Foreign-partner partnership transfer regs final

Tax Hot Topics newsletter The IRS released final regulations (TD 9891) under Section 721(c) on Jan. 17 that disallow non-recognition treatment with regard to certain transfers of appreciated property to partnerships with foreign partners unless the partnership adopts the remedial allocation method and applies the other requirements of the “gain deferral method.”

The final regulations adopt proposed regulations issued in January 2017 concurrent with temporary regulations. The 2017 temporary regulations had followed on the heels of Notice 2015-54, which described rules to be issued under Section 721(c). The final regulations largely follow the approach taken in the 2017 Temporary Regulations, with some technical modifications. For a more detailed discussion of the regulations under Section 721(c), please see our prior coverage of the temporary regulations.

In 1997, Congress recognized that taxpayers might use a partnership to shift gain to a foreign person and consequently enacted Sections 721(c) and 367(d)(3). Section 721(c) provides the IRS with the authority to promulgate regulations to turn off the non-recognition treatment provided by Section 721(a) in situations where gain on appreciated property transferred to a partnership, when recognized, will be includible in the gross income of a foreign person.

Under the Section 721(c) regulations, Section 721(a) will not apply, and immediate gain recognition is required, when a U.S. transferor transfers certain property having built-in gain to a foreign or domestic partnership, that partnership has one or more foreign partners who are related to the U.S. transferor, and the U.S. transferor and related persons collectively own 80% or more of the interests in partnership capital, profits, deductions, or losses. Immediate gain recognition can be avoided if the requirements of the gain deferral method are met. The gain deferral method generally requires the use of the remedial method under Section 704(c) with respect to the contributed property, underlying an objective to ensure that the built-in gain associated with the contributed property is eventually subject to U.S. tax.

The final regulations made a few changes to the 2017 temporary regulations. They modify the application of the attribution rules contained in Section 267 for the purpose of certain relatedness tests. Under the temporary regulations, these attribution rules could cause Section 721(c) to unexpectedly apply to certain transfers of property to partnerships, even where there was no evident intent to use the transfer to avoid U.S. tax. The final regulations also clarify the application of the gain deferral method in situations where partners’ interests in a Section 721(c) partnership vary during a taxable year. The final regulations also reference and require the use of certain forms for the purpose of reporting information required by the regulations, which the temporary regulations had required to be disclosed on statements attached to returns.

These regulations may significantly affect certain taxpayers considering transfers of appreciated assets, particularly intangibles, to partnerships (foreign or domestic) with foreign related partners. Each transfer of property by a U.S. person to a partnership having a related foreign partner should be evaluated for potential application of Section 721(c).

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
Washington National Tax Office
T +1 202 521 1541

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

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