Accounting for book-tax differences of property contributed to a partnership.

The contribution to a partnership of property with a fair market value (FMV) that differs from basis triggers the application of complicated rules under Sec. 704(c) to determine how allocations of gain, loss, income or deduction on such property are to be made to partners. These rules ensure that the partner who contributed the property receives the benefits or burdens of built-in loss or gain in it, without unreasonably shifting them to the other partners. The first part of this two-part article addressed Sec. 704(c)'s complexities, using numerous examples to illustrate the application of the rules. The second part, below, examines tax planning strategies and pitfalls, and some related provisions.

Ceiling Rule Planning Obstacles

and Opportunities

When the ceiling rule applies, partners can choose among the traditional method, the traditional method with curative allocations, or remedial allocations. In making this decision, the partners are likely to be at arm's length because, if they are in the same marginal tax bracket, a reasonable allocation method that is advantageous to one partner generally will be disadvantageous to another.

Comparison of methods

In Example 7 in Part I of this article, B, a 90% partner, contributed property with a $6 basis and a $90 book value. The ceiling rule applied to the Sec. 704(c) property, so that the partners would have increased (or decreased) income as follows:(18)

Partner A:

           Traditional    Curative       Remedial
    Year    method       allocations    allocations

     1      $-2             $-3            $-1.9
     2       -2              -3             -1.9
     3       -2              -3             -1.9
     4        0               0             -1.7
     5        0               0             -1.7

   Total    $-6             $-9            $-9.0(*)

Partner B:
            Traditional   Curative        Remedial
    Year     method      allocations     allocations

     1        $0              $1            $-0.1
     2         0               1             -0.1
     3         0               1             -0.1
     4         0               0              1.7
     5         0               0              1.7

   Total      $0              $3            $ 3.0(*)

(*)Reflects rounding.

* Noncontributing partner

Curative allocations are likely to be more advantageous than remedial allocations to the noncontributing partner if the Sec. 704(c) property has built-in gain. Curative allocations will provide the noncontributing partner with his full share of the tax depreciation deductions (in this case, $9) over the remaining useful life of the Sec. 704(c) property's inside tax basis.(19)

Remedial allocations will provide the noncontributing partner with the same total depreciation deduction ($9) as provided by the curative allocation method. However, since the built-in gain will be depreciated over a new useful life that begins at the time of contribution, the deduction will be spread over a greater number of years.

The traditional method provides the noncontributing partner with the least amount of depreciation, because the ceiling rule limits the partnership's total depreciation deductions to the depreciation to which the contributing partner would have been entitled (here, $6) had he not contributed the property to the partnership.

* Contributing partner

The traditional method is most advantageous to the contributing partner because no additional income is allocated to him to offset the effects of the ceiling rule. Remedial allocations are likely to be more advantageous than curative allocations to the contributing partner if the property has built-in gain. Both curative and remedial allocations will increase the contributing partner's taxable income by the amount necessary to offset the effects of the ceiling rule; however, with remedial allocations, at least some of the additional income will be allocated to the contributing partner over the new useful life of the Sec. 704(c) property's built-in gain (in this case, five years). Curative allocations will be taken into account over the balance of the remaining useful life of the Sec. 704(c) property at the time of contribution (here, three years).

* Time and manner for electing method

Regs. Sec. 1.704-3(c)(3)(iii)(A) indicates that the partnership agreement should provide, in the year of contribution, the allocation method the partnership will use for each item of Sec. 704(c) property; if it does, the reasonableness of the method will be determined as of the time of contribution. If the partnership agreement is not sufficiently specific as to the precise manner in which allocations are to be made with respect to such property, the reasonableness of the allocation will be tested when it is actually made.

It is generally easier to meet the reasonableness standard at the time of contribution than when allocations are actually made, because the partners' relative tax brackets or other tax attributes may change over time. Therefore, a tax adviser should, at the time of contribution, determine whether the ceiling rule applies and, if so, explain the advantages and disadvantages of the alternatives to the partners. The tax adviser should then specify the selected method in the partnership agreement in the year of the contribution. If one partner does not agree to the method preferred by the others, the tax practitioner should aid the partners in reaching an agreement by advising them to change some other term of the partnership agreement to compensate the objecting partner for the tax disadvantage suffered.

Obstacles in the Absence of the Ceiling Rule

Even if the partners are in the same relative tax bracket and the ceiling rule does not apply, the tax adviser must properly allocate the effects of built-in gain or loss among the partners. If the partners are in the same tax bracket, the IRS will probably not care to whom the Sec. 704(c) gain or related depreciation is allocated, but the partners will.

In Example 3 in Part I of this article, A contributed $10 cash for a 10% interest and B contributed property with an adjusted basis of $60 and a book value of $90 for a 90% interest. B had depreciated the property $20 a year for two prior years. Sec. 168(i)(7) limited the partnership to $20 tax depreciation per year, and the ceiling rule did not apply.

A tax practitioner unaware of Sec. 704(c)'s requirements might allocate the depreciation the same as any other partnership tax item, so that A would receive $2 of depreciation ($20 x 10%). However, as illustrated in Example 3 of Part I, A is entitled to $3 of depreciation. If A learns that he was allocated too little depreciation, A might request the tax adviser to file amended returns for all open tax years, and sue the adviser for malpractice for the closed years. B might have to pay additional taxes (and perhaps, interest and penalties) for all open tax years on the excess depreciation taken.

Reverse Sec. 704(c) Allocations

Regs. Sec. 1.704-3(a)(6)(i) requires partnerships to apply Sec. 704(c) principles when revaluing assets in accordance with the Sec. 704(b) substantial economic effect regulations. One such situation occurs, under Regs. Sec. 1.704-1(b)(2)(iv)(f)(5)(i), when a new partner contributes property with no built-in gain or loss (e.g., cash) to an existing partnership that has assets whose book values do not equal their bases.

Example 11: Reverse Allocation - Revaluation of

Partnership Property

After its first year, partnership AB wants to admit C as a new partner. As shown in Example 3 in Part I, at the end of AB's first year, the property contributed by B has a $60 book value and a $40 adjusted basis. Pursuant to the capital account maintenance rules in the substantial economic effect regulations, AB revalues its assets and determines that the current FMV of the property contributed by B is $80. C will contribute $30 cash and have a 25% interest in partnership profits, losses and capital. After the revaluation of assets and C's contribution, ABC's balance sheets are as follows:

          Partnership assets       Partners' capital

             Inside               Outside
              tax         Book      tax         Book
             basis        value    basis       value

       $10         $10                    $ 7
Cash    30  $40     30    $40    A  $ 7     2   $ 9

                    60                     63
Property     40     20     80    B   43    18    81

                                 C   30          30

Total       $80          $120       $80        $120

Sec. 704(c) requires that the partnership allocate the $40 ($80 - $40) book-tax difference of the property. If the property were then sold for $80, C would not be allocated any of the tax gain, because it was attributable to periods before he became a partner.

The remaining $20 ($60 - $40) of the original $40 built-in gain would first be allocated to B. The other $20 tax gain ($80 - $60) would be allocated between A and B according to their shares of partnership gain prior to C becoming a partner. Thus, $2 ($20 x 10%) would be allocated to A and $18 ($20 x 90%) would be allocated to B. After these allocations, ABC's balance sheets would be as follows:

              Partnership assets            Partners' capital

              Inside                        Outside
               tax          Book             tax     Book
              basis         value           basis    value

        $ 40          $40              $ 7
Cash      80  $120    80   $120    A     2  $ 9       $ 9

                                        43
                                        20
Property         -            -    B    18   81        81

                                   C         30        30
Total         $120         $120            $120      $120

If ABC were to liquidate, none of the partners would recognize any gain or loss, because their capital accounts equal their outside bases.

* Securities aggregation

Securities partnerships frequently must make reverse Sec. 704(c) allocations because of the need for numerous capital account restatements under Regs. Sec. 1.704-1(b)(2)(iv)(f). The large number of partnership assets with book-tax differences may make it unduly burdensome to make reverse Sec. 704(c) allocations on an asset-by-asset basis.

The proposed regulations recognize this potential difficulty and attempt to alleviate the record-keeping burden by providing special aggregation rules for "securities partnerships," as defined in Regs. Sec. 1.704-3(e)(3)(iii). According to the preamble, partnerships may now net book gains with book losses and may also net tax gains with tax losses, as long as the partnership's aggregate approach is reasonable and does not violate the anti-abuse rules. In addition, the IRS may permit aggregation of Sec. 704(c) gains and losses with reverse Sec. 704(c) gains and losses.

Effective Date

Regs. Sec. 1.704-3(f) provides that the final regulations apply to property contributed to a partnership and to property restatements after Dec. 20, 1993.

Related Code Provisions

As previously discussed, Sec. 721 provides that a taxpayer can contribute appreciated property to a partnership without recognizing gain currently. Similarly, under Sec. 731(a) and (b), a partnership can distribute appreciated property to a partner without current gain recognition by either party. Clever use of these provisions in tandem could allow taxpayers to avoid recognizing built-in gain. Therefore, in addition to Sec. 704(c), Congress enacted provisions that cause current gain recognition on certain related distributions.

* Distributions of contributed property

to another partner

Under Sec. 704(c)(1)(B) and the recently proposed regulations,(20) built-in gain or loss must be recognized and allocated to the contributing partner if Sec. 704(c) property is distributed to another partner within five years of contribution. Prop. Regs. Sec. 1.704-4(a)(1) provides that the gain or loss recognized is the amount that would have been allocated to the contributing partner under Sec. 704(c)(1)(A) if the distributed property had been sold at its FMV at the time of the distribution.

In determining the gain, Prop. Regs. Sec. 1.704-4(a)(5), Example 3, demonstrates the use of the remedial method when the ceiling rule applies. Although not explicitly mentioned, presumably, curative allocations could also be used.

* Character of gain

Prop. Regs. Sec. 1.704-4(b) provides that the gain recognized has the same character as the gain that would have resulted had the distributed property been sold by the partnership to the distributee partner. Thus, under Sec. 707(b)(2)(A), the gain will be ordinary if the Sec. 704(c) property is distributed to a partner that has a greater-than-50% interest in partnership profits or capital; any built-in loss would be disallowed under Sec. 707(b)(1)(A).

* Basis adjustments

Under Prop. Regs. Sec. 1.704-4(e)(1), the contributing partner's outside basis is increased by the amount of gain (or reduced by the amount of loss) recognized under Sec. 704(c)(1)(B). In the case of a distribution of money or other property that is part of the same plan as the distribution of the Sec. 704(c) property, this increase or decrease is taken into account in determining the basis of other distributed property under Sec. 732 and any gain recognized by the contributing partner under Sec. 731 or 737.

Similarly, under Prop. Regs. Sec. 1.704-4(e)(2), the partnership's inside basis in the Sec. 704(c) distributed property is increased or decreased immediately before the distribution by the gain or loss recognized by the contributing partner under Sec. 704(c)(1)(B). Any such basis adjustment is taken into account in determining the distributee partner's basis in the property under Sec. 732.

Example 12: Distributions of Contributed Property

to Another Partner

ABC partnership has three equal partners, A, B and C. Property X was contributed by A, with a basis of $50 and an FMV of $100; B and C each contributed $100 cash. Property Y was purchased by ABC for $125, and therefore has no built-in gain or loss.

After ABC experienced three years of profitable operations, B decided to leave the partnership. ABC will distribute X, which has appreciated in value, to B in liquidation of his interest. Thus, ABC revalued its assets and restated the partners' capital accounts pursuant to Regs. Sec. 1.704-1(b)(2)(iv)(f)(5). After the revaluation, ABC's balance sheets are as follows:

      Partnership assets      Partners' capital

       Inside                 Outside
        tax       Book         tax      Book
       basis      value       basis     value

Cash    $200      $200    A   $ 75      $200
X         50       200    B    150       200
Y        125       200    C    150       200

Total   $375      $600        $375      $600A, B and C have equal one-third interests in partnership profits, losses and capital.

Although under Sec. 731(b), ABC does not recognize gain on the distribution, under Sec. 704(c)(1)(B)(1), A recognizes $50 gain ($100 FMV on contribution - $50 basis to ABC on contribution). Appropriate adjustments under Sec. 704(c)(1)(B)(iii) are made to A's outside basis and ABC's basis in X, as follows:

              Partnership assets         Partners' capital

             Inside                     Outside
              tax     Book               tax      Book
             basis    value             basis     value

                                  $75
Cash          $200    $200    A    50   $125      $200
        $50
X        50    100     200    B          150       200
Y              125     200    C          150       200

Total         $425    $600              $425      $600

Thus, the built-in gain applicable to A and X has been recognized. X is then distributed to B; under Sec. 73 1 (a)(1), B does not recognize gain on the distribution. In B's hands, X has a transferred basis of $150, B's outside basis before the liquidating distribution. After the distribution, ABC's balance sheets are as follows:

       Partnership assets      Partners' capital

        Inside                Outside
         tax     Book          tax      Book
        basis    value        basis     value

Cash    $200     $200     A   $125      $200
X          -        -     B      -         -
Y        125      200     C    150       200

Total   $325     $400         $275      $400

The difference between X's basis in B's hands ($150) and X's basis in ABC's hands ($100), $50, will decrease the basis of other property in ABC's hands, under Sec. 734(b)(2)(B) and Regs. Sec. 1.755-1(a)(1)(iii). After that adjustment, the equality between total inside basis and total outside basis will be restored.

Distributions of Other Property

to the Contributing Partner

Under Sec. 73 7(a)(21) and Prop. Regs. Sec. 1.737-1(a), if a partner contributes property with built-in gain to a partnership, and the partnership distribute other property to him within five years of the contribution, the contributing partner must recognize as gain the lesser of: 1. the excess ("excess distribution"), if any, of - the FMV of property (other than money) received, over - the contributing partner's outside basis immediately before the distribution, or 2. the net Sec. 704(c) gain ("net precontribution gain").

Gain recognized under this provision is in addition to any gain recognized under Sec. 731 by virtue of any money distributed at that time.

* Determining the excess distribution

Prop. Regs. Sec. 1.737-1(b)(2) provides that, in determining the excess distribution, the FMV assigned to the distributed property will be respected if the value is reasonably agreed to among the partners in an arm's-length negotiation and the partners have sufficiently adverse interests.

Prop. Regs. Sec. 1.737-1(b)(3) states that, for this purpose, the distributee's outside basis includes any adjustment resulting from the distribution subject to Sec. 737 (including adjustments required by Sec. 752) and from other distributions or transactions part of the same plan (e.g., basis adjustments for gain recognized under Sec. 751(b)). However, outside basis is not increased for gain recognized under Sec. 737(a) and is not decreased under Sec. 733(2) for other property distributed to the partner.

* Calculating net precontribution gain

Under Prop. Regs. Sec. 1.737-1(c)(1), the net precontribution gain is the net gain (if any) the distributee partner would have recognized under Sec. 704(c)(1)(B) if, at the time of the Sec. 737 distribution, the partnership had actually distributed to another partner all Sec. 704(c) property contributed (after Oct. 3, 1989) to the partnership by the distributee partner. However, Prop. Regs. Sec. 1.737-1(c)(2)(ii) allows a partnership to reduce the distributee partner's net precontribution gain by any basis adjustment made to Sec. 704(c) property (contributed by the distributee partner) under Sec. 734(b)(1)(A) for distributions of money as part of the same plan or arrangement as the Sec. 737 distribution.

* Character of gain

Under Prop. Regs. Sec. 1.737-1(d), the character of the gain recognized is the same as that of the net precontribution gain. For this purpose, character includes any item that would be taken into account separately by a contributing partner under Sec. 702(a).

When the contributing partner has contributed several items of varying character, Prop. Regs. Sec. 1.737-1(d) provides that the character of the gain is determined by, and is proportionate to, the character of the partner's net precontribution gain. For this purpose, all gains and losses on Sec. 704(c) property are taken into account in determining the partner's net precontribution gain and are netted according to their character; any character with a net negative amount is disregarded. The character of the partner's Sec. 737 gain is the same as, and in proportion to, any character with a net positive amount.

* Adjustment of distributee partner's outside basis

Under Prop. Regs. Sec. 1.737-3(a), the outside basis of the distributee partner (i.e., the partner who contributed Sec. 704(c) property) is increased by the Sec. 737 gain recognized. However, this increase is not taken into account in determining the gain recognized under either Sec. 731 or 737 on the distribution of money in the same or any related distribution.

* Distributed property's basis

Under Prop. Regs. Sec. 1.737-3(b), the distributee partner's basis in the distributed property is determined under Sec. 732(a) or (b), as applicable. The increase in the distributee partner's outside basis under Sec. 737, discussed above, is taken into account in determining the basis of the distributed property (other than property previously contributed by the partner).

* Basis adjustment of partnership's Sec. 704(c)

property

Sec. 737(c)(2) provides that appropriate adjustments are to be made to the basis of the Sec. 704(c) property. Prop. Regs. Sec. 1.737-3(c)(2) and (3) provide elaborate rules to allocate basis adjustments stemming from the distributee partner's contribution of more than one piece of Sec. 704(c) property (e.g., in different years). Prop. Regs. Sec. 1.737-3(c) provides that if gain is recognized on a Sec. 737 distribution, only the basis of "eligible" property will be increased.

Eligible property is defined by Prop. Regs. Sec. 1.737-3(c)(2) as property that (1) entered into the calculation of the distributee partner's net precontribution gain, (2) has an adjusted basis less than its FMV at the time of distribution, (3) would have the same character of gain on a sale by the partnership as was recognized by the distributee partner under Sec. 737 and (4) was not distributed to another partner in a distribution subject to Sec. 704(c)(1)(B). Thus, the basis increase is limited to built-in gain property held by the partnership after the distribution with the same character as that of the gain recognized under Sec. 737.

According to the preamble, the basis increase is allocated to built-in gain property with the same character as the character of the gain recognized. The basis increase allocated to property of a particular character is allocated to the property in the order contributed to the partnership, starting with the earliest contributed property. This ordering rule preserves the effect of the five-year rule to the extent possible.

Prop. Regs. Sec. 1.737-3(c)(4) provides that these Sec. 737 basis adjustments are not elective and must be made regardless of whether the partnership has made a Sec. 754 election. Sec. 734(b)(1)(A) adjustments made pursuant to money distributed as part of the same plan as the Sec. 737 distribution are made before any Sec. 737 adjustments to distributed property or the distributee partner's outside basis. Any other adjustments under Sec. 734(b) are made after (and must take into account) any basis adjustments to distributed property or the distributee partner's outside basis under Sec. 737.

Recovery of Increase to Tax Basis

Prop. Regs. Sec. 1.737-3(d) provides that any basis increase resulting from Sec. 737 is recovered using any applicable recovery method and period available to the partnership for newly purchased property placed in service at the time of the distribution.

Example 13: Distributions of Other Property

to the Contributing Partner

The facts are the same as in Example 12, except that ABC distributes Y to A, the partner who contributed X. The distribution is made within five years of A's contribution of X to ABC. A has $50 built-in gain remaining.

A must recognize $50 gain on receipt of the distribution. The gain under Sec. 737(a)(1) is the amount of the remaining Sec. 704(c) gain (net precontribution gain). The character of the gain is the same as that of the net precontribution gain. Immediately before the distribution, A's outside basis is increased under Sec. 737(c)(1) to $125 ($75 before the distribution + $50 Sec. 704(c) gain recognized). Under Sec. 737(c)(2), the basis of the contributed property, X, is adjusted to $100 ($50 before the distribution + $50 gain recognized on the distribution). A takes a $125 basis in Y, via Sec. 732. After the distribution, ABC's balance sheets are as follows:

              Partnership assets        Partners' capital

             Inside                    Outside
              tax     Book              tax      Book
             basis    value            basis     value

Cash         $200     $200         A      -         -

       $50
X       50    100      200         B   $150      $200

                                   C    150       200

Total        $300     $400             $300      $400

Interaction Between Sec. 704(c)(1)(B)

and See. 737

The distribution of a single piece of property to one partner can trigger both Secs. 704(c)(1)(B) and 737; this will occur if the distributee partner had previously contributed Sec. 704(c) property with built-in gain, so that Sec. 737 will trigger gain recognition to the distributee partner. If the property distributed had previously been contributed by another partner, and at the time of contribution the property had built-in gain, its distribution to another partner will trigger gain recognition under Sec. 704(c)(1)(B) to the contributing partner.

The preamble to the proposed regulations states that in fashioning the rules regarding the interaction between the two sections, the proposed regulations focus on the purpose of Secs. 704(c)(1)(B) and 737, rather than merely their language.

Although the proposed regulations do not state it directly, they seem to require that Sec. 704(c)(1)(B) be applied before Sec. 737. Sec. 704(c)(1)(B) gain is recognized and the resulting adjustments are made to the Sec. 704(c) property's basis and the contributing partner's outside basis before determining the gain to be recognized under Sec. 737 to the distributee partner and the resulting basis adjustments. See Example 14 on page 294-295.

Example 14: Interaction between Secs. 704(c)(1)(B) and 737

A, B and C form general partnership ABC by contributing the following property:

           Partner   Property      FMV    Basis   Debt

              A         X          $100   $100     $ 0
              B         Y           100     40       0
              C         Z           220    100     120A, B and C are equal partners and each is responsible for an equal amount of partnership debt. After a few years of operation, with profits totaling $300 (retained as cash) allocated equally among the partners, the partnership's balance sheets are as follows:
        Partnership assets                    Partner's capital
       Inside                            Outside
        tax     Book                      tax                Book
       basis    value                    basis               value

Cash   $300     $300    Debt                                 $120
                               $100(^)             $100(^)
 X      100      100             40(*)                -
                         A      100(#)   $240       100(#)    200

                                 40(^)              100(^)
                                 40(*)                -
Y        40      100     B      100(#)    180       100(#)    200

                                100(^)              220(^)
                               -120(*)             -120(*)
                                 40(*)
Z       100      220     C      100(#)    120       100(#)    200

Total  $540     $720                     $540                $720

(^) Initial contribution.
(*) Debt increase or decrease.
(#) Income (loss) from operations.The partnership decides to liquidate B's interest in the partnership by distributing Z, which has declined in value to $160, and $20 cash. The partnership will remain liable for the debt. This transaction invokes Sec. 704(c)(1)(B) with respect to C (distribution of contributed property to another partner) and Sec. 737 with respect to B (distribution of other property to partner who had contributed Sec. 704(c) property).

Sec. 704(c)(1)(B) is applied to C first. There is a $60 tax gain ($160 - $100) and a $60 book loss ($160 - $220) on Z's revaluation and distribution. The ceiling rule applies and the partnership uses remedial allocations to counteract its effects.

C, the contributing partner, is allocated the $60 tax gain; the $60 book loss is allocated equally among the partners. A and B each receive a remedial allocation of $20 tax loss; C receives an offsetting remedial allocation of $40 tax gain. After these allocations, the partners' balance sheets are as follows:

[TABULAR DATA OMITTED]

Next, Sec. 737 is applied to determine the tax consequences of the distribution of Z (valued at $160) and $20 cash to B. The value of the distribution equals B's revised capital account; B's gain is the lesser of the excess distribution or the net precontribution gain.

[TABULAR DATA OMITTED]

The excess distribution and the net precontribution gain are equal, so that B will recognize $60 gain; thus, Y's basis will be increased by $60, as will B's outside basis. After these adjustments, the partnership's balance sheets are as follows:

[TABULAR DATA OMITTED]

After the distribution to B of Z and $20 cash, the partnership's balance sheets are as follows:

[TABULAR DATA OMITTED]

Because this was a liquidating distribution, under Sec. 732(b), B's basis in Z is $160, his basis in his partnership interest ($220 before the distribution - $20 cash - $40 debt relief, under Secs. 752(b) and 733).

Anti-Abuse Rules

Prop. Regs. Secs. 1.704-4(f) and 1.737-4(a) provide that Secs. 704(c)(1)(B) and 737 (and the proposed regulations thereunder) must be applied in a manner consistent with those sections' purposes. If a principal purpose of a transaction is to achieve a tax-result inconsistent with the purposes of either provision, the IRS can recast the transaction for Federal tax purposes to achieve tax consequences consistent with the purposes of those provisions. The determination of whether the tax results of a transaction are consistent with the purposes of Sec. 704(c)(1)(B) or 737 is based on all the facts and circumstances.

Effective Dates

Prop. Regs. Secs. 1.704-4(c)(1) and 1.737-1(c)(2)(i) provide that these rules do not apply to property contributed to a partnership before Oct. 3, 1989.

Disguised Sales

Congress became concerned that taxpayers would use the provisions of subchapter K regarding tax-free contributions and distributions of appreciated property in tandem to indirectly sell or exchange property.(22) Such disguised sales are now blocked by Sec. 707(a)(2)(B).

Final Sec. 707 regulations (issued in September 1992) establish a presumption that transfers between a partner and a partnership within a two-year period are related and are part of a taxable sale or exchange.(23) The seller in the presumed sale or exchange is the transferor; the buyer is the transferee title holder. Exceptions to this presumed sale or exchange under Regs. Sec. 1.704-3(c)(2)(iii) are allocations and distributions of operating cash flow, certain preferred returns and guaranteed payments, and reimbursements of certain preformation expenditures.

Sec. 707(a)(2)(A) and the related regulations are beyond the scope of this article. If the disguised sales rules apply to the entire contributed property, there obviously will not be any built-in gain in the partnership; it will have been recognized on the deemed taxable sale or exchange.(24)

Conclusion

Sec. 704(c)(1)(A)'s requirement that partnerships properly account for the variation between the basis of the property and its FMV at the time of contribution imposes a time-consuming record-keeping and accounting burden on taxpayers and their advisers. Unfortunately, clients are not likely to understand or appreciate the extent of this burden, nor are they likely to be willing to pay for its costs.

Fortunately, the final Sec. 704(c) regulations and the proposed regulations under Secs. 704(c)(1)(B) and 737 are a welcome example of brevity and clarity. They protect the interests of the government and also provide taxpayers and their advisers with a great deal of flexibility in determining how to meet this significant accounting burden. It is hoped that the regulations are the beginning of the end of tax "hyperlexis" by the Treasury and serve as a model for future tax regulations.

(18) This methodology is adapted from Coopers & Lybrand, Tax Topics Advisory (7/19/94). (19) Frankel, Loffman and Presant, "Final Allocation Regulations Add Simplicity but Retain Planning Opportunities," 80 Journal of Taxation 330 (June 1994); Schmalz & Brumbaugh, "Final Regulations on Contributed Property Under Section 704(c) Make Major Changes," 11 Journal of Partnership Taxation 91 (Summer 1994); Coopers & Lybrand, id. (20) PS-76-92 and PS-51-93 (both 1/6/95). (21) Enacted by Section 1937(a) of the Energy Policy Act of 1992. (22) Sec. 707(a)(2)(B) was enacted by Congress as part of the Deficit Reduction Act of 1984 in response to such cases as John H. Otey, 70 TC 312 (1978), aff'd per curiam, 634 F2d 1046 (6th Cir. 1980)(47 AFTR2d 81-301, 80-2 USTC [paragraph]9817). See Staff of the Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, 98th Cong., 2d Sess. 214 (1984). (23) TD 8439 (9/25/92). See Regs. Sec. 1.707-3(c)(1). (24) See Ricketts, "Partnership Property Transactions," 24 The Tax Adviser 80 (Feb. 1993).