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New IRS, Treasury Guidance Focuses on “Basis Shifting” Transactions Used by Partnerships

Posted by Admin Posted on June 25 2024

The Department of the Treasury and the Internal Revenue Service issued guidance on the inappropriate use of partnership rules to inflate the basis of the underlying assets without causing any meaningful change to the economics of their business.

The guidance issued by Treasury and the IRS follows work by IRS exam teams, which have seen repeated instances of abusive basis-shifting taking place in sophisticated maneuvers by related-party partnerships.

As part of the larger IRS compliance efforts, the guidance issued relates to certain partnership transactions that the IRS believes generate inappropriate tax benefits.

Generally, these transactions may employ several steps over a period of years and use sophisticated tax technology to ensure that little or no tax is paid while large amounts of tax basis is “stripped” from certain assets and shifted to other assets to generate tax benefits. In essence, these deals allow increased depreciation deductions or reduced gain on the sale of an asset with little or no substantive economic consequence.

These basis shifting transactions targeted in the new guidance generally fall into three groups:

Transfer of partnership interest to related party: In this transaction, a partner with a low share of the partnership’s “inside” tax basis and a high “outside” tax basis transfers the interest in a tax-free transaction to a related person or to a person who is related to other partners in the partnership. This related-party transfer generates a tax-free basis increase to the transferee partner’s share of “inside” basis.

Distribution of property to a related party: In this transaction, a partnership with related partners distributes a high-basis asset to one of the related partners that has a low outside basis. After this, the distributee partner reduces the basis of the distributed asset and the partnership increases the basis of its remaining assets. The related partners can arrange this transaction so that the reduced tax basis of the distributed asset will not adversely impact the related partners, while the basis increase to the partnership’s retained assets can produce tax savings for the related parties.

Liquidation of related partnership or partner: In this transaction, a partnership with related partners liquidates and distributes (1) a low-basis asset that is subject to accelerated cost recovery or for which the parties intend to sell to a partner with a high outside basis and (2) a high-basis property that is subject to longer cost recovery (or no cost recovery at all) or for which the parties intend to hold to a partner with a low outside basis. Under the partnership liquidation rules, the first related partner increases the basis of the property with a shorter life or which is held for sale while the second related partner decreases the basis of the long-lived or non-depreciable property, with the result that the related parties generate or accelerate tax benefits.

To help address these areas, Notice 2024-54 announces two sets of upcoming regulations:

  • The first set of regulations would require partnerships to treat basis adjustments arising from covered transactions in a way that would restrict them from deriving inappropriate tax benefits from the basis adjustments.
  • The second set of regulations would provide rules to ensure clear reflection of the taxable income and tax liability of a consolidated group of corporations when members of the group own interests in partnerships. The notice further announces that that the covered transactions governed by these regulations would involve basis adjustments under Internal Revenue Code sections 732, 734(b) and/or 743(b).

Basis shifting identified as Transactions of Interest (TOI)

The proposed regulations Treasury and IRS issued identify certain basis shifting transactions by partnerships as reportable Transactions of Interest (TOI).

“These proposed regulations will provide the IRS with information about potentially abusive partnership transactions involving basis shifting leading to significant tax benefits without causing any meaningful change to the economics of their business,” IRS Commissioner Danny Werfel said. “Our teams are seeing these very problems. There are cases at either the litigation or the audit stage that involve transactions that are the same or similar to those described as transactions of interest in the proposed regulations issued.”

The proposed regulations identify related-party partnership basis adjustment transactions and substantially similar transactions as a TOI – a type of reportable transaction. These proposed regulations would affect partnerships that are participating in the identified transactions by distributing partnership property or by transferring an interest in the partnership transferred in an identified transaction. The affected taxpayers and material advisors would be subject to the disclosure requirements for reportable transactions.

The TOIs generally involve positive basis adjustments of $5 million or more under subchapter K of the Internal Revenue Code – specifically sections 732(b) or (d), 734(b) or 743(b) – to which no corresponding tax is paid. The transactions would include either a distribution of partnership property to a partner that is related to one or more other partners in the partnership, or the transfer of a partnership interest in which the transferor is related to the transferee, or the transferee is related to one or more of the partners.

In these transactions, the basis increase allows related parties an opportunity for decreasing their taxable income through increased cost recovery deductions or through decreasing their taxable gain (or increasing their taxable loss) on the subsequent transfer of the property in a transaction in which gain or loss is recognized in whole or in part.

The proposed regulations would affect the partnership and the partners that are participating in the identified transactions, including by receiving a distribution of partnership property, transferring a partnership interest or receiving a partnership interest.

“You can see by these descriptions that these involve complex arrangements where taxable income can be shielded from scrutiny,” Werfel said. “These proposed regulations demonstrate the agency’s commitment to use new resources to unpack complicated noncompliance by partnerships and other high-income taxpayers, which is an important part of our efforts to bring more fairness to the tax system.”

Revenue Ruling informs the public that IRS will challenge basis stripping

Revenue Ruling 2024-14 notifies taxpayers and advisors using partnerships that engage in three variations of these transactions that the IRS will apply the codified economic substance doctrine to challenge inappropriate basis adjustments and other aspects of these transactions.

Under Revenue Ruling 2024-14, the IRS announces that the economic substance doctrine will be raised in cases where related parties:

1.   create inside/outside basis disparities through various methods, including the use of certain partnership allocations and distributions,

2.   capitalize on the disparity by either transferring a partnership interest in a nonrecognition transaction or making a current or liquidating distribution of partnership property to a partner, and

3.   claim a basis adjustment under Internal Revenue Code sections 732(b), 734(b), or 743(b) resulting from the nonrecognition transaction or distribution.

If you have any questions regarding Essential Business Accounting, Domestic Taxation, International Taxation, IRS Representation, U.S. Tax Implications of Real Estate Transactions or Financial Statements, please give us a call at +1-305-274-5811

Source : IRS     

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