Capital Gains, Partnership, Subchapter S, & Trust Provisions

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-106527-98] RIN 1545-AW22

TITLE: Capital Gains, Partnership, Subchapter S, and Trust
Provisions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations relating to
sales or exchanges of interests in partnerships, S corporations, and
trusts. The proposed regulations interpret the look-through
provisions of section 1(h), added by section 311 of the Taxpayer
Relief Act of 1997 and amended by sections 5001 and 6005(d) of the
Internal Revenue Service Restructuring and Reform Act of 1998, and
explain the rules relating to the division of the holding period of
a partnership interest. The proposed regulations affect
partnerships, partners, S corporations, S corporation shareholders,
trusts, and trust beneficiaries.

DATES: Written comments must be received by November 8, 1999.

Requests to speak and outlines of topics to be discussed at the
public hearing scheduled for November 18, 1999, must be received by
October 28, 1999.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-106527-98), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday
through Friday between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG-106527-98), Courier's Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW, Washington, DC.
Alternatively, taxpayers may submit comments electronically via the
Internet by selecting the A Tax Regs @ option on the IRS Home Page,
or by submitting comments directly to the IRS Internet site at
http://www.irs.ustreas.gov/tax_ regs/regslist.html. The public
hearing will be held in room 3411, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed
regulations, Jeanne Sullivan (202) 622-3050; concerning submissions
of comments, the hearing, and/or to be placed on the building access
list to attend the hearing, LaNita VanDyke (202) 622-7180 (not toll-
free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in this notice of proposed
rulemaking have been submitted to the Office of Management and
Budget for review in accordance with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)).

Comments on the collections of information should be sent 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, with copies to the IRS, Attn: IRS
Reports Clearance Officer, OP:FS:FP, Washington, DC 20224.

Comments on the collections of information should be received by
October 8, 1999. Comments are specifically requested concerning:

Whether the proposed collections of information are necessary for
the proper performance of the functions of the IRS, including
whether the collections will have a practical utility; The accuracy
of the estimated burden associated with the proposed collections of
information (see below);

How the quality, utility, and clarity of the information to be
collected may be enhanced; How the burden of complying with the
proposed collections of information may be minimized, including
through application of automated collection techniques or other
forms of information technology; and Estimates of capital or start-
up costs and costs of operation, maintenance, and purchase of
services to provide information.

The collections of information in these proposed regulations are in
�1.1(h)-1(e). This information is required by the IRS to implement
section 311 of the Taxpayer Relief Act of 1997, as amended by the
Internal Revenue Service Restructuring and Reform Act of 1998. The
collections of information are required to provide information to
the IRS regarding the capital gain attributable to collectibles and
section 1250 property held by a partnership when a partner sells or
exchanges an interest in that partnership and the capital gain
attributable to collectibles when a shareholder sells or exchanges
an interest in an S corporation or a trust beneficiary sells or
exchanges an interest in a trust. This information will be used to
verify compliance with section 1(h) and to determine that the tax on
capital gains has been computed correctly. The collection of
information is mandatory. The likely respondents are individuals and
businesses.

Respondent taxpayers provide information by attaching a statement to
the appropriate tax return. The burden for this requirement is
reflected in the burden estimates for: Form 1040, U.S. Individual
Income Tax Return; Form 1065, U.S. Partnership Return of Income;
Form 1041, U.S. Income Tax Return for Estates and Trusts; and Form
1120S, U.S. Income Tax Return for an S Corporation. The estimated
burden of information collection for the statement required is 10
minutes.

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.

Books or records relating to a collection 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 tax return information are confidential, as required by 26
U.S.C. 6103.

Background

This document contains proposed amendments to the Income Tax
Regulations (26 CFR Part 1) relating to taxation of capital gains in
the case of sales or exchanges of interests in partnerships, S
corporations, and trusts. The Taxpayer Relief Act of 1997, Public
Law 105-34, 111 Stat. 788, 831 (1997 Act), amended section 1(h) of
the Internal Revenue Code to reduce the maximum statutory tax rates
for long-term capital gains of individuals in general.

Certain technical corrections and other amendments to section 1(h)
were enacted as part of the Internal Revenue Service Restructuring
and Reform Act of 1998, Public Law 105-206, 112 Stat. 685, 787, 800
(1998 Act).

Section 1(h) provides that intermediate level rates apply to long-
term capital gains from certain transactions, such as sales or
exchanges of collectibles, section 1202 stock (with respect to a
portion of the gain), and section 1250 property with gain
attributable to straight-line depreciation. Section 1(h)(11)
provides authority to the Secretary to issue such regulations as are
appropriate to apply these rules in the case of sales or exchanges
by pass-thru entities and of interests in pass-thru entities. This
document provides rules for sales or exchanges of interests in
partnerships, S corporations, and trusts. This document also
provides rules relating to dividing the holding period of a
partnership interest.

Explanation of Provisions

In general, prior to the 1997 Act, individuals were taxed on capital
gains at the same rate as ordinary income, except that the rate for
net capital gain was capped at 28 percent. The 1997 Act provided for
lower maximum rates of taxation on gain from the sale or exchange of
certain types of property. As amended by the 1998 Act, section 1(h)
currently provides for maximum capital gains rates on the sale or
exchange of certain types of property in three categories: 20-
percent rate gain, 25-percent rate gain, and 28-percent rate gain.
Twenty percent rate gain is net capital gain from the sale or
exchange of capital assets held for more than one year, reduced by
the sum of 25-percent rate gain and 28-percent rate gain. Twenty-
five percent rate gain is limited to unrecaptured section 1250 gain.
Unrecaptured section 1250 gain is the amount of long-term capital
gain (not otherwise treated as ordinary income) which would be
treated as ordinary income if section 1250(b)(1) included all
depreciation and the applicable percentage under section 1250(a)
were 100 percent, reduced by any net loss in the 28-percent rate
gain category.

Twenty-eight percent rate gain is capital gains and losses from the
sale or exchange of collectibles (as defined in section 408(m)
without regard to section 408(m)(3)) held for more than one year, a
portion of the gain attributable to the sale of section 1202 stock,
and capital gains and losses determined under the rules of section
1(h)(13), reduced by net short-term capital loss for the taxable
year and any long-term capital loss carryover under section 1212(b)
(1)(B).

Collectibles Gain and Unrecaptured Section 1250 Gain The sale or
exchange of an interest in a partnership with a long-term holding
period generally will result in capital gain in the 20-percent rate
gain category to the extent that section 751(a) is not applicable.
Section 751(a) generally provides that an amount received in
exchange for a partnership interest, to the extent attributable to
unrealized receivables and inventory, shall be considered as an
amount realized from the sale or exchange of property other than a
capital asset. Section 1250 property is treated as an unrealized
receivable for purposes of section 751 to the extent of the amount
that would be treated as gain to which section 1250(a) would apply.

The sale or exchange of stock in an S corporation with a long-term
holding period generally will result in gain or loss in the 20-
percent rate gain category, unless an exception to capital gain
treatment applies. Certain of those exceptions are provided in
sections 304, 306, 341, and 1254.

The sale or exchange of an interest in a trust with a long-term
holding period generally will result in gain or loss in the 20-
percent rate gain category. However, if the transferor is treated as
the owner of the portion of the trust attributable to an interest
under sections 673 through 679, the transferor is treated as
transferring an undivided interest in the assets of the trust rather
than an interest in the trust itself.

Effective for taxable years ending after May 6, 1997, when an
interest in a partnership, an S corporation, or a trust held for
more than one year (or more than 18 months during certain periods in
1997) is sold or exchanged, section 1(h) provides special treatment
for A collectibles gain @ in property held by a partnership, S
corporation, or trust and for A section 1250 capital gain @ in
property held by a partnership. Specifically, section 1(h)(6)(B)
provides that any gain from the sale of an interest in a
partnership, S corporation, or trust which is attributable to
unrealized appreciation in the value of collectibles shall be
treated as gain from the sale or exchange of a collectible, applying
rules similar to section 751(a) to determine the amount of the gain.
In addition, under section 1(h)(7)(A) (in conjunction with sections
751(a) and (c)), the amount of long-term capital gain (not otherwise
treated as ordinary income under section 751(a)) that would be
treated as ordinary income under section 751(a) if section 1250
applied to all depreciation (section 1250 capital gain) must be
taken into account in computing unrecaptured section 1250 gain when
an interest in a partnership (with a holding period of more than one
year, or more than 18 months during certain periods in 1997) is sold
or exchanged. See H. Rep. No. 105-356, 105 Cong. 1 Sess. (1997), th
st at 16, fn. 11; S. Rep. No. 105-174, 105 Cong. 2d Sess. (1998), th
at 149, fn. 65.

The proposed regulations provide guidance with respect to the
application of these rules to a sale or exchange of an interest in a
partnership, S corporation, or trust holding assets with
collectibles gain and a partnership holding assets with section 1250
capital gain. Generally, the amount of such gain is determined by
reference to the gain that would be allocated to the selling
partner, shareholder, or beneficiary (to the extent attributable to
the portion of the transferred interest that is subject to long-term
capital gain) if the partnership, S corporation, or trust had sold
all of its collectibles or if the partnership had sold all of its
section 1250 property in a fully taxable transaction immediately
before the transfer of the partnership, S corporation, or trust
interest. Special rules are provided where the partner, S
corporation shareholder, or trust beneficiary recognizes less than
all of the gain upon the sale or exchange of its interest.

In addition, for purposes of applying section 1(h)(7)(B), which
provides that a taxpayer's unrecaptured section 1250 gain cannot
exceed the taxpayer's net section 1231 gain, gain from the sale of a
partnership interest that results in section 1250 capital gain is
not treated as section 1231 gain even if section 1231 could apply to
the disposition of the underlying partnership property. Although
section 1(h)(7) (in combination with section 751) applies a limited
look-thru rule for purposes of determining the capital gain rate
applicable to the sale of a partnership interest, no similar look-
thru rule applies for purposes of applying section 1231. Anomalous
results would follow if section 1250 capital gain derived from the
sale of a partnership interest were treated as section 1231 gain for
purposes of applying the limitation in section 1(h)(7)(B) but not
for purposes of actually applying section 1231.

Determination of Holding Period in a Partnership In view of the
long-established principle that a partner has a single basis in a
partnership interest (see Rev. Rul. 84-53 (1984-1 C.B. 159)), there
is some confusion under current law as to how the principles of
section 1223 apply to the sale of an interest, or a portion of an
interest, in a partnership. The proposed regulations provide rules
relating to the allocation of a divided holding period with respect
to an interest in a partnership. These rules generally provide that
the holding period of a partnership interest will be divided if a
partner acquires portions of an interest at different times or if an
interest is acquired in a single transaction that gives rise to
different holding periods under section 1223. The holding period of
a portion of a partnership interest shall be determined based on a
fraction that is equal to the fair market value of the portion of
the partnership interest to which the holding period relates
(determined immediately after the acquisition) over the fair market
value of the entire partnership interest. A selling partner may use
the actual holding period of the portion of a partnership interest
sold if the partnership is a A publicly traded partnership @ (as
defined under section 7704(b)), the partnership interest is divided
into identifiable units with ascertainable holding periods, and the
selling partner can identify the portion of the interest
transferred. Otherwise, the holding period(s) of the transferred
interest must be divided in the same ratio as the holding period(s)
of the partner's entire partnership interest.

These proposed regulations do not contain a specific anti-abuse rule
regarding holding periods. However, there may be situations where
taxpayers will attempt to undertake abusive transactions using the
rules in these regulations. For instance, taxpayers may attempt to
shift gain from property with a short-term holding period to
property with a long-term holding period by contributing the short-
term property to a partnership and selling the partnership interest.
Because the basis of a partnership interest cannot be segregated to
a portion of an interest, basis in the portion of a partnership
interest with a long-term holding period could reduce gain
attributable to the portion of a partnership interest with a short-
term holding period in situations where such interest was recently
received in exchange for contributed short-term capital gain
property. In appropriate situations, the IRS may attack such abusive
transactions under a variety of judicial doctrines, including
substance over form or step transaction, or under �1.701-2 of the
regulations.

Proposed Effective Date

The amendments are proposed to be effective for all transfers of
interests in a partnership, S corporation, or trust and for all
distributions from a partnership on or after the date the
regulations are published as final regulations in the Federal
Register.

Special Analyses

It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. Pursuant
to section 7805(f), this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business. 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 on
the facts that: (1) the time required to prepare and file the
statement is minimal (currently estimated at 10 minutes per
statement); and (2) it is anticipated that, as a result of these
regulations, small entities will file no more than one statement per
year. Furthermore, taxpayers will have to respond to the requests
for information contained in �1.1(h)-1(e) only if there is a sale or
exchange of an interest in a partnership, an S corporation, or a
trust that holds certain property. Therefore, a Regulatory
Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C.
Chapter 6) is not required.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed
original and eight (8) copies) that are submitted timely to the IRS.
The IRS and Treasury request comments on the clarity of the proposed
rule and how it may be made easier to understand. All comments will
be available for public inspection and copying.

A public hearing has been scheduled for November 18, 1999, beginning
at 1 p.m. in room 3411 of the Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10 Street entrance, located
between Constitution and th Pennsylvania Avenues, NW. In addition,
all visitors must present photo identification to enter the
building. Because of access restrictions, visitors will not be
admitted beyond the immediate entrance area more than 15 minutes
before the hearing starts.

For information about having your name placed on the building access
list to attend the hearing, see the A FOR FURTHER INFORMATION
CONTACT @ section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons who wish to present oral comments at the hearing must
request to speak and submit written comments and an outline of the
topics to be discussed and the time to be devoted to each topic
(signed original and eight (8) copies) by October 28, 1999.

A period of 10 minutes will be allotted to each person for making
comments. An agenda showing the scheduling of the speakers will be
prepared after the deadline for receiving outlines has passed.

Copies of the agenda will be available free of charge at the
hearing.

Drafting Information

The principal author of these proposed regulations is Jeanne
Sullivan, Office of the Assistant Chief Counsel (Passthroughs and
Special Industries). However, other personnel from the IRS and
Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

Part 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in
part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.1(h)-1 is added to
read as follows:

�1.1(h)-1 Capital gains look-through rule for sales or exchanges of
interests in a partnership, S corporation, or trust.

(a) In general. When an interest in a partnership held for more than
one year is sold or exchanged, the transferor may recognize ordinary
income (e.g., section 751(a)), collectibles gain, section 1250
capital gain, and residual long-term capital gain or loss. When
stock in an S corporation held for more than one year is sold or
exchanged, the transferor may recognize ordinary income (e.g.,
sections 304, 306, 341, 1254), collectibles gain, and residual long-
term capital gain or loss.

When an interest in a trust held for more than one year is sold or
exchanged, a transferor who is not treated as the owner of the
portion of the trust attributable to the interest sold or exchanged
(sections 673 through 679) (a non-grantor transferor) may recognize
collectibles gain and residual long-term capital gain or loss.

(b) Look-through capital gain--(1) In general. Look-through capital
gain is the share of collectibles gain allocable to an interest in a
partnership, S corporation, or trust, plus the share of section 1250
capital gain allocable to an interest in a partnership, determined
under paragraphs (b)(2) and (3) of this section.

(2) Collectibles gain and collectibles loss--(i)

Definitions. For purposes of this section, collectibles gain and
collectibles loss mean gain or loss, respectively, from the sale or
exchange of a collectible (as defined in section 408(m) without
regard to section 408(m)(3)) that is a capital asset held for more
than 1 year, but only to the extent such gain is taken into account
in computing gross income, and such loss is taken into account in
computing taxable income.

(ii) Share of collectibles gain allocable to an interest in a
partnership, S corporation, or trust. When an interest in a
partnership, S corporation, or trust held for more than one year is
sold or exchanged in a transaction in which all realized gain is
recognized, the transferor shall recognize as collectibles gain the
amount of net collectibles gain (but not net collectibles loss) that
would be allocated to that partner (taking into account any remedial
allocation under �1.704-3(d)), shareholder, or beneficiary (to the
extent attributable to the portion of the partnership interest, S
corporation stock, or trust interest transferred that was held for
more than one year) if the partnership, S corporation, or trust
transferred all of its collectibles in a fully taxable transaction
immediately before the transfer of the interest in the partnership,
S corporation, or trust. If less than all of the realized gain is
recognized upon the sale or exchange of an interest in a
partnership, S corporation, or trust, the same methodology shall
apply to determine the collectibles gain recognized by the
transferor, except that the partnership, S corporation, or trust
shall be treated as transferring only a proportionate amount of each
of its collectibles determined as a fraction that is the amount of
gain recognized in the sale or exchange over the amount of gain
realized in the sale or exchange. With respect to the transfer of an
interest in a trust, this paragraph applies only to transfers by
non-grantor transferors (as defined in paragraph (a) of this
section).

(3) Section 1250 capital gain--(i) Definition. For purposes of this
section, section 1250 capital gain means the long-term capital gain
(not otherwise treated as ordinary income) that would be treated as
ordinary income if section 1250(b)(1) included all depreciation and
the applicable percentage under section 1250(a) were 100 percent.

(ii) Share of section 1250 capital gain allocable to interest in
partnership. When an interest in a partnership held for more than
one year is sold or exchanged in a transaction in which all realized
gain is recognized, there shall be taken into account under section
1(h)(7)(A)(i) in determining the partner's unrecaptured section 1250
gain the amount of section 1250 capital gain that would be allocated
(taking into account any remedial allocation under �1.704-3(d)) to
that partner (to the extent attributable to the portion of the
partnership interest transferred that was held for more than one
year) if the partnership transferred all of its section 1250
property in a fully taxable transaction immediately before the
transfer of the interest in the partnership. If less than all of the
realized gain is recognized upon the sale or exchange of an interest
in a partnership, the same methodology shall apply to determine the
section 1250 gain recognized by the transferor, except that the
partnership shall be treated as transferring only a proportionate
amount of each section 1250 property determined as a fraction that
is the amount of gain recognized in the sale or exchange over the
amount of gain realized in the sale or exchange.

(iii) Limitation with respect to net section 1231 gain. In
determining a transferor partner's net section 1231 gain (as defined
in section 1231(c)(3)) for purposes of section 1(h)(7)(B), the
transferor partner's allocable share of section 1250 capital gain in
partnership property shall not be treated as section 1231 gain,
regardless of whether the partnership property is used in the trade
or business (as defined in section 1231(b)).

(c) Residual long-term capital gain or loss. The amount of residual
long-term capital gain or loss recognized by a partner, shareholder
of an S corporation, or beneficiary of a trust on account of the
sale or exchange of an interest in a partnership, S corporation, or
trust shall equal the amount of long-term capital gain or loss that
the partner would recognize under section 741, that the shareholder
would recognize upon the sale or exchange of stock of an S
corporation, or that the beneficiary would recognize upon the sale
or exchange of an interest in a trust (pre-look-through long-term
capital gain or loss) minus the amount of long-term capital gain
determined under paragraph (b) of this section (look-through capital
gain).

(d) Special rule for tiered entities. In determining whether a
partnership, S corporation, or trust has collectibles gain and
whether a partnership has section 1250 capital gain, such
partnership, S corporation, or trust shall be treated as owning its
proportionate share of the property of any partnership, S
corporation, or trust in which it owns an interest, either directly
or indirectly through a chain comprised exclusively of such
entities.

(e) Notification requirements. Rules similar to those that apply to
the partners and the partnership under section 751(a) shall apply in
the case of sales or exchanges of interests in a partnership, S
corporation, or trust that holds property with collectibles gain and
in the case of sales or exchanges of interests in a partnership that
holds property with section 1250 capital gain. See �1.751-1(a)(3).

(f) Examples . The following examples illustrate the requirements of
this section:

Example 1. Collectibles gain . (i) A and B are equal partners in a
personal service partnership (PRS). B transfers B's interest in PRS
to T for $15,000 when PRS's balance sheet (reflecting a cash
receipts and disbursements method of accounting) is as follows:

ASSETS
                                  Adjusted  Market
                                  Basis     Value
Cash............................  $3,000    $3,000
Loans Owed to Partnership ......  10,000    10,000
Collectibles...................    1,000     3,000
Other Capital Assets......         6,000     2,000
Capital Assets...................  7,000     5,000
Unrealized Receivables............     0    14,000
Total........................    $20,000   $32,000
LIABILITIES AND CAPITAL
Liabilities....................   $2,000    $2,000

Capital:
A...........................       9,000    15,000
B...........................       9,000    15,000
Total.......................     $20,000   $32,000

(ii) At the time of the transfer, B has held the interest in PRS for
more than one year, and none of the property owned by PRS is section
704(c) property. The total amount realized by B is $16,000,
consisting of the cash received, $15,000, plus $1,000, B's share of
the partnership liabilities assumed by T. See section 752. B's basis
for the partnership interest is $10,000 ($9,000 plus $1,000, B's
share of partnership liabilities). B's undivided one-half interest
in PRS includes a one-half interest in the partnership's unrealized
receivables and a one-half interest in the partnership's
collectibles.

(iii) If PRS were to sell all of its section 751 property in a fully
taxable transaction immediately prior to the transfer of B's
partnership interest to T, B would be allocated $7,000 of ordinary
income from the sale of PRS's unrealized receivables.

Therefore, B will recognize $7,000 of ordinary income with respect
to the unrealized receivables. The difference between the amount of
capital gain or loss that the partner would realize in the absence
of section 751 ($6,000) and the amount of ordinary income or loss
determined under �1.751-1(a)(2) ($7,000) is the partner's capital
gain or loss on the sale of the partnership interest under section
741. In this case, the transferor has a $1,000 pre-look-through
long-term capital loss.

(iv) If PRS were to sell all of its collectibles in a fully taxable
transaction immediately prior to the transfer of B's partnership
interest to T, B would be allocated $1,000 of collectibles gain from
the sale of the collectibles. Therefore, B will recognize $1,000 of
collectibles gain on account of the collectibles held by PRS.

(v) The difference between the transferor's pre-look-through long-
term capital gain or loss (-$1,000) and the look-through capital
gain determined under this section ($1,000) is the transferor's
residual long-term capital gain or loss on the sale of the
partnership interest. Under these facts, B will recognize a $2,000
residual long-term capital loss on account of the sale or exchange
of the interest in PRS.

Example 2. Special allocations. Assume the same facts as in Example
1, except that under the partnership agreement, all gain from the
sale of the collectibles is specially allocated to B, and B
transfers B's interest to T for $16,000. All items of income, gain,
loss, or deduction of PRS, other than the collectibles gain, are
divided equally between A and B. Under these facts, B's pre-look-
through long-term capital gain would be $0. If PRS were to sell all
of its collectibles in a fully taxable transaction immediately prior
to the transfer of B's partnership interest to T, B would be
allocated $2,000 of collectibles gain from the sale of the
collectibles. Therefore, B will recognize $2,000 of collectibles
gain on account of the collectibles held by PRS. B also will
recognize $7,000 of ordinary income (determined under �1.751-1(a)
(2)) and a $2,000 long-term capital loss on account of the sale of
B's interest in PRS.

Example 3. Net collectibles loss ignored . Assume the same facts as
in Example 1, except that the collectibles held by PRS have an
adjusted basis of $3,000 and a fair market value of $1,000, and the
other capital assets have an adjusted basis of $4,000 and a fair
market value of $4,000. If PRS were to sell all of its collectibles
in a fully taxable transaction immediately prior to the transfer of
B's partnership interest to T, B would be allocated $1,000 of
collectibles loss. Because none of the gain from the sale of the
interest in PRS is attributable to unrealized appreciation in the
value of collectibles held by PRS, the net loss in collectibles held
by PRS is not recognized at the time B transfers the interest in
PRS. B will recognize $7,000 of ordinary income (determined under
�1.751-1(a)(2)) and a $1,000 long-term capital loss on account of
the sale of B's interest in PRS.

Example 4. Collectibles gain in an S corporation. (i) A corporation
(X) has always been an S corporation and is owned by individuals A,
B, and C. In 1996, X invested in antiqU.S. Subsequent to their
purchase, the antiques appreciated in value by $300. A owns one-
third of the shares of X stock and has held that stock for more than
one year. A's adjusted basis in the X stock is $100. If A were to
sell all of the X stock to T for $150, A would realize $50 of pre-
look-through long-term capital gain.

(ii) If X were to sell its antiques in a fully taxable transaction
immediately before the transfer to T, A would be allocated $100 of
collectibles gain on account of the sale.

Therefore, A will recognize $100 of collectibles gain (look-through
capital gain) on account of the collectibles held by X.

(iii) The difference between the transferor's pre-look-through long-
term capital gain or loss ($50) and the look-through capital gain
determined under this section ($100) is the transferor's residual
long-term capital gain or loss on the sale of the S corporation
stock. Under these facts, A will recognize $100 of collectibles gain
and a $50 residual long-term capital loss on account of the sale of
A's interest in X.

(g) Effective date. This section applies to transfers of interests
in partnerships, S corporations, and trusts that occur on or after
the date these regulations are published as final regulations in the
Federal Register.

Par. 3. Section 1.1223-3 is added to read as follows:

�1.1223-3 Rules relating to the holding periods of partnership
interests.

(a) In general. A partner shall have a divided holding period in an
interest in a partnership if:

(1) The partner acquired portions of an interest at different times;
or

(2) The partner acquired portions of the partnership interest in
exchange for property transferred at the same time but resulting in
different holding periods determined under section 1223.

(b) Accounting for holding periods of an interest in a partnership.
The portion of a partnership interest to which a holding period
relates shall be determined by reference to a fraction that is the
fair market value of the portion of the partnership interest
received in the transaction to which the holding period relates over
the fair market value of the entire partnership interest (determined
immediately after the transaction).

(c) Sale or exchange of all or a portion of an interest in a
partnership--(1) Sale or exchange of entire interest in a
partnership. If a partner sells or exchanges the partner's entire
interest in a partnership, any capital gain or loss recognized shall
be divided between long-term and short-term capital gain or loss in
the same proportions as the holding period of the interest in the
partnership is divided between the portion of the interest held for
more than one year and the portion of the interest held for one year
or less.

(2) Sale or exchange of a portion of an interest in a partnership.
(i) If the ownership interest in a publicly traded partnership (as
defined under section 7704(b)) is divided into identifiable units
with ascertainable holding periods, and the selling partner can
identify the portion of the partnership interest transferred, the
selling partner may use the actual holding period of the portion
transferred.

(ii) If a partner has a divided holding period in a partnership
interest, and paragraph (c)(2)(i) of this section does not apply,
then the holding period of the transferred interest shall be divided
between long-term and short-term capital gain or loss in the same
proportions as the long-term and short-term capital gain or loss
that the transferor partner would realize if the entire interest in
the partnership were transferred in a fully taxable transaction
immediately before the actual transfer.

(d) Distributions--(1) In general. A partner's holding period in a
partnership interest is not affected by distributions from the
partnership.

(2) Character of capital gain or loss recognized as a result of a
distribution from a partnership. If a partner is required to
recognize capital gain or loss as a result of a distribution from a
partnership, then the capital gain or loss recognized shall be
divided between long-term and short-term capital gain or loss in the
same proportions as the long-term and short-term capital gain or
loss that the distributee partner would realize if such partner's
entire interest in the partnership were transferred in a fully
taxable transaction immediately before the distribution.

(e) Examples. The provisions of this section are illustrated by the
following examples:

Example 1. Division of holding period--contribution of money and a
capital asset. (i) A contributes $5,000 of cash and a nondepreciable
capital asset A has held for two years to a partnership (PRS) for a
50% interest in PRS. A's basis in the capital asset is $5,000, and
the fair market value of the asset is $10,000. After the exchange,
A's basis in A's interest in PRS is $10,000, and the fair market
value of the interest is $15,000.

A received one-third of the interest in PRS for a cash payment of
$5,000 ($5,000/$15,000). Therefore, A's holding period in one-third
of the interest received (attributable to the contribution of money
to the partnership) begins on the day after the contribution. A
received two-thirds of the interest in PRS in exchange for the
capital asset ($10,000/$15,000). Accordingly, pursuant to section
1223(1), A has a two-year holding period in two-thirds of the
interest received in PRS.

(ii) Six months later, when A's basis in PRS is $12,000 (due to a
$2,000 allocation of partnership income to A), A sells the interest
in PRS for $15,000. Assuming PRS holds no inventory or unrealized
receivables (as defined under section 751(c)) and no collectibles or
section 1250 property, A will realize $3,000 of capital gain. As
determined above, one-third of A's interest in PRS has a holding
period of one year or less, and two-thirds of A's interest in PRS
has a holding period equal to two years and six months. Therefore,
one-third of the capital gain will be short-term capital gain, and
two-thirds of the capital gain will be long-term capital gain.

Example 2. Division of holding period--contribution of money,
section 1231 property, and other property. In exchange for a 30%
interest in a partnership (ABC), A contributes to ABC $50,000 cash
and equipment used in a trade or business and held for more than one
year with a fair market value of $100,000 and an adjusted basis of
$40,000. The equipment has a recomputed basis under section 1245 of
$60,000. Accordingly, a portion of the equipment equal in value to
$20,000 is section 1245 property that is not section 1231 property.
See �1.1245-6(a). A's partnership interest has a fair market value
of $150,000, a basis of $90,000, and a divided holding period. A
received 46.67% ($70,000/$150,000) of the interest in ABC in
exchange for property that is neither a capital asset nor section
1231 property (that is, cash of $50,000 and a portion of the
equipment attributable to section 1245 recapture in an amount equal
to $20,000). Therefore, A's holding period for 46.67% of A's
interest begins on the day after the exchange of the property for
the partnership interest. A received 53.33% ($80,000/$150,000) of
A's interest in ABC in exchange for section 1231 property.

Accordingly, A's holding period for 53.33% of A's interest includes
A's holding period for the section 1231 property.

Example 3. Division of holding period when capital account is
increased by contribution. A, B, C, and D are equal partners in a
partnership (PRS), and the fair market value of a 25% interest in
PRS is $90x. A, B, C, and D each contribute an additional $10x to
partnership capital, thereby increasing the fair market value of
each partner's interest to $100x. As a result of the contribution,
each partner has a new holding period in the portion of the
partner's interest in PRS that is attributable to the contribution.
That portion equals 10% ($10x/$100x) of each partner's interest in
PRS.

Example 4. Sale or exchange of a portion of an interest in a
partnership. (i) A contributes $5,000 in cash and a capital asset
with a fair market value of $5,000 and a basis of $2,000 to a
partnership (PRS) in exchange for an interest in PRS. At the time of
the contribution, A had held the contributed property for two years.
Six months later, when A's basis in PRS is $7,000, A transfers one-
half of A's interest in PRS to T for $6,000 at a time when PRS's
balance sheet (reflecting a cash receipts and disbursements method
of accounting) is as follows:

ASSETS
                                  Adjusted  Market
                                  Basis     Value
Cash............................. $5,000    $5,000
Unrealized Receivables...........      0     6,000
Capital Asset 1.............       3,000     8,000
Capital Asset 2.............       2,000     5,000
Capital Assets...................  5,000    13,000
Total........................... $10,000   $24,000

(ii) Although at the time of the transfer A has not held A's
interest in PRS for more than one year, 50% of the fair market value
of A's interest in PRS was received in exchange for property with a
long-term holding period. Therefore, 50% of A's interest in PRS has
a long-term holding period.

(iii) If PRS were to sell all of its section 751 property in a fully
taxable transaction immediately before A's transfer of the
partnership interest, A would be allocated $3,000 of ordinary
income. One-half of that amount ($1,500) is attributable to the
portion of A's interest in PRS transferred to T. Accordingly, A will
recognize $1,500 ordinary income and $1,000 ($2,500 -$ 1,500) of
capital gain on account of the transfer to T of one-half of A's
interest in PRS. Fifty percent ($500) of that gain is long-term
capital gain and 50% ($500) is short-term capital gain.

Example 5. Sale or exchange of a portion of an interest in a
partnership. (i) The facts are the same as in Example 4, except that
capital asset 1 is a collectible that was purchased by PRS more than
one year earlier. If capital asset 1 were sold or exchanged in a
fully taxable transaction immediately before A's transfer of the
partnership interest, A would be allocated $2,500 of collectibles
gain. Fifty percent of that amount ($1,250) is attributable to the
portion of A's interest in PRS sold to T. The collectibles gain
allocable to the portion of the transferred interest in PRS with a
long-term holding period is $625 (50% of $1,250). Accordingly, A
will recognize $625 of collectibles gain on account of the transfer
of one-half of the interest in PRS.

(ii) The difference between the amount of pre-look-through long-term
capital gain or loss ($500) and the look-through capital gain ($625)
is the amount of residual long-term capital gain or loss that A will
recognize on account of the transfer of one-half of the interest in
PRS. Under these facts, A will recognize a residual long-term
capital loss of $125 and a short-term capital gain of $500.

Example 6. Sale of units of interests in partnership. A publicly
traded partnership (PRS) has ownership interests that are segregated
into identifiable units of interest. A owns 10 limited partnership
units in PRS for which A paid $10,000 three years ago. Later, A
purchases five additional units for $10,000 at a time when the fair
market value of each unit has increased to $2,000. A's holding
period for one-third ($10,000/$30,000) of the interest in PRS begins
on the day after the purchase of the five additional units. Less
than one year later, A sells five units of ownership in PRS for
$11,000. At the time, A's basis in the 15 units of PRS is $20,000,
and A's capital gain on the sale of 5 units is $4,333 (amount
realized of $11,000 - one-third of the adjusted basis or $6,667).
For purposes of determining the holding period, A can designate the
specific units of PRS sold.

If A properly identifies the five units sold as five of the ten
units for which A has a long-term holding period, the capital gain
realized will be long-term capital gain.

Example 7. Disproportionate distribution . In 1997, A and B each
contribute cash of $50,000 to form and become equal partners in a
partnership (PRS). Sometime later, A receives a distribution worth
$22,000 from PRS, which reduces A's interest in PRS to 36%. After
the distribution, B owns 64% of PRS. The holding periods of A and B
in their interests in PRS are not affected by the distribution.

Example 8. Gain or loss as a result of a distribution. In 1996, A
contributes property with a basis of $10 and a fair market value of
$10,000 in exchange for an interest in a partnership (ABC). In 1999,
when A's interest in ABC is worth $12,000, A contributes $6,000 cash
in exchange for an additional interest in ABC, bringing the fair
market value of A's interest to $18,000. The holding period of A's
interest in ABC is determined immediately after that exchange. A's
holding period in one-third of A's interest in ABC ($6,000 cash
contributed over the $18,000 value of the entire interest) begins on
the day after the cash contribution. (ABC holds no inventory or
unrealized receivables.) Later in 1999, ABC makes a cash
distribution to A of $10,000. A's basis in ABC immediately before
the distribution is $6,010. Accordingly, A must recognize $3990 of
capital gain as a result of the distribution. See section 731(a)(1).
One-third of the capital gain recognized as a result of the
distribution is short-term capital gain, and two-thirds of the
capital gain is long-term capital gain. After the distribution, A's
basis in the interest in PRS is $0, and the holding period for the
interest in PRS continues to be divided in the same proportions as
before the distribution.

(f) Effective date. This section applies to transfers of partnership
interests and distributions of property from a partnership that
occur on or after the date final regulations are published in the
Federal Register.

Par. 4. Section 1.741-1 is amended by adding paragraphs (e) and (f)
to read as follows:

�1.741-1 Recognition and character of gain or loss on sale or
exchange.

* * * * *

(e) For rules relating to the capital gain or loss recognized when a
partner sells or exchanges an interest in a partnership that holds
appreciated collectibles or section 1250 property with section 1250
capital gain, see �1.1(h)-1.

(f) For rules relating to dividing the holding period of an interest
in a partnership, see �1.1223-3.

Deputy Commissioner of Internal Revenue

SEARCH:

You can search the entire Tax Professionals section, or all of Uncle Fed's Tax*Board. For a more focused search, put your search word(s) in quotes.

1999 Regulations Main | IRS Regulations Main | Home