WIXLIB

Effects Of The Sect. 754 Election (Cont.)EXAMPLE 3: Non-liquidating distributions to partners – cash andpropertyPartner D has an outside basis of 40,000 in the DEF Partnership. PartnerD receives a distributiondboff cashh off 50,000 andd a distributiondboff llandd thathhas a fair market value (FMV) of 75,000 and an inside basis of 50,000. Partner D recognizes a gain of 10,000 from the distribution of cash (Sect.731) andd itsit outsidet id basisb i isi reduceddd tot 0. 0 If no Sect.S t 754 electionl ti isi iniplace, Partner D will hold the land with a basis of 0. 50,000 of basis is“lost.” If a SectSect. 754 election is in placeplace, the DEF Partnership would increase itsbasis in its remaining assets by 60,000 under Sect. 734(b) – the sum of 10,000 in gain recognized by Partner D and 50,000 of “lost basis.”18

Effects Of The Sect. 754 Election (Cont.)EXAMPLE 4: Liquidating distributions to partnersPartner D has an outside basis of 40,000 in the DEF Partnership. PartnerD receives a liquidatinglddistributiondboff landl d thath hash a fairf marketk valuel(FMV) of 75,000 and an inside basis of 25,000. If no Sect.S t 754 electionl ti isi ini place,lPPartnertA willill holdh ld ththe landl d withith abasis of 40,000, and there will be no impact on Partnership DEF’s otherassets. If a Sect. 754 election is in place, Partner A will hold the land with a basisof 40,000, but the DEF Partnership would be required to decrease itsbasis in its remaining assets by 15,000 under Sect. 734(b).19

Janice Eiseman, Cummings & LockwoodSECT. 743(B) ADJUSTMENTS ONSECTTRANSFER OF PARTNERSHIPINTERESTS

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISAbilit ToAbilityT MakeM k A Sect.S t 754 ElElectiontiDue To A TransferA.Sect. 743(b): Election may be made when there is a sale orexchange of a partnership interest or upon the death of a partner.If a triggering event has not occurred, no Sect. 754 election can bemade, and, therefore there will be no change to the tax basis ofpartnership assets with regard to the transferee unless themandatory rule for basis adjustment applies.1. Sales or exchanges: This includes a carryover basis exchange,such as under Sect. 351. Transfers by gift do not trigger aSect. 754 election, because transfers by gift are not sales orexchanges under Sect. 743(b).2121 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISAbility ToAbilitT MakeM k A Sect.S t 754 ElElectiontiDue To A Transfer (Cont.)2.Distribution of partnership interest: Note that Sect. 761(e)(2) providesthat for purposes of Sect. 743, any distribution of an interest in apartnership (not otherwise treated as an exchange) shall be treated as anexchange. Thus, if there is a “constructive termination” under Sect.708(b)(1)(B), i.e. sale or exchange of 50% or more of the total interestin partnership capital and profits within a period of 12 consecutivemonths, then the deemed distribution of an interest in the newpartnership by a terminating partnership is treated as an exchange of theinterest in the new partnership for interest in the terminatingpartnership,thi forf purposes off Sect.743.S t 743 ThisThi allowslltheth new partnershipthito make a Sect. 754 election because the exchange requirement of Sect.743(b) is satisfied.2222 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISWhat Happens Under Sect.Sect 743(b) When ASect. 754 Election Is Made?AA.The actual amount of the Sect.Sect 743(b) adjustment: Sect.Sect 743(b) states that theadjustment to the basis of partnership property to the transferee equals the differencebetween the (i) transferee’s tax basis in his partnership interest (i.e., the purchase price ofthe interest or its fair market value at date of death plus his share of partnershipliabilities) and (ii) the transfereeliabilities),transferee’ss “proportionateproportionate share of the adjusted basis ofpartnership property.” Treasury Reg. §1.743-1 flushes out how to determine thetransferee’s “proportionate share of the adjusted basis of partnership property.” Tounderstand the regulations, it is important to always remember what the Sect. 743(b)adjustment is designed to do; namely,namely to prevent the transferee from recognizing gain orloss already accounted for in the purchase price of the partnership interest.1.Treasury Reg. §1.743-1(d) provides that the transferee’s “share of the adjustedb i to thebasish partnershiphi off partnershiphi property”” isi equall to theh sum off thehtransferee’s interest as a partner in the partnership’s “previously taxed capital” plushis share of partnership liabilities. The transferee’s share of “previously taxedcapital” is defined to be the amount of cash the transferee would receive if thepartnershipthi were liquidatedli id t d byb sellinglli itsit assetst att fairf i marketk t value.l2323 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISWhat Happens Under Sect.Sect 743(b) When ASect. 754 Election Is Made? (Cont.)andd (i) increasingii theth amountt off cashh byb theth taxt lossl(including(i l di any remedialdi lallocations under Treasury Reg. §1.704-3(d)) that would be allocated to thetransferee to the extent attributable to the transferred interest, or (ii) decreasing theamount by the amount of tax gain (including any remedial allocations underTTreasuryReg.R §1.704-3(d))§1 704 3(d)) ththatt wouldld bbe allocatedll t d tto ththe ttransfereeftto ththe extentt tattributable to the transferred interest. (Note that non-contingent liabilities do notaffect the amount of the adjustment because they are included in the transferee’stax basis and the computation of the transferee’s share of the adjusted basis ofpartnershipthi property.)t )2.In essence, the tax capital account that the transferee inherits from his transferordetermines the transferee’s share of the partnership basis in its assets. By usingtransferor’s tax capital account as a measure of inside basis, the Treasuryregulations generally ensure that a transferee receives a basis adjustment that takesinto account both pre-contribution gain or loss and post-contribution changes invalue.2424 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISWhat Happens Under Sect. 743(b) When ASect. 754 Election Is Made?3.Example 2 of Treasury Reg. §1.743-1(d)(3) illustrates thecomputation of the Sect. 743(b) adjustment. See Exhibit A.4.As this example shows, if the partnership sells the land for 1,300, the gain from the sale equals 900. Transferee will have 700 of the gain allocated to him, and the other two partners willeach have 100 allocated to them. Because the transferee has a taxbasis of 700 in the land, he will recognize no gain.2525 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISWhat Happens Under Sect.Sect 743(b) When ASect. 754 Election Is Made?B.Note the following with regard to a Sect. 743(b) adjustment:1. The adjustment applies only to the transferee partner. There is no adjustmentto common basis of partnership property. The adjustment essentially operatesoutside the partnership. Treas. Reg. § 1.743-1(j)(1)22.The adjustmentThdj tt hhas no effectff t on theth computationt ti off theth partnership’sthi ’ incomeior loss. Treas. Reg. § 1.743-1(j)(1)3.The adjustment has no effect on the transferee’s capital account. Thetransferee steps into the capital account of the transferor.transferor Treas.Treas Reg.Reg § 1.7431 7431(j)(2)4.The adjustments to the transferee’s distributive share of income or loss mustbe shown on the Form K-1K 1 issued to the transferee.transferee TreasTreas. RegReg.§ 1.743-1(j)(2)5.Where there has been more than one transfer of a partnership interest, atransferee’ss basis adjustment is determined without regard to any priortransfereetransferee’s basis adjustment. Treas. Reg. § 1.743-1(f)2626 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISS t 755 BSect.Basisi AdjAdjustmentsttA.Three sets of rules11.Transfer of partnership interest when assets of partnership do not constitute a trade or business.businessTreas. Reg. § 1.755-1(b)(1)-(b)(4)2.Transfer of partnership interest involving “substituted basis exchanges” (e.g., Sect. 351 and721 exchanges). Treas. Reg. §1.755-1(b)(5). Also, Treasury Reg. §1.755-1(b)(5) applies tobasis adjustments that result from exchanges in which the transferee’stransferee s basis in the partnershipinterest is determined by reference to other property held at any time by the transferee e.g. aconstructive termination under Sect. 708(b)(1)(B) in which the terminated partnership isdeemed to contribute its assets to a new partnership in exchange for an interest in the newpartnership and the terminated partnership is deemed to distribute interests in the newpartnership in liquidation of the partner’s interest in the terminated partnership. Sect. 761(e)provides the “exchange,” meaning the distribution of partnership interests in the newpartnership is an “exchange” for purposes of Sect. 743(b). Because the distribute-partner of theterminated partnership receives its interest in the new partnership in a liquidating distribution,the distributee takes a substituted basis in the new partnership under SectSect.732(b).732(b) A SectSect. 754election by the new partnership will bring into play Treasury Reg. §1.755-1(b)(5).3.Transfer of a partnership interest when the assets of the partnership constitute a trade orbusiness, as described in Reg. §1.1060-1(b)(2)Treas Reg.Treas.Reg §1.755-1(a)(2)-(a)(6)§1 755 1(a)(2) (a)(6)2727 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISS t 755 BSect.Basisi AdjAdjustmentstt (C(Cont.)t)B.Transfer of partnership interest when assets of partnership do not constitute a“tradetrade or business”business1.First, determine the adjusted basis and the fair market value of the partnershipassets immediately after the transfer and determine how much income, gain orloss (including remedial allocations under Treasury Reg. §1.704-3(d)) would beallocated to the transferee-partner, if the partnership were to sell all of its assetsfor cash in a hypothetical sale for an amount equal to their fair market values. If,in fact, the purchase price for the partnership interest equals the fair market valueof the assets, then the adjustment to the basis of partnership property with respectto the transferee-partner is done.Treas. Reg. §1.755-1(b)(1)(ii); Example 1, Treas. Reg. 1.755-1(b)(2)(ii)2.The portion of the transferee-partner’s basis adjustment allocated to ordinaryincome property is equal to the total income gain or loss (including remedialallocations) that would be allocated to the transferee with respect to thehypotheticalypsale of ordinaryy income property.p p y Treas. Reg.g §§1.755-1(b)(2)( )( )2828 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISS t 755 BSect.Basisi AdjAdjustmentstt (C(Cont.)t)3.The portion of the transferee-partner’s basis adjustment allocated to capital gainproperty is equal to the Sect. 743(b) adjustment reduced by the amount allocatedto ordinary income property. If the purchase price of the partnership interest isless than the purchase price based upon fair market value, and there has to be adecrease in capital gain property, the decrease cannot be greater than the“partnership’s basis” in the property or the transferee’s share of any remedial lossunder Treasury Reg. §1.704-3(d). Any excess is applied to reduce the basis ofordinary income property. Treas. Reg. §1.755-1(b)(2) 44.Note that this approach allocates any overpayment or underpayment forthe partnership interest to the basis of capital gain property.AdjustmentsAdjtt can beb maded tot individuali di id l assetst even thoughthh theth totalt t l amountt offbasis adjustment is zero. Treas. Reg. §1.755-1(b)(1)(i) Note that in a substituted basis transaction, no adjustment can be made ifthe total amount of the Sect. 743(b) adjustment is zero.2929 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISS t 755 BSect.Basisi AdjAdjustmentstt (C(Cont.)t)5.Allocations have to be made within the class of ordinaryy income propertyp p y and withinthe class of capital gain property.a.Within the class of ordinary income property, the basis of each property isgenerally adjusted by an amount equal to the income, gain or loss (includingremedial allocations) that would be allocated to the transferee upon a sale ofthe property in the hypothetical transaction.b.Within the class of capital gain property, the basis of such property isgenerally adjusted by (1) the amount of income, gain or loss that would beallocated to the transferee in the hypothetical transaction,transaction minus (2) a portion(based on the market value of a particular property) compared to theaggregate market value of all capital gain property. Treas. Reg. §1.7551(b)(3)c.N t thatNoteth t thereth mustt beb an adjustmentdj tt wheneverhtheth actualt l Sect.S t 743(b)adjustment is either more or less than what it would be if the transferee hadpaid fair market value for each partnership asset.6.See subsequent exhibits B and C for examples of Sect. 755 allocations3030 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISSect 755 Basis Adjustments (Cont.)Sect.(Cont )C.Substituted basis exchanges1.The rules for “substituted basis exchanges” are set forth in Treasury Reg. §1.755-1(b)(5). If thebasis adjustment is positive,positive an adjustment can be made only if the hypothetical sale of thepartnership’s assets results in a net gain to the transferee.a.The increase is allocated between classes of assets (ordinary and capital) in proportion to thenet income or gain of each class allocable to the transferee.bb.Within each class,class increases are first allocated to properties with unrealized appreciation inproportion to the transferee’s share of such unrealized appreciation until the transferee’sshare of the appreciation is eliminated. Any remaining amount is allocated among assets inthe class according to the transferee’s share of the amount realized from the hypothetical saleof each asset in the class.2.Likewise, if the basis adjustment is negative, an adjustment can only be made if thehypothetical sale results in the allocation of a net loss to the transferee.a.The decrease is allocated between asset classes in proportion to the net loss allocable to thetransferee from the hypothetical sale of all assets in each class.bb.Withini hi eachh class,ltheh decreasedisi allocatedlld to propertiesi withi h unrealizedli d depreciationdi i iniproportion to the transferee’s shares of such unrealized depreciation until they are eliminated.Remaining decreases are allocated in proportion to the transferee’s shares of the adjustedbases of all assets in the class until these shares of adjusted bases are reduced to zero, withanyy remainingg downward adjustmentjsuspendedpuntil the partnershippp acquiresqadditionalproperty in that class.3131 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISSect 755 Basis Adjustments (ContSect.(Cont.))D.Sale of business1.2.If the assets of the partnership constitute a trade or business (as described in Treasury Reg.§1.1060-1(b)(2)),§( )( )), the partnershippp must use the residual method to assigng values to thepartnership’s Sect. 197 intangibles. Treas. Reg. §1.755-1(a)(2)Residual method involves the following steps:a.b.c.d.e.First, the partnership must determine the value of its assets other than Sect. 197.Second, the partnership must determine “partnership gross value” under Treasury Reg.§1.755-1(a)(4).Third, the partnership gross value is then compared to the aggregate value of all partnershipproperty other than Sect. 197 intangibles. If there is no residual value, then the value of all Sect.197 intangibles is deemed to be zero. If there is a residual value, then the amount must beSect. 197 intangiblesgin order to assigng a value to them under the rules of Treasuryyallocated to SReg. §1.755-1(a)(5).“Partnership gross value” generally is equal to the amount that, if assigned to all partnershipproperty, would result in a liquidating distribution to the partner equal to the transferee’s basisin the transferred partnership interest immediately following the relevant transfer (reduced bythe amountamount, if anyany, of such basis that is attributable to partnership liabilities)liabilities). TreasTreas. RegReg.§1.755-1(a)(4)(i)(A).Treasury Reg. §1.755-1(a)(5)(i) requires that the residual value be allocated first among Sect.197 intangibles other than goodwill and going concern value, but the value assigned to a Sect.197 intangible (other than goodwill and going concern value) is limited to its actual fair marketvaluel on theh dated off theh relevantltransfer.f AnyA remainingi i residualid l valuel isi thenh allocatedlld togoodwill and going concern value.3232 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISExhibit AExample 2 of Treasury Reg. Sect. 1.743-1(d)(3)TaxLandCashTotalABCFair market value on contribution dateSale of partnership interest for fair market value by A 400 2,000 2,400 1,000 2,000 3,000 1,300 2,000 3,300 400 1,000 1,000 1,000 1,000 1,000 1,100 1,100 1,100Transferee's share of previously taxed capital:Cash received on sale of assets for fair market valueLess: Gain allocated to transfereeShare of previously taxed capital 1,100 700 (Pre-contribution gain & post-contribution gain) 400Section 743(b) adjustment:Outside basis of price paid for partnership interestLess: Share of previous taxed capitalAmount of Section 743(b) adjustment to the basis of the land 1,100 400 7003333 Cummings & Lockwood LLC 2011

PARTNERSHIP BASIS: INSIDE AND OUTSIDE BASISExhibit BExample 2 of Treasury Reg. §1.755-1(b)(3)(iv): T buys A’s partnership interest for 110,000.Capital gain propertyAssett 1AAsset 2Ordinary Income propertyAsset 3Asset 4AdjustedBasisFair Market Valueat time of contribution 25 000 25,000 100,000 50 000 50,000 100,000 75 000 75,000 117,500 192,500 33,604 33604 2,646 36,250 40,000 10,000 175 000 175,000 40,000 10,000 200 000 200,000 45,000 2,500 47 500 47,500 2,500( 3,750)( 1 250)( 1,250) 240,000 35,000TotalBook Capita

entity, i e , no adjustments to basis of partnership property unless mandatory, i.e., no adjustments to basis of partnership property unless mandatory adjustments are required. If a Sect. 754 election is made, then adjustments can be made to the basis of partnership property (the "inside basis") under sections 734(b) and 743(b).