IRS Issues Proposed Regulations on Partnership Built-In Loss Transactions

Jan. 23, 2014

In the American Jobs Creation Act of 2004 (JOBs Act), Congress limited a taxpayer’s ability to duplicate losses through the contribution of built-in loss property to a partnership. On Jan. 15, the IRS issued proposed regulations that implement the built-in loss rules, providing guidance beyond the interim rules of Notice 2005-32. The regulations also address two significant Section 704(c) “layering” issues that the IRS highlighted in its request for comments in Notice 2009-70 and fix a technical Section 743(b) basis recomputation problem. Overall, the regulations are taxpayer-favorable and simplify some technical computational issues that weren’t clear. The regulations generally are effective when finalized.

The JOBs Act mandates that when a partner contributes built-in loss property to a partnership, that loss must remain with the contributing partner and may not be shared with the other partners. The proposed regulations clarify the following points about contributions of built-in loss property made to partnerships after Oct. 22, 2004:

  • The mandatory write-down provisions of the JOBs Act apply only when a partner contributes built-in loss property. They do not apply when a partnership with built-in loss assets admits a new partner.
  • In most circumstances, the general rules regarding basis adjustments, cost recovery, and distributions that apply when a partner contributes property and has an adjustment to basis as a result of his or her contribution also apply to property contributed with a built-in loss.
  • Any basis difference related to the contribution of built-in loss property to a partnership on the sale of the related partnership interest is eliminated because the contributing partner is permitted to take a loss against his or her basis in the partnership interest. However, in the case of most tax-free transfers, the transferee will step into the shoes of the previous owner with regard to the built-in loss basis adjustment.
  • Reporting is required for partnerships that make basis adjustments for built-in loss property.

The regulations also clarify the application of the built-in loss rules to transfers of partnership interests and distributions of partnership property where there is a substantial basis reduction ($250,000 or more) during a tax year.

The proposed regulations bring some clarity to a complex area of federal income tax law, but they don’t answer every question. Partnerships that receive or have received frequent or substantial contributions of built-in loss property should review the proposed regulations to determine the potential impact on the taxable income of their partners.

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