IRS issues notice on certain partnership property transfers and controlled transactions involving partnerships

Tax Hot Topics:Notice on certain partnership property transfersThe IRS recently released Notice 2015-54, which announced the IRS and Treasury’s intention to issue regulations under Section 721(c) to ensure that when a U.S. person transfers certain property to a partnership that has foreign partners, income or gain that can be attributed to the property would be taken into account by the transferor either immediately or periodically. The notice also announced forthcoming amendments to Treas. Reg. Sec. 1.482-7 regarding the application of certain rules (currently applicable to cost-sharing arrangements) to controlled transactions involving partnerships. This notice may significantly affect certain taxpayers considering outbound transfers of assets, particularly intangibles, to partnerships with foreign related partners. Taxpayers considering such transfers should carefully evaluate the impact of Notice 2015-54.

Transfers to partnerships
Section 721(a) generally provides that “[no] gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.” The anticipated regulations discussed in the notice aim to curb transactions that would otherwise try to take advantage of tax-free treatment under Section 721(a).  

According to the notice, current guidance under Sections 367(a) and 367(d) addresses transfers to foreign corporations in a Section 351 exchange or Section 361 exchange under certain circumstances involving partnerships.  In the case of a transfer of property to a foreign corporation by a partnership in which a U.S. person is a partner, the partnership’s transfer is treated as if the U.S. partner had transferred its proportionate share of the partnership’s assets directly to the foreign corporation. In the case of a transfer of a partnership interest to a foreign corporation by a U.S. person, the U.S. partner is treated as if it had transferred its proportionate share of the property of the partnership directly to the foreign corporation. In both cases, if Section 367(a) requires gain recognition, the regulations provide rules for making basis adjustments to account for the gain recognized.

The notice explains that because Section 367 applies only to the transfer of property to a foreign corporation, without the regulations under Section 721(c) or Section 367(d)(3), a U.S. person generally doesn’t recognize gain on the contribution of built-in-gain property to a partnership with foreign partners. Treasury and the IRS further noted that they are aware of such transactions and have determined that it is appropriate to exercise the regulatory authority granted in Section 721(c) to override the application of Section 721(a) on the transfer of property to a partnership (domestic or foreign) in certain circumstances in which the gain, when recognized, ultimately could be included in the gross income of a foreign person. By applying the authority of Section 721(c) rather than the authority in Section 367(d), the IRS and Treasury apparently intend that the regulations will not be limited to intangible property.

The notice defines numerous terms, only a few of which are included in this summary. Accordingly, fully understanding the notice’s application requires reading the whole notice.

A Section 721(c) partnership includes any partnership (domestic or foreign) if, after the contribution and any transactions related to the contribution, (1) a related foreign person is a direct or indirect partner in the partnership and (2) the U.S. transferor and one or more related persons own more than 50% of the interests in partnership capital, profits, deductions or losses.

The notice states that under the to-be-issued regulations, Section 721(a) won’t apply when a U.S. person (a U.S. transferor) transfers certain property (defined in the notice as Section 721(c) property) to a foreign or domestic partnership, which is a “Section 721(c) partnership,” unless the requirements of a new method concerning partnership allocations, called the “gain deferral method,” are met. Additionally, the regulations will include a de minimis rule providing that Section 721(a) (if otherwise applicable) will continue to apply if during the U.S. transferor’s taxable year, (1) the sum of the built-in gain with respect to all Section 721(c) property contributed to the Section 721(c) partnership by the U.S. transferor and all related U.S. transferors does not exceed $1 million, and (2) the Section 721(c) partnership is not applying the gain deferral method related to a prior contribution of Section 721(c) property by the U.S. transferor or certain related persons.

The gain deferral method requires all of the following:

  • The Section 721(c) partnership must adopt the remedial allocation method under Section 704(c) for all Section 721(c) property contributed to the Section 721(c) partnership pursuant to the same plan by a U.S. transferor and all other U.S. transferors that are related persons.
  • During any taxable year in which there is remaining built-in gain related to an item of Section 721(c) property, the partnership allocates all items of Section 704(b) income, gain, loss and deduction related to that Section 721(c) Property in the same proportion.
  • Certain reporting requirements set forth in the notice are satisfied.   
  • Gain is recognized by the U.S. transferor(s) upon an acceleration event.
  • The gain deferral method is adopted for all Section 721(c) property subsequently contributed to the partnership until the earlier of (1) the date that no built-in gain remains or (2) 60 months after the date of the initial contribution of the Section 721(c) property to which the gain deferral method first applied.

If the gain deferral method is adopted, a U.S. transferor may still be required to recognize all remaining built-in gain if an “acceleration event” occurs.  An acceleration event is broadly defined as any transaction that either would reduce the amount of remaining built-in gain that a U.S. transferor would recognize under the gain deferral method, or any transaction that could defer the recognition of the built-in gain. Furthermore, failure to comply with all of the requirements of the gain deferral method will result in an acceleration event occurring related to all Section 721(c) property.

The notice also indicates that regulations are forthcoming describing additional reporting requirements for a U.S. transferor for each taxable year in which the gain deferral method applies. However, no new filings for taxable years that end before the date of publication of the regulations will be required.

The notice also provides that the regulations will include an additional requirement for applying the gain deferral method to extend the statute of limitations eight full taxable years following the taxable year of contribution.

Controlled transactions involving partnerships
The notice announced that regulations will be issued that provide specified methods for controlled transactions involving partnerships based on the specified methods in Treas. Reg. Sec. 1.482-7(g) as appropriately adjusted in light of the differences in the facts and circumstances between partnerships and cost-sharing arrangements.  

The regulations will further provide periodic adjustment rules (based on the principles of Treas. Reg. Sec. 1.482-7(i)(6) applicable to cost-sharing agreements) for controlled transactions involving partnerships. Specifically, the regulations will provide that in the event of a trigger based on a significant divergence of actual returns from projected returns for controlled transactions involving a partnership, the IRS may make periodic adjustments to the results of such transactions, as well as any necessary corresponding adjustments to Section 704(b) or Section 704(c) allocations.

The notice also announced that Treasury and the IRS are considering additional documentation requirements for certain controlled transactions involving partnership. This documentation may include projected returns for property contributed to a partnership, projected partnership allocations and support for the arm’s length standard.

Effective date
The notice is generally effective for transfers made on or after Aug. 6, 2015. The notice also applies to certain transfers made before Aug. 6, 2015, if the transfer resulted from an entity classification election made under Treas. Reg. Sec. 301.7701-3 that is filed on or after Aug. 6, 2015, and that is effective on or before Aug. 6, 2015. The reporting requirements described in the notice and additional requirements under the gain deferral method to extend the statute of limitations will apply to transfers occurring on or after the date of publication of the regulations.  

The anticipated Section 482 regulations discussed in the notice will apply to transfers and controlled transactions occurring on or after the date of publication of the regulations.

The notice states that no inference is intended regarding the treatment of transaction described in the notice under current law and that the IRS may challenge the transactions under applicable code provisions, regulations and judicial doctrines (for example, the 704(c) anti-abuse rule in Treas. Reg. Sec. 1.704-3(a)(10)).

Taxpayers should carefully review this new guidance because if includes numerous mechanical rules. They should pay close attention if they’re adopting the gain deferral method, because any failure to comply could trigger immediate recognition of remaining built-in gain for all contributed property to which Section 721(c) applies. Further, the acceleration event rules are drafted broadly and therefore may be triggered by events that are otherwise common practices by partners or partnerships or even required under certain partnership agreements (for example, the U.S. transferor’s sale of all or part of its interest in the partnership and certain distributions of property).


Grace Kim
+1 202 521 1590

Jose Carrasco
+1 202 521 1552

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