Sec. 708(b)(2)(B) and Regs. Sec. 1. 708 - 1 (d) govern the tax treatment of partnership divisions. This item provides an overview of the division rules and touches on some key issues to consider when a transaction involves a partnership division.
Regs. Sec. 1. 708 - 1 (d)(4) introduces four definitions specific to partnership divisions: (1) divided partnership, (2) recipient partnership, (3) prior partnership, and (4) resulting partnership.
The divided partnership is the continuing partnership, which is treated as transferring the assets and liabilities to the recipient partnership. A recipient partnership, in turn, is a partnership that is treated as receiving assets and liabilities from a divided partnership.
The prior partnership is the partnership subject to division. A resulting partnership is a partnership resulting from the division that has at least two partners who were partners in the prior partnership.
The divided partnership and a recipient partnership are U.S. federal income tax concepts, while the prior partnership and a resulting partnership are the legal entities under applicable law.
Any resulting partnership is considered a continuation of the prior partnership if the members of the resulting partnership had an interest of more than 50% 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 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. Contrast this treatment with the partnership merger rules, in which the regulations determine which entity is the surviving partnership based on relative value (Regs. Sec. 1. 708 - 1 (c)(1)).
Regs. Sec. 1. 708 - 1 (d)(3) provides two choices of form: assets - over and assets - up . The assets - over form is the default method if no form of a division is specified. The assets - over form is more common because the assets - up form requires the partners to be treated, under the laws of the applicable jurisdiction, as the owner of the assets (i.e., it requires the legal transfer and retitling of assets).
Assets-over form:
Assets-up form:
Under either the assets - over or assets - up form, every partnership division contains a contribution into a partnership and a distribution out of a partnership. While partnership contributions and distributions generally are nonrecognition transactions, numerous exceptions could result in a taxable transaction.
Below is a checklist to help consider the U.S. federal income tax consequences of some of these exceptions.
Secs. 721(b) and 721(c): Contributions into a partnership are not tax-deferred if the investment company or related foreign partner exceptions apply.
Sec. 751(b) — disproportionate distributions: Distributions that result in a shift in any partner's share of "hot" or "cold" assets are treated as a sale or exchange of the property between the distributee and the partnership.
If disproportionate distributions are made, consider whether Prop. Regs. Sec. 1. 751 - 1 (b) may help address this concern.
Secs. 731(a) and 752(b) — deemed distributions from liability shifts: The decrease in a partner's share of liabilities, or any decrease in a partner's individual liabilities by reason of the assumption by the partnership of the individual liabilities, is considered a distribution of money to the partner by the partnership. In addition, a partner recognizes gain to the extent that any money distributed exceeds the adjusted basis of the partner's interest in the partnership.
Secs. 704(c)(1)(B) and 737 — the "mixing-bowl rules": The mixing-bowl rules are intended to prevent partners from using a partnership to swap property in a nonrecognition transaction. If a partner has contributed property within the past seven years and either (1) that property is distributed to a different partner, or (2) different property is distributed to the contributing partner, then tax-deferred treatment is turned off and gain may be recognized.
Note that the partnership division will restart the seven - year clock for any mixing - bowl applicable transactions on a go - forward basis for a recipient or resulting partnership. Consider also the application of the successor rules under Regs. Secs. 1. 704 - 4 (d)(2) and 1. 737 - 1 (c)(2)(iii) on the deemed contribution of assets under the assets - over form.
Sec. 707(a)(2)(B) — the "disguised-sale rules": If a transfer of property by a partner to a partnership and one or more transfers of money or other consideration by the partnership to that partner are made, the transfers may be treated as a sale of property between the partner and partnership. Transfers made within two years are presumed to be a sale unless the facts and circumstances clearly establish that the transfers do not constitute a sale, and ordering does not matter.
Like the mixing - bowl rules, the contribution of property into a new partnership will restart a two - year clock to monitor disguised sales on a go - forward basis for a recipient or resulting partnership.
Editor Notes
Christine M. Turgeon, CPA, is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in New York City.
For additional information about these items, contact Ms. Turgeon at 973-202-6615 or christine.turgeon@pwc.com.
Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.