This past summer, the IRS and Treasury issued guidance on the inappropriate use of partnership rules to inflate the basis of assets without causing meaningful changes to a taxpayer’s business’s economics.
The guidance focuses on complex transactions involving related-party partnerships, through which taxpayers “strip” basis from certain assets and shift that basis to other assets. The increased basis is intended to generate tax benefits—through increased cost recovery deductions or reduced gain (or increased loss) on asset sales—in transactions that have little or no economic substance.
The guidance states that there are generally three categories of basis-shifting transactions:
To address what it deems the inappropriate use of such transactions to generate tax benefits, the IRS announced two sets of upcoming regulations through Notice 2024-54:
The proposed regulations issued concurrently with Notice 2024-54 identify related-partnership basis adjustment transactions and substantially similar transactions as reportable Transactions of Interest.
Under the proposed rules, disclosure requirements for these transactions would apply to taxpayers and material advisers regarding partnerships participating in the identified transactions, including by receiving a distribution of partnership property, transferring a partnership interest, or receiving a partnership interest.
Generally, the identified Transactions of Interest would involve positive basis adjustments of $5 million or more under Subchapter K of the Internal Revenue Code in excess of the gain recognized from such transactions, if any, on which tax imposed under subtitle A is required to be paid by any of the related partners (or tax-indifferent party) to such transactions – specifically, Section 732(b) or (d), Section 734(b), or Section 743(b) – for which no corresponding tax is paid.
The transactions would include either:
The proposed regulations identify that a transaction would be substantially similar to the related-partnership basis adjustment transactions above if the transaction does not involve related partners and one or more partners of the partnership is a tax-indifferent party.
The IRS proposes these rules to apply to identify certain partnership-related-party basis adjustment transactions and substantially similar transactions as transactions of interest effective as of the date of publication of final regulations in the Federal Register.
In Revenue Ruling 2024-14, the IRS notifies taxpayers and advisors that the IRS will apply the codified economic substance doctrine to challenge basis adjustments and other aspects of certain transactions between related-party partnerships. The IRS will raise the economic substance doctrine with respect to transactions in which related parties:
The revenue ruling describes three situations in which related parties coordinate to create disparities between inside and outside basis through various methods, such as the contribution or distribution of property with specific tax attributes or the allocation of tax items by Section 704(b) and (c). The parties then attempt to exploit these disparities by engaging in transfers resulting in basis adjustments under the rules of Section 732(b), 734(b), or 743(b) to reduce taxable income through increased deductions, reduced gain, or increased loss.
In the revenue ruling, the IRS rules that the transactions in the three described situations lack economic substance under Section 7701(o) and that taxpayers involved are not entitled to the associated basis adjustments.