Time to adjust: adding to the list of partnership revaluation events.

• Author: Stoner, Megan

The regulations under Sec. 704(b) provide a safe harbor under which the IRS will respect a partnership's allocations as having economic effect (Regs. Sec. 1.704-1(b)(2)(ii)(b)). The requirements of the safe harbor are that the partnership must maintain the partners' capital accounts in accordance with the Sec. 704(b) capital accounting rules, that upon liquidation, the partnership must make liquidating distributions in accordance with the partners' positive capital account balances, and that a partner is unconditionally obligated to restore a deficit capital account balance following a liquidation of the partner's partnership interest.

The capital account generally should reflect a partner's equity in the partnership. The Sec. 704(b) capital account maintenance rules require the partnership to credit a partner's capital account with the amount of cash or net fair market value (FMV) of property invested in the partnership. The capital account is further adjusted to reflect the partner's additional capital contributions, allocable shares of partnership income and loss, and any distributions of cash or other property. In addition, the capital account maintenance rules permit a partnership to revalue its assets and restate the partners' capital accounts to reflect each partner's economic share of the underlying assets at FMV, but only if the adjustments are made principally for a substantial nontax business purpose in connection with specific events. These events are commonly referred to as "revaluation events."

Regs. Sec. 1.704-1(b)(2)(iv)(f) permits a partnership to revalue its property in connection with: (1) contributions of money or property by a new or existing partner in exchange for a partnership interest; (2) distributions of money or property to a partner as consideration for a partnership interest; (3) the grant of a partnership interest in exchange for services; (4) the issuance of a noncompensatory option; and (5) under GAAP, if the partnership is a securities partnership (substantially all the assets of which are readily traded on an established securities market).

The enumerated revaluation events generally are considered to be events that change the economic entitlements of the partners. In other words, an adjustment to the capital accounts is warranted to "true up" the partners' capital accounts just prior to the change in economics by allocating to the partners any unrealized income, gain, loss, or deduction inherent in the...