Don't forget the mandatory application of sec. 732(d).

AuthorKim, Grace

Determining a partner's tax basis in properties distributed from a partnership to the partner can be a complicated endeavor. The analysis typically involves more than just ascertaining the basis of the properties in the hands of the partnership and the partner's basis in the partnership interest and knowing whether the properties have appreciated or depreciated.

Numerous provisions (e.g., Secs. 707(a)(2)(B), 704(c)(1)(B), 737, 7.51(b), 736, and 731(c)) may apply in determining the tax consequences of the distribution and, in turn, affect the bases of the distributed properties. Once the Sec. 732 basis rules come into play, there may still be unanticipated complications in the form of Sec. 732(d). In particular, the mandatory piece of the provision, which is often overlooked, contains uncertainties in its application and can be difficult to apply as a practical matter.

Sec. 732(d) applies to situations in which a partnership does not have a Sec. 754 election in effect and a partner who would have a positive Sec. 743(b) adjustment if the partnership had a Sec. 754 election in effect receives a current or liquidating distribution of property from the partnership. When Sec. 732(d) applies, the adjusted partnership basis of the property distributed to the transferee partner is treated as the adjusted partnership basis the property would have if the adjustment in Sec. 743(b) were in effect.

This treatment is provided as either an elective or a mandatory application under Sec. 732(d). A partner may elect, under regulations prescribed by Treasury, to apply the special basis adjustment of Sec. 732(d) in determining its basis of the distributed property under the rules of Secs. 732(a), (b), and (c). However, Treasury may by regulations require such application of the Sec. 732(d) special basis adjustment if at the time of the transfer the fair market value (FMV) of the property (other than money) exceeded 110% of its adjusted basis to the partnership. As discussed below, in 1956, Treasury issued regulations concerning the mandatory application of Sec. 732(d). This item focuses on the latter (mandatory) piece of Sec. 732(d) and issues in applying it.

Background to Sec. 732(d)

Some background on Sec. 732(d) may assist in understanding its purpose and also whether it continues to prevent the perceived tax-advantaged result that it was originally intended to address. Sec. 732(d) appears initially to have been intended to prevent distortions caused by Sec. 732(c) that might inflate the basis of depreciable, depletable, or amortizable property above its FMV. When Sec. 732(d) was originally enacted in 1954, the basis allocation rules under Sec. 732(c) looked to the relative bases of the distributed assets regardless of whether the assets' bases were increased or decreased from the partnership's bases in those assets under Sec. 732(a)(2) or Sec. 732(b), as relevant.

Prior to 1997, after allocation of the partner's basis in its partnership interest to unrealized receivables and inventory items distributed in an amount equal to the adjusted basis of each property to the partnership (or if the basis to be allocated was less than the sum of the adjusted bases of those properties to the partnership, in proportion to those bases), any remaining basis was to be allocated to any other distributed properties in proportion to their adjusted bases to the partnership. In 1997, Sec. 732(c) was amended in the Taxpayer Relief Act of 1997, P.L. 105-34, to read as follows:

(c) Allocation of basis. (1) In general. The basis of distributed properties to which subsection (a)(2) or (b) is...

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