IRS Finalizes Regs on Reporting Partnership Related Party Basis Shifting Transactions

(Parker Tax Publishing January 2025)

The IRS issued final regulations that identify certain partnership related-party basis adjustment transactions and substantially similar transactions as transactions of interest, a type of reportable transaction. The regulations, which finalize proposed regulations issued in June of 2024 (REG-124593-23), increase the threshold amount for a basis increase in a transaction of interest from $5 million to $25 million for tax years before 2025, and $10 million thereafter. T.D. 10028.

Background

A distribution by a partnership of the partnership's property or a transfer of an interest in a partnership may result in an adjustment to the basis of the distributed property, partnership property, or both. A key factor is whether an election made by the partnership under Code Sec. 754 (i.e., a Section 754 election) is in effect. If a Section 754 election is in effect for a partnership, the basis of its partnership property will be adjusted, in the case of a distribution of property, in the manner provided by Code Sec. 734, and in the case of a transfer of a partnership interest, in the manner provided in Code Sec. 743.

Code Sec. 732 applies to determine a distributee partner's basis in distributed property other than money. In the case of a distribution of partnership property other than in liquidation of the distributee partner's partnership interest (current distribution), Code Sec. 732(a)(1) generally provides that the distributee partner's basis in distributed property equals the partnership's adjusted basis in the distributed property immediately before the distribution. Under Code Sec. 732(a)(2), however, a distributee partner's basis in distributed property is limited to the adjusted basis of the distributee partner's partnership interest reduced by any money distributed to such partner in the same transaction.

In the case of a distribution of partnership property in liquidation of the distributee partner's partnership interest (liquidating distribution), Code Sec. 732(b) provides that the distributee partner's basis in distributed property equals the adjusted basis of the distributee partner's partnership interest reduced by any money distributed to such partner in the same transaction. In the case of a distribution of more than one property from a partnership, the basis of the distributed properties to which Code Sec. 732(a)(2) and (b) apply must be allocated among the distributed properties under the rules of Code Sec. 732(c). Code Sec. 732(d) through (f) provide additional rules applicable to certain distributed property.

Proposed Regulations

In June of 2024, the IRS issued proposed regulations under Code Sec. 6011 (REG-124593-23). The proposed regulations would have added Reg. Sec. 1.6011-18 identifying certain partnership related party basis adjustment transactions as transactions of interest for purposes of Code Secs. 6011, 6111, and Code Sec. 6112 and Reg. Sec. 1.6011-4(b)(6).

Observation: The IRS stated in the preamble to the proposed regulations that the proposed rules were aimed at related persons using partnerships to engage in transactions that inappropriately exploit the basis adjustment rules in Code Sec. 734 and Code Sec. 743. According to the IRS, these transactions are carefully structure to exploit the mechanical basis adjustment provisions of

Subchapter K to produce significant tax benefits with little or no economic impact on the related parties, and in a manner that would not be a likely arrangement between partners negotiating at arm's-length.

In Prop. Reg. Sec. 1.6011-18(a), the proposed regulations identified transactions that are the same as or substantially similar to transactions described in Prop. Reg. Sec. 1.611-18(c) as transactions of interest for purposes of Reg. Sec. 1.6011-4(b)(6). Prop. Reg. Sec. 1.6011-18(c) included a relatedness requirement and a $5 million minimum threshold requirement.

Under Prop. Reg. Sec. 1.6011-18(c), a transaction of interest is a transaction the factual elements of which are described in Prop. Reg. Sec. 1.6011-18(c)(1)(i) through (iii) or (c)(2). A basis adjustment transaction under Prop. Reg. Sec. 1.6011-18(c)(1)(i) would occur when a partnership makes a current or liquidating distribution of property to a partner who is related to one or more partners, the partnership increases the basis of one or more of its remaining properties under Code Sec. 734(b) and (c), and the $5 million threshold was met. A basis adjustment transaction under Prop. Reg. Sec. 1.6011-18(c)(1)(ii) would occur when a partnership distributes property to a partner who is related to one or more partners in liquidation of a partnership interest (or in complete liquidation of the partnership), the basis of one or more distributed properties is increased under Code sec. 732(b) and (c), and the $5 million threshold was met. A basis adjustment transaction under Prop. Reg. Sec. 1.6011-18(c)(1)(iii) would occur when a partnership distributes property to a partner who is related to one or more partners, the basis of one or more distributed properties is increased under Code Sec. 732(d), the related partner acquired all or a part of its interest in the partnership in a transaction that would have been a transaction described in Prop. Reg. Sec. 1.6011-18(c)(2) if the partnership had a Code Sec. 754 election in effect for the year of transfer, and the $5 million threshold was met. A basis adjustment transaction under Prop. Reg. Sec. 1.6011-18(c)(2) would occur when a partner transfers an interest in the partnership to a related transferee or to a person who is related to one or more existing partners in a nonrecognition transaction, the basis of one or more partnership properties is increased under Code Sec. 743(b)(1) and (c), and the $5 million threshold was met.

T.D. 10028

On January 14, the IRS issued final regulations in T.D. 10028 that adopt the proposed regulations with modification in response to practitioners' comments. Among other changes, the final regulations (1) adopt a six-year lookback period for required disclosures, and (2) increase the threshold amount for reporting from $5 million to $25 million for transactions occurring within the six-year lookback period and $10 million for transactions after the lookback period.

Lookback Period for Required Disclosures

Under Prop. Reg. Sec. 1.6011-18(3)(2)-(4), a participating partnership, participating partner, or related subsequent transferee would have participated in a transaction of interest in any tax year in which it participates in a transaction described in Prop. Reg. Sec. 1.6011-18(c). Additionally, a participating partnership, participating partner, or related subsequent transferee would have participated in a transaction of interest in any tax year in which its tax return reflected the tax consequences of a basis increase resulting from a transaction described in Prop. Reg. Sec. 1.6011-18(c) (subsequent realization of tax benefit rule). Therefore, under the proposed regulations, as a result of the subsequent realization of tax benefit rule, a transaction that occurred many years ago could require reporting if a taxpayer's tax return in an open tax year reflected the tax consequences (such as cost recovery deductions) arising from the transaction of interest.

Practitioners commented that the subsequent realization of tax benefit rule would be unduly burdensome and they recommended eliminating the retroactive effect of that rule. The IRS agreed with this suggestion. Thus, the final regulations adopt a six-year lookback period for required disclosures. Under the final regulations, for a tax year described in Reg. Sec. 1.6011-4(e)(2)(i), a participant must provide the information described in the final regulations only if the transaction of interest occurred within the six-year lookback period. Reg. Sec. 1.6011-18(b)(11) of the final regulations provides that the six-year lookback period means the seventy-two months immediately preceding the first month of the taxpayer's most recent tax year that began before January 14, 2025.

Threshold Amount for Reporting

Under Prop. Reg. Sec. 1.6011-18(c)(3), a partnership related-party basis adjustment transaction would have included those transactions in which the total basis increases from all transactions described in Prop. Reg. Sec. 1.6011-18(c)(1) or (2), (d)(1) or (2) engaged in by the same partner or partnership during the tax year (without netting for any basis adjustment that results in a basis decrease in the same transaction or another transaction), reduced by the gain recognized, if any, on which federal income tax is required to be paid by any of the related parties to the transaction, equal or exceed $5 million. Accordingly, a transaction of a partner or partnership that resulted in a basis increase of less than $5 million would have been a transaction of interest under the proposed regulations if, in the same tax year, the partner or partnership participated in another related party basis shifting transaction or transactions if, in the aggregate, the transactions resulted in a basis increase that equals or exceeds $5 million, without regard to any basis decrease resulting from the transactions and after reducing the resulting aggregate amount by the gain recognized, if any, on which federal income tax is required to be paid by any of the related parties to the transactions.

In comments, many practitioners asserted that the $5 million threshold was too low, particularly considering the aggregation requirement, and would catch common business transactions. The IRS determined that increasing the threshold would reduce the administrative burden imposed on taxpayers. Accordingly, the final regulations provide that, in the case of related-party basis adjustment transactions occurring within the six-year lookback period described in Reg. Sec. 1.6011-18(c)(3)(ii), the applicable threshold amount is $25 million. For related-party basis adjustment transactions occurring after the six-year lookback period, the final regulations provide an applicable threshold amount of $10 million.

In each case, the applicable threshold amount is met for a tax year if the sum of all related party basis increases resulting from all transactions described in the final regulations of a participant during the tax year (without netting for any downward basis adjustment in the same transaction or another transaction) exceeds by at least the applicable threshold amount the gain recognized from such transactions, if any, on which federal income tax is required to be paid by any of the related partners (or tax-indifferent party) who are a party to such transactions. If the applicable threshold amount is met for a tax year, all transactions of the participant described in the final regulations for the tax year are reportable as transactions of interest regardless of whether an individual transaction meets the applicable threshold amount.

For a discussion of partnership related party basis adjustment transactions, see Parker Tax ¶24,670.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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