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IRS proposes allowing basis aggregation in partnership distributions of stock to corporate partners

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Tax Hot TopicsThe IRS has issued proposed regulations (REG-138759-14) to refine the application of Section 732(f) in certain factual situations related to the distribution of stock to corporate partners.

First, consolidated group members that receive a distribution by a partnership of stock in the same corporation would be allowed to aggregate their bases in the distributed stock to limit the application (and extent of) the reduction to the basis of property in the distributed corporation. Second, the proposed regulations would extend the application of the basis reduction rules in Section 732(f) to certain corporations that engage in so-called “gain elimination transactions.” Additionally, the proposed regulations would require taxpayers to apply these regulations to tiered partnerships in a manner consistent with the purpose of Section 732(f).

Section 732(f) was enacted in 1999 to prevent a corporate partner from having the ability to negate the effect of a downward basis adjustment to distributed property under Section 732(b) by applying the reduction in basis to distributed stock of a corporation. A downward basis adjustment results if the inside basis of partnership property is greater than the corporate partner’s outside basis in its partnership interest immediately prior to the distribution. Section 732(f) applies if the following three conditions are met:
  1. A partnership distributes corporate stock to a corporate partner.
  2. The corporate partner has control (as defined in Section 1504(a)(2)) of the distributed corporation after the distribution.
  3. The corporate partner’s adjusted basis in the distributed stock immediately after the distribution is less than the partnership’s adjusted basis in the distributed stock immediately before the distribution.

Section 732(f) is generally applied on a partner-by-partner basis. However, the IRS believes that in certain circumstances it would be appropriate to allow the bases of consolidated corporate group members in a partnership to be aggregated in applying Section 732(f). Thus, the proposed regulations would add a rule that provides such an aggregation to take place, if two conditions exist:
  1. Two or more corporate partners receive a distribution of stock in another corporation.
  2. The distributed corporation is or becomes a member of the distributee partners’ consolidated group following the distribution.

Two examples where an aggregation could apply are in a check-the-box transaction and a transaction involving Rev. Rul. 99-6.

The proposed regulations would also extend the application of Section 732(f) to instances where a corporate partner’s acquisition of property of a distributed corporation does not meet the control test, but the transaction has the same effect as a similar transaction in which a control test of Section 732(f) would have been met. Thus, the proposed regulations provide that in the event of a gain elimination transaction, the corporate partner would be treated as if it acquired control of the distributed corporation immediately before the transaction. A gain elimination transaction is defined as a transaction in which distributed stock is disposed of and less than all of the gain is recognized, with limited exceptions. An example of a gain elimination transaction includes a reorganization under Section 368(a) where the corporate partner and distributed corporation not controlled by the corporate partner merge and no gain is recognized.

The proposed regulations would be applicable to any distributions or gain elimination transactions occurring on or after the date that these regulations are published as final regulations in the Federal Register.

Contact
Grace Kim
+1 202 521 1590
grace.kim@us.gt.com

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