Casting a wide net: aggregate allocations for partners in investment partnerships.

• Author: Ross, Laura L.
• Position: Investmentregs

Investment partnerships. often referred to a, hedge funds. allocate capital gains to partners based 1.113011 the regulations that expand upon MC Sec. 704(c), which addresses property contributions. It's often not inherently obvious to the investor's tax adviser that the gains will be allocated using a method other than ownership percentage.

Investment partnerships are subject to multiple withdrawals and contributions during the course of the year by the partners. When the partner's ownership percentage changes due to one of these events, there is a "break." and each period of different ownership percentage is referred to as a "break period." Book income, which includes unrealized gains. is allocated to the partners by ownership percentage within each break period.

Because partners have been in the partnership for varying periods of time with varying ownership percentages. their accumulation of unrealized gains may not mimic current ownership percentage. When securities are sold and capital gains are realized, it's then that preparers must turn to keg. Secs. 1.704-(e)(3)(iv) and 1.704(e)(3)(v) to determine how to prepare allocations with substantial economic effect.

Methods of Aggregate Allocation

See, 1.704(e)(3)(v) describes the full-netting appnroach, and See. 1.704(e)(3)(iv) describes the partial-netting approach. Both are methods of aggregate allocation, which means the realized gains and losses are aggregated prior to doing the allocation.

Under the full-netting method, realized gains and losses are netted together to derive a net figure to allocate. Under partial netting. realized gains and losses are aggregated and allocated separately. This analysis will focus on the full-netting method, though in this particular example partial netting would obtain the same result.

Assume Partners A and B form a partnership Jan. 1,2015, with each contributing $100,000 in cash. The partnership then purchases $100,000 of Stock X and $100,000 of Stock Y. Stock X has appreciated to $160,000, and Stock Y has depreciated to $90,000 as of Aug. 31, 2015. The capital accounts and portfolio are shown in Figure 1.

The difference till each partner's hook capital account and tax basis is tracked by investment partnerships for the purpose of capital gain allocations. This account may be referred to as a "revalue account," a "reverse 704(e) account" or a "disparity account." Note in Figure 1 example, the total appreciation of the portfolio ties exactly to the...