| T.D. 8902 |
September 21, 2000 |
Capital Gains, Partnership, Subchapter S, &
Trust Provisions
DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Parts 1 and 602 [TD 8902] RIN 1545-
AW22
TITLE: Capital Gains, Partnership, Subchapter S, and Trust
Provisions
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains final regulations relating to sales
or exchanges of interests in partnerships, S corporations, and
trusts. The regulations interpret the look- through provisions of
section 1(h), added by section 311 of the Taxpayer Relief Act of
1997 and amended by sections 5001 and 6005(d) of the Internal
Revenue Service Restructuring and Reform Act of 1998, and explain
the rules relating to the division of the holding period of a
partnership interest. The regulations affect partnerships,
partners, S corporations, S corporation shareholders, trusts, and
trust beneficiaries.
DATES: Effective Date: These regulations are effective September
21, 2000.
FOR FURTHER INFORMATION CONTACT: Jeanne M. Sullivan or David J.
Sotos (202) 622-3050 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act The collections of information contained in
these final regulations have been reviewed and approved by the
Office of Management and Budget in accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C. 3507) under control number 1545-
1654. Responses to these collections of information are required to
verify compliance with section 1(h) and to determine that the tax on
capital gains has been computed correctly.
An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless the
collection of information displays a valid control number assigned
by the Office of Management and Budget.
The estimated annual burden per respondent/recordkeeper is 10
minutes.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service , Attn: IRS reports Clearance Officer, OP:FS:FP,
Washington, DC 20224, and to the Office of Management and Budget ,
Attn: Desk Officer for the Department of the Treasury, Office of
Information and Regulatory Affairs, Washington, DC 20503. Books or
records relating to this collection of information must be retained
as long as their contents may become material in the administration
of any internal revenue law. Generally, tax returns and tax return
information are confidential, as required by 26 U.S.C. 6103.
Background
Section 311 of the Taxpayer Relief Act of 1997, Public Law
105-34 (111 Stat. 788, 831) (the 1997 Act), as modified by sections
5001 and 6005(d) of the Internal Revenue Service Restructuring and
Reform Act of 1998, Public Law 105-206 (112 Stat. 685, 787, 800)
(the 1998 Act), reduced the maximum statutory tax rates for long-
term capital gains of individuals in general and provided regulatory
authority to apply the rules to sales and exchanges of interests in
pass-thru entities and to sales and exchanges by pass-thru entities.
On August 9, 1999, the IRS published in the Federal Register a
notice of proposed rulemaking (REG-106527-98, 64 FR 43117) relating
to the taxation of capital gains in the case of sales or exchanges
of interests in partnerships, S corporations, and trusts. The
regulations interpreted rules added by the 1997 Act and amended by
the 1998 Act, and provided guidance relating to the division of the
holding period of a partnership interest. The IRS received no
requests to speak at a public hearing that was scheduled for
November 18, 1999, and canceled the hearing. Written comments were
received in response to the notice of proposed rulemaking. After
consideration of the comments, the proposed regulations under
sections 1(h), 741, and 1223 are adopted, as revised by this
Treasury decision. The comments received and revisions made are
discussed below.
Explanation of Revisions and Summary of Comments
1. Look-through Capital Gain
a. In General
Section 1(h) provides maximum capital gains rates in three
categories: 20- percent rate gain, 25-percent rate gain, and 28-
percent rate gain. Twenty percent rate gain is net capital gain
from the sale or exchange of capital assets held for more than one
year, reduced by the sum of 25-percent rate gain and 28-percent
rate gain. Twenty-five percent rate gain is limited to unrecaptured
section 1250 gain. Twenty- eight percent rate gain includes capital
gains and losses from the sale or exchange of collectibles (as
defined in section 408(m) without regard to section 408(m)(3)) held
for more than one year and certain other types of gain.
Capital gain attributable to the sale or exchange of an
interest in a pass-thru entity held for more than one year
generally is in the 20-percent rate gain category. However, the
proposed regulations provide that, when a taxpayer sells or
exchanges an interest in a partnership, S corporation, or trust
that holds collectibles, rules similar to the rules under section
751(a) apply to determine the capital gain that is attributable to
certain unrealized gain in the collectibles. Furthermore, under the
proposed regulations, rules similar to the rules under section
751(a) also apply to determine the capital gain attributable to
certain unrealized gain in section 1250 property held by a
partnership when a taxpayer sells or exchanges an interest in a
partnership that holds such property.
b. Net Collectibles Loss
Twenty-eight percent rate gain is the excess (if any) of
(i) the sum of collectibles gain and section 1202 gain, over (ii)
the sum of collectibles loss, the net short-term loss, and the
amount of long-term capital loss carried under section 1212(b)(1)
(B) to the taxable year. One commentator suggested that, when an
interest in a partnership, S corporation, or trust is transferred,
net collectibles loss as well as net collectibles gain in property
held by such an entity should be taken into account in determining
a taxpayer’s overall collectibles gain or collectibles loss. The
Treasury Department (Treasury) and the IRS believe that the
proposed regulations are consistent with the rule in section 1(h)
(6)(B), which, in providing look-through treatment with respect to
collectibles, refers only to "gain from the sale of an interest in
a partnership, S corporation, or trust which is attributable to
unrealized appreciation in the value of collectibles . . ."
Accordingly, the comment is not adopted in the final regulations.
c. Limitations with Respect to Section 1231 Property
Section 1(h)(7)(B) limits the amount of unrecaptured section
1250 gain recognized as a consequence of sales, exchanges, and
conversions described in section 1231(a)(3)(A) to the taxpayer’s
net section 1231 gain (as defined in section 1231(c)(3)) for the
taxable year. The proposed regulations provide that, upon a
partner’s transfer of a partnership interest, the partner’s
allocable share of section 1250 capital gain (as defined in
§1.1(h)-1(b)(3)) is not treated as section 1231 gain for purposes
of applying the limitation in section 1(h)(7)(B). There has been
some confusion regarding whether the section 1(h)(7)(B) limitation
applies to all unrecaptured section 1250 gain, including section
1250 capital gain recognized on the transfer of a partnership
interest.
Because the transfer of an interest in a partnership is not
described in section 1231(a)(3)(A), the limitation provided in
section 1(h)(7)(B) is not applicable with respect to such
transfers. Accordingly, under the final regulations (and consistent
with the proposed regulations), where a partner sells an interest
in a partnership, the partner must take into account the entire
allocable share of section 1250 capital gain in determining the
unrecaptured section 1250 gain under section 1(h)(7)(A), without
regard to the limitation set forth in section 1(h)(7)(B).
d. Redemption of a Partnership Interest
Some practitioners have expressed concern that the look-
through capital gains provisions of the proposed regulations apply
to the redemption of a partnership interest. To apply the
regulations in the context of redemptions, it would be necessary to
import the concepts utilized in section 751(b). Treasury and the
IRS believe that this would not be advisable. Accordingly, these
regulations do not apply to any transaction that is treated as a
redemption of a partnership interest for Federal income tax
purposes.
e. Allocating Section 704(c) Gain and Loss
Certain commentators requested that the final regulations
provide guidance with respect to the proportionate part of the
section 704(c) built-in gain or loss that is transferred to the
purchaser when a section 704(c) partner sells a portion of a
partnership interest. This issue is relevant because, in
determining a taxpayer’s share of collectibles gain or section 1250
capital gain on the sale of a partnership interest, it is necessary
to calculate how much of such gain would be allocated with respect
to the partnership interest sold if the underlying collectibles or
section 1250 property held by the partnership were sold for their
fair market value. In making this determination where a partner
sells only a portion of its interest in a partnership, it is
necessary to determine how much section 704(c) gain relating to
collectibles or section 1250 property is allocable to the portion
of the partnership interest that is sold. Although relevant,
Treasury and the IRS believe that this issue is beyond the scope of
these regulations. Accordingly, this comment is not addressed in
these regulations.
f. Look-Through Capital Gain Where the Pass-Thru Entity Has a
Short-Term Holding
Period in Collectibles
The final regulations modify the proposed regulations to
provide that a pass-thru entity’s holding period in the
collectibles is not relevant in determining whether long- term
capital gain recognized on the sale of an interest in the entity is
collectibles gain (taxable at a 28-percent rate). Consistent with
the purpose of the look-through provisions contained in section
1(h), these regulations characterize a transferor’s long- term
capital gain recognized on the sale of the interest in a pass-thru
entity by reference to the entity’s underlying assets that give
rise to such gain. Where a transferor recognizes long-term capital
gain on the sale of an interest in a partnership, S corporation, or
trust, it would be anomalous to provide the transferor with a
better tax result if the entity has a short-term holding period in
collectibles than if the entity has a long-term holding period in
such property. This rule is not relevant with respect to section
1250 property. Because all depreciation with respect to section
1250 property held for one year or less is treated as additional
depreciation under section 1250(b)(1), such amounts will be treated
as unrealized receivables under section 751(c) and thus will give
rise to ordinary income under section 751(a) upon a disposition of
the partnership interest.
2. Determination of Holding Period in a Partnership
a. In General
The proposed regulations provide rules relating to the
allocation of a divided holding period with respect to an interest
in a partnership. These rules generally provide that the holding
period of a partnership interest will be divided if a partner
acquires portions of an interest at different times or if an
interest is acquired in a single transaction that gives rise to
different holding periods under section 1223. Under the proposed
regulations, the holding period of a portion of a partnership
interest generally is determined based on a fraction that is equal
to the fair market value of the portion of the partnership interest
to which the holding period relates (determined immediately after
the acquisition) over the fair market value of the entire
partnership interest.
Under the proposed regulations, a selling partner generally
cannot identify and use the actual holding period for a portion of
the partner’s interest. However, the proposed regulations provide
that a selling partner is permitted to identify the portion of a
partnership interest sold with its holding period if the
partnership is a publicly traded partnership (as defined under
section 7704(b)), the partnership interest is divided into
identifiable units with ascertainable holding periods, and the
selling partner can identify the portion of the interest
transferred.
b. Contributions of Cash by Existing Partners
The proposed regulations include an example of a pro rata
contribution of cash by partners that results in a divided holding
period in those partners’ interests in the partnership.
Commentators suggested that it is inappropriate to provide for a
divided holding period where an existing partner contributes cash
to the partnership, particularly where the contribution is pro rata
by all of the partners. According to these commentators, such an
approach may unfairly convert portions of long-term appreciation of
partnership assets into a short-term capital gain on the sale of a
long held partnership interest. (This conversion occurs regardless
of whether the partner sells all or a portion of a partnership
interest.)
The conversion of long-term appreciation in partnership
assets into short-term capital gain upon the sale of a partnership
interest as a result of cash contributions to the partnership is
largely the product of partners having unitary bases in their
partnership interests. See Rev. Rul. 84-53 (1984-1 C.B. 159) (a
partner has a single basis in a partnership interest). Under this
rule, gain attributable to previously contributed or acquired
assets may be allocated to the short-term portion of a partnership
interest even though the value of the short-term portion is no
greater than the amount of cash contributed to the partnership. If
basis from contributed cash or property could be traced to a
segregated interest in the partnership, this conversion of long-
term capital appreciation into short-term capital gain would not
occur. Larger problems would arise, however, in the context of
partnership taxation if a partner were allowed to have a divided
basis in a partnership interest.
An aggregate approach to determining the holding period of
an interest in a partnership would make it more likely that a
contribution of cash would not give rise to a short-term holding
period. Under an aggregate approach, one could trace contributed
funds into the partnership and determine whether a new holding
period was created by reference to whether the funds were used for
capital expenditures (in which circumstance, a short-term holding
period generally would be appropriate) or for operating
expenditures of the partnership (in which circumstance, no new
holding period should be created). On the other hand, to the extent
that a partnership interest is a capital asset that is distinct
from the partnership’s assets (an entity approach), its holding
period and basis should be determined independently and should not
be affected by the partnership’s use of the contributed funds. In
choosing the entity approach in the proposed regulations, Treasury
and the IRS concluded that tracing funds to their ultimate use in
the partnership is not an administrable means of determining
whether a contribution to a partnership creates a new holding
period.
Furthermore, the proposed regulations are consistent with
general rules relating to the holding period of capital and section
1231 assets. Where a capital asset (including a capital asset held
for one year or less) or property described in section 1231 is
contributed to a partnership, section 1223(1) requires the tacking
of the holding period in the partnership interest, whether the
partners make pro rata contributions of property or instead make
non-pro rata contributions that increase the proportionate
interests of one or more partners.
In addition, the proposed regulations avoid inappropriate results
that may occur if cash contributions are ignored after the
formation of a partnership. If cash contributions were ignored, it
would be possible for partners to form shelf partnerships with
nominal cash contributions in order to start their holding period
in the interests, where the majority of cash would not be
contributed (and significant operating assets of the partnership
would not be acquired) until some time in the future. This clearly
would not be a proper result.
Based upon the foregoing, Treasury and the IRS continue to
believe that the approach taken in the proposed regulations is
appropriate. However, in response to comments, Treasury and the IRS
have provided one exception, and explicitly grant authority for
another, where the contribution of cash will not create a new
holding period in a partnership interest.
If a partner makes cash contributions and receives cash
distributions from a partnership during the one-year period before
sale of all or a portion of the interest in the partnership,
Treasury and the IRS believe it is appropriate that the net cash
contribution to the partnership determine the portion of the
interest that is held for one year or less. Therefore, the final
regulations provide that, if a partner makes one or more cash
contributions and receives one or more cash distributions with
respect to the partnership during the one-year period ending on the
date of the sale or exchange of all or a portion of the partner’s
interest in the partnership, in applying the rules for determining
the partner’s holding period in its partnership interest with
respect to cash contributions, the partner may reduce the cash
contributions made during the year by cash distributions received
on a last-in-first-out basis, treating all cash distributions as if
they were received by the partner immediately before the sale or
exchange. This rule also applies in determining the holding period
of a partnership interest where gain or loss is recognized under
section 731(a) upon a distribution by the partnership.
In addition, the final regulations include authority for
the Secretary to provide, in published guidance, additional
exceptions to the general holding period rules with respect to
other cash contributions, including de minimis cash contributions,
to a partnership. Treasury and the IRS request comments as to the
appropriate level for a de minimis exception.
c. Treatment of Deemed Cash Contributions under Section 752(a)
Section 752(a) provides that an increase in a partner’s
share of partnership liabilities, or an increase in a partner’s
individual liabilities by reason of the partner’s assumption of
partnership liabilities, shall be treated as a contribution of
money by the partner to the partnership. Some practitioners have
questioned whether a partner’s deemed contribution of cash under
section 752(a) will give rise to a new holding period in that
partner’s interest in the partnership. A deemed contribution of
cash resulting from a shift among partners in their share of
liabilities or as a result of a partnership incurring new debt
does not expand the net asset base of the partners represented by
their interests in the partnership. Accordingly, it is
inappropriate to create a new holding period as a result of such
deemed contributions. However, to the extent that a partner
actually assumes a debt of the partnership, thus causing an
increase in the net asset base of the partnership, the creation of
a new holding period with respect to a portion of the partner’s
interest is appropriate.
In addressing a similar issue, the capital account rules
regarding the treatment of liabilities under §1.704-1(b)(2)(iv)(c)
attempt to measure the increase or decrease in a partner’s economic
interest in the partnership resulting from the assumption of
liabilities by either the partner or the partnership. Those rules
provide:
(1) money contributed by a partner to a partnership includes the
amount of any partnership liabilities that are assumed by such
partner (other than [certain] liabilities that are assumed by a
distributee partner [in connection with a distribution of property
by the partnership]) but does not include increases in such
partner’s share of partnership liabilities (see section 752(a)), and
(2) money distributed to a partner by a partnership includes the
amount of such partner’s individual liabilities that are assumed by
the partnership (other than [certain] liabilities that are assumed
by the partnership [in connection with a contribution of property to
the partnership]) but does not include decreases in such partner’s
share of partnership liabilities (see section 752(b))..
This rule is incorporated in the final regulations. The final
regulations provide that deemed contributions and distributions of
cash under sections 752(a) and (b) will be disregarded in
determining a partner’s holding period in its partnership interest
to the same extent that such amounts are disregarded under
§1.704-1(b)(2)(iv)(c). (Deemed distributions under section 752(b)
are relevant as a result of the cash netting rule added in these
final regulations.)
d. Contribution of Section 751 Assets
Commentators noted that, if a partner has a short-term
holding period in a partnership interest on account of the
contribution of assets described in section 751(c) or (d) (section
751 assets), the rules of section 751(a) in conjunction with the
proposed regulations cause the section 751 assets to be counted
twice if a partnership interest is sold within 12 months of the
contribution, once in applying section 751(a) to treat part of the
amount received as ordinary income, and again in determining the
selling partner’s short-term capital gain. In response to these
comments, the final regulations provide that, if a partner
recognizes ordinary income or loss on account of section 751 assets,
either under section 751(a) as a result of the sale of all or part
of the partnership interest or as a result of the sale by the
partnership of the section 751 assets, the section 751 assets shall
be disregarded in determining the division of the holding period of
an interest in a partnership upon a sale of such partnership
interest during the one-year period following the contribution. This
rule does not apply if, in the absence of the rule, a partner would
not be treated as having held any portion of the interest for more
than one year. Accordingly, if a partner’s only contributions to a
partnership are contributions of section 751 assets or section 751
assets and cash within the prior one-year period, the adjustment
will not be available, and the partner appropriately will be treated
as having a short-term holding period with respect to the entire
interest.
A similar rule disregarding the contribution of section 751
assets does not apply in determining the holding period of a
partnership interest with respect to gain or loss recognized under
section 731 upon a distribution by a partnership. Properly
coordinating the holding period rules with gain or loss
determinations under section 751(b) would be inordinately complex.
In addition, where, within a one-year period, a partner contributes
section 751 assets to a partnership and receives a cash distribution
large enough to require the recognition of gain, it is likely that
the contribution and distribution will constitute a disguised sale
of the section 751 assets to the partnership under section 707(a)(2)
(B), thus rendering the holding period rules irrelevant since the
sale of an asset to a partnership does not affect the holding period
of an interest in the partnership.
e. Treatment of Recapture and Other Unrealized Receivables
An example in the proposed regulations treats the portion of
a contributed asset that would be recaptured as ordinary income
under section 1245 upon disposition as non-section 1231 property for
purposes of the tacked holding period rule in section 1223(1). Some
commentators have raised questions regarding the position taken in
this example. For purposes of these regulations, Treasury and the
IRS believe that it is appropriate to characterize all properties
and potential gain treated as unrealized receivables under section
751(c) and the regulations thereunder as separate assets that are
not capital assets or property described in section 1231.
Accordingly, while the example in the proposed regulations has been
eliminated, a specific rule has been added in the final regulations
to provide for such a result. This rule is consistent with the rule
added in the final regulations regarding the holding period
exception for contributed section 751 assets. As discussed above,
that rule will disregard the contribution of section 751 assets
(including properties and potential gain treated as unrealized
receivables under section 751(c)) in computing the holding period of
a partnership interest where the interest is sold within one year
after contribution. Accordingly, while section 1245 recapture (and
similar items treated as unrealized receivables) will be treated as
a separate asset that is not a capital or section 1231 asset, the
asset will not give rise to a short-term holding period where a
partnership interest is sold. This rule also is similar to the rule
contained in § 1.755-1(a), which provides that properties and
potential gain treated as unrealized receivables under section
751(c) are considered separate ordinary income assets for purposes
of allocating basis adjustments under section 755.
f. Identification of Publicly Traded Partnership Units
The proposed regulations provide that a selling partner may
use the actual holding period of the portion of a partnership
interest sold if the partnership is a "publicly traded partnership"
(as defined under section 7704(b)), the partnership interest is
divided into identifiable units with ascertainable holding periods,
and the selling partner can identify the portion of the interest
transferred. Commentators suggested that it may be appropriate to
provide that a partner must be consistent in electing, for holding
period purposes, to identify units of a publicly traded partnership
that are sold or exchanged in order to avoid distortion in the total
long-term and short- term capital gain recognized. This suggestion
is adopted in the final regulations.
g. Conversion from General Partnership to Limited Partnership
A commentator requested clarification that a partner’s
holding period in its partnership interest carries over when a
partnership converts from a general partnership to a limited
partnership, as described in Rev. Rul. 84-52 (1984-1 C.B. 157). The
ruling concludes that, pursuant to section 1223(1), there will be no
change to the holding period of any partner’s interest in the
partnership as a result of such a conversion. The final regulations
do not change the result set forth in Rev. Rul. 84-52.
h. Other Miscellaneous Issues
The proposed regulations contain an example which, consistent
with Rev. Rul. 84-53, states that a partner has a single basis in
its partnership interest. Certain commentators suggested that the
principle that a partner has a single basis in its partnership
interest should be set forth in regulations, rather than simply
relying on Rev. Rul. 84-53. The rules set forth in these regulations
address only holding period and character issues. In illustrating
the operation of certain of these rules, the example accurately
reflects current law. Treasury and the IRS believe that the
inclusion of a separate rule providing that a partner has a single
basis in its partnership interest is unnecessary and is beyond the
scope of these regulations.
Finally, it was suggested that the final regulations cross-
reference section 83(f), which provides that in determining the
holding period of property to which section 83(a) applies, only the
holding period during which rights are transferable or are not
subject to a substantial risk of forfeiture shall be included.
Treasury and the IRS currently are studying the extent to which
section 83(a) applies to the issuance of certain partnership
interests (i.e., a profits interest in a partnership) in exchange
for services. Section 83(f) is relevant to the extent that section
83(a) applies with respect to a partnership interest. However, in
order to avoid any implication that section 83(a) applies to all
partnership interests issued in exchange for services, a cross
reference to section 83(f) has not been included in the final
regulations.
Special Analyses
It has been determined that this Treasury decision 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. It is
hereby certified that the collection of information in these
regulations will not have a significant impact on a substantial
number of small businesses. This certification is based upon the
fact that the economic burden imposed on taxpayers by the collection
of information and recordkeeping requirements of these regulations
is insignificant. For example, the estimated average annual burden
per respondent is 10 minutes. Therefore, a Regulatory Flexibility
Analysis is not required under the Regulatory Flexibility Act (5
U.S.C. chapter 6). Pursuant to section 7805(f) of the Internal
Revenue Code, the notice of proposed rulemaking preceding these
regulations was submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
Drafting Information
The principal authors of these regulations are Jeanne M.
Sullivan and David J. Sotos of the Associate Chief Counsel
(Passthroughs and Special Industries). However, other personnel from
Treasury and the IRS participated in their development.
List of Subjects
26 CFR Part 1 Income taxes, Reporting and recordkeeping
requirements.
26 CFR Part 602 Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations Accordingly, 26 CFR parts
1 and 602 are amended as follows:
PART 1-- INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
adding an entry in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1(h)-1 is also issued under 26 U.S.C. 1(h); * * *
Par. 2. Section 1.1(h)-1 is added to read as follows:
§1.1(h)-1 Capital gains look-through rule for sales or exchanges of
interests in a partnership, S corporation, or trust.
(a) In general. When an interest in a partnership held for
more than one year is sold or exchanged, the transferor may
recognize ordinary income (e.g., under section 751(a)), collectibles
gain, section 1250 capital gain, and residual long- term capital
gain or loss. When stock in an S corporation held for more than one
year is sold or exchanged, the transferor may recognize ordinary
income (e.g., under sections 304, 306, 341, 1254), collectibles
gain, and residual long-term capital gain or loss. When an interest
in a trust held for more than one year is sold or exchanged, a
transferor who is not treated as the owner of the portion of the
trust attributable to the interest sold or exchanged (sections 673
through 679) (a non-grantor transferor) may recognize collectibles
gain and residual long-term capital gain or loss.
(b) Look-through capital gain--(1) In general. Look-through
capital gain is the share of collectibles gain allocable to an
interest in a partnership, S corporation, or trust, plus the share
of section 1250 capital gain allocable to an interest in a
partnership, determined under paragraphs (b)(2) and (3) of this
section.
(2) Collectibles gain--(i) Definition. For purposes of this
section, collectibles gain shall be treated as gain from the sale or
exchange of a collectible (as defined in section 408(m) without
regard to section 408(m)(3)) that is a capital asset held for more
than 1 year.
(ii) Share of collectibles gain allocable to an interest in a
partnership, S corporation, or a trust. When an interest in a
partnership, S corporation, or trust held for more than one year is
sold or exchanged in a transaction in which all realized gain is
recognized, the transferor shall recognize as collectibles gain the
amount of net gain (but not net loss) that would be allocated to
that partner (taking into account any remedial allocation under
§1.704-3(d)), shareholder, or beneficiary (to the extent
attributable to the portion of the partnership interest, S
corporation stock, or trust interest transferred that was held for
more than one year) if the partnership, S corporation, or trust
transferred all of its collectibles for cash equal to the fair
market value of the assets in a fully taxable transaction
immediately before the transfer of the interest in the partnership,
S corporation, or trust. If less than all of the realized gain is
recognized upon the sale or exchange of an interest in a
partnership, S corporation, or trust, the same methodology shall
apply to determine the collectibles gain recognized by the
transferor, except that the partnership, S corporation, or trust
shall be treated as transferring only a proportionate amount of each
of its collectibles determined as a fraction that is the amount of
gain recognized in the sale or exchange over the amount of gain
realized in the sale or exchange. With respect to the transfer of an
interest in a trust, this paragraph (b)(2) applies only to transfers
by non-grantor transferors (as defined in paragraph (a) of this
section). This paragraph (b)(2) does not apply to a transaction that
is treated, for Federal income tax purposes, as a redemption of an
interest in a partnership, S corporation, or trust.
(3) Section 1250 capital gain--(i) Definition. For purposes
of this section, section 1250 capital gain means the capital gain
(not otherwise treated as ordinary income) that would be treated as
ordinary income if section 1250(b)(1) included all depreciation and
the applicable percentage under section 1250(a) were 100 percent.
(ii) Share of section 1250 capital gain allocable to interest
in partnership. When an interest in a partnership held for more than
one year is sold or exchanged in a transaction in which all realized
gain is recognized, there shall be taken into account under section
1(h)(7)(A)(i) in determining the partner’s unrecaptured section 1250
gain the amount of section 1250 capital gain that would be allocated
(taking into account any remedial allocation under §1.704-3(d)) to
that partner (to the extent attributable to the portion of the
partnership interest transferred that was held for more than one
year) if the partnership transferred all of its section 1250
property in a fully taxable transaction for cash equal to the fair
market value of the assets immediately before the transfer of the
interest in the partnership. If less than all of the realized gain
is recognized upon the sale or exchange of an interest in a
partnership, the same methodology shall apply to determine the
section 1250 capital gain recognized by the transferor, except that
the partnership shall be treated as transferring only a
proportionate amount of each section 1250 property determined as a
fraction that is the amount of gain recognized in the sale or
exchange over the amount of gain realized in the sale or exchange.
This paragraph (b)(3) does not apply to a transaction that is
treated, for Federal income tax purposes, as a redemption of a
partnership interest.
(iii) Limitation with respect to net section 1231 gain. In
determining a transferor partner’s net section 1231 gain (as defined
in section 1231(c)(3)) for purposes of section 1(h)(7)(B), the
transferor partner’s allocable share of section 1250 capital gain in
partnership property shall not be treated as section 1231 gain,
regardless of whether the partnership property is used in the trade
or business (as defined in section 1231(b)). (c) Residual long-term
capital gain or loss. The amount of residual long- term capital gain
or loss recognized by a partner, shareholder of an S corporation, or
beneficiary of a trust on account of the sale or exchange of an
interest in a partnership, S corporation, or trust shall equal the
amount of long-term capital gain or loss that the partner would
recognize under section 741, that the shareholder would recognize
upon the sale or exchange of stock of an S corporation, or that the
beneficiary would recognize upon the sale or exchange of an interest
in a trust (pre-look-through long- term capital gain or loss) minus
the amount of look-through capital gain determined under paragraph
(b) of this section.
(d) Special rule for tiered entities. In determining whether
a partnership, S corporation, or trust has gain from collectibles,
such partnership, S corporation, or trust shall be treated as owning
its proportionate share of the collectibles of any partnership, S
corporation, or trust in which it owns an interest either directly
or indirectly through a chain of such entities. In determining
whether a partnership has section 1250 capital gain, such
partnership shall be treated as owning its proportionate share of
the section 1250 property of any partnership in which it owns an
interest, either directly or indirectly through a chain of
partnerships.
(e) Notification requirements. Reporting rules similar to
those that apply to the partners and the partnership under section
751(a) shall apply in the case of sales or exchanges of interests in
a partnership, S corporation, or trust that cause holders of such
interests to recognize collectibles gain and in the case of sales or
exchanges of interests in a partnership that cause holders of such
interests to recognize section 1250 capital gain. See §1.751-1(a)
(3).
(f) Examples. The following examples illustrate the
requirements of this section:
Example 1. Collectibles gain. (i) A and B are equal partners
in a personal service partnership (PRS). B transfers B’s interest in
PRS to T for $15,000 when PRS’s balance sheet (reflecting a cash
receipts and disbursements method of accounting) is as follows:
ASSETS
Adjusted Market
Basis Value
Cash.................................... $ 3,000 $3,000
Loans Owed to Partnership................ 10,000 10,000
Collectibles....................... 1,000 3,000
Other Capital Assets............... 6,000 2,000
Capital Assets............................ 7,000 5,000
Unrealized Receivables...................... 0 14,000
Total $20,000 $32,000
LIABILITIES AND CAPITAL
Liabilities............................. $ 2,000 $ 2,000
Capital:
A...................................... 9,000 15,000
B...................................... 9,000 15,000
Total................................ $20,000 $32,000
(ii) At the time of the transfer, B has held the interest in
PRS for more than one year, and B’s basis for the partnership
interest is $10,000 ($9,000 plus $1,000, B’s share of partnership
liabilities). None of the property owned by PRS is section 704(c)
property. The total amount realized by B is $16,000, consisting of
the cash received, $15,000, plus $1,000, B’s share of the
partnership liabilities assumed by T. See section 752. B’s undivided
one-half interest in PRS includes a one-half interest in the
partnership’s unrealized receivables and a one-half interest in the
partnership’s collectibles.
(iii) If PRS were to sell all of its section 751 property in a
fully taxable transaction for cash equal to the fair market value of
the assets immediately prior to the transfer of B’s partnership
interest to T, B would be allocated $7,000 of ordinary income from
the sale of PRS’s unrealized receivables. Therefore, B will
recognize $7,000 of ordinary income with respect to the unrealized
receivables. The difference between the amount of capital gain or
loss that the partner would realize in the absence of section 751
($6,000) and the amount of ordinary income or loss determined under
§1.751-1(a)(2) ($7,000) is the partner’s capital gain or loss on the
sale of the partnership interest under section 741. In this case,
the transferor has a $1,000 pre-look-through long-term capital loss.
(iv) If PRS were to sell all of its collectibles in a fully
taxable transaction for cash equal to the fair market value of the
assets immediately prior to the transfer of B’s partnership interest
to T, B would be allocated $1,000 of gain from the sale of the
collectibles. Therefore, B will recognize $1,000 of collectibles
gain on account of the collectibles held by PRS.
(v) The difference between the transferor’s pre-look-through
long-term capital gain or loss (-$1,000) and the look-through
capital gain determined under this section ($1,000) is the
transferor’s residual long-term capital gain or loss on the sale of
the partnership interest. Under these facts, B will recognize a
$2,000 residual long-term capital loss on account of the sale or
exchange of the interest in PRS.
Example 2. Special allocations. Assume the same facts as in
Example 1, except that under the partnership agreement, all gain
from the sale of the collectibles is specially allocated to B, and B
transfers B’s interest to T for $16,000. All items of income, gain,
loss, or deduction of PRS, other than the gain from the
collectibles, are divided equally between A and B. Under these
facts, B’s amount realized is $17,000, consisting of the cash
received, $16,000, plus $1,000, B’s share of the partnership
liabilities assumed by T. See section 752. B will recognize $7,000
of ordinary income with respect to the unrealized receivables
(determined under §1.751-1(a)(2)). Accordingly, B’s pre-look-through
long-term capital gain would be $0. If PRS were to sell all of its
collectibles in a fully taxable transaction for cash equal to the
fair market value of the assets immediately prior to the transfer of
B’s partnership interest to T, B would be allocated $2,000 of gain
from the sale of the collectibles. Therefore, B will recognize
$2,000 of collectibles gain on account of the collectibles held by
PRS. B will recognize a $2,000 residual long-term capital loss on
account of the sale of B’s interest in PRS.
Example 3. Net collectibles loss ignored. Assume the same
facts as in Example 1, except that the collectibles held by PRS have
an adjusted basis of $3,000 and a fair market value of $1,000, and
the other capital assets have an adjusted basis of $4,000 and a fair
market value of $4,000. (The total adjusted basis and fair market
value of the partnership’s capital assets are the same as in Example
1.) If PRS were to sell all of its collectibles in a fully taxable
transaction for cash equal to the fair market value of the assets
immediately prior to the transfer of B’s partnership interest to T,
B would be allocated $1,000 of loss from the sale of the
collectibles. Because none of the gain from the sale of the interest
in PRS is attributable to unrealized appreciation in the value of
collectibles held by PRS, the net loss in collectibles held by PRS
is not recognized at the time B transfers the interest in PRS. B
will recognize $7,000 of ordinary income (determined under
§1.751-1(a)(2)) and a $1,000 long-term capital loss on account of
the sale of B’s interest in PRS.
Example 4. Collectibles gain in an S corporation. (i) A
corporation (X) has always been an S corporation and is owned by
individuals A, B, and C. In 1996, X invested in antiques. Subsequent
to their purchase, the antiques appreciated in value by $300. A owns
one-third of the shares of X stock and has held that stock for more
than one year. A’s adjusted basis in the X stock is $100. If A were
to sell all of A’s X stock to T for $150, A would realize $50 of
pre-look-through long-term capital gain.
(ii) If X were to sell its antiques in a fully taxable
transaction for cash equal to the fair market value of the assets
immediately before the transfer to T, A would be allocated $100 of
gain on account of the sale. Therefore, A will recognize $100 of
collectibles gain (look-through capital gain) on account of the
collectibles held by X.
(iii) The difference between the transferor’s pre-look-
through long-term capital gain or loss ($50) and the look-through
capital gain determined under this section ($100) is the
transferor’s residual long-term capital gain or loss on the sale of
the S corporation stock. Under these facts, A will recognize $100 of
collectibles gain and a $50 residual long-term capital loss on
account of the sale of A’s interest in X.
Example 5. Sale or exchange of partnership interest where
part of the interest has a short-term holding period. (i) A, B, and
C form an equal partnership (PRS). In connection with the formation,
A contributes $5,000 in cash and a capital asset with a fair market
value of $5,000 and a basis of $2,000; B contributes $7,000 in cash
and a collectible with a fair market value of $3,000 and a basis of
$3,000; and C contributes $10,000 in cash. At the time of the
contribution, A had held the contributed property for two years. Six
months later, when A’s basis in PRS is $7,000, A transfers A’s
interest in PRS to T for $14,000 at a time when PRS’s balance sheet
(reflecting a cash receipts and disbursements method of accounting)
is as follows:
ASSETS
Adjusted Market
Basis Value
Cash ..................... $22,000 $22,000
Unrealized Receivables .... 0 6,000
Capital Asset ...... 2,000 5,000
Collectible ........ 3,000 9,000
Capital Assets ............ 5,000 14,000
Total ............. 27,000 $42,000
(ii) Although at the time of the transfer A has not held A’s
interest in PRS for more than one year, 50 percent of the fair
market value of A’s interest in PRS was received in exchange for a
capital asset with a long-term holding period. Therefore, 50 percent
of A’s interest in PRS has a long-term holding period. See
§1.1223-3(b)(1).
(iii) If PRS were to sell all of its section 751 property in
a fully taxable transaction immediately before A’s transfer of the
partnership interest, A would be allocated $2,000 of ordinary
income. Accordingly, A will recognize $2,000 ordinary income and
$5,000 ($7,000 - $2,000) of capital gain on account of the transfer
to T of A’s interest in PRS. Fifty percent ($2,500) of that gain is
long-term capital gain and 50 percent ($2,500) is short-term capital
gain. See §1.1223-3(c)(1).
(iv) If the collectible were sold or exchanged in a fully
taxable transaction immediately before A’s transfer of the
partnership interest, A would be allocated $2,000 of gain
attributable to the collectible. The gain attributable to the
collectible that is allocable to the portion of the transferred
interest in PRS with a long-term holding period is $1,000 (50
percent of $2,000). Accordingly, A will recognize $1,000 of
collectibles gain on account of the transfer of A’s interest in PRS.
(v) The difference between the amount of pre-look-through
long-term capital gain or loss ($2,500) and the look-through capital
gain ($1,000) is the amount of residual long-term capital gain or
loss that A will recognize on account of the transfer of A’s
interest in PRS. Under these facts, A will recognize a residual
long-term capital gain of $1,500 and a short-term capital gain of
$2,500.
(g) Effective date. This section applies to transfers of
interests in partnerships, S corporations, and trusts that occur on
or after September 21, 2000.
Par. 3. Section 1.741-1 is amended by adding paragraphs (e) and (f)
to read as follows:
§1.741-1 Recognition and character of gain or loss on sale or
exchange. * * * * *
(e) For rules relating to the capital gain or loss recognized
when a partner sells or exchanges an interest in a partnership that
holds appreciated collectibles or section 1250 property with section
1250 capital gain, see § 1.1(h)-1. This paragraph (e) applies to
transfers of interests in partnerships that occur on or after
September 21, 2000
(f) For rules relating to dividing the holding period of an
interest in a partnership, see §1.1223-3. This paragraph (f) applies
to transfers of partnership interests and distributions of property
from a partnership that occur on or after September 21, 2000.
Par. 4. Section 1.1223-3 is added under the undesignated
center heading "General Rules for Determining Capital Gains and
Losses" to read as follows: §1.1223-3 Rules relating to the holding
periods of partnership interests.
(a) In general. A partner shall not have a divided holding
period in an interest in a partnership unless--
(1) The partner acquired portions of an interest at different
times; or
(2) The partner acquired portions of the partnership interest
in exchange for property transferred at the same time but resulting
in different holding periods (e.g., section 1223).
(b) Accounting for holding periods of an interest in a
partnership--(1) General rule. The portion of a partnership interest
to which a holding period relates shall be determined by reference
to a fraction, the numerator of which is the fair market value of
the portion of the partnership interest received in the transaction
to which the holding period relates, and the denominator of which is
the fair market value of the entire partnership interest (determined
immediately after the transaction).
(2) Special rule. For purposes of applying paragraph (b)(1) of
this section to determine the holding period of a partnership
interest (or portion thereof) that is sold or exchanged (or with
respect to which gain or loss is recognized upon a distribution
under section 731), if a partner makes one or more contributions of
cash to the partnership and receives one or more distributions of
cash from the partnership during the one-year period ending on the
date of the sale or exchange (or distribution with respect to which
gain or loss is recognized under section 731), the partner may
reduce the cash contributions made during the year by cash
distributions received on a last-in-first-out basis, treating all
cash distributions as if they were received immediately before the
sale or exchange (or at the time of the distribution with respect to
which gain or loss is recognized under section 731).
(3) Deemed contributions and distributions. For purposes of
paragraphs (b)(1) and (2) of this section, deemed contributions of
cash under section 752(a) and deemed distributions of cash under
section 752(b) shall be disregarded to the same extent that such
amounts are disregarded under §1.704–1(b)(2)(iv)(c).
(4) Adjustment with respect to contributed section 751
assets. For purposes of applying paragraph (b)(1) of this section to
determine the holding period of a partnership interest (or portion
thereof) that is sold or exchanged, if a partner receives a portion
of the partnership interest in exchange for property described in
section 751(c) or (d) (section 751 assets) within the one-year
period ending on the date of the sale or exchange of all or a
portion of the partner’s interest in the partnership, and the
partner recognizes ordinary income or loss on account of such a
section 751 asset in a fully taxable transaction (either as a result
of the sale of all or part of the partner’s interest in the
partnership or the sale by the partnership of the section 751
asset), the contribution of the section 751 asset during the one-
year period shall be disregarded. However, if, in the absence of
this paragraph, a partner would not be treated as having held any
portion of the interest for more than one year (e.g., because the
partner’s only contributions to the partnership are contributions of
section 751 assets or section 751 assets and cash within the prior
one-year period), this adjustment is not available.
(5) Exception. The Commissioner may prescribe by guidance
published in the Internal Revenue Bulletin (see §601.601(d)(2) of
this chapter) a rule disregarding certain cash contributions
(including contributions of a de minimis amount of cash) in applying
paragraph (b)(1) of this section to determine the holding period of
a partnership interest (or portion thereof) that is sold or
exchanged
(c) Sale or exchange of all or a portion of an interest in a
partnership--(1) Sale or exchange of entire interest in a
partnership. If a partner sells or exchanges the partner’s entire
interest in a partnership, any capital gain or loss recognized shall
be divided between long-term and short-term capital gain or loss in
the same proportions as the holding period of the interest in the
partnership is divided between the portion of the interest held for
more than one year and the portion of the interest held for one year
or less.
(2) Sale or exchange of a portion of an interest in a
partnership- (i) Certain publicly traded partnerships. A selling
partner in a publicly traded partnership (as defined under section
7704(b)) may use the actual holding period of the portion of a
partnership interest transferred if--
(A) The ownership interest is divided into identifiable units
with ascertainable holding periods;
(B) The selling partner can identify the portion of the
partnership interest transferred; and
(C) The selling partner elects to use the identification
method for all sales or exchanges of interests in the partnership
after September 21, 2000. The selling partner makes the election
referred to in this paragraph (c)(2)(i)(C) by using the actual
holding period of the portion of the partner’s interest in the
partnership first transferred after September 21, 2000, in reporting
the transaction for federal income tax purposes.
(ii) Other partnerships. If a partner has a divided holding
period in a partnership interest, and paragraph (c)(2)(i) of this
section does not apply, then the holding period of the transferred
interest shall be divided between long-term and short-term capital
gain or loss in the same proportions as the long-term and short-term
capital gain or loss that the transferor partner would realize if
the entire interest in the partnership were transferred in a fully
taxable transaction immediately before the actual transfer.
(d) Distributions--(1) In general. Except as provided in
paragraph (b)(2) of this section, a partner’s holding period in a
partnership interest is not affected by distributions from the
partnership.
(2) Character of capital gain or loss recognized as a result
of a distribution from a partnership. If a partner is required to
recognize capital gain or loss as a result of a distribution from a
partnership, then the capital gain or loss recognized shall be
divided between long-term and short-term capital gain or loss in the
same proportions as the long-term and short-term capital gain or
loss that the distributee partner would realize if such partner’s
entire interest in the partnership were transferred in a fully
taxable transaction immediately before the distribution.
(e) Section 751(c) assets. For purposes of this section,
properties and potential gain treated as unrealized receivables
under section 751(c) shall be treated as separate assets that are
not capital assets as defined in section 1221 or property described
in section 1231.
(f) Examples. The provisions of this section are illustrated
by the following examples:
Example 1. Division of holding period--contribution of money
and a capital asset. (i) A contributes $5,000 of cash and a
nondepreciable capital asset A has held for two years to a
partnership (PRS) for a 50 percent interest in PRS. A’s basis in the
capital asset is $5,000, and the fair market value of the asset is
$10,000. After the exchange, A’s basis in A’s interest in PRS is
$10,000, and the fair market value of the interest is $15,000. A
received one-third of the interest in PRS for a cash payment of
$5,000 ($5,000/$15,000). Therefore, A’s holding period in one-third
of the interest received (attributable to the contribution of money
to the partnership) begins on the day after the contribution. A
received two-thirds of the interest in PRS in exchange for the
capital asset ($10,000/$15,000). Accordingly, pursuant to section
1223(1), A has a two-year holding period in two-thirds of the
interest received in PRS.
(ii) Six months later, when A’s basis in PRS is $12,000 (due
to a $2,000 allocation of partnership income to A), A sells the
interest in PRS for $17,000. Assuming PRS holds no inventory or
unrealized receivables (as defined under section 751(c)) and no
collectibles or section 1250 property, A will realize $5,000 of
capital gain. As determined above, one-third of A’s interest in PRS
has a holding period of one year or less, and two-thirds of A’s
interest in PRS has a holding period equal to two years and six
months. Therefore, one-third of the capital gain will be short-term
capital gain, and two-thirds of the capital gain will be long-term
capital gain.
Example 2. Division of holding period--contribution of
section 751 asset and a capital asset. A contributes inventory with
a basis of $2,000 and a fair market value of $6,000 and a capital
asset which A has held for more than one year with a basis of $4,000
and a fair market value of $6,000, and B contributes cash of $12,000
to form a partnership (AB). As a result of the contribution, one-
half of A’s interest in AB is treated as having been held for more
than one year under section 1223(1). Six months later, A transfers
one-half of A’s interest in AB to C for $6,000, realizing a gain of
$3,000. If AB were to sell all of its section 751 property in a
fully taxable transaction immediately before A’s transfer of the
partnership interest, A would be allocated $4,000 of ordinary income
on account of the inventory. Accordingly, A will recognize $2,000 of
ordinary income and $1,000 of capital gain ($3,000 - $2,000) on
account of the transfer to C. Because A recognizes ordinary income
on account of the inventory that was contributed to AB within the
one year period ending on the date of the sale, the inventory will
be disregarded in determining the holding period of A’s interest in
AB. All of the capital gain will be long-term.
Example 3. Netting of cash contributions and distributions.
(i) On January 1, 2000, A holds a 50 percent interest in the capital
and profits of a partnership (PS). The value of A’s PS interest is
$900, and A’s holding period in the entire interest is long- term.
On January 2, 2000, when the value of A’s PS interest is still $900,
A contributes $100 to PS. On June 1, 2000, A receives a distribution
of $40 cash from the partnership. On September 1, 2000, when the
value of A’s interest in PS is $1,350, A contributes an additional
$230 cash to PS, and on October 1, 2000, A receives another $40 cash
distribution from PS. A sells A’s entire partnership interest on
November 1, 2000, for $1,600. A’s adjusted basis in the PS interest
at the time of the sale is $1,000.
(ii) For purposes of netting cash contributions and
distributions in determining the holding period of A’s interest in
PS, A is treated as having received a distribution of $80 on
November 1, 2000. Applying that distribution on a last-in-first-out
basis to reduce prior contributions during the year, the
contribution made on September 1, 2000, is reduced to $150 ($230 -
$80). The holding period then is determined as follows: Immediately
after the contribution of $100 on January 2, 2000, A’s holding
period in A’s PS interest is 90 percent long-term ($900/($900 +
$100)) and 10 percent short-term ($100/($900 + $100)). The
contribution of $150 on September 1, 2000, causes 10 percent of A’s
partnership interest ($150/($1,350 + $150)) to have a short-term
holding period. Accordingly, immediately after the contribution on
September 1, 2000, A’s holding period in A’s PS interest is 81
percent long-term (.90 x .90) and 19 percent short-term ((.10 x .90)
+ .10). Accordingly, $486 ($600 x .81) of the gain from A’s sale of
the PS interest is long-term capital gain, and $114 ($600 x .19) is
short-term capital gain.
Example 4. Division of holding period when capital account
is increased by contribution. A, B, C, and D are equal partners in a
partnership (PRS), and the fair market value of a 25 percent
interest in PRS is $100. A, B, C, and D each contribute an
additional $100 to partnership capital, thereby increasing the fair
market value of each partner’s interest to $200. As a result of the
contribution, each partner has a new holding period in the portion
of the partner’s interest in PRS that is attributable to the
contribution. That portion equals 50 percent ($100/$200) of each
partner’s interest in PRS.
Example 5. Sale or exchange of a portion of an interest in a
partnership. (i) A, B, and C form an equal partnership (PRS). In
connection with the formation, A contributes $5,000 in cash and a
capital asset (capital asset 1) with a fair market value of $5,000
and a basis of $2,000; B contributes $7,000 in cash and a capital
asset (capital asset 2) with a fair market value of $3,000 and a
basis of $3,000; and C contributes $10,000 in cash. At the time of
the contribution, A had held the contributed property for two years.
Six months later, when A’s basis in PRS is $7,000, A transfers one-
half of A’s interest in PRS to T for $7,000 at a time when PRS’s
balance sheet (reflecting a cash receipts and disbursements method
of accounting) is as follows:
ASSETS
Adjusted Market
Basis Value
Cash ...................... $22,000 $22,000
Unrealized Receivables ...... 0 6,000
Capital Asset 1 ..... 2,000 5,000
Capital Asset 2 ..... 3,000 9,000
Capital Assets .............. 5,000 14,000
Total ............ $27,000 $42,000
(ii) Although at the time of the transfer A has not held A’s
interest in PRS for more than one year, 50 percent of the fair
market value of A’s interest in PRS was received in exchange for a
capital asset with a long-term holding period. Therefore, 50 percent
of A’s interest in PRS has a long-term holding period.
(iii) If PRS were to sell all of its section 751 property in
a fully taxable transaction immediately before A’s transfer of the
partnership interest, A would be allocated $2,000 of ordinary
income. One-half of that amount ($1,000) is attributable to the
portion of A’s interest in PRS transferred to T. Accordingly, A will
recognize $1,000 ordinary income and $2,500 ($3,500 - $1,000) of
capital gain on account of the transfer to T of one-half of A’s
interest in PRS. Fifty percent ($1,250) of that gain is long-term
capital gain and 50 percent ($1,250) is short-term capital gain.
Example 6. Sale of units of interests in a partnership. A
publicly traded partnership (PRS) has ownership interests that are
segregated into identifiable units of interest. A owns 10 limited
partnership units in PRS for which A paid $10,000 on January 1,
1999. On August 1, 2000, A purchases five additional units for
$10,000. At the time of purchase, the fair market value of each unit
has increased to $2,000. A’s holding period for one-third
($10,000/$30,000) of the interest in PRS begins on the day after the
purchase of the five additional units. Less than one year later, A
sells five units of ownership in PRS for $11,000. At the time, A’s
basis in the 15 units of PRS is $20,000, and A’s capital gain on the
sale of 5 units is $4,333 (amount realized of $11,000 - one-third of
the adjusted basis or $6,667). For purposes of determining the
holding period, A can designate the specific units of PRS sold. If A
properly identifies the five units sold as five of the ten units for
which A has a long-term holding period and elects to use the
identification method for all subsequent sales or exchanges of
interests in the partnership by using the actual holding period in
reporting the transaction on A’s federal income tax return, the
capital gain realized will be long-term capital gain.
Example 7. Disproportionate distribution. In 1997, A and B
each contribute cash of $50,000 to form and become equal partners in
a partnership (PRS). More than one year later, A receives a
distribution worth $22,000 from PRS, which reduces A’s interest in
PRS to 36 percent. After the distribution, B owns 64 percent of PRS.
The holding periods of A and B in their interests in PRS are not
affected by the distribution.
Example 8. Gain or loss as a result of a distribution--(i)
On January 1, 1996, A contributes property with a basis of $10 and a
fair market value of $10,000 in exchange for an interest in a
partnership (ABC). On September 30, 2000, when A’s interest in ABC
is worth $12,000 (and the basis of A’s partnership interest is still
$10), A contributes $12,000 cash in exchange for an additional
interest in ABC. A is allocated a loss equal to $10,000 by ABC for
the taxable year ending December 31, 2000, thereby reducing the
basis of A’s partnership interest to $2,010. On February 1, 2001,
ABC makes a cash distribution to A of $10,000. ABC holds no
inventory or unrealized receivables. (Assume that A is allocated no
gain or loss for the taxable year ending December 31, 2001, so that
the basis of A’s partnership interest does not increase or decrease
as a result of such allocations.)
(ii) The netting rule contained in paragraph (b)(2) of this
section provides that, in determining the holding period of A’s
interest in ABC, the cash contribution made on September 30, 2000,
must be reduced by the distribution made on February 1, 2001.
Accordingly, for purposes of determining the holding period of A’s
interest in ABC, A is treated as having made a cash contribution of
$2,000 ($12,000 - $10,000) to ABC on September 30, 2000. A’s holding
period in one-seventh of A’s interest in ABC ($2,000 cash
contributed over the $14,000 value of the entire interest
(determined as if only $2,000 were contributed rather than $12,000))
begins on the day after the cash contribution. A recognizes $7,990
of capital gain as a result of the distribution. See section 731(a)
(1). One-seventh of the capital gain recognized as a result of the
distribution is short-term capital gain, and six-sevenths of the
capital gain is long-term capital gain. After the distribution, A’s
basis in the interest in PRS is $0, and the holding period for the
interest in PRS continues to be divided in the same proportions as
before the distribution.
(g) Effective date. This section applies to transfers of
partnership interests and distributions of property from a
partnership that occur on or after September 21, 2000. PART 602--OMB
CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT Par. 5. The
authority citation for part 602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 6. In § 602.101, paragraph (b) is amended by adding an
entry in numerical order to the table to read as follows: §602.101
OMB Control numbers.
* * * * *
(b) * * *
_____________________________________________________________
CFR part or section where Current OMB identified and described
control No.
_____________________________________________________________
1.1(h)-1(e).........................................1545-1654
* * * * *
_____________________________________________________________
Robert E. Wenzel
Deputy Commissioner of Internal Revenue
Approved: 8/29/00
Jonathan Talisman
Acting Assistant Secretary of the Treasury
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