Page 89 - TaxAdviser_Jan_Apr23_Neat

PARTNERS & PARTNERSHIPS

A partnership interest is not considered of like kind to real property
and thus does not qualify for Sec. 1031 exchange treatment.

The withdrawing partners filed Character of partner’s loss Sec. 1221(a)(1) and thus were capital.
Forms 8082 contesting the income The character of a loss was at issue in a The taxpayer alternatively argued that
allocations. The IRS audited the part- case24 in 2022 in which a taxpayer and the lots were inventory as defined in
nership return and issued an FPAA his colleague formed a partnership that Sec. 751(d) and that, pursuant to Sec.
that disregarded the distributions and purchased lots for investment purposes. 735(a), they retained their inventory
redetermined the allocations of ordi- Before any lots were sold or distrib- character from the partnership. There-
nary income, contending that the dis- uted, the partnership did not make fore, he argued, he was allowed an
tributions had not been substantiated any improvements to develop the lots. ordinary loss upon their sale within five
and that the corresponding allocations Later, some of the lots were distributed years of the partnership’s distribution.
of income lacked substantial economic to the taxpayer, and he sold them at The court also rejected this argument.
effect. The partnership petitioned the a loss. The taxpayer reported the loss
Tax Court. as ordinary. Final regulations address
The Tax Court agreed with the The character of income reported foreign stock owned through
partnership and rejected the IRS’s de- by a partner is generally determined domestic partnerships
termination to disregard the distribu- at the partnership level. In this situa- In 2018, Treasury and the IRS issued
tions. Instead, the court found that the tion, the IRS determined that the loss proposed regulations regarding the
distribution treatment was correct and on the sale should be capital and not treatment of domestic partnerships
that the partnership’s method for valu- ordinary, as reported. It noted that the for purposes of determining amounts
ing the distributions met the definition lots were purchased by the partner- included in the gross income of their
of fair market value (FMV) under ship for investment purposes, not for partners with respect to controlled
Regs. Sec. 1.704-1(b)(2)(iv)(h)(1). development; therefore, any losses at foreign corporations for purposes of
However, the court also found that the the partnership level would have been Sec. 951A.25 In 2019, these proposed
partnership’s special income allocations capital. It also indicated that, even regulations were finalized in modi-
to the withdrawing partners lacked if the lots were initially intended for fied form26 and additional proposed
substantial economic effect because the development, the development plan was regulations issued (the 2019 proposed
partnership had not maintained capital abandoned well before the lots were regulations)27 that would extend the
accounts for the partners. Thus, the distributed and that no improvements treatment of domestic partnerships as
distributions did not meet the require- were in fact made. Other factors that aggregates of their partners for pur-
ments under Regs. Sec. 1.704-1(b)(2)(iv) indicated the loss was capital included poses of determining income inclusions
for maintaining capital accounts and that the sale was an isolated transaction under Sec. 951 and provisions appli-
had to be reallocated in accordance for the taxpayer and that the taxpayer’s cable by reference to it. Then, in 2020,
with the partnership interests under regular business was a law practice, not Treasury and the IRS finalized the por-
Sec. 704(b) and Regs. Sec. 1.704-1(b) real estate. The facts that the taxpayer tions of the 2019 proposed regulations
(3). In addition, since the withdrawing hired a broker and advertised the lots relating to Secs. 951A and 954 address-
partners had negative capital accounts for sale were not enough to counter the ing the treatment of income subject to
at the end of the year and the partner- other facts. a high rate of foreign tax.28
ship agreement included a qualified The Tax Court agreed with the In 2022, Treasury and the IRS final-
income offset provision, ordinary in- IRS and concluded that the lots in ized an additional portion of the 2019
come had to be allocated first to those the taxpayer’s hands were neither his proposed regulations.29 These final reg-
partners in the amount necessary to stock in trade, inventory, nor property ulations apply to U.S. persons that own
bring their respective capital accounts held primarily for sale to customers in stock of foreign corporations through
up to zero. the ordinary course of business under domestic partnerships and domestic

24. Musselwhite, T.C. Memo. 2022-57. 27. REG-101828-19.
25. REG-104390-18. 28. T.D. 9902.
26. T.D. 9866. 29. T.D. 9960.

34 February 2023 The Tax Adviser