4408 Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules

economic impact, positive or negative,

on a substantial number of small entities

under the criteria of the Regulatory

Flexibility Act. A copy of the draft

regulatory evaluation prepared for this

action is contained in the Rules Docket.

A copy of it may be obtained by

contacting the Rules Docket at the

location provided under the caption

ADDRESSES.

List of Subjects in 14 CFR Part 39

Air transportation, Aircraft, Aviation

safety, Safety.

The Proposed Amendment

Accordingly, pursuant to the

authority delegated to me by the

Administrator, the Federal Aviation

Administration proposes to amend part

39 of the Federal Aviation Regulations

(14 CFR part 39) as follows:

PART 39—AIRWORTHINESS

DIRECTIVES

1. The authority citation for part 39

continues to read as follows:

Authority: 49 U.S.C. 106(g), 40113, 44701.

§ 39.13 [Amended]

2. Section 39.13 is amended by

adding the following new airworthiness

directive:

Fokker: Docket 97–NM–278–AD.

Applicability: All Model F28 Mark 0070

and 0100 series airplanes, certificated in any

category.

Note 1: This AD applies to each airplane

identified in the preceding applicability

provision, regardless of whether it has been

modified, altered, or repaired in the area

subject to the requirements of this AD. For

airplanes that have been modified, altered, or

repaired so that the performance of the

requirements of this AD is affected, the

owner/operator must request approval for an

alternative method of compliance in

accordance with paragraph (c) of this AD.

The request should include an assessment of

the effect of the modification, alteration, or

repair on the unsafe condition addressed by

this AD; and, if the unsafe condition has not

been eliminated, the request should include

specific proposed actions to address it.

Compliance: Required as indicated, unless

accomplished previously.

To prevent failure of the main landing gear

(MLG) due to loose connections between the

upper and lower torque links of the MLG,

accomplish the following:

(a) Inspect the torque links of the left and

right MLG assemblies to determine if the

lockwire is installed on the apex bolt, in

accordance with Fokker F100 All Operator

Message (AOM) AOF100.013, Reference

TS96.68988, dated December 19, 1996, at the

time specified in paragraph (a)(1) or (a)(2) of

this AD, as applicable. If any discrepancy is

found, prior to further flight, retorque the

apex bolt and install lockwire in accordance

with the AOM.

(1) For airplanes equipped with Menasco

Aerospace, Ltd., MLG assemblies: Inspect

within 5 days after the effective date of this

AD.

(2) For airplanes equipped with MessierDowty, Ltd., MLG assemblies: Inspect within

30 days after the effective date of this AD.

(b) As of the effective date of this AD, no

person shall install on any airplane an MLG

torque link unless it has been inspected and

corrective action has been accomplished, in

accordance with Fokker F100 All Operator

Message (AOM) AOF100.013, Reference

TS96.68988, dated December 19, 1996.

(c) An alternative method of compliance or

adjustment of the compliance time that

provides an acceptable level of safety may be

used if approved by the Manager,

International Branch, ANM–116, FAA,

Transport Airplane Directorate. Operators

shall submit their requests through an

appropriate FAA Principal Maintenance

Inspector, who may add comments and then

send it to the Manager, International Branch,

ANM–116.

Note 2: Information concerning the

existence of approved alternative methods of

compliance with this AD, if any, may be

obtained from the International Branch,

ANM–116.

(d) Special flight permits may be issued in

accordance with sections 21.197 and 21.199

of the Federal Aviation Regulations (14 CFR

21.197 and 21.199) to operate the airplane to

a location where the requirements of this AD

can be accomplished.

Note 3: The subject of this AD is addressed

in Dutch airworthiness directive 1996–147

(A), dated December 23, 1996.

Issued in Renton, Washington, on January

22, 1998.

Stewart R. Miller,

Acting Manager, Transport Airplane

Directorate, Aircraft Certification Service.

[FR Doc. 98–2137 Filed 1–28–98; 8:45 am]

BILLING CODE 4910–13–U

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG–209682–94]

RIN 1545–AS39

Adjustments Following Sales of

Partnership Interests

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Partial withdrawal of notice of

proposed rulemaking, amendment to

notice of proposed rulemaking; notice of

proposed rulemaking and notice of

public hearing.

SUMMARY: This document withdraws a

portion of the notice of proposed

rulemaking published in the Federal

Register, February 16, 1984 (49 FR

5940); contains proposed regulations

relating to the optional adjustments to

the basis of partnership property

following certain transfers of

partnership interests under section 743,

the calculation of gain or loss under

section 751(a) following the sale or

exchange of a partnership interest, the

allocation of basis adjustments among

partnership assets under section 755,

and the allocation of a partner’s basis in

its partnership interest to properties

distributed to the partner by the

partnership under section 732(c); and,

finally, amends proposed regulations

relating to the computation of a

partner’s proportionate share of the

adjusted basis of depreciable property

(or depreciable real property) under

section 1017. The changes are necessary

to provide clearer guidance on the

proper application of these sections and

will effect partnerships and partners

where there are transfers of partnership

interests, distributions of property, or

elections under sections 108(b)(5) or (c).

In addition, the proposed regulations

under section 732(c) reflect changes to

the law made by the Taxpayer Relief Act

of 1997.

DATES: Written comments must be

received by April 29, 1998. Outlines of

topics to be discussed at the public

hearing scheduled for Wednesday, July

8, 1998, at 10 a.m. must be received by

Wednesday, June 24, 1998.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–209682–94),

room 5226, Internal Revenue Service,

POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions

may be hand delivered between the

hours of 8 a.m. and 5 p.m. to:

CC:DOM:CORP:R (REG–209682–94),

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 on

the IRS Home Page, or by submitting

comments directly to the IRS internet

site at http://www.irs.ustreas.gov/prod/

taxlregs/comments.html. The public

hearing will be held in the IRS

Auditorium, Internal Revenue Building,

1111 Constitution Avenue, NW,

Washington, DC.

FOR FURTHER INFORMATION CONTACT:

Concerning the regulations, Terri A.

Belanger, (202) 622–3070; concerning

submissions and the hearing, LaNita

VanDyke, (202) 622–7180 (not toll-free

numbers).
Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules 4409

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information

contained in this notice of proposed

rulemaking has been submitted to the

Office of Management and Budget for

review in accordance with the

Paperwork Reduction Act of 1995 (44

U.S.C. 3507(d)). Comments on the

collection of information should be sent

to the Office of Management and

Budget, Attn: Desk Officer for the

Department of the Treasury, Office of

Information and Regulatory Affairs,

Washington, DC 20503, with copies to

the Internal Revenue Service, Attn: IRS

Reports Clearance Officer, T:FP,

Washington, DC 20224. Comments on

the collection of information should be

received by March 30, 1998. Comments

are specifically requested concerning:

Whether the proposed collection of

information is necessary for the proper

performance of the functions of the

Internal Revenue Service, including

whether the information will have

practical utility;

The accuracy of the estimated burden

associated with the proposed collection

of information (see below);

How the quality, utility, and clarity of

the information to be collected may be

enhanced;

How the burden of complying with

the proposed collection of information

may be minimized, including through

the application of automated collection

techniques or other forms of information

technology; and

Estimates of capital or start-up cost

and costs of operation, maintenance,

and purchase of service to provide

information.

The collection of information in this

proposed regulation is in §§ 1.743–1(b),

1.743–1(k), and 1.755–1. This

information is required in order for

partners to have adequate knowledge to

comply with section 743 and for the IRS

to verify compliance with section 743.

This information will be used to

determine whether the amount of tax

has been computed correctly. Responses

to this collection of information are

mandatory for partnerships that have

made an election under section 754 and

for which a section 743 transfer has

been made. The likely respondents are

businesses or other for-profit

institutions.

Estimated total annual recordkeeping

burden under § 1.743–1(b): 600,000

hours.

The estimated annual burden per

recordkeeper varies from 1 hour to 300

hours, depending on the individual

circumstances, with an estimated

average of 4 hours.

Estimated number of recordkeepers:

150,000.

Estimated total annual reporting

burden under § 1.743–1(k)(1): 225,000

hours.

The estimated annual burden per

respondent is estimated at an average of

3 hours.

Estimated number of respondents:

75,000.

Estimated frequency of responses: On

occasion.

Estimated total annual reporting

burden under § 1.743–1(k)(2): 75,000

hours.

The estimated annual burden per

respondent is estimated at an average of

1 hour.

Estimated number of respondents:

75,000.

Estimated frequency of responses: On

occasion.

An agency may not conduct or

sponsor, and a person is not required to

respond to, a collection of information

unless the collection of information

displays a valid OMB control number.

Books or records relating to a

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.

Background

This document proposes to (a) revise

§§ 1.743–1 and 1.755–1 of the Income

Tax Regulations (26 CFR part 1), (b)

withdraw § 1.168–2(n) of the proposed

Income Tax Regulations published on

February 16, 1984 (49 FR 5940), and (c)

amend §§ 1.732–1, 1.732–2, 1.734–1,

1.751–1 of the Income Tax Regulations,

and § 1.1017–1 of the proposed Income

Tax Regulations published January 7,

1997 (62 FR 955).

Section 743(b) provides for an

optional adjustment to the basis of

partnership property following certain

transfers of partnership interests. The

Code provides for basis adjustments in

an attempt to coordinate the transferee’s

tax consequences and economic

consequences. The amount of the basis

adjustment is the difference between the

transferee’s basis in the partnership

interest (outside basis) and its share of

the partnership’s basis in the

partnership’s assets (inside basis). Once

the amount of the basis adjustment is

determined, it is allocated among the

partnership’s various assets pursuant to

section 755.

The proposed regulations coordinate

sections 704(c), 743, 751, and 755, and

reflect changes in the Code and Income

Tax Regulations since the adoption of

the current regulations. The proposed

regulations also provide rules

concerning adjustments to the basis of

partnership property made pursuant to

section 1017(b)(3)(C). The proposed

regulations describe how to determine a

partner’s proportionate share of the

adjusted basis of depreciable property

(or depreciable real property) under

section 1017, and clarify that an

adjustment to the basis of partnership

property made under section

1017(b)(3)(C) is treated in the same

manner as an adjustment to the basis of

partnership property made under

section 743.

Section 732(c) provides for the

allocation of a partner’s basis in its

partnership interest upon certain

distributions of property to the partner

by the partnership. Section 732(c) was

amended by the Taxpayer Relief Act of

1997, Public Law 105–34, section 1061,

111 Stat. 788, 945–46 (1997). Under

prior law, the allocation was made

based on the adjusted basis of the

distributed property to the partnership

immediately before the distribution.

Under the new law, the allocation is

made, in general, based on the fair

market value of the distributed property

on the date of distribution. The

proposed regulations amend the existing

regulations under section 732 to reflect

this change.

Explanation of Provisions

A. Section 743

In General

If an election is in effect under section

754, section 743 requires the

partnership to adjust the basis of

partnership property upon the transfer

of an interest in the partnership by sale

or exchange or on the death of a partner.

The partnership is required to increase

the adjusted basis of partnership

property by the excess of the transferee’s

basis in the transferred partnership

interest over the transferee’s share of the

adjusted basis to the partnership of the

partnership’s property. The partnership

is also required to decrease the adjusted

basis of partnership property by the

excess of the transferee’s share of the

adjusted basis to the partnership of

partnership property over the

transferee’s basis in the transferred

partnership interest.

The proposed regulations address a

number of issues raised in connection

with the calculation, treatment, and

reporting of basis adjustments under

section 743. In particular, the proposed

regulations (i) Clarify the manner in

which the partnership calculates a

transferee’s income, gain, loss, or

deduction when the transferee has a
4410 Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules

basis adjustment under section 743

(including the recovery of negative basis

adjustments) and (ii) coordinate sections

743 and 704(c) when partnerships elect

the remedial allocation method under

§ 1.704–3(d). The proposed regulations

also provide that partnerships (rather

than partners) are required to make and

report the basis adjustments under

section 743(b). Partnerships are required

to adjust the transferee’s distributive

share of partnership tax items so that

the information reported on the

transferee’s Schedule K–1 reflects the

adjustments to the transferee’s

distributive share of the partnership

items affected by the basis adjustment.

Determining the Amount of the Basis

Adjustment

The amount of the basis adjustment

with respect to partnership property

under section 743 is the difference

between the transferee’s share of the

partnership’s inside basis and the

transferee’s outside basis. The current

regulations provide that a partner’s

share of the adjusted basis of

partnership property is equal to the sum

of the partner’s interest as a partner in

partnership capital and surplus, plus

the partner’s share of partnership

liabilities. The current regulations also

provide that where section 704(c)

applies to property contributed to the

partnership, section 704(c) is taken into

account in determining a partner’s share

of the adjusted basis of partnership

property.

The current regulations do not

provide, other than by example, specific

guidance on how to determine a

transferee partner’s share of the adjusted

basis of partnership property. The

proposed regulations provide that a

transferee’s share of the adjusted basis

to the partnership of partnership

property is equal to the sum of the

transferee’s interest as a partner in the

partnership’s previously taxed capital,

plus the transferee’s share of

partnership liabilities. The partner’s

share of the partnership’s previously

taxed capital is determined by reference

to a hypothetical transaction in which

(immediately after the transfer of the

partnership interest) the partnership is

assumed to have sold all of its assets in

a fully taxable transaction for cash equal

to the fair market value of the assets.

The partner’s share of the partnership’s

previously taxed capital is equal to: (i)

The amount of cash that the transferee

would receive on liquidation of the

partnership immediately following the

hypothetical transaction, increased by

(ii) the amount of tax loss that would be

allocated to the transferee from the

hypothetical transaction, and decreased

by (iii) the amount of tax gain that

would be allocated to the transferee

from the hypothetical transaction.

Calculation of Income, Gain, or Loss

The basis adjustment under section

743, like any other basis amount, is a

reference used to calculate income, gain,

loss, and deduction. However, generally

the basis adjustment under section 743

is an adjustment with respect to the

transferee. No adjustment is made to the

common basis of partnership property

(i.e., the partnership’s adjusted basis for

the property). Thus, for purposes of

income, deduction, gain, loss, and

distribution, the transferee will have a

special basis for those partnership

properties that are adjusted under

section 743(b). The proposed

regulations clarify the rules contained in

the current regulations. The basis adjustment under section

743 does not affect the partnership’s

computation of any item under section

703, and does not have any effect on the

partners’ capital accounts. Partnerships

compute their tax items at the

partnership level under section 703

without regard to the basis adjustments.

Partnership level tax items (including

any remedial allocations under § 1.704–

3(d)) are then allocated among the

partners, including the transferee, in

accordance with section 704. Finally,

the partnership adjusts the transferee’s

distributive share of partnership tax

items to reflect the transferee’s special

basis in the properties that give rise to

the tax items. A transferee’s income,

gain, or loss from the sale of partnership

property in which the transferee has a

basis adjustment is equal to the

transferee’s distributive share of

partnership income, gain, or loss

(including any remedial allocations

under § 1.704–3(d)) from the sale of the

property adjusted to account for the

amount of the transferee’s basis

adjustment with respect to the property.

Coordination of Section 743 With

Section 704(c)

Section 704(c) is taken into account in

determining a transferee’s share of the

partnership’s basis in the partnership’s

assets. As a result, some or all of a

transferee’s basis adjustment may be

attributable to section 704(c) built-in

gain or loss when a transferee purchases

a partnership interest from a partner

that contributed section 704(c) property

to the partnership. For example, assume

that A contributes property with a fair

market value of $100 and an adjusted

tax basis of $10 to a partnership for a

fifty percent interest and B contributes

$100 of cash for the remaining fifty

percent interest. Immediately after the

formation of the partnership, A’s share

of the partnership’s basis in the

partnership property is $10, while B’s

share is $100. The contributed asset

then appreciates in value to $120, and

A transfers its entire interest to T for

$110 while an election is in effect under

section 754. T will have a basis

adjustment of $100. The first $90 of the

basis adjustment is attributable to the

section 704(c) built-in gain, while the

remaining $10 of the basis adjustment is

attributable to T’s fifty percent share of

the $20 of post-contribution

appreciation in the contributed

property.

Despite the fact that a portion of the

basis adjustment may be attributable to

a property’s section 704(c) built-in gain,

section 704(c) and section 743 operate

independently. Section 1.704–

1(b)(2)(iv)(g)(3) requires a partnership to

recover the value of section 704(c)

property on the books of the partnership

over the property’s remaining useful

life, determined with reference to the

property’s useful life in the hands of the

contributing partner. At the same time,

§ 1.168–2(n)(1) of the proposed Income

Tax Regulations provides that the entire

basis adjustment is recovered as though

it is new property. Cf. Sections 168(i)(7)

and 197(f)(2). As a result, the book and

tax items representing the section 704(c)

built-in gain are recovered over different

periods.

Although a portion of the basis

adjustment may represent actual tax

basis equal to the amount of the section

704(c) built-in gain, the deductions

attributable to the basis adjustment

cannot be allocated to the

noncontributing partner. The basis

adjustment does not, therefore,

eliminate any book-tax disparities that

result from ceiling rule problems

relating to the section 704(c) property.

Because the basis adjustment only

affects the transferee, the Service and

Treasury believe that it is appropriate

for sections 704(c) and 743(b) to operate

independently.

When a partnership adopts the

remedial allocation method, however,

the partners may be viewed as agreeing

to shift, over time, a portion of the

partnership’s basis in its assets from the

noncontributing partner to the

contributing partner. Partnership basis

that was considered part of the

noncontributing partner’s share of the

partnership’s basis at the time the

adjustment to basis was made will be

transferred to the contributing partner as

the property is recovered on the

partnership’s books. In addition, a

partnership that adopts the remedial

allocation method with respect to

contributed property must depreciate or

amortize the portion of the contributed
Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules 4411

property’s book basis that is attributable

to section 704(c) built-in gain as though

it is new property at the time of

contribution. As a result, the Service

and Treasury believe that it is

appropriate to coordinate the recovery

periods of the section 704(c) built-in

gain and the built-in gain portion of the

basis adjustment where the partnership

uses the remedial allocation method.

Where a partnership adopts the

remedial allocation method, the

proposed regulations treat the portion of

any basis adjustment that is attributable

to section 704(c) built-in gain differently

from the rest of the basis adjustment.

Instead of treating the section 704(c)

built-in gain portion of the basis

adjustment and the basis adjustment in

excess of such amount as newly

acquired property, the section 704(c)

built-in gain portion of the basis

adjustment is recovered over the

remaining cost recovery period for the

section 704(c) built-in gain. The

recovery period for the partner’s share

of common basis continues to be

determined by reference to the

property’s useful life in the hands of the

contributing partner, and the remaining

basis adjustment in excess of the section

704(c) built-in gain portion of the basis

adjustment is recovered as if it were

new property.

If a partnership receives remedial

allocations of income under § 1.704–

3(d) with respect to an item of adjusted

partnership property, the partner does

not offset the cost recovery deductions

from the property against the remedial

allocations of income. Rather, the

partner will receive an allocation of

remedial income and a separate cost

recovery deduction. If a partner receives

remedial allocations of deductions

under § 1.704-3(d) with respect to an

item of partnership property that has a

negative basis adjustment, the partner

first adds the amount of the remedial

allocation of deduction to any common

basis deductions received from the

property. The partner then reduces the

total amount of deductions from the

property by the amount of the negative

basis adjustment recovered in that year.

One result of this proposal is that the

interests in a partnership will generally

be fungible (i.e. the tax consequences

that stem from the purchase of a

partnership interest do not vary with the

identity of the transferor), if: (i) Each

partnership interest has an identical

right in capital and profits, and (ii) each

item of the partnership’s section 704(c)

property is subject to the remedial

allocation method. The Service and

Treasury request comments on

situations in which the fungibility of

partnership interests may otherwise be

accommodated without significantly

adding to the complexity of subchapter

K. In addition, comments are requested

concerning the application of the

remedial allocation method to

contributed property where there are no

distortions caused by the ceiling rule at

the time the property is contributed to

the partnership.

Recovery of Negative Basis Adjustments

Section 1.168–2(n)(2) of the proposed

Income Tax Regulations provides that a

negative basis adjustment to depreciable

property is recovered over the

property’s remaining recovery period in

the hands of the partnership (i.e., the

adjustment made to the common basis

of the partnership property). The

portion of the adjustment that is

recovered in any year is equal to the

product of (i) the amount of the decrease

to the item’s adjusted basis (determined

as of the date of the transfer), multiplied

by (ii) a fraction, the numerator of

which is the portion of the adjusted

basis of the item recovered by the

partnership in that year, and the

denominator of which is the adjusted

basis of the item on the date of transfer

(determined prior to any basis

adjustments).

Because the basis adjustment under

section 743 is personal to the transferee,

the primary method adopted by the

proposed regulations for recovering a

negative basis adjustment provides that

the basis adjustment does not affect the

common basis of partnership property

and does not affect the tax consequences

of partners other than the transferee.

Under this method, the recovery of the

negative basis adjustment may generate

ordinary income to the extent that it

exceeds the transferee’s share of the

depreciation deductions. The proposed

regulations provide that, unless the

partnership elects to make a common

basis adjustment, as described below,

the amount of the basis adjustment

recovered in any year first decreases the

transferee’s distributive share of the

partnership’s deductions from the

adjusted item of property for that year.

If, in any year, a partnership does not

allocate to a transferee sufficient

deductions from the adjusted property

to offset the recovery of the negative

basis adjustment, then the transferee’s

distributive share of the deductions

from other items of partnership property

is decreased. The transferee then

recognizes income equal to the excess of

the amount of the negative basis

adjustment recovered in the year over

the transferee’s share of deductions from

the other items of property for the year.

As an alternative, the proposed

regulations also allow partnerships to

elect to follow the approach of the old

proposed regulations. If this election is

made, the partnership treats the amount

of the negative basis adjustment as an

item of built-in gain, decreasing the total

amount of depreciation or amortization

that the partnership may allocate for tax

purposes. This election would prevent

the transferee from ever recognizing

income in situations where the

partnership did not allocate to the

transferee sufficient depreciation to

offset the negative basis adjustment. It

should be noted, however, that this

election has no effect on the partners’

capital accounts, which continue to be

adjusted to reflect the depreciation or

amortization of the adjusted property as

though there was no basis adjustment to

the property. Consequently, to the

extent that the basis adjustment causes

the amount of the deductions allocated

to the non-transferee partners for book

purposes to exceed the amount of tax

depreciation available to be allocated to

them by the partnership, a book-tax

disparity results for the non-transferee

partners.

The Service and Treasury request

comments concerning the recovery of

negative basis adjustments under

section 743. Specifically, the Service

and Treasury request comments

regarding whether there are other

possible ways of accounting for the

recovery of negative basis adjustments

that treat the basis adjustment as

personal to the transferee and, at the

same time, do not interfere with the

economic agreement among the

partners.

Reporting and Returns

The statutory language of section

743(b) indicates that partnerships are

responsible for making the basis

adjustments. This mandate is repeated

in the language of the current

regulations issued under both sections

743 and 755. Notwithstanding that

partnerships are required to make and

allocate basis adjustments under the

current regulations, transferees are

required to report the basis adjustments.

Transferees accomplish this by

attaching statements to their returns that

show how the section 743(b) adjustment

was determined and how the

adjustment was allocated among the

various partnership properties. No

existing guidance indicates when (i.e.,

before or after the Schedule K–1) the

effect of the basis adjustment to specific

partnership items is to be determined or

who is required to make and report the

adjustments to the partnership items.

The proposed regulations clarify that

partnerships are required to make the

basis adjustments. In addition, the
4412 Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules

proposed regulations place the

responsibility for reporting basis

adjustments on partnerships.

Partnerships report basis adjustments by

attaching statements to their partnership

returns when they acquire knowledge of

transfers subject to section 743. In

addition, partnerships are required to

adjust specific partnership items in light

of the basis adjustments. Consequently,

amounts reported on the transferee’s

Schedule K–1 are adjusted amounts.

Transferees are subject to an

affirmative obligation to notify

partnerships of their basis in acquired

partnership interests. To accommodate

partnership concerns about the

reliability of the information provided,

partnerships are entitled to rely on the

written representations of transferees

concerning either the amount paid for

the partnership interest or the

transferee’s basis in the partnership

interest under section 1014 (unless

clearly erroneous).

B. Section 751

Section 751(a) provides that to the

extent an amount realized on the sale or

exchange of a partnership interest is

attributable to the transferor’s interest in

unrealized receivables or inventory

items of the partnership, the amount

realized is considered to be an amount

realized from the sale or exchange of

property other than a capital asset.

Thus, the transferor partner may

recognize ordinary income or loss on

the sale or exchange of its partnership

interest. Under the current section 751

regulations, the amount of income or

loss realized by a partner on the sale or

exchange of an interest in section 751

property is equal to the difference

between: (i) The portion of the total

amount realized for the partnership

interest allocated to section 751

property, and (ii) the portion of the

transferor partner’s basis in its

partnership interest allocated to the

property. Generally, the portion of the

total amount realized allocated to

section 751 property is determined by

the seller and purchaser in an arm’s

length agreement. The portion of the

partner’s adjusted basis in the

partnership interest allocated to the

section 751 property equals the basis

that the property would have had under

section 732 if the transferor partner had

received its proportionate share of the

property in a current distribution

immediately before the sale.

The proposed regulations amend

these rules for determining the

transferor partner’s gain or loss from the

sale or exchange of its interest in section

751 property. Rather than attempting to

allocate a portion of the transferor

partner’s amount realized and adjusted

basis to the section 751 property, the

proposed regulations adopt a

hypothetical sale approach. Thus, the

income or loss realized by a partner

from section 751 property upon the sale

or exchange of its interest is the amount

of income or loss that would have been

allocated to the partner from section 751

property (to the extent attributable to

the partnership interest sold or

exchanged) if the partnership had sold

all of its property in a fully taxable

transaction for fair market value

immediately prior to the partner’s

transfer of the partnership interest.

C. Section 755

In General

The current regulations under section

755 contain a number of problems that

prevent partnerships from allocating the

section 743(b) basis adjustments to

appropriate assets. The proposed

regulations resolve these problems and

implement the purposes of section

743(b) by focusing on the items that the

transferee partner would receive upon a

fair market value sale of all of the

partnership’s assets.

At the same time, the proposed

regulations recognize that adjustments

under section 734 differ significantly

from adjustments under section 743.

Specifically, adjustments under section

743(b) are intended to affect the

transferee partner only. In contrast,

adjustments under section 734 affect all

of the partners. As a result, the proposed

regulations under section 755 contain

two separate regimes—one that applies

to adjustments under section 734, and

another that applies to adjustments

under section 743. While the regime

allocating adjustments under section

743 focuses on the transferee, the regime

allocating adjustments under section

734 focuses on the difference between

value and basis at the partnership entity

level.

Allocating Adjustments Under Section

743(b)

The proposed regulations provide that

allocations of basis adjustments under

section 743 among partnership assets

are made based on the amount of

income, gain, or loss (including

remedial allocations under § 1.704–3(d))

that the transferee would be allocated if,

immediately after the section 743(b)

transfer, all of the partnership’s assets

were disposed of in a fully taxable

transaction at fair market value. By

adopting this method, in some

situations the proposed regulations will

require adjustments to be made that

increase the basis of some assets and

decrease the basis of others.

Hypothetical Sale

The current regulations do not take

each partner’s interest in specific assets

into account. The amount of the section

743 adjustment is allocated among

partnership properties to reduce the

difference between the fair market value

and the adjusted basis of partnership

properties at the partnership entity level

rather than at the partner level. This

formulation of the rule fails to take into

account special allocations or the

varying treatment of different partners

by virtue of the operation of section

704(c) or the minimum gain chargeback.

Therefore, basis adjustments will often

be made to the wrong assets, exposing

the partners to tax consequences that

may vary significantly from the

partners’ economic consequences.

Rather than attempt to define a

partner’s share of the basis or fair

market value of a specific partnership

asset, the proposed regulations focus on

the actual tax items that would be

allocated to the transferee in a fully

taxable, fair market value sale. Under

the proposed regulations, partnerships

are required to adjust the basis of

partnership assets in a manner that

reflects the amount of income, gain, or

loss that the transferee would recognize

if all of the partnership’s assets were

sold in the hypothetical transaction.

Two-Way Adjustments

Under the current regulations, the

partnership may not increase the basis

of assets that have a fair market value

in excess of basis and, at the same time,

decrease the basis of assets that have a

basis in excess of fair market value.

Thus, if the section 743(b) adjustment is

positive, the partnership may only

increase the basis of assets that have a

basis that is less than their fair market

value. This restriction prevents the

partnership from adjusting the basis of

its assets in a manner that coordinates

a transferee’s tax consequences with its

economic consequences.

The proposed regulations remove this

restriction. Instead, the amount of the

section 743 adjustment is viewed as a

net adjustment. This net amount is then

allocated between the partnership’s two

classes of assets (capital gain property

and ordinary income property). The

amount of the adjustment allocated to

ordinary income property may be an

increase while the amount of the

adjustment allocated to capital gain

property is a decrease. The amount of

the adjustment allocated to each class is

then allocated among the assets within

each class. The amount of the
Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules 4413

adjustment allocated to one item within

the class may also be an increase even

if the amount allocated to another item

is a decrease.

Allocation Between Classes

The amount of the basis adjustment

allocated to the class of ordinary income

property is equal to the total amount of

income, gain, or loss (including any

remedial allocations under § 1.704–3(d))

that would be allocated to the transferee

from the sale of all ordinary income

property in the hypothetical transaction.

The amount of the basis adjustment to

capital gain property is equal to (i) the

total amount of the basis adjustment

under section 743, less (ii) the amount

of the basis adjustment allocated to

ordinary income; provided, however,

that in no event may the amount of any

decrease in basis allocated to capital

gain property exceed the partnership’s

basis in capital gain property.

In the event that a decrease in basis

allocated to capital gain property

exceeds the partnership’s basis in

capital gain property, the excess is

applied to reduce the basis of ordinary

income property.

Allocation Within Classes

The amount of the basis adjustment

allocated to each item of property

within the class of ordinary income

property equals:

(a) The amount of income, gain, or

loss (including any remedial allocations

under § 1.704–3(d)) that would be

allocated to the transferee from the

hypothetical sale of the item, minus

(b) The product of (1) any decrease to

the amount of the basis adjustment to

ordinary income property required

because the partnership did not have

enough basis in capital gain property to

reduce, multiplied by (2) a fraction, the

numerator of which is the fair market

value of the item of property to the

partnership and the denominator of

which is the total fair market value of

all items of the partnership’s ordinary

income property.

The amount of the basis adjustment

allocated to each item of property

within the class of capital gain property

equals:

(a) The amount of income, gain, or

loss (including any remedial allocations

under § 1.704–3(d)) that would be

allocated to the transferee from the

hypothetical sale of the item, minus

(b) The product of (1) the total amount

of gain or loss (including any remedial

allocations under § 1.704–3(d)) that

would be allocated to the transferee

from the hypothetical sale of all items

of capital gain property, minus the

amount of the positive basis adjustment

to all items of capital gain property or

plus the amount of the negative basis

adjustment to all items of capital gain

property, multiplied by (2) a fraction,

the numerator of which is the fair

market value of the item of property to

the partnership and the denominator of

which is the total fair market value of

all of the partnership’s items of capital

gain property.

Allocating Adjustments Under Section

734

As under the current regulations, the

proposed regulations provide that

allocations of section 734 adjustments

among partnership assets are made

based on the difference between the

value of the property and the property’s

basis. Where there is a distribution of

partnership property resulting in an

adjustment to the basis of undistributed

partnership property under section

734(b)(1)(B) or (b)(2)(B), the adjustment

must be allocated to remaining

partnership property of a character

similar to that of the distributed

property with respect to which the

adjustment arose. If there is an increase

in basis to be allocated within a class of

property, the increase must be allocated

first to properties with unrealized

appreciation in proportion to their

respective amounts of unrealized

appreciation before such increase (but

only to the extent of each property’s

unrealized appreciation). Any

remaining increase must be allocated

among the properties within the class in

proportion to their fair market values. If

there is a decrease in basis to be

allocated within a class, the decrease

must be allocated first to properties with

unrealized depreciation in proportion to

their respective amounts of unrealized

depreciation before such decrease (but

only to the extent of each property’s

unrealized depreciation). Any

remaining decrease must be allocated

among the properties within the class in

proportion to their adjusted bases (as

adjusted under the preceding sentence).

D. Section 1017

Section 1017 provides rules

concerning basis reductions resulting

from a taxpayer’s exclusion of

cancellation of indebtedness income. In

general, under § 1.1017–1(f) of the

proposed Income Tax Regulations, if a

partner makes an election under section

108(b)(5) or section 108(c), the partner

may treat a partnership interest as

depreciable property (or depreciable

real property) to the extent the

partnership correspondingly reduces the

partner’s proportionate share of the

adjusted basis of depreciable property

(or depreciable real property) held by

the partnership. These proposed

regulations provide guidance regarding

the determination of a partner’s

proportionate share of the partnership’s

basis in depreciable property (or

depreciable real property) and the

consequences of the basis reductions

required under sections 108 and 1017.

In general, these proposed regulations

provide that a partner’s share of the

partnership’s basis in depreciable

property (or depreciable real property)

equals the sum of (a) the partner’s

section 743(b) basis adjustment, if any,

in the partnership items of depreciable

property (or depreciable real property)

and (b) the common basis depreciation

deductions (not including remedial

allocations of depreciation under

§ 1.704–3(d)) that are reasonably

expected to be allocated to the partner

over the partnership property’s

remaining useful life. The amount of

common basis depreciation deductions

that a partner may reasonably expect to

be allocated over the partnership

property’s useful life is based on all the

facts and circumstances in effect at the

time of the basis reduction. It is per se

unreasonable, however, for the

partnership to treat the same

depreciation deductions as ‘‘reasonably

expected’’ by more than one partner.

Thus, the amount of the partners’ total

basis reductions under sections

108(b)(5) and 108(c) cannot exceed the

partnership’s basis in depreciable

property (or depreciable real property).

The proposed regulations further

provide that any reduction to the basis

of depreciable property required under

sections 108 and 1017 constitutes an

adjustment to the basis of partnership

property with respect to the partner

only. These adjustments, therefore, are

similar to the basis adjustments required

under section 743(b). Accordingly, the

proposed regulations provide that these

adjustments have the same effect and

are recovered in the same manner as

basis adjustments required under

section 743(b); provided, however, that

the election to treat the negative basis

adjustment as an item of built-in gain

(which decreases the amount of

depreciation or amortization that the

partnership may allocate) is not

applicable. Consequently, if a partner’s

actual share of the partnership’s

common basis depreciation deductions

in any year is less than the amount that

was included in determining the

partner’s proportionate share of the

partnership’s common basis

depreciation deductions for that year,

the partner will recognize income.
4414 Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules

E. Section 732

In General

With some exceptions, partners

generally may receive distributions of

partnership property without

recognition of gain or loss. Rules are

provided for determining the basis of

the distributed property in the hands of

the distributee. In the event that

multiple properties are distributed by a

partnership, section 732(c) provides

allocation rules for determining their

bases in the distributee partner’s hands.

Section 732(c) was amended by the

Taxpayer Relief Act of 1997, Public Law

105–34, § 1061, 111 Stat. 788, 945–46

(1997). Under prior law, a partner’s

basis in its partnership interest was

allocated among property distributed to

the partner based on the distributed

properties’ adjusted bases. The rules

allocated the partner’s basis in its

partnership interest first to unrealized

receivables and inventory items in an

amount equal to the partnership’s

adjusted basis (or if the basis to be

allocated was less than the partnership’s

basis, then in proportion to the

partnership’s basis). To the extent that

there was any basis remaining to be

allocated among distributed properties,

the basis was allocated among the other

properties in proportion to their

adjusted bases to the partnership.

Section 1061 of the Taxpayer Relief

Act of 1997, Public Law 105–34, section

1061, 111 Stat. 788, 945–46 (1997),

revised the allocation rules for

determining basis in the distributee

partner’s hands. As under prior law,

basis is allocated first to any distributed

unrealized receivables and inventory

items before it is allocated to any other

distributed property. Basis is then

allocated among the other distributed

properties to the extent of each such

property’s adjusted basis to the

partnership. Any remaining basis

adjustment, if an increase, is allocated

among properties with unrealized

appreciation in proportion to their

respective amounts of unrealized

appreciation (to the extent of each

property’s appreciation), and then in

proportion to their respective fair

market values. If the remaining basis

adjustment is a decrease, it is allocated

among properties with unrealized

depreciation in proportion to their

respective amounts of unrealized

depreciation (to the extent of each

property’s depreciation), and then in

proportion to their respective adjusted

bases (taking into account the

adjustment already made). The

proposed regulations amend the current

regulations to incorporate these changes

to section 732(c).

Section 732(d)

Section 732(d) provides a special rule

that applies to determine the basis of

property distributed to a transferee

partner who acquired any part of its

partnership interest in a transfer when

an election under section 754 was not

in effect. When the special rule applies,

the basis of distributed property is

adjusted immediately before the

distribution to reflect the basis that the

property would have had if the

partnership had a section 754 election

in effect at the time the transferee

acquired the partnership interest. As a

result, the basis of the distributed

property in the hands of the partnership

immediately before the distribution

more closely approximates its fair

market value. Consequently, the

transferee’s basis in the distributed

property will also more closely

approximate its fair market value.

Section 1.732–1(d)(4) of the current

regulations requires transferees to apply

the special basis rule in certain cases.

Specifically, transferees are required to

apply the special basis rule if at the time

of the acquisition of the partnership

interest—

(i) The fair market value of all

partnership property (other than money)

exceeded 110 percent of its adjusted

basis to the partnership,

(ii) An allocation of basis under

section 732(c) upon a liquidation of the

partnership interest immediately after

the transfer of the interest would have

resulted in a shift of basis from property

not subject to an allowance for

depreciation, depletion, or amortization,

to property subject to such an

allowance, and

(iii) A basis adjustment under section

743(b) would change the basis to the

transferee partner of the property

actually distributed.

The purpose of § 1.732–1(d)(4) was to

prevent distortions caused by section

732(c) that might inflate the basis of

depreciable, depletable, or amortizable

property above its fair market value. At

the time that the regulations were

adopted, such distortions might occur

because section 732(c) allocated basis

among distributed properties based on

their relative bases. The changes made

to section 732(c) by the Taxpayer Relief

Act of 1997, Public Law 105–34, section

1061, 111 Stat. 788, 945–46 (1997),

make the distortions targeted by the

regulations less likely to occur. As a

result, the Service and Treasury request

comments on the proper scope of

section 732(d), and specifically, under

what circumstances, if any, the

Secretary should exercise its authority

to mandate the application of section

732(d) to a transferee.

Proposed Effective Date

The regulations are proposed to be

effective: (i) For all transfers of

partnership interests on and after the

date the regulations are published as

final regulations in the Federal Register,

(ii) for all distributions from

partnerships on and after the date the

regulations are published as final

regulations in the Federal Register, and

(iii) for all elections under sections

108(b)(5) and 108(c) made on or after

the date the regulations are published as

final regulations 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 EO 12866. Therefore, a regulatory

assessment is not required. An initial

regulatory flexibility analysis has been

prepared for the collection of

information in this notice of proposed

rulemaking under 5 U.S.C. 603. A

summary of the analysis is set forth

below under the heading ‘‘Summary of

Initial Regulatory Flexibility Analysis.’’

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.

Summary of Initial Regulatory

Flexibility Analysis

This initial analysis is prepared

pursuant to the Regulatory Flexibility

Act (5 U.S.C. chapter 6). In general, the

proposed regulations require a

transferee that acquires an interest in a

partnership with an election under

section 754 in effect, to notify the

partnership of the transfer. This

notification must include the name and

taxpayer identification number of the

transferee and the transferee’s basis in

the acquired partnership interest. The

partnership is required to include a

statement with its Form 1065, U.S.

Partnership Return of Income for the

taxable year in which the partnership

acquires knowledge of the transfer. This

statement must identify the name and

taxpayer identification number of the

transferee and the computation of the

basis adjustment and the allocation of

that adjustment to partnership

properties. These requirements will

ensure that the partnership has notice

that a transfer has occurred and that the

proper basis adjustments are computed.

The legal basis for this requirement is
Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules 4415

contained in sections 743(b), 6001,

7805(a).

There were approximately 1,494,000

partnerships in 1994. However, these

proposed regulations apply only to

partnerships that have made an election

under section 754. The election under

section 754 is generally not made unless

there has been a transfer of a

partnership interest or a distribution by

the partnership. Moreover, the effects of

the election attach to specific items of

partnership property and may provide

only temporary benefits for the partners.

The election also cannot be revoked

without the consent of the Secretary.

Accordingly, the Service and Treasury

believe that most partnerships do not

make the election under section 754.

Therefore, most partnerships will not be

affected by the proposed regulations in

any given year.

After a partner conveys information to

the partnership concerning a transfer of

a partnership interest, the partnership

must adjust the partner’s interest in the

basis of partnership property. Because

these basis adjustments will affect the

partner’s share of depreciation or

amortization deductions and amounts of

gain or loss on the disposition of certain

items of partnership property, the

partnership must prepare and maintain

special entries on its books. However, in

many cases, partnership returns are

prepared using computer software that

can prepare and maintain these special

entries after the initial year.

The IRS and Treasury Department are

not aware of any federal rules that may

duplicate, overlap, or conflict with the

proposed rule.

As an alternative to the disclosure

described above, the Service and

Treasury considered, but rejected, a rule

that would have required the partners,

and not the partnerships, to make the

basis reductions and to determine the

effects of the basis adjustments on the

partner’s distributive shares. This

alternative was rejected because the

Service and Treasury believe that

partnerships generally have better

access to the information necessary to

report section 743 basis adjustments

properly. To require the partners rather

than the partnerships to bear the burden

of reporting would require the

partnerships to provide the partners

with significant amounts of information

not otherwise needed by the partners.

There are no known alternative rules

that are less burdensome to the

partnerships and their partners but that

accomplish the purpose of the statute.

The Service and Treasury request

comments concerning possible

alternatives.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations,

consideration will be given to any

written comments (a signed original and

eight (8) copies) that are timely

submitted to the IRS. All comments will

be available for public inspection and

copying.

A public hearing has been scheduled

for Wednesday, July 8, 1998, at 10 a.m.

in the IRS Auditorium of the Internal

Revenue Building. Because of access

restrictions, visitors will not be

admitted beyond the Internal Revenue

Building lobby more than 15 minutes

before the hearing starts.

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 written comments by April

29, 1998, and submit an outline of the

topics to be discussed and the time to

be devoted to each topic (signed original

and eight (8) copies) by Wednesday,

June 24, 1998.

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 authors of these

proposed regulations are Brian M. Blum

and Terri A. Belanger of the Office of

the Assistant Chief Counsel

(Passthroughs and Special Industries).

However, personnel from other offices

of the Internal Revenue Service and the

Treasury Department participated in

their development.

Partial Withdrawal of Notice of

Proposed Rulemaking

Accordingly, under the authority of

26 U.S.C. 7805, § 1.168–2(n) in the

notice of proposed rulemaking

published February 16, 1984 (49 FR

5940) is withdrawn.

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 is amended by adding entries

in numerical order to read as follows:

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

Section 1.168–2 also issued under 26 U.S.C.

168. * * *

Section 1.732–1 also issued under 26 U.S.C.

732.

Section 1.732–2 also issued under 26 U.S.C.

732.

Section 1.734–1 also issued under 26 U.S.C.

734.

Section 1.743–1 also issued under 26 U.S.C.

743.

Section 1.751–1 also issued under 26 U.S.C.

751.

Section 1.755–1 also issued under 26 U.S.C.

755. * * *

Section 1.1017–1 also issued under 26 U.S.C.

1017. * * *

Par. 2. Section 1.732–1 is amended by

revising paragraphs (c), (d)(1)(vi),

(d)(4)(iii) and the last sentence of

paragraph (d)(1)(v) and removing the

undesignated text including the

examples immediately following

paragraph (d)(4)(iii) to read as follows:

§ 1.732–1 Basis of distributed property

other than money.

* * * * *

(c) Allocation of basis among

properties distributed to a partner—(1)

General rule—(i) Unrealized receivables

and inventory items. The basis to be

allocated to properties distributed to a

partner under section 732(a)(2) or (b) is

allocated first to any unrealized

receivables (as defined in section 751(c))

and inventory items (as defined in

section 751(d)(2)) in an amount equal to

the adjusted basis of each such property

to the partnership immediately before

the distribution. If the basis to be

allocated is less than the sum of the

adjusted bases to the partnership of the

distributed unrealized receivables and

inventory items, the adjusted basis of

the distributed property must be

decreased in the manner provided in

paragraph (c)(2)(i) of this section.

(ii) Other distributed property. Any

basis not allocated to unrealized

receivables or inventory items under

paragraph (c)(1)(i) of this section is

allocated to any other property

distributed to the partner in the same

transaction by assigning to each

distributed property an amount equal to

the adjusted basis of the property to the

partnership immediately before the

distribution. However, if the sum of the

adjusted bases to the partnership of

such other distributed property does not

equal the basis to be allocated among

the distributed property, any increase or

decrease required to make the amounts

equal is allocated among the distributed

property as provided in paragraph (c)(2)

of this section.

(2) Adjustment to basis allocation—(i)

Decrease in basis.
4416 Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules

Any decrease to the basis of

distributed property required under

paragraph (c)(1) of this section is

allocated first to distributed property

with unrealized depreciation in

proportion to each property’s respective

amount of unrealized depreciation

before any decrease (but only to the

extent of each property’s unrealized

depreciation). If the required decrease

exceeds the amount of unrealized

depreciation in the distributed property,

the excess is allocated to the distributed

property in proportion to the adjusted

bases of the distributed property, as

adjusted pursuant to the immediately

preceding sentence.

(ii) Increase in basis. Any increase to

the basis of distributed property

required under paragraph (c)(1)(ii) of

this section is allocated first to

distributed property (other than

unrealized receivables and inventory

items) with unrealized appreciation in

proportion to each property’s respective

amount of unrealized appreciation

before any increase (but only to the

extent of each property’s unrealized

appreciation). If the required increase

exceeds the amount of unrealized

appreciation in the distributed property,

the excess is allocated to the distributed

property (other than unrealized

receivables or inventory items) in

proportion to the fair market value of

the distributed property.

(3) Unrealized receivables and

inventory items. If the basis to be

allocated upon a distribution in

liquidation of the partner’s entire

interest in the partnership is greater

than the adjusted basis to the

partnership of the unrealized

receivables and inventory items

distributed to the partner, and if there

is no other property distributed to

which the excess can be allocated, the

distributee partner sustains a capital

loss under section 731(a)(2) to the extent

of the unallocated basis of the

partnership interest.

(4) Examples. The provisions of this

paragraph (c) are illustrated by the

following examples:

Example 1. A is a one-fourth partner in

partnership PRS and has an adjusted basis in

its partnership interest of $650. PRS

distributes inventory items and Assets X and

Y to A in liquidation of A’s entire

partnership interest. The distributed

inventory items have a basis to the

partnership of $100 and a fair market value

of $200. Asset X has an adjusted basis to the

partnership of $50 and a value of $400. Asset

Y has an adjusted basis to the partnership

and value of $100. Neither Asset X nor Asset

Y consists of inventory items or unrealized

receivables. Under this paragraph (c), A’s

basis in its partnership interest is allocated

first to the inventory items in an amount

equal to their adjusted basis to the

partnership. A, therefore, has an adjusted

basis in the inventory items of $100. The

remaining basis, $550, is allocated to the

distributed property first in an amount equal

to the property’s adjusted basis to the

partnership. Thus, Asset X is allocated $50

and Asset Y is allocated $100. Asset X is then

allocated $350, the amount of unrealized

appreciation in Asset X. Finally, the

remaining basis, $50, is allocated to Assets X

and Y in proportion to their fair market

values: $40 to Asset X (400/500 x $50), and

$10 to Asset Y (100/500 x $50). Therefore,

after the distribution, A has an adjusted basis

of $440 in Asset X and $110 in Asset Y.

Example 2. B is a one-fourth partner in

partnership PRS and has an adjusted basis in

its partnership interest of $200. PRS

distributes Asset X and Asset Y to B in

liquidation of its entire partnership interest.

Asset X has an adjusted basis to the

partnership and fair market value of $150.

Asset Y has an adjusted basis to the

partnership of $150 and a fair market value

of $50. Neither of the assets consists of

inventory items or unrealized receivables.

Under this paragraph (c), B’s basis is first

assigned to the distributed property to the

extent of the partnership’s basis in each

distributed property. Thus, Asset X and Asset

Y are each assigned $150. Because the

aggregate adjusted basis of the distributed

property, $300, exceeds the basis to be

allocated, $200, a decrease of $100 in the

basis of the distributed property is required.

Assets X and Y have unrealized depreciation

of zero and $100, respectively. Thus, the

entire decrease is allocated to Asset Y. After

the distribution, B has an adjusted basis of

$150 in Asset X and $50 in Asset Y.

Example 3. C, a partner in partnership

PRS, receives a distribution in liquidation of

its entire partnership interest of $6,000 cash,

inventory items having an adjusted basis to

the partnership of $6,000, and real property

having an adjusted basis to the partnership

of $4,000. C’s basis in its partnership interest

is $9,000. The cash distribution reduces C’s

basis to $3,000, which is allocated entirely to

the inventory items. The real property has a

zero basis in C’s hands. The partnership

bases not carried over to C for the distributed

properties are lost unless an election under

section 754 is in effect requiring the

partnership to adjust the bases of remaining

partnership properties under section 734(b).

Example 4. Assume the same facts as in

Example 3 of this paragraph except C

receives a distribution in liquidation of its

entire partnership interest of $1,000 cash and

inventory items having a basis to the

partnership of $6,000. The cash distribution

reduces C’s basis to $8,000, which can be

allocated only to the extent of $6,000 to the

inventory items. The remaining $2,000 basis,

not allocable to the distributed property,

constitutes a capital loss to partner C under

section 731(a)(2). If the election under

section 754 is in effect, see section 734(b) for

adjustment of the basis of undistributed

partnership property.

(5) Effective date. This paragraph (c)

applies to distributions of property from

a partnership that occur on or after the

date final regulations are published in

the Federal Register.

(d) * * *

(1) * * *

(v) * * * (For a shift of transferee’s

basis adjustment to like property, see

§ 1.743–1(g).)

(vi) The provisions of this paragraph

(d)(1) may be illustrated by the

following example:

Example. (i) Transferee partner, T,

purchased a one-fourth interest in

partnership PRS for $17,000. At the time T

purchased the partnership interest, the

election under section 754 was not in effect

and the partnership inventory had a basis to

the partnership of $14,000 and a value of

$16,000. T’s purchase price reflected $500 of

this difference. Thus, $4,000 of the $17,000

paid by T for the partnership interest was

attributable to T’s share of partnership

inventory with a basis of $3,500. Within 2

years after T acquired the partnership

interest, T retired from the partnership and

received in liquidation of its entire

partnership interest the following property:

Assets

Adjusted

basis to

PRS

Market

value

Cash .............................. $1,500 $1,500

Inventory ....................... 3,500 4,000

Asset X .......................... 2,000 4,000

Asset Y .......................... 4,000 5,000

(ii) The value of the inventory received by

T was one-fourth of the value of all

partnership inventory and was T’s share of

such property. It is immaterial whether the

inventory T received was on hand when T

acquired the interest. In accordance with T’s

election under section 732(d), the amount of

T’s share of partnership basis that is

attributable to partnership inventory is

increased by $500 (one-fourth of the $2,000

difference between the value of the property,

$16,000, and its $14,000 basis to the

partnership at the time T purchased its

interest). This adjustment under section

732(d) applies only for purposes of

distributions to T, and not for purposes of

partnership depreciation, depletion, or gain

or loss on disposition. Thus, the amount to

be allocated among the properties received

by T in the liquidating distribution is $15,500

($17,000, T’s basis for the partnership

interest, reduced by the amount of cash

received, $1,500). This amount is allocated as

follows: The basis of the inventory items

received is $4,000, consisting of the $3,500

common partnership basis, plus the basis

adjustment of $500 which T would have had

under section 743(b). The remaining basis of

$11,500 ($15,500 minus $4,000) is allocated

among the remaining property distributed to

T by assigning to each property the adjusted

basis to the partnership of such property and

adjusting that basis by any required increase

or decrease. Thus, the adjusted basis to T of

Asset X is $5,111 ($2,000, the adjusted basis

of Asset X to the partnership, plus $2,000,

the amount of unrealized appreciation in
Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules 4417

Asset X, plus $1,111 ($4,000/$9,000

multiplied by $2,500). Similarly, the adjusted

basis of Asset Y to T is $6,389 ($4,000, the

adjusted basis of Asset Y to the partnership,

plus $1,000, the amount of unrealized

appreciation in Asset Y, plus, $1,389 ($5,000/

$9,000 multiplied by $2,500).

* * * * *

(4) * * *

(iii) A basis adjustment under section

743(b) would change the basis to the

transferee partner of the property

actually distributed.

* * * * *

Par. 3. Section 1.732–2 is amended by

adding a new sentence at the end of the

Example in paragraph (b) to read as

follows:

§ 1.732–2 Special partnership basis of

distributed property.

* * * * *

(b) * * *

Example. * * * See § 1.743–1(g).

* * * * *

Par. 4. In § 1.734–1, paragraph (e) is

added to read as follows:

§ 1.734–1 Optional adjustment to basis of

undistributed partnership property.

* * * * *

(e) Recovery of adjustments to basis of

partnership property—(1) Increases in

basis. For purposes of section 168, if the

basis of a partnership’s recovery

property is increased as a result of the

distribution of property to a partner,

then the increased portion of the basis

must be taken into account as if it were

newly-purchased recovery property

placed in service when the distribution

occurs. Consequently, any applicable

recovery period and method may be

used to determine the recovery

allowance with respect to the increased

portion of the basis. However, no

change is made for purposes of

determining the recovery allowance

under section 168 for the portion of the

basis for which there is no increase.

(2) Decreases in basis. For purposes of

section 168, if the basis of a

partnership’s recovery property is

decreased as a result of the distribution

of property to a partner, then the

decrease in basis must be accounted for

over the remaining recovery period of

the property beginning with the

recovery period in which the basis is

decreased.

(3) Effective date. This paragraph (e)

applies to distributions of property from

a partnership that occur on or after the

date final regulations are published in

the Federal Register.

Par. 5. Section 1.743–1 is revised to

read as follows:

§ 1.743–1 Optional adjustment to basis of

partnership property.

(a) Generally. The basis of partnership

property is adjusted as a result of the

transfer of an interest in a partnership

by sale or exchange or on the death of

a partner only if the election provided

by section 754 (relating to optional

adjustments to the basis of partnership

property) is in effect with respect to the

partnership. Whether or not the election

provided in section 754 is in effect, the

basis of partnership property is not

adjusted as the result of a contribution

of property, including money, to the

partnership.

(b) Determination of adjustment. In

the case of the transfer of an interest in

a partnership, either by sale or exchange

or as a result of the death of a partner,

a partnership that has an election under

section 754 in effect—

(1) Increases the adjusted basis of

partnership property by the excess of

the transferee’s basis for the transferred

partnership interest over the transferee’s

share of the adjusted basis to the

partnership of the partnership’s

property; or

(2) Decreases the adjusted basis of

partnership property by the excess of

the transferee’s share of the adjusted

basis to the partnership of the

partnership’s property over the

transferee’s basis for the transferred

partnership interest.

(c) Determination of transferee’s basis

in the transferred partnership interest.

In the case of the transfer of a

partnership interest by sale or exchange

or as a result of the death of a partner,

the transferee’s basis in the transferred

partnership interest is determined under

section 742. See also section 752 and

§§ 1.752–1 through 1.752–5.

(d) Determination of transferee’s share

of the adjusted basis to the partnership

of the partnership’s property—(1)

Generally. A transferee’s share of the

adjusted basis to the partnership of

partnership property is equal to the sum

of the transferee’s interest as a partner

in the partnership’s previously taxed

capital, plus the transferee’s share of

partnership liabilities. Generally, a

transferee’s interest as a partner in the

partnership’s previously taxed capital is

equal to—

(i) The amount of cash that the

transferee would receive on a

liquidation of the partnership following

the hypothetical transaction, as defined

in paragraph (d)(2) of this section;

increased by

(ii) The amount of tax loss (including

any remedial allocations under § 1.704–

3(d)) that would be allocated to the

transferee from the hypothetical

transaction, as defined in paragraph

(d)(2) of this section; and decreased by

(iii) The amount of tax gain (including

any remedial allocations under § 1.704–

3(d)) that would be allocated to the

transferee from the hypothetical

transaction, as defined in paragraph

(d)(2) of this section.

(2) Hypothetical transaction defined.

For purposes of paragraph (d)(1) of this

section, the hypothetical transaction

means the disposition by the

partnership of all of the partnership’s

assets, immediately after the transfer of

the partnership interest, in a fully

taxable transaction for cash equal to the

fair market value of the assets. For

example, if the partnership properly

maintains capital accounts under the

rules of § 1.704–1(b)(2)(iv), the

transferee’s interest as a partner in the

partnership’s previously taxed capital is

equal to—

(i) The transferee’s capital account

adjusted for the hypothetical

transaction; increased by

(ii) The amount of tax loss (including

any remedial allocations under § 1.704–

3(d)) that would be allocated to the

transferee from the hypothetical

transaction; and decreased by

(iii) The amount of tax gain (including

any remedial allocations under § 1.704–

3(d)) that would be allocated to the

transferee from the hypothetical

transaction.

(3) Examples. The provisions of this

paragraph (d) are illustrated by the

following examples:

Example 1. (i) A is a member of

partnership PRS in which the partners have

equal interests in capital and profits. The

partnership has made an election under

section 754, relating to the optional

adjustment to the basis of partnership

property. A sells its interest to T for $22,000.

The balance sheet of the partnership at the

date of sale shows the following:

Assets

Adjusted

basis

Market

value

Cash .............................. $ 5,000 $5,000

Accounts receivable ...... 10,000 10,000

Inventory ....................... 20,000 21,000

Depreciable assets ....... 20,000 40,000

Total ....................... 55,000 76,000

Liabilities and

capital

Adjusted

per

books

Market

value

Liabilities ....................... $10,000 $10,000

Capital:

A ................................ 15,000 22,000

B ................................ 15,000 22,000
4418 Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules

Liabilities and

capital

Adjusted

per

books

Market

value

C ................................ 15,000 22,000

Total ....................... 55,000 76,000

(ii) The amount of the basis adjustment

under section 743(b) is the difference

between the basis of T’s interest in the

partnership and T’s share of the adjusted

basis to the partnership of the partnership’s

property. Under section 742, the basis of T’s

interest is $25,333 (the cash paid for A’s

interest, $22,000, plus $3,333, T’s share of

partnership liabilities). T’s interest in the

partnership’s previously taxed capital is

$15,000 ($22,000, the amount of cash T

would receive if PRS liquidated immediately

after the hypothetical transaction, decreased

by $7,000, the amount of tax gain allocated

to T from the hypothetical transaction). T’s

share of the adjusted basis to the partnership

of the partnership’s property is $18,333

($15,000 share of previously taxed capital,

plus $3,333 share of the partnership’s

liabilities). The amount of the basis

adjustment to partnership property therefore,

is $7,000, the difference between $25,333 and

$18,333.

Example 2. A, B, and C form partnership

PRS, to which A contributes land worth

$1,000 (Asset 1) with an adjusted basis to A

of $400, and B and C each contribute $1,000

cash. Each partner has $1,000 credited to it

on the books of the partnership as its capital

contribution. The partners share in profits

equally. During the partnership’s first taxable

year, Asset 1 appreciates in value to $1,300.

A sells its one-third interest in the

partnership to T for $1,100, when an election

under section 754 is in effect. The amount of

tax gain that would be allocated to T from the

hypothetical transaction is $700 ($600

section 704(c) built-in gain, plus one-third of

the additional gain). Thus, T’s interest in the

partnership’s previously taxed capital is $400

($1,100, the amount of cash T would receive

if PRS liquidated immediately after the

hypothetical transaction, decreased by $700,

T’s share of gain from the hypothetical

transaction). The amount of T’s basis

adjustment to partnership property is $700

(the excess of $1,100, T’s cost basis for its

interest, over $400, T’s share of the adjusted

basis to the partnership of partnership

property).

(e) Allocation of basis adjustment. For

the allocation of the basis adjustment

under this section among the individual

items of partnership property, see

section 755 and the regulations

thereunder.

(f) Subsequent transfers. Where there

has been more than one transfer of a

partnership interest, a transferee’s basis

adjustment is determined without

regard to any prior transferee’s basis

adjustment. In the case of a gift of an

interest in a partnership, the donor is

treated as transferring, and the donee as

receiving, that portion of the basis

adjustment attributable to the gifted

partnership interest. The provisions of

this paragraph (f) may be illustrated by

the following example:

Example. (i) A, B, and C form partnership

PRS. A and B each contribute $1,000 cash

and C contributes land with a basis and value

of $1,000. When the land has appreciated in

value to $1,300, A sells its interest to T1 for

$1,100 (one-third of $3,300, the value of the

partnership property). An election under

section 754 is in effect; therefore, T1 has a

basis adjustment of $100.

(ii) After the land has further appreciated

in value to $1,600, T1 sells its interest to T2

for $1,200 (one-third of $3,600, the value of

the partnership property). T2 has a basis

adjustment of $200. This amount is

determined without regard to any basis

adjustment that T1 may have had in the

partnership assets.

(iii) During the following year, T2 makes a

gift to T3 of fifty percent of T2’s interest in

PRS. At the time of the transfer, T2 has a

$200 basis adjustment. T2 is treated as

transferring $100 of the basis adjustment to

T3 with the gift of the partnership interest.

(g) Distributions—(1) Distribution of

adjusted property to the transferee—(i)

Coordination with section 732. If a

partnership distributes property to a

transferee and the transferee has a basis

adjustment for the property, the basis

adjustment is taken into account under

section 732. See § 1.732–2(b).

(ii) Coordination with section 734. For

certain adjustments to the common

basis of remaining partnership property

after the distribution of adjusted

property to a transferee, see § 1.734–

2(b).

(2) Distribution of adjusted property

to another partner—(i) Coordination

with section 732. If a partner receives a

distribution of property with respect to

which another partner has a basis

adjustment, the distributee does not take

the basis adjustment into account under

section 732.

(ii) Reallocation of basis. A transferee

with a basis adjustment in property that

is distributed to another partner

reallocates the basis adjustment among

the remaining items of partnership

property pursuant to § 1.755–1(c).

(3) Distributions in complete

liquidation of a partner’s interest. If a

transferee receives a distribution of

property (whether or not the transferee

has a basis adjustment in such property)

in liquidation of its interest in the

partnership, the adjusted basis to the

partnership of the distributed property

immediately before the distribution

includes the transferee’s basis

adjustment for the property in which

the transferee relinquished an interest

(either because it remained in the

partnership or was distributed to

another partner). Any basis adjustment

to property in which the transferee is

deemed to relinquish its interest is

reallocated among the properties

distributed to the transferee under

§ 1.755–1(c).

(4) Coordination with other

provisions. The rules of sections

704(c)(1)(B), 731, 737, and 751 apply

before the rules of this paragraph (g).

(5) Example. The provisions of this

paragraph (g) are illustrated by the

following example:

Example. (i) A, B, and C are equal partners

in partnership PRS. Each partner originally

contributed $10,000 in cash, and PRS used

the contributions to purchase five

nondepreciable capital assets. PRS has no

liabilities. After five years, PRS’s balance

sheet appears as follows:

Assets

Adjusted

basis

Market

value

Asset 1 .......................... $10,000 $10,000

Asset 2 .......................... 4,000 6,000

Asset 3 .......................... 6,000 6,000

Asset 4 .......................... 7,000 4,000

Asset 5 .......................... 3,000 13,000

Total ....................... 30,000 39,000

Capital

Adjusted

per

books

Market

value

Partner A ....................... $10,000 $13,000

Partner B ....................... 10,000 13,000

Partner C ....................... 10,000 13,000

Total ....................... 30,000 39,000

(ii) A sells its interest to T for $13,000

when PRS has an election in effect under

section 754. T receives a basis adjustment in

the partnership property that is equal to

$3,000 (the excess of T’s basis in the

partnership interest, $13,000, over T’s share

of the adjusted basis to the partnership of

partnership property, $10,000). The basis

adjustment is allocated under section 755,

and the partnership’s balance sheet appears

as follows:
Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules 4419

Assets

Adjusted

basis

Market

value

Basis adjustment

Asset 1 ................................................................................................................................................... $10,000 $10,000 0.00

Asset 2 ................................................................................................................................................... 4,000 6,000 666.67

Asset 3 ................................................................................................................................................... 6,000 6,000 0.00

Asset 4 ................................................................................................................................................... 7,000 4,000 (1,000.00)

Asset 5 ................................................................................................................................................... 3,000 13,000 3,333.33

Total .................................................................................................................................................... 30,000 39,000 4,000.00

Capital

Adjusted

per books

Market

value

Special

basis

Partner T .................................................................................................................................................. $10,000 $13,000 $3,000

Partner B .................................................................................................................................................. 10,000 13,000 0

Partner C .................................................................................................................................................. 10,000 13,000 0

Total .................................................................................................................................................. 30,000 39,000 3,000

(iii) Assume that PRS distributes Asset 2 to

T in partial liquidation of T’s interest in the

partnership. T has a basis adjustment of

$666.67 in Asset 2. Under paragraph (g)(1)(i)

of this section, T takes the basis adjustment

into account under section 732. Therefore, T

will have a basis in Asset 2 of $4,666.67

following the distribution.

(iv) Assume instead that PRS distributes

Asset 5 to C in complete liquidation of C’s

interest in PRS. T has a basis adjustment of

$3,333.33 in Asset 5. Under paragraph

(g)(2)(i) of this section, C does not take T’s

basis adjustment into account under section

732. Therefore, the partnership’s basis for

purposes of sections 732 and 734 is $3,000.

Under paragraph (g)(2)(ii) of this section, T’s

$3,333.33 basis adjustment is reallocated

among the remaining partnership assets

under § 1.755–1(c).

(v) Assume instead that PRS distributes

Asset 5 to T in complete liquidation of its

interest in PRS. Under paragraph (g)(3) of this

section, immediately prior to the distribution

of Asset 5 to T, PRS must adjust the basis of

Asset 5. Therefore, immediately prior to the

distribution, PRS’s basis in Asset 5 is equal

to $6,000, which is the sum of (A) $3,000,

PRS’s common basis in Asset 5, plus (B)

$3,333.33, T’s basis adjustment to Asset 5,

plus (C) ($333.33), the sum of T’s basis

adjustments in Assets 2 and 4. For purposes

of sections 732 and 734, therefore, PRS will

be treated as having a basis in Asset 5 equal

to $6,000.

(h) Contributions of adjusted

property—(1) Section 721(a)

transactions. If, in a transaction

described in section 721(a), a

partnership (the upper tier) contributes

to another partnership (the lower tier)

property with respect to which a basis

adjustment has been made, the basis

adjustment is treated as contributed to

the lower tier, regardless of whether the

lower tier partnership makes a section

754 election. The lower tier’s basis in

the contributed assets and the upper

tier’s basis in the partnership interest

received in the transaction are

determined with reference to the basis

adjustment. However, that portion of the

basis of the upper tier’s interest in the

lower tier attributable to the basis

adjustment must be segregated and

allocated solely to the transferee partner

for whom the basis adjustment was

made. Similarly, that portion of the

lower tier’s basis in its assets

attributable to the basis adjustment must

be segregated and allocated solely to the

upper tier and the transferee. A partner

with a basis adjustment in property held

by a partnership that terminates under

section 708(b)(1)(B) will continue to

have the same basis adjustment with

respect to property deemed contributed

by the terminated partnership to the

new partnership under § 1.708–

1(b)(1)(iv), regardless of whether the

new partnership makes a section 754

election.

(2) Section 351 transactions—(i) Basis

in transferred property. A corporation’s

adjusted tax basis in property

transferred to the corporation by a

partnership in a transaction described in

section 351 is determined with

reference to any basis adjustment to the

property under section 743(b) (other

than any basis adjustment that reduces

a partner’s gain under paragraph

(h)(2)(ii) of this section).

(ii) Partnership gain. The amount of

gain, if any, recognized by the

partnership on a transfer of property by

the partnership to a corporation in a

transfer described in section 351 is

determined without reference to any

basis adjustment to the transferred

property under section 743(b). The

amount of gain, if any, recognized by

the partnership on the transfer that is

allocated to a partner with a basis

adjustment in the transferred property is

adjusted to reflect the partner’s basis

adjustment in the transferred property.

(iii) Basis in stock. The partnership’s

adjusted tax basis in stock received from

a corporation in a transfer described in

section 351 is determined without

reference to the basis adjustment in

property transferred to the corporation

in the section 351 exchange. A partner

with a basis adjustment in property

transferred to the corporation, however,

has a special basis adjustment in the

stock received by the partnership in the

section 351 exchange in an amount

equal to the partner’s basis adjustment

in the transferred property, reduced by

any basis adjustment that reduced the

partner’s gain under paragraph (h)(2)(ii)

of this section.

(i) [Reserved].

(j) Effect of basis adjustment—(1) In

general. The basis adjustment

constitutes an adjustment to the basis of

partnership property with respect to the

transferee only. No adjustment is made

to the common basis of partnership

property. Thus, for purposes of income,

deduction, gain, loss, and distribution,

the transferee will have a special basis

for those partnership properties the

bases of which are adjusted under

section 743(b) and this section. The

adjustment to the basis of partnership

property under section 743 has no effect

on the partnership’s computation of any

item under section 703.

(2) Computation of partner’s

distributive share of partnership items.

The partnership first computes its items

of income, deduction, gain, or loss at the

partnership level under section 703. The

partnership then allocates the

partnership items among the partners,

including the transferee, in accordance
4420 Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules

with section 704, and adjusts the

partners’ capital accounts accordingly.

The partnership then adjusts the

transferee’s distributive share of the

items of partnership income, deduction,

gain, or loss, in accordance with

paragraphs (j)(3) and (4) of this section,

to reflect the effects of the transferee’s

basis adjustment to the property that is

the source of the item of partnership

income, deduction, gain, or loss. These

adjustments to the transferee’s

distributive shares do not affect the

transferee’s capital account.

(3) Effect of basis adjustment in

determining items of income, gain, or

loss—(i) In general. The amount of a

transferee’s income, gain, or loss from

the sale or exchange of a partnership

asset in which the transferee has a basis

adjustment is equal to the transferee’s

share of the partnership’s gain or loss

from the sale of the asset (including any

remedial allocations of gain or loss

under § 1.704–3(d)), minus the amount

of the transferee’s positive basis

adjustment for the partnership asset

(determined by taking into account the

recovery of the basis adjustment under

paragraph (j)(4)(i)(B) of this section) or

plus the amount of the transferee’s

negative basis adjustment for the

partnership asset (determined by taking

into the account the recovery of the

basis adjustment under paragraph

(j)(4)(ii)(B) of this section).

(ii) Examples. The following

examples illustrate the principles of this

paragraph (j)(3):

Example 1. A and B form equal partnership

PRS. A contributes nondepreciable property

with a fair market value of $50 and an

adjusted tax basis of $100. PRS will use the

traditional allocation method under § 1.704–

3(b). B contributes $50 cash. A sells its

interest to T for $50. PRS has an election in

effect to adjust the basis of partnership

property under section 754. T receives a

negative $50 basis adjustment that, under

section 755, is allocated to the

nondepreciable property. PRS then sells the

property for $60. PRS recognizes a book gain

of $10 and a tax loss of $40. T will receive

an allocation of $40 of tax loss under the

principles of section 704(c). Because T has a

negative $50 basis adjustment in the

nondepreciable property, T recognizes a $10

gain from the partnership’s sale of the

property.

Example 2. A and B form equal partnership

PRS. A contributes nondepreciable property

with a fair market value of $100 and an

adjusted tax basis of $50. B contributes $100

cash. PRS will use the traditional allocation

method under § 1.704–3(b). A sells its

interest to T for $100. PRS has an election in

effect to adjust the basis of partnership

property under section 754. Therefore, T

receives a $50 basis adjustment that, under

section 755, is allocated to the

nondepreciable property. PRS then sells the

nondepreciable property for $90. PRS

recognizes a book loss of $10 and a tax gain

of $40. T will receive an allocation of the

entire $40 of tax gain under the principles of

section 704(c). Because T has a $50 basis

adjustment in the property, T recognizes a

$10 loss from the partnership’s sale of the

property.

Example 3. A and B form equal partnership

PRS. PRS will make allocations under section

704(c) using the remedial allocation method

described in § 1.704–3(d). A contributes

property with a fair market value of $100 and

an adjusted tax basis of $150. B contributes

$100 cash. A sells its partnership interest to

T for $100. PRS has an election in effect to

adjust the basis of partnership property

under section 754. T receives a negative $50

basis adjustment that, under section 755, is

allocated to the property. The partnership

then sells the property for $120. The

partnership recognizes a $20 book gain and

a $30 tax loss. The book gain will be

allocated equally between the partners. The

entire $30 tax loss will be allocated to T

under the principles of section 704(c). To

match its $10 share of book gain, B will be

allocated $10 of remedial gain and T will be

allocated an offsetting $10 of remedial loss.

T was allocated a total of $40 of tax loss with

respect to the property. Because T has a

negative $50 basis adjustment to the

property, T recognizes a $10 gain from the

partnership’s sale of the property.

(4) Effect of basis adjustment in

determining items of deduction—(i)

Increases—(A) Additional deduction.

The amount of any positive basis

adjustment that is recovered by the

transferee in any year is added to the

transferee’s distributive share of the

partnership’s depreciation or

amortization deductions for the year.

The basis adjustment is adjusted under

section 1016(a)(2) to reflect the recovery

of the basis adjustment.

(B) Recovery period—(1) In general.

Except as provided in paragraph

(j)(4)(i)(B)(2) of this section, for

purposes of section 168, if the basis of

a partnership’s recovery property is

increased as a result of the transfer of a

partnership interest, then the increased

portion of the basis is taken into account

as if it were newly-purchased recovery

property placed in service when the

transfer occurs. Consequently, any

applicable recovery period and method

may be used to determine the recovery

allowance with respect to the increased

portion of the basis. However, no

change is made for purposes of

determining the recovery allowance

under section 168 for the portion of the

basis for which there is no increase.

(2) Remedial allocation method. If a

partnership elects to use the remedial

allocation method described in § 1.704–

3(d) with respect to an item of the

partnership’s recovery property, then

the portion of any increase in the basis

of the item of the partnership’s recovery

property under section 743(b) that is

attributable to section 704(c) built-in

gain is recovered over the remaining

recovery period for the partnership’s

excess book basis in the property as

determined in the final sentence of

§ 1.704–3(d)(2). Any remaining portion

of the basis increase is recovered under

paragraph (j)(4)(i)(B)(1) of this section.

(C) Examples. The provisions of this

paragraph (j)(4)(i) are illustrated by the

following examples:

Example 1. (i) A, B, and C are equal

partners in partnership PRS, which owns

Asset 1, an item of depreciable property that

has a fair market value in excess of its

adjusted tax basis. C sells its interest in PRS

to T while PRS has an election in effect

under section 754. PRS, therefore, increases

the basis of Asset 1 with respect to T.

(ii) Assume that in the year following the

transfer of the partnership interest to T, T’s

distributive share of the partnership’s

common basis depreciation deductions from

Asset 1 is $1,000. Also assume that, under

paragraph (j)(4)(i)(B) of this section, the

amount of the basis adjustment that T

recovers during the year is $500. The total

amount of depreciation deductions from

Asset 1 reported by T is equal to $1,500.

Example 2. (i) A and B form equal

partnership PRS. A contributes property with

an adjusted basis of $100,000 and a fair

market value of $500,000. B contributes

$500,000 cash. When PRS is formed, the

property has five years remaining in its

recovery period. The partnership’s adjusted

basis of $100,000 will, therefore, be

recovered over the five years remaining in

the property’s recovery period. PRS elects to

use the remedial allocation method under

§ 1.704–3(d) with respect to the property. If

PRS had purchased the property at the time

of the partnership’s formation, the basis of

the property would have been recovered over

a 10 year period. The $400,000 of section

704(c) built-in gain will, therefore, be

amortized under § 1.704–3(d) over a 10 year

period beginning at the time of the

partnership’s formation.

(ii) Except for the depreciation deductions,

PRS’s expenses equal its income in each year

of the first two years commencing with the

year the partnership is formed. After two

years, A’s share of the adjusted basis of

partnership property is $120,000, while B’s is

$440,000:
Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules 4421

CAPITAL ACCOUNTS

A B

Book Tax Book Tax

Initial Contribution ....................................................................................................... $500,000 $100,000 $500,000 $500,000

Depreciation Year 1 .................................................................................................... (30,000) .................... (30,000) (20,000)

Remedial ..................................................................................................................... ...................... 10,000 ...................... (10,000)

Subtotal ............................................................................................................... 470,000 110,000 470,000 470,000

Depreciation Year 2 .................................................................................................... (30,000) .................... (30,000) (20,000)

Remedial ..................................................................................................................... ...................... 10,000 ...................... (10,000)

Total ..................................................................................................................... 440,000 120,000 440,000 440,000

(iii) A sells its interest in PRS to T for its

fair market value of $440,000. A valid

election under section 754 is in effect with

respect to the sale of the partnership interest.

Accordingly, PRS makes an adjustment,

pursuant to section 743(b), to increase the

basis of partnership property. Under section

743(b), the amount of the basis adjustment is

equal to $320,000. Under section 755, the

entire basis adjustment is allocated to the

property.

(iv) At the time of the transfer, $320,000 of

section 704(c) built-in gain from the property

was still reflected on the partnership’s books,

and all of the basis adjustment is attributable

to section 704(c) built-in gain. Therefore, the

basis adjustment will be recovered over the

remaining recovery period for the section

704(c) built-in gain under § 1.704–3(d).

(ii) Decreases—(A) Effect on

depreciation deductions—(1)—Reduced

deduction to transferee. Except as

provided in paragraph (j)(4)(ii)(A)(2) of

this section, the amount of the basis

adjustment to an item of depreciable or

amortizable property that is recovered

in any year first decreases the

transferee’s distributive share of the

partnership’s depreciation or

amortization deductions from that item

of property for the year. If the amount

of the basis adjustment recovered in any

year exceeds the transferee’s distributive

share of the partnership’s depreciation

or amortization deductions from the

item of property, then the transferee’s

distributive share of the partnership’s

depreciation or amortization deductions

from other items of partnership property

is decreased. The transferee then

recognizes ordinary income to the

extent of the excess, if any, of the

amount of the basis adjustment

recovered in any year over the

transferee’s distributive share of the

partnership’s depreciation or

amortization deductions from all items

of property.

(2) Election to reduce deduction of

other partners by excess adjustment.

The partnership may elect to treat the

amount of the basis adjustment as an

item of built-in gain, decreasing the

amount of depreciation or amortization

that the partnership may allocate for tax

purposes. This election has no effect on

the depreciation or amortization of the

property on the books of the

partnership. The partnership must make

this election on the statement required

to be attached to its return pursuant to

paragraph (k) of this section for the year

that the adjustment is made to the item

of property.

(B) Recovery period. For purposes of

section 168, if the basis of an item of a

partnership’s recovery property is

decreased as the result of the transfer of

an interest in the partnership then the

decrease is recovered over the

remaining useful life of the item of the

partnership’s recovery property. The

portion of the decrease that is recovered

in any year during the recovery period

is equal to the product of—

(1) The amount of the decrease to the

item’s adjusted basis (determined as of

the date of the transfer); multiplied by

(2) A fraction, the numerator of which

is the portion of the adjusted basis of the

item recovered by the partnership in

that year, and the denominator of which

is the adjusted basis of the item on the

date of the transfer (determined prior to

any basis adjustments).

(C) Examples. The provisions of this

paragraph (j)(4)(ii) are illustrated by the

following examples:

Example 1. (i) A, B, and C are equal

partners in partnership PRS, which owns

Asset 2, an item of depreciable property that

has a fair market value that is less than its

adjusted tax basis. C sells its interest in PRS

to T while PRS has an election in effect

under section 754. PRS, therefore, decreases

the basis of Asset 2 with respect to T.

(ii) Assume that in the year following the

transfer of the partnership interest to T, T’s

distributive share of the partnership’s

common basis depreciation deducations from

Asset 2 is $1,000. Also assume that, under

paragraph (j)(4)(ii)(B) of this section, the

amount of the basis adjustment that T

recovers during the year is $500. The total

amount of depreciation deductions from

Asset 2 reported by T is equal to $500.

Example 2. (i) A and B form equal

partnership PRS. A contributes property with

an adjusted basis of $100,000 and a fair

market value of $50,000. B contributes

$50,000 cash. When PRS is formed, the

property has five years remaining in its

recovery period. The partnership’s adjusted

basis of $100,000 will, therefore, be

recovered over the five years remaining in

the property’s recovery period. PRS uses the

traditional allocation method under § 1.704–

3(b) with respect to the property. As a result,

B will receive $5,000 of depreciation

deductions from the property in each of years

1–5, and A, as the contributing partner, will

receive $15,000 of depreciation deductions in

each of these years.

(ii) Except for the depreciation deductions,

PRS’s expenses equal its income in each of

the first two years commencing with the year

the partnership is formed. After two years,

A’s share of the adjusted basis of partnership

property is $70,000, while B’s is $40,000. A

sells its interest in PRS to T for its fair market

value of $40,000. A valid election under

section 754 is in effect with respect to the

sale of the partnership interest. Accordingly,

PRS makes an adjustment, pursuant to

section 743(b), to decrease the basis of

partnership property. Under section 743(b),

the amount of the adjustment is equal to

($30,000). Under section 755, the entire

adjustment is allocated to the property.

(iii) The basis of the property at the time

of the transfer of the partnership interest was

$60,000. In each of years 3 through 5, the

partnership will realize depreciation

deductions of $20,000 from the property.

Thus, one third of the negative basis

adjustment ($10,000) will be recovered in

each of years 3 through 5. Consequently, T

will be allocated for tax purposes

depreciation of $15,000 each year from the

partnership and will recover $10,000 of its

negative basis adjustment. Thus, T’s net

depreciation deducation from the partnership

in each year is $5,000.

Example 3. (i) A, B, and C are equal

partners in partnership PRS, which owns

Asset 2, an item of depreciable property that

has a fair market value that is less than its

adjusted tax basis. C sells its interest in PRS

to T while PRS has an election in effect

under section 754. PRS, therefore, decreases

the basis of Asset 2 with respect to T.

(ii) Assume that in the year following the

transfer of the partnership interest to T, T’s

distributive share of the partnership’s

common basis depreciation deductions from

Asset 2 is $500. PRS allocates no other

depreciation to T. Also assume that, under

paragraph (j)(4)(ii)(B) of this section, the

amount of the negative basis adjustment that
4422 Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules

T recovers during the year is $1,000. T will

report $500 of ordinary income because the

amount of the negative basis adjustment

recovered during the year exceeds T’s

distributive share of the partnership’s

common basis depreciation deductions from

Asset 2.

Example 4. (i) A and B are equal partners

in partnership PRS. PRS has one depreciable

asset that it purchased with cash. On the first

day of a year, A transfers its interest to T at

a time when the fair market value of the

depreciable asset is $50 and its adjusted tax

basis is $200. The partnership has an election

in effect under section 754, resulting in a $75

decrease in the basis of the depreciable asset

to T under section 743.

(ii) The depreciable asset has a remaining

useful life of two years and is being

recovered using the straight-line method. The

partnership elects, under paragraph

(j)(4)(ii)(A)(2) of this section, to treat the

decrease in basis under section 743 as an

item of built-in gain, decreasing the amount

of depreciation that the partnership can

allocate from $200 to $125. This reduces the

amount of depreciation available to be

allocated to the partners in each year from

$100 to $62.50. This election has no effect on

the depreciation or amortization of the

property on the books of the partnership.

Therefore, the partnership will recover $100

of depreciation on its books in each year.

(iii) At the end of the year, the partnership

allocates each partner $50 of depreciation for

book purposes. Under the principles of

section 704(c), the first $50 of tax

depreciation is allocated to B. The remaining

$12.50 of tax depreciation is allocated to T.

(5) Depletion. Where an adjustment is

made under section 743(b) to the basis

of partnership property subject to

depletion, any depletion allowance is

determined separately for each partner,

including the transferee partner, based

on the partner’s interest in such

property. See § 1.702–1(a)(8).

(6) Example. The provisions of

paragraph (j)(5) of this section are

illustrated by the following example:

Example. A, B, and C each contributes

$5,000 cash to form partnership PRS, which

purchases oil property for $15,000. A, B, and

C have equal interests in capital and profits.

C subsequently sells its partnership interest

to T for $100,000 when the election under

section 754 is in effect. T has a basis

adjustment for the oil property of $95,000

(the difference between T’s basis, $100,000,

and its share of the basis of partnership

property, $5,000). Assume that the depletion

allowance computed under the percentage

method would be $21,000 for the taxable year

so that each partner would be entitled to

$7,000 as its share of the deduction for

depletion. However, under the cost depletion

method, at an assumed rate of 10 percent, the

allowance with respect to T’s one-third

interest which has a basis to him of $100,000

($5,000, plus its basis adjustment of $95,000)

is $10,000, although the cost depletion

allowance with respect to the one-third

interest of A and B in the oil property, each

of which has a basis of $5,000, is only $500.

For partners A and B, the percentage

depletion is greater than cost depletion and

each will deduct $7,000 based on the

percentage depletion method. However, as to

T, the transferee partner, the cost depletion

method results in a greater allowance and T

will, therefore, deduct $10,000 based on cost

depletion. See section 613(a).

(k) Returns—(1) Statement of

adjustments. A partnership that must

adjust the bases of partnership

properties under section 743 must

attach a statement to the partnership

return for the year of the transfer setting

forth the name and taxpayer

identification number of the transferee

as well as the computation of the

adjustment and the partnership

properties to which the adjustment has

been allocated.

(2) Requirement that transferee notify

partnership—(i) Sale or exchange. A

transferee that acquires, by sale or

exchange, an interest in a partnership

with an election under section 754 in

effect, must notify the partnership, in

writing, within 30 days of the sale or

exchange (or, if earlier, by January 15 of

the calendar year following the calendar

year in which the sale or exchange

occurred). The written notice to the

partnership must include the names and

addresses of both parties to the sale or

exchange, the taxpayer identification

numbers of the transferee and (if

known) of the transferor, the date of the

transfer, and the amount of any money

and the fair market value of any other

property delivered or to be delivered for

the transferred interest in the

partnership.

(ii) Transfer on death. A transferee

that acquires, on the death of a partner,

an interest in a partnership with an

election under section 754 in effect,

must notify the partnership, in writing,

within one year of the death of the

deceased partner. The written notice to

the partnership must include the names

and addresses of the deceased partner

and the transferee, the taxpayer

identification numbers of the deceased

partner and the transferee, the date on

which the transferee became the owner

of the partnership interest, the fair

market value of the partnership interest

on the applicable date of valuation set

forth in section 1014, and the manner in

which the fair market value of the

partnership interest was determined.

(3) Reliance. In making the

adjustments under section 743 and any

statement or return relating to such

adjustments under this section, a

partnership may rely on the written

notice provided by a transferee pursuant

to paragraph (k)(2) of this section to

determine the transferee’s basis in a

partnership interest. The previous

sentence shall not apply if the tax

matters partner (as defined under

section 6231(a)(7)) or any other partner

who has responsibility for federal

income tax reporting by the partnership

has knowledge of facts indicating that

the statement is clearly erroneous.

(4) Partnership not required to make

or report adjustments under section 743

until it has notice of the transfer. A

partnership is not required to make the

adjustments under section 743 (or any

statement or return relating to those

adjustments) with respect to any

transfer until it has been notified of the

transfer. For purposes of this section, a

partnership is notified of a transfer

when either—

(i) The partnership receives the

written notice from the transferee

required under paragraph (k)(2) of this

section; or

(ii) The tax matters partner (as defined

under section 6231(a)(7)) or any other

partner who has responsibility for

federal income tax reporting by the

partnership has knowledge that there

has been a transfer of a partnership

interest.

(5) Effect on partnership of the failure

of the transferee to comply. If the

transferee fails to provide the

partnership with the written notice

required by paragraph (k)(2) of this

section, the partnership must attach a

statement to its return in the year that

the partnership is otherwise notified of

the transfer. This statement must set

forth the name and taxpayer

identification number (if known) of the

transferee. In addition, the following

statement must be prominently

displayed in capital letters on the first

page of the partnership’s return for such

year, and on the first page of any

schedule or information statement

relating to such transferee’s share of

income, credits, deductions, etc.:

‘‘RETURN FILED PURSUANT TO

§ 1.743–1(k)(5).’’ The partnership will

then be entitled to report the transferee’s

share of partnership items without

adjustment to reflect the transferee’s

basis adjustment in partnership

property. If, following the filing of a

return pursuant to this paragraph (k)(5),

the transferee provides the applicable

written notice to the partnership, the

partnership must make such

adjustments as are necessary to adjust

the basis of partnership property (as of

the date of the transfer) in any amended

return otherwise to be filed by the

partnership or in the next annual

partnership return of income to be

regularly filed by the partnership. At

such time, the partnership must also

provide the transferee with such

information as is necessary for the
Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules 4423

transferee to amend its prior returns to

properly reflect the adjustment under

section 743.

(l) Effective date. This section applies

to transfers of partnership interests that

occur on or after the date final

regulations are published in the Federal

Register.

Par. 6. Section 1.751–1 is amended

by:

1. Revising paragraphs (a)(2) and

(a)(3) and Example 1 of paragraph (g).

2. Adding a sentence at the end of

paragraph (f).

The addition and revisions read as

follows:

§ 1.751–1 Unrealized receivables and

inventory items.

(a) * * *

(2) Determination of gain or loss. The

income or loss realized by a partner

upon the sale or exchange of its interest

in section 751 property is the amount of

income or loss from section 751

property (including any remedial

allocation under § 1.704–3(d)) that

would have been allocated to the

partner (to the extent attributable to the

partnership interest sold or exchanged)

if the partnership had sold all of its

property in a fully taxable transaction

immediately prior to the partner’s

transfer of the interest in the

partnership. Any gain or loss recognized

that is attributable to section 751

property will be ordinary gain or loss.

The difference between the amount of

capital gain or loss that the partner

would realize in the absence of section

751 and the amount of ordinary income

or loss determined under this paragraph

(a)(2) is the transferor’s capital gain or

loss on the sale of its partnership

interest.

(3) Statement required. A partner

selling or exchanging any part of an

interest in a partnership that has any

section 751 property at the time of sale

or exchange must submit with its

income tax return for the taxable year in

which the sale or exchange occurs a

statement setting forth separately the

following information—

(i) The date of the sale or exchange;

(ii) The amount of any gain or loss

attributable to the section 751 property;

and

(iii) The amount of any gain or loss

attributable to capital gain or loss on the

sale of the partnership interest.

* * * * *

(f) * * * The rules contained in

paragraphs (a) (2) and (3) of this section

apply to transfers of partnership

interests that occur on or after the date

final regulations are published in the

Federal Register.

(g) * * *

Example 1. (i) A and B are equal partners

in personal service partnership PRS. B

transfers its interest in PRS to T for $15,000

when PRS’s balance sheet (reflecting a cash

receipts and disbursements method of

accounting) is as follows:

Assets

Adjusted

basis

Market

value

Cash .............................. $3,000 $3,000

Loans Receivable ......... 10,000 10,000

Capital Assets ............... 7,000 5,000

Unrealized receivables .. 0 14,000

Total ....................... 20,000 32,000

Liabilities and

capital

Adjusted

per books

Market

value

Liabilities ................... $2,000 $2,000

Capital:

A ......................... 9,000 15,000

B ......................... 9,000 15,000

Total ............... 20,000 32,000

(ii) None of the assets owned by PRS is

section 704(c) property. The total amount

realized by B is $16,000, consisting of the

cash received, $15,000, plus $1,000, B’s share

of the partnership liabilities assumed by T.

See section 752. B’s undivided half-interest

in the partnership property includes a halfinterest in the partnership’s unrealized

receivables items. B’s basis for its partnership

interest is $10,000 ($9,000, plus $1,000, B’s

share of partnership liabilities). If section

751(a) did not apply to the sale, B would

recognize $6,000 of capital gain from the sale

of the interest in PRS. However, section

751(a) does apply to the sale.

(iii) If PRS sold all of its section 751

property in a fully taxable transaction

immediately prior to the transfer of B’s

partnership interest to T, B would have been

allocated $7,000 of ordinary income from the

sale of PRS’s unrealized receivables.

Therefore, B will recognize $7,000 of

ordinary income with respect to the

unrealized receivables. The difference

between the amount of capital gain or loss

that the partner would realize in the absence

of section 751 ($6,000) and the amount of

ordinary income or loss determined under

paragraph (a)(2) of this section ($7,000) is the

transferor’s capital gain or loss on the sale of

its partnership interest. In this case, B will

recognize a $1,000 capital loss.

* * * * *

Par. 7. Section 1.755–1 is revised to

read as follows:

§ 1.755–1 Rules for allocation of basis.

(a) Generally. A partnership that has

an election in effect under section 754

must adjust the basis of partnership

property under the provisions of section

734(b) and section 743(b) pursuant to

the provisions of this section. The basis

adjustment is first allocated between the

two classes of property described in

section 755(b). These classes of property

consist of—

(1) Capital assets and section 1231(b)

property (capital gain property); and

(2) Any other property of the

partnership (ordinary income property).

The portion of the basis adjustment

allocated to each class is then allocated

among the items within the class.

Adjustments under section 743(b) are

allocated under paragraph (b) of this

section. Adjustments under section

734(b) are allocated under paragraph (c)

of this section.

(b) Adjustments under section

743(b)—(1) Generally. In general, the

allocation of the basis adjustment under

section 743 between the classes of

property and among the items of

property within each class are made

based on the allocations of income, gain,

or loss (including remedial allocations

under § 1.704–3(d)) that the transferee

partner would receive (to the extent

attributable to the acquired partnership

interest) if, immediately after the

transfer of the partnership interest, all of

the partnership’s assets were disposed

of in a fully taxable transaction for fair

market value (the hypothetical

transaction). The portion of the basis

adjustment allocated to one class of

property may be an increase while the

portion allocated to the other class is a

decrease. This would be the case even

though the total amount of the basis

adjustment is zero. The portion of the

basis adjustment allocated to one item

of property within a class may be an

increase while the portion allocated to

another is a decrease. This would be the

case even though the basis adjustment

allocated to the class is zero.

(2) Allocations between classes of

property—(i) In general. The amount of

the basis adjustment allocated to the

class of ordinary income property is

equal to the total amount of income,

gain, or loss (including any remedial

allocations under § 1.704–3(d)) that

would be allocated to the transferee (to

the extent attributable to the acquired

partnership interest) from the sale of all

ordinary income property in the

hypothetical transaction. The amount of

the basis adjustment to capital gain

property is equal to—

(A) The total amount of the basis

adjustment under section 743; less

(B) The amount of the basis

adjustment allocated to ordinary income

property under the preceding sentence;

provided, however, that in no event may

the amount of any decrease in basis

allocated to capital gain property exceed

the partnership’s basis (or in the case of
4424 Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules

property subject to the remedial

allocation method, the transferee’s share

of any remedial loss under § 1.704-3(d)

from the hypothetical transaction) in

capital gain property. In the event that

a decrease in basis allocated to capital

gain property would otherwise exceed

the partnership’s basis in capital gain

property, the excess must be applied to

reduce the basis of ordinary income

property.

(ii) Examples. The provisions of this

paragraph (b)(2) are illustrated by the

following example:

Example 1. (i) A and B form equal

partnership PRS. A contributes $50,000 and

Asset 1, a capital asset with a fair market

value of $50,000 and an adjusted tax basis of

$25,000. B contributes $100,000. PRS uses

the cash to purchase Assets 2, 3, and 4. After

a year, A sells its interest in PRS to T for

$120,000. At the time of the transfer, A’s

share of the partnership’s basis in

partnership assets is $75,000. Therefore, T

receives a $45,000 basis adjustment.

(ii) Immediately after the transfer of the

partnership interest to T, the adjusted basis

and fair market value of PRS’s assets are as

follows:

Assets

Adjusted

basis

Market

value

Capital Gain Property:

Asset 1 ............... $25,000 $75,000

Asset 2 ............... 100,000 117,500

Ordinary Income

Property:

Asset 3 ............... 40,000 45,000

Asset 4 ............... 10,000 2,500

Total ............... 175,000 240,000

(iii) If PRS sold all of its assets in a

fully taxable transaction at fair market

value immediately after the transfer of

the partnership interest to T, the total

amount of capital gain that would be

allocated to T is equal to $46,250

($25,000 section 704(c) built-in gain

from Asset 1, plus fifty percent of the

$42,500 appreciation in capital gain

property). T would also be allocated a

$1,250 ordinary loss from the sale of the

ordinary income property.

(iv) The amount of the basis

adjustment that is allocated to ordinary

income property is equal to ($1,250) (the

amount of the loss allocated to T from

the hypothetical sale of the ordinary

income property).

(v) The amount of the basis

adjustment that is allocated to capital

gain property is equal to $46,250 (the

amount of the basis adjustment,

$45,000, less ($1,250), the amount of

loss allocated to T from the hypothetical

sale of the ordinary income property).

Example 2. (i) A and B form equal

partnership PRS. A and B each

contribute $1,000 cash which the

partnership uses to purchase Assets 1, 2,

3, and 4. After a year, A sells its

partnership interest to T for $1,000. T’s

basis adjustment under section 743 is

zero.

(ii) Immediately after the transfer of

the partnership interest to T, the

adjusted basis and fair market value of

PRS’ assets are as follows:

Assets

Adjusted

basis

Market

value

Capital Gain Property:

Asset 1 ................... $500 $750

Asset 2 ................... 500 500

Ordinary Income Property:

Asset 3 ................... 500 250

Asset 4 ................... 500 500

Total ................... 2,000 2,000

(iii) If, immediately after the transfer of the

partnership interest to T, PRS sold all of its

assets in a fully taxable transaction at fair

market value, T would be allocated a loss of

$125 from the sale of the ordinary income

property. Thus, the amount of the basis

adjustment to ordinary income property is

($125). The amount of the basis adjustment

to capital gain property is $125 (zero, the

amount of the basis adjustment under section

743, less ($125), amount of the basis

adjustment allocated to ordinary income

property).

(3) Allocation within the class—(i)

Ordinary income property. The amount

of the basis adjustment to each item of

property within the class of ordinary

income property is equal to—

(A) The amount of income, gain, or

loss (including any remedial allocations

under § 1.704–3(d)) that would be

allocated to the transferee (to the extent

attributable to the acquired partnership

interest) from the hypothetical sale of

the item; reduced by

(B) The product of—

(1) Any decrease to the amount of the

basis adjustment to ordinary income

property required pursuant to the last

sentence of paragraph (b)(2)(i) of this

section; multiplied by

(2) A fraction, the numerator of which

is the fair market value of the item of

property to the partnership and the

denominator of which is the total fair

market value of all of the partnership’s

items of ordinary income property.

(ii) Capital gain property. The amount

of the basis adjustment to each item of

property within the class of capital gain

property is equal to—

(A) The amount of income, gain, or

loss (including any remedial allocations

under § 1.704–3(d)) that would be

allocated to the transferee (to the extent

attributable to the acquired partnership

interest) from the hypothetical sale of

the item; minus

(B) The product of—

(1) The total amount of gain or loss

(including any remedial allocations

under § 1.704–3(d)) that would be

allocated to the transferee (to the extent

attributable to the acquired partnership

interest) from the hypothetical sale of all

items of capital gain property, minus the

amount of the positive basis adjustment

to all items of capital gain property or

plus the amount of the negative basis

adjustment to capital gain property;

multiplied by

(2) A fraction, the numerator of which

is the fair market value of the item of

property to the partnership and the

denominator of which is the total fair

market value of all of the partnership’s

items of capital gain property.

(iii) Examples. The provisions of this

paragraph (b)(3) are illustrated by the

following example:

Example 1. (i) Assume the same facts as

Example 1 in paragraph (b)(2)(ii) of this

section. Of the $45,000 basis adjustment,

$46,250 was allocated to capital gain

property. The amount allocated to ordinary

income property was ($1,250).

(ii) Asset 1 is a capital gain asset, and T

would be allocated $37,500 from the sale of

Asset 1 in the hypothetical transaction.

Therefore, the amount of the adjustment to

Asset 1 is $37,500.

(iii) Asset 2 is a capital gain asset, and T

would be allocated $8,750 from the sale of

Asset 2 in the hypothetical transaction.

Therefore, the amount of the adjustment to

Asset 2 is $8,750.

(iv) Asset 3 is ordinary income property,

and T would be allocated $2,500 from the

sale of Asset 3 in the hypothetical

transaction. Therefore, the amount of the

adjustment to Asset 3 is $2,500.

(v) Asset 4 is ordinary income property,

and T would be allocated ($3,750) from the

sale of Asset 4 in the hypothetical

transaction. Therefore, the amount of the

adjustment to Asset 4 is ($3,750).

Example 2. (i) Assume the same facts as

Example 1 in paragraph (b)(2)(ii) of this

section, except that A sold its interest in PRS

to T for $110,000 rather than $120,000. T,

therefore, receives a basis adjustment under

section 743 of $35,000. Of the $35,000 basis

adjustment, ($1,250) is allocated to ordinary

income property, and $36,250 is allocated to

capital gain property.

(ii) Asset 3 is ordinary income property,

and T would be allocated $2,500 from the

sale of Asset 3 in the hypothetical

transaction. Therefore, the amount of the

adjustment to Asset 3 is $2,500.

(iii) Asset 4 is ordinary income property,

and T would be allocated ($3,750) from the

sale of Asset 4 in the hypothetical

transaction. Therefore, the amount of the

adjustment to Asset 4 is ($3,750).

(iv) Asset 1 is a capital gain asset, and T

would be allocated $37,500 from the sale of

Asset 1 in the hypothetical transaction. Asset

2 is a capital gain asset, and T would be
Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules 4425

allocated $8,750 from the sale of Asset 2 in

the hypothetical transaction. The total

amount of gain that would be allocated to T

from the sale of the capital gain assets in the

hypothetical transaction is $46,250, which

exceeds the amount of the basis adjustment

allocated to capital gain property. The

amount of the adjustment to Asset 1 is

$33,604 (the sum of $37,500, less $3,896

($10,000 x $75,000/192,500)). The amount of

the basis adjustment to Asset 2 is $2,646 (the

sum of $8,750, less $6,104 ($10,000 x

$117,500/192,500)).

(c) Adjustments under section

734(b)—(1) Allocations between classes

of property—(i) General rule. Where

there is a distribution of partnership

property resulting in an adjustment to

the basis of undistributed partnership

property under section 734(b)(1)(B) or

(b)(2)(B), the adjustment must be

allocated to remaining partnership

property of a character similar to that of

the distributed property with respect to

which the adjustment arose. Thus, when

the partnership’s adjusted basis of

distributed capital gain property

immediately prior to distribution

exceeds the basis of the property to the

distributee partner (as determined under

section 732), the basis of the

undistributed capital gain property

remaining in the partnership is

increased by an amount equal to the

excess. Conversely, when the basis to

the distributee partner (as determined

under section 732) of distributed capital

gain property exceeds the partnership’s

adjusted basis of such property

immediately prior to the distribution,

the basis of the undistributed capital

gain property remaining in the

partnership is decreased by an amount

equal to such excess. Similarly, where

there is a distribution of ordinary

income property, and the basis of the

property to the distributee partner (as

determined under section 732) is not the

same as the partnership’s adjusted basis

of the property immediately prior to

distribution, the adjustment is made

only to undistributed property of the

same class remaining in the partnership.

(ii) Special rule. Where there is a

distribution resulting in an adjustment

under section 734(b)(1)(A) or (b)(2)(A) to

the basis of undistributed partnership

property, the adjustment is allocated

only to capital gain property.

(2) Allocations within the classes—(i)

Increases. If there is an increase in basis

to be allocated within a class, the

increase must be allocated first to

properties with unrealized appreciation

in proportion to their respective

amounts of unrealized appreciation

before such increase (but only to the

extent of each property’s unrealized

appreciation). Any remaining increase

must be allocated among the properties

within the class in proportion to their

fair market values.

(ii) Decreases. If there is a decrease in

basis to be allocated within a class, the

decrease must be allocated first to

properties with unrealized depreciation

in proportion to their respective

amounts of unrealized depreciation

before such decrease (but only to the

extent of each property’s unrealized

depreciation). Any remaining decrease

must be allocated among the properties

within the class in proportion to their

adjusted bases (as adjusted under the

preceding sentence).

(3) Limitation in decrease of basis.

Where a decrease in the basis of

partnership assets is required under

section 734(b)(2) and the amount of the

decrease exceeds the adjusted basis to

the partnership of property of the

required character, the basis of such

property is reduced to zero (but not

below zero).

(4) Carryover adjustment. Where, in

the case of a distribution, an increase or

a decrease in the basis of undistributed

property cannot be made because the

partnership owns no property of the

character required to be adjusted, or

because the basis of all the property of

a like character has been reduced to

zero, the adjustment is made when the

partnership subsequently acquires

property of a like character to which an

adjustment can be made.

(5) Goodwill. The application of the

rules with respect to the allocation of an

adjustment in basis under this

paragraph (c) requires that a portion of

the adjustment be allocated to

partnership goodwill, to the extent that

goodwill exists and is reflected in the

value of the property distributed in

accordance with the difference between

such value of the goodwill and its

adjusted basis at the time of the

distribution.

(6) Example. The following example

illustrates this paragraph (c):

Example. (i) A, B, and C form equal

partnership PRS. A contributes $50,000 and

Asset 1, capital gain property with a fair

market value of $50,000 and an adjusted tax

basis of $25,000. B and C each contributes

$100,000. PRS uses the cash to purchase

Assets 2, 3, 4, 5, and 6. None of the

partnership’s assets are section 751 property.

The partnership has an election in effect

under section 754. After five years, the

adjusted basis and fair market value of PRS’s

assets are as follows:

Assets

Adjusted

basis

Market

value

Capital Gain Property:

Asset 1 ................... $25,000 $75,000

Asset 2 ................... 100,000 117,500

Assets

Adjusted

basis

Market

value

Asset 3 ................... 50,000 60,000

Ordinary Income Property:

Asset 4 ................... 40,000 45,000

Asset 5 ................... 50,000 60,000

Asset 6 ................... 10,000 2,500

Total ................... 275,000 360,000

(ii) Allocation between classes. Assume

that PRS distributes Assets 3 and 5 to A in

complete liquidation of A’s interest in the

partnership. A’s basis in the partnership

interest was $75,000. The partnership’s basis

in Assets 3 and 5 was $50,000 each. A’s

$75,000 basis in its partnership interest is

allocated between Assets 3 and 5 under

sections 732(b) and (c). A will, therefore,

have a basis of $37,500 in each of Assets 3

and 5. The distribution results in a $12,500

increase in the basis of both capital gain

property and ordinary income property.

(iii) Allocation within classes—(A) Capital

gain property. The amount of the basis

increase to capital gain property is $12,500,

and must be allocated among the remaining

capital gain assets in proportion to the

difference between the value and basis of

each. The fair market value of Asset 1

exceeds its basis by $50,000. The fair market

value of Asset 2 exceeds its basis by $17,500.

Therefore, the basis of Asset 1 will be

increased by $9,260 ($12,500, multiplied by

$50,000, divided by $67,500), and the basis

of Asset 2 will be increased by $3,240

($12,500 multiplied by $17,500, divided by

$67,500).

(B) Ordinary income property. The amount

of the basis increase to ordinary income

property is $12,500, and must be allocated

among the remaining ordinary income assets

in proportion to the difference between the

value and basis of each. Because the basis of

Asset 6 exceeds its fair market value, no part

of the basis adjustment will be allocated to

Asset 6. The fair market value of Asset 4,

$45,000, exceeds its basis, $40,000, by

$5,000. Because the partnership owns no

other ordinary income property that has a

value in excess of its basis, the entire basis

adjustment will be allocated to Asset 4,

increasing its basis from $40,000 to $52,500.

(d) Effective date. This section applies

to transfers of partnership interests and

distributions of property from a

partnership that occur on or after the

date final regulations are published in

the Federal Register.

Par. 8. Section 1.1017–1 as proposed

to be revised at 62 FR 958, January 7,

1997, is amended by:

1. Revising paragraph (f)(2)(iv).

2. Adding paragraph (f)(2)(v).

The addition and revision read as

follows:

§ 1.1017–1 Basis reductions following a

discharge of indebtedness.

* * * * *
4426 Federal Register / Vol. 63, No. 19 /Thursday, January 29, 1998 / Proposed Rules

(f) * * *

(2) * * *

(iv) Partner’s share of partnership

basis—(A) In general. For purposes of

this paragraph (f), a partner’s

proportionate share of the partnership’s

basis in depreciable property (or

depreciable real property) is equal to the

sum of—

(1) The partner’s section 743(b) basis

adjustments to items of partnership

depreciable property (or depreciable

real property); and

(2) The common basis depreciation

deductions (but not including remedial

allocations of depreciation deductions

under § 1.704–3(d)) that, under the

terms of the partnership agreement, are

reasonably expected to be allocated to

the partner over the property’s

remaining useful life. The assumptions

made by a partnership in determining

the reasonably expected allocation of

depreciation deductions must be

consistent for each partner. For

example, a partnership may not treat the

same depreciation deductions as being

reasonably expected by more than one

partner.

(B) Effective date. This paragraph

(f)(2)(iv) applies to elections made

under sections 108(b)(5) and 108(c) on

or after the date the regulations are

published as final regulations in the

Federal Register.

(v) Treatment of basis reduction—(A)

Basis adjustment. The amount of the

reduction to the basis of depreciable

partnership property constitutes an

adjustment to the basis of partnership

property with respect to the partner

only. No adjustment is made to the

common basis of partnership property.

Thus, for purposes of income,

deduction, gain, loss, and distribution,

the partner will have a special basis for

those partnership properties the bases of

which are adjusted under section 1017

and this section.

(B) Recovery of adjustments to basis

of partnership property. Adjustments to

the basis of partnership property under

this section are recovered in the manner

described in § 1.743–1.

(C) Effect of basis reduction.

Adjustments to the basis of partnership

property under this section are treated

in the same manner and have the same

effect as an adjustment to the basis of

partnership property under section 743,

provided, however, that the election in

§ 1.743–1(j)(4)(ii)(A)(2) is not available.

The following example illustrates this

paragraph (f)(2)(v):

Example. (i) A, B, and C are equal partners

in partnership PRS, which owns (among

other things) Asset 1, an item of depreciable

property with a basis of $30,000. A’s basis in

its partnership interest is $20,000. Under the

terms of the partnership agreement, A’s share

of the depreciation deductions from Asset 1

over its remaining useful life will be $10,000.

Under section 1017, A requests, and PRS

agrees to decrease the basis of Asset 1 with

respect to A by $10,000.

(ii) In the year following the reduction of

basis under section 1017, PRS amends its

partnership agreement to provide that items

of depreciation and loss from Asset 1 will be

allocated equally between B and C. In that

year, A’s distributive share of the

partnership’s common basis depreciation

deductions from Asset 1 is now $0. Under

§ 1.743–1(j)(4)(ii)(B), the amount of the

section 1017 basis adjustment that A recovers

during the year is $1,000. A will report

$1,000 of ordinary income because A’s

distributive share of the partnership’s

common basis depreciation deductions from

Asset 1 ($0) is insufficient to offset the

amount of the section 1017 basis adjustment

recovered by A during the year ($1,000).

(iii) In the following year, PRS sells Asset

1 for $15,000 and recognizes a $12,000 loss.

This loss is allocated equally between B and

C, and A’s share of the loss is $0. Upon the

sale of Asset 1, A recovers its entire

remaining section 1017 basis adjustment

($9,000). A will report $9,000 of ordinary

income.

(D) Effective date. This paragraph

(f)(2)(v) applies to elections made under

sections 108(b)(5) and 108(c) on or after

the date the regulations are published as

final regulations in the Federal Register.

* * * * *

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

[FR Doc. 98–1949 Filed 1–28–98; 8:45 am]

BILLING CODE 4830–01–U

DEPARTMENT OF LABOR

Occupational Safety and Health

Administration

29 CFR Part 1915

Fire Protection for Shipyard

Employment Negotiated Rulemaking

Advisory Committee; Notice of Meeting

AGENCY: Occupational Safety and Health

Administration (OSHA), Labor.

ACTION: Fire protection for shipyard

employment negotiated rulemaking

advisory committee; notice of open

meeting.

SUMMARY: The Occupational Safety and

Health Administration announces a

meeting of the Negotiated Rulemaking

Advisory Committee for Fire Protection

for Shipyard Employment. OSHA

invites all interested persons to attend.

The committee members represent

groups interested in, or significantly

affected by, the outcome of the

rulemaking: They come from shipyards,

labor unions, professional associations,

and government agencies. The

committee will continue its discussions

on scope and application,

administrative, engineering, and work

practice controls, fire brigades, written

fire plans, technological advances, costs

of fire protection, and the content of

appendices for a proposed standard to

protect workers from hazards in

shipyard employment. The committee’s

goal is to recommend to the Assistant

Secretary a safety standard and

explanatory preamble that the members

support.

DATES: The meeting dates are Tuesday,

February 24, 1998, through Thursday,

February 26, 1998, from 9:00 a.m. to

about 5:00 p.m. daily. Submit

comments, requests for oral

presentation, and requests for disability

accommodations by February 10, 1998.

ADDRESSES: The meeting will be held at

the Holiday Inn on the Bay, 1355 North

Harbor Drive at the Embarcadero, San

Diego, CA, 92101; telephone 619–232–

3861. Mail comments and requests for

oral presentations to Ms. Odet Shaw,

U.S. Dapartment of Labor, OSHA Office

of Maritime Standards, 200 Constitution

Avenue, NW, Room N–3647,

Washington, D.C. 20210.

FOR FURTHER INFORMATION CONTACT: Mr.

Joseph V. Daddura, Project Officer,

Office of Maritime Standards, OSHA

(202–219–7234 ext. 123). For disability

accommodations, contact Ms. Theda

Kenney (202–219–8061 ext. 100; FAX:

202–219–7477).

SUPPLEMENTARY INFORMATION:

Meeting Agenda. The Committee will

focus its discussions on fire brigades

and current rules.

Public Participation. Interested

persons may send written comments,

data, views, or statements for

consideration by the Fire Protection for

Shipyard Employment Negotiated

Rulemaking Committee to Ms. Odet

Shaw. Interested persons may also

submit requests for presentations by

providing to Ms. Shaw a summary of the

proposed presentation, an estimate of

the time desired, and a statement of the

interest that the person represents.

Authority. This notice is issued under the

authority of Section 3 of the Negotiated

Rulemaking Act of 1990 (104 Stat. 4969; Title

5 U.S.C. 561 et seq.) and Section 7(b) of the

Occupational Safety and Health Act of 1970

(84 Stat. 1597; Title 29 U.S.C. 656).

Signed at Washington, D.C., this 23rd day

of January, 1998.

Charles N. Jeffress,

Assistant Secretary of Labor.

[FR Doc. 98–2097 Filed 1–28–98; 8:45 am]

BILLING CODE 4510–26–M