Partnership Mergers and Divisions

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-111119-99]

RIN 1545-AX32

Partnership Mergers and Divisions

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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SUMMARY: This document contains proposed regulations on the tax

consequences of partnership mergers and divisions. The proposed

regulations affect partnerships and their partners. This document also

contains a notice of public hearing on these proposed regulations.

DATES: Written comments must be received by April 10, 2000. Requests to

speak (with outlines of oral comments) at the public hearing scheduled

for May 4, 2000, must be submitted by April 13, 2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-111119-99), room

5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. In the alternative, submissions may be hand

delivered Monday through Friday between the hours of 8 a.m. and 5 p.m.

to: CC:DOM:CORP:R (REG-111119-99), Courier's Desk, Internal Revenue

Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively,

taxpayers may submit comments electronically via the Internet by

selecting the ``Tax Regs'' option of the IRS Home Page, or by

submitting comments directly to the IRS Internet site at: http://

www.irs.ustreas.gov/tax__regs/regslist.html. The public hearing will be

held in room 2615, Internal Revenue Building, 1111 Constitution Avenue,

NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Dan

Carmody, (202) 622-3080; concerning submissions of comments, the

hearing, and/or to be placed on the building access list to attend the

hearing, LaNita VanDyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: This document proposes to amend sections

708, 743, and 752 of the Income Tax Regulations (26 CFR part 1)

regarding partnership mergers and divisions.

Partnership Mergers

Background

Section 708(b)(2)(A) provides that in the case of a merger or

consolidation of two or more partnerships, the resulting partnership

is, for purposes of section 708, considered the continuation of any

merging or consolidating partnership whose members own an interest of

more than 50 percent in the capital and profits of the resulting

partnership. Section 1.708-1(b)(2)(i) of the Income Tax Regulations

provides that if the resulting partnership can be considered a

continuation of more than one of the merging partnerships, the

resulting partnership is the continuation of the partnership that is

credited with the contribution of the greatest dollar value of assets

to the resulting partnership. If none of the members of the merging

[[Page 1573]]

partnerships own more than a 50 percent interest in the capital and

profits of the resulting partnership, all of the merged partnerships

are considered terminated, and a new partnership results. The taxable

years of the merging partnerships that are considered terminated are

closed under section 706(c).

Although section 708 and the applicable regulations provide which

partnership continues when two or more partnerships merge, the statute

and regulations do not prescribe a form for the partnership merger.

(Often, state merger statutes do not provide a particular form for a

partnership merger.) In revenue rulings, however, the IRS has

prescribed the form of a partnership merger for Federal income tax

purposes.

In Rev. Rul. 68-289 (1968-1 C.B. 314), three existing partnerships

(P1, P2, and P3) merged into one partnership with P3 continuing under

section 708(b)(2)(A). The revenue ruling holds that P1 and P2, the two

terminating partnerships, are treated as having contributed all of

their respective assets and liabilities to P3, the resulting

partnership, in exchange for a partnership interest in P3. P1 and P2

are considered terminated and the partners of P1 and P2 receive

interests in P3 with a basis under section 732(b) in liquidation of P1

and P2 (Assets-Over Form). Rev. Rul. 77-458 (1977-2 C.B. 220), and Rev.

Rul. 90-17 (1990-1 C.B. 119), also follow the Assets-Over Form for a

partnership merger.

Explanation of Provisions

A. Form of a Partnership Merger

The IRS and Treasury are aware that taxpayers may accomplish a

partnership merger by undertaking transactions in accordance with

jurisdictional laws that follow a form other than the Assets-Over Form.

For example, the terminating partnership could liquidate by

distributing its assets and liabilities to its partners who then

contribute the assets and liabilities to the resulting partnership

(Assets-Up Form). In addition, the partners in the terminating

partnership could transfer their terminating partnership interests to

the resulting partnership in exchange for resulting partnership

interests, and the terminating partnership could liquidate into the

resulting partnership (Interest-Over Form).

In the partnership incorporation area, a taxpayer's form generally

is respected if the taxpayer actually undertakes, under the relevant

jurisdictional law, all the steps of a form that is set forth in one of

three situations provided in Rev. Rul. 84-111 (1984-2 C.B. 88). The

three situations that Rev. Rul. 84-111 sets forth are the Assets-Over

Form, Assets-Up Form, and Interest-Over Form. Rev. Rul. 84-111 explains

that, depending on the form chosen to incorporate the partnership, the

adjusted basis and holding periods of the various assets received by

the corporation and the adjusted basis and holding periods of the stock

received by the former partners can vary. Like partnership

incorporations, each form of a partnership merger has potentially

different tax consequences.

Under the Assets-Up Form, partners could recognize gain under

sections 704(c)(1)(B) and 737 (and incur state or local transfer taxes)

when the terminating partnership distributes the assets to the

partners. However, under the Assets-Over Form, gain under sections

704(c)(1)(B) and 737 is not triggered. See Secs. 1.704-4(c)(4) and

1.737-2(b). Additionally, under the Assets-Up Form, because the

adjusted basis of the assets contributed to the resulting partnership

is determined first by reference to section 732 (as a result of the

liquidation) and then section 723 (by virtue of the contribution), in

certain circumstances, the adjusted basis of the assets contributed may

not be the same as the adjusted basis of the assets in the terminating

partnership. These circumstances occur if the partners' aggregate

adjusted basis of their interests in the terminating partnership does

not equal the terminating partnership's adjusted basis in its assets.

Under the Assets-Over Form, because the resulting partnership's

adjusted basis in the assets it receives is determined solely under

section 723, the adjusted basis of the assets in the resulting

partnership is the same as the adjusted basis of the assets in the

terminating partnership.

The regulations propose to respect the form of a partnership merger

for Federal income tax purposes if the partnerships undertake, pursuant

to the laws of the applicable jurisdiction, the steps of either the

Assets-Over Form or the Assets-Up Form. (This rule applies even if none

of the merged partnerships are treated as continuing for Federal income

tax purposes.) Generally, when partnerships merge, the assets move from

one partnership to another at the entity level, or in other words, like

the Assets-Over Form. However, if as part of the merger, the

partnership titles the assets in the partners' names, the proposed

regulations treat the transaction under the Assets-Up Form. If

partnerships use the Interest-Over Form to accomplish the result of a

merger, the partnerships will be treated as following the Assets-Over

Form for Federal income tax purposes.

In the context of partnership incorporations, Rev. Rul. 84-111

distinguishes among all three forms of incorporation. However, with

respect to the Interest-Over Form, the revenue ruling respects only the

transferors' conveyances of partnership interests, while treating the

receipt of the partnership interests by the transferee corporation as

the receipt of the partnership's assets (i.e., the Assets-Up Form). The

theory for this result, based largely on McCauslen v. Commissioner, 45

T.C. 588 (1966), is that the transferee corporation can only receive

assets since it is not possible, as a sole member, for it to receive

and hold interests in a partnership (i.e., a partnership cannot have

only one member; so, the entity is never a partnership in the hands of

the transferee corporation).

Adherence to the approach followed in Rev. Rul. 84-111 creates

problems in the context of partnership mergers that are not present

with respect to partnership incorporations. Unlike the corporate rules,

the partnership rules impose certain tax results on partners based upon

a concept that matches a contributed asset to the partner that

contributed the asset. Sections 704(c) and 737 are examples of such

rules. The operation of these rules breaks down if the partner is

treated as contributing an asset that is different from the asset that

the partnership is treated as receiving.

Given that the hybrid treatment of the Interest-Over Form

transactions utilized in Rev. Rul. 84-111 is difficult to apply in the

context of partnership mergers, another characterization will be

applied to such transactions. The Assets-Over Form generally will be

preferable for both the IRS and taxpayers. For example, when

partnerships merge under the Assets-Over Form, gain under sections

704(c)(1)(B) and 737 is not triggered. Moreover, the basis of the

assets in the resulting partnership is the same as the basis of the

assets in the terminating partnership, even if the partners' aggregate

adjusted basis of their interests in the terminating partnership does

not equal the terminating partnership's adjusted basis in its assets.

If partnerships merge under applicable law without implementing a

form, the proposed regulations treat the partnerships as following the

Assets-Over Form. This approach is consistent with the treatment of

partnership to corporation elective conversions under the check-the-box

regulations and technical terminations under section

[[Page 1574]]

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

B. Adverse Tax Consequences of the Assets-Over Form

The IRS and Treasury are aware that certain adverse tax

consequences may occur for partnerships that merge in a transaction

that will be taxed in accordance with the Assets-Over Form. These

proposed regulations address some of the adverse tax consequences

regarding section 752 liability shifts and buyouts of exiting partners.

1. Section 752 Revisions

If a highly leveraged partnership (the terminating partnership)

merges with another partnership (the resulting partnership), all of the

partners in the terminating partnership could recognize gain because of

section 752 liability shifts. Under the Assets-Over Form, the

terminating partnership becomes a momentary partner in the resulting

partnership when the terminating partnership contributes its assets and

liabilities to the resulting partnership in exchange for interests in

the resulting partnership. If the terminating partnership (as a

momentary partner in the resulting partnership) is considered to

receive a deemed distribution under section 752 (after netting

increases and decreases in liabilities under Sec. 1.752-1(f)) that

exceeds the terminating partnership's adjusted basis of its interests

in the resulting partnership, the terminating partnership would

recognize gain under section 731. The terminating partnership's gain

then would be allocated to each partner in the terminating partnership

under section 704(b). In this situation, a partner in the terminating

partnership could recognize gain even though the partner's adjusted

basis in its resulting partnership interest or its share of partnership

liabilities in the resulting partnership is large enough to avoid the

recognition of gain, provided that the decreases in liabilities in the

terminating partnership are netted against the increases in liabilities

in the resulting partnership.

The proposed regulations clarify that when two or more partnerships

merge under the Assets-Over Form, increases or decreases in partnership

liabilities associated with the merger are netted by the partners in

the terminating partnership and the resulting partnership to determine

the effect of the merger under section 752. The IRS and Treasury

consider it appropriate to treat the merger as a single transaction for

determining the net liability shifts under section 752. Therefore, a

partner in the terminating partnership will recognize gain on the

contribution under section 731 only if the net section 752 deemed

distribution exceeds that partner's adjusted basis of its interest in

the resulting partnership.

2. Buyout of a Partner

Another adverse tax consequence may occur when a partner in the

terminating partnership does not want to become a partner in the

resulting partnership and would like to receive money or property

instead of an interest in the resulting partnership. Under the Assets-

Over Form, the terminating partnership will not recognize gain or loss

under section 721 when it contributes its property to the resulting

partnership in exchange for interests in the resulting partnership.

However, if, in order to facilitate the buyout of the exiting partner,

the resulting partnership transfers money or other consideration to the

terminating partnership in addition to the resulting partnership

interests, the terminating partnership may be treated as selling part

of its property to the resulting partnership under section

707(a)(2)(B). Any gain or loss recognized by the terminating

partnership generally would be allocated to all the partners in the

terminating partnership even though only the exiting partner would

receive the consideration.

The IRS and Treasury believe that, under certain circumstances,

when partnerships merge and one partner does not become a partner in

the resulting partnership, the receipt of cash or property by that

partner should be treated as a sale of that partner's interest in the

terminating partnership to the resulting partnership, not a disguised

sale of the terminating partnership's assets. Accordingly, the proposed

regulations provide that if the merger agreement (or similar document)

specifies that the resulting partnership is purchasing the exiting

partner's interest in the terminating partnership and the amount paid

for the interest, the transaction will be treated as a sale of the

exiting partner's interest to the resulting partnership. This treatment

will apply even if the resulting partnership sends the consideration to

the terminating partnership on behalf of the exiting partner, so long

as the designated language is used in the relevant document.

In this situation, the exiting partner is treated as selling a

partnership interest in the terminating partnership to the resulting

partnership (and the resulting partnership is treated as purchasing the

partner's interest in the terminating partnership) immediately prior to

the merger. Immediately after the sale, the resulting partnership

becomes a momentary partner in the terminating partnership.

Consequently, the resulting partnership and ultimately its partners

(determined prior to the merger) inherit the exiting partner's capital

account in the terminating partnership and any section 704(c) liability

of the exiting partner. If the terminating partnership has an election

in effect under section 754 (or makes an election under section 754),

the resulting partnership will have a special basis adjustment

regarding the terminating partnership's property under section 743. The

proposed regulations provide that the resulting partnership's basis

adjustments under section 743 must be ultimately allocated solely to

the partners who were partners in the resulting partnership immediately

before the merger; the adjustments do not affect the common basis of

the resulting partnership's assets.

C. Merger as Part of a Larger Transaction

The proposed regulations provide that if the merger is part of a

larger series of transactions, and the substance of the larger series

of transactions is inconsistent with following the form prescribed for

the merger, the form may not be respected, and the larger series of

transactions may be recast in accordance with their substance. An

example illustrating the application of this rule is included in the

proposed regulations.

D. Measurement of Dollar Value of Assets

As discussed above, the regulations currently provide that in a

merger of partnerships, if the resulting partnership can be considered

a continuation of more than one of the merging partnerships, the

resulting partnership is the continuation of the partnership that is

credited with the contribution of the greatest dollar value of assets

to the resulting partnership. Commentators have questioned whether this

rule refers to the gross or net value of the assets of a partnership.

The proposed regulations provide that the value of assets of a

partnership is determined net of the partnership's liabilities.

E. Effective Date

The regulations are proposed to apply to mergers occurring on or

after the date final regulations are published in the Federal Register.

Partnership Divisions

Background

Section 708(b)(2)(B) provides that, in the case of a division of a

partnership into two or more partnerships, the resulting partnerships

(other than any

[[Page 1575]]

resulting partnership the members of which had an interest of 50

percent or less in the capital and profits of the prior partnership)

are considered a continuation of the prior partnership. Section 1.708-

1(b)(2)(ii) provides that any other resulting partnership is not

considered a continuation of the prior partnership but is considered a

new partnership. If the members of none of the resulting partnerships

owned an interest of more than 50 percent in the capital and profits of

the prior partnership, the prior partnership is terminated. Where

members of a partnership that has been divided do not become members of

a resulting partnership that is considered a continuation of the prior

partnership, such partner's interest is considered liquidated as of the

date of the division.

Section 708(b)(2)(B) and the applicable regulations do not

prescribe a particular form for the division involving continuing

partnerships. The IRS has not addressed in published guidance how the

assets and liabilities of the prior partnership move into the resulting

partnerships. Taxpayers generally have followed either the Assets-Over

Form or the Assets-Up Form for partnership divisions.

Under the Assets-Over Form, the prior partnership transfers certain

assets to a resulting partnership in exchange for interests in the

resulting partnership. The prior partnership then immediately

distributes the resulting partnership interests to partners who are

designated to receive interests in the resulting partnership.

Under the Assets-Up Form, the prior partnership distributes certain

assets to some or all of its partners who then contribute the assets to

a resulting partnership in exchange for interests in the resulting

partnership.

Explanation of Provisions

A. Form of a Partnership Division

As with partnership mergers, the IRS and Treasury recognize that

different tax consequences can arise depending on the form of the

partnership division. Because of the potential different tax results

that could occur depending on the form followed by the partnership, the

regulations propose to respect for Federal income tax purposes the form

of a partnership division accomplished under laws of the applicable

jurisdiction if the partnership undertakes the steps of either the

Assets-Over Form or the Assets-Up Form. Thus, the same forms allowed

for partnership mergers will be allowed for partnership divisions.

Generally, an entity cannot be classified as a partnership if it

has only one member. This universally has been held to be the case in

classifying transactions where interests in a partnership are

transferred to a single person, so that the partnership goes out of

existence. McCauslen v. Commissioner, 45 T.C. 588 (1966); Rev. Rul. 99-

6, 1999-6 I.R.B. 6; Rev. Rul.

67-65, 1967-1 C.B. 168; Rev. Rul. 55-68, 1955-1 C.B. 372.

However, in at least one instance involving the contribution of

assets by an existing partnership to a newly-formed partnership,

regulations have provided that the momentary existence of the new

partnership will be respected for Federal income tax purposes. See

Sec. 1.708-1(b)(1)(iv). Pursuant to the proposed regulations, under the

Assets-Over Form of a partnership division, the prior partnership's

momentary ownership of all the interests in a resulting partnership

will not prevent the resulting partnership from being classified as a

partnership on formation.

The example in current Sec. 1.708-1(b)(2)(ii) indicates that when a

partnership is not considered a continuation of the prior partnership

under section 708(b)(2)(B) (partnership considered a new partnership

under current Sec. 1.708-1(b)(2)(ii)), the new partnership is created

under the Assets-Up Form. The regulations propose to modify this result

and provide examples illustrating that partnerships can divide and

create a new partnership under either the Assets-Over Form or the

Assets-Up Form.

Consistent with partnership mergers, if a partnership divides using

a form other than the two prescribed, it will be treated as undertaking

the Assets-Over Form.

These proposed regulations use four terms to describe the form of a

partnership division. Two of these terms, prior partnership and

resulting partnership, describe partnerships that exist under the

applicable jurisdictional law. The prior partnership is the partnership

that exists under the applicable jurisdictional law before the

division, and the resulting partnerships are the partnerships that

exist under the applicable jurisdictional law after the division. The

other two terms, divided partnership and recipient partnership, are

Federal tax concepts. A divided partnership is a partnership that is

treated, for Federal income tax purposes, as transferring assets in

connection with a division, and a recipient partnership is a

partnership that is treated, for Federal income tax purposes, as

receiving assets in connection with a division. The divided partnership

must be a continuation of the prior partnership. Although the divided

partnership is considered one continuing partnership for Federal income

tax purposes, it may actually be two different partnerships under the

applicable jurisdictional law (i.e., the prior partnership and a

different resulting partnership that is considered a continuation of

the prior partnership for Federal income tax purposes).

Finally, because in a formless division it generally will be

unclear which partnership should be treated, for Federal income tax

purposes, as transferring assets (i.e., the divided partnership) to

another partnership (i.e., the recipient partnership) where more than

one partnership is a continuation of the prior partnership, the

proposed regulations provide that the continuing resulting partnership

with the assets having the greatest fair market value (net of

liabilities) will be treated as the divided partnership. This issue

also is present where the partnership that, in form, transfers assets

is not a continuation of the prior partnership, but more than one of

the other resulting partnerships are continuations of the prior

partnership. The same rule applies to these situations.

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

Gain under sections 704(c)(1)(B) and 737 may be triggered when

section 704(c) property or substituted section 704(c) property is

distributed to certain partners. These rules often will be implicated

in the context of partnership divisions.

Where a division is accomplished in a transaction that is taxed in

accordance with the Assets-Over Form, the partnership interest in the

recipient partnership will be treated as a section 704(c) asset to the

extent that the interest is received by the divided partnership in

exchange for section 704(c) property. Section 1.704-4(d)(1).

Accordingly, the distribution of the partnership interests in the

recipient partnership by the divided partnership generally will trigger

section 704(c)(1)(B) where the interests in the recipient partnership

are received by a partner of the divided partnership other than the

partner who contributed the section 704(c) property to the divided

partnership. In addition, section 737 may be triggered if a partner who

contributed section 704(c) property to the divided partnership receives

an interest in the recipient partnership that is not attributable to

the section 704(c) property.

Where a division is accomplished under the Assets-Up Form, assets

are distributed directly to the partners who will hold interests in the

recipient partnership. The distribution could trigger section

704(c)(1)(B) or 737 depending on the identity of the

[[Page 1576]]

distributed asset and the distributee partner.

The regulations under section 737 provide an exception for certain

partnership divisions. Section 737 does not apply when a transferor

partnership transfers all the section 704(c) property contributed by a

partner to a second partnership in a section 721 exchange, followed by

a distribution of an interest in the transferee partnership in complete

liquidation of the interest of the partner that originally contributed

the section 704(c) property to the transferor partnership. Section

1.737-2(b)(2). This rule, however, may not apply to many partnership

divisions because the original contributing partner often remains a

partner in the divided partnership. No similar rule is provided under

section 704(c)(1)(B).

In many instances, the application of sections 704(c)(1)(B) and 737

will be appropriate when a partnership divides under either the Assets-

Over Form or the Assets-Up Form. Consider the following example: A, B,

C, and D form a partnership. A contributes appreciated property X ($0

basis and $200 value), B contributes property Y ($200 basis and $200

value), and C and D each contribute $200 cash. The partnership

subsequently divides into two partnerships using the Assets-Over Form,

distributing interests in the recipient partnership in accordance with

each partner's pro rata interest in the prior partnership. Property X

remains in the prior partnership, and property Y is contributed to the

recipient partnership. Under these facts, section 737 could be avoided

if an exception were created for the distribution of the recipient

partnership interests. If, subsequent to the division, half of property

Y is distributed to A, section 737 would not be triggered because

property X (the section 704(c) property) is no longer in the same

partnership as property Y.

While the IRS and Treasury generally believe that it is appropriate

to apply sections 704(c)(1)(B) and 737 in the context of partnership

divisions, comments are invited on whether it would be appropriate to

expand the exceptions to these sections in certain circumstances

relating to divisive transactions.

C. Division as Part of a Larger Transaction

The proposed regulations provide the same rule for partnership

divisions that applies to partnership mergers.

D. Effective Date

The regulations are proposed to apply to divisions occurring on or

after the date final regulations are published in the Federal Register.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment is not required. It also has

been determined that section 553(b) of the Administrative Procedure Act

(5 U.S.C. chapter 5) does not apply to these regulations, and because

these regulations do not impose on small entities a collection of

information requirement, the Regulatory Flexibility Act (5 U.S.C.

chapter 6) does not apply. Therefore, a Regulatory Flexibility Analysis

is not required. Pursuant to section 7805(f) of the Internal Revenue

Code, this notice of proposed rulemaking will be submitted to the Chief

Counsel for Advocacy of the Small Business Administration for comment

on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (preferably a

signed original and eight (8) copies) that are submitted timely to the

IRS. The IRS and the Department of Treasury specifically request

comments on the clarity of the proposed regulations and how they may be

made easier to understand. All comments will be available for public

inspection and copying.

A public hearing has been scheduled for May 4, 2000, beginning at

10 a.m., in room 2615, Internal Revenue Building, 1111 Constitution

Avenue, NW, Washington, DC. Due to building security procedures,

visitors must enter at the 10th Street entrance, located between

Constitution and Pennsylvania Avenues, NW. In addition, all visitors

must present photo identification to enter the building. Because of

access restrictions, visitors will not be admitted beyond the immediate

entrance area more than 15 minutes before the hearing starts. For

information about having your name placed on the building access list

to attend the hearing, see the FOR FURTHER INFORMATION CONTACT section

of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons

that wish to present oral comments at the hearing must submit timely

written comments and must submit an outline of the topics to be

discussed and the time to be devoted to each topic (preferably a signed

original and eight (8) copies) by April 13, 2000.

A period of 10 minutes will be allotted to each person for making

comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting information: The principal author of these regulations is

Mary Beth Collins, Office of Chief Counsel (Passthroughs and Special

Industries). However, other personnel from the IRS and Treasury

Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

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

follows:

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

Par. 2. Section 1.708-1 is amended as follows:

1. Paragraph (b) is amended by removing paragraph (b)(2) and by

redesignating each paragraph listed in the first column of the

following table as the paragraph listed in the second column:

------------------------------------------------------------------------

Old paragraph Redesignated paragraph

------------------------------------------------------------------------

(b)(1)(i)................................. (b)(1)

(b)(1)(i)(a).............................. (b)(1)(i)

(b)(1)(i)(b).............................. (b)(1)(ii)

(b)(1)(ii)................................ (b)(2)

(b)(1)(iii)............................... (b)(3)

(b)(1)(iii)(a)............................ (b)(3)(i)

(b)(1)(iii)(b)............................ (b)(3)(ii)

(b)(1)(iv)................................ (b)(4)

(b)(1)(v)................................. (b)(5)

------------------------------------------------------------------------

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

Sec. 1.708-1 Continuation of partnership.

* * * * *

(c) Merger or consolidation--(1) General rule. If two or more

partnerships merge or consolidate into one partnership, the resulting

partnership shall be considered a continuation of the merging or

consolidating partnership the members of which own an interest of more

than 50 percent in the capital and profits of the resulting

partnership. If the resulting partnership can, under the preceding

sentence, be considered a continuation of more than one of the merging

or

[[Page 1577]]

consolidating partnerships, it shall, unless the Commissioner permits

otherwise, be considered the continuation of that partnership which is

credited with the contribution of assets having the greatest fair

market value (net of liabilities) to the resulting partnership. Any

other merging or consolidating partnerships shall be considered as

terminated. If the members of none of the merging or consolidating

partnerships have an interest of more than 50 percent in the capital

and profits of the resulting partnership, all of the merged or

consolidated partnerships are terminated, and a new partnership

results. The taxable years of such merging or consolidating

partnerships which are considered terminated shall be closed in

accordance with the provisions of section 706(c), and such partnerships

shall file their returns for a taxable year ending upon the date of

termination, i.e., the date of merger or consolidation. The resulting

partnership shall file a return for the taxable year of the merging or

consolidating partnership that is considered as continuing. The return

shall state that the resulting partnership is a continuation of such

merging or consolidating partnership and shall include the names and

addresses of the merged or consolidated partnerships. The respective

distributive shares of the partners for the periods prior to and

subsequent to the date of merger or consolidation shall be shown as a

part of the return.

(2) Form of a merger or consolidation--(i) Assets-over form. When

two or more partnerships merge or consolidate into one partnership

under the applicable jurisdictional law without undertaking a form for

the merger or consolidation, or undertake a form for the merger or

consolidation that is not described in paragraph (c)(2)(ii) of this

section, any merged or consolidated partnership that is considered

terminated under paragraph (c)(1) of this section is treated as

undertaking the assets-over form for Federal income tax purposes. Under

the assets-over form, the merged or consolidated partnership that is

considered terminated under paragraph (c)(1) of this section

contributes all of its assets and liabilities to the resulting

partnership in exchange for an interest in the resulting partnership;

and, immediately thereafter, the terminated partnership distributes

interests in the resulting partnership to its partners in liquidation

of the terminated partnership.

(ii) Assets-up form. Despite the partners' transitory ownership of

the terminated partnership's assets and liabilities, the form of a

partnership merger or consolidation will be respected for Federal

income tax purposes if the merged or consolidated partnership that is

considered terminated under paragraph (c)(1) of this section

distributes its assets and liabilities to its partners in liquidation

of the partners' interests in the terminated partnership; and,

immediately thereafter, the partners in the terminated partnership

contribute the distributed assets and liabilities to the resulting

partnership in exchange for interests in the resulting partnership.

(3) Sale of an interest in the merging or consolidating

partnership. In a transaction characterized under the assets-over form,

a sale of an interest in the terminated partnership to the resulting

partnership that occurs as part of a merger or consolidation under

section 708(b)(2)(A), as described in paragraph (c)(2)(i) of this

section, will be respected as a sale of a partnership interest if the

merger agreement (or similar document) specifies that the resulting

partnership is purchasing interests from a particular partner in the

merging or consolidating partnership and the consideration that is

transferred for each interest sold. See section 741 and Sec. 1.741-1

for determining the selling partner's gain or loss on the sale or

exchange of the partnership interest.

(4) Examples. The following examples illustrate the rules in

paragraphs (c)(1) through (3) of this section:

Example 1. Partnership AB, in whose capital and profits A and B

each own a 50-percent interest, and partnership CD, in whose capital

and profits C and D each own a 50-percent interest, merge on

September 30, 1999, and form partnership ABCD. Partners A, B, C, and

D are on a calendar year, and partnership AB and partnership CD are

also on a calendar year. After the merger, the partners have capital

and profits interests as follows: A, 30 percent; B, 30 percent; C,

20 percent; and D, 20 percent. Since A and B together own an

interest of more than 50 percent in the capital and profits of

partnership ABCD, such partnership shall be considered a

continuation of partnership AB and shall continue to file returns on

a calendar year basis. Since C and D own an interest of less than 50

percent in the capital and profits of partnership ABCD, the taxable

year of partnership CD closes as of September 30, 1999, the date of

the merger, and partnership CD is terminated as of that date.

Partnership ABCD is required to file a return for the taxable year

January 1 to December 31, 1999, indicating thereon that, until

September 30, 1999, it was partnership AB. Partnership CD is

required to file a return for its final taxable year, January 1

through September 30, 1999.

Example 2. (i) Partnership X, in whose capital and profits A

owns a 40-percent interest and B owns a 60-percent interest, and

partnership Y, in whose capital and profits B owns a 60-percent

interest and C owns a 40-percent interest, merge on September 30,

1999. The dollar-value of the partnership X assets (net of

liabilities) is $100X, and the dollar-value of the partnership Y

assets (net of liabilities) is $200X. The merger is accomplished

under state law by partnership Y contributing its assets and

liabilities to partnership X in exchange for interests in

partnership X, with partnership Y then liquidating, distributing

interests in partnership X to B and C.

(ii) B, a partner in both partnerships prior to the merger, owns

a greater than 50-percent interest in the resulting partnership

following the merger. Accordingly, because the dollar-value of

partnership Y's assets (net of liabilities) was greater than that of

partnership X's, under paragraph (c)(1) of this section, X will be

considered to terminate in the merger. As a result, even though, for

state law purposes, the transaction was undertaken with partnership

Y contributing its assets and liabilities to partnership X and

distributing interests in partnership X to its partners, pursuant to

paragraph (c)(2)(i) of this section, for Federal income tax

purposes, the transaction will be treated as if partnership X

contributed its assets to partnership Y in exchange for interests in

partnership Y and then liquidated, distributing interests in

partnership Y to A and B.

Example 3. (i) Partnership X and partnership Y merge when the

partners of partnership X transfer their partnership X interests to

partnership Y in exchange for partnership Y interests. Immediately

thereafter, partnership X liquidates into partnership Y. The

resulting partnership is considered a continuation of partnership Y,

and partnership X is considered terminated.

(ii) The partnerships are treated as undertaking the assets-over

form described in paragraph (c)(2)(i) of this section because the

partnerships undertook a form that is not the assets-up form

described in paragraph (c)(2)(ii) of this section. Accordingly, for

Federal income tax purposes, partnership X is deemed to contribute

its assets and liabilities to partnership Y in exchange for

interests in partnership Y; and, immediately thereafter, partnership

X is deemed to have distributed the interests in partnership Y to

its partners in liquidation of their interests in partnership X.

Example 4. (i) A, B, and C are partners in partnership X. D, E,

and F are partners in Partnership Y. Partnership X and partnership Y

merge within the meaning of section 708(b)(2)(A), and the resulting

partnership is considered a continuation of partnership Y.

Partnership X is considered terminated. Under state law,

partnerships X and Y undertake the assets-over form of paragraph

(c)(2)(i) of this section to accomplish the partnership merger. C

does not want to become a partner in partnership Y, and partnership

X does not have the resources to buy C's interest before the merger.

C, partnership X, and partnership Y enter into an agreement that

specifies that partnership Y will purchase C's interest in

partnership X for $150 immediately before the merger. As

[[Page 1578]]

part of the merger, partnership X receives from partnership Y $150

that will be distributed to C immediately before the merger, and

interests in partnership Y in exchange for partnership X's assets

and liabilities. Partnership X has made an election under section

754.

(ii) Because the merger agreement satisfies the requirements of

paragraph (c)(3) of this section, C will be treated as selling its

interest in partnership X to partnership Y for $150 immediately

before the merger. See section 741 and Sec. 1.741-1 to determine the

amount and character of C's gain or loss on the sale or exchange of

its interest in partnership X.

(iii) Because the merger agreement satisfies the requirements of

paragraph (c)(3) of this section, partnership Y is considered to

have purchased C's interest in partnership X for $150 immediately

before the merger. See Sec. 1.704-1(b)(2)(iv)(l) for determining

partnership Y's capital account in partnership X. Partnership Y's

adjusted basis of its interest in partnership X is determined under

section 742 and Sec. 1.742-1. To the extent any built-in gain or

loss on section 704(c) property in partnership X would have been

allocated to C (including any allocations with respect to property

revaluations under section 704(b) (reverse section 704(c)

allocations)), see section 704 and Sec. 1.704-3(a)(7) for

determining the built-in gain or loss or reverse section 704(c)

allocations apportionable to partnership Y. Similarly, after the

merger is completed, the built-in gain or loss and reverse section

704(c) allocations attributable to C's interest are apportioned to

D, E, and F under section 704(c) and Sec. 1.704-3(a)(7).

(iv) Because partnership X has an election under section 754 in

effect, partnership Y, as a momentary partner in partnership X, will

have a special basis adjustment regarding the basis of partnership

X's property under section 743 and Sec. 1.743-1. See section 743 and

Sec. 1.743-1 for determining the amount of the adjustment. After the

merger, the adjustment is allocated solely to D, E, and F--the

partners in partnership Y immediately before the merger.

(v) Under paragraph (c)(2)(i) of this section, partnership X

contributes assets and liabilities attributable to the interests of

A and B to partnership Y in exchange for interests in partnership Y;

and, immediately thereafter, partnership X distributes the interests

in partnership Y to A and B in liquidation of their interests in

partnership X. At the same time, partnership X distributes assets to

partnership Y in liquidation of partnership Y's interest in

partnership X.

(5) Prescribed form not followed in certain circumstances. (i) If

any transactions described in paragraph (c)(2) or (3) of this section

are part of a larger series of transactions, and the substance of the

larger series of transactions is inconsistent with following the form

prescribed in such paragraph, the Commissioner may disregard such form,

and may recast the larger series of transactions in accordance with

their substance.

(ii) The following example illustrates the rule in paragraph (c)(5)

of this section:

Example. A, B, and C are equal partners in partnership ABC. ABC

holds no section 704(c) property. D and E are equal partners in

partnership DE. B and C want to exchange their interest in ABC for

all of the interests in DE. However, rather than exchanging

partnership interests, DE merges with ABC by undertaking the assets-

up form described in paragraph (c)(2)(ii) of this section, with D

and E receiving title to the DE assets and then contributing the

assets to ABC in exchange for interests in ABC. As part of a

prearranged transaction, the assets acquired from DE are contributed

to a new partnership, and the interests in the new partnership are

distributed to B and C in complete liquidation of their interests in

ABC. The merger and division in this example represent a series of

transactions that in substance are an exchange of interests in ABC

for interests in DE. Even though paragraph (c)(2)(ii) of this

section provides that the form of a merger will be respected for

Federal income tax purposes if the steps prescribed under the asset-

up form are followed, and paragraph (d)(2)(i) of this section

provides a form that will be followed for Federal income tax

purposes in the case of partnership divisions, these forms will not

be respected for Federal income tax purposes under these facts, and

the transactions will be recast in accordance with their substance

as a taxable exchange of interests in ABC for interests in DE.

(6) Effective date. This paragraph (c) is applicable to partnership

mergers occurring on or after the date final regulations are published

in the Federal Register.

(d) Division of a partnership--(1) General rule. Upon the division

of a partnership into two or more partnerships, any resulting

partnership (as defined in paragraph (d)(3)(iv) of this section) or

resulting partnerships shall be considered a continuation of the prior

partnership (as defined in paragraph (d)(3)(ii) of this section) if the

members of the resulting partnership or partnerships had an interest of

more than 50 percent in the capital and profits of the prior

partnership. Any other resulting partnership will not be considered a

continuation of the prior partnership but will be considered a new

partnership. If the members of none of the resulting partnerships owned

an interest of more than 50 percent in the capital and profits of the

prior partnership, none of the resulting partnerships will be

considered a continuation of the prior partnership and the prior

partnership will be considered to have terminated. Where members of a

partnership which has been divided into two or more partnerships do not

become members of a resulting partnership which is considered a

continuation of the prior partnership, such partner's interests shall

be considered liquidated as of the date of the division. The resulting

partnership that is regarded as continuing shall file a return for the

taxable year of the partnership that has been divided. The return shall

state that the partnership is a continuation of the prior partnership

and shall set forth separately the respective distributive shares of

the partners for the periods prior to and subsequent to the date of

division.

(2) Form of a division--(i) Assets-over form. When a partnership

divides into two or more partnerships under applicable jurisdictional

law without undertaking a form for the division, or undertakes a form

that is not described in paragraph (d)(2)(ii) of this section, the

transaction will be characterized under the assets-over form for

Federal income tax purposes.

(A) Assets-over form where at least one resulting partnership is a

continuation of the prior partnership. In a division under the assets-

over form where at least one resulting partnership is a continuation of

the prior partnership, the divided partnership (as defined in paragraph

(d)(3)(i) of this section) contributes certain assets and liabilities

to a recipient partnership (as defined in paragraph (d)(3)(iv) of this

section) or recipient partnerships in exchange for interests in such

recipient partnership or partnerships; and, immediately thereafter,

distributes the interests in such recipient partnership or partnerships

to some or all of its partners in partial or complete liquidation of

the partners' interests in the divided partnership.

(B) Assets-over form where none of the resulting partnerships is a

continuation of the prior partnership. In a division under the assets-

over form where none of the resulting partnerships is a continuation of

the prior partnership, the prior partnership will be treated as

contributing all of its assets and liabilities to new resulting

partnerships in exchange for interests in the resulting partnerships;

and, immediately thereafter, the prior partnership will be treated as

liquidating by distributing the interests in the new resulting

partnerships to the prior partnership's partners.

(ii) Assets-up form--(A) Assets-up form where the partnership

distributing assets is a continuation of the prior partnership. Despite

the partners' transitory ownership of some of the prior partnership's

assets and liabilities, the form of a partnership division will be

respected for Federal income tax purposes if the divided partnership,

which by definition is a continuing partnership, distributes certain

assets and liabilities to some or all of its partners in partial or

complete liquidation of the partners' interests in

[[Page 1579]]

the divided partnership; and, immediately thereafter, such partners

contribute the distributed assets and liabilities to a recipient

partnership or partnerships in exchange for interests in such recipient

partnership or partnerships.

(B) Assets-up form where none of the resulting partnerships are a

continuation of the prior partnership. If none of the resulting

partnerships are a continuation of the prior partnership, then despite

the partners' transitory ownership of some or all of the prior

partnership's assets and liabilities, the form of a partnership

division will be respected for Federal income tax purposes if the prior

partnership distributes certain assets and liabilities to some or all

of its partners in partial or complete liquidation of the partners'

interests in the prior partnership; and, immediately thereafter, such

partners contribute the distributed assets and liabilities to a

resulting partnership or partnerships in exchange for interests in such

resulting partnership or partnerships. If the prior partnership does

not liquidate under the applicable jurisdictional law, then with

respect to the assets and liabilities that, in form, are not

transferred to a new resulting partnership, the prior partnership will

be treated as transferring these assets and liabilities to a new

resulting partnership under the assets over form described in paragraph

(d)(2)(i)(B) of this section.

(3) Definitions--(i) Divided partnership--For purposes of paragraph

(d) of this section, the divided partnership is the partnership which

is treated, for Federal income tax purposes, as transferring the assets

and liabilities to the recipient partnership or partnerships, either

directly (under the assets-over form) or indirectly (under the assets-

up form). If the resulting partnership that, in form, transferred the

assets and liabilities in connection with the division is a

continuation of the prior partnership, then such resulting partnership

will be treated as the divided partnership. If a partnership divides

into two or more partnerships and only one of the resulting

partnerships is a continuation of the prior partnership, then the

resulting partnership that is a continuation of the prior partnership

will be treated as the divided partnership. If a partnership divides

into two or more partnerships without undertaking a form for the

division that is recognized under paragraph (d)(2) of this section, or

if the resulting partnership that had, in form, transferred assets and

liabilities is not considered a continuation of the prior partnership,

and more than one resulting partnership is considered a continuation of

the prior partnership, the continuing resulting partnership with the

assets having the greatest fair market value (net of liabilities) will

be treated as the divided partnership.

(ii) Prior partnership--For purposes of paragraph (d) of this

section, the prior partnership is the partnership subject to division

that exists under applicable jurisdictional law before the division.

(iii) Recipient partnership--For purposes of paragraph (d) of this

section, a recipient partnership is a partnership that is treated as

receiving, for Federal income tax purposes, assets and liabilities from

a divided partnership, either directly (under the assets-over form) or

indirectly (under the assets-up form).

(iv) Resulting partnership--For purposes of paragraph (d) of this

section, a resulting partnership is a partnership resulting from the

division that exists under applicable jurisdictional law after the

division. For example, where a prior partnership divides into two

partnerships, both partnerships existing after the division are

resulting partnerships.

(4) Examples. The following examples illustrate the rules in

paragraphs (d)(1), (2), and (3) of this section:

Example 1. Partnership ABCD is in the real estate and insurance

business. A owns a 40-percent interest, and B, C, and D each owns a

20-percent interest, in the capital and profits of the partnership.

The partnership and the partners report their income on a calendar

year. They agree to separate the real estate and insurance business

as of November 1, 1999, and to form two partnerships; partnership AB

to take over the real estate business, and partnership CD to take

over the insurance business. Because members of resulting

partnership AB owned more than a 50-percent interest in the capital

and profits of partnership ABCD (A, 40 percent, and B, 20 percent),

partnership AB shall be considered a continuation of partnership

ABCD. Partnership AB is required to file a return for the taxable

year January 1 to December 31, 1999, indicating thereon that until

November 1, 1999, it was partnership ABCD. Partnership CD is

considered a new partnership formed on November 1, 1999, and is

required to file a return for the taxable year it adopts pursuant to

section 706(b) and the applicable regulations.

Example 2. (i) Partnership ABCD owns properties W, X, Y, and Z,

and divides into partnership AB and partnership CD. Under paragraph

(d)(1) of this section, partnership AB is considered a continuation

of partnership ABCD and partnership CD is considered a new

partnership. Partnership ABCD distributes property Y to C and titles

property Y in C's name. Partnership ABCD distributes property Z to D

and titles property Z in D's name. C and D then contribute

properties Y and Z, respectively, to partnership CD in exchange for

interests in partnership CD. Properties W and X remain in

partnership AB.

(ii) Under paragraph (d)(2)(ii) of this section, partnership

ABCD will be treated as following the assets-up form for Federal

income tax purposes.

Example 3. (i) Partnership ABCD owns three parcels of property:

property X, with a value of $500; property Y, with a value of $300;

and property Z, with a value of $200. A and B each own a 40-percent

interest in the capital and profits of partnership ABCD, and C and D

each own a 10 percent interest in the capital and profits of

partnership ABCD. On November 1, 1999, partnership ABCD divides into

three partnerships (AB1, AB2, and CD) by contributing property X to

a newly formed partnership (AB1) and distributing all interests in

such partnership to A and B as equal partners, and by contributing

property Z to a newly formed partnership (CD) and distributing all

interests in such partnership to C and D as equal partners in

exchange for all of their interests in partnership ABCD.

(ii) Partnerships AB1 and AB2 both are considered a continuation

of partnership ABCD, while partnership CD is considered a new

partnership formed on November 1, 1999. Under paragraph (d)(2)(i)(A)

of this section, partnership ABCD will be treated as following the

assets-over form, with partnership ABCD contributing property X to

partnership AB1 and property Z to partnership CD, and distributing

the interests in such partnerships to the designated partners.

Example 4. (i) The facts are the same as in example 3, except

that partnership ABCD divides into three partnerships by operation

of state law, without undertaking a form.

(ii) Under the last sentence of paragraph (d)(3)(i) of this

section, partnership AB1 will be treated as the resulting

partnership that is the divided partnership. Under paragraph

(d)(2)(i)(A) of this section, partnership ABCD will be treated as

following the assets-over form, with partnership ABCD contributing

property Y to partnership AB2 and property Z to partnership CD, and

distributing the interests in such partnerships to the designated

partners.

Example 5. (i) The facts are the same as in example 3, except

that partnership ABCD divides into three partnerships by

contributing property X to newly-formed partnership AB1 and property

Y to newly-formed partnership AB2 and distributing all interests in

each partnership to A and B in exchange for all of their interests

in partnership ABCD.

(ii) Because resulting partnership CD is not a continuation of

the prior partnership (partnership ABCD), partnership CD cannot be

treated, for Federal income tax purposes, as the partnership that

transferred assets (i.e., the divided partnership), but instead must

be treated as a recipient partnership. Under the last sentence of

paragraph (d)(3)(i) of this section, partnership AB1 will be treated

as the resulting partnership that is the divided partnership. Under

paragraph (d)(2)(i)(A) of this section, partnership ABCD will be

treated as following the assets-over form, with partnership ABCD

contributing property Y to partnership AB2 and property Z to

[[Page 1580]]

partnership CD, and distributing the interests in such partnerships

to the designated partners.

Example 6. (i) Partnership ABCDE owns Blackacre, Whiteacre, and

Redacre, and divides into partnership AB, partnership CD, and

partnership DE. Under paragraph (d)(1) of this section, partnership

ABCDE is considered terminated (and, hence, none of the resulting

partnerships are a continuation of the prior partnership) because

none of the members of the new partnerships (partnership AB,

partnership CD, and partnership DE) owned an interest of more than

50 percent in the capital and profits of partnership ABCDE.

(ii) Partnership ABCDE distributes Blackacre to A and B and

titles Blackacre in the names of A and B. A and B then contribute

Blackacre to partnership AB in exchange for interests in partnership

AB. Partnership ABCDE will be treated as following the assets-up

form described in paragraph (d)(2)(ii)(B) of this section for

Federal income tax purposes.

(iii) Partnership ABCDE distributes Whiteacre to C and D and

titles Whiteacre in the names of C and D. C and D then contribute

Whiteacre to partnership CD in exchange for interests in partnership

CD. Partnership ABCDE will be treated as following the assets-up

form described in paragraph (d)(2)(ii)(B) of this section for

Federal income tax purposes.

(iv) Partnership ABCDE does not liquidate under state law so

that, in form, the assets in new partnership DE are not considered

to have been transferred under state law. Partnership ABCDE will be

treated as undertaking the assets-over form described in paragraph

(d)(2)(i)(B) of this section for Federal income tax purposes with

respect to the assets of partnership DE. Thus, partnership ABCDE

will be treated as contributing Redacre to partnership DE in

exchange for interests in partnership DE; and, immediately

thereafter, partnership ABCDE will be treated as distributing

interests in partnership DE to D and E in liquidation of their

interests in partnership ABCDE. Partnership ABCDE then terminates.

(5) Prescribed form not followed in certain circumstances. If any

transactions described in paragraph (d)(2) of this section are part of

a larger series of transactions, and the substance of the larger series

of transactions is inconsistent with following the form prescribed in

such paragraph, the Commissioner may disregard such form, and may

recast the larger series of transactions in accordance with their

substance.

(6) Effective date. This paragraph (d) is applicable to partnership

divisions occurring on or after the date final regulations are

published in the Federal Register.

Par. 3. Section 1.743-1 is amended by adding two sentences to the

end of paragraph (h)(1).

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

* * * * *

(h) * * *

(1) * * * When a resulting partnership that is considered a

continuation of a merged or consolidated partnership under section

708(b)(2)(A) has a basis adjustment in property held by the merged or

consolidated partnership that is considered terminated under

Sec. 1.708-1(c)(1) (as a result of the resulting partnership acquiring

an interest in such merged or consolidated partnership, see Sec. 1.708-

1(c)(3)), the resulting partnership will continue to have the same

basis adjustments with respect to property distributed (see Sec. 1.708-

1(c)(4), Example 4(v)) by the terminated partnership to the resulting

partnership, regardless of whether the resulting partnership makes a

section 754 election. The portion of the resulting partnership's

adjusted basis in its assets attributable to the basis adjustment with

respect to the property distributed by the terminating partnership must

be segregated and allocated solely to the partners who were partners in

the resulting partnership immediately before the merger or

consolidation.

* * * * *

Par. 4. Section 1.752-1 is amended as follows:

1. A sentence is added to the end of paragraph (f).

2. The current Example in paragraph (g) is redesignated as Example

1.

3. Example 2 is added in paragraph (g).

Sec. 1.752-1 Treatment of partnership liabilities.

* * * * *

(f) * * * When two or more partnerships merge or consolidate under

section 708(b)(2)(A), as described in Sec. 1.708-1(c)(2)(i), increases

and decreases in partnership liabilities associated with the merger or

consolidation are netted by the partners in the terminating partnership

and the resulting partnership to determine the effect of the merger

under section 752.

(g) * * *

Example 1. * * *

Example 2. Merger or consolidation of partnerships holding

property encumbered by liabilities. (i) B owns a 70 percent interest

in partnership T. Partnership T's sole asset is property X, which is

encumbered by a $900 liability. Partnership T's adjusted basis in

property X is $600, and the value of property X is $1,000. B's

adjusted basis in its partnership T interest is $420. B also owns a

20 percent interest in partnership S. Partnership S's sole asset is

property Y, which is encumbered by a $100 liability. Partnership S's

adjusted basis in property Y is $200, the value of property Y is

$1,000, and B's adjusted basis in its partnership S interest is $40.

(ii) Partnership T and partnership S merge under section

708(b)(2)(A). Under section 708(b)(2)(A) and Sec. 1.708-1(c)(1),

partnership T is considered terminated and the resulting partnership

is considered a continuation of partnership S. Partnerships T and S

undertake the form described in Sec. 1.708-1(c)(2)(i) for the

partnership merger. Under Sec. 1.708-1(c)(2)(i), partnership T

contributes property X and its $900 liability to partnership S in

exchange for an interest in partnership S. Immediately thereafter,

partnership T distributes the interests in partnership S to its

partners in liquidation of their interests in partnership T. B owns

a 25 percent interest in partnership S after partnership T

distributes the interests in partnership S to B.

(iii) Under paragraph (f) of this section, B nets the increases

and decreases in its share of partnership liabilities associated

with the merger of partnership T and partnership S. Before the

merger, B's share of partnership liabilities was $650 (B had a $630

share of partnership liabilities in partnership T and a $20 share of

partnership liabilities in partnership S immediately before the

merger). B's share of S's partnership liabilities after the merger

is $250 (25 percent of S's total partnership liabilities of $1,000).

Accordingly, B has a $400 net decrease in its share of S's

partnership liabilities. Thus, B is treated as receiving a $400

distribution from partnership S under section 752(b). Because B's

adjusted basis in its partnership S interest before the deemed

distribution under section 752(b) is $460 ($420 + $40), B will not

recognize gain under section 731. After the merger, B's adjusted

basis in its partnership S interest is $60.

* * * * *

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

[FR Doc. 00-14 Filed 1-10-00; 8:45 am]

BILLING CODE 4830-01-U