 

on June 30, 2023, and one-sixth of GP’s 

interest has a one year holding period 

from the contribution of the $5,000. 

(g) Applicability dates. * * * 

Paragraphs (b)(5) and (f)(9) and (10) of 

this section apply to taxable years 

beginning on or after January 19, 2021. 

Sunita Lough, 

Deputy Commissioner for Services and 

Enforcement. 

Approved: January 5, 2021. 

David J. Kautter, 

Assistant Secretary of the Treasury (Tax 

Policy). 

[FR Doc. 2021–00427 Filed 1–13–21; 4:15 pm] 

BILLING CODE 4830–01–P 


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