Adjustments Following Sales of Partnership Interests

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8847]

RIN 1545-AS39

Adjustments Following Sales of Partnership Interests

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document finalizes regulations relating to the optional

adjustments to the basis of partnership property following certain

transfers of partnership interests under section 743, the calculation

of gain or loss under section 751(a) following the sale or exchange of

a partnership interest, the allocation of basis adjustments among

partnership assets under section 755, the allocation of a partner's

basis in its partnership interest to properties distributed to the

partner by the partnership under section 732(c), and the computation of

a partner's proportionate share of the adjusted basis of depreciable

property (or depreciable real property) under section 1017. The changes

will affect partnerships and partners where there are transfers of

partnership interests, distributions of property, or elections under

sections 108(b)(5) or (c). In addition, the final regulations under

section 732(c) reflect changes to the law made by the Taxpayer Relief

Act of 1997.

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

1999.

Applicability Date: These regulations apply to transfers of

partnership interests and distributions occurring on or after December

15, 1999.

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

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information in these final regulations have been

reviewed and approved by the Office of Management and Budget in

accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under

control number 1545-1588. Responses to these collections of information

are mandatory for partnerships that have made an election under section

754 and for which a section 743 transfer has been made, and for

partnerships which distribute property in a transaction subject to

section 732(d).

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless the collection of

information displays a valid control number assigned by the Office of

Management and Budget.

The estimated annual burden per respondent varies from 1 hour to

300 hours, depending on the individual circumstances, with an estimated

average of 4 hours.

Comments concerning the accuracy of this burden estimate and

suggestions for reducing this burden should be sent to the Internal

Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP,

Washington, DC 20224, and to the Office of Management and Budget, Attn:

Desk Officer for the Department of the Treasury, Office of Information

and Regulatory Affairs, Washington, DC 20503.

Books or records relating to these collections of information must

be retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background

This document (a) revises Secs. 1.743-1 and 1.755-1 of the Income

Tax Regulations (26 CFR part 1), and (b) amends Secs. 1.732-1, 1.732-2,

1.734-1, 1.751-1, 1.754-1, and Sec. 1.1017-1 of the Income Tax

Regulations.

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

published in the Federal Register (63 FR 4408). Written comments were

received in response to the notice of proposed rulemaking. One speaker

provided testimony at a public hearing held on September 10, 1998.

After consideration of all the comments, the proposed regulations

under sections 732, 734, 743, 751, 755, and 1017 are adopted, as

revised by this Treasury Decision.

Explanation of Revisions and Summary of Contents

1. Basis in Distributed Property

(a) Mandatory application of section 732(d). Section 1.732-1(d)(4)

of the current regulations requires transferees to apply the special

basis rule in certain

[[Page 69904]]

cases. In the preamble to the proposed regulations, the IRS and the

Treasury Department requested comments on the proper scope of section

732(d), and specifically, under what circumstances, if any, the

Secretary should continue to exercise his authority to mandate the

application of section 732(d) to a transferee. Several commentators

suggested that the mandatory application of section 732(d) no longer

should be required, because the changes made to section 732(c) by the

Taxpayer Relief Act of 1997, Public Law 105-34, 111 Stat. 788, 945-46

(1997), make the distortions targeted by the regulations less likely to

occur. However, other commentators noted that distortions caused by

section 732(c) still may occur. Accordingly, the rule contained in

Sec. 1.732-1(d)(4), which requires the mandatory application of section

732(d) in certain cases, remains in effect.

(b) Statement required by partnership. Because partners, rather

than partnerships, are required to report basis adjustments under

section 732(d), the final regulations require partnerships to provide

transferees with such information as is necessary for the transferees

properly to compute basis adjustments made under section 732(d). This

information must be provided if a transferee notifies a partnership

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

partnership makes a distribution subject to the mandatory application

of section 732(d).

(c) Effective date. One commentator asked for clarification

regarding the application of the final regulations to section 732(d)

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

necessary to calculate the basis adjustments which would have been

required under section 743(b) if a section 754 election were in effect

for the partnership in the taxable year in which the partnership

interest was transferred to the partner. In calculating these basis

adjustments, the partnership should apply the final regulations under

section 743 and 755 if the distribution to which section 732(d) applies

occurs after December 15, 1999.

2. Basis Adjustments Under Section 743(b)

(a) Coordination with section 704(c). Where a partnership adopts

the remedial allocation method, the proposed regulations provide that

the section 704(c) built-in gain portion of a basis adjustment under

section 743(b) shall be recovered over the remaining cost recovery

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

suggested that the final regulations should provide this treatment for

the section 704(c) built-in gain portion of the adjustment regardless

of the method elected by the partnership for allocating section 704(c)

built-in gain and loss. The IRS and the Treasury Department continue to

believe that, except for partnerships which adopt the remedial

allocation method, it is appropriate for sections 704(c) and 743(b) to

operate independently. Accordingly, this change has not been adopted.

In the preamble to the proposed regulations, comments were

requested concerning the application of the remedial allocation method

to contributed property where there are no distortions caused by the

ceiling rule at the time the property was contributed to the

partnership. Even if it is not clear that the ceiling rule will apply

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

the contributed property is sufficient so that the non-contributing

partners will be allocated their appropriate share of depreciation or

amortization attributable to the property, the partnership's adoption

of the remedial method still may be relevant due to allocations

resulting from a subsequent disposition of the property. For instance,

suppose that partners A and B form a partnership and agree that each

partner will be allocated a 50 percent share of all partnership items,

and that the partnership will make allocations under section 704(c)

using the traditional method. A contributes depreciable property with

an adjusted tax basis of $40 and a book value of $50, and B contributes

$50 in cash. At the time of the contribution, it is not readily

apparent that the ceiling rule will have any application. However, if,

before any federal income tax depreciation accrues with respect to the

contributed property, the property's value declines to $40, and the

property is sold for that amount, there will be no tax gain or loss.

The book loss of $10 would be shared equally between A and B. In this

situation, the ceiling rule would prevent B from being allocated the $5

tax loss to which it otherwise would be entitled. However, if the

partnership elected to use the remedial method with respect to the

contributed property, B would be allocated a $5 tax loss, and A would

be allocated a corresponding $5 tax gain. In addition, if a

contributing partner transfers its interest in a partnership during a

period when a section 754 election is in effect, the section 704(c)

method adopted by the partnership will determine the recovery period

for the built-in gain portion of the transferee's section 743(b)

adjustment. The IRS and the Treasury Department believe that under the

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

remedial method under Sec. 1.704-3, even where it is not readily

apparent at the time the property is contributed that the ceiling rule

will be applicable.

(b) Previously taxed capital. One commentator suggested that the

second sentence in proposed Sec. 1.743-1(d)(2), relating to the

correlation between a partner's interest in previously taxed capital

and the partnership's capital accounts, is redundant and should be

deleted. This suggestion has been adopted; however, no substantive

change is intended by the deletion.

(c) Common basis election. Some commentators suggested that the

provision in the proposed regulations that permitted the partners to

elect to apply negative basis adjustments under section 743(b) to the

partnership's common basis should be deleted. The commentators argued

that the provision was contrary to the purpose of section 743(b),

because it permitted basis adjustments under section 743(b) to affect

nontransferring partners. The commentators also argued that the

provision would be used by a small number of partnerships and would add

unnecessary complexity to the regulations. In response to these

suggestions, the provision that permitted the partners to elect to

apply negative basis adjustments under section 743(b) to the

partnership's common basis has been deleted.

(d) Statements by partners. Some commentators suggested modifying

the statements which partners are required to provide to the

partnership in the case of transfers which result in basis adjustments

under section 743(b). Many of these suggestions have been adopted. For

example, the regulations specify that the transferee of a partnership

interest is required to provide the name, address, and taxpayer

identification number of the transferor only if that information is

ascertainable by the transferee. The regulations also specify that if a

partnership interest is transferred to a nominee which is required to

furnish the statement under Sec. 1.6031(c)-1T to the partnership, the

nominee may satisfy the notice requirements of both the section 743 and

6031 regulations by providing a single statement with respect to that

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

regulations.

The regulations require the transferee to sign the statement under

penalties of perjury, and require the transferee to provide the amount

of any liabilities assumed or taken subject to by the transferee, and

any other information

[[Page 69905]]

necessary for the partnership to compute the transferee's basis in the

partnership interest. In order to assist the partnership in properly

calculating depreciation and amortization deductions which may be

subject to anti-churning provisions, the regulations require the

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

Finally, the statement required by a transferee that acquires an

interest by death must include the date of the decedent's death.

One commentator suggested that the statement required by a

transferee that acquires a partnership interest by sale or exchange

should be provided within 30 days of the sale or exchange, regardless

of whether or not the transfer occurs at the end of the calendar year.

This change has been adopted.

One commentator suggested that references to the tax matters

partner in Sec. 1.743-1(k) of the proposed regulations (regarding the

partnership's obligations where a partner's statement is clearly

erroneous, or a partner fails to notify the partnership that an

interest has been transferred and the partnership has actual knowledge

of the transfer) should be changed. This commentator emphasized that

while the tax matters partner has a specialized role with respect to

consolidated administrative and judicial proceedings to determine the

tax treatment of partnership items at the partnership level, the tax

matters partner does not have any special responsibilities with respect

to federal income tax reporting. The final regulations adopt this

comment. Section 1.743-1(k) now refers to partners who are responsible

for federal income tax reporting by the partnership.

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

described in Sec. 1.743-1(j)(6) should be changed to describe a non-oil

and gas property. This change has been made. The commentator also

suggested that in the case of domestic oil and gas properties that are

depleted at the partner level, the transferee partner (rather than the

partnership) should be required to make and allocate basis adjustments

among such properties. The final regulations adopt this comment.

The same commentator suggested that the regulations should specify

a method for adjusting the basis of section 613A(c)(7)(D) properties in

order to account for percentage depletion made by a partner with

respect to such properties. Under the principles of Sec. 1.743-1(j),

percentage depletion should reduce first any carryover basis under

Sec. 1.613A-3(e)(6)(iv). After the carryover basis has been recovered,

any further percentage depletion should reduce the section 743

adjustment for the property.

3. Sales of Partnership Interests

One commentator suggested that references to fair market value

should specify whether fair market value is determined taking into

account section 7701(g), which generally provides that fair market

value shall be treated as being not less than the amount of any

nonrecourse indebtedness to which the property is subject. The

regulations specify that for purposes of the hypothetical sale employed

to determine the income or loss realized by a partner upon the sale or

exchange of its interest in section 751 property, fair market value is

determined taking into account section 7701(g). Basis adjustments under

section 743(b) also are allocated by reference to a hypothetical

transaction. The IRS and the Treasury Department intend to issue

guidance in the near future which will provide rules for determining

the fair market value of partnership assets in certain situations,

including for purposes of allocating section 743(b) basis adjustments

upon the transfer of a partnership interest. The IRS and the Treasury

Department anticipate that the guidance will provide that section

7701(g) will apply in determining the fair market value of partnership

assets for purposes of allocating section 743(b) basis adjustments.

One commentator suggested that where a partnership interest is sold

or exchanged, the transferor and the transferee of a partnership

interest should be permitted jointly to assign values to partnership

assets in a written agreement. Because this approach is inconsistent

with the hypothetical sale approach of the regulations, this suggestion

has not been adopted.

4. Elections Under Section 754

One commentator requested that partnerships be granted a one-time

right to revoke section 754 elections in effect for such partnerships.

Given the significant changes to the rules made by these final

regulations as compared to the regulations that were in effect at the

time that section 754 elections previously were made, the IRS and

Treasury believe that it is appropriate to provide for a one-time

revocation of such elections. Accordingly, a partnership having an

election in effect under section 754 for its taxable year that includes

December 15, 1999 may revoke such election by attaching a statement to

the partnership's return for that year. The return must be filed on or

before the due date (including extensions) for the return for that

year.

5. Allocation of Basis Adjustments Among Partnership Assets

(a) Income in respect of a decedent. One commentator requested that

the final regulations illustrate the allocation of basis adjustments

among partnership assets where one or more of such assets represents

income in respect of a decedent. Where a partnership interest is

transferred as a result of the death of a partner, under section

1014(c) the transferee's basis in its partnership interest is not

adjusted for that portion of the interest, if any, which is

attributable to items representing income in respect of a decedent

under section 691. Because the transferee's basis in its partnership

interest does not include the value of assets which represent income in

respect of a decedent, the section 743(b) adjustment likewise does not

reflect the value of such assets. George Edward Quick's Trust, 54 TC

1336 (1970) (acq.), aff'd per curiam, 444 F.2d 90 (8th Cir. 1971);

Chrissie H. Woodhall, 28 T.C.M. 1438 (1969), aff'd, 454 F.2d 226 (9th

Cir. 1972); Rev. Rul. 66-325, 1966-2 C.B. 249. Where a partnership

holds assets that represent income in respect of a decedent, the

section 743(b) adjustment should be allocated solely to other assets.

Accordingly, the final regulations provide that if a partnership

interest is transferred as a result of the death of a partner, and the

partnership holds assets representing income in respect of a decedent,

no part of the basis adjustment under section 743(b) is allocated to

these assets.

(b) Transferred basis transactions. One commentator called for a

revised system for allocating basis adjustments under section 743(b)

which are triggered by exchanges in which the transferee's basis in the

interest is determined in whole or in part by reference to the

transferor's basis in the interest. In many such cases, the net section

743(b) adjustment will be zero. However, a positive or negative section

743(b) adjustment may result, because the transferee's basis in the

interest may not be equal to the transferee's share of the

partnership's bases in its assets.

The IRS and the Treasury Department believe that, although these

transferred basis transactions involve transfers which are subject to

section 743(b), the new, comprehensive basis allocation rules in the

proposed regulations should not be available. For example, where a

partnership interest is contributed to a corporation in a transaction

to which section 351 applies, or to a partnership in a transaction to

which section 721(a) applies, the transferor merely has changed the

form of its investment. If

[[Page 69906]]

the allocation rules which apply to other section 743(b) transfers were

applied to these exchanges, then partners could use these exchanges to

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

versa.

Therefore, the final regulations contain special basis allocation

rules for transferred basis exchanges. The special rules generally are

modeled on the rules for allocating basis adjustments under section

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

regarding the special basis allocation rules which are applicable to

such transfers. However, there may be situations where taxpayers will

attempt to undertake abusive transactions using these special rules.

For instance, a partner could acquire a partnership interest during a

year in which no section 754 election is in effect, and then (in a

related transaction) contribute the property to a wholly-owned

corporation in order to take advantage of the basis allocation rules

applicable to transferred basis exchanges. In appropriate situations,

the IRS may attack such abusive transactions under a variety of

judicial doctrines, including substance over form or step transaction,

or under Sec. 1.701-2 of the regulations.

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

requested that the final regulations illustrate the effect of

depreciation recapture on the allocation of basis adjustments among

partnership assets under section 755. For purposes of this section, the

final regulations treat depreciation recapture, and any other

properties or potential gain treated as unrealized receivables under

section 751(c) and the regulations thereunder, as separate assets that

are ordinary income property.

(d) Special rules for securities partnerships and tiered

partnerships. One commentator suggested that the regulations permit

securities partnerships to allocate basis adjustments among partnership

assets using an aggregation method. Another commentator requested that

the regulations clarify how the regulations would apply to tiered

partnerships. The IRS and the Treasury Department believe that a method

for allocating basis adjustments among partnership assets on an

aggregate basis is not consistent with the hypothetical sale of

individual assets, which is required by the regulations. In addition,

the IRS and Treasury Department believe that special rules for tiered

partnerships would make the regulations more complex. Therefore, these

changes have not been adopted.

6. Other Comments

One commentator suggested that for purposes of allocating basis

adjustments among partnership assets, the values of all partnership

assets should be determined by reference to the basis of the transferee

or distributee partner in its partnership interest. This suggestion is

being considered in connection with a separate project currently under

review by the IRS and the Treasury Department.

One commentator suggested that the language of section 743 does not

authorize regulations that permit both positive and negative

adjustments as part of the same transaction. The IRS and the Treasury

Department continue to believe that this aspect of the regulations is

within the IRS's authority to administer sections 743 and 755.

Special Analyses

It has been determined that these final regulations are not a

significant regulatory action as defined in Executive Order 12866.

Therefore, a regulatory assessment is not required. It has been

determined that a final regulatory flexibility analysis is required for

the collection of information in this Treasury decision under 5 U.S.C.

604. A summary of the analysis is set forth below under the heading

``Summary of Final Regulatory Flexibility Act Analysis.'' Pursuant to

section 7805(f) of the Internal Revenue Code, these final regulations

have been submitted to the Chief Counsel for Advocacy of the Small

Business Administration for comment on their impact on small business.

Summary of Final Regulatory Flexibility Act Analysis

This analysis is required under the Regulatory Flexibility Act (5

U.S.C. chapter 6). In general, the regulations require a transferee

that acquires an interest in a partnership with an election under

section 754 in effect to notify the partnership of the transfer. This

notification must include the name and taxpayer identification number

of the transferee and the transferee's basis in the acquired

partnership interest. The partnership is required to include a

statement with its Form 1065, U.S. Partnership Return of Income, for

the taxable year in which the partnership acquires knowledge of the

transfer. This statement must identify the name and taxpayer

identification number of the transferee, the computation of the basis

adjustment, and the allocation of that adjustment to partnership

properties. These requirements will ensure that the partnership has

notice that a transfer has occurred and that the proper basis

adjustments are computed. The legal basis for these requirements is

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

If an interest is transferred in a partnership holding domestic oil

and gas properties that are depleted at the partner level under

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

than the partnership) to make and allocate basis adjustments under

section 743(b) among such properties.

There were approximately 1,494,000 partnerships in 1994. However,

these regulations apply only to partnerships that have made an election

under section 754. The election under section 754 is generally not made

unless there has been a transfer of a partnership interest or a

distribution by the partnership. Moreover, the effects of the election

attach to specific items of partnership property and may provide only

temporary benefits for the partners. Except for the one-time revocation

which is allowed in connection with the promulgation of these final

regulations, the election cannot be revoked without the consent of the

Secretary. The IRS and the Treasury Department believe that most

partnerships do not make the election under section 754. Therefore,

most partnerships will not be affected by the regulations in any given

year.

After a partner conveys information to the partnership concerning a

transfer of a partnership interest, the partnership must adjust the

partner's interest in the basis of partnership property. Because these

basis adjustments will affect the partner's share of depreciation or

amortization deductions and amounts of gain or loss on the disposition

of certain items of partnership property, the partnership must prepare

and maintain special entries on its books. However, in many cases,

partnership returns are prepared using computer software that can

prepare and maintain these special entries after the initial year.

The IRS and the Treasury Department are not aware of any federal

rules that may duplicate, overlap, or conflict with the rule.

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

the Treasury Department considered, but rejected, a rule that would

have required the partners, and not the partnerships, to make the basis

adjustments and to determine the effects of the basis adjustments on

the partners' distributive shares. This alternative was rejected

because the IRS and the Treasury Department believe that partnerships

generally have better access to the information necessary to report

section 743 basis adjustments properly. To

[[Page 69907]]

require the partners rather than the partnerships to bear the burden of

reporting would require the partnerships to provide the partners with

significant amounts of information not otherwise needed by the

partners. There are no known alternative rules that are less burdensome

to the partnerships and their partners but that accomplish the purpose

of the statute.

Finally, because partners, rather than partnerships, are required

to report basis adjustments under section 732(d), the final regulations

require partnerships to provide transferees with such information as is

necessary for the transferees properly to compute basis adjustments

made under section 732(d). This information must be provided if a

transferee notifies a partnership that it plans to make the election

under section 732(d) or if a partnership makes a distribution subject

to the mandatory application of section 732(d). The IRS and the

Treasury Department believe that this requirement will apply under

limited circumstances to a small percentage of partnerships.

Drafting Information

The principal author of these regulations is Matthew Lay of the

Office of the Assistant Chief Counsel (Passthroughs and Special

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

Department participated in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding

entries in numerical order to read as follows:

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

Section 1.732-1 also issued under 26 U.S.C. 732.

Section 1.732-2 also issued under 26 U.S.C. 732.

Section 1.734-1 also issued under 26 U.S.C. 734.

Section 1.743-1 also issued under 26 U.S.C. 743.

Section 1.751-1 also issued under 26 U.S.C. 751.

Section 1.755-1 also issued under 26 U.S.C. 755. * * *

Section 1.1017-1 also issued under 26 U.S.C. 1017. * * *

Par. 2. Section 1.732-1 is amended as follows:

1. Revise paragraph (c).

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

3. Revise the last sentence of paragraph (d)(1)(v).

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

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

6. Remove the flush text and Examples 1 and 2 following paragraph

(d)(4)(iii).

7. Add paragraph (d)(5).

The additions and revisions read as follows:

Sec. 1.732-1 Basis of distributed property other than money.

* * * * *

(c) Allocation of basis among properties distributed to a partner--

(1) General rule--(i) Unrealized receivables and inventory items. The

basis to be allocated to properties distributed to a partner under

section 732(a)(2) or (b) is allocated first to any unrealized

receivables (as defined in section 751(c)) and inventory items (as

defined in section 751(d)(2)) in an amount equal to the adjusted basis

of each such property to the partnership immediately before the

distribution. If the basis to be allocated is less than the sum of the

adjusted bases to the partnership of the distributed unrealized

receivables and inventory items, the adjusted basis of the distributed

property must be decreased in the manner provided in paragraph

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

(ii) Other distributed property. Any basis not allocated to

unrealized receivables or inventory items under paragraph (c)(1)(i) of

this section is allocated to any other property distributed to the

partner in the same transaction by assigning to each distributed

property an amount equal to the adjusted basis of the property to the

partnership immediately before the distribution. However, if the sum of

the adjusted bases to the partnership of such other distributed

property does not equal the basis to be allocated among the distributed

property, any increase or decrease required to make the amounts equal

is allocated among the distributed property as provided in paragraph

(c)(2) of this section.

(2) Adjustment to basis allocation--(i) Decrease in basis. Any

decrease to the basis of distributed property required under paragraph

(c)(1) of this section is allocated first to distributed property with

unrealized depreciation in proportion to each property's respective

amount of unrealized depreciation before any decrease (but only to the

extent of each property's unrealized depreciation). If the required

decrease exceeds the amount of unrealized depreciation in the

distributed property, the excess is allocated to the distributed

property in proportion to the adjusted bases of the distributed

property, as adjusted pursuant to the immediately preceding sentence.

(ii) Increase in basis. Any increase to the basis of distributed

property required under paragraph (c)(1)(ii) of this section is

allocated first to distributed property (other than unrealized

receivables and inventory items) with unrealized appreciation in

proportion to each property's respective amount of unrealized

appreciation before any increase (but only to the extent of each

property's unrealized appreciation). If the required increase exceeds

the amount of unrealized appreciation in the distributed property, the

excess is allocated to the distributed property (other than unrealized

receivables or inventory items) in proportion to the fair market value

of the distributed property.

(3) Unrealized receivables and inventory items. If the basis to be

allocated upon a distribution in liquidation of the partner's entire

interest in the partnership is greater than the adjusted basis to the

partnership of the unrealized receivables and inventory items

distributed to the partner, and if there is no other property

distributed to which the excess can be allocated, the distributee

partner sustains a capital loss under section 731(a)(2) to the extent

of the unallocated basis of the partnership interest.

(4) Examples. The provisions of this paragraph (c) are illustrated

by the following examples:

Example 1. A is a one-fourth partner in partnership PRS and has

an adjusted basis in its partnership interest of $650. PRS

distributes inventory items and Assets X and Y to A in liquidation

of A's entire partnership interest. The distributed inventory items

have a basis to the partnership of $100 and a fair market value of

$200. Asset X has an adjusted basis to the partnership of $50 and a

fair market value of $400. Asset Y has an adjusted basis to the

partnership and a fair market value of $100. Neither Asset X nor

Asset Y consists of inventory items or unrealized receivables. Under

this paragraph (c), A's basis in its partnership interest is

allocated first to the inventory items in an amount equal to their

adjusted basis to the partnership. A, therefore, has an adjusted

basis in the inventory items of $100. The remaining basis, $550, is

allocated to the distributed property first in an amount equal to

the property's adjusted basis to the partnership. Thus, Asset X is

allocated $50 and Asset Y is allocated $100. Asset X is then

allocated $350, the amount of unrealized appreciation in Asset

[[Page 69908]]

X. Finally, the remaining basis, $50, is allocated to Assets X and Y

in proportion to their fair market values: $40 to Asset X (400/500

x $50), and $10 to Asset Y (100/500 x $50). Therefore, after the

distribution, A has an adjusted basis of $440 in Asset X and $110 in

Asset Y.

Example 2. B is a one-fourth partner in partnership PRS and has

an adjusted basis in its partnership interest of $200. PRS

distributes Asset X and Asset Y to B in liquidation of its entire

partnership interest. Asset X has an adjusted basis to the

partnership and fair market value of $150. Asset Y has an adjusted

basis to the partnership of $150 and a fair market value of $50.

Neither of the assets consists of inventory items or unrealized

receivables. Under this paragraph (c), B's basis is first assigned

to the distributed property to the extent of the partnership's basis

in each distributed property. Thus, Asset X and Asset Y are each

assigned $150. Because the aggregate adjusted basis of the

distributed property, $300, exceeds the basis to be allocated, $200,

a decrease of $100 in the basis of the distributed property is

required. Assets X and Y have unrealized depreciation of zero and

$100, respectively. Thus, the entire decrease is allocated to Asset

Y. After the distribution, B has an adjusted basis of $150 in Asset

X and $50 in Asset Y.

Example 3. C, a partner in partnership PRS, receives a

distribution in liquidation of its entire partnership interest of

$6,000 cash, inventory items having an adjusted basis to the

partnership of $6,000, and real property having an adjusted basis to

the partnership of $4,000. C's basis in its partnership interest is

$9,000. The cash distribution reduces C's basis to $3,000, which is

allocated entirely to the inventory items. The real property has a

zero basis in C's hands. The partnership bases not carried over to C

for the distributed properties are lost unless an election under

section 754 is in effect requiring the partnership to adjust the

bases of remaining partnership properties under section 734(b).

Example 4. Assume the same facts as in Example 3 of this

paragraph except C receives a distribution in liquidation of its

entire partnership interest of $1,000 cash and inventory items

having a basis to the partnership of $6,000. The cash distribution

reduces C's basis to $8,000, which can be allocated only to the

extent of $6,000 to the inventory items. The remaining $2,000 basis,

not allocable to the distributed property, constitutes a capital

loss to partner C under section 731(a)(2). If the election under

section 754 is in effect, see section 734(b) for adjustment of the

basis of undistributed partnership property.

(5) Effective date. This paragraph (c) applies to distributions of

property from a partnership that occur on or after December 15, 1999.

(d) * * *

(1) * * *

(ii) Where an election under section 754 is in effect, see section

743(b) and Secs. 1.743-1 and 1.732-2.

* * * * *

(v) * * * (For a shift of transferee's basis adjustment under

section 743(b) to like property, see Sec. 1.743-1(g).)

(vi) The provisions of this paragraph (d)(1) may be illustrated by

the following example:

Example. (i) Transferee partner, T, purchased a one-fourth

interest in partnership PRS for $17,000. At the time T purchased the

partnership interest, the election under section 754 was not in

effect and the partnership inventory had a basis to the partnership

of $14,000 and a fair market value of $16,000. T's purchase price

reflected $500 of this difference. Thus, $4,000 of the $17,000 paid

by T for the partnership interest was attributable to T's share of

partnership inventory with a basis of $3,500. Within 2 years after T

acquired the partnership interest, T retired from the partnership

and received in liquidation of its entire partnership interest the

following property:

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

Assets

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

Adjusted basis Fair market

to PRS value

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

Cash.................................... $1,500 $1,500

Inventory............................... 3,500 4,000

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

Asset Y................................. 4,000 5,000

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

(ii) The fair market value of the inventory received by T was

one-fourth of the fair market value of all partnership inventory and

was T's share of such property. It is immaterial whether the

inventory T received was on hand when T acquired the interest. In

accordance with T's election under section 732(d), the amount of T's

share of partnership basis that is attributable to partnership

inventory is increased by $500 (one-fourth of the $2,000 difference

between the fair market value of the property, $16,000, and its

$14,000 basis to the partnership at the time T purchased its

interest). This adjustment under section 732(d) applies only for

purposes of distributions to T, and not for purposes of partnership

depreciation, depletion, or gain or loss on disposition. Thus, the

amount to be allocated among the properties received by T in the

liquidating distribution is $15,500 ($17,000, T's basis for the

partnership interest, reduced by the amount of cash received,

$1,500). This amount is allocated as follows: The basis of the

inventory items received is $4,000, consisting of the $3,500 common

partnership basis, plus the basis adjustment of $500 which T would

have had under section 743(b). The remaining basis of $11,500

($15,500 minus $4,000) is allocated among the remaining property

distributed to T by assigning to each property the adjusted basis to

the partnership of such property and adjusting that basis by any

required increase or decrease. Thus, the adjusted basis to T of

Asset X is $5,111 ($2,000, the adjusted basis of Asset X to the

partnership, plus $2,000, the amount of unrealized appreciation in

Asset X, plus $1,111 ($4,000/$9,000 multiplied by $2,500)).

Similarly, the adjusted basis of Asset Y to T is $6,389 ($4,000, the

adjusted basis of Asset Y to the partnership, plus $1,000, the

amount of unrealized appreciation in Asset Y, plus, $1,389 ($5,000/

$9,000 multiplied by $2,500)).

* * * * *

(4) * * *

(iii) A basis adjustment under section 743(b) would change the

basis to the transferee partner of the property actually distributed.

(5) Required statements. If a transferee partner notifies a

partnership that it plans to make the election under section 732(d)

under paragraph (d)(3) of this section, or if a partnership makes a

distribution to which paragraph (d)(4) of this section applies, the

partnership must provide the transferee with such information as is

necessary for the transferee properly to compute the transferee's basis

adjustments under section 732(d).

* * * * *

Par. 3. Section 1.732-2 is amended by revising the sentence at the

end of the Example in paragraph (b) to read as follows:

Sec. 1.732-2 Special partnership basis of distributed property.

* * * * *

(b) * * *

Example. * * * See Sec. 1.743-1(g).

* * * * *

Par. 4. In Sec. 1.734-1, paragraph (e) is added to read as follows:

Sec. 1.734-1 Optional adjustment to basis of undistributed partnership

property.

* * * * *

(e) Recovery of adjustments to basis of partnership property--(1)

Increases in basis. For purposes of section 168, if the basis of a

partnership's recovery property is increased as a result of the

distribution of property to a partner, then the increased portion of

the basis

[[Page 69909]]

must be taken into account as if it were newly-purchased recovery

property placed in service when the distribution occurs. Consequently,

any applicable recovery period and method may be used to determine the

recovery allowance with respect to the increased portion of the basis.

However, no change is made for purposes of determining the recovery

allowance under section 168 for the portion of the basis for which

there is no increase.

(2) Decreases in basis. For purposes of section 168, if the basis

of a partnership's recovery property is decreased as a result of the

distribution of property to a partner, then the decrease in basis must

be accounted for over the remaining recovery period of the property

beginning with the recovery period in which the basis is decreased.

(3) Effective date. This paragraph (e) applies to distributions of

property from a partnership that occur on or after December 15, 1999.

Par. 5. Section 1.743-1 is revised to read as follows:

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

(a) Generally. The basis of partnership property is adjusted as a

result of the transfer of an interest in a partnership by sale or

exchange or on the death of a partner only if the election provided by

section 754 (relating to optional adjustments to the basis of

partnership property) is in effect with respect to the partnership.

Whether or not the election provided in section 754 is in effect, the

basis of partnership property is not adjusted as the result of a

contribution of property, including money, to the partnership.

(b) Determination of adjustment. In the case of the transfer of an

interest in a partnership, either by sale or exchange or as a result of

the death of a partner, a partnership that has an election under

section 754 in effect--

(1) Increases the adjusted basis of partnership property by the

excess of the transferee's basis for the transferred partnership

interest over the transferee's share of the adjusted basis to the

partnership of the partnership's property; or

(2) Decreases the adjusted basis of partnership property by the

excess of the transferee's share of the adjusted basis to the

partnership of the partnership's property over the transferee's basis

for the transferred partnership interest.

(c) Determination of transferee's basis in the transferred

partnership interest. In the case of the transfer of a partnership

interest by sale or exchange or as a result of the death of a partner,

the transferee's basis in the transferred partnership interest is

determined under section 742 and Sec. 1.742-1. See also section 752 and

Secs. 1.752-1 through 1.752-5.

(d) Determination of transferee's share of the adjusted basis to

the partnership of the partnership's property--(1) Generally. A

transferee's share of the adjusted basis to the partnership of

partnership property is equal to the sum of the transferee's interest

as a partner in the partnership's previously taxed capital, plus the

transferee's share of partnership liabilities. Generally, a

transferee's interest as a partner in the partnership's previously

taxed capital is equal to--

(i) The amount of cash that the transferee would receive on a

liquidation of the partnership following the hypothetical transaction,

as defined in paragraph (d)(2) of this section (to the extent

attributable to the acquired partnership interest); increased by

(ii) The amount of tax loss (including any remedial allocations

under Sec. 1.704-3(d)), that would be allocated to the transferee from

the hypothetical transaction (to the extent attributable to the

acquired partnership interest); and decreased by

(iii) The amount of tax gain (including any remedial allocations

under Sec. 1.704-3(d)), that would be allocated to the transferee from

the hypothetical transaction (to the extent attributable to the

acquired partnership interest).

(2) Hypothetical transaction defined. For purposes of paragraph

(d)(1) of this section, the hypothetical transaction means the

disposition by the partnership of all of the partnership's assets,

immediately after the transfer of the partnership interest, in a fully

taxable transaction for cash equal to the fair market value of the

assets.

(3) Examples. The provisions of this paragraph (d) are illustrated

by the following examples:

Example 1. (i) A is a member of partnership PRS in which the

partners have equal interests in capital and profits. The

partnership has made an election under section 754, relating to the

optional adjustment to the basis of partnership property. A sells

its interest to T for $22,000. The balance sheet of the partnership

at the date of sale shows the following:

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

Assets

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

Fair market

Adjusted basis value

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

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

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

Inventory............................... 20,000 21,000

Depreciable assets...................... 20,000 40,000

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

Total............................... 55,000 76,000

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

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

Liabilities and Capital

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

Adjusted per Fair market

books value

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

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

Capital:

A................................... 15,000 22,000

B................................... 15,000 22,000

C................................... 15,000 22,000

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

Total........................... 55,000 76,000

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

[[Page 69910]]

(ii) The amount of the basis adjustment under section 743(b) is

the difference between the basis of T's interest in the partnership

and T's share of the adjusted basis to the partnership of the

partnership's property. Under section 742, the basis of T's interest

is $25,333 (the cash paid for A's interest, $22,000, plus $3,333,

T's share of partnership liabilities). T's interest in the

partnership's previously taxed capital is $15,000 ($22,000, the

amount of cash T would receive if PRS liquidated immediately after

the hypothetical transaction, decreased by $7,000, the amount of tax

gain allocated to T from the hypothetical transaction). T's share of

the adjusted basis to the partnership of the partnership's property

is $18,333 ($15,000 share of previously taxed capital, plus $3,333

share of the partnership's liabilities). The amount of the basis

adjustment under section 743(b) to partnership property therefore,

is $7,000, the difference between $25,333 and $18,333.

Example 2. A, B, and C form partnership PRS, to which A

contributes land (Asset 1) with a fair market value of $1,000 and an

adjusted basis to A of $400, and B and C each contribute $1,000

cash. Each partner has $1,000 credited to it on the books of the

partnership as its capital contribution. The partners share in

profits equally. During the partnership's first taxable year, Asset

1 appreciates in value to $1,300. A sells its one-third interest in

the partnership to T for $1,100, when an election under section 754

is in effect. The amount of tax gain that would be allocated to T

from the hypothetical transaction is $700 ($600 section 704(c)

built-in gain, plus one-third of the additional gain). Thus, T's

interest in the partnership's previously taxed capital is $400

($1,100, the amount of cash T would receive if PRS liquidated

immediately after the hypothetical transaction, decreased by $700,

T's share of gain from the hypothetical transaction). The amount of

T's basis adjustment under section 743(b) to partnership property is

$700 (the excess of $1,100, T's cost basis for its interest, over

$400, T's share of the adjusted basis to the partnership of

partnership property).

(e) Allocation of basis adjustment. For the allocation of the basis

adjustment under this section among the individual items of partnership

property, see section 755 and the regulations thereunder.

(f) Subsequent transfers. Where there has been more than one

transfer of a partnership interest, a transferee's basis adjustment is

determined without regard to any prior transferee's basis adjustment.

In the case of a gift of an interest in a partnership, the donor is

treated as transferring, and the donee as receiving, that portion of

the basis adjustment attributable to the gifted partnership interest.

The provisions of this paragraph (f) are illustrated by the following

example:

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

contribute $1,000 cash, and C contributes land with a basis and fair

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

$1,300, A sells its interest to T1 for $1,100 (one-third of $3,300,

the fair market value of the partnership property). An election

under section 754 is in effect; therefore, T1 has a basis adjustment

under section 743(b) of $100.

(ii) After the land has further appreciated in value to $1,600,

T1 sells its interest to T2 for $1,200 (one-third of $3,600, the

fair market value of the partnership property). T2 has a basis

adjustment under section 743(b) of $200. This amount is determined

without regard to any basis adjustment under section 743(b) that T1

may have had in the partnership assets.

(iii) During the following year, T2 makes a gift to T3 of fifty

percent of T2's interest in PRS. At the time of the transfer, T2 has

a $200 basis adjustment under section 743(b). T2 is treated as

transferring $100 of the basis adjustment to T3 with the gift of the

partnership interest.

(g) Distributions--(1) Distribution of adjusted property to the

transferee--(i) Coordination with section 732. If a partnership

distributes property to a transferee and the transferee has a basis

adjustment for the property, the basis adjustment is taken into account

under section 732. See Sec. 1.732-2(b).

(ii) Coordination with section 734. For certain adjustments to the

common basis of remaining partnership property after the distribution

of adjusted property to a transferee, see Sec. 1.734-2(b).

(2) Distribution of adjusted property to another partner--(i)

Coordination with section 732. If a partner receives a distribution of

property with respect to which another partner has a basis adjustment,

the distributee does not take the basis adjustment into account under

section 732.

(ii) Reallocation of basis. A transferee with a basis adjustment in

property that is distributed to another partner reallocates the basis

adjustment among the remaining items of partnership property under

Sec. 1.755-1(c).

(3) Distributions in complete liquidation of a partner's interest.

If a transferee receives a distribution of property (whether or not the

transferee has a basis adjustment in such property) in liquidation of

its interest in the partnership, the adjusted basis to the partnership

of the distributed property immediately before the distribution

includes the transferee's basis adjustment for the property in which

the transferee relinquished an interest (either because it remained in

the partnership or was distributed to another partner). Any basis

adjustment for property in which the transferee is deemed to relinquish

its interest is reallocated among the properties distributed to the

transferee under Sec. 1.755-1(c).

(4) Coordination with other provisions. The rules of sections

704(c)(1)(B), 731, 737, and 751 apply before the rules of this

paragraph (g).

(5) Example. The provisions of this paragraph (g) are illustrated

by the following example:

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

Each partner originally contributed $10,000 in cash, and PRS used

the contributions to purchase five nondepreciable capital assets.

PRS has no liabilities. After five years, PRS's balance sheet

appears as follows:

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

Assets

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

Fair market

Adjusted basis value

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

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

Asset 2................................. 4,000 6,000

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

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

Asset 5................................. 3,000 13,000

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

Total............................... 30,000 39,000

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

[[Page 69911]]

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

Capital

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

Adjusted per Fair market

books value

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

Partner A............................... $10,000 $13,000

Partner B............................... 10,000 13,000

Partner C............................... 10,000 13,000

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

Total............................... 30,000 39,000

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

(ii) A sells its interest to T for $13,000 when PRS has an

election in effect under section 754. T receives a basis adjustment

under section 743(b) in the partnership property that is equal to

$3,000 (the excess of T's basis in the partnership interest,

$13,000, over T's share of the adjusted basis to the partnership of

partnership property, $10,000). The basis adjustment is allocated

under section 755, and the partnership's balance sheet appears as

follows:

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

Assets

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

Fair market Basis

Adjusted basis value adjustment

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

Asset 1......................................................... $10,000 $10,000 $0.00

Asset 2......................................................... 4,000 6,000 666.67

Asset 3......................................................... 6,000 6,000 0.00

Asset 4......................................................... 7,000 4,000 (1,000.00)

Asset 5......................................................... 3,000 13,000 3,333.33

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

Total....................................................... 30,000 39,000 3,000.00

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

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

Capital

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

Adjusted per Fair market

books value Special basis

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

Partner T....................................................... $10,000 $13,000 $3,000

Partner B....................................................... 10,000 13,000 0

Partner C....................................................... 10,000 13,000 0

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

Total....................................................... 30,000 39,000 3,000

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

(iii) Assume that PRS distributes Asset 2 to T in partial

liquidation of T's interest in the partnership. T has a basis

adjustment under section 743(b) of $666.67 in Asset 2. Under

paragraph (g)(1)(i) of this section, T takes the basis adjustment

into account under section 732. Therefore, T will have a basis in

Asset 2 of $4,666.67 following the distribution.

(iv) Assume instead that PRS distributes Asset 5 to C in

complete liquidation of C's interest in PRS. T has a basis

adjustment under section 743(b) of $3,333.33 in Asset 5. Under

paragraph (g)(2)(i) of this section, C does not take T's basis

adjustment into account under section 732. Therefore, the

partnership's basis for purposes of sections 732 and 734 is $3,000.

Under paragraph (g)(2)(ii) of this section, T's $3,333.33 basis

adjustment is reallocated among the remaining partnership assets

under Sec. 1.755-1(c).

(v) Assume instead that PRS distributes Asset 5 to T in complete

liquidation of its interest in PRS. Under paragraph (g)(3) of this

section, immediately prior to the distribution of Asset 5 to T, PRS

must adjust the basis of Asset 5. Therefore, immediately prior to

the distribution, PRS's basis in Asset 5 is equal to $6,000, which

is the sum of (A) $3,000, PRS's common basis in Asset 5, plus (B)

$3,333.33, T's basis adjustment to Asset 5, plus (C) ($333.33), the

sum of T's basis adjustments in Assets 2 and 4. For purposes of

sections 732 and 734, therefore, PRS will be treated as having a

basis in Asset 5 equal to $6,000.

(h) Contributions of adjusted property--(1) Section 721(a)

transactions. If, in a transaction described in section 721(a), a

partnership (the upper tier) contributes to another partnership (the

lower tier) property with respect to which a basis adjustment has been

made, the basis adjustment is treated as contributed to the lower-tier

partnership, regardless of whether the lower-tier partnership makes a

section 754 election. The lower tier's basis in the contributed assets

and the upper tier's basis in the partnership interest received in the

transaction are determined with reference to the basis adjustment.

However, that portion of the basis of the upper tier's interest in the

lower tier attributable to the basis adjustment must be segregated and

allocated solely to the transferee partner for whom the basis

adjustment was made. Similarly, that portion of the lower tier's basis

in its assets attributable to the basis adjustment must be segregated

and allocated solely to the upper tier and the transferee. A partner

with a basis adjustment in property held by a partnership that

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

basis adjustment with respect to property deemed contributed by the

terminated partnership to the new partnership under Sec. 1.708-

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

754 election.

(2) Section 351 transactions--(i) Basis in transferred property. A

corporation's adjusted tax basis in property transferred to the

corporation by a partnership in a transaction described in section 351

is determined with reference to any basis adjustments to the property

under section 743(b) (other than any basis adjustment that reduces a

partner's gain under paragraph (h)(2)(ii) of this section).

(ii) Partnership gain. The amount of gain, if any, recognized by

the partnership on a transfer of property by the partnership to a

corporation in a transfer described in section 351 is determined

without reference to any basis adjustment to the transferred property

under section 743(b). The amount of gain, if any, recognized by the

partnership on the transfer that is allocated to a partner with a basis

adjustment in the transferred property is

[[Page 69912]]

adjusted to reflect the partner's basis adjustment in the transferred

property.

(iii) Basis in stock. The partnership's adjusted tax basis in stock

received from a corporation in a transfer described in section 351 is

determined without reference to the basis adjustment in property

transferred to the corporation in the section 351 exchange. A partner

with a basis adjustment in property transferred to the corporation,

however, has a basis adjustment in the stock received by the

partnership in the section 351 exchange in an amount equal to the

partner's basis adjustment in the transferred property, reduced by any

basis adjustment that reduced the partner's gain under paragraph

(h)(2)(ii) of this section.

(iv) Example. The following example illustrates the principles of

this paragraph (h):

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

The partnership's only asset, Asset 1, has an adjusted tax basis of

$60 and a fair market value of $120. Asset 1 is a nondepreciable

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

its partnership interest of $40, and a positive section 743(b)

adjustment of $20 in Asset 1. In a transaction to which section 351

applies, PRS contributes Asset 1 to X, a corporation, in exchange

for $15 in cash and X stock with a fair market value of $105.

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

$60 of gain on the transfer of Asset 1 to X ($120, its amount

realized, minus $60, its adjusted basis), but recognizes only $15 of

that gain under section 351(b)(1). Of this amount, $5 is allocated

to each partner. A must use $5 of its basis adjustment in Asset 1 to

offset A's share of PRS's gain. Under paragraph (h)(2)(iii) of this

section, PRS's basis in the stock received from X is $60. However, A

has a basis adjustment in the stock received by PRS equal to $15

(its basis adjustment in Asset 1, $20, reduced by the portion of the

adjustment which reduced A's gain, $5). Under paragraph (h)(2)(i) of

this section, X's basis in Asset 1 equals $75 (PRS's common basis in

the asset, $60, plus A's basis adjustment under section 743(b), $20,

less the portion of the adjustment which reduced A's gain, $5).

(i) [Reserved].

(j) Effect of basis adjustment--(1) In general. The basis

adjustment constitutes an adjustment to the basis of partnership

property with respect to the transferee only. No adjustment is made to

the common basis of partnership property. Thus, for purposes of

calculating income, deduction, gain, and loss, the transferee will have

a special basis for those partnership properties the bases of which are

adjusted under section 743(b) and this section. The adjustment to the

basis of partnership property under section 743(b) has no effect on the

partnership's computation of any item under section 703.

(2) Computation of partner's distributive share of partnership

items. The partnership first computes its items of income, deduction,

gain, or loss at the partnership level under section 703. The

partnership then allocates the partnership items among the partners,

including the transferee, in accordance with section 704, and adjusts

the partners' capital accounts accordingly. The partnership then

adjusts the transferee's distributive share of the items of partnership

income, deduction, gain, or loss, in accordance with paragraphs (j)(3)

and (4) of this section, to reflect the effects of the transferee's

basis adjustment under section 743(b). These adjustments to the

transferee's distributive shares must be reflected on Schedules K and

K-1 of the partnership's return (Form 1065). These adjustments to the

transferee's distributive shares do not affect the transferee's capital

account.

(3) Effect of basis adjustment in determining items of income,

gain, or loss--(i) In general. The amount of a transferee's income,

gain, or loss from the sale or exchange of a partnership asset in which

the transferee has a basis adjustment is equal to the transferee's

share of the partnership's gain or loss from the sale of the asset

(including any remedial allocations under Sec. 1.704-3(d)), minus the

amount of the transferee's positive basis adjustment for the

partnership asset (determined by taking into account the recovery of

the basis adjustment under paragraph (j)(4)(i)(B) of this section) or

plus the amount of the transferee's negative basis adjustment for the

partnership asset (determined by taking into the account the recovery

of the basis adjustment under paragraph (j)(4)(ii)(B) of this section).

(ii) Examples. The following examples illustrate the principles of

this paragraph (j)(3):

Example 1. A and B form equal partnership PRS. A contributes

nondepreciable property with a fair market value of $50 and an

adjusted tax basis of $100. PRS will use the traditional allocation

method under Sec. 1.704-3(b). B contributes $50 cash. A sells its

interest to T for $50. PRS has an election in effect to adjust the

basis of partnership property under section 754. T receives a

negative $50 basis adjustment under section 743(b) that, under

section 755, is allocated to the nondepreciable property. PRS then

sells the property for $60. PRS recognizes a book gain of $10

(allocated equally between T and B) and a tax loss of $40. T will

receive an allocation of $40 of tax loss under the principles of

section 704(c). However, because T has a negative $50 basis

adjustment in the nondepreciable property, T recognizes a $10 gain

from the partnership's sale of the property.

Example 2. A and B form equal partnership PRS. A contributes

nondepreciable property with a fair market value of $100 and an

adjusted tax basis of $50. B contributes $100 cash. PRS will use the

traditional allocation method under Sec. 1.704-3(b). A sells its

interest to T for $100. PRS has an election in effect to adjust the

basis of partnership property under section 754. Therefore, T

receives a $50 basis adjustment under section 743(b) that, under

section 755, is allocated to the nondepreciable property. PRS then

sells the nondepreciable property for $90. PRS recognizes a book

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

$40. T will receive an allocation of the entire $40 of tax gain

under the principles of section 704(c). However, because T has a $50

basis adjustment in the property, T recognizes a $10 loss from the

partnership's sale of the property.

Example 3. A and B form equal partnership PRS. PRS will make

allocations under section 704(c) using the remedial allocation

method described in Sec. 1.704-3(d). A contributes nondepreciable

property with a fair market value of $100 and an adjusted tax basis

of $150. B contributes $100 cash. A sells its partnership interest

to T for $100. PRS has an election in effect to adjust the basis of

partnership property under section 754. T receives a negative $50

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

allocated to the property. The partnership then sells the property

for $120. The partnership recognizes a $20 book gain and a $30 tax

loss. The book gain will be allocated equally between the partners.

The entire $30 tax loss will be allocated to T under the principles

of section 704(c). To match its $10 share of book gain, B will be

allocated $10 of remedial gain, and T will be allocated an

offsetting $10 of remedial loss. T was allocated a total of $40 of

tax loss with respect to the property. However, because T has a

negative $50 basis adjustment to the property, T recognizes a $10

gain from the partnership's sale of the property.

(4) Effect of basis adjustment in determining items of deduction--

(i) Increases--(A) Additional deduction. The amount of any positive

basis adjustment that is recovered by the transferee in any year is

added to the transferee's distributive share of the partnership's

depreciation or amortization deductions for the year. The basis

adjustment is adjusted under section 1016(a)(2) to reflect the recovery

of the basis adjustment.

(B) Recovery period--(1) In general. Except as provided in

paragraph (j)(4)(i)(B)(2) of this section, for purposes of section 168,

if the basis of a partnership's recovery property is increased as a

result of the transfer of a partnership interest, then the increased

portion of the basis is taken into account as if it were newly-

purchased recovery

[[Page 69913]]

property placed in service when the transfer occurs. Consequently, any

applicable recovery period and method may be used to determine the

recovery allowance with respect to the increased portion of the basis.

However, no change is made for purposes of determining the recovery

allowance under section 168 for the portion of the basis for which

there is no increase.

(2) Remedial allocation method. If a partnership elects to use the

remedial allocation method described in Sec. 1.704-3(d) with respect to

an item of the partnership's recovery property, then the portion of any

increase in the basis of the item of the partnership's recovery

property under section 743(b) that is attributable to section 704(c)

built-in gain is recovered over the remaining recovery period for the

partnership's excess book basis in the property as determined in the

final sentence of Sec. 1.704-3(d)(2). Any remaining portion of the

basis increase is recovered under paragraph (j)(4)(i)(B)(1) of this

section.

(C) Examples. The provisions of this paragraph (j)(4)(i) are

illustrated by the following examples:

Example 1. (i) A, B, and C are equal partners in partnership

PRS, which owns Asset 1, an item of depreciable property that has a

fair market value in excess of its adjusted tax basis. C sells its

interest in PRS to T while PRS has an election in effect under

section 754. PRS, therefore, increases the basis of Asset 1 with

respect to T.

(ii) Assume that in the year following the transfer of the

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

partnership's common basis depreciation deductions from Asset 1 is

$1,000. Also assume that, under paragraph (j)(4)(i)(B) of this

section, the amount of the basis adjustment under section 743(b)

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

depreciation deductions from Asset 1 reported by T is equal to

$1,500.

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

property with an adjusted basis of $100,000 and a fair market value

of $500,000. B contributes $500,000 cash. When PRS is formed, the

property has five years remaining in its recovery period. The

partnership's adjusted basis of $100,000 will, therefore, be

recovered over the five years remaining in the property's recovery

period. PRS elects to use the remedial allocation method under

Sec. 1.704-3(d) with respect to the property. If PRS had purchased

the property at the time of the partnership's formation, the basis

of the property would have been recovered over a 10-year period. The

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

amortized under Sec. 1.704-3(d) over a 10-year period beginning at

the time of the partnership's formation.

(ii)(A) Except for the depreciation deductions, PRS's expenses

equal its income in each year of the first two years commencing with

the year the partnership is formed. After two years, A's share of

the adjusted basis of partnership property is $120,000, while B's is

$440,000:

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

Capital accounts

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

A B

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

Book Tax Book Tax

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

Initial Contribution............................ $500,000 $100,000 $500,000 $500,000

Depreciation Year 1............................. (30,000) .............. (30,000) (20,000)

Remedial........................................ .............. 10,000 .............. (10,000)

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

470,000 110,000 470,000 470,000

Depreciation Year 2............................. (30,000) .............. (30,000) (20,000)

Remedial........................................ .............. 10,000 .............. (10,000)

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

440,000 120,000 440,000 440,000

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

(B) A sells its interest in PRS to T for its fair market value

of $440,000. A valid election under section 754 is in effect with

respect to the sale of the partnership interest. Accordingly, PRS

makes an adjustment, pursuant to section 743(b), to increase the

basis of partnership property. Under section 743(b), the amount of

the basis adjustment is equal to $320,000. Under section 755, the

entire basis adjustment is allocated to the property.

(iii) At the time of the transfer, $320,000 of section 704(c)

built-in gain from the property was still reflected on the

partnership's books, and all of the basis adjustment is attributable

to section 704(c) built-in gain. Therefore, the basis adjustment

will be recovered over the remaining recovery period for the section

704(c) built-in gain under Sec. 1.704-3(d).

(ii) Decreases--(A) Reduced deduction. The amount of any negative

basis adjustment allocated to an item of depreciable or amortizable

property that is recovered in any year first decreases the transferee's

distributive share of the partnership's depreciation or amortization

deductions from that item of property for the year. If the amount of

the basis adjustment recovered in any year exceeds the transferee's

distributive share of the partnership's depreciation or amortization

deductions from the item of property, then the transferee's

distributive share of the partnership's depreciation or amortization

deductions from other items of partnership property is decreased. The

transferee then recognizes ordinary income to the extent of the excess,

if any, of the amount of the basis adjustment recovered in any year

over the transferee's distributive share of the partnership's

depreciation or amortization deductions from all items of property.

(B) Recovery period. For purposes of section 168, if the basis of

an item of a partnership's recovery property is decreased as the result

of the transfer of an interest in the partnership, then the decrease is

recovered over the remaining useful life of the item of the

partnership's recovery property. The portion of the decrease that is

recovered in any year during the recovery period is equal to the

product of--

(1) The amount of the decrease to the item's adjusted basis

(determined as of the date of the transfer); multiplied by

(2) A fraction, the numerator of which is the portion of the

adjusted basis of the item recovered by the partnership in that year,

and the denominator of which is the adjusted basis of the item on the

date of the transfer (determined prior to any basis adjustments).

(C) Examples. The provisions of this paragraph (j)(4)(ii) are

illustrated by the following examples:

Example 1. (i) A, B, and C are equal partners in partnership

PRS, which owns Asset 2, an item of depreciable property that has a

fair market value that is less than its adjusted tax basis. C sells

its interest in PRS to T while PRS has an election in effect under

section 754. PRS, therefore, decreases the basis of Asset 2 with

respect to T.

(ii) Assume that in the year following the transfer of the

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

partnership's common basis depreciation deductions from Asset 2 is

$1,000. Also assume that, under paragraph (j)(4)(ii)(B) of this

section, the amount of the basis adjustment under section 743(b)

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

depreciation

[[Page 69914]]

deductions from Asset 2 reported by T is equal to $500.

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

property with an adjusted basis of $100,000 and a fair market value

of $50,000. B contributes $50,000 cash. When PRS is formed, the

property has five years remaining in its recovery period. The

partnership's adjusted basis of $100,000 will, therefore, be

recovered over the five years remaining in the property's recovery

period. PRS uses the traditional allocation method under Sec. 1.704-

3(b) with respect to the property. As a result, B will receive

$5,000 of depreciation deductions from the property in each of years

1-5, and A, as the contributing partner, will receive $15,000 of

depreciation deductions in each of these years.

(ii) Except for the depreciation deductions, PRS's expenses

equal its income in each of the first two years commencing with the

year the partnership is formed. After two years, A's share of the

adjusted basis of partnership property is $70,000, while B's is

$40,000. A sells its interest in PRS to T for its fair market value

of $40,000. A valid election under section 754 is in effect with

respect to the sale of the partnership interest. Accordingly, PRS

makes an adjustment, pursuant to section 743(b), to decrease the

basis of partnership property. Under section 743(b), the amount of

the adjustment is equal to ($30,000). Under section 755, the entire

adjustment is allocated to the property.

(iii) The basis of the property at the time of the transfer of

the partnership interest was $60,000. In each of years 3 through 5,

the partnership will realize depreciation deductions of $20,000 from

the property. Thus, one third of the negative basis adjustment

($10,000) will be recovered in each of years 3 through 5.

Consequently, T will be allocated, for tax purposes, depreciation of

$15,000 each year from the partnership and will recover $10,000 of

its negative basis adjustment. Thus, T's net depreciation deduction

from the partnership in each year is $5,000.

Example 3. (i) A, B, and C are equal partners in partnership

PRS, which owns Asset 2, an item of depreciable property that has a

fair market value that is less than its adjusted tax basis. C sells

its interest in PRS to T while PRS has an election in effect under

section 754. PRS, therefore, decreases the basis of Asset 2 with

respect to T.

(ii) Assume that in the year following the transfer of the

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

partnership's common basis depreciation deductions from Asset 2 is

$500. PRS allocates no other depreciation to T. Also assume that,

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

negative basis adjustment that T recovers during the year is $1,000.

T will report $500 of ordinary income because the amount of the

negative basis adjustment recovered during the year exceeds T's

distributive share of the partnership's common basis depreciation

deductions from Asset 2.

(5) Depletion. Where an adjustment is made under section 743(b) to

the basis of partnership property subject to depletion, any depletion

allowance is determined separately for each partner, including the

transferee partner, based on the partner's interest in such property.

See Sec. 1.702-1(a)(8). For partnerships that hold oil and gas

properties that are depleted at the partner level under section

613A(c)(7)(D), the transferee partner (and not the partnership) must

make the basis adjustments, if any, required under section 743(b) with

respect to such properties. See Sec. 1.613A-3(e)(6)(iv).

(6) Example. The provisions of paragraph (j)(5) of this section are

illustrated by the following example:

Example. A, B, and C each contributes $5,000 cash to form

partnership PRS, which purchases a coal property for $15,000. A, B,

and C have equal interests in capital and profits. C subsequently

sells its partnership interest to T for $100,000 when the election

under section 754 is in effect. T has a basis adjustment under

section 743(b) for the coal property of $95,000 (the difference

between T's basis, $100,000, and its share of the basis of

partnership property, $5,000). Assume that the depletion allowance

computed under the percentage method would be $21,000 for the

taxable year so that each partner would be entitled to $7,000 as its

share of the deduction for depletion. However, under the cost

depletion method, at an assumed rate of 10 percent, the allowance

with respect to T's one-third interest which has a basis to him of

$100,000 ($5,000, plus its basis adjustment of $95,000) is $10,000,

although the cost depletion allowance with respect to the one-third

interest of A and B in the coal property, each of which has a basis

of $5,000, is only $500. For partners A and B, the percentage

depletion is greater than cost depletion and each will deduct $7,000

based on the percentage depletion method. However, as to T, the

transferee partner, the cost depletion method results in a greater

allowance and T will, therefore, deduct $10,000 based on cost

depletion. See section 613(a).

(k) Returns--(1) Statement of adjustments--(i) In general. A

partnership that must adjust the bases of partnership properties under

section 743(b) must attach a statement to the partnership return for

the year of the transfer setting forth the name and taxpayer

identification number of the transferee as well as the computation of

the adjustment and the partnership properties to which the adjustment

has been allocated.

(ii) Special rule. Where an interest is transferred in a

partnership which holds oil and gas properties that are depleted at the

partner level under section 613A(c)(7)(D), the transferee must attach a

statement to the transferee's return for the year of the transfer,

setting forth the computation of the basis adjustment under section

743(b) which is allocable to such properties and the specific

properties to which the adjustment has been allocated.

(iii) Example. The provisions of paragraph (k)(1)(ii) of this

section are illustrated by the following example:

Example. (i) Partnership XYZ owns a single section 613A(c)(7)(D)

domestic oil and gas property (Property) and other non-depletable

assets. A, a partner in XYZ with an adjusted tax basis in Property

of $100 (excluding any prior adjustments under section 743(b)),

sells its partnership interest to B for $800 cash. Under

Sec. 1.613A-3(e)(6)(iv), A's adjusted basis of $100 in Property

carries over to B.

(ii) Under section 755, XYZ determines that Property accounts

for 50% of the fair market value of all partnership assets. The

remaining 50% of B's purchase price ($400) is attributable to non-

depletable property. XYZ must provide a statement to B containing

the portion of B's adjusted basis attributable to non-depletable

property ($400). Under this paragraph (k)(1), XYZ must report basis

adjustments under section 743(b) to non-depletable property. B must

report basis adjustments under section 743(b) to Property.

(2) Requirement that transferee notify partnership--(i) Sale or

exchange. A transferee that acquires, by sale or exchange, an interest

in a partnership with an election under section 754 in effect for the

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

within 30 days of the sale or exchange. The written notice to the

partnership must be signed under penalties of perjury and must include

the names and addresses of the transferee and (if ascertainable) of the

transferor, the taxpayer identification numbers of the transferee and

(if ascertainable) of the transferor, the relationship (if any) between

the transferee and the transferor, the date of the transfer, the amount

of any liabilities assumed or taken subject to by the transferee, and

the amount of any money, the fair market value of any other property

delivered or to be delivered for the transferred interest in the

partnership, and any other information necessary for the partnership to

compute the transferee's basis.

(ii) Transfer on death. A transferee that acquires, on the death of

a partner, an interest in a partnership with an election under section

754 in effect for the taxable year of the transfer, must notify the

partnership, in writing, within one year of the death of the deceased

partner. The written notice to the partnership must be signed under

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

deceased partner and the transferee, the taxpayer identification

numbers of the deceased partner and the transferee, the relationship

(if any) between the

[[Page 69915]]

transferee and the transferor, the deceased partner's date of death,

the date on which the transferee became the owner of the partnership

interest, the fair market value of the partnership interest on the

applicable date of valuation set forth in section 1014, and the manner

in which the fair market value of the partnership interest was

determined.

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

to a nominee which is required to furnish the statement under section

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

requirement contained in this paragraph (k)(2) by providing the

statement required under Sec. 1.6031(c)-1T, provided that the statement

satisfies all requirements of Sec. 1.6031(c)-1T and this paragraph

(k)(2).

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

any statement or return relating to such adjustments under this

section, a partnership may rely on the written notice provided by a

transferee pursuant to paragraph (k)(2) of this section to determine

the transferee's basis in a partnership interest. The previous sentence

shall not apply if any partner who has responsibility for federal

income tax reporting by the partnership has knowledge of facts

indicating that the statement is clearly erroneous.

(4) Partnership not required to make or report adjustments under

section 743(b) until it has notice of the transfer. A partnership is

not required to make the adjustments under section 743(b) (or any

statement or return relating to those adjustments) with respect to any

transfer until it has been notified of the transfer. For purposes of

this section, a partnership is notified of a transfer when either--

(i) The partnership receives the written notice from the transferee

required under paragraph (k)(2) of this section; or

(ii) Any partner who has responsibility for federal income tax

reporting by the partnership has knowledge that there has been a

transfer of a partnership interest.

(5) Effect on partnership of the failure of the transferee to

comply. If the transferee fails to provide the partnership with the

written notice required by paragraph (k)(2) of this section, the

partnership must attach a statement to its return in the year that the

partnership is otherwise notified of the transfer. This statement must

set forth the name and taxpayer identification number (if

ascertainable) of the transferee. In addition, the following statement

must be prominently displayed in capital letters on the first page of

the partnership's return for such year, and on the first page of any

schedule or information statement relating to such transferee's share

of income, credits, deductions, etc.: ``RETURN FILED PURSUANT TO

Sec. 1.743-1(k)(5).'' The partnership will then be entitled to report

the transferee's share of partnership items without adjustment to

reflect the transferee's basis adjustment in partnership property. If,

following the filing of a return pursuant to this paragraph (k)(5), the

transferee provides the applicable written notice to the partnership,

the partnership must make such adjustments as are necessary to adjust

the basis of partnership property (as of the date of the transfer) in

any amended return otherwise to be filed by the partnership or in the

next annual partnership return of income to be regularly filed by the

partnership. At such time, the partnership must also provide the

transferee with such information as is necessary for the transferee to

amend its prior returns to properly reflect the adjustment under

section 743(b).

(l) Effective date. This section applies to transfers of

partnership interests that occur on or after December 15, 1999.

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

1. Revising paragraphs (a)(2) and (a)(3).

2. Revising paragraph (c)(3).

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

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

5. Revising Example 1 of paragraph (g).

The addition and revisions read as follows:

Sec. 1.751-1 Unrealized receivables and inventory items.

* * * * *

(a) * * *

(2) Determination of gain or loss. The income or loss realized by a

partner upon the sale or exchange of its interest in section 751

property is the amount of income or loss from section 751 property

(including any remedial allocations under Sec. 1.704-3(d)) that would

have been allocated to the partner (to the extent attributable to the

partnership interest sold or exchanged) if the partnership had sold all

of its property in a fully taxable transaction for cash in an amount

equal to the fair market value of such property (taking into account

section 7701(g)) immediately prior to the partner's transfer of the

interest in the partnership. Any gain or loss recognized that is

attributable to section 751 property will be ordinary gain or loss. The

difference between the amount of capital gain or loss that the partner

would realize in the absence of section 751 and the amount of ordinary

income or loss determined under this paragraph (a)(2) is the

transferor's capital gain or loss on the sale of its partnership

interest.

(3) Statement required. A partner selling or exchanging any part of

an interest in a partnership that has any section 751 property at the

time of sale or exchange must submit with its income tax return for the

taxable year in which the sale or exchange occurs a statement setting

forth separately the following information--

(i) The date of the sale or exchange;

(ii) The amount of any gain or loss attributable to the section 751

property; and

(iii) The amount of any gain or loss attributable to capital gain

or loss on the sale of the partnership interest.

* * * * *

(c) Unrealized receivables. * * *

(3) In determining the amount of the sale price attributable to

such unrealized receivables, or their value in a distribution treated

as a sale or exchange, full account shall be taken not only of the

estimated cost of completing performance of the contract or agreement,

but also of the time between the sale or distribution and the time of

payment.

* * * * *

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

this section apply to transfers of partnership interests that occur on

or after December 15, 1999.

(g) * * *

Example 1. (i)(A) A and B are equal partners in personal service

partnership PRS. B transfers its interest in PRS to T for $15,000

when PRS's balance sheet (reflecting a cash receipts and

disbursements method of accounting) is as follows:

[[Page 69916]]

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

Assets

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

Fair market

Adjusted basis value

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

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

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

Capital Assets.......................... 7,000 5,000

Unrealized Receivables.................. 0 14,000

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

Total............................... 20,000 32,000

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

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

Liabilities and Capital

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

Adjusted per Fair market

books value

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

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

Capital:

A................................... 9,000 15,000

B................................... 9,000 15,000

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

Total........................... 20,000 32,000

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

(B) None of the assets owned by PRS is section 704(c) property,

and the capital assets are nondepreciable. The total amount realized

by B is $16,000, consisting of the cash received, $15,000, plus

$1,000, B's share of the partnership liabilities assumed by T. See

section 752. B's undivided half-interest in the partnership property

includes a half-interest in the partnership's unrealized receivables

items. B's basis for its partnership interest is $10,000 ($9,000,

plus $1,000, B's share of partnership liabilities). If section

751(a) did not apply to the sale, B would recognize $6,000 of

capital gain from the sale of the interest in PRS. However, section

751(a) does apply to the sale.

(ii) If PRS sold all of its section 751 property in a fully

taxable transaction immediately prior to the transfer of B's

partnership interest to T, B would have been allocated $7,000 of

ordinary income from the sale of PRS's unrealized receivables.

Therefore, B will recognize $7,000 of ordinary income with respect

to the unrealized receivables. The difference between the amount of

capital gain or loss that the partner would realize in the absence

of section 751 ($6,000) and the amount of ordinary income or loss

determined under paragraph (a)(2) of this section ($7,000) is the

transferor's capital gain or loss on the sale of its partnership

interest. In this case, B will recognize a $1,000 capital loss.

* * * * *

Par. 7. Section 1.754-1 is amended as follows:

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

paragraph (c)(1).

2. Add a heading to newly designated paragraph (c)(1).

3. Add paragraph (c)(2).

The additions read as follows:

Sec. 1.754-1 Time and manner of making election to adjust basis of

partnership property.

* * * * *

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

(2) Revocations made for first taxable year ending after December

15, 1999. Notwithstanding paragraph (c)(1) of this section, any

partnership having an election in effect under this section for its

taxable year that includes December 15, 1999 may revoke such election

by attaching a statement to the partnership's return for such year. For

the revocation to be valid, the statement must be filed not later than

the time prescribed by Sec. 1.6031(a)-1(e) (including extensions

thereof) for filing the return for such taxable year, and must set

forth the name and address of the partnership revoking the election, be

signed by any one of the partners who is authorized to sign the

partnership's federal income tax return, and contain a declaration that

the partnership revokes its election under section 754 to apply the

provisions of section 734(b) and 743(b). In addition, the following

statement must be prominently displayed in capital letters on the first

page of the partnership's return for such year: ``RETURN FILED PURSUANT

TO 1.754-1(c)(2).''

Par. 8. Section 1.755-1 is revised to read as follows:

Sec. 1.755-1 Rules for allocation of basis.

(a) Generally. A partnership that has an election in effect under

section 754 must adjust the basis of partnership property under the

provisions of section 734(b) and section 743(b) pursuant to the

provisions of this section. The basis adjustment is first allocated

between the two classes of property described in section 755(b). These

classes of property consist of capital assets and section 1231(b)

property (capital gain property), and any other property of the

partnership (ordinary income property). For purposes of this section,

properties and potential gain treated as unrealized receivables under

section 751(c) and the regulations thereunder shall be treated as

separate assets that are ordinary income property. The portion of the

basis adjustment allocated to each class is then allocated among the

items within the class. Adjustments under section 743(b) are allocated

under paragraph (b) of this section. Adjustments under section 734(b)

are allocated under paragraph (c) of this section.

(b) Adjustments under section 743(b)--(1) Generally. (i) For

exchanges in which the transferee's basis in the interest is determined

in whole or in part by reference to the transferor's basis in the

interest, paragraph (b)(5) of this section shall apply. For all other

transfers which result in a basis adjustment under section 743(b),

paragraphs (b)(2) through (b)(4) of this section shall apply. Except as

provided in paragraph (b)(5) of this section, the portion of the basis

adjustment allocated to one class of property may be an increase while

the portion allocated to the other class is a decrease. This would be

the case even though the total amount of the basis adjustment is zero.

Except as provided in paragraph (b)(5) of this section, the portion of

the basis adjustment allocated to one item of property within a class

may be an increase while the portion allocated to another is a

decrease. This would be the case even though the basis adjustment

allocated to the class is zero.

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

through (b)(4) of this section, the allocation of

[[Page 69917]]

the basis adjustment under section 743(b) between the classes of

property and among the items of property within each class are made

based on the allocations of income, gain, or loss (including remedial

allocations under Sec. 1.704-3(d)) that the transferee partner would

receive (to the extent attributable to the acquired partnership

interest) if, immediately after the transfer of the partnership

interest, all of the partnership's property were disposed of in a fully

taxable transaction for cash in an amount equal to the fair market

value of such property (the hypothetical transaction).

(2) Allocations between classes of property--(i) In general. The

amount of the basis adjustment allocated to the class of ordinary

income property is equal to the total amount of income, gain, or loss

(including any remedial allocations under Sec. 1.704-3(d)) that would

be allocated to the transferee (to the extent attributable to the

acquired partnership interest) from the sale of all ordinary income

property in the hypothetical transaction. The amount of the basis

adjustment to capital gain property is equal to--

(A) The total amount of the basis adjustment under section 743(b);

less

(B) The amount of the basis adjustment allocated to ordinary income

property under the preceding sentence; provided, however, that in no

event may the amount of any decrease in basis allocated to capital gain

property exceed the partnership's basis (or in the case of property

subject to the remedial allocation method, the transferee's share of

any remedial loss under Sec. 1.704-3(d) from the hypothetical

transaction) in capital gain property. In the event that a decrease in

basis allocated to capital gain property would otherwise exceed the

partnership's basis in capital gain property, the excess must be

applied to reduce the basis of ordinary income property.

(ii) Examples. The provisions of this paragraph (b)(2) are

illustrated by the following examples:

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

$50,000 and Asset 1, a nondepreciable capital asset with a fair

market value of $50,000 and an adjusted tax basis of $25,000. B

contributes $100,000. PRS uses the cash to purchase Assets 2, 3, and

4. After a year, A sells its interest in PRS to T for $120,000. At

the time of the transfer, A's share of the partnership's basis in

partnership assets is $75,000. Therefore, T receives a $45,000 basis

adjustment.

(ii) Immediately after the transfer of the partnership interest

to T, the adjusted basis and fair market value of PRS's assets are

as follows:

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

Assets

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

Fair market

Adjusted basis value

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

Capital Gain Property:

Asset 1............................. $25,000 $75,000

Asset 2............................. 100,000 117,500

Ordinary Income Property:

Asset 3............................. 40,000 45,000

Asset 4............................. 10,000 2,500

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

Total........................... 175,000 240,000

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

(iii) If PRS sold all of its assets in a fully taxable

transaction at fair market value immediately after the transfer of

the partnership interest to T, the total amount of capital gain that

would be allocated to T is equal to $46,250 ($25,000 section 704(c)

built-in gain from Asset 1, plus fifty percent of the $42,500

appreciation in capital gain property). T would also be allocated a

$1,250 ordinary loss from the sale of the ordinary income property.

(iv) The amount of the basis adjustment that is allocated to

ordinary income property is equal to ($1,250) (the amount of the

loss allocated to T from the hypothetical sale of the ordinary

income property).

(v) The amount of the basis adjustment that is allocated to

capital gain property is equal to $46,250 (the amount of the basis

adjustment, $45,000, less ($1,250), the amount of loss allocated to

T from the hypothetical sale of the ordinary income property).

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

contribute $1,000 cash which the partnership uses to purchase Assets

1, 2, 3, and 4. After a year, A sells its partnership interest to T

for $1,000. T's basis adjustment under section 743(b) is zero.

(ii) Immediately after the transfer of the partnership interest

to T, the adjusted basis and fair market value of PRS's assets are

as follows:

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

Assets

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

Fair market

Adjusted basis value

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

Capital Gain Property:

Asset 1............................. $500 $750

Asset 2............................. 500 500

Ordinary Income Property:

Asset 3............................. 500 250

Asset 4............................. 500 500

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

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

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

(iii) If, immediately after the transfer of the partnership

interest to T, PRS sold all of its assets in a fully taxable

transaction at fair market value, T would be allocated a loss of

$125 from the sale of the ordinary income property. Thus, the amount

of the basis adjustment to ordinary income property is ($125). The

amount of the basis adjustment to capital gain property is $125

(zero, the amount of the basis adjustment under section 743(b), less

($125), amount of the basis adjustment allocated to ordinary income

property).

(3) Allocation within the class--(i) Ordinary income property. The

amount of the basis adjustment to each item of property within the

class of ordinary income property is equal to--

[[Page 69918]]

(A) The amount of income, gain, or loss (including any remedial

allocations under Sec. 1.704-3(d)) that would be allocated to the

transferee (to the extent attributable to the acquired partnership

interest) from the hypothetical sale of the item; reduced by

(B) The product of--

(1) Any decrease to the amount of the basis adjustment to ordinary

income property required pursuant to the last sentence of paragraph

(b)(2)(i) of this section; multiplied by

(2) A fraction, the numerator of which is the fair market value of

the item of property to the partnership and the denominator of which is

the total fair market value of all of the partnership's items of

ordinary income property.

(ii) Capital gain property. The amount of the basis adjustment to

each item of property within the class of capital gain property is

equal to--

(A) The amount of income, gain, or loss (including any remedial

allocations under Sec. 1.704-3(d)) that would be allocated to the

transferee (to the extent attributable to the acquired partnership

interest) from the hypothetical sale of the item; minus

(B) The product of--

(1) The total amount of gain or loss (including any remedial

allocations under Sec. 1.704-3(d)) that would be allocated to the

transferee (to the extent attributable to the acquired partnership

interest) from the hypothetical sale of all items of capital gain

property, minus the amount of the positive basis adjustment to all

items of capital gain property or plus the amount of the negative basis

adjustment to capital gain property; multiplied by

(2) A fraction, the numerator of which is the fair market value of

the item of property to the partnership, and the denominator of which

is the fair market value of all of the partnership's items of capital

gain property.

(iii) Examples. The provisions of this paragraph (b)(3) are

illustrated by the following examples:

Example 1. (i) Assume the same facts as Example 1 in paragraph

(b)(2)(ii) of this section. Of the $45,000 basis adjustment, $46,250

was allocated to capital gain property. The amount allocated to

ordinary income property was ($1,250).

(ii) Asset 1 is a capital gain asset, and T would be allocated

$37,500 from the sale of Asset 1 in the hypothetical transaction.

Therefore, the amount of the adjustment to Asset 1 is $37,500.

(iii) Asset 2 is a capital gain asset, and T would be allocated

$8,750 from the sale of Asset 2 in the hypothetical transaction.

Therefore, the amount of the adjustment to Asset 2 is $8,750.

(iv) Asset 3 is ordinary income property, and T would be

allocated $2,500 from the sale of Asset 3 in the hypothetical

transaction. Therefore, the amount of the adjustment to Asset 3 is

$2,500.

(v) Asset 4 is ordinary income property, and T would be

allocated ($3,750) from the sale of Asset 4 in the hypothetical

transaction. Therefore, the amount of the adjustment to Asset 4 is

($3,750).

Example 2. (i) Assume the same facts as Example 1 in paragraph

(b)(2)(ii) of this section, except that A sold its interest in PRS

to T for $110,000 rather than $120,000. T, therefore, receives a

basis adjustment under section 743(b) of $35,000. Of the $35,000

basis adjustment, ($1,250) is allocated to ordinary income property,

and $36,250 is allocated to capital gain property.

(ii) Asset 3 is ordinary income property, and T would be

allocated $2,500 from the sale of Asset 3 in the hypothetical

transaction. Therefore, the amount of the adjustment to Asset 3 is

$2,500.

(iii) Asset 4 is ordinary income property, and T would be

allocated ($3,750) from the sale of Asset 4 in the hypothetical

transaction. Therefore, the amount of the adjustment to Asset 4 is

($3,750).

(iv) Asset 1 is a capital gain asset, and T would be allocated

$37,500 from the sale of Asset 1 in the hypothetical transaction.

Asset 2 is a capital gain asset, and T would be allocated $8,750

from the sale of Asset 2 in the hypothetical transaction. The total

amount of gain that would be allocated to T from the sale of the

capital gain assets in the hypothetical transaction is $46,250,

which exceeds the amount of the basis adjustment allocated to

capital gain property by $10,000. The amount of the adjustment to

Asset 1 is $33,604 ($37,500 minus $3,896 ($10,000 x $75,000/

192,500)). The amount of the basis adjustment to Asset 2 is $2,646

($8,750 minus $6,104 ($10,000 x $117,500/192,500)).

(4) Income in respect of a decedent--(i) In general. Where a

partnership interest is transferred as a result of the death of a

partner, under section 1014(c) the transferee's basis in its

partnership interest is not adjusted for that portion of the interest,

if any, which is attributable to items representing income in respect

of a decedent under section 691. See Sec. 1.742-1. Accordingly, if a

partnership interest is transferred as a result of the death of a

partner, and the partnership holds assets representing income in

respect of a decedent, no part of the basis adjustment under section

743(b) is allocated to these assets. See Sec. 1.743-1(b).

(ii) The provisions of this paragraph (b)(4) are illustrated by the

following example:

Example. (i) A and B are equal partners in personal service

partnership PRS. As a result of B's death, B's partnership interest

is transferred to T when PRS's balance sheet (reflecting a cash

receipts and disbursements method of accounting) is as follows:

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

Assets

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

Fair market

Adjusted basis value

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

Capital Asset........................... $2,000 $5,000

Unrealized Receivables.................. 0 15,000

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

Total............................... 2,000 20,000

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

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

Liabilities and Capital

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

Adjusted per Fair market

books value

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

Capital:

A................................... 1,000 10,000

B................................... 1,000 10,000

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

Total........................... 2,000 20,000

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

(ii) None of the assets owned by PRS is section 704(c) property,

and the capital asset is nondepreciable. The fair market value of

T's partnership interest on the applicable date of valuation set

forth in section 1014 is $10,000. Of this amount, $2,500 is

[[Page 69919]]

attributable to T's share of the partnership's capital asset, and

$7,500 is attributable to T's 50% share of the partnership's

unrealized receivables. The partnership's unrealized receivables

represent income in respect of a decedent. Accordingly, under

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

adjusted for that portion of the interest which is attributable to

the unrealized receivables. Therefore, T's basis in its partnership

interest is $2,500.

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

partnership's basis in partnership assets is $1,000. Accordingly, T

receives a $1,500 basis adjustment under section 743(b). Under this

paragraph (b)(4), the entire basis adjustment is allocated to the

partnership's capital asset.

(5) Transferred basis exchanges--(i) In general. This paragraph

(b)(5) applies to basis adjustments under section 743(b) which result

from exchanges in which the transferee's basis in the interest is

determined in whole or in part by reference to the transferor's basis

in the interest. For example, this paragraph applies if a partnership

interest is contributed to a corporation in a transaction to which

section 351 applies or to a partnership in a transaction to which

section 721(a) applies.

(ii) Allocations between classes of property. If the total amount

of the basis adjustment under section 743(b) is zero, then no

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

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

partnership assets, such increase must be allocated to capital gain

property or ordinary income property, respectively, only if the total

amount of gain or loss (including any remedial allocations under

Sec. 1.704-3(d)) that would be allocated to the transferee (to the

extent attributable to the acquired partnership interest) from the

hypothetical sale of all such property would result in a net gain or

net income, as the case may be, to the transferee. Where, under the

preceding sentence, an increase in basis may be allocated to both

capital gain assets and ordinary income assets, the increase shall be

allocated to each class in proportion to the net gain or net income,

respectively, which would be allocated to the transferee from the sale

of all assets in each class. If there is a decrease in basis to be

allocated to partnership assets, such decrease must be allocated to

capital gain property or ordinary income property, respectively, only

if the total amount of gain or loss (including any remedial allocations

under Sec. 1.704-3(d)) that would be allocated to the transferee (to

the extent attributable to the acquired partnership interest) from the

hypothetical sale of all such property would result in a net loss to

the transferee. Where, under the preceding sentence, a decrease in

basis may be allocated to both capital gain assets and ordinary income

assets, the decrease shall be allocated to each class in proportion to

the net loss which would be allocated to the transferee from the sale

of all assets in each class.

(iii) Allocations within the classes--(A) Increases. If there is an

increase in basis to be allocated within a class, the increase must be

allocated first to properties with unrealized appreciation in

proportion to the transferee's share of the respective amounts of

unrealized appreciation before such increase (but only to the extent of

the transferee's share of each property's unrealized appreciation). Any

remaining increase must be allocated among the properties within the

class in proportion to the transferee's share of the amount that would

be realized by the partnership upon the hypothetical sale of each asset

in the class.

(B) Decreases. If there is a decrease in basis to be allocated

within a class, the decrease must be allocated first to properties with

unrealized depreciation in proportion to the transferee's shares of the

respective amounts of unrealized depreciation before such decrease (but

only to the extent of the transferee's share of each property's

unrealized depreciation). Any remaining decrease must be allocated

among the properties within the class in proportion to the transferee's

shares of their adjusted bases (as adjusted under the preceding

sentence).

(C) Limitation in decrease of basis. Where, as the result of a

transaction to which this paragraph (b)(5) applies, a decrease in basis

must be allocated to capital gain assets, ordinary income assets, or

both, and the amount of the decrease otherwise allocable to a

particular class exceeds the transferee's share of the adjusted basis

to the partnership of all depreciated assets in that class, the

transferee's negative basis adjustment is limited to the transferee's

share of the partnership's adjusted basis in all depreciated assets in

that class.

(D) Carryover adjustment. Where a transferee's negative basis

adjustment under section 743(b) cannot be allocated to any asset,

because the adjustment exceeds the transferee's share of the adjusted

basis to the partnership of all depreciated assets in a particular

class, the adjustment is made when the partnership subsequently

acquires property of a like character to which an adjustment can be

made.

(iv) Examples. The provisions of this paragraph (b)(5) are

illustrated by the following examples:

Example 1. A is a member of partnership LTP, which has made an

election under section 754. The three partners in LTP have equal

interests in capital and profits. Solely in exchange for a

partnership interest in UTP, A contributes its interest in LTP to

UTP in a transaction described in section 721. At the time of the

transfer, A's basis in its partnership interest ($5,000) equals its

share of inside basis (also $5,000). Under section 723, UTP's basis

in its interest in LTP is $5,000. LTP's only two assets on the date

of contribution are inventory with a basis of $5,000 and a fair

market value of $7,500, and a nondepreciable capital asset with a

basis of $10,000 and a fair market value of $7,500. The amount of

the basis adjustment under section 743(b) to partnership property is

$0 ($5,000, UTP's basis in its interest in LTP, minus $5,000, UTP's

share of LTP's basis in partnership assets). Because UTP acquired

its interest in LTP in a transferred basis exchange, and the total

amount of the basis adjustment under section 743(b) is zero, UTP

receives no special basis adjustments under section 743(b) with

respect to the partnership property of LTP.

Example 2. (i) A purchases a partnership interest in LTP at a

time when an election under section 754 is not in effect. The three

partners in LTP have equal interests in capital and profits. During

a later year for which LTP has an election under section 754 in

effect, and in a transaction that is unrelated to A's purchase of

the LTP interest, A contributes its interest in LTP to UTP in a

transaction described in section 721 (solely in exchange for a

partnership interest in UTP). At the time of the transfer, A's

adjusted basis in its interest in LTP is $20,433. Under section 721,

A recognizes no gain or loss as a result of the contribution of its

partnership interest to UTP. Under section 723, UTP's basis in its

partnership interest in LTP is $20,433. The balance sheet of LTP on

the date of the contribution shows the following:

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

Assets

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

Fair market

Adjusted basis value

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

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

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

Inventory............................... 20,000 21,000

[[Page 69920]]

Nondepreciable capital asset............ 20,000 40,000

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

Total............................... 55,000 76,000

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

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

Liabilities and Capital

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

Adjusted per Fair market

books value

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

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

Capital:

A................................... 15,000 22,000

B................................... 15,000 22,000

C................................... 15,000 22,000

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

Total........................... 55,000 76,000

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

(ii) The amount of the basis adjustment under section 743(b) is

the difference between the basis of UTP's interest in LTP and UTP's

share of the adjusted basis to LTP of partnership property. UTP's

interest in the previously taxed capital of LTP is $15,000 ($22,000,

the amount of cash UTP would receive if LTP liquidated immediately

after the hypothetical transaction, decreased by $7,000, the amount

of tax gain allocated to UTP from the hypothetical transaction).

UTP's share of the adjusted basis to LTP of partnership property is

$18,333 ($15,000 share of previously taxed capital, plus $3,333

share of LTP's liabilities). The amount of the basis adjustment

under section 743(b) to partnership property therefore, is $2,100

($20,433 minus $18,333).

(iii) The total amount of gain that would be allocated to UTP

from the hypothetical sale of capital gain property is $6,666.67

(one-third of the excess of the fair market value of LTP's

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

total amount of gain that would be allocated to UTP from the

hypothetical sale of ordinary income property is $333.33 (one-third

of the excess of the fair market value of LTP's inventory, $21,000,

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

$2,000 ($6,666.67 divided by $7,000 times $2,100) of UTP's basis

adjustment to the nondepreciable capital asset. LTP must allocate

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

adjustment to the inventory.

(c) Adjustments under section 734(b)--(1) Allocations between

classes of property--(i) General rule. Where there is a distribution of

partnership property resulting in an adjustment to the basis of

undistributed partnership property under section 734(b)(1)(B) or

(b)(2)(B), the adjustment must be allocated to remaining partnership

property of a character similar to that of the distributed property

with respect to which the adjustment arose. Thus, when the

partnership's adjusted basis of distributed capital gain property

immediately prior to distribution exceeds the basis of the property to

the distributee partner (as determined under section 732), the basis of

the undistributed capital gain property remaining in the partnership is

increased by an amount equal to the excess. Conversely, when the basis

to the distributee partner (as determined under section 732) of

distributed capital gain property exceeds the partnership's adjusted

basis of such property immediately prior to the distribution, the basis

of the undistributed capital gain property remaining in the partnership

is decreased by an amount equal to such excess. Similarly, where there

is a distribution of ordinary income property, and the basis of the

property to the distributee partner (as determined under section 732)

is not the same as the partnership's adjusted basis of the property

immediately prior to distribution, the adjustment is made only to

undistributed property of the same class remaining in the partnership.

(ii) Special rule. Where there is a distribution resulting in an

adjustment under section 734(b)(1)(A) or (b)(2)(A) to the basis of

undistributed partnership property, the adjustment is allocated only to

capital gain property.

(2) Allocations within the classes--(i) Increases. If there is an

increase in basis to be allocated within a class, the increase must be

allocated first to properties with unrealized appreciation in

proportion to their respective amounts of unrealized appreciation

before such increase (but only to the extent of each property's

unrealized appreciation). Any remaining increase must be allocated

among the properties within the class in proportion to their fair

market values.

(ii) Decreases. If there is a decrease in basis to be allocated

within a class, the decrease must be allocated first to properties with

unrealized depreciation in proportion to their respective amounts of

unrealized depreciation before such decrease (but only to the extent of

each property's unrealized depreciation). Any remaining decrease must

be allocated among the properties within the class in proportion to

their adjusted bases (as adjusted under the preceding sentence).

(3) Limitation in decrease of basis. Where a decrease in the basis

of partnership assets is required under section 734(b)(2) and the

amount of the decrease exceeds the adjusted basis to the partnership of

property of the required character, the basis of such property is

reduced to zero (but not below zero).

(4) Carryover adjustment. Where, in the case of a distribution, an

increase or a decrease in the basis of undistributed property cannot be

made because the partnership owns no property of the character required

to be adjusted, or because the basis of all the property of a like

character has been reduced to zero, the adjustment is made when the

partnership subsequently acquires property of a like character to which

an adjustment can be made.

(5) Example. The following example illustrates this paragraph (c):

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

contributes $50,000 and Asset 1, capital gain property with a fair

market value of $50,000 and an adjusted tax basis of $25,000. B and

C each contributes $100,000. PRS uses the cash to purchase Assets 2,

3, 4, 5, and 6. Assets 4, 5, and 6 are the only assets held by the

partnership which are subject to section 751. The partnership has an

election in effect under section 754. After seven years, the

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

[[Page 69921]]

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

Assets

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

Fair market

Adjusted basis value

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

Capital Gain Property:

Asset 1............................. $ 25,000 $ 75,000

Asset 2............................. 100,000 117,500

Asset 3............................. 50,000 60,000

Ordinary Income Property:

Asset 4............................. $ 40,000 $ 45,000

Asset 5............................. 50,000 60,000

Asset 6............................. 10,000 2,500

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

Total............................. 275,000 360,000

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

(ii) Allocation between classes. Assume that PRS distributes

Assets 3 and 5 to A in complete liquidation of A's interest in the

partnership. A's basis in the partnership interest was $75,000. The

partnership's basis in Assets 3 and 5 was $50,000 each. A's $75,000

basis in its partnership interest is allocated between Assets 3 and

5 under sections 732(b) and (c). A will, therefore, have a basis of

$25,000 in Asset 3 (capital gain property), and a basis of $50,000

in Asset 5 (section 751 property). The distribution results in a

$25,000 increase in the basis of capital gain property. There is no

change in the basis of ordinary income property.

(iii) Allocation within class. The amount of the basis increase

to capital gain property is $25,000 and must be allocated among the

remaining capital gain assets in proportion to the difference

between the fair market value and basis of each. The fair market

value of Asset 1 exceeds its basis by $50,000. The fair market value

of Asset 2 exceeds its basis by $17,500. Therefore, the basis of

Asset 1 will be increased by $18,519 ($25,000, multiplied by

$50,000, divided by $67,500), and the basis of Asset 2 will be

increased by $6,481 ($25,000 multiplied by $17,500, divided by

$67,500).

(d) Effective date. This section applies to transfers of

partnership interests and distributions of property from a partnership

that occur on or after December 15, 1999.

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

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

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

The addition and revision read as follows:

Sec. 1.1017-1 Basis reductions following a discharge of indebtedness.

* * * * *

(g) * * *

(2) * * *

(iv) Partner's share of partnership basis--(A) In general. For

purposes of this paragraph (g), a partner's proportionate share of the

partnership's basis in depreciable property (or depreciable real

property) is equal to the sum of--

(1) The partner's section 743(b) basis adjustments to items of

partnership depreciable property (or depreciable real property); and

(2) The common basis depreciation deductions (but not including

remedial allocations of depreciation deductions under Sec. 1.704-3(d))

that, under the terms of the partnership agreement effective for the

taxable year in which the discharge of indebtedness occurs, are

reasonably expected to be allocated to the partner over the property's

remaining useful life. The assumptions made by a partnership in

determining the reasonably expected allocation of depreciation

deductions must be consistent for each partner. For example, a

partnership may not treat the same depreciation deductions as being

reasonably expected by more than one partner.

(B) Effective date. This paragraph (g)(2)(iv) applies to elections

made under sections 108(b)(5) and 108(c) on or after December 15, 1999.

(v) Treatment of basis reduction--(A) Basis adjustment. The amount

of the reduction to the basis of depreciable partnership property

constitutes an adjustment to the basis of partnership property with

respect to the partner only. No adjustment is made to the common basis

of partnership property. Thus, for purposes of income, deduction, gain,

loss, and distribution, the partner will have a special basis for those

partnership properties the bases of which are adjusted under section

1017 and this section.

(B) Recovery of adjustments to basis of partnership property.

Adjustments to the basis of partnership property under this section are

recovered in the manner described in Sec. 1.743-1.

(C) Effect of basis reduction. Adjustments to the basis of

partnership property under this section are treated in the same manner

and have the same effect as an adjustment to the basis of partnership

property under section 743(b). The following example illustrates this

paragraph (g)(2)(v):

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

which owns (among other things) Asset 1, an item of depreciable

property with a basis of $30,000. A's basis in its partnership

interest is $20,000. Under the terms of the partnership agreement,

A's share of the depreciation deductions from Asset 1 over its

remaining useful life will be $10,000. Under section 1017, A

requests, and PRS agrees, to decrease the basis of Asset 1 with

respect to A by $10,000.

(ii) In the year following the reduction of basis under section

1017, PRS amends its partnership agreement to provide that items of

depreciation and loss from Asset 1 will be allocated equally between

B and C. In that year, A's distributive share of the partnership's

common basis depreciation deductions from Asset 1 is now $0. Under

Sec. 1.743-1(j)(4)(ii)(B), the amount of the section 1017 basis

adjustment that A recovers during the year is $1,000. A will report

$1,000 of ordinary income because A's distributive share of the

partnership's common basis depreciation deductions from Asset 1 ($0)

is insufficient to offset the amount of the section 1017 basis

adjustment recovered by A during the year ($1,000).

(iii) In the following year, PRS sells Asset 1 for $15,000 and

recognizes a $12,000 loss. This loss is allocated equally between B

and C, and A's share of the loss is $0. Upon the sale of Asset 1, A

recovers its entire remaining section 1017 basis adjustment

($9,000). A will report $9,000 of ordinary income.

(D) Effective date. This paragraph (g)(2)(v) applies to elections

made under sections 108(b)(5) and 108(c) on or after December 15, 1999.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 10. The authority citation for part 602 continues to read as

follows:

Authority: 26 U.S.C. 7805.

Par. 11. In Sec. 602.101, paragraph (b) is amended by revising the

entries for 1.732-1 and 1.743-1 in the table to read as follows:

Sec. 602.101 OMB Control numbers.

* * * * *

(b) * * *

[[Page 69922]]

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

Current OMB

CFR part or section where identified and described control No.

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

* * * * *

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

1545-1588

* * * * *

1.743-1.................................................... 1545-0074

1545-1588

* * * * *

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

David A. Mader,

Acting Deputy Commissioner of Internal Revenue.

Approved November 29, 1999.

Jonathan Talisman,

Acting Assistant Secretary of the Treasury.

[FR Doc. 99-32400 Filed 12-14-99; 8:45 am]

BILLING CODE 4830-01-U