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TAX CLINIC

of liabilities (i.e., positive tax capital). 704(c), particularly when Sec. 704(c) equitable result. With respect to nontax-
In Situation 4, however, where the became mandatory in 1984. Further, able distributions of partial interests
partner had negative tax capital, the IRS regulations under other provisions of the in partnership property, Sec. 732 is
calculated gain on the sale of a partial 1954 Code take Sec. 704(c) principles silent on the issue, but there are several
partnership interest by allocating basis as into account. For example, former Regs. examples in the Code, regulations, and
a function of the liabilities relieved. The Sec. 1.751-1(a)(2) (T.D. 6175) required legislative history that take Sec. 704(c)
IRS’s approach in Situation 4 reflects the that Sec. 704(c) principles be taken into principles into account in determining
apparent flexibility of the equitable ap- account when determining a partner’s basis. As reflected in the example above,
portionment standard, indicating that in share of inside tax basis in a hypotheti- a Sec. 704(c) approach could result in
cases where FMV apportionment leads cal distribution of property. an arguably more correct economic out-
to an inequitable result, another metric Regs. Secs. 1.704-3(a)(8) and come without creating disparity, shifting
could be viewed as appropriate. 1.743-1(d) look to Sec. 704(c) principles basis, or trapping losses that otherwise
Because the regulations address when determining a partner’s inside would occur under an FMV approach.
transactions in which gain is realized, basis of partnership property in specific However, it is unclear whether a Sec.
it is unclear how Regs. Sec. 1.61-6(a) circumstances (e.g., partnership contri- 704(c) approach would conform to the
may apply in the context of a property butions of stock in a Sec. 351 exchange, requirements of Sec. 732 and Regs. Sec.
distribution in which gain is not recog- and the allocation of Sec. 743(b) adjust- 1.61-6(a).
nized. It is also unclear to what extent ments), but not in the context of a dis- From Timothy Steitz, CPA, J.D.,
Sec. 704(c) principles could be used tribution of a partial interest in property. LL.M., Washington, D.C.
as a mechanism to maintain equity in Finally, the preamble to the final
basis apportionment under Regs. Sec. and temporary and proposed regula- A practical guide to
1.61-6(a), which is silent on this issue tions under Sec. 337(d) and Sec. 732(f) partnership division planning
(as it only applies equitable apportion- highlights the uncertainty of applying Sec. 708(b)(2)(B) and Regs. Sec.
ment in the context of FMV). Sec. 704(c) in the context of a distribu- 1.708-1(d) govern the tax treatment
tion of corporate stock. In an effort to of partnership divisions. This item
Potential availability of preclude basis shifting, Treasury and the provides an overview of the division
Sec. 704(c) principles IRS requested comments on whether rules and touches on some key issues to
Additional guidance on whether Sec. additional guidance should be given consider when a transaction involves a
704(c) principles can be used as a “under section 732 providing that on partnership division.
measure of “equitable apportionment” a distribution of a partial interest in
is found in Sec. 704(c) itself and in the partnership property, the basis of the Definitions
way other provisions of the Code and distributed property in the hands of the Regs. Sec. 1.708-1(d)(4) introduces
regulations apply Sec. 704(c) for basis distributee partner is determined by four definitions specific to partnership
allocation purposes. Sec. 704(c) specifi- taking the principles of section 704(c) divisions: (1) divided partnership, (2)
cally allocates income, gain, loss, and de- into account” (T.D. 9722). It is unclear recipient partnership, (3) prior partner-
duction — but not tax basis. However, whether Treasury and the IRS view ship, and (4) resulting partnership.
Sec. 704(c) principles have been applied such guidance as necessary to apply Sec. The divided partnership is the con-
for purposes of allocating basis among 704(c) principles in a Sec. 732 context tinuing partnership, which is treated as
distributed properties. or whether it would be viewed as clari- transferring the assets and liabilities to
The 1954 legislative history of Sec. fying current law. Regardless, it appears the recipient partnership. A recipient
704(c) describes an approach that al- that Treasury and the IRS would view partnership, in turn, is a partnership
locates the tax basis of contributed the application of Sec. 704(c) principles that is treated as receiving assets and li-
property between the contributing and as a potentially viable method of pre- abilities from a divided partnership.
noncontributing partners “for purposes venting basis shifting in the context of a The prior partnership is the partner-
of computing depreciation, depletion, property distribution. ship subject to division. A resulting
and gain or loss upon sale but not in partnership is a partnership resulting
the case of distributions” (S. Rep’t No. Takeaway from the division that has at least two
83-1622, 83d Cong., 2d Sess., p. 93 The broad requirement that basis be partners who were partners in the
(June 18, 1954)). This carveout for equitably apportioned could be viewed prior partnership.
distributions was not meaningfully ad- as allowing flexibility in determining The divided partnership and a recip-
dressed in subsequent versions of Sec. basis when FMV does not provide an ient partnership are U.S. federal income

14 July 2022 The Tax Adviser