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with the LTP’s business interest expense that the amount of income to be rechar-
(BIE), the UTP treats any BIE paid or acterized under Sec. 1061 is determined The IRS has been
accrued by the LTP as a nondeductible solely by the owner taxpayer. An owner
noncapitalizable expenditure solely for taxpayer and a passthrough taxpayer diligent in examining
purposes of Sec. 704(b). The UTP treats each are treated as a taxpayer for the transactions that it
the UTP EBIE as a nondepreciable purpose of determining the existence of
capital asset with a value of zero and a an API under Sec. 1061(c). considers to lack
economic substance
tax basis equal to the amount of UTP The regulations also make clear that
EBIE. A direct or indirect UTP partner once a partnership interest is an API, or to be a sham
that has a Sec. 704(b) capital account it remains an API and never loses that
transaction.
reduction because of UTP EBIE is a character, unless one of the exceptions
“specified partner,” and UTP EBIE is to the definition of an API applies.
tracked to each “specified partner” and The final regulations provide that if a
their transferees. partnership disposes of an asset, it is the electing real property trade or business
The final regulations also provide partnership’s holding period in the asset for property that meets the definition of
that if a partner disposes of a partner- that controls. If a partner disposes of “qualified property.” In response, the IRS
ship interest, the adjusted basis of the an API, generally the partner’s holding issued Rev. Proc. 2021-29, which allows
partnership interest is increased im- period in the API controls. partnerships to file amended returns for
mediately before the disposition by the The final regulations also include a 2018, 2019, and 2020 if they want to
entire amount of the partner’s remaining limited “lookthrough rule.” In the case change their depreciation method for
EBIE (basis addback rule). Partners also of a taxable disposition of a directly held this type of property. The revenue pro-
may now add back a proportionate basis API with a holding period of more than cedure also explains how a partnership
on partial sales of partnership interests. three years, the lookthrough rule applies under the centralized partnership audit
Partnerships are required to create a new if the assets of the partnership in which regime that wishes to change its recovery
block of “inert” basis in the assets equal the API is held meet a “substantially all period under Sec. 168(g) of the Code for
to the amount added back on the sale test.” The substantially all test generally such property may do so without filing
or distribution. would be met if 80% or more of the an administrative adjustment request.
assets of the partnership include assets
Carried interests that would produce capital gain or loss Audit issues
The TCJA added Sec. 1061 to the that is not excluded from the rules of Before summarizing recent develop-
Internal Revenue Code. Sec. 1061 gov- Sec. 1061 and that have a holding period ments related to partnership audits, a
erns how to treat partnership income of three years or less. If the lookthrough broad overview may be helpful. Back
allocated to a partner that has a carried rule applies, a percentage of the gain or in 1982, the Tax Equity and Fiscal
interest. Generally, income allocated to a loss on the sale is potentially subject to Responsibility Act (TEFRA)8 enacted
carried interest will be treated as a short- Sec. 1061(a) recharacterization, based on “unified audit rules” to simplify IRS au-
term capital gain instead of a long-term the relative gain inside the partnership dits of large partnerships by determining
capital gain. on a hypothetical sale of the partner- partnership tax items at the partnership
In February 2021, Treasury released ship’s assets at the aggregate fair market level. Any adjustments would then flow
final regulations6 under Sec. 1061. The value (FMV). through to the partners, whom the IRS
final regulations include general defini- would assess deficiencies. Two issues
tions, guidance, and rules specific to CARES Act that arose frequently under TEFRA
applicable partnership interests (APIs) Under the Coronavirus Aid, Relief, and concerned partnership-level items of
and applicable trades or businesses Economic Security (CARES) Act,7 Sec. income and the statute of limitation for
and exceptions to the definition of an 168 was amended so that qualified im- the partners and the partnership.
API. They also provide computational provement property now meets the defi- In an effort to streamline the audit
and operational rules, rules for certain nition of “qualified property” for bonus process for large partnerships, Congress
related-partner transfers of an API, and depreciation purposes. Thus, bonus enacted Section 1101 of the Bipartisan
reporting rules. The regulations spell out depreciation would be available to an Budget Act of 2015 (BBA),9 which

6. T.D. 9945. 8. Tax Equity and Fiscal Responsibility Act of 1982, P.L. 97-248.
7. Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136. 9. Bipartisan Budget Act of 2015, P.L. 114-74.

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