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Final regulations on application of anti-churning rules for amortization of intangible assets, November 20, 2000.

            When the IRS issued final regulations on amortization of intangible assets on January 25, 2000, it also issued proposed regulations providing guidance on a special provision in the anti-churning rules.  Under that provision, with regard to increases in basis of intangibles held by partnerships due to basis adjustments under sections 732, 734, or 743 (which could potentially provide partners with increased amortization), the anti-churning rules will be applied at the partner level, with each partner treated as having owned and used his proportionate share of the partnership's intangible assets.

              For basis adjustments under sections 732(b) and 734(b), this rule requires taxpayers and the IRS to analyze transactions involving a distribution of property from the partnership to a partner as Adeemed [email protected] of property directly among the partners.  The proposed regulations use a two-step analysis in determining whether the anti-churning rules apply to this deemed transfer:

                          The first step is to determine whether the portion of an intangible asset that is deemed transferred to the partner was subject to the anti-churning rules immediately before the transfer.  The asset is not subject to these rules if it was held by the partnership at the time the partner or its predecessor acquired its partnership interest and it would have been able to amortize the intangible if it had acquired it directly.

              Second, if the partner's share of the deemed transfer is treated as being subject to the anti-churning rules, it is necessary to determine whether the deemed transferor and transferee are related.  If they are not, the anti-churning rules will not  apply.  However, the final rules add provisions under which a related transferee will not be subject to the anti-churning rules if the transferor acquired the interest from a partner unrelated to him after August 10, 1993 and after acquisition of the intangible.

              Under the proposed regulations, the continuing partnerís share of the basis increase was the ratio of his share of unrealized appreciation in the intangible that would be realized if it were sold for fair market value over the total appreciation.  The final regulations change this: the partnerís share is determined by comparing his post-≠distribution capital account to the aggregate of all continuing partnersí capital accounts.

              The proposed regulations provide that a taxpayer may use any reasonable method to determine amortization for book purposes when some but not all of a basis adjustment under section 734(b) is amortizable, providing the method used does not contravene the purposes of the anti-churning rules.  The final regulations add an example of one method that will be considered reasonable in cases where part, but not all, of a section 743(b) adjustment is attributable to an intangible that is subject to the anti-churning rules. 

  The section of the proposed regulations that applies the anti-churning rules when a partner becomes a direct user of a partnership intangible is changed in the final regulations to make clear that the provision applies only to actual use by the partner or a related person, not attributed use from the partnership to a partner.  In addition, the final regulations contain a provision to ensure that once a partnership interest that includes intangibles subject to the anti-churning rules is transferred to an unrelated party, the intangible's "taint" is cured, and any subsequent holders of the interest, even if they are related to the party from whom they obtain it, will not be subject to the anti-churning rules.

The final regulations also make clear that remedial allocations of amortization deductions can be used when the contributing partner (as opposed to the non-contributing partner) is related to the partnership.  They also extend the disallowance of remedial allocations when the contributing partner is related to the non-contributing part≠ner to cover situations where, in a series of related transactions that includes the contribution of the intangible to the partnership, the contributing partner becomes a direct user of the intangible.

  These regulations apply to distributions or transfers occurring on or after November 20, 2000; but may be applied to property acquired or transactions occurring after August 10, 1993 (or July 25, 1991, if a valid retroactive election was made).

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Final regulations on allocation of nonrecourse debt by a partnership, October 31, 2000.  

             On January 13, 2000, the IRS published proposed regulations modifying the three-tiered system for allocating nonrecourse partnership liabilities among partners Reg. Section 1.752-3 by changing the third tier.  The change allows a partnership to allocate the portion of a nonrecourse liability that remains after tiers one and two based on the excess section 704(c) gain attributable to the property securing the liability.  The proposed regulations also stated that when a partnership holds multiple properties subject to a single liability, it may allocate the liability among the properties based on any reasonable method, but may not allocate to any property an amount exceeding its fair market value.  The final regulations adopt the proposed regulations with a modification allowing tier three allocations based on excess reverse 704(c) gain as well as excess 704(c) gain.  The final regulations also clarify an ambiguity regarding the interaction of these regulations with the regulations under the disguised sale rule of Code section 707, and clarify that excess 704(c) gain remaining after nonrecourse liability has been fully allocated should be taken into account in as one factor in determining a partnerís interest in partnership profits under tier three.

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Final regulations on capital gains on the sale or exchange of a partnership interest, September 21, 2000.

              On August 9, 1999, the IRS and Treasury issued proposed regulations providing guidance on the taxation of capital gain from the sale or exchange of a partnership interest (as well as interests in subchapter S corporations and trusts) under the different categories of capital gains rates created by the Taxpayer Relief Act of 1997.  The proposed regulations provide rules for determining the amount of gain or loss from the sale or a partnership interest that should be treated as 25% gain/loss and 28% gain/loss, rather than taxed at the general 20% capital gains rate:  it should be the amount that would be allocated to the partner if the properties producing such gain or loss had been sold immediately before the transfer of the interest. The final regulations modify the rule to provide that a passthrough entityís holding period in collectibles is not relevant in determining whether long-term capital gain recognized on the sale of an interest in the entity is collectibles (28%) gain.  The final regulations also clarify that the rule in the Code that unrecaptured  section 1250 gain (25% gain) cannot exceed net section 1231 gain does not apply to transfers of partnership interests, and that the regulations as a whole do not apply to redemptions of partnership interests.

              The proposed regulations also provide rules for determining the holding period for the sale of an interest different portions of which have been acquired at different times.  In the sale of an entire interest the gain or loss will be divided between long-term and short-term in the same proportions as the holding period in the overall interest is divided between long-and short term.  Sales of partial interests and distributions are divided in the same proportions as the partner would realize if the entire interest were sold.  However, if the partnership is a PTP and the interest is divided into readily identifiable units with ascertainable holding periods, the transferor may use the actual holding period of the units transferred.  The final regulations add a requirement that a partner must be consistent in electing to identify units of a PTP for holding period purposes.

              The final regulations make some changes and clarifications with regard to the rule that a contribution of cash to the partnership by a partner divides the partnerís holding period in its partnership interest. In response to comments, the final regulations add one exception and authorize another, and also clarify that deemed contributions and distributions of cash will be disregarded for purposes of the holding period. 

              Also added are a provision allowing partners which contribute section 751 assets to a partnership, and within a year recognize ordinary income when they sell their partnership interest or the partnership sells the assets, to disregard those assets in determining the division of the holding period; and a provision specifying that assets treated as unrealized receivables under section 751(c)are separate assets that will not be treated as section 1231 property and will not give rise to a short-term holding period when the partnership interest is sold.  Finally, the final regulations clarify that a partnerís holding period in its partnership interest carries over if the partnership converts from a general to a limited partnership.  The final regulations are effective September 21, 2000.

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Proposed Regulations on Coordination of Sections 755 And 1060 for Allocation of Basis Adjustments Among Partnership Assets, April 5, 2000

On April 5, 2000, the IRS and Treasury issued proposed regulations (REG-10872-89) on the coordination of sections 755 and 1060 for allocation of basis adjustments among partnership assets.  Section 1060 states that when a taxpayer acquires assets constituting a trade or business, and the basis in the assets is determined wholly by the taxpayer=s purchase price, basis is allocated among the assets by the Aresidual method,@  under which the basis allocated to of each of the assets will be the asset=s fair market value and any remaining amount of the purchase price after this allocation is allocated to intangible assets.

         Section 1060(d), enacted in 1993 states that the rule will apply in the distribution of partnership property or a transfer of a partnership interest, but only for the purpose of determining the value of section 197 intangibles for the purpose of applying Code section 755.  Section 755 provides rules for allocating increases and decreases in the partnership=s adjusted basis under 734(b) and 743(b) among partnership assets.   The new proposed regulations, differ from preceeding temporary regulations in that they apply to all transfers of partnership interests and partnership distributions to which section 755 applies, not just the transfer of assets comprising a trade or business.

    For basis adjustments under section 743(b) and 732(d), the proposed regulations determine the market value of the assets in two steps:

1)    Determine partnership gross value.   This generally equals the amount that, if assigned to all partnership property, would result in liquidating distributions to the partner equal to the transferee=s basis in the partnership interest immediately following the relevant transfer (minus the amount, if any, of basis that is attributable to partnership liabilities).  Thus, the amount paid for the partnership interest provides the frame of reference for valuing the entire partnership.   The preamble notes that no rules are provided for a transferred basis exchange (i.e., an exchange of a partnership interest in which the transferee=s basis in the interest is determined by the transferor=s basis) and requests comments as to how the residual method should apply if under section 743(b), basis adjustments are triggered by a transferred basis exchange, or if 732(d) basis adjustments relate to prior transferred basis exchanges. 

2)  Allocate partnership gross value among partnership property.   The gross value is allocated among five types of property in this order: 1) first, to cash and general deposit accounts (other than certificates of deposit); 2) then to partnership assets other than cash, capital assets, section 1231(b) property, and section 197 intangibles (i.e., ordinary income property); 3) to capital assets and section 1231(b) property other than section 197 intangibles; 4) to section 197 intangibles other than goodwill and going concern value; 5) and finally to goodwill and going concern value.  In determining the values to be assigned to the third through fifth classes, properties that are treated as unrealized receivables under section 751(c) are not counted as class two assets.  If the value assigned to a class under this allocation is less than the total of the fair market values of the assets within the class, the class value is allocated among the individual assets in proportion to their fair market values (determined without regard to the residual method).

         Generally, if partnership gross value exceeds the aggregate fair market value of the partnership=s assets, the excess must be allocated entirely to goodwill.  However, if goodwill could not under any circumstances attach to the assets, the excess gross value must be allocated among all assets other than cash in proportion to their fair market value (determined without regard to the residual method).    Provisions are also made for cases where partnership gross value varies according to the value of particular assets, and therefore cannot be determined first and then allocated among assets.  In this case, the fair market value of all individual assets is determined first and then assigned to the tiers in such a way that the combined market value of all assets would cause the appropriate liquidating distributions to the partner.

The preamble states that the proposed regulations do not provide a rule for valuing partnership assets in the case of distributions resulting in a section 734(b) basis adjustment, but it discusses three possible approaches.  Two approaches use a rule similar to the one for basis adjustments under sections 743(b) and 732(d), the third a different approach.  They are:

1)         For 734(b) adjustments which cause the distributee partner=s interest to decrease, partnership gross value would equal the amount that if assigned to all partnership property would result in a liquidating distribution to the partner equal to the value of the consideration received by the partner in the distribution.  Thus, the amount distributed in exchange for the relinquished interest provides the framework for valuation.

2)         Determine gross partnership value as the value of the entire partnership as a going concern, then apply the residual method by reference to the overall value.  This separates the valuation of partnership property from the transaction giving rise to the adjustment. 

3)         Allocate value to goodwill for section 755 purposes only if the amount of a positive 734(b) basis adjustment exceeds the amount of appreciation in all assets required to be adjusted which are not goodwill.

        The preamble states that the IRS and Treasury are considering applying the rules in the proposed regulations in additional areas, specifically, to determine the value of assets for purposes of applying section 1(h)(6)(B) (gain or loss from collectibles) to partnerships, section 1(h)(7) (section 1250 capital gain), and section 751(a) (ordinary income treatment for unrealized receivables and inventory).  It notes that while applying the rules to these provisions would be consistent with the legislative history of section 1060(d) and provide greater uniformity of treatment of income recognized upon the transfer of a partnership interest and the basis adjustment of partnership assets.  On the other hand, the rules could cause increased complexity, particularly if a section 754 election is not in effect in a year in which the transfer of a partnership interest occurs.  The IRS and Treasury request comments on whether partnership assets should be valued using the residual method for purposes of these Code sections.

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