IRS: Assets-over merger triggers basis stepdown

Tax Hot Topics newsletter The IRS issued a Technical Advice Memorandum (TAM 201929019) starting that the distribution of the resulting partnership’s interest in an assets-over merger results in a mandatory basis adjustment under Section 743 when the partnership has a substantial built-in loss in its assets.

The heavily redacted facts in the TAM indicate that two partnerships with the same majority owner merged together. Using the assets-over form, the merging partnership was treated as contributing all of its assets and liabilities in exchange for an interest in the resulting partnership, and then distributing the interest in the resulting partnership to its partners in complete liquidation. The resulting partnership had a substantial built-in loss in its assets, which results when either the adjusted basis in the partnership property exceeds its fair market value by more than $250,000 or the transferee partner is allocated a loss of more than $250,000 if the partnership sells off its assets for fair-market value immediately after the merger.

Section 743 requires a mandatory adjustment to the basis of partnership assets in connection with the sale or exchange of a partnership interest where a substantial built-in loss exists. The issue addressed in the TAM is whether such a mandatory basis adjustment applies to deemed distribution of an interest. The IRS asserts that the deemed distribution of an interest in the resulting partnership as part of an assets-over merger is treated as a sale or exchange of the interest of the resulting partnership under Sections 761(e) and 743. Thus, the resulting partnership would be required to make a negative adjustment to its basis in its assets with respect to the former partners of the merging partnership.

The IRS also addressed two additional issues. First, the IRS determined that in calculating a transferee partner’s adjusted basis in the transferred partnership interest and a transferee partner’s share of adjusted basis of the resulting partnership’s property for purposes of the Section 743 basis adjustment, the resulting partnership’s liabilities are included in the transferee partner’s basis in the transferred partnership interest and the transferee partner’s share of the resulting partnership’s liabilities to the extent of the amount of the Section 731(a) gain that the transferee partner would recognize after the assets-over step, absent the netting rule in Section 1.752-1(f). The IRS also stated that deferred COD income under Section 108(i) is not treated as a tax gain in a hypothetical sale of the partnership’s property in the Section 743(b) adjustment computation.

The TAM serves as a reminder of various issues that can arise when dealing with partnership mergers. As a threshold matter, practitioners dealing with a partnership merger transaction need to know the tax characterization of the transaction. For instance, the application of the partnership merger rules in the Section 708 regulations could result in the merging and resulting partnerships being different than those under local law as well as the form of the partnership merger differing than the anticipated form under local law. Additional computational issues, such as the impact of a merger on the resulting partners’ capital accounts or the application of Section 704(c) should also be considered.

Grace Kim
Principal, Partnerships
Washington National Tax Office
T +1 202 521 1590

Jose Carrasco
Senior Manager, Partnerships
Washington National Tax Office
T +1 202 521 1552

Whit Cocanower
Senior Associate
Washington National Tax Office
T +1 202 521 1541

Ryan Nodal
Washington National Tax Office
T +1 803 231 3020

Tax professional standards statement
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.