Recent regs. significantly change taxation of certain partnership contributions.

• Author: Austin, Sean

On Jan. 18, 2017, Treasury and the IRS issued final and temporary regulations under Sec. 721(c) that generally override Sec. 721(a) nonrecognition treatment for certain contributions of property to partnerships (T.D. 9814). The Sec. 721(c) regulations build on and replace the rules set forth in Notice 2015-54, which was issued on Aug. 6,2015.

The IRS issued the Sec. 721(c) regulations in response to certain taxpayer positions relating to the allocation of income or gain from property contributed to a partnership. According to the preamble, some taxpayers have taken the position that income or gain associated with property contributed by a U.S. person can be allocated to a related foreign partner that is not subject to U.S. federal income tax in a manner that is consistent with Sees. 704(b), 704(c), and 482 (T.D. 9814, preamble). In those situations, the preamble notes that the applicable partnerships may have adopted Sec. 704(c) methods other than the remedial method or applied valuation techniques that do not reflect arm's-length principles.

Sec. 721 (c) regs. generally

Sec. 721(a) generally provides that when a partner contributes property to a partnership in exchange for an interest in the partnership, the partner and the partnership do not recognize gain or loss. The Sec. 721(c) regulations effectively turn off the general nonrecognition rule and require immediate gain recognition if a U.S. person (a U.S. transferor) transfers certain appreciated property (Sec. 721(c) property) to a domestic or foreign partnership in which the U.S. transferor and related persons, including at least one related foreign person, own 80% or more of the interests in the partnership's capital, profits, deductions, or losses following the transfer and any related transactions (a Sec. 721(c) partnership). The requirement that a U.S. transferor recognize gain on a transfer of Sec. 721(c) property to a Sec. 721(c) partnership is referred to in this item as the gain-recognition rule.

Sec. 721(c) property generally includes any property that has built-in gain at the time it is contributed to the partnership, other than (1) a cash equivalent; (2) a "security" within the meaning of Sec. 475(c)(2); (3) tangible property that has either built-in gain of $20,000 or less or built-in loss; and (4) an interest in a partnership that holds property 90% or more of the value of which consists of the items described in clauses (1) through (3). A "related person" for this...