IRS prohibits corporations from circumventing gain on appreciated property using partnerships.

• Author: Schreiber, Sally P.

The IRS issued more regulations in June that take aim at transactions that attempt to avoid the repeal of the General Utilities doctrine. T.D. 9722 contains new rules designed to prevent "a corporate partner from avoiding corporate-level gain through transactions with a partnership involving equity interests of the partner."

The General Utilities doctrine was repealed by the Tax Reform Act of 1986, P.L. 99-514. The doctrine grew out of General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935), a Supreme Court case permitting tax-free liquidations to allow taxpayers to avoid potential multiple taxation of the same economic gain.

After the repeal, the IRS became aware that taxpayers were using partnerships to postpone or avoid gain generally required to be recognized under Sec. 311(b). For example, a corporation would enter into a partnership and contribute appreciated property. The partnership would then acquire that corporate partner's stock and make a liquidating distribution of this stock to the corporate partner. Because of Sec. 731(a), the corporate partner would not recognize gain on the partnership's distribution of its stock. The corporation had thus disposed of the appreciated property it formerly held and had acquired its own stock, permanently avoiding recognizing gain on the appreciated property. If the corporation had directly exchanged the appreciated property for its own stock, under Sec. 311(b) the corporation would have been required to recognize gain on the exchange.

As part of its efforts to curb these transactions, the IRS issued proposed regulations in 1992. The proposed regulations (REG-208989-90), in particular, had two rules designed to curb these transactions: (1) the deemed redemption rule and (2) the distribution rule. The deemed redemption rule required a corporate partner to recognize gain at the time of, and to the extent that, any transaction (or series of transactions) that has the economic effect of the partner's exchange of its interest in appreciated property for an interest in its stock (or the stock of any member of the affiliated group of which such partner is a member) owned, acquired, or distributed by the partnership. The distribution rule required a partnership's distribution to a partner of the partner's stock be treated as a redemption or an exchange of the partner's stock for a portion of the partner's partnership interest with a value equal to the distributed stock.

The recently issued...