Transfers of Partnership Interests and Related Basis Adjustments Require Increased Reporting

In December 1999, the IRS finalized regulations on adjustments following sales or exchanges of partnership interests occurring after Dec. 14, 1999. The regulations generally dealt with several extremely important partnership concepts, including: (1) optional basis adjustments following the transfer of partnership interests; (2) calculations of gain or loss under Sec. 751(a); and (3) allocation of basis among assets, both within the partnership under Sec. 755 and for properties distributed to partners under Sec. 732. More importantly, these same regulations imposed notification requirements on the recipient partner, as well as substantial additional reporting obligations on the partnership. Since the 2000 tax year is the first full year during which these provisions are applicable, it is extremely important that the returns reflect all of the pertinent information for all partnership transfers that occurred.

A review of a partnership's books and records, beginning in 2000 and each year thereafter, should focus on whether any such transfers have occurred. Moreover, the next step should be to determine whether notification was in accordance with the regulations and, if not, to advise the partnership to contact the transferee partner immediately to secure all of the pertinent information.

Notice

The specific obligations imposed on both the partnership and the transferee partner, when a Sec. 754 election is in effect or is desired, are as follows:

• When an interest is acquired by sale or exchange, any transferee partner is required, within 30 days of the transfer, to notify the partnership of the transfer in writing, signed under penalties of perjury, including the following information:

1. Transferee's name and address and, if available, the transferor's;

2. Transferee's taxpayer identification number (TIN) and, if available, the transferor's;

3. Relationship (if any) between the transferee and the transferor;

4. Transfer date;

5. Liabilities assumed or taken subject to by the transferee;

6. Amount of money or fair market value (FMV) of any other property delivered or to be delivered for the interest; and

7. Any other information needed by the partnership to compute basis.

• When an interest is acquired on a partner's death, a written statement under penalties of perjury must be submitted within one year of the date of death, containing similar information. It must provide not only the value at death, but also the manner in which the FMV was determined.

• Although required to be in writing, notice is also deemed received when any partner who has the responsibility for income tax reporting has knowledge that there has been a transfer.

Partnership Reporting

A partnership is not required to make or report adjustments under Sec. 743(b) until it has received notice of a transfer. Once this occurs, the partnership must attach a statement to the return for the transfer year, containing the transferee's name and TIN, as well as a computation of the adjustment and the properties to which the adjustment has been allocated.

When a partnership is notified of a transfer but the transferee fails to provide the required information, the partnership must set forth the transferee's name and TIN. It must also note in capital letters on the first page of the return (and on the first page of any schedule or information statement relating to the transferee's income, credits, deductions, etc.), "RETURN FILED PURSUANT TO 1.743-1(k)(5)." The partnership can then reflect those items without any adjustment.

Once the transferee provides all of the information, the partnership must make the required adjustments to the partnership property's basis and provide them in any amended return to be filed or on the next annual partnership return. The information must be sufficient to provide the transferee with the information necessary for him to amend his tax returns, if required.

If a Sec. 754 election has been made or is in effect, the partnership is required to increase (or decrease, if applicable) the partnership property basis by the excess of the transferee's basis in the partnership over the transferee's share of the adjusted basis of the partnership property.

Example: S acquired a 25% interest in the XY Partnership for $50,000. At the time he acquired his interest, the partnership held the following property:

Because S's $50,000 basis exceeded his allocable share of the underlying partnership assets by $5,000, in accordance with Sec. 755, the basis in his portion of the assets would have to be stepped up on the partnership's books. To the extent depreciable assets are required to be stepped up, S would be allocated additional depreciation expense. Similarly, on the disposition of any partnership assets, the computation of taxable gain or loss allocable to S is required to be adjusted for his basis in the underlying assets.

Importantly, the transferee partner's distributive share of each partnership item otherwise allocable to S must reflect these adjustments. At present, it is unclear whether the adjustments are to be reflected on each separate line item on Schedule K-1 of Form 1065, U.S. Partnership Return of Income, or are to be reflected on Line 25 as "Other Separately Stated Items." However, the language in the regulations indicating that the amounts reported on the transferee's Schedule K-1 are adjusted amounts suggests that each separate line item must be adjusted. While the IRS has not yet addressed the proper method for reporting this information, it would appear that the information should be presented in this manner. Hopefully, the Service will issue guidance.

From Richard Nichols, CPA, J.D., LL.M., New York, NY