Par. 5. Section 1.734-1 is amended by: 1. Revising the section heading. 2. Revising paragraph (a). 3. Revising paragraph (b)(2)(i). 4. Adding Example 3 following paragraph (b)(2)(ii). 5. Adding a sentence at the end of paragraph (d). 6. Adding paragraphs (f), (g), and (h). The revisions and additions read as follows:
(a) General rule —(1) Adjustments to basis. A partnership shall not adjust the basis of partnership property as the result of a distribution of property to a partner unless the election provided in section 754 (relating to optional adjustment to basis of partnership property) is in effect or there is a substantial basis reduction (within the meaning of paragraph (a)(2)(i) of this section) with respect to the distribution.
(2) Substantial basis reduction —(i) In general. For purposes of this section, there is a substantial basis reduction with respect to a distribution of property or properties to a partner if the sum of the amounts described in section 734(b)(2)(A) and (b)(2)(B) exceeds $250,000. If there is a substantial basis reduction under this section, the partnership is treated as having an election under section 754 in effect solely for the distribution to which the substantial basis reduction relates.
(ii) Special rules for tiered partnerships. See paragraph (f) of this section for special rules regarding tiered partnerships.
(iii) Special rules for securitization partnerships. See paragraph (g) of this section for special rules regarding securitization partnerships.
(b) * * *
(2) Decrease in basis. (i) When a partnership with a section 754 election in effect makes a distribution in liquidation of a partner's entire interest in the partnership, or when there is a substantial basis reduction (within the meaning of paragraph (a)(2)(i) of this section), the partnership shall decrease the adjusted basis of the remaining partnership property by—
(ii) * * *
Example 3
—(i) A, B, and C each contribute $2 million to PRS, a partnership. PRS purchases Property 1 and Property 2, both of which are capital assets, for $1 million and $5 million respectively. In Year 2, the fair market value of Property 1 increases to $3 million and the fair market value of Property 2 increases to $6 million. Also in Year 2, PRS distributes Property 1 to C in liquidation of C's interest in PRS at a time when C's basis in its PRS interest is still $2 million. PRS does not have an election under section 754 in effect.
(ii) Under section 732, the basis of Property 1 in the hands of C is $2 million. Because the excess of C's adjusted basis in Property 1 ($2 million) over PRS's adjusted basis in Property 1 ($1 million) is $1 million, the amount described in section 734(b)(2)(B) ($1 million) exceeds $250,000, and therefore, there is a substantial basis reduction with respect to the distribution. Accordingly, pursuant to paragraph (a)(2)(i) of this section, PRS is treated as having a section 754 election in effect in Year 2 and must reduce its basis in Property 2 in accordance with paragraph (b)(2)(i) of this section.
* * * * *
(d) * * * A partnership required to adjust the basis of partnership property following the distribution of property because there is a substantial basis reduction (within the meaning of paragraph (a)(2)(i) of this section) with respect to the distribution is subject to, and required to comply with, the provisions of this paragraph (d) solely with respect to the distribution to which the substantial basis reduction relates.
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(f) Adjustments with respect to tiered partnerships —(1) In general. If an upper-tier partnership makes an adjustment under paragraph (b) of this section to the basis of an interest it holds in a lower-tier partnership that has an election under section 754 in effect, the lower-tier partnership must make adjustments under paragraph (b) of this section to the upper-tier partnership's share of the lower-tier partnership's assets. The amount of the lower-tier partnership's adjustment is equal to the adjustment made by the upper-tier partnership to the basis of its interest in the lower-tier partnership. The lower-tier partnership's adjustment to the upper-tier partnership's share of its assets is for the upper-tier partnership only and does not affect the basis in the lower-tier partnership's property for the other partners of the lower-tier partnership. Additionally, if there is a substantial basis reduction (within the meaning of paragraph (a)(2)(i) of this section) with respect to a distribution by an upper-tier partnership that (either directly or indirectly through one or more partnerships) holds an interest in a lower-tier partnership, each lower-tier partnership is treated, solely with respect to the distribution, as if it had made an election under section 754 for the taxable year in which the distribution occurs. For additional examples of the application of the principles of this paragraph (f)(1), see Revenue Ruling 92-15, 1992-1 CB 215. See § 601.601(d)(2)(ii)(b)
(2) Example
—(i) Facts. A, B, and C are equal partners in UTP, a partnership. Each partner's interest in UTP has an adjusted basis and fair market value of $3 million. UTP owns two capital assets with the following adjusted bases and fair market values:
| Adjusted basis | Fair market value | |
|---|---|---|
| Property 1 | $2.2 million | $3 million. |
| Property 2 | $2.8 million | $3 million. |
UTP also owns a 50 percent interest in LTP, a partnership. UTP's interest in LTP has an adjusted basis of $4 million and a fair market value of $3 million. LTP owns one asset, Property 3, a capital asset, which has an adjusted basis of $8 million and a fair market value of $6 million. Neither UTP nor LTP has an election under section 754 in effect.
(ii) Liquidating distribution to A of Property 1. UTP distributes Property 1 to A in complete liquidation of A's interest in UTP. Under section 732(b), the adjusted basis of Property 1 to A is $3 million. Therefore, there is a substantial basis reduction with respect to the distribution to A because the sum of the amounts described in section 734(b)(2)(A) ($0) and section 734(b)(2)(B) (the excess of $3 million over $2.2 million, or $800,000) exceeds $250,000. Therefore, pursuant to paragraph (b)(2) of this section, UTP must decrease the basis of its property by $800,000. Under § 1.755-1(c), UTP must decrease the adjusted basis of its 50 percent interest in LTP by $800,000. Likewise, pursuant to paragraph (f)(1) of this section, LTP must decrease its basis in UTP's share of Property 3 by $800,000 in accordance with § 1.755-1(c).
(g) Securitization partnerships. A securitization partnership (as defined in § 1.743-1(o)(2)) shall not be treated as having a substantial basis reduction with respect to any distribution of property to a partner.
(h) Effective/applicability date. The rules relating to substantial basis reductions in paragraphs (a) and (b) of this section and paragraphs (f) and (g) of this section apply to partnership distributions occurring on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register .