Partnership taxation developments.

EXECUTIVE SUMMARY

* Proposed regulations addressed the calculation of partner basis.

* Sec. 706(b) requires a partnership to have the same year-end as the majority interest, all principal partners or the calendar year.

* Final regulations clarified the treatment of partnership mergers and divisions.

The number of Code sections addressing partner and partnership taxation is quite small; thus, tax advisers must rely on regulations, cases and rulings. During the period of this update (Nov. 1, 2000-Oct. 31, 2001), Treasury issued several sets of proposed and final partnership regulations; the IRS issued a number of revenue procedures as notices to address changes in tax year-ends. There were also various rulings on the operation of the Sec. 701 anti-abuse rules.

The enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 on June 7, 2001, will have little direct effect on partnerships. The new law increased the estate tax exclusion to $1 million and reduced the estate and gift tax rate to 50% beginning in 2002 (1); these changes, when coupled with a slight reduction in the individual income tax rates, (2) will indirectly affect partnerships. The greatest effect will be on choice of entity.

The IRS has announced (3) that it will host a small business Website to help practitioners and taxpayers with important rulings and cases. Also, the IRS Strategic Plan for fiscal years 2000-2005 includes matching 100% of Schedules K-1 to individual returns and scrutinizing passthrough entities for noncompliance (due to rapid growth in the number of and income from these entities). One reason for the rise in the number of passthrough entities is the increase in the number of limited liability companies (LLCs) and limited liability partnerships. This addition to the IRS Strategic Plan will result in more partnership and LLC audits.

Definitions

A "partnership" is any unincorporated organization through which a business is carried on; a "partner" is any member of a partnership. Because of the brevity of these definitions, the question of whether an entity is a partnership must be addressed on a regular basis. Once it has been determined that an entity is a partnership, the next question is whether an investor is a partner.

Anti-Abuse Rules

In the early 1990s, Treasury issued anti-abuse regulations under Sec. 701. Under Regs. Sec. 1.701-2(b), if a partnership is formed or availed of in connection with a transaction, a principal purpose of which is to reduce substantially the partners' aggregate Federal tax liability inconsistent with Subchapter K, the IRS can recast the transaction as appropriate to achieve tax results consistent with Subchapter K.

In a recent ruling, (4) a corporation was created to acquire an interest in leased property and transfer it to other investors. The company transferred its interest in the property to a partnership for an interest therein, then sold the partnership interest to a general partner (GP) at a loss. The IRS determined the partnership investment was transitory and lacked economic substance, as did the loss on the assets contributed to the partnership. The IRS determined the transaction was actually a sale by the corporation directly to the GP. Because the partnership was created to generate losses and avoid Federal tax, the Service used the Regs. Sec. 1.701-2 anti-abuse rules to recharacterize the transaction.

In another ruling, (5) a taxpayer transferred assets to a corporation for its stock. Ten days later, the taxpayer sold the stock to a partnership. Under Sec. 732(b) and (c), the partnership allocated basis to the assets equal to the basis in the corporation's hands, resulting in an increase in the bases of fixed assets and intangibles. The IRS determined that when a transaction is set up solely to use Sec. 732 to increase asset basis, it should be recast under Regs. Sec. 1.701-2.

In Boca Investerings Partnership, (6) the Service tried to reallocate income and loss to partners of a partnership created solely to generate capital losses, which partners could use to offset personal capital gains. Unlike previous pro-IRS rulings, the court found that the parties had acted in good faith and with a business purpose in conducting partnership operations. Thus, the entity was a bona fide partnership and the transaction had sufficient economic substance.

In Salina Partnership LP, (7) the IRS sought to disallow a capital loss from a sham partnership with no business purpose. Like the district court in Boca, the Tax Court ruled the partnership was not a sham, as the partner had invested in the partnership to achieve legitimate business objectives independent of the tax benefits from the capital loss. The investment also produced objective economic consequences outside of the partner's control, permitting use of the capital loss.

Taxation on Formation

Under Sec. 721(a), no gain or loss is recognized on the contribution of property to a partnership for a partnership interest. "Property" includes tangible and intangible property (including cash), but not services. Previously, Rev. Proc. 93-27 (8) had distinguished between receiving a capital interest in a partnership for services and receiving a profits interest. Under Rev. Proc. 93-27, a partner who receives only a profits interest for services generally will not recognize gain or loss on receipt of the interest.

Rev. Proc. 2001-43 (9) clarified the taxability of the receipt of a substantially nonvested profits interest in exchange for services. Under the procedure, the determination of whether a partnership interest is a profits interest is made when the interest is granted, even if the interest is substantially nonvested. As long as the procedure's conditions are met, neither the grant of the interest nor its vesting will be a taxable event. In addition, no Sec. 83(b) election need be filed at the time of grant. The interest's recipient is treated as receiving the interest on the grant date if the partnership treats the service provider as the interest's owner from the grant date and the service provider includes his share of the partnership's income in computing his income tax liability.

The contribution of LIFO inventory to an S corporation triggers a tax on ,the recapture of the LIFO reserve; this rule does not apply to partnerships. In Letter Ruling 200123035, (10) an automobile dealership and its general manager created an LLC. The dealership transferred its assets (including LIFO inventory) to the LLC. The IRS ruled that the exchange would fall under Sec. 721(a) and that the contribution of the inventory would not trigger LIFO reserve recapture. In addition, the Service determined that the LLC would not be required to treat the goods received from the dealership and physically identical goods subsequently acquired as separate items for LIFO purposes. If the subsequently purchased assets were treated as separate items, the contributed property's built-in gain would be triggered when the items were sold, accelerating gain recognition under LIFO. By treating the subsequently purchased goods as the same item, Sec. 721 gain nonrecognition is preserved. The LIFO inventory, however, is Sec. 704(c) property; any built-in gain or loss will be allocated to the dealership on the inventory's subsequent sale.

FLPs

Family limited partnerships (FLPs) are a very popular income and estate planning tool. Parents can create a FLP with business property and gift partnership interests to their children and grandchildren. This type of entity accomplishes two goals: a reduction in the value of the parent's estate and a shift of current income to children, who presumably are in a lower tax bracket. The gift of a FLP interest qualifies for the gift tax annual exclusion. In addition, the courts have allowed both minority-interest and marketability discounts when determining the value of the gifted interest. By reducing the value of the interest by both discounts, the amount parents can gift annually can increase substantially.

In Est. of Jones, II, (11) a taxpayer created two FLPs with his children. Both the taxpayer and the children contributed property to the partnerships on formation. The taxpayer received a limited partnership interest and the children received both general and limited partnership interests. The IRS contended the taxpayer made taxable gifts when the partnership was formed, because the value of the contributed assets was more than the value of the limited partnership interest received. The Service based its gift calculation on the value of the partnership interest listed on the taxpayer's estate tax return. However, relying on Est. of Strangi, (12) the Tax Court ruled that the taxpayer did not make a gift when the partnership was formed. The factors the court used in making this decision included the fact that the taxpayer contributed property to the FLPs and received continuing limited partnership interests therein, his contribution was allocated to his own capital account and the value of the other partners' interests was not enhanced by the taxpayer's contribution.

Investment Partnerships

Sec. 721(a) provides that no gain or loss is recognized on a contribution of property to a partnership for a partnership interest. Sec. 721(b) provides an exception to this rule for a partnership that would be classified as an investment company if it were incorporated. In Letter Ruling 200125053, (13) an investment partnership was created with two partners that were regulated investment companies. One partner contributed cash; the other contributed a diversified portfolio of stock and securities. The IRS determined that the transfers were not to a partnership that would be treated as an investment company if it were incorporated. Thus, Sec. 721(a), not Sec. 721(b), applied to the transaction, triggering no gain. Following the new Sec. 704(c) regulations (discussed below), the Service allowed the partnership to aggregate basis for Sec. 704(c) allocation purposes using the full netting approach.

In another ruling, (14) cooperative-housing-corporation shareholders exchanged their stock for LLC interests. The Service determined that Sec. 721(a), not 721(b), applied, because the contributed shares were not an interest in a regulated investment company, real estate investment trust or traded on a securities or the over-the-counter exchange. Thus, there was no gain or loss on the transaction.

TEFRA Issues

The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) first enacted unified partnership audit procedures (UPAP). The Tax Reform Act of 1997 and the Internal Revenue Service Restructuring and Reform Act of 1998 later amended these procedures. The UPAP is a set of administrative rules for auditing a partnership and partners. Final regulations were issued effective for audits after Oct. 4, 2001. (15) The final regulations are substantially the same as previously proposed and currently effective temporary regulations under Secs. 6221-6231. Some of the substantive changes in the final regulations clarify that (1) the IRS does not have to issue a final partnership administrative adjustment if it does not make any adjustments to the tax return; (2) a partnership with a nonresident alien partner cannot qualify for the small partnership exception under Sec. 6231(a)(1)(B)(i); (3) a settlement agreement between the tax matters partner and the IRS as to penalties binds all partners; and (4) the application of Sec. 469 to a partner for a loss flowing from a partnership is an affected item to the extent it is not a partnership item.

There were various rulings on the TEFRA audit procedures; most dealt with whether an item was a partnership item. For example, in FSA 200112005, (16) the IRS determined that proposed adjustments to partnership items of a TEFRA partnership for years not before a court cannot be used in determining a partner's basis in his partnership interest.

Other Administrative Issues

SCA 200135029 (17) determined that the IRS could change its administrative procedures to alleviate the effect of the Sec. 6698 failure-to-file penalty on small partnerships (as defined in Sec. 6231(a)(1)(B)). The advice suggested that the Service amend its procedures to include a letter to be mailed to the partnership, along with a notice and demand for payment of the Sec. 6698 penalty, informing the partnership it could qualify for penalty abatement if it is a domestic partnership with 10 or fewer partners, all of whom are natural persons or estates. In addition, to qualify for abatement, the partnership cannot make special allocations and all the partners must fully report their share of partnership income.

Partnership Year-end Election

Sec. 706(b) requires a partnership to have the same year-end as the majority interest, all principal partners or the calendar year. A partnership may have a different tax year not described in Sec. 706(b) if it establishes a business purpose to the IRS's satisfaction. In 2001, the IRS issued two proposed revenue procedures as notices to deal with adopting, changing or retaining a yearend for passthrough entities.

The first, Notice 2001-34, (18) granted approval for taxpayers to adopt, change or retain an annual accounting period based on considerations other than a natural business year, if specified conditions are met to offset any substantial distortion of income due to the change. Partnerships can obtain approval for an accounting-period change, either by establishing a business purpose under one of three enumerated tests or by meeting a facts-and-circumstances test. The three tests are the annual-business-cycle test, the seasonal-business test and the 25%-gross-receipts test. This ruling allows partnerships with a seasonal business to choose a fiscal year-end, even though they cannot meet the 25%-gross-receipts test.

A companion proposed procedure, Notice 2001-35, (19) eased how passthrough entities obtain automatic approval to adopt, change or retain their annual accounting periods. The new rules allow automatic approval in more 52-53-week-year circumstances. The proposed procedure applies when a passthrough entity changes from a permitted tax year to a 52-53-week year with the same month-end, or changes to or retains a natural business year that meets the 25%-gross-receipts test or to a 52-53-week year that refers to that year, etc. (Historically, a 52-53-week year has applied to retail stores.)

Because a partnership's tax year must be the same as that of the majority interest, it is possible for a partnership to have a year-end of a taxpayer not subject to U.S. taxation, if the majority partner is a foreign person; this may defer income taxation for the other partners. The IRS issued proposed regulations (20) on tax years for partnerships with foreign partners.

Prop. Regs. Sec. 1.706-4(a)(1) requires partnerships to disregard foreign partners not subject to U.S. taxation on their partnership income when determining the partnership's tax year-end, thereby eliminating the income deferral. The tax year will be determined only by reference to partners subject to U.S. taxation.

An exception under Prop. Regs. Sec. 1.706-4(b) allows foreign partners to be included if the partnership's tax year would be determined by reference to partners who individually hold a less-than-10% interest (and in the aggregate, a less-than-20% interest) in the partnership if the foreign partner is disregarded. Partnerships that have previously elected a tax year with reference to a foreign partner may have to change their year-end. This change could cause a "bunching" of more than 12 months' income into one return.

Example: XYZ Partnership has a July 31 tax year-end because of a 75% foreign partner who is not subject to U.S. taxation on his partnership income. This year-end creates a five-month deferral for X, a calendar-year, 25% domestic partner. Under Prop. Regs. Sec. 1.706-4, XYZ will have to change to a calendar year-end. In the change year, two partnership tax years (August 1-July 31 and August 1-December 31) will close during X's tax year, requiring X to recognize 17 months of partnership income during a single tax year. To alleviate any hardship the income bunching would cause X, the Temp. Regs. Sec. 1.702-3T four-year-spread provisions will apply.

A partnership must file an election stating its tax year-end, by filing the first partnership return, noting the election on the application for an employer identification number (EIN) or filing Form 1128, Application to Adopt, Change, or Retain a Tax Year. In Letter Ruling 200113021, (21) a partnership fried Form 1128 late, requesting the adoption of a tax year-end. Nevertheless, the IRS determined the election was timely filed because the partnership acted reasonably and in good faith.

Basis Issues

Under Sec. 705, a partner's basis in his partnership interest is determined by increasing his initial basis by his distributive share of partnership income items (taxable and nontaxable) and decreasing it by his share of partnership losses and deductions (deductible and nondeductible). New proposed regulations (22) addressed the determination of a partner's basis.

Prop. Regs. Sec. 1.705-2(a) prevents inappropriate changes in a corporate partner's basis resulting from the partnership's disposition of the corporate partner's stock. The proposed regulations apply when a corporation acquires an interest in a partnership that holds stock in the corporation, the partnership does not have a Sec. 754 election in effect and the partnership later sells the stock. Under Prop. Regs. Sec. 1.705-2(a), the allowed increase or decrease to the corporate partner's basis is the gain or loss the partner would recognize had a Sec. 754 election been in effect when the corporation acquired its partnership interest. The proposed regulations' purpose cannot be avoided by creating tiered partnerships or other arrangements.

Liability Allocation

Unique to partnerships, under Sec. 752(a), a partner can increase his basis in his partnership interest by his share of partnership liabilities, thus increasing the losses he can deduct. The increase in liability share is a deemed cash contribution. In Dynadeck Rotary Systems Ltd., (23) the Tax Court held that a partner's direct acquisition of debt for a partnership, on which he was the obligor, was not partnership debt that increased partners' bases.

Sec. 752 allocates debt to partners differently, depending on whether it is recourse or nonrecourse. Recourse debt is allocated using a constructive liquidation method; nonrecourse debt is allocated using three tiers: (1) share of partnership minimum gain; (2) share of Sec. 704(c) gain; and (3) ownership interest. Partnership minimum gain is the difference between the debt and the adjusted basis of the asset securing it.

In Letter Ruling 200120020, (24) a partnership refinanced debt by obtaining a line of credit and an unsecured debt; both were nonrecourse. The IRS determined that the partnership could allocate the debts among its properties in any amounts it determined, as long as the aggregate allocation to each property did not exceed the lesser of the property's fair market value (FMV) or the debt allocated to the property before the refinancing. Subsequent reductions in the unsecured debt had to be made in the same manner and proportion as the initial allocation. The IRS also decided that each advance of the line of credit could be treated as a separate loan. By allowing this very lenient allocation of the refinanced debt to the partnership assets, the debt allocated to each partner could be significantly changed from the original allocation, perhaps allowing a higher loss deduction.

However, the debt reallocation could create gain; Sec. 752(b) states that a decrease in a partner's share of partnership liabilities is a deemed cash distribution. If the decrease in the partner's share of liabilities is more than his adjusted basis, he must report a gain on the deemed distribution.

In FSA 200131013, (25) a partnership restructured its debt, resulting in cancellation-of-debt income and a recharacterization of the debt from nonrecourse to recourse. After the restructuring, one partner transferred his interest to another partner and the partnership redeemed two other partners' interests. The question arose as to when to allocate partnership liabilities, because the amount of gain or loss to each partner could change depending on the liability allocation. The IRS ruled the liability allocation had to be considered before and after each of the three transactions. Before the transactions, the liability was nonrecourse and allocated based on ownership percentages. After the restructuring, the liability was recourse and allocated almost entirely to one partner. The reallocation would not create additional gain to the partners that exchanged their partnership interests, but might create gain to any remaining partners if the decrease in their share of partnership liabilities exceeded their partnership interest bases.

Losses

Three items determine whether a partner can deduct his share of partnership losses currently: (1) partnership interest basis under Sec. 704(d); (2) Sec. 465 amount at-risk; and (3) Sec. 469 passive activity income.

In a case of partnerships and passive activity losses (PALs), Hillman, (26) the Fourth Circuit reversed a pro-taxpayer Tax Court decision. The taxpayer owned and materially participated in an S corporation that performed management services. The S corporation charged management fees to many partnerships the taxpayer owned. The corporate income that passed through to him was active income; the payment for the partnerships' management services was limited by the PAL rules. The taxpayer argued that this type of transaction should be covered by the self-charged rules, which would allow a portion of the active income to be characterized as passive and offset PALs. However, the self-charged rules (Prop. Regs. Sec. 1.469-7) addressed only interest, not other types of income.

The Tax Court held that the IRS unduly delayed the issuance of self-charged rules; thus, it applied the self-charged concept to management fees. However, the Fourth Circuit reversed, holding that in the absence of specific regulatory authority, the taxpayer could not offset self-charged management fees.

It is unclear whether the qualified real estate professional rules (Sec. 469(c)(7)) would avoid this situation in the future. Because the self-charged interest proposed regulations were issued in 1991, perhaps Treasury should issue final regulations to cover this and other activities.

Income Allocation

Under Sec. 704(a), the allocation of partnership items is made based on the partnership agreement. When a partner joins or leaves a partnership during the tax year, he is allocated partnership items based on the number of days during the year he owned his partnership interest. In Katz, (27) the taxpayer, a partner in several partnerships, declared bankruptcy. On his return, he reported his share of partnership income and loss items attributable to the period prior to the bankruptcy filing; the remainder was reported on his bankruptcy estate's return.

The taxpayer argued that he should be allowed part of the partnership's income, because the transfer to the bankruptcy estate was a disposition under Sec. 706(d). However, according to the Tax Court, the transfer of the partnership interests to the bankruptcy estate was not a disposition of property under Sec. 1398(f)(1); thus, the taxpayer did not experience a "change of interest" under Sec. 706(d)(1). The partnership's income and loss items could not be prorated; all of the items for the entire year had to be reported on the bankruptcy estate's return. This decision reduced the income the taxpayer reported during the current year, thus reducing the losses he could deduct from other sources.

There are several exceptions to the general allocation rule. Sec. 704(c) applies to the allocation of gains and losses a partnership recognizes from property contributed to the partnership. Any built-in gain or loss attributed to the property before the contribution has to be allocated to the partner making the contribution. Only gain or loss accruing after the property was contributed to the partnership is allocated based on the partnership agreement. The built-in gain or loss at the time of the contribution is defined as the difference between the property's FMV and the partner's adjusted basis in the property.

Rev. Proc. 2001-36 (28) allowed certain securities partnerships to automatically aggregate contributed property for Sec. 704(c) purposes. It also provides guidance on how partnerships that cannot automatically aggregate contributed property can obtain a ruling on this issue. Partnerships that can automatically aggregate contributed property must meet the "qualified master feeder" (QMF) structure (two or more investors contribute cash or qualified financial assets to a "master portfolio" (MP) in exchange for interests therein). To meet the QMF structure, each partner in the MP must be a feeder fund, an investment advisor, an underwriter or a manager. In addition, the only property that can be contributed to an MP is cash or a portfolio of diversified stock and securities.

Transactions Between Partnership and Partner

Under Sec. 707, if a partner engages in a transaction with a partnership other than in his capacity as a partner, the transaction is considered as occurring between the partnership and a nonpartner. Sec. 707(a)(2)(B) applies to disguised sales of partnership interests. If there is a transfer of property between the partnership and the partner that should properly be characterized as a sale or exchange of property, the transaction should be viewed as a transaction between two unrelated parties. This provision prevents partners from selling their partnership interests and treating the sale as a nontaxable distribution. The IRS has announced that it is considering issuing regulations on disguised sales of partnership interests. (29) Comments are requested on the scope and substance of this guidance by March 31, 2002.

To the extent distributions to partners are not determined by partnership income, the payments are deemed made to an unrelated party under Sec. 707(c) (a guaranteed payment). Partners are required to include guaranteed payments in taxable income; the partnership can deduct the payments.

In Letter Ruling 200138028, (30) a FLP agreement called for the GP to receive an annual distribution of the first x dollars of partnership net profit, plus five percent of the remaining net profit (preferential return). The GP was guaranteed to receive no less than y dollars each year (guaranteed return). The issue was how the payments should be treated in years the GP receives the preferential return.

The IRS ruled based on Regs. Sec. 1.707-1(c), Example 2. It determined that all distributions made to the GP in years net profits exceeded the guaranteed return would be a distribution of his distributive share, not a guaranteed payment. Thus, the distribution will not be additional income to the partner and the partnership cannot deduct the payment.

Terminations

Partnerships do not have unlimited life; thus, they must always be aware of transactions that could cause termination. A partnership terminates under Sec. 708 when 50% or more of the total interest in the partnership's capital and profits is sold or exchanged within 12-month period. Notice 2001-5 (31) explains the returns to be fried if a partnership terminates under Sec. 708(b)(1)(B). The original partnership must file a short-year return ending with the termination date, even when the succeeding partnership continues to use the EIN. The succeeding partnership must file a short-year return beginning after the termination.

In FSA 200132009, (32) a partnership terminated under Sec. 708(b)(1)(B), but fried only one return for the year. The IRS determined that the filing of a year-long return was acceptable and started the statute of limitations for both short periods. This decision was based on a case-by-case test used by the Tax Court (33) to evaluate flawed returns. The test applied because the income for each short period could be determined from the fried return.

Mergers and Divisions

Sec. 708(b)(2)(A) provides that in the case of a merger of two or more partnerships, the resulting partnership is deemed the continuation of any merging partnership whose members own more than 50% of the capital and profits interests. (34) Sec. 708(b)(2)(B) provides that in the case of a division of a partnership into two or more partnerships, the resulting partnerships (other than a resulting partnership with members having a 50%-or-less interest in the capital and profits of the prior partnership) are deemed continuations of the prior partnership.

Final regulations clarified the partnership merger and division rules, effective for transactions occurring after Jan. 4, 2001. (35) Under Regs. Sec. 1.708-1(c)(3), a merger or division will be respected if the partnership undertakes the transaction using either the assets-over or the assets-up form.

In the assets-over form, the existing partnership contributes its assets and liabilities to a new partnership in exchange for a partnership interest therein. The old partnership distributes the interest in the new partnership to its partners in liquidation. In the assets-up form, the partnership distributes all its assets and liabilities to its partners in liquidation; the partners contribute the assets and liabilities to the new partnership. If a method is not elected in a merger or division, the default is the assets-over form.

The final regulations also clarify some of the tax consequences in a partnership division. Specifically, under Regs. Sec. 1.708-1(c)(2), when more than one resulting partnership is deemed continuing, the resulting partnership treated as the divided partnership retains the prior partnership's EIN. All other resulting partnerships are deemed new partnerships. However, all resulting partnerships deemed continuing partnerships are subject to the prior partnership's elections.

One open issue is the treatment of the contribution of property to the new partnerships under Sec. 704(c). As was discussed, the contribution of property with a difference in FMV and adjusted basis creates Sec. 704(c) gain or loss to be allocated to the contributing partner when the partnership recognizes it. In a merger or division, there may be built-in gain or loss associated with some of the contributed assets that accrued while the property was held by the prior partnership. The question is whether this built-in gain or loss should be treated as Sec. 704(c) gain or loss. Under Kegs. Sec. 1.708-1(c)(5), Example 5, a pro-rata division should not create additional Sec. 704(c) property. However, Treasury is still studying this issue for non-pro-rata divisions.

Sec. 754 Election

When a partnership distributes property or a partner sells his interest, the partnership can elect under Sec. 754 to adjust the basis of partnership property. A Sec. 754 election allows a step-up or step-down in basis to reflect the FMV at the time of the exchange. This election has the advantage of not taxing the new partner on gains or losses already reflected in the purchase price of his partnership interest. The election must be fried by the due date of the return for the year the election is effective. Normally, the election is fried with the return. In Letter Ruling 200130025, (36) the IRS granted an extension of time to make a Sec. 754 election. A partnership inadvertently omitted the election when filing its return. The Service reasoned that the partnership acted reasonably and in good faith in granting an extension to file the election under Regs. Sec. 301.9100-1 and -3. The partnership had 60 days after the ruling to file the election. A 60-day extension is normal; however, only a 30-day extension was granted in Letter Ruling 200110023. (37)

Once a Sec. 754 election is made, it is effective for all exchanges thereafter. A partnership can revoke a Sec. 754 election only with IRS consent. To be effective, the election must be revoked before a transaction occurs. In Letter Ruling 200120023, (38) a partnership sought to revoke its Sec. 754 election, but inadvertently failed to file the revocation with its return. The IRS granted the partnership an extension of time to file the revocation and treated the transfer in question as if the Sec. 754 election had been revoked timely.

(1) For a discussion, see Sawyers and Whitlock, "Estates, Trusts & Gifts: Post-EGTRRA Analysis and Planning," 32 The Tax Adviser 822 (December 2001).

(2) For a discussion, see Hegt, "EGTRRA Lowers Rates and Expands Credits, Education Benefits," 32 The Tax Adviser 677 (October 2001).

(3) IR-2001-26 (2/26/01).

(4) FSA 200134002 (8/28/01).

(5) FSA 200128053 (7/17/01).

(6) Boca Investerings Partnership, DC DC, 10/5/01.

(7) Salina Partnership LP, TC Memo 2000-352.

(8) Rev. Proc. 93-27, 1993-2 CB 343.

(9) Rev. Proc. 2001-43, IRB 2001-34, 191.

(10) IRS Letter Ruling 200123035 (3/8/01).

(11) Est. of W. W. Jones, II, 116 TC 121 (2001).

(12) Eat. of Albert Strangi, 115 TC 478 (2000).

(13) IRS Letter Ruling 200125053 (3/23/01); see also IRS Letter Rulings 200121016 (2/14/01) and 200118039 (2/5/01).

(14) IRS Letter Ruling 200125013 (3/15/01).

(15) TD 8965 (10/3/01).

(16) FSA 200112005 (3/26/01).

(17) Service Center Advice (SCA) 200135029 (9/5/01).

(18) Notice 2001-34, IRB 2001-23, 1302.

(19) Notice 2001-35, IRB 2001-23, 1314; see Beattie, Tax Clinic, "Adopting, Retaining and Changing Accounting Periods," 32 The Tax Adviser 575 (September 2001).

(20) REG-104876-00 (1/17/01).

(21) IRS Letter Ruling 200113021 (12/28/00).

(22) REG-106702-00 (1/3/01, corrected 2/27/01).

(23) Dynadeck Rotary Systems Ltd., TC Memo 2000-382.

(24) IRS Letter Ruling 200120020 (2/13/01).

(25) FSA 200131013 (5/1/01).

(26) David H.. Hillman, 250 F3d 228 (4th Cir. 2001), rev'g 114 TC 103 (2000).

(27) Aron B. Katz, 116 TC 5 (2001).

(28) Rev. Proc. 2001-36, IRB 2001-23, 1326.

(29) Notice 2001-64, IRB 2001-41,316.

(30) IRS Letter Ruling 200138028 (6/21/01).

(31) Notice 2001-5, IRB 2001-3, 327.

(32) FSA 200132009 (8/14/01).

(33) See Robert D. Beard, 82 TC 766 (1984), aff'd per cur., 793 F2d 139 (6th Cir. 1986).

(34) For a discussion of proposed regulations in this area, see Orbach and Heller, "Merger and Division Prop. Kegs.," 31 The Tax Adviser 854 (December 2000).

(35) TD 8925 (1/4/01).

(36) IRS Letter Ruling 200130025 (4/30/01); see also IRS Letter Rulings 200128052 (4/18/01) and 200123049 (3/12/01).

(37) IRS Letter Ruling 200110023 (12/7/00).

(38) IRS Letter Ruling 200120023 (2/13/01).

Editor's note: Dr. Burton is a member of the AICPA Tax Division's Partnership Taxation Technical Resource Panel.

Hughlene Burton, Ph.D., CPA
Associate Professor
University of North Carolina--Charlotte
Charlotte, NC