SALES AND EXCHANGES OF PARTNERSHIP INTERESTS

Transcription

1 SALES AND EXCHANGES OF PARTNERSHIP INTERESTS I. SECTION 741. Code 741 sets forth the basic rules with respect to the sale or exchange of a partnership interest. Section 741 treats gains and losses on sale of a partnership interest as sales or exchanges of capital assets. A. From the seller's perspective, an amount realized and an adjusted basis need to be determined in measuring gain/loss under B. From the buyer's view, an initial outside basis and capital account must be established. II. SELLING PARTNER. A. General Rules. 1. First, in determining amount realized per 1001, the partner must include his share of partnership debt as a part of the amount received from the purchasing partner. 2. Second, in determining his adjusted basis, the selling partner must include his share of partnership income or loss as a basis adjustment up to the time of sale. B. Closing the Tax Year of the Selling Partner. Although outside basis for income and loss is not generally adjusted prior to the close of a tax year under 705, per 706( c), the sale or exchange of an entire interest closes the tax year of a partnership (only) with respect to a selling partner, thereby authorizing and requiring such a basis adjustment for tax purposes ( c) does not authorize the closing of the partnership's tax year with respect to a partner who sells or exchanges less than his entire interest. In such a case, the varying interest rules of 706(d)(1) kick in, requiring the partnership and the partner to appropriately account for the impact such a sale or change in interest has on basis, capital account, income sharing, etc. III. "HOT ASSETS." To the extent the partnership holds inventory or unrealized receivables (collectively referred to as "Hot Assets"), a selling partner's capital gain or loss may be recharacterized as {09000.BKW / DOC.1 } 1

2 ordinary income to the extent of the Hot Assets under 751(a). The rule that a sale or exchange of a partnership interest results in capital gain under 741 is expressly overridden by 751. IV. SELLING PARTNERS - INSTALLMENT SALES TREATMENT. Partnership interests, like other capital assets, may be sold, with gains thereon reported on the installment method under 453. Under this method of accounting (assuming adequate stated interest), otherwise taxable capital gains are reported as and when principal payments are received on the note on the basis of a gross profit ratio. This method of accounting permits selling partners the opportunity to pay tax on capital gains as and when payments are received. The interest portion is, of course, taxed on a non-installment sales method (usually the accrual method). However, gains on sale of an interest subject to 751(a) recapture items, per 453(i)(2), may not be subject to installment sales reporting. (See also, Rev. Rul (denying 453 treatment to the extent of 751(a) substantially appreciated inventory items) V. EXCHANGES OF PARTNERSHIP INTERESTS. Since 1984, 1031(a)(2)(D) has clearly disallowed like-kind exchange treatment for swaps of partnership interests. This statutory provision repealed the favorable case law taxpayers were relying upon. However, conversions of a partner's interest in a single partnership (general to limited and vice versa) may still be accomplished tax free. (See Rev. Rul ) Watch out, however, for liability allocation shifts which may trigger 752(b) deemed cash distributions resulting in 731(a)(1) gains. A partnership may, however, opt out of Subchapter K under IRC 761 and the partners are then treated as cotenants whose interests can be exchanged. VI. BUYING PARTNER. A. Adjusted Basis. The rules applicable to the purchasing partner are generally straightforward. As to outside basis, the purchasing partner acquires a cost basis in the acquired partnership interest equal to the cash and fair market value of property paid to seller in consideration of the interest, plus the new partner's allocable share of partnership debt. B. 754 Considerations. An important consideration to a purchasing partner whose purchase price (outside basis) exceeds his underlying share of the assets of the basis of partnership assets (inside basis) is whether to demand or request that the partnership elect to {09000.BKW / DOC.1 } 2

3 adjust its inside asset bases under 754. If a 754 election is already in effect, there's no need for further action, since the election is only made once. C. Interim Income Loss Allocations. Just as the selling partner is concerned as to the partnership's determination of interim income and loss for allocation and basis purposes, the incoming partner is also interested in income and loss allocations which take into account the method of accounting the partnership has selected for dividing up income and loss for the two deemed short periods. D. Capital Account. The buying partner generally takes over the selling partner's capital account without adjustment. VII. THE PARTNERSHIP AND OTHER PARTNERS. A. General Rule No Effect. Generally, the sale or exchange of a partner's interest to a new or existing partner does not trigger any particularly difficult issues for the partnership or its other partners. B. Exception 708 Termination. A "tax termination" is triggered when sales or exchanges of capital and profits interests aggregate to 50% or more within a 12-month period. EXAMPLE #1 Straight cash sale-no Partnership Income or Debt. Assume that Alice, a partner in partnership ABC decides to sell her 1/3 overall interest in the partnership to Dorothy for $100,000. At the time of sale, the partnership has no income or loss. At the time of sale, the partnership books reflect the following: Partnership ABC Tax Basis Book Value Cash $50,000 $50,000 Stock 160, ,000 Total Assets: $210,000 $300,000 Liabilities $ N/A $ -0- Alice 70, ,000 Betsy 70, ,000 Charles 70, ,000 Total Liabilities & Capital: $210,000 $300,000 {09000.BKW / DOC.1 } 3

4 Taxable gain to Alice per 741: Amount Realized on Sale: $100,000 Alice s Adjusted Basis: <70,000> 741 Taxable Capital Gain $30,000 Tax effects to Dorothy per 742: Dorothy acquires a cost basis of $100,000 and takes over Alice's capital account. Assuming that the partnership books reflect Alice's capital account at $100,000, then Dorothy would have a $100,000 capital account. Taxable effects to Partnership: Generally none. EXAMPLE #2 Same Facts, But Income That Needs Allocating: Assume the same facts as in Week 9, Example 1, except that, at the time of sale (6/30/XX), the partnership has $30,000 ordinary income and at the end of the tax year the partnership has $120,000 of ordinary income. Per 706( c) the partnership's tax year closes with respect to Alice only: But, if the partnership uses the pro rata method of accounting, even though Alice's actual stub period income through 6/30/XX was $10,000 (1/3 of $30,000 to 6/30/XX) her income allocation is $20,000 ($120,000 x 1/2 year x 1/3 interest). Per 705, Alice must adjust her basis upwards by the $20,000, so that: Amount Realized On Sale: $100,000 Alice's Adjusted Basis: < 90,000> Reflects Basis Adjustment For Income 741 Taxable Capital Gain: $ 10,000 Plus: Alice must report the $20,000 ordinary income that appears on her final K-1. {09000.BKW / DOC.1 } 4

5 EXAMPLE #3 Assume the same facts as in Example 1, except that the partnership, prior to A s sale to D, borrows $60,000. ABC's Balance Sheet is thus revised at time of sale to show: Partnership ABC Tax Basis Book Value Cash $110,000 $110,000 Stock 160, ,000 Total Assets: $270,000 $360,000 Liabilities $60,000 $60,000 Alice 70, ,000 Betsy 70, ,000 Charles 70, ,000 Total Liabilities & Capital: $270,000 $360,000 Taxable gain to Alice per 741: On cash payment of $100,000 by Dorothy to Alice: Amount Realized On Sale: $120,000 Reflects Adjustment For Debt Relief Alice's Adjusted Basis: < 90,000> 741 Taxable Capital Gain $ 30,000 Basis to Dorothy per 742, 722 and 752(a): Dorothy has paid $100,000 and she receives an allocation of $20,000 debt per 752. Her basis is $120,000. Straight cash sale-no Partnership Income or Debt: Sale of Partial Interest. Assume that Alice, a partner in partnership ABC decides to sell 2 of her 1/3 overall interest in the partnership to Dorothy for $50,000. At the time of sale, the partnership has no income or loss. At the time of sale, the partnership books reflect the following: {09000.BKW / DOC.1 } 5

6 Partnership ABC Tax Basis Book Value Cash $50,000 $50,000 Stock 160, ,000 Total Assets: $210,000 $300,000 Liabilities $ N/A $ -0- Alice 70, ,000 Betsy 70, ,000 Charles 70, ,000 Total Liabilities & Capital: $210,000 $300,000 Taxable gain to Alice per 741: Amount Realized On Sale: $ 50,000 Alice's Adjusted Basis: < 35,000> 741 taxable Capital Gain $ 15,000 Tax effects to Dorothy per 742: Dorothy acquires a cost basis of $50,000 and a capital account of $50,000 (because its 2 of the transferors capital account, not because Dorothy paid $50,000). Taxable effects to Partnership: Generally none. {09000.BKW / DOC.1 } 6

7 WEEK 9 --PART II TAX TERMINATIONS I. INTRODUCTION Code 708 sets forth the basic events which trigger a so-called termination for tax purposes. Under Subchapter K, absent a termination, a partnership is treated as continuing. This means that, despite partner changes or shifts in percentage interests in debt, cash flow, profits, losses and capital, absent a termination, the partnership will continue to be treated as the same tax entity. In this regard, 708(a) provides that: "a partnership shall be considered as terminated only if-- A. 708(b)(1)(A) no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership, or B. 708(b)(1)(B) within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits." II. 708(b)(1)(a): NO FURTHER BUSINESS CARRIED ON BY THE PARTNERS IN A PARTNERSHIP A. Explanation of (b)(1)(a) Terminations. Prior to liquidation of the partnership, it's hard to trigger (b)(1)(a) terminations, because even if a modicum of business is carried on by the partnership, it will not be deemed terminated. Even mere collection of interest and principal on a note receivable held by the partnership upon sale of all of its assets will still constitute sufficient business to avoid termination per (b)(1)(a). 1. A "(b)(1)(a)" termination can occur when there is only one partner left. For example, one person in a 2 person partnership sells out to the other. 2. Upon the death of one partner in a 2-member partnership, the partnership shall not be considered as terminated if the estate or other successor in interest of the deceased partner continues to share in the profits or losses of the partnership business. (Treas. Reg (b)(1)(i)(a)). B. Dissolution Distinguished. Local law concepts of dissolution and windup, or liquidation, are not meaningful terms of art in determining whether a tax termination has or will {09000.BKW / DOC.1 } 7

8 occur. A dissolution may occur under local law without necessity of a tax termination occurring and, conversely, a tax termination may arise without a dissolution. C. Liquidation. A partnership liquidation takes place when all of the assets are marshaled, all creditors paid and the assets are distributed to the partners in satisfaction of their equity interests. III. 708(b)(1)(B): SALES OR EXCHANGES OF 50% OR MORE CAPITAL AND PROFITS INTERESTS WITHIN 12 MONTHS 708(b)(1)(B) terminating events are based upon the sales or exchanges of partnership interests. For a termination to occur, there must be a sale or exchange of at least 50% of the total interests in partnership capital AND profits during a 12 month period. The same interest sold more than once during the 12 month period is only counted once, although the later sale rolls forward the 12 month period. EXAMPLE #4 In partnership ABC, where Alice, Betsy and Charlie each hold an equal 1/3 interest in capital, profits and losses, if Alice sells her 1/3 capital and profits interest to Xavier on June 1, 20X0, and Xavier sells the same 1/3 interest to Yetta on September 15, 20X0, no termination arises, since only 33.3% has been sold, but the 12 month period will run forward to September 15 of the next year. A. 12 Months Means 12 Months. The 12-month period is not a reference to a taxable year, but an actual 12-months. B. Multiple Sales. Other than the same interest being sold twice, multiple interest sales are counted within the 12 month period for the 50% test, and, so long as the sum total of capital and profits interest shifts equals 50% or more within the 12 month period, a termination occurs under 708(b)(1)(B). In partnership ABC, where A, B and C each hold an equal 1/3 interest in capital, profits and losses, if Alice sells her 1/3 capital and profits interest to Xavier on June 1, 20X0 and Betsy sells her 1/3 capital and profits interest to Yetta on January 1, 20X1, a termination results. The termination occurs despite the fact that the second sale by Betsy to Yetta occurred during the following taxable year. {09000.BKW / DOC.1 } 8

9 EXAMPLE #5 Distributions. In partnership ABC, where A, B and C each hold an equal 1/3 interest in capital, profits and losses, if Alice and Betsy each receive a current distribution from ABC, resulting in their overall interests reduced to 5% each, no termination occurs because there's no sale or exchange for 708 purposes. This result would be true under 708 even if Alice and Betsy receive money distributions in excess of their adjusted basis resulting in 731 gains (treated as gains from the sale or exchange of an interest). Contributions. The same result (i.e. no termination) would arise if Charlie alone contributed additional property/capital, resulting in a 50% or more shift in profits and capital interest. IV. GIFTS AND BEQUESTS The regulations further provide that other events are not deemed sales or exchanges for termination purposes, including gifts, bequests, and inheritances. V. CLOSING THE TAX YEAR FOR ALL PARTNERS A. Date of Closing. For purposes of subchapter K, a partnership taxable year closes with respect to all partners on the date on which the partnership terminates. See 706(c)(1) and Treasury Regulation ( c)(1). Per the regs, the date of termination is: 1. For purposes of Section 708(b)(1)(A), the date on which the winding up of the partnership affairs is completed. 2. For purposes of Section 708(b)(1)(B), the date of the sale or exchange of a partnership interest which, of itself or together with sales or exchanges in the preceding 12 months, transfers an interest of 50 percent or more in both partnership capital and profits. B. Effect of Closing. 1. Create a short year final return. 2. Require income/loss for the short period to be determined and allocated and attendant reporting by the partners. 3. Outside basis adjustments are then required for the income/loss adjustments per 705. {09000.BKW / DOC.1 } 9

10 EXAMPLE #6 Assume that Alice, a partner in partnership ABC decides to sell her entire 1/3 overall interest in the partnership to Dorothy for $100,000 cash. At the time of sale, June 30, 20X0, the partnership has $30,000 of capital gains income and $30,000 of dividend income; however, assume that, within 12 months prior to June 30, 20X0, Betsy acquired her 1/3 interest by purchasing it from Xavier. At the time of sale to Dorothy, the partnership books reflect the following: Partnership ABC Tax Basis Book Value Cash $110,000 $110,000 Stock 160, ,000 Total Assets: 270, ,000 Liabilities 60,000 60,000 Alice 70, ,000 Betsy 70, ,000 Charles 70, ,000 Total Liabilities & Capital: $270,000 $360,000 Questions: Is there a tax termination triggered on Alice's sale of a 1/3interest in ABC to Dorothy? Yes, there has been a 50% or more capital and profits interest transfer when considering the earlier transfer of Xavier's interest to Betsy. Does the partnership tax year close with respect to Alice? Yes, and because it's a sale triggering a tax termination per 708(b)(1)(B), the Partnership tax year closes as regards all partners. Note, this would be true even if Alice sold less than her entire interest, so long as she sold at least 17% which, when added to Xavier's 1/3 interest would total 50%, thereby triggering a termination. Since there is a termination, the tax year of the partnership closes, and an interim adjustment for profits and losses would have to be made to compute gain or loss to Alice. VI. DEEMED CONTRIBUTION AND DISTRIBUTION If a tax termination occurs, the partnership is deemed to contribute all of its assets and liabilities to a new partnership in exchange for an interest in the new partnership; and, immediately thereafter, the terminated partnership distributes interests in the new partnership to the purchasing partner and the other remaining partners in proportion to their respective interests in the terminated partnership in liquidation of the terminated partnership. {09000.BKW / DOC.1 } 10

11 EXAMPLE #7 (i) A and B each contribute $10,000 cash to form AB, a general partnership, as equal partners. AB purchases depreciable Property X for $20,000. Property X increases in value to $30,000, at which time A sells its entire 50 percent interest to C for $15,000 in a transfer that terminates the partnership under Section 708(b)(1)(B). At the time of the sale, Property X had an adjusted tax basis of $16,000 and a book value of $16,000 (original $20,000 tax basis and book value reduced by $4,000 of depreciation). In addition, A and B each had a capital account balance of $8,000 (original $10,000 capital account reduced by $2,000 of depreciation allocations with respect to Property X). (ii) Following the deemed contribution of assets and liabilities by the terminated AB partnership to a new partnership (new AB) and the liquidation of the terminated AB partnership, the adjusted tax basis of Property X in the hands of new AB is $16,000. See Section 723. The book value of Property X in the hands of new partnership AB is also $16,000 (the book value of Property X immediately before the termination) and B and C each have a capital account of $8,000 in new AB (the balance of their capital accounts in AB prior to the termination). See (b)(2)(iv)(l) (providing that the deemed contribution and liquidation with regard to the terminated partnership are disregarded in determining the capital accounts of the partners and the books of the new partnership). Additionally, new AB retains the taxpayer identification number of the terminated AB partnership. (iii) Property X was not Section 704(c) property in the hands of terminated AB and is therefore not treated as Section 704(c) property in the hands of new AB, even though Property X is deemed contributed to new AB at a time when the fair market value of Property X ($30,000) was different from its adjusted tax basis ($16,000). See (a)(3)(i) (providing that property contributed to a new partnership under (b)(1)(iv) is treated as Section 704(c) property only to the extent that the property was Section 704(c) property in the hands of the terminated partnership immediately prior to the termination). (iv) If a partnership is terminated by a sale or exchange of an interest in the partnership, a Section 754 election (including a Section 754 election made by the terminated partnership on its final return) that is in effect for the taxable year of the terminated partnership in which the sale occurs, applies with respect to the incoming partner. Therefore, the bases of partnership assets are adjusted pursuant to Sections 743 and 755 prior to their deemed contribution to the new partnership. {09000.BKW / DOC.1 } 11

12 VII. WHAT ABOUT 704(D) SUSPENDED LOSSES IF 708(B)(1)(B) TERMINATION OCCURS? It's currently unclear. Under the old termination rules, the suspended losses were lost irretrievably. Under the new rules, suspended losses should carry over to the new entity. VIII. WHAT ABOUT 704 (C )(1) (b) GAINS AND 737 GAINS? A. Recall that 704(c)(1)(B) requires gain to be recognized by contributing partner if built-in gain property is distributed to another partner within7 years of contribution. Will 704(c)(1)(B) deemed distributions rule be triggered if 708(b)(1)(B) termination occurs? No, per ( c)(3). B. Recall that 737 requires net pre-contribution gain to be recognized by a contributing partner if built-in gain property is contributed and distributions are made to the contributing partner within 7 years of contribution. Will 737 be triggered if 708(b)(1)(B) termination occurs? No, per (a) no gain is triggered, but the 704( c) partner is still a 704( c) partner subject to 737 in the new partnership. IX. ARE THERE 731 GAINS POSSIBLE IN A TAX TERMINATION UNDER 708(b)(1)(B)? A. Under the old rules, a termination deemed the partnership to distribute all of its properties in a liquidating distribution to the new and remaining partners, with this group recontributing such assets (and liabilities) back to the partnership in exchange for their new interests in the new partnership. Therefore, theoretically, cash could have been distributed in excess of basis, triggering 731 gains. The new ordering, that is, deeming the old partnership to contribute assets and liabilities to a new partnership in exchange for the issuance of new interests in the new partnership to the new partner and continuing partners, does not create this possibility, since only interests are distributed to the partners. See (g)(2). {09000.BKW / DOC.1 } 12

13 PART III -- MERGERS, CONSOLIDATIONS AND DIVISIONS I. SECTION 708(b)(2) A. Mergers. Section 708(b)(2) provides special rules regarding partnership mergers, consolidations and divisions. 1. Section 708(b)(2)(A) provides that in the case of the merger or consolidation of two or more partnerships, the Resulting Partnership shall be considered the continuation of any merging or consolidating partnership whose members own an interest of more than 50 percent in the capital and profits of the Resulting Partnership. All other partnerships terminate. 2. The regulations provide that if no group of members owns more than 50%, all of the partnerships terminate. B. Divisions. As to partnership divisions, 708(b)(2)(B) provides that where a partnership divides into two or more partnerships, the Resulting Partnerships (other than any Resulting Partnership the members of which had an interest of 50 percent or less in the capital and profits of the Prior Partnership) shall, for purposes of this section, be considered a continuation of the Prior Partnership. C. Tax Consequences to Terminating Partnership. In general, all of the tax consequences outlined above on termination apply in this context. II. MERGERS AND CONSOLIDATIONS A. Surviving Partnership. Under 708(b)(2)(A), if two or more partnerships merge or consolidate into a single partnership, the resulting partnership is treated as a continuation of any merging partnership whose members own more than 50 percent of the capital and profits of the resulting partnership. The other partnerships are terminated. B. Cross-Membership. If there is a cross-membership among the merging partnerships and the members of more than one merging partnership own more than 50 percent of the capital and profits of the resulting partnership, the merging partnership "which is credited with the contribution of assets having the greatest fair market value (net of liabilities) to the resulting partnership" is the continuing partnership, and all other partnerships terminate. C. No 50% Survivor. If the members of none of the merging partnerships have an interest of more than 50 percent in the capital and profits of the resulting partnership, all of the {09000.BKW / DOC.1 } 13

14 merging partnerships are terminated and a new partnership results. The taxable years of all terminating partnerships are closed pursuant to the provisions of 706(c)(1) as of the date of the merger. D. Forms of Merger. The Regulations recognize the following merger forms: 1. The "Assets-Over" form in which terminating partnerships are treated as transferring their assets and liabilities to the resulting partnership in exchange for interests in the resulting partnership, which interests; and 2. The "Assets-Up" form in which terminating partnerships are treated as distributing their assets and liabilities to their partners in liquidation, and immediately thereafter the partners are treated as contributing such assets and liabilities to the resulting partnership in exchange for interests in the resulting partnership. E. Default to Assets Over. The Assets-Up form applies whenever a terminated partnership distributes its assets to its partners in any manner that causes them to be treated as the owners of the assets under local law. Under these circumstances, the form is respected despite the transitory ownership of the distributed assets. The form is also respected even if the transfer involves assets (e.g., goodwill) that generally could not be held by the partners are undivided interest holders. However, a transaction case in the Assets-Up form will be recast as an Assets- Over transaction if the terminated partnership is not liquidated under local law. All mergers and consolidations that are not cast in the Assets-Up form are treated as Assets-Over transactions, regardless of their form (or lack of form) under local law. If a merger involves multiple terminating partnerships, each terminating partnership is analyzed separately, so that the Assets- Over form may apply to some transfers and the Assets-Up form to others. F. Tax Effects of Choice. The choice between the Assets-Up and Assets-Over forms controls for all income tax purpose and may have significant repercussions. For example, under the Assets-Over form, the tax basis of assets contributed to the resulting partnership is determined under 723, and thus should be generally unaltered by the transaction. By contrast, under the Assets-Up form, the basis of the assets of a terminating partnership are first determined under 732(b) and 732(c) upon distribution to the partners, and then under 723 upon contribution to the continuing partnership a process that can lead to significant basis changes, particularly if the terminating partnership has inside-outside basis differences. {09000.BKW / DOC.1 } 14

15 G. Application of Disguised Sale Rule. Finally, the choice of form will cause 704(c)(1)(B) and 737 to apply in strikingly different ways. Under the Assets-Up form, both 704(c)(1)(B) and 737 are applicable if any assets distributed to the partners were previously contributed to the distributing partnership within seven years of the distribution. By contrast, neither 704(c)(1)(B) nor 737 applies to a transaction cast in the Assets-Over form. However, the deemed contribution of assets from a terminating partnership may create a new layer of builtin gain for purposes of those rules. H. Effect of Termination. The taxable years of all terminated partnership are closed under 706(c), so that each terminated partnership must file a short-year return for the period ending on the date of the merger or consolidation. The resulting partnership files a full-year return for the taxable year of the partnership that is not terminated. This return should state that the resulting partnership is a continuation of the non-terminated partnership; retain the employer identification number (EIN) of the non-terminated partnership; and ;include the names, addresses, and EINs of the terminated partnerships. The distributive shares of the partners for periods prior to and including the date of the merger or consolidation, as well as subsequent to the date of merger or consolidation, are included in this return. III. DIVISIONS A. Surviving a Partnership. In the event of a division of a partnership into two more partnerships, any resulting partnership whose members had an interest of more than 50 percent in the capital and profits of the original partnership is deemed to be a continuation of the original partnership. Any other resulting partnership is treated as a new partnership. B. Termination of Partnership. If no resulting partnership is treated as a continuation of the original partnership under this rule, the original partnership is treated as terminating. C. Effect on Partners. If a member of the original partnership does not become a member of a partnership deemed to be a continuation of the original partnership, his interest in the original partnership is considered liquidated as of the date of the division. D. Forms of Division. As with mergers, the Regulations delineate two permissible forms of division: 1. The "Assets-Over" form in which an existing partnership transfers some portion of its assets and/or liabilities to a new partnership (which {09000.BKW / DOC.1 } 15

16 momentarily has but one partner, a foot-fault that is quickly forgiven by the Regulations), and immediately thereafter distributes interests in the new partnership to some or all of its partners; and 2. The "Assets-Up" form in which an existing partnership distributes assets and/or liabilities to some or all of its partners, who then contribute them to a new partnership. E. Default to "Assets Over." 1. As with mergers, the Regulations effectively prefer the Assets-Over form for divisions. Any transaction that is not clearly in the Assets-Up form is taxed under the Assets- Over form. 2. The Regulations make it clear that actual state law transfers from the "Prior Partnership" to its partners and from the partners to a "Resulting Partnership" are required for the Assets-Up form to be respected. The Supplementary information issued in connection with the Regulations makes it equally clear that when several Resulting Partnerships are produced by a single division transaction, some may be formed using the Assets-Up form while others can be formed using the Assets-Over form. F. Reporting Requirements. The Resulting Partnership that is treated as the Divided Partnership files a return for the taxable year of the partnership that has been divided and retains the EIN of the Prior Partnership. The return must include the names, addresses, and EINs of all other Resulting Partnerships that are regarded as continuing. The return must also state that the partnership is a continuation of the Prior Partnership and set forth separately the distributive shares of the partners for the periods through the date of the division and subsequent to the date of division. All other Resulting Partnerships that are treated as continuing and all new partnerships are required to file separate returns, using new EINs for each partnership, for the taxable year beginning on the day after the date of the division. The return for any Resulting Partnership that is regarded as continuing but is not the Divided Partnership must include the name, address, and EIN of the Prior Partnership. All Resulting Partnerships that are regarded as continuing are subject to the Prior Partnership's elections. Any subsequent election made by a Resulting Partnership does not affect the other Resulting Partnerships. The Regulations include a number of examples. Several of the examples illustrate some of the planning flexibility afforded partners under these rules. {09000.BKW / DOC.1 } 16

17 EXAMPLE #8 Partnership ABCD owns three properties: X with a value of $500; Y with a value of $300; and Z with a value of $200. Partners A and B are each for 40% partners, while partners C and D are each 10% partners. ABCD divides three partnerships by contributing property X to AB1 and property Z to CD. Old ABCD is renamed AB2. AB1 is distributed to partners A and B, while CD is distributed to partners C and D in complete liquidation of their interest in ABCD (new AB20. AB1 and AB2 are both continuations of ABCD, while CD is a new partnership. The Assets-Over form applies. ABCD, as the Divided Partnership, is viewed as contributing properties X and Y to new partnerships AB1 and CD, and then distributing the interests in AB1 to partners A and B and the interests in CD to partners C and D. EXAMPLE #9 The facts are the same as in Example #8, except that the division is accomplished in a formless division transaction under state law. Now, the Divided Partnership is AB1, instead of AB2, because the transaction has not been cast in either the Assets-Up form or the Assets-Over form. Consequently, it does not matter which partnership in form was the transferor, and AB1 has the larger net fair market value than AB2. AB1 as the Divided Partnership is viewed as contributing properties Y and Z to new partnerships AB2 and CD, and then distributing the interests in the new partnerships as indicated. EXAMPLE #10 The facts are the same as in Example #8, except that the division is accomplished by having ABCD contribute property X to AB1 and property Y to AB2. All the interests in AB1 and AB2 are distributed to partners A and B in complete liquidation of their interests in ABCD. Because the formal transferor, which is renamed CD, is not a continuation of ABCD, it cannot be the Divided Partnership. Instead, AB1 is selected as the Divided Partnership because its net fair market value is larger than AB2's. As the Divided Partnership, AB1 is viewed as contributing properties Y and Z to new partnerships AB2 and CD and then distributing the interests in the new partnerships as indicated. {09000.BKW / DOC.1 } 17