Treasury Issues Regulations Regarding Transfers of Certain Property by U.S. Persons to Partnerships with Related Foreign Partners

January 2020

Summary

On January 23, 2020, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) published in the Federal Register final regulations that provide guidance applicable to transfers of appreciated property by U.S. persons to partnerships with foreign partners related to the transferor. Specifically, when a U.S. person transfers appreciated property to a partnership with a foreign partner related to the transferor, the regulations override the general nonrecognition rule unless the partnership adopts the remedial allocation method and certain other requirements are satisfied. The regulations affect U.S. partners in domestic or foreign partnerships.
 

Details

On January 19, 2017, Treasury published temporary and final regulations (T.D. 9814) under Sections 721(c), 197, 704, and 6038B in the Federal Register (82 FR 7582) (the temporary regulations). A notice of proposed rulemaking (REG-127203-15) cross-referencing the temporary regulations was published in the same issue of the Federal Register (82 FR 6368) (the proposed regulations and together with the temporary regulations the 2017 regulations). For a discussion of the 2017 regulations, see our February 2017 tax alert.
 
The final regulations adopt the rules contained in the proposed regulations with certain modifications. The key modifications and clarifications in the final regulations are summarized below.
 
First, the final regulations modify the definition of related person for purposes of the Section 721(c) rules. The final regulations add a new paragraph in §1.721(c)-1(b)(12) stating that for purposes of determining if a person is a related person with respect to a U.S. transferor, Section 267(b) is applied without regard to Section 267(c)(3). This modification to the definition of related person provides relief in cases when certain foreign individual partners of a partnership would be treated as a related person with respect to a domestic corporation by reason of Section 267(c)(3). See the preamble to the final regulations for an example of the specific fact pattern the modification is intended to address.
 
The consistent allocation method, as described in §1.721(c)-3T(c)(1), is intended to prevent a U.S. transferor from rendering the remedial allocation method ineffective and ensures that the built-in gain in Section 721(c) property will be subject to U.S. tax. In the preamble, Treasury states that a modification to clarify the application of the consistent allocation method is needed. Specifically, a new sentence is added in §1.721(c)-3(c)(1) that provides upon a variation (as described in §1.706-4(a)(1)) of a U.S. transferor’s interest in a Section 721(c) partnership, book items with respect to Section 721(c) property that are allocated under the interim closing method (as described in §1.706-4) will be treated as allocated in the same percentage for purposes of applying the consistent allocation method in a single taxable year unless the variation results from a transaction undertaken with a principal purpose of avoiding the tax consequences of the gain deferral method. The modification to the consistent allocation method when the interim closing method is applied is intended to clarify that a U.S. transferor continues to comply with the consistent allocation method following certain economic events that do not close the taxable year of the Section 721(c) partnership.
 
The final regulations reference and require the use of the updated Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, and new Form 8838-P, Consent To Extend the Time To Assess Tax Pursuant to the Gain Deferral Method (Section 721(c)), to fulfill the reporting requirements provided in the 2017 regulations. For
tax returns filed before January 23, 2020, however, §1.721(c)-6(g)(3)(ii) provides relief for reporting that met the requirements of §1.721(c)-6T (as in effect before January 1, 2020).
 
The final regulations also clarify the duration for which the U.S. transferor must extend the period of limitations on the assessment of tax under §1.721(c)-6(b). Section 1.721(c)-6(b)(5) clarifies the relevant periods to which Form 8838-P applies by measuring each period by the number of months occurring after the relevant date. Accordingly, the final regulations measure each period by a fixed term that is determinable on the date of contribution. The final regulations also provide a similar clarification in §1.721(c)-6(f)(2).
 
The Tax Cuts and Jobs Act (TCJA) repealed Section 708(b)(1)(B) (rules regarding partnership technical terminations) for all partnership taxable years beginning after December 31, 2017. The rules provided in the final regulations regarding technical terminations have limited applicability. The rules will only apply to technical terminations occurring on or after the applicability date provided in the 2017 regulations but before the effective date for the repeal of Section 708(b)(1)(B) provided in the TCJA.
 
Lastly, Treasury notes in the preamble that they are studying the use of partnerships to shift tax liability, in whole or in part, with respect to earnings of a CFC attributable to Subpart F income (within the meaning of Section 952) or tested income (within the meaning of Section 951A(c)(2)(A) and §1.951A-2(b)(1)) to a related foreign partner that is not owned (within the meaning of Section 958(a)) by a U.S. shareholder (within the meaning of Section 951(b)) and requests comments on this matter.
 
For dates of applicability, see §§1.197-2(l)(5)(i), 1.704-1(f), 1.704-3(g)(1), 1.721(c)-1(e), 1.721(c)-2(e), 1.721(c)-3(e), 1.721(c)-4(d), 1.721(c)-5(g),1.721(c)-6(g), and 1.6038B-2(j)(4).
 

BDO Insights

The final regulations provide additional guidance to Section 721(c) partnerships and their partners. U.S. persons that have transferred or plan to transfer certain appreciated property to a Section 721(c) partnership should review the application of the final regulations to their specific situations. Please contact an International Tax Specialist if you would like more information regarding the content of this tax alert.
 
 

CONTACT:

Joe Calianno
National Tax Office Partner and International Tax Technical Practice Leader
  Monika Loving
Partner and International Tax Practice Leader

 
Brandon Boyle
Principal
  Reese Fredrickson
Partner

 
Annie Lee
Partner
  Chip Morgan
Partner

 
Robert Pedersen
Partner
  Jerry Seade
Principal

 
Natallia Shapel
Partner
  Sean Dokko
National Tax Office Managing Director