Par. 9. Section 1.755-1 is amended by: 1. Revising paragraph (b)(5). 2. Redesignating paragraph (e) as paragraph (f). 3. Adding a new paragraph (e). 4. Revising newly redesignated paragraph (f). The revisions and addition read as follows:
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(b) * * *
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(5) Substituted basis transactions —(i) In general. This paragraph (b)(5) applies to basis adjustments under section 743(b) that result from exchanges in which the transferee's basis in the partnership interest is determined in whole or in part by reference to the transferor's basis in that interest and from exchanges in which the transferee's basis in the partnership interest is determined by reference to other property held at any time by the transferee. For example, this paragraph (b)(5) applies if a partnership interest is contributed to a corporation in a transaction to which section 351 applies, if a partnership interest is contributed to a partnership in a transaction to which section 721(a) applies, or if a partnership interest is distributed by a partnership in a transaction to which section 731(a) applies.
(ii) Allocations between classes of property —(A) No adjustment. If the total amount of the basis adjustment under section 743(b) is zero, then no adjustment to the basis of partnership property will be made under this paragraph (b)(5).
(B) Increases. If there is an increase in basis to be allocated to partnership assets, the increase must be allocated between capital gain property and ordinary income property in proportion to, and to the extent of, the gross gain or gross income (including any remedial allocations under § 1.704-3(d)) that would be allocated to the transferee (to the extent attributable to the acquired partnership interest) from the hypothetical sale of all property in each class. Any remaining increase must be allocated between the classes in proportion to the fair market value of all property in each class.
(C) Decreases. If there is a decrease in basis to be allocated to partnership assets, the decrease must be allocated between capital gain property and ordinary income property in proportion to, and to the extent of, the gross loss (including any remedial allocations under § 1.704-3(d)) that would be allocated to the transferee (to the extent attributable to the acquired partnership interest) from the hypothetical sale of all property in each class. Any remaining decrease must be allocated between the classes in proportion to the transferee's shares of the adjusted bases of all property in each class (as adjusted under the preceding sentence).
(iii) Allocations within the classes —(A) Increases. If, under paragraph (b)(5)(ii) of this section, there is an increase in basis to be allocated within a class, the increase must be allocated first to properties with unrealized appreciation in proportion to the transferee's share of the respective amounts of unrealized appreciation (to the extent attributable to the acquired partnership interest) before the increase (but only to the extent of the transferee's share of each property's unrealized appreciation). Any remaining increase must be allocated among the properties within the class in proportion to their fair market values.
(B) Decreases. If, under paragraph (b)(5)(ii) of this section, there is a decrease in basis to be allocated within a class, the decrease must be allocated first to properties with unrealized depreciation in proportion to the transferee's shares of the respective amounts of unrealized depreciation (to the extent attributable to the acquired partnership interest) before the decrease (but only to the extent of the transferee's share of each property's unrealized depreciation). Any remaining decrease must be allocated among the properties within the class in proportion to the transferee's shares of their adjusted bases (as adjusted under the preceding sentence).
(C) Limitation in decrease of basis. Where, as a result of a transaction to which this paragraph (b)(5) applies, a decrease in basis must be allocated to capital gain assets, ordinary income assets, or both, and the amount of the decrease otherwise allocable to a particular class exceeds the transferee's share of the adjusted basis to the partnership of all assets in that class, the basis of the property is reduced to zero (but not below zero).
(D) Carryover adjustment. Where a transferee's negative basis adjustment under section 743(b) cannot be allocated to any asset, the adjustment is made when the partnership subsequently acquires property of a like character to which an adjustment can be made.
(iv) Examples. The provisions of this paragraph (b)(5) are illustrated by the following examples—
Example 1.
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Example 2.
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Example 3
—(i) A is a one-third partner in UTP, a partnership, which has a valid election in effect under section 754. The three partners in UTP have equal interests in the capital and profits of UTP. UTP has three assets with the following adjusted bases and fair market values:
| Assets | Adjusted basis | Fair market value |
|---|---|---|
| Intangible 1 | $30 | $200 |
| Land | 200 | 200 |
| 50% interest in LTP | 190 | 200 |
LTP, a partnership, has a section 754 election in effect for the year of the distribution. LTP owns three assets with the following adjusted bases and fair market values:
| Assets | Adjusted basis | Fair market value |
|---|---|---|
| Intangible 2 | $340 | $100 |
| Intangible 3 | 20 | 280 |
| Inventory | 20 | 20 |
UTP distributes its interest in LTP in redemption of A's interest in UTP. At the time of the distribution, A's adjusted basis in its UTP interest is $140. A recognizes no gain or loss on the distribution. Under section 732(b), A's basis in the distributed LTP interest is $140. Under sections 734(b) and 755, UTP increases its adjusted basis in Intangible 1 by $50, the amount of the basis adjustment to the LTP interest in the hands of A.
(ii) The amount of the basis adjustment with respect to LTP under section 743(b) is the difference between A's basis in LTP of $140 and A's share of the adjusted basis to LTP of partnership property. A's share of the adjusted basis to LTP of partnership property is equal to the sum of A's share of LTP's liabilities of $0 plus A's interest in the previously taxed capital of LTP of $190 ($200, A's cash on liquidation, increased by $120, the amount of tax loss allocated to A from the sale of Intangible 2 in the hypothetical transaction, decreased by $130, the amount of tax gain allocated to A from the sale of Intangible 3 in the hypothetical transaction). Therefore, the amount of the negative basis adjustment under section 743(b) to partnership property is $50.
(iii) Under this paragraph (b)(5), LTP must allocate $50 of A's negative basis adjustment between capital gain property and ordinary income property in proportion to, and to the extent of, the gross loss (including any remedial allocations under § 1.704-3(d)) that would be allocated to A from the hypothetical sale of all property in each class. If LTP disposed of its assets in a hypothetical sale, A would be allocated $120 of gross loss from Intangible 2 only. Accordingly, the $50 negative adjustment must be allocated to capital assets. Under paragraph (b)(5)(iii)(B) of this section, the $50 negative adjustment must be allocated to the assets in the capital class first to properties with unrealized depreciation in proportion to the transferee's shares of the respective amounts of unrealized depreciation. Thus, the $50 negative adjustment must be allocated entirely to Intangible 2.
Example 4
—(i) A is a one-third partner in LTP, a partnership that has made an election under section 754. The three partners in LTP have equal interests in the capital and profits of LTP. LTP has two assets: accounts receivable with an adjusted basis of $300 and a fair market value of $240 and a nondepreciable capital asset with an adjusted basis of $60 and a fair market value of $240. A contributes its interest in LTP to UTP in a transaction described in section 721. At the time of the transfer, A's basis in its LTP interest is $150. Under section 723, UTP's basis in its interest in LTP is $150.
(ii) The amount of the basis adjustment under section 743(b) is the difference between UTP's $150 basis in its LTP interest and UTP's share of the adjusted basis to LTP of LTP's property. UTP's share of the adjusted basis to LTP of LTP's property is equal to the sum of UTP's share of LTP's liabilities of $0 plus UTP's interest in the previously taxed capital of LTP of $120 ($160, the amount of cash on liquidation, increased by $20, the amount of tax loss allocated to UTP from the hypothetical transaction, and decreased by $60, the amount of tax gain allocated to UTP from the hypothetical transaction). Therefore, the amount of the negative basis adjustment under section 743(b) to partnership property is $30.
(iii) The total amount of gross loss that would be allocated to UTP from the hypothetical sale of LTP's ordinary income property is $20 (one third of the excess of the basis of the accounts receivable ($300) over their fair market value ($240)). The hypothetical sale of LTP's capital gain property would result in a net gain. Therefore, under this paragraph (b)(5), $20 of the $30 basis adjustment must be allocated to ordinary income property. Because LTP holds only one ordinary income property, the $20 decrease must be allocated entirely to the accounts receivable. Pursuant to paragraph (b)(5)(ii)(C) of this section, the remaining $10 basis adjustment must be allocated between ordinary income property and capital gain property according to UTP's share of the adjusted bases of such properties. Therefore, $8 ($10 multiplied by $80 divided by $100) would be allocated to the accounts receivable and $2 ($10 multiplied by $20 divided by $100) would be allocated to the nondepreciable capital asset. * * *
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(e) No allocation of basis decrease to stock of corporate partner —(1) In general. In making an allocation under section 755(a) of any decrease in the adjusted basis of partnership property under section 734(b)—
(A) No allocation may be made to stock in a corporation (or any person related (within the meaning of sections 267(b) or 707(b)(1)) to such corporation) that is a partner in the partnership; and
(B) Any amount not allocable to stock by reason of paragraph (c)(1) of this section shall be allocated under section 755(a) to other partnership property.
(2) Recognition of gain. Gain shall be recognized to the partnership to the extent that the amount required to be allocated under paragraph (e)(1)(B) of this section to other partnership property exceeds the aggregate adjusted basis of such other property immediately before the allocation required by paragraph (e)(1)(B) of this section.
(3) Example.
A, B, and C are equal partners in PRS, a partnership. C is a corporation. The adjusted basis and fair market value for each of their interests in PRS are $100. PRS owns Capital Asset 1 with an adjusted basis of $0 and a fair market value of $100, Capital Asset 2 with an adjusted basis of $150 and a fair market value of $50, and stock in Corp, a corporation that is related to C under section 267(b), with an adjusted basis and fair market value of $150. PRS has a section 754 election in effect. PRS distributes Capital Asset 1 to A in liquidation of A's interest in PRS. PRS will reduce the basis of its remaining assets under section 734(b) by $100, to be allocated under section 755. The entire adjustment is allocated to Capital Asset 2, reducing its basis by $100 to $50. Pursuant to the general rule of paragraph (c) of this section, PRS would reduce the basis of Capital Asset 2 by $50 and the stock of Corp by $50. However, Pursuant to paragraph (e)(1)(A) of this section, the basis of the Corp stock is not adjusted. Thus, the basis of Capital Asset 2 is reduced by $100 from $150 to $50.
(f) Effective date —(1) Generally. Except as provided in paragraph (f)(2) of this section, this section applies to transfers of partnership interests and distributions of property from a partnership that occur on or after December 15, 1999.
(2) Special rules. Paragraphs (a) and (b)(3)(iii) of this section apply to transfers of partnership interests and distributions of property from a partnership that occur on or after June 9, 2003. Paragraph (b)(5) of this section applies to transfers of partnership interests occurring on or after January 16, 2014. Paragraph (e) of this section applies to transfers of partnership interests 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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