[Federal Register Volume 65, Number 7 (Tuesday, January 11, 2000)]
[Proposed Rules]
[Pages 1572-1580]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-14]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-111119-99]
RIN 1545-AX32


Partnership Mergers and Divisions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations on the tax 
consequences of partnership mergers and divisions. The proposed 
regulations affect partnerships and their partners. This document also 
contains a notice of public hearing on these proposed regulations.

DATES: Written comments must be received by April 10, 2000. Requests to 
speak (with outlines of oral comments) at the public hearing scheduled 
for May 4, 2000, must be submitted by April 13, 2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-111119-99), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. In the alternative, submissions may be hand 
delivered Monday through Friday between the hours of 8 a.m. and 5 p.m. 
to: CC:DOM:CORP:R (REG-111119-99), Courier's Desk, Internal Revenue 
Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, 
taxpayers may submit comments electronically via the Internet by 
selecting the ``Tax Regs'' option of the IRS Home Page, or by 
submitting comments directly to the IRS Internet site at: <a href="http://
www.irs.ustreas.gov/tax__regs/regslist.html">http://
www.irs.ustreas.gov/tax__regs/regslist.html</a>. The public hearing will be 
held in room 2615, Internal Revenue Building, 1111 Constitution Avenue, 
NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Dan 
Carmody, (202) 622-3080; concerning submissions of comments, the 
hearing, and/or to be placed on the building access list to attend the 
hearing, LaNita VanDyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: This document proposes to amend sections 
708, 743, and 752 of the Income Tax Regulations (26 CFR part 1) 
regarding partnership mergers and divisions.

Partnership Mergers

Background

    Section 708(b)(2)(A) provides that in the case of a merger or 
consolidation of two or more partnerships, the resulting partnership 
is, for purposes of section 708, considered the continuation of any 
merging or consolidating partnership whose members own an interest of 
more than 50 percent in the capital and profits of the resulting 
partnership. Section 1.708-1(b)(2)(i) of the Income Tax Regulations 
provides that if the resulting partnership can be considered a 
continuation of more than one of the merging partnerships, the 
resulting partnership is the continuation of the partnership that is 
credited with the contribution of the greatest dollar value of assets 
to the resulting partnership. If none of the members of the merging

[[Page 1573]]

partnerships own more than a 50 percent interest in the capital and 
profits of the resulting partnership, all of the merged partnerships 
are considered terminated, and a new partnership results. The taxable 
years of the merging partnerships that are considered terminated are 
closed under section 706(c).
    Although section 708 and the applicable regulations provide which 
partnership continues when two or more partnerships merge, the statute 
and regulations do not prescribe a form for the partnership merger. 
(Often, state merger statutes do not provide a particular form for a 
partnership merger.) In revenue rulings, however, the IRS has 
prescribed the form of a partnership merger for Federal income tax 
purposes.
    In Rev. Rul. 68-289 (1968-1 C.B. 314), three existing partnerships 
(P1, P2, and P3) merged into one partnership with P3 continuing under 
section 708(b)(2)(A). The revenue ruling holds that P1 and P2, the two 
terminating partnerships, are treated as having contributed all of 
their respective assets and liabilities to P3, the resulting 
partnership, in exchange for a partnership interest in P3. P1 and P2 
are considered terminated and the partners of P1 and P2 receive 
interests in P3 with a basis under section 732(b) in liquidation of P1 
and P2 (Assets-Over Form). Rev. Rul. 77-458 (1977-2 C.B. 220), and Rev. 
Rul. 90-17 (1990-1 C.B. 119), also follow the Assets-Over Form for a 
partnership merger.

Explanation of Provisions

A. Form of a Partnership Merger

    The IRS and Treasury are aware that taxpayers may accomplish a 
partnership merger by undertaking transactions in accordance with 
jurisdictional laws that follow a form other than the Assets-Over Form. 
For example, the terminating partnership could liquidate by 
distributing its assets and liabilities to its partners who then 
contribute the assets and liabilities to the resulting partnership 
(Assets-Up Form). In addition, the partners in the terminating 
partnership could transfer their terminating partnership interests to 
the resulting partnership in exchange for resulting partnership 
interests, and the terminating partnership could liquidate into the 
resulting partnership (Interest-Over Form).
    In the partnership incorporation area, a taxpayer's form generally 
is respected if the taxpayer actually undertakes, under the relevant 
jurisdictional law, all the steps of a form that is set forth in one of 
three situations provided in Rev. Rul. 84-111 (1984-2 C.B. 88). The 
three situations that Rev. Rul. 84-111 sets forth are the Assets-Over 
Form, Assets-Up Form, and Interest-Over Form. Rev. Rul. 84-111 explains 
that, depending on the form chosen to incorporate the partnership, the 
adjusted basis and holding periods of the various assets received by 
the corporation and the adjusted basis and holding periods of the stock 
received by the former partners can vary. Like partnership 
incorporations, each form of a partnership merger has potentially 
different tax consequences.
    Under the Assets-Up Form, partners could recognize gain under 
sections 704(c)(1)(B) and 737 (and incur state or local transfer taxes) 
when the terminating partnership distributes the assets to the 
partners. However, under the Assets-Over Form, gain under sections 
704(c)(1)(B) and 737 is not triggered. See Secs. 1.704-4(c)(4) and 
1.737-2(b). Additionally, under the Assets-Up Form, because the 
adjusted basis of the assets contributed to the resulting partnership 
is determined first by reference to section 732 (as a result of the 
liquidation) and then section 723 (by virtue of the contribution), in 
certain circumstances, the adjusted basis of the assets contributed may 
not be the same as the adjusted basis of the assets in the terminating 
partnership. These circumstances occur if the partners' aggregate 
adjusted basis of their interests in the terminating partnership does 
not equal the terminating partnership's adjusted basis in its assets. 
Under the Assets-Over Form, because the resulting partnership's 
adjusted basis in the assets it receives is determined solely under 
section 723, the adjusted basis of the assets in the resulting 
partnership is the same as the adjusted basis of the assets in the 
terminating partnership.
    The regulations propose to respect the form of a partnership merger 
for Federal income tax purposes if the partnerships undertake, pursuant 
to the laws of the applicable jurisdiction, the steps of either the 
Assets-Over Form or the Assets-Up Form. (This rule applies even if none 
of the merged partnerships are treated as continuing for Federal income 
tax purposes.) Generally, when partnerships merge, the assets move from 
one partnership to another at the entity level, or in other words, like 
the Assets-Over Form. However, if as part of the merger, the 
partnership titles the assets in the partners' names, the proposed 
regulations treat the transaction under the Assets-Up Form. If 
partnerships use the Interest-Over Form to accomplish the result of a 
merger, the partnerships will be treated as following the Assets-Over 
Form for Federal income tax purposes.
    In the context of partnership incorporations, Rev. Rul. 84-111 
distinguishes among all three forms of incorporation. However, with 
respect to the Interest-Over Form, the revenue ruling respects only the 
transferors' conveyances of partnership interests, while treating the 
receipt of the partnership interests by the transferee corporation as 
the receipt of the partnership's assets (i.e., the Assets-Up Form). The 
theory for this result, based largely on McCauslen v. Commissioner, 45 
T.C. 588 (1966), is that the transferee corporation can only receive 
assets since it is not possible, as a sole member, for it to receive 
and hold interests in a partnership (i.e., a partnership cannot have 
only one member; so, the entity is never a partnership in the hands of 
the transferee corporation).
    Adherence to the approach followed in Rev. Rul. 84-111 creates 
problems in the context of partnership mergers that are not present 
with respect to partnership incorporations. Unlike the corporate rules, 
the partnership rules impose certain tax results on partners based upon 
a concept that matches a contributed asset to the partner that 
contributed the asset. Sections 704(c) and 737 are examples of such 
rules. The operation of these rules breaks down if the partner is 
treated as contributing an asset that is different from the asset that 
the partnership is treated as receiving.
    Given that the hybrid treatment of the Interest-Over Form 
transactions utilized in Rev. Rul. 84-111 is difficult to apply in the 
context of partnership mergers, another characterization will be 
applied to such transactions. The Assets-Over Form generally will be 
preferable for both the IRS and taxpayers. For example, when 
partnerships merge under the Assets-Over Form, gain under sections 
704(c)(1)(B) and 737 is not triggered. Moreover, the basis of the 
assets in the resulting partnership is the same as the basis of the 
assets in the terminating partnership, even if the partners' aggregate 
adjusted basis of their interests in the terminating partnership does 
not equal the terminating partnership's adjusted basis in its assets.
    If partnerships merge under applicable law without implementing a 
form, the proposed regulations treat the partnerships as following the 
Assets-Over Form. This approach is consistent with the treatment of 
partnership to corporation elective conversions under the check-the-box 
regulations and technical terminations under section

[[Page 1574]]

708(b)(1)(B), other formless movements of a partnership's assets.

B. Adverse Tax Consequences of the Assets-Over Form

    The IRS and Treasury are aware that certain adverse tax 
consequences may occur for partnerships that merge in a transaction 
that will be taxed in accordance with the Assets-Over Form. These 
proposed regulations address some of the adverse tax consequences 
regarding section 752 liability shifts and buyouts of exiting partners.
1. Section 752 Revisions
    If a highly leveraged partnership (the terminating partnership) 
merges with another partnership (the resulting partnership), all of the 
partners in the terminating partnership could recognize gain because of 
section 752 liability shifts. Under the Assets-Over Form, the 
terminating partnership becomes a momentary partner in the resulting 
partnership when the terminating partnership contributes its assets and 
liabilities to the resulting partnership in exchange for interests in 
the resulting partnership. If the terminating partnership (as a 
momentary partner in the resulting partnership) is considered to 
receive a deemed distribution under section 752 (after netting 
increases and decreases in liabilities under Sec. 1.752-1(f)) that 
exceeds the terminating partnership's adjusted basis of its interests 
in the resulting partnership, the terminating partnership would 
recognize gain under section 731. The terminating partnership's gain 
then would be allocated to each partner in the terminating partnership 
under section 704(b). In this situation, a partner in the terminating 
partnership could recognize gain even though the partner's adjusted 
basis in its resulting partnership interest or its share of partnership 
liabilities in the resulting partnership is large enough to avoid the 
recognition of gain, provided that the decreases in liabilities in the 
terminating partnership are netted against the increases in liabilities 
in the resulting partnership.
    The proposed regulations clarify that when two or more partnerships 
merge under the Assets-Over Form, increases or decreases in partnership 
liabilities associated with the merger are netted by the partners in 
the terminating partnership and the resulting partnership to determine 
the effect of the merger under section 752. The IRS and Treasury 
consider it appropriate to treat the merger as a single transaction for 
determining the net liability shifts under section 752. Therefore, a 
partner in the terminating partnership will recognize gain on the 
contribution under section 731 only if the net section 752 deemed 
distribution exceeds that partner's adjusted basis of its interest in 
the resulting partnership.
2. Buyout of a Partner
    Another adverse tax consequence may occur when a partner in the 
terminating partnership does not want to become a partner in the 
resulting partnership and would like to receive money or property 
instead of an interest in the resulting partnership. Under the Assets-
Over Form, the terminating partnership will not recognize gain or loss 
under section 721 when it contributes its property to the resulting 
partnership in exchange for interests in the resulting partnership. 
However, if, in order to facilitate the buyout of the exiting partner, 
the resulting partnership transfers money or other consideration to the 
terminating partnership in addition to the resulting partnership 
interests, the terminating partnership may be treated as selling part 
of its property to the resulting partnership under section 
707(a)(2)(B). Any gain or loss recognized by the terminating 
partnership generally would be allocated to all the partners in the 
terminating partnership even though only the exiting partner would 
receive the consideration.
    The IRS and Treasury believe that, under certain circumstances, 
when partnerships merge and one partner does not become a partner in 
the resulting partnership, the receipt of cash or property by that 
partner should be treated as a sale of that partner's interest in the 
terminating partnership to the resulting partnership, not a disguised 
sale of the terminating partnership's assets. Accordingly, the proposed 
regulations provide that if the merger agreement (or similar document) 
specifies that the resulting partnership is purchasing the exiting 
partner's interest in the terminating partnership and the amount paid 
for the interest, the transaction will be treated as a sale of the 
exiting partner's interest to the resulting partnership. This treatment 
will apply even if the resulting partnership sends the consideration to 
the terminating partnership on behalf of the exiting partner, so long 
as the designated language is used in the relevant document.
    In this situation, the exiting partner is treated as selling a 
partnership interest in the terminating partnership to the resulting 
partnership (and the resulting partnership is treated as purchasing the 
partner's interest in the terminating partnership) immediately prior to 
the merger. Immediately after the sale, the resulting partnership 
becomes a momentary partner in the terminating partnership. 
Consequently, the resulting partnership and ultimately its partners 
(determined prior to the merger) inherit the exiting partner's capital 
account in the terminating partnership and any section 704(c) liability 
of the exiting partner. If the terminating partnership has an election 
in effect under section 754 (or makes an election under section 754), 
the resulting partnership will have a special basis adjustment 
regarding the terminating partnership's property under section 743. The 
proposed regulations provide that the resulting partnership's basis 
adjustments under section 743 must be ultimately allocated solely to 
the partners who were partners in the resulting partnership immediately 
before the merger; the adjustments do not affect the common basis of 
the resulting partnership's assets.

C. Merger as Part of a Larger Transaction

    The proposed regulations provide that if the merger is part of a 
larger series of transactions, and the substance of the larger series 
of transactions is inconsistent with following the form prescribed for 
the merger, the form may not be respected, and the larger series of 
transactions may be recast in accordance with their substance. An 
example illustrating the application of this rule is included in the 
proposed regulations.

D. Measurement of Dollar Value of Assets

    As discussed above, the regulations currently provide that in a 
merger of partnerships, if the resulting partnership can be considered 
a continuation of more than one of the merging partnerships, the 
resulting partnership is the continuation of the partnership that is 
credited with the contribution of the greatest dollar value of assets 
to the resulting partnership. Commentators have questioned whether this 
rule refers to the gross or net value of the assets of a partnership. 
The proposed regulations provide that the value of assets of a 
partnership is determined net of the partnership's liabilities.

E. Effective Date

    The regulations are proposed to apply to mergers occurring on or 
after the date final regulations are published in the Federal Register.

Partnership Divisions

Background

    Section 708(b)(2)(B) provides that, in the case of a division of a 
partnership into two or more partnerships, the resulting partnerships 
(other than any

[[Page 1575]]

resulting partnership the members of which had an interest of 50 
percent or less in the capital and profits of the prior partnership) 
are considered a continuation of the prior partnership. Section 1.708-
1(b)(2)(ii) provides that any other resulting partnership is not 
considered a continuation of the prior partnership but is considered a 
new partnership. If the members of none of the resulting partnerships 
owned an interest of more than 50 percent in the capital and profits of 
the prior partnership, the prior partnership is terminated. Where 
members of a partnership that has been divided do not become members of 
a resulting partnership that is considered a continuation of the prior 
partnership, such partner's interest is considered liquidated as of the 
date of the division.
    Section 708(b)(2)(B) and the applicable regulations do not 
prescribe a particular form for the division involving continuing 
partnerships. The IRS has not addressed in published guidance how the 
assets and liabilities of the prior partnership move into the resulting 
partnerships. Taxpayers generally have followed either the Assets-Over 
Form or the Assets-Up Form for partnership divisions.
    Under the Assets-Over Form, the prior partnership transfers certain 
assets to a resulting partnership in exchange for interests in the 
resulting partnership. The prior partnership then immediately 
distributes the resulting partnership interests to partners who are 
designated to receive interests in the resulting partnership.
    Under the Assets-Up Form, the prior partnership distributes certain 
assets to some or all of its partners who then contribute the assets to 
a resulting partnership in exchange for interests in the resulting 
partnership.

Explanation of Provisions

A. Form of a Partnership Division

    As with partnership mergers, the IRS and Treasury recognize that 
different tax consequences can arise depending on the form of the 
partnership division. Because of the potential different tax results 
that could occur depending on the form followed by the partnership, the 
regulations propose to respect for Federal income tax purposes the form 
of a partnership division accomplished under laws of the applicable 
jurisdiction if the partnership undertakes the steps of either the 
Assets-Over Form or the Assets-Up Form. Thus, the same forms allowed 
for partnership mergers will be allowed for partnership divisions.
    Generally, an entity cannot be classified as a partnership if it 
has only one member. This universally has been held to be the case in 
classifying transactions where interests in a partnership are 
transferred to a single person, so that the partnership goes out of 
existence. McCauslen v. Commissioner, 45 T.C. 588 (1966); Rev. Rul. 99-
6, 1999-6 I.R.B. 6; Rev. Rul.
67-65, 1967-1 C.B. 168; Rev. Rul. 55-68, 1955-1 C.B. 372.
    However, in at least one instance involving the contribution of 
assets by an existing partnership to a newly-formed partnership, 
regulations have provided that the momentary existence of the new 
partnership will be respected for Federal income tax purposes. See 
Sec. 1.708-1(b)(1)(iv). Pursuant to the proposed regulations, under the 
Assets-Over Form of a partnership division, the prior partnership's 
momentary ownership of all the interests in a resulting partnership 
will not prevent the resulting partnership from being classified as a 
partnership on formation.
    The example in current Sec. 1.708-1(b)(2)(ii) indicates that when a 
partnership is not considered a continuation of the prior partnership 
under section 708(b)(2)(B) (partnership considered a new partnership 
under current Sec. 1.708-1(b)(2)(ii)), the new partnership is created 
under the Assets-Up Form. The regulations propose to modify this result 
and provide examples illustrating that partnerships can divide and 
create a new partnership under either the Assets-Over Form or the 
Assets-Up Form.
    Consistent with partnership mergers, if a partnership divides using 
a form other than the two prescribed, it will be treated as undertaking 
the Assets-Over Form.
    These proposed regulations use four terms to describe the form of a 
partnership division. Two of these terms, prior partnership and 
resulting partnership, describe partnerships that exist under the 
applicable jurisdictional law. The prior partnership is the partnership 
that exists under the applicable jurisdictional law before the 
division, and the resulting partnerships are the partnerships that 
exist under the applicable jurisdictional law after the division. The 
other two terms, divided partnership and recipient partnership, are 
Federal tax concepts. A divided partnership is a partnership that is 
treated, for Federal income tax purposes, as transferring assets in 
connection with a division, and a recipient partnership is a 
partnership that is treated, for Federal income tax purposes, as 
receiving assets in connection with a division. The divided partnership 
must be a continuation of the prior partnership. Although the divided 
partnership is considered one continuing partnership for Federal income 
tax purposes, it may actually be two different partnerships under the 
applicable jurisdictional law (i.e., the prior partnership and a 
different resulting partnership that is considered a continuation of 
the prior partnership for Federal income tax purposes).
    Finally, because in a formless division it generally will be 
unclear which partnership should be treated, for Federal income tax 
purposes, as transferring assets (i.e., the divided partnership) to 
another partnership (i.e., the recipient partnership) where more than 
one partnership is a continuation of the prior partnership, the 
proposed regulations provide that the continuing resulting partnership 
with the assets having the greatest fair market value (net of 
liabilities) will be treated as the divided partnership. This issue 
also is present where the partnership that, in form, transfers assets 
is not a continuation of the prior partnership, but more than one of 
the other resulting partnerships are continuations of the prior 
partnership. The same rule applies to these situations.

B. Consequences under Sections 704(c)(1)(B) and 737

    Gain under sections 704(c)(1)(B) and 737 may be triggered when 
section 704(c) property or substituted section 704(c) property is 
distributed to certain partners. These rules often will be implicated 
in the context of partnership divisions.
    Where a division is accomplished in a transaction that is taxed in 
accordance with the Assets-Over Form, the partnership interest in the 
recipient partnership will be treated as a section 704(c) asset to the 
extent that the interest is received by the divided partnership in 
exchange for section 704(c) property. Section 1.704-4(d)(1). 
Accordingly, the distribution of the partnership interests in the 
recipient partnership by the divided partnership generally will trigger 
section 704(c)(1)(B) where the interests in the recipient partnership 
are received by a partner of the divided partnership other than the 
partner who contributed the section 704(c) property to the divided 
partnership. In addition, section 737 may be triggered if a partner who 
contributed section 704(c) property to the divided partnership receives 
an interest in the recipient partnership that is not attributable to 
the section 704(c) property.
    Where a division is accomplished under the Assets-Up Form, assets 
are distributed directly to the partners who will hold interests in the 
recipient partnership. The distribution could trigger section 
704(c)(1)(B) or 737 depending on the identity of the

[[Page 1576]]

distributed asset and the distributee partner.
    The regulations under section 737 provide an exception for certain 
partnership divisions. Section 737 does not apply when a transferor 
partnership transfers all the section 704(c) property contributed by a 
partner to a second partnership in a section 721 exchange, followed by 
a distribution of an interest in the transferee partnership in complete 
liquidation of the interest of the partner that originally contributed 
the section 704(c) property to the transferor partnership. Section 
1.737-2(b)(2). This rule, however, may not apply to many partnership 
divisions because the original contributing partner often remains a 
partner in the divided partnership. No similar rule is provided under 
section 704(c)(1)(B).
    In many instances, the application of sections 704(c)(1)(B) and 737 
will be appropriate when a partnership divides under either the Assets-
Over Form or the Assets-Up Form. Consider the following example: A, B, 
C, and D form a partnership. A contributes appreciated property X ($0 
basis and $200 value), B contributes property Y ($200 basis and $200 
value), and C and D each contribute $200 cash. The partnership 
subsequently divides into two partnerships using the Assets-Over Form, 
distributing interests in the recipient partnership in accordance with 
each partner's pro rata interest in the prior partnership. Property X 
remains in the prior partnership, and property Y is contributed to the 
recipient partnership. Under these facts, section 737 could be avoided 
if an exception were created for the distribution of the recipient 
partnership interests. If, subsequent to the division, half of property 
Y is distributed to A, section 737 would not be triggered because 
property X (the section 704(c) property) is no longer in the same 
partnership as property Y.
    While the IRS and Treasury generally believe that it is appropriate 
to apply sections 704(c)(1)(B) and 737 in the context of partnership 
divisions, comments are invited on whether it would be appropriate to 
expand the exceptions to these sections in certain circumstances 
relating to divisive transactions.

C. Division as Part of a Larger Transaction

    The proposed regulations provide the same rule for partnership 
divisions that applies to partnership mergers.

D. Effective Date

    The regulations are proposed to apply to divisions occurring on or 
after the date final regulations are published in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
these regulations do not impose on small entities a collection of 
information requirement, the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) does not apply. Therefore, a Regulatory Flexibility Analysis 
is not required. Pursuant to section 7805(f) of the Internal Revenue 
Code, this notice of proposed rulemaking will be submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (preferably a 
signed original and eight (8) copies) that are submitted timely to the 
IRS. The IRS and the Department of Treasury specifically request 
comments on the clarity of the proposed regulations and how they may be 
made easier to understand. All comments will be available for public 
inspection and copying.
    A public hearing has been scheduled for May 4, 2000, beginning at 
10 a.m., in room 2615, Internal Revenue Building, 1111 Constitution 
Avenue, NW, Washington, DC. Due to building security procedures, 
visitors must enter at the 10th Street entrance, located between 
Constitution and Pennsylvania Avenues, NW. In addition, all visitors 
must present photo identification to enter the building. Because of 
access restrictions, visitors will not be admitted beyond the immediate 
entrance area more than 15 minutes before the hearing starts. For 
information about having your name placed on the building access list 
to attend the hearing, see the FOR FURTHER INFORMATION CONTACT section 
of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons 
that wish to present oral comments at the hearing must submit timely 
written comments and must submit an outline of the topics to be 
discussed and the time to be devoted to each topic (preferably a signed 
original and eight (8) copies) by April 13, 2000.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.
    Drafting information: The principal author of these regulations is 
Mary Beth Collins, Office of Chief Counsel (Passthroughs and Special 
Industries). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read as 
follows:

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

    Par. 2. Section 1.708-1 is amended as follows:
    1. Paragraph (b) is amended by removing paragraph (b)(2) and by 
redesignating each paragraph listed in the first column of the 
following table as the paragraph listed in the second column:

------------------------------------------------------------------------
               Old paragraph                   Redesignated  paragraph
------------------------------------------------------------------------
(b)(1)(i).................................  (b)(1)
(b)(1)(i)(a)..............................  (b)(1)(i)
(b)(1)(i)(b)..............................  (b)(1)(ii)
(b)(1)(ii)................................  (b)(2)
(b)(1)(iii)...............................  (b)(3)
(b)(1)(iii)(a)............................  (b)(3)(i)
(b)(1)(iii)(b)............................  (b)(3)(ii)
(b)(1)(iv)................................  (b)(4)
(b)(1)(v).................................  (b)(5)
------------------------------------------------------------------------

    2. Paragraphs (c) and (d) are added to read as follows:


Sec. 1.708-1  Continuation of partnership.

* * * * *
    (c) Merger or consolidation--(1) General rule. If two or more 
partnerships merge or consolidate into one partnership, the resulting 
partnership shall be considered a continuation of the merging or 
consolidating partnership the members of which own an interest of more 
than 50 percent in the capital and profits of the resulting 
partnership. If the resulting partnership can, under the preceding 
sentence, be considered a continuation of more than one of the merging 
or

[[Page 1577]]

consolidating partnerships, it shall, unless the Commissioner permits 
otherwise, be considered the continuation of that partnership which is 
credited with the contribution of assets having the greatest fair 
market value (net of liabilities) to the resulting partnership. Any 
other merging or consolidating partnerships shall be considered as 
terminated. If the members of none of the merging or consolidating 
partnerships have an interest of more than 50 percent in the capital 
and profits of the resulting partnership, all of the merged or 
consolidated partnerships are terminated, and a new partnership 
results. The taxable years of such merging or consolidating 
partnerships which are considered terminated shall be closed in 
accordance with the provisions of section 706(c), and such partnerships 
shall file their returns for a taxable year ending upon the date of 
termination, i.e., the date of merger or consolidation. The resulting 
partnership shall file a return for the taxable year of the merging or 
consolidating partnership that is considered as continuing. The return 
shall state that the resulting partnership is a continuation of such 
merging or consolidating partnership and shall include the names and 
addresses of the merged or consolidated partnerships. The respective 
distributive shares of the partners for the periods prior to and 
subsequent to the date of merger or consolidation shall be shown as a 
part of the return.
    (2) Form of a merger or consolidation--(i) Assets-over form. When 
two or more partnerships merge or consolidate into one partnership 
under the applicable jurisdictional law without undertaking a form for 
the merger or consolidation, or undertake a form for the merger or 
consolidation that is not described in paragraph (c)(2)(ii) of this 
section, any merged or consolidated partnership that is considered 
terminated under paragraph (c)(1) of this section is treated as 
undertaking the assets-over form for Federal income tax purposes. Under 
the assets-over form, the merged or consolidated partnership that is 
considered terminated under paragraph (c)(1) of this section 
contributes all of its assets and liabilities to the resulting 
partnership in exchange for an interest in the resulting partnership; 
and, immediately thereafter, the terminated partnership distributes 
interests in the resulting partnership to its partners in liquidation 
of the terminated partnership.
    (ii) Assets-up form. Despite the partners' transitory ownership of 
the terminated partnership's assets and liabilities, the form of a 
partnership merger or consolidation will be respected for Federal 
income tax purposes if the merged or consolidated partnership that is 
considered terminated under paragraph (c)(1) of this section 
distributes its assets and liabilities to its partners in liquidation 
of the partners' interests in the terminated partnership; and, 
immediately thereafter, the partners in the terminated partnership 
contribute the distributed assets and liabilities to the resulting 
partnership in exchange for interests in the resulting partnership.
    (3) Sale of an interest in the merging or consolidating 
partnership. In a transaction characterized under the assets-over form, 
a sale of an interest in the terminated partnership to the resulting 
partnership that occurs as part of a merger or consolidation under 
section 708(b)(2)(A), as described in paragraph (c)(2)(i) of this 
section, will be respected as a sale of a partnership interest if the 
merger agreement (or similar document) specifies that the resulting 
partnership is purchasing interests from a particular partner in the 
merging or consolidating partnership and the consideration that is 
transferred for each interest sold. See section 741 and Sec. 1.741-1 
for determining the selling partner's gain or loss on the sale or 
exchange of the partnership interest.
    (4) Examples. The following examples illustrate the rules in 
paragraphs (c)(1) through (3) of this section:

    Example 1. Partnership AB, in whose capital and profits A and B 
each own a 50-percent interest, and partnership CD, in whose capital 
and profits C and D each own a 50-percent interest, merge on 
September 30, 1999, and form partnership ABCD. Partners A, B, C, and 
D are on a calendar year, and partnership AB and partnership CD are 
also on a calendar year. After the merger, the partners have capital 
and profits interests as follows: A, 30 percent; B, 30 percent; C, 
20 percent; and D, 20 percent. Since A and B together own an 
interest of more than 50 percent in the capital and profits of 
partnership ABCD, such partnership shall be considered a 
continuation of partnership AB and shall continue to file returns on 
a calendar year basis. Since C and D own an interest of less than 50 
percent in the capital and profits of partnership ABCD, the taxable 
year of partnership CD closes as of September 30, 1999, the date of 
the merger, and partnership CD is terminated as of that date. 
Partnership ABCD is required to file a return for the taxable year 
January 1 to December 31, 1999, indicating thereon that, until 
September 30, 1999, it was partnership AB. Partnership CD is 
required to file a return for its final taxable year, January 1 
through September 30, 1999.
    Example 2. (i) Partnership X, in whose capital and profits A 
owns a 40-percent interest and B owns a 60-percent interest, and 
partnership Y, in whose capital and profits B owns a 60-percent 
interest and C owns a 40-percent interest, merge on September 30, 
1999. The dollar-value of the partnership X assets (net of 
liabilities) is $100X, and the dollar-value of the partnership Y 
assets (net of liabilities) is $200X. The merger is accomplished 
under state law by partnership Y contributing its assets and 
liabilities to partnership X in exchange for interests in 
partnership X, with partnership Y then liquidating, distributing 
interests in partnership X to B and C.
    (ii) B, a partner in both partnerships prior to the merger, owns 
a greater than 50-percent interest in the resulting partnership 
following the merger. Accordingly, because the dollar-value of 
partnership Y's assets (net of liabilities) was greater than that of 
partnership X's, under paragraph (c)(1) of this section, X will be 
considered to terminate in the merger. As a result, even though, for 
state law purposes, the transaction was undertaken with partnership 
Y contributing its assets and liabilities to partnership X and 
distributing interests in partnership X to its partners, pursuant to 
paragraph (c)(2)(i) of this section, for Federal income tax 
purposes, the transaction will be treated as if partnership X 
contributed its assets to partnership Y in exchange for interests in 
partnership Y and then liquidated, distributing interests in 
partnership Y to A and B.
    Example 3. (i) Partnership X and partnership Y merge when the 
partners of partnership X transfer their partnership X interests to 
partnership Y in exchange for partnership Y interests. Immediately 
thereafter, partnership X liquidates into partnership Y. The 
resulting partnership is considered a continuation of partnership Y, 
and partnership X is considered terminated.
    (ii) The partnerships are treated as undertaking the assets-over 
form described in paragraph (c)(2)(i) of this section because the 
partnerships undertook a form that is not the assets-up form 
described in paragraph (c)(2)(ii) of this section. Accordingly, for 
Federal income tax purposes, partnership X is deemed to contribute 
its assets and liabilities to partnership Y in exchange for 
interests in partnership Y; and, immediately thereafter, partnership 
X is deemed to have distributed the interests in partnership Y to 
its partners in liquidation of their interests in partnership X.
    Example 4. (i) A, B, and C are partners in partnership X. D, E, 
and F are partners in Partnership Y. Partnership X and partnership Y 
merge within the meaning of section 708(b)(2)(A), and the resulting 
partnership is considered a continuation of partnership Y. 
Partnership X is considered terminated. Under state law, 
partnerships X and Y undertake the assets-over form of paragraph 
(c)(2)(i) of this section to accomplish the partnership merger. C 
does not want to become a partner in partnership Y, and partnership 
X does not have the resources to buy C's interest before the merger. 
C, partnership X, and partnership Y enter into an agreement that 
specifies that partnership Y will purchase C's interest in 
partnership X for $150 immediately before the merger. As

[[Page 1578]]

part of the merger, partnership X receives from partnership Y $150 
that will be distributed to C immediately before the merger, and 
interests in partnership Y in exchange for partnership X's assets 
and liabilities. Partnership X has made an election under section 
754.
    (ii) Because the merger agreement satisfies the requirements of 
paragraph (c)(3) of this section, C will be treated as selling its 
interest in partnership X to partnership Y for $150 immediately 
before the merger. See section 741 and Sec. 1.741-1 to determine the 
amount and character of C's gain or loss on the sale or exchange of 
its interest in partnership X.
    (iii) Because the merger agreement satisfies the requirements of 
paragraph (c)(3) of this section, partnership Y is considered to 
have purchased C's interest in partnership X for $150 immediately 
before the merger. See Sec. 1.704-1(b)(2)(iv)(l) for determining 
partnership Y's capital account in partnership X. Partnership Y's 
adjusted basis of its interest in partnership X is determined under 
section 742 and Sec. 1.742-1. To the extent any built-in gain or 
loss on section 704(c) property in partnership X would have been 
allocated to C (including any allocations with respect to property 
revaluations under section 704(b) (reverse section 704(c) 
allocations)), see section 704 and Sec. 1.704-3(a)(7) for 
determining the built-in gain or loss or reverse section 704(c) 
allocations apportionable to partnership Y. Similarly, after the 
merger is completed, the built-in gain or loss and reverse section 
704(c) allocations attributable to C's interest are apportioned to 
D, E, and F under section 704(c) and Sec. 1.704-3(a)(7).
    (iv) Because partnership X has an election under section 754 in 
effect, partnership Y, as a momentary partner in partnership X, will 
have a special basis adjustment regarding the basis of partnership 
X's property under section 743 and Sec. 1.743-1. See section 743 and 
Sec. 1.743-1 for determining the amount of the adjustment. After the 
merger, the adjustment is allocated solely to D, E, and F--the 
partners in partnership Y immediately before the merger.
    (v) Under paragraph (c)(2)(i) of this section, partnership X 
contributes assets and liabilities attributable to the interests of 
A and B to partnership Y in exchange for interests in partnership Y; 
and, immediately thereafter, partnership X distributes the interests 
in partnership Y to A and B in liquidation of their interests in 
partnership X. At the same time, partnership X distributes assets to 
partnership Y in liquidation of partnership Y's interest in 
partnership X.

    (5) Prescribed form not followed in certain circumstances. (i) If 
any transactions described in paragraph (c)(2) or (3) of this section 
are part of a larger series of transactions, and the substance of the 
larger series of transactions is inconsistent with following the form 
prescribed in such paragraph, the Commissioner may disregard such form, 
and may recast the larger series of transactions in accordance with 
their substance.
    (ii) The following example illustrates the rule in paragraph (c)(5) 
of this section:

    Example. A, B, and C are equal partners in partnership ABC. ABC 
holds no section 704(c) property. D and E are equal partners in 
partnership DE. B and C want to exchange their interest in ABC for 
all of the interests in DE. However, rather than exchanging 
partnership interests, DE merges with ABC by undertaking the assets-
up form described in paragraph (c)(2)(ii) of this section, with D 
and E receiving title to the DE assets and then contributing the 
assets to ABC in exchange for interests in ABC. As part of a 
prearranged transaction, the assets acquired from DE are contributed 
to a new partnership, and the interests in the new partnership are 
distributed to B and C in complete liquidation of their interests in 
ABC. The merger and division in this example represent a series of 
transactions that in substance are an exchange of interests in ABC 
for interests in DE. Even though paragraph (c)(2)(ii) of this 
section provides that the form of a merger will be respected for 
Federal income tax purposes if the steps prescribed under the asset-
up form are followed, and paragraph (d)(2)(i) of this section 
provides a form that will be followed for Federal income tax 
purposes in the case of partnership divisions, these forms will not 
be respected for Federal income tax purposes under these facts, and 
the transactions will be recast in accordance with their substance 
as a taxable exchange of interests in ABC for interests in DE.

    (6) Effective date. This paragraph (c) is applicable to partnership 
mergers occurring on or after the date final regulations are published 
in the Federal Register.

    (d) Division of a partnership--(1) General rule. Upon the division 
of a partnership into two or more partnerships, any resulting 
partnership (as defined in paragraph (d)(3)(iv) of this section) or 
resulting partnerships shall be considered a continuation of the prior 
partnership (as defined in paragraph (d)(3)(ii) of this section) if the 
members of the resulting partnership or partnerships had an interest of 
more than 50 percent in the capital and profits of the prior 
partnership. Any other resulting partnership will not be considered a 
continuation of the prior partnership but will be considered a new 
partnership. If the members of none of the resulting partnerships owned 
an interest of more than 50 percent in the capital and profits of the 
prior partnership, none of the resulting partnerships will be 
considered a continuation of the prior partnership and the prior 
partnership will be considered to have terminated. Where members of a 
partnership which has been divided into two or more partnerships do not 
become members of a resulting partnership which is considered a 
continuation of the prior partnership, such partner's interests shall 
be considered liquidated as of the date of the division. The resulting 
partnership that is regarded as continuing shall file a return for the 
taxable year of the partnership that has been divided. The return shall 
state that the partnership is a continuation of the prior partnership 
and shall set forth separately the respective distributive shares of 
the partners for the periods prior to and subsequent to the date of 
division.
    (2) Form of a division--(i) Assets-over form. When a partnership 
divides into two or more partnerships under applicable jurisdictional 
law without undertaking a form for the division, or undertakes a form 
that is not described in paragraph (d)(2)(ii) of this section, the 
transaction will be characterized under the assets-over form for 
Federal income tax purposes.
    (A) Assets-over form where at least one resulting partnership is a 
continuation of the prior partnership. In a division under the assets-
over form where at least one resulting partnership is a continuation of 
the prior partnership, the divided partnership (as defined in paragraph 
(d)(3)(i) of this section) contributes certain assets and liabilities 
to a recipient partnership (as defined in paragraph (d)(3)(iv) of this 
section) or recipient partnerships in exchange for interests in such 
recipient partnership or partnerships; and, immediately thereafter, 
distributes the interests in such recipient partnership or partnerships 
to some or all of its partners in partial or complete liquidation of 
the partners' interests in the divided partnership.
    (B) Assets-over form where none of the resulting partnerships is a 
continuation of the prior partnership. In a division under the assets-
over form where none of the resulting partnerships is a continuation of 
the prior partnership, the prior partnership will be treated as 
contributing all of its assets and liabilities to new resulting 
partnerships in exchange for interests in the resulting partnerships; 
and, immediately thereafter, the prior partnership will be treated as 
liquidating by distributing the interests in the new resulting 
partnerships to the prior partnership's partners.
    (ii) Assets-up form--(A) Assets-up form where the partnership 
distributing assets is a continuation of the prior partnership. Despite 
the partners' transitory ownership of some of the prior partnership's 
assets and liabilities, the form of a partnership division will be 
respected for Federal income tax purposes if the divided partnership, 
which by definition is a continuing partnership, distributes certain 
assets and liabilities to some or all of its partners in partial or 
complete liquidation of the partners' interests in

[[Page 1579]]

the divided partnership; and, immediately thereafter, such partners 
contribute the distributed assets and liabilities to a recipient 
partnership or partnerships in exchange for interests in such recipient 
partnership or partnerships.
    (B) Assets-up form where none of the resulting partnerships are a 
continuation of the prior partnership. If none of the resulting 
partnerships are a continuation of the prior partnership, then despite 
the partners' transitory ownership of some or all of the prior 
partnership's assets and liabilities, the form of a partnership 
division will be respected for Federal income tax purposes if the prior 
partnership distributes certain assets and liabilities to some or all 
of its partners in partial or complete liquidation of the partners' 
interests in the prior partnership; and, immediately thereafter, such 
partners contribute the distributed assets and liabilities to a 
resulting partnership or partnerships in exchange for interests in such 
resulting partnership or partnerships. If the prior partnership does 
not liquidate under the applicable jurisdictional law, then with 
respect to the assets and liabilities that, in form, are not 
transferred to a new resulting partnership, the prior partnership will 
be treated as transferring these assets and liabilities to a new 
resulting partnership under the assets over form described in paragraph 
(d)(2)(i)(B) of this section.
    (3) Definitions--(i) Divided partnership--For purposes of paragraph 
(d) of this section, the divided partnership is the partnership which 
is treated, for Federal income tax purposes, as transferring the assets 
and liabilities to the recipient partnership or partnerships, either 
directly (under the assets-over form) or indirectly (under the assets-
up form). If the resulting partnership that, in form, transferred the 
assets and liabilities in connection with the division is a 
continuation of the prior partnership, then such resulting partnership 
will be treated as the divided partnership. If a partnership divides 
into two or more partnerships and only one of the resulting 
partnerships is a continuation of the prior partnership, then the 
resulting partnership that is a continuation of the prior partnership 
will be treated as the divided partnership. If a partnership divides 
into two or more partnerships without undertaking a form for the 
division that is recognized under paragraph (d)(2) of this section, or 
if the resulting partnership that had, in form, transferred assets and 
liabilities is not considered a continuation of the prior partnership, 
and more than one resulting partnership is considered a continuation of 
the prior partnership, the continuing resulting partnership with the 
assets having the greatest fair market value (net of liabilities) will 
be treated as the divided partnership.
    (ii) Prior partnership--For purposes of paragraph (d) of this 
section, the prior partnership is the partnership subject to division 
that exists under applicable jurisdictional law before the division.
    (iii) Recipient partnership--For purposes of paragraph (d) of this 
section, a recipient partnership is a partnership that is treated as 
receiving, for Federal income tax purposes, assets and liabilities from 
a divided partnership, either directly (under the assets-over form) or 
indirectly (under the assets-up form).
    (iv) Resulting partnership--For purposes of paragraph (d) of this 
section, a resulting partnership is a partnership resulting from the 
division that exists under applicable jurisdictional law after the 
division. For example, where a prior partnership divides into two 
partnerships, both partnerships existing after the division are 
resulting partnerships.
    (4) Examples. The following examples illustrate the rules in 
paragraphs (d)(1), (2), and (3) of this section:

    Example 1. Partnership ABCD is in the real estate and insurance 
business. A owns a 40-percent interest, and B, C, and D each owns a 
20-percent interest, in the capital and profits of the partnership. 
The partnership and the partners report their income on a calendar 
year. They agree to separate the real estate and insurance business 
as of November 1, 1999, and to form two partnerships; partnership AB 
to take over the real estate business, and partnership CD to take 
over the insurance business. Because members of resulting 
partnership AB owned more than a 50-percent interest in the capital 
and profits of partnership ABCD (A, 40 percent, and B, 20 percent), 
partnership AB shall be considered a continuation of partnership 
ABCD. Partnership AB is required to file a return for the taxable 
year January 1 to December 31, 1999, indicating thereon that until 
November 1, 1999, it was partnership ABCD. Partnership CD is 
considered a new partnership formed on November 1, 1999, and is 
required to file a return for the taxable year it adopts pursuant to 
section 706(b) and the applicable regulations.
    Example 2. (i) Partnership ABCD owns properties W, X, Y, and Z, 
and divides into partnership AB and partnership CD. Under paragraph 
(d)(1) of this section, partnership AB is considered a continuation 
of partnership ABCD and partnership CD is considered a new 
partnership. Partnership ABCD distributes property Y to C and titles 
property Y in C's name. Partnership ABCD distributes property Z to D 
and titles property Z in D's name. C and D then contribute 
properties Y and Z, respectively, to partnership CD in exchange for 
interests in partnership CD. Properties W and X remain in 
partnership AB.
    (ii) Under paragraph (d)(2)(ii) of this section, partnership 
ABCD will be treated as following the assets-up form for Federal 
income tax purposes.
    Example 3. (i) Partnership ABCD owns three parcels of property: 
property X, with a value of $500; property Y, with a value of $300; 
and property Z, with a value of $200. A and B each own a 40-percent 
interest in the capital and profits of partnership ABCD, and C and D 
each own a 10 percent interest in the capital and profits of 
partnership ABCD. On November 1, 1999, partnership ABCD divides into 
three partnerships (AB1, AB2, and CD) by contributing property X to 
a newly formed partnership (AB1) and distributing all interests in 
such partnership to A and B as equal partners, and by contributing 
property Z to a newly formed partnership (CD) and distributing all 
interests in such partnership to C and D as equal partners in 
exchange for all of their interests in partnership ABCD.
    (ii) Partnerships AB1 and AB2 both are considered a continuation 
of partnership ABCD, while partnership CD is considered a new 
partnership formed on November 1, 1999. Under paragraph (d)(2)(i)(A) 
of this section, partnership ABCD will be treated as following the 
assets-over form, with partnership ABCD contributing property X to 
partnership AB1 and property Z to partnership CD, and distributing 
the interests in such partnerships to the designated partners.
    Example 4. (i) The facts are the same as in example 3, except 
that partnership ABCD divides into three partnerships by operation 
of state law, without undertaking a form.
    (ii) Under the last sentence of paragraph (d)(3)(i) of this 
section, partnership AB1 will be treated as the resulting 
partnership that is the divided partnership. Under paragraph 
(d)(2)(i)(A) of this section, partnership ABCD will be treated as 
following the assets-over form, with partnership ABCD contributing 
property Y to partnership AB2 and property Z to partnership CD, and 
distributing the interests in such partnerships to the designated 
partners.
    Example 5. (i) The facts are the same as in example 3, except 
that partnership ABCD divides into three partnerships by 
contributing property X to newly-formed partnership AB1 and property 
Y to newly-formed partnership AB2 and distributing all interests in 
each partnership to A and B in exchange for all of their interests 
in partnership ABCD.
    (ii) Because resulting partnership CD is not a continuation of 
the prior partnership (partnership ABCD), partnership CD cannot be 
treated, for Federal income tax purposes, as the partnership that 
transferred assets (i.e., the divided partnership), but instead must 
be treated as a recipient partnership. Under the last sentence of 
paragraph (d)(3)(i) of this section, partnership AB1 will be treated 
as the resulting partnership that is the divided partnership. Under 
paragraph (d)(2)(i)(A) of this section, partnership ABCD will be 
treated as following the assets-over form, with partnership ABCD 
contributing property Y to partnership AB2 and property Z to

[[Page 1580]]

partnership CD, and distributing the interests in such partnerships 
to the designated partners.
    Example 6. (i) Partnership ABCDE owns Blackacre, Whiteacre, and 
Redacre, and divides into partnership AB, partnership CD, and 
partnership DE. Under paragraph (d)(1) of this section, partnership 
ABCDE is considered terminated (and, hence, none of the resulting 
partnerships are a continuation of the prior partnership) because 
none of the members of the new partnerships (partnership AB, 
partnership CD, and partnership DE) owned an interest of more than 
50 percent in the capital and profits of partnership ABCDE.
    (ii) Partnership ABCDE distributes Blackacre to A and B and 
titles Blackacre in the names of A and B. A and B then contribute 
Blackacre to partnership AB in exchange for interests in partnership 
AB. Partnership ABCDE will be treated as following the assets-up 
form described in paragraph (d)(2)(ii)(B) of this section for 
Federal income tax purposes.
    (iii) Partnership ABCDE distributes Whiteacre to C and D and 
titles Whiteacre in the names of C and D. C and D then contribute 
Whiteacre to partnership CD in exchange for interests in partnership 
CD. Partnership ABCDE will be treated as following the assets-up 
form described in paragraph (d)(2)(ii)(B) of this section for 
Federal income tax purposes.
    (iv) Partnership ABCDE does not liquidate under state law so 
that, in form, the assets in new partnership DE are not considered 
to have been transferred under state law. Partnership ABCDE will be 
treated as undertaking the assets-over form described in paragraph 
(d)(2)(i)(B) of this section for Federal income tax purposes with 
respect to the assets of partnership DE. Thus, partnership ABCDE 
will be treated as contributing Redacre to partnership DE in 
exchange for interests in partnership DE; and, immediately 
thereafter, partnership ABCDE will be treated as distributing 
interests in partnership DE to D and E in liquidation of their 
interests in partnership ABCDE. Partnership ABCDE then terminates.

    (5) Prescribed form not followed in certain circumstances. If any 
transactions described in paragraph (d)(2) of this section are part of 
a larger series of transactions, and the substance of the larger series 
of transactions is inconsistent with following the form prescribed in 
such paragraph, the Commissioner may disregard such form, and may 
recast the larger series of transactions in accordance with their 
substance.
    (6) Effective date. This paragraph (d) is applicable to partnership 
divisions occurring on or after the date final regulations are 
published in the Federal Register.
    Par. 3. Section 1.743-1 is amended by adding two sentences to the 
end of paragraph (h)(1).


Sec. 1.743-1  Optional adjustment to basis of partnership property.

* * * * *
    (h) * * *
    (1) * * * When a resulting partnership that is considered a 
continuation of a merged or consolidated partnership under section 
708(b)(2)(A) has a basis adjustment in property held by the merged or 
consolidated partnership that is considered terminated under 
Sec. 1.708-1(c)(1) (as a result of the resulting partnership acquiring 
an interest in such merged or consolidated partnership, see Sec. 1.708-
1(c)(3)), the resulting partnership will continue to have the same 
basis adjustments with respect to property distributed (see Sec. 1.708-
1(c)(4), Example 4(v)) by the terminated partnership to the resulting 
partnership, regardless of whether the resulting partnership makes a 
section 754 election. The portion of the resulting partnership's 
adjusted basis in its assets attributable to the basis adjustment with 
respect to the property distributed by the terminating partnership must 
be segregated and allocated solely to the partners who were partners in 
the resulting partnership immediately before the merger or 
consolidation.
* * * * *
    Par. 4. Section 1.752-1 is amended as follows:
    1. A sentence is added to the end of paragraph (f).
    2. The current Example in paragraph (g) is redesignated as Example 
1.
    3. Example 2 is added in paragraph (g).


Sec. 1.752-1  Treatment of partnership liabilities.

* * * * *
    (f) * * * When two or more partnerships merge or consolidate under 
section 708(b)(2)(A), as described in Sec. 1.708-1(c)(2)(i), increases 
and decreases in partnership liabilities associated with the merger or 
consolidation are netted by the partners in the terminating partnership 
and the resulting partnership to determine the effect of the merger 
under section 752.
    (g) * * *
    Example 1. * * *
    Example 2. Merger or consolidation of partnerships holding 
property encumbered by liabilities. (i) B owns a 70 percent interest 
in partnership T. Partnership T's sole asset is property X, which is 
encumbered by a $900 liability. Partnership T's adjusted basis in 
property X is $600, and the value of property X is $1,000. B's 
adjusted basis in its partnership T interest is $420. B also owns a 
20 percent interest in partnership S. Partnership S's sole asset is 
property Y, which is encumbered by a $100 liability. Partnership S's 
adjusted basis in property Y is $200, the value of property Y is 
$1,000, and B's adjusted basis in its partnership S interest is $40.
    (ii) Partnership T and partnership S merge under section 
708(b)(2)(A). Under section 708(b)(2)(A) and Sec. 1.708-1(c)(1), 
partnership T is considered terminated and the resulting partnership 
is considered a continuation of partnership S. Partnerships T and S 
undertake the form described in Sec. 1.708-1(c)(2)(i) for the 
partnership merger. Under Sec. 1.708-1(c)(2)(i), partnership T 
contributes property X and its $900 liability to partnership S in 
exchange for an interest in partnership S. Immediately thereafter, 
partnership T distributes the interests in partnership S to its 
partners in liquidation of their interests in partnership T. B owns 
a 25 percent interest in partnership S after partnership T 
distributes the interests in partnership S to B.
    (iii) Under paragraph (f) of this section, B nets the increases 
and decreases in its share of partnership liabilities associated 
with the merger of partnership T and partnership S. Before the 
merger, B's share of partnership liabilities was $650 (B had a $630 
share of partnership liabilities in partnership T and a $20 share of 
partnership liabilities in partnership S immediately before the 
merger). B's share of S's partnership liabilities after the merger 
is $250 (25 percent of S's total partnership liabilities of $1,000). 
Accordingly, B has a $400 net decrease in its share of S's 
partnership liabilities. Thus, B is treated as receiving a $400 
distribution from partnership S under section 752(b). Because B's 
adjusted basis in its partnership S interest before the deemed 
distribution under section 752(b) is $460 ($420 + $40), B will not 
recognize gain under section 731. After the merger, B's adjusted 
basis in its partnership S interest is $60.
* * * * *
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 00-14 Filed 1-10-00; 8:45 am]
BILLING CODE 4830-01-U