For Tax Professionals  
T.D. 8847 December 16, 1999

Adjustments Following Sales of Partnership Interests

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Parts 1 and 602 [TD 8847] RIN 1545-
AS39

TITLE: Adjustments Following Sales of Partnership Interests

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final Regulations.

SUMMARY: This document finalizes regulations relating to the
optional adjustments to the basis of partnership property following
certain transfers of partnership interests under section 743, the
calculation of gain or loss under section 751(a) following the sale
or exchange of a partnership interest, the allocation of basis
adjustments among partnership assets under section 755, the
allocation of a partner's basis in its partnership interest to
properties distributed to the partner by the partnership under
section 732(c), and the computation of a partner's proportionate
share of the adjusted basis of depreciable property (or depreciable
real property) under section 1017. The changes will affect
partnerships and partners where there are transfers of partnership
interests, distributions of property, or elections under sections
108(b)(5) or (c). In addition, the final regulations under section
732(c) reflect changes to the law made by the Taxpayer Relief Act of
1997.

DATES: Effective Dates: These regulations are effective December 15,
1999.

Applicability Date: These regulations apply to transfers of
partnership interests and distributions occurring on or after
December 15, 1999.

FOR FURTHER INFORMATION CONTACT: Matthew Lay, (202) 622-3050.

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information in these final regulations have been
reviewed and approved by the Office of Management and Budget in
accordance with the Paperwork Reduction Act (44 U.S.C.

3507) under control number 1545-1588. Responses to these collections
of information are mandatory for partnerships that have made an
election under section 754 and for which a section 743 transfer has
been made, and for partnerships which distribute property in a
transaction subject to section 732(d).

An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number assigned by the Office
of Management and Budget.

The estimated annual burden per respondent varies from 1 hour to 300
hours, depending on the individual circumstances, with an estimated
average of 4 hoU.S. Comments concerning the accuracy of this burden
estimate and suggestions for reducing this burden should be sent to
the Internal Revenue Service, Attn: IRS Reports Clearance Officer,
OP:FS:FP, Washington, DC 20224, and to the Office of Management and
Budget, Attn: Desk Officer for the Department of the Treasury,
Office of Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to these collections of information must
be retained as long as their contents may become material in the
administration of any internal revenue law.

Generally, tax returns and tax return information are confidential,
as required by 26 U.S.C. 6103.

Background

This document (a) revises §§1.743-1 and 1.755-1 of the Income Tax
Regulations (26 CFR part 1), and (b) amends §§1.732-1, 1.732-2,
1.734-1, 1.751-1, 1.754-1, and §1.1017-1 of the Income Tax
Regulations.

On January 29, 1998, proposed regulations (REG 209682-94) were
published in the Federal Register (63 FR 4408). Written comments
were received in response to the notice of proposed rulemaking. One
speaker provided testimony at a public hearing held on September 10,
1998.

After consideration of all the comments, the proposed regulations
under sections 732, 734, 743, 751, 755, and 1017 are adopted, as
revised by this Treasury Decision.

Explanation of Revisions and Summary of Contents

1. Basis in Distributed Property

(a) Mandatory application of section 732(d). Section 1.732-1(d)(4)
of the current regulations requires transferees to apply the special
basis rule in certain cases. In the preamble to the proposed
regulations, the IRS and the Treasury Department requested comments
on the proper scope of section 732(d), and specifically, under what
circumstances, if any, the Secretary should continue to exercise his
authority to mandate the application of section 732(d) to a
transferee. Several commentators suggested that the mandatory
application of section 732(d) no longer should be required, because
the changes made to section 732(c) by the Taxpayer Relief Act of
1997, Public Law 105-34, 111 Stat. 788, 945-46 (1997), make the
distortions targeted by the regulations less likely to occur.
However, other commentators noted that distortions caused by section
732(c) still may occur. Accordingly, the rule contained in §1.732-
1(d)(4), which requires the mandatory application of section 732(d)
in certain cases, remains in effect.

(b) Statement required by partnership. Because partners, rather than
partnerships, are required to report basis adjustments under section
732(d), the final regulations require partnerships to provide
transferees with such information as is necessary for the
transferees properly to compute basis adjustments made under section
732(d). This information must be provided if a transferee notifies a
partnership that it plans to make the election under section 732(d)
or if a partnership makes a distribution subject to the mandatory
application of section 732(d).

(c) Effective date. One commentator asked for clarification
regarding the application of the final regulations to section 732(d)
adjustments. If section 732(d) applies to a distribution, it is
necessary to calculate the basis adjustments which would have been
required under section 743(b) if a section 754 election were in
effect for the partnership in the taxable year in which the
partnership interest was transferred to the partner. In calculating
these basis adjustments, the partnership should apply the final
regulations under section 743 and 755 if the distribution to which
section 732(d) applies occurs after December 15, 1999.

2. Basis Adjustments Under Section 743(b)

(a) Coordination with section 704(c). Where a partnership adopts the
remedial allocation method, the proposed regulations provide that
the section 704(c) built-in gain portion of a basis adjustment under
section 743(b) shall be recovered over the remaining cost recovery
period for the section 704(c) built-in gain. Some commentators
suggested that the final regulations should provide this treatment
for the section 704(c) built-in gain portion of the adjustment
regardless of the method elected by the partnership for allocating
section 704(c) built-in gain and loss. The IRS and the Treasury
Department continue to believe that, except for partnerships which
adopt the remedial allocation method, it is appropriate for sections
704(c) and 743(b) to operate independently. Accordingly, this change
has not been adopted.

In the preamble to the proposed regulations, comments were requested
concerning the application of the remedial allocation method to
contributed property where there are no distortions caused by the
ceiling rule at the time the property was contributed to the
partnership. Even if it is not clear that the ceiling rule will
apply at the time the property is contributed because the adjusted
basis of the contributed property is sufficient so that the non-
contributing partners will be allocated their appropriate share of
depreciation or amortization attributable to the property, the
partnership's adoption of the remedial method still may be relevant
due to allocations resulting from a subsequent disposition of the
property. For instance, suppose that partners A and B form a
partnership and agree that each partner will be allocated a 50
percent share of all partnership items, and that the partnership
will make allocations under section 704(c) using the traditional
method. A contributes depreciable property with an adjusted tax
basis of $40 and a book value of $50, and B contributes $50 in cash.
At the time of the contribution, it is not readily apparent that the
ceiling rule will have any application. However, if, before any
federal income tax depreciation accrues with respect to the
contributed property, the property's value declines to $40, and the
property is sold for that amount, there will be no tax gain or loss.
The book loss of $10 would be shared equally between A and B. In
this situation, the ceiling rule would prevent B from being
allocated the $5 tax loss to which it otherwise would be entitled.
However, if the partnership elected to use the remedial method with
respect to the contributed property, B would be allocated a $5 tax
loss, and A would be allocated a corresponding $5 tax gain. In
addition, if a contributing partner transfers its interest in a
partnership during a period when a section 754 election is in
effect, the section 704(c) method adopted by the partnership will
determine the recovery period for the built-in gain portion of the
transferee's section 743(b) adjustment. The IRS and the Treasury
Department believe that under the current regulations under section
704(c), a partnership may use the remedial method under §1.704-3,
even where it is not readily apparent at the time the property is
contributed that the ceiling rule will be applicable.

(b) Previously taxed capital. One commentator suggested that the
second sentence in proposed §1.743-1(d)(2), relating to the
correlation between a partner's interest in previously taxed capital
and the partnership's capital accounts, is redundant and should be
deleted. This suggestion has been adopted; however, no substantive
change is intended by the deletion.

(c) Common basis election. Some commentators suggested that the
provision in the proposed regulations that permitted the partners to
elect to apply negative basis adjustments under section 743(b) to
the partnership's common basis should be deleted. The commentators
argued that the provision was contrary to the purpose of section
743(b), because it permitted basis adjustments under section 743(b)
to affect nontransferring partners. The commentators also argued
that the provision would be used by a small number of partnerships
and would add unnecessary complexity to the regulations. In response
to these suggestions, the provision that permitted the partners to
elect to apply negative basis adjustments under section 743(b) to
the partnership's common basis has been deleted.

(d) Statements by partners. Some commentators suggested modifying
the statements which partners are required to provide to the
partnership in the case of transfers which result in basis
adjustments under section 743(b). Many of these suggestions have
been adopted. For example, the regulations specify that the
transferee of a partnership interest is required to provide the
name, address, and taxpayer identification number of the transferor
only if that information is ascertainable by the transferee. The
regulations also specify that if a partnership interest is
transferred to a nominee which is required to furnish the statement
under §1.6031(c)-1T to the partnership, the nominee may satisfy the
notice requirements of both the section 743 and 6031 regulations by
providing a single statement with respect to that transfer, but only
if the statement satisfies all requirements of both regulations.

The regulations require the transferee to sign the statement under
penalties of perjury, and require the transferee to provide the
amount of any liabilities assumed or taken subject to by the
transferee, and any other information necessary for the partnership
to compute the transferee's basis in the partnership interest. In
order to assist the partnership in properly calculating depreciation
and amortization deductions which may be subject to anti-churning
provisions, the regulations require the transferee to describe its
relationship, if any, to the transferor. Finally, the statement
required by a transferee that acquires an interest by death must
include the date of the decedent's death.

One commentator suggested that the statement required by a
transferee that acquires a partnership interest by sale or exchange
should be provided within 30 days of the sale or exchange,
regardless of whether or not the transfer occurs at the end of the
calendar year. This change has been adopted.

One commentator suggested that references to the tax matters partner
in §1.743-1(k) of the proposed regulations (regarding the
partnership's obligations where a partner's statement is clearly
erroneous, or a partner fails to notify the partnership that an
interest has been transferred and the partnership has actual
knowledge of the transfer) should be changed. This commentator
emphasized that while the tax matters partner has a specialized role
with respect to consolidated administrative and judicial proceedings
to determine the tax treatment of partnership items at the
partnership level, the tax matters partner does not have any special
responsibilities with respect to federal income tax reporting. The
final regulations adopt this comment. Section 1.743-1(k) now refers
to partners who are responsible for federal income tax reporting by
the partnership.

(e) Oil and gas. One commentator suggested that the example
described in §1.743-1(j)(6) should be changed to describe a non-oil
and gas property. This change has been made. The.10 commentator also
suggested that in the case of domestic oil and gas properties that
are depleted at the partner level, the transferee partner (rather
than the partnership) should be required to make and allocate basis
adjustments among such properties. The final regulations adopt this
comment.

The same commentator suggested that the regulations should specify a
method for adjusting the basis of section 613A(c)(7)(D) properties
in order to account for percentage depletion made by a partner with
respect to such properties. Under the principles of §1.743-1(j),
percentage depletion should reduce first any carryover basis under
§1.613A-3(e)(6)(iv). After the carryover basis has been recovered,
any further percentage depletion should reduce the section 743
adjustment for the property.

3. Sales of Partnership Interests One commentator suggested that
references to fair market value should specify whether fair market
value is determined taking into account section 7701(g), which
generally provides that fair market value shall be treated as being
not less than the amount of any nonrecourse indebtedness to which
the property is subject. The regulations specify that for purposes
of the hypothetical sale employed to determine the income or loss
realized by a partner upon the sale or exchange of its interest in
section 751 property, fair market value is determined taking into
account section 7701(g). Basis adjustments under section 743(b) also
are allocated by reference to a hypothetical transaction. The IRS
and the Treasury Department intend to issue guidance in the near
future which will provide rules for determining the fair market
value of partnership assets in certain situations, including for
purposes of allocating section 743(b) basis adjustments upon the
transfer of a partnership interest. The IRS and the Treasury
Department anticipate that the guidance will provide that section
7701(g) will apply in determining the fair market value of
partnership assets for purposes of allocating section 743(b) basis
adjustments.

One commentator suggested that where a partnership interest is sold
or exchanged, the transferor and the transferee of a partnership
interest should be permitted jointly to assign values to partnership
assets in a written agreement. Because this approach is inconsistent
with the hypothetical sale approach of the regulations, this
suggestion has not been adopted.

4. Elections Under Section 754

One commentator requested that partnerships be granted a one-time
right to revoke section 754 elections in effect for such
partnerships. Given the significant changes to the rules made by
these final regulations as compared to the regulations that were in
effect at the time that section 754 elections previously were made,
the IRS and Treasury believe that it is appropriate to provide for a
one-time revocation of such elections.

Accordingly, a partnership having an election in effect under
section 754 for its taxable year that includes December 15, 1999 may
revoke such election by attaching a statement to the partnership's
return for that year. The return must be filed on or before the due
date (including extensions) for the return for that year.

5. Allocation of Basis Adjustments Among Partnership Assets

(a) Income in respect of a decedent. One commentator requested that
the final regulations illustrate the allocation of basis adjustments
among partnership assets where one or more of such assets represents
income in respect of a decedent. Where a partnership interest is
transferred as a result of the death of a partner, under section
1014(c) the transferee's basis in its partnership interest is not
adjusted for that portion of the interest, if any, which is
attributable to items representing income in respect of a decedent
under section 691. Because the transferee's basis in its partnership
interest does not include the value of assets which represent income
in respect of a decedent, the section 743(b) adjustment likewise
does not reflect the value of such assets. George Edward Quick's
Trust, 54 TC 1336 (1970) (acq.), aff'd per curiam, 444 F.2d 90 (8th
Cir.

1971); Chrissie H. Woodhall, 28 T.C.M. 1438 (1969), aff'd, 454 F.2d
226 (9th Cir. 1972); Rev. Rul. 66-325, 1966-2 C.B. 249.

Where a partnership holds assets that represent income in respect of
a decedent, the section 743(b) adjustment should be allocated solely
to other assets. Accordingly, the final regulations provide that if
a partnership interest is transferred as a result of the death of a
partner, and the partnership holds assets representing income in
respect of a decedent, no part of the basis adjustment under section
743(b) is allocated to these assets.

(b) Transferred basis transactions. One commentator called for a
revised system for allocating basis adjustments under section 743(b)
which are triggered by exchanges in which the transferee's basis in
the interest is determined in whole or in part by reference to the
transferor's basis in the interest.

In many such cases, the net section 743(b) adjustment will be zero.
However, a positive or negative section 743(b) adjustment may
result, because the transferee's basis in the interest may not be
equal to the transferee's share of the partnership's bases in its
assets.

The IRS and the Treasury Department believe that, although these
transferred basis transactions involve transfers which are subject
to section 743(b), the new, comprehensive basis allocation rules in
the proposed regulations should not be available. For example, where
a partnership interest is contributed to a corporation in a
transaction to which section 351 applies, or to a partnership in a
transaction to which section 721(a) applies, the transferor merely
has changed the form of its investment. If the allocation rules
which apply to other section 743(b) transfers were applied to these
exchanges, then partners could use these exchanges to shift basis
from capital gain assets to ordinary income assets, or vice versa.

Therefore, the final regulations contain special basis allocation
rules for transferred basis exchanges. The special rules generally
are modeled on the rules for allocating basis adjustments under
section 734(b). The final regulations do not contain a specific
anti-abuse rule regarding the special basis allocation rules which
are applicable to such transfers.

However, there may be situations where taxpayers will attempt to
undertake abusive transactions using these special rules. For
instance, a partner could acquire a partnership interest during a
year in which no section 754 election is in effect, and then (in a
related transaction) contribute the property to a wholly-owned
corporation in order to take advantage of the basis allocation rules
applicable to transferred basis exchanges. In appropriate
situations, the IRS may attack such abusive transactions under a
variety of judicial doctrines, including substance over form or step
transaction, or under §1.701-2 of the regulations.

(c) Unrealized receivables under section 751(c). One commentator
requested that the final regulations illustrate the effect of
depreciation recapture on the allocation of basis adjustments among
partnership assets under section 755. For purposes of this section,
the final regulations treat depreciation recapture, and any other
properties or potential gain treated as unrealized receivables under
section 751(c) and the regulations thereunder, as separate assets
that are ordinary income property.

(d) Special rules for securities partnerships and tiered
partnerships. One commentator suggested that the regulations permit
securities partnerships to allocate basis adjustments among
partnership assets using an aggregation method. Another commentator
requested that the regulations clarify how the regulations would
apply to tiered partnerships. The IRS and the Treasury Department
believe that a method for allocating basis adjustments among
partnership assets on an aggregate basis is not consistent with the
hypothetical sale of individual assets, which is required by the
regulations. In addition, the IRS and Treasury Department believe
that special rules for tiered partnerships would make the
regulations more complex. Therefore, these changes have not been
adopted.

6. Other Comments One commentator suggested that for purposes of
allocating basis adjustments among partnership assets, the values of
all partnership assets should be determined by reference to the
basis of the transferee or distributee partner in its partnership
interest. This suggestion is being considered in connection with a
separate project currently under review by the IRS and the Treasury
Department.

One commentator suggested that the language of section 743 does not
authorize regulations that permit both positive and negative
adjustments as part of the same transaction. The IRS and the
Treasury Department continue to believe that this aspect of the
regulations is within the IRS's authority to administer sections 743
and 755.

Special Analyses

It has been determined that these final regulations are not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has been
determined that a final regulatory flexibility analysis is required
for the collection of information in this Treasury decision under 5
U.S.C. 604. A summary of the analysis is set forth below under the
heading "Summary of Final Regulatory Flexibility Act Analysis."
Pursuant to section 7805(f) of the Internal Revenue Code, these
final regulations have been submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on their
impact on small business.

Summary of Final Regulatory Flexibility Act Analysis This analysis
is required under the Regulatory Flexibility Act (5 U.S.C. chapter
6). In general, the regulations require a transferee that acquires
an interest in a partnership with an election under section 754 in
effect to notify the partnership of the transfer. This notification
must include the name and taxpayer identification number of the
transferee and the transferee's basis in the acquired partnership
interest. The partnership is required to include a statement with
its Form 1065, U.S. Partnership Return of Income, for the taxable
year in which the partnership acquires knowledge of the transfer.
This statement must identify the name and taxpayer identification
number of the transferee, the computation of the basis adjustment,
and the allocation of that adjustment to partnership properties.
These requirements will ensure that the partnership has notice that
a transfer has occurred and that the proper basis adjustments are
computed. The legal basis for these requirements is contained in
sections 743(b), 6001, and 7805(a).

If an interest is transferred in a partnership holding domestic oil
and gas properties that are depleted at the partner level under
613A(c)(7)(D), the regulations require the transferee partner
(rather than the partnership) to make and allocate basis adjustments
under section 743(b) among such properties.

There were approximately 1,494,000 partnerships in 1994.

However, these regulations apply only to partnerships that have made
an election under section 754. The election under section 754 is
generally not made unless there has been a transfer of a partnership
interest or a distribution by the partnership.

Moreover, the effects of the election attach to specific items of
partnership property and may provide only temporary benefits for the
partners. Except for the one-time revocation which is allowed in
connection with the promulgation of these final regulations, the
election cannot be revoked without the consent of the Secretary. The
IRS and the Treasury Department believe that most partnerships do
not make the election under section 754. Therefore, most
partnerships will not be affected by the regulations in any given
year.

After a partner conveys information to the partnership concerning a
transfer of a partnership interest, the partnership must adjust the
partner's interest in the basis of partnership property. Because
these basis adjustments will affect the partner's share of
depreciation or amortization deductions and amounts of gain or loss
on the disposition of certain items of partnership property, the
partnership must prepare and maintain special entries on its books.
However, in many cases, partnership returns are prepared using
computer software that can prepare and maintain these special
entries after the initial year.

The IRS and the Treasury Department are not aware of any federal
rules that may duplicate, overlap, or conflict with the rule.

As an alternative to the disclosure described above, the IRS and the
Treasury Department considered, but rejected, a rule that would have
required the partners, and not the partnerships, to make the basis
adjustments and to determine the effects of the basis adjustments on
the partners' distributive shares. This alternative was rejected
because the IRS and the Treasury Department believe that
partnerships generally have better access to the information
necessary to report section 743 basis adjustments properly. To
require the partners rather than the partnerships to bear the burden
of reporting would require the partnerships to provide the partners
with significant amounts of information not otherwise needed by the
partners. There are no known alternative rules that are less
burdensome to the partnerships and their partners but that
accomplish the purpose of the statute.

Finally, because partners, rather than partnerships, are required to
report basis adjustments under section 732(d), the final regulations
require partnerships to provide transferees with such information as
is necessary for the transferees properly to compute basis
adjustments made under section 732(d).

This information must be provided if a transferee notifies a
partnership that it plans to make the election under section 732(d)
or if a partnership makes a distribution subject to the mandatory
application of section 732(d). The IRS and the Treasury Department
believe that this requirement will apply under limited circumstances
to a small percentage of partnerships.

Drafting Information

The principal author of these regulations is Matthew Lay of the
Office of the Assistant Chief Counsel (Passthroughs and Special
Industries). However, other personnel from the IRS and the Treasury
Department participated in their development.

List of Subjects

26 CFR Part 1 Income taxes, Reporting and recordkeeping
requirements.

26 CFR Part 602 Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations Accordingly, 26 CFR parts
1 and 602 are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read as follows:

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

Section 1.732-1 also issued under 26 U.S.C. 732.

Section 1.732-2 also issued under 26 U.S.C. 732.

Section 1.734-1 also issued under 26 U.S.C. 734.

Section 1.743-1 also issued under 26 U.S.C. 743.

Section 1.751-1 also issued under 26 U.S.C. 751.

Section 1.755-1 also issued under 26 U.S.C. 755. * * *

Section 1.1017-1 also issued under 26 U.S.C. 1017. * * *

Par. 2. Section 1.732-1 is amended as follows:

1. Revise paragraph (c).

2. Revise paragraph (d)(1)(ii).

3. Revise the last sentence of paragraph (d)(1)(v).

4. Revise paragraph (d)(1)(vi).

5. Revise paragraph (d)(4)(iii).

6. Remove the flush text and Examples 1 and 2 following paragraph
(d)(4)(iii).

7. Add paragraph (d)(5).

The additions and revisions read as follows:

§1.732-1 Basis of distributed property other than money.

* * * * *

(c) Allocation of basis among properties distributed to a
partner--(1) General rule--(i) Unrealized receivables and inventory
items. The basis to be allocated to properties distributed to a
partner under section 732(a)(2) or (b) is allocated first to any
unrealized receivables (as defined in section 751(c)) and inventory
items (as defined in section 751(d)(2)) in an amount equal to the
adjusted basis of each such property to the partnership immediately
before the distribution.

If the basis to be allocated is less than the sum of the adjusted
bases to the partnership of the distributed unrealized receivables
and inventory items, the adjusted basis of the distributed property
must be decreased in the manner provided in paragraph (c)(2)(i) of
this section.

(ii) Other distributed property. Any basis not allocated to
unrealized receivables or inventory items under paragraph (c)(1)(i)
of this section is allocated to any other property distributed to
the partner in the same transaction by assigning to each distributed
property an amount equal to the adjusted basis of the property to
the partnership immediately before the distribution. However, if the
sum of the adjusted bases to the partnership of such other
distributed property does not equal the basis to be allocated among
the distributed property, any increase or decrease required to make
the amounts equal is allocated among the distributed property as
provided in paragraph (c)(2) of this section.

(2) Adjustment to basis allocation--(i) Decrease in basis.

Any decrease to the basis of distributed property required under
paragraph (c)(1) of this section is allocated first to distributed
property with unrealized depreciation in proportion to each
property's respective amount of unrealized depreciation before any
decrease (but only to the extent of each property's unrealized
depreciation). If the required decrease exceeds the amount of
unrealized depreciation in the distributed property, the excess is
allocated to the distributed property in proportion to the adjusted
bases of the distributed property, as adjusted pursuant to the
immediately preceding sentence.

(ii) Increase in basis. Any increase to the basis of distributed
property required under paragraph (c)(1)(ii) of this section is
allocated first to distributed property (other than unrealized
receivables and inventory items) with unrealized appreciation in
proportion to each property's respective amount of unrealized
appreciation before any increase (but only to the extent of each
property's unrealized appreciation). If the required increase
exceeds the amount of unrealized appreciation in the distributed
property, the excess is allocated to the distributed property (other
than unrealized receivables or inventory items) in proportion to the
fair market value of the distributed property.

(3) Unrealized receivables and inventory items. If the basis to be
allocated upon a distribution in liquidation of the partner's entire
interest in the partnership is greater than the adjusted basis to
the partnership of the unrealized receivables and inventory items
distributed to the partner, and if there is no other property
distributed to which the excess can be allocated, the distributee
partner sustains a capital loss under section 731(a)(2) to the
extent of the unallocated basis of the partnership interest.

(4) Examples. The provisions of this paragraph (c) are illustrated
by the following examples:

Example 1. A is a one-fourth partner in partnership PRS and has an
adjusted basis in its partnership interest of $650. PRS distributes
inventory items and Assets X and Y to A in liquidation of A's entire
partnership interest. The distributed inventory items have a basis
to the partnership of $100 and a fair market value of $200. Asset X
has an adjusted basis to the partnership of $50 and a fair market
value of $400. Asset Y has an adjusted basis to the partnership and
a fair market value of $100. Neither Asset X nor Asset Y consists of
inventory items or unrealized receivables. Under this paragraph (c),
A's basis in its partnership interest is allocated first to the
inventory items in an amount equal to their adjusted basis to the
partnership. A, therefore, has an adjusted basis in the inventory
items of $100. The remaining basis, $550, is allocated to the
distributed property first in an amount equal to the property's
adjusted basis to the partnership. Thus, Asset X is allocated $50
and Asset Y is allocated $100. Asset X is then allocated $350, the
amount of unrealized appreciation in Asset X.

Finally, the remaining basis, $50, is allocated to Assets X and Y in
proportion to their fair market values: $40 to Asset X (400/500 x
$50), and $10 to Asset Y (100/500 x $50). Therefore, after the
distribution, A has an adjusted basis of $440 in Asset X and $110 in
Asset Y.

Example 2. B is a one-fourth partner in partnership PRS and has an
adjusted basis in its partnership interest of $200. PRS distributes
Asset X and Asset Y to B in liquidation of its entire partnership
interest. Asset X has an adjusted basis to the partnership and fair
market value of $150. Asset Y has an adjusted basis to the
partnership of $150 and a fair market value of $50. Neither of the
assets consists of inventory items or unrealized receivables. Under
this paragraph (c), B's basis is first assigned to the distributed
property to the extent of the partnership's basis in each
distributed property. Thus, Asset X and Asset Y are each assigned
$150. Because the aggregate adjusted basis of the distributed
property, $300, exceeds the basis to be allocated, $200, a decrease
of $100 in the basis of the distributed property is required. Assets
X and Y have unrealized depreciation of zero and $100, respectively.
Thus, the entire decrease is allocated to Asset Y. After the
distribution, B has an adjusted basis of $150 in Asset X and $50 in
Asset Y.

Example 3. C, a partner in partnership PRS, receives a distribution
in liquidation of its entire partnership interest of $6,000 cash,
inventory items having an adjusted basis to the partnership of
$6,000, and real property having an adjusted basis to the
partnership of $4,000. C's basis in its partnership interest is
$9,000. The cash distribution reduces C's basis to $3,000, which is
allocated entirely to the inventory items. The real property has a
zero basis in C's hands. The partnership bases not carried over to C
for the distributed properties are lost unless an election under
section 754 is in effect requiring the partnership to adjust the
bases of remaining partnership properties under section 734(b).

Example 4. Assume the same facts as in Example 3 of this paragraph
except C receives a distribution in liquidation of its entire
partnership interest of $1,000 cash and inventory items having a
basis to the partnership of $6,000. The cash distribution reduces
C's basis to $8,000, which can be allocated only to the extent of
$6,000 to the inventory items. The remaining $2,000 basis, not
allocable to the distributed property, constitutes a capital loss to
partner C under section 731(a)(2). If the election under section 754
is in effect, see section 734(b) for adjustment of the basis of
undistributed partnership property.

(5) Effective date. This paragraph (c) applies to distributions of
property from a partnership that occur on or after December 15,
1999.

(d) * * * (1) * * *

(ii) Where an election under section 754 is in effect, see section
743(b) and §§1.743-1 and 1.732-2.

* * * * *

(v) * * * (For a shift of transferee's basis adjustment under
section 743(b) to like property, see §1.743-1(g).) (vi) The
provisions of this paragraph (d)(1) may be illustrated by the
following example:

Example. (i) Transferee partner, T, purchased a one-fourth interest
in partnership PRS for $17,000. At the time T purchased the
partnership interest, the election under section 754 was not in
effect and the partnership inventory had a basis to the partnership
of $14,000 and a fair market value of $16,000. T's purchase price
reflected $500 of this difference. Thus, $4,000 of the $17,000 paid
by T for the partnership interest was attributable to T's share of
partnership inventory with a basis of $3,500. Within 2 years after T
acquired the partnership interest, T retired from the partnership
and received in liquidation of its entire partnership interest the
following property:


Assets     Adjusted   Fair
           Basis to   Market
           PRS        Value

Cash      $1,500     $1,500
Inventory $3,500     $4,000
Asset X   $2,000     $4,000
Asset Y   $4,000     $5,000

(ii) The fair market value of the inventory received by T was one-
fourth of the fair market value of all partnership inventory and was
T's share of such property. It is immaterial whether the inventory T
received was on hand when T acquired the interest. In accordance
with T's election under section 732(d), the amount of T's share of
partnership basis that is attributable to partnership inventory is
increased by $500 (one-fourth of the $2,000 difference between the
fair market value of the property, $16,000, and its $14,000 basis to
the partnership at the time T purchased its interest). This
adjustment under section 732(d) applies only for purposes of
distributions to T, and not for purposes of partnership
depreciation, depletion, or gain or loss on disposition. Thus, the
amount to be allocated among the properties received by T in the
liquidating distribution is $15,500 ($17,000, T's basis for the
partnership interest, reduced by the amount of cash received,
$1,500). This amount is allocated as follows: The basis of the
inventory items received is $4,000, consisting of the $3,500 common
partnership basis, plus the basis adjustment of $500 which T would
have had under section 743(b). The remaining basis of $11,500
($15,500 minus $4,000) is allocated among the remaining property
distributed to T by assigning to each property the adjusted basis to
the partnership of such property and adjusting that basis by any
required increase or decrease. Thus, the adjusted basis to T of
Asset X is $5,111 ($2,000, the adjusted basis of Asset X to the
partnership, plus $2,000, the amount of unrealized appreciation in
Asset X, plus $1,111 ($4,000/$9,000 multiplied by $2,500)).

Similarly, the adjusted basis of Asset Y to T is $6,389 ($4,000, the
adjusted basis of Asset Y to the partnership, plus $1,000, the
amount of unrealized appreciation in Asset Y, plus, $1,389
($5,000/$9,000 multiplied by $2,500)).

* * * * *

(4) * * *

(iii) A basis adjustment under section 743(b) would change the basis
to the transferee partner of the property actually distributed.

(5) Required statements. If a transferee partner notifies a
partnership that it plans to make the election under section 732(d)
under paragraph (d)(3) of this section, or if a partnership makes a
distribution to which paragraph (d)(4) of this section applies, the
partnership must provide the transferee with such information as is
necessary for the transferee properly to compute the transferee's
basis adjustments under section 732(d).

* * * * *

Par. 3. Section 1.732-2 is amended by revising the sentence at the
end of the Example in paragraph (b) to read as follows:

§1.732-2 Special partnership basis of distributed property.

* * * * *

(b) * * *

Example. * * * See §1.743-1(g).

* * * * *

Par. 4. In §1.734-1, paragraph (e) is added to read as follows:

§1.734-1 Optional adjustment to basis of undistributed partnership
property.

* * * * *

(e) Recovery of adjustments to basis of partnership property--(1)
Increases in basis. For purposes of section 168, if the basis of a
partnership's recovery property is increased as a result of the
distribution of property to a partner, then the increased portion of
the basis must be taken into account as if it were newly-purchased
recovery property placed in service when the distribution occurs.
Consequently, any applicable recovery period and method may be used
to determine the recovery allowance with respect to the increased
portion of the basis. However, no change is made for purposes of
determining the recovery allowance under section 168 for the portion
of the basis for which there is no increase.

(2) Decreases in basis. For purposes of section 168, if the basis of
a partnership's recovery property is decreased as a result of the
distribution of property to a partner, then the decrease in basis
must be accounted for over the remaining recovery period of the
property beginning with the recovery period in which the basis is
decreased.

(3) Effective date. This paragraph (e) applies to distributions of
property from a partnership that occur on or after December 15,
1999.

Par. 5. Section 1.743-1 is revised to read as follows:

§1.743-1 Optional adjustment to basis of partnership property.

(a) Generally. The basis of partnership property is adjusted as a
result of the transfer of an interest in a partnership by sale or
exchange or on the death of a partner only if the election provided
by section 754 (relating to optional adjustments to the basis of
partnership property) is in effect with respect to the partnership.
Whether or not the election provided in section 754 is in effect,
the basis of partnership property is not adjusted as the result of a
contribution of property, including money, to the partnership.

(b) Determination of adjustment. In the case of the transfer of an
interest in a partnership, either by sale or exchange or as a result
of the death of a partner, a partnership that has an election under
section 754 in effect-- (1) Increases the adjusted basis of
partnership property by the excess of the transferee's basis for the
transferred partnership interest over the transferee's share of the
adjusted basis to the partnership of the partnership's property; or
(2) Decreases the adjusted basis of partnership property by the
excess of the transferee's share of the adjusted basis to the
partnership of the partnership's property over the transferee's
basis for the transferred partnership interest.

(c) Determination of transferee's basis in the transferred
partnership interest. In the case of the transfer of a partnership
interest by sale or exchange or as a result of the death of a
partner, the transferee's basis in the transferred partnership
interest is determined under section 742 and §1.742-1. See also
section 752 and §§1.752-1 through 1.752-5.

(d) Determination of transferee's share of the adjusted basis to the
partnership of the partnership's property--(1) Generally. A
transferee's share of the adjusted basis to the partnership of
partnership property is equal to the sum of the transferee's
interest as a partner in the partnership's previously taxed capital,
plus the transferee's share of partnership liabilities. Generally, a
transferee's interest as a partner in the partnership's previously
taxed capital is equal to--

(i) The amount of cash that the transferee would receive on a
liquidation of the partnership following the hypothetical
transaction, as defined in paragraph (d)(2) of this section (to the
extent attributable to the acquired partnership interest); increased
by

(ii) The amount of tax loss (including any remedial allocations
under §1.704-3(d)), that would be allocated to the transferee from
the hypothetical transaction (to the extent attributable to the
acquired partnership interest); and decreased by

(iii) The amount of tax gain (including any remedial allocations
under §1.704-3(d)), that would be allocated to the transferee from
the hypothetical transaction (to the extent attributable to the
acquired partnership interest).

(2) Hypothetical transaction defined. For purposes of paragraph (d)
(1) of this section, the hypothetical transaction means the
disposition by the partnership of all of the partnership's assets,
immediately after the transfer of the partnership interest, in a
fully taxable transaction for cash equal to the fair market value of
the assets.

(3) Examples. The provisions of this paragraph (d) are illustrated
by the following examples:

Example 1. (i) A is a member of partnership PRS in which the
partners have equal interests in capital and profits. The
partnership has made an election under section 754, relating to the
optional adjustment to the basis of partnership property. A sells
its interest to T for $22,000. The balance sheet of the partnership
at the date of sale shows the following:


Assets
                                                     Fair
                                           Adjusted  Market
                                           Basis     Value
Cash ...................................   $5,000    $5,000
Accounts receivable ...................... 10,000    10,000
Inventory ................................ 20,000    21,000
Depreciable assets ....................... 20,000    40,000
Total .................................   $55,000   $76,000
Liabilities and Capital
Fair
Adjusted Market
Per Books Value
Liabilities ............................. $10,000   $10,000
Capital:

A .......................................  15,000    22,000
B .......................................  15,000    22,000
C .......................................  15,000    22,000
Total ................................... $55,000   $76,000

(ii) The amount of the basis adjustment under section 743(b) is the
difference between the basis of T's interest in the partnership and
T's share of the adjusted basis to the partnership of the
partnership's property. Under section 742, the basis of T's interest
is $25,333 (the cash paid for A's interest, $22,000, plus $3,333,
T's share of partnership liabilities). T's interest in the
partnership's previously taxed capital is $15,000 ($22,000, the
amount of cash T would receive if PRS liquidated immediately after
the hypothetical transaction, decreased by $7,000, the amount of tax
gain allocated to T from the hypothetical transaction). T's share of
the adjusted basis to the partnership of the partnership's property
is $18,333 ($15,000 share of previously taxed capital, plus $3,333
share of the partnership's liabilities). The amount of the basis
adjustment under section 743(b) to partnership property therefore,
is $7,000, the difference between $25,333 and $18,333.

Example 2. A, B, and C form partnership PRS, to which A contributes
land (Asset 1) with a fair market value of $1,000 and an adjusted
basis to A of $400, and B and C each contribute $1,000 cash. Each
partner has $1,000 credited to it on the books of the partnership as
its capital contribution. The partners share in profits equally.
During the partnership's first taxable year, Asset 1 appreciates in
value to $1,300. A sells its one-third interest in the partnership
to T for $1,100, when an election under section 754 is in effect.
The amount of tax gain that would be allocated to T from the
hypothetical transaction is $700 ($600 section 704(c) built-in gain,
plus one-third of the additional gain). Thus, T's interest in the
partnership's previously taxed capital is $400 ($1,100, the amount
of cash T would receive if PRS liquidated immediately after the
hypothetical transaction, decreased by $700, T's share of gain from
the hypothetical transaction). The amount of T's basis adjustment
under section 743(b) to partnership property is $700 (the excess of
$1,100, T's cost basis for its interest, over $400, T's share of the
adjusted basis to the partnership of partnership property).

(e) Allocation of basis adjustment. For the allocation of the basis
adjustment under this section among the individual items of
partnership property, see section 755 and the regulations
thereunder.

(f) Subsequent transfers. Where there has been more than one
transfer of a partnership interest, a transferee's basis adjustment
is determined without regard to any prior transferee's basis
adjustment. In the case of a gift of an interest in a partnership,
the donor is treated as transferring, and the donee as receiving,
that portion of the basis adjustment attributable to the gifted
partnership interest. The provisions of this paragraph (f) are
illustrated by the following example:.32 Example. (i) A, B, and C
form partnership PRS. A and B each contribute $1,000 cash, and C
contributes land with a basis and fair market value of $1,000. When
the land has appreciated in value to $1,300, A sells its interest to
T1 for $1,100 (one-third of $3,300, the fair market value of the
partnership property).

An election under section 754 is in effect; therefore, T1 has a
basis adjustment under section 743(b) of $100.

(ii) After the land has further appreciated in value to $1,600, T1
sells its interest to T2 for $1,200 (one-third of $3,600, the fair
market value of the partnership property). T2 has a basis adjustment
under section 743(b) of $200. This amount is determined without
regard to any basis adjustment under section 743(b) that T1 may have
had in the partnership assets.

(iii) During the following year, T2 makes a gift to T3 of fifty
percent of T2's interest in PRS. At the time of the transfer, T2 has
a $200 basis adjustment under section 743(b).

T2 is treated as transferring $100 of the basis adjustment to T3
with the gift of the partnership interest.

(g) Distributions--(1) Distribution of adjusted property to the
transferee--(i) Coordination with section 732. If a partnership
distributes property to a transferee and the transferee has a basis
adjustment for the property, the basis adjustment is taken into
account under section 732. See §1.732- 2(b).

(ii) Coordination with section 734. For certain adjustments to the
common basis of remaining partnership property after the
distribution of adjusted property to a transferee, see §1.734- 2(b).

(2) Distribution of adjusted property to another partner--

(i) Coordination with section 732. If a partner receives a
distribution of property with respect to which another partner has a
basis adjustment, the distributee does not take the basis adjustment
into account under section 732..33

(ii) Reallocation of basis. A transferee with a basis adjustment in
property that is distributed to another partner reallocates the
basis adjustment among the remaining items of partnership property
under §1.755-1(c).

(3) Distributions in complete liquidation of a partner's interest.
If a transferee receives a distribution of property (whether or not
the transferee has a basis adjustment in such 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 transferee's basis adjustment for the
property in which the transferee relinquished an interest (either
because it remained in the partnership or was distributed to another
partner). Any basis adjustment for property in which the transferee
is deemed to relinquish its interest is reallocated among the
properties distributed to the transferee under §1.755-1(c).

(4) Coordination with other provisions. The rules of sections 704(c)
(1)(B), 731, 737, and 751 apply before the rules of this paragraph
(g).

(5) Example. The provisions of this paragraph (g) are illustrated by
the following example:

Example. (i) A, B, and C are equal partners in partnership PRS. Each
partner originally contributed $10,000 in cash, and PRS used the
contributions to purchase five nondepreciable capital assets. PRS
has no liabilities. After five years, PRS's balance sheet appears as
follows:

Assets
                                                     Fair
                                           Adjusted  Market
                                           Basis     Value
Asset 1 . . . . . . . . . . . . . . . .    $10,000   $10,000
Asset 2 . . . . . . . . . . . . . . . .      4,000     6,000
Asset 3 . . . . . . . . . . . . . . . .      6,000     6,000
Asset 4 . . . . . . . . . . . . . . . .      7,000     4,000
Asset 5 . . . . . . . . . . . . . . . .      3,000    13,000
Total . . . . . . . . . . . .              $30,000   $39,000
Capital
                                                     Fair
                                           Adjusted  Market
                                           Per Books Value
Partner A . . . . . . . . . . . . . . .    $10,000   $13,000
Partner B . . . . . . . . . . . . . . .     10,000    13,000
Partner C . . . . . . . . . . . . . . .     10,000    13,000
Total . . . . . . . . . . . .              $30,000   $39,000

(ii) A sells its interest to T for $13,000 when PRS has an election
in effect under section 754. T receives a basis adjustment under
section 743(b) in the partnership property that is equal to $3,000
(the excess of T's basis in the partnership interest, $13,000, over
T's share of the adjusted basis to the partnership of partnership
property, $10,000). The basis adjustment is allocated under section
755, and the partnership's balance sheet appears as follows:

Assets
                                               Fair
                                     Adjusted  Market   Basis
                                     Basis     Value    Adjustment
Asset 1 . . . . . . . . . . .        $10,000   $10,000  $0.00
Asset 2 . . . . . . . . . . .          4,000     6,000 666.67
Asset 3 . . . . . . . . . . .          6,000     6,000   0.00
Asset 4 . . . . . . . . . . .          7,000     4,000 (1,000.00)
Asset 5 . . . . . . . . . . .          3,000    13,000  3,333.33
Total . . . . . . .                  $30,000   $39,000 $3,000.00
Capital
                                               Fair
                                     Adjusted  Market   Special
                                     Per Books Value    Basis
Partner T . . . . . . . . . .        $10,000   $13,000  $3,000
Partner B . . . . . . . . . .         10,000    13,000   0
Partner C . . . . . . . . . .         10,000    13,000   0
Total . . . . . . .                  $30,000   $39,000  $3,000

(iii) Assume that PRS distributes Asset 2 to T in partial
liquidation of T's interest in the partnership. T has a basis
adjustment under section 743(b) of $666.67 in Asset 2. Under
paragraph (g)(1)(i) of this section, T takes the basis adjustment
into account under section 732. Therefore, T will have a basis in
Asset 2 of $4,666.67 following the distribution.

(iv) Assume instead that PRS distributes Asset 5 to C in complete
liquidation of C's interest in PRS. T has a basis adjustment under
section 743(b) of $3,333.33 in Asset 5. Under paragraph (g)(2)(i) of
this section, C does not take T's basis adjustment into account
under section 732. Therefore, the partnership's basis for purposes
of sections 732 and 734 is $3,000. Under paragraph (g)(2)(ii) of
this section, T's $3,333.33 basis adjustment is reallocated among
the remaining partnership assets under §1.755-1(c).

(v) Assume instead that PRS distributes Asset 5 to T in complete
liquidation of its interest in PRS. Under paragraph (g)(3) of this
section, immediately prior to the distribution of Asset 5 to T, PRS
must adjust the basis of Asset 5. Therefore, immediately prior to
the distribution, PRS's basis in Asset 5 is equal to $6,000, which
is the sum of (A) $3,000, PRS's common basis in Asset 5, plus (B)
$3,333.33, T's basis adjustment to Asset 5, plus (C) ($333.33), the
sum of T's basis adjustments in Assets 2 and 4. For purposes of
sections 732 and 734, therefore, PRS will be treated as having a
basis in Asset 5 equal to $6,000.

(h) Contributions of adjusted property--(1) Section 721(a)
transactions. If, in a transaction described in section 721(a), a
partnership (the upper tier) contributes to another partnership (the
lower tier) property with respect to which a basis adjustment has
been made, the basis adjustment is treated as contributed to the
lower-tier partnership, regardless of whether the lower-tier
partnership makes a section 754 election. The lower tier's basis in
the contributed assets and the upper tier's basis in the partnership
interest received in the transaction are determined with reference
to the basis adjustment. However, that portion of the basis of the
upper tier's interest in the lower tier attributable to the basis
adjustment must be segregated and allocated solely to the transferee
partner for whom the basis adjustment was made. Similarly, that
portion of the lower tier's basis in its assets attributable to the
basis adjustment must be segregated and allocated solely to the
upper tier and the transferee. A partner with a basis adjustment in
property held by a partnership that terminates under section 708(b)
(1)(B) will continue to have the same basis adjustment with respect
to property deemed contributed by the terminated partnership to the
new partnership under §1.708-1(b)(1)(iv), regardless of whether the
new partnership makes a section 754 election.

(2) Section 351 transactions--(i) Basis in transferred property. A
corporation's adjusted tax basis in property transferred to the
corporation by a partnership in a transaction described in section
351 is determined with reference to any basis adjustments to the
property under section 743(b) (other than any basis adjustment that
reduces a partner's gain under paragraph (h)(2)(ii) of this
section).

(ii) Partnership gain. The amount of gain, if any, recognized by the
partnership on a transfer of property by the partnership to a
corporation in a transfer described in section 351 is determined
without reference to any basis adjustment to the transferred
property under section 743(b). The amount of gain, if any,
recognized by the partnership on the transfer that is allocated to a
partner with a basis adjustment in the transferred property is
adjusted to reflect the partner's basis adjustment in the
transferred property.

(iii) Basis in stock. The partnership's adjusted tax basis in stock
received from a corporation in a transfer described in section 351
is determined without reference to the basis adjustment in property
transferred to the corporation in the section 351 exchange. A
partner with a 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 basis adjustment in the transferred property, reduced
by any basis adjustment that reduced the partner's gain under
paragraph (h)(2)(ii) of this section.

(iv) Example. The following example illustrates the principles of
this paragraph (h):

Example. (i) A, B, and C are equal partners in partnership PRS. The
partnership's only asset, Asset 1, has an adjusted tax basis of $60
and a fair market value of $120. Asset 1 is a nondepreciable capital
asset and is not section 704(c) property.

A has a basis in its partnership interest of $40, and a positive
section 743(b) adjustment of $20 in Asset 1. In a transaction to
which section 351 applies, PRS contributes Asset 1 to X, a
corporation, in exchange for $15 in cash and X stock with a fair
market value of $105.

(ii) Under paragraph (h)(2)(ii) of this section, PRS realizes $60 of
gain on the transfer of Asset 1 to X ($120, its amount realized,
minus $60, its adjusted basis), but recognizes only $15 of that gain
under section 351(b)(1). Of this amount, $5 is allocated to each
partner. A must use $5 of its basis adjustment in Asset 1 to offset
A's share of PRS's gain. Under paragraph (h)(2)(iii) of this
section, PRS's basis in the stock received from X is $60. However, A
has a basis adjustment in the stock received by PRS equal to $15
(its basis adjustment in Asset 1, $20, reduced by the portion of the
adjustment which reduced A's gain, $5). Under paragraph (h)(2)(i) of
this section, X's basis in Asset 1 equals $75 (PRS's common basis in
the asset, $60, plus A's basis adjustment under section 743(b), $20,
less the portion of the adjustment which reduced A's gain, $5).

(i) [Reserved].

(j) Effect of basis adjustment--(1) In general. The basis adjustment
constitutes an adjustment to the basis of partnership property with
respect to the transferee only. No adjustment is made to the common
basis of partnership property. Thus, for purposes of calculating
income, deduction, gain, and loss, the transferee will have a
special basis for those partnership properties the bases of which
are adjusted under section 743(b) and this section. The adjustment
to the basis of partnership property under section 743(b) has no
effect on the partnership's computation of any item under section
703.

(2) Computation of 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 transferee, in accordance with section 704,
and adjusts the partners' capital accounts accordingly. The
partnership then adjusts the transferee's distributive share of the
items of partnership income, deduction, gain, or loss, in accordance
with paragraphs (j)(3) and (4) of this section, to reflect the
effects of the transferee's basis adjustment under section 743(b).
These adjustments to the transferee's distributive shares must be
reflected on Schedules K and K-1 of the partnership's return (Form
1065). These adjustments to the transferee's distributive shares do
not affect the transferee's capital account.

(3) Effect of basis adjustment in determining items of income, gain,
or loss--(i) In general. The amount of a transferee's income, gain,
or loss from the sale or exchange of a partnership asset in which
the transferee has a basis adjustment is equal to the transferee's
share of the partnership's gain or loss from the sale of the asset
(including any remedial allocations under §1.704-3(d)), minus the
amount of the transferee's positive basis adjustment for the
partnership asset (determined by taking into account the recovery of
the basis adjustment under paragraph (j)(4)(i)(B) of this section)
or plus the amount of the transferee's negative basis adjustment for
the partnership asset (determined by taking into the account the
recovery of the basis adjustment under paragraph (j)(4)(ii)(B) of
this section).

(ii) Examples. The following examples illustrate the principles of
this paragraph (j)(3):

Example 1. A and B form equal partnership PRS. A contributes
nondepreciable property with a fair market value of $50 and an
adjusted tax basis of $100. PRS will use the traditional allocation
method under §1.704-3(b). B contributes $50 cash. A sells its
interest to T for $50. PRS has an election in effect to adjust the
basis of partnership property under section 754. T receives a
negative $50 basis adjustment under section 743(b) that, under
section 755, is allocated to the nondepreciable property. PRS then
sells the property for $60.

PRS recognizes a book gain of $10 (allocated equally between T and
B) and a tax loss of $40. T will receive an allocation of $40 of tax
loss under the principles of section 704(c). However, because T has
a negative $50 basis adjustment in the nondepreciable property, T
recognizes a $10 gain from the partnership's sale of the property.

Example 2. A and B form equal partnership PRS. A contributes
nondepreciable property with a fair market value of $100 and an
adjusted tax basis of $50. B contributes $100 cash.

PRS will use the traditional allocation method under §1.704-3(b).

A sells its interest to T for $100. PRS has an election in effect to
adjust the basis of partnership property under section 754.
Therefore, T receives a $50 basis adjustment under section 743(b)
that, under section 755, is allocated to the nondepreciable
property. PRS then sells the nondepreciable property for $90. PRS
recognizes a book loss of $10 (allocated equally between T and B)
and a tax gain of $40. T will receive an allocation of the entire
$40 of tax gain under the principles of section 704(c). However,
because T has a $50 basis adjustment in the property, T recognizes a
$10 loss from the partnership's sale of the property.

Example 3. A and B form equal partnership PRS. PRS will make
allocations under section 704(c) using the remedial allocation
method described in §1.704-3(d). A contributes nondepreciable
property with a fair market value of $100 and an adjusted tax basis
of $150. B contributes $100 cash. A sells its partnership interest
to T for $100. PRS has an election in effect to adjust the basis of
partnership property under section 754. T receives a negative $50
basis adjustment under section 743(b) that, under section 755, is
allocated to the property.

The partnership then sells the property for $120. The partnership
recognizes a $20 book gain and a $30 tax loss. The book gain will be
allocated equally between the partners. The entire $30 tax loss will
be allocated to T under the principles of section 704(c). To match
its $10 share of book gain, B will be allocated $10 of remedial
gain, and T will be allocated an offsetting $10 of remedial loss. T
was allocated a total of $40 of tax loss with respect to the
property. However, because T has a negative $50 basis adjustment to
the property, T recognizes a $10 gain from the partnership's sale of
the property.

(4) Effect of basis adjustment in determining items of
deduction--(i) Increases--(A) Additional deduction. The amount of
any positive basis adjustment that is recovered by the transferee in
any year is added to the transferee's distributive share of the
partnership's depreciation or amortization.41 deductions for the
year. The basis adjustment is adjusted under section 1016(a)(2) to
reflect the recovery of the basis adjustment.

(B) Recovery period--(1) In general. Except as provided in paragraph
(j)(4)(i)(B)(2) of this section, for purposes of section 168, if the
basis of a partnership's recovery property is increased as a result
of the transfer of a partnership interest, then the increased
portion of the basis is taken into account as if it were newly-
purchased recovery property placed in service when the transfer
occurs. Consequently, any applicable recovery period and method may
be used to determine the recovery allowance with respect to the
increased portion of the basis. However, no change is made for
purposes of determining the recovery allowance under section 168 for
the portion of the basis for which there is no increase.

(2) Remedial allocation method. If a partnership elects to use the
remedial allocation method described in §1.704-3(d) with respect to
an item of the partnership's recovery property, then the portion of
any increase in the basis of the item of the partnership's recovery
property under section 743(b) that is attributable to section 704(c)
built-in gain is recovered over the remaining recovery period for
the partnership's excess book basis in the property as determined in
the final sentence of §1.704-3(d)(2). Any remaining portion of the
basis increase is recovered under paragraph (j)(4)(i)(B)(1) of this
section.

(C) Examples. The provisions of this paragraph (j)(4)(i) are
illustrated by the following examples:

Example 1. (i) A, B, and C are equal partners in partnership PRS,
which owns Asset 1, an item of depreciable property that has a fair
market value in excess of its adjusted tax basis. C sells its
interest in PRS to T while PRS has an election in effect under
section 754. PRS, therefore, increases the basis of Asset 1 with
respect to T.

(ii) Assume that in the year following the transfer of the
partnership interest to T, T's distributive share of the
partnership's common basis depreciation deductions from Asset 1 is
$1,000. Also assume that, under paragraph (j)(4)(i)(B) of this
section, the amount of the basis adjustment under section 743(b)
that T recovers during the year is $500. The total amount of
depreciation deductions from Asset 1 reported by T is equal to
$1,500.

Example 2. (i) A and B form equal partnership PRS. A contributes
property with an adjusted basis of $100,000 and a fair market value
of $500,000. B contributes $500,000 cash.

When PRS is formed, the property has five years remaining in its
recovery period. The partnership's adjusted basis of $100,000 will,
therefore, be recovered over the five years remaining in the
property's recovery period. PRS elects to use the remedial
allocation method under §1.704-3(d) with respect to the property.

If PRS had purchased the property at the time of the partnership's
formation, the basis of the property would have been recovered over
a 10-year period. The $400,000 of section 704(c) built-in gain will,
therefore, be amortized under §1.704- 3(d) over a 10-year period
beginning at the time of the partnership's formation.

(ii)(A)Except for the depreciation deductions, PRS's expenses equal
its income in each year of the first two years commencing with the
year the partnership is formed. After two years, A's share of the
adjusted basis of partnership property is $120,000, while B's is
$440,000:

Capital Accounts
                               A                    B
                       Book        Tax       Book        Tax
Initial
Contribution           $500,000    $100,000  $500,000    $500,000
Depreciation
Year 1                  (30,000)              (30,000)    (20,000)
Remedial                             10,000               (10,000)
                        470,000     110,000   470,000     470,000
Depreciation
Year 2                  (30,000)              (30,000)    (20,000)
Remedial                             10,000               (10,000)
                       $440,000    $120,000  $440,000    $440,000
                        
(B) A sells its interest in PRS to T for its fair market value of
$440,000. A valid election under section 754 is in effect with
respect to the sale of the partnership interest.

Accordingly, PRS makes an adjustment, pursuant to section 743(b), to
increase the basis of partnership property. Under section 743(b),
the amount of the basis adjustment is equal to $320,000.

Under section 755, the entire basis adjustment is allocated to the
property.

(iii) At the time of the transfer, $320,000 of section 704(c) built-
in gain from the property was still reflected on the partnership's
books, and all of the basis adjustment is attributable to section
704(c) built-in gain. Therefore, the basis adjustment will be
recovered over the remaining recovery period for the section 704(c)
built-in gain under §1.704-3(d).

(ii) Decreases--(A) Reduced deduction. The amount of any negative
basis adjustment allocated to an item of depreciable or amortizable
property that is recovered in any year first decreases the
transferee's distributive share of the partnership's depreciation or
amortization deductions from that item of property for the year. If
the amount of the basis adjustment recovered in any year exceeds the
transferee's distributive share of the partnership's depreciation or
amortization deductions from the item of property, then the
transferee's distributive share of the partnership's depreciation or
amortization deductions from other items of partnership property is
decreased. The transferee then recognizes ordinary income to the
extent of the excess, if any, of the amount of the basis adjustment
recovered in any year over the transferee's distributive share of
the partnership's depreciation or amortization deductions from all
items of property.

(B) Recovery period. For purposes of section 168, if the basis of an
item of a partnership's recovery property is decreased as the result
of the transfer of an interest in the partnership, then the decrease
is recovered over the remaining useful life of the item of the
partnership's recovery property.

The portion of the decrease that is recovered in any year during the
recovery period is equal to the product of-- (1) The amount of the
decrease to the item's adjusted basis (determined as of the date of
the transfer); multiplied by (2) A fraction, the numerator of which
is the portion of the adjusted basis of the item recovered by the
partnership in that year, and the denominator of which is the
adjusted basis of the item on the date of the transfer (determined
prior to any basis adjustments).

(C) Examples. The provisions of this paragraph (j)(4)(ii) are
illustrated by the following examples:

Example 1. (i) A, B, and C are equal partners in partnership PRS,
which owns Asset 2, an item of depreciable property that has a fair
market value that is less than its adjusted tax basis. C sells its
interest in PRS to T while PRS has an election in effect under
section 754. PRS, therefore, decreases the basis of Asset 2 with
respect to T.

(ii) Assume that in the year following the transfer of the
partnership interest to T, T's distributive share of the
partnership's common basis depreciation deductions from Asset 2 is
$1,000. Also assume that, under paragraph (j)(4)(ii)(B) of this
section, the amount of the basis adjustment under section 743(b)
that T recovers during the year is $500. The total amount of
depreciation deductions from Asset 2 reported by T is equal to $500.

Example 2. (i) A and B form equal partnership PRS. A contributes
property with an adjusted basis of $100,000 and a fair market value
of $50,000. B contributes $50,000 cash. When PRS is formed, the
property has five years remaining in its recovery period. The
partnership's adjusted basis of $100,000 will, therefore, be
recovered over the five years remaining in the property's recovery
period. PRS uses the traditional allocation method under §1.704-3(b)
with respect to the property.

As a result, B will receive $5,000 of depreciation deductions from
the property in each of years 1-5, and A, as the contributing
partner, will receive $15,000 of depreciation deductions in each of
these years.

(ii) Except for the depreciation deductions, PRS's expenses equal
its income in each of the first two years commencing with the year
the partnership is formed. After two years, A's share of the
adjusted basis of partnership property is $70,000, while B's is
$40,000. A sells its interest in PRS to T for its fair market value
of $40,000. A valid election under section 754 is in effect with
respect to the sale of the partnership interest.

Accordingly, PRS makes an adjustment, pursuant to section 743(b), to
decrease the basis of partnership property. Under section 743(b),
the amount of the adjustment is equal to ($30,000).

Under section 755, the entire adjustment is allocated to the
property.

(iii) The basis of the property at the time of the transfer of the
partnership interest was $60,000. In each of years 3 through 5, the
partnership will realize depreciation deductions of $20,000 from the
property. Thus, one third of the negative basis adjustment ($10,000)
will be recovered in each of years 3 through 5. Consequently, T will
be allocated, for tax purposes, depreciation of $15,000 each year
from the partnership and will recover $10,000 of its negative basis
adjustment. Thus, T's net depreciation deduction from the
partnership in each year is $5,000.

Example 3. (i) A, B, and C are equal partners in partnership PRS,
which owns Asset 2, an item of depreciable property that has a fair
market value that is less than its adjusted tax basis. C sells its
interest in PRS to T while PRS has an election in effect under
section 754. PRS, therefore, decreases the basis of Asset 2 with
respect to T.

(ii) Assume that in the year following the transfer of the
partnership interest to T, T's distributive share of the
partnership's common basis depreciation deductions from Asset 2 is
$500. PRS allocates no other depreciation to T. Also assume that,
under paragraph (j)(4)(ii)(B) of this section, the amount of the
negative basis adjustment that T recovers during the year is $1,000.
T will report $500 of ordinary income because the amount of the
negative basis adjustment recovered during the year exceeds T's
distributive share of the partnership's common basis depreciation
deductions from Asset 2.

(5) Depletion. Where an adjustment is made under section 743(b) to
the basis of partnership property subject to depletion, any
depletion allowance is determined separately for each partner,
including the transferee partner, based on the partner's interest in
such property. See §1.702-1(a)(8). For partnerships that hold oil
and gas properties that are depleted at the partner level under
section 613A(c)(7)(D), the transferee partner (and not the
partnership) must make the basis adjustments, if any, required under
section 743(b) with respect to such properties.

See §1.613A-3(e)(6)(iv).

(6) Example. The provisions of paragraph (j)(5) of this section are
illustrated by the following example:

Example. A, B, and C each contributes $5,000 cash to form
partnership PRS, which purchases a coal property for $15,000. A, B,
and C have equal interests in capital and profits. C subsequently
sells its partnership interest to T for $100,000 when the election
under section 754 is in effect. T has a basis adjustment under
section 743(b) for the coal property of $95,000 (the difference
between T's basis, $100,000, and its share of the basis of
partnership property, $5,000). Assume that the depletion allowance
computed under the percentage method would be $21,000 for the
taxable year so that each partner would be entitled to $7,000 as its
share of the deduction for depletion.

However, under the cost depletion method, at an assumed rate of 10
percent, the allowance with respect to T's one-third interest which
has a basis to him of $100,000 ($5,000, plus its basis adjustment of
$95,000) is $10,000, although the cost depletion allowance with
respect to the one-third interest of A and B in the coal property,
each of which has a basis of $5,000, is only $500. For partners A
and B, the percentage depletion is greater than cost depletion and
each will deduct $7,000 based on the percentage depletion method.
However, as to T, the transferee partner, the cost depletion method
results in a greater allowance and T will, therefore, deduct $10,000
based on cost depletion.

See section 613(a).

(k) Returns--(1) Statement of adjustments--(i) In general.

A partnership that must adjust the bases of partnership properties
under section 743(b) must attach a statement to the partnership
return for the year of the transfer setting forth the name and
taxpayer identification number of the transferee as well as the
computation of the adjustment and the partnership properties to
which the adjustment has been allocated.

(ii) Special rule. Where an interest is transferred in a partnership
which holds oil and gas properties that are depleted at the partner
level under section 613A(c)(7)(D), the transferee must attach a
statement to the transferee's return for the year of the transfer,
setting forth the computation of the basis adjustment under section
743(b) which is allocable to such properties and the specific
properties to which the adjustment has been allocated.

(iii) Example. The provisions of paragraph (k)(1)(ii) of this
section are illustrated by the following example:

Example. (i) Partnership XYZ owns a single section 613A(c)(7)(D)
domestic oil and gas property (Property) and other non-depletable
assets. A, a partner in XYZ with an adjusted tax basis in Property
of $100 (excluding any prior adjustments under section 743(b)),
sells its partnership interest to B for $800 cash. Under
§1.613A-3(e)(6)(iv), A's adjusted basis of $100 in Property carries
over to B..48 (ii) Under section 755, XYZ determines that Property
accounts for 50% of the fair market value of all partnership assets.
The remaining 50% of B's purchase price ($400) is attributable to
non-depletable property. XYZ must provide a statement to B
containing the portion of B's adjusted basis attributable to non-
depletable property ($400). Under this paragraph (k)(1), XYZ must
report basis adjustments under section 743(b) to non-depletable
property. B must report basis adjustments under section 743(b) to
Property.

(2) Requirement that transferee notify partnership--(i) Sale or
exchange. A transferee that acquires, by sale or exchange, an
interest in a partnership with an election under section 754 in
effect for the taxable year of the transfer, must notify the
partnership, in writing, within 30 days of the sale or exchange.

The written notice to the partnership must be signed under penalties
of perjury and must include the names and addresses of the
transferee and (if ascertainable) of the transferor, the taxpayer
identification numbers of the transferee and (if ascertainable) of
the transferor, the relationship (if any) between the transferee and
the transferor, the date of the transfer, the amount of any
liabilities assumed or taken subject to by the transferee, and the
amount of any money, the fair market value of any other property
delivered or to be delivered for the transferred interest in the
partnership, and any other information necessary for the partnership
to compute the transferee's basis.

(ii) Transfer on death. A transferee that acquires, on the death of
a partner, an interest in a partnership with an election under
section 754 in effect for the taxable year of the transfer, must
notify the partnership, in writing, within one year of the death of
the deceased partner. The written notice to the partnership must be
signed under penalties of perjury and must include the names and
addresses of the deceased partner and the transferee, the taxpayer
identification numbers of the deceased partner and the transferee,
the relationship (if any) between the transferee and the transferor,
the deceased partner's date of death, the date on which the
transferee became the owner of the partnership interest, the fair
market value of the partnership interest on the applicable date of
valuation set forth in section 1014, and the manner in which the
fair market value of the partnership interest was determined.

(iii) Nominee reporting. If a partnership interest is transferred to
a nominee which is required to furnish the statement under section
6031(c)(1) to the partnership, the nominee may satisfy the notice
requirement contained in this paragraph (k)(2) by providing the
statement required under §1.6031(c)-1T, provided that the statement
satisfies all requirements of §1.6031(c)-1T and this paragraph (k)
(2).

(3) Reliance. In making the adjustments under section 743(b) and any
statement or return relating to such adjustments under this section,
a partnership may rely on the written notice provided by a
transferee pursuant to paragraph (k)(2) of this section to determine
the transferee's basis in a partnership interest. The previous
sentence shall not apply if any partner who has responsibility for
federal income tax reporting by the partnership has knowledge of
facts indicating that the statement is clearly erroneous.

(4) Partnership not required to make or report adjustments under
section 743(b) until it has notice of the transfer. A partnership is
not required to make the adjustments under section 743(b) (or any
statement or return relating to those adjustments) with respect to
any transfer until it has been notified of the transfer. For
purposes of this section, a partnership is notified of a transfer
when either-- (i) The partnership receives the written notice from
the transferee required under paragraph (k)(2) of this section; or
(ii) Any partner who has responsibility for federal income tax
reporting by the partnership has knowledge that there has been a
transfer of a partnership interest.

(5) Effect on partnership of the failure of the transferee to
comply. If the transferee fails to provide the partnership with the
written notice required by paragraph (k)(2) of this section, the
partnership must attach a statement to its return in the year that
the partnership is otherwise notified of the transfer. This
statement must set forth the name and taxpayer identification number
(if ascertainable) of the transferee. In addition, the following
statement must be prominently displayed in capital letters on the
first page of the partnership's return for such year, and on the
first page of any schedule or information statement relating to such
transferee's share of income, credits, deductions, etc.: "RETURN
FILED PURSUANT TO §1.743-1(k)(5)." The partnership will then be
entitled to report the transferee's share of partnership items
without adjustment to reflect the transferee's basis adjustment in
partnership property. If, following the filing of a return pursuant
to this paragraph (k)(5), the transferee provides the applicable
written notice to the partnership, the partnership must make such
adjustments as are necessary to adjust the basis of partnership
property (as of the date of the transfer) in any amended return
otherwise to be filed by the partnership or in the next annual
partnership return of income to be regularly filed by the
partnership. At such time, the partnership must also provide the
transferee with such information as is necessary for the transferee
to amend its prior returns to properly reflect the adjustment under
section 743(b).

(l) Effective date. This section applies to transfers of partnership
interests that occur on or after December 15, 1999.

Par. 6. Section 1.751-1 is amended by:

1. Revising paragraphs (a)(2) and (a)(3).

2. Revising paragraph (c)(3).

3. Removing paragraph (c)(4)(x).

4. Adding a sentence at the end of paragraph (f).

5. Revising Example 1 of paragraph (g).

The addition and revisions read as follows:

§1.751-1 Unrealized receivables and inventory items.

* * * * *

(a) * * *

(2) Determination of gain or loss. The income or loss realized by a
partner upon the sale or exchange of its interest in section 751
property is the amount of income or loss from section 751 property
(including any remedial allocations under §1.704-3(d)) that would
have been allocated to the partner (to the extent attributable to
the partnership interest sold or exchanged) if the partnership had
sold all of its property in a fully taxable transaction for cash in
an amount equal to the fair market value of such property (taking
into account section 7701(g)) immediately prior to the partner's
transfer of the interest in the partnership. Any gain or loss
recognized that is attributable to section 751 property will be
ordinary gain or loss. The difference between the amount of capital
gain or loss that the partner would realize in the absence of
section 751 and the amount of ordinary income or loss determined
under this paragraph (a)(2) is the transferor's capital gain or loss
on the sale of its partnership interest.

(3) Statement required. A partner selling or exchanging any part of
an interest in a partnership that has any section 751 property at
the time of sale or exchange must submit with its income tax return
for the taxable year in which the sale or exchange occurs a
statement setting forth separately the following information--

(i) The date of the sale or exchange;

(ii) The amount of any gain or loss attributable to the section 751
property; and

(iii) The amount of any gain or loss attributable to capital gain or
loss on the sale of the partnership interest.

* * * * *

(c) Unrealized receivables. * * *

(3) In determining the amount of the sale price attributable to such
unrealized receivables, or their value in a distribution treated as
a sale or exchange, full account shall be taken not only of the
estimated cost of completing performance of the contract or
agreement, but also of the time between the sale or distribution and
the time of payment.

* * * * *

(f) * * * The rules contained in paragraphs (a)(2) and (a)(3) of
this section apply to transfers of partnership interests that occur
on or after December 15, 1999.

(g) * * *

Example 1. (i)(A) A and B are equal partners in personal service
partnership PRS. B transfers its interest in PRS to T for $15,000
when PRS's balance sheet (reflecting a cash receipts and
disbursements method of accounting) is as follows:

Assets
                                    Fair
                          Adjusted  Market
                          Basis     Value
Cash . . . . . . . . . .  $3,000    $3,000
Loans Receivable . . . .  10,000    10,000
Capital Assets . . . . .   7,000     5,000
Unrealized Receivables .       0    14,000
Total . . . . . . .       20,000    32,000
Liabilities and Capital
Fair
Adjusted Market
Per Books Value
Liabilities . . . . . .   $2,000    $2,000
Capital:
A . . . . . . . . . .      9,000    15,000
B . . . . . . . . . .      9,000    15,000
Total . . . . . . .       20,000    32,000

(B) None of the assets owned by PRS is section 704(c) property, and
the capital assets are nondepreciable. The total amount realized by
B is $16,000, consisting of the cash received, $15,000, plus $1,000,
B's share of the partnership liabilities assumed by T. See section
752. B's undivided half-interest in the partnership property
includes a half-interest in the partnership's unrealized receivables
items. B's basis for its partnership interest is $10,000 ($9,000,
plus $1,000, B's share of partnership liabilities). If section
751(a) did not apply to the sale, B would recognize $6,000 of
capital gain from the sale of the interest in PRS. However, section
751(a) does apply to the sale.

(ii) If PRS sold all of its section 751 property in a fully taxable
transaction immediately prior to the transfer of B's partnership
interest to T, B would have been allocated $7,000 of ordinary income
from the sale of PRS's unrealized receivables.

Therefore, B will recognize $7,000 of ordinary income with respect
to the unrealized receivables. The difference between the amount of
capital gain or loss that the partner would realize in the absence
of section 751 ($6,000) and the amount of ordinary income or loss
determined under paragraph (a)(2) of this section ($7,000) is the
transferor's capital gain or loss on the sale of its partnership
interest. In this case, B will recognize a $1,000 capital loss.

* * * * *

Par. 7. Section 1.754-1 is amended as follows:

1. Designate the text following the heading of paragraph (c) as
paragraph (c)(1).

2. Add a heading to newly designated paragraph (c)(1).

3. Add paragraph (c)(2).

The additions read as follows:.55 §1.754-1 Time and manner of making
election to adjust basis of partnership property.

* * * * *

(c) Revocation of election--(1) In general. * * *

(2) Revocations made for first taxable year ending after December
15, 1999. Notwithstanding paragraph (c)(1) of this section, any
partnership having an election in effect under this section for its
taxable year that includes December 15, 1999 may revoke such
election by attaching a statement to the partnership's return for
such year. For the revocation to be valid, the statement must be
filed not later than the time prescribed by §1.6031(a)-1(e)
(including extensions thereof) for filing the return for such
taxable year, and must set forth the name and address of the
partnership revoking the election, be signed by any one of the
partners who is authorized to sign the partnership's federal income
tax return, and contain a declaration that the partnership revokes
its election under section 754 to apply the provisions of section
734(b) and 743(b).

In addition, the following statement must be prominently displayed
in capital letters on the first page of the partnership's return for
such year: "RETURN FILED PURSUANT TO §1.754-1(c)(2)." Par. 8.
Section 1.755-1 is revised to read as follows:

§1.755-1 Rules for allocation of basis.

(a) Generally. A partnership that has an election in effect under
section 754 must adjust the basis of partnership property under the
provisions of section 734(b) and section 743(b) pursuant to the
provisions of this section. The basis adjustment is first allocated
between the two classes of property described in section 755(b).
These classes of property consist of capital assets and section
1231(b) property (capital gain property), and any other property of
the partnership (ordinary income property).

For purposes of this section, properties and potential gain treated
as unrealized receivables under section 751(c) and the regulations
thereunder shall be treated as separate assets that are ordinary
income property. The portion of the basis adjustment allocated to
each class is then allocated among the items within the class.
Adjustments under section 743(b) are allocated under paragraph (b)
of this section. Adjustments under section 734(b) are allocated
under paragraph (c) of this section.

(b) Adjustments under section 743(b)--(1) Generally. (i) For
exchanges in which the transferee's basis in the interest is
determined in whole or in part by reference to the transferor's
basis in the interest, paragraph (b)(5) of this section shall apply.
For all other transfers which result in a basis adjustment under
section 743(b), paragraphs (b)(2) through (b)(4) of this section
shall apply. Except as provided in paragraph (b)(5) of this section,
the portion of the basis adjustment allocated to one class of
property may be an increase while the portion allocated to the other
class is a decrease. This would be the case even though the total
amount of the basis adjustment is zero. Except as provided in
paragraph (b)(5) of this section, the portion of the basis
adjustment allocated to one item of property within a class may be
an increase while the portion allocated to another is a decrease.
This would be the case even though the basis adjustment allocated to
the class is zero.

(ii) Hypothetical transaction. For purposes of paragraphs (b)(2)
through (b)(4) of this section, the allocation of the basis
adjustment under section 743(b) between the classes of property and
among the items of property within each class are made based on the
allocations of income, gain, or loss (including remedial allocations
under §1.704-3(d)) that the transferee partner would receive (to the
extent attributable to the acquired partnership interest) if,
immediately after the transfer of the partnership interest, all of
the partnership's property were disposed of in a fully taxable
transaction for cash in an amount equal to the fair market value of
such property (the hypothetical transaction).

(2) Allocations between classes of property--(i) In general.

The amount of the basis adjustment allocated to the class of
ordinary income property is equal to the total amount of income,
gain, or 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 sale of
all ordinary income property in the hypothetical transaction.

The amount of the basis adjustment to capital gain property is equal
to--

(A) The total amount of the basis adjustment under section 743(b);
less

(B) The amount of the basis adjustment allocated to ordinary income
property under the preceding sentence; provided, however, that in no
event may the amount of any decrease in basis allocated to capital
gain property exceed the partnership's basis (or in the case of
property subject to the remedial allocation method, the transferee's
share of any remedial loss under §1.704-3(d) from the hypothetical
transaction) in capital gain property. In the event that a decrease
in basis allocated to capital gain property would otherwise exceed
the partnership's basis in capital gain property, the excess must be
applied to reduce the basis of ordinary income property.

(ii) Examples. The provisions of this paragraph (b)(2) are
illustrated by the following examples:

Example 1. (i) A and B form equal partnership PRS. A contributes
$50,000 and Asset 1, a nondepreciable capital asset with a fair
market value of $50,000 and an adjusted tax basis of $25,000. B
contributes $100,000. PRS uses the cash to purchase Assets 2, 3, and
4. After a year, A sells its interest in PRS to T for $120,000. At
the time of the transfer, A's share of the partnership's basis in
partnership assets is $75,000. Therefore, T receives a $45,000 basis
adjustment.

(ii) Immediately after the transfer of the partnership interest to
T, the adjusted basis and fair market value of PRS's assets are as
follows:

Assets
                                          Fair
                                Adjusted  Market
                                Basis     Value
Capital Gain Property:
Asset 1 . . . . . . . . . . .    $25,000   $75,000
Asset 2 . . . . . . . . . . .    100,000   117,500

Ordinary Income Property:
Asset 3 . . . . . . . . . . .    $40,000   $45,000
Asset 4 . . . . . . . . . . .     10,000     2,500
Total . . . . . . . .           $175,000  $240,000

(iii) If PRS sold all of its assets in a fully taxable transaction
at fair market value immediately after the transfer of the
partnership interest to T, the total amount of capital gain that
would be allocated to T is equal to $46,250 ($25,000 section 704(c)
built-in gain from Asset 1, plus fifty percent of the $42,500
appreciation in capital gain property). T would also be allocated a
$1,250 ordinary loss from the sale of the ordinary income property.

(iv) The amount of the basis adjustment that is allocated to
ordinary income property is equal to ($1,250) (the amount of the
loss allocated to T from the hypothetical sale of the ordinary
income property).

(v) The amount of the basis adjustment that is allocated to capital
gain property is equal to $46,250 (the amount of the basis
adjustment, $45,000, less ($1,250), the amount of loss allocated to
T from the hypothetical sale of the ordinary income property).

Example 2. (i) A and B form equal partnership PRS. A and B each
contribute $1,000 cash which the partnership uses to purchase Assets
1, 2, 3, and 4. After a year, A sells its partnership interest to T
for $1,000. T's basis adjustment under section 743(b) is zero.

(ii) Immediately after the transfer of the partnership interest to
T, the adjusted basis and fair market value of PRS's assets are as
follows:

Assets
                                         Fair
                                Adjusted Market
                                Basis    Value
Capital Gain Property:
Asset 1 . . . . . . . . . . .   $500     $750
Asset 2 . . . . . . . . . . .    500      500

Ordinary Income Property:
Asset 3 . . . . . . . . . . .   $500     $250
Asset 4 . . . . . . . . . . .    500      500
Total . . . . . . . .         $2,000   $2,000

(iii) If, immediately after the transfer of the partnership interest
to T, PRS sold all of its assets in a fully taxable transaction at
fair market value, T would be allocated a loss of $125 from the sale
of the ordinary income property. Thus, the amount of the basis
adjustment to ordinary income property is ($125). The amount of the
basis adjustment to capital gain property is $125 (zero, the amount
of the basis adjustment under section 743(b), less ($125), amount of
the basis adjustment allocated to ordinary income property).

(3) Allocation within the class--(i) Ordinary income property. The
amount of the basis adjustment to each item of property within the
class of ordinary income property is equal to--

(A) The amount of income, gain, or 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 the item; reduced by

(B) The product of--

(1) Any decrease to the amount of the basis adjustment to ordinary
income property required pursuant to the last sentence of paragraph
(b)(2)(i) of this section; multiplied by

(2) A fraction, the numerator of which is the fair market value of
the item of property to the partnership and the denominator of which
is the total fair market value of all of the partnership's items of
ordinary income property.

(ii) Capital gain property. The amount of the basis adjustment to
each item of property within the class of capital gain property is
equal to--

(A) The amount of income, gain, or 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 the item; minus

(B) The product of--

(1) The total amount of gain or 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 items of capital gain
property, minus the amount of the positive basis adjustment to all
items of capital gain property or plus the amount of the negative
basis adjustment to capital gain property; multiplied by

(2) A fraction, the numerator of which is the fair market value of
the item of property to the partnership, and the denominator of
which is the fair market value of all of the partnership's items of
capital gain property.

(iii) Examples. The provisions of this paragraph (b)(3) are
illustrated by the following examples:

Example 1. (i) Assume the same facts as Example 1 in paragraph (b)
(2)(ii) of this section. Of the $45,000 basis adjustment, $46,250
was allocated to capital gain property. The amount allocated to
ordinary income property was ($1,250).

(ii) Asset 1 is a capital gain asset, and T would be allocated
$37,500 from the sale of Asset 1 in the hypothetical transaction.
Therefore, the amount of the adjustment to Asset 1 is $37,500.

(iii) Asset 2 is a capital gain asset, and T would be allocated
$8,750 from the sale of Asset 2 in the hypothetical transaction.
Therefore, the amount of the adjustment to Asset 2 is $8,750.

(iv) Asset 3 is ordinary income property, and T would be allocated
$2,500 from the sale of Asset 3 in the hypothetical transaction.
Therefore, the amount of the adjustment to Asset 3 is $2,500.

(v) Asset 4 is ordinary income property, and T would be allocated
($3,750) from the sale of Asset 4 in the hypothetical transaction.
Therefore, the amount of the adjustment to Asset 4 is ($3,750).

Example 2. (i) Assume the same facts as Example 1 in paragraph (b)
(2)(ii) of this section, except that A sold its interest in PRS to T
for $110,000 rather than $120,000. T, therefore, receives a basis
adjustment under section 743(b) of $35,000. Of the $35,000 basis
adjustment, ($1,250) is allocated to ordinary income property, and
$36,250 is allocated to capital gain property.

(ii) Asset 3 is ordinary income property, and T would be allocated
$2,500 from the sale of Asset 3 in the hypothetical transaction.
Therefore, the amount of the adjustment to Asset 3 is $2,500.

(iii) Asset 4 is ordinary income property, and T would be allocated
($3,750) from the sale of Asset 4 in the hypothetical transaction.
Therefore, the amount of the adjustment to Asset 4 is ($3,750).

(iv) Asset 1 is a capital gain asset, and T would be allocated
$37,500 from the sale of Asset 1 in the hypothetical transaction.
Asset 2 is a capital gain asset, and T would be allocated $8,750
from the sale of Asset 2 in the hypothetical transaction. The total
amount of gain that would be allocated to T from the sale of the
capital gain assets in the hypothetical transaction is $46,250,
which exceeds the amount of the basis adjustment allocated to
capital gain property by $10,000. The amount of the adjustment to
Asset 1 is $33,604 ($37,500 minus $3,896 ($10,000 x
$75,000/192,500)). The amount of the basis adjustment to Asset 2 is
$2,646 ($8,750 minus $6,104 ($10,000 x $117,500/192,500)).

(4) Income in respect of a decedent--(i) In general. Where a
partnership interest is transferred as a result of the death of a
partner, under section 1014(c) the transferee's basis in its
partnership interest is not adjusted for that portion of the
interest, if any, which is attributable to items representing income
in respect of a decedent under section 691. See §1.742-1.

Accordingly, if a partnership interest is transferred as a result of
the death of a partner, and the partnership holds assets
representing income in respect of a decedent, no part of the basis
adjustment under section 743(b) is allocated to these assets. See
§1.743-1(b).

(ii) The provisions of this paragraph (b)(4) are illustrated by the
following example:

Example. (i) A and B are equal partners in personal service
partnership PRS. As a result of B's death, B's partnership interest
is transferred to T when PRS's balance sheet (reflecting a cash
receipts and disbursements method of accounting) is as follows:

Assets
                                          Fair
                                Adjusted  Market
                                Basis     Value
Capital Asset . . . . .         $2,000    $5,000
Unrealized Receivables .             0    15,000
Total . . . . . . .              2,000    20,000

Liabilities and Capital
                                          Fair
                                Adjusted  Market
                                Per Books Value
Capital:
A . . . . . . . . . .           1,000     10,000
B . . . . . . . . . .           1,000     10,000
Total . . . . . . .             2,000     20,000

(ii) None of the assets owned by PRS is section 704(c) property, and
the capital asset is nondepreciable. The fair market value of T's
partnership interest on the applicable date of valuation set forth
in section 1014 is $10,000. Of this amount, $2,500 is attributable
to T's share of the partnership's capital asset, and $7,500 is
attributable to T's 50% share of the partnership's unrealized
receivables. The partnership's unrealized receivables represent
income in respect of a decedent.

Accordingly, under section 1014(c), T's basis in its partnership
interest is not adjusted for that portion of the interest which is
attributable to the unrealized receivables. Therefore, T's basis in
its partnership interest is $2,500.

(iii) At the time of the transfer, B's share of the partnership's
basis in partnership assets is $1,000.

Accordingly, T receives a $1,500 basis adjustment under section
743(b). Under this paragraph (b)(4), the entire basis adjustment is
allocated to the partnership's capital asset.

(5) Transferred basis exchanges--(i) In general. This paragraph (b)
(5) applies to basis adjustments under section 743(b) which result
from exchanges in which the transferee's basis in the interest is
determined in whole or in part by.65 reference to the transferor's
basis in the interest. For example, this paragraph applies if a
partnership interest is contributed to a corporation in a
transaction to which section 351 applies or to a partnership in a
transaction to which section 721(a) applies.

(ii) Allocations between classes of property. 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). If there is an increase in basis to be
allocated to partnership assets, such increase must be allocated to
capital gain property or ordinary income property, respectively,
only if the total amount of gain or 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 such property would
result in a net gain or net income, as the case may be, to the
transferee. Where, under the preceding sentence, an increase in
basis may be allocated to both capital gain assets and ordinary
income assets, the increase shall be allocated to each class in
proportion to the net gain or net income, respectively, which would
be allocated to the transferee from the sale of all assets in each
class. If there is a decrease in basis to be allocated to
partnership assets, such decrease must be allocated to capital gain
property or ordinary income property, respectively, only if the
total amount of gain or loss (including any remedial allocations
under §1.704-3(d)).66 that would be allocated to the transferee (to
the extent attributable to the acquired partnership interest) from
the hypothetical sale of all such property would result in a net
loss to the transferee. Where, under the preceding sentence, a
decrease in basis may be allocated to both capital gain assets and
ordinary income assets, the decrease shall be allocated to each
class in proportion to the net loss which would be allocated to the
transferee from the sale of all assets in each class.

(iii) Allocations within the classes--(A) Increases. If 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 before such 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 the transferee's share
of the amount that would be realized by the partnership upon the
hypothetical sale of each asset in the class.

(B) Decreases. If 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 before
such 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 the 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 depreciated assets in that class,
the transferee's negative basis adjustment is limited to the
transferee's share of the partnership's adjusted basis in all
depreciated assets in that class.

(D) Carryover adjustment. Where a transferee's negative basis
adjustment under section 743(b) cannot be allocated to any asset,
because the adjustment exceeds the transferee's share of the
adjusted basis to the partnership of all depreciated assets in a
particular class, 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. A is a member of partnership LTP, which has made an
election under section 754. The three partners in LTP have equal
interests in capital and profits. Solely in exchange for a
partnership interest in UTP, 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 partnership interest ($5,000) equals its
share of inside basis (also $5,000). Under section 723, UTP's basis
in its interest in LTP is $5,000. LTP's only two assets on the date
of contribution are inventory with a basis of $5,000 and a fair
market value of $7,500, and a nondepreciable.68 capital asset with a
basis of $10,000 and a fair market value of $7,500. The amount of
the basis adjustment under section 743(b) to partnership property is
$0 ($5,000, UTP's basis in its interest in LTP, minus $5,000, UTP's
share of LTP's basis in partnership assets). Because UTP acquired
its interest in LTP in a transferred basis exchange, and the total
amount of the basis adjustment under section 743(b) is zero, UTP
receives no special basis adjustments under section 743(b) with
respect to the partnership property of LTP.

Example 2. (i) A purchases a partnership interest in LTP at a time
when an election under section 754 is not in effect. The three
partners in LTP have equal interests in capital and profits. During
a later year for which LTP has an election under section 754 in
effect, and in a transaction that is unrelated to A's purchase of
the LTP interest, A contributes its interest in LTP to UTP in a
transaction described in section 721 (solely in exchange for a
partnership interest in UTP). At the time of the transfer, A's
adjusted basis in its interest in LTP is $20,433.

Under section 721, A recognizes no gain or loss as a result of the
contribution of its partnership interest to UTP. Under section 723,
UTP's basis in its partnership interest in LTP is $20,433. The
balance sheet of LTP on the date of the contribution shows the
following:

Assets
                                          Fair
                                Adjusted  Market
                                Basis     Value
Cash .......................... $5,000    $5,000
Accounts receivable ........... 10,000    10,000
Inventory ..................... 20,000    21,000
Nondepreciable capital asset... 20,000    40,000
Total ........................ $55,000    $76,000

Liabilities and Capital
                                          Fair
                                Adjusted  Market
                                Per Books Value
Liabilities ................... $10,000   $10,000
Capital:
A .............................  15,000    22,000
B .............................  15,000    22,000
C .............................  15,000    22,000
Total .......................   $55,000   $76,000

(ii) The amount of the basis adjustment under section 743(b) is the
difference between the basis of UTP's interest in LTP and UTP's
share of the adjusted basis to LTP of partnership property.

UTP's interest in the previously taxed capital of LTP is $15,000
($22,000, the amount of cash UTP would receive if LTP liquidated
immediately after the hypothetical transaction, decreased by $7,000,
the amount of tax gain allocated to UTP from the hypothetical
transaction). UTP's share of the adjusted basis to LTP of
partnership property is $18,333 ($15,000 share of previously taxed
capital, plus $3,333 share of LTP's liabilities). The amount of the
basis adjustment under section 743(b) to partnership property
therefore, is $2,100 ($20,433 minus $18,333).

(iii) The total amount of gain that would be allocated to UTP from
the hypothetical sale of capital gain property is $6,666.67 (one-
third of the excess of the fair market value of LTP's nondepreciable
capital asset, $40,000, over its basis, $20,000). The total amount
of gain that would be allocated to UTP from the hypothetical sale of
ordinary income property is $333.33 (one-third of the excess of the
fair market value of LTP's inventory, $21,000, over its basis,
$20,000). Under paragraph (b)(5), LTP must allocate $2,000
($6,666.67 divided by $7,000 times $2,100) of UTP's basis adjustment
to the nondepreciable capital asset. LTP must allocate $100 ($333.33
divided by $7,000 times $2,100) of UTP's basis adjustment to the
inventory.

(c) Adjustments under section 734(b)--(1) Allocations between
classes of property--(i) General rule. Where there is a distribution
of partnership property resulting in an adjustment to the basis of
undistributed partnership property under section 734(b)(1)(B) or (b)
(2)(B), the adjustment must be allocated to remaining partnership
property of a character similar to that of the distributed property
with respect to which the adjustment arose. Thus, when the
partnership's adjusted basis of distributed capital gain property
immediately prior to distribution exceeds the basis of the property
to the distributee partner (as determined under section 732), the
basis of the undistributed capital gain property remaining in the
partnership is increased by an amount equal to the excess.
Conversely, when the basis to the distributee partner (as determined
under section 732) of distributed capital gain property exceeds the
partnership's adjusted basis of such property immediately prior to
the distribution, the basis of the undistributed capital gain
property remaining in the partnership is decreased by an amount
equal to such excess. Similarly, where there is a distribution of
ordinary income property, and the basis of the property to the
distributee partner (as determined under section 732) is not the
same as the partnership's adjusted basis of the property immediately
prior to distribution, the adjustment is made only to undistributed
property of the same class remaining in the partnership.

(ii) Special rule. Where there is a distribution resulting in an
adjustment under section 734(b)(1)(A) or (b)(2)(A) to the basis of
undistributed partnership property, the adjustment is allocated only
to capital gain property.

(2) Allocations within the classes--(i) Increases. If 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 their respective amounts of unrealized appreciation
before such increase (but only to the extent of each property's
unrealized appreciation). Any remaining increase must be allocated
among the properties within the class in proportion to their fair
market valU.S. (ii) Decreases. If 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 their
respective amounts of unrealized depreciation before such decrease
(but only to the extent of each property's unrealized depreciation).
Any remaining decrease must be allocated among the properties within
the class in proportion to their adjusted bases (as adjusted under
the preceding sentence).

(3) Limitation in decrease of basis. Where a decrease in the basis
of partnership assets is required under section 734(b)(2) and the
amount of the decrease exceeds the adjusted basis to the partnership
of property of the required character, the basis of such property is
reduced to zero (but not below zero).

(4) Carryover adjustment. Where, in the case of a distribution, an
increase or a decrease in the basis of undistributed property cannot
be made because the partnership owns no property of the character
required to be adjusted, or because the basis of all the property of
a like character has been reduced to zero, the adjustment is made
when the partnership subsequently acquires property of a like
character to which an adjustment can be made.

(5) Example. The following example illustrates this paragraph (c):

Example. (i) A, B, and C form equal partnership PRS. A contributes
$50,000 and Asset 1, capital gain property with a fair market value
of $50,000 and an adjusted tax basis of $25,000. B and C each
contributes $100,000. PRS uses the cash to purchase Assets 2, 3, 4,
5, and 6. Assets 4, 5, and 6 are the only assets held by the
partnership which are subject to section 751. The partnership has an
election in effect under section 754. After seven years, the
adjusted basis and fair market value of PRS's assets are as follows:

Assets
                                          Fair
                                Adjusted  Market
                                Basis     Value

Capital Gain Property:
Asset 1 . . . . . . . . . . .    $25,000   $75,000
Asset 2 . . . . . . . . . . .    100,000   117,500
Asset 3 . . . . . . . . . . .     50,000    60,000

Ordinary Income Property:
Asset 4 . . . . . . . . . . .    $40,000   $45,000
Asset 5 . . . . . . . . . . .     50,000    60,000
Asset 6 . . . . . . . . . . .     10,000     2,500
Total . . . . . . . .           $275,000  $360,000

(ii) Allocation between classes. Assume that PRS distributes Assets
3 and 5 to A in complete liquidation of A's interest in the
partnership. A's basis in the partnership interest was $75,000. The
partnership's basis in Assets 3 and 5 was $50,000 each. A's $75,000
basis in its partnership interest is allocated between Assets 3 and
5 under sections 732(b) and (c). A will, therefore, have a basis of
$25,000 in Asset 3 (capital gain property), and a basis of $50,000
in Asset 5 (section 751 property). The distribution results in a
$25,000 increase in the basis of capital gain property. There is no
change in the basis of ordinary income property.

(iii) Allocation within class. The amount of the basis increase to
capital gain property is $25,000 and must be allocated among the
remaining capital gain assets in proportion to the difference
between the fair market value and basis of each. The fair market
value of Asset 1 exceeds its basis by $50,000. The fair market value
of Asset 2 exceeds its basis by $17,500. Therefore, the basis of
Asset 1 will be increased by $18,519 ($25,000, multiplied by
$50,000, divided by $67,500), and the basis of Asset 2 will be
increased by $6,481 ($25,000 multiplied by $17,500, divided by
$67,500).

(d) Effective date. This section applies to transfers of partnership
interests and distributions of property from a partnership that
occur on or after December 15, 1999.

Par. 9. Section 1.1017-1 is amended by:

1. Revising paragraph (g)(2)(iv).

2. Adding paragraph (g)(2)(v).

The addition and revision read as follows:

§1.1017-1 Basis reductions following a discharge of indebtedness.

* * * * *

(g) * * *

(2) * * *

(iv) Partner's share of partnership basis--(A) In general.

For purposes of this paragraph (g), a partner's proportionate share
of the partnership's basis in depreciable property (or depreciable
real property) is equal to the sum of--

(1) The partner's section 743(b) basis adjustments to items of
partnership depreciable property (or depreciable real property); and

(2) The common basis depreciation deductions (but not including
remedial allocations of depreciation deductions under §1.704-3(d))
that, under the terms of the partnership agreement effective for the
taxable year in which the discharge of indebtedness occurs, are
reasonably expected to be allocated to the partner over the
property's remaining useful life. The assumptions made by a
partnership in determining the reasonably expected allocation of
depreciation deductions must be consistent for each partner. For
example, a partnership may not treat the same depreciation
deductions as being reasonably expected by more than one partner..74
(B) Effective date. This paragraph (g)(2)(iv) applies to elections
made under sections 108(b)(5) and 108(c) on or after December 15,
1999.

(v) Treatment of basis reduction--(A) Basis adjustment. The amount
of the reduction to the basis of depreciable partnership property
constitutes an adjustment to the basis of partnership property with
respect to the partner only. No adjustment is made to the common
basis of partnership property. Thus, for purposes of income,
deduction, gain, loss, and distribution, the partner will have a
special basis for those partnership properties the bases of which
are adjusted under section 1017 and this section.

(B) Recovery of adjustments to basis of partnership property.
Adjustments to the basis of partnership property under this section
are recovered in the manner described in §1.743-1.

(C) Effect of basis reduction. Adjustments to the basis of
partnership property under this section are treated in the same
manner and have the same effect as an adjustment to the basis of
partnership property under section 743(b). The following example
illustrates this paragraph (g)(2)(v):

Example. (i) A, B, and C are equal partners in partnership PRS,
which owns (among other things) Asset 1, an item of depreciable
property with a basis of $30,000. A's basis in its partnership
interest is $20,000. Under the terms of the partnership agreement,
A's share of the depreciation deductions from Asset 1 over its
remaining useful life will be $10,000.

Under section 1017, A requests, and PRS agrees, to decrease the
basis of Asset 1 with respect to A by $10,000.

(ii) In the year following the reduction of basis under section
1017, PRS amends its partnership agreement to provide that items of
depreciation and loss from Asset 1 will be allocated equally between
B and C. In that year, A's distributive share of the partnership's
common basis depreciation deductions from Asset 1 is now $0. Under
§1.743-1(j)(4)(ii)(B), the amount of the section 1017 basis
adjustment that A recovers during the year is $1,000. A will report
$1,000 of ordinary income because A's distributive share of the
partnership's common basis depreciation deductions from Asset 1 ($0)
is insufficient to offset the amount of the section 1017 basis
adjustment recovered by A during the year ($1,000).

(iii) In the following year, PRS sells Asset 1 for $15,000 and
recognizes a $12,000 loss. This loss is allocated equally between B
and C, and A's share of the loss is $0. Upon the sale of Asset 1, A
recovers its entire remaining section 1017 basis adjustment
($9,000). A will report $9,000 of ordinary income.

(D) Effective date. This paragraph (g)(2)(v) applies to elections
made under sections 108(b)(5) and 108(c) on or after December 15,
1999.

PART 602--OMB CONTROL NUMBERS UNDER THE Paperwork Reduction Act

Par. 10. The authority citation for part 602 continues to read as
follows:

Authority: 26 U.S.C. 7805.

Par. 11. In §602.101, paragraph (b) is amended by revising the
entries for 1.732-1 and 1.743-1 in the table to read as follows:

§602.101 OMB Control numbers.

* * * * *

(b) * * *.75A

CFR part or section where Current OMB identified and described
control No.

* * * * *

1.732-1..........................................1545-0099

1545-1588

* * * * *

1.743-1..........................................1545-0074

1545-1588

* * * * *

David A. Mader
Acting Deputy Commissioner of Internal Revenue
Approved November 29, 1999
Jonathan Talisman
Acting Assistant Secretary of the Treasury


SEARCH:

You can search the entire Tax Professionals section, or all of Uncle Fed's Tax*Board. For a more focused search, put your search word(s) in quotes.





1999 Regulations Main | IRS Regulations Main | Home