28 Federal Register / Vol. 61, No. 1 / Tuesday, January 2, 1996 / Proposed Rules

For the Nuclear Regulatory Commission.

Robert J. Dube,

Deputy Chief, Safeguards Branch, Division

of Reactor Program Management, Office of

Nuclear Reactor Regulation.

[FR Doc. 95–31546 Filed 12–29–95; 8:45 am]

BILLING CODE 7590–01–P

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[PS–2–95]

RIN 1545–AT19

Distribution of Marketable Securities

by a Partnership

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Notice of proposed rulemaking

and notice of public hearing.

SUMMARY: This document contains

proposed regulations relating to the

treatment of a distribution of marketable

securities by a partnership under

section 731(c) of the Internal Revenue

Code of 1986, as amended (Code). These

proposed regulations provide taxpayers

with guidance needed to comply with

certain changes made by the Uruguay

Round Agreements Act of 1994 (Pub. L.

No. 103–465). This document also

provides notice of a public hearing on

these proposed regulations.

DATES: Written comments and requests

to speak (with outlines of oral

comments) at a public hearing

scheduled for 10 a.m. on Wednesday,

April 3, 1996 must be received by

Wednesday, March 13, 1996.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (PS–2–95), room 5228,

Internal Revenue Service, POB 7604,

Ben Franklin Station, Washington, DC

20044. In the alternative, submissions

may be hand delivered between the

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

CC:DOM:CORP:R (PS–2–95), Courier’s

Desk, Internal Revenue Service, 1111

Constitution Avenue NW., Washington,

DC. The public hearing will be held in

the IRS Auditorium.

FOR FURTHER INFORMATION CONTACT:

Concerning the regulations, Terri A.

Belanger or William M. Kostak, (202)

622–3080; concerning submissions and

the hearing, Christina Vasquez, (202)

622–7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Introduction

This document proposes to add

§ 1.731–2 to the Income Tax Regulations

(26 CFR part 1) under section 731(c) of

the Code. Section 731(c) was amended

by section 741(a) of the Uruguay Round

Agreements Act of 1994 (Public Law

103–465).

Background

Section 731(a)(1) of the Code provides

that a partner must recognize gain on a

distribution from a partnership to the

extent that any money distributed

exceeds the adjusted basis of the

partner’s interest in the partnership

immediately before the distribution.

Section 737 provides that a partner must

recognize gain on a distribution of

property other than money in an

amount equal to the lesser of (i) the

partner’s net precontribution gain or (ii)

the excess of the fair market value of the

distributed property over the partner’s

basis in the partnership interest.

Section 731(c) provides that the term

money includes marketable securities

for purposes of section 731(a)(1) and

section 737. As discussed in the

legislative history accompanying section

731(c), treating marketable securities as

money for this purpose is appropriate

because marketable securities are

economically equivalent to money.

Section 731(c) affects only the tax

consequences to the distributee partner;

section 731(c) does not require the

partnership or any partner other than

the distributee partner to recognize gain

on a distribution of marketable

securities.

Explanation of Provisions

Marketable Securities Treated as Money

Distributions of marketable securities

are treated as distributions of money

under section 731(c) only for purposes

of sections 731(a)(1) and 737. For

example, a distribution of marketable

securities is not treated as a distribution

of money to the extent it is subject to

section 707 or section 751(b) because

the distribution is not subject to section

731(a)(1) or section 737. In addition,

marketable securities are not treated as

money for purposes of section 731(a)(2),

so that a partner does not recognize a

loss on a distribution of marketable

securities. Finally, marketable securities

contributed by a partner are treated as

property other than money for purposes

of determining the partner’s net

precontribution gain under section

737(b).

Reduction of Amount Treated as Money

Under section 731(c)(3)(B), the

amount of marketable securities that is

treated as money is reduced by the

excess of (i) the partner’s share of the

net gain of the partnership’s securities

of the same class and issuer as the

distributed securities immediately

before the distribution over (ii) the

partner’s share of such net gain

immediately after the distribution. This

provision allows a partner to withdraw

the partner’s share of appreciation in the

partnership’s marketable securities

without recognizing gain on the

distribution. As a result, section 731(c)

generally applies only when a partner

receives a distribution of marketable

securities in exchange for the partner’s

share of appreciated assets other than

marketable securities.

Under the authority of section

731(c)(3)(B), the proposed regulations

provide that all marketable securities

held by a partnership are treated as

marketable securities of the same class

and issuer as the distributed securities.

Treating all marketable securities as a

single asset for this purpose is

consistent with the basic rationale of

section 731(c) that marketable securities

are the economic equivalent of money.

As a result, the amount of the

distribution that is not treated as money

will depend on the partner’s share of the

net appreciation in all partnership

securities, not on the partner’s share of

the appreciation in the type of securities

distributed.

Definition of Marketable Securities

In general, the term marketable

securities includes any financial

instruments—such as stocks, options,

and derivatives—that are actively traded

within the meaning of section

1092(d)(1). In addition, section

731(c)(2)(B)(v) provides that an interest

in an entity is a marketable security if

substantially all of the assets of the

entity consist of marketable securities or

money. The proposed regulations

provide that substantially all of the

assets of an entity consist of marketable

securities or money only if 90 percent

or more of the assets of the entity at the

time of the distribution consist of such

assets.

Section 731(c)(2)(B)(vi) provides that,

to the extent provided in regulations, an

interest in an entity not described in

section 731(c)(2)(B)(v) is a marketable

security to the extent that the value of

such interest is attributable to

marketable securities or money. The

proposed regulations provide that an

interest in an entity is a marketable

security to the extent that the value of

the interest is attributable to marketable

securities or money that constitute less

than 90 percent but 20 percent or more

of the assets of the entity. The 20

percent threshold means that an interest

in an entity holding only a small
Federal Register / Vol. 61, No. 1 / Tuesday, January 2, 1996 / Proposed Rules 29

amount of marketable securities will not

be treated as a marketable security.

The proposed regulations also provide

that a marketable security will continue

to be treated as a marketable security,

even if the partnership or its partners

are restricted by agreement or otherwise

from selling or exchanging the security.

This provision is intended to prevent a

partnership from avoiding section

731(c) by temporarily restricting the

transferability of the distributed

security.

Exceptions

Consistent with the provisions of

section 731(c)(3)(A), the proposed

regulations provide three exceptions to

section 731(c). First, the proposed

regulations provide that if the

marketable security was contributed to

the partnership by the distributee

partner, section 731(c) does not apply to

the distribution of that security.

Second, the proposed regulations

provide that section 731(c) does not

apply to the distribution of a marketable

security to the extent that the security

was acquired by the partnership in a

nonrecognition transaction in exchange

for property other than marketable

securities or cash and (i) the security is

actively traded as of the date of

distribution and (ii) the security is

distributed by the partnership within

five years of either the date the security

was acquired by the partnership or, if

later, the date the security became

actively traded. For example, if a

partnership contributed substantially all

of its assets to a corporation in a

transaction described in section 351 and

the stock of the corporation became

marketable, the distribution of the stock

by the partnership within five years

would not be subject to section 731(c).

This exception recognizes that the

marketable security in these situations

is simply a substitute for the underlying

assets exchanged in the nonrecognition

transaction.

The proposed regulations also provide

that section 731(c) does not apply to the

distribution of a marketable security if

(i) the security was not actively traded

on the date acquired by the partnership

and the entity to which the security

relates had no outstanding actively

traded securities at the time the security

was acquired by the partnership; (ii) the

security is actively traded as of the date

of distribution; and (iii) the security was

held by the partnership for at least six

months before it became actively traded

and the security was distributed by the

partnership within five years of the date

on which the security became actively

traded.

In addition, the proposed regulations

provide a successor security rule that

applies to these exceptions. This rule

provides that the exceptions continue to

apply to a security acquired in a

nonrecognition transaction in exchange

for a security that was already subject to

an exception.

Investment Partnerships

Section 731(c) does not apply to the

distribution of marketable securities by

an investment partnership to an eligible

partner. An investment partnership is

defined as a partnership that has never

been engaged in a trade or business and

substantially all of the assets of which

consist of the investment assets

described in section 731(c)(3)(C)(i). The

proposed regulations provide that a

partner can qualify as an eligible partner

even if the partner contributed services

to the partnership. In addition, the

proposed regulations provide that a

partnership will not be treated as

engaged in a trade or business if the

partnership provides reasonable and

customary management services to a

lower-tier investment partnership. This

exception allows an upper-tier

investment partnership to manage the

investments and other activities of a

lower-tier investment partnership

without disqualifying the upper-tier

partnership as an investment

partnership. The exception does not

extend to management services

provided to lower-tier partnerships

other than investment partnerships

because, as discussed below, the tiering

rules of section 731(c)(3)(C)(iv) treat the

upper-tier management partnership as

engaged in the trade or business of the

lower-tier partnership, thereby

preventing the upper-tier partnership

from qualifying as an investment

partnership.

The proposed regulations also provide

that a partnership will not be treated as

engaged in a trade or business if the

partnership provides reasonable and

customary services in assisting the

formation, capitalization, expansion, or

offering of interests in an entity in

which the partnership holds a

significant equity interest, provided that

the anticipated receipt of compensation

for the services does not represent a

significant purpose for the partnership’s

investment in the entity and is

incidental to the investment in the

entity.

Section 731(c)(3)(C)(iv) provides that,

except as otherwise provided in

regulations, a partnership is treated as

engaged in any trade or business

engaged in by (and as holding the assets

of) any partnership in which the

partnership holds an interest. The

proposed regulations provide that this

look-through rule does not apply if the

upper-tier partnership does not

participate in the management of the

lower-tier partnership and the interest

held by the upper-tier partnership is

less than 10 percent of the total profits

and capital interests in the lower-tier

partnership.

Coordination With Other Sections

The proposed regulations provide

rules for coordinating section 731(c)

with section 704(c)(1)(B) and section

737. This coordination is necessary

because a distribution of marketable

securities could occur as part of a larger

distribution in which property

contributed by the distributee partner is

distributed to another partner (section

704(c)(1)(B)) or the distributee partner

receives property in addition to

marketable securities (section 737).

Under the proposed regulations, the

basis increase in the partner’s interest in

the partnership as a result of any gain

recognized by the partner under section

704(c)(1)(B) is taken into account in

determining the distributee partner’s

gain under section 731(c) and the

partner’s basis in the distributed

securities. Taking the stepped-up basis

into account for purposes of section 731

reflects the fact that the general effect of

section 704(c)(1)(B) is to treat the

contributing partner as having

contributed property with a full fair

market value basis at the time of

contribution. The proposed regulations,

however, provide that the basis increase

in the partner’s interest as a result of

any gain recognized by the partner

under section 737 is not taken into

account for these purposes. The

proposed regulations are consistent with

section 737, which generally treats a

distribution of money as occurring

before, and independent of, a

distribution of other property.

Anti-Abuse Rule

The proposed regulations provide that

the provisions of section 731(c) and this

section must be applied in a manner

that is consistent with the purpose of

section 731(c) and the substance of the

transaction.

Proposed Effective Date

This section is proposed to apply to

distributions of marketable securities by

a partnership to a partner on or after

December 29, 1995.

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
30 Federal Register / Vol. 61, No. 1 / Tuesday, January 2, 1996 / Proposed Rules

assessment is not required. It also has

been determined that section 553(b) of

the Administrative Procedure Act (5

U.S.C. chapter 5) and the Regulatory

Flexibility Act (5 U.S.C. chapter 6) do

not apply to these regulations, and,

therefore, a Regulatory Flexibility

Analysis is not required. Pursuant to

section 7805(f) of the Internal Revenue

Code, this notice of proposed

rulemaking will be submitted to the

Chief Counsel for Advocacy of the Small

Business Administration for comment

on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations,

consideration will be given to any

written comments (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, April 3, 1996 at 10:00

a.m. in the Auditorium of the Internal

Revenue Building, 1111 Constitution

Avenue NW., Washington, DC. 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 Wednesday,

March 13, 1996 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, March 13, 1996.

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

regulations are Terri A. Belanger and

William M. Kostak, Office of Assistant

Chief Counsel (Passthroughs and

Special Industries), IRS. However, other

personnel from the IRS and Treasury

Department participated in their

development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Proposed Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding an entry

in numerical order to read as follows:

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

Section 1.731–2 also issued under 26

U.S.C. 731(c).* * *

Par. 2. Section 1.731–2 is added to

read as follows:

§ 1.731–2 Partnership distributions of

marketable securities.

(a) Marketable securities treated as

money. Except as otherwise provided in

section 731(c) and this section, for

purposes of section 731(a)(1) and 737,

the term money includes marketable

securities and such securities are taken

into account at their fair market value as

of the date of the distribution.

(b) Reduction of amount treated as

money—(1) Aggregation of securities.

For purposes of section 731(c)(3)(B) and

this paragraph (b), all marketable

securities held by a partnership are

treated as marketable securities of the

same class and issuer as the distributed

security.

(2) Amount of reduction. The amount

of the distribution of marketable

securities that is treated as a distribution

of money under section 731(c) and

paragraph (a) of this section is reduced

(but not below zero) by the excess, if

any, of—

(i) The distributee partner’s

distributive share of the net gain, if any,

which would be recognized if all the

marketable securities held by the

partnership were sold (immediately

before the transaction to which the

distribution relates) by the partnership

for fair market value; over

(ii) The distributee partner’s

distributive share of the net gain, if any,

which is attributable to the marketable

securities held by the partnership

immediately after the transaction,

determined by using the same fair

market value as used under paragraph

(b)(2)(i) of this section.

(3) Distributee partner’s share of net

gain. For purposes of section

731(c)(3)(B) and paragraph (b)(2) of this

section, a partner’s distributive share of

net gain is determined—

(i) By taking into account any basis

adjustments under section 743(b) with

respect to that partner; and

(ii) Without taking into account any

special allocations adopted with a

principal purpose of avoiding the effect

of section 731(c) and this section.

(c) Marketable securities—(1) Actively

traded. For purposes of section 731(c)

and this section, a financial instrument

is actively traded (and thus is a

marketable security) if it is of a type that

is, as of the date of distribution, actively

traded within the meaning of section

1092(d)(1). Thus, for example, if XYZ

common stock is listed on a national

securities exchange, particular shares of

XYZ common stock that are distributed

by a partnership are marketable

securities even if those particular shares

cannot be resold by the distributee

partner for a designated period of time.

(2) Interests in an entity—(i)

Substantially all. For purposes of

section 731(c)(2)(B)(v) and this section,

substantially all of the assets of an entity

consist (directly or indirectly) of

marketable securities, money, or both

only if 90 percent or more of the assets

of the entity (by value) at the time of the

distribution of an interest in the entity

consist (directly or indirectly) of

marketable securities, money, or both.

(ii) Less than substantially all. For

purposes of section 731(c)(2)(B)(vi) and

this section, an interest in an entity is

a marketable security to the extent that

the value of the interest is attributable

(directly or indirectly) to marketable

securities, money, or both, if less than

90 percent but 20 percent or more of the

assets of the entity (by value) at the time

of the distribution of an interest in the

entity consist (directly or indirectly) of

marketable securities, money, or both.

(d) Exceptions—(1) Previously

contributed property. Section 731(c) and

this section do not apply to the

distribution of a marketable security if

the security was contributed to the

partnership by the distributee partner,

except to the extent that the value of the

distributed security is attributable to

marketable securities or money

contributed (directly or indirectly) by

the partnership to the entity to which

the distributed security relates.

(2) Security acquired in

nonrecognition transaction. Section

731(c) and this section do not apply to

the distribution of a marketable security

to the extent that—

(i) The security was acquired by the

partnership in a nonrecognition

transaction in exchange for any property

except money or marketable securities

(including a security that would have

been treated as a marketable security

under paragraph (c)(2) of this section if

distributed at the time of the exchange);

(ii) The distributed security is actively

traded as of the date of distribution; and

(iii) The security is distributed within

five years of either the date on which

the security was acquired by the

partnership or, if later, the date on
Federal Register / Vol. 61, No. 1 / Tuesday, January 2, 1996 / Proposed Rules 31

which the security became actively

traded.

(3) Security not marketable when

acquired. Section 731(c) and this

section do not apply to the distribution

of a marketable security if—

(i) The security was not actively

traded as of the date acquired by the

partnership and the entity to which the

security relates had no outstanding

actively traded securities on that date;

(ii) The security is actively traded as

of the date of distribution; and

(iii) The security was held by the

partnership for at least six months

before the date the security became

actively traded and the security was

distributed within five years of the date

on which the security became actively

traded.

(4) Successor security. Section 731(c)

and this section do not apply to the

distribution of a marketable security to

the extent that the security was acquired

by the partnership in a nonrecognition

transaction in exchange for a security

the distribution of which immediately

prior to the exchange would have been

excepted under this paragraph (d).

(e) Investment partnerships—(1) In

general. Section 731(c) and this section

do not apply to the distribution of

marketable securities by an investment

partnership (as defined in section

731(c)(3)(C)(i)) to an eligible partner (as

defined in section 731(c)(3)(C)(iii)).

(2) Eligible partner. For purposes of

section 731(c)(3)(C)(iii) and this section,

a partner is not treated as a partner other

than an eligible partner solely because

the partner contributed services to the

partnership.

(3) Trade or business activities. For

purposes of section 731(c)(3)(C) and this

section, a partnership is not treated as

engaged in a trade or business by reason

of—

(i) Any activity undertaken as an

investor, trader, or dealer in any asset

described in section 731(c)(3)(C)(i),

including the receipt of commitment

fees, break-up fees, guarantee fees,

director’s fees, or similar fees that are

customary in and incidental to any

activities of the partnership as an

investor, trader, or dealer in such assets;

(ii) Reasonable and customary

management services (including the

receipt of reasonable and customary fees

in exchange for such management

services) provided to an investment

partnership (within the meaning of

section 731(c)(3)(C)(i)) in which the

partnership holds a partnership interest;

or

(iii) Reasonable and customary

services provided by the partnership in

assisting the formation, capitalization,

expansion, or offering of interests in a

corporation (or other entity) in which

the partnership holds or acquires a

significant equity interest (including the

provision of advice or consulting

services, bridge loans, guarantees of

obligations, or service on a company’s

board of directors), provided that the

anticipated receipt of compensation for

the services, if any, does not represent

a significant purpose for the

partnership’s investment in the entity

and is incidental to the investment in

the entity.

(4) Partnership tiers. For purposes of

section 731(c)(3)(C)(iv) and this section,

a partnership (upper-tier partnership) is

not treated as engaged in a trade or

business engaged in by, or as holding

(instead of a partnership interest) a

proportionate share of the assets of, a

partnership (lower-tier partnership) in

which the partnership holds a

partnership interest if—

(i) The upper-tier partnership does

not participate in the management of the

lower-tier partnership; and

(ii) The interest held by the upper-tier

partnership is less than 10 percent of

the total profits and capital interests in

the lower-tier partnership.

(f) Basis rules—(1) Partner’s basis—(i)

Partner’s basis in distributed securities.

The distributee partner’s basis in

distributed marketable securities with

respect to which gain is recognized by

reason of section 731(c) and this section

is the basis of the security determined

under section 732, increased by the

amount of such gain. Any increase in

the basis of the marketable securities

attributable to gain recognized by reason

of section 731(c) and this section is

allocated to marketable securities in

proportion to their respective amounts

of unrealized appreciation in the hands

of the partner before such increase.

(ii) Partner’s basis in partnership

interest. The basis of the distributee

partner’s interest in the partnership is

determined under section 733 as if no

gain were recognized by the partner on

the distribution by reason of section

731(c) and this section.

(2) Basis of partnership property. No

adjustment is made to the basis of

partnership property under section 734

as a result of any gain recognized by a

partner, or any step-up in the basis in

the distributed marketable securities in

the hands of the distributee partner, by

reason of section 731(c) and this section.

(g) Coordination with other sections—

(1) Section 704(c)(1)(B). The basis of the

distributee partner’s interest in the

partnership for purposes of determining

the amount of gain, if any, recognized

by reason of section 731(c) (and for

determining the basis of the marketable

securities in the hands of the distributee

partner) includes the increase, if any, in

the partner’s basis that occurs under

section 704(c)(1)(B)(iii) as a result of a

distribution to another partner of

property contributed by the distributee

partner in a distribution that is part of

the same distribution as the marketable

securities.

(2) Section 737—(i) Marketable

securities as other property. A

distribution of marketable securities is

treated as a distribution of property

other than money for purposes of

section 737 to the extent that the

marketable securities are not treated as

money under section 731(c). In

addition, marketable securities

contributed to the partnership are

treated as property other than money in

determining the contributing partner’s

net precontribution gain under section

737(b).

(ii) Basis increase under section 737.

The basis of the distributee partner’s

interest in the partnership for purposes

of determining the amount of gain, if

any, recognized by reason of section

731(c) (and for determining the basis of

the marketable securities in the hands of

the distributee partner) does not include

the increase, if any, in the partner’s

basis that occurs under section 737(c)(1)

as a result of a distribution of property

to the distributee partner in a

distribution that is part of the same

distribution as the marketable securities.

(h) Anti-abuse rule. The provisions of

section 731(c) and this section must be

applied in a manner consistent with the

purpose of section 731(c) and the

substance of the transaction.

Accordingly, if a principal purpose of a

transaction is to achieve a tax result that

is inconsistent with the purpose of

section 731(c) and this section, the

Commissioner can recast the transaction

for federal tax purposes as appropriate

to achieve tax results that are consistent

with the purpose of section 731(c) and

this section. Whether a tax result is

inconsistent with the purpose of section

731(c) and this section must be

determined based on all the facts and

circumstances. For example, under the

provisions of this paragraph (h)—

(1) A change in partnership

allocations or distribution rights with

respect to marketable securities may be

treated as a distribution of the

marketable securities subject to section

731(c) if the change in allocations or

distribution rights is, in substance, a

distribution of the securities;

(2) A distribution of substantially all

of the assets of the partnership other

than marketable securities and money to

some partners may also be treated as a

distribution of marketable securities to

the remaining partners if the
32 Federal Register / Vol. 61, No. 1 / Tuesday, January 2, 1996 / Proposed Rules

distribution of the other property and

the withdrawal of the other partners is,

in substance, equivalent to a

distribution of the securities to the

remaining partners; and

(3) The distribution of multiple

properties to one or more partners at

different times may also be treated as

part of a single distribution if the

distributions are part of a single plan of

distribution.

(i) [Reserved]

(j) Examples. The following examples

illustrate the rules of this section.

Unless otherwise specified, all

securities held by a partnership are

marketable securities within the

meaning of section 731(c); the

partnership holds no marketable

securities other than the securities

described in the example; all

distributions by the partnership are

subject to section 731(a) and are not

subject to sections 704(c)(1)(B), 751(b),

or 737; and no securities are eligible for

an exception to section 731(c).

Example 1. Recognition of gain. (i) A and

B form partnership AB as equal partners. A

contributes property with a fair market value

of $1,000 and an adjusted tax basis of $250.

B contributes $1,000 cash. AB subsequently

purchases Security X for $500 and

immediately distributes the security to A in

a current distribution. The basis in A’s

interest in the partnership at the time of

distribution is $250.

(ii) The distribution of Security X is treated

as a distribution of money in an amount

equal to the fair market value of Security X

on the date of distribution ($500). (The

amount of the distribution that is treated as

money is not reduced under section

731(c)(3)(B) and paragraph (b) of this section

because, if Security X had been sold

immediately before the distribution, there

would have been no gain recognized by AB

and A’s distributive share of the gain would

therefore have been zero.) As a result, A

recognizes $250 of gain under section

731(a)(1) on the distribution ($500

distribution of money less $250 adjusted tax

basis in A’s partnership interest).

Example 2. Reduction in amount treated as

money—in general. (i) A and B form

partnership AB as equal partners. AB

subsequently distributes Security X to A in

a current distribution. Immediately before the

distribution, AB held securities with the

following fair market values, adjusted tax

bases, and unrecognized gain or loss:

Value Basis Gain

(loss)

Security X ....... 100 70 30

Security Y ....... 100 80 20

Security Z ........ 100 110 (10)

(ii) If AB had sold the securities for fair

market value immediately before the

distribution to A, the partnership would have

recognized $40 of net gain ($30 gain on

Security X plus $20 gain on Security Y minus

$10 loss on Security Z). A’s distributive share

of this gain would have been $20 (one-half

of $40 net gain). If AB had sold the remaining

securities immediately after the distribution

of Security X to A, the partnership would

have $10 of net gain ($20 of gain on Security

Y minus $10 loss on Security Z). A’s

distributive share of this gain would have

been $5 (one-half of $10 net gain). As a

result, the distribution resulted in a decrease

of $15 in A’s distributive share of the net gain

in AB’s securities ($20 net gain before

distribution minus $5 net gain after

distribution).

(iii) Under paragraph (b) of this section, the

amount of the distribution of Security X that

is treated as a distribution of money is

reduced by $15. The distribution of Security

X is therefore treated as a distribution of $85

of money to A ($100 fair market value of

Security X minus $15 reduction).

Example 3. Reduction in amount treated as

money—carried interest. (i) A and B form

partnership AB. A contributes $1,000 and

provides substantial services to the

partnership in exchange for a 60 percent

interest in partnership profits. B contributes

$1,000 in exchange for a 40 percent interest

in partnership profits. AB subsequently

distributes Security X to A in a current

distribution. Immediately before the

distribution, AB held securities with the

following fair market values, adjusted tax

bases, and unrecognized gain:

Value Basis Gain

Security X ......... 100 80 20

Security Y ......... 100 90 10

(ii) If AB had sold the securities for fair

market value immediately before the

distribution to A, the partnership would have

recognized $30 of net gain ($20 gain on

Security X plus $10 gain on Security Y). A’s

distributive share of this gain would have

been $18 (60 percent of $30 net gain). If AB

had sold the remaining securities

immediately after the distribution of Security

X to A, the partnership would have $10 of

net gain ($10 gain on Security Y). A’s

distributive share of this gain would have

been $6 (60 percent of $10 net gain). As a

result, the distribution resulted in a decrease

of $12 in A’s distributive share of the net gain

in AB’s securities ($18 net gain before

distribution minus $6 net gain after

distribution).

(iii) Under paragraph (b) of this section, the

amount of the distribution of Security X that

is treated as a distribution of money is

reduced by $12. The distribution of Security

X is therefore treated as a distribution of $88

of money to A ($100 fair market value of

Security X minus $12 reduction).

Example 4. Reduction in amount treated as

money—change in partnership allocations.

(i) A is admitted to partnership ABC as a

partner with a 1 percent interest in

partnership profits. At the time of A’s

admission, ABC held no securities. ABC

subsequently acquires Security X. A’s

interest in partnership profits is subsequently

increased to 2 percent for securities acquired

after the increase. A retains a 1 percent

interest in all securities acquired before the

increase. ABC then acquires Securities Y and

Z and later distributes Security X to A in a

current distribution. Immediately before the

distribution, the securities held by ABC had

the following fair market values, adjusted tax

bases, and unrecognized gain or loss:

Value Basis Gain (loss)

Security X ....... 1,000 500 500

Security Y ....... 1,000 800 200

Security Z ........ 1,000 1,100 (100)

(ii) If ABC had sold the securities for fair

market value immediately before the

distribution to A, the partnership would have

recognized $600 of net gain ($500 gain on

Security X plus $200 gain on Security Y

minus $100 loss on Security Z). A’s

distributive share of this gain would have

been $7 (1 percent of $500 gain on Security

X plus 2 percent of $200 gain on Security Y

minus 2 percent of $100 loss on Security Z).

(iii) If ABC had sold the remaining

securities immediately after the distribution

of Security X to A, the partnership would

have $100 of net gain ($200 gain on Security

Y minus $100 loss on Security Z). A’s

distributive share of this gain would have

been $2 (2 percent of $200 gain on Security

Y minus 2 percent of $100 loss on Security

Z). As a result, the distribution resulted in a

decrease of $5 in A’s distributive share of the

net gain in ABC’s securities ($7 net gain

before distribution minus $2 net gain after

distribution).

(iv) Under paragraph (b) of this section, the

amount of the distribution of Security X that

is treated as a distribution of money is

reduced by $5. The distribution of Security

X is therefore treated as a distribution of $95

of money to A ($100 fair market value of

Security X minus $5 reduction).

Example 5. Basis consequences—

distribution of marketable security. (i) A and

B form partnership AB as equal partners. A

contributes nondepreciable real property

with a fair market value and adjusted tax

basis of $100.

(ii) AB subsequently distributes Security X

with a fair market value of $120 and an

adjusted tax basis of $90 to A in a current

distribution. At the time of distribution, the

basis in A’s interest in the partnership is

$100. The amount of the distribution that is

treated as money is reduced under section

731(c)(3)(B) and paragraph (b)(2) of this

section by $15 (one- half of $30 net gain in

Security X). As a result, A recognizes $5 of

gain under section 731(a) on the distribution

(excess of $105 distribution of money over

$100 adjusted tax basis in A’s partnership

interest).

(iii) A’s adjusted tax basis in Security X is

$95 ($90 adjusted basis of Security X

determined under section 732(a)(1) plus $5 of

gain recognized by A by reason of section

731(c)). The basis in A’s interest in the

partnership is $10 as determined under

section 733 ($100 pre-distribution basis

minus $90 basis allocated to Security X

under section 732).

Example 6. Basis consequences—

distribution of marketable security and other

property. (i) A and B form partnership AB as

equal partners. A contributes nondepreciable
Federal Register / Vol. 61, No. 1 / Tuesday, January 2, 1996 / Proposed Rules 33

real property, with a fair market value of

$100 and an adjusted tax basis of $10.

(ii) AB subsequently distributes Security X

with a fair market value and adjusted tax

basis of $40 to A in a current distribution

and, as part of the same distribution, AB

distributes Property Z to A with an adjusted

tax basis and fair market value of $40. At the

time of distribution, the basis in A’s interest

in the partnership is $10. A recognizes $30

of gain under section 731(a) on the

distribution (excess of $40 distribution of

money over $10 adjusted tax basis in A’s

partnership interest).

(iii) A’s adjusted tax basis in Security X is

$35 ($5 adjusted basis determined under

section 732(a)(2) plus $30 of gain recognized

by A by reason of section 731(c)). A’s basis

in Property Z is $5, as determined under

section 732(a)(2). The basis in A’s interest in

the partnership is $0 as determined under

section 733 ($10 pre-distribution basis minus

$10 basis allocated between Security X and

Property Z under section 732).

(iv) AB’s adjusted tax basis in the

remaining partnership assets is unchanged

unless the partnership has a section 754

election in effect. If AB made such an

election, the aggregate basis of AB’s assets

would be increased by $70 (the difference

between the $80 combined basis of Security

X and Property Z in the hands of the

partnership before the distribution and the

$10 combined basis of the distributed

property in the hands of A under section 732

after the distribution). Under section

731(c)(5), no adjustment is made to

partnership property under section 734 as a

result of any gain recognized by A by reason

of section 731(c) or as a result of any stepup in basis in the distributed marketable

securities in the hands of A by reason of

section 731(c).

Example 7. Coordination with section 737.

(i) A and B form partnership AB. A

contributes Property A, nondepreciable real

property with a fair market value of $200 and

an adjusted basis of $100 in exchange for a

25 percent interest in partnership capital and

profits. AB owns marketable Security X.

(ii) Within five years of the contribution of

Property A, AB subsequently distributes

Security X, with a fair market value of $120

and an adjusted tax basis of $100, to A in a

current distribution that is subject to section

737. As part of the same distribution, AB

distributes Property Y to A with a fair market

value of $20 and an adjusted tax basis of $0.

At the time of distribution, there has been no

change in the fair market value of Property

A or the adjusted tax basis in A’s interest in

the partnership.

(iii) If AB had sold Security X for fair

market value immediately before the

distribution to A, the partnership would have

recognized $20 of gain. A’s distributive share

of this gain would have been $5 (25 percent

of $20 gain). Because AB has no other

marketable securities, A’s distributive share

of gain in partnership securities after the

distribution would have been $0. As a result,

the distribution resulted in a decrease of $5

in A’s share of the net gain in AB’s securities

($5 net gain before distribution minus $0 net

gain after distribution). Under paragraph

(b)(2) of this section, the amount of the

distribution of Security X that is treated as

a distribution of money is reduced by $5. The

distribution of Security X is therefore treated

as a distribution of $115 of money to A ($120

fair market value of Security X minus $5

reduction). The portion of the distribution of

the marketable security that is not treated as

a distribution of money ($5) is treated as

other property for purposes of section 737.

(iv) A recognizes total gain of $40 on the

distribution. A recognizes $15 of gain under

section 731(a)(1) on the distribution of the

portion of Security X treated as money ($115

distribution of money less $100 adjusted tax

basis in A’s partnership interest). A

recognizes $25 of gain under section 737 on

the distribution of Property Y and the portion

of Security X that is not treated as money. A’s

section 737 gain is equal to the lesser of (i)

A’s precontribution gain ($100) or (ii) the

excess of the fair market value of property

received ($20 fair market value of Property Y

plus $5 portion of Security X not treated as

money) over the adjusted basis in A’s interest

in the partnership immediately before the

distribution ($100) reduced (but not below

zero) by the amount of money received in the

distribution ($115).

(v) A’s adjusted tax basis in Security X is

$115 ($100 basis of Security X determined

under section 732(a) plus $15 of gain

recognized by reason of section 731(c)). A’s

adjusted tax basis in Property Y is $0 under

section 732(a). The basis in A’s interest in the

partnership is $25 ($100 basis before

distribution minus $100 basis allocated to

Security X under section 732(a) plus $25 gain

recognized under section 737).

(k) Effective date. This section applies

to distributions of marketable securities

made on or after December 29, 1995.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 95–31457 Filed 12–29–95; 8:45 am]

BILLING CODE 4830–01–U

DEPARTMENT OF DEFENSE

Department of the Army

33 CFR Part 207

St. Marys Falls Canal and Locks,

Michigan; Use, Administration, and

Navigation

AGENCY: Corps of Engineers, Department

of the Army, DOD.

ACTION: Notice of proposed rulemaking.

SUMMARY: The Corps of Engineers

proposes to amend the regulations

which establish the operating schedule

for Soo Locks at the St. Marys Falls

Canal, Sault Ste. Marie, Michigan, to

change the annual opening date from

April 1 to March 25. The locks will not

open earlier than March 25, except in

case of emergency and are subject to

closure at any time in a national

emergency involving a vessel disaster or

other extraordinary circumstances as

currently provided in 33 CFR

207.440(u).

DATES: Written comments should be

received February 1, 1996.

ADDRESSES: Submit written comments,

in duplicate, to: Mr. William Willis,

Acting Chief, Construction-Operations

Division, Detroit District, U.S. Army

Corps of Engineers, P.O. Box 1027,

Detroit, Michigan 48231–1027, Phone:

(313) 226–6794, or deliver them to Mr.

Willis at the Detroit District office at 477

Michigan Avenue, Detroit, Michigan,

between the hours of 7:30 a.m. and 4:00

p.m. Monday through Friday.

Comments received and other materials

relevant to this proposed rulemaking

can be inspected at Mr. Willis’ office

during the same hours. An appointment

may be required for inspection, so

please call ahead to confirm availability

and to avoid any conflicts with

inspections by other interested persons.

A reasonable fee may be charged for

copying services.

FOR FURTHER INFORMATION CONTACT:

Mr. Michael Kidby at Corps of Engineers

Headquarters in Washington, D.C., by

telephone at (202) 761–8835.

SUPPLEMENTARY INFORMATION:

Legal Authority

The legal authority for the regulation

governing the use, administration, and

navigation of the St. Marys Falls Canal

and Locks is Section 4 of the River and

Harbor Act of August 18, 1894 (28 Stat.

362), as amended, which is codified at

33 U.S.C. Section 1. This statute

requires the Secretary of the Army to

‘‘prescribe such regulations for the use,

administration, and navigation of the

navigable waters of the United States’’

as the Secretary determines may be

required by public necessity.

Background

The regulation governing the

operation of the St. Marys Falls Canal

and Locks, in 33 CFR 207.440, was

adopted on November 27, 1945 (10 FR

14451), and has been the subject of nine

amendments. The legislation allows the

period of operation to be adjusted to

meet the reasonable demands of

commerce. The provision setting out the

current opening date for the locks was

adopted on October 30, 1956 (21 FR

8285). It establishes an opening date of

April 1, subject to annual modification

by the Division Engineer if the public

interest would be best served by the

modification or in the event of

emergency.

The opening date of the Soo Locks has

been modified on a number of occasions

and the length of the operating season

has been the subject of a number of