Section 1045 Application to Partnerships, 45346-45358 [E7-15948]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 72, Number 156 (Tuesday, August 14, 2007)]
[Rules and Regulations]
[Pages 45346-45358]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-15948]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9353]
RIN 1545-BC67


Section 1045 Application to Partnerships

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
application of section 1045 of the Internal Revenue Code (Code) to 
partnerships and their partners. These regulations provide rules 
regarding the deferral of gain on a partnership's sale of qualified 
small business stock (QSB stock) and a partner's sale of QSB stock 
distributed by a partnership. These regulations also provide rules for 
a taxpayer (other than a C corporation) who sells QSB stock and 
purchases replacement QSB stock through a partnership. The regulations 
affect partnerships that invest in QSB stock and their partners.

DATES: Effective Date: These regulations are effective August 14, 2007.
    Applicability Dates: For dates of applicability of these 
regulations, see Sec.  1.1045-1(j).

FOR FURTHER INFORMATION CONTACT: Jian H. Grant at (202) 622-3050 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in these final regulations 
have been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control number 1545-1893. Responses to these collections 
of information are mandatory and are required to obtain a benefit. The 
collections of information in these final regulations are in Sec.  
1.1045-1(b)(3)(ii)(C), (b)(5)(ii), and (c)(4)(ii). The information 
collected in Sec.  1.1045-1(b)(5)(ii) is required to ensure that gain 
from the sale of QSB stock by a partnership is reported correctly. The 
information collected in Sec.  1.1045-1(b)(3)(ii)(C) and (c)(4)(ii) 
will be used by the partnership and the partner to make the basis 
adjustments upon the sale of QSB stock and the purchase of replacement 
QSB stock when necessary. The likely respondents are businesses or 
other for-profit institutions and small businesses or organizations.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Estimated total annual reporting burden: 1,500 hours.
    The estimated annual burden per respondent varies from 45 to 75 
minutes, depending on individual circumstances, with an estimated 
average of 1 hour.
    Estimated number of respondents: 1,500.
    Estimated annual frequency of responses: On occasion.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, 
SE:W:CAR:MP:T:T:SP Washington, DC 20224, and to the Office of 
Management and Budget, Attn: Desk Officer for the Department of the 
Treasury, Office of Information and Regulatory Affairs, Washington, DC 
20503.
    Books or records relating to these collections of information must 
be retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document amends 26 CFR part 1 under section 1045 of the Code 
by adding Sec.  1.1045-1 regarding the application of section 1045 to 
partnerships and their partners.
    Section 1045 permits a non-corporate taxpayer that holds QSB stock 
for more than six months and sells it after August

[[Page 45347]]

5, 1997, to elect to defer recognizing gain (other than gain treated as 
ordinary income) on the sale. To qualify for such deferral, the 
taxpayer must purchase QSB stock (replacement QSB stock) within a 60-
day period beginning on the date of the sale of the QSB stock. Any gain 
not recognized reduces the cost basis of the replacement QSB stock. The 
taxpayer recognizes gain to the extent the amount realized on the sale 
of the QSB stock exceeds the cost basis of the replacement QSB stock. 
The benefits of section 1045 with respect to a sale of QSB stock by a 
partnership flow through to a non-corporate partner that held an 
interest in the partnership at all times the partnership held the QSB 
stock. See section 1045(b)(5) and the legislative history accompanying 
section 6005(f)(2) of the Internal Revenue Service Restructuring and 
Reform Act of 1998, Public Law 105-206 (112 Stat. 6005(f)(2)), July 22, 
1998. In response to inquiries, the IRS issued Rev. Proc. 98-48 (1998-2 
CB 367) which provides procedures for taxpayers (including passthrough 
entities and individuals holding interests in a passthrough entity) to 
elect to apply section 1045. Since Rev. Proc. 98-48 was published, the 
IRS and the Treasury Department received further inquiries regarding 
the application of section 1045 to partnerships and their partners. See 
Sec.  601.601(d)(2)(ii)(b) of this chapter.
    On July 15, 2004, in response to those inquiries, a notice of 
proposed rulemaking and a notice of public hearing (REG-150562-03; 
2004-32 IRB 175) were published in the Federal Register (69 FR 42370) 
regarding the application of section 1045 to partnerships and their 
partners. No one requested to speak at the public hearing. Accordingly, 
the public hearing scheduled for November 9, 2004, was cancelled in the 
Federal Register (69 FR 62631) on October 27, 2004. Comments responding 
to the proposed regulations were received. After consideration of the 
comments, the proposed regulations are adopted as revised by this 
Treasury decision.

Summary of Comments and Explanation of Revisions

1. QSB Stock--Replacement QSB Stock Requirement

    The proposed regulations provided that the term ``QSB stock'' had 
the same meaning given such term by section 1202(c) and did not include 
an interest in a partnership that held QSB stock. Thus, under the 
proposed regulations, an investment in a partnership that held QSB 
stock was not treated as an investment in QSB stock. Consequently, a 
partner that sold an interest in a partnership that held QSB stock was 
not treated as selling QSB stock, and could not elect to apply section 
1045 with respect to gain realized on the sale of the partnership 
interest. Similarly, under the proposed regulations, a partner that 
made a section 1045 election with respect to QSB stock sold by the 
partnership could not treat as replacement QSB stock an interest in a 
second partnership that held QSB stock.
    Commentators agreed that an interest in a partnership that owns QSB 
stock should not be treated as an investment in QSB stock. Some 
commentators, however, argued that the final regulations should permit 
a partner that makes a section 1045 election with respect to QSB stock 
sold by one partnership to satisfy the replacement QSB stock 
requirement of section 1045 by holding an interest in a partnership, 
which acquires QSB stock within the statutory period. Commentators 
believed that the suggested rule is consistent with the intent of 
Congress to encourage investments in QSB stock.
    The final regulations adopt this comment. A taxpayer (other than a 
C corporation) that sells QSB stock and elects to apply section 1045 
may satisfy the replacement QSB stock requirement with QSB stock that 
is purchased within the statutory period by a partnership in which the 
taxpayer is a partner on the date the QSB stock is purchased 
(purchasing partnership). In addition, the final regulations provide 
that an eligible partner of a partnership that sells QSB stock (selling 
partnership) and elects to apply section 1045 may satisfy the 
replacement QSB stock requirement with QSB stock purchased by a 
purchasing partnership during the statutory period. The IRS and the 
Treasury Department believe that these rules are appropriate because 
they are consistent with the underlying continuous economic interest 
requirement of section 1045. Although the final regulations permit the 
replacement QSB stock requirement to be satisfied in this manner, for 
the reasons stated, a partner that sells its interest in the purchasing 
partnership is not treated as selling replacement QSB stock.
    The final regulations contain rules for calculating a partner's 
distributive share of partnership gain that is not recognized as a 
result of an election under section 1045 by the partner. These rules 
are necessary for determining how much gain a partner can defer upon a 
sale of QSB stock under section 1045. These rules address instances in 
which the eligible partner continues to defer gain under section 1045 
from a prior sale or sales of QSB stock.

2. Basis Adjustments

    The proposed regulations provided rules regarding adjustments to an 
eligible partner's basis in a partnership interest and a partnership's 
basis in replacement QSB stock. One rule required a partnership to make 
a basis adjustment to the partnership's replacement QSB stock by the 
amount of gain from the partnership's sale of QSB stock that is 
deferred by an eligible partner, the effect of which is determined 
under the principles of Sec.  1.743-1(g), (h), and (j). Under this 
rule, the basis adjustments constitute an adjustment to the basis of 
the partnership's replacement QSB stock with respect to that eligible 
partner only. To allow the partnership to make the appropriate basis 
adjustments, the proposed regulations required any partner that must 
recognize all or a part of the partner's distributive share of 
partnership section 1045 gain to notify the partnership of the amount 
of the partnership section 1045 gain that was recognized.
    One commentator argued that many partnerships that invest in QSB 
stock are thinly staffed, and that they would incur additional 
administrative expenses to comply with the notification and basis 
adjustment requirements. Therefore, the commentator suggested that the 
partner make the basis adjustments with respect to the partnership's 
replacement QSB stock, unless the partnership makes an election to make 
the basis adjustments.
    The IRS and the Treasury Department believe that, if the 
partnership makes an election under section 1045 and purchases 
replacement QSB stock, the partnership is the proper party to make the 
appropriate basis adjustments with respect to that stock. Accordingly, 
this comment is not adopted. As noted below, a partnership is not 
required to maintain these basis adjustments for eligible partners that 
separately make the election under section 1045. The final regulations 
also clarify that if a partnership makes an election under section 
1045, the partnership must attach a statement to the partnership return 
for the taxable year in which the partnership purchases replacement QSB 
stock setting forth the computation of the adjustment, the replacement 
QSB stock to which the adjustment has been made, the date(s) on which 
such stock was acquired by the partnership, and each partner's 
distributive share of deferred partnership section 1045 gain.
    If a taxpayer or an eligible partner makes an election under 
section 1045

[[Page 45348]]

and treats its interest in QSB stock purchased by a purchasing 
partnership as its replacement QSB stock, the final regulations provide 
specific rules for the determination of the partner's basis in the 
replacement QSB stock and interest in the purchasing partnership. In 
these cases, the partner's adjusted basis in the partnership interest 
is reduced by the partner's gain that is deferred under section 1045, 
and the electing partner must reduce its share of the partnership's 
adjusted basis of the replacement QSB stock by the amount of gain 
deferred. When the basis reduction results from a partner-level 
election, the final regulations require the partner, rather than the 
partnership, to retain records setting forth the computation of this 
basis adjustment, the replacement QSB stock to which the adjustment has 
been made, and the date(s) on which such stock was acquired by the 
purchasing partnership.

3. Gain Recognition Upon Certain Distributions

    The final regulations provide rules requiring a partner to 
recognize gain upon a distribution of replacement QSB stock to another 
partner that reduces the partner's share of the replacement QSB stock 
held by a partnership. The amount of gain that the partner must 
recognize is determined based on the amount of gain that the partner 
would have recognized upon a sale of the distributed replacement QSB 
stock for its fair market value on the date of the distribution (not to 
exceed the amount of gain previously deferred by the partner with 
respect to the distributed replacement QSB stock). Any gain recognized 
by a partner whose interest is reduced must be taken into account in 
determining the adjusted basis of the partner's interest in the 
partnership and also taken into account in determining the 
partnership's adjusted basis in the QSB stock distributed to another 
partner under Sec.  1.1045-1(e)(4). These rules apply in the case of a 
partner election or a partnership election under section 1045.

4. Nonrecognition Limitation

    The proposed regulations provided that the amount of gain that an 
eligible partner may defer under section 1045 may not exceed: (A) The 
partner's smallest percentage interest in the partnership's income, 
gain, or loss with respect to the QSB stock that was sold, multiplied 
by (B) the partnership's realized gain from the sale of such stock. 
This nonrecognition rule follows section 1202(g)(2) and (3) by ensuring 
that the partner can defer recognition of only the gain that relates to 
the partner's continuous economic interest in the QSB stock that was 
sold.
    Commentators agreed with the underlying ``continuous ownership'' 
requirement in the proposed regulations, but raised concerns that the 
nonrecognition limitation rule may be difficult to administer when a 
partnership does not have a simple ``pro rata'' partnership 
arrangement. One commentator suggested that the nonrecognition 
limitation rule only apply in certain situations.
    The IRS and the Treasury Department continue to believe that a 
nonrecognition limitation rule is consistent with section 1045 and the 
underlying continuous economic interest requirement in section 
1202(g)(2) and (3). The continuous economic interest requirement as 
applied under section 1202(c)(1)(B) requires that QSB stock must be 
acquired by the taxpayer at its original issuance in exchange for money 
or other property or as compensation for services provided to such 
corporation. Taxpayers that invest through a partnership acquire the 
requisite interest for purposes of the continuous economic interest 
requirement by an investment of capital in the partnership. 
Accordingly, to address the commentator's concerns, the nonrecognition 
rule has been modified to provide that the amount of gain that an 
eligible partner may defer under section 1045 may not exceed: (A) The 
partner's smallest percentage interest in partnership capital from the 
time the QSB stock is acquired until the time the QSB stock is sold, 
multiplied by (B) the partnership's realized gain from the sale of such 
stock. The IRS and the Treasury Department believe that this 
nonrecognition rule in the final regulations will be easier to 
administer, is consistent with each partner's economic interest in the 
partnership, and will not inappropriately limit the amount of gain that 
can be deferred.

5. Opt Out of Partnership Election by Partner

    The proposed regulations allowed an eligible partner to make a 
section 1045 election with respect to all or part of the partner's 
share of gain from the partnership's sale of QSB stock only if the 
partnership did not make a section 1045 election, or the partnership 
did make a section 1045 election, but failed to purchase any (or 
enough) replacement QSB stock within the statutory time period. If a 
partnership elected to apply section 1045 and purchased replacement QSB 
stock, all eligible partners of the partnership were required to defer 
their distributive shares of the partnership section 1045 gain. One 
commentator suggested that an eligible partner should be allowed to opt 
out of a partnership section 1045 election and either purchase separate 
replacement QSB stock directly, and elect to apply section 1045 at the 
partner level, or recognize the partner's distributive share of the 
partnership section 1045 gain. The IRS and the Treasury Department 
believe that allowing a partner to opt out of a partnership section 
1045 election is consistent with providing the intended and desired 
flexibility for investments in QSB stock. Accordingly, this comment is 
adopted. The final regulations provide that a partner that elects out 
of a partnership's section 1045 election must notify the partnership in 
writing. If an eligible partner opts out of a partnership section 1045 
election, such action does not constitute a revocation of the 
partnership section 1045 election and the partnership section 1045 
election continues to apply to the other partners.
    The final regulations do not impose a deadline for when a partner 
must notify the partnership that the partner is opting out of a 
partnership section 1045 election. The IRS and the Treasury Department 
believe partnerships are responsible for obtaining the required 
information to report gain properly, and that the partnership agreement 
should require that partners supply this notice to the partnership in a 
timely manner.

6. Tiered-Partnership Rules

    Under the proposed regulations, only an eligible partner was 
entitled to defer gain under section 1045. The proposed regulations 
provided special rules for determining whether a partner was an 
eligible partner if a partnership (upper-tier partnership) held an 
interest in a partnership (lower-tier partnership) that held QSB stock. 
The proposed regulations disregarded the upper-tier partnership's 
ownership of the lower-tier partnership and treated each partner of the 
upper-tier partnership as owning an interest in the lower-tier 
partnership directly. The preamble to the proposed regulations 
explained that, although this rule provided a simple approach, it 
limited the availability of section 1045 in situations involving tiered 
partnerships. The IRS and the Treasury Department requested comments 
specifically on the application of section 1045 in tiered-partnership 
situations.
    Commentators suggested that an upper-tier partnership should be an 
``eligible partner'' of a lower-tier partnership and allowed to make an 
election to defer gain under section 1045 with respect to the 
distributive share of the gain from the lower-tier

[[Page 45349]]

partnership's sale of QSB stock. After careful consideration, the IRS 
and the Treasury Department have concluded that treating an upper-tier 
partnership as an ``eligible partner'' of a lower-tier partnership 
would create an unacceptable administrative burden and increased 
complexity to the rules. Therefore, the final regulations retain the 
rule in the proposed regulations relating to tiered-partnership 
structures. The final regulations, however, clarify that the rule does 
not preclude a partner in an upper-tier partnership from treating its 
interest in QSB stock that was purchased by either the upper-tier 
partnership or a lower-tier partnership as replacement QSB stock. The 
final regulations contain an example illustrating this rule.

7. Disregarded Entity Rules

    One commentator suggested that the final regulations set forth 
rules that are specific to disregarded entities. It has been determined 
that this suggestion is beyond the scope of the regulations and, 
therefore, is not included in the final regulations.

8. Election Procedures and Reporting Rules

    The proposed regulations provided that a partnership making a 
section 1045 election must do so on the partnership's timely filed 
return (including extensions) for the taxable year during which the 
partnership sells the QSB stock. The proposed regulations also provided 
that a partner making an election under section 1045 with respect to 
its distributive share of gain on the partnership's sale of QSB stock 
must do so on the partner's timely filed Federal income tax return 
(including extensions) for the taxable year in which such gain is taken 
into account. The final regulations retain these rules. However, in 
both cases, the proposed regulations stated that the electing 
partnership or partner also must follow the procedures of Rev. Proc. 
98-48. In contrast, the final regulations provide that a partnership 
making an election under section 1045 or a partner making an election 
under section 1045 must do so in accordance with the applicable forms 
and instructions. It is anticipated that the applicable forms and 
instructions will be revised to take into account the rules in the 
final regulations.

Effective Date

    The final regulations apply to sales of QSB stock on or after 
August 14, 2007.

Effect on Other Documents

    Rev. Proc. 98-48 (1998-2 CB 367) is modified to include the 
following sentence at the end of the PURPOSE section: ``This revenue 
procedure does not apply in situations described in Sec.  1.1045-1 of 
the Income Tax regulations.'' See Sec.  601.601(d)(2)(ii)(b) of this 
chapter.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. It is hereby 
certified that the collection of information in these regulations will 
not have a significant economic impact on a substantial number of small 
entities. This certification is based upon the fact that QSB stock is 
not held by a substantial number of small entities and that the time 
required to make the election is estimated to average 1 hour. 
Therefore, a Regulatory Flexibility Analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to 
section 7805(f) of the Code, the notice of proposed rulemaking that 
preceded these regulations was submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Drafting Information

    The principal author of these regulations is Jian H. Grant, Office 
of the Associate Chief Counsel (Passthroughs and Special Industries). 
However, other personnel from the IRS and the Treasury Department 
participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
0
Paragraph 1. The authority citation for part 1 continues to read, in 
part, as follows:

    Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.1045-1 is added to read as follows:


Sec.  1.1045-1  Application to partnerships.

    (a) Overview of section. A partnership that holds qualified small 
business stock (QSB stock) (as defined in paragraph (g)(1) of this 
section) for more than 6 months, sells such QSB stock, and purchases 
replacement QSB stock (as defined in paragraph (g)(2) of this section) 
may elect to apply section 1045. An eligible partner (as defined in 
paragraph (g)(3) of this section) of a partnership that sells QSB 
stock, may elect to apply section 1045 if the eligible partner 
purchases replacement QSB stock directly or through a purchasing 
partnership (as defined in paragraph (c)(1)(i) of this section). A 
taxpayer (other than a C corporation) that holds QSB stock for more 
than 6 months, sells such QSB stock and purchases replacement QSB stock 
through a purchasing partnership may elect to apply section 1045. A 
section 1045 election is revocable only with the prior written consent 
of the Commissioner. To obtain the Commissioner's prior written 
consent, the person who made the section 1045 election must submit a 
request for a private letter ruling. (For further guidance, see Rev. 
Proc. 2007-1, 2007-1 CB 1 (or any applicable successor) and Sec.  
601.601(d)(2)(ii)(b) of this chapter.) Paragraph (b) of this section 
provides rules for partnerships that elect to apply section 1045. 
Paragraph (c) of this section provides rules for certain taxpayers 
other than C corporations and for eligible partners that elect to apply 
section 1045. Paragraph (d) of this section provides a limitation on 
the amount of gain that an eligible partner does not recognize under 
section 1045. Paragraph (e) of this section provides rules for 
partnership distributions of QSB stock to an eligible partner. 
Paragraph (f) of this section provides rules for contributions of QSB 
stock or replacement QSB stock to a partnership. Paragraph (g) of this 
section provides definitions of certain terms used in section 1045 and 
this section. Paragraph (h) of this section provides reporting rules 
for partnerships and partners that elect to apply section 1045. 
Paragraph (i) of this section provides examples illustrating the 
provisions of this section. Paragraph (j) of this section contains the 
effective/applicability date.
    (b) Partnership election--(1) Partnership purchase of replacement 
QSB stock. A partnership that holds QSB stock for more than 6 months, 
sells such QSB stock, and purchases replacement QSB stock may elect in 
accordance with paragraph (h) of this section to apply section 1045. If 
the partnership elects to apply section 1045, then, subject to the 
provisions of

[[Page 45350]]

paragraphs (b)(4) and (d) of this section, each eligible partner shall 
not recognize its distributive share of any partnership section 1045 
gain (as determined under paragraph (b)(2) of this section). For this 
purpose, partnership section 1045 gain equals the partnership's gain 
from the sale of the QSB stock reduced by the greater of--
    (i) The amount of the gain from the sale of the QSB stock that is 
treated as ordinary income; or
    (ii) The excess of the amount realized by the partnership on the 
sale over the total cost of all replacement QSB stock purchased by the 
partnership (excluding the cost of any replacement QSB stock purchased 
by the partnership that is otherwise taken into account under section 
1045).
    (2) Partner's distributive share of partnership section 1045 gain. 
A partner's distributive share of partnership section 1045 gain shall 
be in the same proportion as the partner's distributive share of the 
partnership's gain from the sale of the QSB stock. For this purpose, 
the partnership's gain from the sale of QSB stock and the partner's 
distributive share of that gain are determined without regard to basis 
adjustments under section 743(b) and paragraph (b)(3)(ii) of this 
section.
    (3) Basis adjustments--(i) Partner's interest in a partnership. The 
adjusted basis of an eligible partner's interest in a partnership shall 
not be increased under section 705(a)(1) by gain from a partnership's 
sale of QSB stock that is not recognized by the partner as the result 
of a partnership election under paragraph (b)(1) of this section.
    (ii) Partnership's replacement QSB stock--(A) Rule. The basis of a 
partnership's replacement QSB stock is reduced (in the order acquired) 
by the amount of gain from the partnership's sale of QSB stock that is 
not recognized by an eligible partner as a result of the partnership's 
election under section 1045. The basis adjustment with respect to any 
amount described in this paragraph (b)(3)(ii) constitutes an adjustment 
to the basis of the partnership's replacement QSB stock with respect to 
that partner only. The effect of such a basis adjustment is determined 
under the principles of Sec.  1.743-1(g), (h), and (j) except as 
modified in this paragraph (b)(3)(ii)(A). If a partnership sells QSB 
stock with respect to which a basis adjustment has been made under this 
paragraph (b)(3)(ii), and the partnership makes an election under 
paragraph (b)(1) of this section with respect to the sale and purchases 
replacement QSB stock, the basis adjustment shall carry over to the 
replacement QSB stock except to the extent otherwise provided in this 
paragraph (b)(3)(ii). The basis adjustment that carries over to the 
replacement QSB stock shall be reduced (but not below zero) by the 
eligible partner's distributive share of the excess, if any, of the 
greater of the amount determined under paragraph (b)(1)(i) or (ii) of 
this section from the sale of the QSB stock, over the partnership's 
gain from the sale of the QSB stock (determined without regard to basis 
adjustments under section 743 or paragraph (b)(3)(ii) of this section). 
The excess amount that reduces the basis adjustment shall be accounted 
for as gain in accordance with Sec.  1.743-1(j)(3). See Example 5 of 
paragraph (i) of this section. For purposes of this paragraph 
(b)(3)(ii), a partnership must presume that a partner did not recognize 
that partner's distributive share of the partnership section 1045 gain 
as a result of the partnership's section 1045 election unless the 
partner notifies the partnership to the contrary as described in 
paragraph (b)(5)(ii) of this section. However, if a partnership knows 
that a particular partner is classified, for Federal tax purposes, as a 
C corporation, then the partnership may presume that the partner did 
not defer recognition of its distributive share of the partnership 
section 1045 gain, even in the absence of a notification by the 
partner. If a partnership makes an election under section 1045, but an 
eligible partner opts out of the election under paragraph (b)(4) of 
this section and provides to the partnership the notification required 
under paragraph (b)(5)(ii) of this section, no basis adjustments under 
this paragraph (b)(3)(ii) are required with respect to that partner as 
a result of the section 1045 election by the partnership.
    (B) Tiered-partnership rule. If a partnership (upper-tier 
partnership) holds an interest in another partnership (lower-tier 
partnership) that makes an election under section 1045, the portion of 
the lower-tier partnership's basis adjustment as provided in paragraph 
(b)(3)(ii)(A) of this section in the replacement QSB stock must be 
segregated and allocated to the upper-tier partnership and any eligible 
partner as defined in paragraph (g)(3)(iii) of this section. Similarly, 
that portion of the basis of the upper-tier partnership's interest in 
the lower-tier partnership attributable to the basis adjustment as 
provided in paragraph (b)(3)(ii)(A) of this section in the lower-tier 
partnership's replacement QSB stock must be segregated and allocated 
solely to any eligible partner as defined in paragraph (g)(2)(iii) of 
this section.
    (C) Statement of adjustments. A partnership that must adjust the 
basis of replacement QSB stock under this paragraph (b) must attach a 
statement to the partnership return for the taxable year in which the 
partnership purchases replacement QSB stock setting forth the 
computation of the adjustment, the replacement QSB stock to which the 
adjustment has been made, the date(s) on which such QSB stock was 
acquired by the partnership, and the amount of the adjustment that is 
allocated to each partner.
    (4) Eligible partners may opt out of partnership's section 1045 
election. An eligible partner may opt out of the partnership's section 
1045 election with respect to QSB stock either by recognizing the 
partner's distributive share of the partnership section 1045 gain, or 
by making a partner section 1045 election under paragraph (c) of this 
section with respect to the partner's distributive share of the 
partnership section 1045 gain. See paragraph (b)(5)(ii) of this section 
for applicable notification requirements. Opting out of a partnership's 
section 1045 election under this paragraph (b)(4) does not constitute a 
revocation of the partnership's election, and such election shall 
continue to apply to other partners of the partnership.
    (5) Notice requirements--(i) Partnership notification to partners. 
A partnership that makes an election under paragraph (b)(1) of this 
section must notify all of its partners of the election and the 
purchase of replacement QSB stock, in accordance with the applicable 
forms and instructions, and separately state each partner's 
distributive share of partnership section 1045 gain from the sale of 
QSB stock under section 702. Each partner shall determine whether the 
partner is an eligible partner within the meaning of paragraph (g)(3) 
of this section and report the partner's distributive share of 
partnership section 1045 gain from the partnership's sale of QSB stock, 
including gain not recognized, in accordance with the applicable forms 
and instructions.
    (ii) Partner notification to partnership. Any partner that must 
recognize all or part of the partner's distributive share of 
partnership section 1045 gain must notify the partnership, in writing, 
of the amount of partnership section 1045 gain that is recognized by 
the partner. Similarly, an eligible partner that opts out of a 
partnership's section 1045 election under paragraph (b)(4) of this 
section must notify the partnership, in writing, that the partner is 
opting out of the partnership's section 1045 election.

[[Page 45351]]

    (c) Partner election--(1) In general--(i) Rule. An eligible partner 
of a partnership that sells QSB stock (selling partnership) may elect 
in accordance with paragraph (h) of this section to apply section 1045 
if replacement QSB stock is purchased by the eligible partner. An 
eligible partner of a selling partnership may elect in accordance with 
paragraph (h) of this section to apply section 1045 if replacement QSB 
stock is purchased by a partnership in which the taxpayer is a partner 
(directly or through an upper-tier partnership) on the date on which 
the partnership acquires the replacement QSB stock (purchasing 
partnership). A taxpayer other that a C corporation that sells QSB 
stock held for more than 6 months at the time of the sale may elect in 
accordance with paragraph (h) of this section to apply section 1045 if 
replacement QSB stock is purchased by a purchasing partnership 
(including a selling partnership).
    (ii) Partner purchase of replacement QSB stock. Subject to 
paragraph (d) of this section, an eligible partner of a selling 
partnership that elects to apply section 1045 with respect to the 
eligible partner's purchase of replacement QSB stock must recognize its 
distributive share of gain from the sale of QSB stock by the selling 
partnership only to the extent of the greater of--
    (A) The amount of the eligible partner's distributive share of the 
selling partnership's gain from the sale of the QSB stock that is 
treated as ordinary income; or
    (B) The excess of the eligible partner's share of the selling 
partnership's amount realized (as determined under paragraph (c)(2) of 
this section) on the sale by the selling partnership of the QSB stock 
(excluding the cost of any replacement QSB stock purchased by the 
selling partnership) over the cost of any replacement QSB stock 
purchased by the eligible partner (excluding the cost of any 
replacement QSB stock that is otherwise taken into account under 
section 1045).
    (iii) Partnership purchase of replacement QSB stock--(A) Partner of 
a selling partnership. Subject to paragraph (d) of this section, an 
eligible partner that treats its interest in QSB stock purchased by a 
purchasing partnership as a purchase of replacement QSB stock by the 
eligible partner and that elects to apply section 1045 with respect to 
such purchase must recognize its total gain (the eligible partner's 
distributive share of gain from the selling partnership's sale of QSB 
stock and any gain taken into account under paragraph (c)(5) of this 
section from the sale of replacement QSB stock) only to the extent of 
the greater of--
    (1) The amount of the eligible partner's distributive share of the 
selling partnership's gain from the sale of the QSB stock that is 
treated as ordinary income; or
    (2) The excess of the eligible partner's share of the selling 
partnership's amount realized (as determined under paragraph (c)(2) of 
this section) on the sale by the selling partnership of the QSB stock 
(excluding the cost of any replacement QSB stock purchased by the 
selling partnership) over the eligible partner's share of the 
purchasing partnership's cost of the replacement QSB stock, as 
determined under paragraph (c)(3) of this section (excluding the cost 
of any QSB stock that is otherwise taken into account under section 
1045).
    (B) Taxpayer other than a C corporation. Subject to paragraph (d) 
of this section, a taxpayer other than a C corporation that treats its 
interest in QSB stock purchased by a purchasing partnership with 
respect to which the taxpayer is a partner as a purchase of replacement 
QSB stock by the taxpayer must recognize its gain from the sale of the 
QSB stock only to the extent of the greater of--
    (1) The amount of gain from the sale of the QSB stock that is 
treated as ordinary income; or
    (2) The excess of the amount realized by the taxpayer on the sale 
of the QSB stock over the partner's share of the purchasing 
partnership's cost of the replacement QSB stock, as determined under 
paragraph (c)(3) of this section (excluding the cost of any QSB stock 
that is otherwise taken into account under section 1045).
    (2) Eligible partner's share of amount realized by partnership--
(i)--General rule. The eligible partner's share of the amount realized 
by the selling partnership is the amount realized by the partnership on 
the sale of the QSB stock (excluding the cost of any replacement QSB 
stock otherwise taken into account under section 1045) multiplied by 
the following fraction--
    (A) The numerator of which is the eligible partner's distributive 
share of the partnership's realized gain from the sale of the QSB 
stock; and
    (B) The denominator of which is the partnership's realized gain on 
the sale of the QSB stock.
    (ii) General rule modified for determining eligible partner's share 
of amount realized by purchasing partnership upon a sale of replacement 
QSB stock in certain situations--(A) No gain realized or loss realized 
on sale of replacement QSB stock. If a purchasing partnership does not 
realize a gain or realizes a loss from the sale of replacement QSB 
stock for which an election under this section was made for purposes of 
applying paragraph (c)(1)(iii)(A) of this section, the eligible 
partner's share of the amount realized is--
    (1) The greater of--
    (i) The amount determined in paragraph (c)(2)(i) of this section 
from a prior sale of QSB stock (that is not otherwise taken into 
account under paragraph (c)(2) of this section) in which the eligible 
partner had a distributive share of gain allocated to the eligible 
partner that was not recognized under paragraph (c)(1)(iii)(A) of this 
section; or
    (ii) The amount realized by a taxpayer other than a C corporation 
from a prior sale of QSB stock (that is not otherwise taken into 
account under paragraph (c)(2) of this section) in which the taxpayer 
realized gain that was not recognized under paragraph (c)(1)(iii)(B) of 
this section; less
    (2) The eligible partner's distributive share of any loss 
recognized on the sale of replacement QSB stock, if applicable.
    (B) Eligible partner's interest in purchasing partnership is 
reduced and gain realized on sale of replacement QSB stock. If an 
eligible partner's interest in a purchasing partnership is reduced 
subsequent to the sale of QSB stock and the purchasing partnership 
realizes a gain from the sale of the replacement QSB stock, the 
eligible partner's share of the amount realized upon a sale of 
replacement QSB stock must be determined under paragraph (c)(2)(i) of 
this section based on the distributive share of the partnership's 
realized gain that would have been allocated to the eligible partner if 
the eligible partner's interest in the partnership had not been 
reduced.
    (iii) Eligible partner's share of the amount realized. For purposes 
of determining the eligible partner's share of the amount realized by 
the partnership, the partnership's realized gain from the sale of QSB 
stock and the eligible partner's distributive share of that gain are 
determined without regard to basis adjustments under section 743(b) and 
paragraphs (b)(3)(ii) and (c) of this section.
    (3) Partner's share of the cost of QSB stock purchased by a 
purchasing partnership. The partner's share of the cost (adjusted 
basis) of replacement QSB stock purchased by a purchasing partnership 
is the percentage of the partnership's future income and gain, if any, 
that is reasonably expected to be allocated to the partner (determined 
without regard to any adjustment under

[[Page 45352]]

section 1045) with respect to the replacement QSB stock that was 
purchased by the partnership, multiplied by the cost of that 
replacement QSB stock. The assumptions made by a partnership in 
determining the reasonably expected allocation of income and gain must 
be consistent for each partner. For example, a partnership may not 
treat the same item of income or gain as being reasonably expected to 
be allocated to more than one partner.
    (4) Basis adjustments--(i) Eligible partner's interest in selling 
partnership. Under section 705(a)(1), the adjusted basis of an eligible 
partner's interest in a selling partnership that sells QSB stock is 
increased by the partner's distributive share of gain without regard to 
paragraph (c)(1) of this section. However, if the selling partnership 
is also a purchasing partnership, the adjusted basis of an eligible 
partner's interest in a partnership that sells QSB stock may be reduced 
under paragraph (c)(4)(iii) of this section.
    (ii) Replacement QSB stock. A partner's basis in any replacement 
QSB stock that is purchased by the partner, as well as the adjusted 
basis of any replacement QSB stock that is purchased by a purchasing 
partnership and that is treated as the partner's replacement QSB stock 
must be reduced (in the order replacement QSB stock is acquired by the 
partner and purchasing partnership, as applicable) by the partner's 
distributive share of the gain on the sale of the selling partnership's 
QSB stock that is not recognized by the partner under paragraph (c)(1) 
of this section, or by the gain on a sale of QSB stock by the partner 
that is not recognized by the partner under section 1045, as 
applicable. If replacement QSB stock is purchased by the purchasing 
partnership, the purchasing partnership shall maintain its adjusted 
basis in the replacement QSB stock without regard to any basis 
adjustments required by this paragraph (c)(4)(ii). The eligible 
partner, however, shall in computing its distributive share of income, 
gain, loss and deduction from the purchasing partnership with respect 
to the replacement QSB stock take into account the variation between 
the adjusted basis in the QSB stock as determined under this paragraph 
(c)(4)(ii) and the adjusted basis determined without regard to this 
paragraph (c)(4)(ii). A partner must retain records setting forth the 
computation of this basis adjustment, the replacement QSB stock to 
which the adjustment has been made, and the date(s) on which such stock 
was acquired. See Examples 7 and 8 of paragraph (i) of this section.
    (iii) Partner's basis in purchasing partnership interest. A partner 
that treats the partner's interest in QSB stock purchased by a 
purchasing partnership as the partner's replacement QSB stock must 
reduce (in the order replacement QSB stock is acquired) the adjusted 
basis of the partner's interest in the purchasing partnership by the 
partner's distributive share of the gain on the sale of the selling 
partnership's QSB stock that is not recognized by the partner pursuant 
to paragraph (c)(1) of this section, or by the gain on a sale of QSB 
stock by the partner that is not recognized by the partner under 
section 1045, as applicable. Similarly, a partner of an upper-tier 
partnership that treats the partner's interest in QSB stock purchased 
by a lower-tier purchasing partnership as the partner's replacement QSB 
stock must reduce (in the order replacement QSB stock is acquired) the 
adjusted basis of the partner's interest in the upper-tier partnership 
by the partner's distributive share of the gain on the sale of the 
selling partnership's QSB stock that is not recognized by the partner 
pursuant to paragraph (c)(1) of this section, or by the gain on a sale 
of QSB stock by the partner that is not recognized by the partner under 
section 1045, as applicable.
    (iv) Increase in basis on sale of QSB stock by purchasing 
partnership. A partner that recognizes gain under paragraph (c)(5) of 
this section must increase the adjusted basis of the partner's interest 
in the purchasing partnership under section 705(a)(1) by the amount of 
the gain recognized by that partner. Similarly, a partner in an upper-
tier partnership that recognizes gain under paragraph (c)(5) of this 
section must increase the adjusted basis of the partner's interest in 
the upper-tier partnership under section 705(a)(1) by the amount of the 
gain recognized by that partner.
    (5) Partner recognition of gain. At the time that either the 
partner or the purchasing partnership (whichever applies) sells or 
exchanges replacement QSB stock, the amount recognized by the partner 
is determined by taking into account the basis adjustments described in 
paragraph (c)(4)(ii) of this section. Similarly, a partner of an upper-
tier partnership that owns an interest in a lower-tier partnership that 
holds replacement QSB stock must take into account the basis 
adjustments described in paragraph (c)(4)(ii) of this section in 
determining the amount recognized by the partner on a sale of the 
interest in the lower-tier partnership by the upper-tier partnership or 
the partner's distributive share of gain from the upper-tier 
partnership. See paragraph (e)(4) of this section for rules applicable 
to certain distributions of replacement QSB stock.
    (d) Nonrecognition limitation--(1) In general. For purposes of this 
section, the amount of gain that an eligible partner does not recognize 
under paragraphs (b)(1) and (c)(1) of this section cannot exceed the 
nonrecognition limitation. Except as otherwise provided in paragraph 
(d)(2) of this section, the nonrecognition limitation is equal to the 
product of--
    (i) The partnership's realized gain from the sale of the QSB stock, 
determined without regard to any basis adjustment under section 734(b) 
or section 743(b) (other than basis adjustments described in paragraph 
(b)(3)(ii) of this section); and
    (ii) The eligible partner's smallest percentage interest in 
partnership capital as determined in paragraph (d)(2) of this section. 
See Example 9 of paragraph (i) of this section.
    (2) Eligible partner's smallest percentage interest in partnership 
capital. An eligible partner's smallest percentage interest in 
partnership capital is the eligible partner's percentage share of 
capital determined at the time of the acquisition of the QSB stock as 
adjusted prior to the time the QSB stock is sold to reflect any 
reduction in the capital of the eligible partner including a reduction 
as a result of a disproportionate capital contribution by other 
partners, a disproportionate capital distribution to the eligible 
partner or the transfer of an interest by the eligible partner, but 
excluding income and loss allocations.
    (3) Special rule for tiered partnerships. For purposes of paragraph 
(d)(1)(ii) of this section, if an eligible partner is treated as owning 
an interest in a lower-tier purchasing partnership through an upper-
tier partnership, the eligible partner's percentage interest in the 
purchasing partnership shall be proportionately adjusted to reflect the 
eligible partner's percentage interest in the upper-tier partnership.
    (e) Partnership distribution of QSB stock to a partner--(1) In 
general. Subject to paragraphs (e)(2) and (3) of this section, in the 
case of a partnership distribution of QSB stock to a partner, the 
partner shall be treated for purposes of this section as--
    (i) Having acquired such stock in the same manner as the 
partnership; and
    (ii) Having held such stock during any continuous period 
immediately preceding the distribution during which it was held by the 
partnership. See

[[Page 45353]]

Examples 10 and 11 of paragraph (i) of this section.
    (2) Eligibility under section 1202(c). Paragraph (e)(1) of this 
section does not apply unless all eligibility requirements with respect 
to QSB stock as defined in section 1202(c) are met by the distributing 
partnership with respect to its investment in QSB stock.
    (3) Distribution nonrecognition limitation--(i) Generally. The 
amount of gain that an eligible partner does not recognize under this 
section on the sale of QSB stock that was distributed by the 
partnership to the partner cannot exceed the distribution 
nonrecognition limitation. For this purpose, the distribution 
nonrecognition limitation is--
    (A) The partner's section 1045 amount realized (determined under 
paragraph (e)(3)(ii) of this section); reduced by
    (B) The partner's section 1045 adjusted basis (determined under 
paragraph (e)(3)(iii) of this section).
    (ii) Section 1045 amount realized--(A) QSB stock received in 
liquidation of partner's interest and in certain nonliquidating 
distributions. If a partner receives QSB stock from the partnership in 
a distribution in liquidation of the partner's interest in the 
partnership or as part of a series of related distributions by the 
partnership in which the partnership distributes all of the 
partnership's QSB stock of a particular type, then the partner's 
section 1045 amount realized is the partner's amount realized from the 
sale of the distributed QSB stock, multiplied by a fraction--
    (1) The numerator of which is the partner's smallest percentage 
interest in partnership capital determined under paragraph 
(e)(3)(ii)(B) of this section; and
    (2) The denominator of which is the partner's percentage interest 
in that type of QSB stock immediately after the distribution 
(determined under paragraph (e)(3)(iv) of this section).
    (B) Partner's smallest percentage interest in partnership capital. 
A partner's smallest percentage interest in partnership capital is the 
partner's percentage share of capital determined at the time of the 
acquisition of the QSB stock as adjusted prior to the time the QSB 
stock is distributed to the partner to reflect any reduction in the 
capital of the partner including a reduction as a result of a 
disproportionate capital contribution by other partners, a 
disproportionate capital distribution to the partner, or the transfer 
of a capital interest by the partner, but excluding income and loss 
allocations.
    (C) QSB stock received in other distributions. If a partner 
receives QSB stock in a distribution from the partnership that is not 
described in paragraph (e)(3)(ii)(A) of this section, the partner's 
section 1045 amount realized is the partner's amount realized from the 
sale of the distributed QSB stock multiplied by the partner's smallest 
percentage interest in partnership capital determined under paragraph 
(e)(3)(ii)(B) of this section.
    (iii) Section 1045 adjusted basis--(A) QSB stock received in 
liquidation of partner's interest and in certain nonliquidating 
distributions. If a partner receives QSB stock from the partnership in 
a distribution in liquidation of the partner's interest in the 
partnership or as part of a series of related distributions by the 
partnership in which the partnership distributes all of the 
partnership's QSB stock of a particular type, then the partner's 
section 1045 adjusted basis is the product of--
    (1) The partnership's basis in all of the QSB stock of the type 
distributed (without regard to basis adjustments under section 734(b) 
or section 743(b), other than basis adjustments described in paragraphs 
(b)(3)(ii) and (c)(4)(ii) of this section);
    (2) The partner's smallest percentage interest in partnership 
capital determined under paragraph (e)(3)(ii)(B) of this section; and
    (3) The proportion of the distributed QSB stock that was sold by 
the partner.
    (B) QSB stock received in other distributions. If a partner 
receives QSB stock in a distribution from the partnership that is not 
described in paragraph (e)(3)(iii)(A) of this section, the partner's 
section 1045 adjusted basis is the product of--
    (1) The partnership's basis in the QSB stock sold by the partner 
(without regard to basis adjustments under section 734(b) or section 
743(b), other than basis adjustments described in paragraphs (b)(3)(ii) 
and (c)(4)(ii) of this section); and
    (2) The partner's smallest percentage interest in partnership 
capital determined under paragraph (e)(3)(ii)(B) of this section.
    (iv) Partner's percentage interest in distributed QSB stock. For 
purposes of this paragraph (e)(3), a partner's percentage interest in a 
type of QSB stock immediately after a partnership distribution is the 
value (as of the date of the distribution) of the QSB stock distributed 
to the partner divided by the value (as of the date of the 
distribution) of all of that type of QSB stock that was acquired by the 
partnership.
    (v) QSB stock of the same type. For purposes of this paragraph 
(e)(3), QSB stock will be of the same type as the distributed QSB stock 
if it has the same issuer and the same rights and preferences as the 
distributed QSB stock and was acquired by the partnership at original 
issue.
    (4) Distribution of replacement QSB stock to a partner that reduces 
another partner's interest in the replacement QSB stock. For purposes 
of this section, a partner must recognize gain upon a distribution of 
replacement QSB stock to another partner that reduces the partner's 
share of the replacement QSB stock held by a partnership. The amount of 
gain that the partner must recognize is determined based on the amount 
of gain that the partner would recognize upon a sale of the distributed 
replacement QSB stock for its fair market value on the date of the 
distribution but not to exceed the amount that was previously not 
recognized by the partner under section 1045 with respect to the 
distributed replacement QSB stock. Any gain recognized by a partner 
whose interest is reduced must be taken into account in determining the 
adjusted basis of the partner's interest in the partnership and also 
taken into account in determining the partnership's adjusted basis in 
the QSB stock distributed to another partner under paragraph (e)(3) of 
this section.
    (f) Contribution of QSB stock or replacement QSB stock to a 
partnership. Section 721 applies to a contribution of QSB stock to a 
partnership. Except as provided in section 721(b), any gain that was 
not recognized by the taxpayer under section 1045 is not recognized 
when the taxpayer contributes QSB stock to a partnership in exchange 
for a partnership interest. Stock that is contributed to a partnership 
is not QSB stock in the hands of the partnership. See Example 12 of 
paragraph (i) of this section.
    (g) Definitions. For purposes of section 1045 and this section, the 
following terms are defined as follows:
    (1) Qualified small business stock. The term qualified small 
business stock (QSB stock) has the meaning provided in section 1202(c). 
The term ``QSB stock'' does not include an interest in a partnership 
that purchases or holds QSB stock. See Example 1 of paragraph (i) of 
this section.
    (2) Replacement QSB stock. The term replacement QSB stock is any 
QSB stock purchased within 60 days beginning on the date of a sale of 
QSB stock.
    (3) Eligible partner--(i) In general. Except as provided in 
paragraphs (e)(1), (g)(3)(ii), (iii) and (iv) of this section, an 
eligible partner with respect to QSB stock is a taxpayer other than a C 
corporation that holds an interest in a partnership on the date the 
partnership acquires the QSB stock and at all times thereafter for more 
than 6 months until

[[Page 45354]]

the partnership sells or distributes the QSB stock.
    (ii) Acquisition by gift or at death. For purposes of paragraph 
(g)(3)(i) of this section, a taxpayer who acquires from a partner 
(other than a C corporation) by gift or at death an interest in a 
partnership that holds QSB stock is treated as having held the acquired 
interest in the partnership during the period the partner (other than a 
C corporation) held the interest in the partnership.
    (iii) Tiered partnership. For purposes of paragraph (g)(3)(i) of 
this section, if a partnership (upper-tier partnership) holds an 
interest in another partnership (lower-tier partnership) that holds QSB 
stock, then the upper-tier partnership's ownership of the lower-tier 
partnership is disregarded and each partner of the upper-tier 
partnership is treated as owning the interest in the lower-tier 
partnership directly. The partner of the upper-tier partnership is 
treated as owning the interest in the lower-tier partnership during the 
period in which both--
    (A) The partner of the upper-tier partnership held an interest in 
the upper-tier partnership; and
    (B) The upper-tier partnership held an interest in the lower-tier 
partnership. See Examples 3 and 4 of paragraph (i) of this section.
    (iv) Multiple tiers of partnerships. Principles similar to those 
described in paragraph (g)(3)(iii) of this section apply where a 
taxpayer holds an interest in a lower-tier partnership through multiple 
tiers of partnerships.
    (4) Month(s). For purposes of this section, the term month(s) means 
a period commencing on the same numerical day of any calendar month as 
the day on which the QSB stock is sold and ending with the close of the 
day preceding the numerically corresponding day of the succeeding 
calendar month or, if there is no corresponding day, with the last day 
of the succeeding calendar month.
    (h) Reporting and election rules--(1) Time and manner of making 
election. A partnership making an election under section 1045 (as 
described under paragraph (b)(1) of this section) must do so on the 
partnership's timely filed (including extensions) Federal income tax 
return for the taxable year during which the sale of QSB stock occurs. 
A partner making an election under section 1045 (as described under 
paragraph (c)(1) of this section) must do so on the partner's timely 
filed (including extensions) Federal income tax return for the taxable 
year during which the partner's distributive share of the partnership's 
gain from the sale of the QSB stock is taken into account by such 
partner under section 706. In addition, a partnership or partner making 
an election under section 1045 must make such election in accordance 
with the applicable forms and instructions.
    (2) Purchases, distributions, and sales of QSB stock or replacement 
QSB stock by partnerships. A partnership that purchases, distributes to 
a partner, or sells or exchanges QSB stock or replacement QSB stock 
must provide information to the Commissioner and to the partnership's 
partners to the extent provided by the applicable forms and 
instructions.
    (3) Nonrecognition of gain by eligible partners. An eligible 
partner that does not recognize gain under section 1045 must provide 
information to the Commissioner to the extent provided by the 
applicable forms and instructions.
    (i) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. Sale of a partnership interest. On January 1, 2008, 
A, an individual, X, a C corporation, and Y, a C corporation, form 
PRS, a partnership. A, X, and Y each contribute $250 to PRS and 
agree to share all partnership items equally. PRS purchases QSB 
stock for $750 on February 1, 2008. On November 4, 2008, A sells A's 
interest in PRS for $500, realizing $250 of capital gain. Under 
paragraph (g)(1) of this section, an interest in a partnership that 
holds QSB stock is not treated as QSB stock. Therefore, the sale of 
an interest in a partnership that holds QSB stock is not treated as 
a sale of QSB stock, and A may not elect to apply section 1045 with 
respect to A's $250 gain from the sale of A's interest in PRS.
    Example 2. Election by partner; replacement by partnership. (i) 
Assume the same facts as in Example 1, except that A does not sell 
A's interest in PRS. Instead, PRS sells the QSB stock (QSB1 stock) 
for $1,500 on November 3, 2008. PRS realizes $750 of gain from the 
sale of the QSB1 stock (none of which is treated as ordinary income) 
and allocates $250 of gain to each of A, X, and Y. PRS does not make 
a section 1045 election. On November 30, 2008, A contributes $500 to 
ABC, a partnership, in exchange for a 10 percent interest in ABC. 
ABC then purchases QSB stock (QSB2 stock) for $5,000 on December 1, 
2008. ABC has no other assets. A makes an election under paragraph 
(c)(1) of this section and treats A's percentage interest in ABC's 
QSB2 stock as replacement QSB stock under paragraph (c)(1)(iii) of 
this section with respect to the $250 gain PRS allocated to A. Under 
paragraph (c)(3) of this section, A's share of the cost of QSB2 
stock purchased by ABC is $500 (A's reasonably expected income and 
gain with respect to QSB2 stock, or 10 percent multiplied by the 
cost of the QSB2 stock, $5,000). Under paragraph (c)(1)(iii) of this 
section, A will not recognize the $250 gain PRS allocated to A, 
because A's share of the amount realized by PRS, $500 (the total 
amount realized by the partnership on the sale of the QSB1 stock 
($1,500) multiplied by A's share of the gain from the sale of the 
QSB1 stock ($250) over the total gain realized by the partnership on 
the sale of the QSB1 stock ($750)), does not exceed A's share of 
ABC's cost of the QSB2 stock acquired by ABC, $500. Under paragraph 
(c)(4)(ii) of this section, A must reduce A's share of ABC's basis 
in the QSB2 stock by $250. Under paragraph (c)(4)(iii) of this 
section, A must reduce A's basis in A's interest in ABC by $250. 
Under paragraph (c)(4)(i) of this section, A's basis in A's interest 
in PRS is increased by $250.
    (ii) Assume the same facts as in paragraph (i) of this Example 
2, except that A does not contribute $500 to ABC in exchange for a 
partnership interest. Instead, on November 30, 2008, EFG, a 
partnership in which A has an existing 10 percent partnership 
interest, purchases QSB stock for $5,000. Under paragraph (c)(1) of 
this section, A may treat A's 10 percent interest in EFG's QSB stock 
as replacement QSB stock with respect to the $250 of gain PRS 
allocated to A.
    (iii) Assume the same facts as in paragraph (i) of this Example 
2, except that ABC owns QSB stock that ABC purchased on November 10, 
2008, and ABC does not purchase QSB stock on December 1, 2008. Under 
paragraph (c)(1) of this section, ABC is not a purchasing 
partnership with respect to A for the QSB stock ABC purchased on 
November 10, 2008. A may not treat A's percentage interest in ABC's 
QSB stock as replacement QSB stock to defer the $250 gain PRS 
allocated to A, because A acquired its interest in ABC after ABC 
acquired the QSB stock.
    (iv) Assume the same facts as in paragraph (i) of this Example 
2, except that ABC sells QSB2 stock on July 30, 2009, for $5,000. 
ABC realizes no gain or loss on the sale of QSB2 stock. A desires to 
continue to rollover the $250 gain from the sale of QSB1 stock. 
Under paragraph (c)(2)(ii)(A) of this section, A's share of the 
amount realized is $500, which was A's share of the amount realized 
on the prior sale of QSB1 stock. Accordingly, A must elect to apply 
section 1045 and purchase $500 of replacement QSB stock either 
directly or through a purchasing partnership to continue to defer 
the $250 gain from the sale of QSB1 stock.
    Example 3. Tiered partnerships; partnership election. (i) On 
January 1, 2008, A, an individual, and B, an individual, each 
contrib