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April 7, 2015

2015-Issue 10—Often, Subchapter K, the codification of partnership taxation, can involve deemed transactions that raise the specter of gain recognition under a number of anti-deferral provisions or simultaneous transactions where an ordering of steps is necessary to determine the tax consequences to the parties. Sequencing requires careful thought, planning and execution to ensure that the desired and intended tax outcomes are achieved. The recently released PLR 201505001 touches on this issue under the narrow fact pattern described in that ruling. Nevertheless, the private letter ruling may evidence a willingness by the IRS to respect the description of steps set forth in transactional documents in the context of other transactions.

Background on Section 732(f)

Very generally, Section 732(f) was enacted to address certain transactions that the government felt could lead to the inappropriate elimination of gain by taxpayers in connection with certain partnership distributions of property.

As an example, assume that X corporation is a partner in a partnership, that the fair market value of X’s partnership interest is $1,000 and the tax basis in such interest is -0-, and that the partnership has assets with a tax basis and fair market value of $1,000 that X would like in connection with the liquidation of its interest in the partnership. If X’s interest was liquidated for the $1,000 in assets it wants, the basis of those assets would generally be stepped down to -0- when distributed to X. Alternatively, the partnership could contribute these assets to a corporate subsidiary ("Subsidiary") and distribute out the stock of Subsidiary to X in liquidation of its interest. Under the general provisions of Section 732, X would take a basis in the Subsidiary stock equal to -0-, the basis in its pre-distribution partnership interest (Section 732(b)).

Prior to the enactment of Section 732(f), the assets of Subsidiary would have retained their high basis even though the basis of Subsidiary stock was stepped down in connection with the distribution. X could then liquidate Subsidiary in a tax-free liquidation, pursuant to Section 332, taking the assets with a carryover basis (Section 334). Essentially, the gain originally embedded in X’s partnership interest would be eliminated.

In general, Section 732(f)(1) provides that if:

(A)  a corporation (hereafter in this subsection referred to as the “Corporate Partner”) receives a distribution from a partnership of stock in another corporation (hereafter in referred to as the “Distributed Corporation”);

(B)  the Corporate Partner has control (pursuant to Treas. Reg. Section1.1502-34 and Treas. Reg. Section1.732-3) of the Distributed Corporation immediately after the distribution or at any time thereafter; and

(C)  the partnership’s adjusted basis in such stock immediately before the distribution exceeded the Corporate Partner’s adjusted basis in such stock immediately after the distribution,

…then an amount equal to such excess shall be applied to reduce (in accordance with Section 732(c)) the basis of property held by the Distributed Corporation at such time (or, if the Corporate Partner does not control the Distributed Corporation at such time, at the time the Corporate Partner first has such control). If the Distributed Corporation does not possess sufficient asset tax basis to absorb a basis step down, the distributee partner must recognize gain (Section 732(f)(4)).

PLR 201505001 (January 30, 2015)

In a very simplified version of the facts of the PLR, Parent company owned two corporate subsidiaries, S1 and S2. Parent, S1 and S2 each owned an interest in an entity treated as a partnership for federal income tax purposes (the "Partnership"). Together Parent, S1 and S2 owned 100 percent of the interests in Partnership. Some property had been contributed to Partnership by the partners with a fair market value that differed from its basis (i.e., Partnership had Section 704(c) property). Immediately prior to the deemed liquidation of Partnership, its property was contributed to a new corporate subsidiary (“Newco”).

In the interest of simplifying the corporate structure, it was proposed that each of S1 and S2 would liquidate into their parent tax-free pursuant to Section 332. Upon the liquidation of each of S1 and S2, Partnership became wholly owned by Parent and, therefore, became classified as a disregarded entity for federal income tax purposes. In this deemed liquidation, S1 and S2 were treated as transferring interests in the partnership to Parent, and Parent would normally be treated as having received its proportionate share of Partnership’s assets (i.e., a share of the Newco stock determined by reference to its percentage interest in Partnership) directly from Partnership and S1 and S2’s share of Partnership’s assets from S1 and S2.

Note, this appears to be the first published guidance applying Rev. Rul. 99-6 (which describes the tax consequences when either one partner purchases the partnership interests of the remaining partners or a third party purchases the partnership interests of all partners in a taxable transaction) to a tax-free transaction. Although not explicitly stated in the PLR, it can be inferred that a proportional distribution of the Newco stock would have resulted in a step down in basis of the corporate stock distributed to one or more of the Corporate Partners, raising the application of Section 732(f).

The parties, therefore, drafted language in the transactional documents providing that, in connection with the deemed liquidation of Partnership, Newco stock would be deemed distributed to the Corporate Partners in a manner such that no basis step down in the distributed Newco stock would occur. Furthermore, the parties represented to the IRS that they would report this transaction consistent with the language describing the deemed steps. Based on the language of the transactional documents and the representation of the parties, the IRS ruled that Section 732(f) would not apply to the deemed liquidation of Partnership.

Alvarez & Marsal Taxand Says:

While taxpayers may not rely on the PLR as precedential authority, the PLR evidences a willingness by the IRS to respect the description of steps set forth in transactional documents where the taxpayers agree to report the transaction consistent with the description of those steps, lending clarity to potentially uncertain tax consequences. Moreover, depending on the magnitude of the issue involved, taxpayers can also consider obtaining a private letter ruling to achieve certainty on the tax consequences associated with deemed transactions or simultaneous transactions where the ordering of the steps is critical to a determination of the tax consequences. 


Deanna Trapp
Senior Director, Chicago
+1 312 288 4008

For More Information:

Patrick Hoehne
Managing Director, San Francisco
+1 415 490 2134

Tyler Horton
Managing Director, Washington DC
+1 202 688 4218

Andrew Johnson
Managing Director, Washington DC
+1 202 688 4289

Keith Kechik
Managing Director, Chicago
+1 312 288 4024

Ernie Perez
Managing Director, New York
+1 305 704 6720

Steven Klig
Senior Advisor, New York
+1 516 512 4681


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The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.

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