Coordination of Sections 755 & 1060 Relating to
Allocation of Basis Adjustments Among Partnership Assets

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-107872-99] RIN 1545-AXI8

TITLE: Coordination of Sections 755 and 1060 Relating to Allocation
of Basis Adjustments Among Partnership Assets

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations relating to the
allocation of basis adjustments among partnership assets under
section 755. The proposed regulations are necessary to implement
section 1060(d), which applies the residual method to certain
partnership transactions. This document also provides notice of a
public hearing on these proposed regulations.

DATES: Written comments must be received by July 4, 2000. Outlines
of topics to be discussed at the public hearing scheduled for July
12, 2000, must be received by June 21, 2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-107872-99), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday
through Friday between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG-107872-99), Courier's Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW., Washington, DC.
Alternatively, taxpayers may submit comments electronically via the
internet by selecting the "Tax Regs" option on the IRS Home Page, or
by submitting comments directly to the IRS internet site at
http://www.irs.ustreas.gov/tax_regs/reglist.html. The public hearing
will be held in room 2716, Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Matthew
Lay or Craig Gerson, (202) 622-3050; concerning submissions, the
hearing, and/or to be placed on the building access list to attend
the hearing, LaNita VanDyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

As part of the Tax Reform Act of 1986, Congress enacted section
1060, which generally requires the use of the residual method in
order to allocate the purchase price of "applicable asset
acquisitions" among individual assets purchased. An applicable asset
acquisition is defined as any transfer of assets that constitute a
trade or business where the transferee's basis is determined wholly
by reference to the consideration paid for the assets. Both direct
and indirect transfers of a business.3 were intended to be covered
by the provision, including "the sale of a partnership interest in
which the basis of the purchasing partner's proportionate share of
the partnership's assets is adjusted to reflect the purchase price."
See section 1060(c) and S. Rep. No. 99-313, 1986-3 C.B. Vol. 3 at
254-255.

In July of 1988, the IRS and the Treasury Department issued
temporary and proposed regulations, which, among other things,
provided guidance concerning the application of section 1060 and
coordinated the application of sections 755 and 1060. TD 8215
(1988-2 C.B. 305).

In 1988, shortly after the IRS and the Treasury Department issued
its temporary and proposed regulations, Congress enacted section
1060(d), which expressly addresses the extent to which section 1060
should apply to transactions involving partnerships. As amended in
1993, section 1060(d)(1) applies the section 1060 residual method in
the case of a distribution of partnership property or a transfer of
an interest in a partnership, but only in determining the value of
section 197 intangibles for purposes of applying section 755.
Section 1060(d)(2) provides that if section 755 applies, such
distribution or transfer (as the case may be) shall be treated as an
applicable asset acquisition for purposes of section 1060(b) (which
imposes certain reporting requirements for applicable asset
acquisitions).

Section 755 governs the allocation of certain adjustments to the
basis of partnership property among partnership assets. Section
1.755-2T applies the residual method to transfers and distributions
which trigger basis adjustments under section 743(b) (involving
certain transfers of partnership interests) or section 732(d)
(involving certain distributions within two years of a partnership
interest transfer) if the assets of the partnership constitute a
trade or business for purposes of section 1060(c). Section
1.755-2T(c) contains a cross reference to the reporting requirements
applicable to such transfers and distributions.

Explanation of Provisions

1. Application of Proposed Regulations

The temporary regulations under section 755 apply only if the assets
of the partnership comprise a trade or business within the meaning
of section 1060(c), and the basis adjustments are made under section
743(b) or section 732(d). They do not apply the residual method in
valuing partnership property for the purpose of allocating basis
adjustments under section 734(b). However, the temporary regulations
were issued prior to the enactment of section 1060(d)(1), which
expressly refers to basis adjustments triggered by partnership
distributions, and does not reference a trade or business
requirement.

The IRS and the Treasury Department anticipate that the regulations
under §1.755-2, when finalized, will apply to all transfers of
partnership interests and partnership distributions to which section
755 applies, and not just to transfers and distributions relating to
partnerships conducting a trade or business. This approach is
consistent with the language of section 1060(d) and is supported by
language contained in the legislative history. See H.R. Rep. No.
100-795, at 70 n.34 (1988) (the IRS is not precluded from applying
the residual method under other provisions of the Code).

Proposed §1.755-2(d) contains a cross reference to the reporting
requirements applicable to such transfers and distributions.

2. Basis Adjustments Under Section 743(b) or 732(d) In the case of a
basis adjustment under section 743(b) or section 732(d), the
proposed regulations determine the fair market value of partnership
assets in two steps. In most situations, it first is necessary to
determine partnership gross value. Second, partnership gross value
must be allocated among partnership property.

(a) Partnership gross value. In general, partnership gross value
equals the amount that, if assigned to all partnership property,
would result in a liquidating distribution to the.6 partner equal to
the transferee's basis in the transferred partnership interest
immediately following the relevant transfer (reduced by the amount,
if any, of such basis that is attributable to partnership
liabilities). Here, the amount paid for the partnership interest
provides the frame of reference for valuing the entire partnership.

In the case of basis adjustments which are triggered by an exchange
of a partnership interest 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 (transferred basis exchange), the
transferee's basis does not necessarily have any connection to the
value of partnership assets. Accordingly, a transferred basis
exchange provides no frame of reference for valuing partnership
assets. Furthermore, if the valuation rules which apply to other
transfers were applied to transferred basis exchanges, then partners
could use these exchanges to shift basis from capital gain assets to
ordinary income assets, or vice versa. The proposed regulations do
not provide a rule addressing transferred basis exchanges. Comments
are requested as to how the residual method should apply if basis
adjustments under section 743(b) are triggered by transferred basis
exchanges, or if basis adjustments under section 732(d) relate to
prior transferred basis exchanges.

(b) Allocating partnership gross value among partnership property.
Once determined, partnership gross value is allocated among five
classes of property, as follows: first among cash and general
deposit accounts (including savings and checking accounts) other
than certificates of deposit held in banks, savings and loan
associations, and other depository institutions (referred to
hereafter as cash); then among partnership assets other than cash,
capital assets, section 1231(b) property, and section 197
intangibles (referred to hereafter as ordinary income property);
then among capital assets and section 1231(b) property other than
section 197 intangibles; then among section 197 intangibles other
than goodwill and going concern value; and finally to goodwill and
going concern value (referred to hereafter as goodwill).

In determining the values to be assigned to assets in the third,
fourth, and fifth classes, properties or potential gain within these
classes that are treated as unrealized receivables under the flush
language in section 751(c) are not counted as assets in the second
class. To provide otherwise would be inconsistent with the residual
method, because the residual method is justified, at least in part,
by the fact that goodwill is not readily subject to valuation. Where
goodwill is subject to amortization under section 197, the portion
of the intangible that is subject to recapture under section 1245
will be treated as an unrealized receivable under the flush language
of section 751(c). To assign value to this portion of the asset in
the second class would require a determination that the goodwill has
a value equal to at least the amount of the recapture. If these
assets are not readily subject to valuation, this determination
presumably could not be made. Accordingly, in allocating value among
the five classes under the residual method, it is appropriate to
include properties or potential gain treated as unrealized
receivables under the flush language of section 751(c) within the
overall class to which the underlying property belongs rather than
treating the section 751(c) portion of such property as a separate
asset included in the second class.

Although properties or potential gain treated as unrealized
receivables under the flush language of section 751(c) are not
included in the second class of assets under these proposed
regulations for purposes of allocating value, they are treated as
separate assets that are ordinary income property for purposes of
allocating basis adjustments among such assets under §1.755-1. With
respect to allocating value within the asset classes, in general, if
the value assigned to a class is less than the sum of the fair
market values of the assets in that class (determined without regard
to the residual method), then the assigned value must be allocated
among the individual assets in proportion to their fair market
values. Although, as discussed above, it is not appropriate to treat
properties or potential gain treated as unrealized receivables under
the flush language of section 751(c) as separate ordinary income
assets, it is appropriate to allocate value within each class by
giving priority to the portions of the assets that will be taxed at
higher rates as ordinary income.

Such treatment better equates the basis adjustments of the
transferee with the higher taxed income recognized by the
transferor, thereby avoiding duplicative recognition of ordinary
income on subsequent transfers with respect to the same asset.
Accordingly, once values have been assigned generally to the third,
fourth, and fifth classes of assets, such values will be assigned
within each of these classes first to properties or potential gain
treated as unrealized receivables under the flush language in
section 751(c), if any, in proportion to the income that would be
recognized if the underlying assets were sold for their fair market
values (determined without regard to the residual method), but only
to the extent of the income attributable to the unrealized
receivables. Any remaining value in each class will be allocated
among the remaining portions of the assets in that class in
proportion to the fair market values of such portions (determined
without regard to the residual method).

In general, the value assigned to an asset (other than goodwill)
cannot exceed the fair market value (determined without regard to
the residual method) of that asset on the date of the relevant
transfer. Therefore, if partnership gross value exceeds the
aggregate value of the partnership's individual assets, the excess
must be allocated entirely to the value of goodwill. However, an
exception is provided if partnership gross value exceeds the
aggregate value of the partnership's individual assets, and goodwill
could not under any circumstances attach to the assets. Under this
exception, the excess partnership gross value must be allocated
among all partnership assets other than cash in proportion to their
fair market values (determined without regard to the residual
method).

(c) Special situations. In general, partnership gross value may be
determined without reference to the value of individual partnership
assets. In calculating partnership gross value, it is only necessary
to determine the relevant partner's share of book value in
partnership assets and how much book gain or loss must be recognized
by the partnership on the disposition of all such assets to cause
the partner to receive the appropriate liquidating distribution. The
manner in which the book gain or loss is allocated among the
partnership's assets generally will not affect the amount of the
liquidating distribution to the partner.

In certain circumstances, however, such as where book income or loss
with respect to particular partnership properties is allocated
differently among partners, partnership gross value may vary
depending on the value of particular partnership assets. In these
situations, it is not possible to first determine the total value of
the partnership (i.e., partnership gross value) and then apply the
residual method to allocate that value to the partnership's
individual assets. Instead, it is necessary first to determine the
fair market value of the partnership's individual assets (determined
taking into account all relevant facts and circumstances), and then
to assign such value among the asset tiers described in the residual
method such that the combined value of all partnership assets would
cause the appropriate distribution to the relevant partner. The
proposed regulations include a rule to address these special
situations. In addition, under this rule, if the value determined
for assets in the first four asset classes is not sufficient to
cause the appropriate liquidating distribution, then, so long as
goodwill could attach to the assets of the partnership, the value of
goodwill is presumed to be an amount that, if assigned to such
property, would cause the appropriate liquidating distribution.

3. Basis Adjustments Under Section 734(b)

The proposed regulations do not provide a rule for valuing
partnership assets in the case of distributions that result in a
basis adjustment under section 734(b). The IRS and the Treasury
Department have considered several alternative approaches, described
below. Two of these approaches utilize a method similar to the one
provided for basis adjustments under sections 743(b) and 732(d);
that is, first determine partnership gross value and then allocate
such amount among the partnership property applying the residual
method. The third approach does not rely on the concept of
partnership gross value. The IRS and the Treasury Department request
comments as to which, if any, of these approaches should be utilized
in applying the residual method in the context of basis adjustments
under section 734(b). In addition, comments are requested concerning
whether the second or third approach should be adopted in the
context of basis adjustments under sections 743(b) and 732(d)
involving transferred basis transactions.

Under the first approach, in the case of a distribution which
results in a basis adjustment under section 734(b) and which causes
the distributee partner's interest in the partnership to decrease,
partnership gross value would be deemed to equal the amount that, if
assigned to all partnership property, would result in a liquidating
distribution to the partner (attributable to the reduction in
interest) equal to the value of the consideration received by the
distributee partner in the distribution. Under this approach, the
amount distributed in exchange for the relinquished interest would
provide the frame of reference for valuing the entire partnership.
The reduction in a partner's interest could be measured as the
difference between the partner's interest in the partnership
immediately before the distribution and the partner's interest in
the partnership immediately after the distribution. However, the IRS
and the Treasury Department recognize that measuring the reduction
in a partner's interest in the partnership in connection with a
distribution can be difficult in some situations (for example,
situations in which partners do not share profits or other items in
proportion to their relative capital account balances). Moreover, in
the case of a distribution that results in a basis adjustment under
section 734(b) and does not reduce the distributee partner's
interest in the partnership (such as in a pro rata distribution of
cash), the transaction provides no frame of reference to value the
partnership.

A second approach would be to determine partnership gross value as
the value of the entire partnership as a going concern, and to apply
the residual method by reference to that overall value. This method
has the disadvantage of divorcing the valuation of partnership
property from the transaction that gives rise to the adjustment.
However, there would be no need to measure the reduction in the
distributee partner's interest or even to have a reduction in the
distributee partner's interest to apply this method. The method
would work equally well for distributions where the partner's
interest in the partnership is reduced and for distributions where
it is not.

Under a third possible approach, the concept of partnership gross
value would be disregarded, and, instead, value would be allocated
to goodwill for section 755 purposes only if the amount of a
positive basis adjustment under section 734(b) exceeds the
appreciation in all assets of the character required to be adjusted
which are not goodwill. This approach avoids the problems relating
to the measurement or presence of a reduction in the distributee
partner's interest and has the added benefit of avoiding a valuation
of the partnership's overall operations.

In contrast with the second approach, however, the value that is
assigned to goodwill under this approach would not necessarily bear
any relation to the actual value of goodwill in the hands of the
partnership. In addition, this rule arguably would be inconsistent
with the rule in §1.755-1(c), which requires that positive basis
adjustments must be allocated to undistributed property of like
character to the distributed property (or capital gain property in
the case of adjustments attributable to gain recognized by the
distributee partner) first in proportion to unrealized appreciation
with respect to such property and then in proportion to fair market
value. Under the third approach, a basis adjustment under section
734(b) to the class of assets composed of capital assets and
property described in section 1231(b) could not exceed the
unrealized appreciation with respect to any such partnership
property other than goodwill.

Accordingly, a section 734(b) basis adjustment never would be made
in proportion to the fair market value of the property in the class
of capital assets and property described in section 1231(b).

4. Effect on §1.755-1

Section 1.755-1(b)(3)(ii)(B) of the Income Tax Regulations published
on December 15, 1999 (64 FR 69903) contains a rule allocating
discounts among capital assets following the transfer of a
partnership interest that results in a basis adjustment under
section 743(b). Because proposed §1.755-2 takes discounts and
premiums into account when assigning values to partnership property
for purposes of section 755 in such cases, the rule in §1.755-1(b)
(3)(ii)(B) would become unnecessary.

5. Possible Expansion of Regulations

With respect to transfers of partnership interests, the IRS and the
Treasury Department are considering applying the rules contained in
these proposed regulations not just for valuing partnership assets
for purposes of applying section 755, but also to determine the
value of assets for purposes of applying section 1(h)(6)(B)
(collectibles gain or loss) with respect to partnerships, section
1(h)(7) (section 1250 capital gain), and section 751(a) (ordinary
income treatment upon sale or exchange of an interest in a
partnership). Applying the rules in these proposed regulations in
connection with these provisions is consistent with the legislative
history to section 1060(d) and would provide greater uniformity with
respect to the amount and character of income recognized upon the
transfer of a partnership interest and the basis adjustments to
partnership assets to which the different income character is
attributable. However, this application of the rules could cause an
increase in complexity, particularly if a section 754 election is
not in effect for a year in which the transfer of a partnership
interest occurs (so that application of the residual method
otherwise would not be required). The IRS and the Treasury
Department request comments on whether partnerships should value
partnership assets using the residual method for purposes of
sections 1(h)(6)(B), 1(h)(7), and 751(a).

Proposed Effective Date

The regulations are proposed to be effective for any basis
adjustment resulting from any distribution of partnership property
or transfer of a partnership interest that occurs on or after the
date final regulations are published in the Federal Register.

Special Analyses

It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also
has been determined that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does not apply to these
regulations, and because the regulations do not impose a collection
of information on small entities, the Regulatory Flexibility Act (5
U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the
Internal Revenue Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small businesses.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed
original and eight (8) copies) that are timely submitted to the IRS.
The IRS and the Treasury Department request comments on the clarity
of the proposed rule and how it may be made easier to understand.
All comments will be available for public inspection and copying.

A public hearing has been scheduled for July 12, 2000, beginning at
10 a.m., in room 2716 of the Internal Revenue Building. Due to
building security procedures, visitors must enter at the 10th Street
entrance, located between Constitution and Pennsylvania Avenues, NW.
In addition, all visitors must present photo identification to enter
the building. Because of access restrictions, visitors will not be
admitted beyond the immediate entrance area more than 15 minutes
before the hearing starts. For information about having your name
placed on the building access list to attend the hearing, see the
"FOR FURTHER INFORMATION CONTACT" section of the preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons that
wish to present oral comments at the hearing must submit written
comments and an outline of the topics to be discussed and the time
to be devoted to each topic (signed original and eight (8) copies)
by June 21, 2000.

A period of 10 minutes will be allotted to each person for making
comments.

An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.

Drafting Information

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

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements. Proposed
Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

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

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

Section 1.755-2 also issued under 26 U.S.C. 755 and 26 U.S.C. 1060.
***

Par. 2. Section 1.755-2 is added to read as follows:

§1.755-2 Coordination of sections 755 and 1060.

(a) Coordination with section 1060--(1) In general. If there is a
basis adjustment to which this section applies, the partnership must
determine the fair market value of each item of partnership property
under the residual method, as described in paragraph (b) of this
section, and the rules of §1.755-1 must be applied using the values
so determined.

(2) Application of this section. This section applies to any basis
adjustment made under section 743(b) (relating to certain transfers
of interests in a partnership) or section 732(d) or section 734(b)
(relating to certain partnership distributions).

(b) Residual method--(1) In general--(i) Five classes.

(A) Except as provided in paragraph (b)(3) of this section,
partnership gross value (as defined in paragraph (c) of this
section) is allocated among five asset classes in the following
order--

(1) Among cash and general deposit accounts (including savings and
checking accounts) other than certificates of deposit held in banks,
savings and loan associations, and other depository institutions
(referred to hereafter as cash);

(2) Among partnership assets other than cash, capital assets,
section 1231(b) property, and section 197 intangibles (referred to
hereafter as ordinary income property);

(3) Among capital assets and section 1231(b) property other than
section 197 intangibles;

(4) Among section 197 intangibles other than goodwill and going
concern value; and

(5) To goodwill and going concern value (referred to hereafter as
goodwill).

(B) In determining the values to be assigned to each class,
properties or potential gain treated as unrealized receivables under
the flush language in section 751(c) are not counted as assets in
the second class. For example, any portion of goodwill that would
result in ordinary income under section 1245 if the goodwill were
sold would be included in the residual class for goodwill.

(ii) Impaired classes. If the value assigned to a class is less than
the sum of the fair market values (determined under paragraph (b)(2)
(i) of this section) of the assets in that class, then the assigned
value generally must be allocated among the individual assets in
proportion to such fair market values. However, in the third,
fourth, and fifth classes, values must be assigned first to
properties or potential gain treated as unrealized receivables under
the flush language in section 751(c), if any, in proportion to the
income that would be recognized if the underlying assets were sold
for their fair market values (determined under paragraph (b)(2)(i)
of this section), but only to the extent of the income attributable
to the unrealized receivables. Any remaining value in each class
will be allocated among the remaining portions of the assets in that
class in proportion to the fair market values of such portions
(determined under paragraph (b)(2)(i) of this section). (2) Special
rules. For purposes of this section:

(i) Except as otherwise provided in this section, the fair market
value of each item of partnership property (other than goodwill)
shall be determined on the basis of all the facts and circumstances,
taking into account section 7701(g).

(ii) If goodwill could not under any circumstances attach to the
assets of a partnership, then the value of goodwill is zero. This
might occur, for example, if a partnership's only asset is a vacant
parcel of real estate that does not produce current income.

(iii) (A) The value assigned to an asset (other than goodwill) shall
not exceed the fair market value (determined under paragraph (b)(2)
(i)) of that asset on the date of the relevant transfer, unless--

(1) Partnership gross value (as defined in paragraph (c) of this
section) exceeds the aggregate value of the partnership's individual
assets; and

(2) Goodwill could not under any circumstances attach to the assets.

(B) If both of these conditions are satisfied, the excess must be
allocated among all partnership assets other than cash in proportion
to such fair market values.

(3) Special situations. In certain circumstances, such as where book
income or loss with respect to particular partnership properties is
allocated differently among partners, partnership gross value may
vary depending on the value of particular partnership assets. In
these special situations, the fair market value of each item of
partnership property (other than goodwill) first shall be determined
on the basis of all the facts and circumstances, taking into account
section 7701(g). Such value then shall be assigned within the first
four asset classes under the residual method described in paragraph
(b)(1) of this section in a manner that is consistent with the
ordering rule used in paragraph (b)(1) of this section (together
with the special rules in paragraph (b)(2) of this section) so that
the amount of the liquidating distribution described in paragraph
(c)(1) of this section would equal the transferee's basis in the
transferred partnership interest. If the value so determined for the
assets in the first four asset classes is not sufficient to cause
the appropriate liquidating distribution, then, so long as goodwill
may attach to the assets of the partnership, the fair market value
of goodwill shall be presumed to equal an amount that if assigned to
goodwill would cause the appropriate liquidating distribution.

(c) Partnership gross value--(1) Basis adjustments under section
743(b) and section 732(d)--(i) In general. In the case of a basis
adjustment under section 743(b) or 732(d), partnership gross value
generally is equal to the amount that, if assigned to all
partnership property, would result in a liquidating distribution to
the partner equal to the transferee's basis in the transferred
partnership interest immediately following the relevant transfer
(reduced by the amount, if any, of such basis that is attributable
to partnership liabilities) pursuant to the hypothetical transaction
(as defined in paragraph (c)(3) of this section). Solely for the
purpose of determining partnership gross value under the preceding
sentence, where a partnership interest is transferred as a result of
the death of a partner, the transferee's basis in its partnership
interest is determined without regard to section 1014(c), and is
deemed to be adjusted for that portion of the interest, if any,
which is attributable to items representing income in respect of a
decedent under section 691.

(ii) Transferred basis transactions. [Reserved]

(2) Basis adjustments under section 734(b). [Reserved]

(3) Hypothetical transaction. For purposes of this paragraph (c),
the hypothetical transaction means the disposition by the
partnership of all partnership property in a fully taxable
transaction for cash, followed by the payment of all partnership
liabilities (within the meaning of section 752 and the regulations
thereunder), and the distribution of all remaining proceeds to the
partners.

(d) Required statements. See §1.743-1(k)(2) for provisions requiring
the transferee of a partnership interest to provide information to
the partnership relating to the transfer of an interest in the
partnership. See §1.743-1(k)(1) for a provision requiring the
partnership to attach a statement to the partnership return showing
the computation of a basis adjustment under section 743(b) and the
partnership properties to which the adjustment is allocated under
section 755. See §1.732-1(d)(3) for a provision requiring a
transferee partner to attach a statement to its return showing the
computation of a basis adjustment under section 732(d) and the
partnership properties to which the adjustment is allocated under
section 755. See §1.732-1(d)(5) for a provision requiring the
partnership to provide information to a transferee partner reporting
a basis adjustment under section 732(d).

(e) Examples. The provisions of this section are illustrated by the
following examples, which assume that the partnerships have an
election in effect under section 754 at the time of the transfer.
Except as provided, no partnership asset (other than inventory) is
property described in section 751(a). The examples are as follows:

Example 1. (i) A is the sole general partner in ABC, a limited
partnership. ABC has goodwill and three other assets with fair
market values (determined under paragraph (b)(2)(i) of this section)
as follows: inventory worth $1,000,000, a building (a capital asset)
worth $2,000,000, and section 197 intangibles (other than goodwill)
worth $800,000. ABC has one liability of $1,000,000, for which A
bears the entire risk of loss under section 752 and the regulations
thereunder. Each partner has a one-third interest in partnership
capital and profits. D purchases A's partnership interest for
$1,000,000.

(ii) D's basis in the transferred partnership interest (reduced by
the amount of such basis that is attributable to partnership
liabilities) is $1,000,000 ($2,000,000 - $1,000,000). Under
paragraph (c) of this section, partnership gross value is $4,000,000
(the amount that, if assigned to all partnership property, would
result in a liquidating distribution to D equal to $1,000,000).

(iii) Under paragraph (b) of this section, partnership gross value
is allocated first to the inventory ($1,000,000), then to the
building ($2,000,000), and third to section 197 intangibles
$800,000. The partnership must allocate the remainder of partnership
gross value, $200,000, to goodwill ($4,000,000 -$ 3,800,000). D's
section 743(b) adjustment must be allocated under §1.755-1 using
these fair market value calculations for the partnership's assets.

Example 2. (i) D is the sole general partner in DEF, a.27 limited
partnership. DEF has goodwill and three other assets with fair
market values (determined under paragraph (b)(2)(i) of this section)
as follows: inventory worth $1,000,000, a building (a capital asset)
worth $2,000,000, and equipment (section 1231(b) property) worth
$750,000. DEF has one liability of $1,000,000, for which D bears the
entire risk of loss under section 752 and the regulations
thereunder. Each partner has a one-third interest in partnership
capital and profits. If the equipment were sold for $750,000,
$250,000 would be depreciation recapture treated as an unrealized
receivable under the flush language in section 751(c). G purchases
E's limited partnership interest for $750,000.

(ii) Under paragraph (c) of this section, partnership gross value is
$3,250,000 (the amount that, if assigned to all partnership
property, would result in a liquidating distribution to G equal to
$750,000).

(iii) Under paragraph (b) of this section, partnership gross value
is allocated first to inventory ($1,000,000), and then to the class
containing capital assets and section 1231(b) property ($2,250,000).
Within that class, value must be assigned first to the $250,000
ordinary gain portion of the equipment (properties or potential gain
treated as unrealized receivables under the flush language in
section 751(c)). The remaining value in the class ($2,250,000 minus
$250,000, which is $2,000,000) must be allocated among the remaining
portions of the assets in that class in proportion to the fair
market values of such portions (determined under paragraph (b)(2)(i)
of this section). The remaining portion of the building is
$2,000,000. The remaining portion of the equipment is $500,000
($750,000, its fair market value, minus $250,000, the section 751(c)
portion). Thus, the remaining portion of the building will be
allocated $1,600,000 ($2,000,000 multiplied by
$2,000,000/$2,500,000) and the remaining portion of the equipment
will be allocated $400,000 ($2,000,000 multiplied by
$500,000/$2,500,000). Nothing is allocated to goodwill. G's section
743(b) adjustment must be allocated under §1.755-1 using these fair
market value calculations for the partnership's assets.

Example 3. (i) G and H are partners in partnership GH. GH has
goodwill and three other assets with fair market values (determined
under paragraph (b)(2)(i) of this section) as follows: inventory
worth $1,000,000 and two buildings (capital assets), each worth
$500,000. GH has no liabilities. The GH partnership agreement
provides that the partners will allocate all income, gain, loss, and
deductions equally, except with respect to depreciation, loss, and
gain from the buildings. With respect to the buildings, depreciation
and loss are allocated two-thirds to G and one-third to H. Gain from
the disposition of the buildings is charged back two-thirds to G and
one-third to H to the extent of accrued depreciation, and then is
allocated equally between G and H. G transfers one-half of its
interest in GH to I for $450,000. At the time of the transfer, the
book value of the inventory is $900,000, the book value of each
building is $300,000, and $150,000 of book depreciation has accrued
with respect to each building. The capital account attributable to
the partnership interest purchased by I from G is equal to $350,000.
H's capital account is equal to $800,000, and the capital account
attributable to G's retained partnership interest is equal to
$350,000.

(ii) Because gain with respect to the inventory and buildings are
shared in different ratios as between H, and G and I, a partnership
gross value cannot be determined without assuming values for the
individual assets of the partnership. Accordingly, the rule for
special situations in paragraph (b)(3) of this section must be used
to compute the value of the partnership's assets.

(iii) Applying paragraph (b)(2)(i) of this section, the fair market
value of the inventory is $1,000,000 and the fair market value of
each building is $500,000. These values would result in a
liquidating distribution to I under paragraph (c)(1) of this section
equal to $500,000, determined as follows. The book gain from the
sale of the inventory would equal $100,000 ($1,000,000 -$ 900,000)
and the book gain from the sale of each building would equal
$200,000 ($500,000 - $300,000). Book gain from the inventory equal
to $25,000 ($100,000 x 1/4) and book gain from each building equal
to $62,500 (($150,000 x 1/3) + ($50,000 x 1/4)) would be allocated
to I. The sum of this book gain ($25,000 + $62,500 + $62,500 =
$150,000) and I's capital account inherited from G ($350,000) would
equal $500,000.

(iv) Because I's basis in the transferred partnership interest is
only $450,000, under paragraph (b)(2)(ii) of this section, the value
with respect to the buildings must be reduced in proportion to the
fair market values of such assets to an amount that would cause a
liquidating distribution to I equal to $450,000. This calculation is
accomplished as follows. In order for I to receive a liquidating
distribution of $450,000, the book gain attributable to the
buildings that is allocated to I must equal $75,000 ($350,000
inherited capital account + $25,000 book gain from inventory +
$75,000 book gain from buildings). Each building has the same book
value and fair market value, and the allocations with respect to
each building are the same as between G, H, and I. Accordingly, I's
share of book gain should be allocated equally between the two
buildings, $37,500 to each. In order for I to be allocated $37,500
of book gain with respect to each building, the total amount of book
gain with respect to each building would have to be $112,500
($112,500 x 1/3 = $37,500). Adding this book gain to the current
book value of each building results in a value for each building of
$412,500 ($300,000 + $112,500). Nothing is allocated to goodwill.
I's section 743(b) adjustment must be allocated under §1.755-1 using
these fair market value calculations for the partnership's assets.

Example 4. The facts are the same as Example 3, except that I
purchases one-half of G's partnership interest for $550,000. Because
the fair market value of the partnership's assets (as determined
under paragraph (b)(2)(i) of this section) in the first four asset
classes under the residual method is not sufficient to cause a
liquidating distribution to I equal to its basis in the purchased
interest (i.e., $550,000), the additional value necessary to cause
such a distribution must be allocated to goodwill. Accordingly,
under paragraph (b)(3) of this section, the value of the
partnership's assets is as follows: inventory $1,000,000, each
building $500,000, and goodwill $200,000. I's section 743(b)
adjustment must be allocated under §1.755-1 using these fair market
value calculations for the partnership's assets..(f) Effective date.
This section applies to any basis adjustment resulting from any
distribution of partnership property or transfer of a partnership
interest that occurs on or after the date final regulations are
published in the Federal Register.

§1.755-2T [Removed]

Par. 3. Section 1.755-2T is removed.
Robert E. Wenzel
Deputy Commissioner of Internal Revenue

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