Proposed regulations eliminate deemed distributions on technical termination of partnerships.

• Author: Fox, Gary A.

Background

Sec. 708(b)(1)(B) provides that if within a 12-month period there is a sale or exchange of 50% or more of the total interest in partnership capital or profits, a partnership shall be considered terminated. However, the Code and legislative history do not specify the tax consequences or steps by which the termination occurs. Regs. Sec. 1.7081(b)(1)(iv) has interpreted Sec. 708(b)(1)(B) to provide that on termination the partnership distributes its assets and liabilities to the purchaser and the other continuing partners in proportion to their respective partnership interests, and the purchaser and other continuing partners contribute these assets and liabilities to a new partnership. This deemed distribution could result in taxable gain to a continuing partner (under Sec. 731(a)) and may affect the basis of the partnership property in the hands of the new partnership (under Sec. 732(b)). Also, the holding period of the partners, interests in the partnership may be affected.

Deemed Distribution

The deemed distribution raises concerns as to its interaction with other partnership provisions, specifically Secs. 704(c) and 737. Sec. 704(c) provides that, if property is contributed by a partner and distributed to another partner within a five-year period, the contributing partner must recognize gain or loss in an amount equal to the gain or loss the partner would have been allocated on a sale of the property by the partnership. Sec. 737 provides that property distributed to a partner who contributed other property to the partnership within five years must recognize gain equal to the lesser of the partners net precontribution gain or the excess of the value of die distributed property over the adjusted basis of the partners interest.

The legislative history of Secs. 704(c) and 737 indicates that these sections are to be coordinated with the Sec. 708(b)(1)(B) termination provisions. The deemed distribution regulations under Sec. 708(b)(1)(B), as noted, indicate that the deemed distributions are made pro rata. The pro rata deemed distribution under these regulations appears to conflict with Secs. 704(c) and 737, which contemplate that Partnership property previously contributed will be distributed to...