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Sect 704(c): Partnership and LLC ContributionsSect. 704(c): Partnership and LLC ContributionsNavigating Complex Rules and Electing Allocation Methods to Avoid Adverse Tax Consequences

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WEDNESDAY, JULY 6, 2011

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1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

David Patch Senior Director and Leader National Tax Pass-Throughs Group BDO USA Bethesda MdDavid Patch, Senior Director and Leader, National Tax Pass Throughs Group, BDO USA, Bethesda, Md.

Leo Hitt, Partner, Reed Smith, Pittsburgh

Telma Nadvorny, Senior Manager, Ernst & Young, Houston

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S ti ( ) P t hi d LLC Section 704(c): Partnership and LLC Contributions Seminar

July 6, 2011

David Patch, BDO USAdpatch@bdo.com

Telma Nadvorny, Ernst & Youngtelma.nadvorny@ey.com

Leo Hitt, Reed Smith lhitt@reedsmith.com

Today’s Program

Sect. 704(c) Fundamentals[Telma Nadvorny]

Slide 26

Reverse Sect. 704(c) Allocations[David Patch]

Slide 46

Distribution Of Sect. 704(c) Property, Partnership Mergers And Anti-Abuse Rules[Leo Hitt]

Slide 63

SECT 704(c) FUNDAMENTALSTelma Nadvorny, Ernst & Young

SECT. 704(c) FUNDAMENTALS

Disclaimer► Ernst & Young refers to the global organization of member firms of Ernst

& Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Li it d l t d i th U SLimited located in the U.S.

► This presentation is © 2011 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means electronic or mechanicaldistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is indistribution of this form or any of the material herein is prohibited and is in violation of U.S. and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party.

► The views expressed by the presenter in this webinar are not necessarily those of Ernst & Young LLP.

Disclaimer (Cont.)

► Any U.S. tax advice contained herein was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed under the Interval Revenue Code or applicable state or local tax laws.

Sect. 704(c): Introduction

► If the basis of contributed property differs from its §704(b) “book”► If the basis of contributed property differs from its §704(b) book value, §704(c)(1)(A) requires that income, gain, loss and deduction with respect to such property be allocated among the partners “so as to take account of the variation between the basis of the property to th t hi d it FMV t th ti f t ib ti ”the partnership and its FMV at the time of contribution.”

► Regulations require “a reasonable method that is consistent with the f §704( ) ”purpose of §704(c).”

► Sect. 704(c) principles also apply in the context of a §704(b) re al ation or “book p ” thro gh so called “re erse §704(c) ”revaluation, or “book-up,” through so-called “reverse §704(c).”

Interface Of §§704(b) And (c): Two Universes

► The purpose of §704(b) is to govern the economics; it looks to fair► The purpose of §704(b) is to govern the economics; it looks to fair market value upon contribution.

► Th f §704( ) i t t t bl i l i h t i► The purpose of §704(c) is to prevent taxable gain or loss inherent in property at the time of contribution from being shifted to another partner; it looks to the difference between adjusted tax basis and fair market value upon contributionmarket value upon contribution.

► Sect. 704(c) tax allocations are determined after §704(b) book allocations are determined.

Sect. 704(c) Available Methods

► Traditional method

► Traditional method with curative allocations

► Remedial method

► Other reasonable methods

Choice Of Method: Impact

► Method affects taxable income.► Method affects taxable income.► Partners have adverse interests — negotiate the method up front.► Method chosen is more important if property’s depreciable tax basis is

less than the non contributing partner’s aggregate share of book valueless than the non-contributing partner s aggregate share of book value (i.e., ceiling rule).

► If parties are in different tax positions, the choice of method may result in aggregate tax savings to parties that may be shared (subjectresult in aggregate tax savings to parties that may be shared (subject to anti-abuse rule).

► A partnership may retain flexibility by: (1) determining the method on t b t b i d (2) iti til th t hi ta property-by-property basis, and (2) waiting until the partnership must

report a §704(c) item on a tax return before choosing methods.

Mix-And-Match Rules

► Different methods allowed for different propertyp p y

► Different methods can apply for “forward” §704(c) and to each layer of “reverse” §704(c) in the same propertyof reverse §704(c) in the same property

► Must consistently apply method to item of property

► Overall mix-and-match must be reasonable

► Aggregation is possible for securities partnerships and a few others — see Treas. Reg. §1.704-3(e)

Traditional Method

► Operative rule – “tax follows book”p► Non-contributing partner receives tax allocations equal to its share

of book items.► Contributing partner receives residual tax allocations► Contributing partner receives residual tax allocations.

► Ceiling limitation► If there are insufficient tax items, non-contributing partners may

not receive tax allocations equal to their share of book items.

► Applies to gain or loss from sale of property and to depreciation and/or amortization; generally does not apply to income from the §704(c) property

Five-Step Approach

Step 1: Compute tax itemStep 1: Compute tax item

Step 2: Compute book item

Step 3: Allocate book item

Step 4: Allocate tax to non-contributing partner to the extent of its share of the book item

Step 5: Allocate residual tax, if any, to contributing/§704(c) partner

Example 2Traditional Method – Allocating Depreciationg p

Step 1: Compute annual tax depreciation $50/4 = $12 5 Money Co Op Co$50/4 = $12.5

Remaining tax life on

Money Co. Op. Co.

50% 50%Step 2: Compute annual book depreciation

$12.5/$50 x $100 = $25Step 3: Allocate book depreciation (50-50)

equipment: 4 years JV

EquipmentFMV=100

LandFMV=100

CashFMV=200

Step 4: Allocate tax depreciation to Money Co. (non-contributing partner) to extent of bookStep 5: Allocate residual tax depreciation (if any) to Op Co as contributing partner ATB=50 ATB=80ATB=200

O CM CJV(50%)(50%)Partnership

any) to Op. Co. as contributing partner

$12.5$12.5$25.0TaxBookTaxBookTaxBook

Op. Co.Money Co.JV

$12.5 $12.5 $0.0

$$$ $ $ $

Example 3Traditional Method: Allocating Gain On Saleg

Step 1: Compute partnership tax gain$100 - $50 = $50 Money Co. Op. Co.

50% 50%Step 2: Compute partnership book gain

$100 - $100 = $0Step 3: Allocate book gain (50-50)

EquipmentFMV=100ATB=50

LandFMV=100ATB=80

CashFMV=200ATB=200

Step 4: Allocate tax gain to Money Co. (non-contributing partner) to extent of book

Step 5: Allocate residual tax gain (if any) to Op Co as contributing partner

JV sells equipment for $100Op. Co. as contributing partner

Op. Co.Money Co.JV

$50.0$50.0 $0.0

Ceiling Rule

► Th R l T t l i i l d d ti ll t d t► The Rule: Total income, gain, loss or deduction allocated to non-contributing partners with respect to contributed property may not exceed total partnership income, gain, loss or deduction recognized by partnership with respect to that property for the taxable year (theby partnership with respect to that property for the taxable year (the ceiling rule).

► Impact: To the extent that tax items allocated to a non-contributing partner fall short of matching book items allocated to it, a portion of the built-in gain or loss is shifted to such partner.

Example 4: Illustration Of Ceiling Limitation

Step 1: Compute annual tax depreciation$40/4 = $10 Money Co Op Co$ $

Remaining tax life on equipment: 4 years

Money Co. Op. Co.

50% 50%Step 2: Compute annual book depreciation

$10/$40 x $100 = $25Step 3: Allocate book depreciation (50-50)

equipment: 4 years

EquipmentFMV=100ATB 40

LandFMV=100ATB 80

CashFMV=200ATB 200

Step 4: Allocate tax depreciation to Money Co. (non-contributing partner) to extent of book

Step 5: Allocate residual tax depreciation (if any) to Op Co as contributing partner

ATB=40 ATB=80ATB=200any) to Op. Co. as contributing partner

Op. Co.Money Co.JV

$0.0$10.0 $10.0

Traditional Method With Curative AllocationsAddressing Ceiling Limitationsg g

► This method is designed to help correct distortions created by the ceiling rule.

► Partnerships may make reasonable curative allocations to reduce or eliminate disparities between book and tax items of non-contributing

tpartners.

► Same five-step process as traditional method is followed, except that t it ( i /l /d i ti ) f th t d ttax items (gain/loss/depreciation) from other property are used to make up for some or all ceiling rule distortions in Step 4.

► T ll ti l ff t d b k ll ti ff t d► Tax allocations only are affected; book allocations are unaffected.

Traditional Method With Curative AllocationsAddressing Ceiling Limitations (Cont.)g g ( )

► Curative allocations must be reasonable in amount timing and type► Curative allocations must be reasonable in amount, timing and type.► Amount: Curative allocation can’t exceed ceiling distortion for that

year (or prior years, if cure is for ceiling limitation on disposition).► Timing: A curative allocation can offset ceiling distortions for► Timing: A curative allocation can offset ceiling distortions for

prior years if an allocation is made over the economic life of the property, and is provided for in the partnership agreement at time of contributionof contribution.

► Type: A curative allocation must be expected to have substantially the same effect on each partner’s tax liability as the tax item limited by the ceiling rule The expectation is generally tested at time theby the ceiling rule. The expectation is generally tested at time the property is contributed, and the curative allocation is made part of the partnership agreement.

Remedial Method

► Allows partnership to create (i e "fabricate") income and deduction► Allows partnership to create (i.e., fabricate ) income and deduction items

► N t d d t d f t hi it th l t l► Not dependent on adequacy of partnership items; thus completely prevents any ceiling rule limitations

► Remedial items have no effect on book capital accounts.

► Calculation of book depreciation is different than traditional or► Calculation of book depreciation is different than traditional or curative method.

Book Depreciation: Remedial Method

► Book basis of asset is split into two components:► Tax amount that equals the actual tax basis► Tax amount that equals the actual tax basis► Book amount calculated as excess of book basis over tax basis

► Amount of book basis equal to tax basis is recovered over remaining tax recovery period.

► Excess book basis is treated as new asset and depreciated over applicable asset life.

► Follow same five-step process as traditional method, except that remedial tax items are “made up” to equal ceiling limitations in Step 4.

General Rules For Planning: Which MethodIs Best For You Or Your Client?

► Generally, methods will differ only if the ceiling rule will apply. Otherwise, you reach the same result using the traditional method.y g► Note that the remedial method is available even if there is not a

current ceiling limitation as a protective measure for ceiling limited sale.

► If you are, or represent, a property contributor:► Negotiate for the traditional method (with potential for shifting tax

consequences to money partner)consequences to money partner)► Don’t want curatives — too fast a burn-off of built-in gain with

phantom income allocated to property contributor► C i di l► Compromise on remedials

► Especially if big book-up and long lives► Stretches out realization of built-in gain

General Rules For Planning: Which MethodIs Best For You Or Your Client? (Cont.)( )

► If you are, or represent, a cash contributor: ► Negotiate for curatives (if adequate items)

► Fastest expensing of investment► Especially if short remaining recovery cycle

► Don’t want traditional method with exposure for shifting p gtax consequences

► Compromise on remedials

REVERSE SECT 704(c) David Patch, BDO USA

REVERSE SECT. 704(c) ALLOCATIONS

Circular 230 Disclaimer

Any U.S. tax advice contained herein is not intended or written to be d d b d b f h f idi used, and cannot be used, by any taxpayer for the purpose of avoiding

penalties that may be imposed under the Internal Revenue Code or applicable state or local tax laws. You should consult with your professional tax advisor before taking any action based on information professional tax advisor before taking any action based on information presented during this webinar.

Section 704(c) Allocations

Reverse 704(c)Reverse 704(c)

• “Forward” 704(c)- Sect. 704(c) applies to contributed property to the extent that

its 704(b) basis (fair market value) is different than its tax basis at the time of contribution.

• “Reverse” 704(c)Reverse 704(c)- Revaluations may also cause a difference between a property’s

704(b) basis and its tax basis.- This difference is also subject to Sect 704(c)- This difference is also subject to Sect. 704(c).- The existing partners are considered “contributing” partners to

the extent of unrealized gain in the partnership’s property.

Revaluations

• Partnerships may revalue capital accounts upon certain events:• Partnerships may revalue capital accounts upon certain events:• Contributions in exchange for an interest• Distributions in exchange for an interest

G f f • Grant of an interest for services• Standard industry practice (hedge funds)

• Must reflect fair market value of partnership property

• Unrealized gain or loss allocated as if recognizedUnrealized gain or loss allocated as if recognized

• Technically optional, but generally necessary to preserve economic deal

Reverse 704(c)( )

A and B form equal partnership AB. $70 Each contributes $70, and AB buys

land for $140.$70

LandValue =$140Basis = $140

Reverse 704(c) (Cont.)( ) ( )

When the land is worth $200, AB $100

50% admits new partner C as an equal partner for $100. 50%

$10050%

LandValue =$200Basis = $140

Cash $100

AB Sells the land for $230

How should the gain be allocated?

Proceeds $230Basis $140Gain $ 90

$230Buyer

Reverse 704(c): Capital AccountsReverse 704(c): Capital Accounts

Without Revaluation

Beginning Capital 70 70Beginning Capital 70. 70.

Revaluation Gain 0. 0. 0.C’s Contribution 100.Gain On Sale 30. 30. 30.Ending Capital 100. 100. 130.

Taxable Gain 30. 30. 30.

Reverse 704(c): Capital Accounts (Cont )Reverse 704(c): Capital Accounts (Cont.)

With Revaluation

Beginning Capital 70 70Beginning Capital 70. 70.

Revaluation Gain 30. 30. 0.C’s Contribution 100.Gain On Sale 10. 10. 10.Ending Capital 110. 110. 110.

Taxable Gain 40. 40. 10.

A BConceptually, reverse 704(c) allocations

k if hi i d A B work as if a new partnership is created with every revaluation.

Property

ABCDProperty

704(c) Layers( ) y

Property A $10,000

50% 50%

Property ABasis = $4,000

Value = $10,000

$10,000

Tax Basis 704(b) Layer 1Property A $ 4,000 $10,000 $6,000

AB buys property AB for $10,000

p y , , ,Property AB $10,000 $10,000 $0

704(c) Layers (Cont )704(c) Layers (Cont.)

• Assumptions• Assumptions• $400 tax depreciation on Property A• $1,000 tax depreciation on Property AB

d l h d d

Total Depreciation B's share A's Share

• Traditional method is used

Tax Basis 704(b) Tax 704(b) Tax 704(b) Tax 704(b)

Property A 4,000 10,000 400 1,000 400 500 0 500

Property AB 10,000 10,000 1,000 1,000 500 500 500 500

704(c) Layers (Cont.)( ) y ( )

A B50% 50%

Tax Basis 704(b) Layer 1Property A $ 3,600 $9,000 $5,400p y $ , $ , $ ,Property AB $ 9,000 $9,000 $0

704(c) Layers (Cont.)( ) y ( )

BA BC25% 25%The actual values of properties A

and AB increase to $12,000 and

AB$30,000

50%$18,000. C is admitted as a 50% partner for $30,000. AB Buys property ABC for $30,000.

Properties A AB and ABC have tax

Tax Basis 704(b) Layer 1 Layer 2Property A $ 3,600 $12,000 $5,400 $3,000

Properties A, AB and ABC have tax depreciation of $400, $1,000 and $3,000, respectively

p y $ , $ , $ , $ ,Property AB $ 9,000 $18,000 $0 $9,000Property ABC $30,000 $30,000 $0 $0

Separate Layersp y

A BA B50% 50%

Separate Layer Approach

$30,000Tax Basis 704(b)Property A $ 3,600 $12,000

50%50%

Property AB $ 9,000 $18,000

Separate Layers (Cont )Separate Layers (Cont.)

ABC ABC Partnership Total Depreciation C's share AB's Share

Tax 704(b) Tax 704(b) Tax 704(b) Tax 704(b)

Property A 3,600 12,000 400 1,333 400 667 0 667p y , , ,

Property AB 9,000 18,000 1,000 2,000 1,000 1,000 0 1,000

Property ABC 30,000 30,000 3,000 3,000 1,500 1,500 1,500 1,500

AB Partnership Total Depreciation B's share A's Share

Tax Basis 704(b) Tax 704(b) Tax 704(b) Tax 704(b)

Property A 3 600 12 000 0 667 0 334 0 334Property A 3,600 12,000 0 667 0 334 0 334

Property AB 9,000 18,000 0 1,000 0 500 0 500

Property ABC 30,000 30,000 1,500 1,500 750 750 750 750

Collapsed Layersp y

A B CA B C

50%25% 25%

Collapsed Layer Approach

Basis 704(b) Ptr A Ptr B Ptr CProperty A $ 3,600 $12,000 $6,900 $1,500 $0

Share of 704(b)/Tax “Disparity”

p y $ , $ , $ , $ , $Property AB $ 9,000 $18,000 $4,500 $4,500 $0Property ABC $30,000 $30,000 $0 $0 $0

Collapsed Layers (Cont )Collapsed Layers (Cont.)

Property A Depreciation

A B Total Original 704(c) 5,400 - 5,400 Revaluation 1 500 1 500 3 000

Property A Depreciation

Revaluation 1,500 1,500 3,000 Total Basis Disparity 6,900 1,500 8,400 CY Depreciation Disparity 767 167 933

A B C Total 704(b) Depreciation 333 333 667 1,333 Less: CY Disparity (767) (167) - (933)Before Ceiling Rule (433) 167 667 400 Ceiling Rule Limitation 433 (87) (346) -

Tax Depreciation (0) 80 320 400

Aggregation For SecuritiesAggregation For SecuritiesPartnerships

• Investment partnershipsSEC i d i • SEC-registered management companies

• Applies only to qualified financial assets (QFAs)- Actively traded personal property (e.g., stock)- Expanded definition for management companies

• Allocations in proportion to capital• Reverse 704(c) allocations onlyReverse 704(c) allocations only

- IRS may grant permission to combine with forward 704(c).

Aggregation for SecuritiesAggregation for SecuritiesPartnerships (Cont.)

• Reverse Sect. 704(c) layers for all QFAs are combined into a “revaluation account” for each partner.

• All recognized gains and losses are allocated based on the relative g grevaluation accounts.

• Full netting - One combined revaluation account for both gains and lossesOne combined revaluation account for both gains and losses- All gains and losses allocated based on the single revaluation

account• Partial netting • Partial netting

- Separate revaluation accounts for gains and losses - Gains allocated based on gain revaluation account, losses based

on loss re al ation acco nt

on loss revaluation account

DISTRIBUTION OF SECT. Leo Hitt, Reed Smith

704(c) PROPERTY, PARTNERSHIP MERGERS AND PARTNERSHIP MERGERS AND ANTI‐ABUSE RULES

StraffordSect. 704(c): Partnership and LLC Contributions

Statutory Backstopping Of Sect. 704(c)

There are two potential ways to avoid Sect. 704(c)’s application that were addressed by statute. Property subject to the Sect. 704(c) allocation is distributed to

someone other than the contributing partner. [Sect. 704(c)(1)(B)]

Property, other than the property subject to the Sect. 704(c) allocation, is distributed to the contributing partner. [Sect. 737]

Statutory Backstopping Of Section 704(c) (Cont.)

Sect 704(c)(1)(B) Sect. 704(c)(1)(B) Contributing partner must recognize a gain or loss, if the

property contributed is distributed to another partner within seven years of the contributionseven years of the contribution.

The amount of the gain or loss recognized is the amount that would have been allocated to the contributing partner if the property had been sold for its fair market valueproperty had been sold for its fair market value.

The character of the gain or loss is treated as if sold to the distributee partner.

Statutory Backstopping Of Section 704(c) (Cont.)

Sect 704(c)(1)(B) (Cont ) Sect. 704(c)(1)(B) (Cont.) Consistent basis adjustments are made to the basis of the

contributing partner in the partnership and the distributed propertyproperty.

The gain or loss is recognized only by the contributing partner, not by the partnership or the other partners.

There are a number of exceptions, including: Certain transactions in which the built-in gain or loss is

preserved Incorporation transactions. if the partnership is liquidated Pre-effective date contributions (10/3/1989)

Statutory Backstopping Of Sect. 704(c)Sect. 704(c)(1)(B): Example

Susan contributed Susan contributed Property A Sect 704(c)Property A Sect 704(c)Property A, Sect. 704(c) Property A, Sect. 704(c) property, to PRS.property, to PRS.

Susan GabrielleContributes:Property AFMV = $100

PRSFMV = $100AB = $60

51 51© 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity.

Statutory Backstopping Of Sect. 704(c) Sect. 704(c)(1)(B): Example (Cont.)

If Property A is distributed by PRS withinIf Property A is distributed by PRS within

Susan contributed Property A, Susan contributed Property A, Sect. 704(c) property, to PRS.Sect. 704(c) property, to PRS.

If Property A is distributed by PRS within If Property A is distributed by PRS within seven years of the date of contribution, seven years of the date of contribution, Susan recognizes gain or loss under Susan recognizes gain or loss under Sect. 704(c)(1)(B) as if such property Sect. 704(c)(1)(B) as if such property were sold for its FMV at the time of thewere sold for its FMV at the time of theSect. 704(c) property, to PRS.Sect. 704(c) property, to PRS. were sold for its FMV at the time of the were sold for its FMV at the time of the distribution.distribution.

Susan would recognize a $40 gain, Susan would recognize a $40 gain, presuming FMV has not declined.presuming FMV has not declined.

Sect. 704(c)(1)(B) does not trigger Sect. 704(c)(1)(B) does not trigger reversereverse--Sect. 704(c) gain or loss.Sect. 704(c) gain or loss.

ExceptionsExceptionsP t A b di t ib t d b kP t A b di t ib t d b k

Susan GabrielleContributes:Property AFMV = $100 Property A can be distributed back Property A can be distributed back

to Susan.to Susan. LikeLike--kind property exceptionkind property exception

PRSFMV $100AB = $60 Property A

52 52© 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity.

Statutory Backstopping Of Sect. 704(c) (Cont.)

Sect 737 Sect. 737 In the case of a distribution to a contributing partner of

property, the partner shall recognize gain equal to the lesser of:of: The value of the distributed property over the partner’s

basis in the partnership interest, before the distribution less cash distributed (not below zero); orcash distributed (not below zero); or

The net pre-contribution gain of the partner. The Sect. 737 gain is in addition to any gain recognized on

th di t ib ti d S t 731the distribution under Sect. 731.

Sect. 737 (Cont.) The character of the Sect. 737 gain is a proportionate share

of the net pre-contribution gain. Net pre-contribution gain is the net gain which would be

recognized under Sect. 704(c)(1)(B) if there was a distribution to another partner of any property contributed by the contributing partner within seven years of the distribution, and still held by the partnership at the time of distribution.

Appropriate basis adjustments are made to the basis of the partner in the partnership and to the adjusted basis of the partnership in the contributed propertypartnership in the contributed property.

Exceptions Distributions of previously contributed property to the

contributor The extent to which Sect. 751’s hot asset rule applies.

Statutory Backstopping Of Sect. 704(c) Sect. 737: Example

Susan contributed Property A, Susan contributed Property A, Sect. 704(c) property, to PRSSect. 704(c) property, to PRSSect. 704(c) property, to PRS Sect. 704(c) property, to PRS on 1/1/2006.on 1/1/2006.

S san GabrielleSusan Gabrielle

Property A Cash $100

PRSFMV = $100AB = $50

Property A

Property AProperty B (acquired by PRS for $80)

© 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity.

Statutory Backstopping Of Sect. 704(c) Sect. 737 Example (Cont.)

S i i d S tS i i d S t

Susan contributed Property A, Sect. Susan contributed Property A, Sect. 704(c) property, to PRS on 1/1/2006.704(c) property, to PRS on 1/1/2006.

Susan recognizes gain under Sect. Susan recognizes gain under Sect. 737. 737. Gain triggered is equal to the lesser Gain triggered is equal to the lesser of Susan’s:of Susan’s:

PRS distributes Property B to Susan on PRS distributes Property B to Susan on 1/1/2010.1/1/2010.

of Susan s:of Susan s: Net preNet pre--contribution gain ($50).contribution gain ($50).,, or or Excess distribution (FMV of the Excess distribution (FMV of the

distributed propertydistributed property –– Susan’sSusan’sS san Gabrielle distributed property distributed property Susan s Susan s outside basis = $80 outside basis = $80 –– $50 = $30).$50 = $30).

ExceptionsExceptions Any property Susan contributed to Any property Susan contributed to

Susan Gabrielle

Property A Cash $100

Property B

y p p yy p p yPRS can be distributed back to PRS can be distributed back to Susan.Susan.

Sect. 751(b)Sect. 751(b)PRS

FMV = $100AB = $50

Property A

Property AProperty B (acquired by PRS for $80,

FMV $80 on distribution)© 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss

Sect. 704(c) In Partnership Mergers And Divisions

Notice 2009-70 The Treasury Department invited comments regarding the

proper application of Sect. 704(c) in the context of partnership mergers and division.

Areas raised within the Notice included: Tiered partnerships Multiple layers of forward and reverse of Sect. 704(c) gain

and loss International issues

Section 704(c) In Partnership Mergers And Divisions (Cont.)

Notice 2009-70 (Cont.) Numerous groups provided comments and raised a variety of

concerns. No guidance has yet been provided by the IRS on these

issues. As a practical result, there is substantial flexibility as to how to

apply the rules but little agreement as to the reliability of any selected methodology.

Final Sect. 704(c) Anti-Abuse Regulation

An allocation method (or combination of methods) is An allocation method (or combination of methods) is unreasonable if the allocation, either in a direct or reverse Sect. 704(c) context, results in a shifting of the tax consequences of built-in gain or loss among the partners in a manner thatbuilt in gain or loss among the partners in a manner that substantially reduces the present value (PV) of the partners’ (or members’) aggregate tax liability.

The final regulations amended the anti-abuse rule to provide that the tax effect of an allocation method (or combination of methods) on both direct and indirect partners must bemethods) on both direct and indirect partners must be considered.

Final Sect. 704(c) Anti-Abuse Regulation (Cont.)

Indirect partners Indirect partners An indirect partner is any direct or indirect owner of a

partnership, S corporation or controlled foreign corporation, or direct or indirect beneficiary of a trust or estate that is adirect or indirect beneficiary of a trust or estate, that is a partner in the partnership; and any consolidated group of which the partner in the partnership is a member per Treas. Reg. § 1.1502-1(h).

A CFC shareholder is treated as an indirect partner only for allocation of items that: (1) enter into the computation of a U.S. shareholder’s inclusion for the CFC, (2) enter into any person’s income attributable to a U S shareholder’s inclusionperson s income attributable to a U.S. shareholder s inclusion under Sect. 951(a), or (3) would enter into these computation if the items were allocated to the CFC.

Final Sect. 704(c) Anti-Abuse Regulation (Cont.)

The final regulations also provide that the principles of Sect The final regulations also provide that the principles of Sect. 704(c), together with the allocation method, only apply to contributions of property to the partnership.

In determining if a purported contribution of property to a partnership should be recast to avoid results that are inconsistent with subchapter K, one factor that is relevant is the use of the remedial method in which allocations of remedial items of income, gain, loss or deduction are made to one partner, and ll ti f ff tti di l it d t l t dallocations of offsetting remedial items are made to a related

partner.

To ensure compliance with Treasury Department regulations we inform you that unless otherwiseregulations, we inform you that, unless otherwise expressly indicated, any U.S. Federal tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of (1) avoiding tax-related penalties under the Internal Revenue Code or (2) promoting, marketing, or recommending to another partypromoting, marketing, or recommending to another party the tax-related matters addressed herein.

sect. 704(c): partnership and llc contributionsmedia.straffordpub.com/products/sect-704-c...jul 06,...

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