Tax planning using partnership divisions.

• Author: Ellentuck, Albert B.

Facts: Bruce and Harrison formed the Jackson Hole Development Partnership (JHD) in 1996 to develop resort properties in Wyoming. The partnership currently owns a hotel in Jackson Hole with a $1 million basis and a $2 million fair market value (FMV), and two undeveloped parcels of land, each with a $500,000 basis and a $1 million FMV. JHD needs an additional $1 million of capital to continue development activities.

The partners have asked Kevin to invest in their business. Kevin wants to invest in the hotel, but does not want to own land or participate in any ongoing development activities. He would like to invest in the hotel through an interest in a new entity that would not be subject to any of JHD's known or unknown liabilities. Bruce and Harrison do not want to recognize the gain that would result from selling an interest in JHD to Kevin. Issue: Can JHD structure a transaction using the partnership division rules to transfer a portion of the ownership?

Analysis

Under the partnership division rules, a transaction generally will be respected for tax purposes if the division is an "assets-up" or "assets-over" transaction. Generally, an assets-over transaction is one in which the dividing partnership transfers its assets to the resulting partnerships for interests in the latter. The divided partnership immediately distributes to its partners the interests in the resulting partnerships. An assets-up transaction is one in which the dividing partnership distributes its assets to its partners, who then contribute the assets to the resulting partnerships for interests in the latter. (For background on the partnership division final regulations, see MacNeil, Tax Clinic, "Partnership Mergers and Divisions," TTA, April 2001, p. 239.)

Under JHD's facts, it seems logical to transfer the hotel to a new partnership (or a limited liability company (LLC) classified as a partnership), then have Kevin make a $1 million contribution of capital to the new entity. This would be an assets-over transaction, because the old JHD would transfer assets to a new entity (e.g., JHDK), then transfer ownership interests in it to its existing partners (Bruce and Harrison). The transaction's form would be respected for Federal tax purposes; the property contribution to JHDK would be nontaxable under Sec. 721 and the distribution of JHDK interests to old JHD's partners would be nontaxable under Sec. 731.

Because old JHD's partners would own more than 50% of both new JHD...