Bulletin No. 1999–52

Bulletin No. 1999–52

December 27, 1999

Internal Revenue

bulletin

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

Rev. Rul. 99–58, page 701.

Continuity of interest on repurchase of issuer’s shares.

This ruling holds that an open market repurchase of shares

through a broker, following a potential reorganization, has no

effect on continuity of interest in a potential reorganization.

T.D. 8847, page 701.

Final regulations under section 743, 755, and 1017 of the

Code provide guidance to partnerships and their partners concerning the optional adjustments to the basis of partnership

property, the allocation of basis adjustments among partnership assets, and the computation of a partner’s share of the

adjusted basis of depreciable partnership property.

Rev. Proc. 99–50, page 757.

Combined information reporting. Combined information

reporting by a successor business entity following a merger

or acquisition is permitted in certain situations. Rev. Proc.

90–57 and Rev. Rul. 69-556 modified and superseded.

EMPLOYEE PLANS

Notice 99–61, page 762.

Weighted average interest rate update. The weighted

average interest rate for December 1999 and the resulting

permissible range of interest rates used to calculate current

liabilities for purposes of the full funding limitation of section

412(c)(7) of the Code are set forth.

EXEMPT ORGANIZATIONS

Announcement 99–115, page 763.

A list is given of organizations now classified as private foundations.

ADMINISTRATIVE

T.D. 8848, page 723.

This rule establishes the procedures under which the Ser-

vice may use penalty mail to aid in the location and recovery

of missing children.

Rev. Proc. 99–49, page 725.

Methods of accounting; automatic consent. Procedures

are provided under which a taxpayer may obtain automatic

consent of the Commissioner to change certain methods of

accounting. REv. Proc. 98–60 modified and superseded.

Rev. Proc. 99–51, page 760.

This procedure amplifies section 5 of Rev. Proc. 99–3,

which sets forth areas of the Code under the jurisdiction of

the Associate Chief Counsel (Domestic) in which the Service

will not issue advance rulings or determination letters. The

following issue is added to those listed in section 5: Whether

a state law limited partnership electing under section

301.7701–3 to be classified as an association taxable as a

corporation has more than one class of stock for purposes

of section 1361(b)(1)(D). Rev. Proc. 99–3 amplified.

Notice 99–59, page 761.

Tax avoidance using distributions of encumbered property. Taxpayers and their representatives are alerted that the

purported losses arising from certain types of transactions are

not properly allowable for federal income tax purposes. Also,

the Service may impose penalties on participants in these

transactions or, as applicable on persons who participate in

the promotion or reporting of these transactions.

Notice 99–60, page 762.

Information reporting; royalty payments; Indians. Taxpayers are informed that the information reporting requirements

of section 6050N of the Code do no apply to payments of royalties that are not subject to income tax because they are derived directly by a noncompetent Indian from allotted and restricted land under the General Allotment Act of similar acts.

Announcement 99–116, page 763.

This document corrects the Actions on Decisions published

in 1999–35 I.R.B. 314. All 7 footnotes describing the “Acquiescence” or “Nonacquiescence” in each decision included the words “in result only,” which were erroneous. The

correct footnotes are printed in this announcement.

Social Security Contribution and Benefit Base for 2000 on page 763.

Finding Lists begin on page ii.

Department of the Treasury

Internal Revenue Service

The IRS Mission

Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities

and by applying the tax law with integrity and fairness to

all.

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly and may be obtained

from the Superintendent of Documents on a subscription

basis. Bulletin contents are consolidated semiannually into

Cumulative Bulletins, which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements

of internal practices and procedures that affect the rights

and duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service on

the application of the law to the pivotal facts stated in the

revenue ruling. In those based on positions taken in rulings

to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature

are deleted to prevent unwarranted invasions of privacy and

to comply with statutory requirements.

Rulings and procedures reported in the Bulletin do not have

the force and effect of Treasury Department Regulations,

but they may be used as precedents. Unpublished rulings

will not be relied on, used, or cited as precedents by Service

personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances

are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions, and Subpart B, Legislation and Related

Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings

are issued by the Department of the Treasury’s Office of the

Assistant Secretary (Enforcement).

Part IV.—Items of General Interest.

This part includes notices of proposed rulemakings, disbarment and suspension lists, and announcements.

The first Bulletin for each month includes a cumulative index

for the matters published during the preceding months.

These monthly indexes are cumulated on a semiannual basis,

and are published in the first Bulletin of the succeeding semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 368.—Definitions Relating

to Corporate Reorganizations

26 CFR 1.368–1(e): Continuity of interest.

Continuity of interest on repurchase

of issuer’s shares. This ruling holds that

an open market repurchase of shares

through a broker has no effect on continuity of interest in a potential reorganization.

Rev. Rul. 99-58

ISSUE

What is the effect on continuity of interest when a potential reorganization is

followed by an open market reacquisition

of P’s stock?

FACTS

T merges into P, a corporation whose

stock is widely held, and is publicly and

actively traded. P has one class of common stock authorized and outstanding. In

the merger, T shareholders receive 50 percent common stock of P and 50 percent

cash. Viewed in isolation, the exchange

would satisfy the continuity of interest requirement of § 1.368-1(e) of the Income

Tax Regulations. However, in an effort to

prevent dilution resulting from the issuance of P shares in the merger, P’s preexisting stock repurchase program is

modified to enable P to reacquire a number of its shares equal to the number issued in the acquisition of T. The number

of shares repurchased will not exceed the

total number of P shares issued and outstanding prior to the merger. The repurchases are made following the merger, on

the open market, through a broker for the

prevailing market price. P’s intention to

repurchase shares was announced prior to

the T merger, but the repurchase program

was not a matter negotiated with T or the

T shareholders. There was not an understanding between the T shareholders and

P that the T shareholders’ ownership of P

stock would be transitory. Because of the

mechanics of an open market purchase, P

does not know the identity of a seller of P

stock, nor does a former T shareholder

who receives P stock in the merger and

1999–52 I.R.B.

subsequently sells it know whether P is

the buyer. Without regard to the repurchase program, a market exists for the

newly-issued P stock held by the former T

shareholders. During the time P undertakes its repurchase program, there are

sales of P stock on the open market,

which may include sales of P shares by

former T shareholders.

LAW AND ANALYSIS

Requisite to a reorganization under the

Internal Revenue Code is a continuity of

interest as described in § 1.368–1(e).

Section 1.368–1(b). The general purpose

of the continuity of interest requirement is

“to prevent transactions that resemble

sales from qualifying for nonrecognition

of gain or loss available to corporate reorganizations.” Section 1.368–1(e)(1)(i).

To achieve this purpose, the regulation

provides that a proprietary interest in the

target corporation is not preserved to the

extent that, “in connection with the potential reorganization, . . . stock of the issuing corporation furnished in exchange for

a proprietary interest in the target corporation in the potential reorganization is redeemed.” Id. However, for purposes of

the continuity requirement, “a mere disposition of stock of the issuing corporation received in the potential reorganization to persons not related . . . to the

issuing corporation is disregarded.” Id.

The regulation provides that all facts and

circumstances will be considered in determining whether, in substance, a proprietary interest in the target corporation is

preserved.

Under the facts set forth above, continuity of interest is satisfied. There was

not an understanding between the T

shareholders and P that the T shareholders’ ownership of the P shares would be

transitory. Further, because of the mechanics of an open market repurchase, the

repurchase program does not favor participation by the former T shareholders.

Therefore, even if it could be established

that P has repurchased P shares from former T shareholders in the repurchase program, any such purchase would be coincidental. The merger and the stock

repurchase together in substance would

not resemble a sale of T stock to P by the

701

former T shareholders and, thus, the repurchase would not be treated as “in connection with” the merger. Under the facts

presented, a sale of P stock on the open

market by a former T shareholder during

the repurchase program will have the same

effect on continuity of interest as a mere

disposition to persons not related to P.

HOLDING

Under the facts presented, the open

market repurchase of shares through a

broker has no effect on continuity of interest in the potential reorganization.

DRAFTING INFORMATION

The principal author of this revenue

ruling is Marie C. Milnes-Vasquez of the

Office of Assistant Chief Counsel (Corporate). For further information regarding

this revenue ruling, contact Ms. MilnesVasquez on (202) 622-7770 (not a tollfree call).

Section 743.—Optional

Adjustment to Basis of

Partnership Property

26 CFR 1.743-1: Optional adjustment to basis of

partnership property.

T.D. 8847

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

Adjustments Following Sales of Partnership Interests

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final Regulations.

SUMMARY: This document finalizes

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, the allocation of a partner’s

basis in its partnership interest to proper-

December 27, 1999

ties distributed to the partner by the partnership under section 732(c), and the

computation of a partner’s proportionate

share of the adjusted basis of depreciable

property (or depreciable real property)

under section 1017. The changes will affect 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

final regulations under section 732(c) reflect changes to the law made by the Taxpayer Relief Act of 1997.

DATES: Effective Dates: These regulations are effective December 15, 1999.

Applicability Date: These regulations

apply to transfers of partnership interests

and distributions occurring on or after December 15, 1999.

FOR FURTHER INFORMATION CONTACT: Matthew Lay, (202) 622-3050.

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information in these

final regulations have been reviewed and

approved by the Office of Management

and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507)

under control number 1545-1588. Responses to these collections of information are mandatory for partnerships that

have made an election under section 754

and for which a section 743 transfer has

been made, and for partnerships which

distribute property in a transaction subject

to section 732(d).

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

control number assigned by the Office of

Management and Budget.

The estimated annual burden per respondent varies from 1 hour to 300 hours,

depending on the individual circumstances, with an estimated average of 4

hours.

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing this burden should be sent to the

Internal Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224, and to the Office of

Management and Budget, Attn: Desk

Officer for the Department of the Treasury, Office of Information and Regula-

December 27, 1999

tory Affairs, Washington, DC 20503.

Books or records relating to these collections 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 (a) revises §§1.743-1

and 1.755-1 of the Income Tax Regulations (26 CFR part 1), and (b) amends

§§1.732-1, 1.732-2, 1.734-1, 1.751-1,

1.754-1, and §1.1017-1 of the Income Tax

Regulations.

On January 29, 1998, proposed regulations (REG 209682-94) were published in

the Federal Register (63 FR 4408).

Written comments were received in response to the notice of proposed rulemaking. One speaker provided testimony at a

public hearing held on September 10,

1998.

After consideration of all the comments, the proposed regulations under

sections 732, 734, 743, 751, 755, and

1017 are adopted, as revised by this Treasury Decision.

Explanation of Revisions and

Summary of Contents

1. Basis in Distributed Property

(a) Mandatory application of section

732(d). Section 1.732-1(d)(4) of the current regulations requires transferees to

apply the special basis rule in certain

cases. In the preamble to the proposed

regulations, the IRS and the Treasury Department requested comments on the

proper scope of section 732(d), and

specifically, under what circumstances, if

any, the Secretary should continue to exercise his authority to mandate the application of section 732(d) to a transferee.

Several commentators suggested that the

mandatory application of section 732(d)

no longer should be required, because the

changes made to section 732(c) by the

Taxpayer Relief Act of 1997, Public Law

105-34, 111 Stat. 788, 945-46 (1997),

make the distortions targeted by the regulations less likely to occur. However,

other commentators noted that distortions

702

caused by section 732(c) still may occur.

Accordingly, the rule contained in

§1.732-1(d)(4), which requires the

mandatory application of section 732(d)

in certain cases, remains in effect.

(b) Statement required by partnership.

Because partners, rather than partnerships, are required to report basis adjustments under section 732(d), the final regulations require partnerships to provide

transferees with such information as is

necessary for the transferees properly to

compute basis adjustments made under

section 732(d). This information must be

provided if a transferee notifies a partnership that it plans to make the election

under section 732(d) or if a partnership

makes a distribution subject to the mandatory application of section 732(d).

(c) Effective date. One commentator

asked for clarification regarding the application of the final regulations to section

732(d) adjustments. If section 732(d) applies to a distribution, it is necessary to

calculate the basis adjustments which

would have been required under section

743(b) if a section 754 election were in

effect for the partnership in the taxable

year in which the partnership interest was

transferred to the partner. In calculating

these basis adjustments, the partnership

should apply the final regulations under

section 743 and 755 if the distribution to

which section 732(d) applies occurs after

December 15, 1999.

2. Basis Adjustments Under Section

743(b)

(a) Coordination with section 704(c).

Where a partnership adopts the remedial

allocation method, the proposed regulations provide that the section 704(c) builtin gain portion of a basis adjustment

under section 743(b) shall be recovered

over the remaining cost recovery period

for the section 704(c) built-in gain. Some

commentators suggested that the final

regulations should provide this treatment

for the section 704(c) built-in gain portion

of the adjustment regardless of the

method elected by the partnership for allocating section 704(c) built-in gain and

loss. The IRS and the Treasury Department continue to believe that, except for

partnerships which adopt the remedial allocation method, it is appropriate for sec-

1999–52 I.R.B.

tions 704(c) and 743(b) to operate independently. Accordingly, this change has

not been adopted.

In the preamble to the proposed regulations, comments were 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

was contributed to the partnership. Even

if it is not clear that the ceiling rule will

apply at the time the property is contributed because the adjusted basis of the

contributed property is sufficient so that

the non-contributing partners will be allocated their appropriate share of depreciation or amortization attributable to the

property, the partnership’s adoption of the

remedial method still may be relevant due

to allocations resulting from a subsequent

disposition of the property. For instance,

suppose that partners A and B form a partnership and agree that each partner will be

allocated a 50 percent share of all partnership items, and that the partnership will

make allocations under section 704(c)

using the traditional method. A contributes depreciable property with an adjusted tax basis of $40 and a book value

of $50, and B contributes $50 in cash. At

the time of the contribution, it is not readily apparent that the ceiling rule will have

any application. However, if, before any

federal income tax depreciation accrues

with respect to the contributed property,

the property’s value declines to $40, and

the property is sold for that amount, there

will be no tax gain or loss. The book loss

of $10 would be shared equally between

A and B. In this situation, the ceiling rule

would prevent B from being allocated the

$5 tax loss to which it otherwise would be

entitled. However, if the partnership

elected to use the remedial method with

respect to the contributed property, B

would be allocated a $5 tax loss, and A

would be allocated a corresponding $5 tax

gain. In addition, if a contributing partner

transfers its interest in a partnership during a period when a section 754 election

is in effect, the section 704(c) method

adopted by the partnership will determine

the recovery period for the built-in gain

portion of the transferee’s section 743(b)

adjustment. The IRS and the Treasury

Department believe that under the current

regulations under section 704(c), a partnership may use the remedial method

1999–52 I.R.B.

under §1.704-3, even where it is not readily apparent at the time the property is

contributed that the ceiling rule will be

applicable.

(b) Previously taxed capital. One commentator suggested that the second sentence in proposed §1.743-1(d)(2), relating

to the correlation between a partner’s interest in previously taxed capital and the

partnership’s capital accounts, is redundant and should be deleted. This suggestion has been adopted; however, no substantive change is intended by the

deletion.

(c) Common basis election. Some

commentators suggested that the provision in the proposed regulations that permitted the partners to elect to apply negative basis adjustments under section

743(b) to the partnership’s common basis

should be deleted. The commentators argued that the provision was contrary to

the purpose of section 743(b), because it

permitted basis adjustments under section

743(b) to affect nontransferring partners.

The commentators also argued that the

provision would be used by a small number of partnerships and would add unnecessary complexity to the regulations. In

response to these suggestions, the provision that permitted the partners to elect to

apply negative basis adjustments under

section 743(b) to the partnership’s common basis has been deleted.

(d) Statements by partners. Some commentators suggested modifying the statements which partners are required to provide to the partnership in the case of

transfers which result in basis adjustments

under section 743(b). Many of these suggestions have been adopted. For example, the regulations specify that the transferee of a partnership interest is required

to provide the name, address, and taxpayer identification number of the transferor only if that information is ascertainable by the transferee. The regulations

also specify that if a partnership interest is

transferred to a nominee which is required

to furnish the statement under §1.6031(c)1T to the partnership, the nominee may

satisfy the notice requirements of both the

section 743 and 6031 regulations by providing a single statement with respect to

that transfer, but only if the statement satisfies all requirements of both regulations.

The regulations require the transferee

to sign the statement under penalties of

703

perjury, and require the transferee to provide the amount of any liabilities assumed

or taken subject to by the transferee, and

any other information necessary for the

partnership to compute the transferee’s

basis in the partnership interest. In order

to assist the partnership in properly calculating depreciation and amortization deductions which may be subject to antichurning provisions, the regulations

require the transferee to describe its relationship, if any, to the transferor. Finally,

the statement required by a transferee that

acquires an interest by death must include

the date of the decedent’s death.

One commentator suggested that the

statement required by a transferee that acquires a partnership interest by sale or exchange should be provided within 30 days

of the sale or exchange, regardless of

whether or not the transfer occurs at the

end of the calendar year. This change has

been adopted.

One commentator suggested that references to the tax matters partner in §1.7431(k) of the proposed regulations (regarding the partnership’s obligations where a

partner’s statement is clearly erroneous,

or a partner fails to notify the partnership

that an interest has been transferred and

the partnership has actual knowledge of

the transfer) should be changed. This

commentator emphasized that while the

tax matters partner has a specialized role

with respect to consolidated administrative and judicial proceedings to determine

the tax treatment of partnership items at

the partnership level, the tax matters partner does not have any special responsibilities with respect to federal income tax reporting. The final regulations adopt this

comment. Section 1.743-1(k) now refers

to partners who are responsible for federal

income tax reporting by the partnership.

(e) Oil and gas. One commentator suggested that the example described in

§1.743-1(j)(6) should be changed to describe a non- oil and gas property. This

change has been made. The commentator

also suggested that in the case of domestic

oil and gas properties that are depleted at

the partner level, the transferee partner

(rather than the partnership) should be required to make and allocate basis adjustments among such properties. The final

regulations adopt this comment.

The same commentator suggested that

the regulations should specify a method

December 27, 1999

for adjusting the basis of section

613A(c)(7)(D) properties in order to account for percentage depletion made by a

partner with respect to such properties.

Under the principles of §1.743-1(j), percentage depletion should reduce first any

carryover basis under §1.613A3(e)(6)(iv). After the carryover basis has

been recovered, any further percentage

depletion should reduce the section 743

adjustment for the property.

3. Sales of Partnership Interests

One commentator suggested that references to fair market value should specify

whether fair market value is determined

taking into account section 7701(g),

which generally provides that fair market

value shall be treated as being not less

than the amount of any nonrecourse indebtedness to which the property is subject. The regulations specify that for purposes of the hypothetical sale employed

to determine the income or loss realized

by a partner upon the sale or exchange of

its interest in section 751 property, fair

market value is determined taking into account section 7701(g). Basis adjustments

under section 743(b) also are allocated by

reference to a hypothetical transaction.

The IRS and the Treasury Department intend to issue guidance in the near future

which will provide rules for determining

the fair market value of partnership assets

in certain situations, including for purposes of allocating section 743(b) basis

adjustments upon the transfer of a partnership interest. The IRS and the Treasury Department anticipate that the guidance will provide that section 7701(g)

will apply in determining the fair market

value of partnership assets for purposes of

allocating section 743(b) basis adjustments.

One commentator suggested that where

a partnership interest is sold or exchanged, the transferor and the transferee

of a partnership interest should be permitted jointly to assign values to partnership

assets in a written agreement. Because

this approach is inconsistent with the hypothetical sale approach of the regulations, this suggestion has not been

adopted.

4. Elections Under Section 754

One commentator requested that partnerships be granted a one-time right to revoke section 754 elections in effect for

such partnerships. Given the significant

December 27, 1999

changes to the rules made by these final

regulations as compared to the regulations

that were in effect at the time that section

754 elections previously were made, the

IRS and Treasury believe that it is appropriate to provide for a one-time revocation of such elections. Accordingly, a

partnership having an election in effect

under section 754 for its taxable year that

includes December 15, 1999 may revoke

such election by attaching a statement to

the partnership’s return for that year. The

return must be filed on or before the due

date (including extensions) for the return

for that year.

5. Allocation of Basis Adjustments Among

Partnership Assets

(a) Income in respect of a decedent.

One commentator requested that the final

regulations illustrate the allocation of

basis adjustments among partnership assets where one or more of such assets represents income in respect of a decedent.

Where a partnership interest is transferred

as a result of the death of a partner, under

section 1014(c) the transferee’s basis in

its partnership interest is not adjusted for

that portion of the interest, if any, which is

attributable to items representing income

in respect of a decedent under section

691. Because the transferee’s basis in its

partnership interest does not include the

value of assets which represent income in

respect of a decedent, the section 743(b)

adjustment likewise does not reflect the

value of such assets. George Edward

Quick’s Trust, 54 TC 1336 (1970) (acq.),

aff’d per curiam, 444 F.2d 90 (8th Cir.

1971); Chrissie H. Woodhall, 28 T.C.M.

1438 (1969), aff’d, 454 F.2d 226 (9th Cir.

1972); Rev. Rul. 66-325, 1966-2 C.B.

249. Where a partnership holds assets

that represent income in respect of a decedent, the section 743(b) adjustment

should be allocated solely to other assets.

Accordingly, the final regulations provide

that if a partnership interest is transferred

as a result of the death of a partner, and

the partnership holds assets representing

income in respect of a decedent, no part

of the basis adjustment under section

743(b) is allocated to these assets.

(b) Transferred basis transactions. One

commentator called for a revised system

for allocating basis adjustments under

section 743(b) which are triggered by exchanges in which the transferee’s basis in

the interest is determined in whole or in

704

part by reference to the transferor’s basis

in the interest. In many such cases, the

net section 743(b) adjustment will be

zero. However, a positive or negative

section 743(b) adjustment may result, because the transferee’s basis in the interest

may not be equal to the transferee’s share

of the partnership’s bases in its assets.

The IRS and the Treasury Department

believe that, although these transferred

basis transactions involve transfers which

are subject to section 743(b), the new,

comprehensive basis allocation rules in

the proposed regulations should not be

available. For example, where a partnership interest is contributed to a corporation in a transaction to which section 351

applies, or to a partnership in a transaction to which section 721(a) applies, the

transferor merely has changed the form of

its investment. If the allocation rules

which apply to other section 743(b) transfers were applied to these exchanges, then

partners could use these exchanges to

shift basis from capital gain assets to ordinary income assets, or vice versa.

Therefore, the final regulations contain

special basis allocation rules for transferred basis exchanges. The special rules

generally are modeled on the rules for allocating basis adjustments under section

734(b). The final regulations do not contain a specific anti-abuse rule regarding

the special basis allocation rules which

are applicable to such transfers. However, there may be situations where taxpayers will attempt to undertake abusive

transactions using these special rules. For

instance, a partner could acquire a partnership interest during a year in which no

section 754 election is in effect, and then

(in a related transaction) contribute the

property to a wholly-owned corporation

in order to take advantage of the basis allocation rules applicable to transferred

basis exchanges. In appropriate situations, the IRS may attack such abusive

transactions under a variety of judicial

doctrines, including substance over form

or step transaction, or under §1.701-2 of

the regulations.

(c) Unrealized receivables under section 751(c). One commentator requested

that the final regulations illustrate the effect of depreciation recapture on the allocation of basis adjustments among partnership assets under section 755. For

purposes of this section, the final regula-

1999–52 I.R.B.

tions treat depreciation recapture, and any

other properties or potential gain treated

as unrealized receivables under section

751(c) and the regulations thereunder, as

separate assets that are ordinary income

property.

(d) Special rules for securities partnerships and tiered partnerships. One commentator suggested that the regulations

permit securities partnerships to allocate

basis adjustments among partnership assets using an aggregation method. Another commentator requested that the regulations clarify how the regulations would

apply to tiered partnerships. The IRS and

the Treasury Department believe that a

method for allocating basis adjustments

among partnership assets on an aggregate

basis is not consistent with the hypothetical sale of individual assets, which is required by the regulations. In addition, the

IRS and Treasury Department believe that

special rules for tiered partnerships would

make the regulations more complex.

Therefore, these changes have not been

adopted.

6. Other Comments

One commentator suggested that for

purposes of allocating basis adjustments

among partnership assets, the values of all

partnership assets should be determined

by reference to the basis of the transferee

or distributee partner in its partnership interest. This suggestion is being considered in connection with a separate project

currently under review by the IRS and the

Treasury Department.

One commentator suggested that the

language of section 743 does not authorize regulations that permit both positive

and negative adjustments as part of the

same transaction. The IRS and the Treasury Department continue to believe that

this aspect of the regulations is within the

IRS’s authority to administer sections 743

and 755.

Special Analyses

It has been determined that these final

regulations are not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment is not required. It has been determined that a final regulatory flexibility

analysis is required for the collection of

information in this Treasury decision

under 5 U.S.C. 604. This analysis is set

1999–52 I.R.B.

forth below under the heading “Final

Regulatory Flexibility Act Analysis.”

Pursuant to section 7805(f) of the Internal

Revenue Code, the notice of proposed

rulemaking preceding these regulations

was submitted to the Chief Counsel for

Advocacy of the Small Business Administration for comment on their impact on

small business. No comments were received regarding the impact of the regulations on small business.

Final Regulatory Flexibility Act

Analysis

This analysis is required under the Regulatory Flexibility Act (5 U.S.C. chapter

6). In general, the 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, 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

these requirements is contained in sections 743(b), 6001, and 7805(a).

If an interest is transferred in a partnership holding domestic oil and gas properties that are depleted at the partner level

under 613A(c)(7)(D), the regulations require the transferee partner (rather than

the partnership) to make and allocate

basis adjustments under section 743(b)

among such properties.

There were approximately 1,494,000

partnerships in 1994. However, these

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 spe-

705

cific items of partnership property and

may provide only temporary benefits for

the partners. Except for the one-time revocation which is allowed in connection

with the promulgation of these final regulations, the election cannot be revoked

without the consent of the Secretary. The

IRS and the Treasury Department believe

that most partnerships do not make the

election under section 754. Therefore,

most partnerships will not be affected by

the 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 the Treasury Department

are not aware of any federal rules that

may duplicate, overlap, or conflict with

the rule.

As an alternative to the disclosure described above, the IRS and the Treasury

Department considered, but rejected, a

rule that would have required the partners, and not the partnerships, to make the

basis adjustments and to determine the effects of the basis adjustments on the partners’ distributive shares. This alternative

was rejected because the IRS and the

Treasury Department 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.

Finally, because partners, rather than

partnerships, are required to report basis

adjustments under section 732(d), the

final regulations require partnerships to

provide transferees with such information

December 27, 1999

as is necessary for the transferees properly to compute basis adjustments made

under section 732(d). This information

must be provided if a transferee notifies a

partnership that it plans to make the election under section 732(d) or if a partnership makes a distribution subject to the

mandatory application of section 732(d).

The IRS and the Treasury Department believe that this requirement will apply

under limited circumstances to a small

percentage of partnerships.

Drafting Information

The principal author of these regulations

is Matthew Lay of the Office of the Assistant Chief Counsel (Passthroughs and Special Industries). However, other personnel

from the IRS and the Treasury Department

participated in their development.

*****

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR parts 1 and 602

are ammended 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 1.732-1 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 as

follows:

1. Revise paragraph (c).

2. Revise paragraph (d)(1)(ii).

3. Revise the last sentence of paragraph

(d)(1)(v).

4. Revise paragraph (d)(1)(vi).

5. Revise paragraph (d)(4)(iii).

6. Remove the flush text and Examples

1 and 2 following paragraph (d)(4)(iii).

December 27, 1999

7. Add paragraph (d)(5).

The additions and revisions 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. 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,

706

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 fair market value of

$400. Asset Y has an adjusted basis to the partnership and a fair market 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

1999–52 I.R.B.

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 dis-

tribution, 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 December 15, 1999.

(d) * * * (1) * * *

(ii) Where an election under section

754 is in effect, see section 743(b) and

§§1.743-1 and 1.732-2.

*****

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

basis adjustment under section 743(b)

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 fair market

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

Fair

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 fair market value of the inventory received by T was one-fourth of

the fair market 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 (onefourth of the $2,000 difference between

the fair market 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

1999–52 I.R.B.

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

707

($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 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,

December 27, 1999

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.

(5) Required statements. If a transferee

partner notifies a partnership that it plans

to make the election under section 732(d)

under paragraph (d)(3) of this section, or

if a partnership makes a distribution to

which paragraph (d)(4) of this section applies, the partnership must provide the

transferee with such information as is

necessary for the transferee properly to

compute the transferee’s basis adjustments under section 732(d).

*****

Par. 3. Section 1.732-2 is amended by

revising the 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

December 27, 1999

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 December 15, 1999.

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

708

section 742 and §1.742-1. 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 (to the extent attributable to the acquired partnership interest); increased by

(ii) The amount of tax loss (including

any remedial allocations under §1.7043(d)), that would be allocated to the

transferee from the hypothetical transaction (to the extent attributable to the acquired partnership interest); 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 (to the extent attributable to

the acquired partnership interest).

(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.

(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:

1999–52 I.R.B.

Assets

Adjusted

Basis

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

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

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

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

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$55,000

Fair

Market

Value

$5,000

10,000

21,000

40,000

$76,000

Liabilities and Capital

Adjusted

Per Books

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

Capital:

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

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

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

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$55,000

(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 under section 743(b) 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 (Asset 1) with a fair

market value of $1,000 and 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

1999–52 I.R.B.

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 under

section 743(b) 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) are illustrated

by the following example:

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

A and B each contribute $1,000 cash, and C con-

709

Fair

Market

Value

$10,000

22,000

22,000

22,000

$76,000

tributes land with a basis and fair market value of

$1,000. When the land has appreciated in value to

$1,300, A sells its interest to T1 for $1,100 (onethird of $3,300, the fair market value of the partnership property). An election under section 754 is in

effect; therefore, T1 has a basis adjustment under

section 743(b) 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 fair market value of the partnership

property). T2 has a basis adjustment

under section 743(b) of $200. This

amount is determined without regard to

any basis adjustment under section 743(b)

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

under section 743(b). 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).

December 27, 1999

(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 under

§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 for 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

Fair

Market

Value

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

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

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

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

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

$10,000

6,000

6,000

4,000

13,000

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$30,000

$39,000

Capital

Adjusted

Per Books

Fair

Market

Value

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

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

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

$13,000

13,000

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 under section 743(b) in the partner-

ship 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 partner-

ship property, $10,000). The basis adjustment is allocated under section 755, and

the partnership’s balance sheet appears as

follows:

Assets

Adjusted

Basis

Fair

Market

Value

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

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

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

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

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

$10,000

6,000

6,000

4,000

13,000

0.00

666.67

0.00

(1,000.00)

3,333.33

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$30,000

$39,000

$3,000.00

December 27, 1999

710

Basis

Adjustment

$

1999–52 I.R.B.

Capital

Adjusted

Per Books

Fair

Market

Value

Special

Basis

Partner T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$10,000

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

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

$13,000

13,000

13,000

$3,000

0

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 under section 743(b) 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 under section 743(b) 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 partnership, 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 adjust-

1999–52 I.R.B.

ment. 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 adjustments 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

711

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 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.

(iv) Example. The following example

illustrates the principles of this paragraph

(h):

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

partnership PRS. The partnership’s only asset, Asset

1, has an adjusted tax basis of $60 and a fair market

value of $120. Asset 1 is a nondepreciable capital

asset and is not section 704(c) property. A has a

basis in its partnership interest of $40, and a positive

section 743(b) adjustment of $20 in Asset 1. In a

transaction to which section 351 applies, PRS contributes Asset 1 to X, a corporation, in exchange for

$15 in cash and X stock with a fair market value of

$105.

(ii) Under paragraph (h)(2)(ii) of this section,

PRS realizes $60 of gain on the transfer of Asset 1 to

X ($120, its amount realized, minus $60, its adjusted

basis), but recognizes only $15 of that gain under

section 351(b)(1). Of this amount, $5 is allocated to

each partner. A must use $5 of its basis adjustment

in Asset 1 to offset A’s share of PRS’s gain. Under

paragraph (h)(2)(iii) of this section, PRS’s basis in

the stock received from X is $60. However, A has a

basis adjustment in the stock received by PRS equal

to $15 (its basis adjustment in Asset 1, $20, reduced

by the portion of the adjustment which reduced A’s

gain, $5). Under paragraph (h)(2)(i) of this section,

X’s basis in Asset 1 equals $75 (PRS’s common

basis in the asset, $60, plus A’s basis adjustment

under section 743(b), $20, less the portion of the adjustment which reduced A’s gain, $5).

(i) [Reserved].

(j) Effect of basis adjustment—(1) In

general. The basis adjustment constitutes

December 27, 1999

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 calculating income, deduction, gain, and loss, 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(b) 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 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 under section 743(b).

These adjustments to the transferee’s distributive shares must be reflected on

Schedules K and K-1 of the partnership’s

return (Form 1065). 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

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):

December 27, 1999

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 under section 743(b) that, under section 755, is

allocated to the nondepreciable property. PRS then

sells the property for $60. PRS recognizes a book

gain of $10 (allocated equally between T and B) and

a tax loss of $40. T will receive an allocation of $40

of tax loss under the principles of section 704(c).

However, 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 under section 743(b) 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 (allocated

equally between T and B) 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). However, 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 nondepreciable 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 under section 743(b) 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.

However, because T has a negative $50 basis adjustment to the property, T recognizes a $10 gain from

the partnership’s sale of the property.

712

(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 §1.7043(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

1999–52 I.R.B.

of the partnership interest to T, T’s distributive share

$500,000. B contributes $500,000 cash. When

$400,000 of section 704(c) built-in gain will,

of the partnership’s common basis depreciation de-

PRS is formed, the property has five years re-

therefore, be amortized under §1.704-3(d) over a

ductions from Asset 1 is $1,000. Also assume that,

maining in its recovery period. The partnership’s

10-year period beginning at the time of the part-

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

adjusted basis of $100,000 will, therefore, be re-

nership’s formation.

amount of the basis adjustment under section 743(b)

covered over the five years remaining in the

that T recovers during the year is $500. The total

property’s recovery period. PRS elects to use the

(ii)(A)Except for the depreciation deductions,

amount of depreciation deductions from Asset 1 re-

remedial allocation method under §1.704-3(d)

PRS’s expenses equal its income in each year of

ported by T is equal to $1,500.

with respect to the property. If PRS had pur-

the first two years commencing with the year the

Example 2. (i) A and B form equal partnership

chased the property at the time of the partner-

partnership is formed. After two years, A’s share

PRS. A contributes property with an adjusted

ship’s formation, the basis of the property would

of the adjusted basis of partnership property is

basis of $100,000 and a fair market value of

have been recovered over a 10-year period. The

$120,000, while B’s is $440,000:

Capital Accounts

A

Initial

Contribution

Depreciation

Year 1

Remedial

Book

Tax

Book

Tax

$500,000

$100,000

$500,000

$500,000

(30,000)

(20,000)

(10,000)

470,000

(30,000)

470,000

Depreciation

Year 2

Remedial

10,000

110,000

470,000

(30,000)

$440,000

(B) 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.

(iii) 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) Reduced deduction. The amount of any negative basis

adjustment allocated 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

1999–52 I.R.B.

B

(30,000)

10,000

$120,000

$440,000

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.

(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

713

(20,000)

(10,000)

$440,000

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 deductions from Asset 2 is $1,000. Also assume that,

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

amount of the basis adjustment under section 743(b)

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 re-

December 27, 1999

ceive $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 deduction 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 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.

(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 §1.7021(a)(8). For partnerships that hold oil and

gas properties that are depleted at the

December 27, 1999

partner

level

under

section

613A(c)(7)(D), the transferee partner

(and not the partnership) must make the

basis adjustments, if any, required under

section 743(b) with respect to such properties. See §1.613A-3(e)(6)(iv).

(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 a

coal 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 under section 743(b) for the coal 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 onethird interest of A and B in the coal 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—(i) In general. A partnership that

must adjust the bases of partnership properties under section 743(b) 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.

(ii) Special rule. Where an interest is

transferred in a partnership which holds

oil and gas properties that are depleted at

the partner level under section

613A(c)(7)(D), the transferee must attach

a statement to the transferee’s return for

the year of the transfer, setting forth the

computation of the basis adjustment

under section 743(b) which is allocable to

such properties and the specific properties

714

to which the adjustment has been allocated.

(iii) Example. The provisions of paragraph (k)(1)(ii) of this section are illustrated by the following example:

Example. (i) Partnership XYZ owns a single section 613A(c)(7)(D) domestic oil and gas property

(Property) and other non-depletable assets. A, a

partner in XYZ with an adjusted tax basis in Property of $100 (excluding any prior adjustments under

section 743(b)), sells its partnership interest to B for

$800 cash. Under §1.613A-3(e)(6)(iv), A’s adjusted

basis of $100 in Property carries over to B.

(ii) Under section 755, XYZ determines that

Property accounts for 50% of the fair market value

of all partnership assets. The remaining 50% of B’s

purchase price ($400) is attributable to non-depletable property. XYZ must provide a statement to

B containing the portion of B’s adjusted basis attributable to non-depletable property ($400). Under this

paragraph (k)(1), XYZ must report basis adjustments under section 743(b) to non-depletable property. B must report basis adjustments under section

743(b) to Property.

(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 for

the taxable year of the transfer, must notify the partnership, in writing, within 30

days of the sale or exchange. The written

notice to the partnership must be signed

under penalties of perjury and must include the names and addresses of the

transferee and (if ascertainable) of the

transferor, the taxpayer identification

numbers of the transferee and (if ascertainable) of the transferor, the relationship

(if any) between the transferee and the

transferor, the date of the transfer, the

amount of any liabilities assumed or taken

subject to by the transferee, and the

amount of any money, the fair market

value of any other property delivered or to

be delivered for the transferred interest in

the partnership, and any other information

necessary for the partnership to compute

the transferee’s basis.

(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 for the taxable

year of the transfer, must notify the partnership, in writing, within one year of the

death of the deceased partner. The written

notice to the partnership must be signed

under penalties of perjury and must in-

1999–52 I.R.B.

clude the names and addresses of the deceased partner and the transferee, the taxpayer identification numbers of the deceased partner and the transferee, the

relationship (if any) between the transferee and the transferor, the deceased

partner’s date of death, 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.

(iii) Nominee reporting. If a partnership interest is transferred to a nominee

which is required to furnish the statement

under section 6031(c)(1) to the partnership, the nominee may satisfy the notice

requirement contained in this paragraph

(k)(2) by providing the statement required

under §1.6031(c)-1T, provided that the

statement satisfies all requirements of

§1.6031(c)-1T and this paragraph (k)(2).

(3) Reliance. In making the adjustments under section 743(b) 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

any 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(b)

until it has notice of the transfer. A partnership is not required to make the adjustments under section 743(b) (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) Any 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 para-

1999–52 I.R.B.

graph (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

ascertainable) 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 transferee to amend

its prior returns to properly reflect the

adjustment under section 743(b).

(l) Effective date. This section applies

to transfers of partnership interests that

occur on or after December 15, 1999.

Par. 6. Section 1.751-1 is amended by:

1. Revising paragraphs (a)(2) and

(a)(3).

2. Revising paragraph (c)(3).

3. Removing paragraph (c)(4)(x).

4. Adding a sentence at the end of paragraph (f).

5. Revising Example 1 of paragraph

(g).

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

715

or loss from section 751 property (including any remedial allocations 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

for cash in an amount equal to the fair

market value of such property (taking into

account section 7701(g)) 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.

*****

(c) Unrealized receivables. * * *

(3) In determining the amount of the

sale price attributable to such unrealized

receivables, or their value in a distribution

treated as a sale or exchange, full account

shall be taken not only of the estimated

cost of completing performance of the

contract or agreement, but also of the time

between the sale or distribution and the

time of payment.

*****

(f) * * * The rules contained in paragraphs (a)(2) and (a)(3) of this section

apply to transfers of partnership interests

that occur on or after December 15, 1999.

(g) * * *

Example 1. (i)(A) 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:

December 27, 1999

Assets

Adjusted

Basis

Fair

Market

Value

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

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

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

Unrealized Receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0

$ 3,000

10,000

5,000

14,000

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

32,000

Liabilities and Capital

Adjusted

Per Books

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

Capital:

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

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

Total

(B) None of the assets owned by PRS is section

704(c) property, and the capital assets are nondepreciable. 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 half-interest 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.

(ii) 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 1.754-1 is amended as

follows:

1. Designate the text following the heading of paragraph (c) as paragraph (c)(1).

December 27, 1999

20,000

2. Add a heading to newly designated

paragraph (c)(1).

3. Add paragraph (c)(2).

The additions read as follows:

§1.754-1 Time and manner of making

election to adjust basis of partnership

property.

*****

(c) Revocation of election—(1) In general. * * *

(2) Revocations made for first taxable

year ending after December 15, 1999.

Notwithstanding paragraph (c)(1) of this

section, any partnership having an election in effect under this section for its taxable year that includes December 15,

1999 may revoke such election by attaching a statement to the partnership’s return

for such year. For the revocation to be

valid, the statement must be filed not later

than the time prescribed by §1.6031(a)1(e) (including extensions thereof) for filing the return for such taxable year, and

must set forth the name and address of the

partnership revoking the election, be

signed by any one of the partners who is

authorized to sign the partnership’s federal income tax return, and contain a declaration that the partnership revokes its

election under section 754 to apply the

provisions of section 734(b) and 743(b).

In addition, the following statement must

be prominently displayed in capital letters

716

Fair

Market

Value

$ 2,000

15,000

15,000

32,000

on the first page of the partnership’s return for such year: “RETURN FILED

PURSUANT TO §1.754-1(c)(2).”

Par. 8. 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 capital assets and section 1231(b) property (capital gain property), and any other

property of the partnership (ordinary income property). For purposes of this section, properties and potential gain treated

as unrealized receivables under section

751(c) and the regulations thereunder

shall be treated as separate assets that are

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. (i) For ex-

1999–52 I.R.B.

changes in which the transferee’s basis in

the interest is determined in whole or in

part by reference to the transferor’s basis

in the interest, paragraph (b)(5) of this

section shall apply. For all other transfers which result in a basis adjustment

under section 743(b), paragraphs (b)(2)

through (b)(4) of this section shall apply.

Except as provided in paragraph (b)(5) of

this section, 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. Except as provided in paragraph

(b)(5) of this section, 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.

(ii) Hypothetical transaction. For purposes of paragraphs (b)(2) through (b)(4)

of this section, the allocation of the basis

adjustment under section 743(b) 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 property were disposed of in a fully

taxable transaction for cash in an amount

equal to the fair market value of such

property (the hypothetical transaction).

(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(b); 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 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 examples:

Example 1. (i) A and B form equal partnership

PRS. A contributes $50,000 and Asset 1, a nondepreciable 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

Fair

Market

Value

Capital Gain Property:

Asset 1

Asset 2

$ 25,000

100,000

$ 75,000

117,500

Ordinary Income Property:

Asset 3

Asset 4

$ 40,000

10,000

$ 45,000

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.

1999–52 I.R.B.

(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 ordi-

717

nary 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(b) is zero.

(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:

December 27, 1999

Assets

Adjusted

Basis

Fair

Market

Value

Capital Gain Property:

Asset 1

Asset 2

$ 500

500

$ 750

500

Ordinary Income Property:

Asset 3

Asset 4

Total

$ 500

500

$2,000

$ 250

500

$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(b), 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 in-

December 27, 1999

terest) 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 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 examples:

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).

718

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(b) 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 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 by $10,000. The amount of the adjustment to

Asset 1 is $33,604 ($37,500 minus $3,896 ($10,000

x $75,000/192,500)). The amount of the basis adjustment to Asset 2 is $2,646 ($8,750 minus $6,104

($10,000 x $117,500/192,500)).

(4) Income in respect of a decedent—

(i) In general. Where a partnership interest is transferred as a result of the

death of a partner, under section 1014(c)

the transferee’s basis in its partnership

interest is not adjusted for that portion

of the interest, if any, which is attributable to items representing income in respect of a decedent under section 691.

See §1.742-1. Accordingly, if a partnership interest is transferred as a result of

the death of a partner, and the partnership holds assets representing income in

respect of a decedent, no part of the

1999–52 I.R.B.

basis adjustment under section 743(b) is

allocated to these assets. See §1.7431(b).

(ii) The provisions of this paragraph

(b)(4) are illustrated by the following example:

Example. (i) A and B are equal partners in personal service partnership PRS. As a result of B’s

death, B’s partnership interest is transferred to T

when PRS’s balance sheet (reflecting a cash receipts and disbursements method of accounting) is

as follows:

Assets

Adjusted

Basis

Fair

Market

Value

Capital Asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 2,000

Unrealized Receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0

$ 5,000

15,000

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

20,000

Liabilities and Capital

Adjusted

Per Books

Fair

Market

Value

Capital:

A

B

1,000

1,000

10,000

10,000

Total

2,000

20,000

(ii) None of the assets owned by PRS is section

704(c) property, and the capital asset is nondepreciable. The fair market value of T’s partnership interest

on the applicable date of valuation set forth in section 1014 is $10,000. Of this amount, $2,500 is attributable to T’s share of the partnership’s capital

asset, and $7,500 is attributable to T’s 50% share of

the partnership’s unrealized receivables. The partnership’s unrealized receivables represent income in

respect of a decedent. Accordingly, under section

1014(c), T’s basis in its partnership interest is not

adjusted for that portion of the interest which is attributable to the unrealized receivables. Therefore,

T’s basis in its partnership interest is $2,500.

(iii) At the time of the transfer, B’s share of the

partnership’s basis in partnership assets is $1,000.

Accordingly, T receives a $1,500 basis adjustment

under section 743(b). Under this paragraph (b)(4),

the entire basis adjustment is allocated to the partnership’s capital asset.

(5) Transferred basis exchanges—(i) In

general. This paragraph (b)(5) applies to

basis adjustments under section 743(b)

which result from exchanges in which the

transferee’s basis in the interest is determined in whole or in part by reference to

the transferor’s basis in the interest. For

example, this paragraph applies if a partnership interest is contributed to a corporation in a transaction to which section

1999–52 I.R.B.

351 applies or to a partnership in a transaction to which section 721(a) applies.

(ii) Allocations between classes of property. If the total amount of the basis adjustment under section 743(b) is zero, then no

adjustment to the basis of partnership property will be made under this paragraph

(b)(5). If there is an increase in basis to be

allocated to partnership assets, such increase must be allocated to capital gain

property or ordinary income property, respectively, only if 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 such property

would result in a net gain or net income, as

the case may be, to the transferee. Where,

under the preceding sentence, an increase

in basis may be allocated to both capital

gain assets and ordinary income assets, the

increase shall be allocated to each class in

proportion to the net gain or net income, respectively, which would be allocated to the

transferee from the sale of all assets in each

class. If there is a decrease in basis to be allocated to partnership assets, such decrease

must be allocated to capital gain property or

ordinary income property, respectively,

719

only if 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 such property would

result in a net loss to the transferee. Where,

under the preceding sentence, a decrease in

basis may be allocated to both capital gain

assets and ordinary income assets, the decrease shall be allocated to each class in

proportion to the net loss which would be

allocated to the transferee from the sale of

all assets in each class.

(iii) Allocations within the classes—(A)

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 the

transferee’s share of the respective amounts

of unrealized appreciation before such increase (but only to the extent of the transferee’s share of each property’s unrealized

appreciation). Any remaining increase

must be allocated among the properties

within the class in proportion to the transferee’s share of the amount that would be

realized by the partnership upon the hypothetical sale of each asset in the class.

(B) Decreases. If there is a decrease

December 27, 1999

in basis to be allocated within a class,

the decrease must be allocated first to

properties with unrealized depreciation

in proportion to the transferee’s shares

of the respective amounts of unrealized

depreciation before such decrease (but

only to the extent of the transferee’s

share of each property’s unrealized depreciation). Any remaining decrease

must be allocated among the properties

within the class in proportion to the

transferee’s shares of their adjusted

bases (as adjusted under the preceding

sentence).

(C) Limitation in decrease of basis.

Where, as the result of a transaction to

which this paragraph (b)(5) applies, a

decrease in basis must be allocated to

capital gain assets, ordinary income assets, or both, and the amount of the decrease otherwise allocable to a particular

class exceeds the transferee’s share of

the adjusted basis to the partnership of

all depreciated assets in that class, the

transferee’s negative basis adjustment is

limited to the transferee’s share of the

partnership’s adjusted basis in all depre-

ciated assets in that class.

(D) Carryover adjustment. Where a

transferee’s negative basis adjustment

under section 743(b) cannot be allocated

to any asset, because the adjustment exceeds the transferee’s share of the adjusted basis to the partnership of all depreciated assets in a particular class, the

adjustment is made when the partnership subsequently acquires property of a

like character to which an adjustment

can be made.

(iv) Examples. The provisions of this

paragraph (b)(5) are illustrated by the following examples:

Example 1. A is a member of partnership LTP,

which has made an election under section 754. The

three partners in LTP have equal interests in capital

and profits. Solely in exchange for a partnership interest in UTP, A contributes its interest in LTP to

UTP in a transaction described in section 721. At

the time of the transfer, A’s basis in its partnership

interest ($5,000) equals its share of inside basis

(also $5,000). Under section 723, UTP’s basis in its

interest in LTP is $5,000. LTP’s only two assets on

the date of contribution are inventory with a basis

of $5,000 and a fair market value of $7,500, and a

nondepreciable capital asset with a basis of $10,000

and a fair market value of $7,500. The amount of

the basis adjustment under section 743(b) to partnership property is $0 ($5,000, UTP’s basis in its

interest in LTP, minus $5,000, UTP’s share of LTP’s

basis in partnership assets). Because UTP acquired

its interest in LTP in a transferred basis exchange,

and the total amount of the basis adjustment under

section 743(b) is zero, UTP receives no special

basis adjustments under section 743(b) with respect

to the partnership property of LTP.

Example 2. (i) A purchases a partnership interest

in LTP at a time when an election under section 754

is not in effect. The three partners in LTP have equal

interests in capital and profits. During a later year

for which LTP has an election under section 754 in

effect, and in a transaction that is unrelated to A’s

purchase of the LTP interest, A contributes its interest in LTP to UTP in a transaction described in section 721 (solely in exchange for a partnership interest in UTP). At the time of the transfer, A’s adjusted

basis in its interest in LTP is $20,433. Under section

721, A recognizes no gain or loss as a result of the

contribution of its partnership interest to UTP.

Under section 723, UTP’s basis in its partnership interest in LTP is $20,433. The balance sheet of LTP

on the date of the contribution shows the following:

Assets

Adjusted

Basis

Fair

Market

Value

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

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

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

Nondepreciable capital asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20,000

$5,000

10,000

21,000

40,000

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$55,000

$76,000

Liabilities and Capital

Adjusted

Per Books

Fair

Market

Value

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

Capital:

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

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

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

$10,000

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$55,000

$76,000

22,000

22,000

22,000

(ii) The amount of the basis adjustment under

interest in the previously taxed capital of LTP is

amount of tax gain allocated to UTP from the hypo-

section 743(b) is the difference between the basis of

$15,000 ($22,000, the amount of cash UTP would

thetical transaction). UTP’s share of the adjusted

UTP’s interest in LTP and UTP’s share of the ad-

receive if LTP liquidated immediately after the hy-

basis to LTP of partnership property is $18,333

justed basis to LTP of partnership property. UTP’s

pothetical transaction, decreased by $7,000, the

($15,000 share of previously taxed capital, plus

December 27, 1999

720

1999–52 I.R.B.

$3,333 share of LTP’s liabilities). The amount of the

basis adjustment under section 743(b) to partnership

property therefore, is $2,100 ($20,433 minus

$18,333).

(iii) The total amount of gain that would be allocated to UTP from the hypothetical sale of capital

gain property is $6,666.67 (one-third of the excess

of the fair market value of LTP’s nondepreciable

capital asset, $40,000, over its basis, $20,000). The

total amount of gain that would be allocated to UTP

from the hypothetical sale of ordinary income property is $333.33 (one-third of the excess of the fair

market value of LTP’s inventory, $21,000, over its

basis, $20,000). Under paragraph (b)(5), LTP must

allocate $2,000 ($6,666.67 divided by $7,000 times

$2,100) of UTP’s basis adjustment to the nondepreciable capital asset. LTP must allocate $100

($333.33 divided by $7,000 times $2,100) of UTP’s

basis adjustment to the inventory.

(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 deter-

mined 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) 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. Assets 4, 5, and 6 are

the only assets held by the partnership which are

subject to section 751. The partnership has an election in effect under section 754. After seven years,

the adjusted basis and fair market value of PRS’s assets are as follows:

Assets

Adjusted

Basis

Fair

Market

Value

Capital Gain Property:

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

Asset 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100,000

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

$ 75,000

117,500

60,000

Ordinary Income Property:

Asset 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 40,000

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

Asset 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

$ 45,000

60,000

2,500

Total

1999–52 I.R.B.

$275,000

721

$360,000

December 27, 1999

(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 $25,000 in

Asset 3 (capital gain property), and a basis of

$50,000 in Asset 5 (section 751 property). The distribution results in a $25,000 increase in the basis of

capital gain property. There is no change in the

basis of ordinary income property.

(iii) Allocation within class. The amount of the

basis increase to capital gain property is $25,000 and

must be allocated among the remaining capital gain

assets in proportion to the difference between the

fair market 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 $18,519 ($25,000, multiplied by

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

2 will be increased by $6,481 ($25,000 multiplied

by $17,500, divided by $67,500).

(d) Effective date. This section applies to

transfers of partnership interests and distributions of property from a partnership that

occur on or after December 15, 1999.

Par. 9. Section 1.1017-1 is amended by:

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

2. Adding paragraph (g)(2)(v).

The addition and revision read as follows:

§1.1017-1 Basis reductions following a

discharge of indebtedness.

*****

(g) * * *

(2) * * *

(iv) Partner’s share of partnership

basis—(A) In general. For purposes of

this paragraph (g), 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 effective for the

taxable year in which the discharge of indebtedness occurs, 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 de-

December 27, 1999

preciation deductions as being reasonably

expected by more than one partner.

(B) Effective date. This paragraph

(g)(2)(iv) applies to elections made under

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

December 15, 1999.

(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(b). The following

example illustrates this paragraph (g)(2)(v):

(b) * * *

CFR part or section where

identified and described

ship’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

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

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

December 15, 1999.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 10. The authority citation

for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 11. In §602.101, paragraph (b) is

amended by

revising the entries for 1.732-1 and

1.743-1 in the table to read as follows:

§602.101 OMB Control numbers.

*****

Current OMB

control No.

*****

1.732-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545–0099

1545–1588

*****

1.732-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545–0074

1545–1588

****

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 partner-

722

David A. Mader,

Acting Deputy Commissioner

of Internal Revenue.

Approved November 29, 1999

Jonathan Talisman,

Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on December 14, 1999, 8:45 a.m., and published in the

issue of the Federal Register for December 15, 1999,

64 F.R. 69903)

1999–52 I.R.B.

Section 1361.—S Corporation

Defined

SUPPLEMENTARY INFORMATION:

26 CFR 1.1361–1: S corporation defined.

Background

If a state law limited partnership elects

under § 301.7701–3 to be classified as an

association taxable as a corporation, does

the entity have more than one class of

stock for purposes of § 1361(b)(1)(D)?

See Rev. Proc. 99–51, page 760.

26 CFR 601.901: Missing children shown on penalty

mail.

T.D. 8848

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 601

Use of Penalty Mail in the Location

and Recovery of Missing Children

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Procedural rules.

SUMMARY: This rule establishes the

procedures under which the IRS may use

penalty mail to aid in the location and

recovery of missing children. The IRS

can participate in this cause as a result of

the Juvenile Justice and Delinquency

Prevention Act of 1974. Printing pictures

and biographical data of missing children

on blank pages of annual tax forms and

instructions, taxpayer information

publications, and other IRS products will

assist the National Center for Missing

and Exploited Children (National

Center).

On August 9, 1985, Congress enacted

Public Law 99–87, 99 Stat. 290, which

added a new section 3220 to title 39,

United States Code. That provision authorized Federal agencies to place photographs and biographical data of missing

children on penalty mail in accordance

with guidelines promulgated by the Department of Justice. On December 1,

1997, Congress amended the statute to

provide that the use of missing children

photographs and biographical data on

penalty mail would be continued until December 31, 2002.

The Office of Juvenile Justice and

Delinquency Prevention (OJJDP) within

the Department of Justice is directed by

39 U.S.C. 3220 (a) (1), after consultation

with appropriate public and private agencies, to prescribe general guidelines under

which penalty mail may be used to assist

in the location and recovery of missing

children. These guidelines were published on November 8, 1985 (50 FR

46622). In addition, each executive department of the Government of the United

States is required by 39 U.S.C. 3220 (a)

(2) to promulgate or authorize subunits to

promulgate regulations under which

penalty mail sent by such departments

may be used in conformance with the

OJJDP guidelines.

Applicability Date: For dates of applicability of these regulations, see §601.901 (e).

This rule is being promulgated in compliance with 39 U.S.C. 3220 (a)(2) and is

in conformance with the OJJDP guidelines. The rule sets forth information on

U.S. Postal Service restrictions on the

placement of information, “shelf-life” restrictions on the use of missing children

information, and other applicable administrative factors.

FOR FURTHER INFORMATION

CONTACT:

Concerning the

regulations, Randall Hall, (202) 2837900. Concerning the IRS’ forms and

publications program, Sandy Kopta,

(202) 622-3726 (not toll-free

numbers).

The IRS will receive photographic and

biographical information on missing children through the National Center. The

IRS will then give priority to the use of

missing children information in mail addressed to members of the public.

DATES: Effective Date: These regulations

are effective December 13, 1999

1999–52 I.R.B.

723

Findings and Other Matters

The Commissioner has determined that

notice and prior public procedure are not

required for this regulation because the

subject matter of the regulation pertains

only to the IRS’s use of penalty mail in

the location and recovery of missing children. The regulation does not directly affect the rights and interests of the general

public. For these reasons, the rule is to be

effective on the date of publication in the

Federal Register.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive

Order 12866. Therefore, a regulatory

assessment is not required. It also has

been determined that section 553 (b) of

the Administrative Procedure Act (5

U.S.C. Chapter 5) does not apply to

these regulations, and because the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. Chapter 6)

does not apply. Pursuant to section

7805 (f) of the Internal Revenue Code,

this statement of procedural rule will be

submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on

small business.

Drafting Information

The principal author of this statement of

procedural rule is Randall Hall, Office of

Chief Counsel (General Legal Services).

However, other personnel from the IRS

participated in its development.

*****

Adoption of Amendments to the

Statement of Procedural Rules

Accordingly, 26 CFR part 601 is

amended as follows:

PART 601–STATEMENT OF

PROCEDURAL RULES

Paragraph 1. The authority citation for

part 601 is revised to read as follows:

Authority: 5 U.S.C. 301 and 552, unless otherwise noted.

Subpart I also issued under 39 U.S.C.

December 27, 1999

3220.

Par. 2. Subpart I, consisting of

§601.901, is added to read as follows:

Subpart I–Use of Penalty Mail in the

Location and Recovery

of Missing Children

§601.901 Missing children shown on

penalty mail.

(a) Purpose. To support the national

effort to locate and recover missing children, the Internal Revenue Service (IRS)

joins other executive departments and

agencies of the Government of the United

States in using official mail to disseminate photographs and biographical information on hundreds of missing children.

(b) Procedures for obtaining and disseminating data. (1) The IRS shall publish pictures and biographical data related to missing children in domestic

penalty mail containing annual tax

forms and instructions, taxpayer information publications, and other IRS

products directed to members of the

December 27, 1999

public in the United States and its territories and possessions.

(2) Missing children information shall

not be placed on the “Penalty Indicia,”

“OCR Read Area,” “Bar Code Read

Area,” and “Return Address” areas of letter-size envelopes.

(3) The IRS shall accept photographic

and biographical materials solely from the

National Center for Missing and Exploited

Children (National Center). Photographs

that were reasonably current as of the time

of the child’s disappearance, or those which

have been updated to reflect a missing

child’s current age through computer enhancement technique, shall be the only acceptable form of visual media or pictorial

likeness used in penalty mail.

(c) Withdrawal of data. The shelf life

of printed penalty mail is limited to 3

months for missing child cases. The IRS

shall follow those guidelines whenever

practicable. For products with an extended shelf life, such as those related to

filing and paying taxes, the IRS will not

print any pictures or biographical data re-

724

lating to missing children without obtaining from the National Center a waiver of

the 3-month shelf-life guideline.

(d) Reports and contact official. IRS

shall compile and submit to OJJDP reports

on its experience in implementing Public

Law 99–87, 99 Stat. 290, as required by

that office. The IRS contact person is:

Chief, Business Publications Section (or

successor office), Tax Forms and Publications Division, Technical Publications

Branch, OP:FS:FP:P:3, Room 5613, Internal Revenue Service, 1111 Constitution

Ave., N.W., Washington, DC 20224.

(e) Period of applicability. This section is applicable December 13, 1999

through December 31, 2002.

Robert E. Wenzel,

Deputy Commissioner

of Internal Revenue.

(Filed by the Office of the Federal Register on December 10, 1999, 8:45 a.m., and published in the

issue of the Federal Register for December 13,

1999, 64 F.R. 69398)

1999–52 I.R.B.

Part III. Administrative, Procedural, and Miscellaneous

26 CFR 601.204: Changes in accounting periods

and in methods of accounting.

(Also Part I, §§ 56, 162, 165, 166, 167, 168, 171,

174, 197, 263, 263A, 404, 446, 451, 454, 455, 461,

471, 472, 475, 481, 585, 1272, 1273, 1278, 1281,

1363; 1.165–2, 1.167(a)–11, 1.167(e)–1, 1.171–4,

1.174–1, 1.174–3, 1.174–4, 1.263(a)–2, 1.263A–1,

1.263A–3, 1.446–1, 1.446–2, 1.451–1, 1.454–1,

1.455–6, 1.461–4, 1.461–5, 1.471–1, 1.471–2,

1.471–3, 1.472–6, 1.472–8, 1.481–1, 1.481–4,

1.1272–1, 1.1273–1, 1.1273–2.)

Rev. Proc. 99–49

SECTION 1. PURPOSE . . . . . . . . . . . .9

SECTION 2. BACKGROUND

AND CHANGES . . . . . . . . . . . . . . . . .10

.01 Change in method of accounting

defined . . . . . . . . . . . . . . . . . . .10

.02 Securing permission to make a

method change . . . . . . . . . . . . .12

.03 Terms and conditions of a method

change . . . . . . . . . . . . . . . . . . .12

.04 No retroactive method

change . . . . . . . . . . . . . . . . . . .13

.05 Method change with a § 481(a)

adjustment . . . . . . . . . . . . . . . .13

(1) Need for adjustment . . . . . . .13

(2) Adjustment period . . . . . . . .14

.06 Method change using a cut-off

method . . . . . . . . . . . . . . . . . . .15

.07 Consistency and clear reflection

of income . . . . . . . . . . . . . . . . .16

.08 Separate trades or businesses .16

.09 Penalties . . . . . . . . . . . . . . . . .17

.10 Change made as part of an

examination . . . . . . . . . . . . . . .17

.11 Significant changes . . . . . . . . .18

SECTION 3. DEFINITIONS . . . . . . .20

.01 Application . . . . . . . . . . . . . . .20

.02 Taxpayer . . . . . . . . . . . . . . . . .20

(1) In general . . . . . . . . . . . . . . .20

(2) Consolidated group . . . . . . .21

.03 Filed . . . . . . . . . . . . . . . . . . . . .21

.04 Mailed . . . . . . . . . . . . . . . . . . .21

.05 Timely performance of acts . . .22

.06 Year of change . . . . . . . . . . . . .22

.07 Section 481(a)

adjustment period . . . . . . . . . . .22

.08 Under examination . . . . . . . . .22

(1) In general . . . . . . . . . . . . . . .22

(2) Partnerships and S corporations subject to TEFRA . . . .24

.09 Issue under consideration . . . .25

(1) Under examination . . . . . . . .25

(2) Before an appeals office . . . .26

1999–52 I.R.B.

(3) Before a federal court . . . . . .27

.10 Change within the

LIFO inventory method . . . . . .27

.11 District director . . . . . . . . . . . .27

SECTION 4. SCOPE . . . . . . . . . . . . . .27

.01 Applicability . . . . . . . . . . . . . .27

.02 Inapplicability . . . . . . . . . . . . .28

(1) Under examination . . . . . . . .28

(2) Before an appeals office . . . .28

(3) Before a federal court . . . . . .29

(4) Consolidated group

member . . . . . . . . . . . . . . . . .29

(5) Partnerships and

S corporations . . . . . . . . . . . .29

(6) Prior change . . . . . . . . . . . . .30

(7) Section 381(a) transaction . .30

(8) Final year of trade

or business. . . . . . . . . . . . . . .30

.03 Nonautomatic changes . . . . . .30

SECTION 5. TERMS AND CONDITIONS

OF CHANGE . . . . . . . . . . . . . . . . . . . .31

.01 In general . . . . . . . . . . . . . . . . .31

.02 Year of change . . . . . . . . . . . . .31

.03 Section 481(a) adjustment . . . .31

.04 Section 481(a)

adjustment period . . . . . . . . . . .31

(1) In general . . . . . . . . . . . . . . .31

(2) Short period as a

separate taxable year . . . . . .32

(3) Shortened or accelerated

adjustment periods . . . . . . . .32

.05 NOL carryback limitation

for taxpayer subject to criminal

investigation . . . . . . . . . . . . . . .38

.06 Change treated as

initiated by the taxpayer . . . . . .38

SECTION 6. GENERAL APPLICATION

PROCEDURES . . . . . . . . . . . . . . . . . .38

.01 Consent . . . . . . . . . . . . . . . . . .38

.02 Filing requirements . . . . . . . . .39

(1) Waiver of taxable year filing requirement . . . . . . . . . . . . . . .39

(2) Timely duplicate

filing requirement . . . . . . . . .39

(3) Label . . . . . . . . . . . . . . . . . . .40

(4) Signature requirements . . . . .41

(5) Where to file copy . . . . . . . . .42

(6) No user fee . . . . . . . . . . . . . .44

(7) Single application for certain

consolidated groups . . . . . . . . .44

.03 Taxpayer under examination . .45

(1) In general . . . . . . . . . . . . . . .45

(2) 90-day window period . . . . .45

725

(3) 120-day window period . . . .46

(4) Consent of district director .47

.04 Taxpayer before

an appeals office . . . . . . . . . . .48

.05 Taxpayer before

a federal court . . . . . . . . . . . . .49

.06 Compliance with provisions . .50

SECTION 7. AUDIT PROTECTION

FOR TAXABLE YEARS PRIOR TO

YEAR OF CHANGE . . . . . . . . . . . . .50

.01 In general . . . . . . . . . . . . . . . . .50

.02 Exceptions . . . . . . . . . . . . . . . .51

(1) Change not made or

made improperly . . . . . . . . .51

(2) Change in sub-method . . . . .51

(3) Prior year Service-initiated

change . . . . . . . . . . . . . . . . .51

(4) Criminal investigation . . . . .52

SECTION 8. EFFECT OF

CONSENT . . . . . . . . . . . . . . . . . . . . .52

.01 In general . . . . . . . . . . . . . . . . .52

.02 Retroactive change

or modification . . . . . . . . . . . .53

SECTION 9. REVIEW BY DISTRICT

DIRECTOR . . . . . . . . . . . . . . . . . . . . .53

.01 In general . . . . . . . . . . . . . . . . .54

.02 National office

consideration . . . . . . . . . . . . . .55

SECTION 10. REVIEW BY NATIONAL

OFFICE . . . . . . . . . . . . . . . . . . . . . . . .55

.01 In general . . . . . . . . . . . . . . . . .55

.02 Incomplete application —

30 day rule . . . . . . . . . . . . . . . .55

.03 Conference in the

national office . . . . . . . . . . . . .56

.04 National office

determination . . . . . . . . . . . . . .57

(1) Consent not granted . . . . . . .57

(2) Application changed . . . . . .57

SECTION 11. APPLICABILITY OF

REV. PROCS. 99–1 AND 99–4 . . . . .58

SECTION 12. INQUIRIES . . . . . . . . .58

SECTION 13. EFFECTIVE DATE . . .58

.01 In general . . . . . . . . . . . . . . . . .58

.02 Transition rules . . . . . . . . . . . .59

.03 Special rules. . . . . . . . . . . . . . .59

(1) Change in method of

accounting to comply with

§ 404(a)(11) . . . . . . . . . . . . .59

(2) Changes in methods of accounting for rental agreements. . . .60

December 27, 1999

(3) Change in method of accounting

to discontinue the mark-to-market method of accounting . . . .60

(4) Change in method of

accounting for a pool of debt

instruments . . . . . . . . . . . . . .60

.03 Sale or lease transactions . . . .89

(1) Description of change

and scope . . . . . . . . . . . . . . .89

(2) Manner of making

the change . . . . . . . . . . . . . .90

(3) No audit protection . . . . . . .90

SECTION 14. EFFECT ON OTHER

DOCUMENTS . . . . . . . . . . . . . . . . . .60

SECTION 2A. RESEARCH AND

EXPERIMENTAL EXPENDITURES

(§ 174) . . . . . . . . . . . . . . . . . . . . . . . .90

.01 Changes to a different

method or different

amortization period . . . . . . . . .91

(1) Description of change . . . . .91

(2) Scope . . . . . . . . . . . . . . . . . .92

(3) Manner of making

the change . . . . . . . . . . . . . .93

(4) Additional requirement . . . .94

(5) No audit protection . . . . . . .95

.02 Reserved . . . . . . . . . . . . . . . . .95

SECTION 15. PAPERWORK

REDUCTION ACT . . . . . . . . . . . . . . .61

DRAFTING INFORMATION . . . . . .62

APPENDIX . . . . . . . . . . . . . . . . . . . . .64

SECTION 1. TRADE OR BUSINESS

EXPENSES (§ 162) . . . . . . . . . . . . . .64

.01 Advances made by a lawyer on

behalf of clients — Description of

change and scope . . . . . . . . . .64

.02 Year 2000 costs — Description of

change and scope . . . . . . . . . .65

SECTION 1A. AMORTIZABLE BOND

PREMIUM (§ 171) . . . . . . . . . . . . . . .65

.01 Revocation of

§ 171(c) election . . . . . . . . . . .65

(1) Description of

change and scope . . . . . . . . .65

(2) Revocation of election . . . . .66

(3) Manner of making

the change . . . . . . . . . . . . . .66

(4) Additional requirements . . . .66

(5) Audit protection . . . . . . . . . .67

.02 Reserved . . . . . . . . . . . . . . . . .67

SECTION 2. DEPRECIATION OR

AMORTIZATION (§ 56(a)(1),

56(g)(4)(A), 167, 168, OR 197, OR

FORMER § 168) . . . . . . . . . . . . . . . . .67

.01 Impermissible to permissible

method of accounting for depreciation or amortization . . . . . . . .67

(1) Description of change . . . . .67

(2) Scope . . . . . . . . . . . . . . . . . .68

(3) Additional requirements . . . .73

(4) Section 481(a) adjustment . .77

(5) Basis adjustment . . . . . . . . .78

(6) Meaning of depreciation

allowable . . . . . . . . . . . . . . .78

.02 Permissible to permissible

method of accounting

for depreciation . . . . . . . . . . . .81

(1) Description of change . . . . .82

(2) Scope . . . . . . . . . . . . . . . . . .82

(3) Changes covered . . . . . . . . .84

(4) Additional requirements . . . .87

(5) Section 481(a) adjustment . .88

December 27, 1999

SECTION 3. CAPITAL

EXPENDITURES (§ 263) . . . . . . . . .95

.01 Package design costs . . . . . . . .95

(1) Description of change

and scope . . . . . . . . . . . . . . .95

(2) Additional requirements . . . .96

.02 Line pack gas; cushion gas. . . .96

(1) Description of change

and scope . . . . . . . . . . . . . . .96

(2) Additional requirements . . . .97

SECTION 4. UNIFORM

CAPITALIZATION (§ 263A) . . . . . . .97

.01 Certain uniform capitalization

(UNICAP) methods used by small

resellers, formerly small resellers,

and reseller-producers . . . . . . .97

(1) Description of change

and scope . . . . . . . . . . . . . . .97

(2) Definitions . . . . . . . .

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