Page 344 - TaxAdviser_2022

Sec. 732 and its
regulations do
not address basis

allocations on
distributions of partial
interests in property.

of the distributed shares in the hands
of the partnership for Sec. 732 pur-
poses. This item examines two alterna-
tive approaches:
1. Apportion basis relative to the stock’s
FMV; or
2. Apportion basis by applying the prin-
ciples of Sec. 704(c). Partner A’s basis in its partnership corresponding loss in its partnership
Under an FMV approach (and as- interest is $190. Upon distribution of interest. Under the Sec. 704(c) approach,
suming Partner B has sufficient outside the $180 cash proceeds to Partner A in however, the basis purchased by Partner
basis to avoid a step-down under Sec. liquidation, Partner A recognizes a $10 A remains with Partner A; as a result,
732(b)), the distributed stock would capital loss ($180 of cash over its basis upon sale of the stock, Partner A recog-
have a tax basis of $10 (i.e., $1 dollar of $190), recouping the excess gain that nizes gain equal to its economic share
per share), leaving $90 of basis in the it was initially allocated. Partner B is not of the gain (i.e., $80) with no offsetting
stock remaining in the partnership. entitled to a liquidating distribution and loss trapped in the partner’s interest.
Alternatively, if Sec. 704(c) principles generally recognizes no gain or loss upon
were taken into account, the distributed the termination of its interest. However, Review of authority
stock basis would be zero, to account to the extent Partner B’s outside tax Sec. 732 and its regulations do not ad-
for Partner A’s $100 capital contribu- basis was supported by debt, Partner B dress basis allocations on distributions of
tion being used to purchase the stock may recognize gain upon repayment of partial interests in property. The FMV
being distributed to Partner B. This the debt under Secs. 752 and 731. approach described above is derived
Sec. 704(c) approach maintains the $80 Under a Sec. 704(c) approach, the from Regs. Sec. 1.61-6(a), which pro-
of built-in gain allocable to Partner A resulting gain from the sale of the stock vides that the basis of the entire property
(further demonstrated below) and leaves is $80 ($180 amount realized over $100 must be “equitably apportioned” among
$100 of basis in the stock remaining in tax basis). The entire $80 of gain is al- the divided parts (i.e., sold portions)
the partnership. locable to Partner A because Partner B’s of the property in order to calculate
Now assume further that the partner- profits interest was previously satisfied. gain on the sale of a partial interest in
ship immediately sells the remaining Immediately thereafter, Partner A’s basis property. Although equitable apportion-
stock for its residual value of $180, satis- in its interest is $180, which is reduced ment is not defined, the regulation’s two
fies all debt, and distributes the cash in to zero upon the receipt of the $180 examples use relative FMV to apportion
liquidation to its partners. cash in liquidation. No further gain or basis among divisible properties.
Under an FMV approach, the result- loss is recognized by either Partner A or Notwithstanding Regs. Sec. 1.61-6,
ing gain from the sale of the stock is Partner B. the IRS has applied the equitable ap-
$90 ($180 amount realized over $90 tax The practical effect of the FMV portionment standard without regard to
basis). The entire $90 gain is allocable basis approach under these facts is to FMV. For example, in Rev. Rul. 84-53,
to Partner A because Partner B’s profits shift basis from Partner A (i.e., the the IRS examined the sale of a partial PHOTO BY ANDRII YALANSKYI/ISTOCK
interest was previously satisfied, resulting economic buyer of the stock basis) to partnership interest. In Situations 1
in $10 more of gain allocable to Partner Partner B. Partner A is initially required through 3 of the ruling, the IRS applied
A than Partner A was economically enti- to recognize excess gain, which can only an FMV approach where the partner’s
tled to (i.e., $80). Immediately thereafter, be offset by the later recognition of a basis in its interest exceeded its share

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