Courtesy of AHP
In June, the IRS and the Department of the Treasury issued guidance to close potential loopholes in the tax code for partnership entities. Utilizing funding from the Inflation Reduction Act, one of the IRS’ focal points is partnership basis and how shifting it between related parties (either partnerships or partners) is generating potentially unfair tax benefits for taxpayers.
The benefits result from large amounts of tax basis, in either assets or partnership interest, being transferred to other entities after they already created tax savings for the initial partnership, which in turn can lead to increased depreciation deductions or reduced gain on the sale of an asset. This is especially problematic since with these types of transactions, there was no true substantial economic impact. These transactions are referred to as “related party basis adjustments” (RPBA).
The basis shifting transactions typically fall into three categories: 1) transfer of partnership interest to a related party, 2) distribution of property to a related party or 3) liquidation of a related partnership or partner.
In the first instance, when the partnership interest is transferred to a related party, it can result in a tax-free increase of the receiving party’s basis in the company. In the second instance, the partner who distributed a high-basis asset to one of the related partners that has a low outside basis reduces the basis of that asset and the partnership increases the basis of the remaining assets. This increased basis can produce potential tax benefits as basis is moved to properties with more beneficial cost recovery rules or that may be sold soon. In the third instance, when low-basis assets that are subject to favorable cost recovery are distributed as part of a liquidation of partnership interest to a partner with high basis in the partnership itself or high-basis assets (subject to longer or no longer subject to cost recovery) are distributed to a partner with low basis in the partnership itself, the property involved is now considered to have a stepped up basis equal to the partner’s prior basis in the partnership interests.
The new regulations proposed by the IRS will address the question of basis shifting on two fronts: 1) prevent partnerships and related partners from utilizing these basis adjustments by requiring certain treatment by partnerships of covered transactions and 2) create clear rules on annual disclosures, especially regarding taxable income and tax liability when members in the group own interests in partnerships.
The proposed regulations will consider these basis-related transactions “transactions of interest” (TOI). The TOI typically involve positive basis adjustments of $5 million or more under subchapter K of the Internal Revenue Code to which no corresponding tax is paid. In each transaction, the recipient partner of the transaction would need to be related to one or more partners in the partnership, the transferor is related to the transferee, or the transferee is related to one or more of the partners.
