# Statutory Disallowance of Deductions for Certain Qualified Conservation Contributions Made by Partnerships and S Corporations

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2023-25423

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** November 20, 2023
- **Citation:** 88 FR 80910

## Text

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-112916-23]
RIN 1545-BQ90
Statutory Disallowance of Deductions for Certain Qualified Conservation Contributions Made by Partnerships and S Corporations

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Notice of proposed rulemaking and notice of public hearing.

SUMMARY:

This document contains proposed regulations concerning the statutory disallowance rule enacted by the SECURE 2.0 Act of 2022 to disallow a Federal income tax deduction for a qualified conservation contribution made by a partnership or an S corporation after December 29, 2022, if the amount of the contribution exceeds 2.5 times the sum of each partner's or S corporation shareholder's relevant basis. The proposed regulations would provide guidance regarding this statutory disallowance rule, including definitions, appropriate methods to calculate the relevant basis of a partner or an S corporation shareholder, the three statutory exceptions to the statutory disallowance rule, and related reporting requirements. In addition, the proposed regulations would provide reporting requirements for partners and S corporation shareholders that receive a distributive share or pro rata share of any noncash charitable contribution made by a partnership or S corporation, regardless of whether the contribution is a qualified conservation contribution (and regardless of whether the contribution is of real property or other noncash property). These proposed regulations would affect partnerships and S corporations that claim qualified conservation contributions, and partners and S corporation shareholders that receive a distributive share or pro rata share, as applicable, of a noncash charitable contribution. This document also provides a notice of public hearing on these proposed regulations.

DATES:

Written or electronic comments must be received by December 20, 2023. The public hearing on these proposed regulations is scheduled to be held on January 3, 2024, at 10 a.m. ET. Requests to speak and outlines of topics to be discussed at the public hearing must be received by December 20, 2023. If no outlines are received by December 20, 2023, the public hearing will be cancelled. Requests to attend the public hearing must be received by 5 p.m. on December 29, 2023. The public hearing will be made accessible to people with disabilities. Requests for special assistance during the hearing must be received by 5 p.m. on December 28, 2023.

ADDRESSES:

Commenters are strongly encouraged to submit public comments electronically. Submit electronic submissions via the Federal eRulemaking Portal at
https://www.regulations.gov
(indicate IRS and REG-112916-23) by following the online instructions for submitting comments. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The Department of Treasury (Treasury Department) and the IRS will publish for public availability any comments submitted, whether electronically or on paper, to the IRS's public docket. Requests for a public hearing must be submitted as prescribed in the “Comments and Public Hearing” section.

Send paper submissions to:
CC:PA:01:PR (REG-112916-23), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT:

Concerning the proposed regulations under §§ 1.170A-14, 1.706-3, and 1.706-4, contact Benjamin Weaver at (202) 317-6850 (not a toll-free number); concerning the proposed regulations under § 1.170A-16 and issues regarding section 170 other than section 170(h)(7), contact Elizabeth Boone at (202) 317-5100 and Hannah Kim at (202) 317-7003 (not toll-free numbers); and concerning submissions of comments and requests for a public hearing, contact Vivian Hayes at (202) 317-6901 (not a toll-free number) or by email to
publichearings@irs.gov
(preferred).

SUPPLEMENTARY INFORMATION:

Background

I. Overview

This document contains proposed regulations that would amend the Income Tax Regulations (26 CFR part 1) under sections 170 and 706 of the Internal Revenue Code (Code) to implement the provisions of section 605(a) and (b) of the SECURE 2.0 Act of 2022 (SECURE 2.0 Act), enacted as Division T of the Consolidated Appropriations Act, 2023, Public Law 117-328, 136 Stat. 4459, 5393 (December 29, 2022), which apply to contributions of property made after December 29, 2022.

II. Charitable Contribution Deductions

Section 170(a) provides, subject to certain limitations and requirements, a deduction for any charitable contribution, as defined in section 170(c), of cash or other property the payment of which is made within the taxable year. Section 170(f) disallows charitable contribution deductions in certain cases and provides special rules. Section 170(f)(3)(A) provides that, in the case of a contribution (not made by a transfer in trust) of an interest in property that consists of less than the taxpayer's entire interest in such property, a deduction will be allowed only to the extent that the value of the interest contributed would be allowable as a deduction under section 170 if such interest had been transferred in trust. Section 170(f)(3)(B)(iii) provides that section 170(f)(3)(A) does not apply to a qualified conservation contribution (discussed in part III of this Background section).

Section 170(f)(11) requires a qualified appraisal and other documentation for a charitable contribution deduction to be allowed with respect to certain contributions of property. Section 170(f)(11) also includes special rules for contributions of property other than cash (noncash charitable contributions) of more than $5,000 and for noncash charitable contributions of more than $500,000. In addition, section 170(f)(11)(H) provides that the Secretary of the Treasury or her delegate (Secretary) may prescribe such regulations as may be necessary or appropriate to carry out the purposes of section 170(f)(11). Section 6001 provides that every person liable for any tax imposed by title 26, United States Code (title 26) must keep such records, render such statements, make such returns, and comply with such rules and regulations as the Secretary may from time to time prescribe. In addition, section 6011 provides, in part, that, whenever required by regulations prescribed by the Secretary, any person made liable for any tax imposed by title 26 must make a return or statement according to the forms and regulations prescribed by the Secretary and include therein the information required by such forms or regulations. Under the authority of sections 170(f)(11)(H), 6001, and 6011, existing regulations under § 1.170A-16 provide substantiation and reporting requirements that must be satisfied for a deduction to be allowed under section 170 with respect to noncash charitable contributions.

III. Qualified Conservation Contributions

Section 170(h)(1) provides that, in general, for purposes of section 170(f)(3)(B)(iii), the term “qualified conservation contribution” means a contribution (1) of a qualified real property interest, (2) to a qualified organization, (3) exclusively for conservation purposes. Section 170(h)(2) defines the term “qualified real property interest,” section 170(h)(3) defines the term “qualified organization,” section 170(h)(4) defines the term “conservation purpose,” and section 170(h)(5) defines the term “exclusively for conservation purposes.” In general, a qualified conservation contribution may include a contribution of a conservation easement.

The existing regulations under § 1.170A-14 provide rules for qualified conservation contributions described in section 170(h). Consistent with section 170(f)(3), § 1.170A-14(a) provides that a deduction under section 170 generally is not allowed for a charitable contribution of any interest in property that consists of less than the donor's entire interest in the property other than certain transfers in trust. However, by reason of section 170(f)(3)(B)(iii), a deduction may be allowed for the value of a qualified conservation contribution if the requirements of § 1.170A-14 are met. To be eligible for a deduction under § 1.170A-14, the conservation purpose of the contribution must be protected in perpetuity.
See
§ 1.170A-14(a) and (g).

IV. Syndicated Conservation Easement Transactions

On December 23, 2016, the Treasury Department and the IRS released Notice 2017-10, 2017-4 I.R.B. 544, which identified transactions that are the same as or substantially similar to certain syndicated conservation easement transactions as “listed transactions” under § 1.6011-4 subject to certain disclosure and list maintenance requirements. Notice 2017-10 explains that the Treasury Department and the IRS are aware that some promoters are syndicating conservation easement transactions that purport to give investors the opportunity to obtain charitable contribution deductions in amounts that significantly exceed the amounts invested. In addition, Notice 2017-10 provides that a transaction is a listed transaction if (1) an investor receives promotional materials that offer a prospective investor in a pass-through entity the possibility of a charitable contribution deduction that equals or exceeds an amount that is 2.5 times the amount of the investor's investment, (2) the investor purchases an interest directly or indirectly (through one or more tiers of pass-through entities) in the pass-through entity that holds real property, (3) the pass-through entity contributes a conservation easement and allocates, directly or through one or more tiers of pass-through entities, a charitable contribution to the investor, and (4) the investor reports on the investor's Federal income tax return a charitable contribution deduction with respect to the conservation easement.

Congress continued to be concerned about abusive syndicated conservation easement transactions even after Notice 2017-10 was issued, and the transactions were the subject of an investigation by the U.S. Senate Committee on Finance, which issued a report on August 25, 2020. S. Committee on Finance, Comm. Print 116-44,
Syndicated Conservation-Easement Transactions,
116th Cong., 2nd Sess. (2020) (Committee Report). The Committee Report found that the syndicated conservation easement transactions examined were nothing more than retail tax shelters allowing taxpayers to buy tax deductions at the end of any given tax year.
Id.
at 3. The Committee Report further stated that these tax deductions could be purchased with no economic risk.
Id.
As such, the Finance Committee concluded that further action was necessary to preserve the integrity of the conservation easement tax deduction despite ongoing efforts to combat this abuse such as the issuance of Notice 2017-10 and IRS enforcement action.
Id.
at 4.

In a separate report accompanying an earlier proposal for amending section 170(h), in legislation proposed as the “Enhancing American Retirement Now Act,” the Committee on Finance recognized charitable deductions for the donation of conservation easements as an important tool and incentive to protect the environment and historic structures. S. Rep. No. 117-142 on S. 4808, at 218, 117th Cong., 2nd Sess. (2022). Citing its findings from the 2020 Committee Report, the Committee noted, however, that abusive tax shelter transactions put the conservation easement tax deduction at risk. The Committee ultimately found it appropriate to take legislative action to protect the integrity of the conservation easement tax deduction for easement donations with a legitimate conservation purpose.
Id.

On December 8, 2022, the Treasury Department and the IRS published in the
Federal Register
(87 FR 75185) a notice of proposed rulemaking (REG-106134-22) identifying syndicated conservation easement transactions and substantially similar transactions as listed transactions (listing NPRM). The definition of a syndicated conservation easement transaction in proposed § 1.6011-9 of the listing NPRM is similar to the definition in Notice 2017-10. The purpose of the listing NPRM was to eliminate any confusion and ensure consistent enforcement of Federal tax laws throughout the nation in light of certain judicial decisions holding that, under the Administrative Procedure Act, 5 U.S.C. chapter 5, subchapter II, listed transactions may be identified only after following notice and comment procedures.
See, e.g., Mann Construction, Inc.
v.
United States,
27 F.4th 1138 (6th Cir. 2022), and
Green Valley Investors, LLC, et al.
v.
Commissioner,
159 T.C. No. 5 (2022). The Treasury Department and the IRS are in the process of considering the comments received and finalizing the listing NPRM.

V. Section 605 of the SECURE 2.0 Act

Section 170(h)(7) was added to the Code by section 605(a)(1) of the SECURE 2.0 Act. Section 170(h)(7)(A) states that a contribution by a partnership (whether directly or as a distributive share of a contribution of another partnership) is not treated as a qualified conservation contribution for purposes of section 170 if the amount of such contribution exceeds 2.5 times the sum of each partner's relevant basis in such partnership (Disallowance Rule). Thus, a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes is not a qualified conservation contribution if the Disallowance Rule applies. Section 170(h)(7)(F) provides that the rules of section 170(h)(7) “apply to S corporations and other pass-through entities in the same manner as such rules apply to partnerships” except as the Secretary may otherwise provide.

Section 170(h)(7)(B) defines the terms “relevant basis” and “modified basis,” section 170(h)(7)(C), (D), and (E) provide three exceptions to the Disallowance Rule, and section 170(h)(7)(G) provides a specific grant of regulatory authority to the Secretary to issue regulations or other guidance as the Secretary determines are necessary or appropriate to carry out the purposes of the Disallowance Rule, including reporting requirements and rules to prevent the avoidance of the Disallowance Rule.

Section 605(a)(2) of the SECURE 2.0 Act modifies certain penalty provisions in sections 6662, 6664, and 6751 of the Code to provide special rules for

charitable contribution deductions disallowed by section 170(h)(7). Section 605(a)(3) of the SECURE 2.0 Act provides that any charitable contribution for which a deduction was disallowed under section 170(h)(7) is treated, for purposes of the period of limitations on assessment and collection of tax in section 6501 of the Code and the period of limitations on making adjustments in section 6235 of the Code, as a transaction specifically identified by the Secretary as a tax-avoidance transaction.

Section 605(b) of the SECURE 2.0 Act added section 170(f)(19) to the Code, which provides that, in the case of a partnership or S corporation claiming a qualified conservation contribution for the preservation of a building that is a certified historic structure (as defined in section 170(h)(4)(C)) in an amount that exceeds 2.5 times the sum of each partner's or S corporation shareholder's relevant basis (as defined in section 170(h)(7)), no deduction under section 170 is allowed unless, as provided in section 170(f)(19)(A)(i) and (ii), the partnership or S corporation includes on its return for the taxable year a statement that such contribution was made and any other information as the Secretary may require. A contribution to preserve a certified historic structure is one of the three exceptions to the Disallowance Rule.

Section 605(c) of the SECURE 2.0 Act provides that the amendments made by section 605 of the SECURE 2.0 Act apply to contributions made after December 29, 2022, and that no inference is intended as to the appropriate treatment of contributions made in taxable years ending on or before that date, or as to any contribution for which a deduction is not disallowed by reason of section 170(h)(7).

VI. Overview of the Disallowance Rule

The Disallowance Rule provides that a contribution by a partnership (whether directly or as a distributive share of a contribution of another partnership) is not treated as a qualified conservation contribution for purposes of section 170 if the amount of such contribution exceeds 2.5 times the sum of each partner's relevant basis in such partnership. If such a contribution is not treated as a qualified conservation contribution, then the general rule under section 170(f)(3)(A) disallowing a charitable contribution deduction under section 170 for a contribution of a partial interest in property applies. Thus, if the Disallowance Rule applies, any amount of deduction under section 170 for a qualified conservation contribution is disallowed.

Section 170(h)(7)(B)(i) provides that, for purposes of section 170(h)(7), the term “relevant basis” means, with respect to any partner, the portion of such partner's modified basis in the partnership that is allocable (under rules similar to the rules of section 755 of the Code for allocating certain special basis adjustments to partnership property) to the portion of the real property with respect to which the contribution described in section 170(h)(7)(A) is made. Section 170(h)(7)(B)(ii) provides that, for purposes of section 170(h)(7), the term “modified basis” means, with respect to any partner, such partner's adjusted basis in the partnership as determined (1) immediately before the contribution described in section 170(h)(7)(A), (2) without regard to the treatment of partnership liabilities in section 752, and (3) by the partnership after taking into account these first two adjustments and such other adjustments as the Secretary may provide.

Section 170(h)(7) contains three exceptions to the Disallowance Rule. First, section 170(h)(7)(C) provides that the Disallowance Rule does not apply to any contribution made at least three years after the latest of (1) the last date on which the partnership that made such contribution acquired any portion of the real property with respect to which such contribution is made, (2) the last date on which any partner in the partnership that made such contribution acquired any interest in such partnership, and (3) if the interest in the partnership that made such contribution is held through one or more partnerships, the last date on which any such partnership acquired any interest in any other such partnership, and the last date on which any partner in any such partnership acquired any interest in such partnership.

Second, section 170(h)(7)(D)(i) provides that the Disallowance Rule does not apply to any contribution made by any partnership if substantially all of the partnership interests in such partnership are held, directly or indirectly, by an individual and members of the family of such individual. Section 170(h)(7)(D)(ii) provides that, for purposes of section 170(h)(7)(D), the term “members of the family” means, with respect to any individual (I) the spouse of such individual, and (II) any individual who bears a relationship to such individual that is described in section 152(d)(2)(A) through (G) of the Code for purposes of determining whether an individual is a qualifying relative.

Third, section 170(h)(7)(E) provides that the Disallowance Rule does not apply to any qualified conservation contribution the conservation purpose of which is the preservation of any building that is a certified historic structure (as defined in section 170(h)(4)(C)).

Section 170(h)(7)(F) provides that, except as may be otherwise provided by the Secretary, the rules of section 170(h)(7) apply to S corporations and other pass-through entities in the same manner as such rules apply to partnerships.

Section 170(h)(7)(G) authorizes the Secretary to prescribe such regulations or other guidance as may be necessary or appropriate to carry out the purposes of section 170(h)(7), including regulations or other guidance (1) to require reporting, including reporting related to tiered partnerships and the modified basis of partners, and (2) to prevent the avoidance of the purposes of section 170(h)(7).

Explanation of Provisions

I. Overview

These proposed regulations would address several requirements added by section 605 of the SECURE 2.0 Act and make several related clarifying changes to the existing regulations applicable to qualified charitable contributions. First, these proposed regulations would make changes to existing § 1.170A-14, including modifying paragraph (a) to reference the Disallowance Rule and adding new paragraphs (j) through (n) to § 1.170A-14 to provide guidance on the application of the Disallowance Rule to partnerships and S corporations, the computation of relevant basis and modified basis, including in tiered structures, and the three statutory exceptions to the Disallowance Rule.

These proposed regulations would provide specific rules for partnerships and S corporations, but do not specifically address other types of pass-through entities. The Treasury Department and the IRS continue to study whether specific rules are needed for other types of pass-through entities and request comments on the application of section 170(f)(19) and (h)(7) to pass-through entities other than partnerships and S corporations. The Treasury Department and the IRS intend to issue future guidance on other issues relating to section 605 of SECURE 2.0 Act, including additional guidance relating to the three statutory exceptions to the Disallowance Rule.

Second, these proposed regulations would make changes to the reporting requirements in § 1.170A-16 to address

substantiation of charitable contribution deductions as well as to implement section 170(f)(19)(A)(i). The Treasury Department and the IRS intend to issue future guidance addressing section 170(f)(19)(A)(ii).

Finally, these proposed regulations propose new language in §§ 1.706-3 and 1.706-4 to facilitate the operation of the Disallowance Rule in the case of a qualified conservation contribution made by a partnership.

II. Clarifying Change to § 1.170A-14(a)

The second sentence of existing § 1.170A-14(a) provides that a deduction may be allowed under section 170(f)(3)(B)(iii) for the value of a qualified conservation contribution if the requirements of § 1.170A-14 are met. Because the Disallowance Rule provided in section 170(h)(7) is proposed to be contained in § 1.170A-14(j) through (n), proposed § 1.170A-14(a) would amend this sentence to provide that a deduction may be allowed under section 170(f)(3)(B)(iii) for the value of a qualified conservation contribution if the requirements of § 1.170A-14 are met and the contribution is not a disallowed qualified conservation contribution within the meaning of proposed § 1.170A-14(j).

III. Disallowance Rule and Its Exceptions

Proposed § 1.170A-14(j) would provide guidance on the general applicability of the Disallowance Rule to partnerships and S corporations. Proposed § 1.170A-14(j)(3) would provide definitions. Consistent with section 170(h)(7)(B), proposed § 1.170A-14(k) would provide that the term “relevant basis” means, with respect to any ultimate member (as defined in proposed § 1.170A-14(j)(3)(x)), the portion of such ultimate member's modified basis (as determined under proposed § 1.170A-14(l)) that is allocable (under the rules of proposed § 1.170A-14(m)) to the portion of the real property with respect to which the qualified conservation contribution is made. Proposed § 1.170A-14(l) would provide guidance on the determination of modified basis. Proposed § 1.170A-14(m) would provide guidance on the allocation of modified basis to the portion of the real property with respect to which the qualified conservation contribution was made. Proposed § 1.170A-14(m)(6) would impose recordkeeping requirements for substantiating the computation of each ultimate member's adjusted basis, modified basis, and relevant basis by the due date, including extensions, of the partnership's or S corporation's Federal income tax return. Proposed § 1.170A-14(n) would provide guidance on the three statutory exceptions to the Disallowance Rule.

A. General Disallowance Rule for Partnerships and S Corporations

Consistent with section 170(h)(7)(A), proposed § 1.170A-14(j)(1) would provide that proposed § 1.170A-14(j) applies the rules of section 170(h)(7), which disallow a deduction under the Code and § 1.170A-14 for certain qualified conservation contributions, as defined in section 170(h)(1) and § 1.170A-14, made by, or allocated to, partnerships or S corporations if the amount of the qualified conservation contribution exceeds 2.5 times the sum of the relevant bases, as determined by proposed § 1.170A-14(j) through (m). Proposed § 1.170A-14(j)(3)(vii) would define a contribution for which a deduction is disallowed by § 1.170A-14(j) as a “disallowed qualified conservation contribution.” Proposed § 1.170A-14(j)(2)(i) would provide that, except as provided in proposed § 1.170A-14(n), a qualified conservation contribution by a contributing partnership or a contributing S corporation is a disallowed qualified conservation contribution if the amount of the qualified conservation contribution exceeds 2.5 times the sum of each of the contributing partnership's or contributing S corporation's ultimate member's relevant basis as determined under proposed § 1.170A-14(j) through (m).

Proposed § 1.170A-14(j)(2)(ii) would provide that, except as provided in proposed § 1.170A-14(n), an allocated portion of a contribution received by an upper-tier partnership or upper-tier S corporation is a disallowed qualified conservation contribution if either the contribution is a disallowed qualified conservation contribution with respect to the partnership that allocated the allocated portion to the upper-tier partnership or upper-tier S corporation, or such allocated portion exceeds 2.5 times the sum of each of that upper-tier partnership's or upper-tier S corporation's ultimate member's relevant basis as determined under proposed § 1.170A-14(j) through (m). Thus, if a contribution is a disallowed qualified conservation contribution with respect to a partnership, then the contribution is a disallowed qualified conservation contribution with respect to any upper-tier partnership or upper-tier S corporation owning a direct or indirect interest in that partnership. On the other hand, if a contribution is not a disallowed qualified conservation contribution with respect to a partnership, then the rules of proposed § 1.170A-14(j) through (m) must be applied to the next tier of upper-tier partnerships and upper-tier S corporations (which own a direct interest in the partnership) to determine if the Disallowance Rule applies to those upper-tier partnerships and upper-tier S corporations. In other words, the test of § 1.170A-14(j) through (m) must be applied at each tier unless and until the test is failed at one tier, in which case that portion of the contribution will be a disallowed qualified conservation contribution to that tier and any subsequent tiers.

B. Definitions

Proposed § 1.170A-14(j)(3) would contain definitions, including definitions of terms, including “contributing partnership,” “contributing S corporation,” “ultimate member,” “allocated portion,” “upper-tier partnership,” and “upper-tier S corporation.”

1. Allocated Portion

Proposed § 1.170A-14(j)(3)(i) would provide that, in the case of an upper-tier partnership or upper-tier S corporation that receives, directly or indirectly, a distributive share of a qualified conservation contribution, the phrase “allocated portion” means the amount of such distributive share.

2. Amount of Qualified Conservation Contribution

Proposed § 1.170A-14(j)(3)(ii) would provide that the amount of a contributing partnership's or contributing S corporation's qualified conservation contribution is the amount claimed as a qualified conservation contribution on the return of the contributing partnership or contributing S corporation for the taxable year in which the contribution is made. It would also provide that, if the contributing partnership or contributing S corporation files an amended return or administrative adjustment request under section 6227 of the Code claiming a different amount with respect to the qualified conservation contribution, the rules of § 1.170A-14 must be re-applied with respect to such different amount to determine the application of section 170(h)(7) and § 1.170A-14.

3. Contributing Partnership

The Disallowance Rule applies to a partnership or S corporation that makes a qualified conservation contribution, as well as a partnership or S corporation that is allocated a distributive share of a qualified conservation contribution of

another partnership. For clarity, proposed § 1.170A-14(j)(3)(iii) would provide that the term “contributing partnership” means a partnership that makes a qualified conservation contribution.

4. Contributing S Corporation

Proposed § 1.170A-14(j)(3)(iv) would provide that the term “contributing S corporation” means an S corporation that makes a qualified conservation contribution.

5. Direct Interest

Proposed § 1.170A-14(j)(3)(v) would provide that the term “direct interest” refers to an ownership interest in a contributing partnership, upper-tier partnership, contributing S corporation, or upper-tier S corporation that is held directly, or through an entity disregarded as separate from its owner for Federal income tax purposes, a qualified subchapter S subsidiary as defined in section 1361(b)(3) of the Code, or through a grantor trust (under subpart E of part 1 of subchapter J of chapter 1 of the Code). In the case of a partner that is a C corporation, non-grantor trust, or an estate, or an S corporation shareholder that is a non-grantor trust or an estate, the direct interest in the partnership or S corporation, as applicable, would be considered to be held by the C corporation, non-grantor trust, or estate; the C corporation's shareholders, trust beneficiaries, and estate beneficiaries would not be considered to hold any interest in the partnership or S corporation, as applicable, for purposes of proposed § 1.170A-14(j) through (n).

6. Directly

Proposed § 1.170A-14(j)(3)(vi) would provide that an ownership interest is held “directly” if it is not held through one or more upper-tier partnerships or upper-tier S corporations. Similarly, a distributive share or pro rata share of a qualified conservation contribution would be received “directly” if it does not pass through one or more upper-tier partnerships or upper-tier S corporations.

7. Disallowed Qualified Conservation Contribution

Proposed § 1.170A-14(j)(3)(vii) would provide that the term “disallowed qualified conservation contribution” means a qualified conservation contribution or allocated portion for which no deduction is allowed pursuant to section 170(h)(7) and proposed § 1.170A-14(j).

8. Indirect Interest

Proposed § 1.170A-14(j)(3)(viii) would provide that the term “indirect interest” refers to an ownership interest in a contributing partnership, contributing S corporation, upper-tier partnership, or upper-tier S corporation held through an upper-tier S corporation or one or more upper-tier partnerships.

9. Indirectly

Proposed § 1.170A-14(j)(3)(ix) would provide that an ownership interest is held “indirectly” if it is held through one or more upper-tier partnerships or upper-tier S corporations. Similarly, a distributive share or pro rata share of a qualified conservation contribution would be received “indirectly” if it passes through one or more upper-tier partnerships or upper-tier S corporations.

10. Ultimate Member

Proposed § 1.170A-14(j)(3)(x) would provide that the term “ultimate member” means, with respect to any partnership or S corporation, any partner (that is not itself a partnership or S corporation) or S corporation shareholder that receives a distributive share or pro rata share, directly or indirectly, of a qualified conservation contribution. Thus, ultimate members would either be partners holding a direct interest in a partnership, which may be the contributing partnership or an upper-tier partnership, or shareholders holding a direct interest in an S corporation, which may be the contributing S corporation or an upper-tier S corporation. Proposed § 1.170A-14(j)(3)(x) would provide that upper-tier S corporations and upper-tier partnerships themselves are not considered ultimate members.

Several considerations played a role in the decision of the Treasury Department and the IRS to propose this rule that looks to the relevant basis of the ultimate members for determining whether a qualified conservation contribution will be disallowed. Although section 170(h)(7)(A) provides that the Disallowance Rule applies in tiered structures, the statutory language does not explicitly explain whether the determination of relevant basis is made with respect to partners (who may themselves be pass-through entities) and S corporation shareholders holding a direct interest in the contributing partnership or contributing S corporation, or whether the determination of relevant basis is made with respect to the ultimate members. The Disallowance Rule is meant to compare the amount of a claimed qualified conservation contribution with the equity investment made by those persons expected to claim a deduction with respect to such contribution. Because it is the ultimate members, such as individuals, estates, and C corporations (that is, non-pass-through entities), who ultimately claim a deduction for a qualified conservation contribution, the proposed regulations would require that the determination of relevant basis be made with respect to those ultimate partners and S corporation shareholders. For example, assume a contributing partnership has two partners: (1) an upper-tier S corporation, which has two individual shareholders, and (2) an upper-tier partnership, which has three partners—a C corporation, an estate, and an individual. Under these proposed regulations, relevant basis would be computed with respect to the three individuals, C corporation, and estate, and not with respect to the upper-tier S corporation or upper-tier partnership. The proposed regulations would refer to these persons as the “ultimate members.” In the case of a tiered arrangement, the use of the term “partner” to refer to such ultimate members might be confusing or inaccurate because such persons may not be partners of the contributing partnership, and in fact, may not be partners at all, if they are shareholders of an upper-tier S corporation that is itself a partner in the contributing partnership. As such, the proposed regulations use the term “member.”

The Treasury Department and the IRS considered alternatives to the ultimate member rule. One possible approach would be to determine the application of the Disallowance Rule with respect to the contributing partnership by looking only to the relevant bases of the contributing partnership's direct partners. In the example in which a contributing partnership has two partners, an upper-tier S corporation and an upper-tier partnership, the direct partners would be the upper-tier S corporation and the upper-tier partnership. The modified basis (and thus, relevant basis) of the upper-tier S corporation or upper-tier partnership could include basis attributable to shareholders or partners of the upper-tier entity that will not be expected to claim the deduction. For example, this might be the case because the contributing partnership allocates all of the qualified conservation contribution to the upper-tier S corporation. Because the Disallowance Rule is meant to compare the amount of a claimed

qualified conservation contribution with the equity investment made by those persons expected to claim a deduction with respect to such contribution, it is more consistent with the purposes of the Disallowance Rule to compute relevant basis only using the basis of those persons who are expected to claim a deduction with respect to the contribution.

Additionally, in the example earlier, if the contributing partnership's qualified conservation contribution was not disallowed by the Disallowance Rule, the upper-tier S corporation and the upper-tier partnership would each be required to determine the application of the Disallowance Rule by looking to their direct owners. Because section 170(h)(7)(B)(i) requires that relevant basis be traced to the portion of the real property with respect to which the contribution is made, the upper-tier S corporation's and upper-tier partnership's determinations would necessarily involve computations by both the upper-tier entity and the contributing partnership. Thus, in many cases, computing relevant basis only with respect to direct partners would not simplify the computations required to apply the Disallowance Rule, because it would still be necessary to carry the computations through each tier.

These proposed regulations would provide numerous examples to determine who is an ultimate member. Comments are requested on the definition of ultimate member, and whether additional examples for specific situations would be helpful.

11. Upper-Tier Partnership

Proposed § 1.170A-14(j)(3)(xi) would provide that the term “upper-tier partnership” means a partnership that receives an allocated portion.

Where appropriate, the proposed regulations would provide separate rules for contributing partnerships, contributing S corporations, upper-tier partnerships, and upper-tier S corporations. The Treasury Department and the IRS are aware that sometimes different naming conventions are used to refer to tiered partnership arrangements. For example, some may refer to the contributing partnership as the “property partnership” or “top-tier partnership,” and in fact the IRS has used that naming convention in some correspondence. That naming convention is not inherently wrong, as different practitioners refer to the “bottom” and “top” of a tiered structure differently. However, the regulations under subchapter K of chapter 1 of the Code generally would refer to the contributing partnership as the lower-tier partnership, and to a partnership that owns an interest in the contributing partnership (either directly or indirectly) as an upper-tier partnership. Accordingly, in a tiered partnership ownership structure, these proposed regulations reflect a naming convention under which the contributing partnership would be the “lower-tier partnership,” and a partnership receiving a distributive share of a qualified conservation contribution from the contributing partnership would be an “upper-tier partnership.”

12. Upper-Tier S Corporation

Proposed § 1.170A-14(j)(3)(xii) would provide that the term “upper-tier S corporation” means an S corporation that receives an allocated portion.

C. Effect of the Disallowance Rule

As noted previously, section 170(h)(7)(A) applies the Disallowance Rule to both contributing partnerships and upper-tier partnerships. Section 170(h)(7) does not explicitly address what effect the application of the Disallowance Rule to one partnership or S corporation in a tiered structure has on the other partnerships or S corporations in the tiered structure. These proposed regulations would provide that if the Disallowance Rule applies to a partnership or S corporation, then the qualified conservation contribution is a disallowed qualified conservation contribution to that entity as well as to any person receiving a distributive share or pro rata share, directly or indirectly, of that entity's disallowed qualified conservation contribution; however, the disallowance would not affect the qualified conservation contribution with respect to any lower-tier entities. In other words, if the application of the Disallowance Rule with respect to an upper-tier partnership or upper-tier S corporation results in a disallowed qualified conservation contribution, that would affect Federal income tax consequences up the chain of tiers, but not down the chain of tiers, so, for example, the contributing partnership would not be affected.

The Treasury Department and the IRS considered other approaches, such as always re-testing the application of the Disallowance Rule to an upper-tier partnership's or upper-tier S corporation's allocated portion, even when the contribution is a disallowed qualified conservation contribution with respect to the lower-tier partnership. Under this approach, if the allocated portion does not exceed 2.5 times the sum of each of the upper-tier partnership's or upper-tier S corporation's ultimate member's relevant basis, the allocated portion would be a qualified conservation contribution and not disallowed to the upper-tier partnership's non-pass-through partners or the upper-tier S corporation's shareholders, even though the contribution was a disallowed qualified conservation contribution to the non-pass-through partners of the lower-tier partnership. Allowing re-testing of contributions that have already failed the Disallowance Rule would be inconsistent with the purposes of the Disallowance Rule because it would inappropriately encourage the creation of tiered structures to allow some ultimate members to avoid the Disallowance Rule. These proposed regulations are intended to prevent avoidance of the purposes of section 170(h)(7) and ensure disallowance of deductions attributable to disallowed qualified conservation contributions. The Treasury Department and the IRS request comments on the application of the Disallowance Rule in tiered structures.

Under the authority of section 170(h)(7)(G)(ii) to issue regulations or other guidance to prevent the avoidance of the purposes of section 170(h)(7), proposed § 1.170A-14(j)(4)(i) would provide that, if a contributing partnership's or contributing S corporation's qualified conservation contribution is a disallowed qualified conservation contribution, then: (1) any upper-tier partnership's or upper-tier S corporation's allocated portion of such contribution is a disallowed qualified conservation contribution, regardless of whether such allocated portion exceeds 2.5 times the sum of each of the upper-tier partnership's or upper-tier S corporation's ultimate member's relevant basis; and (2) no person (whether holding a direct or indirect interest in such contributing partnership or contributing S corporation) may claim a deduction under any provision of the Code with respect to any amount of such disallowed qualified conservation contribution, regardless of whether that person's distributive share or pro rata share of the disallowed qualified conservation contribution exceeds 2.5 times its relevant basis. The reference to “any provision of the Code” is necessary to prevent taxpayer attempts to avoid the Disallowance Rule by claiming a deduction with respect to any amount of a qualified conservation contribution under a provision of the Code other than section 170 in cases in which no deduction is allowable under section 170 by reason of section 170(h)(7). For example, this proposed

rule would disallow a deduction under section 642(c) of the Code for a trust that is a partner in a partnership with respect to a distributive share of a disallowed qualified conservation contribution from the partnership.

Proposed § 1.170A-14(j)(4)(ii) would provide that if a contributing partnership's or contributing S corporation's qualified conservation contribution is not a disallowed qualified conservation contribution, then: (1) the distributive share or pro rata share of any ultimate member holding a direct interest in the contributing partnership or contributing S corporation is not a disallowed qualified conservation contribution; and (2) any upper-tier partnership or upper-tier S corporation that receives an allocated portion of such qualified conservation contribution must separately apply the rules of section 170(h)(7) and proposed § 1.170A-14(j) through (m) to determine whether that upper-tier partnership's or upper-tier S corporation's allocated portion is a disallowed qualified conservation contribution.

Proposed § 1.170A-14(j)(4)(iii) would provide that, if an upper-tier partnership's or upper-tier S corporation's allocated portion is a disallowed qualified conservation contribution, then: (1) any subsequent upper-tier partnership's or upper-tier S corporation's allocated portion of such allocated portion would be a disallowed qualified conservation contribution, regardless of whether the subsequent upper-tier partnership's or upper-tier S corporation's allocated portion exceeds 2.5 times the sum of each of the subsequent upper-tier partnership's or upper-tier S corporation's ultimate member's relevant basis; and (2) no person (whether holding a direct or indirect interest in that upper-tier partnership or upper-tier S corporation) would be able to claim a deduction under any provision of the Code with respect to any amount of that upper-tier partnership's or upper-tier S corporation's allocated portion, regardless of whether that person's distributive share or pro rata share of the allocated portion exceeds 2.5 times its relevant basis. Similar to proposed § 1.170A-14(j)(4)(i), proposed § 1.170A-14(j)(4)(iii) would be issued under the authority of section 170(h)(7)(G)(ii) to issue regulations or other guidance to prevent the avoidance of the purposes of section 170(h)(7). However, this proposed rule would not affect the application of proposed § 1.170A-14(j) through (m) to another partner of the contributing partnership; for example, if the qualified conservation contribution is not a disallowed qualified conservation contribution with respect to the contributing partnership, then the distributive share of such contribution of an ultimate member holding a direct interest in the contributing partnership is not a disallowed qualified conservation contribution, notwithstanding that the qualified conservation contribution is a disallowed qualified conservation contribution with respect to one or more upper-tier partnerships or upper-tier S corporations.

Proposed § 1.170A-14(j)(4)(iv) would provide that, if an upper-tier partnership's or upper-tier S corporation's allocated portion is not a disallowed qualified conservation contribution, then: (1) the distributive share or pro rata share of such allocated portion of any ultimate member holding a direct interest in the upper-tier partnership or upper-tier S corporation is not a disallowed qualified conservation contribution; and (2) any subsequent upper-tier partnership or upper-tier S corporation that receives an allocated portion of such allocated portion must separately apply the rules of section 170(h)(7) and proposed § 1.170A-14(j) through (m) to determine whether that subsequent upper-tier partnership's or upper-tier S corporation's allocated portion is treated as a disallowed qualified conservation contribution.

The proposed regulations contain examples illustrating the rules with respect to tiers of entities. The Treasury Department and the IRS request comments on whether additional examples would be helpful.

D. No Inference

The Treasury Department and the IRS are aware that, even though section 605(c)(2) of the SECURE 2.0 Act plainly states that no inference is intended as to any contribution for which a deduction is not disallowed by reason of section 170(h)(7), some practitioners have taken the position that section 170(h)(7) operates as a “safe harbor.” According to these practitioners, a qualified conservation contribution that is not disallowed by the Disallowance Rule is somehow immune to a challenge on other grounds, including failure to comply with other rules under section 170 and overvaluation of the contribution. Such a position is baseless and contradicted by the statutory language.

To clarify this issue, proposed § 1.170A-14(j)(5) would provide that there is no presumption that a qualified conservation contribution that is not a disallowed qualified conservation contribution is compliant with section 170, any other section of the Code, the regulations, or any other guidance thereunder. It would also provide that compliance with section 170(h)(7) and proposed § 1.170A-14(j) through (n) is not a safe harbor for purposes of any other provision of law, including the other requirements of section 170 and the value of the contribution. Such transactions are subject to adjustment or disallowance for any other reason, including failure to satisfy the requirements of section 170 and the overvaluation of the contribution; for example, failure to properly execute Form 8283,
Noncash Charitable Contributions,
violation of the partnership anti-abuse rule of § 1.701-2, lack of economic substance, or other rules or judicial doctrines. In addition, compliance with proposed § 1.170A-14(j) through (n) would not preclude the application of any penalty, including penalties for valuation misstatement, negligence, and fraud. Proposed § 1.170A-14(j)(5) would also provide that taxpayers who engage in such transactions may be required to disclose under § 1.6011-4 the transactions as listed transactions.

E. Determination of Relevant Basis

Consistent with section 170(h)(7)(B)(i), proposed § 1.170A-14(k) would provide that, for purposes of § 1.170A-14, the term “relevant basis” means, with respect to any ultimate member, the portion of such ultimate member's modified basis (as defined in proposed § 1.170A-14(l)) that is allocable (under the rules of proposed § 1.170A-14(m)) to the portion of the real property with respect to which the qualified conservation contribution is made.

1. Modified Basis

Proposed § 1.170A-14(l)(1) would provide that, in the case of an ultimate member holding a direct interest in a partnership, the ultimate member's modified basis is determined by such partnership immediately before the qualified conservation contribution is made in the manner described in § 1.170A-14(l)(2). In the case of an ultimate member holding a direct interest in an S corporation, the ultimate member's modified basis would be determined by such S corporation in the manner described in § 1.170A-14(l)(3).

a. Modified Basis of Ultimate Members That Are Partners

Consistent with section 170(h)(7)(B)(ii), the proposed regulations would provide rules that are designed to determine a partner's

modified basis immediately prior to the qualified conservation contribution. Without additional guidance under section 706, there may be situations in which the contribution is allocated to partners that did not hold an interest at the time of the qualified conservation contribution. Such partners would not have any bases in their partnership interests immediately before the contribution, and thus, without additional rules, their modified bases and relevant bases would be zero. As discussed later in this preamble, these proposed regulations would contain rules under section 706 that would treat a qualified conservation contribution as an extraordinary item under § 1.706-4(e) that must be allocated only to partners holding an interest in the partnership at the time of the contribution. Proposed rules under § 1.706-3 would ensure that only partners holding an interest in an upper-tier partnership at the time of the contribution would receive a distributive share of an allocated portion. Thus, all ultimate members who are partners would be partners at the time of day the contribution is made. In other words, for a partner to be an ultimate member, the partner must have been a partner at the time of day the contribution is made and must have been allocated a distributive share of that contribution. These proposed rules are intended to facilitate the computation of modified basis immediately before the contribution, consistent with section 170(h)(7)(B)(ii)(I).

The proposed regulations would provide a process for determining a partner's modified basis. Proposed § 1.170A-14(l)(2)(i) would provide that, for purposes of § 1.170A-14, the term “modified basis” means, with respect to any ultimate member that is a direct partner in either a contributing partnership or an upper-tier partnership, such ultimate member's adjusted basis in its interest in the partnership in which the ultimate member holds a direct interest as of the beginning of the first day of the partnership's taxable year in which the qualified conservation contribution is made with adjustments as determined under proposed § 1.170A-14(l)(2)(ii) through (v). However, if the ultimate member was not a partner as of the beginning of the first day of the partnership's taxable year, then the term “modified basis” would mean such ultimate member's adjusted basis in its interest in the partnership immediately after the transaction that resulted in the ultimate member becoming a partner with adjustments as determined under proposed § 1.170A-14(l)(2)(ii) through (v). The Treasury Department and the IRS considered alternatives to this rule, including simply requiring that “adjusted basis” be computed immediately prior to the contribution. However, adjusted basis is typically computed as of the beginning of a taxable year, and it may be unclear to taxpayers how to compute adjusted basis as of another time during the year. Current regulations generally do not require partners to compute their adjusted bases in their partnership interests as of the time events, such as the making of a qualified conservation contribution, occur. Accordingly, these proposed regulations would start with a calculation of adjusted basis that partners are familiar with computing, and then make adjustments to arrive at an amount that reflects the partner's modified basis immediately before the contribution.

Proposed § 1.170A-14(l)(2)(ii) through (v) would provide four adjustments that must be made to a partner's adjusted basis to arrive at modified basis. These adjustments would be required to be made in the order in which they are listed. First, proposed § 1.170A-14(l)(2)(ii) would provide that the computation of modified basis must start with the ultimate member's adjusted basis under proposed § 1.170A-14(l)(2)(i) and then reflect an increase for any contributions made by the ultimate member to the partnership during the portion of the year commencing with the beginning of the taxable year of the partnership and ending immediately prior to the time of day at which the qualified conservation contribution is made as provided in section 722 of the Code.

Second, proposed § 1.170A-14(l)(2)(iii) would provide that the amount determined under proposed § 1.170A-14(l)(2)(ii) must be adjusted, as provided in section 705 of the Code, by the ultimate member's hypothetical distributive share of partnership items attributable to the portion of the year commencing with the beginning of the taxable year of the partnership and ending immediately prior to the time of day at which the qualified conservation contribution is made. For example, if a calendar-year partnership makes a qualified conservation contribution at 9:17 a.m. on November 19 of Year 1, then the hypothetical distributive share would be required to be made based on the partnership items attributable to the period between the beginning of the day on January 1 Year 1 and 9:16 a.m. on November 19 Year 1. In making this determination, the partnership would be required to apply the rules of § 1.706-4 and apply a hypothetical interim closing method to allocate the partnership's items attributable to the portion of the year commencing with the beginning of the taxable year of the partnership and ending immediately prior to the time of day at which the qualified conservation contribution is made. Proposed § 1.170A-14(l)(2)(iii) would provide that the partnership cannot apply any convention in § 1.706-4(c) to the hypothetical determination of the partners' distributive shares, but rather must perform the calculation as though the determination occurred immediately prior to the time of day at which the qualified conservation contribution is made. Proposed § 1.170A-14(l)(2)(iii) would clarify that this hypothetical determination of the partners' distributive shares is only for purposes of calculating modified basis. Proposed § 1.170A-14(l)(2)(iii) would also make clear that proposed § 1.170A-14(l) does not require the partnership to use the interim closing method with respect to the determination of its partners' actual distributive shares for the taxable year in which the qualified conservation contribution is made or otherwise.
See
section 706(d) and the regulations thereunder for the permissible methods that may be used in the determination of the partners' distributive shares for a partnership taxable year in which there is a variation in a partner's interest in the partnership. As described later this preamble, proposed §§ 1.706-3(a) and 1.706-4(e)(2)(ix) would provide special rules for the allocation of qualified conservation contributions.

The Treasury Department and the IRS considered using the partners' actual distributive shares, determined as of the time of the contribution. In the case of a partnership using the proration method, however, such an approach would result in the partners' modified bases reflecting a portion of partnership items earned or incurred by the partnership after the time of the contribution, and thus would be inconsistent with the requirement in section 170(h)(7)(B)(ii)(I) that partners' modified bases be determined immediately before the contribution. The Treasury Department and the IRS request comments on the approach taken in the proposed regulations to determine the partners' distributive shares of partnership items attributable to the portion of the year commencing with the beginning of the taxable year of the partnership and ending immediately prior to the time of day at which the

qualified conservation contribution is made.

Third, proposed § 1.170A-14(l)(2)(iv) would provide that the amount determined under proposed § 1.170A-14(l)(2)(iii) must be reduced (but not below zero) by any distributions made by the partnership to the ultimate member during the portion of the year commencing with the beginning of the taxable year of the partnership and ending immediately prior to the time of day at which the qualified conservation contribution is made as provided in section 733 of the Code.

Fourth, consistent with section 170(h)(7)(B)(ii)(II), proposed § 1.170A-14(l)(2)(v) would provide that the amount determined under proposed § 1.170A-14(l)(2)(iv) must be reduced by the full amount of the ultimate member's share of § 1.752-1 liabilities of any partnership (including a lower-tier partnership). The remaining amount would be such ultimate member's modified basis. Thus, under the proposed regulations, an ultimate member's modified basis may be less than zero. Under the formulas for the determination of relevant basis discussed later in this preamble, a negative modified basis will result in a negative relevant basis. Because the application of the Disallowance Rule is based on the sum of each ultimate member's relevant basis, if one ultimate member's relevant basis is negative, it will be added to all other ultimate members' relevant bases, and the sum may be a positive or negative number.

b. Modified Basis of Ultimate Members That Are Shareholders in an S Corporation

Unlike the rules for partnerships discussed previously, S corporations do not have extraordinary items that must be allocated only to shareholders as of the time of day the item occurs. Instead, section 1377 of the Code and existing § 1.1377-1 generally require pro rata allocations. Section 1.1377-1(a) provides that each shareholder's pro rata share of any S corporation item described in section 1366(a) of the Code for any taxable year is the sum of the amounts determined with respect to the shareholder by assigning an equal portion of the item to each day of the S corporation's taxable year, and then dividing that portion pro rata among the shares outstanding on that day. If a shareholder disposes of its entire interest in an S corporation, § 1.1377-1(b) allows the S corporation to make a terminating election, under which the S corporation will determine the terminating shareholder's share as though the S corporation's taxable year closed on the day of the termination. However, there is no extraordinary item rule for S corporations similar to § 1.706-4(e). As such, it may be the case that an S corporation allocates a portion of a qualified conservation contribution to someone that was not a shareholder at the time of the contribution, but that shareholder would still be treated as an ultimate member because the shareholder received a pro rata share of the qualified conservation contribution.

As described previously, the rules for determining a partner's modified basis start with the partner's adjusted basis at the start of the partnership's taxable year and work forward to determine modified basis immediately before the contribution. However, the Treasury Department and the IRS are concerned that such an approach is not appropriate for S corporation shareholders, as it could be unnecessarily burdensome and, in some cases, impossible to determine each shareholder's modified basis immediately prior to the qualified conservation contribution (because some ultimate members may not be shareholders at the time of the contribution). To provide an administrable standard consistent with the purposes of section 170(h)(7), these proposed regulations would require the computation of an S corporation shareholder's modified basis under an approach that is similar in purpose to the approach for partners but different in application.

Proposed § 1.170A-14(l)(3)(i) would provide that, for purposes of § 1.170A-14, the term “modified basis” means, with respect to any ultimate member that is a shareholder of either a contributing S corporation or an upper-tier S corporation, such ultimate member's adjusted basis in its shares in the S corporation as of the end of the S corporation's taxable year in which the qualified conservation contribution is made with adjustments as determined under proposed § 1.170A-14(l)(3)(ii) and (iii). However, if the ultimate member was not a shareholder at the end of the S corporation's taxable year in which the qualified conservation contribution is made, then the term “modified basis” would mean such ultimate member's adjusted basis in its shares in the S corporation immediately prior to the transaction that terminated its interest in the S corporation with adjustments as determined under proposed § 1.170A-14(l)(3)(ii) and (iii).

The Treasury Department and the IRS considered several alternatives to this rule. One method would be to require a determination of a portion of modified basis for every day during the S corporation's taxable year, because S corporations generally allocate the contribution on a pro rata basis among the shareholders on each day of the taxable year. These proposed regulations do not take that approach because the Treasury Department and the IRS are concerned that such an approach, although technically accurate and consistent with the purposes of section 170(h)(7), would be too burdensome for taxpayers and difficult for the IRS to administer. The Treasury Department and the IRS also considered using the shareholders' adjusted bases as of the beginning of the S corporation's taxable year (rather than as of the end of the year). However, because qualified conservation contributions are typically made in the second half of the year, especially in syndicated transactions, the Treasury Department and the IRS determined that such an approach would be less accurate than using the shareholders' adjusted bases as of the end of the year (or a shareholder's adjusted basis immediately prior to the transaction that terminated their interest in the S corporation).

Proposed § 1.170A-14(l)(3)(i) would also clarify that modified basis does not include the ultimate member's adjusted basis of any indebtedness of the S corporation to the ultimate member.
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1
As described previously, section 170(h)(7)(B)(ii)(II) provides that the determination of modified basis is to be made without regard to section 752. However, the Code does not contain a rule substantially similar to section 752 for S corporations. Unlike a partner's basis in the partner's interest in the partnership, an S corporation shareholder's basis in stock of the S corporation does not include any share of the S corporation's liabilities. Under section 1367(b)(2)(A) of the Code and § 1.1367-2(b), if an S corporation shareholder's pro rata share of the S corporation's losses, deductions, noncapital, nondeductible expenses, and certain oil and gas depletion deductions exceed the shareholder's stock basis, then these items may reduce the shareholder's basis in indebtedness owed to them by the S corporation (but not below zero). Under section 1367(b)(2)(B) and § 1.1367-2(c), if the basis in indebtedness has been so reduced, then any future net increase must be applied to restore such reduction in indebtedness basis before any of it may be used to increase the shareholder's basis in its stock of the S corporation.

Proposed § 1.170A-14(l)(3)(ii) and (iii) would provide two adjustments that must be made to arrive at modified basis. These adjustments would be required to be made in the order in which they are listed. First, proposed § 1.170A-14(l)(3)(ii) would provide that the computation of modified basis must start with the ultimate member's adjusted basis under proposed § 1.170A-14(l)(3)(i) and then must reflect an increase for the extent to which the adjusted basis reflects a reduction as a result of the qualified

conservation contribution. Thus, the ultimate member's modified basis with respect to a qualified conservation contribution would not reflect any reduction for the ultimate member's pro rata share of the S corporation's basis in the conservation easement or other property contributed in the qualified conservation contribution. This adjustment in proposed § 1.170A-14(l)(3)(ii) would be made because it would not be appropriate or consistent with section 170(h)(7)(B)(ii)(I) for modified basis, and thus relevant basis, to reflect a reduction for the very contribution that is being analyzed under the Disallowance Rule as such an approach might result in deductions being inappropriately disallowed by the Disallowance Rule.

Second, proposed § 1.170A-14(l)(3)(iii) would provide that the amount determined under proposed § 1.170A-14(l)(3)(ii) must be multiplied by the number of days during the S corporation's taxable year in which the ultimate member was a shareholder and divided by the total number of days during the S corporation's taxable year. The resulting amount would be such ultimate member's modified basis. Inappropriate double counting of relevant basis might occur unless the proposed regulations provide this rule. For example, assume individual A owns a portion of the outstanding shares of an S corporation. In early July, A sells all its shares to B. In December, the S corporation makes a qualified conservation contribution. Absent a terminating election under § 1.1377-1(b), the S corporation would allocate some of the qualified conservation contribution to each of A and B. Unless A's and B's modified bases (and thus, their relevant bases) are adjusted to reflect that each was a shareholder for approximately half of the year, the S corporation's computation of the sum of each of its ultimate member's relevant basis would be inappropriately overstated. The Treasury Department and the IRS request comments on whether there are certain situations in which the divisor should be less than the full number of days in the S corporation's taxable year. In particular, the Treasury Department and the IRS request comments on whether, and how, elections under §§ 1.1368-1(g)(2) and 1.1377-1(b) should result in the divisor being less than the full number of days in the S corporation's taxable year. It would be particularly helpful for commenters to address situations in which elections under §§ 1.1368-1(g)(2) and 1.1377-1(b) affect some, but not all, of the shareholders.

Section 170(h)(7)(B)(ii)(III) provides authority for the Secretary to provide for other adjustments in the computation of modified basis. The Treasury Department and the IRS request comments on whether any additional adjustments to arrive at modified basis would be appropriate.

The proposed regulations also contain examples illustrating the determination of modified basis. Comments are requested on whether it would be helpful to add examples with other factual scenarios.

2. Allocation of Modified Basis and Determination of Relevant Basis

Proposed § 1.170A-14(m) would provide rules for determining the portion of an ultimate member's modified basis that is allocable to the portion of the real property with respect to which the contribution is made, which is the final step in the determination of relevant basis. Section 170(h)(7)(B)(i) provides that the allocation is made under rules similar to the rules of section 755. Section 755 provides rules for allocating special basis adjustments to partnership property resulting from partnership distributions or transfers of partnership interests, such as adjustments under section 734(b) of the Code and adjustments under section 743(b) of the Code.

Section 755(a) generally provides that any increase or decrease in the adjusted basis of partnership property under section 734(b) (relating to the optional adjustment to the basis of undistributed partnership property) or section 743(b) (relating to the optional adjustment to the basis of partnership property in the case of a transfer of an interest in a partnership) is allocated (1) in a manner that reduces the difference between the fair market value and the adjusted basis of partnership properties, or (2) in any other manner permitted by regulations. The regulations under section 755 provide rules for performing these allocations. Those rules can be complex and involve several different methods for allocating basis adjustments among the partnership's properties, including:

(1) Allocating in a manner that reduces the difference between the fair market value and the adjusted basis of partnership properties.
See
§ 1.755-1(b)(2)(i) and (b)(3).

(2) Allocating in proportion to the transferee's share of the amount that would be realized by the partnership upon the hypothetical sale of each property.
See
§ 1.755-1(b)(5)(iii)(A).

(3) Allocating in proportion to the fair market values of the partnership's properties.
See
§ 1.755-1(c)(2)(i).

(4) Allocating in proportion to the partnership's adjusted bases in its properties.
See
§ 1.755-1(c)(2)(ii).

(5) Allocating in proportion to the partner's share of the adjusted bases in the partnership's properties.
See
§ 1.755-1(b)(5)(iii)(B).

In considering which of these allocation rules would be most appropriate to determine relevant basis, the Treasury Department and the IRS considered the special basis adjustment and loss limitation rules for charitable contributions. Those rules look to a partner's or shareholder's share of the partnership's or S corporation's basis in the contributed property.

Generally, section 705(a)(2) provides that the adjusted basis of a partner's interest in a partnership is decreased (but not below zero) by distributions by the partnership and by the sum of the partner's distributive share for the taxable year and prior taxable years of (1) losses of the partnership, and (2) expenditures of the partnership not deductible in computing its taxable income and not properly chargeable to capital account. Generally, when a partnership makes a charitable contribution, the partners are not required to reduce their adjusted bases in their partnership interests by the fair market value of the contribution. Instead, Revenue Ruling 96-11, 1996-1 C.B. 140, provides that after a partnership makes a charitable contribution of property, the basis of each partner's interest in the partnership is decreased (but not below zero) by the partner's share of the partnership's basis in the property contributed. Revenue Ruling 96-11 explains that reducing the partners' bases in their partnership interests by their respective shares of the permanent decrease in the partnership's basis in its properties preserves the intended benefit of providing a deduction (in circumstances not under section 170(e)) for the fair market value of appreciated property without recognition of the appreciation. In contrast, reducing the partners' bases in their partnership interests by the fair market value of the contributed property would subsequently cause the partners to recognize gain (or a reduced loss), for example, upon a disposition of their partnership interests, attributable to the unrecognized appreciation in the contributed property at the time of the contribution.

The partnership loss limitation rules in section 704(d) of the Code have a similar rule for charitable contributions. Generally, section 704(d)(1) provides that a partner's distributive share of partnership loss is allowed only to the

extent such partner's adjusted basis in its partnership interest at the end of the partnership year in which such loss occurred. Section 704(d)(3)(A) provides, in part, that in determining the amount of any loss under section 704(d)(1), the partner's distributive share of charitable contributions as defined in section 170(c) must be taken into account. However, section 704(d)(3)(B) provides that, in the case of a charitable contribution of property whose fair market value exceeds its adjusted basis, section 704(d)(3)(A) does not apply to the extent of the partner's distributive share of such excess.

The rules for S corporations also look to the shareholder's share of the S corporation's basis in the contributed property. Section 1367(a)(2)(B) of the Code provides that the basis of each shareholder's stock is reduced by the items of loss and deduction described in section 1366(a)(1)(A). However, the second sentence of section 1367(a)(2) provides that the decrease in basis under section 1367(a)(2)(B) by reason of a charitable contribution (as defined in section 170(c)) of property is the amount equal to the shareholder's pro rata share of the adjusted basis of such property.
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2
Whether a qualified conservation contribution is a disallowed qualified conservation contribution has no effect on the application of sections 705 and 1367 to the contribution. These basis reductions remain required regardless of whether a qualified conservation contribution is a disallowed qualified conservation contribution.

Generally, section 1366(d)(1) provides that the aggregate amount of losses and deductions taken into account by a shareholder under section 1366(a) for any taxable year cannot exceed the sum of (1) the adjusted basis of the shareholder's stock in the S corporation, and (2) the shareholder's adjusted basis of any indebtedness of the S corporation to the shareholder. However, section 1366(d)(4) provides that, in the case of any charitable contribution of property to which the second sentence of section 1367(a)(2) applies, section 1366(d)(1) does not apply to the extent of the excess (if any) of (1) the shareholder's pro rata share of such contribution, over (2) the shareholder's pro rata share of the adjusted basis of such property.
See also
Rev. Rul. 2008-16, 2008-1 C.B. 585.

Therefore, generally partnerships and S corporations making charitable contributions are already required to track each partner's and shareholder's share of the entity's basis in the contributed property. And as noted previously, in certain circumstances the rules under section 755 also look to the partner's share of the partnership's basis in its properties. Accordingly, as described in this section of the preamble, these proposed regulations would require the allocation of an ultimate member's modified basis to the portion of the real property with respect to which the qualified conservation contribution is made to be based on the ultimate member's share of the entity's bases in its properties. This provides an administrable standard consistent with the purposes of section 170(h)(7).

The Treasury Department and the IRS considered alternatives to this rule. In particular, the Treasury Department and the IRS considered simply cross-referencing the rules under section 755. Under that alternative approach, the amount of each partner's modified basis would be treated for purposes of the computation of relevant basis as a special basis adjustment under section 734(b) or section 743(b); relevant basis would be the portion of modified basis that would be allocated under the rules of section 755 to the portion of the real property with respect to which the contribution was made. Such an approach would be less consistent with the purposes of the Disallowance Rule. As noted previously, basis allocations under section 755 are sometimes made in a way to reduce or eliminate built-in gain or loss in partnership property. The relevant basis rule of section 170(h)(7) is designed to determine the portion of a partner's modified basis that is allocable to the portion of the real property with respect to which the contribution is made, which is a broader and, generally, different concept than determining the partner's share of built-in gain or loss in that property. The approach in the proposed regulations is similar to the rules of section 755 and consistent with the rule of section 170(h)(7)(B)(i). The Treasury Department and the IRS request comments on whether another acceptable allocation approach would be easier or more administrable.

Proposed § 1.170A-14(m)(1) would provide that the allocation of an ultimate member's modified basis to the portion of the real property with respect to which the qualified conservation contribution is made must be made in accordance with proposed § 1.170A-14(m). Rules for allocating an ultimate member's modified basis in a contributing partnership would be provided in proposed § 1.170A-14(m)(2). Rules for allocating an ultimate member's modified basis in a contributing S corporation would be provided in proposed § 1.170A-14(m)(3). Rules for allocating an ultimate member's modified basis in an upper-tier partnership would be provided in proposed § 1.170A-14(m)(4). Rules for allocating an ultimate member's modified basis in an upper-tier S corporation would be provided in proposed § 1.170A-14(m)(5). Records would be required to be kept in accordance with proposed § 1.170A-14(m)(6).

a. Determination of Relevant Basis for an Ultimate Member Holding a Direct Interest in a Contributing Partnership

Proposed § 1.170A-14(m)(2)(i) through (iii) would provide a narrative rule applicable in the case of an ultimate member holding a direct interest in a contributing partnership and would provide that a contributing partnership must determine each such ultimate member's relevant basis as provided therein. Relevant basis would equal each ultimate member's modified basis as determined under proposed § 1.170A-14(l)(2) multiplied by a fraction (1) the numerator of which is the ultimate member's share of the contributing partnership's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made as determined under proposed § 1.170A-14(m)(2)(ii); and (2) the denominator of which is the ultimate member's portion of the adjusted basis in all the contributing partnership's properties as determined under proposed § 1.170A-14(m)(2)(iii).

The Treasury Department and the IRS note that this numerator determines the ultimate member's share of the contributing partnership's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made, which is what is required by the statute, but may be different than the ultimate member's share of the contributing partnership's adjusted basis in the contributed property. As noted previously, section 704(d) and Revenue Ruling 96-11 require a partner's basis in its interest in the partnership to be decreased (but not below zero) by the partner's share of the partnership's basis in the contributed property. For example, assume a partnership owns 100 acres of real property, and grants a conservation easement that is a qualified conservation contribution on 60 of those acres. Assume the partnership's adjusted basis in the 100 acres is $100,000, its adjusted basis in the 60 acres is $60,000, and its adjusted basis in the conservation easement itself is $45,000. Section 705(a)(2)(B) and Revenue Ruling 96-11 would require each partner's basis in its interest in the partnership to be decreased (but not below zero) by the partner's share of the partnership's $45,000 basis in the easement. On the other hand, the

computation of each ultimate member's relevant basis would look to the ultimate member's share of the partnership's $60,000 basis in the 60 acres (the portion of the real property with respect to which the qualified conservation contribution was made). As described in the following paragraphs, these proposed regulations would provide computational rules for determining an ultimate member's share of the contributing partnership's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made. The Treasury Department and the IRS request comments on whether these computations generally align with the methods used by partnerships to determine each partner's share of the partnership's basis in the contributed property for purposes of sections 704(d) and 705(a)(2)(B) and Revenue Ruling 96-11. In terms of the example in this paragraph, the Treasury Department and the IRS request comments on whether the rules in the proposed regulations for determining each ultimate member's share of the partnership's $60,000 basis in the 60 acres align with the way in which the partnership would determine each partner's share of the partnership's $45,000 basis in the conservation easement for purposes of applying sections 704(d) and 705(a)(2)(B) and Revenue Ruling 96-11.

Proposed § 1.170A-14(m)(2)(ii) would provide that, for purposes of proposed § 1.170A-14(m), an ultimate member's share of the contributing partnership's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made equals the contributing partnership's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made multiplied by a fraction (1) the numerator of which is the ultimate member's distributive share of the qualified conservation contribution; and (2) the denominator of which is the total amount of the contributing partnership's qualified conservation contribution.

The Treasury Department and the IRS considered several alternatives to this rule, including determining the ultimate member's share of the contributing partnership's adjusted basis in the property based on the ultimate member's share of gain, loss, and cash distributions attributable to the property. However, there may be situations in which the allocation of a qualified conservation contribution does not match the partners' shares of gain, loss, or cash distributions with respect to the property. Accordingly, the Treasury Department and the IRS determined that such an approach would be less accurate. In addition, the proposed rule would be less burdensome for taxpayers and more easily administrable for the IRS because it would be based on the partnership's actual allocation of the contribution, rather than on a hypothetical sale of the property.

Proposed § 1.170A-14(m)(2)(iii) would provide that, for purposes of proposed § 1.170A-14(m), an ultimate member's portion of the adjusted basis in all the contributing partnership's properties is equal to the sum of: (1) the ultimate member's share of the contributing partnership's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made as determined under proposed § 1.170A-14(m)(2)(ii), plus (2) the ultimate member's portion of the adjusted basis in all the contributing partnership's properties other than the portion of the real property with respect to which the qualified conservation contribution is made. Proposed § 1.170A-14(m)(2)(iii) would provide that, to determine the ultimate member's share of the adjusted basis in all the contributing partnership's properties, the contributing partnership must apportion among its partners in accordance with their interests in the partnership under section 704(b) its adjusted basis in each of its properties (except the portion of the real property with respect to which the qualified conservation contribution is made), using the adjusted bases immediately before the qualified conservation contribution, without duplication or omission of any property, and by treating the adjusted basis in each property as not less than zero.

The Treasury Department and the IRS considered alternatives to this rule, including determining the ultimate member's portion of the partnership's adjusted basis in all its properties in accordance with § 1.743-1(d), which provides for the determination of a transferee partner's share of the partnership's adjusted basis of its property for purposes of computing special basis adjustments under section 743(b). The Treasury Department and the IRS also considered determining the ultimate member's portion of the partnership's adjusted basis in all its properties in proportion to the ultimate member's share of the built-in gain in each of the partnership's properties. The Treasury Department and the IRS determined that these approaches would be more complex and could reach results that are less accurate for purposes of the Disallowance Rule. In particular, as previously mentioned, the partnership's allocation of the qualified conservation contribution might differ from the way that the partnership would allocate gain and loss and make cash distributions with respect to the contributed property. Moreover, these approaches would require the partnership to obtain a valuation of each of its properties at the time of the qualified conservation contribution. The Treasury Department and the IRS also considered an approach under which each ultimate member's portion of the partnership's adjusted basis in all its properties would be determined in proportion to the ultimate member's share of the qualified conservation contribution. Although such an approach would be simpler than using the partners' interests in the partnership, it would be less accurate. The Treasury Department and the IRS also considered an approach based on section 704(b) capital accounts. However, not all partnerships use the section 704(b) capital account safe harbor, and such an approach would also require a revaluation of partnership properties as of the time of the contribution. The Treasury Department and the IRS also considered a rule based on how the partnership would allocate depreciation from the properties, similar to the rule in § 1.199A-2(a)(3)(ii). However, such a rule would not address property that is not depreciable. The Treasury Department and the IRS request comments on these proposed rules and alternatives.

Proposed § 1.170A-14(m)(2)(iv) would provide a formulaic version of the narrative rules in proposed § 1.170A-14(m)(2)(i) through (iii).

b. Determination of Relevant Basis for an Ultimate Member Holding a Direct Interest in a Contributing S Corporation

Proposed § 1.170A-14(m)(3)(i) would provide a narrative rule for the determination of relevant basis for an ultimate member holding a direct interest in a contributing S corporation. It would provide that a contributing S corporation must determine each such ultimate member's relevant basis as provided therein. Relevant basis would equal each ultimate member's modified basis as determined under proposed § 1.170A-14(l)(3) multiplied by a fraction (1) the numerator of which is the ultimate member's pro rata portion of the contributing S corporation's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made; and (2) the denominator of which is the ultimate member's pro rata portion of the adjusted basis in all the

contributing S corporation's properties (including the portion of the real property with respect to which the qualified conservation contribution is made). The Treasury Department and the IRS request comments on whether this rule is sufficiently clear, and whether additional rules are needed regarding the time at which the pro rata portions of bases are determined. For example, the regulations could provide that these determinations are made as of the time of the qualified conservation contribution; however, in the event that an ultimate member is not a shareholder at that time, it would be unclear when the determination is to be made.

Proposed § 1.170A-14(m)(3)(ii) would provide a formulaic version of the narrative rules in proposed § 1.170A-14(m)(3)(i).

c. Determination of Relevant Basis for an Ultimate Member Holding a Direct Interest in an Upper-Tier Partnership

Proposed § 1.170A-14(m)(4) would provide rules for determining the relevant basis of an ultimate member holding a direct interest in an upper-tier partnership. Proposed § 1.170A-14(m)(4)(i) would provide that each such ultimate member's modified basis must be traced through all upper-tier partnerships to the contributing partnership, and the contributing partnership must determine the relevant basis. This would involve a multi-step process under which, beginning with the upper-tier partnership in which the ultimate member holds a direct interest, each upper-tier partnership would be required to perform calculations, and then finally the contributing partnership would be required to use those calculations to compute the ultimate member's relevant basis. For simplicity, proposed § 1.170A-14(m)(4) would describe a situation in which there are two tiers of partnerships—a contributing partnership and an upper-tier partnership. Proposed § 1.170A-14(m)(4)(i) would provide that, in a situation involving more tiers, each partnership must apply the rules and principles of proposed § 1.170A-14(m)(4) iteratively to determine relevant basis. In a tiered structure, the determination of relevant basis should reflect the basis of the ultimate members that intend to claim a portion of the deduction and thus, cannot be done without computations at the level of each entity. The Treasury Department and the IRS request comments on whether, and how, these rules can be simplified, and whether any additional rules are necessary to prevent the avoidance of the Disallowance Rule in tiered structures.

Proposed § 1.170A-14(m)(4)(ii)(A) would provide a narrative rule for the upper-tier partnership. It would provide that the upper-tier partnership must determine the portion of each ultimate member's modified basis that is allocable to the upper-tier partnership's interest in the partnership in which it holds a direct interest (in a situation involving only two tiers of partnerships, that would be the contributing partnership). This proposed regulation would require this determination to be made in accordance with the principles of proposed § 1.170A-14(m)(2), and the formula provided in proposed § 1.170A-14(m)(4)(ii)(B). In other words, the formula provided in proposed § 1.170A-14(m)(4)(ii)(B) would be similar to the formula provided in proposed § 1.170A-14(m)(2)(iv), except that, instead of determining the portion of modified basis that is allocable to the portion of the real property with respect to which the qualified conservation contribution is made, the formula in proposed § 1.170A-14(m)(4)(ii)(B) would determine the portion of modified basis that is allocable to the upper-tier partnership's interest in the next lower-tier partnership. As explained in proposed § 1.170A-14(m)(4)(iii), the contributing partnership then would be required to use the amount determined as the result of the formula in proposed § 1.170A-14(m)(4)(ii)(B) in another set of computations that would determine the portion of modified basis that is allocable to the portion of the real property with respect to which the qualified conservation contribution is made.

Proposed § 1.170A-14(m)(4)(ii)(B) would provide that the rule of proposed § 1.170A-14(m)(4)(ii) is also expressed in the following formula:
3

3
Under the order of operations for mathematical computations, operations contained in parenthesis (such as the addition of J and U) are performed before the rest of the equation.

G = M × (U ÷ (J + U))

Where:

G = The portion of the ultimate member's modified basis that is allocable to the upper-tier partnership's interest in the contributing partnership.

M = Modified basis as determined under proposed § 1.170A-14(l).

J = Ultimate member's portion of the adjusted basis in all the upper-tier partnership's properties (other than the upper-tier partnership's interest in the contributing partnership), determined by apportioning among the partners of the upper-tier partnership in accordance with their interests in the partnership under section 704(b) its adjusted basis in each of its properties (other than the upper-tier partnership's interest in the contributing partnership), using the adjusted bases immediately before the qualified conservation contribution, without duplication or omission of any property, and by treating the adjusted basis in each property as not less than zero.

U = Ultimate member's share of the upper-tier partnership's adjusted basis in its interest in the contributing partnership, determined according to the following formula: H × (B ÷ K).

H = Upper-tier partnership's adjusted basis in its interest in the contributing partnership.

B = Ultimate member's distributive share of the qualified conservation contribution.

K = Upper-tier partnership's allocated portion of the qualified conservation contribution.

After this formula is computed, then the contributing partnership must perform computations using the amount determined for item “G” to determine relevant basis. Proposed § 1.170A-14(m)(4)(iii)(A) would provide a narrative rule for the contributing partnership to complete this second step. It would provide that the contributing partnership must determine the portion of the amount determined under proposed § 1.170A-14(m)(4)(ii) with respect to each ultimate member that is allocable to the portion of the real property with respect to which the qualified conservation contribution is made. The proposed regulations would require this determination to be made in accordance with the principles of proposed § 1.170A-14(m)(2), and the formula provided in proposed § 1.170A-14(m)(4)(iii)(B).

Proposed § 1.170A-14(m)(4)(iii)(B) would provide that the rule of proposed § 1.170A-14(m)(4)(iii) is also expressed in the following formula:

R = G × (V ÷ (L + V))

Where:

R = Relevant basis.

G = Amount determined with respect to item G as described previously under proposed § 1.170A-14(m)(4)(ii)(B).

L = Upper-tier partnership's portion of adjusted basis in all the contributing partnership's properties (other than the portion of the real property with respect to which the qualified conservation contribution is made), determined by apportioning among the partners of the contributing partnership in accordance with their interests in the partnership under section 704(b) its adjusted basis in each of its properties (except the portion of the real property with respect to which the qualified conservation contribution is made), using the adjusted bases immediately before the qualified conservation contribution, without duplication or omission of any property, and by treating the adjusted basis in each property as not less than zero.

V = Upper-tier partnership's share of the contributing partnership's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made, determined according to the following formula: A × (K ÷ C).

A = Contributing partnership's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made.

K = Upper-tier partnership's allocated portion of the qualified conservation contribution.

C = Total amount of the contributing partnership's qualified conservation contribution.

d.
Determination of Relevant Basis for an Ultimate Member Holding a Direct Interest in an Upper-Tier S Corporation

Proposed § 1.170A-14(m)(5) would provide rules for determining relevant basis for an ultimate member holding a direct interest in an upper-tier S corporation. Proposed § 1.170A-14(m)(5)(i) would provide that each such ultimate member's modified basis must be traced through the upper-tier S corporation and any upper-tier partnerships to the contributing partnership, and the contributing partnership must determine the relevant basis. This would involve a multi-step process under which, beginning with the upper-tier S corporation, the upper-tier S corporation and any upper-tier partnerships would be required to perform calculations, and then finally the contributing partnership would be required to use those calculations to compute the ultimate member's relevant basis. For simplicity, proposed § 1.170A-14(m)(5) would describe a situation in which there are two tiers—a contributing partnership and an upper-tier S corporation. Proposed § 1.170A-14(m)(5)(i) would provide that, in a situation involving more tiers, each partnership and the upper-tier S corporation must apply the rules and principles of proposed § 1.170A-14(m) iteratively to determine relevant basis.

Proposed § 1.170A-14(m)(5)(ii)(A) would provide a narrative rule for the upper-tier S corporation. It would provide that the upper-tier S corporation must determine the portion of each ultimate member's modified basis that is allocable to the upper-tier S corporation's interest in the partnership in which it holds a direct interest (in a situation involving only two tiers, that would be the contributing partnership). The proposed regulations would require this determination to be made in accordance with the principles of proposed § 1.170A-14(m)(3), and the formula provided in proposed § 1.170A-14(m)(5)(ii)(B). In other words, the formula provided in proposed § 1.170A-14(m)(5)(ii)(B) would be similar to the formula provided in proposed § 1.170A-14(m)(3)(ii), except that, instead of determining the portion of modified basis that is allocable to the portion of the real property with respect to which the qualified conservation contribution is made, the formula in proposed § 1.170A-14(m)(5)(ii)(B) would determine the portion of modified basis that is allocable to the upper-tier S corporation's interest in the next lower-tier partnership. As explained in proposed § 1.170A-14(m)(5)(iii), the contributing partnership then would be required to use the amount determined as the result of the formula in proposed § 1.170A-14(m)(5)(ii)(B) in another set of computations that would determine the portion of modified basis that is allocable to the portion of the real property with respect to which the qualified conservation contribution is made.

Proposed § 1.170A-14(m)(5)(ii)(B) would provide that the rule of proposed § 1.170A-14(m)(5)(ii) is also expressed in the following formula:

N = M × (P ÷ Q)

Where:

N = Portion of the ultimate member's modified basis that is allocable to the upper-tier S corporation's interest in the contributing partnership.

M = Modified basis as determined under proposed § 1.170A-14(l).

P = Ultimate member's pro rata portion of the upper-tier S corporation's adjusted basis in its interest in the contributing partnership.

Q = Ultimate member's pro rata portion of the adjusted basis in all the upper-tier S corporation's properties (including the upper-tier S corporation's interest in the contributing partnership).

After this formula is computed, then the contributing partnership must perform computations using the amount determined for item “N” to determine relevant basis. Proposed § 1.170A-14(m)(5)(iii)(A) would provide a narrative rule for the contributing partnership to compute this second step. It would provide that the contributing partnership must determine the portion of the amount determined under proposed § 1.170A-14(m)(5)(ii) with respect to each ultimate member that is allocable to the portion of the real property with respect to which the qualified conservation contribution is made. The proposed regulations would require this determination to be made in accordance with the principles of proposed § 1.170A-14(m)(2), and the formula provided in proposed § 1.170A-14(m)(5)(iii)(B).

Proposed § 1.170A-14(m)(5)(iii)(B) would provide that the rule of proposed § 1.170A-14(m)(5)(iii) is also expressed in the following formula:

R = N × (W ÷ (S + W))

Where:

R = Relevant basis.

N = Amount determined with respect to item N as described previously under proposed § 1.170A-14(m)(5)(ii)(B).

S = Upper-tier S corporation's portion of the adjusted basis in all the contributing partnership's properties (other than the portion of the real property with respect to which the qualified conservation contribution is made), determined by apportioning among the partners of the contributing partnership in accordance with their interests in the partnership under section 704(b) its adjusted basis in each of its properties (other than the portion of the real property with respect to which the qualified conservation contribution is made), using the adjusted bases immediately before the qualified conservation contribution, without duplication or omission of any property, and by treating the adjusted basis in each property as not less than zero.

W = Upper-tier S corporation's share of the contributing partnership's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made, determined according to the following formula: A × (Y ÷ C).

A = Contributing partnership's adjusted basis in the portion of the real property with respect to which the qualified conservation contribution is made.

Y = Upper-tier S corporation's distributive share of the qualified conservation contribution.

C = Total amount of the contributing partnership's qualified conservation contribution.

The proposed regulations would provide examples illustrating these rules. The Treasury Department and the IRS request comments on the determination of relevant basis.

3. Recordkeeping Requirements

Proposed § 1.170A-14(m)(6) would provide that contributing partnerships, contributing S corporations, upper-tier partnerships, and upper-tier S corporations must each maintain dated, written statements in their books and records, by the due date, including extensions, of their Federal income tax returns, substantiating the computation of each ultimate member's adjusted basis, modified basis, and relevant basis. It would also provide that these statements need not be maintained (nor does modified basis or relevant basis need to be computed) with respect to contributions that meet an exception in proposed § 1.170A-14(n)(2) (contributions outside a three-year holding period) or (n)(3) (family pass-

through entities). However, these statements must be maintained with respect to contributions that meet the exception in proposed § 1.170A-14(n)(4) for certified historic structures because section 170(f)(19) imposes special reporting requirements for such contributions if they exceed 2.5 times the sum of relevant basis.

F. Exceptions to the Disallowance Rule

Consistent with section 170(h)(7)(C), (D), and (E), the rules in proposed § 1.170A-14(n) would provide definitions and additional guidance relating to the three exceptions to the Disallowance Rule. It would also provide that there is no presumption that such a contribution otherwise is compliant with section 170, any other section of the Code, or the regulations or any other guidance thereunder; being described in proposed § 1.170A-14(n) is not a safe harbor for purposes of any other provision of law or with respect to the value of the contribution; such transactions are subject to adjustment or disallowance for any other reason, including failure to satisfy the other requirements of section 170 and overvaluation of the contribution; and taxpayers who engage in such transactions may be required to disclose under § 1.6011-4 the transactions as listed transactions.

1. Exception for Contributions Outside Three-Year Holding Period

Consistent with section 170(h)(7)(C), proposed § 1.170A-14(n)(2)(i) would provide that § 1.170A-14(j) does not apply to any qualified conservation contribution by a contributing partnership or contributing S corporation that is made at least three years after the latest of (1) the last date on which the contributing partnership or contributing S corporation acquired any portion of the real property with respect to which such qualified conservation contribution is made, (2) the last date on which any partner in the contributing partnership or shareholder in the contributing S corporation acquired any interest in such partnership or S corporation, and (3) if the interest in the contributing partnership is held through one or more upper-tier partnerships or upper-tier S corporations (A) the last date on which any such upper-tier partnership or upper-tier S corporation acquired any interest in the contributing partnership or any other such upper-tier partnership, and (B) the last date on which any partner or shareholder in any such upper-tier partnership or upper-tier S corporation acquired any interest in such upper-tier partnership or upper-tier S corporation.

Neither section 605 of SECURE 2.0 Act nor section 170 defines the phrase “acquired any interest.” An acquisition of an interest in a partnership can occur in several ways, including by inheritance, purchase from an existing partner, in a section 721 exchange with the partnership, in exchange for the provision of services, or as a distribution from an upper-tier partnership. An existing partner can also acquire additional interests in the partnership. In addition, one partner's complete or partial disposition of an interest in the partnership can be economically similar to the acquisition of an interest in the partnership by the remaining partners. For example, if a partnership makes a distribution that reduces one partner's interest in the profits or losses of the partnership, the remaining partners' interests, in the aggregate, may increase in the same manner as if they had acquired additional interests in the partnership.

The rules under section 706(c) and (d) address partnership allocations in situations involving variations in partners' interests attributable to acquisitions and dispositions. Section 1.706-4(a)(1) provides rules for determining the partners' distributive shares of partnership items when a partner's interest in a partnership varies during the taxable year as a result of the disposition of a partial or entire interest in a partnership as described in § 1.706-1(c)(2) and (3),
4

or with respect to a partner whose interest in a partnership is reduced as described in § 1.706-1(c)(3), including by the entry of a new partner, collectively referred to as a “variation.” Generally, a variation includes any acquisition, partial disposition, or complete disposition of an interest in the partnership. However, § 1.706-4(b)(1) provides that the rules in § 1.706-4(a)(3) do not preclude changes in the allocations of the distributive share of items described in section 702(a) among contemporaneous partners, provided that any variation in a partner's interest is not attributable to a contribution of money or property by a partner to the partnership or a distribution of money or property by the partnership to a partner, and the allocations resulting from the modification satisfy the requirements in section 704(b) and the regulations thereunder. Generally, partnerships are familiar with the rules under § 1.706-4 because they must apply such rules in computing allocations whenever there is an acquisition or disposition of a partner's interest during the taxable year.

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Section 1.706-1(c)(2) provides in part that a partnership taxable year closes with respect to a partner who sells or exchanges the partner's entire interest in the partnership, with respect to a partner whose entire interest in the partnership is liquidated, and with respect to a partner who dies. Section 1.706-1(c)(3) provides that if a partner sells or exchanges a part of the partner's interest in a partnership, or if the interest of a partner is reduced, the partnership taxable year continues to its normal end.

The definition of “variation” in § 1.706-4 would provide an administrable standard consistent with the purposes of section 170(h)(7)(C). Accordingly, proposed § 1.170A-14(n)(2)(ii) would provide that, for purposes of § 1.170A-14(n)(2), an acquisition of any interest in a partnership is any “variation” within the meaning of that term in § 1.706-4(a)(1); however, a variation would not include a change in allocations that satisfies the requirements of § 1.706-4(b)(1). The Treasury Department and the IRS considered alternatives to this rule, including defining acquisition as any acquisition by purchase, contribution, or gift. However, because certain other transactions such as redemptions and abandonments may reach results that are substantively similar to an acquisition by purchase, contribution, or gift, the Treasury Department and the IRS determined that the variation rules of § 1.706-4 would be more appropriate in this context.

Proposed § 1.170A-14(n)(2)(iii) would define an acquisition of any interest in an S corporation as any transfer, issuance, redemption, or other disposition of stock in the S corporation; however, an acquisition would not include any issuance or redemption involving all shareholders that does not affect the proportionate ownership of any shareholder (for example, a stock split). The Treasury Department and the IRS considered alternatives to this rule, including defining acquisition as any acquisition by purchase, contribution, or gift. However, because certain other transactions such as redemptions and abandonments may reach results that are substantively similar to an acquisition by purchase, contribution, or gift, the Treasury Department and the IRS determined that the proposed rule would be more appropriate in this context.

Proposed § 1.170A-14(n)(2)(iv) would provide that, if the contributing partnership or contributing S corporation does not satisfy the requirements of proposed § 1.170A-14(n)(2), then proposed § 1.170A-14(n)(2) would not apply to any person who receives a distributive share or pro rata share of the qualified conservation

contribution (including an upper-tier partnership or upper-tier S corporation), regardless of whether the person receiving such distributive share or pro rata share would have satisfied the requirements of proposed § 1.170A-14(n)(2) if the person had been the one to make the qualified conservation contribution. The Treasury Department and the IRS considered alternatives to this rule, such as allowing upper-tier partnerships and upper-tier S corporations to apply the three-year-holding-period exception even if the contributing partnership failed to satisfy the exception. Such an approach, however, would be inconsistent with section 170(h)(7)(C), which explicitly applies the holding period requirements to the contributing partnership.

The proposed regulations contain two examples illustrating these rules. The Treasury Department and the IRS request comments on whether any additional rules or examples should be provided for the three-year holding period exception.

2. Exception for Family Pass-Through Entities

As mentioned earlier, section 170(h)(7)(D)(i) provides the Disallowance Rule does not apply to any contribution made by any partnership if substantially all of the partnership interests in such partnership are held, directly or indirectly, by an individual and members of the family of such individual. The Treasury Department and the IRS are aware that the meaning of the term “substantially all” in section 170(h)(7)(D)(i) may not be clear and that such ambiguity could impair taxpayers' ability to determine whether they qualify for the family pass-through entity exception. For purposes of applying different provisions of the Code that also use that term, various Income Tax Regulations define the term “substantially all” as comprising different percentages, including: 70 percent (§ 1.1400Z2(d)-2(d)(4)); 80 percent (§§ 1.41-2(d)(2), 1.41-4(a)(6)); 85 percent (§§ 1.45D-1(c)(5), 1.72(e)-1T, Q&A 3; 1.528-4(b) and (c)); 90 percent (§§ 1.103-8(a)(1)(i), 1.103-16(c), 1.731-2(c)(3)(i); 1.1400Z2(d)-2(d)(3)); and 95 percent (§§ 1.448-1T(e)(4)(i) and (e)(5)(i), 1.460-6(d)(4)(i)(D)(
1
)). It is appropriate to select a percentage at the higher end of this range to carry out the purpose of section 170(h)(7) of preventing abusive syndications of qualified conservation contributions. Accordingly, the Treasury Department and the IRS propose to define “substantially all” for purposes of section 170(h)(7)(D)(i) and § 1.170A-14(n)(3)(i) as 90 percent of the interests in the contributing partnership or contributing S corporation that meets the requirements of proposed § 1.170A-14(n)(3).

Thus, proposed § 1.170A-14(n)(3)(i) would provide that § 1.170A-14(j) does not apply with respect to any qualified conservation contribution made by a contributing partnership or contributing S corporation if at least 90 percent of the interests in the contributing partnership or contributing S corporation are held by an individual and members of the family of such individual, and the contributing partnership or contributing S corporation meets the requirements of proposed § 1.170A-14(n)(3).

The Treasury Department and the IRS are also aware that it may be unclear what “interests” in the contributing partnership or contributing S corporation are to be taken into account for purposes of the family pass-through entity exception. Generally, the Code characterizes interests in a partnership as comprising the “capital interests” in the partnership and the “profits interests” in the partnership.
See,
for example, section 707(b) of the Code. The Treasury Department and the IRS propose limiting the family pass-through entity exception to situations in which an individual and the family members of such individual own at least 90 percent of both the capital and profits interests in the contributing partnership. Doing so would help to ensure that the family pass-through entity exception does not apply in situations in which persons outside an individual's family own a substantial economic interest in the partnership. Accordingly, proposed § 1.170A-14(n)(3)(ii)(A) would provide that, in the case of a contributing partnership, at least 90 percent of the interests in the contributing partnership are held by an individual and members of the family of such individual if, at the time of the qualified conservation contribution, at least 90 percent of the interests in capital and profits in such partnership are held, directly or indirectly, by an individual and members of the family of such individual.

A similar rule is proposed for S corporations. Section 1361(b)(1)(D) requires that an S corporation have only one class of stock. However, section 1361(c)(4) provides that differences in voting rights alone do not create a second class of stock. The Treasury Department and the IRS propose limiting the family pass-through entity exception in the case of S corporations to situations in which the individual and the family of such individual own stock in the contributing S corporation possessing at least 90 percent of the total voting power and at least 90 percent of the total value of the outstanding stock of the contributing S corporation. Doing so would help to ensure that the family pass-through exception does not apply in situations in which persons outside an individual's family own a substantial economic interest in the S corporation. Accordingly, proposed § 1.170A-14(n)(3)(ii)(B) would provide that, in the case of a contributing S corporation, at least 90 percent of the interests in the contributing S corporation are held by an individual and members of the family of such individual if, at the time of the qualified conservation contribution, at least 90 percent of the total value and at least 90 percent of the total voting power of the outstanding stock in such S corporation are held by an individual and members of the family of such individual.

The Treasury Department and the IRS request comments on whether these definitions of “substantially all of the interests” in the contributing partnership or contributing S corporation are appropriate and sufficient to ensure the intended application of the family pass-through entity exception.

Consistent with section 170(h)(7)(D)(ii), proposed § 1.170A-14(n)(3)(iii) would provide that, for purposes of § 1.170A-14(n)(3), the term “members of the family” means, with respect to any individual (1) the spouse of such individual, and (2) any individual who bears a relationship to such individual that is described in section 152(d)(2)(A) through (G). Under these proposed regulations, members of the family would be limited to individuals. The Treasury Department and the IRS request comments on whether certain estates or trusts should be treated as members of the family for purposes of this rule. The Treasury Department and the IRS note that, under existing § 1.1361-1(e)(3)(ii), certain estates and trusts of deceased members of the family are treated as members of the family for purposes of the limitation on the number of shareholders in an S corporation.

As described earlier in this preamble, the Disallowance Rule and its exceptions in section 170(h)(7) are generally mechanical. However, Congress recognized that additional guidance may be needed to prevent situations in which those mechanical rules are used to avoid the purposes of the Disallowance Rule. As mentioned previously, section 170(h)(7)(G)(ii) provides the Secretary with authority to issue regulations or other guidance to

prevent the avoidance of the purposes of section 170(h)(7). Accordingly, these proposed regulations would provide two anti-abuse rules designed to ensure that the family pass-through entity exception in proposed § 1.170A-14(n)(3) is not used inappropriately to circumvent the Disallowance Rule.

First, the Treasury Department and the IRS propose to limit the family pass-through entity exception to situations in which an individual and members of that individual's family have held the requisite ownership interest in the property for at least one year prior to the contribution. The need for such a rule is the concern that, in the absence of a requirement that the members of the family hold the contributed property for a certain period of time before the contribution, promoters could structure transactions to inappropriately take advantage of tacked holding periods under section

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2023-25423. Public record. Not legal advice.