Guidance issued on the allocation of depreciation recapture from partnership dispositions.

• Author: Redman, Mark A.

On Dec. 11, 1996, the IRS issued proposed regulations on the allocation of depreciation recapture from the disposition of partnership property. The current regulations are unclear as to how depreciation recapture should be allocated under Sec. 704. Prior to the issuance of the proposed regulations, depreciation recapture was typically allocated to partners in the same manner as total gain. This technique increased the likelihood that the gain recapture was allocated in a method that differed from the allocation of the depreciation deductions that resulted in the recapture. Additionally, there was no guidance on the allocation of recapture gain from contributed property subject to Sec. 704(c). The proposed regulations (primarily revising Regs. Sec. 1.1245-1(e)(2)) are designed to achieve parity between those partners who received the depreciation deductions and those who are allocated the recapture.

Generally, a partner's distributive share of gain recognized under Sec. 1245(a)(1) by the partnership is the lesser of (1) the partner's share of the total gain from the sale of property or (2) the partner's share of the depreciation or amortization on the property. Any remaining recapture gain is allocated to the partners in proportion to their share of (but not in excess of) their total gain. A partner's share of depreciation or amortization on property equals the depreciation allowed or allowable that has been allocated to him. If a partner transfers an interest in the partnership, the previously allocated depreciation is also transferred to the transferee partner. A partner's share of depreciation or amortization with respect to his contributed property includes all depreciation or amortization allowed or allowable prior to the contribution. The depreciation allowed or allowable prior to contribution to a 1.704-3(c) or remedial allocations under Regs. Sec. 1.704-3(d).

Two examples, based on Regs. Sec. 1.1245- 1 (e) (2) (iv), show how these new rules are intended to work.

Example 1: A and B contribute $5,000 cash each to form AB, a general partnership. The partnership agreement provides that depreciation deductions will be allocated 90% to A and 10% to B, and, on the sale of depreciable property, A will first be allocated gain to the extent necessary to equalize A's and B's capital accounts. Any remaining gain will be allocated 50% to A and 50% to B. In its first year of operations, AB purchases depreciable equipment of $5,000. AB depreciates...