Termination of a Partnership Under Section 708(b)(1)(B)

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[TD 8717]

RIN 1545-AU14

Termination of a Partnership Under Section 708(b)(1)(B)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the

termination of a partnership upon the sale or exchange of 50 percent or

more of the total interest in partnership capital and profits within a

12-month period. The final regulations affect all partnerships that

terminate under section 708(b)(1)(B).

DATES: These regulations are effective May 9, 1997.

For applicability dates, see Effective Dates under Supplementary

Information.

FOR FURTHER INFORMATION CONTACT: Steven R. Schneider, (202) 622-3060

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On May 13, 1996, a notice of proposed rulemaking (PS-5-96) was

published in the Federal Register (61 FR 21985) containing proposed

amendments to the Income Tax Regulations (26 CFR part 1) under section

708 of the Internal Revenue Code (Code). The notice of proposed

rulemaking also contained proposed amendments to other sections of the

Income Tax Regulations to reflect the amendments to the regulations

under section 708. Written comments responding to this notice were

received. A public hearing was held on September 5, 1996, pursuant to

the notice published in the Federal Register on May 13, 1996. After

consideration of all comments received, the proposed amendments are

adopted as revised by this Treasury decision.

Explanation of Provisions

Section 708(b)(1)(B) provides that, for purposes of section 708(a),

a partnership shall be considered terminated if within a 12-month

period there is a sale or exchange of 50 percent or more of the total

interest in partnership capital and profits. The existing regulations

under Sec. 1.708-1(b)(1)(iv) provide that, if a partnership is

terminated by a sale or exchange of an interest, the following is

deemed to occur: The partnership distributes its properties to the

purchaser and the other remaining partners in proportion to their

respective interests in the partnership properties; and, immediately

thereafter, the purchaser and the other remaining partners contribute

the properties to a new partnership, either for the continuation of the

business or for its dissolution and winding up. The final regulations

adopt the proposed regulations and change the mechanics of a

termination under section 708(b)(1)(B) so that the following is deemed

to occur on a termination: The partnership contributes all of its

assets and liabilities to a new partnership in exchange for an interest

in the new partnership; and, immediately thereafter, the partnership

liquidates by distributing interests in the new partnership to the

purchaser and the other remaining partners, followed by the

continuation of the business by the new partnership or its dissolution

and winding up. The final regulations also clarify certain aspects of

the proposed regulations in response to comments received.

One commentator requested clarification of the section 704(c)

consequences of a termination. The proposed regulations provide for a

section 704(b) capital account ``book up'' upon the deemed contribution

of assets by the terminated partnership to

[[Page 25499]]

the new partnership and also upon the deemed distribution in

liquidation of the terminated partnership. This would have resulted in

a new layer of section 704(c) property. The final regulations amend the

regulations under section 704(b) to provide that the deemed

contribution of assets to a new partnership and the distribution of the

new partnership interests to the partners of the terminated partnership

are disregarded for purposes of maintaining capital accounts. As a

result, the termination of a partnership does not change the capital

accounts of the partners or the books of the partnership and the deemed

contribution of assets to a new partnership does not create additional

section 704(c) property. The final regulations also provide that the

new partnership is not bound by the section 704(c) method used by the

terminated partnership.

A commentator requested clarification of whether a termination

under the new section 708(b)(1)(B) construct will trigger recapture of

investment tax credit under section 47.

Although not specifically addressed in the regulations, a section

708(b)(1)(B) termination no longer triggers recapture of the investment

tax credit under the ``mere change in form'' exception in Sec. 1.47-

3(f) of the regulations.

Commentators also requested guidance on whether a section 1491

excise tax may be triggered upon a section 708(b)(1)(B) termination of

a foreign partnership with U.S. partners. This issue is currently under

study and the IRS and Treasury welcome comments from interested

taxpayers and practitioners.

One commentator requested clarification of whether the distribution

of the interests in the new partnership will be subject to section

731(c). The section 731(c) final regulations, December 26, 1996 (61 FR

67936), provide that the deemed distribution of partnership interests

under Sec. 1.708-1(b)(1)(iv) does not trigger the application of

section 731(c).

Several commentators suggested that partnerships should be allowed

to apply the final regulations to terminations under section

708(b)(1)(B) occurring on or after the date the proposed regulations

were filed with the Federal Register. In response, the final

regulations provide that the regulations may be applied to terminations

occurring on or after May 9, 1996, provided that the partnership and

its partners apply the regulations to the termination in a consistent

manner.

The final regulations also provide an example illustrating the

mechanics of a termination under section 708(b)(1)(B). In addition, the

final regulations provide that the new partnership retains the TIN of

the terminated partnership. However, if the new partnership has already

applied for a new TIN, the partnership should continue to use the new

TIN.

Finally, the regulations make several revenue rulings obsolete. The

holdings of revenue rulings 87-50 and 87-51 (dealing with the effect of

terminations under section 708(b)(1)(B) on lower-tier partnerships) and

revenue rulings 86-73 and 88-42 (dealing with the effect of a Sec. 754

election made by the terminating partnership) are now incorporated,

without substantive change, into the regulations under Sec. 1.708-1.

Additionally, the final regulations make revenue ruling 93-90 (dealing

with minimum gain chargeback in a section 708(b)(1)(B) termination)

obsolete because the Sec. 704(b) capital account ``book up'' that is

the subject of the revenue ruling is eliminated.

Effective Date

These regulations apply to terminations of partnerships under

section 708(b)(1)(B) occurring on or after May 9, 1997; however, these

regulations may be applied to terminations occurring on or after May 9,

1996, provided that the partnership and its partners apply these

regulations to the termination in a consistent manner.

Effect on Other Documents

The following publications are obsolete as of May 9, 1997:

Rev. Rul. 86-73, 1986-1 C.B. 282

Rev. Rul. 87-50, 1987-1 C.B. 157

Rev. Rul. 87-51, 1987-1 C.B. 158

Rev. Rul. 88-42, 1988-1 C.B. 265

Rev. Rul. 93-90, 1993-2 C.B. 238

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It has also been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

does not apply to these regulations, and because the regulation does

not impose a collection of information on small entities, the

Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.

Therefore, a Regulatory Flexibility Analysis is not required. Pursuant

to section 7805(f) of the Internal Revenue Code, the notice of proposed

rulemaking preceding these regulations was submitted to the Small

Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Steven R. Schneider of

the Office of Assistant Chief Counsel (Passthroughs and Special

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

Department participated in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income

taxes, Penalties, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 301 are amended as follows:

PART 1--INCOME TAXES

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

part as follows:

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

Par. 2. Section 1.704-1 is amended as follows:

1. Paragraph (b)(2)(iv)(d)(1) is amended by revising the second

sentence.

2. Paragraph (b)(2)(iv)(l) is amended by removing the last three

sentences and adding four sentences in their place.

3. Paragraph (b)(5) Example 13(v) is amended by removing all the

text following the third sentence and adding four sentences in its

place.

The revisions and additions read as follows:

Sec. 1.704-1 Partner's distributive share.

* * * * *

(b) * * *

(2) * * *

(iv) * * *

(d) * * *

(1) * * * See Example 13(i) of paragraph (b)(5) of this section. *

* *

* * * * *

(l) * * * If the transfer of an interest in a partnership causes a

termination of the partnership under section 708(b)(1)(B), the capital

account of the transferee partner and the capital accounts of the other

partners of the terminated partnership carry over to the new

partnership that is formed as a result of the termination of the

partnership under Sec. 1.708-1(b)(1)(iv). Moreover, the deemed

contribution of assets and liabilities by the terminated partnership to

a new partnership and

[[Page 25500]]

the deemed liquidation of the terminated partnership that occur under

Sec. 1.708-1(b)(1)(iv) are disregarded for purposes of this paragraph

(b)(2)(iv). See Example 13 of paragraph (b)(5) of this section and the

example in Sec. 1.708-1(b)(1)(iv). The previous three sentences apply

to terminations of partnerships under section 708(b)(1)(B) occurring on

or after May 9, 1997; however, the sentences may be applied to

terminations occurring on or after May 9, 1996, provided that the

partnership and its partners apply the sentences to the termination in

a consistent manner.

* * * * *

(5) * * *

Example 13. * * *

(v) * * * Immediately preceding the constructive liquidation,

the capital accounts of Z and LK equal $11,000 each (LK having

inherited Y's $11,000 capital account) and the book value of the G

Corp. securities is $22,000 (original purchase price of securities).

Under paragraph (b)(2)(iv)(l) of this section, the deemed

contribution of assets and liabilities by the terminated partnership

to the new partnership and the deemed liquidation of the terminated

partnership that occur under Sec. 1.708-1(b)(1)(iv) in connection

with the constructive liquidation of the terminated partnership are

disregarded in the maintenance and computation of the partners'

capital accounts. As a result, the capital accounts of Z and LK in

the new partnership equal $11,000 each (their capital accounts in

the terminated partnership immediately prior to the termination),

and the book value of the G Corp. securities remains $22,000 (its

book value immediately prior to the termination). This Example 13(v)

applies to terminations of partnerships under section 708(b)(1)(B)

occurring on or after May 9, 1997; however, this Example 13(v) may

be applied to terminations occurring on or after May 9, 1996,

provided that the partnership and its partners apply this Example

13(v) to the termination in a consistent manner.

* * * * *

Par. 3. Section 1.704-3 is amended as follows:

1. Paragraph (a)(2) is amended by adding two sentences at the end

of the paragraph.

2. Paragraph (a)(3)(i) is amended by adding three sentences at the

end of the paragraph.

The additions read as follows:

Sec. 1.704-3 Contributed property.

(a) * * *

(2) * * * A new partnership formed as the result of the termination

of a partnership under section 708(b)(1)(B) is not required to use the

same method as the terminated partnership with respect to section

704(c) property deemed contributed to the new partnership by the

terminated partnership under Sec. 1.708-1(b)(1)(iv). The previous

sentence applies to terminations of partnerships under section

708(b)(1)(B) occurring on or after May 9, 1997; however, the sentence

may be applied to terminations occurring on or after May 9, 1996,

provided that the partnership and its partners apply the sentence to

the termination in a consistent manner.

(3) * * *

(i) * * * Property deemed contributed to a new partnership as the

result of the termination of a partnership under section 708(b)(1)(B)

is treated as section 704(c) property in the hands of the new

partnership only to the extent that the property was section 704(c)

property in the hands of the terminated partnership immediately prior

to the termination. See Sec. 1.708-1(b)(1)(iv) for an example of the

application of this rule. The previous two sentences apply to

terminations of partnerships under section 708(b)(1)(B) occurring on or

after May 9, 1997; however, the sentences may be applied to

terminations occurring on or after May 9, 1996, provided that the

partnership and its partners apply the sentences to the termination in

a consistent manner.

* * * * *

Par. 4. Section 1.704-4 is amended by revising paragraphs

(a)(4)(ii) and (c)(3) to read as follows:

Sec. 1.704-4 Distribution of contributed property.

(a) * * *

(4) * * *

(ii) Section 708(b)(1)(B) terminations. A termination of the

partnership under section 708(b)(1)(B) does not begin a new five-year

period for each partner with respect to the built-in gain and built-in

loss property that the terminated partnership is deemed to contribute

to the new partnership under Sec. 1.708-1(b)(1)(iv). See Sec. 1.704-

3(a)(3)(ii) for the definitions of built-in gain and built-in loss on

section 704(c) property. This paragraph (a)(4)(ii) applies to

terminations of partnerships under section 708(b)(1)(B) occurring on or

after May 9, 1997; however, this paragraph (a)(4)(ii) may be applied to

terminations occurring on or after May 9, 1996, provided that the

partnership and its partners apply this paragraph (a)(4)(ii) to the

termination in a consistent manner.

* * * * *

(c) * * *

(3) Section 708(b)(1)(B) terminations. Section 704(c)(1)(B) and

this section do not apply to the deemed distribution of interests in a

new partnership caused by the termination of a partnership under

section 708(b)(1)(B). A subsequent distribution of section 704(c)

property by the new partnership to a partner of the new partnership is

subject to section 704(c)(1)(B) to the same extent that a distribution

by the terminated partnership would have been subject to section

704(c)(1)(B). See also Sec. 1.737-2(a) for a similar rule in the

context of section 737. This paragraph (c)(3) applies to terminations

of partnerships under section 708(b)(1)(B) occurring on or after May 9,

1997; however, this paragraph (c)(3) may be applied to terminations

occurring on or after May 9, 1996, provided that the partnership and

its partners apply this paragraph (c)(3) to the termination in a

consistent manner.

* * * * *

Par. 5. Section 1.708-1 is amended as follows:

1. Paragraph (b)(1)(ii) is amended by adding three sentences after

the third sentence.

2. Paragraph (b)(1)(iv) is revised.

3. Paragraph (b)(1)(v) is added.

The additions and revisions read as follows:

1.708-1 Continuation of partnership.

* * * * *

(b) * * *

(1) * * *

(ii) * * * Moreover, if the sale or exchange of an interest in a

partnership (upper-tier partnership) that holds an interest in another

partnership (lower-tier partnership) results in a termination of the

upper-tier partnership, the upper-tier partnership is treated as

exchanging its entire interest in the capital and profits of the lower-

tier partnership. If the sale or exchange of an interest in an upper-

tier partnership does not terminate the upper-tier partnership, the

sale or exchange of an interest in the upper-tier partnership is not

treated as a sale or exchange of a proportionate share of the upper-

tier partnership's interest in the capital and profits of the lower-

tier partnership. The previous two sentences apply to terminations of

partnerships under section 708(b)(1)(B) occurring on or after May 9,

1997; however, the sentences may be applied to terminations occurring

on or after May 9, 1996, provided that the partnership and its partners

apply the sentences to the termination in a consistent manner. * * *

* * * * *

(iv) If a partnership is terminated by a sale or exchange of an

interest, the following is deemed to occur: The partnership contributes

all of its assets and liabilities to a new partnership in exchange for

an interest in the new partnership; and, immediately

[[Page 25501]]

thereafter, the terminated partnership distributes interests in the new

partnership to the purchasing partner and the other remaining partners

in proportion to their respective interests in the terminated

partnership in liquidation of the terminated partnership, either for

the continuation of the business by the new partnership or for its

dissolution and winding up. In the latter case, the new partnership

terminates in accordance with (b)(1)(i) of this section. This paragraph

(b)(1)(iv) applies to terminations of partnerships under section

708(b)(1)(B) occurring on or after May 9, 1997; however, this paragraph

(b)(1)(iv) may be applied to terminations occurring on or after May 9,

1996, provided that the partnership and its partners apply this

paragraph (b)(1)(iv) to the termination in a consistent manner. The

provisions of this paragraph (b)(1)(iv) are illustrated by the

following example:

Example. (i) A and B each contribute $10,000 cash to form AB, a

general partnership, as equal partners. AB purchases depreciable

Property X for $20,000. Property X increases in value to $30,000, at

which time A sells its entire 50 percent interest to C for $15,000

in a transfer that terminates the partnership under section

708(b)(1)(B). At the time of the sale, Property X had an adjusted

tax basis of $16,000 and a book value of $16,000 (original $20,000

tax basis and book value reduced by $4,000 of depreciation). In

addition, A and B each had a capital account balance of $8,000

(original $10,000 capital account reduced by $2,000 of depreciation

allocations with respect to Property X).

(ii) Following the deemed contribution of assets and liabilities

by the terminated AB partnership to a new partnership (new AB) and

the liquidation of the terminated AB partnership, the adjusted tax

basis of Property X in the hands of new AB is $16,000. See Section

723. The book value of Property X in the hands of new partnership AB

is also $16,000 (the book value of Property X immediately before the

termination) and B and C each have a capital account of $8,000 in

new AB (the balance of their capital accounts in AB prior to the

termination). See Sec. 1.704-1(b)(2)(iv)(l) (providing that the

deemed contribution and liquidation with regard to the terminated

partnership are disregarded in determining the capital accounts of

the partners and the books of the new partnership). Additionally,

under Sec. 301.6109-1(d)(2)(iii) of this chapter, new AB retains the

taxpayer identification number of the terminated AB partnership.

(iii) Property X was not section 704(c) property in the hands of

terminated AB and is therefore not treated as section 704(c)

property in the hands of new AB, even though Property X is deemed

contributed to new AB at a time when the fair market value of

Property X ($30,000) was different from its adjusted tax basis

($16,000). See Sec. 1.704-3(a)(3)(i) (providing that property

contributed to a new partnership under Sec. 1.708-1(b)(1)(iv) is

treated as section 704(c) property only to the extent that the

property was section 704(c) property in the hands of the terminated

partnership immediately prior to the termination).

(v) If a partnership is terminated by a sale or exchange of an

interest in the partnership, a section 754 election (including a

section 754 election made by the terminated partnership on its final

return) that is in effect for the taxable year of the terminated

partnership in which the sale occurs, applies with respect to the

incoming partner. Therefore, the bases of partnership assets are

adjusted pursuant to sections 743 and 755 prior to their deemed

contribution to the new partnership. This paragraph (b)(1)(v) applies

to terminations of partnerships under section 708(b)(1)(B) occurring on

or after May 9, 1997; however, this paragraph (b)(1)(v) may be applied

to terminations occurring on or after May 9, 1996, provided that the

partnership and its partners apply this paragraph (b)(1)(v) to the

termination in a consistent manner.

* * * * *

Par. 6. Section 1.737-2 is amended as follows:

1. Paragraph (a) is revised.

2. In paragraph (d)(1), the first sentence is revised and one

sentence is added after the first sentence.

The additions and revisions read as follows:

Sec. 1.737-2 Exceptions and special rules.

(a) Section 708(b)(1)(B) terminations. Section 737 and this section

do not apply to the deemed distribution of interests in a new

partnership caused by the termination of a partnership under section

708(b)(1)(B). A subsequent distribution of property by the new

partnership to a partner of the new partnership that was formerly a

partner of the terminated partnership is subject to section 737 to the

same extent that a distribution from the terminated partnership would

have been subject to section 737.

See also Sec. 1.704-4(c)(3) for a similar rule in the context of

section 704(c)(1)(B). This paragraph (a) applies to terminations of

partnerships under section 708(b)(1)(B) occurring on or after May 9,

1997; however, this paragraph (a) may be applied to terminations

occurring on or after May 9, 1996, provided that the partnership and

its partners apply this paragraph (a) to the termination in a

consistent manner.

* * * * *

(d) * * * (1) * * * Any portion of the distributed property that

consists of property previously contributed by the distributee partner

(previously contributed property) is not taken into account in

determining the amount of the excess distribution or the partner's net

precontribution gain. The previous sentence applies on or after May 9,

1997. * * *

* * * * *

Par. 7. In section 1.743-1, paragraph (d) is added to read as

follows:

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

* * * * *

(d) Section 708(b)(1)(B) terminations. A partner with a special

basis adjustment in property held by a partnership that terminates

under section 708(b)(1)(B) will continue to have the same special basis

adjustment with respect to property deemed contributed by the

terminated partnership to the new partnership under Sec. 1.708-

1(b)(1)(iv), regardless of whether the new partnership makes a section

754 election. This paragraph (d) applies to terminations of

partnerships under section 708(b)(1)(B) occurring on or after May 9,

1997; however, this paragraph (d) may be applied to terminations

occurring on or after May 9, 1996, provided that the partnership and

its partners apply this paragraph (d) to the termination in a

consistent manner.

Par. 8. In Sec. 1.761-1, paragraph (e) is added to read as follows:

Sec. 1.761-1 Terms defined.

* * * * *

(e) Distribution of partnership interest. For purposes of section

708(b)(1)(B) and Sec. 1.708-1(b)(1)(iv), the deemed distribution of an

interest in a new partnership by a partnership that terminates under

section 708(b)(1)(B) is not a sale or exchange of an interest in the

new partnership. However, the deemed distribution of an interest in a

new partnership by a partnership that terminates under section

708(b)(1)(B) is treated as an exchange of the interest in the new

partnership for purposes of section 743. This paragraph (e) applies to

terminations of partnerships under section 708(b)(1)(B) occurring on or

after May 9, 1997; however, this paragraph (e) may be applied to

terminations occurring on or after May 9, 1996, provided that the

partnership and its partners apply this paragraph (e) to the

termination in a consistent manner.

PART 301--PROCEDURE AND ADMINISTRATION

Par. 9. The authority citation for part 301 continues to read in

part as follows:

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

[[Page 25502]]

Par. 10. Section 301.6109-1 is amended by adding paragraph

(d)(2)(iii) as follows:

Sec. 301.6109-1 Identifying numbers.

* * * * *

(d) * * *

(2) * * *

(iii) Special rule for Section 708(b)(1)(B) terminations. A new

partnership that is formed as a result of the termination of a

partnership under section 708(b)(1)(B) will retain the employer

identification number of the terminated partnership. This paragraph

(d)(2)(iii) applies to terminations of partnerships under section

708(b)(1)(B) occurring on or after May 9, 1997; however, this paragraph

(d)(2)(iii) may be applied to terminations occurring on or after May 9,

1996, provided that the partnership and its partners apply this

paragraph (d)(2)(iii) to the termination in a consistent manner.

* * * * *

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved: May 1, 1997.

Donald C. Lubick,

Acting Assistant Secretary of the Treasury (Tax Policy).

[FR Doc. 97-12061 Filed 5-8-97; 8:45 am]

BILLING CODE 4830-01-U