Partnership Mergers & Divisions

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-111119-99] RIN 1545-AX32

TITLE: Partnership Mergers and Divisions

AGENCY: Internal Revenue Service (IRS), Treasury.

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

SUMMARY: This document contains proposed regulations on the tax
consequences of partnership mergers and divisions. The proposed
regulations affect partnerships and their partners. This document
also contains a notice of public hearing on these proposed
regulations.

DATES: Written comments must be received by April 10, 2000. Requests
to speak (with outlines of oral comments) at the public hearing
scheduled for May 4, 2000, must be submitted by April 13, 2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-111119-99), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. In the alternative, 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-111119-99), 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 of the IRS Home Page, or
by submitting comments directly to the IRS Internet site at:

http://www.irs.ustreas.gov/tax_regs/regslist.html. The public
hearing will be held in room 2615, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Dan
Carmody, (202) 622-3080; concerning submissions of comments, 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: This document proposes to amend sections
708, 743, and 752 of the Income Tax Regulations (26 CFR part 1)
regarding partnership mergers and divisions.

Partnership Mergers

Background

Section 708(b)(2)(A) provides that in the case of a merger or
consolidation of two or more partnerships, the resulting partnership
is, for purposes of section 708, considered the continuation of any
merging or consolidating partnership whose members own an interest
of more than 50 percent in the capital and profits of the resulting
partnership. Section 1.708-1(b)(2)(i) of the Income Tax Regulations
provides that if the resulting partnership can be considered a
continuation of more than one of the merging partnerships, the
resulting partnership is the continuation of the partnership that is
credited with the contribution of the greatest dollar value of
assets to the resulting partnership. If none of the members of the
merging partnerships own more than a 50 percent interest in the
capital and profits of the resulting partnership, all of the merged
partnerships are considered terminated, and a new partnership
results. The taxable years of the merging partnerships that are
considered terminated are closed under section 706(c).

Although section 708 and the applicable regulations provide which
partnership continues when two or more partnerships merge, the
statute and regulations do not prescribe a form for the partnership
merger. (Often, state merger statutes do not provide a particular
form for a partnership merger.) In revenue rulings, however, the IRS
has prescribed the form of a partnership merger for Federal income
tax purposes.

In Rev. Rul. 68-289 (1968-1 C.B. 314), three existing partnerships
(P1, P2, and P3) merged into one partnership with P3 continuing
under section 708(b)(2)(A). The revenue ruling holds that P1 and P2,
the two terminating partnerships, are treated as having contributed
all of their respective assets and liabilities to P3, the resulting
partnership, in exchange for a partnership interest in P3. P1 and P2
are considered terminated and the partners of P1 and P2 receive
interests in P3 with a basis under section 732(b) in liquidation of
P1 and P2 (Assets-Over Form). Rev. Rul. 77-458 (1977-2 C.B. 220),
and Rev. Rul. 90-17 (1990-1 C.B. 119), also follow the Assets-Over
Form for a partnership merger.

Explanation of Provisions

A. Form of a Partnership Merger

The IRS and Treasury are aware that taxpayers may accomplish a
partnership merger by undertaking transactions in accordance with
jurisdictional laws that follow a form other than the Assets-Over
Form. For example, the terminating partnership could liquidate by
distributing its assets and liabilities to its partners who then
contribute the assets and liabilities to the resulting partnership
(Assets-Up Form). In addition, the partners in the terminating
partnership could transfer their terminating partnership interests
to the resulting partnership in exchange for resulting partnership
interests, and the terminating partnership could liquidate into the
resulting partnership (Interest-Over Form).

In the partnership incorporation area, a taxpayer's form generally
is respected if the taxpayer actually undertakes, under the relevant
jurisdictional law, all the steps of a form that is set forth in one
of three situations provided in Rev. Rul. 84-111 (1984-2 C.B. 88).
The three situations that Rev. Rul. 84-111 sets forth are the
Assets-Over Form, Assets-Up Form, and Interest-Over Form. Rev. Rul.
84-111 explains that, depending on the form chosen to incorporate
the partnership, the adjusted basis and holding periods of the
various assets received by the corporation and the adjusted basis
and holding periods of the stock received by the former partners can
vary. Like partnership incorporations, each form of a partnership
merger has potentially different tax consequences.

Under the Assets-Up Form, partners could recognize gain under
sections 704(c)(1)(B) and 737 (and incur state or local transfer
taxes) when the terminating partnership distributes the assets to
the partners. However, under the Assets-Over Form, gain under
sections 704(c)(1)(B) and 737 is not triggered. See §§1.704-4(c)(4)
and 1.737-2(b). Additionally, under the Assets-Up Form, because the
adjusted basis of the assets contributed to the resulting
partnership is determined first by reference to section 732 (as a
result of the liquidation) and then section 723 (by virtue of the
contribution), in certain circumstances, the adjusted basis of the
assets contributed may not be the same as the adjusted basis of the
assets in the terminating partnership. These circumstances occur if
the partners' aggregate adjusted basis of their interests in the
terminating partnership does not equal the terminating partnership's
adjusted basis in its assets. Under the Assets-Over Form, because
the resulting partnership's adjusted basis in the assets it receives
is determined solely under section 723, the adjusted basis of the
assets in the resulting partnership is the same as the adjusted
basis of the assets in the terminating partnership.

The regulations propose to respect the form of a partnership merger
for Federal income tax purposes if the partnerships undertake,
pursuant to the laws of the applicable jurisdiction, the steps of
either the Assets-Over Form or the Assets-Up Form. (This rule
applies even if none of the merged partnerships are treated as
continuing for Federal income tax purposes.) Generally, when
partnerships merge, the assets move from one partnership to another
at the entity level, or in other words, like the Assets-Over Form.
However, if as part of the merger, the partnership titles the assets
in the partners' names, the proposed regulations treat the
transaction under the Assets-Up Form. If partnerships use the
Interest-Over Form to accomplish the result of a merger, the
partnerships will be treated as following the Assets-Over Form for
Federal income tax purposes. In the context of partnership
incorporations, Rev. Rul. 84-111 distinguishes among all three forms
of incorporation.

However, with respect to the Interest-Over Form, the revenue ruling
respects only the transferors' conveyances of partnership interests,
while treating the receipt of the partnership interests by the
transferee corporation as the receipt of the partnership's assets
(i.e., the Assets-Up Form). The theory for this result, based
largely on McCauslen v. Commissioner, 45 T.C. 588 (1966), is that
the transferee corporation can only receive assets since it is not
possible, as a sole member, for it to receive and hold interests in
a partnership (i.e., a partnership cannot have only one member; so,
the entity is never a partnership in the hands of the transferee
corporation).

Adherence to the approach followed in Rev. Rul. 84-111 creates
problems in the context of partnership mergers that are not present
with respect to partnership incorporations. Unlike the corporate
rules, the partnership rules impose certain tax results on partners
based upon a concept that matches a contributed asset to the partner
that contributed the asset.

Sections 704(c) and 737 are examples of such rules. The operation of
these rules breaks down if the partner is treated as contributing an
asset that is different from the asset that the partnership is
treated as receiving.

Given that the hybrid treatment of the Interest-Over Form
transactions utilized in Rev. Rul. 84-111 is difficult to apply in
the context of partnership mergers, another characterization will be
applied to such transactions. The Assets-Over Form generally will be
preferable for both the IRS and taxpayers. For example, when
partnerships merge under the Assets-Over Form, gain under sections
704(c)(1)(B) and 737 is not triggered. Moreover, the basis of the
assets in the resulting partnership is the same as the basis of the
assets in the terminating partnership, even if the partners'
aggregate adjusted basis of their interests in the terminating
partnership does not equal the terminating partnership's adjusted
basis in its assets.

If partnerships merge under applicable law without implementing a
form, the proposed regulations treat the partnerships as following
the Assets-Over Form. This approach is consistent with the treatment
of partnership to corporation elective conversions under the check-
the-box regulations and technical terminations under section 708(b)
(1)(B), other formless movements of a partnership's assets.

B. Adverse Tax Consequences of the Assets-Over Form The IRS and
Treasury are aware that certain adverse tax consequences may occur
for partnerships that merge in a transaction that will be taxed in
accordance with the Assets-Over Form. These proposed regulations
address some of the adverse tax consequences regarding section 752
liability shifts and buyouts of exiting partners.

1. Section 752 Revisions

If a highly leveraged partnership (the terminating partnership)
merges with another partnership (the resulting partnership), all of
the partners in the terminating partnership could recognize gain
because of section 752 liability shifts. Under the Assets-Over Form,
the terminating partnership becomes a momentary partner in the
resulting partnership when the terminating partnership contributes
its assets and liabilities to the resulting partnership in exchange
for interests in the resulting partnership. If the terminating
partnership (as a momentary partner in the resulting partnership) is
considered to receive a deemed distribution under section 752 (after
netting increases and decreases in liabilities under §1.752-1(f))
that exceeds the terminating partnership's adjusted basis of its
interests in the resulting partnership, the terminating partnership
would recognize gain under section 731. The terminating
partnership's gain then would be allocated to each partner in the
terminating partnership under section 704(b). In this situation, a
partner in the terminating partnership could recognize gain even
though the partner's adjusted basis in its resulting partnership
interest or its share of partnership liabilities in the resulting
partnership is large enough to avoid the recognition of gain,
provided that the decreases in liabilities in the terminating
partnership are netted against the increases in liabilities in the
resulting partnership.

The proposed regulations clarify that when two or more partnerships
merge under the Assets-Over Form, increases or decreases in
partnership liabilities associated with the merger are netted by the
partners in the terminating partnership and the resulting
partnership to determine the effect of the merger under section 752.
The IRS and Treasury consider it appropriate to treat the merger as
a single transaction for determining the net liability shifts under
section 752. Therefore, a partner in the terminating partnership
will recognize gain on the contribution under section 731 only if
the net section 752 deemed distribution exceeds that partner's
adjusted basis of its interest in the resulting partnership.

2. Buyout of a Partner

Another adverse tax consequence may occur when a partner in the
terminating partnership does not want to become a partner in the
resulting partnership and would like to receive money or property
instead of an interest in the resulting partnership. Under the
Assets-Over Form, the terminating partnership will not recognize
gain or loss under section 721 when it contributes its property to
the resulting partnership in exchange for interests in the resulting
partnership. However, if, in order to facilitate the buyout of the
exiting partner, the resulting partnership transfers money or other
consideration to the terminating partnership in addition to the
resulting partnership interests, the terminating partnership may be
treated as selling part of its property to the resulting partnership
under section 707(a)(2)(B). Any gain or loss recognized by the
terminating partnership generally would be allocated to all the
partners in the terminating partnership even though only the exiting
partner would receive the consideration.

The IRS and Treasury believe that, under certain circumstances, when
partnerships merge and one partner does not become a partner in the
resulting partnership, the receipt of cash or property by that
partner should be treated as a sale of that partner's interest in
the terminating partnership to the resulting partnership, not a
disguised sale of the terminating partnership's assets. Accordingly,
the proposed regulations provide that if the merger agreement (or
similar document) specifies that the resulting partnership is
purchasing the exiting partner's interest in the terminating
partnership and the amount paid for the interest, the transaction
will be treated as a sale of the exiting partner's interest to the
resulting partnership. This treatment will apply even if the
resulting partnership sends the consideration to the terminating
partnership on behalf of the exiting partner, so long as the
designated language is used in the relevant document.

In this situation, the exiting partner is treated as selling a
partnership interest in the terminating partnership to the resulting
partnership (and the resulting partnership is treated as purchasing
the partner's interest in the terminating partnership) immediately
prior to the merger. Immediately after the sale, the resulting
partnership becomes a momentary partner in the terminating
partnership. Consequently, the resulting partnership and ultimately
its partners (determined prior to the merger) inherit the exiting
partner's capital account in the terminating partnership and any
section 704(c) liability of the exiting partner. If the terminating
partnership has an election in effect under section 754 (or makes an
election under section 754), the resulting partnership will have a
special basis adjustment regarding the terminating partnership's
property under section 743. The proposed regulations provide that
the resulting partnership's basis adjustments under section 743 must
be ultimately allocated solely to the partners who were partners in
the resulting partnership immediately before the merger; the
adjustments do not affect the common basis of the resulting
partnership's assets.

C. Merger as Part of a Larger Transaction

The proposed regulations provide that if the merger is part of a
larger series of transactions, and the substance of the larger
series of transactions is inconsistent with following the form
prescribed for the merger, the form may not be respected, and the
larger series of transactions may be recast in accordance with their
substance. An example illustrating the application of this rule is
included in the proposed regulations.

D. Measurement of Dollar Value of Assets

As discussed above, the regulations currently provide that in a
merger of partnerships, if the resulting partnership can be
considered a continuation of more than one of the merging
partnerships, the resulting partnership is the continuation of the
partnership that is credited with the contribution of the greatest
dollar value of assets to the resulting partnership. Commentators
have questioned whether this rule refers to the gross or net value
of the assets of a partnership. The proposed regulations provide
that the value of assets of a partnership is determined net of the
partnership's liabilities.

E. Effective Date

The regulations are proposed to apply to mergers occurring on or
after the date final regulations are published in the Federal
Register.

Partnership Divisions

Background

Section 708(b)(2)(B) provides that, in the case of a division of a
partnership into two or more partnerships, the resulting
partnerships (other than any resulting partnership the members of
which had an interest of 50 percent or less in the capital and
profits of the prior partnership) are considered a continuation of
the prior partnership. Section 1.708-1(b)(2)(ii) provides that any
other resulting partnership is not considered a continuation of the
prior partnership but is considered a new partnership. If the
members of none of the resulting partnerships owned an interest of
more than 50 percent in the capital and profits of the prior
partnership, the prior partnership is terminated. Where members of a
partnership that has been divided do not become members of a
resulting partnership that is considered a continuation of the prior
partnership, such partner's interest is considered liquidated as of
the date of the division.

Section 708(b)(2)(B) and the applicable regulations do not prescribe
a particular form for the division involving continuing
partnerships. The IRS has not addressed in published guidance how
the assets and liabilities of the prior partnership move into the
resulting partnerships. Taxpayers generally have followed either the
Assets-Over Form or the Assets-Up Form for partnership divisions.

Under the Assets-Over Form, the prior partnership transfers certain
assets to a resulting partnership in exchange for interests in the
resulting partnership. The prior partnership then immediately
distributes the resulting partnership interests to partners who are
designated to receive interests in the resulting partnership.

Under the Assets-Up Form, the prior partnership distributes certain
assets to some or all of its partners who then contribute the assets
to a resulting partnership in exchange for interests in the
resulting partnership.

Explanation of Provisions

A. Form of a Partnership Division

As with partnership mergers, the IRS and Treasury recognize that
different tax consequences can arise depending on the form of the
partnership division. Because of the potential different tax results
that could occur depending on the form followed by the partnership,
the regulations propose to respect for Federal income tax purposes
the form of a partnership division accomplished under laws of the
applicable jurisdiction if the partnership undertakes the steps of
either the Assets-Over Form or the Assets-Up Form. Thus, the same
forms allowed for partnership mergers will be allowed for
partnership divisions. Generally, an entity cannot be classified as
a partnership if it has only one member. This universally has been
held to be the case in classifying transactions where interests in a
partnership are transferred to a single person, so that the
partnership goes out of existence. McCauslen v. Commissioner, 45
T.C. 588 (1966); Rev. Rul. 99-6, 1999-6 I.R.B. 6; Rev. Rul. 67-65,
1967-1 C.B. 168; Rev. Rul. 55-68, 1955-1 C.B. 372.

However, in at least one instance involving the contribution of
assets by an existing partnership to a newly-formed partnership,
regulations have provided that the momentary existence of the new
partnership will be respected for Federal income tax purposes. See
§1.708-1(b)(1)(iv). Pursuant to the proposed regulations, under the
Assets-Over Form of a partnership division, the prior partnership's
momentary ownership of all the interests in a resulting partnership
will not prevent the resulting partnership from being classified as
a partnership on formation.

The example in current §1.708-1(b)(2)(ii) indicates that when a
partnership is not considered a continuation of the prior
partnership under section 708(b)(2)(B) (partnership considered a new
partnership under current §1.708-1(b)(2)(ii)), the new partnership
is created under the Assets-Up Form. The regulations propose to
modify this result and provide examples illustrating that
partnerships can divide and create a new partnership under either
the Assets-Over Form or the Assets-Up Form.

Consistent with partnership mergers, if a partnership divides using
a form other than the two prescribed, it will be treated as
undertaking the Assets-Over Form.

These proposed regulations use four terms to describe the form of a
partnership division. Two of these terms, prior partnership and
resulting partnership, describe partnerships that exist under the
applicable jurisdictional law. The prior partnership is the
partnership that exists under the applicable jurisdictional law
before the division, and the resulting partnerships are the
partnerships that exist under the applicable jurisdictional law
after the division. The other two terms, divided partnership and
recipient partnership, are Federal tax concepts. A divided
partnership is a partnership that is treated, for Federal income tax
purposes, as transferring assets in connection with a division, and
a recipient partnership is a partnership that is treated, for
Federal income tax purposes, as receiving assets in connection with
a division. The divided partnership must be a continuation of the
prior partnership.

Although the divided partnership is considered one continuing
partnership for Federal income tax purposes, it may actually be two
different partnerships under the applicable jurisdictional law
(i.e., the prior partnership and a different resulting partnership
that is considered a continuation of the prior partnership for
Federal income tax purposes).

Finally, because in a formless division it generally will be unclear
which partnership should be treated, for Federal income tax
purposes, as transferring assets (i.e, the divided partnership) to
another partnership (i.e., the recipient partnership) where more
than one partnership is a continuation of the prior partnership, the
proposed regulations provide that the continuing resulting
partnership with the assets having the greatest fair market value
(net of liabilities) will be treated as the divided partnership.
This issue also is present where the partnership that, in form,
transfers assets is not a continuation of the prior partnership, but
more than one of the other resulting partnerships are continuations
of the prior partnership. The same rule applies to these situations.

B. Consequences under Sections 704(c)(1)(B) and 737 Gain under
sections 704(c)(1)(B) and 737 may be triggered when section 704(c)
property or substituted section 704(c) property is distributed to
certain partners. These rules often will be implicated in the
context of partnership divisions.

Where a division is accomplished in a transaction that is taxed in
accordance with the Assets-Over Form, the partnership interest in
the recipient partnership will be treated as a section 704(c) asset
to the extent that the interest is received by the divided
partnership in exchange for section 704(c) property. Section
1.704-4(d)(1). Accordingly, the distribution of the partnership
interests in the recipient partnership by the divided partnership
generally will trigger section 704(c)(1)(B) where the interests in
the recipient partnership are received by a partner of the divided
partnership other than the partner who contributed the section
704(c) property to the divided partnership. In addition, section 737
may be triggered if a partner who contributed section 704(c)
property to the divided partnership receives an interest in the
recipient partnership that is not attributable to the section 704(c)
property.

Where a division is accomplished under the Assets-Up Form, assets
are distributed directly to the partners who will hold interests in
the recipient partnership. The distribution could trigger section
704(c)(1)(B) or 737 depending on the identity of the distributed
asset and the distributee partner. The regulations under section 737
provide an exception for certain partnership divisions. Section 737
does not apply when a transferor partnership transfers all the
section 704(c) property contributed by a partner to a second
partnership in a section 721 exchange, followed by a distribution of
an interest in the transferee partnership in complete liquidation of
the interest of the partner that originally contributed the section
704(c) property to the transferor partnership. Section 1.737-2(b)
(2). This rule, however, may not apply to many partnership divisions
because the original contributing partner often remains a partner in
the divided partnership. No similar rule is provided under section
704(c)(1)(B).

In many instances, the application of sections 704(c)(1)(B) and 737
will be appropriate when a partnership divides under either the
Assets-Over Form or the Assets-Up Form. Consider the following
example: A, B, C, and D form a partnership. A contributes
appreciated property X ($0 basis and $200 value), B contributes
property Y ($200 basis and $200 value), and C and D each contribute
$200 cash. The partnership subsequently divides into two
partnerships using the Assets-Over Form, distributing interests in
the recipient partnership in accordance with each partner's pro rata
interest in the prior partnership. Property X remains in the prior
partnership, and property Y is contributed to the recipient
partnership. Under these facts, section 737 could be avoided if an
exception were created for the distribution of the recipient
partnership interests. If, subsequent to the division, half of
property Y is distributed to A, section 737 would not be triggered
because property X (the section 704(c) property) is no longer in the
same partnership as property Y.

While the IRS and Treasury generally believe that it is appropriate
to apply sections 704(c)(1)(B) and 737 in the context of partnership
divisions, comments are invited on whether it would be appropriate
to expand the exceptions to these sections in certain circumstances
relating to divisive transactions.

C. Division as Part of a Larger Transaction

The proposed regulations provide the same rule for partnership
divisions that applies to partnership mergers.

D. Effective Date

The regulations are proposed to apply to divisions occurring 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 these regulations do not impose on small
entities a collection of information requirement, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Therefore, a
Regulatory Flexibility Analysis is not required. 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
business.

Comments and Public Hearing

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

A public hearing has been scheduled for May 4, 2000, beginning at 10
a.m., in room 2615, Internal Revenue Building, 1111 Constitution
Avenue, NW, Washington, DC. 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 A FOR FURTHER
INFORMATION CONTACT @ section of this 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 timely
written comments and must submit an outline of the topics to be
discussed and the time to be devoted to each topic (preferably a
signed original and eight (8) copies) by April 13, 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 regulations is Mary Beth Collins,
Office of Chief Counsel (Passthroughs and Special Industries).
However, other personnel from the IRS and 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 continues to read as
follows:

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

Par. 2. Section 1.708-1 is amended as follows:

1. Paragraph (b) is amended by removing paragraph (b)(2) and by
redesignating each paragraph listed in the first column of the
following table as the paragraph listed in the second column as
indicated in the following table:

Old Paragraph Redesignated Paragraph

(b)(1)(i) (b)(1)
(b)(1)(i)(a) (b)(1)(i)
(b)(1)(i)(b) (b)(1)(ii)
(b)(1)(ii) (b)(2)
(b)(1)(iii) (b)(3)
(b)(1)(iii)(a) (b)(3)(i)
(b)(1)(iii)(b) (b)(3)(ii)
(b)(1)(iv) (b)(4)
(b)(1)(v) (b)(5)

2. Paragraphs (c) and (d) are added to read as follows: §1.708-1
Continuation of partnership.

* * * * *

(c) Merger or consolidation--(1) General rule. If two or more
partnerships merge or consolidate into one partnership, the
resulting partnership shall be considered a continuation of the
merging or consolidating partnership the members of which own an
interest of more than 50 percent in the capital and profits of the
resulting partnership. If the resulting partnership can, under the
preceding sentence, be considered a continuation of more than one of
the merging or consolidating partnerships, it shall, unless the
Commissioner permits otherwise, be considered the continuation of
that partnership which is credited with the contribution of assets
having the greatest fair market value (net of liabilities) to the
resulting partnership. Any other merging or consolidating
partnerships shall be considered as terminated.

If the members of none of the merging or consolidating partnerships
have an interest of more than 50 percent in the capital and profits
of the resulting partnership, all of the merged or consolidated
partnerships are terminated, and a new partnership results. The
taxable years of such merging or consolidating partnerships which
are considered terminated shall be closed in accordance with the
provisions of section 706(c), and such partnerships shall file their
returns for a taxable year ending upon the date of termination,
i.e., the date of merger or consolidation. The resulting partnership
shall file a return for the taxable year of the merging or
consolidating partnership that is considered as continuing. The
return shall state that the resulting partnership is a continuation
of such merging or consolidating partnership and shall include the
names and addresses of the merged or consolidated partnerships. The
respective distributive shares of the partners for the periods prior
to and subsequent to the date of merger or consolidation shall be
shown as a part of the return.

(2) Form of a merger or consolidation--(i) Assets-over form. When
two or more partnerships merge or consolidate into one partnership
under the applicable jurisdictional law without undertaking a form
for the merger or consolidation, or undertake a form for the merger
or consolidation that is not described in paragraph (c)(2)(ii) of
this section, any merged or consolidated partnership that is
considered terminated under paragraph (c)(1) of this section is
treated as undertaking the assets-over form for Federal income tax
purposes. Under the assets-over form, the merged or consolidated
partnership that is considered terminated under paragraph (c)(1) of
this section contributes all of its assets and liabilities to the
resulting partnership in exchange for an interest in the resulting
partnership; and, immediately thereafter, the terminated partnership
distributes interests in the resulting partnership to its partners
in liquidation of the terminated partnership.

(ii) Assets-up form. Despite the partners' transitory ownership of
the terminated partnership's assets and liabilities, the form of a
partnership merger or consolidation will be respected for Federal
income tax purposes if the merged or consolidated partnership that
is considered terminated under paragraph (c)(1) of this section
distributes its assets and liabilities to its partners in
liquidation of the partners' interests in the terminated
partnership; and, immediately thereafter, the partners in the
terminated partnership contribute the distributed assets and
liabilities to the resulting partnership in exchange for interests
in the resulting partnership.

(3) Sale of an interest in the merging or consolidating partnership.
In a transaction characterized under the assets-over form, a sale of
an interest in the terminated partnership to the resulting
partnership that occurs as part of a merger or consolidation under
section 708(b)(2)(A), as described in paragraph (c)(2)(i) of this
section, will be respected as a sale of a partnership interest if
the merger agreement (or similar  document) specifies that the
resulting partnership is purchasing interests from a particular
partner in the merging or consolidating partnership and the
consideration that is transferred for each interest sold. See
section 741 and §1.741-1 for determining the selling partner's gain
or loss on the sale or exchange of the partnership interest.

(4) Examples. The following examples illustrate the rules in
paragraphs (c)(1) through (3) of this section: Example 1.
Partnership AB, in whose capital and profits A and B each own a 50-
percent interest, and partnership CD, in whose capital and profits C
and D each own a 50-percent interest, merge on September 30, 1999,
and form partnership ABCD. Partners A, B, C, and D are on a calendar
year, and partnership AB and partnership CD are also on a calendar
year. After the merger, the partners have capital and profits
interests as follows: A, 30 percent; B, 30 percent; C, 20 percent;
and D, 20 percent. Since A and B together own an interest of more
than 50 percent in the capital and profits of partnership ABCD, such
partnership shall be considered a continuation of partnership AB and
shall continue to file returns on a calendar year basis. Since C and
D own an interest of less than 50 percent in the capital and profits
of partnership ABCD, the taxable year of partnership CD closes as of
September 30, 1999, the date of the merger, and partnership CD is
terminated as of that date. Partnership ABCD is required to file a
return for the taxable year January 1 to December 31, 1999,
indicating thereon that, until September 30, 1999, it was
partnership AB. Partnership CD is required to file a return for its
final taxable year, January 1 through September 30, 1999.

Example 2. (i) Partnership X, in whose capital and profits A owns a
40-percent interest and B owns a 60-percent interest, and
partnership Y, in whose capital and profits B owns a 60- percent
interest and C owns a 40-percent interest, merge on September 30,
1999. The dollar-value of the partnership X assets (net of
liabilities) is $100X, and the dollar-value of the partnership Y
assets (net of liabilities) is $200X. The merger is accomplished
under state law by partnership Y contributing its assets and
liabilities to partnership X in exchange for interests in
partnership X, with partnership Y then liquidating, distributing
interests in partnership X to B and C.

(ii) B, a partner in both partnerships prior to the merger, owns a
greater than 50-percent interest in the resulting partnership
following the merger. Accordingly, because the dollar-value of
partnership Y's assets (net of liabilities) was greater than that of
partnership X's, under paragraph (c)(1) of this section, X will be
considered to terminate in the merger. As a result, even though, for
state law purposes, the transaction was undertaken with partnership
Y contributing its assets and liabilities to partnership X and
distributing interests in partnership X to its partners, pursuant to
paragraph (c)(2)(i) of this section, for Federal income tax
purposes, the transaction will be treated as if partnership X
contributed its assets to partnership Y in exchange for interests in
partnership Y and then liquidated, distributing interests in
partnership Y to A and B. Example 3. (i) Partnership X and
partnership Y merge when the partners of partnership X transfer
their partnership X interests to partnership Y in exchange for
partnership Y interests. Immediately thereafter, partnership X
liquidates into partnership Y. The resulting partnership is
considered a continuation of partnership Y, and partnership X is
considered terminated.

(ii) The partnerships are treated as undertaking the assets-over
form described in paragraph (c)(2)(i) of this section because the
partnerships undertook a form that is not the assets-up form
described in paragraph (c)(2)(ii) of this section. Accordingly, for
Federal income tax purposes, partnership X is deemed to contribute
its assets and liabilities to partnership Y in exchange for
interests in partnership Y; and, immediately thereafter, partnership
X is deemed to have distributed the interests in partnership Y to
its partners in liquidation of their interests in partnership X.

Example 4. (i) A, B, and C are partners in partnership X. D, E, and
F are partners in Partnership Y. Partnership X and partnership Y
merge within the meaning of section 708(b)(2)(A), and the resulting
partnership is considered a continuation of partnership Y.
Partnership X is considered terminated. Under state law,
partnerships X and Y undertake the assets-over form of paragraph (c)
(2)(i) of this section to accomplish the partnership merger. C does
not want to become a partner in partnership Y, and partnership X
does not have the resources to buy C's interest before the merger.
C, partnership X, and partnership Y enter into an agreement that
specifies that partnership Y will purchase C's interest in
partnership X for $150 immediately before the merger. As part of the
merger, partnership X receives from partnership Y $150 that will be
distributed to C immediately before the merger, and interests in
partnership Y in exchange for partnership X's assets and
liabilities. Partnership X has made an election under section 754.

(ii) Because the merger agreement satisfies the requirements of
paragraph (c)(3) of this section, C will be treated as selling its
interest in partnership X to partnership Y for $150  immediately
before the merger. See section 741 and §1.741-1 to determine the
amount and character of C's gain or loss on the sale or exchange of
its interest in partnership X.

(iii) Because the merger agreement satisfies the requirements of
paragraph (c)(3) of this section, partnership Y is considered to
have purchased C's interest in partnership X for $150 immediately
before the merger. See §1.704-1(b)(2)(iv)(l) for determining
partnership Y's capital account in partnership X. Partnership Y's
adjusted basis of its interest in partnership X is determined under
section 742 and §1.742-1. To the extent any built-in gain or loss on
section 704(c) property in partnership X would have been allocated
to C (including any allocations with respect to property
revaluations under section 704(b) (reverse section 704(c)
allocations)), see section 704 and §1.704-3(a)(7) for determining
the built-in gain or loss or reverse section 704(c) allocations
apportionable to partnership Y. Similarly, after the merger is
completed, the built-in gain or loss and reverse section 704(c)
allocations attributable to C's interest are apportioned to D, E,
and F under section 704(c) and §1.704- 3(a)(7).

(iv) Because partnership X has an election under section 754 in
effect, partnership Y, as a momentary partner in partnership X, will
have a special basis adjustment regarding the basis of partnership
X's property under section 743 and §1.743-1. See section 743 and
§1.743-1 for determining the amount of the adjustment. After the
merger, the adjustment is allocated solely to D, E, and F--the
partners in partnership Y immediately before the merger.

(v) Under paragraph (c)(2)(i) of this section, partnership X
contributes assets and liabilities attributable to the interests of
A and B to partnership Y in exchange for interests in partnership Y;
and, immediately thereafter, partnership X distributes the interests
in partnership Y to A and B in liquidation of their interests in
partnership X. At the same time, partnership X distributes assets to
partnership Y in liquidation of partnership Y's interest in
partnership X. (5) Prescribed form not followed in certain
circumstances.

(i) If any transactions described in paragraph (c)(2) or (3) of this
section are part of a larger series of transactions, and the
substance of the larger series of transactions is inconsistent with
following the form prescribed in such paragraph, the Commissioner
may disregard such form, and may recast the larger series of
transactions in accordance with their substance. (ii) Example. The
following example illustrates the rules in paragraph (c)(5) of this
section:

Example. A, B, and C are equal partners in partnership ABC. ABC
holds no section 704(c) property. D and E are equal partners in
partnership DE. B and C want to exchange their interest in ABC for
all of the interests in DE. However, rather than exchanging
partnership interests, DE merges with ABC by undertaking the assets-
up form described in paragraph (c)(2)(ii) of this section, with D
and E receiving title to the DE assets and then contributing the
assets to ABC in exchange for interests in ABC. As part of a
prearranged transaction, the assets acquired from DE are contributed
to a new partnership, and the interests in the new partnership are
distributed to B and C in complete liquidation of their interests in
ABC. The merger and division in this example represent a series of
transactions that in substance are an exchange of interests in ABC
for interests in DE. Even though paragraph (c)(2)(ii) of this
section provides that the form of a merger will be respected for
Federal income tax purposes if the steps prescribed under the asset-
up form are followed, and paragraph (d)(2)(i) of this section
provides a form that will be followed for Federal income tax
purposes in the case of partnership divisions, these forms will not
be respected for Federal income tax purposes under these facts, and
the transactions will be recast in accordance with their substance
as a taxable exchange of interests in ABC for interests in DE. (6)
Effective date. This paragraph (c) is applicable to partnership
mergers occurring on or after the date final regulations are
published in the Federal Register.

(d) Division of a partnership--(1) General rule. Upon the division
of a partnership into two or more partnerships, any resulting
partnership (as defined in paragraph (d)(3)(iv) of this section) or
resulting partnerships shall be considered a continuation of the
prior partnership (as defined in paragraph (d)(3)(ii) of this
section) if the members of the resulting partnership or partnerships
had an interest of more than 50 percent in the capital and profits
of the prior partnership. Any other resulting partnership will not
be considered a continuation of the prior partnership but will be
considered a new partnership. If the members of none of the
resulting partnerships owned an interest of more than 50 percent in
the capital and profits of the prior partnership, none of the
resulting partnerships will be considered a continuation of the
prior partnership and the prior partnership will be considered to
have terminated. Where members of a partnership which has been
divided into two or more partnerships do not become members of a
resulting partnership which is considered a continuation of the
prior partnership, such partner's interests shall be considered
liquidated as of the date of the division. The resulting partnership
that is regarded as continuing shall file a return for the taxable
year of the partnership that has been divided. The return shall
state that the partnership is a continuation of the prior
partnership and shall set forth separately the respective
distributive shares of the partners for the periods prior to and
subsequent to the date of division.

(2) Form of a division--(i) Assets-over form. When a partnership
divides into two or more partnerships under applicable
jurisdictional law without undertaking a form for the division, or
undertakes a form that is not described in paragraph (d)(2)(ii) of
this section, the transaction will be characterized under the
assets-over form for Federal income tax purposes. (A) Assets-over
form where at least one resulting partnership is a continuation of
the prior partnership. In a division under the assets-over form
where at least one resulting partnership is a continuation of the
prior partnership, the divided partnership (as defined in paragraph
(d)(3)(i) of this section) contributes certain assets and
liabilities to a recipient partnership (as defined in paragraph (d)
(3)(iv) of this section) or recipient partnerships in exchange for
interests in such recipient partnership or partnerships; and,
immediately thereafter, distributes the interests in such recipient
partnership or partnerships to some or all of its partners in
partial or complete liquidation of the partners' interests in the
divided partnership.

(B) Assets-over form where none of the resulting partnerships is a
continuation of the prior partnership. In a division under the
assets-over form where none of the resulting partnerships is a
continuation of the prior partnership, the prior partnership will be
treated as contributing all of its assets and liabilities to new
resulting partnerships in exchange for interests in the resulting
partnerships; and, immediately thereafter, the prior partnership
will be treated as liquidating by distributing the interests in the
new resulting partnerships to the prior partnership's partners.

(ii) Assets-up form--(A) Assets-up form where the partnership
distributing assets is a continuation of the prior partnership.
Despite the partners' transitory ownership of some of the prior
partnership's assets and liabilities, the form of a partnership
division will be respected for Federal income tax purposes if the
divided partnership, which by definition is a continuing
partnership, distributes certain assets and liabilities to some or
all of its partners in partial or complete liquidation of the
partners' interests in the divided partnership; and, immediately
thereafter, such partners contribute the distributed assets and
liabilities to a recipient partnership or partnerships in exchange
for interests in such recipient partnership or partnerships.

(B) Assets-up form where none of the resulting partnerships are a
continuation of the prior partnership. If none of the resulting
partnerships are a continuation of the prior partnership, then
despite the partners' transitory ownership of some or all of the
prior partnership's assets and liabilities, the form of a
partnership division will be respected for Federal income tax
purposes if the prior partnership distributes certain assets and
liabilities to some or all of its partners in partial or complete
liquidation of the partners' interests in the prior partnership;
and, immediately thereafter, such partners contribute the
distributed assets and liabilities to a resulting partnership or
partnerships in exchange for interests in such resulting partnership
or partnerships. If the prior partnership does not liquidate under
the applicable jurisdictional law, then with respect to the assets
and liabilities that, in form, are not transferred to a new
resulting partnership, the prior partnership will be treated as
transferring these assets and liabilities to a new resulting
partnership under the assets over form described in paragraph (d)(2)
(i)(B) of this section.

(3) Definitions--(i) Divided partnership--For purposes of paragraph
(d) of this section, the divided partnership is the partnership
which is treated, for Federal income tax purposes, as transferring
the assets and liabilities to the recipient partnership or
partnerships, either directly (under the assets-over form) or
indirectly (under the assets-up form). If the resulting partnership
that, in form, transferred the assets and liabilities in connection
with the division is a continuation of the prior partnership, then
such resulting partnership will be treated as the divided
partnership. If a partnership divides into two or more partnerships
and only one of the resulting partnerships is a continuation of the
prior partnership, then the resulting partnership that is a
continuation of the prior partnership will be treated as the divided
partnership. If a partnership divides into two or more partnerships
without undertaking a form for the division that is recognized under
paragraph (d)(2) of this section, or if the resulting partnership
that had, in form, transferred assets and liabilities is not
considered a continuation of the prior partnership, and more than
one resulting partnership is considered a continuation of the prior
partnership, the continuing resulting partnership with the assets
having the greatest fair market value (net of liabilities) will be
treated as the divided partnership.

(ii) Prior partnership--For purposes of paragraph (d) of this
section, the prior partnership is the partnership subject to
division that exists under applicable jurisdictional law before the
division.

(iii) Recipient partnership--For purposes of paragraph (d) of this
section, a recipient partnership is a partnership that is treated as
receiving, for Federal income tax purposes, assets and liabilities
from a divided partnership, either directly (under the assets-over
form) or indirectly (under the assets-up form). (iv) Resulting
partnership--For purposes of paragraph (d) of this section, a
resulting partnership is a partnership resulting from the division
that exists under applicable jurisdictional law after the division.
For example, where a prior partnership divides into two
partnerships, both partnerships existing after the division are
resulting partnerships.

(4) Examples. The following examples illustrate the rules in
paragraphs (d)(1), (2), and (3) of this section:

Example 1. Partnership ABCD is in the real estate and insurance
business. A owns a 40-percent interest, and B, C, and D each owns a
20-percent interest, in the capital and profits of the partnership.
The partnership and the partners report their income on a calendar
year. They agree to separate the real estate and insurance business
as of November 1, 1999, and to form two partnerships; partnership AB
to take over the real estate business, and partnership CD to take
over the insurance business. Because members of resulting
partnership AB owned more than a 50-percent interest in the capital
and profits of partnership ABCD (A, 40 percent, and B, 20 percent),
partnership AB shall be considered a continuation of partnership
ABCD. Partnership AB is required to file a return for the taxable
year January 1 to December 31, 1999, indicating thereon that until
November 1, 1999, it was partnership ABCD. Partnership CD is
considered a new partnership formed on November 1, 1999, and is
required to file a return for the taxable year it adopts pursuant to
section 706(b) and the applicable regulations. E xample 2. (i)
Partnership ABCD owns properties W, X, Y, and Z, and divides into
partnership AB and partnership CD. Under paragraph (d)(1) of this
section, partnership AB is considered a continuation of partnership
ABCD and partnership CD is considered a new partnership. Partnership
ABCD distributes property Y to C and titles property Y in C's name.
Partnership ABCD distributes property Z to D and titles property Z
in D's name. C and D then contribute properties Y and Z,
respectively, to partnership CD in exchange for interests in
partnership CD. Properties W and X remain in partnership AB.

(ii) Under paragraph (d)(2)(ii) of this section, partnership ABCD
will be treated as following the assets-up form for Federal income
tax purposes.

Example 3. (i) Partnership ABCD owns three parcels of property:
property X, with a value of $500; property Y, with a value of $300;
and property Z, with a value of $200. A and B each own a 40-percent
interest in the capital and profits of partnership ABCD, and C and D
each own a 10 percent interest in the capital and profits of
partnership ABCD. On November 1, 1999, partnership ABCD divides into
three partnerships (AB1, AB2, and CD) by contributing property X to
a newly formed partnership (AB1) and distributing all interests in
such partnership to A and B as equal partners, and by contributing
property Z to a newly formed partnership (CD) and distributing all
interests in such partnership to C and D as equal partners in
exchange for all of their interests in partnership ABCD.

(ii) Partnerships AB1 and AB2 both are considered a continuation of
partnership ABCD, while partnership CD is considered a new
partnership formed on November 1, 1999. Under paragraph (d)(2)(i)(A)
of this section, partnership ABCD will be treated as following the
assets-over form, with partnership ABCD contributing property X to
partnership AB1 and property Z to partnership CD, and distributing
the interests in such partnerships to the designated partners.

Example 4. (i) The facts are the same as in example 3, except that
partnership ABCD divides into three partnerships by operation of
state law, without undertaking a form. (ii) Under the last sentence
of paragraph (d)(3)(i) of this section, partnership AB1 will be
treated as the resulting partnership that is the divided
partnership. Under paragraph (d)(2)(i)(A) of this section,
partnership ABCD will be treated as following the assets-over form,
with partnership ABCD contributing property Y to partnership AB2 and
property Z to partnership CD, and distributing the interests in such
partnerships to the designated partners.

Example 5. (i) The facts are the same as in example 3, except that
partnership ABCD divides into three partnerships by contributing
property X to newly-formed partnership AB1 and property Y to newly-
formed partnership AB2 and distributing all  interests in each
partnership to A and B in exchange for all of their interests in
partnership ABCD.

(ii) Because resulting partnership CD is not a continuation of the
prior partnership (partnership ABCD), partnership CD cannot be
treated, for Federal income tax purposes, as the partnership that
transferred assets (i.e., the divided partnership), but instead must
be treated as a recipient partnership. Under the last sentence of
paragraph (d)(3)(i) of this section, partnership AB1 will be treated
as the resulting partnership that is the divided partnership. Under
paragraph (d)(2)(i)(A) of this section, partnership ABCD will be
treated as following the assets-over form, with partnership ABCD
contributing property Y to partnership AB2 and property Z to
partnership CD, and distributing the interests in such partnerships
to the designated partners.

Example 6. (i) Partnership ABCDE owns Blackacre, Whiteacre, and
Redacre, and divides into partnership AB, partnership CD, and
partnership DE. Under paragraph (d)(1) of this section, partnership
ABCDE is considered terminated (and, hence, none of the resulting
partnerships are a continuation of the prior partnership) because
none of the members of the new partnerships (partnership AB,
partnership CD, and partnership DE) owned an interest of more than
50 percent in the capital and profits of partnership ABCDE.

(ii) Partnership ABCDE distributes Blackacre to A and B and titles
Blackacre in the names of A and B. A and B then contribute Blackacre
to partnership AB in exchange for interests in partnership AB.
Partnership ABCDE will be treated as following the assets-up form
described in paragraph (d)(2)(ii)(B) of this section for Federal
income tax purposes.

(iii) Partnership ABCDE distributes Whiteacre to C and D and titles
Whiteacre in the names of C and D. C and D then contribute Whiteacre
to partnership CD in exchange for interests in partnership CD.
Partnership ABCDE will be treated as following the assets-up form
described in paragraph (d)(2)(ii)(B) of this section for Federal
income tax purposes.

(iv) Partnership ABCDE does not liquidate under state law so that,
in form, the assets in new partnership DE are not considered to have
been transferred under state law. Partnership ABCDE will be treated
as undertaking the assets-over form described in paragraph (d)(2)(i)
(B) of this section for Federal income tax purposes with respect to
the assets of partnership DE. Thus, partnership ABCDE will be
treated as contributing Redacre to partnership DE in exchange for
interests in partnership DE; and, immediately thereafter,
partnership ABCDE will be treated as distributing interests in
partnership DE to D and E in liquidation of their interests in
partnership ABCDE. Partnership ABCDE then terminates.

(5) Prescribed form not followed in certain circumstances. If any
transactions described in paragraph (d)(2) of this section are part
of a larger series of transactions, and the substance of the larger
series of transactions is inconsistent with following the form
prescribed in such paragraph, the Commissioner may disregard such
form, and may recast the larger series of transactions in accordance
with their substance.

(6) Effective date. This paragraph (d) is applicable to partnership
divisions occurring on or after the date final regulations are
published in the Federal Register. Par. 3. Section 1.743-1 is
amended by adding two sentences to the end of paragraph (h)(1).

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

* * * * *

(h) * * *

(1) * * * When a resulting partnership that is considered a
continuation of a merged or consolidated partnership under section
708(b)(2)(A) has a basis adjustment in property held by the merged
or consolidated partnership that is considered terminated under
§1.708-1(c)(1) (as a result of the resulting partnership acquiring
an interest in such merged or consolidated partnership, see
§1.708-1(c)(3)), the resulting partnership will continue to have the
same basis adjustments with respect to property distributed (see
§1.708-1(c)(4), Example 4(v)) by the terminated partnership to the
resulting partnership, regardless of whether the resulting
partnership makes a section 754 election. The portion of the
resulting partnership's adjusted basis in its assets attributable to
the basis adjustment with respect to the property distributed by the
terminating partnership must be segregated and allocated solely to
the partners who were partners in the resulting partnership
immediately before the merger or consolidation.

* * * * *

Par. 4. Section 1.752-1 is amended as follows:

1. A sentence is added to the end of paragraph (f).

2. The current Example in paragraph (g) is redesignated as

Example 1.

3. Example 2 is added in paragraph (g).

§1.752-1 Treatment of partnership liabilities.

* * * * *

(f) * * * When two or more partnerships merge or consolidate under
section 708(b)(2)(A), as described in §1.708-1(c)(2)(i), increases
and decreases in partnership liabilities associated with the merger
or consolidation are netted by the partners in the terminating
partnership and the resulting partnership to determine the effect of
the merger under section 752.

(g) * * *

Example 1. * * *

Example 2. Merger or consolidation of partnerships holding property
encumbered by liabilities. (i) B owns a 70 percent interest in
partnership T. Partnership T's sole asset is property X, which is
encumbered by a $900 liability. Partnership T's adjusted basis in
property X is $600, and the value of property X is $1,000. B's
adjusted basis in its partnership T interest is $420. B also owns a
20 percent interest in partnership S. Partnership S's sole asset is
property Y, which is encumbered by a $100 liability. Partnership S's
adjusted basis in property Y is $200, the value of property Y is
$1,000, and B's adjusted basis in its partnership S interest is $40.

(ii) Partnership T and partnership S merge under section 708(b)(2)
(A). Under section 708(b)(2)(A) and §1.708-1(c)(1), partnership T is
considered terminated and the resulting partnership is considered a
continuation of partnership S. Partnerships T and S undertake the
form described in §1.708-1(c)(2)(i) for the partnership merger.
Under §1.708-1(c)(2)(i), partnership T contributes property X and
its $900 liability to partnership S in exchange for an interest in
partnership S. Immediately thereafter, partnership T distributes the
interests in partnership S to its partners in liquidation of their
interests in partnership T. B owns a 25 percent interest in
partnership S after partnership T distributes the interests in
partnership S to B.

(iii) Under paragraph (f) of this section, B nets the increases and
decreases in its share of partnership liabilities associated with
the merger of partnership T and partnership S. Before the merger,
B's share of partnership liabilities was $650 (B had a $630 share of
partnership liabilities in partnership T and a $20 share of
partnership liabilities in partnership S immediately before the
merger). B's share of S's partnership liabilities after the merger
is $250 (25 percent of S's total partnership liabilities of $1,000).
Accordingly, B has a $400 net decrease in its share of S's
partnership liabilities. Thus, B is treated as receiving a $400
distribution from partnership S under section 752(b). Because B's
adjusted basis in its partnership S interest before the deemed
distribution under section 752(b) is $460 ($420 + $40), B will not
recognize gain under section 731. After the merger, B's adjusted
basis in its partnership S interest is $60.

* * * * *

Deputy Commissioner of Internal Revenue
Robert E. Wenzel

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