Joint Report on IRC Section 1031
Open Issues Involving Partnerships
February 8, 2001
Contents | Introduction | I | II | III
| IV | V
Discussion of Partnership Section 1031 Open Issues: Questions and
Answers
Q-2: Can a Section 1031 deferred exchange be completed if the
partnership that transferred the relinquished property is terminated under Section
708(b)(1)(B) because of the sale or exchange of 50% or more of the capital or profits
interest in the partnership?
A-2: Yes, the new partnership that arises out of the Section
708(b)(1)(B) termination can acquire the replacement property to complete the Section 1031
exchange.
Under Treas. Reg. §1.708-1(b)(1)(iv), upon the termination of a
partnership, the terminating partnership contributes all of its assets to a new
partnership in exchange for an interest in the new partnership and, immediately
thereafter, the terminated partnership distributes the interests in the new partnership to
the purchasing partner and to the remaining partners in the terminated partnership in
proportion to their respective interests in the terminated partnership.
Under Sections 704(b), 704(c) and 737, the effects of a Section
708(b)(1)(B) termination are disregarded. The capital accounts of the partners in the
terminated partnership are carried over to the new partnership. Treas. Reg.
§1.704-1(b)(2)(iv)(1). See also Treas. Reg. §1.704-3(a)(3)(i),
§1.737-2(a). The holding period and the character of the terminated partnership’s
assets in the hands of the new partnership are determined under the general rules for
contributions of property to a partnership. Treas. Reg. §1.708-1(b)(1)(iv).
The overall effect of Treas. Reg. §1.708-1(b)(1)(iv) and the related
changes made under other regulations has been to minimize or eliminate any artificial
adverse effect of a partnership termination caused by Section 708(b)(1)(B). There is no
policy reason why a like-kind exchange, which "straddles" a Section 708(b)(1)(B)
termination, should fail to be governed by Section 1031 because a "new"
partnership completes the exchange. The new partnership should be viewed as a continuation
of the old partnership for purposes of Section 1031.
The principles of this treatment can be illustrated by the following
example:
Example No 2(a)
ABCD, a limited liability company ("ABCD") owns Whiteacre, which
has an adjusted basis of $100,000 and a fair market value of $400,000. ABCD is treated as
a partnership for income tax purposes.
A has a 40% interest in the capital, profits and losses of ABCD. Each of
B, C and D have a 20% interest in the capital, profits and losses of ABCD. ABCD begins a
deferred exchange and transfer Whiteacre to a qualified intermediary under an exchange
agreement. Thereafter, A and B sell their interests in ABCD to X for $240,000 before ABCD
acquires Blackacre as a replacement property. A and B collectively own a 60% interest in
the profits and capital of ABCD. Consequently, the purchase by X of the 60% interest
causes the ABCD partnership to terminate under Section 708(b)(1)(B). Nevertheless, for
purposes of Section 1031, the new partnership of XCD is viewed as a continuation of ABCD.
The result in this illustration would not change if, alternatively, X acquired the 60%
interest in ABCD immediately before the transfer of Whiteacre or immediately after the
acquisition of Blackacre.5, 6
Contents | Introduction
| I | II | III | IV | V |