Partnership Transactions Involving Equity Interests of a Partner, 33402-33412 [2015-14405]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 80, Number 113 (Friday, June 12, 2015)]
[Rules and Regulations]
[Pages 33402-33412]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-14405]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9722]
RIN 1545-BM35


Partnership Transactions Involving Equity Interests of a Partner

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations that 
prevent a corporate partner from avoiding corporate-level gain through 
transactions with a partnership involving equity interests of the 
partner. These regulations affect partnerships and their partners. The 
text of these temporary regulations serves as the text of proposed 
regulations (REG-149518-03) published in the Proposed Rules section in 
this issue of the Federal Register.

DATES: Effective Date: These regulations are effective on June 12, 
2015.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.337(d)-3T(i) and 1.732-1T(c)(5).

FOR FURTHER INFORMATION CONTACT: Concerning the final and temporary 
regulations, Kevin I. Babitz, (202) 317-6852.

SUPPLEMENTARY INFORMATION:

Background

The General Utilities Doctrine and Its Repeal

    In General Utilities & Operating Co. v. Helvering, 296 U.S. 200 
(1935), the Supreme Court held that corporations generally could 
distribute appreciated property to their shareholders without the 
recognition of any corporate level gain (the General Utilities 
doctrine). Beginning in 1969, Congress enacted a series of exceptions 
to the General Utilities doctrine, starting with certain non-
liquidating distributions of depreciable property. In the Tax Equity 
and Fiscal Responsibility Act of 1982, Public Law 97-248, 96 Stat. 324, 
Congress enacted current section 311(b) (originally designated as 
section 311(d)), which required a corporation to recognize gain on 
appreciated property distributed to a shareholder in redemption of 
shares. In 1984, Congress enacted legislation that required gain 
recognition for all non-liquidating distributions. Finally, as part of 
the Tax Reform Act of 1986, Public Law 99-514, 100 Stat. 2085, (the 
Act), Congress repealed what remained of the General Utilities doctrine 
by enacting section 336(a) of the Internal Revenue Code (Code) to apply 
gain and loss recognition to liquidating distributions. Under current 
law, sections 311(b) and 336(a) of the Code require a corporation that 
distributes appreciated property to its shareholders to recognize gain 
determined as if the property were sold to the shareholders for its 
fair market value. Additionally, section 631 of the Act added section 
337(d) to the Code to permit the Secretary to prescribe regulations 
that are necessary or appropriate to carry out the purposes of the 
General Utilities repeal, ``including regulations to ensure that [the 
repeal of the General Utilities doctrine] may not be circumvented 
through the use of any provision of law or regulations.''

1992 Proposed Regulations

    After the enactment of sections 311(b) and 337(d), the Treasury 
Department and the IRS became aware of transactions in which taxpayers 
used a partnership to postpone or avoid completely gain generally 
required to be recognized under section 311(b). In one example of this 
transaction, a corporation entered into a partnership and contributed 
appreciated property. The partnership then acquired stock of that 
corporate partner, and later made a liquidating distribution of this 
stock to the corporate partner. Under section 731(a), the corporate 
partner did not recognize gain on the partnership's distribution of its 
stock. By means of this transaction, the corporation had disposed of 
the appreciated property it formerly held and had acquired its own 
stock, permanently avoiding its gain in the appreciated property. If 
the corporation had directly exchanged the appreciated property for its 
own stock, section 311(b) would have required the

[[Page 33403]]

corporation to recognize gain upon the exchange.
    In response to this type of transaction, the Treasury Department 
and the IRS issued Notice 89-37, 1989-1 CB 679, on March 9, 1989. 
Notice 89-37 announced that future regulations under section 337(d) 
would address the use of partnerships to avoid the repeal of the 
General Utilities doctrine. Specifically, the Treasury Department and 
the IRS determined that, in certain circumstances, the acquisition (or 
ownership) by a partnership of stock in one of its corporate partners 
(or stock of any member of the affiliated group of which the partner is 
a member) results in avoidance of the repeal of the General Utilities 
doctrine. Such avoidance occurs to the extent that a corporate partner, 
in substance, relinquishes an interest in appreciated property in 
exchange for an interest in its stock (or the stock of an affiliate). 
The Notice provided that section 311(b), rather than section 731(a), 
would apply when a partner received a distribution of its own stock, 
and that the partner would recognize gain whenever a pre-distribution 
transaction has the economic effect of an exchange of appreciated 
property for the partner's own stock.
    On December 15, 1992, the Treasury Department and the IRS published 
a notice of proposed rulemaking under section 337(d) (PS-91-90, REG-
208989-90, 1993-1 CB 919) in the Federal Register (57 FR 59324) 
addressing partnership transactions involving stock of a partner (the 
1992 proposed regulations). The 1992 proposed regulations adopted two 
rules to protect the repeal of the General Utilities doctrine: the 
deemed redemption rule (the 1992 deemed redemption rule) and the 
distribution rule (the 1992 distribution rule). The 1992 proposed 
regulations also provided de minimis and inadvertence exceptions to 
these two rules.
    The 1992 deemed redemption rule addressed pre-distribution 
transactions involving corporate partner stock owned or acquired by the 
partnership. The Treasury Department and the IRS believed that certain 
of these transactions created the economic effect of an exchange of 
appreciated property for corporate partner stock. The 1992 deemed 
redemption rule provided that a corporate partner recognizes gain at 
the time of, and to the extent that, any transaction (or series of 
transactions) has the economic effect of an exchange by the partner of 
its interest in appreciated property for an interest in its stock (or 
the stock of any member of the affiliated group of which such partner 
is a member) owned, acquired, or distributed by the partnership.
    The 1992 distribution rule provided that a partnership's 
distribution to a partner of the partner's stock is treated as a 
redemption or an exchange of the stock of the partner for a portion of 
the partner's partnership interest with a value equal to the 
distributed stock. Thus, the 1992 distribution rule applied section 
311(b) principles to the distribution to trigger gain to the corporate 
partner, rather than applying section 731, which would not have 
required gain recognition. The 1992 distribution rule ensured that 
section 311(b) would apply to any acquisition by the corporate partner 
of its own stock where the 1992 deemed redemption rule had not applied. 
The preamble to the 1992 proposed regulations indicated that commenters 
on the Notice raised concerns that the 1992 distribution rule could 
duplicate gain recognition and suggested a modified approach. However, 
the 1992 proposed regulations rejected the modified approach as overly 
complex.
    As noted previously, the 1992 proposed regulations applied to stock 
of a partner, to stock of a partner's affiliate, and to other equity 
interests in the partner or affiliate. The 1992 proposed regulations 
used a modified affiliation standard to determine whether a partner and 
another corporation were affiliates. The 1992 proposed regulations 
treated a corporation as an affiliate of a partner at the time of a 
deemed redemption or distribution by the partnership if, immediately 
thereafter, the partner and corporation were members of an affiliated 
group as defined in section 1504(a) without regard to section 1504(b) 
(section 337(d) affiliation). On January 19, 1993, the Treasury 
Department and the IRS issued Notice 93-2, 1993-1 CB 292, which stated 
that the 1992 proposed regulations would be amended to limit the 
application of the regulations to transactions in which section 337(d) 
affiliation existed immediately before the deemed redemption or 
distribution. The Treasury Department and the IRS indicated that 
further study was required for cases in which section 337(d) 
affiliation did not exist prior to a distribution of stock by a 
partnership to a corporate partner, but resulted from the distribution.
    The Treasury Department and the IRS received several written 
comments in response to Notice 89-37, the 1992 proposed regulations, 
and Notice 93-2. Commenters largely supported the 1992 deemed 
redemption rule, though some suggested modifications. Some commenters, 
however, opposed the 1992 distribution rule, asserting that the rule is 
overly broad and inconsistent with the deemed redemption rule. These 
comments are discussed in detail in the Explanation of Provisions 
section of this preamble.
    After considering these comment letters, and taking into account 
subsequent changes in relevant law as described in part 1 of this 
preamble, the Treasury Department and the IRS are withdrawing the 1992 
proposed regulations and simultaneously issuing temporary and final 
regulations that also serve as the text of new proposed regulations 
published in the Proposed Rules section of this issue of the Federal 
Register.

Explanation of Provisions

    The purpose of these regulations authorized under section 337(d) is 
to prevent corporate taxpayers from using a partnership to circumvent 
gain required to be recognized under section 311(b) or section 336(a). 
These regulations, including the rules governing the amount and timing 
of recognized gain, must be applied in a manner consistent with, and 
which reasonably carries out, this purpose.
    These regulations apply when a partnership, either directly or 
indirectly, owns, acquires, or distributes Stock of the Corporate 
Partner (as defined in part 1 of this preamble). Under these 
regulations, a Corporate Partner (as defined in part 1 of this 
preamble) may recognize gain when it is treated as acquiring or 
increasing its interest in Stock of the Corporate Partner held by a 
partnership in exchange for appreciated property in a manner that 
avoids gain recognition under section 311(b) or section 336(a). The 
regulations also provide exceptions under which a Corporate Partner is 
not required to recognize gain.
    These regulations retain the 1992 deemed redemption rule with the 
modifications described in part 2 of this preamble. However, these 
regulations remove the 1992 distribution rule in response to comments. 
In its place, these regulations apply the deemed redemption rule to 
partnership distributions of Stock of the Corporate Partner to the 
Corporate Partner as though the partnership amended its agreement, 
immediately before the distribution, to allocate 100 percent of the 
distributed stock to the Corporate Partner.

1. Scope and Definitions

    These regulations apply to certain partnerships that hold stock of 
a Corporate Partner. For this purpose, a ``Corporate Partner'' is 
defined as a

[[Page 33404]]

person that holds or acquires an interest in a partnership and that is 
classified as a corporation for federal income tax purposes. The 
regulations define ``Stock of the Corporate Partner'' expansively to 
include the Corporate Partner's stock, or other equity interests, 
including options, warrants, and similar interests, in the Corporate 
Partner or a corporation that controls (within the meaning of section 
304(c)) the Corporate Partner. Stock of the Corporate Partner also 
includes interests in any entity to the extent that the value of the 
interest is attributable to Stock of the Corporate Partner.
    These definitions of Corporate Partner and Stock of the Corporate 
Partner are consistent with those set forth in the 1992 proposed 
regulations except for two changes. First, these regulations modify the 
definition of Stock of the Corporate Partner. Based on changes in the 
law and comments received, the Treasury Department and the IRS have 
determined that the scope of the definition of ``Stock of a Partner'' 
in the 1992 proposed regulations was too narrow in certain instances 
and too broad in others. These regulations broaden the definition of 
Stock of a Corporate Partner to include stock or other equity interests 
of any corporation that controls the Corporate Partner within the 
meaning of section 304(c) (section 304(c) control), whereas the 1992 
proposed regulations' definition was limited to stock or other equity 
interests issued by the Corporate Partner and its section 337(d) 
affiliates. Section 304(c) control generally exists when there is 
ownership of stock of a corporation possessing at least 50 percent of 
the total combined voting power of all classes of the corporation's 
stock that is entitled to vote or at least 50 percent of the value of 
the shares of all classes of stock of the corporation, while control of 
a corporation under section 1504(a)(2) requires ownership of stock of 
the corporation possessing at least 80 percent of the total voting 
power of the stock of the corporation and at least 80 percent of the 
total value of the stock of the corporation. The Treasury Department 
and the IRS believe the lower threshold for control set forth in 
section 304(c) is the more appropriate standard for this purpose 
because General Utilities repeal could be avoided by acquiring stock of 
a corporation that owns less than 80 percent of the vote and value of 
the Corporate Partner's stock. In addition, these regulations narrow 
the definition of Stock of a Corporate Partner to exclude stock of any 
corporation that does not possess section 304(c) control of the 
Corporate Partner, even if the corporation is a section 337(d) 
affiliate or a member of the same consolidated group as the Corporate 
Partner. The enactment of sections 732(f) and 755(c) subsequent to the 
issuance of the 1992 proposed regulations generally have served to 
prevent abusive transactions involving partnerships that own stock of 
lower tier section 337(d) affiliates of the Corporate Partner. 
Accordingly, these regulations do not apply to a partnership that owns, 
acquires, or distributes stock of any section 337(d) affiliate of the 
Corporate Partner unless that affiliate possesses section 304(c) 
control of the Corporate Partner. The Treasury Department and the IRS 
continue to study the application of these provisions and plan to issue 
additional guidance as needed to address further abuses in this area. 
Comments are requested regarding such guidance.
    Second, these regulations add an exception for certain related-
party partners. Under this exception, Stock of the Corporate Partner 
does not include any stock or other equity interest held or acquired by 
a partnership if all interests in the partnership's capital and profits 
are held by members of an affiliated group defined in section 1504(a) 
that includes the Corporate Partner. Thus, these regulations do not 
apply if, for example, a domestic corporation and its wholly owned 
domestic subsidiary (each of which is an includible corporation under 
section 1504(b)) are the only partners in a partnership and either 
corporation contributes stock of another affiliate. The Treasury 
Department and the IRS have determined that this additional exception 
is appropriate because the purpose of these regulations is not 
implicated if a partnership is owned entirely by affiliated 
corporations. The Treasury Department and the IRS invite comments on 
whether this exception should be extended, for example, to partnerships 
owned by controlled foreign corporations that are owned entirely by a 
single affiliated group.
    For partnerships that hold Stock of the Corporate Partner, these 
regulations apply to a transaction (or series of transactions) that is 
a ``Section 337(d) Transaction.'' These regulations define a Section 
337(d) Transaction as a transaction that has the effect of an exchange 
by a Corporate Partner of its interest in appreciated property for an 
interest in Stock of the Corporate Partner owned, acquired, or 
distributed by a partnership. For example, a Section 337(d) Transaction 
may occur if: (i) A Corporate Partner contributes appreciated property 
to a partnership that owns Stock of the Corporate Partner; (ii) a 
partnership acquires Stock of the Corporate Partner; (iii) a 
partnership that owns Stock of the Corporate Partner distributes 
appreciated property to a partner other than the Corporate Partner; 
(iv) a partnership distributes stock of the Corporate Partner to the 
Corporate Partner; or (v) a partnership agreement is amended in a 
manner that increases a Corporate Partner's interest in the Stock of 
the Corporate Partner (including in connection with a contribution to, 
or distribution from, a partnership).
    If a partnership engages in a Section 337(d) Transaction, the 
Corporate Partner must recognize gain. The regulations define a ``Gain 
Percentage'' that the partnership uses to quantify the amount of gain 
recognized. The computation of the Gain Percentage is set forth in part 
2 of this preamble.

2. Deemed Redemption Rule

    These regulations largely retain the 1992 deemed redemption rule. 
If a transaction is a Section 337(d) Transaction described in part 1 of 
this preamble, a Corporate Partner must recognize gain under the deemed 
redemption rule. To determine the amount of gain, the Corporate Partner 
must first determine the amount of appreciated property (other than 
Stock of the Corporate Partner) effectively exchanged for Stock of the 
Corporate Partner (by value) and then calculate the amount of taxable 
gain recognized.
    These regulations set forth general principles that apply in 
determining the amount of appreciated property effectively exchanged 
for Stock of the Corporate Partner. These general principles require 
that the Corporate Partner's economic interest with respect to both 
Stock of the Corporate Partner and all other appreciated property of 
the partnership be determined based on all facts and circumstances, 
including the allocation and distribution rights set forth in the 
partnership agreement. The deemed redemption rule applies only to the 
extent that the transaction has the effect of an exchange by the 
Corporate Partner of its interest in appreciated property for Stock of 
the Corporate Partner. Thus, these regulations do not apply to the 
extent a transaction has the effect of an exchange by a Corporate 
Partner of non-appreciated property for Stock of the Corporate Partner 
or has the effect of an exchange by a Corporate Partner of appreciated 
property for property other than Stock of the Corporate Partner.
    A Corporate Partner must recognize gain under these regulations 
even if the

[[Page 33405]]

Section 337(d) Transaction would not otherwise change the Corporate 
Partner's allocable share of gain under section 704(c). For example, if 
a Corporate Partner contributes appreciated property to a newly-formed 
partnership and an individual contributes cash that the partnership 
subsequently uses to purchase Stock of the Corporate Partner, then the 
purchase of the stock is a Section 337(d) Transaction even though the 
Corporate Partner's allocable share of gain in the appreciated property 
under section 704(c) is the same before and after the purchase. The 
Treasury Department and the IRS believe that this gain recognition is 
appropriate because a Section 337(d) Transaction may create an 
immediate benefit to the Corporate Partner equivalent to the benefit 
associated with the redemption of corporate stock in exchange for 
appreciated property. See Example 4 of Sec.  1.337(d)-3T(h) in these 
regulations.
    If the Corporate Partner has an existing interest in the 
partnership's Stock of the Corporate Partner prior to the Section 
337(d) Transaction, the deemed redemption rule applies only with 
respect to the Corporate Partner's incremental increase in the Stock of 
the Corporate Partner. For example, changing allocations to increase a 
Corporate Partner's interest in the Stock of the Corporate Partner from 
50 percent to 80 percent and to decrease the Corporate Partner's 
interest in other appreciated property from 80 percent to 50 percent 
would have the effect of an exchange by the Corporate Partner of the 
30-percent incremental decrease in its interest in the appreciated 
property for the 30-percent incremental increase in the Stock of the 
Corporate Partner. See Example 5 of Sec.  1.337(d)-3T(h) in these 
regulations.
    For purposes of recognizing gain under the deemed redemption rule, 
the Corporate Partner's interest in an identified share of Stock of the 
Corporate Partner will never be less than the Corporate Partner's 
largest interest (by value) in that share of Stock of the Corporate 
Partner that was taken into account when the partnership previously 
determined whether there had been a Section 337(d) Transaction 
(regardless of whether the Corporate Partner recognized gain in the 
earlier transaction). See Example 6 of Sec.  1.337(d)-3T(h) in these 
regulations. This rule ensures that alternating increases and decreases 
in a Corporate Partner's interest in Stock of the Corporate Partner do 
not cause duplicate gain recognition. This limitation does not apply if 
any reduction in the Corporate Partner's interest in the identified 
share of Stock of the Corporate Partner occurred as part of a plan or 
arrangement to circumvent the purpose of these regulations. See Example 
7 of Sec.  1.337(d)-3T(h) in these regulations.
    In certain limited circumstances, a partnership's acquisition of 
Stock of the Corporate Partner does not have the effect of an exchange 
of appreciated property for that stock. For example, as one commenter 
asserted, if a partnership with an operating business uses the cash 
generated in that business to purchase Stock of the Corporate Partner, 
the deemed redemption rule should not apply to the stock purchase 
because the Corporate Partner's share in appreciated property has not 
been reduced, and thus no exchange has occurred. The Treasury 
Department and the IRS acknowledge that such stock acquisitions would 
not contravene the purposes of these regulations. Accordingly, these 
regulations adopt this comment and do not apply to stock purchases or 
other transactions that do not have the effect of an exchange of 
appreciated property for Stock of the Corporate Partner.
    If a transaction is a Section 337(d) Transaction, the deemed 
redemption rule requires the Corporate Partner to recognize a 
percentage of its total gain in partnership appreciated property equal 
to a fraction, the numerator of which is the Corporate Partner's 
interest (by value) in appreciated property effectively exchanged for 
Stock of the Corporate Partner under the deemed redemption rule, and 
the denominator of which is the Corporate Partner's interest (by value) 
in appreciated property immediately before the Section 337(d) 
Transaction. This fraction is defined in these regulations as the 
``Gain Percentage.'' The Corporate Partner's gain under the deemed 
redemption rule equals the product of (i) the Corporate Partner's Gain 
Percentage and (ii) the gain from the appreciated property that is the 
subject of the exchange that the that the Corporate Partner would 
recognize if, immediately before the Section 337(d) Transaction, all 
assets of the partnership and any assets contributed to the partnership 
in the section 337(d) Transaction were sold in a fully taxable 
transaction for cash in an amount equal to the fair market value of 
such property (taking into account section 7701(g)), reduced, but not 
below zero, by any gain the Corporate Partner is required to recognize 
with respect to the appreciated property in the Section 337(d) 
Transaction under any other section of the Code. For example, if a 
Corporate Partner would be allocated $100x of tax gain on a sale of 
appreciated partnership property (other than Stock of the Corporate 
Partner) and the Corporate Partner's interest in that appreciated 
partnership property (determined under all facts and circumstances) is 
$500x, and if the partnership engages in a Section 337(d) Transaction 
that reduces the Corporate Partner's interest in appreciated 
partnership property by $200x and increases the Corporate Partner's 
interest in Stock of the Corporate Partner by $200x, then the Corporate 
Partner's Gain Percentage equals 40% (200x/500x), and the Corporate 
Partner's gain under the deemed redemption rule is $40x (40% of $100x).
    The gain from the hypothetical sale used to compute gain under the 
deemed redemption rule is determined by applying the principles of 
section 704(c), which generally requires the partnership to take into 
account variations between the adjusted tax basis and fair market value 
of partnership property at the time it is contributed to the 
partnership and upon certain other events that allow or require the 
value of partnership property to be redetermined under Sec.  1.704-
1(b)(2)(iv)(f). See Examples 3 and 5 of Sec.  1.337(d)-3T(h) in these 
regulations. A partner's share of gain under section 704(c) for this 
purpose includes any remedial allocations under Sec.  1.704-3(d) for a 
partnership that has elected under section 704(c) to report notional 
items of offsetting tax gain and loss to its partners to eliminate 
distortions that may arise when the partnership's total tax gain or 
loss on the sale of partnership property is less than all partners' 
aggregate share of gain or loss from the property.
    These regulations also contain two rules related to the effect of 
the deemed redemption rule on partner and partnership basis. First, 
these regulations require the Corporate Partner to increase its basis 
in its partnership interest by an amount equal to the gain that the 
Corporate Partner recognizes in a Section 337(d) Transaction. This 
basis increase is necessary to prevent the Corporate Partner from 
recognizing gain a second time when the partnership liquidates (or, if 
property is distributed to the Corporate Partner, when that property is 
sold).
    Second, the regulations require the partnership to increase its 
adjusted tax basis in the appreciated property that is treated as the 
subject of a Section 337(d) Transaction by the amount of gain that the 
Corporate Partner recognized with respect to that property as a result 
of the Section 337(d) Transaction. This basis

[[Page 33406]]

increase applies regardless of whether the partnership has elected 
under section 754 to adjust the basis of partnership property. This 
rule prevents the Corporate Partner from recognizing gain a second time 
when the partnership sells the property that was effectively exchanged 
under the deemed redemption rule.
    One commenter suggested that when a partnership owns or acquires 
stock in a Corporate Partner's subsidiary or a sister of the Corporate 
Partner and the stock is not issued as part of the transaction, the 
deemed redemption rule should not apply unless and until a subsequent 
transaction relating to the stock creates tax consequences that are 
inconsistent with General Utilities repeal. As discussed in part 1 of 
this preamble, these regulations only apply to Stock of a Corporate 
Partner, which under these regulations, does not include stock in a 
Corporate Partner's sister corporation or subsidiary unless such 
corporation possesses section 304(c) control of the Corporate Partner. 
Such control could exist, if, for example, a Corporate Partner's 
subsidiary were to own so-called ``hook stock'' in the Corporate 
Partner. If such control of the Corporate Partner does exist, then it 
is appropriate to treat stock of a Corporate Partner's subsidiary or 
sister corporation as Stock of the Corporate Partner because the value 
of that sister or subsidiary corporation's stock owned or acquired by 
the partnership is in part attributable to the Corporate Partner's 
stock.
    Another commenter suggested that the deemed redemption rule is no 
longer necessary. The commenter explained that the acquisition of Stock 
of the Corporate Partner is not the appropriate time to impose tax and 
that the 1992 distribution rule and changes in the law since 1989 make 
it more difficult to exit a partnership tax-free. The Treasury 
Department and the IRS do not adopt this comment because a Section 
337(d) Transaction may create an immediate benefit to the Corporate 
Partner equivalent to the benefit associated with the redemption of 
corporate stock in exchange for appreciated property. If the deemed 
redemption rule does not apply at the time of this exchange, the 
Corporate Partner can defer paying tax on this economic benefit in a 
manner that is inconsistent with section 311(b).

3. Partnership Distributions of Stock of the Corporate Partner

    The 1992 distribution rule required a Corporate Partner to 
recognize gain when the partnership distributes Stock of the Corporate 
Partner to the Corporate Partner. Commenters noted a number of concerns 
with this rule and recommended eliminating it.
    Several commenters noted that the rule was overly broad because it 
could cause the Corporate Partner to recognize gain in an amount that 
exceeded the appreciation in property effectively exchanged for the 
stock. For example, the rule could require a Corporate Partner to 
recognize gain upon a partnership's distribution of appreciated Stock 
of the Corporate Partner even though the partnership held no other 
appreciated property. One commenter stated that the 1992 distribution 
rule would therefore require the Corporate Partner to recognize gain on 
appreciation inherent in its partnership interest, even though the 
distribution does not implicate the repeal of the General Utilities 
doctrine and even though section 1032 provides for nonrecognition of 
gain on the distribution. The commenter maintained that the 1992 
distribution rule should not apply when a Corporate Partner merely 
exchanges an indirect interest in its own stock for a direct interest 
in its own stock.
    The Treasury Department and the IRS agree with these comments and 
adopt new rules governing the tax consequences of a distribution of 
Stock of the Corporate Partner to that Corporate Partner. Instead of 
adopting the 1992 distribution rule, these regulations extend the 
deemed redemption rule to certain distributions to the Corporate 
Partner of Stock of the Corporate Partner. These new rules governing 
distributions apply only if the distributed stock has previously been 
the subject of a Section 337(d) Transaction or becomes the subject of a 
Section 337(d) Transaction as a result of the distribution (a section 
337(d) distribution). Additionally, these regulations do not apply to a 
distribution to the Corporate Partner of the Stock of the Corporate 
Partner to which section 732(f) applies at the time of the 
distribution. If the deemed redemption rule applies to a distribution, 
these regulations deem the partnership to amend its agreement 
immediately before the distribution to allocate 100 percent of the 
distributed stock to the Corporate Partner and to allocate an 
appropriately reduced interest in other partnership property away from 
the Corporate Partner. This deemed allocation is solely for purposes of 
recognizing gain under these regulations, and no inference is intended 
with regard to the treatment of such allocations generally.
    If a distribution is a section 337(d) distribution, then in 
addition to any gain recognized under the deemed redemption rule upon 
the distribution of Stock of the Corporate Partner to the Corporate 
Partner, these regulations also require the Corporate Partner to 
recognize gain to the extent that the partnership's basis in the 
distributed Stock of the Corporate Partner exceeds the Corporate 
Partner's basis in its partnership interest (as reduced by any cash 
distributed in the transaction) immediately before the distribution. 
Recognition of gain in this circumstance is necessary to prevent the 
Corporate Partner from shifting basis away from its own stock onto 
other property of the partnership. The regulations provide an exception 
to this additional gain recognition rule if the gain recognition or 
basis reduction rules of section 732(f) apply at the time of the 
distribution. Although this exception generally ensures that gain 
recognized as a result of these regulations will not be duplicated as a 
result of section 732(f), duplication may still result in certain 
circumstances. For example, if a Corporate Partner recognizes gain 
under section 337(d) on a partnership distribution and section 732(f) 
does not apply to the distribution because the section 732(f) control 
requirement is not satisfied at the time of the distribution, but the 
control requirement is subsequently satisfied triggering section 
732(f), then the Corporate Partner could recognize gain under both 
provisions. The Treasury Department and the IRS invite comments on how 
the rules in these regulations should be coordinated with section 
732(f).
    These regulations set forth two rules under sections 337 and 732 to 
coordinate the effects of the rule requiring gain recognition when the 
Stock of the Corporate Partner is stepped down on a section 337(d) 
distribution with existing rules for determining the basis of property 
upon partnership distributions. The first rule applies for purposes of 
determining the basis of property distributed to the Corporate Partner 
(other than the basis of the Corporate Partner in its own stock), the 
basis of the Corporate Partner's remaining partnership interest, and 
the partnership's basis in undistributed Stock of the Corporate 
Partner, and for purposes of computing gain on the distribution. For 
these purposes, the basis of Stock of the Corporate Partner distributed 
to the Corporate Partner equals the greater of: (i) The partnership's 
basis of that distributed Stock of the Corporate Partner immediately 
before the distribution, or (ii) the fair market value of that 
distributed Stock of the

[[Page 33407]]

Corporate Partner immediately before the distribution less the 
Corporate Partner's allocable share of gain from all of the Stock of 
the Corporate Partner if the partnership sold all of its assets in a 
fully taxable transaction for cash in an amount equal to the fair 
market value of such property (taking into account section 7701(g)) 
immediately before the distribution. See Examples 2 and 3 of Sec.  
1.337(d)-3T(h) in these regulations. This special rule is necessary to 
prevent basis from shifting away from distributed Stock of the 
Corporate Partner to other property. This basis shift could occur, for 
example, upon a distribution of less than all of the partnership's 
Stock of the Corporate Partner to the Corporate Partner. The Treasury 
Department and the IRS request comments on this rule, including 
comments on whether its objectives would be better achieved through 
guidance under section 732 providing that on a distribution of a 
partial interest in partnership property, the basis of the distributed 
property in the hands of the distributee partner is determined by 
taking the principles of section 704(c) into account.
    A second rule applies when a Corporate Partner receives both Stock 
of the Corporate Partner and other property in a section 337(d) 
distribution. Under this rule, the basis to be allocated to the 
properties distributed under section 732(a) or (b) is allocated first 
to the Stock of the Corporate Partner before taking into account the 
distribution of any other property (other than cash). Therefore, before 
taking into account the distribution of other property, the Corporate 
Partner will reduce its basis in its partnership interest by the 
Corporate Partner's basis in the distributed Stock of the Corporate 
Partner (but not below zero). The Corporate Partner will determine its 
basis in other distributed partnership property and in its remaining 
partnership interest after giving effect to this reduction. This rule, 
which governs the application of sections 732(a) and 732(b), is being 
promulgated pursuant to the specific statutory grant of authority in 
section 337(d)(1) to ensure that the purposes of the repeal of the 
General Utilities doctrine are not circumvented through the use of any 
provision of law or regulations.
    When a Corporate Partner receives a partnership distribution of its 
own stock, it is unclear under existing law whether the Corporate 
Partner has basis in that stock. (See, for example, Rev. Rul. 2006-2, 
2006-1 CB 261.) The resolution of this question is beyond the scope of 
these regulations. However, because the distribution to a Corporate 
Partner of its own stock affects the Corporate Partner's basis in other 
distributed property and any retained partnership interest, these 
regulations require the partnership and the Corporate Partner to 
determine the basis of other distributed property and any retained 
partnership interest by reference to the partnership's basis in the 
distributed Stock of the Corporate Partner. That is, the Corporate 
Partner determines its basis in other distributed property and in any 
retained partnership interest as though the distributed stock was stock 
other than Stock of the Corporate Partner. Similarly, the regulations 
compute any gain recognition on the distribution by comparing the 
Corporate Partner's basis in its partnership interest to the basis of 
that Stock of the Corporate Partner in the hands of the partnership 
(without regard to whether the Corporate Partner can have basis in the 
distributed stock). No inference is intended with respect to the 
question of whether a corporation has or does not have basis in its own 
stock.

4. De Minimis and Inadvertence Exceptions

    These regulations retain the de minimis and inadvertence exceptions 
from the 1992 proposed regulations, but make small modifications to the 
de minimis rule to reduce burden. As set forth in these regulations, 
the de minimis rule provides that these regulations do not apply to a 
Corporate Partner if three conditions are satisfied. These conditions 
are tested upon the occurrence of a Section 337(d) Transaction and upon 
any subsequent revaluation event described in Sec.  1.704-
1(b)(2)(iv)(f).
    The first condition requires that both the Corporate Partner and 
any persons related to the Corporate Partner under section 267(b) or 
section 707(b) own, in the aggregate, less than five percent of the 
partnership. The second condition requires that the partnership hold 
Stock of the Corporate Partner worth less than two percent of the value 
of the partnership's gross assets, including Stock of the Corporate 
Partner. The third condition requires that the partnership has never, 
at any point in time, held more than $1,000,000 in Stock of the 
Corporate Partner or more than two percent of any particular class of 
Stock of the Corporate Partner. The 1992 proposed regulations contained 
similar conditions, but capped the permissible value of the 
partnership's Stock of the Corporate Partner at $250,000.
    These regulations provide a special rule that applies if the 
conditions of the de minimis rule are satisfied at the time of a 
Section 337(d) Transaction, but are not satisfied at the time of a 
subsequent Section 337(d) Transaction or revaluation event described in 
Sec.  1.704-1(b)(2)(iv)(f). This rule provides that, solely for 
purposes of the deemed redemption rule, a Corporate Partner may 
determine its gain on the subsequent acquisition or revaluation event 
as if it had already recognized gain at the previous event. 
Accordingly, the Corporate Partner would only recognize gain with 
respect to appreciation arising between the earlier acquisition or 
revaluation event and the subsequent event. Neither the Corporate 
Partner nor the partnership increases its basis by the gain the 
Corporate Partner would have recognized if the de minimis rule did not 
apply to the prior acquisition or revaluation event.
    These regulations also contain an inadvertence exception. The 
inadvertence exception provides that these regulations do not apply to 
Section 337(d) Transactions in which the partnership satisfies two 
requirements. First, the partnership must dispose of, by sale or 
distribution, the Stock of the Corporate Partner before the due date 
(including extensions) of its federal income tax return for the taxable 
year in which the partnership acquired the stock (or in which the 
Corporate Partner joined the partnership, if applicable). Second, the 
partnership must not have distributed the Stock of the Corporate 
Partner to the Corporate Partner or a person possessing section 304(c) 
control of the Corporate Partner. Other than broadening and narrowing 
the scope of related distributees as a result of the modified 
definition of Stock of the Corporate Partner, this inadvertence 
exception is generally unchanged from the 1992 proposed regulations. 
However, the Treasury Department and the IRS will consider comments 
with respect to removing the prohibition against distributions of Stock 
of the Corporate Partner to the Corporate Partner in light of the 
enactment of section 737, which requires a partner to recognize gain on 
property with built-in gain contributed to a partnership when the 
partnership distributes other property to the partner within seven 
years of the contribution.

5. Tiered Partnerships

    The Treasury Department and the IRS are concerned that taxpayers 
could use tiered partnerships to circumvent these regulations. 
Therefore, these regulations require taxpayers to apply these 
regulations to tiered partnerships in a

[[Page 33408]]

manner consistent with the regulations' purpose. See Example 8 of Sec.  
1.337(d)-3T(h) in these regulations.

Effective/Applicability Date

    These regulations apply to transactions occurring on or after June 
12, 2015.

Special Analyses

    It has been determined that this Treasury Decision is not a 
significant regulatory action as defined in Executive Order 12866, as 
supplemented by Executive Order 13563. Therefore, a regulatory 
assessment is not required. For the applicability of the Regulatory 
Flexibility Act (5 U.S.C. chapter 6), refer to the Special Analyses 
section of the preamble to the cross-referenced notice of proposed 
rulemaking published in the Proposed Rules section in this issue of the 
Federal Register. Pursuant to section 7805(f) of the Code, these 
regulations have been submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on its impact on small 
business.

Drafting Information

    The principal authors of these regulations are Joseph R. Worst and 
Kevin I. Babitz, Office of the Associate Chief Counsel (Passthroughs 
and Special Industries). However, other personnel from the Treasury 
Department and the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendment to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART I--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.337(d)-3T also issued under 26 U.S.C. 337(d). * * *


0
Par. 2. Section 1.337(d)-3T is added to read as follows:


Sec.  1.337(d)-3T  Gain recognition upon certain partnership 
transactions involving a partner's stock (temporary).

    (a) Purpose. The purpose of this section is to prevent corporate 
taxpayers from using a partnership to circumvent gain required to be 
recognized under section 311(b) or section 336(a). The rules of this 
section, including the determination of the amount of gain, must be 
applied in a manner that is consistent with and that reasonably carries 
out this purpose.
    (b) In general. This section applies when a partnership, either 
directly or indirectly, owns, acquires, or distributes Stock of the 
Corporate Partner (within the meaning of paragraph (c)(2) of this 
section). Under paragraphs (d) or (e) of this section, a Corporate 
Partner (within the meaning of paragraph (c)(1) of this section) is 
required to recognize gain when a transaction has the effect of the 
Corporate Partner acquiring or increasing an interest in its own stock 
in exchange for appreciated property in a manner that contravenes the 
purpose of this section as set forth in paragraph (a) of this section. 
Paragraph (f) of this section sets forth exceptions under which a 
Corporate Partner does not recognize gain.
    (c) Definitions. The following definitions apply for purposes of 
this section:
    (1) Corporate Partner. A Corporate Partner is a person that is 
classified as a corporation for federal income tax purposes and holds 
or acquires an interest in a partnership.
    (2) Stock of the Corporate Partner--(i) In general. With respect to 
a Corporate Partner, Stock of the Corporate Partner includes the 
Corporate Partner's stock, or other equity interests, including 
options, warrants, and similar interests, in the Corporate Partner or a 
corporation that controls (within the meaning of section 304(c)) the 
Corporate Partner. Stock of the Corporate Partner also includes 
interests in any entity to the extent that the value of the interest is 
attributable to Stock of the Corporate Partner.
    (ii) Affiliated partner exception. Stock of the Corporate Partner 
does not include any stock or other equity interests held or acquired 
by a partnership if all interests in the partnership's capital and 
profits are held by members of an affiliated group as defined in 
section 1504(a) that includes the Corporate Partner.
    (3) Section 337(d) Transaction. A Section 337(d) Transaction is a 
transaction (or series of transactions) that has the effect of an 
exchange by a Corporate Partner of its interest in appreciated property 
for an interest in Stock of the Corporate Partner owned, acquired, or 
distributed by a partnership. For example, a Section 337(d) Transaction 
may occur when--
    (i) A Corporate Partner contributes appreciated property to a 
partnership that owns Stock of the Corporate Partner;
    (ii) A partnership acquires Stock of the Corporate Partner;
    (iii) A partnership that owns Stock of the Corporate Partner 
distributes appreciated property to a partner other than a Corporate 
Partner;
    (iv) A partnership distributes Stock of the Corporate Partner to 
the Corporate Partner; or
    (v) A partnership agreement is amended in a manner that increases a 
Corporate Partner's interest in Stock of the Corporate Partner 
(including in connection with a contribution to, or distribution from, 
a partnership).
    (4) Gain Percentage. A Corporate Partner's Gain Percentage equals a 
fraction, the numerator of which is the Corporate Partner's interest 
(by value) in appreciated property effectively exchanged for Stock of 
the Corporate Partner under the test described in paragraphs (d)(1) and 
(2) of this section, and the denominator of which is the Corporate 
Partner's interest (by value) in that appreciated property immediately 
before the Section 337(d) Transaction. Paragraph (d) of this section 
requires a partnership to multiply the Gain Percentage by the Corporate 
Partner's aggregate gain in appreciated property to determine gain 
recognized under this section.
    (d) Deemed redemption rule--(1) In general. A Corporate Partner in 
a partnership that engages in a Section 337(d) Transaction recognizes 
gain at the time, and to the extent, that the Corporate Partner's 
interest in appreciated property (other than Stock of the Corporate 
Partner) is reduced in exchange for an increased interest in Stock of 
the Corporate Partner, as determined under paragraph (d)(2) of this 
section. This section does not apply to the extent a transaction has 
the effect of an exchange by a Corporate Partner of non-appreciated 
property for Stock of the Corporate Partner or has the effect of an 
exchange by a Corporate Partner for property other than Stock of the 
Corporate Partner.
    (2) Corporate Partner's Interest in Partnership Property. The 
Corporate Partner's interest with respect to both Stock of the 
Corporate Partner and the appreciated property that is the subject of 
the exchange is determined based on all facts and circumstances, 
including the allocation and distribution rights set forth in the 
partnership agreement. The Corporate Partner's interest in an 
identified share of Stock of the Corporate Partner will never be less 
than the Corporate Partner's largest interest (by value) in that share 
of Stock of the Corporate Partner that was taken into account when the 
partnership previously determined whether there had been a Section 
337(d) Transaction with respect to such share (regardless of

[[Page 33409]]

whether the Corporate Partner recognized gain in the earlier 
transaction). See Example 6 of paragraph (h) of this section. However, 
this limitation will not apply if any reduction in the Corporate 
Partner's interest in the identified share of Stock of the Corporate 
Partner occurred as part of a plan or arrangement to circumvent the 
purpose of this section. See Example 7 of paragraph (h) of this 
section.
    (3) Amount of gain recognized on the exchange. The amount of gain 
the Corporate Partner recognizes under paragraph (d)(1) of this section 
equals the product of the Corporate Partner's Gain Percentage and the 
gain from the appreciated property that is the subject of the exchange 
that the Corporate Partner would recognize if, immediately before the 
Section 337(d) Transaction, all assets of the partnership and any 
assets contributed to the partnership in the Section 337(d) Transaction 
were sold in a fully taxable transaction for cash in an amount equal to 
the fair market value of such property (taking into account section 
7701(g)), reduced, but not below zero, by any gain the Corporate 
Partner is required to recognize with respect to the appreciated 
property in the Section 337(d) Transaction under any other provision of 
this chapter. This gain is computed taking into account allocations of 
tax items applying the principles of section 704(c), including any 
remedial allocations under Sec.  1.704-3(d).
    (4) Basis adjustments--(i) Corporate Partner's basis in the 
partnership interest. The basis of the Corporate Partner's interest in 
the partnership is increased by the amount of gain that the Corporate 
Partner recognizes under this paragraph (d).
    (ii) Partnership's basis in partnership property. The partnership's 
adjusted tax basis in the appreciated property that is treated as the 
subject of the exchange under this paragraph (d) is increased by the 
amount of gain recognized with respect to that property by the 
Corporate Partner as a result of that exchange, regardless of whether 
the partnership has an election in effect under section 754.
    (e) Distribution of Stock of the Corporate Partner--(1) In general. 
This paragraph (e) applies to distributions to the Corporate Partner of 
Stock of the Corporate Partner to which section 732(f) does not apply 
and that have previously been the subject of a Section 337(d) 
Transaction or become the subject of a Section 337(d) Transaction as a 
result of the distribution. Upon the distribution of Stock of the 
Corporate Partner to the Corporate Partner, paragraph (d) of this 
section will apply as though immediately before the distribution the 
partners amended the partnership agreement to allocate to the Corporate 
Partner a 100 percent interest in that portion of the Stock of the 
Corporate Partner that is distributed and to allocate an appropriately 
reduced interest in other partnership property away from the Corporate 
Partner.
    (2) Basis rules--(i) Basis allocation on distributions of stock and 
other property. If, as part of the same transaction, a partnership 
distributes Stock of the Corporate Partner and other property (other 
than cash) to the Corporate Partner, see Sec.  1.732-1T(c)(1)(iii) for 
a rule allocating basis first to the Stock of the Corporate Partner 
before the distribution of the other property.
    (ii) Computation of Basis. For purposes of determining the basis of 
property distributed to the Corporate Partner (other than the basis of 
the Corporate Partner in its own stock), the basis of the Corporate 
Partner's remaining partnership interest, and the partnership's basis 
in undistributed Stock of the Corporate Partner, and for purposes of 
computing gain under paragraph (e)(3) of this section, the 
partnership's basis of Stock of the Corporate Partner distributed to 
the Corporate Partner equals the greater of--
    (A) The partnership's basis of that distributed Stock of the 
Corporate Partner immediately before the distribution, or
    (B) The fair market value of that distributed Stock of the 
Corporate Partner immediately before the distribution less the 
Corporate Partner's allocable share of gain from all of the Stock of 
the Corporate Partner if the partnership sold all of its assets in a 
fully taxable transaction for cash in an amount equal to the fair 
market value of such property (taking into account section 7701(g)) 
immediately before the distribution.
    (3) Gain recognition. The Corporate Partner will recognize gain on 
a distribution of Stock of the Corporate Partner to the Corporate 
Partner to the extent that the partnership's basis in the distributed 
Stock of the Corporate Partner (as determined under paragraph 
(e)(2)(ii) of this section) exceeds the Corporate Partner's basis in 
its partnership interest (as reduced by any cash distributed in the 
transaction) immediately before the distribution.
    (f) Exceptions--(1) De minimis rule--(i) In general. This section 
does not apply to a Corporate Partner if at the time that the 
partnership acquires Stock of the Corporate Partner or at the time of a 
revaluation event as described in Sec.  1.704-1(b)(2)(iv)(f) (without 
regard to whether or not the partnership revalues its assets)--
    (A) The Corporate Partner and any persons related to the Corporate 
Partner under section 267(b) or section 707(b) own in the aggregate 
less than five percent of the partnership;
    (B) The partnership holds Stock of the Corporate Partner with a 
value of less than two percent of the partnership's gross assets 
(including the Stock of the Corporate Partner); and
    (C) The partnership has never, at any point in time, held in the 
aggregate--
    (1) Stock of the Corporate Partner with a fair market value greater 
than $1,000,000; or
    (2) More than two percent of any particular class of Stock of the 
Corporate Partner.
    (ii) De minimis rule ceases to apply. If a partnership satisfies 
the conditions of the de minimis rule of paragraph (f)(1) of this 
section upon an acquisition of Stock of the Corporate Partner or 
revaluation event as described in Sec.  1.704-1(b)(2)(iv)(f), but later 
fails to satisfy the conditions of the de minimis rule upon a 
subsequent acquisition or revaluation event, then solely for purposes 
of paragraph (d) of this section, the Corporate Partner may compute its 
gain on the subsequent acquisition or revaluation event as if it had 
already recognized gain at the previous event. Neither the Corporate 
Partner nor the partnership increases its basis by the gain the 
Corporate Partner would have recognized if the de minimis rule of 
paragraph (f)(1) of this section did not apply to the prior acquisition 
or revaluation event.
    (2) Inadvertence rule. Unless acquired as part of a plan to 
circumvent the purpose of this section, this section does not apply to 
Stock of the Corporate Partner that--
    (i) Is disposed of (by sale or distribution) by the partnership 
before the due date (including extensions) of its federal income tax 
return for the taxable year during which the Stock of the Corporate 
Partner is acquired (or for the taxable year in which the Corporate 
Partner becomes a partner, whichever is applicable); and
    (ii) Is not distributed to the Corporate Partner or a corporation 
possessing section 304(c) control of the Corporate Partner.
    (g) Tiered partnerships. The rules of this section shall apply to 
tiered partnerships in a manner that is consistent with the purpose set 
forth in paragraph (a) of this section.
    (h) Examples. The following examples illustrate the principles of 
this section.

[[Page 33410]]

All amounts in the following examples are reported in millions of 
dollars:

    Example 1. Deemed redemption rule--contribution of Stock of a 
Corporate Partner. (i) In Year 1, X, a corporation, and A, an 
individual, form partnership AX as equal partners in all respects. X 
contributes Asset 1 with a fair market value of $100 and a basis of 
$20. A contributes X stock, which is Stock of the Corporate Partner, 
with a basis and fair market value of $100.
    (ii) Because A and X are equal partners in AX in all respects, 
the partnership formation causes X's interest in X stock to increase 
from $0 to $50 and its interest in Asset 1 to decrease from $100 to 
$50. Thus, the partnership formation is a Section 337(d) Transaction 
because the formation has the effect of an exchange by X of $50 of 
Asset 1 for $50 of X stock.
    (iii) X must recognize gain under paragraph (d) of this section 
with respect to Asset 1 to prevent the circumvention of section 
311(b) principles. X's gain equals the product of X's Gain 
Percentage and the gain from Asset 1 that X would recognize 
(decreased, but not below zero, by any gain that X recognized with 
respect to Asset 1 in the Section 337(d) Transaction under any other 
provision of this chapter) if, immediately before the Section 337(d) 
Transaction, all assets were sold in a fully taxable transaction for 
cash in an amount equal to the fair market value of such property. 
If Asset 1 had been sold in a fully taxable transaction immediately 
before the formation of partnership AX, X's allocable share of gain 
would have been $80. X's Gain Percentage is 50% (equal to a 
fraction, the numerator of which is X's $50 interest in Asset 1 
effectively exchanged for X stock, and the denominator of which is 
X's $100 interest in Asset 1 immediately before the Section 337(d) 
Transaction). Thus, X recognizes $40 of gain ($80 multiplied by 50%) 
under the deemed redemption rule in paragraph (d) of this section. 
Under paragraph (d)(4)(i) of this section, X's basis in its AX 
partnership interest increases from $20 to $60. Under paragraph 
(d)(4)(ii) of this section, AX's basis in Asset 1 increases from $20 
to $60 because Asset 1 is the appreciated property treated as the 
subject of the exchange.

    Example 2. Distribution of Stock of the Corporate Partner--pro 
rata distribution. (i) The facts are the same as in Example 1(i). AX 
liquidates in Year 9, when Asset 1 and the X stock each have a fair 
market value of $200. X and A each receive 50% of Asset 1 and 50% of 
the X stock in the liquidation. At the time AX liquidates, X's basis 
in its AX partnership interest is $60 and A's basis in its AX 
partnership interest is $100.
    (ii) When AX liquidates, X's interests in its stock and in Asset 
1 do not change. Thus, the liquidation is not a Section 337(d) 
Transaction because it does not have the effect of an exchange by X 
of appreciated property for Stock of the Corporate Partner.
    (iii) Paragraph (e) of this section applies because the 
distributed X stock was the subject of a previous Section 337(d) 
Transaction and because section 732(f) does not apply. Under Sec.  
1.732-1T(c)(1)(iii), the distribution to X of X stock is deemed to 
immediately precede the distribution of 50% of Asset 1 to X for 
purposes of determining X's basis in the distributed property. For 
purposes of determining X's basis in Asset 1 and X's gain on 
distribution, the basis of the distributed X stock is treated as 
$50, the greater of $50 (50% of the stock's $100 basis in the hands 
of the partnership), or $50, the fair market value of that 
distributed X stock ($100) less X's allocable share of gain from the 
distributed X stock if AX had sold all of its assets in a fully 
taxable transaction for cash in an amount equal to the fair market 
value of such property immediately before the distribution ($50). 
Thus, X reduces its basis in its partnership interest by $50 prior 
to the distribution of Asset 1. Accordingly, X's basis in the 
distributed portion of Asset 1 is $10. Because AX's basis in the 
distributed X stock immediately before the distribution ($50) does 
not exceed X's basis in its AX partnership interest immediately 
before the distribution ($60), X recognizes no gain under paragraph 
(e)(3) of this section.

    Example 3. Distribution of Stock of the Corporate Partner--non 
pro rata distribution. (i) The facts are the same as Example 2(i), 
except that when AX liquidates, X receives 75% of the X stock and 
25% of Asset 1 and A receives 25% of the X stock and 75% of Asset 1.
    (ii) The liquidation of AX causes X's interest in X stock to 
increase from $100 to $150 and its interest in Asset 1 to decrease 
from $100 to $50. Thus, AX's liquidating distributions of X stock 
and Asset 1 to X are a Section 337(d) Transaction because the 
distributions have the effect of an exchange by X of $50 of Asset 1 
for $50 of X stock.
    (iii) X must recognize gain with respect to Asset 1 to prevent 
the circumvention of section 311(b) principles. Under paragraph 
(e)(1) of this section, paragraph (d) of this section is applied as 
if X and A amended the AX partnership agreement to allocate to X a 
100% interest in the distributed portion of the X stock. X must 
recognize gain equal to the product of X's Gain Percentage and the 
gain from Asset 1 that X would have recognized (decreased, but not 
below zero, by any gain X recognized with respect to Asset 1 in the 
Section 337(d) Transaction under any other provision of this 
chapter) if, immediately before the Section 337(d) Transaction, AX 
had sold all of its assets in a fully taxable transaction for cash 
in an amount equal to the fair market value of such property.
    (iv) If Asset 1 had been sold in a fully taxable transaction 
immediately before the amendment of the AX partnership agreement, 
X's allocable share of gain would have been $90, or the sum of X's 
$40 remaining gain under section 704(c) and $50 of the $100 post-
contribution appreciation. X's Gain Percentage is 50% (equal to a 
fraction, the numerator of which is X's $50 interest in Asset 1 
effectively exchanged for X stock, and the denominator of which is 
X's $100 interest in Asset 1 immediately before the Section 337(d) 
Transaction). Thus, X recognizes $45 of gain ($90 multiplied by 50%) 
under the deemed redemption rule in paragraph (d) of this section. 
Under paragraph (d)(4)(i) of this section, X's basis in its AX 
partnership interest increases from $60 to $105. Under paragraph 
(d)(4)(ii) of this section, AX's basis in Asset 1 increases from $60 
to $105 because Asset 1 is the appreciated property treated as the 
subject of the exchange.
    (v) Paragraph (e) of this section applies because the 
distributed X stock was the subject of a previous Section 337(d) 
Transaction and because section 732(f) does not apply. Under Sec.  
1.732-1T(c)(1)(iii), AX is treated as first distributing the X stock 
to X before the distribution of 25% of Asset 1. For purposes of 
determining X's basis in Asset 1 and X's gain on distribution, the 
basis of the distributed X stock is treated as $100, the greater of 
$75 (75% of the stock's $100 basis in the hands of the partnership) 
or $100, the fair market value of the distributed X stock ($150) 
less X's allocable share of gain if the partnership had sold all of 
the X stock immediately before the distribution for cash in an 
amount equal to its fair market value ($50). Thus, X will reduce its 
basis in its partnership interest by $100 prior to the distribution 
of Asset 1. Accordingly, X's basis in the distributed portion of 
Asset 1 is $5. Because AX's basis in the distributed X stock 
immediately before the distribution as computed for purposes of this 
section ($100) does not exceed X's basis in its AX partnership 
interest immediately before the distribution ($105), X recognizes no 
additional gain under paragraph (e)(3) of this section.

    Example 4. Deemed redemption rule--subsequent purchase of Stock 
of the Corporate Partner. The facts are the same as Example 1(i), 
except that A contributes cash of $100 instead of X stock. In a 
later year, when the value of Asset 1 has not changed, AX uses the 
contributed cash to purchase X stock for $100. AX's purchase of X 
stock has the effect of an exchange by X of appreciated property for 
X stock, and thus, is a Section 337(d) Transaction. X must recognize 
gain at the time, and to the extent, that X's share of appreciated 
property (other than X stock) is reduced in exchange for X stock. 
Thus, the consequences of the partnership's purchase of X stock are 
the same as those described in Example 1(ii) and (iii), resulting in 
X recognizing $40 of gain.

    Example 5. Change in allocation ratios--amendment of partnership 
agreement. (i) The facts are the same as Example 2(i), except that 
in Year 9, AX does not liquidate, and the AX partnership agreement 
is amended to allocate to X 80% of the income, gain, loss, and 
deduction from the X stock and to allocate to A 80% of the income, 
gain, loss, and deduction from Asset 1. If AX had sold the 
partnership assets immediately before the change to the partnership 
agreement, X would have been allocated $90 of gain from Asset 1 and 
$50 of gain from the X stock.
    (ii) The amendment to the AX partnership agreement causes X's 
interest in its stock to increase from $100 (50% of the stock value 
immediately before the amendment of the agreement) to $160 (80% of 
stock value immediately following amendment of agreement) and its 
interest in Asset 1 to decrease from $100 to $40. Thus, the 
amendment of the partnership agreement is a Section 337(d) 
Transaction because the amendment has the effect of an exchange by X 
of $60 of Asset 1 for $60 of its stock.

[[Page 33411]]

    (iii) X must recognize gain equal to the product of X's Gain 
Percentage and the gain from Asset 1 that X would have recognized 
(decreased, but not below zero, by any gain X recognized with 
respect to Asset 1 in the Section 337(d) Transaction under any other 
provision of this chapter) if, immediately before the Section 337(d) 
Transaction, AX had sold all of its assets in a fully taxable 
transaction for cash in an amount equal to the fair market value of 
such property. If Asset 1 had been sold in a fully taxable 
transaction immediately before the amendment of the AX partnership 
agreement, X's allocable share of gain would have been $90, or the 
sum of X's $40 remaining gain under section 704(c) and 50% of the 
$100 post-contribution appreciation. X's Gain Percentage is 60% 
(equal to a fraction, the numerator of which is X's $60 interest in 
Asset 1 effectively exchanged for X stock, and the denominator of 
which is X's $100 interest in Asset 1 immediately before the Section 
337(d) Transaction). Thus, X recognizes $54 of gain ($90 multiplied 
by 60%) under the deemed redemption rule in paragraph (d) of this 
section. Under paragraph (d)(4)(i) of this section, X's basis in its 
AX partnership interest increases from $60 to $114. Under paragraph 
(d)(4)(ii) of this section, AX's basis in Asset 1 increases from $60 
to $114 because Asset 1 is the appreciated property treated as the 
subject of the exchange.

    Example 6. Change in allocation ratios--admission and exit of a 
partner. (i) The facts are the same as Example 1(i). In addition, in 
Year 2, when the values of Asset 1 and the X stock have not changed, 
B contributes $100 of cash to AX in exchange for a one-third 
interest in the partnership. Upon the admission of B as a partner, 
X's interest in Asset 1 decreases from $50 to $33.33, and its 
interest in B's contributed cash increases. B's admission is not a 
Section 337(d) Transaction because it does not have the effect of an 
exchange by X of its interest in Asset 1 for X stock. Accordingly, X 
does not recognize gain under paragraph (d) of this section.
    (ii) In Year 9, when the values of Asset 1 and the X stock have 
not changed, the partnership distributes $50 of cash and 50% of 
Asset 1 (valued at $50) to B in liquidation of B's interest. X and A 
are equal partners in all respects after the distribution. Upon the 
liquidation of B's interest, X's interest in Asset 1 decreases from 
$33.33 to $25, and its interest in X stock increases from $33.33 to 
$50. AX's liquidation of B's interest has the effect of an exchange 
by X of appreciated property for X stock, and thus, is a Section 
337(d) Transaction.
    (iii) Pursuant to paragraph (d)(2) of this section, X's interest 
in X stock and other appreciated property held by the partnership is 
determined based on all facts and circumstances, including 
allocation and distribution rights in the partnership agreement. 
However, paragraph (d)(2) of this section also requires that X's 
interest in its stock for purposes of paragraph (d) will never be 
less than the Corporate Partner's largest interest (by value) in 
those shares of Stock of the Corporate Partner taken into account 
when the partnership previously determined whether there had been a 
Section 337(d) Transaction (regardless of whether the Corporate 
Partner recognized gain in the earlier transaction). Although X's 
interest in X stock increases to $50 upon AX's liquidation of B's 
interest, X's largest interest previously taken into account under 
paragraph (d)(1) of this section was $50. Thus, X's interest in its 
stock is not considered to be increased, and X therefore recognizes 
no gain under paragraph (d) of this section, provided that the 
transactions did not occur as part of a plan or arrangement to 
circumvent the purpose of this section.

    Example 7. Change in allocation ratios--plan to circumvent 
purpose of this section. (i) In Year 1, X, a corporation, and A, an 
individual, contribute a small amount of capital to newly-formed 
partnership AX, with X receiving a 99% interest in AX and A 
receiving a 1% interest in AX. AX borrows $100 from a third-party 
lender and uses the proceeds to purchase X stock, which is Stock of 
the Corporate Partner. Later, as part of a plan or arrangement to 
circumvent the purposes of this section, A contributes $100 of cash, 
which AX uses to repay the loan, and X contributes Asset 1 with a 
fair market value of $100 and basis of $20. After these 
contributions, A and X are equal partners in AX in all respects.
    (ii) Pursuant to paragraph (d)(2) of this section, X's interest 
in X stock and other appreciated property held by the partnership is 
determined based on all facts and circumstances, including 
allocation and distribution rights in the partnership agreement. 
Generally pursuant to paragraph (d)(2) of this section, X's interest 
in X stock for purposes of paragraph (d) will never be less than the 
Corporate Partner's largest interest (by value) in those shares of 
Stock of the Corporate Partner taken into account when the 
partnership previously determined whether there had been a Section 
337(d) Transaction (regardless of whether the Corporate Partner 
recognized gain in the earlier transaction). This limitation does 
not apply, however, if the reduction in X's interest in X's stock 
occurred as part of a plan or arrangement to circumvent the purpose 
of this section. Because the transactions described in this example 
are part of a plan or arrangement to circumvent the purpose of this 
section, the limitation in paragraph (d)(2) of this section does not 
apply. Accordingly, the deemed redemption rule under paragraph (d) 
of this section applies to the transactions with the consequences 
described in Example 1(iii) of this section, resulting in X 
recognizing $40 of gain.

    Example 8. Tiered partnership. (i) In Year 1, X, a corporation, 
and A, an individual, form partnership UTP. X contributes Asset 1 
with a fair market value of $80 and a basis of $0 in exchange for an 
80% interest in UTP. A contributes $20 of cash in exchange for a 20% 
interest in UTP. UTP and B, an individual, form partnership LTP as 
equal partners. UTP contributes Asset 1 and $20 of cash. B 
contributes X stock, which is Stock of the Corporate Partner, with a 
basis and fair market value of $100.
    (ii) Pursuant to paragraph (g) of this section, the rules of 
this section shall apply to tiered partnerships in a manner that is 
consistent with the purpose set forth in paragraph (a) of this 
section. Pursuant to paragraph (d)(1) of this section, if X is in a 
partnership that engages in a Section 337(d) Transaction, X must 
recognize gain at the time, and to the extent, that X's share of 
appreciated property is reduced in exchange for X stock. The 
formation of LTP causes X's interest in X stock to increase from $0 
to $40 and its interest in Asset 1 to decrease from $64 to $32. 
Thus, LTP's formation is a Section 337(d) Transaction because the 
formation has the effect of an exchange by X of $32 of Asset 1 for 
$32 of X stock.
    (iii) X must recognize gain with respect to Asset 1 to prevent 
the circumvention of section 311(b) principles. X must recognize 
gain equal to the product of X's Gain Percentage and the gain from 
Asset 1 (decreased, but not below zero, by any gain X recognized 
with respect to Asset 1 in the Section 337(d) Transaction under any 
other provision of this chapter) that X would recognize if, 
immediately before the Section 337(d) Transaction, all assets were 
sold in a fully taxable transaction for cash in an amount equal to 
the fair market value of such property. If Asset 1 had been sold in 
a fully taxable transaction immediately before LTP's formation, X's 
allocable share of gain would have been $80 pursuant to section 
704(c). X's Gain Percentage is 50% (equal to a fraction, the 
numerator of which is X's $32 interest in Asset 1 effectively 
exchanged for X stock, and the denominator of which is X's $64 
interest in Asset 1 immediately before the Section 337(d) 
Transaction). Thus, X recognizes $40 of gain ($80 multiplied by 50%) 
under the deemed redemption rule in paragraph (d) of this section. 
Under paragraphs (d)(4)(i) and (d)(4)(ii) of this section, X's basis 
in its UTP partnership interest increases from $0 to $40, UTP's 
basis in its LTP partnership interest increases from $20 to $60, and 
LTP's basis in Asset 1 increases from $0 to $40 pursuant to 
paragraph (g) of this section.

    (i) Effective/applicability date. This section applies to 
transactions occurring on or after June 12, 2015.
    (j) Expiration date. This section expires on June 11, 2018.

0
Par. 3. Section 1.732-1 is amended by revising paragraphs (c)(1) and 
(5) to read as follows:


Sec.  1.732-1  Basis of distributed property other than money.

* * * * *
    (c) * * * (1) [Reserved]. For further guidance, see Sec.  1.732-
1T(c)(1).
* * * * *
    (5) Effective/applicability date--(i) In general. This paragraph 
(c) applies to distributions of property from a partnership that occur 
on or after December 15, 1999.
    (ii) [Reserved]. For further guidance, see Sec.  1.732-
1T(c)(5)(ii).
* * * * *

0
Par. 4. Section 1.732-1T is added to read as follows:

[[Page 33412]]

Sec.  1.732-1T  Basis of distributed property other than money 
(temporary).

    (a) and (b) [Reserved]. For further guidance, see Sec.  1.732-1(a) 
and (b).
    (c) Allocation of basis among properties distributed to a partner--
(1) General rule--(i) Unrealized receivables and inventory items. 
Except as provided in paragraph (c)(1)(iii) of this section, the basis 
to be allocated to properties distributed to a partner under section 
732(a)(2) or (b) is allocated first to any unrealized receivables (as 
defined in section 751(c)) and inventory items (as defined in section 
751(d)(2)) in an amount equal to the adjusted basis of each such 
property to the partnership immediately before the distribution. If the 
basis to be allocated is less than the sum of the adjusted bases to the 
partnership of the distributed unrealized receivables and inventory 
items, the adjusted basis of the distributed property must be decreased 
in the manner provided in Sec.  1.732-1(c)(2)(i). See Sec.  1.460-
4(k)(2)(iv)(D) for a rule determining the partnership's basis in long-
term contract accounted for under a long-term contract method of 
accounting.
    (ii) Other distributed property. Any basis not allocated to 
unrealized receivables or inventory items under paragraph (c)(1)(i) of 
this section or to stock of persons that control the corporate partner 
or to the corporate partner's stock under paragraph (c)(1)(iii) of this 
section is allocated to any other property distributed to the partner 
in the same transaction by assigning to each distributed property an 
amount equal to the adjusted basis of the property to the partnership 
immediately before the distribution. However, if the sum of the 
adjusted bases to the partnership of such other distributed property 
does not equal the basis to be allocated among the distributed 
property, any increase or decrease required to make the amounts equal 
is allocated among the distributed property as provided in Sec.  1.732-
1(c)(2).
    (iii) Stock distributed to the corporate partner. If a partnership 
makes a distribution described in Sec.  1.337(d)-3T(e)(1), then for 
purposes of this section, the basis to be allocated to properties 
distributed under section 732(a)(2) or (b) is allocated first to the 
Stock of the Corporate Partner, as defined in Sec.  1.337(d)-3T(c)(2), 
before the distribution of any other property (other than cash). The 
amount allocated to the Stock of the Corporate Partner is as provided 
in Sec.  1.337(d)-3T(e)(2).
    (2) through (5)(i) [Reserved]. For further guidance, see Sec.  
1.732-1(c)(2) through (c)(5)(i).
    (ii) Exception. Nothwithstanding paragraph (c)(5)(i), the first 
sentence of each of paragraphs (c)(1)(i) and (c)(1)(ii) of this 
section, and paragraph (c)(1)(iii) of this section in its entirety, 
apply to distributions of Stock of the Corporate Partner, as defined in 
Sec.  1.337(d)-3T(c)(2), that occur on or after June 12, 2015.
    (d) and (e) [Reserved]. For further guidance, see Sec.  1.732-1(d) 
and (e).
    (f) Expiration date. This section expires on June 11, 2018.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: June 1, 2015.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2015-14405 Filed 6-11-15; 8:45 am]
BILLING CODE 4830-01-P