Par. 2. Section 1.704-3 is amended by: 1. Revising paragraph (a)(3)(ii). 2. Adding paragraph (a)(3)(iii). 3. Revising paragraph (a)(6)(i). 4. Adding paragraph (a)(6)(iii). 5. Adding paragraph (a)(6)(iv). 6. Revising paragraph (a)(7). 7. Revising the first sentence in paragraph (a)(10) by removing the word “allocation” before the word “method”. 8. Redesignating paragraph (f) as paragraph (g). 9. Adding a new paragraph (f). 10. Adding a sentence at the end of newly redesignated paragraph (g). The revisions and additions read as follows.
(a) * * *
(3) * * *
(ii) Built-in gain and built-in loss. The built-in gain on section 704(c) property is the excess of the property's book value over the contributing partner's adjusted tax basis upon contribution. The built-in gain is thereafter reduced by decreases in the difference between the property's book value and adjusted tax basis (other than decreases to the property's book value pursuant to § 1.704-1(b)(2)(iv)( f )). The built-in loss on section 704(c) property is the excess of the contributing partner's adjusted tax basis over the property's book value upon contribution. The built-in loss is thereafter reduced by decreases in the difference between the property's adjusted tax basis and book value (other than increases to the property's book value pursuant to § 1.704-1(b)(2)(iv)( f )). For purposes of paragraph (a)(6)(iii) and (iv) of this section, a built-in gain or built-in loss referred to in this paragraph shall be referred to as a forward section 704(c) allocation. See § 1.460-4(k)(3)(v)(A) for a rule relating to the amount of built-in income or built-in loss attributable to a contract accounted for under a long-term contract method of accounting.
(iii) Effective/applicability date. The provisions of paragraph (a)(3)(ii) of this section apply to partnership contributions and transactions occurring on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register . * * *
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(6) (i) Revaluations under section 704(b). The principles of this section apply with respect to property for which differences between book value and adjusted tax basis are created when a partnership revalues partnership property pursuant to section 1.704-1(b)(2)(iv)( f ) (reverse section 704(c) allocations). Each such revaluation creates a separate amount of built-in gain or built-in loss, as the case may be (a section 704(c) layer), that must be tracked separately from built-in gain or built-in loss arising from contribution (a forward section 704(c) layer) and any other revaluation (a reverse section 704(c) layer). For instance, one section 704(c) layer with respect to a particular property may be of built-in gain, and another section 704(c) layer with respect to the same property may be of built-in loss.
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(iii) Allocation method. A partnership may use any reasonable method to allocate the items of income, gain, loss, and deduction associated with an item of property among the property's forward and reverse section 704(c) layers.
(iv) Effective/applicability date. The provisions of paragraph (a)(6)(iii) of this section apply to partnership contributions and transactions occurring on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register .
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(7) Transfers of a partnership interest. If a contributing partner transfers a partnership interest, built-in gain must be allocated to the transferee partner as it would have been allocated to the transferor partner. If the contributing partner transfers a portion of the partnership interest, the share of built-in gain proportionate to the interest transferred must be allocated to the transferee partner. Rules for the allocation of built-in loss are provided in paragraph (f) of this section.
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(f) Special rules for built-in loss property —(1) General principles —(i) Contributing partner. If a partner contributes section 704(c)(1)(C) property (as defined in paragraph (f)(2)(i) of this section) to a partnership, the excess of the adjusted basis of the section 704(c)(1)(C) property (determined without regard to paragraph (f)(1)(ii) of this section) over its fair market value immediately before the contribution will be taken into account only in determining the amount of items allocated to the section 704(c)(1)(C) partner (as defined in paragraph (f)(2)(ii) of this section) that contributed such section 704(c)(1)(C) property.
(ii) Non-contributing partners. In determining the amount of items allocated to partners other than the section 704(c)(1)(C) partner, the initial basis of section 704(c)(1)(C) property in the hands of the partnership is equal to the property's fair market value at the time of contribution.
(2) Definitions. For purposes of this section—
(i) Section 704(c)(1)(C) property. The term section 704(c)(1)(C) property means section 704(c) property (as defined in paragraph (a)(3)(i) of this section) with a built-in loss at the time of contribution. Section 704(c)(1)(C) property does not include a § 1.752-7 liability (within the meaning of § 1.752-7(b)(3)) or property for which differences between book value and adjusted tax basis are created when a partnership revalues property pursuant to § 1.704-1(b)(2)(iv)( f ).
(ii) Section 704(c)(1)(C) partner. The term section 704(c)(1)(C) partner means a partner that contributes section 704(c)(1)(C) property to a partnership.
(iii) Section 704(c)(1)(C) basis adjustment. A property's section 704(c)(1)(C) basis adjustment is initially equal to the excess of the adjusted basis of section 704(c)(1)(C) property (determined without regard to paragraph (f)(1)(ii) of this section) over its fair market value immediately before the contribution, and is subsequently adjusted for the recovery of the section 704(c)(1)(C) basis adjustment under paragraph (f)(3)(ii)(D) of this section.
(3) Operational rules —(i) In general. Except as provided in this section, section 704(c)(1)(C) property is subject to the rules and regulations applicable to section 704(c) property. See, for example, § 1.704-3(a)(9).
(ii) Effect of section 704(c)(1)(C) basis adjustment —(A) In general. The section 704(c)(1)(C) basis adjustment is an adjustment to the basis of partnership property with respect to the section 704(c)(1)(C) partner only. A section 704(c)(1)(C) basis adjustment amount is excluded from the partnership's basis of section 704(c)(1)(C) property. Thus, for purposes of calculating income, deduction, gain, and loss, the section 704(c)(1)(C) partner will have a special basis for section 704(c)(1)(C) property in which the partner has a section 704(c)(1)(C) basis adjustment. The section 704(c)(1)(C) basis adjustment has no effect on the partnership's computation of any item under section 703.
(B) Computation of section 704(c)(1)(C) 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 section 704(c)(1)(C) partner, in accordance with section 704, and adjusts the partners' capital accounts accordingly. The partnership then adjusts the section 704(c)(1)(C) partner's distributive share of the items of partnership income, deduction, gain, or loss in accordance with paragraphs (f)(3)(ii)(C) and (D) of this section, to reflect the effects of the section 704(c)(1)(C) partner's section 704(c)(1)(C) basis adjustment. These adjustments to the section 704(c)(1)(C) partner's distributive share must be reflected on Schedules K and K-1 of the partnership's return (Form 1065). The adjustments to the section 704(c)(1)(C) partner's distributive shares do not affect the section 704(c)(1)(C) partner's capital account.
(C) Effect of section 704(c)(1)(C) basis adjustment in determining items of income, gain, or loss. The amount of a section 704(c)(1)(C) partner's income, gain, or loss from the sale or exchange of partnership property in which the section 704(c)(1)(C) partner has a section 704(c)(1)(C) basis adjustment is equal to the section 704(c)(1)(C) partner's share of the partnership's gain or loss from the sale of the property (including any remedial allocations under § 1.704-3(d)), minus the section 704(c)(1)(C) partner's section 704(c)(1)(C) basis adjustment for the partnership property.
(D) Effect of section 704(c)(1)(C) basis adjustment in determining items of deduction —( 1 ) In general. If section 704(c)(1)(C) property is subject to amortization under section 197, depreciation under section 168, or other cost recovery in the hands of the section 704(c)(1)(C) partner, the section 704(c)(1)(C) basis adjustment associated with the property is recovered in accordance with section 197(f)(2), section 168(i)(7), or another applicable Internal Revenue Code section. The amount of any section 704(c)(1)(C) basis adjustment that is recovered by the section 704(c)(1)(C) partner in any year is added to the section 704(c)(1)(C) partner'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 section 704(c)(1)(C) basis adjustment.
( 2 ) Example.
A contributes Property, with an adjusted basis of $12,000 and a fair market value of $5,000 on January 1 of the year of contribution, and B contributes $5,000 to PRS, a partnership. Prior to the contribution, A depreciates Property under section 168 over 10 years using the straight-line method and the half-year convention. On the contribution date, Property has 7.5 years remaining in its recovery period. Property is section 704(c)(1)(C) property, and A's section 704(c)(1)(C) basis adjustment is $7,000. PRS's basis in Property is $5,000 (fair market value) and, in accordance with section 168(i)(7), the depreciation is $667 per year ($5,000 divided by 7.5 years), which is shared equally between A and B. A's $7,000 section 704(c)(1)(C) basis adjustment is subject to depreciation of $933 per year in accordance with section 168(i)(7) ($7,000 divided by 7.5 years), which is taken into account by A.
(iii) Transfer of section 704(c)(1)(C) partner's partnership interest —(A) General rule. Except as provided in paragraph (f)(3)(iii)(B) of this section, if a section 704(c)(1)(C) partner transfers its partnership interest, the portion of the section 704(c)(1)(C) basis adjustment attributable to the interest transferred is eliminated and the transferee is not treated as the section 704(c)(1)(C) partner with respect to the interest transferred. The transferor remains the section 704(c)(1)(C) partner with respect to any remaining section 704(c)(1)(C) basis adjustment.
(B) Special rules —( 1 ) General rule for transfer of partnership interest in nonrecognition transaction. Except as provided in paragraph (f)(3)(iii)(B)( 2 ) of this section, paragraph (f)(3)(iii)(A) of this section does not apply to the extent a section 704(c)(1)(C) partner transfers its partnership interest in a nonrecognition transaction. Instead, the transferee of all or a portion of a section 704(c)(1)(C) partner's partnership interest succeeds to the transferor's section 704(c)(1)(C) basis adjustments in an amount attributable to the interest transferred and the transferee will be treated as the section 704(c)(1)(C) partner with respect to the transferred interest. Regardless of whether a section 754 election is in effect or a substantial built-in loss exists with respect to the transfer, the amount of any section 704(c)(1)(C) basis adjustment with respect to section 704(c)(1)(C) property to which the transferee succeeds shall be decreased by the amount of the negative section 743(b) adjustment that would be allocated to the section 704(c)(1)(C) property pursuant to the provisions of § 1.755-1 if the partnership had a section 754 election in effect upon the transfer. If the nonrecognition transaction is described in section 168(i)(7)(B), then the rules in section 168(i)(7)(A) apply with respect to transferor's cost recovery deductions under section 168. If gain or loss is recognized on the transaction, appropriate adjustments must be made to the section 704(c)(1)(C) basis adjustment.
( 2 ) Exception for gifts. Paragraph (f)(3)(iii)(B)( 1 ) of this section does not apply to the transfer of all or a portion of a section 704(c)(1)(C) partner's partnership interest by gift.
(C) Examples. The following examples illustrate the principles of this paragraph (f)(3)(iii)—
Example 1.
Sale of entire partnership interest. In Year 1, A contributes non-depreciable Property, with an adjusted basis of $11,000 and a fair market value of $5,000, and B and C each contribute $5,000 cash to PRS, a partnership. PRS's basis in Property is $5,000, and A's section 704(c)(1)(C) basis adjustment in Property is $6,000. In Year 3, Property's fair market value is unchanged and A's section 704(c)(1)(C) basis adjustment remains $6,000. D purchases A's interest in PRS for its fair market value of $5,000. PRS does not have a section 754 election in effect in Year 3. A recognizes a loss of $6,000 on the sale, which equals the excess of its basis in PRS ($11,000) over the amount realized on the sale ($5,000). Pursuant to paragraph (f)(3)(iii)(A) of this section, D does not succeed to A's section 704(c)(1)(C) basis adjustment, which is eliminated upon the sale.
Example 2.
Sale of portion of partnership interest. Assume the same facts as Example 1 except that D purchases 50 percent of A's interest in PRS for its fair market value of $2,500. A recognizes a loss of $3,000 on the sale, which equals the excess of its basis in the 50 percent interest in PRS ($5,500) over the amount realized on the sale ($2,500). Pursuant to paragraph (f)(3)(iii)(A) of this section, D does not succeed to A's section 704(c)(1)(C) basis adjustment, and A's section 704(c)(1)(C) basis adjustment is reduced to $3,000 upon the sale.
Example 3.
Section 721 transaction —(i) Assume the same facts as Example 1 except that instead of selling its interest in PRS to D in Year 3, A contributes its interest in PRS to UTP, a partnership, in exchange for a 50 percent interest in UTP. Following the contribution, UTP's basis in PRS is $5,000 plus a $6,000 section 704(c)(1)(C) basis adjustment solely allocable to A. Under the facts of this example, UTP's share of basis in PRS property is the same.
(ii) Under paragraph (f)(3)(iii)(B)( 1 ) of this section, UTP succeeds to A's $6,000 section 704(c)(1)(C) basis adjustment in Property. PRS does not have a section 754 election in effect and does not have a substantial built-in loss (within the meaning of § 1.743-1(a)(2)(i)) with respect to the transfer. Paragraph (f)(3)(iii)(B)( 1 ) of this section requires PRS to reduce the amount of the section 704(c)(1)(C) basis adjustment by the amount of the negative section 743(b) adjustment that would be allocated to Property if PRS had an election under section 754 in effect. Because UTP's basis in PRS equals UTP's share of basis in PRS property, no negative section 743(b) adjustment would result from the transfer. Accordingly, UTP's section 704(c)(1)(C) basis adjustment in Property is $6,000. Pursuant to paragraph (a)(9) of this section, UTP must allocate its distributive share of PRS's items with respect to the section 704(c)(1)(C) basis adjustment solely to A.
(iii) In Year 3, PRS sells Property for its fair market value of $5,000. PRS realizes no gain or loss on the sale. Pursuant to paragraph (f)(3)(ii)(C) of this section, PRS reduces UTP's allocable gain from the sale of Property ($0) by the amount of UTP's section 704(c)(1)(C) basis adjustment for Property ($6,000). Thus, UTP is allocated a $6,000 loss. Pursuant to paragraph (a)(9) of this section, UTP must allocate the $6,000 loss with respect to the section 704(c)(1)(C) basis adjustment to A. A's basis in UTP decreases from $11,000 to $5,000 and its section 704(c)(1)(C) basis adjustment in UTP is eliminated.
Example 4.
Interaction with section 362(e)(2)(A) —(i) Assume the same facts as Example 1 except that instead of selling its interest in PRS to D in Year 3, A contributes its interest in PRS to Y Corp, a corporation, in a transfer described in section 351. PRS has a section 754 election in effect. A's basis in its Y Corp stock is $11,000 under section 358.
(ii) A and Y Corp do not elect to apply the provisions of section 362(e)(2)(C). Therefore, section 362(e)(2)(A) will apply because Y Corp's basis in PRS ($11,000) would exceed the fair market value of PRS ($5,000) immediately after the transaction. Thus, pursuant to section 362(e)(2)(B), Y Corp's basis in PRS will be $5,000. Y Corp succeeds to A's $6,000 section 704(c)(1)(C) basis adjustment in Property pursuant to paragraph (f)(3)(iii)(B)( 1 ) of this section. Pursuant to § 1.743-1, Y Corp's section 743(b) adjustment is ($6,000), or the difference between Y Corp's basis in PRS of $5,000 and Y Corp's share of the adjusted basis of PRS's property of $11,000 (which is Y Corp's cash on liquidation of $5,000, increased by the $6,000 tax loss that would be allocated to Y Corp upon a hypothetical transaction). The ($6,000) section 743(b) adjustment will be allocated to PRS's property in accordance with section 755 and the regulations thereunder.
Example 5.
Gift of partnership interest. Assume the same facts as Example 1 except that instead of selling its PRS interest to D in Year 3, A makes a gift of its PRS interest to D. Pursuant to paragraph (f)(3)(iii)(B)( 2 ) of this section, D does not succeed to any of A's section 704(c)(1)(C) basis adjustment in Property. The $6,000 section 704(c)(1)(C) basis adjustment is eliminated upon the gift.
(iv) Transfer of section 704(c)(1)(C) property by partnership —(A) Like-kind exchange —( 1 ) General rule. If a partnership disposes of section 704(c)(1)(C) property in a like-kind exchange described in section 1031 and the regulations thereunder, the substituted basis property (as defined in section 7701(a)(42)) received by the partnership is treated, solely with respect to the section 704(c)(1)(C) partner, as section 704(c)(1)(C) property with the same section 704(c)(1)(C) basis adjustment as the section 704(c)(1)(C) property disposed of by the partnership (with appropriate adjustments for any portion of the section 704(c)(1)(C) basis adjustment taken into account in determining the section 704(c)(1)(C) partner's gain or loss recognized on the transfer).
(2) Example.
A contributes Property 1 with an adjusted basis of $12,000 and a fair market value of $10,000 and B contributes $10,000 cash to PRS, a partnership. A has a $2,000 section 704(c)(1)(C) basis adjustment in Property 1, and PRS has an adjusted basis in Property 1 of $10,000, or its fair market value. PRS subsequently engages in a like-kind exchange under section 1031 of Property 1 when the fair market value of Property 1 is $13,000 and receives Property 2 with a fair market value of $12,000 and $1,000 cash in exchange. PRS's gain on the transaction is $3,000 ($13,000 minus PRS's $10,000 adjusted basis) but is recognized only to the extent of the cash received of $1,000, of which $500 is allocable to A. As provided in paragraph (f)(3)(iv)(A)( 1 ) of this section, Property 2 is treated as section 704(c)(1)(C) property with respect to A and has the same section 704(c)(1)(C) basis adjustment as Property 1. Because PRS recognized gain on the transaction, A must use $500 of its section 704(c)(1)(C) basis adjustment to reduce A's gain to $0. Therefore, A's $2,000 section 704(c)(1)(C) basis adjustment is reduced to $1,500.
(B) Contribution of 704(c)(1)(C) property in section 721 transaction —( 1 ) In general. The rules set forth in this paragraph (f)(3)(iv)(B) apply if a section 704(c)(1)(C) partner contributes section 704(c)(1)(C) property to an upper-tier partnership, and that upper-tier partnership subsequently contributes the section 704(c)(1)(C) property to a lower-tier partnership in a transaction described in section 721(a) (whether as part of a single transaction or as separate transactions). The interest in the lower-tier partnership received by the upper-tier partnership is treated as the section 704(c)(1)(C) property with the same section 704(c)(1)(C) basis adjustment as the contributed property. The lower-tier partnership determines its basis in the contributed property by excluding the existing section 704(c)(1)(C) basis adjustment under the principles of paragraph (f)(3)(ii)(A) of this section. However, the lower-tier partnership also succeeds to the upper-tier partnership's section 704(c)(1)(C) basis adjustment. The portion of the upper-tier partnership's basis in its interest in the lower-tier partnership attributable to the section 704(c)(1)(C) basis adjustment must be segregated and allocated solely to the section 704(c)(1)(C) partner for whom the initial section 704(c)(1)(C) basis adjustment was made. Similarly, the section 704(c)(1)(C) basis adjustment to which the lower-tier partnership succeeds must be segregated and allocated solely to the upper-tier partnership, and the section 704(c)(1)(C) partner for whom the initial section 704(c)(1)(C) basis adjustment was made. If gain or loss is recognized on the transaction, appropriate adjustments must be made to the section 704(c)(1)(C) basis adjustment.
( 2 ) Special rules. ( a ) To the extent that any section 704(c)(1)(C) basis adjustment in a tiered partnership is recovered under paragraphs (f)(3)(ii)(C) or (D) of this section, or is otherwise reduced, upper- or lower-tier partnerships in the tiered structure must make conforming reductions to related section 704(c)(1)(C) basis adjustments to prevent duplication of loss.
( b ) Section 704(c)(1)(C) property that is contributed by an upper-tier partnership to a lower-tier partnership will have an additional section 704(c)(1)(C) basis adjustment if the value of the section 704(c)(1)(C) property is less than its tax basis (as adjusted under paragraph (f)(3)(ii) of this section) at the time of the transfer to the lower-tier partnership. Any additional section 704(c)(1)(C) basis adjustment determined under this paragraph will be allocated among the partners of the upper-tier partnership in a manner that reflects their relative shares of that loss.
(3) Example 1—
(i) In Year 1, A contributes Property with an adjusted basis of $11,000 and a fair market value of $5,000, and B contributes $5,000 cash to UTP, a partnership. Later in Year 1, when Property's basis has not changed, and Property is worth at least $5,000, UTP contributes Property to LTP in a section 721 transaction for a 50-percent interest in LTP. In Year 2, LTP sells Property for its fair market value of $29,000.
(ii) A has a $6,000 section 704(c)(1)(C) basis adjustment in Property. After the section 721 transaction, A's section 704(c)(1)(C) basis adjustment in Property becomes A's section 704(c)(1)(C) adjustment in UTP's interest in LTP. UTP has a section 704(c)(1)(C) adjustment in Property in the amount of A's section 704(c)(1)(C) adjustment in Property. This section 704(c)(1)(C) adjustment must be segregated and allocated solely to A. UTP's basis in its interest in LTP is determined without reference to the section 704(c)(1)(C) adjustment. Thus, UTP's basis in LTP is $5,000. LTP's basis in Property is determined without reference to the section 704(c)(1)(C) basis adjustment; therefore, LTP's basis in Property is $5,000.
(iii) Upon the sale of Property, LTP realizes a gain of $24,000 ($29,000 fair market value minus $5,000 adjusted basis). UTP's allocable share of the $24,000 gain from the sale of Property by LTP is $12,000, reduced by UTP's $6,000 section 704(c)(1)(C) basis adjustment in Property. Because UTP's section 704(c)(1)(C) basis adjustment must be segregated and allocated solely to A, UTP allocates the $12,000 of gain equally between A and B, but allocates the recovery of the $6,000 section 704(c)(1)(C) basis adjustment to A. Therefore, pursuant to paragraph (f)(3)(ii)(C) of this section, A recognizes no gain or loss on the sale (A's $6,000 share of UTP's gain minus the $6,000 section 704(c)(1)(C) basis adjustment). Because UTP's section 704(c)(1)(C) adjustment in Property is used, A's section 704(c)(1)(C) basis adjustment in UTP's interest in LTP is reduced to $0 to prevent duplication of loss pursuant to paragraph (f)(3)(iv)(B)( 2 )( a ) of this section.
Example 2—
Assume the same facts as Example 1, except that in Year 2, UTP sells its entire interest in LTP to D for its fair market value of $17,000. UTP recognizes a $12,000 gain on the sale, which equals the excess of UTP's amount realized on the sale ($17,000) over UTP's basis in LTP ($5,000). UTP allocates the $12,000 gain equally to A and B. However, A's $6,000 section 704(c)(1)(C) adjustment in UTP's interest in LTP offsets A's share of the gain. Therefore, A recognizes no gain or loss on the sale. D does not receive any of UTP's section 704(c)(1)(C) basis adjustment in Property, which is eliminated upon the sale.
Example 3—
(i) Assume the same facts as Example 1, except that at the time UTP contributes Property to LTP, the fair market value of Property has fallen to $2,000. In Year 2, LTP sells Property for its fair market value of $2,000.
(ii) A has a $6,000 section 704(c)(1)(C) basis adjustment in Property. After the section 721 transaction, pursuant to paragraph (f)(3)(iv)(B)( 1 ) of this section, A's section 704(c)(1)(C) basis adjustment in Property becomes A's section 704(c)(1)(C) adjustment in UTP's interest in LTP. Pursuant to paragraph (f)(3)(iv)(B)( 1 ) of this section, UTP has a section 704(c)(1)(C) adjustment in Property in the amount of A's section 704(c)(1)(C) adjustment in Property. This section 704(c)(1)(C) adjustment must be segregated and allocated solely to A. Because UTP's basis in Property ($5,000) exceeds the fair market value of Property ($2,000) by $3,000 at the time of UTP's contribution to LTP, UTP has an additional section 704(c)(1)(C) adjustment of $3,000 in Property pursuant to paragraph (f)(3)(iv)(B)( 2 )( b ) of this section. Partners A and B share equally in this $3,000 section 704(c)(1)(C) adjustment. UTP's basis in its interest in LTP is determined without reference to A's section 704(c)(1)(C) adjustment. Thus, UTP's basis in LTP is $5,000. Pursuant to paragraph (f)(3)(iv)(B)( 1 ) of this section, LTP's basis in Property is determined without reference to either section 704(c)(1)(C) basis adjustment; therefore, LTP's basis in Property is $2,000.
(iii) Upon the sale of Property, LTP recognizes no gain or loss ($2,000 sales price minus $2,000 adjusted basis). However, the sale of Property triggers UTP's two separate section 704(c)(1)(C) basis adjustments. First, UTP applies the $3,000 section 704(c)(1)(C) adjustment attributable to the built-in loss in Property arising after A contributed Property to UTP. This results in an allocation of ($1,500) of loss to each of A and B. Next, UTP applies the $6,000 section 704(c)(1)(C) basis adjustment attributable to A's initial contribution of Property to UTP, resulting in an additional ($6,000) of loss allocated to A. Thus, the sale of Property by LTP results in A recognizing ($7,500) of loss, and B recognizing ($1,500) of loss. Pursuant to paragraph (f)(3)(iv)(B)( 2 )( a ) of this section, because UTP's section 704(c)(1)(C) adjustment in Property is used, A's section 704(c)(1)(C) basis adjustment in UTP's interest in LTP is reduced to $0 to prevent duplication of loss.
(C) Section 351 transactions —( 1 ) Basis in transferred property. A corporation's adjusted basis in property transferred to the corporation by a partnership in a transaction described in section 351 is determined under section 362 (including for purposes of applying section 362(e) ) by taking into account any section 704(c)(1)(C) basis adjustment for the property (other than any portion of a section 704(c)(1)(C) basis adjustment that reduces a partner's gain under paragraph (f)(3)(iv)(C)( 2 ) of this section).
( 2 ) Partnership gain. The amount of gain, if any, recognized by the partnership on the transfer of property by the partnership to a corporation in a transfer described in section 351 is determined without regard to any section 704(c)(1)(C) basis adjustment for the transferred property. The amount of gain, if any, recognized by the partnership on the transfer that is allocated to the section 704(c)(1)(C) partner is adjusted to reflect the partner's section 704(c)(1)(C) basis adjustment in the transferred property.
( 3 ) Basis in stock. The partnership's adjusted basis in stock received from a corporation in a transfer described in section 351 is determined without regard to the section 704(c)(1)(C) basis adjustment in property transferred to the corporation in the section 351 exchange. A partner with a section 704(c)(1)(C) 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 section 704(c)(1)(C) basis adjustment in the transferred property, reduced by any portion of the section 704(c)(1)(C) basis adjustment that reduced the partner's gain under paragraph (f)(3)(iv)(C)( 2 ) of this section.
( 4 ) Example. The following example illustrates the provisions of this paragraph (f)(3)(iv)(C).
Example.
Section 351 transaction —(i) In Year 1, A contributes $10,000 cash and B contributes Property with an adjusted basis of $18,000 and a fair market value of $10,000 to PRS, a partnership. PRS takes Property with a basis of $10,000. B's section 704(c)(1)(C) basis adjustment for Property is $8,000. PRS contributes Property to Y Corp in a section 351 transaction. Under section 362(e)(2)(A), Y Corp takes a $10,000 basis in Property. PRS's basis in its Y Corp stock is $10,000 under section 358. Pursuant to paragraph (f)(3)(iv)(C)( 3 ) of this section, B has a section 704(c)(1)(C) basis adjustment of $8,000 in the Y Corp stock received by PRS in the section 351 exchange.
(ii) In Year 2, Y Corp sells Property for its fair market value of $10,000. Y Corp recognizes no gain or loss on the sale of Property. Pursuant to paragraph (f)(3)(iv)(C)( 1 ) of this section, B does not take into account its section 704(c)(1)(C) basis adjustment upon the sale by Y Corp of Property. Instead, B will take the section 704(c)(1)(C) basis adjustment into account when PRS disposes of the Y Corp stock.
(D) Section 708(b)(1)(B) transactions —( 1 ) In general. A partner with a section 704(c)(1)(C) basis adjustment in section 704(c)(1)(C) property held by a partnership that terminates under section 708(b)(1)(B) will continue to have the same section 704(c)(1)(C) basis adjustment for section 704(c)(1)(C) property deemed contributed by the terminated partnership to the new partnership under § 1.708-1(b)(4). In addition, the deemed contribution of property by a terminated partnership to a new partnership is not subject to this section and does not create a section 704(c)(1)(C) basis adjustment.
( 2 ) Example.
A contributes Property with an adjusted basis of $11,000 and a fair market value of $5,000 and B contributes $5,000 cash to PRS, a partnership. B sells its entire interest in PRS to C for its fair market value of $5,000, which terminates PRS under section 708(b)(1)(B). Under § 1.708-1(b)(4), PRS is deemed to contribute all of its assets and liabilities to a new partnership (New PRS) in exchange for an interest in New PRS. Immediately thereafter, PRS is deemed to distribute its interest in New PRS equally to A and C in complete liquidation of PRS. New PRS takes Property with a basis of $5,000 and A retains its $6,000 section 704(c)(1)(C) basis adjustment related to Property inside New PRS.
(E) Disposition in an installment sale. If a partnership disposes of section 704(c)(1)(C) property in an installment sale (as defined in section 453(b)), the installment obligation received by the partnership is treated as the section 704(c)(1)(C) property with the same section 704(c)(1)(C) basis adjustment as the section 704(c)(1)(C) property disposed of by the partnership (with appropriate adjustments for any gain recognized on the installment sale).
(F) Contributed contracts. If a partner contributes to a partnership a contract that is section 704(c)(1)(C) property, and the partnership subsequently acquires property pursuant to the contract in a transaction in which less than all of the loss is recognized, then the acquired property is treated as section 704(c)(1)(C) property with the same section 704(c)(1)(C) basis adjustment as the contract (with appropriate adjustments for any gain or loss recognized on the acquisition). For this purpose, the term contract includes, but is not limited to, options, forward contracts, and futures contracts.
(v) Distributions —(A) Current distribution of section 704(c)(1)(C) property to section 704(c)(1)(C) partner. If a partnership distributes property to a partner and the partner has a section 704(c)(1)(C) basis adjustment for the property, the section 704(c)(1)(C) basis adjustment is taken into account under section 732. See § 1.732-2(a). For certain adjustments to the basis of remaining partnership property after the distribution of section 704(c)(1)(C) property to the section 704(c)(1)(C) partner, see § 1.734-2(c).
(B) Distribution of section 704(c)(1)(C) property to another partner. If a partner receives a distribution of property in which another partner has a section 704(c)(1)(C) basis adjustment, the distributee does not take the section 704(c)(1)(C) basis adjustment into account under section 732. If section 704(c)(1)(B) applies to treat the section 704(c)(1)(C) partner as recognizing loss on the sale of the distributed property, the section 704(c)(1)(C) basis adjustment is taken into account in determining the amount of the loss. A section 704(c)(1)(C) partner with a section 704(c)(1)(C) basis adjustment in the distributed property that is not taken into account as described in the prior sentence reallocates the section 704(c)(1)(C) basis adjustment among the remaining items of partnership property under § 1.755-1(c).
(C) Distributions in complete liquidation of a section 704(c)(1)(C) partner's interest. If a section 704(c)(1)(C) partner receives a distribution of property (whether or not the partner has a section 704(c)(1)(C) basis adjustment in the 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 section 704(c)(1)(C) partner's section 704(c)(1)(C) basis adjustment for the property in which the section 704(c)(1)(C) partner relinquished an interest. For purposes of determining the section 704(c)(1)(C) partner's basis in distributed property under section 732, the partnership reallocates any section 704(c)(1)(C) basis adjustment from section 704(c)(1)(C) property retained by the partnership to distributed properties of like character under the principles of § 1.755-1(c)(i), after applying sections 704(c)(1)(B) and 737. If section 704(c)(1)(C) property is retained by the partnership, and no property of like character is distributed, then that property's section 704(c)(1)(C) basis adjustment is not reallocated to the distributed property for purposes of applying section 732. See § 1.734-2(c)(2) for rules regarding the treatment of any section 704(c)(1)(C) adjustment that is not fully utilized by the section 704(c)(1)(C) partner.
(D) Examples. The following examples illustrate the principles of this paragraph (f)(3)(v).
Example 1.
Current distribution of section 704(c)(1)(C) property to section 704(c)(1)(C) partner —(i) A contributes Property 1 with an adjusted basis of $15,000 and a fair market value of $10,000 and Property 2 with an adjusted basis of $5,000 and a fair market value of $20,000 and B contributes $30,000 cash to PRS, a partnership. Property 1 and Property 2 are both capital assets. When Property 1 has a fair market value of $12,000, and neither A nor B's basis in PRS has changed, PRS distributes Property 1 to A in a current distribution.
(ii) Property 1 has an adjusted basis to PRS of $10,000, and A has a section 704(c)(1)(C) basis adjustment of $5,000 in Property 1. Pursuant to § 1.732-2(c) and paragraph (f)(3)(v)(A) of this section, for purposes of section 732(a)(1), the adjusted basis of Property 1 to PRS immediately before the distribution is $15,000 (PRS's $10,000 adjusted basis increased by A's $5,000 section 704(c)(1)(C) basis adjustment for Property 1) and, therefore. A takes a $15,000 adjusted basis in Property 1 upon the distribution. Accordingly, no adjustment is required to PRS's property under section 734.
Example 2.
Current distribution of section 704(c)(1)(C) property to another partner. Assume the same facts as Example 1 except PRS distributes Property 1 to B in a distribution to which section 704(c)(1)(B) does not apply. B does not take any portion of A's section 704(c)(1)(C) basis adjustment into account. Accordingly, pursuant to § 1.732-1(a) and paragraph (f)(3)(v)(B) of this section, for purposes of section 732(a)(1), the adjusted basis of Property 1 to PRS immediately before the distribution is $10,000 and, therefore, B takes a $10,000 adjusted basis in Property 1 upon the distribution. Accordingly, no adjustment is required to PRS's property under section 734. A's section 704(c)(1)(C) basis adjustment in Property 1 is reallocated to Property 2 in accordance with § 1.755-1(c).
Example 3.
(i) Liquidating distribution to section 704(c)(1)(C) partner. In Year 1, A contributes Property 1 with an adjusted basis of $15,000 and a fair market value of $10,000 and Property 2 with an adjusted basis of $5,000 and a fair market value of $20,000 and B and C each contribute $30,000 cash to PRS, a partnership. Property 1 and Property 2 are both capital assets. In a later year, when the fair market value of Property 2 is still $20,000, and no partner's basis in PRS has changed, PRS distributes Property 2 and $10,000 to A in complete liquidation of A's partnership interest in a distribution to which section 737 does not apply. PRS has a section 754 election in effect for the year of the distribution.
(ii) Property 2 has an adjusted basis to PRS of $5,000, and A has a section 704(c)(1)(C) basis adjustment of $5,000 in Property 1. Pursuant to § 1.732-2(c) and paragraph (f)(3)(v)(C) of this section, for purposes of section 732(b), the adjusted basis of Property 2 to PRS immediately before the distribution is $10,000 (PRS's $5,000 adjusted basis in Property 2 increased by A's $5,000 section 704(c)(1)(C) basis adjustment for Property 1), and A's adjusted basis in Property 2 upon the distribution is $10,000 (A's $20,000 basis in PRS minus the $10,000 cash distributed). Therefore, no adjustment is required to PRS's property under section 734.
(vi) Returns. A partnership that owns property with a section 704(c)(1)(C) basis adjustment must attach a statement to the partnership return for the year of the contribution setting forth the name and taxpayer identification number of the section 704(c)(1)(C) partner as well as the section 704(c)(1)(C) basis adjustment and the section 704(c)(1)(C) property to which the adjustment relates.
(g) * * *. The provisions of paragraph (f) of this section apply to partnership contributions occurring on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register .