Distribution of Marketable Securities by a Partnership

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[PS-2-95]

RIN 1545-AT19

Distribution of Marketable Securities by a Partnership

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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SUMMARY: This document contains proposed regulations relating to the

treatment of a distribution of marketable securities by a partnership

under section 731(c) of the Internal Revenue Code of 1986, as amended

(Code). These proposed regulations provide taxpayers with guidance

needed to comply with certain changes made by the Uruguay Round

Agreements Act of 1994 (Pub. L. No. 103-465). This document also

provides notice of a public hearing on these proposed regulations.

DATES: Written comments and requests to speak (with outlines of oral

comments) at a public hearing scheduled for 10 a.m. on Wednesday, April

3, 1996 must be received by Wednesday, March 13, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (PS-2-95), room 5228,

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

DC 20044. In the alternative, submissions may be hand delivered between

the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (PS-2-95), Courier's

Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,

Washington, DC. The public hearing will be held in the IRS Auditorium.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Terri A.

Belanger or William M. Kostak, (202) 622-3080; concerning submissions

and the hearing, Christina Vasquez, (202) 622-7190 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

Introduction

This document proposes to add Sec. 1.731-2 to the Income Tax

Regulations (26 CFR part 1) under section 731(c) of the Code. Section

731(c) was amended by section 741(a) of the Uruguay Round Agreements

Act of 1994 (Public Law 103-465).

Background

-3080; concerning submissions

and the hearing, Christina Vasquez, (202) 622-7190 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

Introduction

This document proposes to add Sec. 1.731-2 to the Income Tax

Regulations (26 CFR part 1) under section 731(c) of the Code. Section

731(c) was amended by section 741(a) of the Uruguay Round Agreements

Act of 1994 (Public Law 103-465).

Background

Section 731(a)(1) of the Code provides that a partner must

recognize gain on a distribution from a partnership to the extent that

any money distributed exceeds the adjusted basis of the partner's

interest in the partnership immediately before the distribution.

Section 737 provides that a partner must recognize gain on a

distribution of property other than money in an amount equal to the

lesser of (i) the partner's net precontribution gain or (ii) the excess

of the fair market value of the distributed property over the partner's

basis in the partnership interest.

Section 731(c) provides that the term money includes marketable

securities for purposes of section 731(a)(1) and section 737. As

discussed in the legislative history accompanying section 731(c),

treating marketable securities as money for this purpose is appropriate

because marketable securities are economically equivalent to money.

Section 731(c) affects only the tax consequences to the distributee

partner; section 731(c) does not require the partnership or any partner

other than the distributee partner to recognize gain on a distribution

of marketable securities.

Explanation of Provisions

Marketable Securities Treated as Money

purpose is appropriate

because marketable securities are economically equivalent to money.

Section 731(c) affects only the tax consequences to the distributee

partner; section 731(c) does not require the partnership or any partner

other than the distributee partner to recognize gain on a distribution

of marketable securities.

Explanation of Provisions

Marketable Securities Treated as Money

Distributions of marketable securities are treated as distributions

of money under section 731(c) only for purposes of sections 731(a)(1)

and 737. For example, a distribution of marketable securities is not

treated as a distribution of money to the extent it is subject to

section 707 or section 751(b) because the distribution is not subject

to section 731(a)(1) or section 737. In addition, marketable securities

are not treated as money for purposes of section 731(a)(2), so that a

partner does not recognize a loss on a distribution of marketable

securities. Finally, marketable securities contributed by a partner are

treated as property other than money for purposes of determining the

partner's net precontribution gain under section 737(b).

Reduction of Amount Treated as Money

Under section 731(c)(3)(B), the amount of marketable securities

that is treated as money is reduced by the excess of (i) the partner's

share of the net gain of the partnership's securities of the same class

and issuer as the distributed securities immediately before the

distribution over (ii) the partner's share of such net gain immediately

after the distribution. This provision allows a partner to withdraw the

partner's share of appreciation in the partnership's marketable

securities without recognizing gain on the distribution. As a result,

section 731(c) generally applies only when a partner receives a

distribution of marketable securities in exchange for the partner's

share of appreciated assets other than marketable securities

er the distribution. This provision allows a partner to withdraw the

partner's share of appreciation in the partnership's marketable

securities without recognizing gain on the distribution. As a result,

section 731(c) generally applies only when a partner receives a

distribution of marketable securities in exchange for the partner's

share of appreciated assets other than marketable securities.

Under the authority of section 731(c)(3)(B), the proposed

regulations provide that all marketable securities held by a

partnership are treated as marketable securities of the same class and

issuer as the distributed securities. Treating all marketable

securities as a single asset for this purpose is consistent with the

basic rationale of section 731(c) that marketable securities are the

economic equivalent of money. As a result, the amount of the

distribution that is not treated as money will depend on the partner's

share of the net appreciation in all partnership securities, not on the

partner's share of the appreciation in the type of securities

distributed.

Definition of Marketable Securities

In general, the term marketable securities includes any financial

instruments--such as stocks, options, and derivatives--that are

actively traded within the meaning of section 1092(d)(1). In addition,

section 731(c)(2)(B)(v) provides that an interest in an entity is a

marketable security if substantially all of the assets of the entity

consist of marketable securities or money. The proposed regulations

provide that substantially all of the assets of an entity consist of

marketable securities or money only if 90 percent or more of the assets

of the entity at the time of the distribution consist of such assets.

Section 731(c)(2)(B)(vi) provides that, to the extent provided in

regulations, an interest in an entity not described in section

731(c)(2)(B)(v) is a marketable security to the extent that the value

of such interest is attributable to marketable securities or money

ecurities or money only if 90 percent or more of the assets

of the entity at the time of the distribution consist of such assets.

Section 731(c)(2)(B)(vi) provides that, to the extent provided in

regulations, an interest in an entity not described in section

731(c)(2)(B)(v) is a marketable security to the extent that the value

of such interest is attributable to marketable securities or money. The

proposed regulations provide that an interest in an entity is a

marketable security to the extent that the value of the interest is

attributable to marketable securities or money that constitute less

than 90 percent but 20 percent or more of the assets of the entity. The

20 percent threshold means that an interest in an entity holding only a

small

amount of marketable securities will not be treated as a marketable

security.

The proposed regulations also provide that a marketable security

will continue to be treated as a marketable security, even if the

partnership or its partners are restricted by agreement or otherwise

from selling or exchanging the security. This provision is intended to

prevent a partnership from avoiding section 731(c) by temporarily

restricting the transferability of the distributed security.

Exceptions

Consistent with the provisions of section 731(c)(3)(A), the

proposed regulations provide three exceptions to section 731(c). First,

the proposed regulations provide that if the marketable security was

contributed to the partnership by the distributee partner, section

731(c) does not apply to the distribution of that security

icting the transferability of the distributed security.

Exceptions

Consistent with the provisions of section 731(c)(3)(A), the

proposed regulations provide three exceptions to section 731(c). First,

the proposed regulations provide that if the marketable security was

contributed to the partnership by the distributee partner, section

731(c) does not apply to the distribution of that security.

Second, the proposed regulations provide that section 731(c) does

not apply to the distribution of a marketable security to the extent

that the security was acquired by the partnership in a nonrecognition

transaction in exchange for property other than marketable securities

or cash and (i) the security is actively traded as of the date of

distribution and (ii) the security is distributed by the partnership

within five years of either the date the security was acquired by the

partnership or, if later, the date the security became actively traded.

For example, if a partnership contributed substantially all of its

assets to a corporation in a transaction described in section 351 and

the stock of the corporation became marketable, the distribution of the

stock by the partnership within five years would not be subject to

section 731(c). This exception recognizes that the marketable security

in these situations is simply a substitute for the underlying assets

exchanged in the nonrecognition transaction.

The proposed regulations also provide that section 731(c) does not

apply to the distribution of a marketable security if (i) the security

was not actively traded on the date acquired by the partnership and the

entity to which the security relates had no outstanding actively traded

securities at the time the security was acquired by the partnership;

xchanged in the nonrecognition transaction.

The proposed regulations also provide that section 731(c) does not

apply to the distribution of a marketable security if (i) the security

was not actively traded on the date acquired by the partnership and the

entity to which the security relates had no outstanding actively traded

securities at the time the security was acquired by the partnership;

(ii) the security is actively traded as of the date of distribution;

and (iii) the security was held by the partnership for at least six

months before it became actively traded and the security was

distributed by the partnership within five years of the date on which

the security became actively traded.

In addition, the proposed regulations provide a successor security

rule that applies to these exceptions. This rule provides that the

exceptions continue to apply to a security acquired in a nonrecognition

transaction in exchange for a security that was already subject to an

exception.

Investment Partnerships

Section 731(c) does not apply to the distribution of marketable

securities by an investment partnership to an eligible partner. An

investment partnership is defined as a partnership that has never been

engaged in a trade or business and substantially all of the assets of

which consist of the investment assets described in section

731(c)(3)(C)(i). The proposed regulations provide that a partner can

qualify as an eligible partner even if the partner contributed services

to the partnership. In addition, the proposed regulations provide that

a partnership will not be treated as engaged in a trade or business if

the partnership provides reasonable and customary management services

to a lower-tier investment partnership. This exception allows an upper-

tier investment partnership to manage the investments and other

activities of a lower-tier investment partnership without disqualifying

the upper-tier partnership as an investment partnership

rship will not be treated as engaged in a trade or business if

the partnership provides reasonable and customary management services

to a lower-tier investment partnership. This exception allows an upper-

tier investment partnership to manage the investments and other

activities of a lower-tier investment partnership without disqualifying

the upper-tier partnership as an investment partnership. The exception

does not extend to management services provided to lower-tier

partnerships other than investment partnerships because, as discussed

below, the tiering rules of section 731(c)(3)(C)(iv) treat the upper-

tier management partnership as engaged in the trade or business of the

lower-tier partnership, thereby preventing the upper-tier partnership

from qualifying as an investment partnership.

The proposed regulations also provide that a partnership will not

be treated as engaged in a trade or business if the partnership

provides reasonable and customary services in assisting the formation,

capitalization, expansion, or offering of interests in an entity in

which the partnership holds a significant equity interest, provided

that the anticipated receipt of compensation for the services does not

represent a significant purpose for the partnership's investment in the

entity and is incidental to the investment in the entity.

Section 731(c)(3)(C)(iv) provides that, except as otherwise

provided in regulations, a partnership is treated as engaged in any

trade or business engaged in by (and as holding the assets of) any

partnership in which the partnership holds an interest. The proposed

regulations provide that this look-through rule does not apply if the

upper-tier partnership does not participate in the management of the

lower-tier partnership and the interest held by the upper-tier

partnership is less than 10 percent of the total profits and capital

interests in the lower-tier partnership.

Coordination With Other Sections

h the partnership holds an interest. The proposed

regulations provide that this look-through rule does not apply if the

upper-tier partnership does not participate in the management of the

lower-tier partnership and the interest held by the upper-tier

partnership is less than 10 percent of the total profits and capital

interests in the lower-tier partnership.

Coordination With Other Sections

The proposed regulations provide rules for coordinating section

731(c) with section 704(c)(1)(B) and section 737. This coordination is

necessary because a distribution of marketable securities could occur

as part of a larger distribution in which property contributed by the

distributee partner is distributed to another partner (section

704(c)(1)(B)) or the distributee partner receives property in addition

to marketable securities (section 737).

Under the proposed regulations, the basis increase in the partner's

interest in the partnership as a result of any gain recognized by the

partner under section 704(c)(1)(B) is taken into account in determining

the distributee partner's gain under section 731(c) and the partner's

basis in the distributed securities. Taking the stepped-up basis into

account for purposes of section 731 reflects the fact that the general

effect of section 704(c)(1)(B) is to treat the contributing partner as

having contributed property with a full fair market value basis at the

time of contribution. The proposed regulations, however, provide that

the basis increase in the partner's interest as a result of any gain

recognized by the partner under section 737 is not taken into account

for these purposes. The proposed regulations are consistent with

section 737, which generally treats a distribution of money as

occurring before, and independent of, a distribution of other property.

Anti-Abuse Rule

osed regulations, however, provide that

the basis increase in the partner's interest as a result of any gain

recognized by the partner under section 737 is not taken into account

for these purposes. The proposed regulations are consistent with

section 737, which generally treats a distribution of money as

occurring before, and independent of, a distribution of other property.

Anti-Abuse Rule

The proposed regulations provide that the provisions of section

731(c) and this section must be applied in a manner that is consistent

with the purpose of section 731(c) and the substance of the

transaction.

Proposed Effective Date

This section is proposed to apply to distributions of marketable

securities by a partnership to a partner on or after December 29, 1995.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory

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

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

Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these

regulations, and, therefore, a Regulatory Flexibility Analysis is not

required. Pursuant to section 7805(f) of the Internal Revenue Code,

this notice of proposed rulemaking will be submitted to the Chief

Counsel for Advocacy of the Small Business Administration for comment

on its impact on small business.

Comments and Public Hearing

Flexibility Act (5 U.S.C. chapter 6) do not apply to these

regulations, and, therefore, a Regulatory Flexibility Analysis is not

required. Pursuant to section 7805(f) of the Internal Revenue Code,

this notice of proposed rulemaking will be submitted to the Chief

Counsel for Advocacy of the Small Business Administration for comment

on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (a signed original

and eight (8) copies) that are timely submitted to the IRS. All

comments will be available for public inspection and copying.

A public hearing has been scheduled for Wednesday, April 3, 1996 at

10:00 a.m. in the Auditorium of the Internal Revenue Building, 1111

Constitution Avenue NW., Washington, DC. Because of access

restrictions, visitors will not be admitted beyond the Internal Revenue

Building lobby more than 15 minutes before the hearing starts.

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

Persons that wish to present oral comments at the hearing must

submit written comments by Wednesday, March 13, 1996 and submit an

outline of the topics to be discussed and the time to be devoted to

each topic (signed original and eight (8) copies) by Wednesday, March

13, 1996.

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

comments.

An agenda showing the scheduling of the speakers will be prepared

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

agenda will be available free of charge at the hearing.

Drafting Information

The principal authors of these regulations are Terri A. Belanger

and William M. Kostak, Office of Assistant Chief Counsel (Passthroughs

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

Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

The principal authors of these regulations are Terri A. Belanger

and William M. Kostak, Office of Assistant Chief Counsel (Passthroughs

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

Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

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

an entry in numerical order to read as follows:

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

Section 1.731-2 also issued under 26 U.S.C. 731(c).* * *

Par. 2. Section 1.731-2 is added to read as follows:

Sec. 1.731-2 Partnership distributions of marketable securities.

(a) Marketable securities treated as money. Except as otherwise

provided in section 731(c) and this section, for purposes of section

731(a)(1) and 737, the term money includes marketable securities and

such securities are taken into account at their fair market value as of

the date of the distribution.

(b) Reduction of amount treated as money--(1) Aggregation of

securities. For purposes of section 731(c)(3)(B) and this paragraph

(b), all marketable securities held by a partnership are treated as

marketable securities of the same class and issuer as the distributed

security.

(2) Amount of reduction. The amount of the distribution of

marketable securities that is treated as a distribution of money under

section 731(c) and paragraph (a) of this section is reduced (but not

below zero) by the excess, if any, of--

that is,

as of the date of distribution, actively traded within the meaning of

section 1092(d)(1). Thus, for example, if XYZ common stock is listed on

a national securities exchange, particular shares of XYZ common stock

that are distributed by a partnership are marketable securities even if

those particular shares cannot be resold by the distributee partner for

a designated period of time.

(2) Interests in an entity--(i) Substantially all. For purposes of

section 731(c)(2)(B)(v) and this section, substantially all of the

assets of an entity consist (directly or indirectly) of marketable

securities, money, or both only if 90 percent or more of the assets of

the entity (by value) at the time of the distribution of an interest in

the entity consist (directly or indirectly) of marketable securities,

money, or both.

(ii) Less than substantially all. For purposes of section

731(c)(2)(B)(vi) and this section, an interest in an entity is a

marketable security to the extent that the value of the interest is

attributable (directly or indirectly) to marketable securities, money,

or both, if less than 90 percent but 20 percent or more of the assets

of the entity (by value) at the time of the distribution of an interest

in the entity consist (directly or indirectly) of marketable

securities, money, or both.

(d) Exceptions--(1) Previously contributed property. Section 731(c)

and this section do not apply to the distribution of a marketable

security if the security was contributed to the partnership by the

distributee partner, except to the extent that the value of the

distributed security is attributable to marketable securities or money

contributed (directly or indirectly) by the partnership to the entity

to which the distributed security relates.

(2) Security acquired in nonrecognition transaction. Section 731(c)

and this section do not apply to the distribution of a marketable

security to the extent that--

er, except to the extent that the value of the

distributed security is attributable to marketable securities or money

contributed (directly or indirectly) by the partnership to the entity

to which the distributed security relates.

(2) Security acquired in nonrecognition transaction. Section 731(c)

and this section do not apply to the distribution of a marketable

security to the extent that--

(i) The security was acquired by the partnership in a

nonrecognition transaction in exchange for any property except money or

marketable securities (including a security that would have been

treated as a marketable security under paragraph (c)(2) of this section

if distributed at the time of the exchange);

(ii) The distributed security is actively traded as of the date of

distribution; and

(iii) The security is distributed within five years of either the

date on which the security was acquired by the partnership or, if

later, the date on

which the security became actively traded.

(3) Security not marketable when acquired. Section 731(c) and this

section do not apply to the distribution of a marketable security if--

(i) The security was not actively traded as of the date acquired by

the partnership and the entity to which the security relates had no

outstanding actively traded securities on that date;

(ii) The security is actively traded as of the date of

distribution; and

(iii) The security was held by the partnership for at least six

months before the date the security became actively traded and the

security was distributed within five years of the date on which the

security became actively traded.

(4) Successor security. Section 731(c) and this section do not

apply to the distribution of a marketable security to the extent that

the security was acquired by the partnership in a nonrecognition

transaction in exchange for a security the distribution of which

immediately prior to the exchange would have been excepted under this

paragraph (d).

on which the

security became actively traded.

(4) Successor security. Section 731(c) and this section do not

apply to the distribution of a marketable security to the extent that

the security was acquired by the partnership in a nonrecognition

transaction in exchange for a security the distribution of which

immediately prior to the exchange would have been excepted under this

paragraph (d).

(e) Investment partnerships--(1) In general. Section 731(c) and

this section do not apply to the distribution of marketable securities

by an investment partnership (as defined in section 731(c)(3)(C)(i)) to

an eligible partner (as defined in section 731(c)(3)(C)(iii)).

(2) Eligible partner. For purposes of section 731(c)(3)(C)(iii) and

this section, a partner is not treated as a partner other than an

eligible partner solely because the partner contributed services to the

partnership.

(3) Trade or business activities. For purposes of section

731(c)(3)(C) and this section, a partnership is not treated as engaged

in a trade or business by reason of--

(i) Any activity undertaken as an investor, trader, or dealer in

any asset described in section 731(c)(3)(C)(i), including the receipt

of commitment fees, break-up fees, guarantee fees, director's fees, or

similar fees that are customary in and incidental to any activities of

the partnership as an investor, trader, or dealer in such assets;

(ii) Reasonable and customary management services (including the

receipt of reasonable and customary fees in exchange for such

management services) provided to an investment partnership (within the

meaning of section 731(c)(3)(C)(i)) in which the partnership holds a

partnership interest; or

and incidental to any activities of

the partnership as an investor, trader, or dealer in such assets;

(ii) Reasonable and customary management services (including the

receipt of reasonable and customary fees in exchange for such

management services) provided to an investment partnership (within the

meaning of section 731(c)(3)(C)(i)) in which the partnership holds a

partnership interest; or

(iii) Reasonable and customary services provided by the partnership

in assisting the formation, capitalization, expansion, or offering of

interests in a corporation (or other entity) in which the partnership

holds or acquires a significant equity interest (including the

provision of advice or consulting services, bridge loans, guarantees of

obligations, or service on a company's board of directors), provided

that the anticipated receipt of compensation for the services, if any,

does not represent a significant purpose for the partnership's

investment in the entity and is incidental to the investment in the

entity.

(4) Partnership tiers. For purposes of section 731(c)(3)(C)(iv) and

this section, a partnership (upper-tier partnership) is not treated as

engaged in a trade or business engaged in by, or as holding (instead of

a partnership interest) a proportionate share of the assets of, a

partnership (lower-tier partnership) in which the partnership holds a

partnership interest if--

(i) The upper-tier partnership does not participate in the

management of the lower-tier partnership; and

(ii) The interest held by the upper-tier partnership is less than

10 percent of the total profits and capital interests in the lower-tier

partnership.

a proportionate share of the assets of, a

partnership (lower-tier partnership) in which the partnership holds a

partnership interest if--

(i) The upper-tier partnership does not participate in the

management of the lower-tier partnership; and

(ii) The interest held by the upper-tier partnership is less than

10 percent of the total profits and capital interests in the lower-tier

partnership.

(f) Basis rules--(1) Partner's basis--(i) Partner's basis in

distributed securities. The distributee partner's basis in distributed

marketable securities with respect to which gain is recognized by

reason of section 731(c) and this section is the basis of the security

determined under section 732, increased by the amount of such gain. Any

increase in the basis of the marketable securities attributable to gain

recognized by reason of section 731(c) and this section is allocated to

marketable securities in proportion to their respective amounts of

unrealized appreciation in the hands of the partner before such

increase.

(ii) Partner's basis in partnership interest. The basis of the

distributee partner's interest in the partnership is determined under

section 733 as if no gain were recognized by the partner on the

distribution by reason of section 731(c) and this section.

(2) Basis of partnership property. No adjustment is made to the

basis of partnership property under section 734 as a result of any gain

recognized by a partner, or any step-up in the basis in the distributed

marketable securities in the hands of the distributee partner, by

reason of section 731(c) and this section.

the partner on the

distribution by reason of section 731(c) and this section.

(2) Basis of partnership property. No adjustment is made to the

basis of partnership property under section 734 as a result of any gain

recognized by a partner, or any step-up in the basis in the distributed

marketable securities in the hands of the distributee partner, by

reason of section 731(c) and this section.

(g) Coordination with other sections--(1) Section 704(c)(1)(B). The

basis of the distributee partner's interest in the partnership for

purposes of determining the amount of gain, if any, recognized by

reason of section 731(c) (and for determining the basis of the

marketable securities in the hands of the distributee partner) includes

the increase, if any, in the partner's basis that occurs under section

704(c)(1)(B)(iii) as a result of a distribution to another partner of

property contributed by the distributee partner in a distribution that

is part of the same distribution as the marketable securities.

(2) Section 737--(i) Marketable securities as other property. A

distribution of marketable securities is treated as a distribution of

property other than money for purposes of section 737 to the extent

that the marketable securities are not treated as money under section

731(c). In addition, marketable securities contributed to the

partnership are treated as property other than money in determining the

contributing partner's net precontribution gain under section 737(b).

marketable securities is treated as a distribution of

property other than money for purposes of section 737 to the extent

that the marketable securities are not treated as money under section

731(c). In addition, marketable securities contributed to the

partnership are treated as property other than money in determining the

contributing partner's net precontribution gain under section 737(b).

(ii) Basis increase under section 737. The basis of the distributee

partner's interest in the partnership for purposes of determining the

amount of gain, if any, recognized by reason of section 731(c) (and for

determining the basis of the marketable securities in the hands of the

distributee partner) does not include the increase, if any, in the

partner's basis that occurs under section 737(c)(1) as a result of a

distribution of property to the distributee partner in a distribution

that is part of the same distribution as the marketable securities.

(h) Anti-abuse rule. The provisions of section 731(c) and this

section must be applied in a manner consistent with the purpose of

section 731(c) and the substance of the transaction. Accordingly, if a

principal purpose of a transaction is to achieve a tax result that is

inconsistent with the purpose of section 731(c) and this section, the

Commissioner can recast the transaction for federal tax purposes as

appropriate to achieve tax results that are consistent with the purpose

of section 731(c) and this section. Whether a tax result is

inconsistent with the purpose of section 731(c) and this section must

be determined based on all the facts and circumstances. For example,

under the provisions of this paragraph (h)--

(1) A change in partnership allocations or distribution rights with

respect to marketable securities may be treated as a distribution of

the marketable securities subject to section 731(c) if the change in

allocations or distribution rights is, in substance, a distribution of

the securities;

d based on all the facts and circumstances. For example,

under the provisions of this paragraph (h)--

(1) A change in partnership allocations or distribution rights with

respect to marketable securities may be treated as a distribution of

the marketable securities subject to section 731(c) if the change in

allocations or distribution rights is, in substance, a distribution of

the securities;

(2) A distribution of substantially all of the assets of the

partnership other than marketable securities and money to some partners

may also be treated as a distribution of marketable securities to the

remaining partners if the

distribution of the other property and the withdrawal of the other

partners is, in substance, equivalent to a distribution of the

securities to the remaining partners; and

(3) The distribution of multiple properties to one or more partners

at different times may also be treated as part of a single distribution

if the distributions are part of a single plan of distribution.

(i) [Reserved]

(j) Examples. The following examples illustrate the rules of this

section. Unless otherwise specified, all securities held by a

partnership are marketable securities within the meaning of section

731(c); the partnership holds no marketable securities other than the

securities described in the example; all distributions by the

partnership are subject to section 731(a) and are not subject to

sections 704(c)(1)(B), 751(b), or 737; and no securities are eligible

for an exception to section 731(c).

Example 1. Recognition of gain. (i) A and B form partnership AB

as equal partners. A contributes property with a fair market value

of $1,000 and an adjusted tax basis of $250. B contributes $1,000

cash. AB subsequently purchases Security X for $500 and immediately

distributes the security to A in a current distribution. The basis

in A's interest in the partnership at the time of distribution is

$250.

. Recognition of gain. (i) A and B form partnership AB

as equal partners. A contributes property with a fair market value

of $1,000 and an adjusted tax basis of $250. B contributes $1,000

cash. AB subsequently purchases Security X for $500 and immediately

distributes the security to A in a current distribution. The basis

in A's interest in the partnership at the time of distribution is

$250.

(ii) The distribution of Security X is treated as a distribution

of money in an amount equal to the fair market value of Security X

on the date of distribution ($500). (The amount of the distribution

that is treated as money is not reduced under section 731(c)(3)(B)

and paragraph (b) of this section because, if Security X had been

sold immediately before the distribution, there would have been no

gain recognized by AB and A's distributive share of the gain would

therefore have been zero.) As a result, A recognizes $250 of gain

under section 731(a)(1) on the distribution ($500 distribution of

money less $250 adjusted tax basis in A's partnership interest).

Example 2. Reduction in amount treated as money--in general. (i)

A and B form partnership AB as equal partners. AB subsequently

distributes Security X to A in a current distribution. Immediately

before the distribution, AB held securities with the following fair

market values, adjusted tax bases, and unrecognized gain or loss:

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

Gain

Value Basis (loss)

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

Security X.................................. 100 70 30

Security Y.................................. 100 80 20

Security Z.................................. 100 110 (10)

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

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

Gain

Value Basis (loss)

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

Security X.................................. 100 70 30

Security Y.................................. 100 80 20

Security Z.................................. 100 110 (10)

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

(ii) If AB had sold the securities for fair market value

immediately before the distribution to A, the partnership would have

recognized $40 of net gain ($30 gain on Security X plus $20 gain on

Security Y minus $10 loss on Security Z). A's distributive share of

this gain would have been $20 (one-half of $40 net gain). If AB had

sold the remaining securities immediately after the distribution of

Security X to A, the partnership would have $10 of net gain ($20 of

gain on Security Y minus $10 loss on Security Z). A's distributive

share of this gain would have been $5 (one-half of $10 net gain). As

a result, the distribution resulted in a decrease of $15 in A's

distributive share of the net gain in AB's securities ($20 net gain

before distribution minus $5 net gain after distribution).

(iii) Under paragraph (b) of this section, the amount of the

distribution of Security X that is treated as a distribution of

money is reduced by $15. The distribution of Security X is therefore

treated as a distribution of $85 of money to A ($100 fair market

value of Security X minus $15 reduction).

Example 3. Reduction in amount treated as money--carried

interest. (i) A and B form partnership AB. A contributes $1,000 and

provides substantial services to the partnership in exchange for a

60 percent interest in partnership profits. B contributes $1,000 in

exchange for a 40 percent interest in partnership profits. AB

subsequently distributes Security X to A in a current distribution

ion).

Example 3. Reduction in amount treated as money--carried

interest. (i) A and B form partnership AB. A contributes $1,000 and

provides substantial services to the partnership in exchange for a

60 percent interest in partnership profits. B contributes $1,000 in

exchange for a 40 percent interest in partnership profits. AB

subsequently distributes Security X to A in a current distribution.

Immediately before the distribution, AB held securities with the

following fair market values, adjusted tax bases, and unrecognized

gain:

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

Value Basis Gain

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

Security X................................... 100 80 20

Security Y................................... 100 90 10

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

(ii) If AB had sold the securities for fair market value

immediately before the distribution to A, the partnership would have

recognized $30 of net gain ($20 gain on Security X plus $10 gain on

Security Y). A's distributive share of this gain would have been $18

(60 percent of $30 net gain). If AB had sold the remaining

securities immediately after the distribution of Security X to A,

the partnership would have $10 of net gain ($10 gain on Security Y).

A's distributive share of this gain would have been $6 (60 percent

of $10 net gain). As a result, the distribution resulted in a

decrease of $12 in A's distributive share of the net gain in AB's

securities ($18 net gain before distribution minus $6 net gain after

distribution).

ely after the distribution of Security X to A,

the partnership would have $10 of net gain ($10 gain on Security Y).

A's distributive share of this gain would have been $6 (60 percent

of $10 net gain). As a result, the distribution resulted in a

decrease of $12 in A's distributive share of the net gain in AB's

securities ($18 net gain before distribution minus $6 net gain after

distribution).

(iii) Under paragraph (b) of this section, the amount of the

distribution of Security X that is treated as a distribution of

money is reduced by $12. The distribution of Security X is therefore

treated as a distribution of $88 of money to A ($100 fair market

value of Security X minus $12 reduction).

Example 4. Reduction in amount treated as money--change in

partnership allocations. (i) A is admitted to partnership ABC as a

partner with a 1 percent interest in partnership profits. At the

time of A's admission, ABC held no securities. ABC subsequently

acquires Security X. A's interest in partnership profits is

subsequently increased to 2 percent for securities acquired after

the increase. A retains a 1 percent interest in all securities

acquired before the increase. ABC then acquires Securities Y and Z

and later distributes Security X to A in a current distribution.

Immediately before the distribution, the securities held by ABC had

the following fair market values, adjusted tax bases, and

unrecognized gain or loss:

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

Value Basis Gain (loss)

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

Security X.................................. 1,000 500 500

Security Y.................................. 1,000 800 200

Security Z.................................. 1,000 1,100 (100)

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

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

Value Basis Gain (loss)

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

Security X.................................. 1,000 500 500

Security Y.................................. 1,000 800 200

Security Z.................................. 1,000 1,100 (100)

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

(ii) If ABC had sold the securities for fair market value

immediately before the distribution to A, the partnership would have

recognized $600 of net gain ($500 gain on Security X plus $200 gain

on Security Y minus $100 loss on Security Z). A's distributive share

of this gain would have been $7 (1 percent of $500 gain on Security

X plus 2 percent of $200 gain on Security Y minus 2 percent of $100

loss on Security Z).

(iii) If ABC had sold the remaining securities immediately after

the distribution of Security X to A, the partnership would have $100

of net gain ($200 gain on Security Y minus $100 loss on Security Z).

A's distributive share of this gain would have been $2 (2 percent of

$200 gain on Security Y minus 2 percent of $100 loss on Security Z).

As a result, the distribution resulted in a decrease of $5 in A's

distributive share of the net gain in ABC's securities ($7 net gain

before distribution minus $2 net gain after distribution).

(iv) Under paragraph (b) of this section, the amount of the

distribution of Security X that is treated as a distribution of

money is reduced by $5. The distribution of Security X is therefore

treated as a distribution of $95 of money to A ($100 fair market

value of Security X minus $5 reduction).

Example 5. Basis consequences--distribution of marketable

security. (i) A and B form partnership AB as equal partners. A

contributes nondepreciable real property with a fair market value

and adjusted tax basis of $100.

money is reduced by $5. The distribution of Security X is therefore

treated as a distribution of $95 of money to A ($100 fair market

value of Security X minus $5 reduction).

Example 5. Basis consequences--distribution of marketable

security. (i) A and B form partnership AB as equal partners. A

contributes nondepreciable real property with a fair market value

and adjusted tax basis of $100.

(ii) AB subsequently distributes Security X with a fair market

value of $120 and an adjusted tax basis of $90 to A in a current

distribution. At the time of distribution, the basis in A's interest

in the partnership is $100. The amount of the distribution that is

treated as money is reduced under section 731(c)(3)(B) and paragraph

(b)(2) of this section by $15 (one- half of $30 net gain in Security

X). As a result, A recognizes $5 of gain under section 731(a) on the

distribution (excess of $105 distribution of money over $100

adjusted tax basis in A's partnership interest).

(iii) A's adjusted tax basis in Security X is $95 ($90 adjusted

basis of Security X determined under section 732(a)(1) plus $5 of

gain recognized by A by reason of section 731(c)). The basis in A's

interest in the partnership is $10 as determined under section 733

($100 pre-distribution basis minus $90 basis allocated to Security X

under section 732).

Example 6. Basis consequences--distribution of marketable

security and other property. (i) A and B form partnership AB as

equal partners. A contributes nondepreciable

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

basis of $10.

the partnership is $10 as determined under section 733

($100 pre-distribution basis minus $90 basis allocated to Security X

under section 732).

Example 6. Basis consequences--distribution of marketable

security and other property. (i) A and B form partnership AB as

equal partners. A contributes nondepreciable

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

basis of $10.

(ii) AB subsequently distributes Security X with a fair market

value and adjusted tax basis of $40 to A in a current distribution

and, as part of the same distribution, AB distributes Property Z to

A with an adjusted tax basis and fair market value of $40. At the

time of distribution, the basis in A's interest in the partnership

is $10. A recognizes $30 of gain under section 731(a) on the

distribution (excess of $40 distribution of money over $10 adjusted

tax basis in A's partnership interest).

(iii) A's adjusted tax basis in Security X is $35 ($5 adjusted

basis determined under section 732(a)(2) plus $30 of gain recognized

by A by reason of section 731(c)). A's basis in Property Z is $5, as

determined under section 732(a)(2). The basis in A's interest in the

partnership is $0 as determined under section 733 ($10 pre-

distribution basis minus $10 basis allocated between Security X and

Property Z under section 732).

(iv) AB's adjusted tax basis in the remaining partnership assets

is unchanged unless the partnership has a section 754 election in

effect. If AB made such an election, the aggregate basis of AB's

assets would be increased by $70 (the difference between the $80

combined basis of Security X and Property Z in the hands of the

partnership before the distribution and the $10 combined basis of

the distributed property in the hands of A under section 732 after

the distribution)

ess the partnership has a section 754 election in

effect. If AB made such an election, the aggregate basis of AB's

assets would be increased by $70 (the difference between the $80

combined basis of Security X and Property Z in the hands of the

partnership before the distribution and the $10 combined basis of

the distributed property in the hands of A under section 732 after

the distribution). Under section 731(c)(5), no adjustment is made to

partnership property under section 734 as a result of any gain

recognized by A by reason of section 731(c) or as a result of any

step-up in basis in the distributed marketable securities in the

hands of A by reason of section 731(c).

Example 7. Coordination with section 737. (i) A and B form

partnership AB. A contributes Property A, nondepreciable real

property with a fair market value of $200 and an adjusted basis of

$100 in exchange for a 25 percent interest in partnership capital

and profits. AB owns marketable Security X.

(ii) Within five years of the contribution of Property A, AB

subsequently distributes Security X, with a fair market value of

$120 and an adjusted tax basis of $100, to A in a current

distribution that is subject to section 737. As part of the same

distribution, AB distributes Property Y to A with a fair market

value of $20 and an adjusted tax basis of $0. At the time of

distribution, there has been no change in the fair market value of

Property A or the adjusted tax basis in A's interest in the

partnership.

ue of

$120 and an adjusted tax basis of $100, to A in a current

distribution that is subject to section 737. As part of the same

distribution, AB distributes Property Y to A with a fair market

value of $20 and an adjusted tax basis of $0. At the time of

distribution, there has been no change in the fair market value of

Property A or the adjusted tax basis in A's interest in the

partnership.

(iii) If AB had sold Security X for fair market value

immediately before the distribution to A, the partnership would have

recognized $20 of gain. A's distributive share of this gain would

have been $5 (25 percent of $20 gain). Because AB has no other

marketable securities, A's distributive share of gain in partnership

securities after the distribution would have been $0. As a result,

the distribution resulted in a decrease of $5 in A's share of the

net gain in AB's securities ($5 net gain before distribution minus

$0 net gain after distribution). Under paragraph (b)(2) of this

section, the amount of the distribution of Security X that is

treated as a distribution of money is reduced by $5. The

distribution of Security X is therefore treated as a distribution of

$115 of money to A ($120 fair market value of Security X minus $5

reduction). The portion of the distribution of the marketable

security that is not treated as a distribution of money ($5) is

treated as other property for purposes of section 737.

of Security X that is

treated as a distribution of money is reduced by $5. The

distribution of Security X is therefore treated as a distribution of

$115 of money to A ($120 fair market value of Security X minus $5

reduction). The portion of the distribution of the marketable

security that is not treated as a distribution of money ($5) is

treated as other property for purposes of section 737.

(iv) A recognizes total gain of $40 on the distribution. A

recognizes $15 of gain under section 731(a)(1) on the distribution

of the portion of Security X treated as money ($115 distribution of

money less $100 adjusted tax basis in A's partnership interest). A

recognizes $25 of gain under section 737 on the distribution of

Property Y and the portion of Security X that is not treated as

money. A's section 737 gain is equal to the lesser of (i) A's

precontribution gain ($100) or (ii) the excess of the fair market

value of property received ($20 fair market value of Property Y plus

$5 portion of Security X not treated as money) over the adjusted

basis in A's interest in the partnership immediately before the

distribution ($100) reduced (but not below zero) by the amount of

money received in the distribution ($115).

(v) A's adjusted tax basis in Security X is $115 ($100 basis of

Security X determined under section 732(a) plus $15 of gain

recognized by reason of section 731(c)). A's adjusted tax basis in

Property Y is $0 under section 732(a). The basis in A's interest in

the partnership is $25 ($100 basis before distribution minus $100

basis allocated to Security X under section 732(a) plus $25 gain

recognized under section 737).

(k) Effective date. This section applies to distributions of

marketable securities made on or after December 29, 1995.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 95-31457 Filed 12-29-95; 8:45 am]

BILLING CODE 4830-01-U