Guidance Under Section 1061
| Published date | 14 August 2020 |
| Citation | 85 FR 49754 |
| Record Number | 2020-17108 |
| Section | Proposed rules |
| Court | Internal Revenue Service,Treasury Department |
Federal Register, Volume 85 Issue 158 (Friday, August 14, 2020)
[Federal Register Volume 85, Number 158 (Friday, August 14, 2020)]
[Proposed Rules]
[Pages 49754-49795]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-17108]
[[Page 49753]]
Vol. 85
Friday,
No. 158
August 14, 2020
Part III
Department of the Treasury
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Internal Revenue Service
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26 CFR Part 1
Guidance Under Section 1061; Proposed Rule
Federal Register / Vol. 85, No. 158 / Friday, August 14, 2020 /
Proposed Rules
[[Page 49754]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-107213-18]
RIN 1545-BO81
Guidance Under Section 1061
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations that provide
guidance under section 1061 of the Internal Revenue Code (Code).
Section 1061 recharacterizes certain net long-term capital gains of a
partner that holds one or more applicable partnership interests as
short-term capital gains. An applicable partnership interest is an
interest in a partnership that is transferred to or held by a taxpayer,
directly or indirectly, in connection with the performance of
substantial services by the taxpayer, or any other related person, in
any applicable trade or business. These proposed regulations also amend
existing regulations on holding periods to clarify the holding period
of a partner's interest in a partnership that includes in whole or in
part an applicable partnership interest and/or a profits interest.
These regulations affect taxpayers who directly or indirectly hold
applicable partnership interests in partnerships and the passthrough
entities in which the applicable partnership interest is held, directly
or indirectly.
DATES: Written or electronic comments and requests for a public hearing
must be received by October 5, 2020, which is 60 days after the date of
filing for public inspection with the Office of the Federal Register.
Requests for a public hearing must be submitted as prescribed in the
``Comments and Requests for a Public Hearing'' section.
ADDRESSES: Commenters are strongly encouraged to submit public comments
electronically. Submit electronic submissions via the Federal
eRulemaking Portal at www.regulations.gov (indicate IRS and REG-107213-
18) by following the online instructions for submitting comments. Once
submitted to the Federal eRulemaking Portal, comments cannot be edited
or withdrawn. The IRS expects to have limited personnel available to
process public comments that are submitted on paper through mail. Until
further notice, any comments submitted on paper will be considered to
the extent practicable. The Department of the Treasury (Treasury
Department) and the IRS will publish for public availability any
comment submitted electronically, and to the extent practicable on
paper, to its public docket. Send paper submissions to: CC:PA:LPD:PR
(REG-107213-18), Room 5203, Internal Revenue Service, P.O. Box 7604,
Ben Franklin Station, Washington, DC 20044.
FOR FURTHER INFORMATION CONTACT: Concerning submissions of comments
and/or requests for a public hearing, Regina L. Johnson at (202) 317-
5177 (not a toll-free number); Email address:
[email protected]; concerning the proposed
regulations, Kara K. Altman or Sonia K. Kothari at (202) 317-6850 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background and Overview
This document contains proposed regulations under section 1061 of
the Code to amend the Income Tax Regulations (26 CFR part 1). Section
1061 was added to the Code on December 22, 2017, by the enactment of
section 13309 of Public Law 115-97, 131 Stat. 2054 (2017), commonly
referred to as the Tax Cuts and Jobs Act (TCJA). Section 1061 applies
to taxable years beginning after December 31, 2017. Section 1061
recharacterizes certain net long-term capital gain with respect to
applicable partnership interests (APIs) as short-term capital gain.
This Background and Overview section provides an overview of the
statutory provisions and highlights certain critical concepts and terms
used in the proposed regulations. The Explanation of Provisions section
describes the proposed regulations in greater detail.
Section 1061(a): Recharacterization Amount, Owner Taxpayer, and Related
Concepts
Section 1061(a) recharacterizes as short-term capital gain the
difference between a taxpayer's net long-term capital gain with respect
to one or more APIs and the taxpayer's net long-term capital gain with
respect to these APIs if paragraphs (3) and (4) of section 1222, which
define the terms long-term capital gain and long-term capital loss,
respectively, for purposes of subtitle A of the Code, are applied using
a three-year holding period instead of a one-year holding period. These
proposed regulations refer to this difference as the Recharacterization
Amount.
The proposed regulations provide that the person who is subject to
Federal income tax on the Recharacterization Amount is required to
calculate such amounts and refer to this person as the Owner Taxpayer.
Although an API can be held directly by an Owner Taxpayer, it also
may be held indirectly through one or more passthrough entities
(Passthrough Entities). The proposed regulations provide a framework
for determining the Recharacterization Amount when an API is held
through one or more tiers of Passthrough Entities (tiered structure).
Section 1061(a) applies to a taxpayer's net long-term capital gain
with respect to one or more APIs held during the taxable year. The
proposed regulations provide that the determination of a taxpayer's net
long-term capital gain with respect to the taxpayer's APIs held during
the taxable year includes the taxpayer's combined net distributive
share of long-term capital gain or loss from all APIs held during the
taxable year and the Owner Taxpayer's long-term capital gain and loss
from the disposition of any APIs during the taxable year. The proposed
regulations refer to long-term capital gains and losses recognized with
respect to an API as API Gains and Losses. Unrealized API Gains and
Losses are capital gains and losses with respect to an API that have
not yet been realized. In a tiered structure of Passthrough Entities,
API Gains and Losses and Unrealized API Gains and Losses retain their
character as API Gains and Losses as they are allocated through the
tiers.
The proposed regulations provide that API Gains and Losses do not
include long-term capital gain determined under sections 1231 and 1256,
qualified dividends described in section 1(h)(11)(B), and any other
capital gain that is characterized as long-term or short-term without
regard to the holding period rules in section 1222, such as capital
gain characterized under the identified mixed straddle rules described
in section 1092(b). Additionally, API Gains and Losses do not include
API Holder Transition Amounts and Capital Interest Gains and Losses.
API Holder Transition Amounts are allocations to the holder of an API
(API Holder) of long-term capital gain and loss recognized on the
disposition of assets held by the partnership for more than three years
as of January 1, 2018, if the partnership has elected to treat these
amounts as API Holder Transition Amounts. Capital Interest Gains and
Losses are long-term capital gains and losses with respect to an API
Holder's capital investment in a Passthrough Entity.
[[Page 49755]]
Section 1061(c)(1): Definition of an Applicable Partnership Interest
Section 1061(c)(1) provides that an API is a partnership interest
held by, or transferred to, a taxpayer, directly or indirectly, in
connection with the performance of substantial services by the
taxpayer, or by any other related person, in any applicable trade or
business (ATB).
An API is an interest in a partnership's profits that is
transferred or held in connection with the performance of services.
There may be one or more tiers of Passthrough Entities between the
partnership that originally issued the API and the Passthrough Entity
in which the Owner Taxpayer holds its indirect interest in the API.
Each Passthrough Entity in the tiered structure is treated as holding
an API under the proposed regulations, that is, each Passthrough Entity
is an API Holder. An API Holder may be an individual, partnership,
trust, estate, S corporation, or a passive foreign investment company
(PFIC) with respect to which the shareholder has a qualified electing
fund (QEF) election in effect under section 1295.
Section 1061(c)(1), similar to section 1061(a), uses the term
``taxpayer.'' The proposed regulations provide that an Owner Taxpayer
is the taxpayer for purposes of section 1061(a). However, section
1061(c)(1) requires that an API be transferred to a taxpayer in
connection with services performed by the taxpayer or by a related
person. The proposed regulations provide that the reference to
``taxpayer'' in section 1061(c)(1) includes not only an Owner Taxpayer,
but also includes a Passthrough Taxpayer. The proposed regulations
provide that a Passthrough Taxpayer is a Passthrough Entity that is
treated as a taxpayer for the purpose of determining the existence of
an API, regardless of whether the Passthrough Entity itself is subject
to Federal income tax. Generally, if an interest in a partnership is
transferred to a Passthrough Taxpayer in connection with the
performance of its own services, the services of its owners, or the
services of persons related to either the Passthrough Entity or its
owners, the interest is an API as to the Passthrough Taxpayer. The
Passthrough Taxpayer's ultimate owners will be treated as Owner
Taxpayers, unless otherwise excepted.
A partnership interest is an API if it is transferred in connection
with the performance of substantial services. The proposed regulations
presume that services are substantial with respect to the partnership
interest transferred in connection with those services. This
presumption is based on the assumption that the parties have
economically equated the services performed with the potential value of
the partnership interest transferred. The proposed regulations provide
that once a partnership interest is an API, it remains an API and never
loses that character, unless one of the exceptions to the definition of
an API applies.
Section 1061(c)(2): Definition of an Applicable Trade or Business
Under section 1061, for an interest in a partnership to be an API,
the interest must be held or transferred in connection with the
performance of services in an ATB. An ATB is defined in section
1061(c)(2) as any activity conducted on a regular, continuous, and
substantial basis which consists, in whole or in part, of raising or
returning capital, and either (i) investing in (or disposing of)
specified assets (or identifying specified assets for such investing or
disposition), or (ii) developing specified assets. The proposed
regulations refer to these actions, respectively, as Raising or
Returning Capital Actions and Investing or Developing Actions (referred
to as Specified Actions in the aggregate). The proposed regulations
provide that an activity is conducted on a regular, continuous, and
substantial basis if it meets the ATB Activity Test. The ATB Activity
Test is met if the total level of activity (conducted in one or more
entities) meets the level of activity required to establish a trade or
business for purposes of section 162.
In applying the ATB Activity Test, the proposed regulations provide
that, in some cases, it is not necessary for both Raising or Returning
Capital Actions and Investing or Developing Actions to occur in a
single year for an ATB to exist in that year. Further, Raising or
Returning Capital Actions and Investing or Developing Actions of
related persons are aggregated together to determine if the ATB
Activity Test is met.
Section 1061(c)(3) provides that specified assets (Specified
Assets) are securities, as defined in section 475(c)(2) (without regard
to the last sentence thereof), commodities, as defined in section
475(e)(2), real estate held for rental or investment, cash or cash
equivalents, options or derivative contracts with respect to any of the
foregoing, and an interest in a partnership to the extent of the
partnership's proportionate interest in any of the foregoing. The
definition of Specified Assets in the proposed regulations generally
tracks the statutory language. It also includes an option or derivative
contract on a partnership interest to the extent that the partnership
interest represents an interest in other Specified Assets.
Section 1061(c)(4): Exceptions
Section 1061(c)(4)(A) provides that an API does not include any
interest in a partnership directly or indirectly held by a corporation.
In Notice 2018-18 (2018-12 IRB 443, March 19, 2018), the Treasury
Department and the IRS provided notice that the regulations under
section 1061 would provide that the term ``corporation'' for purposes
of section 1061(c)(4)(A) does not include an S corporation. Any timely
comments received on Notice 2018-18 will be considered as part of the
Treasury decision adopting these proposed regulations as final
regulations.
Section 1061(c)(4)(B) also provides that an API does not include
certain capital interests. The proposed regulations implement the
capital interest exception by excepting long-term capital gains and
losses that represent a return on an API Holder's invested capital in a
Passthrough Entity from recharacterization under section 1061. The
proposed regulations refer to these amounts as Capital Interest Gains
and Losses. Specifically, under the proposed regulations, Capital
Interest Allocations, Passthrough Interest Capital Allocations and
Capital Interest Disposition Amounts are treated as Capital Interest
Gains and Losses.
Under the proposed regulations, a partner's invested capital in a
partnership that maintains capital accounts under Sec. 1.704-
1(b)(2)(iv) is the partner's capital account. In the case of a
Passthrough Entity that is not a partnership (or a partnership that
does not maintain capital accounts under Sec. 1.704-1(b)(2)(iv)), if
the Passthrough Entity maintains and determines accounts for its owners
in a manner similar to that provided in Sec. 1.704-1(b)(2)(iv), those
accounts will be treated as capital accounts for purposes of the
proposed regulations. In order for an allocation to be treated as a
Capital Interest Allocation or a Passthrough Interest Capital
Allocation, the allocation must be based on an API Holder's relative
capital account balance in the Passthrough Entity. Although Unrealized
API Gain or Loss is included in an owner's capital account, the gain or
loss will be treated as API Gain or Loss and not as Capital Interest
Gain or Loss when recognized. An allocation of API Gain or Loss from a
lower-tier entity to an upper-tier entity is always API Gain or Loss
when further allocated by the upper-tier entity to its direct interest
[[Page 49756]]
holders. Capital Interest Gains and Losses never include API Gains and
Losses, Unrealized API Gains and Losses, or API Holder Transition
Amounts.
If an owner disposes of an interest that is composed of a capital
interest and an API, the proposed regulations provide a mechanism for
the owner to determine the portion of long-term capital gain or loss
recognized on the disposition that is treated as a Capital Interest
Disposition Amount and thus, a Capital Interest Gain or Loss.
Other Exceptions
Section 1061(c)(1) provides an exception for certain partnership
interests held by employees of entities that are not engaged in an ATB.
The proposed regulations track the statutory language. Also, the
proposed regulations add an exception for an API that is acquired by a
bona fide purchaser who (i) does not provide services, (ii) is
unrelated to any service provider, and (iii) acquired the interest for
fair market value.
Section 1061(b) provides regulatory authority to establish an
exception to section 1061(a) for gain attributable to any assets not
held for portfolio investment on behalf of third party investors. The
proposed regulations reserve on the exercise of this authority.
Section 1061(d): Transfer of API to a Related Party
Section 1061(d) accelerates the recognition of capital gain on a
direct or indirect transfer that would not otherwise be a taxable event
and recharacterizes certain long-term capital gain as short-term
capital gain. Under section 1061(d), if a taxpayer transfers an API to
a related person described in section 1061(d)(2), then, without regard
to whether the transfer is otherwise a taxable event, the taxpayer
includes in gross income, as short-term capital gain, the excess of (A)
the net built-in long-term capital gain in assets attributable to the
transferred interest with a holding period of three years or less, over
(B) the amount of long-term capital gain treated as short term capital
gain under section 1061(a) on the transfer. The proposed regulations
provide that the term transfer includes, but is not limited to,
contributions, distributions, sales and exchanges, and gifts. A related
person for purposes of section 1061(d)(2) is defined more narrowly than
a related person for purposes of section 1061(c)(1) and includes only
members of the taxpayer's family within the meaning of section
318(a)(1), the taxpayer's colleagues (those who provided services in
the ATB during certain time periods) and, under the proposed
regulations, a Passthrough Entity to the extent that a member of the
taxpayer's family or a colleague is an owner. The proposed regulations
provide that a contribution under section 721(a) to a partnership is
not treated as a transfer to a Section 1061(d) Related Person because
the proposed regulations require that, under the principles of section
704(c) and Sec. Sec. 1.704-1(b)(2)(iv)(f) and 1.704-3(a)(9), all
Unrealized API Gains at the time of contribution must be allocated to
the API Holder contributing the interest when those gains are
recognized by the partnership.
Section 1061(e): Reporting
Section 1061(e) provides that the Secretary of the Treasury or his
delegate (Secretary) shall require such reporting as is necessary to
carry out the purposes of section 1061. The proposed regulations
include rules for providing information required to compute the
Recharacterization Amount when there is a tiered structure.
Regulatory Authority
The statute requires that the Secretary issue such regulations or
other guidance as is necessary or appropriate to carry out the purposes
of section 1061. The legislative history indicates that such guidance
is to address the prevention of abuse of the purposes of the provision.
See H.R. Conf. Rep. No. 115-466 at 422 (2017) (Conference Report); see
also Joint Committee on Taxation, General Explanation of Public Law
115-97, JCS-1-18, at 203 (2017) (Blue Book). The Conference Report and
the Blue Book also state that the guidance is to address the
application of the provision to tiered structures of entities. See id.
Explanation of Provisions
Section 1.1061-1 provides definitions of the terms used in
Sec. Sec. 1.1061-1 through 1.1061-6 of these proposed regulations.
Section 1.1061-2 provides rules and examples regarding APIs and ATBs.
Section 1.1061-3 provides guidance on the exceptions to an API,
including the capital interest exception. Section 1.1061-4 provides
guidance on the computation of the Recharacterization Amount and
computation examples. Section 1.1061-5 provides guidance regarding the
application of section 1061(d) to transfers to certain related parties.
Section 1.1061-6 provides reporting rules. Because the application of
section 1061 requires a clear determination of the holding period of a
partnership interest that is, in whole or in part, an API, these
proposed regulations also provide clarifying amendments to Sec.
1.1223-3. Additional clarifying amendments to Sec. 1.702-1(a)(2) and
Sec. 1.704-3(e) are also proposed.
I. Sections 1.1061-1 and 1.1061-2: Definitions, Operational Rules, and
Examples
Section 1.1061-1 provides definitions of terms used in Sec. Sec.
1.1061-1 through 1.1061-6 of these proposed regulations. The
definitions in Sec. 1.1061-1 combined with the operational rules in
Sec. 1.1061-2 identify the taxpayer to which section 1061 applies,
when an interest is an API, what constitutes an ATB, and who is a
related party. These definitions include terms for identifying
interests when an API is held through one or more passthrough entities.
For purposes of these regulations, a Passthrough Entity is defined as a
partnership, an S corporation, or a PFIC with respect to which the
shareholder has a QEF election in effect.
A. API, Owner Taxpayer, Passthrough Taxpayer, Indirect API, and
Passthrough Interest
1. Definitions
Section 1061(a) refers to a taxpayer in terms of the person whose
net long-term capital gains from one or more APIs are recharacterized
as net short-term capital gain under the statute. The proposed
regulations refer to this amount as the Recharacterization Amount.
Section 1061(c) also refers to a taxpayer as the person to whom the API
is transferred or who holds the API in connection with the taxpayer's
or a related person's services.
Section 1061(c)(1) defines an API as any interest in a partnership
which, directly or indirectly, is transferred to (or held by) the
taxpayer in connection with the performance of substantial services by
the taxpayer, or by any other related person, in any ATB. These
proposed regulations also provide that solely for purposes of section
1061, an interest in a partnership includes any financial instrument or
contract, the value of which is determined, in whole or in part, by
reference to the partnership (including the amount of partnership
distributions, the value of partnership assets, or the results of
partnership operations).
a. API, Owner Taxpayer, and Passthrough Taxpayer
Comments and other commentary (collectively referred to as
comments) considered by the Treasury Department and the IRS highlight
the importance of the definition of the term ``taxpayer'' for purposes
of section 1061(a) with respect
[[Page 49757]]
to the determination of the Recharacterization Amount. Additionally,
the definition of the term ``taxpayer'' for purposes of section 1061(c)
is important for the determination of whether a partnership interest is
an API. These comments describe three potential approaches to the
definition of ``taxpayer.'' These approaches are the aggregate
approach, the partial entity approach, and the full entity approach.
Under the aggregate approach, both the existence of the API and the
Recharacterization Amount are determined solely at the owner level. If
the Recharacterization Amount is calculated at the owner level, gains
and losses from multiple APIs held by the owner can be combined and
netted with each other to determine the Recharacterization Amount. In
contrast, under the full entity approach, the Recharacterization Amount
and the existence of an API both are determined at the entity level.
Additionally, under the full entity approach, the Recharacterization
Amount would be calculated for each entity and then netted and combined
at the owner level. Under the partial entity approach, the existence of
an API is determined at the entity level, but the Recharacterization
Amount is determined at the owner level.
The proposed regulations adopt a partial entity approach. To apply
this approach, the proposed regulations provide for two definitions of
a taxpayer (Owner Taxpayer and Passthrough Taxpayer) for purposes of
section 1061. These definitions are provided to define the scope of the
term ``taxpayer'' for purposes of computing the Recharacterization
Amount and for purposes of determining whether a partnership interest
is an API. The proposed regulations define the term Owner Taxpayer as
the person subject to tax on the net gain with respect to the API.
Under the proposed regulations, the Recharacterization Amount is
determined solely by the Owner Taxpayer. For this purpose, the term
Owner Taxpayer includes individuals, simple and complex trusts, and
estates. Thus, if an Owner Taxpayer holds one or more APIs indirectly
(through one or more Passthrough Entities), amounts subject to section
1061 flow through those entities and are netted at the Owner Taxpayer
level to determine the Recharacterization Amount.
The proposed regulations define the term Passthrough Taxpayer as an
entity that generally does not pay tax itself, notwithstanding that a
Passthrough Taxpayer could be responsible for paying an imputed
underpayment calculated based on adjustments to partnership related
items under section 6225 (Partnership adjustment by the Secretary) or
that a Passthrough Taxpayer that is an electing 1987 partnership (as
defined in section 7704(g)(2)) could be responsible for paying the tax
set forth in section 7704(g)(3). An Owner Taxpayer and a Passthrough
Taxpayer each are treated as a taxpayer for the purpose of determining
whether an API exists. In determining whether the elements of an API
are present, a Passthrough Taxpayer can be (i) the service provider,
(ii) a person related to the service provider, (iii) engaged in an ATB,
or (iv) the recipient of an interest in connection with the performance
of substantial services in an ATB. If a Passthrough Taxpayer is treated
as the recipient (or holder) of a partnership interest, directly or
indirectly, for purposes of determining the existence of an API, the
ultimate owners of the Passthrough Taxpayer are treated as Owner
Taxpayers for the purpose of determining the Recharacterization Amount.
Owner Taxpayers do not include owners of a Passthrough Taxpayer who are
excepted from the application of section 1061 under Sec. 1.1061-3.
Additionally, Owner Taxpayers to whom a partnership interest is
directly or indirectly transferred in connection with the Owner
Taxpayer's or a related party's performance of substantial services in
an ATB are also treated as taxpayers for purposes of determining the
existence of an API. Section 1.1061-2 of the proposed regulations
provides examples of how the existence of an API is determined.
b. Interaction With Revenue Procedures 93-27 and 2001-43
Revenue Procedure 93-27 (1993-2 C.B. 343) defines a profits
interest and provides a safe harbor under which the IRS will not treat
the receipt of a profits interest as a taxable event for the partner or
the partnership if certain requirements are met. See also Revenue
Procedure 2001-43 (2001-2 C.B. 191). Section 1061 applies to all
partnership interests that meet the definition of an API, regardless of
whether the receipt of the interest is treated as a taxable event under
Revenue Procedure 93-27. Accordingly, taxpayers should not equate an
interest that meets the definition of an API with an interest the
receipt of which would not be treated as a taxable event under Revenue
Procedure 93-27. For example, Revenue Procedure 93-27 applies to a
person who receives a profits interest for the provision of services to
or for the benefit of a partnership in a partner capacity or in
anticipation of being a partner. Section 1061 applies to partnership
interests transferred or held in connection with the performance of
substantial services in an ATB. Further, these proposed regulations
address only the application of section 1061 and should not be
interpreted as providing guidance regarding the application of Revenue
Procedure 93-27 to transactions in which one party provides services
and another party receives a seemingly associated allocation and
distribution of partnership income and gain. Lastly, although a
financial instrument or contract may be treated as an API under section
1061, a financial instrument or contract is not an interest in a
partnership for purposes of Revenue Procedure 93-27, unless it is
otherwise a partnership interest for Federal tax purposes. The Treasury
Department and the IRS note that arrangements that are not partnership
interests for Federal tax purposes are not eligible for the safe harbor
described in Revenue Procedures 93-27 and 2001-43.
c. API Holder
The proposed regulations include the term API Holder to refer to
any person who holds an interest in a particular API. An API Holder can
include either or both a Passthrough Taxpayer and an Owner Taxpayer.
d. Indirect API
The proposed regulations define an Indirect API as an API that is
held through one or more Passthrough Entities.
e. Passthrough Interest
A Passthrough Interest under the proposed regulations is an
interest in a Passthrough Entity that represents, in whole or in part,
an API.
f. API Gains and Losses and Unrealized API Gains and Losses
API Gains and Losses are long-term capital gains and losses
recognized with respect to an API. The proposed regulations provide
that API Gains and Losses include long-term capital gain or loss from a
deemed or actual disposition of the API (including gain and loss
recognized under section 731(a) and section 752(b)) and the holder's
distributive share of net long-term capital gain or loss from the
partnership under sections 702 and 704 with respect to the API. The
proposed regulations also treat long-term capital gain or loss on the
disposition of a capital asset distributed from a partnership with
respect to an API (Distributed API Property) as API Gain or Loss if the
asset
[[Page 49758]]
is held for more than one year but not more than three years at the
time the distributee-partner disposes of the property. The holding
period of the asset in the partner's hands includes the partnership's
holding period with respect to the asset.
Unrealized API Gains and Losses include unrealized short-term and
long-term capital gains and losses that would be allocated to the API
Holder with respect to its API if the partnership sold all of its
assets at fair market value and the proceeds were distributed in a
complete liquidation of the partnership on any relevant date. For
example, Unrealized API Gains and Losses include all capital gains and
losses that would be allocated to the API pursuant to a capital account
revaluation under Sec. 1.704-1(b)(2)(iv)(f) or Sec. 1.704-
1(b)(2)(iv)(s).
In the case of a Passthrough Entity that contributes property that
on disposition would generate capital gain or loss subject to section
1061 to another Passthrough Entity, Unrealized Capital Gains and Losses
include the appreciation or depreciation in the value of the property
at the time of the contribution. Accordingly, Unrealized API Gains and
Losses include the capital gains and losses that would be allocated to
the API Holder with respect to the API if the property contributed by
the Passthrough Entity to the lower-tier Passthrough Entity were sold
immediately before the contribution for the amount that is included in
the invested capital of the lower-tier Passthrough Entity (i.e.,
included in a partnership's capital account or a similar account
maintained by another type of Passthrough Entity under Sec. 1.1061-
3(c)(3)(ii) of these proposed regulations) with respect to the
contributed property.
In the case of a revaluation of the property of a partnership that
owns an interest in a tiered structure of partnerships or in the case
of the contribution of an API to another Passthrough Entity, the
proposed regulations provide that Unrealized API Gains and Losses
include capital gains and losses that would be allocated directly or
indirectly to the API Holder by lower-tier partnerships determined as
if a taxable disposition of the property of each of the lower-tier
partnerships also occurred on the date of the revaluation or
contribution.
Although the proposed regulations do not require revaluations under
section 1.704-1(b)(2)(iv)(f), solely to determine and identify
Unrealized API Gains and Losses for purposes of section 1061 upon the
occurrence of a revaluation or contribution, these regulations require
that a revaluation under the principles of Sec. 1.704-1(b)(2)(iv)(f)
be made through each relevant tier of partnerships. Thus, the proposed
regulations require revaluations of all the properties held by all
relevant partnerships in a tiered structure to determine the extent to
which the partnership has Unrealized API Gains and Losses. If a
partnership is required to revalue its assets for purposes of section
1061, such partnership is permitted to revalue its property for
purposes of section 704 as though an event in Sec. 1.704-
1(b)(2)(iv)(f)(5) had occurred.
Further, the proposed regulations require that Unrealized API Gains
and Losses of a partnership be allocated when recognized under
principles consistent with Sec. 1.704-3(a)(9). Accordingly, if at the
time an API Holder contributes an interest in a lower-tier partnership
to an upper-tier partnership, and the lower-tier partnership holds
property with Unrealized API Gains and Losses that are allocable to the
API Holder, those gains and losses when recognized by the lower-tier
partnership must be allocated by the upper-tier partnership to the API
Holder for purposes of section 1061.
The Treasury Department and the IRS believe that these rules serve
two purposes. First, the rules ensure that capital gains and losses
that would be API Gains and Losses are not converted to Capital
Interest Gains and Losses by virtue of a revaluation or a contribution.
Second, these rules also ensure that Unrealized API Gains and Losses of
a partnership when recognized are properly allocated to the correct API
Holder in a tiered structure of partnerships. The Treasury Department
and the IRS request comments on whether such section 1061 revaluations
are necessary or whether there is another mechanism that would ensure
that API Gain or Loss is allocated to API Holders when there is a
revaluation event in one or more of the tiers of entities. Further,
comments are requested on whether the section 704(b) regulations should
be amended to specifically include revaluations when such partnership
revalues its assets for purposes of section 1061 or to address
revaluations through tiers of partnerships for purposes of section 704
more generally.
Unrealized API Gains and Losses that are recognized with respect to
an asset or API held for more than one year on the date of its
disposition become API Gains and Losses at the time they are recognized
and do not lose their character as they are allocated through
Passthrough Entities in a tiered structure. API Gains and Losses do not
include any amounts that otherwise are treated as ordinary income under
any Code section including section 751 and section 1245.
The Treasury Department and the IRS are aware that taxpayers may
seek to circumvent section 1061(a) by waiving their rights to gains
generated from the disposition of a partnership's capital assets held
for three years or less and substituting for these amounts gains
generated from capital assets held for more than three years.
Alternatively, taxpayers may waive their rights to API Gains and
substitute gains that are not taken into account for purposes of
determining the Recharacterization Amount. Some arrangements also may
include the ability for an API Holder to periodically waive its right
to an allocation of capital gains from all assets in favor of an
allocation of capital gains from assets held for more than three years
and/or a priority fill up allocation designed to replicate the
economics of an arrangement in which the API Holder shares in all
realized gains over the life of the fund. These arrangements are often
referred to as carry waivers or carried interest waivers. Taxpayers
should be aware that these and similar arrangements may not be
respected and may be challenged under section 707(a)(2)(A), Sec. Sec.
1.701-2 and 1.704-1(b)(2)(iii), and/or the substance over form or
economic substance doctrines.
g. Related Persons
Section 1061(c)(1) provides that an API includes an interest
transferred to or held by a taxpayer in connection with the performance
of substantial services by the taxpayer or a related person in an
applicable trade or business. Section 1061(d) also provides a rule for
transfers of APIs to certain related persons. Section 1061(d)(2)
provides a definition of related person that applies solely to
transfers subject to section 1061(d) and the proposed regulations refer
to that person as a Section 1061(d) Related Person. However, section
1061 does not include a definition of related person for the remainder
of section 1061. Accordingly, in defining Related Person, the proposed
regulations use the general definition of a person or entity that is
related under sections 707(b) or 267(b) of the Code.
2. API Operational Rules
a. An API Retains Its Status as an API
Section 1061 does not contain a provision that would cause an
interest to cease to be an API unless and until one of the exceptions
to the definition of API applies. Therefore, the proposed regulations
clarify that once a
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partnership interest becomes an API, the partnership interest remains
an API unless and until an exception applies, regardless of whether the
taxpayer or a Related Person continues to provide services in an ATB.
Therefore, even after a partner retires and provides no further
services, if the retired partner continues to hold the partnership
interest, it remains an API. Similarly, if the partner provides
services, but the ATB Activity Test (as defined below) is not met in a
later year, the partnership interest will continue to be an API.
Further, an API remains an API if it is contributed to another
Passthrough Entity or a trust or is held by an estate. As discussed
with respect to the definition of API Gains and Losses and further in
paragraph I.A.2.b. of this Explanation of Provisions, any unrecognized
API Gains and Losses included in a capital account upon contribution of
an API to a Passthrough Entity remain subject to section 1061 when they
are recognized under the Code.
b. API Gains and Losses and Unrealized API Gains and Losses Retain
Their Character
API Gain or Loss retains its character as API Gain or Loss as it is
allocated through tiered Passthrough Entities. Similarly, Unrealized
API Gain or Loss retains its character even though it is included in
the invested capital of a Passthrough Entity (i.e., included in a
partnership's capital account or a similar account maintained by
another type of Passthrough Entities under Sec. 1.1061-3(c)(3)(ii)).
c. Substantial Services
Section 1061(c)(1) provides that an interest in a partnership is an
API only if the interest is transferred to or held by the taxpayer in
connection with the performance of substantial services by the
taxpayer, or by a related person, in an ATB. If a taxpayer provides any
services in an ATB and an allocation of a partnership's profits is
transferred to or held by the taxpayer in connection with those
services, the proposed regulations presume that those services are
substantial for purposes of Section 1061. The Treasury Department and
the IRS have concluded that if an interest is granted in connection
with the performance of services, such services are presumed
substantial with respect to the interest transferred. This presumption
is appropriate because the parties to the arrangement have economically
equated the potential value of the interest granted with the value of
the services performed. Therefore, the services provided are presumed
to be substantial with respect to the interest transferred.
The Treasury Department and the IRS request comments on this
presumption and the specifics of any arrangements in which
insubstantial services could be performed in connection with the
receipt of a profits interest such that the presumption could be
overcome. Those comments also should address how and why Revenue
Procedure 93-27 and Revenue Procedure 2001-43 would apply to
partnership interests received in exchange for such insubstantial
services.
d. Disregarded Entities
Entities that are disregarded from their owners (collectively,
disregarded entities) under any provision of the Code or regulations,
including grantor trusts and qualified subchapter S subsidiaries, are
disregarded for purposes of these regulations. Accordingly, if an API
is held by or transferred to a disregarded entity, the API is treated
as held by or transferred to the disregarded entity's owner.
B. ATB and the ATB Activity Test
1. Relevant Definitions
The proposed regulations provide that an ATB means any activity for
which the ATB Activity Test with respect to Specified Actions is met.
The proposed regulations provide that the ATB Activity Test is met if
Specified Actions are conducted at a level of activity required for an
activity to constitute a trade or business under section 162. For
purposes of determining if the ATB Activity Test is met, all of the
Specified Actions conducted by Related Persons are combined. If these
Specified Actions, all taken together, rise to the level of activity
required to establish a trade or business under section 162, then each
Related Person is determined to be engaged in the Relevant ATB. A
Relevant ATB is the ATB in which services were performed in connection
with which the API was transferred. Multiple Related Persons' actions
are combined and then attributed to each Related Person. Therefore, a
single ATB under section 1061 can include the actions taken by multiple
Related Persons. The definition of an ATB is not the same as the
definition of activity under section 469 and does not take into account
any of the grouping rules under section 469. The definition of an ATB
is solely for purposes of section 1061.
Specified Actions include both Raising or Returning Capital Actions
and Investing or Developing Actions. The proposed regulations'
description of Raising or Returning Capital Actions tracks the
statutory language of section 1061(c)(2)(A). Similarly, the proposed
regulations' description of Investing or Developing Actions tracks the
statutory language of section 1061(c)(2)(B). The proposed regulations
also include guidance regarding developing Specified Assets from the
Conference Report. Specifically, the Conference Report states that
developing specified assets takes place, for example, if it is
represented to investors, lenders, regulators, or others that the
value, price, or yield of a portfolio business may be enhanced or
increased in connection with choices or actions of a service provider
or of others acting in concert with or at the direction of a service
provider. However, merely voting shares owned does not amount to
development; for example, a mutual fund that merely votes proxies
received with respect to shares of stock it holds is not engaged in
development. Conference Report at 421. The proposed regulations provide
that Raising or Returning Capital Actions do not include Investing or
Developing Actions.
The definition of Specified Assets in the proposed regulations
generally tracks the statutory definition of specified assets in
section 1061(c)(3). Both the statute and the proposed regulations
provide that a Specified Asset generally includes a security as defined
in section 475(c)(2). Thus, all corporate stock, regardless of the size
of the corporation or whether the corporation is publicly traded, is a
specified asset. Additionally, the proposed regulations, consistent
with the definition of security in section 475(c)(2), provide that an
interest in a partnership or a beneficial ownership interest in a trust
is a Specified Asset if it is a security described in section
475(c)(2). The proposed regulations follow the statute to provide that
options or derivative contracts with respect to any of the foregoing
Specified Assets are also Specified Assets. Further, as provided in
section 1061(c)(3), an interest in a partnership is also a Specified
Asset to the extent that the partnership itself holds Specified Assets.
The Blue Book provides an example in which a hedge fund acquires an
interest in a partnership that is neither publicly traded nor widely
held and whose assets consist of stocks, bonds, positions that are
clearly identified hedges with respect to securities, and commodities.
The Blue Book provides that the partnership interest is a specified
asset for purposes of the provision. Blue Book at 203. The proposed
regulations
[[Page 49760]]
incorporate this concept as illustrated by the Blue Book. Similar to
the statute's treatment of options or derivative contracts of other
Specified Assets as Specified Assets, the proposed regulations provide
that, solely for purposes of section 1061, Specified Assets also
include a derivative of a partnership interest to the extent not
otherwise included in the definition of Specified Assets.
2. The ATB Activity Test
a. Actions Taken With Respect to Specified Assets Held by a Partnership
In the case of a partnership that directly holds Specified Assets,
actions taken with respect to or on account of these assets, as well as
a percentage of the actions taken with respect to the partnership
interest as a whole, will be taken into account for purposes of the ATB
Activity Test. The percentage of the actions taken with respect to the
partnership as a whole that are taken into account for the test is the
ratio of the value of the partnership's Specified Assets over the value
of all of the partnership's assets. Actions taken to manage working
capital will not be taken into account for purposes of the ATB Activity
Test. The Treasury Department and the IRS request comments on the
application of this rule and how it can be tailored to accomplish the
purposes of section 1061.
b. Application of the ATB Activity Test
i. Aggregate Actions Taken Into Account
The proposed regulations provide that the ATB Activity Test takes
into account the aggregate actions conducted with respect to Raising or
Returning Capital Actions and Investing or Developing Actions. In other
words, the ATB Activity Test does not require that Raising or Returning
Capital Actions and Investing or Developing Actions each individually
meet the required activity level for the ATB Activity Test to be
satisfied.
ii. Raising or Returning Capital Actions and Investing or Developing
Actions Are Not Required To Be Taken Every Year
The Treasury Department and the IRS recognize that, in some cases,
once sufficient capital to engage in Investing or Developing Actions
has been raised, actions involving raising or returning capital may not
be taken for a period of time. Additionally, at the beginning and the
end of the activity, actions involving the raising or returning of
capital may be significant and actions involving investing or
developing may not be taken. The ATB Activity Test looks at the actions
taken as a whole. Accordingly, the proposed regulations provide that
the ATB Activity Test is met if Investing or Developing Actions alone
satisfy the ATB Activity Test in the current year if Raising or
Returning Capital Actions have been taken in prior years. Additionally,
the test is satisfied if Raising or Returning Capital Actions during
the year satisfy the ATB Activity Test and Investing or Developing
Actions are anticipated but not yet taken.
iii. Actions of Related Persons Taken Into Account
The proposed regulations further provide that in applying the ATB
Activity Test, the actions of one or more Related Persons are taken
into account, regardless of whether an entity conducts only Raising or
Returning Capital Actions or only Investing or Developing Actions.
iv. Interests Transferred Prior to Existence of an ATB
An API arises when an interest in a partnership is transferred or
held in connection with services in an ATB. The Treasury Department and
the IRS are aware that interests in a partnership may be issued to a
service provider in anticipation of the service provider providing
services to an ATB, but because an ATB does not exist at the time of
the transfer, the interest is not an API. The Treasury Department and
the IRS have concluded that once the service provider is providing
services in an ATB, the interest becomes an API. Once the interest
becomes an API, its status as an API does not depend on whether the ATB
continues to meet the ATB Activity Test.
II. Section 1.1061-3: Exceptions to the Definition of API
Section 1061 includes four exceptions to its application.
Additionally, these regulations provide an additional exception. First,
the statutory definition of an API excepts an interest held by a person
who is employed by another entity that is conducting a trade or
business (other than an ATB) and provides services only to such other
entity (non-ATB employee exception). Second, section 1061(c)(4)(A)
provides that an API does not include any interest in a partnership
directly or indirectly held by a corporation (corporate exception).
Third, section 1061(c)(4)(B) provides that an API does not include any
capital interest in the partnership (Capital Interest Gains and Losses
exception). Fourth, section 1061(b) provides that to the extent
provided by the Secretary, section 1061 will not apply to income or
gain attributable to any asset not held for portfolio investment on
behalf of third party investors (Section 1061(b) exception). Lastly,
Sec. 1.1061-3 introduces a fifth exception that applies to an
unrelated purchaser who is a non-service provider (bona fide unrelated
purchaser exception).
A. Non-ATB Employee Exception
Section 1061(c)(1) provides that an API is not held by a person who
is employed by another entity that is conducting a trade or business
(other than an ATB) and provides services only to such other entity.
The proposed regulations track the language of the statute.
B. Corporate Exception
Section 1061(c)(4)(A) provides that the term API does not include a
partnership interest directly or indirectly held by a corporation. On
March 19, 2018, the Treasury Department and the IRS issued Notice 2018-
18, notifying taxpayers that the Treasury Department and the IRS
intended to issue regulations providing that the term corporation as
used in section 1061(c)(4)(A) does not include an S corporation. The
notice informed taxpayers that the regulations under section 1061 would
provide that this rule is effective for taxable years beginning after
December 31, 2017 to prevent taxpayers from avoiding the application of
section 1061 through the use of an S corporation. See section
7805(b)(3). The Blue Book also provides that the term corporation for
purposes of section 1061(c)(4)(A) does not include an S corporation.
Blue Book, page 201. Accordingly, these proposed regulations provide
that partnership interests held by S corporations are treated as APIs
if the interest otherwise meets the API definition.
The Treasury Department and the IRS also have concluded that a
partnership interest held by a PFIC with respect to which a taxpayer
has a QEF election in effect is treated as an API if the interest meets
the API definition. Under section 1291, generally, a U.S. person who
owns stock of a PFIC is subject to an interest charge regime in which
interest is charged with respect to certain PFIC distributions and
dispositions of PFIC shares. However, the shareholder can avoid the
interest charge regime by making an election under section 1295 to
treat the PFIC as a QEF. If this election is made, then the holder of
the stock generally is not subject to the interest charge regime and
instead includes in income each taxable year its
[[Page 49761]]
pro rata share of the ordinary income and long-term capital gain of the
QEF. The Treasury Department and the IRS are concerned that, absent
this rule, taxpayers may use PFICs with respect to which they have made
QEF elections to avoid the application of section 1061. Such taxpayers
would have the benefit of passthrough tax treatment without the
application of section 1061. The Treasury Department and the IRS
believe it is inappropriate for a PFIC with respect to which the
shareholder has elected to receive passthrough treatment to be treated
as a corporation for purposes of section 1061. Therefore, the proposed
regulations clarify that a PFIC with respect to which the shareholder
has a QEF election in effect is not treated as corporation for purposes
of section 1061(c)(4)(A). As a result, a partnership interest held by a
PFIC with respect to which the shareholder has a QEF election in effect
will be treated as an API if the interest otherwise meets the API
definition.
Section 1061(f) provides that the Secretary has authority to issue
regulations as are necessary or appropriate to carry out the purposes
of section 1061. Both the Conference Report and the Blue Book further
direct the Treasury Department and the IRS to issue regulations to
address the prevention of abuse of the purposes of the provision. The
Treasury Department and the IRS have concluded that the grant of
regulatory authority in section 1061 is sufficient for the government
to issue regulations providing that the exception in section
1061(c)(4)(A) does not include S corporations and PFICs with respect to
which shareholders have QEF elections in effect. The rule that the
exception in section 1061(c)(4)(A) does not apply to a PFIC with
respect to which the shareholder has a QEF election in effect applies
to all taxable years beginning after the date the proposed regulations
are published in the Federal Register.
C. Capital Interest Gains and Losses Exception
Section 1061(c)(4)(B) provides that an API does not include a
capital interest in the partnership that provides a right to share in
partnership capital commensurate with (i) the amount of capital
contributed (determined at the time of receipt of such partnership
interest), or (ii) the value of such interest subject to tax under
section 83 upon the receipt or vesting of such interest. The statutory
language creates an exception from recharacterization under section
1061 for capital gains and losses with respect to a capital interest.
The Conference Report includes an example in which a partnership
agreement provides that a partner's share of the partnership's capital
is commensurate with the amount of capital the partner contributed at
the time the partnership interest was received compared to the total
partnership capital. The reference to the amount of capital contributed
in section 1061(c)(4)(B)(i) and a similar reference in the Conference
Report indicate that the exception for capital interests should apply
only to the extent that a service provider's rights with respect to its
contributed capital matches the rights of other non-service partners
with respect to their shares of contributed capital. Conference Report
at 420-21.
These proposed regulations provide rules for determining if capital
gains and losses allocated to an API Holder are treated as allocations
with respect to its capital investment and therefore, excluded from the
application of section 1061. As discussed in more detail in section
II.C.1, of this Explanation of Provisions, General Rules Applicable to
the Determination of Capital Interest Allocations and Passthrough
Interest Allocations, an allocation must be made in proportion to the
relative value of the API Holder's capital account (including
unrealized gains and losses) in the Passthrough Entity in order to be
an allocation with respect to a capital investment. The proposed
regulations also provide rules for determining the amount of gain or
loss recognized on the disposition of a Passthrough Interest that is
allocable to the capital interest.
The proposed regulations refer to capital gains and losses with
respect to a capital interest as Capital Interest Gains and Losses.
Specifically, the proposed regulations provide that Capital Interest
Gains and Losses are Capital Interest Allocations, Passthrough Interest
Capital Allocations and Capital Interest Disposition Amounts.
1. General Rules Applicable to the Determination of Capital Interest
Allocations and Passthrough Interest Capital Allocations
a. In the Same Manner
The proposed regulations provide that allocations based on the
partners' capital account balances that have the same terms, the same
priority, the same type and level of risk, the same rate of return, the
same rights to cash or property distributions during partnership
operations and on liquidation will be treated as made in the same
manner. The proposed regulations also provide that an allocation to an
API Holder will not fail to be treated as a Capital Interest Allocation
solely because it is subordinated to an allocation to Unrelated Non-
service Partners or because it is not reduced by the cost of services
provided by the API Holder or by a related person.
b. Capital Accounts
In the case of a partnership that maintains capital accounts under
Sec. 1.704-1(b)(2)(iv), in order for an allocation to qualify as a
Capital Interest Allocation or a Passthrough Interest Capital
Allocation, the allocation must be based on the capital account
determined under Sec. 1.704-1(b)(2)(iv). In the case of a Passthrough
Entity that is not a partnership (or a partnership that does not
maintain capital accounts under Sec. 1.704-1(b)(2)(iv)), if the
Passthrough Entity maintains and determines accounts for its owners in
a manner similar to that provided under Sec. 1.704-1(b)(2)(iv), those
accounts will be treated as capital accounts under the proposed
regulations. These accounts must be used in order for an allocation to
qualify as a Capital Interest Allocation or a Passthrough Interest
Capital Allocation. To qualify to be treated as a capital account for
this purpose, each owner's account must be increased by the money and
the net fair market value of property contributed to the Passthrough
Entity and income and gain allocated to the owner. Each owner's account
must be decreased by any money and the net fair market value of
property distributed to the owner and allocations of expenditures,
loss, and deduction.
Generally, Passthrough Interest Capital Allocations must be based
on each owner's share of the Passthrough Entity's capital account in
the partnership making the Capital Interest Allocations to the
Passthrough Entity. Passthrough Interest Direct Investment Allocations
generally must be based on each owner's share of the capital investment
made by the Passthrough Entity. This amount is equal to the capital
account of the owner reduced by that owner's share of a capital account
held directly or indirectly by the Passthrough Entity in a lower-tier
entity. However, if a Passthrough Entity allocates all Passthrough
Interest Capital Allocations for the taxable year in the aggregate,
regardless of whether they are Capital Interest Allocations or
Passthrough Interest Direct Investment Allocations, the Passthrough
Entity may allocate those allocations based on each owner's capital
account in the Passthrough Entity, regardless of whether some or all of
an owner's
[[Page 49762]]
capital contribution is included in the capital account of a lower-tier
entity.
For purposes of section 1061, a capital account does not include
the contribution of amounts directly or indirectly attributable to any
loan or other advance made or guaranteed, directly or indirectly, by
any other partner or the partnership (or any person related to any such
other partner or the partnership). However, the repayments on the loan
are included in capital accounts as those amounts are paid (unless the
repayments are funded with a similar loan from the partners or the
partnership or any person related to such partners or the partnership).
c. Items That Are Not Treated as Capital Interest Allocations or
Passthrough Interest Capital Allocations
Capital Interest Allocations and Passthrough Interest Capital
Allocations never include any amounts that are treated as API Gains and
Losses or Unrealized API Gains and Losses that are allocated to the
Passthrough Entity by a lower-tier Passthrough Entity. Such allocations
also exclude Partnership Transition Amounts and other items not taken
into account for purposes of section 1061 as described in section III.E
of this Explanation of Provisions.
2. Capital Interest Allocations
Capital Interest Allocations can be made only by a partnership that
has both API Holders and Unrelated Non-Service Partners. Unrelated Non-
Service Partners are partners who do not (and did not) provide services
in the Relevant ATB and who are not (and were not) related to an API
Holder in the partnership or any person who provides services in the
Relevant ATB. Capital Interest Allocations are allocations of long-term
capital gain and loss made under the partnership agreement to the API
Holder and Unrelated Non-Service Partners based on their respective
capital account balances if: (1) The allocations are made to Unrelated
Non-Service Partners with a significant aggregate capital account
balance; (2) the allocations are made in the same manner to the API
Holder and the Unrelated Non-Service Partners; and (3) the terms of the
allocations to the API Holder and the Unrelated Non-Service Partners
are identified both in the partnership agreement and on the
partnership's books and records and the allocations are clearly
separate and apart from allocations made with respect to the API.
These proposed regulations provide that allocations made to
Unrelated Non-service Partners with an aggregate capital account
balance of 5 percent or more of the aggregate capital account balance
at the time the allocation is made by the partnership will be treated
as significant.
3. Passthrough Interest Capital Allocations
Passthrough Interest Capital Allocations are long-term capital gain
and loss allocations made by a Passthrough Entity that holds an API.
The proposed regulations provide for two types of Passthrough Interest
Capital Allocations: Passthrough Capital Allocations and Passthrough
Interest Direct Investment Allocations.
a. Passthrough Capital Allocations
Passthrough Capital Allocations are Capital Interest Allocations
made directly or indirectly to the Passthrough Entity from a lower-tier
entity with respect to its capital account balance in the lower-tier
entity. Passthrough Capital Allocations must be made by the Passthrough
Entity to each of its owners in the same manner based on each owner's
share of the capital account in the lower-tier entity making the
Capital Interest Allocation to the Passthrough Entity.
b. Passthrough Interest Direct Investment Allocations
Allocations are treated as Passthrough Interest Direct Investment
Allocations if the allocations are comprised solely of long-term
capital gains and losses derived from assets (other than an API)
directly held by the Passthrough Entity and not through an allocation
from a lower tier Passthrough Entity. Also, if a Passthrough Entity
received Distributed API Property from a lower-tier entity and the
property is no longer Distributed API Property because it has been held
for more than three years, the property is included in the Passthrough
Entity's direct investment at that time. Generally, allocations must be
made in the same manner to each of the owners of the Passthrough Entity
based on each owner's relative investment in the assets held by the
Passthrough Entity. An allocation will not fail to qualify to be a
Passthrough Interest Direct Investment Allocation if the Passthrough
Entity is a partnership and allocations made to one or more Unrelated
Non-Service Partners have more beneficial terms than allocations to the
API Holders if the allocations to the API Holders are made in the same
manner. For example, if an Unrelated Non-Service Partner receives a
priority allocation and distribution of 10 percent of net long-term
capital gain and loss and the other partners, including the API
Holders, share the remaining 90 percent of the net long-term capital
gain from the Passthrough Entity's direct investments, allocations to
the API Holders are Passthrough Interest Direct Investment Allocations.
Further, allocations made in the same manner to some API Holders by a
partnership will not fail to qualify to be treated as a Passthrough
Interest Direct Investment Allocation as to those partners despite
allocations being made to one or more service providers (or related
parties) that are treated as APIs issued by the Passthrough Entity. For
example, if (1) all of the partners of the Passthrough Entity are API
Holders and one partner manages the Passthrough Entity's direct
investments and receives a 20 percent interest in the net long-term
capital gains from those investments that is treated as an API as to
that partner and (2) the other API Holders share the remaining 80
percent of gain from those investments based on their relative
investments in the Passthrough Entity, then (3) the allocation of the
80 percent of net long-term capital gain is a Passthrough Interest
Direct Investment Allocation to those partners.
c. Aggregate Passthrough Interest Allocations
Instead of separately accounting for Passthrough Capital
Allocations and Passthrough Interest Direct Investment Allocations,
owners of the Passthrough Entity may prefer to allocate items of
Capital Interest Gain or Loss without regard to whether these items
arose from direct investment by the Passthrough Entity or from an
investment in a lower-tier Passthrough Entity. Therefore, the proposed
regulations permit an upper-tier Passthrough Entity to allocate its
Passthrough Capital Allocations and Passthrough Interest Direct
Investment Allocations in the same manner to all of its partners using
the partners' capital accounts in such Passthrough Entity unreduced by
amounts that are included in a capital account of the lower-tier
entity.
4. Request for Comments Regarding Other Allocations
The Treasury Department and the IRS understand that the allocations
in the proposed regulations do not include all allocation arrangements.
The Treasury Department and the IRS request comments on other
allocation arrangements that appropriately could be treated as Capital
Interest Gains and Losses under the regulations without inappropriately
expanding the capital interest exception, taking into account the
statutory requirement that the API Holder's right with respect to its
capital interest be commensurate with other
[[Page 49763]]
partners' rights with respect to their contributed capital.
5. Capital Interest Disposition Amounts
The proposed regulations provide rules for determining the extent
to which long-term capital gain or loss recognized on the disposition
of a Passthrough Interest comprised of both an API and a capital
interest is excluded from section 1061 because it is treated as Capital
Interest Gain or Loss. Nothing in section 1061 or these proposed
regulations overrides existing law regarding the determination of gain
recognized on the disposition of all or a portion of a Passthrough
Interest. In particular, in the case of a disposition of a portion of a
Passthrough Interest, Revenue Ruling 84-53 (1984-1 C.B. 159) applies
and basis must be equitably apportioned between the portion of the
interest disposed of and the portion retained. These proposed
regulations contain amendments to Sec. 1.1223-3 for determining a
divided holding period when a partnership interest includes an API and/
or a profits interest.
A commenter requested guidance on whether a capital interest can be
disposed of separately from an API for purposes of section 1061(a). The
disposition of a capital interest will be treated as such under section
1061 and the gain or loss on the disposition is treated as Capital
Interest Gain or Loss if the interest being disposed of is clearly
identified as a capital interest. However, nothing in section 1061 or
these proposed regulations changes the established partnership
principle that a partner has a unitary basis in its partnership
interest. See Revenue Ruling 84-53. As noted above, the basis must be
equitably apportioned to the transferred portion under the principles
described in Rev. Rul. 84-53 and the holding period of the interest
would be determined under the rules of Sec. 1.1223-3. Thus, a partner
may dispose of solely a capital interest or an API, but in either case,
the partner's basis and holding period (including a split holding
period) is apportioned between the interest retained and the interest
transferred.
The proposed regulations provide that the amount of long-term
capital gain or loss recognized on a disposition that is treated as a
Capital Interest Disposition Amount is determined in a multi-step
process. Amounts that are treated as ordinary income under section
751(a) or (b) as a result of the disposition are excluded from all
steps of the calculation. The computation then proceeds as follows.
First, the amount of gain or loss that would be allocated to the
Passthrough Interest (or the portion of the Passthrough Interest sold)
if all of the assets of the Passthrough Entity were sold for their fair
market value in a fully taxable transaction (deemed liquidation)
immediately before the disposition is determined (Step One). Second,
the amount of gain or loss from the deemed liquidation that is
allocable to the Passthrough Interest as a result of Capital Interest
Allocations, and Passthrough Interest Capital Allocations is determined
(Step Two). If a transferor recognizes capital gain under section
751(b), any amount that constitutes API Gain or Loss is added to any
API Gain or Loss that results from the disposition of the interest.
If gain is recognized under the Code on the disposition of a
Passthrough Interest, and the Capital Interest Allocations, Passthrough
Interest Capital Allocations, and API Holder Transition Amounts
determined under Step Two would result in the allocation of a loss,
then all the gain recognized on the disposition will be treated as API
Gain. Similarly, if loss is recognized on the disposition of a
Passthrough Interest, and the Capital Interest Allocations, Passthrough
Interest Capital Allocations, and API Holder Transition Amounts
determined under Step Two would result in an allocation of a gain, then
all of the loss recognized on the disposition will be treated as an API
Loss.
If gain is recognized under the Code on the disposition of a
Passthrough Interest and gain would be recognized with respect to the
Passthrough Interest under both Step One and Step Two, the API Holder
must determine the portion of the gain that is attributable to the
capital interest and the portion of the gain that is attributable to
the API. To determine these portions, the taxpayer must divide the
capital gain that would be allocated to the interest pursuant to
Capital Interest Allocations, Passthrough Interest Capital Allocations,
and API Holder Transition Amounts on the deemed liquidation of the
partnership under Step Two by the total amount of gain that would be
allocated to the interest on the deemed liquidation under Step One.
This amount, expressed as a percentage, is then multiplied by the total
amount of gain recognized on the sale to determine the amount of the
gain that is treated as a Capital Interest Disposition Amount. A
similar analysis would apply if a loss was recognized on the
disposition of the interest, and both Steps One and Two resulted in a
loss. To the extent that the gain or loss is not treated as a Capital
Interest Disposition Amount, it is API Gain or Loss and subject to
section 1061.
6. Recapitalizations and Divisions
The Treasury Department and the IRS are aware that some taxpayers
have taken the position that a recapitalization or division is a
capital contribution under section 1061(c)(4)(B) that would allow
taxpayers to recharacterize what would be API Gains under these
proposed regulations as Capital Interest Gains. Although a
recapitalization or a division may be treated as a section 721
contribution, these transactions would not have the effect of
recharacterizing API Gains and Losses as Capital Interest Gains and
Losses under these proposed regulations. The section 1061 statutory
language does not support this position and the Treasury Department and
the IRS do not believe it to be a reasonable interpretation of the
statute.
D. Section 1061(b) Exception
Section 1061(b) provides that to the extent provided by the
Secretary, section 1061(a) shall not apply to income or gain
attributable to any asset not held for portfolio investment on behalf
of third party investors. The proposed regulations reserve with respect
to the application of section 1061(b). A third party investor is
defined in section 1061(c)(5) as a person who holds an interest in the
partnership which does not constitute property held in connection with
an applicable ATB; and who does not provide substantial services for
such partnership or for any applicable trade or business. Comments have
suggested that the exception is intended to apply to family offices,
that is, portfolio investments made on behalf of the service providers
and persons related to the services providers. The Treasury Department
and the IRS generally agree with these comments and believe that the
section 1061(b) exception effectively is implemented in the proposed
regulations with the exception to section 1061 for Passthrough Interest
Direct Investment Allocations. The Treasury Department and the IRS
request comments on the application of this provision and whether the
proposed regulations' exclusion for Passthrough Interest Direct
Investment Allocations properly implements the exception.
E. Bona Fide Unrelated Purchaser Exception
The proposed regulations add an exception for unrelated taxpayers
who purchase an API. The proposed regulations provide that an interest
in a partnership that would be treated as an API but is purchased by an
unrelated buyer for the fair market value of the interest is not an API
with respect to the
[[Page 49764]]
buyer if (1) the buyer does not currently and has never provided
services in the relevant ATB (or to the Passthrough Entity in which the
interest is held, if different), (2) does not contemplate providing
services in the future, and (3) is not related to a person who provides
services currently or has provided services in the past. However, it
should be noted that this exception does not apply to an unrelated non-
service provider who becomes a partner by making a contribution to a
Passthrough Entity that holds an API and in exchange receives an
interest in the Passthrough Entity's API. In this case, allocations to
the Unrelated Non-Service Partner with respect to the API are API Gains
and Losses and retain their character as API Gains and Losses.
III. Section 1.1061-4: Computing the Recharacterization Amount
As noted in section I of this Explanation of Provisions, under the
proposed regulations, the amount an Owner Taxpayer must treat as short-
term capital gain under section 1061(a) is called the
Recharacterization Amount. The Recharacterization Amount is the amount
by which the Owner Taxpayer's One Year Gain Amount exceeds the Owner
Taxpayer's Three Year Gain Amount. The Owner Taxpayer's One Year Gain
Amount is comprised of two components: (1) The Owner Taxpayer's
combined net API One Year Distributive Share Amount from all APIs held
during the taxable year; and (2) The Owner Taxpayer's API One Year
Disposition Amount. The Owner Taxpayer's Three Year Gain Amount is
comprised of: (1) Its combined net API Three Year Distributive Share
Amount from all APIs held during the taxable year; and (2) its API
Three Year Disposition Amount. As noted earlier in this preamble, API
Gains and Losses retain their character as they flow through each tier
of Passthrough Entities and are netted at the Owner Taxpayer level to
determine the Recharacterization Amount.
A. Determination of the API One Year Distributive Share Amount
Each Passthrough Entity must calculate an API One Year Distributive
Share Amount for each API Holder that directly holds an interest in the
Passthrough Entity for the taxable year. Under the proposed
regulations, all long-term capital gain and loss allocated to the API
Holder by the Passthrough Entity are API Gains and Losses to the API
Holder unless an exception applies.
If the Passthrough Entity is a partnership, the Passthrough Entity
determines its API One Year Distributive Share Amount in a series of
steps. First, the partnership determines the long-term capital gains
and losses that are allocated to the API Holder under the partnership
agreement under sections 702 and 704. This amount includes long-term
capital gains and losses from the taxable disposition of Distributed
API Property by the partnership that was distributed to it from a
lower-tier entity. Second, the partnership reduces this amount by
amounts that are not taken into account under these proposed
regulations for purposes of calculating the Recharacterization Amount.
As discussed in section III.E of this Explanation of Provisions,
section 1231 amounts, section 1256 amounts, and qualified dividends are
excluded from the calculation of the Recharacterization Amount and are
not included in the API One Year Distributive Share amount. The same is
true for the API Holder Transition Amount, which is also discussed in
section III.E of this Explanation of Provisions, and for long-term
capital gain or loss from the disposition of property that was once
Distributed API Property but that has ceased to be Distributed API
property because it was disposed of when the asset had a holding period
that was more than three years. Third, the partnership reduces the
amount determined under the second step by any amounts that are treated
as Capital Interest Gains and Losses under Sec. 1.1061-3(c). The
resulting amount is the API Holder's One Year Distributive Share Amount
and the partnership must report this amount to the API Holder as its
API One Year Distributive Share Amount under Sec. 1.1061-6.
Additionally, under Sec. 1.1061-6, the partnership must report to the
API Holder the amount of Capital Interest Gains and Losses and API
Holder Transition Amounts that have been allocated to the API Holder
for the calendar year.
An API One Year Distributive Share Amount must also be calculated
by an S corporation that holds an API for each direct API Holder in the
S corporation. In this case, the S corporation must report to each API
Holder its pro rata share of the API Gains and Losses allocated to the
S corporation with respect to its API. Such amounts also may be
calculated and reported by a PFIC with respect to which the shareholder
has a QEF election in effect.
B. Determination of the API Three Year Distributive Share Amount
Under the proposed regulations, the API Three Year Distributive
Share Amount is equal to an API Holder's One Year Distributive Share
Amount less amounts that would not be treated as long-term capital gain
and loss if such amount were computed by applying paragraphs (3) and
(4) of section 1222 and substituting three years for one year in those
paragraphs. In addition, if the Passthrough Entity sold an API during
the taxable year and the Lookthrough Rule applies, the API Holder's One
Year Distributive Share Amount is further reduced by the adjustment
required by the Lookthrough Rule as described in section III.E of this
Explanation of Provisions. These amounts must be calculated by the
Passthrough Entity and reported to the API Holder under Sec. 1.1061-6.
C. Determination of the API One Year Disposition Amount and the API
Three Year Disposition Amount
The API One Year Disposition Amount includes the long-term capital
gains and losses that the Owner Taxpayer recognizes from the direct
taxable disposition of an API, including gain or loss under sections
731(a) and 752(b), that has been held for more than one year. The API
One Year Disposition Amount also includes long-term capital gain or
loss recognized on the disposition of Distributed API Property by an
Owner Taxpayer. The API Three Year Disposition Amount includes only the
long-term capital gain or loss from the direct taxable disposition of
an API held by the Owner Taxpayer for more than three years. However,
if the Lookthrough Rule, as described in Sec. 1.1061-4(b)(9) and
discussed further in section III.E.7 of this Explanation of Provisions,
applies, the API Three year Disposition Amount is further reduced by
the adjustment required by the Lookthrough Rule.
Section 751(b) provides that in the case of certain
disproportionate distributions, a partner may be treated as engaging in
a sale or exchange of property with the partnership. To the extent that
such an exchange results in long-term capital gain with respect to an
API under section 751(b), it is included in the One Year Disposition
Amount and additionally, if appropriate, amounts may be included in the
Three Year Disposition Amount. See Sec. 1.751-1(b)(2).
D. Determination of the One Year Gain Amount and Three Year Gain Amount
In determining the One Year Gain Amount and Three Year Gain Amount,
all amounts are netted at the Owner Taxpayer level. If an Owner
Taxpayer holds more than one API, the Owner Taxpayer combines and nets
its API Distributive Share Amounts from each API that it held during
the taxable year
[[Page 49765]]
to determine its combined net API One Year Distributive Share Amount
and net API Three Year Distributive Share Amount. Additionally, the
taxpayer must take into account its API One Year Disposition Amount and
its API Three Year Disposition Amount. If the One Year Gain Amount is
zero or less than zero, section 1061 does not apply because there is no
gain to recharacterize. Further, in applying section 1(h) of the Code,
the Owner Taxpayer determines its net capital gain for the taxable year
taking into account section 1061. Comments are requested regarding the
calculation of collectibles gain and loss under section 1(h)(5) and
unrecaptured section 1250 gain in section 1(h)(6) in cases where
collectibles gain or unrecaptured section 1250 gain is included in the
Recharacterization Amount under section 1061(a) and under section
1061(d).
E. General Calculation Rules
This section discusses general rules included in the proposed
regulations for calculating the One Year Gain Amount and Three Year
Gain Amount.
1. Items Not Taken Into Account for Purposes of Section 1061(a)
Section 1061(a) applies to assets that produce capital gains or
losses that are treated as long-term capital gain under paragraphs (3)
and (4) of section 1222. Section 1231 gains and losses are treated as
long-term based on the operation of section 1231, and not by reference
to paragraphs (3) and (4) of section 1222. Similarly, section 1256
provides for specific character treatment and does not calculate gain
by reference to section 1222. Accordingly, the proposed regulations
provide that long-term capital gains determined under section 1231 or
section 1256 are excluded from both the One Year and Three Year Gain
Amounts. For similar reasons, amounts treated as qualified dividends
under section 1(h)(11) and any capital gain that is characterized as
long term or short term without regard to the holding period rules in
section 1222, such as capital gains characterized under the identified
mixed straddle rules described in section 1092(b) and Sec. Sec.
1.1092(b)-3T, 1.1092(b)-4T, and 1.1092(b)-6, are also excluded.
2. API Holder Transition Amounts
As described in the discussion of Capital Interest Gains and
Losses, section 1061(c)(4) provides an exception with respect to
certain capital interests. Prior to the enactment of section 1061,
taxpayers had no reason to track what portion of the unrealized
appreciation in partnership assets was attributable to capital
interests. Therefore, the Treasury Department and the IRS are aware
that partnerships may not have information readily available to enable
them to comply with these regulations with respect to property that the
partnership held for more than three years as of the effective date of
section 1061. Accordingly, the proposed regulations provide a
transition rule for partnership property that was held by the
partnership for more than three years as of the effective date of
section 1061. Under these proposed regulations, a partnership that was
in existence as of January 1, 2018 may irrevocably elect to treat all
long-term capital gains and losses from the disposition of all assets,
regardless of whether they would be API Gains or Losses in prior
periods, that were held by the partnership for more than three years as
of January 1, 2018 as Partnership Transition Amounts. Partnership
Transition Amounts that are allocated to the API Holder (API Holder
Transition Amounts) are not taken into account for purposes of
determining the Recharacterization Amount. Rather, they are treated as
long-term capital gains and losses and are not subject to
recharacterization under section 1061 and these proposed regulations.
For amounts to be treated as Partnership Transition Amounts, the
partnership must make a signed and dated election (election statement)
by the due date, including extensions, of the Form 1065, ``U.S. Return
of Partnership Income,'' for the first partnership taxable year in
which it treats amounts as Partnership Transition Amounts. The election
statement must be identified as an election under Sec. 1.1061-
4(b)(7)(iii) and filed with the IRS as an attachment to the Form 1065
filed for the partnership's taxable year in which it is making the
election. By the due date of the election, the partnership must clearly
and specifically identify all of the assets held by the partnership for
more than three years as of January 1, 2018 in the partnership's books
and records. The election applies to the year for which the election is
made and all subsequent years. Taxpayers may rely on these proposed
regulations to make the election for taxable years beginning in 2020 or
in a later year before the final regulations apply.
As noted above, Partnership Transition Amounts that are allocated
to the API Holder are called API Holder Transition Amounts under the
proposed regulations. The API Holder Transition Amount in any year is
the amount of the Partnership Transition Amount for the year that is
included in the amount of long-term capital gains and losses allocated
to the API Holder under sections 702 and 704 with respect to its
interest in the partnership under the current partnership agreement.
However, the amount allocated to the API Holder in any taxable year
under the preceding sentence cannot exceed the amount of the
Partnership Transition Amount that would have been allocated to the API
Holder with respect to its partnership interest under the partnership
agreement for the 2017 taxable year to the extent it was amended on or
before March 15, 2018. The partnership must retain an executed copy of
the partnership agreement in effect for the 2017 taxable year to the
extent amended on or before March 15, 2018 as part of its books and
records.
A Passthrough Entity that receives an allocation of API Holder
Transition Amounts from a lower-tier entity cannot allocate more of the
Passthrough Entity's API Holder Transition Amount to the Passthrough
Entity's direct API Holders than the amount of Partnership Transition
Amounts the API Holders would have been allocated by the Passthrough
Entity under the Passthrough Entity's governing documents in effect for
the calendar year ending December 31, 2017 to the extent amended on or
before March 15, 2018. Further, the amount allocated to the Passthrough
Entity's direct API Holders cannot exceed the amount of the Passthrough
Entity's API Holder Transition Amounts the Passthrough Entity was
allocated by the lower-tier Passthrough Entity.
Unlike other provisions of the proposed regulations, API Holders
and Passthrough Entities may elect and treat amounts as Partnership
Transition Amounts and API Holder Transition Amounts for taxable years
beginning in 2020 or a later taxable year without following all of the
provisions of the proposed regulations provided that the partnership
consistently treats long-term capital gains and losses from identified
assets as Partnership Transition Amounts and API Holder Transition
Amounts for the year in which the election is made and all subsequent
taxable years beginning before the final regulations are published in
the Federal Register. The Treasury Department and IRS request comments
on whether a transition rule is needed and whether the Partnership
Transition Amount Rule is useful or whether another approach would be
more helpful in easing transition difficulties.
3. Installment Sale Gain
The proposed regulations provide that the Owner Taxpayer's One Year
Gain
[[Page 49766]]
Amount and Three Year Gain Amount include gains from installment sales,
regardless of whether the installment sale occurred before the
effective date of section 1061. The proposed regulations also make
clear that the holding period of the asset on the date of its
disposition is used for purposes of applying section 1061. Accordingly,
if an API was sold on November 30, 2017 and, at the time of its sale,
it had a holding period of two years, gain recognized on or after
January 1, 2018 is subject to section 1061 even though the disposition
occurred before the effective date of section 1061.
This rule is consistent with the manner in which installment sales
are treated under existing law. See, e.g., Snell v. Commissioner, 97
F.2d 891 (5th Cir. 1938) (the tax laws in effect for the year the
installment gain is recognized apply to the gain); see also Estate of
Kearns v. Commissioner, 73 T.C. 1223 (1980); Klein v. Commissioner, 42
T.C. 1000 (1964); Revenue Ruling 79-22 (1979-1 C.B. 275). The holding
period of the asset disposed of is the holding period on the date of
disposition because section 453 defers gain recognition, not gain
realization, and thus section 1061(a) applies to each year in which
gain is recognized after 2017, even if the gain is recognized more than
three years after the date of sale. Estate of Henry H Rodgers v.
Commissioner, 143 F.2d 695, 696-697 (1944).
4. Regulated Investment Company (RIC) and Real Estate Investment Trust
(REIT) Capital Gain Dividends
Section 852(b)(3)(C)(i) provides generally that a RIC capital gain
dividend is any dividend, or part thereof, which is reported by the RIC
as a capital gain dividend in written statements furnished to its
shareholders. Similarly, section 857(b)(3)(B) provides generally that a
REIT capital gain dividend is any dividend, or part thereof, which is
designated by the REIT as a capital gain dividend in a written notice
mailed to its shareholders. The aggregate amount of capital gain
dividends paid by a RIC or REIT for a taxable year, however, may not
exceed the net capital gain of the RIC or REIT for that taxable year.
Section 852(b)(3)(B) provides that a RIC capital gain dividend
shall be treated by the shareholders as a gain from the sale or
exchange of a capital asset held for more than one year. Similarly,
section 857(b)(3)(A) provides that a REIT capital gain dividend shall
be treated by the shareholders as a gain from the sale or exchange of a
capital asset held for more than one year.
The Treasury Department and the IRS are aware that taxpayers are
concerned that section 1061(a)(2) might be read to prevent RIC and REIT
capital gain dividends received by partnerships from being treated as
long-term capital gains by taxpayers that hold APIs in those
partnerships. Specifically, taxpayers are concerned that these
dividends may not meet the three-year holding period requirement under
section 1061(a) because of the specification in sections 852(b)(3)(B)
and 857(b)(3)(A) that these dividends are treated as a gain from the
sale or exchange of a capital asset held for more than one year. The
Treasury Department and the IRS agree that long-term capital gain
treatment should be available to the extent that the capital gain
dividend is attributable to capital assets held for more than three
years or is attributable to assets that are not subject to section
1061.
The proposed regulations address this issue by allowing a RIC or
REIT to disclose two additional amounts for purposes of section 1061.
The two additional amounts to be disclosed are based on modified
computations of the RIC's or REIT's net capital gain. First, the RIC or
REIT may disclose the amount of the capital gain dividend that is
attributable to the RIC's or REIT's net capital gain excluding any
amounts not taken into account for purposes of section 1061 under Sec.
1.1061-4(b)(6) from the computation. Second, the RIC or REIT may
disclose the amount of the capital gain dividend that is attributable
to the RIC's or REIT's net capital gain both (1) excluding any amounts
not taken into account for purposes of section 1061 under Sec. 1.1061-
4(b)(6) from the computation, and (2) substituting three years for one
year in applying section 1222. The proposed regulations allow a RIC or
REIT to disclose these two additional amounts in writing to its
shareholders with its section 852(b)(3)(C)(i) capital gain dividend
statement or section 857(b)(3)(B) capital gain dividend notice.
The proposed regulations provide that partnerships that receive
either or both of these additional capital gain dividend disclosures
from a RIC or REIT must use each additional disclosed amount in
calculating API distributive share amounts. The first additional
disclosed amount is used for the calculation of an API One Year
Distributive Share Amount. The second additional disclosed amount is
used for the calculation of an API Three Year Distributive Share
Amount. However, the proposed regulations provide that the full amount
of the RIC's or REIT's capital gain dividend must be used for the
calculation of an API One Year Distributive Share Amount if the first
additional amount is not disclosed, and no amount of the RIC's or
REIT's capital gain dividend may be used for the calculation of an API
Three Year Distributive Share Amount if the second additional amount is
not disclosed.
To prevent the avoidance of section 1061, the proposed regulations
also provide that each of the two additional disclosed amounts provided
to each shareholder of a RIC or REIT must be proportionate to the share
of capital gain dividends reported or designated to that shareholder
for the taxable year. Cf. Section 857(g)(2) and Rev. Rul. 89-81, 1981-1
C.B. 226.
Additionally, in accordance with sections 852(b)(4) and 857(b)(8),
the proposed regulations provide that with respect to any shares of RIC
or REIT stock with respect to which a partnership receives a capital
gain dividend distribution and the second additional disclosed amount
that is used to calculate the API Three Year Distributive Share Amount,
any loss on the sale or exchange of such shares held for less than six
months will be treated as capital loss on assets held for more than
three years to the extent of the second additional disclosed amount
that is included in the calculation of an API Three Year Distributive
Share Amount.
5. Distributed API Property
Generally, the distribution of property with respect to an API does
not accelerate the recognition of gain under section 1061 or these
proposed regulations. However, if Distributed API Property is disposed
of by the distributee-partner when the holding period is three years or
less (inclusive of the partnership's holding period), gain or loss with
respect to the disposition is API Gain or Loss. Distributed API
Property retains its character as it is passed from one tier to the
next. However, at the time that Distributed API Property is held for
more than three years, it loses its character and is no longer
Distributed API Property. If Distributed API Property is distributed
from one Passthrough Entity to another and the upper-tier entity
disposes of the property, the long-term capital gain or loss is
included in the upper-tier entity's long-term capital gain or loss as
API Gain or Loss. If the property is distributed to an Owner Taxpayer
and the Owner Taxpayer disposes of the property, the capital gain or
loss is included in the Owner Taxpayer's API One Year Disposition Gain
or Loss. This rule is necessary to prevent the avoidance of section
1061 because,
[[Page 49767]]
absent such a rule, section 1061 could be circumvented by the
partnership's distribution of an asset to the API Holder prior to the
sale of the asset in situations in which the asset has been held by the
partnership for three years or less.
6. Holding Periods Used for Applying Section 1061
The Treasury Department and the IRS considered different approaches
to the holding period rules. As one commentator pointed out, there are
a number of different approaches that can be considered. These
approaches include: (1) Using the holding period of the owner of the
asset sold (whether the asset disposed of is the API itself or is an
underlying capital asset held by the partnership); (2) using the Owner
Taxpayer's holding period in its interest; (3) using the partnership's
holding period in its assets; or (4) using the lesser of the holding
period of the partnership in the assets or the Owner Taxpayer's holding
period in the interest. If the holding period of the owner of the asset
applies, then the partnership's holding period in the asset or the
partner's holding period in the API applies (whichever is disposed of).
The proposed regulations adopt the approach that the holding period
of the owner of the asset sold controls. The Treasury Department and
the IRS have adopted this approach because it is the approach most
consistent with subchapter K of chapter 1 of the Code and the intended
application of section 1061. Additionally, this approach is also the
most administrable for taxpayers and the government.
To this end, the proposed regulations provide that if a partnership
disposes of an asset, it is the partnership's holding period in the
asset that controls. This includes the disposition of an API by the
partnership. This result is consistent with the application of section
702(b) and Revenue Ruling 68-79 (1968-1 C.B. 310) which ruled that when
a partnership sells a capital asset held by the partnership for over 6
months (the then-required holding period for long-term capital gains),
a new partner takes into account his distributive share of gain from
the sale as long-term capital gain notwithstanding that the partner has
not held its interest in the partnership long enough to qualify for
long-term capital gain treatment if the partnership interest itself had
been sold.
Section 741 provides that gain or loss on the sale of a partnership
interest is considered as gain or loss from the sale or exchange of a
capital asset except as otherwise provided in section 751. Therefore,
the sale of a partnership interest generally follows an entity
approach, as opposed to an aggregate approach. Following this approach,
the proposed regulations provide that, except to the extent that the
Lookthrough Rule described in Sec. 1.1061-4(b)(9) and section III.E.7
of this Explanation of Provisions, applies, the holding period that an
API Holder has in an API is the applicable holding period upon the
disposition of an API.
The proposed regulations also provide that for purposes of
computing the Three Year Gain Amount, the relevant holding period of
either an asset or an API is determined under all provisions of the
Code or regulations that are relevant to determining whether an asset
or API has been held for the long-term holding period by applying those
provisions as if the applicable holding period were three years instead
of one year.
These proposed regulations also amend Sec. 1.1223-3 to clarify how
to calculate the holding period of an API when the API comprises a
portion of the partnership interest and the partnership interest has a
divided holding period under Sec. 1.1223-3. This clarification applies
to the calculation of all profits interests and all APIs. Section
1.1223-3(a) provides that a partnership has a divided holding period if
portions of the interest are acquired at different times or the partner
acquired portions of the partnership interest in exchange for property
transferred at the same time but resulting in different holding
periods. The general rule in Sec. 1.1223-3(b)(1) is that the portion
of the interest to which the holding period relates is determined by
reference to a fraction, the numerator of which is the fair market
value of the portion of the partnership interest received in the
transaction to which the holding period relates, and the denominator of
which is the fair market value of the entire partnership interest
determined immediately after the acquisition transaction. In the case
of the portion of a partnership interest that is comprised in part by
one or more APIs or profits interests, the proposed regulations clarify
the timing of this determination as to that portion to the time
immediately before the disposition (as compared to the acquisition) of
all or a part of the interest. Accordingly, in the case of a
partnership interest that has a divided holding period and the
partnership interest includes a profits interests, the relative fair
market of the profits interest is determined at the time of the
interest's disposition (or partial disposition). The holding period of
the portion of the interest that does not include the profits interest
continues to be determined under Sec. 1.1223-3(b)(1). No inference is
intended with respect to the valuation of a profits interest that fails
to meet the safe harbor under Revenue Procedure 93-27 (as clarified in
Revenue Procedure 2001-43).
7. Lookthrough Rule on Sale of APIs
Generally, these proposed regulations do not look through a
partnership to its assets on the sale of a partnership interest.
However, the proposed regulations include a limited Lookthrough Rule
that may apply to the sale of an API with a holding period of more than
three years for capital gain. In the case of a disposition of a
directly held API with a holding period of more than three years, the
Lookthrough Rule applies if the assets of the partnership in which the
API is held meet the Substantially All Test. In the case of a tiered
structure in which an API Holder holds its API through one or more
Passthrough Entities, the Lookthrough Rule applies if the API Holder
disposes of a Passthrough Interest held for more than three years for a
gain and either the Passthrough Entity through which the API is
directly or indirectly held has a holding period in the API that is
three years or less, or the Passthrough Entity through which the API is
held has a holding period in the API of more than three years and the
assets of the partnership in which the API is held meet the
Substantially All Test. The Lookthrough Rule does not apply to the
disposition of an API if section 1061(d) applies.
The Substantially All Test is met if 80 percent or more of the
assets of the partnership in which the API is held, based on fair
market value, are assets that would produce capital gain or loss that
is not described in Sec. 1.1061-4(b)(6) if disposed of by the
partnership and have a holding period of three years or less. The
determination of whether the substantially all test is met is made by
expressing the value of a fraction as a percentage. The numerator of
the fraction is equal to the aggregate fair market value of the
partnership's assets that would produce capital gain or loss that is
not described in Sec. 1.1061-4(b)(6) if disposed of by the partnership
and that have a holding period of three years or less to the
partnership as of the date of disposition of the API. The denominator
is equal to the aggregate fair market value of the partnership's
assets. Cash, cash equivalents, unrealized receivables under section
751(c), and inventory items under section 751(d) are not taken into
account for purposes of the Substantially All Test.
[[Page 49768]]
In the case of a disposition of an API by an API Holder that is an
Owner Taxpayer, all of the long-term capital gain recognized on the
disposition is included in the API One Year Disposition Amount. The
amount included in the API Three Year Disposition Amount with respect
to the disposition is the amount included in the API One Year
Disposition Amount reduced by any adjustment amount required by the
Lookthrough Rule. In the case of a disposition of an API by an API
Holder that is a Passthrough Entity to which the Lookthrough Rule
applies, the long-term capital gain recognized on the sale is included
in the API One Year Distributive Share Amount calculated for the API
Holders of the Passthrough Entity. Section 1.1061-4(a)(3) provides that
the API Three Year Distributive Share Amount is reduced by the
adjustment amount required by the Lookthrough Rule. The adjustment
amount required by the Lookthrough Rule is either the capital gain
recognized on the disposition of the API that is attributable to the
assets whose fair market value is included in the numerator of the
fraction used for the Substantially All Test, or, in the case of an API
indirectly held through a Passthrough Entity for three years or less,
the gain attributable to the API.
IV. Transfers to Related Parties
A. Recognition and Recharacterization
Under section 1061(d), if a taxpayer transfers an API to a related
person described in section 1061(d)(2) in a transfer that would not
otherwise be a taxable event, the taxpayer must include certain capital
gain in gross income as short-term capital gain. The amount of gain
required to be included as short-term capital gain is the excess of the
net built-in long-term capital gain in assets held for three years or
less attributable to the transferred interest, over the amount of long-
term capital gain recognized on the transfer that is treated as short
term capital gain under section 1061(a). If the transfer is otherwise
taxable, section 1061(d) recharacterizes all or a portion of the
capital gain otherwise recognized on the transfer as short-term capital
gain. If the amount of capital gain otherwise recognized by the
taxpayer on a taxable transfer is less than the amount required to be
included under section 1061(d), the taxpayer must include the
difference as short-term capital gain under section 1061(d). The
proposed regulations refer to a related person described in section
1061(d)(2) as a Section 1061(d) Related Person.
One commentator suggested that the Treasury Department and the IRS
suspend the application of section 1061(d) until Congress clarifies its
application. The Treasury Department and the IRS do not believe a
suspension is necessary. Rather, the Treasury Department and the IRS
interpret section 1061(d)(1) to require that gain equal to the amount
described in that section be recognized and included in income as
short-term capital gain on the transfer of an API to a Section 1061(d)
Related Person even if the transfer is not a transaction in which gain
is otherwise recognized under the Code. The term transfer under the
proposed regulations includes, but is not limited to, contributions,
distributions, sales and exchanges, and gifts.
B. Section 1061(d) Related Person
Section 1061(d)(2) defines a related person to be a member of the
taxpayer's family within the meaning of section 318(a)(1) or a person
who performed a service within the current calendar year or the
preceding three calendar years in any ATB in which or for which the
taxpayer performed a service. The Conference Report describes a Section
1061(d) Related Person as a family member or colleague (or recent
former colleague). Conference Report at 422. For these purposes, a
taxpayer is the same taxpayer used for computation purposes (as opposed
to the taxpayer used for determining whether the elements of an API are
met), that is, an Owner Taxpayer. The proposed regulations clarify that
for a service provider to be treated as a Section 1061(d) Related
Person, the service provider must provide services or have provided
services in the same ATB to which the transferred API relates, that is,
in the Relevant ATB. The proposed regulations also include within the
definition of Section 1061(d) Related Person any Passthrough Entity to
the extent that a Section 1061(d) Related Person holds an interest. The
Treasury Department and the IRS request comments on how to calculate
section 1061(d) gain when a Passthrough Entity is only partially a
Related Person.
The proposed regulations provide that a contribution under section
721(a) to a partnership is not treated as a transfer to a Section
1061(d) Related Person because the proposed regulations require that
under the principles of section 704(c) and Sec. Sec. 1.704-
1(b)(2)(iv)(f) and 1.704-3(a)(9) all Unrealized API Gains that would be
directly or indirectly allocated to the API Holder at the time of
contribution must be allocated to the API Holder contributing the
interest when they are recognized. The Treasury Department and the IRS
request comments on transfers other than section 721(a) contributions
that satisfy the foregoing standard and that therefore should be
excluded from section 1061(d).
The proposed regulations use the term ``person'' as the term is
generally used under section 7701(a)(1). Section 7701(a)(1) defines
``person'' to include an individual, trust, estate, partnership,
association, company, or corporation. Under the section 7701(a)(1)
definition of person, for example, a management company could qualify
as a related person under section 1061(d)(2) because the management
company would have performed a service in the same ATB in which the
taxpayer had performed a service in the three years preceding the
transfer.
C. Gain Recharacterized by Section 1061(d)
Section 1061(d)(1) requires the taxpayer to include as short-term
capital gain the excess of the taxpayer's long-term capital gain with
respect to such interest for such taxable year attributable to the sale
or exchange of any asset held for not more than three years as is
allocable to such interest over any amount treated as short-term
capital gain with respect to the transfer of the interest under section
1061(a).
The proposed regulations provide that the long-term capital gain
with respect to the transferred API attributable to the sale or
exchange of any asset held not more than three years is the long-term
capital gain that would be allocated to the transferred API if,
immediately before the transfer, the partnership that issued the API
had sold all of its assets held for three years or less for fair market
value in a hypothetical sale. If the result is negative, the result is
deemed to be zero and section 1061(d) does not apply.
The proposed regulations provide that if the basis of the
transferred API in the transferee's hands is determined in whole or in
part by the basis of the API in the transferor's hands before
application of section 1061(d), then the basis of the transferred API
shall be increased (before the application of section 1015(d), if
applicable) by the capital gain included in gross income by the
transferor solely by reason of section 1061(d). If an Owner Taxpayer
transfers only a portion of an API, section 1061(d) applies only to the
portion transferred.
V. Securities Partnerships
The proposed regulations include an amendment to Sec. 1.704-
3(e)(3). Section 1.704-3(e)(3)(i) provides that for purposes of making
reverse section
[[Page 49769]]
704(c) allocations, a securities partnership may aggregate gains and
losses from financial assets using any reasonable approach that is
consistent with the purpose of section 704(c). The proposed regulations
amend Sec. 1.704-3(e)(3) to provide that an approach will not be
considered reasonable if it fails to take into account the application
of section 1061. Additionally, the proposed regulations provide that if
the partnership aggregates gains and losses with respect to capital
assets held for more than one year, for the partial netting approach in
Sec. 1.704-3(e)(3)(iv) and the full netting approach in Sec. 1.704-
3(e)(3)(v) to be considered reasonable, the partnership must establish
separate accounts (1) for taking into account each API Holder's share
of book API Gains and Losses and book Capital Interest Gains and Losses
and (2) for determining each API Holder's share of tax API Gains and
Losses and tax Capital Interest Gains and Losses. The proposed
regulations do not include rules for dividing existing accounts to
determine API Gains and Losses and Capital Interest Gains and Losses.
However, the proposed regulations provide that the manner in which such
accounts are apportioned must be reasonable. One method that the
Treasury Department and the IRS have concluded is reasonable is to
apportion existing accounts based on the relative API Gain or Loss
amounts and Capital Interest Gain or Loss amounts that would be
allocated to the API Holder as a result of a deemed liquidation of the
partnership. The Treasury Department and the IRS request comments on
whether further guidance on this issue is necessary for securities
partnerships using the aggregation rules in Sec. 1.704-3(e)(3).
VI. Reporting Requirements
These proposed regulations provide that an Owner Taxpayer must
report any information the Commissioner may require in forms,
instructions or other guidance to evidence the taxpayer's compliance
with section 1061. Under the proposed regulations, a Passthrough Entity
in which an Owner Taxpayer holds its interest is required to provide
the information needed by the Owner Taxpayer to comply with section
1061 and to determine its Recharacterization Amount. The Passthrough
Entity is required to provide the Owner Taxpayer with the API One Year
Distributive Share Amount and the API Three Year Distributive Share
Amount. Additionally, the Passthrough Entity must provide the Owner
Taxpayer with the adjustments that must be made to the Owner Taxpayer's
distributive share of long-term capital gain or loss that would allow
the Owner Taxpayer to independently calculate its API One Year
Distributive Share Amount and its API Three Year Distributive Share
amount. Consistent with Sec. 1.6001-1(a) and (e), if an Owner Taxpayer
is not furnished its API One Year Distributive Share Amount, the IRS
will treat the amount of the adjustments necessary to independently
calculate the API One Year Distributive Share as zero and will also
treat the API Three Year Distributive Share as zero to the extent
information is not provided to the Owner Taxpayer and the Owner
Taxpayer is not able to otherwise substantiate all or a part of those
amounts to the satisfaction of the Secretary. For example, if the Owner
Taxpayer is not furnished its API One Year Distributive Share Amount,
the IRS will not take into account amounts that are excluded from
section 1061 under Sec. 1.1061-1(b)(6) unless the Owner Taxpayer is
furnished information regarding this amount or the Owner Taxpayer is
otherwise able to substantiate this amount. Similarly, if the Owner
Taxpayer is not furnished its API Three Year Distributive Share Amount,
to the extent that the Owner Taxpayer is also not furnished information
regarding items that are not treated as long term capital gain or loss
if paragraphs (3) and (4) of section 1222 required a three year holding
period for long-term capital gain treatment, the IRS will treat the API
Three Year Distributive Share Amount as zero if the taxpayer cannot
otherwise substantiate this amount. An Owner Taxpayer that takes a
position that is inconsistent with the information provided to it by a
Passthrough Entity may have to attach Form 8082, ``Notice of
Inconsistent Treatment or Administrative Adjustment Request (AAR),'' to
its federal income tax return.
A Passthrough Entity that has an API Holder must report information
to the API Holder to enable the API Holder to comply with the
regulations under section 1061 as the Commissioner may require in
forms, instructions, or other guidance. It is contemplated that the
Passthrough Entity generally will be required to provide this
information as an attachment to the Schedule K-1 furnished to the API
Holder for the taxable year. The proposed regulations provide that this
information includes (i) the API One Year Distributive Share Amount and
the API Three Year Distributive Share Amount; (ii) long-term capital
gains and losses allocated to the API Holder that are excluded from
section 1061 under Sec. 1.1061-4(b)(6); (iii) Capital Interest Gains
and Losses allocated to the API Holder; (iv) API Holder Transition
Amounts; and (v) in the case of a disposition by an API Holder of an
interest in the Passthrough Entity during the taxable year, any
information required by the API Holder to properly take the disposition
into account under section 1061, including information regarding the
application of Lookthrough Rule and information necessary to determine
its Capital Interest Disposition Amount. Penalties will apply to a
Passthrough Entity that fails to comply with the reporting rules in
these proposed regulations and as further required in forms,
instructions or other guidance. See e.g., section 6698 (Failure to File
Partnership Returns), section 6699 (Failure to File S Corporation
Return), section 6722 (Failure to Furnish Correct Payee Statements).
A Passthrough Entity that holds an interest in a lower-tier entity
may need information from the lower-tier entity to meet its reporting
obligations under the proposed regulations. In this case, the
Passthrough Entity must request information from any lower-tier
entities in which it owns an interest by the later of the 30th day of
the close of the calendar year or within 14 days after having received
a request for information from an API Holder. The lower-tier entity
must respond by the due date (including extensions) of the Schedule K-1
for the taxable year. The proposed regulations provide guidance
regarding an upper-tier Passthrough Entity's reporting requirements if
the lower-tier Passthrough Entity fails to report the required
information to the upper-tier Passthrough Entity.
VII. Applicability Date
The proposed regulations generally provide that the final
regulations apply to taxable years of Owner Taxpayers and Passthrough
Entities beginning on or after the date final regulations are published
in the Federal Register. However, except for the rules in the proposed
regulations regarding Partnership Transition Amounts and API Holder
Transition Amounts, Owner Taxpayers and Passthrough Entities may rely
on the proposed regulations for taxable years beginning before the date
final regulations are published in the Federal Register provided they
follow the proposed regulations in their entirety) and in a consistent
manner. In contrast, taxpayers may rely on the rules in the proposed
regulations regarding Partnership Transition Amounts and API Holder
Transition Amounts for taxable years beginning in 2020 and subsequent
taxable years beginning
[[Page 49770]]
before the date final regulations are published in the Federal
Register, and may do so without consistently following all of the rules
provided in Sec. Sec. 1.1061-1 through 1.1061-6 of these proposed
regulations if the partnership treats capital gains and losses from the
identified assets as Partnership Transition Amounts and API Holder
Transition Amounts for the year in which the election is made and all
subsequent taxable years beginning before the date final regulations
are published in the Federal Register.
As indicated in section 4 of Notice 2018-18, proposed Sec. 1.1061-
3(b)(2)(i), which provides that the term corporation does not include
an S corporation, is proposed to apply to taxable years beginning after
December 31, 2017. See section 7805(b)(3). Additionally, proposed Sec.
1.1061-3(b)(2)(ii), which provides that the term corporation does not
include a PFIC with respect to which the shareholder has a QEF election
under section 1295 in effect, is proposed to apply for taxable years
beginning after August 14, 2020.
With respect to an API in a partnership with a fiscal year ending
after December 31, 2017, section 706 determines the capital gains and
losses the Owner Taxpayer includes in income with respect to an API
after December 31, 2017. Section 706 provides that the taxable income
of a partner for a taxable year includes amounts required by sections
702 and section 707(c) with respect to a partnership based on the
income, gain, loss, deduction, or credit of a partnership for any
taxable year ending within or with the taxable year of the partner.
Accordingly, if a calendar year Owner Taxpayer has an API in a fiscal
year partnership that has a year end after December 31, 2017, section
1061 applies to the Owner Taxpayer's distributive share of long-term
capital gain or loss with respect to the API in calendar year 2018
regardless of whether the partnership disposed of the property giving
rise to the gains and losses in the period prior to January 1, 2018.
See Sec. 1.706-1(a)(1).
VIII. Request for Comments for Smaller Partnerships
Comments are requested on whether a simplified method for
determining and calculating the API gain or loss should be provided for
smaller partnerships and if so, the criteria that should be used to
determine which partnerships should be eligible to use the simplified
method. These comments should include comments and suggestions for a
simplified method.
Special Analyses
l. Regulatory Planning and Review--Economic Analysis
Executive Orders 13771, 13563, and 12866 direct agencies to assess
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits, including potential economic, environmental, public
health and safety effects, distributive impacts, and equity. Executive
Order 13563 emphasizes the importance of quantifying both costs and
benefits, reducing costs, harmonizing rules, and promoting flexibility.
The Executive Order 13771 designation for any final rule resulting from
these proposed regulations will be informed by comments received. The
preliminary Executive Order 13771 designation for this proposed rule is
regulatory.
The proposed regulations have been designated by the Office of
Information and Regulatory Affairs (OIRA) as subject to review under
Executive Order 12866 pursuant to the Memorandum of Agreement (MOA,
April 11, 2018) between the Treasury Department and the Office of
Management and Budget regarding review of tax regulations. It has been
determined that the proposed rulemaking is significant under section
1(b) of the Memorandum of Agreement and thereby subject to review.
Accordingly, the proposed regulations have been reviewed by OMB.
A. Background
Section 1061 of the Internal Revenue Code, enacted by the TCJA,
recharacterizes certain long-term capital gains recognized with respect
to an API as short-term capital gains. Short-term capital gains are
taxed at the ordinary income rate whereas long-term capital gains are
generally taxed at a lower rate.
Section 1061 defines an API as an interest in a partnership
transferred to or held by the taxpayer in connection with the
performance of substantial services by the taxpayer, or any other
related person, in any ATB. Under section 1061 the term ATB encompasses
a range of financial service activities. Specifically, an ATB is any
activity conducted on a regular, continuous, and substantial basis
which consists, in whole or in part, of raising or returning capital,
and either (i) investing in (or disposing of) ``specified assets'' (or
identifying specified assets for such investing or disposition), or
(ii) developing specified assets. ``Specified assets'' are certain
securities, certain commodities, real estate held for rental or
investment, cash or cash equivalents, options or derivative contracts
with respect to any of the foregoing, and an interest in a partnership
to the extent of the partnership's proportionate interest in any of the
foregoing.
Prior to the TCJA, the Internal Revenue Code made no distinction
between capital gains allocated to APIs versus other partnership
interests and partnership assets. Generally, the required holding
period to obtain the lower long-term capital gains tax rate was one
year for all partnership interests and partnership assets. Under the
new provision, the required holding period for an API must be greater
than three years to obtain long-term capital gains treatment.
B. Overview of the Proposed Regulations
The proposed regulations provide taxpayers with definitional and
computational guidance regarding the application of section 1061. In
particular, the proposed regulations provide a number of important
definitions, including the term `taxpayer' for the purpose of
determining the existence of an API. Additionally, the regulations
clarify the rules for certain exceptions to section 1061, including the
exception for capital interests, and provide for an additional
exception for bona fide purchases of APIs by an unrelated party who is
not a service provider. The proposed regulations also provide rules for
calculating the recharacterized gain amount and provide for a
lookthrough rule with respect to the sale of APIs.
C. Economic Analysis
1. Baseline
The Treasury Department and the IRS have assessed the benefits and
costs of the proposed regulations relative to a no-action baseline
reflecting anticipated Federal income tax-related behavior in the
absence of these proposed regulations.
2. Summary of Economic Effects
The proposed regulations provide certainty and consistency in the
application of section 1061 by providing definitions and clarifications
regarding the statute's terms and rules. An economically efficient tax
system generally aims to treat income and expense derived from similar
economic decisions consistently across taxpayers and activities in
order to reduce incentives for individuals and businesses to make
choices based on tax rather than market incentives. In the absence of
the guidance provided in these proposed regulations, taxpayers would
bear the burden of interpreting
[[Page 49771]]
the statute and the chances that different taxpayers might interpret
the statute differently would be exacerbated. For example, two
similarly situated taxpayers might interpret the statutory provisions
pertaining to the definition of taxpayer or the capital interest
exception differently, causing one to enter into a partnership that
another comparable taxpayer might decline because of a different
interpretation of how the income will be treated under section 1061.
Thus, lack of certainty may dissuade economically beneficial actions.
An economic loss may also arise if all taxpayers have identical
interpretations of the tax treatment of particular income streams under
the statute but are more conservative (or less conservative) regarding
the interpretation than Congress intended for these income streams. In
this case, guidance provides value by bringing economic decisions
closer in line with the intents and purposes of the statute.
The Treasury Department and the IRS solicit comments on the
economic analysis of the proposed regulations. The Treasury Department
and the IRS particularly solicit comments that provide data, other
evidence, or models that could enhance the rigor of the analysis.
3. Economic Analysis of Specific Provisions
a. Definition of Taxpayer
The statute requires taxpayers to make a number of determinations,
including the determination of the existence of an API, and the
calculation of the section 1061 amount, or amount of long-term gain
recharacterized under section 1061. However, the term ``taxpayer'' is
not defined in either section 1061 or in the Conference Report.
Comments received by the Treasury Department and IRS highlight the
importance of the definition of the term taxpayer for purposes of
section 1061.\1\ Without guidance, taxpayers could use different
approaches to define ``taxpayer,'' leading otherwise similar taxpayers
to experience different degrees of complexity, and to report different
recharacterized amounts.
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\1\ See comments from the American Bar Association available at:
https://www.americanbar.org/content/dam/aba/administrative/taxation/policy/032219comments.pdf.
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The proposed regulations include two definitions of taxpayer to
address the level at which the determination of the existence of an API
is made and the level at which the calculation of the section 1061
amount is made. The proposed regulations define the Owner Taxpayer as
the person generally required to pay tax on the gain or loss with
respect to the API. Under the proposed regulations, the section 1061
calculation is only performed by the person (the Owner Taxpayer) who
must pay tax on the gains and losses recognized with respect to the
API. The Treasury Department and the IRS estimate that approximately
22,750 Owner Taxpayers will be required to adjust Schedule D filings.
There may be others who meet the definition of Owner Taxpayer but face
no burden because they receive no capital gains allocations in relation
to their API holdings. The proposed regulations also introduce the term
Passthrough Taxpayer. A Passthrough Taxpayer is an entity that does not
itself generally pay tax on capital gains but must determine when an
API exists and allocate income, gain, deduction and loss to its owners.
The Treasury Department and the IRS estimate there are approximately
30,000 Passthrough Taxpayers required to provide information to owner
taxpayers who hold an API. Both the Owner Taxpayer and the Passthrough
Taxpayer are treated as taxpayers for the purpose of determining
whether an API exists.
The Treasury Department and the IRS considered and rejected two
alternative approaches to the definition of taxpayer outlined in
received comments, the ``aggregate approach'' and the ``full entity
approach.'' Under the aggregate approach, a partnership is not treated
as a taxpayer for purposes of section 1061. Instead, section 1061 is
applied solely to the partners that are ultimately subject to tax on
the partnership's items of capital gain and loss. A concern with using
this approach for the purpose of determining whether an API exists is
that it could incentivize partners to use tiered ownership structures
to avoid section 1061 recharacterization. For example, an upper tier
partnership may receive an interest in a lower-tier fund in connection
with the upper-tier partnership's performance of services in an ATB.
Partners of the upper-tier partnership may contend that they did not
receive their interest in the upper-tier partnership in connection with
the services performed by the upper-tier partnership. Stopping such
avoidance strategies would require complex rules and potentially
burdensome reporting requirements when tiered ownership structures are
involved.
Under the ``full entity approach'', the partnership is treated as a
taxpayer for purposes of both determining the existence of an API and
calculating the section 1061 recharacterization amount. Treating the
partnership as a taxpayer for purposes of calculating the section 1061
recharacterization amount was found to be more burdensome than the
approach taken in the proposed regulations for three reasons. First,
using the full entity approach for determining the section 1061
recharacterization amount may lead to increased recharacterization of
gains under section 1061 because individuals would not be able to net
gains and losses across multiple APIs. Second, the administrative
burden on both the taxpayer and the IRS would be increased in cases of
tiered ownership. Under the full entity approach, a separate section
1061 calculation would be required at each level at which an API is
held in a tiered partnership structure. Finally, the full entity
approach may add complexity and burden in cases in which an exception
to section 1061 applies, such as if a corporation is a direct or
indirect partner. Because corporations are excluded from section 1061,
any amount recharacterized at the partnership level would need to be
tracked as it is allocated to partners to ensure that corporate or
other excepted partners are not subject to the three year holding
period under section 1061.
The Treasury and the IRS have concluded that the chosen
alternative, incorporating the concepts of Owner Taxpayer and
Passthrough Taxpayer, is less burdensome than other alternatives and
provides helpful certainty to taxpayers.
b. Clarification of the Treatment of an API Purchased by an Unrelated
Party
The statute states that capital gain or loss recognized by a
taxpayer on the sale of an API held for more than one year is subject
to section 1061. The statute also provides guidance for ongoing
treatment under section 1061 when the API is purchased by, or
transferred to, a related party or another service provider. However,
the statute does not provide guidance for the taxpayer who purchases an
API and is neither a service provider to the relevant ATB, nor related
to the seller of the API. The proposed regulations add an exception to
section 1061 and provide that the term API does not include an interest
in a partnership that would be treated as an API but is held by a bona
fide purchaser of the interest who does not currently and has never
provided services in the relevant ATB and who is not related to a
person who provides services currently or has provided services in the
past. By clarifying the treatment of an API that is sold at arm's
length, the proposed regulations reduce uncertainty and compliance
burdens for
[[Page 49772]]
taxpayers entering into these transactions. The Treasury Department and
the IRS have determined this exception is consistent with the purpose
of section 1061, which applies to service providers and persons related
to service providers and is not meant to apply to bona fide purchasers
of a partnership interest who do not provide services.
The Treasury Department and the IRS considered not providing this
exception. However, it was determined that failure to provide this
exception would treat unrelated purchasers of an API in an inequitable
fashion, and that continued treatment of the partnership interest as an
API is inconsistent with the purpose of section 1061 as unrelated
purchasers did not receive their interest in connection with the
performance of substantial services. Relative to the no-action
baseline, the proposed guidance also provides clarity for taxpayers,
improving economic efficiency as discussed in the Summary of Economic
Effects.
c. Capital Interest Exception
Section 1061(c)(4)(B) provides that the definition of an API does
not include ``any capital interest in the partnership which provides
the taxpayer with a right to share in partnership capital commensurate
with--(i) the amount of capital contributed (determined at the time of
receipt of such partnership interest) or (ii) the value of the interest
included in income under section 83 upon the receipt or vesting of such
interest.'' Comments received by the Treasury Department and the IRS
identify two sources of ambiguity with regard to this capital interest
exception (see footnote 1).
First, there is uncertainty among taxpayers whether unrealized
capital gains with respect to an API (unrealized API gains) can be
converted to gains that would qualify for the capital interest
exception. The proposed regulations clarify that unrealized API gains
cannot be converted to gains that qualify for the capital interest
exception. In the absence of this regulation, a significant share of
taxpayers could potentially avoid section 1061 recharacterization when
capital gains with respect to an API are realized if the partnership
revalues assets prior to realization, and unrealized API gains are
converted to gains that would qualify for the capital interest
exception. A majority of owner taxpayers could use this avoidance
strategy if it were available. The availability of this avoidance
strategy would distort taxpayer behavior, incentivizing complex tiered
ownership strategies, and distorting decisions to revalue assets.
Furthermore, allowing this avoidance strategy would be contrary to the
purposes of section 1061. The statute requires that the Secretary issue
such regulations or other guidance as is necessary or appropriate to
carry out the purposes of section 1061. Both the Conference Report and
the Joint Committee on Taxation's background on 1061, Joint Committee
on Taxation, General Explanation of Public Law 115-97 (JCS-1-18) at 125
FN 542 (Dec. 20, 2018), specifically state that the statute requires
that the Secretary issue regulations or other guidance to address the
prevention of abuse of the purpose of the provision.
Second, the statute does not provide guidance on what it means for
a right to share in partnership capital to be ``commensurate'' with the
amount of capital contributed. Comments received by the Treasury
Department and the IRS identify this as a source of confusion among
taxpayers with respect to section 1061 (see footnote 1). The proposed
regulations clarify that allocations are deemed commensurate with
capital contributed if they are made with respect to the taxpayer's
capital account. The taxpayer's capital account includes realized but
undistributed gains on contributed capital, and any contributions to
capital made after the interest was received. In the absence of these
regulations, taxpayers who have made capital contributions after the
interest was initially received, or taxpayers who made a capital
contribution that appreciated in value, might face confusion regarding
their ability to include the additional contribution when determining
the value of their capital interest. Further, partners with realized
gains would be incentivized to engage in a series of inefficient
transactions, first receiving a distribution reflecting those gains and
then contributing the distributed amount back into the partnership in
order to minimize tax.
The Treasury Department and the IRS considered alternative
interpretations of ``commensurate with capital contributed,'' including
a narrow interpretation of the statute to mean only the value of
capital contributed on the date the interest was initially received.
However, it was determined that the interpretation presented in the
proposed regulations is the only viable interpretation that accurately
reflects the value of capital. Therefore, the proposed regulations
provide helpful guidance and certainty for taxpayers but are not
expected to result in any other economic effects.
d. Lookthrough Rule on Sale of APIs
Section 1061(a) provides that if one or more APIs are held by a
taxpayer at any time during the taxable year, the excess (if any) of
(1) the taxpayer's net long-term capital gain with respect to such
interests for such taxable year, over (2) the taxpayer's net long-term
capital gain with respect to such interests for that taxable year
computed by applying paragraphs (3) and (4) of sections 1222 by
substituting ``3 years'' for ``1 year,'' must be treated as short-term
capital gain, notwithstanding section 83 or any election in effect
under section 83(b). The House Report explains that section 1061
``imposes a three-year holding period (not the generally applicable
one-year holding period) in the case of long-term capital gain from
applicable partnership interests.'' Neither section 1061 nor the
Reports, however, explicitly provides what the relevant holding period
is for purposes of section 1061(a) for the sale of an API with assets
of different holding periods. Comments received by the Treasury
Department and the IRS highlight significant ambiguity, outlining
multiple interpretations that would result in different amounts of gain
recharacterized by taxpayers (see footnote 1).
Pursuant to its regulatory authority to prevent inappropriate
avoidance of section 1061, the proposed regulations include a limited
lookthrough rule that is applied to the sale of an API that has been
held for more than three years at the time of the disposition. The
Lookthrough Rule only applies if 80 percent or more of the value of the
assets held by the partnership at the time of the API disposition are
assets held for three years or less that would produce capital gain or
loss subject to section 1061 if disposed of by the partnership. If the
Lookthrough Rule applies, a percentage of the gain or loss on the
disposition of the API that is included in the one year disposition
amount is not included in the three year disposition amount.
The calculations required by the Lookthrough Rule will impose some
additional compliance burden on individual taxpayers selling an API.
The rules requiring partnerships to furnish taxpayers with the relevant
information to perform the calculations will also impose additional
burden on the relevant partnerships. The Treasury Department and the
IRS believe only a small fraction of API holders will be affected by
these requirements in any year. This rule has limited applicability
because it only applies to taxpayers that sell their interest during
the taxable year
[[Page 49773]]
and that at the time of the sale have held their API more than three
years. Additionally, 80 percent of the value of the assets of the
partnership in which the API being sold is held must have a holding
period to the partnership that is three years or less. The Treasury
Department and the IRS have determined that the Lookthrough Rule is
necessary to prevent inappropriate avoidance of section 1061.
The Treasury Department and the IRS considered and rejected
alternative approaches outlined in received comments, including
applying an interest approach with no Lookthrough Rule, and an
underlying assets approach. The interest approach with no Lookthrough
Rule looks solely to the holding period in the API, regardless of the
holding period of the assets held by the partnership that would produce
capital gain or loss on disposition. This approach would allow
taxpayers to avoid section 1061 characterization for long-term capital
gains on assets that are not held for the more than three years by the
partnership. This result would encourage distortive behavior in
investment funds, which might look to create partnerships for different
investors solely for tax purposes. That is, the partners of that
investment partnership would not be subject to section 1061 if they had
owned their APIs for more than three years, irrespective of how long
the investment partnership had held an asset that it sold.
Alternatively, the underlying asset, or full Lookthrough, approach
looks solely to the holding period in the underlying asset (or assets)
of the partnership, regardless of whether the underlying asset is sold
by the partnership or the API is sold by its owner. The proposed
regulations only apply the Lookthough Rule if substantially all of the
partnership's assets by value are assets held for three years or less
and that would produce on disposition capital gain or loss not
described in Sec. 1.1061-4(b)(6). The underlying asset approach would
be more difficult (and burdensome) for taxpayers to apply as it would
require a determination of the unrealized gain for each asset held by
the partnership, even in cases in which a relatively small share of
assets by value have a holding period of three years or less. We
anticipate many taxpayers would be able to avoid burdensome valuation
of assets and identification of holding periods under the limited
Lookthrough rule but would be required to value each asset under the
full Lookthrough rule.
II. Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking is in Sec. 1.1061-4(b)(7) and Sec. 1.1061-6.
A. Collection of Information Regarding Election To Exclude Partnership
Transition Amounts in Sec. 1.1061-4(b)(7)
The collection of information in proposed Sec. 1.1061-4(b)(7)
requires a partnership that chooses to elect to exclude Partnership
Transition Amounts from section 1061 to complete a statement making the
election and to file the election with its federal tax return for the
first taxable year that it treats amounts as Partnership Transition
Amounts. It also requires the partnership, by the due date of the
election, to clearly and specifically identify in its books and records
the assets held by the partnership for more than three years as of the
effective date of section 1061. This information is necessary for the
IRS to determine whether the partnership has made the election and
whether the partnership is correctly reporting capital gains and losses
from all of the assets subject to the election.
1. Collection of Information on an Existing Form
The partnership is required to attach the election statement to the
Form 1065 filed for the partnership for the first taxable year that the
partnership treats amounts as partnership transition amounts. For
purposes of the Paperwork Reduction Act, the reporting burden
associated with filing the election will be reflected in the Paperwork
Reduction Act Submissions associated with Form 1065 (OMB 1545-0123).
2. Collection of Information Not on an Existing Form
A partnership that elects to exclude Partnership Transition Amounts
must maintain adequate books and records to verify that (i) the
partnership's list of identified assets properly includes all assets
that it has held for more than three years as of December 31, 2017;
(ii) the partnership has treated all capital gains and losses from the
sale of the identified assets consistent with proposed Sec. 1.1061-
4(b)(7); and, (iii) amounts allocated to API Holders have been
determined consistent with Sec. 1.1061-4(b)(7). This collection of
information in Sec. 1.1061-4(b)(7) is mandatory for taxpayers seeking
to treat certain long-term capital gains as Partnership Transition
Amounts. Partnerships seeking to rely on the exception from section
1061 for Partnership Transition Amounts are generally hedge funds and
private equity funds that would have held one or more capital assets
more than three years as of December 31, 2017. The making a list of
assets subject to the election is a one-time requirement. Annually, the
partnership must maintain sufficient records to demonstrate that long-
term capital gains and losses from the disposition of the identified
assets have been treated consistent with the requirements of Sec.
1.1061-4(b)(7) and that API Holder Transition Amounts have been
determined as provided in Sec. 1.1061-4(b)(7). The information
required to be maintained will be used by the IRS for tax compliance
purposes. Estimates with respect to this recordkeeping burden are --
Estimated total annual reporting burden: 34,375 hours.
Estimated average annual burden hours per respondent: 2.75.
Estimated average cost per respondent (in 2017 dollars): $261.31.
Estimated number of respondents: 12,500.
Estimated annual frequency of responses: Once.
Based on these estimates, the annual three-year reporting burden
for those electing to exclude Partnership Transition Amounts from
section 1061 is $261.31 (in 2017 dollars).
These estimates are based on the assumption that only a small
number of hedge funds would have held assets more than three years as
of December 31, 2017. We anticipate that the majority of private equity
funds that were in existence for three years as of December 31, 2017
will make the election. Private equity funds that were not in existence
as of December 31, 2017 will not need to make the election. Once the
election is made, electing funds will have to retain records to
evidence compliance with Sec. 1.1061-4(b)(7).
Comments on the collection of information that results from the
recordkeeping requirement in Sec. 1.1061-4(b)(7) should be sent to the
Office of Management and Budget, Attn: Desk Officer for the Department
of Treasury, Office of Information and Regulatory Affairs, Washington,
DC 20503, with copies to the Internal Revenue Service, Attn: IRS
Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224.
Comments on the collection of information should be received by October
5, 2020.
Comments are specifically requested concerning:
Whether the proposed collection of information is necessary for the
performance of duties of the IRS,
[[Page 49774]]
including whether the information will have practical utility;
The accuracy of the burden estimate associated with the proposed
collection of information (including underlying assumptions and
methodology);
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collection of
information may be minimized, including through the 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.
B. Collection of Information in Sec. 1.1061-6(a) on the Owner Taxpayer
Is on Existing Forms
The collection of information in proposed Sec. 1.1061-6(a)
requires an Owner Taxpayer to file such information with the IRS as the
Commissioner may require in forms, instructions and other published
guidance as is necessary for the IRS to determine that the taxpayer has
properly complied with section 1061 and Sec. Sec. 1.1061-1 through
1.1061-5 of the proposed regulations. This information is necessary for
the IRS to determine that the Owner Taxpayer has properly complied with
section 1061. In general, the Owner Taxpayer is an individual and the
Owner Taxpayer's Recharacterization Amount will be required to be
reported to the IRS as short term capital gain on Schedule D, ``Capital
Gains and Losses,'' of the Form 1040, ``U.S. Individual Income Tax
Return.'' Less frequently, the Owner Taxpayer is a trust and the Owner
Taxpayer's Recharacterization Amount will be required to be reported to
the IRS as short term capital gain on Schedule D, ``Capital Gains and
Losses,'' of the Form 1041, ``U.S. Income Tax Return for Estates and
Trusts.''
The current status of the Paperwork Reduction Action submission
related to Sec. 1.1061-6(a) is provided in the following table. The
burdens associated with the collection of information from the Owner
Taxpayer to comply with section 1061 will be included in the aggregate
burden estimates for Form 1040 under OMB control number 1545-0074 and
Form 1041 under OMB control number 1545-0092. The overall burden
estimates provided in OMB Control Number 1545-0074 represents a total
estimated burden time, including all other related forms and schedules
for individuals, of 1.784 billion hours and total estimated monetized
costs of $31.74 billion (in 2017 dollars). The overall burden estimates
provided in OMB Control Number 1545-0092 represents a total estimated
burden time, including all other forms and schedules for trusts and
estates of 307.8 million hours and total estimated monetized costs of
$9.95 billion (in 2016 dollars). These amounts are aggregate amounts
that relate to all information collections associated with the
applicable OMB control numbers, and will in the future include, but not
isolate, the estimated burden of Owner Taxpayers as a result of the
information collections in the proposed regulations. No burden
estimates specific to the proposed regulations are currently available.
The Treasury Department and IRS have not estimated the burden,
including that of any new information collections, related to the
requirements under the proposed regulations. Those estimates would
capture both changes made by the TCJA and those that arise out of
discretionary authority exercised in the proposed regulations. The
Treasury Department and the IRS request comments on all aspects of
information collection burdens related to the collection of information
applicable to the Owner Taxpayer in the proposed regulations. In
addition, when available, drafts of IRS forms are posted for comment at
www.irs.gov/draftforms.
----------------------------------------------------------------------------------------------------------------
Form Type of filer OMB No(s). Status
----------------------------------------------------------------------------------------------------------------
Form 1040 (Including Schedule D)...... Individual (NEW Model)... 1545-0074 Published in the Federal
Register on 9/30/19. Comment
period closed on 11/29/19.
84 FR 51712. Thirty-day
notice published on 12/18/
19. 84 FR 69458. Approved by
OIRA on 1/30/20.
Form 1041 (Including Schedule D)...... Trusts and Estates 1545-0092 Published in the Federal
(Legacy Model). Register on 4/4/2018. 83 FR
14552. Public comment period
closed 6/4/2018. Thirty-day
notice published on 9/27/18.
83 FR 48894. Approved by
OIRA on 5/8/19.
----------------------------------------------------------------------------------------------------------------
C. Collection of Information on Passthrough Entities in Sec. 1.1061-
6(b) and (c) on Existing forms
1. Passthrough Entities
The collection of information in proposed Sec. 1.1061-6(b)
requires a Passthrough Entity that has issued an API to furnish to the
API Holder, including the Owner Taxpayer, such information at such time
and in such manner as the Commissioner may require in forms,
instructions, and other published guidance as is necessary to determine
the One Year Gain amount and the Three Year Gain Amount with respect to
an Owner Taxpayer. This includes: (i) The API One Year Distributive
Share Amount and the API Three Year Distributive Share Amount (as
determined under Sec. 1.1061-4); (ii) Capital gains and losses
allocated to the API Holder that are excluded from section 1061 under
Sec. 1.1061-4(b)(6); (iii) Capital Interest Gains and Losses allocated
to the API Holder (as determined under Sec. 1.1061-3(c)); (iv) In the
case of a disposition by the API Holder of an interest in the
Passthrough Entity during the taxable year, any information required by
the API Holder to properly take the disposition into account under
section 1061, including information to apply the Lookthrough Rule and
to determine its Capital Interest Disposition Amount. The proposed
regulations seek to minimize the information that a Passthrough Entity
is required to automatically furnish annually. In some cases, an upper
tier Passthrough Entity may be an API Holder in a lower tier
Passthrough Entity, and the information furnished by the lower tier
Passthrough Entity to the upper tier Passthrough Entity may not be
sufficient for the upper tier Passthrough Entity to meet its reporting
obligations under the regulations. In this case, the proposed
regulations require the lower tier Passthrough Entity to furnish
information to the upper tier Passthrough Entity if requested. Thus, if
an upper tier Passthrough Entity in a tiered entity structure holds an
interest in a lower tier Passthrough Entity and it needs information
from the lower tier Passthrough Entity to comply with its obligation to
furnish information under the proposed regulations, it must request
information from the lower tier entity and the lower tier entity must
furnish the requested information. This passing of information upon
request
[[Page 49775]]
between the tiers of entities is necessary to minimize the quantity of
information required to be annually furnished by a Passthrough Entity
and because each Passthrough Entity in a tiered entity arrangement is
the only entity that has access to the information that is required to
be furnished. The collection of information in the proposed regulations
is necessary to ensure that the Owner Taxpayer receives information
sufficient to correctly calculate its Recharacterization Amount under
section 1061.
2. RICs and REITs
Section 1.1061-6(c) permits a RIC or a REIT that reports or
designates all or a part of a dividend as a capital gain dividend, to
disclose additional information to their shareholders for purposes of
section 1061. The furnishing of this information may allow a
Passthrough Entity to include a portion of the capital gain dividend in
the API Three Year Distributive Share amount furnished to API Holders
and may ultimately enable an Owner Taxpayer to reduce its
Recharacterization Amount under the proposed regulations.
3. Table for Collections of Information in Sec. 1.1061-6(b) and (c)
The collection of information with respect to Sec. 1.1061-6(b) and
(c) is provided in the following table. In the case of a Passthrough
Entity that is a partnership, the information will be required to be
furnished as an attachment to the Schedule K-1, ``Partner's Share of
Income, Deduction, Credit, Etc.'' of Form 1065, ``U.S. Return of
Partnership Income.'' In the case of a Passthrough Entity that is an S
corporation, the information will be required to be furnished as an
attachment to the Schedule K-1, ``Shareholder's Share of Income,
Deductions, Credit, Etc.,'' of Form 1120-S, ``U.S. Income Tax Return
for an S Corporation.'' The burdens associated with the collection of
information from the Passthrough Entities will be included in the
aggregate burden estimates for the Form 1065 and the Form 1120S under
OMB control number 1545-0123. The overall burden estimates provided in
OMB Control Number 1545-0123 represents a total estimated burden time,
including all others related forms and schedules, of 3.157 billion
hours and total estimated monetized costs of $58.148 billion (in 2017
dollars). The burden estimates provided in OMB Control Number 1545-0123
are aggregate amounts that relate to all information collections
associated with the applicable OMB control number, and will in the
future include, but not isolate, the Passthrough Entities' estimated
burden as a result of the information collections in the proposed
regulations.
In the case of RICs and REITs the information will be furnished in
connection with the Form 1099-DIV, ``Dividends and Distributions.'' The
burden estimates associated with the collection of information from
RICs and REITs will be included in the aggregate burden estimated for
the Form 1099-DIV under OMB Control Number 1545-0110. The overall
burden estimates provided in OMB Control Number 1545-0110 represents a
total estimated burden time of 32,119,195 hours and total estimated
monetized costs of $1.64 billion (in 2016 dollars). The burden
estimates provided in OMB Control Number 1545-0110 relate to all
information collections associated with the applicable OMB Control
Number, and will in the future include, but not isolate, the RIC and
REIT estimated burden as a result of the information collections in the
proposed regulations.
With the exception of the burden estimate provided with respect to
the recordkeeping requirement related to the Partnership Transition
amount election in Sec. 1.1061-4(b)(7), no burden estimates specific
to the proposed regulations are currently available. The Treasury
Department and IRS have not estimated the burden, including that of any
new information collections, related to the requirements under the
proposed regulations. Those estimates would capture both changes made
by the TCJA and those that arise out of the discretionary authority
exercised in the proposed regulations. The Treasury Department and the
IRS request comments on all aspects of information collection burdens
related to the collection of information applicable to the Passthrough
Entities in the proposed regulations. In addition, when available,
drafts of IRS Forms and the applicable instructions are posted for
comment at https://www.irs.gov/pub/irs-dft/.
----------------------------------------------------------------------------------------------------------------
Form Type of filer OMB No(s). Status
----------------------------------------------------------------------------------------------------------------
Form 1065 (including Schedule K-1).... Business (NEW Model)..... 1545-0123 Sixty-day notice published in
the Federal Register on 9/30/
19. Public Comment period
closed on 11/29/19. 84 FR
51718. Thirty-day notice
published in the Federal
Register on 12/19/19. Public
Comment period closed on 1/
21/20. 84 FR 69825. Approved
by OIRA on 1/30/20.
Form 1120S (Including Schedule K-1)... Business (New Model)..... 1545-0123 Sixty-day notice published in
the Federal Register on 9/30/
19. Public Comment period
closed on 11/29/19.
84 FR 51718. Thirty-day
notice published in the
Federal Register on 12/19/
19. Public Comment period
closed on 1/21/20. 84 FR
69825. Approved by OIRA on 1/
30/20.
Form 1099-DIV......................... (Legacy Model)........... 1545-0110 Sixty-day notice published in
the Federal Register on 9/19/
19. Public comment period
closed 11/18/19.
84 FR 49379. Thirty-day
notice published in the
Federal Register on 12/20/
19. 84 FR 70269.
-------------------------------------------------------------------------
Link: https://www.FederalRegister.gov/documents/2018/05/23/2018-10981/proposed-collection-comment-request-for-form-1099-div.
----------------------------------------------------------------------------------------------------------------
D. Chart Showing Number of Respondents Regarding Existing Forms
The following chart shows the estimated number of returns that are
expected to have attachments providing additional information with
respect to section 1061. As noted above, Owner Taxpayers will be
required to provide section 1061 information on an attachment to
Schedules D for Forms 1040 and 1041. Passthrough Taxpayers will be
required to report section 1061 on Forms 1065 and 1120S to the IRS and
to furnish information to their API Holders on attachments to the
respective K-1s. RICs and REITs may voluntarily report additional
information at an attachment to Form 1099-DIV.
Schedule D Form 1040....................................... 20,475
[[Page 49776]]
Schedule D Form 1041....................................... 2,275
Schedule K Form 1065....................................... 28,500
Schedule K-1s Form 1065.................................... 57,000
Schedule K Form 1120S...................................... 1,500
Schedule K-1s Form 1120.................................... 1,000
Form 1099-DIV filed by REITs............................... 836
Form 1099-DIV filed by RICs................................ 3,880
E. Voluntary Collection of Information in Sec. 1.1061-6(d) on PFIC
Shareholder Will Be Added to Existing OMB Control Number for PFIC
Information Retention
Section 1.1061-6(d) permits a PFIC with respect to which the
shareholder is an API Holder who has a QEF election is in effect for
the taxable year to provide additional information to the shareholder
to determine the amount of the shareholder's inclusion that would be
included in the API One Year Distributive Share Amount and the API
Three Year Distributive Share Amount. If the PFIC furnishes this
information to the shareholder, the shareholder must retain a copy of
this information along with the other information required to be
retained under Sec. 1.1295-1(f)(2)(ii). The burden associated with
retaining this additional information will be included in the aggregate
burden estimates for Sec. 1.1295-1(f) under OMB Control Number 1545-
1555. 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 and records related to the 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.
III. Regulatory Flexibility Act
It is hereby certified that these regulations will not have a
significant economic impact on a substantial number of small entities
within the meaning of section 601(6) of the Regulatory Flexibility Act
(5 U.S.C. chapter 6). These regulations generally only impact
investment funds that have capital gains and losses that derive from
the disposition of assets that have a holding period of more than one
year but not more than three years.
Investment funds are considered small business if they have annual
average receipts of $41.5 million or less (13 CFR 121). The rule may
affect a substantial number of small entities, but data are not readily
available to assess how many entities will be affected.
Even if a substantial number of small entities are affected, the
economic impact of these regulations on small entities is not likely to
be significant. The proposed regulations provide taxpayers with
definitional and computational guidance regarding the application of
section 1061. The impact of the regulations is to impose an additional
reporting obligation that applies only with respect to the sale of
assets held for more than one year but not more than three years. The
Treasury Department and the IRS recognize that this reporting
obligation may increase, at least to some extent, the tax preparation
burden for affected taxpayers beyond that imposed by the statute. This
reporting obligation generally will only apply to a minority of the
asset dispositions by an entity. The entity will also have a reporting
obligation in certain circumstances regarding the disposition of an
API, but the extent of the reporting obligation depends on the number
of assets held by the entity and their holding periods. The information
reported is readily available to taxpayers and reported on forms
already in use beginning with the 2019 tax year. Finally, some
taxpayers may find they need an initial investment of time to read and
understand these regulations at an approximate cost of $95/hour and an
estimated time of ten hours.
Notwithstanding this certification, the Treasury Department and the
IRS invite comments on any impact this rule would have on small
entities.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 requires
that agencies assess anticipated costs and benefits and take certain
other actions before issuing a final rule that includes any Federal
mandate that may result in expenditures in any one year by a state,
local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. This rule does not include any Federal mandate that may
result in expenditures by state, local, or tribal governments, or by
the private sector in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive Order. This rule does not have federalism
implications and does not impose substantial direct compliance costs on
state and local governments or preempt state law within the meaning of
the Executive Order.
Statement of Availability of IRS Documents
Notice 2018-18, 2018-2 I.R.B. 443 (in addition to any other revenue
procedures or revenue rulings, etc. cited in this preamble) is
published in the Internal Revenue Bulletin (or Cumulative Bulletin) and
is available from the Superintendent of Documents, U.S. Government
Publishing Office, Washington, DC 20402, or by visiting the IRS website
at http://www.irs.gov.
Comments and Requests for a Public Hearing
Before these proposed amendments to the regulations are adopted as
final regulations, consideration will be given to comments that are
submitted timely to the IRS as prescribed in the preamble under the
ADDRESSES section. The Treasury Department and the IRS request comments
on all aspects of the proposed regulations. Any electronic comments
submitted, and to the extent practicable any paper comments submitted,
will be made available at www.regulations.gov or upon request.
A public hearing will be scheduled if requested in writing by any
person who timely submits electronic or written comments. Requests for
a public hearing are also encouraged to be made electronically. If a
public hearing is scheduled, notice of the date and time for the public
hearing will be published in the Federal Register. Announcement 2020-4,
2020-17 IRB 1, provides that until further notice, public hearings
conducted by the IRS will be held telephonically. Any telephonic
hearing will be made accessible to people with disabilities.
Drafting Information
The principal author of these proposed regulations is Kara Altman
of the Office of Associate Chief Counsel (Passthroughs and Special
Industries). However, other personnel from the Treasury Department and
the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendment to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
[[Page 49777]]
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Sections 1.1061-0 through 1.1061-6 are added under 26 U.S.C.
1061(f). * * *
0
Par. 2. Section 1.702-1 is amended by adding a sentence at the end of
paragraph (a)(2) and adding paragraph (g) to read as follows.
Sec. 1.702-1 Income and credits of partner.
(a) * * *
(2) * * * Each partner subject to section 1061 shall take into
account gains and losses from sales of capital assets held for more
than one year as provided in that section and Sec. Sec. 1.1061-0
through 1.1061-6.
* * * * *
(g) Applicability date. The last sentence of paragraph (a)(2) of
this section applies for the taxable years beginning on or after [DATE
OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER].
0
Par. 3. Section 1.704-3 is amended by:
0
1. Redesignating paragraphs (e)(3)(vii), (viii), and (ix) as paragraphs
(e)(3)(viii), (ix), and (x), respectively;
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2. Adding new paragraph (e)(3)(vii);
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3. Revising the subject heading and first sentence of paragraph (f) and
adding a sentence to the end of paragraph (f).
The additions and revisions read as follows:
Sec. 1.704-3 Contributed property.
* * * * *
(e) * * *
(3) * * *
(vii) Application of section 1061--(A) In general. A partnership
that is combining gains and losses from qualified financial assets
under this paragraph (e)(3) will not be considered to be using a
reasonable method if that method fails to take into account the
application of section 1061 in an appropriate manner. If a partnership
uses the partial netting approach described in paragraph (e)(3)(iv) of
this section or the full netting approach described in paragraph
(e)(3)(v) of this section (or another otherwise reasonable approach),
the approach will not be considered reasonable if it does not
appropriately take into account the application of section 1061 to any
person who directly or indirectly holds an applicable partnership
interest (API) (as defined in Sec. 1.1061-1(a)). To this end, if a
partnership uses the partial or full netting approach, the partnership
must establish appropriate accounts for the purpose of taking into
account its book Unrealized API Gains and Losses and API Gains and
Losses (as defined in Sec. 1.1061-1(a)) separate from the book Capital
Interest Gains and Losses (as defined in Sec. 1.1061-1(a)) of an API
Holder (as defined in Sec. 1.1061-1(a)) and determining the API
Holder's share of taxable gains and losses that are API Gains and
Losses and Capital Interest Gains and Losses.
(B) Transition rule. If an API Holder holds an interest in a
partnership as of January 1, 2018, the partnership may use any
reasonable method to apportion existing accounts for the purpose of
determining an API Holder's share of book Unrealized API Gains and
Losses, API Gains and Losses, and book Capital Interest Gains and
Losses and for determining an API Holder's share of tax API Gains and
Losses and tax Capital Interest Gains and Losses.
* * * * *
(f) Applicability dates. With the exception of paragraphs (a)(1),
(a)(8)(ii) and (iii), (a)(10) and (11), and (e)(3)(vii) of this
section, and of the last sentence of paragraph (d)(2) of this section,
this section applies to properties contributed to a partnership and to
restatements pursuant to Sec. 1.704-1(b)(2)(iv)(f) on or after
December 21, 1993. * * * Paragraph (e)(3)(vii) of this section applies
to taxable years beginning on or after [DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL REGISTER].
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Par. 4. Sections 1.1061-0 through 1.1061-6 are added before the
undesignated center heading ``Changes to Effectuate F.C.C. Policy'' to
read as follows:
Sec.
* * * * *
1.1061-0 Table of contents.
1.1061-1 Section 1061 Definitions.
1.1061-2 Applicable partnership interests and applicable trades or
businesses.
1.1061-3 Exceptions to the definition of an API.
1.1061-4 Section 1061 computations.
1.1061-5 Section 1061(d) transfers to related persons.
1.1061-6 Reporting rules.
* * * * *
Sec. 1.1061-0 Table of contents.
This section lists the captions that appear in Sec. Sec. 1.1061-1
through 1.1061-6.
Sec. 1.1061-1 Section 1061 Definitions.
(a) Definitions.
(b) Applicability date.
Sec. 1.1061-2 Applicable partnership interests and applicable
trades or businesses.
(a) API rules and examples.
(1) Rules.
(i) An API remains as an API.
(ii) Unrealized API Gains and Losses.
(A) Long-term Unrealized API Gains and Losses become API Gains
and Losses.
(B) Requirement to determine Unrealized API Gains and Losses.
(iii) API Gains and Losses retain their character.
(iv) Substantial services by the Owner Taxpayer, Passthrough
Taxpayer or any Related Person.
(v) Grantor trusts and entities disregarded as separate from
their owners.
(2) Examples.
(b) Application of the ATB Activity Test.
(1) In general.
(i) Rules for applying the ATB Activity Test.
(A) Aggregate Specified Actions taken into account.
(B) Raising or Returning Capital Actions and Investing or
Developing Actions are not both required to be taken each year.
(C) Combined conduct by multiple related entities taken into
account.
(ii) Developing Specified Assets.
(iii) Partnerships.
(2) Examples.
(c) Applicability date.
Sec. 1.1061-3 Exceptions to the definition of an API.
(a) A partnership interest held by an employee of another entity
not conducting an ATB.
(b) Partnership interest held by a corporation.
(1) In general.
(2) Treatment of interests held by an S corporation or a
qualified electing fund.
(c) Capital Interest Gains and Losses.
(1) In general.
(2) Capital Interest Gains and Losses Defined.
(3) General rules for determining Capital Interest Allocations
and Passthrough Interest Capital Allocations.
(i) Allocations made in the same manner.
(ii) Capital accounts.
(A) In general.
(B) Tiers.
(C) Proceeds of partnership or partner loans not included in
capital account.
(iii) Items that are not included in Capital Interest
Allocations or Passthrough Interest Capital Allocations.
(4) Capital Interest Allocations.
(5) Passthrough Interest Capital Allocations.
(i) In general.
(ii) Passthrough Capital Allocations.
(iii) Passthrough Interest Direct Investment Allocations.
(6) Capital Interest Disposition Amounts.
(i) In general.
(ii) Determination of the Capital Interest Disposition Amount.
(7) Examples.
(d) Partnership interest acquired by purchase by an unrelated
taxpayer.
(1) Taxpayer is not a Related Person.
(2) Section 1061(d) not applicable.
(3) Taxpayer not a service provider.
(e) [Reserved]
(f) Applicability date.
[[Page 49778]]
(1) General rule.
(2) Section 1.1061-3(b)(2)(i) exception.
(3) Section 1.1061-3(b)(2)(ii) exception.
Sec. 1.1061-4 Section 1061 computations.
(a) Computations.
(1) Recharacterization Amount.
(2) One Year Gain Amount and Three Year Gain Amount.
(i) One Year Gain Amount.
(ii) Three Year Gain Amount.
(3) API One Year Distributive Share Amount and Three Year
Distributive Share Amount.
(i) API One Year Distributive Share Amount.
(ii) API Three Year Distributive Share Amount.
(4) API One Year Disposition Amount and Three Year Disposition
Amount.
(i) API One Year Disposition Amount.
(ii) API Three Year Disposition Amount.
(b) Special rules for calculating the One Year Gain Amount and
the Three Year Gain Amount.
(1) One Year Gain Amount equals zero or less.
(2) Three Year Gain Amount equals zero or less.
(3) Installment sale gain.
(4) Special rules for capital gain dividends from regulated
investment companies (RICs) and real estate investment trusts
(REITs).
(i) API One Year Distributive Share Amount.
(ii) API Three Year Distributive Share Amount.
(iii) Loss on sale or exchange of stock.
(5) Pro rata share of qualified electing fund (QEF) net capital
gain.
(i) One year QEF net capital gain.
(ii) Three year QEF net capital gain.
(6) Items not taken into account for purposes of section 1061.
(7) API Holder Transition Amounts not taken into account.
(i) In general.
(ii) API Holder Transition Amount.
(iii) Partnership Transition Amounts and Partnership Transition
Amount Election.
(8) Holding period determination.
(i) Determination of holding period for purposes of Three Year
Gain Amount.
(ii) Relevant holding period.
(9) Lookthrough Rule for certain API dispositions.
(i) Determination that the Lookthrough Rule Applies.
(ii) Application of the Lookthrough Rule.
(10) Section 83.
(c) Examples.
(1) Computation examples.
(2) Special rules examples.
(d) Applicability date.
Sec. 1.1061-5 Section 1061(d) transfers to related persons.
(a) In general.
(b) Transfer.
(c) Application of paragraph (a) of this section.
(1) Determination of amounts included in paragraph (a)(1) of
this section.
(2) Application to an otherwise taxable transfer.
(d) Basis of interest increased by additional gain recognized.
(e) Section 1061(d) Related Person.
(1) In general.
(2) Exception.
(f) Examples.
(g) Applicability date.
Sec. 1.1061-6 Reporting rules.
(a) Owner Taxpayer Filing Requirements.
(b) Passthrough Entity Filing Requirements and Reporting.
(1) Requirement to file information with the IRS and to furnish
information to API Holder.
(2) Requirement to request, furnish, and file information in
tiered structures.
(i) Requirement to request information.
(ii) Requirement to furnish and file information.
(iii) Timing of requesting and furnishing information.
(iv) Manner of requesting information.
(v) Recordkeeping requirement.
(vi) Passthrough Entity is not Furnished Information to meet its
Reporting Obligations under paragraph (b)(1) of this section.
(vii) Penalties.
(c) Regulated investment company (RIC) and real estate
investment trust (REIT) reporting.
(1) Section 1061 disclosures.
(i) One Year Amounts Disclosure.
(ii) Three Year Amounts Disclosure.
(2) Pro rata disclosures.
(3) Report to shareholders.
(d) Qualified electing fund (QEF) reporting.
(e) Applicability date.
Sec. 1.1061-1 Section 1061 Definitions.
(a) Definitions. The following definitions apply solely for
purposes of this section and Sec. Sec. 1.1061-2 through 1.1061-6.
Applicable Partnership Interest (API) means any interest in a
partnership which, directly or indirectly, is transferred to (or is
held by) an Owner Taxpayer or Passthrough Taxpayer in connection with
the performance of substantial services by the Owner Taxpayer or by a
Passthrough Taxpayer, or by any Related Person, including services
performed as an employee, in any ATB unless an exception in Sec.
1.1061-3 applies. For purposes of defining an API under this section
and section 1061 of the Internal Revenue Code, an interest in a
partnership also includes any financial instrument or contract, the
value of which is determined in whole or in part by reference to the
partnership (including the amount of partnership distributions, the
value of partnership assets, or the results of partnership operations).
An Owner Taxpayer and a Passthrough Taxpayer can hold an API directly
or indirectly through one or more Passthrough Entities.
API Gains and Losses are any long-term capital gains and capital
losses with respect to an API and include:
(i) The API One Year Distributive Share Amount as defined in Sec.
1.1061-4(a)(3)(i);
(ii) The API Three Year Distributive Share Amount as defined in
Sec. 1.1061-4(a)(3)(ii);
(iii) The API One Year Disposition Amount as defined in Sec.
1.1061-4(a)(4)(i);
(iv) The API Three Year Disposition Amount as defined in Sec.
1.1061-4(a)(4)(ii); and
(v) Capital gains or losses from the disposition of Distributed API
Property.
API Holder is a person who holds an API.
API Holder Transition Amount has the meaning provided in Sec.
1.1061-4(b)(7)(ii).
Applicable Trade or Business (ATB) means any activity for which the
ATB Activity Test with respect to Specified Actions is met, and
includes all Specified Actions taken by Related Persons, including
combining activities occurring in separate partnership tiers or
entities as one ATB.
ATB Activity Test has the meaning provided in Sec. 1.1061-2(b)(1).
Capital Interest Allocations has the meaning provided in Sec.
1.1061-3(c)(4).
Capital Interest Disposition Amount has the meaning provided in
Sec. 1.1061-3(c)(6).
Capital Interest Gains and Losses has the meaning provided in Sec.
1.1061-3(c)(2).
Distributed API Property means property distributed by a
Passthrough Entity to an API Holder with respect to an API if the
holding period, as determined under sections 735 and 1223, in the API
Holder's hands is three years or less at the time of disposition of the
property by the API Holder.
Indirect API means an API that is held through one or more
Passthrough Entities.
Investing or Developing Actions means actions involving either--
(i) Investing in (or disposing of) Specified Assets (or identifying
Specified Assets for such investing or disposition), or
(ii) Developing Specified Assets (see Sec. 1.1061-2(b)(1)(ii)).
Lookthrough Rule has the meaning provided in Sec. 1.1061-4(b)(9).
One Year Gain Amount has the meaning provided in Sec. 1.1061-
4(a)(2)(i).
Owner Taxpayer means the person subject to Federal income tax on
net gain with respect to an API or an Indirect API during the taxable
year, including an owner of a Passthrough Taxpayer unless the owner of
the Passthrough Taxpayer is a Passthrough Entity itself or is excepted
under Sec. 1.1061-3(a), (b), or (d).
[[Page 49779]]
Partnership Transition Amount has the meaning provided in Sec.
1.1061-4(b)(7)(iii).
Passthrough Capital Allocations has the meaning provided in Sec.
1.1061-3(c)(5)(ii).
Passthrough Entity means a partnership, an S corporation described
in Sec. 1.1061-3(b)(2)(i), or passive foreign investment company
described in Sec. 1.1061-3(b)(2)(ii).
Passthrough Interest means an interest in a Passthrough Entity that
represents in whole or in part an API.
Passthrough Interest Capital Allocations has the meaning provided
in Sec. 1.1061-3(c)(5)(i).
Passthrough Interest Direct Investment Allocations has the meaning
provided in Sec. 1.1061-3(c)(5)(iii).
Passthrough Taxpayer means a Passthrough Entity that is treated as
a taxpayer for the purpose of determining the existence of an API.
Raising or Returning Capital Actions means actions involving
raising or returning capital but does not include Investing or
Developing Actions.
Recharacterization Amount has the meaning provided in Sec. 1.1061-
4(a)(1).
Related Person means a person or entity who is treated as related
to another person or entity under sections 707(b) or 267(b).
Relevant ATB means the ATB in which services were provided and in
connection with which an API is held or was transferred.
Section 1061(d) Related Person has the meaning provided in Sec.
1.1061-5(e).
Specified Actions means Raising or Returning Capital Actions and
Investing or Developing Actions.
Specified Assets means--
(i) Securities, including interests in partnerships qualifying as
securities (as defined in section 475(c)(2) without regard to the last
sentence thereof);
(ii) Commodities (as defined in section 475(e)(2));
(iii) Real estate held for rental or investment;
(iv) Cash or cash equivalents; and
(v) An interest in a partnership to the extent that the partnership
holds Specified Assets. See Sec. 1.1061-2(b)(1)(iii).
(vi) Specified Assets include options or derivative contracts with
respect to any of the foregoing.
Substantially All Test has the meaning provided in Sec. 1.1061-
4(b)(9)(i)(C).
Three Year Gain Amount has the meaning provided in Sec. 1.1061-
4(a)(2)(ii).
Unrealized API Gains and Losses means all unrealized capital gains
and losses, (including both short-term and long-term), that would be
allocated to an API Holder with respect to its API, if all relevant
assets were disposed of for fair market value in a taxable transaction
on the relevant date. Unrealized API Gains and Losses include--
(i) Unrealized capital gains and losses that are allocated to the
API Holder with respect to the API pursuant to a capital account
revaluation under Sec. 1.704-1(b)(2)(iv)(f) or Sec. 1.704-
1(b)(2)(iv)(s);
(ii) In the case of a Passthrough Entity that contributes property
to another Passthrough Entity, unrealized capital gains and losses that
would be allocated to the API Holder with respect to the API if the
property contributed by the upper-tier Passthrough Entity to the lower-
tier Passthrough Entity were sold immediately before the contribution
for the amount that is included in the lower-tier partnership's capital
account or, in the case of another type of lower-tier Passthrough
Entity, a similar account maintained under Sec. 1.1061-3(c)(3)(ii)
with respect to the contributed property; and
(iii) In the case of a revaluation of the property of a partnership
that is the owner of a tiered structure of partnerships or in the case
of the contribution of an API to another Passthrough Entity, an API
Holder's Unrealized API Gains or Losses at the time of the revaluation
or contribution include those capital gains or losses that would be
allocated directly or indirectly to the API Holder by the lower-tier
partnerships as if a taxable disposition of the property of each of the
lower-tier partnerships also occurred on the date of the revaluation or
contribution under the principles of Sec. 1.704-1(b)(2)(iv)(f). See
Sec. 1.1061-2(a)(1)(ii)(B).
Unrelated Non-Service Partners mean partners who do not (and did
not) provide services in the Relevant ATB and who are not (and were
not) related to any API Holder in the partnership or any person who
provides or has provided services in the Relevant ATB.
(b) Applicability date. The provisions of this section apply to
taxable years of Owner Taxpayers and Passthrough Entities beginning on
or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL
REGISTER].
Sec. 1.1061-2 Applicable partnership interests and applicable trades
or businesses.
(a) API rules and examples--(1) Rules--(i) An API remains as an
API. Once a partnership interest qualifies as an API, the partnership
interest remains an API unless and until the requirements of one of the
exceptions to qualification of a partnership interest as an API, set
forth in Sec. 1.1061-3, are satisfied.
(ii) Unrealized API Gains and Losses-(A) Long-term Unrealized API
Gains and Losses become API Gains and Losses. Long-term Unrealized API
Gains and Losses are API Gains and Losses subject to section 1061 when
the gains and losses are realized and recognized. Unrealized API Gains
and Losses do not lose their character as such until they are
recognized.
(B) Requirement to determine Unrealized API Gains and Losses. In
the case of a revaluation of the property of a partnership that owns a
tiered structure of partnerships, or in the case of the contribution of
an API to another Passthrough Entity, Unrealized API Gains and Losses
included in the fair market value of the property held by all relevant
partnerships in the tiered structure as of the date of the revaluation
or contribution that are directly or indirectly allocable to the API
Holder must be determined under principles similar to Sec. 1.704-
1(b)(2)(iv)(f). If a partnership is required to revalue its assets for
purposes of section 1061 under this paragraph, such partnership is
permitted to revalue its property for purposes of section 704 as though
an event in Sec. 1.704-1(b)(2)(iv)(f)(5) had occurred. Unrealized API
Gains and Losses of a partnership that become API Gains and Losses
under paragraph (a)(1)(ii)(A) of this section must be allocated to the
API Holder under principles similar to Sec. 1.704-3(a)(9).
(iii) API Gains and Losses retain their character. API Gains and
Losses retain their character as API Gains and Losses as they are
allocated from one Passthrough Entity to another Passthrough Entity and
then to the Owner Taxpayer.
(iv) Substantial services by an Owner Taxpayer, Passthrough
Taxpayer, or any Related Person. If an interest in a partnership is
transferred to or held by an Owner Taxpayer, Passthrough Taxpayer, or
any Related Person in connection with the performance of services, the
Owner Taxpayer, the Passthrough Taxpayer, or the Related Person is
presumed to have provided substantial services.
(v) Grantor trusts and entities disregarded as separate from their
owners. A trust wholly described in subpart E, part I, subchapter J,
chapter 1 of the Code (that is, a grantor trust), a qualified
subchapter S subsidiary described in section 1361(b)(3), and an entity
with a single owner that is treated as disregarded as an entity
separate from its owner under any provision of the Code or any part of
26 CFR (including
[[Page 49780]]
Sec. 301.7701-3 of this chapter) are disregarded for purposes of
Sec. Sec. 1.1061-1 through 1.1061-6.
(2) Examples. The following examples illustrate the provisions of
this paragraph (a).
(i) Example 1. API. (A) A is the general partner of PRS, a
partnership, and provides services to PRS. A is engaged in an ATB as
defined in Sec. 1.1061-1(a). PRS transfers an interest in the net
profits of PRS to A in connection with A's performance of services in
A's ATB and with respect to PRS. A's interest in PRS is an API.
(B) After 6 years, A retires and is no longer engaged in an ATB and
does not perform any services with respect to its ATB and with respect
to PRS. However, A retains the API in PRS. PRS continues to acquire new
capital assets and to allocate gain to A from the disposition of those
assets. A's interest in PRS remains an API after A retires.
(ii) Example 2. Contribution of an API to a partnership.
Individuals A, B, and C each directly hold APIs in PRS, a partnership.
A and B form a new partnership, GP, and contribute their APIs in PRS to
GP. Following the contribution, A and B each hold an Indirect API
because A and B now indirectly hold their APIs in PRS through GP, a
Passthrough Entity. Each of A's and B's interests in GP is a
Passthrough Interest because each of A's and B's interests in GP
represents an indirect interest in an API. See Sec. 1.1061-5 regarding
the potential application of section 1061(d) to this example.
(iii) Example 3. Passthrough Interest, Indirect API, Passthrough
Taxpayer. A, B, and C each provide services to and are equal partners
of GP. GP is the general partner of PRS. GP is engaged in an ATB, as
defined in Sec. 1.1061-1(a), and provides management services to PRS.
In connection with GP's performance of services in an ATB, an interest
in the net profits of PRS is transferred to GP. Because its interest in
PRS's net profits was transferred to GP in connection with GP's
services in an ATB, GP is a Passthrough Taxpayer. Therefore, GP's
interest in PRS is an API. Because A, B, and C are partners in GP, they
each hold a Passthrough Interest in GP and an Indirect API in PRS as a
result of GP's API in PRS. A, B, and C are treated as the Owner
Taxpayers because they are partners in GP, a Passthrough Taxpayer, and
also because they indirectly hold an API in PRS in connection with the
performance of their services to GP's ATB.
(iv) Example 4. S corporation, Passthrough Interest, Indirect API,
and Passthrough Taxpayer. A owns all of the stock of S Corp, an S
corporation. S Corp is engaged in an ATB, as defined in Sec. 1.1061-
1(a). S Corp provides substantial management services to PRS, a
partnership. Additionally, S Corp is the general partner of PRS. A
provides substantial services in S Corp's ATB. In connection with S
Corp's performance of services to PRS, an interest in the net profits
of PRS is transferred to S Corp. S Corp's interest in PRS is its only
asset. Because its interest in PRS's net profits was transferred to S
Corp in connection with substantial services in an ATB, S Corp is a
Passthrough Taxpayer and its interest in PRS is an API. Because A is a
shareholder in S Corp, A holds a Passthrough Interest in S Corp and an
Indirect API in PRS as a result of S Corp's API in PRS. A is treated as
an Owner Taxpayer because A holds an interest in S Corp, a Passthrough
Taxpayer, and also indirectly holds an API in PRS in connection with
A's services in S Corp's ATB.
(v) Example 5. Indirect API, Related Party and Passthrough
Taxpayer. A, B, and C are equal partners of GP, a partnership. GP is
the general partner of PRS. GP's Specified Actions by themselves do not
satisfy the ATB Activity Test under Sec. 1.1061-1(a) and as a result,
GP's actions do not establish an ATB. GP is required under PRS's
partnership agreement to provide management services to PRS, either by
itself or through a delegate. GP enters into an agreement with
Management Company, a partnership, to provide services to PRS, and
Management Company is paid reasonable compensation for such services.
Management Company is related to GP within the meaning of sections
267(b) and 707(b). Management Company provides management services on
behalf of GP to PRS and is engaged in an ATB. GP also is in an ATB
because Management Company's actions are attributed to GP as GP's
delegate. An interest in the net profits of PRS is transferred to GP in
connection with Management Company's services to PRS. Because its
interest in the net profits of PRS is transferred to GP in connection
with services provided by Management Company, a Related Person, GP is a
Passthrough Taxpayer and its interest in PRS is an API. Unless an
exception described in Sec. 1.1061-3 applies, because A, B, and C are
partners in GP, they each hold a Passthrough Interest in GP and an
Indirect API in PRS. A, B, and C are treated as Owner Taxpayers because
they hold an interest in GP, a Passthrough Taxpayer. See also
Sec. Sec. 1.1061-2(b)(1)(i)(C)(2) and 1.1061-2(b)(2)(v), Example 5.
(b) Application of the ATB Activity Test--(1) In general. The ATB
Activity Test is satisfied if Specified Actions are conducted by one or
more Related Persons and the total level of activity, including the
combined activities of all Related Persons, satisfies the level of
activity that would be required to establish a trade or business under
section 162.
(i) Rules for applying the ATB Activity Test--(A) Aggregate
Specified Actions taken into account. The determination of whether the
ATB Activity Test is satisfied is based on the combined activities
conducted that qualify as either Raising or Returning Capital Actions
and Investing or Developing Actions. The fact that either Raising or
Returning Capital Actions or Investing or Developing Actions are only
infrequently taken does not preclude the test from being satisfied if
the combined Specified Actions meet the test.
(B) Raising or Returning Capital Actions and Investing or
Developing Actions are not both required to be taken in each taxable
year. Raising or Returning Capital Actions and Investing or Developing
Actions are not both required to be taken in each taxable year in order
to satisfy the ATB Activity Test. For example, the ATB Activity Test
will be satisfied if Investing or Developing Actions are not taken in
the current taxable year, but sufficient Raising or Returning Capital
Actions are taken in anticipation of future Investing or Developing
Actions. Additionally, the ATB Activity Test will be satisfied if no
Raising or Returning Capital Actions are taken in the current taxable
year, but have been taken in a prior taxable year (regardless of
whether the ATB Activity Test was met in the prior year), and
sufficient Investing or Developing Actions are undertaken by the
taxpayer in the current taxable year.
(C) Combined conduct by multiple related entities taken into
account--(1) Related Entities. If a Related Person(s) (within the
meaning of Sec. 1.1061-1(a)) solely or primarily performs Raising or
Returning Capital Actions and one or more other Related Person(s)
solely or primarily performs Investing or Developing Actions, the
combination of the activities performed by these Related Persons will
be taken into account in determining whether the ATB Activity Test is
satisfied.
(2) Actions taken by an agent or delegate. Specified Actions taken
by an agent or a delegate in its capacity as an agent or a delegate of
a principal will be taken into account by the principal in determining
whether the ATB Activity
[[Page 49781]]
Test is satisfied with respect to the principal. These Specified
Actions are also taken into account in determining whether the ATB
Activity test is satisfied by the agent or the delegate.
(ii) Developing Specified Assets. Developing Specified Assets takes
place if it is represented to investors, lenders, regulators, or other
interested parties that the value, price, or yield of a portfolio
business may be enhanced or increased in connection with choices or
actions of a service provider. Merely exercising voting rights with
respect to shares owned or similar activities do not amount to
developing Specified Assets.
(iii) Partnerships. Investing or Developing Actions directly
conducted with respect to Specified Assets held by a partnership are
counted towards the ATB Activity Test. Additionally, a portion of the
Investing or Developing Actions conducted with respect to the interests
in a partnership that holds Specified Assets is counted towards the ATB
Activity Test. This portion is the value of the partnership's Specified
Assets over the value of all of the partnership's assets. Actions taken
to manage a partnership's working capital will not be taken into
account in determining the portion of Investing or Developing Actions
conducted with respect to the interests in the partnership.
(2) Examples. The following examples illustrate the application of
the ATB Activity Test described in paragraph (b)(1) of this section.
(i) Example 1. Combined activities of Raising or Returning Capital
Actions and Investing or Developing Actions. During the taxable year, B
takes a small number of actions to raise capital for new investments. B
takes numerous actions to develop Specified Assets. B's actions with
respect to raising capital and B's actions with respect to developing
Specified Assets are combined for the purpose of determining whether
the ATB Activity Test is satisfied.
(ii) Example 2. Combining Specified Actions in multiple entities.
GP, a partnership, conducts Raising or Returning Capital Actions.
Management Company, a partnership that is a Related Party to GP,
conducts Investing or Developing Actions. When GP's and Management
Company's activities are combined, the ATB Activity Test is satisfied.
Accordingly, both GP and Management Company are engaged in an ATB, and
services performed by either GP or Management Company are performed in
an ATB.
(iii) Example 3. Investing or Developing Actions taken after
Raising or Returning Capital Actions that do not meet the ATB Activity
Test. In year 1, PRS engaged in Raising or Returning Capital Actions to
fund PRS's investment in Specified Assets. However, PRS' Specified
Actions during year 1 did not satisfy the ATB Activity Test because
they did not satisfy the level of activity required to establish a
trade or business under section 162. Therefore, PRS was not in engaged
in an ATB in year 1. In year 2, PRS engaged in significant Investing or
Developing Actions but did not engage in any Raising or Returning
Capital Actions. In year 2, PRS's Investing or Developing Actions alone
satisfy the ATB Activity Test. Therefore, PRS is engaged in an ATB in
year 2.
(iv) Example 4. Raising or Returning Capital Actions taken in
anticipation of Investing or Developing Actions. In year 1, A spent all
of A's time on Raising or Returning Capital Actions. A's Raising or
Returning Capital Actions were undertaken to raise capital to invest in
Specified Assets with the goal of increasing their value through
Investing or Developing Actions. A did not take Investing or Developing
actions during the taxable year. A's Raising or Returning Capital
Actions alone satisfy the ATB Activity Test. Therefore, the ATB
Activity Test is satisfied, and A is engaged in an ATB in year 1.
(v) Example 5. Attribution of delegate's actions. GP is the general
partner of PRS. GP is responsible for providing management services to
PRS. GP contracts with Management Company to provide management
services on GP's behalf to PRS. GP and Management Company are not
Related Persons. The Specified Actions taken by Management Company on
behalf of GP are attributed to GP for purposes of the ATB Activity Test
because the Management Company is operating as a delegate of the GP.
Additionally, those Specified Actions are taken into account by
Management Company for purposes of the ATB Activity Test and whether it
is engaged in an ATB.
(vi) Example 6. ATB Activity Test not satisfied. A is the manager
of a hardware store. Partnership owns the hardware store, including the
building in which the hardware business is conducted. In connection
with A's services as the manager of the hardware store, a profits
interest in Partnership is transferred to A. Partnership's business
involves buying hardware from wholesale suppliers and selling it to
customers. The hardware is not a Specified Asset. Although real estate
is a Specified Asset if it is held for rental or investment purposes,
Partnership holds the building for the purpose of conducting its
hardware business and not for rental or investment purposes. Therefore,
the building is not a Specified Asset as to Partnership. Partnership
also maintains and manages a certain amount of working capital for its
business, but actions with respect to working capital are not taken
into account for the purpose of determining whether the ATB Activity
Test is met. Partnership is not a Related Person with respect to any
person who takes Specified Actions. Partnership is not engaged in an
ATB because the ATB Activity Test is not satisfied. Although
Partnership raises capital, its Raising or Returning Capital Actions
alone do not satisfy the ATB Activity Test. Further, Partnership takes
no Investing or Developing Actions because it holds no Specified Assets
other than working capital. Partnership is not in an ATB and the
profits interest transferred to A is not an API.
(c) Applicability date. The provisions of this section apply to
taxable years of Owner Taxpayers and Passthrough Entities beginning on
or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL
REGISTER].
Sec. 1.1061-3 Exceptions to the definition of an API.
(a) A partnership interest held by an employee of another entity
not conducting an ATB. An API does not include any interest transferred
to a person in connection with the performance of substantial services
by that person as an employee of another entity that is conducting a
trade or business (other than an ATB) and the person provides services
only to such other entity.
(b) Partnership interest held by a corporation--(1) In general.
Except as provided in paragraph (b)(2) of this section, an API does not
include any interest directly or indirectly held by a corporation.
(2) Treatment of interests held by an S corporation or a qualified
electing fund. For purposes of this section, a corporation does not
include an entity for which an election was made to treat the entity as
a Passthrough Entity. Thus, the following entities are not treated as
corporations for purposes of section 1061--
(i) An S corporation for which an election under section 1362(a) is
in effect; and
(ii) A passive foreign investment company (PFIC) with respect to
which the shareholder has a qualified electing fund (QEF) election
under section 1295 in effect.
(c) Capital Interest Gains and Losses--(1) In general. Capital
Interest Gains and Losses are not subject to section 1061 and,
therefore, are not
[[Page 49782]]
included in calculating an Owner Taxpayer's Recharacterization Amount.
(2) Capital Interest Gains and Losses Defined. For purposes of
paragraph (c)(1) of this section, Capital Interest Gains and Losses are
Capital Interest Allocations that meet the requirements of paragraph
(c)(4) of this section, Passthrough Interest Capital Allocations that
meet the requirements of paragraph (c)(5) of this section, and Capital
Interest Disposition Amounts that meet the requirements of paragraph
(c)(6) of this section.
(3) General rules for determining Capital Interest Allocations and
Passthrough Interest Capital Allocations--(i) Allocations made in the
same manner. Only allocations that are made in the same manner to all
partners can be Capital Interest Allocations or Passthrough Interest
Capital Allocations. In general, allocations will be considered to be
made in the same manner if, under the partnership agreement, the
allocations are based on the relative capital accounts of the partners
(or owners in the case of a Passthrough Entity that is not a
partnership) receiving the allocation and the terms, priority, type and
level of risk, rate of return, and rights to cash or property
distributions during the partnership's operations and on liquidation
are the same. An allocation to an API Holder will not fail to qualify
solely because the allocation is subordinated to allocations made to
Unrelated Non-Service Partners. Further, an allocation to an API Holder
will not fail to qualify because it is not reduced by the cost of
services provided by the API Holder or a Related Person to the
partnership.
(ii) Capital accounts--(A) In general. Capital Interest Allocations
and Passthrough Interest Capital Allocations must be based on an API
Holder's relative capital account balance in a Passthrough Entity. In
the case of a partnership that maintains capital accounts under Sec.
1.704-1(b)(2)(iv), the allocation must be tested under paragraph
(c)(3)(i) of this section based on that capital account. In the case of
a Passthrough Entity that is not a partnership (or a partnership that
does not maintain capital accounts under Sec. 1.704-1(b)(2)(iv)), if
the Passthrough Entity maintains and determines accounts for its owners
using principles similar to those provided under Sec. 1.704-
1(b)(2)(iv), the account will be treated as a capital account for
purposes of this paragraph (c) and an allocation must be tested under
paragraph (c)(3)(i) of this section based on those accounts.
(B) Tiers--(1) Passthrough Capital Allocations. Generally,
Passthrough Capital Allocations must be based on each owner's share of
the Passthrough Entity's capital account in the entity making the
Capital Interest Allocations described under paragraph (c)(4) of this
section to the Passthrough Entity unless the exception in paragraph
(c)(3)(ii)(B)(3) of this section applies.
(2) Passthrough Interest Direct Investment Allocations. Generally,
Passthrough Interest Direct Investment Allocations must be based on
each Owner Taxpayer's or Passthrough Taxpayer's relative capital
account balance in the Passthrough Entity holding the investments,
reduced by that owner's share of a capital account held directly or
indirectly by the Passthrough Entity in a lower-tier entity unless the
exception in paragraph (c)(3)(ii)(B)(3) of this section applies.
(3) Aggregate Allocation of Passthrough Interest Capital
Allocations. A Passthrough Entity that allocates all Passthrough
Interest Capital Allocations for the taxable year in the aggregate
regardless of whether they are Passthrough Capital Allocations or
Passthrough Interest Direct Investment Allocations may make those
allocations based on each Owner Taxpayer's or Passthrough Taxpayer's
relative capital account balance in the Passthrough Entity rather than
under paragraph (c)(3)(ii)(B)(1) and (2) of this section.
(C) Proceeds of partnership or partner loans not included in
capital account. For purposes of Sec. Sec. 1.1061-1 through 1.1061-6,
a capital account does not include the contribution of amounts directly
or indirectly attributable to any loan or other advance made or
guaranteed, directly or indirectly, by any other partner or the
partnership (or any Related Person with respect to any such other
partner or the partnership). However, the repayments on the loan are
included in capital accounts as those amounts are paid by the partner,
provided that the loan is not repaid with the proceeds of another loan
described in this paragraph.
(iii) Items that are not included in Capital Interest Allocations
or Passthrough Interest Capital Allocations. Capital Interest
Allocations and Passthrough Interest Capital Allocations do not
include--
(A) Amounts that are treated as API Gains and Losses and Unrealized
API Gains and Losses;
(B) Partnership Transition Amounts described in Sec. 1.1061-
4(b)(7)(iii); or
(C) Items that are not taken into account for purposes of section
1061 under Sec. 1.1061-4(b)(6).
(4) Capital Interest Allocations. Capital Interest Allocations are
allocations of long-term capital gain or loss made under the
partnership agreement to an API Holder and to Unrelated Non-Service
Partners based on their respective capital account balances that meet
the requirements in paragraphs (c)(4)(i), (ii), and (iii) of this
section.
(i) Allocations are made in the same manner to API Holders and
Unrelated Non-Service Partners;
(ii) The allocations are made to Unrelated Non-Service Partners
with a significant aggregate capital account balance. An aggregate
capital account balance equal to 5 percent or more of the aggregate
capital account balance of the partnership at the time the allocations
are made will be treated as significant. Allocations to more than one
Unrelated Non-Service Partner may be aggregated for determining
significance if such allocations are made in the same manner to each of
the Unrelated Non-Service Partners; and
(iii) The allocations to the API Holder and the Unrelated Non-
Service Partners are clearly identified both under the partnership
agreement and on the partnership's books and records as separate and
apart from allocations made to the API Holder with respect to its API,
and both the partnership agreement and the partnership's books and
records clearly demonstrate that the requirements of paragraphs (c)(3)
and (4) of this section have been met.
(5) Passthrough Interest Capital Allocations--(i) In general.
Passthrough Interest Capital Allocations are made by Passthrough
Entities that hold an API in a lower-tier Passthrough Entity.
Passthrough Interest Capital Allocations can be either Passthrough
Capital Allocations as determined under paragraph (c)(5)(ii) of this
section or Passthrough Interest Direct Investment Allocations as
determined under paragraph (c)(5)(iii) of this section.
(ii) Passthrough Capital Allocations. Passthrough Capital
Allocations are Capital Interest Allocations that are made directly or
indirectly to the Passthrough Entity by a lower-tier entity and that
are allocated by the Passthrough Entity among its direct owners in the
same manner (as provided in paragraph (c)(3)(i) of this section) with
respect to each owner's capital account as determined under paragraph
(c)(3)(ii) of this section.
(iii) Passthrough Interest Direct Investment Allocations.
Allocations are treated as Passthrough Interest Direct Investment
Allocations if--
(A) The allocations solely are comprised of long-term capital gain
and loss derived from assets (other than an API) directly held by the
Passthrough Entity; and
[[Page 49783]]
(B) Allocations are made in the same manner (as provided in
paragraph (c)(3)(i) of this section) based on each direct owner's
capital account as determined under paragraph (c)(3)(ii) of this
section.
(6) Capital Interest Disposition Amounts--(i) In general. The term
Capital Interest Disposition Amount means the amount of long-term
capital gain and loss recognized on the sale or disposition of all or a
portion of a Passthrough Interest that may be treated as Capital
Interest Gain or Loss. The amount of long-term capital gain or loss
that is recognized on the sale or disposition is determined under
federal tax law (see, for example, sections 741 and 751, and Sec.
1.61-6) and the holding period of the Passthrough Interest is
determined as provided in Sec. 1.1061-4(b)(8). In general, long-term
capital gain or loss recognized on the sale or disposition of a
Passthrough Interest is deemed to be API Gain or Loss unless it is
determined under these rules to be a Capital Interest Disposition
Amount.
(ii) Determination of the Capital Interest Disposition Amount. If a
Passthrough Interest that includes a right to allocations of Capital
Interest Gains and Losses is disposed of, the amount of long-term
capital gain or loss that is treated as a Capital Interest Disposition
Amount is determined under the rules provided in this paragraph.
(A) First, determine the amount of long-term capital gain or loss
that would be allocated to the Passthrough Interest (or the portion of
the Passthrough Interest sold) if all the assets of the Passthrough
Entity were sold for their fair market value in a fully taxable
transaction (deemed liquidation) immediately before the disposition of
the Passthrough Interest. To calculate this in tiered entities,
determine the long-term capital gain or loss from a lower-tier
Passthrough Entity.
(B) Second, determine the sum of the amount of Capital Interest
Gain or Loss from the deemed liquidation that is allocated to the
Passthrough Interest (or the portion of the Passthrough Interest sold)
as Capital Interest Allocations under paragraph (c)(4) of this section
and Passthrough Interest Capital Allocations under paragraph (c)(5) of
this section. To calculate this in tiered entities, determine the
capital gain or loss from a lower-tier Passthrough Entity.
(C) If the transferor recognized long-term capital gain upon
disposition of the Passthrough Interest and only capital losses are
allocated to the Passthrough Interest under paragraph (c)(6)(ii)(B) of
this section from the deemed liquidation, then all of the long-term
capital gain is API Gain. If the transferor recognized long-term
capital loss on the disposition of the Passthrough Interest and only
capital gain is allocated to the Passthrough Interest under paragraph
(c)(6)(ii)(B) of this section, then all the long-term capital loss is
API Loss.
(D) If paragraph (c)(6)(ii)(C) of this section does not apply, the
amount of long-term capital gain that the transferor of the Passthrough
Interest recognizes that is treated as a Capital Interest Disposition
Amount is determined by multiplying long-term capital gain recognized
on the disposition of the Passthrough Interest by a fraction, the
numerator of which is the amount of long-term capital gain determined
under paragraph (c)(6)(ii)(B) of this section, and the denominator of
which is the amount of long-term capital gain determined under
paragraph (c)(6)(ii)(A) of this section. Alternatively, if long-term
capital loss is recognized on the disposition of the Passthrough
Interest, the amount of long-term capital loss treated as a Capital
Interest Disposition Amount is determined by multiplying the
transferor's capital loss by a fraction, the numerator of which is the
amount of long-term capital loss determined under paragraph
(c)(6)(ii)(B) of this section, and the denominator of which is the
amount of long-term capital loss determined under paragraph
(c)(6)(ii)(A) of this section.
(E) In applying these rules, allocations of amounts that are not
included in determining the amount of long-term capital gain or loss
recognized on the sale or disposition of the Passthrough Interest are
not included. See, for example, section 751(a).
(7) Examples. The rules of this paragraph (c) are illustrated by
the following examples. For purposes of these examples, unless stated
otherwise, A, B, and C are equal partners of GP, a partnership. GP is
the general partner of PRS, a partnership. The other partners of PRS
are Unrelated Non-Service Partners. GP's and PRS's partnership
agreements both require that the partnership determine and maintain
capital accounts under Sec. 1.704-1(b)(2)(iv). GP holds an API in PRS
that entitles GP to 20 percent of PRS's net profits. GP's API in PRS is
an Indirect API as to each of A, B, and C. In addition, A, B, and C
contributed $100 each to GP in exchange for their interests in GP.
(i) Example 1. Capital Interest Allocations--(A) Facts. GP
contributed the $300 of capital contributed by A, B and C to PRS. GP's
$300 contribution equals 2% of the contributed capital made by all of
PRS's partners. PRS's partnership agreement allocates 20% of its net
profits to GP with respect to its API (20% API allocation). The
partnership agreement allocates the 80% of net profits remaining after
the 20% API allocation to the partners pro rata (including GP) based on
their relative capital account balances (Investment Allocations). Under
PRS's partnership agreement, Investment Allocations to the partners,
both to GP and to the Unrelated Non-service Partners, have the same
priority, type and level of risk, and rate of return. Additionally, all
of the partners have the same rights to cash or property distributions
with respect to the Investment Allocations during the partnership's
operations and on liquidation. GP's capital account balance comprises
2% of PRS's total capital account balance and the capital accounts of
the Unrelated Non-service Partners receiving the Investment Allocations
comprise the other 98% of PRS's total capital account balance. During
the taxable year, PRS has $10,000 of net capital gain. It allocates
$2,000 of net capital gain to GP based on its API allocation providing
for a 20% interest in net profits ($10,000 x 20%). Additionally, GP
receives a 2% Investment Allocation from PRS, or $160 of net capital
gain ($8,000 ($10,000 - $2,000) x 2%). In total, PRS allocates $2,160
of net capital gain to GP for the taxable year. GP allocates $720
($2,160/3) of this net capital gain to each of A, B, and C. The
allocation received by GP from PRS is allocated among the partners of
GP pro rata based on their share of the capital account that GP has in
PRS.
(B) Capital Interest Allocations Analysis. GP's 2% Investment
Allocation of $160 of net capital gain is a Capital Interest
Allocation. Other than GP, PRS's partners are Unrelated Non-Service
Providers. GP is an API Holder. Under PRS's partnership agreement, the
Investment Allocation is made pro rata to GP (an API Holder) and each
of the Unrelated Non-Service Partners based on their relative capital
account balances and the allocations are made in the same manner.
Further, because allocations are made in the same manner with respect
to each Unrelated Non-Service Partner's capital account, the capital
account balances of the Unrelated Non-service Partners can be
aggregated to determine if the allocations to the Unrelated Non-Service
Partners are significant. The capital accounts of the Unrelated Non-
Service Partners are significant because they equal 98% of the
aggregate capital
[[Page 49784]]
account balance of PRS at the time the allocations are made.
Accordingly, the Investment Allocation to GP, the API Holder, is
treated as a Capital Interest Allocation. GP's API allocation of $2,000
of net capital gain is not a Capital Interest Allocation because it is
made irrespective of the balance of GP's capital account. Therefore,
the API allocation is not made in the same manner as any allocation to
an Unrelated Non-Service Partner.
(C) Passthrough Interest Capital Allocation Analysis. GP is
allocated $160 of Capital Interest Allocations by PRS. This amount is
allocated to A, B, and C pro rata and in the same manner based on their
shares of GP's capital account in PRS. As such, they qualify as
Passthrough Capital Allocations by GP. In addition, GP holds an API in
PRS and is allocated $2,000 gain from PRS with respect to its API. This
gain is API Gain when allocated by GP to its partners and cannot be
treated as a Passthrough Capital Allocation by GP. In summary, A, B,
and C are each allocated $720 of long-term capital gain from PRS
($2,160/3). Of this amount, $667 is API Gain ($2,000/3) and $53 is a
Passthrough Interest Capital Allocation ($160/3).
(ii) Example 2. Passthrough Interest Direct Investment Allocation--
(A) Facts. The facts are the same as in Example 1, except that GP does
not contribute any of the $300 contributed to GP by A, B, and C to PRS.
Thus, GP's capital account in PRS is $0. Each of A, B, and C have a
$100 capital account balance in GP. GP invests the contributed $300 in
assets held directly by GP. Under the terms of GP's partnership
agreement, long-term capital gains and losses from assets (other than
an API) held directly by GP are allocated in the same manner to the
partners of GP based on their relative capital accounts in GP less
amounts that are included in the capital account of a lower-tier
Passthrough Entity in which GP holds an interest. For the taxable year,
GP receives an allocation of $2,000 of net capital gain with respect to
the API GP holds in PRS. Additionally, GP earns $30 on the assets it
holds directly. GP allocates $677 to each of A, B, and C for the
taxable year.
(B) Analysis. Of the $677 allocated to each of A, B, and C, $667 is
an allocation of API Gain because it is an allocation of gain received
with respect to GP's API in PRS. The remaining $10 allocated to A, B,
and C was earned from assets which GP, a Passthrough Entity, holds
directly. The $30 was allocated in the same manner, based on the
respective capital account balances of A, B, and C in GP, as determined
under paragraph (c)(3)(ii) of this section. Thus, the $10 allocated to
each of A, B, and C is treated as a Passthrough Interest Direct
Investment Allocation.
(iii) Example 3. Aggregate Allocation of Passthrough Interest
Capital Allocations--(A) Facts. The facts are the same as in Example 2,
except that C is not a partner. A and B each contribute $100 to GP. GP
contributes the $200 contributed by A and B to PRS, which entitles GP
to a 1.5% Investment Allocation in PRS. One month later, C contributes
$100 to GP for a one-third interest in GP. GP does not contribute the
$100 contributed by C to PRS but instead invests the $100 directly.
GP's partnership agreement allocates all items to the partners pro
rata, based on their percentage interests, as represented by their
capital account balances in GP. For the taxable year, GP receives an
allocation of $2,000 of net capital gain with respect to the API GP
holds in PRS. Additionally, GP receives an Investment Allocation from
PRS of $120 of net capital gain. In sum, GP is allocated $2,120 of net
capital gain from PRS. GP earns $30 on the assets it holds directly.
(B) Analysis. GP allocates $667 of the API Gain to each of A, B,
and C, which remains an allocation of API Gain. GP allocates $150 ($120
Capital Interest Allocation which GP received from PRS, plus the $30 GP
earned on its investment made with C's capital contribution) to each of
A, B, and C, based on their percentage interests as represented by
their capital accounts in GP. Thus, of the $150 of net capital gain
that did not arise from GP's API in PRS, GP allocates to each of A, B,
and C $50. Because GP allocates all Passthrough Interest Capital
Allocations in the aggregate pro rata based on its partners' capital
accounts in GP, the $50 allocated to each of A, B, and C is a
Passthrough Interest Capital Allocation.
(iv) Example 4. Sale of a Passthrough Interest. A, B, and C form GP
in Year 1 and contribute $100 each. GP invests the $300 in Asset X in
Year 1. In Year 3, A sells A's interest in GP to an unrelated third
party for $800 and recognizes $700 of capital gain on the sale. GP does
not have a capital account in PRS and is not entitled to Capital
Interest Allocations from PRS. GP is entitled to allocations of API
Gain and Loss in PRS. If PRS had sold its assets in a taxable
transaction for their fair market value and liquidated immediately
before A transferred its interest in GP, GP would have been allocated
$1,800 of long-term capital gain with respect to GP's API in PRS. Of
this $1,800, GP would have allocated $600 to A. If GP sold all of its
assets for fair market value immediately before A's sale of the
interest in GP and liquidated, A would have received a Passthrough
Interest Direct Investment Allocation of $100. Accordingly, total gain
allocable to A as a result of the hypothetical liquidation would be
$700. The percentage of the total gain of $700 that is comprised of a
Passthrough Interest Direct Investment Allocation is $100/$700 or
approximately 14.286%. Accordingly, 14.286% of A's $700 gain, or $100,
is A's Capital Interest Disposition Amount, and not subject to section
1061.
(v) Example 5. Sale of a portion of a Passthrough Interest--(A)
Facts. A, B, and C each hold a one-third interest in GP's profits and
capital. PRS's ownership interests are divided into two classes, Class
A and Class B. The PRS partnership agreement provides for 10 Class A
units which each represent a 2% interest in the net profits of PRS, for
a total of 20% of the total net profits. Additionally, the PRS
partnership agreement provides for 100 Class B units. Each Class B unit
represents a 1% interest in the capital and a 0.8% interest in the
profits of PRS, for a total of 80% of the total net profits. PRS does
not have any outstanding indebtedness. In Year 1, PRS transferred the
10 Class A units to GP in connection with GP's performance of
substantial services to PRS. GP is engaged in an ATB. Additionally, on
the same date, PRS transferred 2 Class B units in exchange for GP's
capital contribution of $2,000 to PRS. The balance of the Class B units
were issued to Unrelated Non-Service Partners for contributions of
$1,000 per unit. In Year 3, when the fair market value of the Class A
units is $7,000, GP sells its Class B units to an Unrelated Non-Service
Partner for $3,000. At the time of the sale, GP's basis in its
partnership interest in PRS is $2,000. Additionally, if all of the
assets of PRS were sold in a taxable transaction immediately before the
Class B units were sold, GP would be allocated $1,000 of capital gain
with respect to GP's Class B units.
(B) Treatment of the Class A and Class B Units under Section 1061.
GP's class A units represent an API as to GP because they were
transferred to GP in connection with the performance of substantial
services in an ATB. Class A units do not provide for allocations that
meet the requirements to be treated as either Capital Interest
Allocations or Passthrough Interest Capital Allocations. GP's Class B
units entitle GP to Capital Interest Allocations. Allocations of gain
made by PRS with respect to the Class B units are treated as Capital
Interest Allocations because the allocations are made to GP as a
[[Page 49785]]
holder of an API with respect to GP's capital account in the same
manner as allocations are made to Unrelated Non-Service Partners with
respect to their capital accounts. Additionally, 98% of the Class B
units representing 98% of the capital account balance in PRS are held
by Unrelated Non-Service Partners. Thus, their interest in PRS is
significant.
(C) Calculation of GP's gain on the sale of the Class B Units.
Although GP's interest in PRS is represented by units of different
classes and some of those units may constitute a right to API Gains and
Losses and other units may constitute a right to Capital Interest
Allocations, under the provisions of subchapter K, chapter 1 of the
Code, GP has a single partnership interest in PRS and a single tax
basis and section 704(b) book capital account in that partnership
interest. GP's basis in its partnership interest is $2,000. To
determine GP's gain on the disposition of the Class B units, GP's tax
basis in its partnership interest must be equitably apportioned between
GP's Class A and Class B units. See Sec. 1.61-6(a). At the time of the
sale, the fair market value of the Class A Units is $7,000 and the fair
market value of the Class B Units is $3,000. GP's overall fair market
value in its interest in PRS is equal to $10,000. Of this amount, the
value of the Class B Units is $3,000, or 30%, of the fair market value
of the entire interest. Accordingly, GP apportions 30% of its tax basis
to the Class B units. This amount is $600 (30% x $2,000). Accordingly,
GP's long-term capital gain on the sale of the Class B units is $2,400
($3,000 less $600).
(D) Determination of Capital Interest Disposition Amount. To
determine the percentage of the long-term capital gain that is treated
as a Capital Interest Disposition Amount, GP determines the amount of
long-term capital gain that would be allocated to the portion of GP's
interest sold if PRS sold all of its assets for fair market value and
liquidated immediately before the disposition. Because Class B units
are only entitled to allocations that are Capital Interest Allocations
and are not entitled to allocations of API Gain or Loss, all of the
$2,400 long-term capital gain is Capital Interest Disposition Gain.
(vi) Example 6. Contribution of an API to a Passthrough Entity with
an Unrelated Non-Service Partner. A and B form partnership GP and are
equal partners in GP. A contributes an API in PRS with a fair market
value of $200 and a tax basis of $0 to GP. B, an Unrelated Non-Service
Partner, contributes $200 cash to GP. GP invests the $200 cash
contributed by B in assets held for investment by GP. Because A
contributes an API in PRS to GP, PRS revalues its assets to determine
the Unrealized API Gains and Losses that are allocable to A's interest
in PRS at the time A contributes its interest in A to GP. See Sec.
1.1061-2(a)(1)(ii)(B). At the time of the contribution of the API to
GP, PRS holds two assets each with $100 of Unrealized API Gains that
are allocable to the API. PRS sells one of its assets and allocates
long-term capital gain of $100 to GP with respect to the API
contributed to GP by A. This gain is API Gain and is first allocated to
GP and then solely to A as required under Sec. 1.1061-2(a)(1)(ii)(B).
The Unrealized API Gain included in A's capital account in GP retains
its character as Unrealized API Gain and is not converted to Capital
Interest Gain or Loss because it is included A's capital account in GP.
Thus, this gain is API Gain as to A when recognized.
(d) Partnership interest acquired by purchase by an unrelated
taxpayer. If a taxpayer acquires an interest in a partnership (target
partnership) by taxable purchase for fair market value that, but for
the exception set forth in this paragraph (d), would be an API, the
taxpayer will not be treated as acquiring an API if, immediately before
the purchase--
(1) Taxpayer not a Related Person. The taxpayer is not a Related
Person (within the meaning of Sec. 1.1061-1(a)) with respect to--
(i) Any person who provides services in the Relevant ATB, or
(ii) Any service providers who provide services to or for the
benefit of the target partnership or a lower-tier partnership in which
the target partnership holds an interest, directly or indirectly.
(2) Section 1061(d) not applicable. Section 1061(d) does not apply
to the transaction (as provided in Sec. 1.1061-5); and
(3) Taxpayer not a service provider. The taxpayer did not and does
not now provide services, and does not anticipate providing services in
the future, to or for the benefit of the target partnership, directly
or indirectly, or any lower-tier partnership in which the target
partnership directly or indirectly holds an interest.
(e) [Reserved]
(f) Applicability date--(1) General rule. Except as provided in
paragraphs (f)(2) and (f)(3) of this section, the provisions of this
section apply to taxable years of Owner Taxpayers and Passthrough
Entities beginning on or after [DATE OF PUBLICATION OF THE FINAL RULE
IN THE FEDERAL REGISTER].
(2) Section 1.1061-3(b)(2)(i) exception. Section 1.1061-3(b)(2)(i),
which provides that the exception under section 1061(c)(1) to the
definition of an API does not apply to a partnership interest held by
an S corporation with an election under section 1362(a) in effect, is
applicable for taxable years beginning after December 31, 2017.
(3) Section 1.1061-3(b)(2)(ii) exception. Section 1.1061-
3(b)(2)(ii) which provides that the exception under section 1061(c)(1)
to the definition of an API does not apply to a partnership interest
held by a PFIC with respect to which the shareholder has a QEF election
in effect under section 1295 is applicable to taxable years of an Owner
Taxpayer and Passthrough Entity beginning after August 14, 2020.
Sec. 1.1061-4 Section 1061 computations.
(a) Computations--(1) Recharacterization Amount. The
Recharacterization Amount is the amount that an Owner Taxpayer must
treat as short-term capital gain and not as long-term capital gain
under section 1061(a). The Recharacterization Amount equals--
(i) The Owner Taxpayer's One Year Gain Amount, less
(ii) The Owner Taxpayer's Three Year Gain Amount.
(2) One Year Gain Amount and Three Year Gain Amount--(i) One Year
Gain Amount. The Owner Taxpayer's One Year Gain Amount is the sum of--
(A) The Owner Taxpayer's combined net API One Year Distributive
Share Amount from all APIs held during the taxable year; and
(B) The Owner Taxpayer's API One Year Disposition Amount.
(ii) Three Year Gain Amount. An Owner Taxpayer's Three Year Gain
Amount is equal to--
(A) The Owner Taxpayer's combined net API Three Year Distributive
Share Amount from all APIs held during the taxable year; and
(B) The Owner Taxpayer's API Three Year Disposition Amount.
(3) API One Year Distributive Share Amount and Three Year
Distributive Share Amount--(i) API One Year Distributive Share Amount.
The API One Year Distributive Share Amount equals--
(A) The API Holder's distributive share of net long-term capital
gain from the partnership for the taxable year, including capital gain
or loss on the disposition of all or a part of an API, with respect to
the partnership interest held by the API Holder calculated without the
application of section 1061, less
(B) To the extent included in the amount determined under paragraph
[[Page 49786]]
(a)(3)(i)(A) of this section, the aggregate of--
(1) Amounts that are excluded from section 1061 under paragraph
(b)(6) of this section;
(2) The API Holder's Transition Amount for the taxable year; and
(3) Capital Interest Gains and Losses as determined under Sec.
1.1061-3(c)(2).
(ii) API Three Year Distributive Share Amount. The API Three Year
Distributive Share Amount equals--
(A) The API One Year Distributive Share Amount; less
(B) Items included in paragraph (a)(3)(ii)(A) of this section that
would not be treated as a long-term gain or loss if three years is
substituted for one year in paragraphs (3) and (4) of section 1222,
and, if the Lookthrough Rule applies to the disposition of all or a
part of an API, the adjustment required under paragraphs (b)(9)(ii)(B)
and (C) of this section.
(4) API One Year Disposition Amount and API Three Year Disposition
Amount--(i) API One Year Disposition Amount. The API One Year
Disposition Amount is the combined net amount of--
(A) Long-term capital gains and losses recognized during the
taxable year by an Owner Taxpayer, including long-term capital gain
computed under the installment method that is taken into account for
the taxable year, on the disposition of all or a portion of an API that
had been held for more than one year, including a disposition to which
the Lookthrough Rule applies;
(B) Long-term capital gain and loss recognized on a distribution
with respect to an API during the taxable year that is treated under
sections 731(a) (and 752(b) if applicable) as gain or loss from the
sale or exchange of a partnership interest held for more than one year;
(C) Long-term capital gains and losses recognized on the
disposition of Distributed API Property during the taxable year that
has a holding period of more than one year but not more than three
years to the distributee Owner Taxpayer on the date of disposition; and
(D) Long-term capital gain or losses recognized as a result of the
application of section 751(b).
(ii) API Three Year Disposition Amount. The API Three Year
Disposition Amount is the combined net amount of--
(A) Long-term capital gains and losses recognized during the
taxable year by an Owner Taxpayer, including long-term capital gain
computed under the installment method that is taken into account for
the taxable year, on the disposition of all or a portion of an API that
had been held for more than three years and to which the Lookthrough
Rule does not apply;
(B) Long-term capital gains and losses recognized by an Owner
Taxpayer on the disposition during the taxable year of all or a portion
of an API that has been held for more than three years less any
adjustments required under the Lookthrough Rule in paragraphs
(b)(9)(ii)(B) and (C) of this section.
(C) Long-term capital gains and losses recognized on a distribution
with respect to an API during the taxable year that is treated under
sections 731(a) (and section 752(b) if applicable) as gain or loss from
the sale or exchange of a partnership interest held for more than three
years; and
(D) Long-term capital gains and losses recognized as a result of
the application of section 751(b) that is treated as derived from an
asset held for more than three years.
(b) Special rules for calculating the One Year Gain Amount and the
Three Year Gain Amount--(1) One Year Gain Amount equals zero or less.
If an Owner Taxpayer's One Year Gain Amount is zero or results in a
loss, the Recharacterization Amount for the taxable year is zero and
section 1061(a) does not apply.
(2) Three Year Gain Amount equals zero or less. If an Owner
Taxpayer's Three Year Gain Amount is zero or results in a loss, the
Three Year Gain Amount shall be zero for purposes of calculating the
Recharacterization Amount.
(3) Installment sale gain. The One Year Gain Amount under paragraph
(a)(2)(i) of this section, and the Three Year Gain Amount, as
determined under paragraph (a)(2)(ii) of this section, include long-
term capital gains from installment sales. This includes long-term
capital gain or loss recognized with respect to an API after December
31, 2017, with respect to an installment sale that occurred on or
before December 31, 2017. The holding period of the asset upon the date
of disposition is used for purposes of determining whether capital gain
is included in the taxpayer's One Year Gain Amount or the Three Year
Gain Amount. See paragraph (b)(8) of this section for rules governing
the holding period of APIs.
(4) Special rules for capital gain dividends from regulated
investment companies (RICs) and real estate investment trusts (REITs)--
(i) API One Year Distributive Share Amount. If a RIC or REIT reports or
designates a dividend as a capital gain dividend and provides the One
Year Amounts Disclosure as defined in Sec. 1.1061-6(c)(1)(i), the
amount provided in the One Year Amounts Disclosure is included in the
calculation of an API One Year Distributive Share Amount. If the RIC or
REIT does not provide the One Year Amounts Disclosure, the full amount
of the RIC's or REIT's capital gain dividend must be included in the
calculation of an API One Year Distributive Share Amount.
(ii) API Three Year Distributive Share Amount. If a RIC or REIT
reports or designates a dividend as a capital gain dividend and
provides the Three Year Amounts Disclosure as defined in Sec. 1.1061-
6(c)(1)(ii), the amount provided in the Three Year Amounts Disclosure
is used for the calculation of an API Three Year Distributive Share
amount. If the RIC or REIT does not provide the Three Year Amounts
Disclosure, no amount of the RIC's or REIT's capital gain dividend may
be used for the calculation of an API Three Year Distributive Share
Amount.
(iii) Loss on sale or exchange of stock. If a RIC or REIT provides
the Three Year Amounts Disclosure as provided in paragraph (b)(4)(ii)
of this section, any loss on the sale or exchange of shares of a RIC or
REIT held for six months or less is treated as a capital loss on an
asset held for more than three years, to the extent of the amount of
the Three Year Amounts Disclosure from that RIC or REIT.
(5) Pro rata share of qualified electing fund (QEF) net capital
gain--(i) One-year QEF net capital gain. The calculation of an API One
Year Distributive Share Amount includes an Owner Taxpayer's share of an
inclusion under section 1293(a)(1) of a pro rata share of the net
capital gain (as defined in Sec. 1.1293-1(a)(2)) of a passive foreign
investment company (as defined in section 1297(a)) for which a QEF
election (as described in section 1295(a)) is in effect for the taxable
year. The amount of the inclusion may be reduced by the amount of long-
term capital gain that is not taken into account for purposes of
section 1061 as provided in paragraph (b)(6) of this section. See Sec.
1.1061-6 for reporting rules.
(ii) Three year QEF net capital gain. The calculation of an API
Three Year Distributive Share Amount includes an Owner Taxpayer's share
of an inclusion under section 1293(a)(1) of a pro rata share of the net
long-term capital gain (as defined in Sec. 1.1293-1(a)(2)) of a QEF
determined for purposes of paragraph (b)(5)(i) of this section if the
QEF provides information to determine the amount of the inclusion that
would constitute net long-term capital gain (as defined in Sec.
1.1293-1(a)(2)) if the QEF's net capital gain for the taxable year were
[[Page 49787]]
calculated under section 1222(11) applying paragraphs (3) and (4) of
section 1222 by substituting three years for one year. See Sec.
1.1061-6 for reporting rules.
(6) Items not taken into account for purposes of section 1061. The
following items of long-term capital gain and loss are excluded from
the calculation of the API One Year Distributive Share Amount in
paragraph (a)(3)(i) of this section and the API Three Year Distributive
Share Amount in paragraph (a)(3)(ii) of this section:
(i) Long-term capital gain and long-term capital loss determined
under section 1231;
(ii) Long-term capital gain and long-term capital loss determined
under section 1256;
(iii) Qualified dividends included in net capital gain for purposes
of section 1(h)(11)(B); and
(iv) Capital gains and losses that are characterized as long-term
or short-term without regard to the holding period rules in section
1222, such as certain capital gains and losses characterized under the
mixed straddle rules described in section 1092(b) and Sec. Sec.
1.1092(b)-3T, 1.1092(b)-4T, and 1.1092(b)-6.
(7) API Holder Transition Amounts not taken into account--(i) In
General. An API Holder Transition Amount is not taken into account for
purposes of determining the Recharacterization Amount.
(ii) API Holder Transition Amount. An API Holder Transition Amount
is the amount of long-term gain or loss that is treated as a
Partnership Transition Amount and that is included in the allocation of
long-term capital gains and losses under sections 702 and 704 to the
API Holder for the taxable year with respect to the API Holder's
interest in the Passthrough Entity. The API Holder Transition Amount
for any taxable year cannot exceed the amount of Partnership Transition
Amount that would have been allocated to the API Holder with respect to
its interest in the partnership under the partnership agreement in
effect on March 15, 2018, with respect to the calendar year ending
December 31, 2017.
(iii) Partnership Transition Amounts and Partnership Transition
Amount Election. A partnership that was in existence as of January 1,
2018, may irrevocably elect to treat all long-term capital gains and
losses recognized from the disposition of all assets held by the
partnership for more than three years as of January 1, 2018, as
Partnership Transition Amounts. To treat amounts as Partnership
Transition Amounts--
(A) The partnership must attach a signed and dated copy of a
statement that the partnership is making an election in accordance with
this paragraph (b)(7)(iii)(A) to the timely filed return (including
extensions) filed by the partnership with the IRS under section 6031(a)
for the first taxable year the partnership treats amounts as
Partnership Transition Amounts;
(B) The partnership must maintain a copy of the election made under
paragraph (b)(7)(iii)(A) of this section and by the due date of the
election must clearly and specifically identify the assets held for
more than three years as of January 1, 2018, in the partnership's books
and records;
(C) The partnership must keep sufficient books and records to
demonstrate to the satisfaction of the Secretary of the Treasury or his
delegate that the identified assets had been held by the partnership
for more than three years as of January 1, 2018, and that long-term
capital gain or loss on the disposition of each asset has been treated
as a Partnership Transition Amounts; and
(D) The partnership must keep an executed copy of its partnership
agreement in effect as of March 15, 2018, and must have sufficient
books and records to demonstrate that the API Holder Transition Amounts
allocated to an API Holder in any taxable year do not exceed the
amounts that would have been allocated to the API Holder with respect
to its API under the partnership agreement in effect as of March 15,
2018, for the year ending December 31, 2017.
(8) Holding period determination--(i) Determination of holding
period for purposes of the Three Year Gain Amount. For purposes of
computing the Three Year Gain Amount, the relevant holding period of
either an asset or an API is determined under all provisions of the
Code or regulations that are relevant to determining whether the asset
or the API has been held for the long-term capital gain holding period
by applying those provisions as if the holding period were three years
instead of one year.
(ii) Relevant Holding Period. The relevant holding period is the
direct owner's holding period in the asset sold. Accordingly, for
purposes of determining an API Holder's Taxpayer's API One Year
Distributive Share Amount and API Three Year Distributive Share Amount
for the taxable year under paragraph (a)(3) of this section, the
partnership's holding period in the asset being sold or disposed of
(whether a directly held asset or a partnership interest) is the
relevant holding period for purposes of section 1061.
(9) Lookthrough Rule for certain API dispositions--(i)
Determination that the Lookthrough Rule applies-(A) Directly held API.
The Lookthrough Rule applies if an API Holder disposes of a directly
held API in a taxable transaction to which section 1061(d) does not
apply and recognizes capital gain, the API Holder's holding period in
the API is more than three years, and the assets of the partnership
meet the Substantially All Test described in paragraph (b)(9)(i)(C) of
this section.
(B) Indirectly held API. In the case of a tiered structure in which
the API Holder holds its API through one or more Passthrough Entities,
the Lookthrough Rule applies if an API Holder disposes of a Passthrough
Interest held for more than three years in a taxable transaction to
which section 1061(d) does not apply and recognizes capital gain, and
either--
(1) The Passthrough Entity, through which the API is directly or
indirectly held, has a holding period in the API of three years or
less; or
(2) The Passthrough Entity, through which the API is directly or
indirectly held, has a holding period in the API of more than three
years and the assets of the partnership in which the API is held meet
the Substantially All Test described paragraph (b)(9)(i)(C) of this
section.
(C) Substantially All Test--(1) In general. The Substantially All
Test is met if 80 percent or more of the assets of the partnership in
which the API is held are assets that would produce capital gain or
loss that is not described in paragraph (b)(6) of this section if
disposed of by the partnership and have a holding period of three years
or less to the partnership. The determination of whether this test is
met is based on fair market value and is made by dividing the amount
determined under paragraph (b)(9)(i)(C)(1)(i) of this section (the
numerator) by the amount determined under paragraph (b)(9)(i)(C)(1)(ii)
of this section (the denominator) and expressing the result as a
percentage. Cash, cash equivalents, unrealized receivables under
section 751(c), and inventory items under section 751(d) are not taken
into account for purposes of determining the numerator or the
denominator.
(i) Numerator. For purposes of determining the fraction described
in paragraph (b)(9)(i)(C)(1) of this section, the numerator is equal to
the aggregate fair market value of the partnership's assets that would
produce capital gain or loss that is not described in paragraph (b)(6)
of this section if
[[Page 49788]]
disposed of by the partnership as of the date of disposition of the API
and that have a holding period of three years or less.
(ii) Denominator. For purposes of determining the fraction
described in paragraph (b)(9)(i)(C)(1) of this section, the denominator
is equal to the aggregate fair market value of all of the partnership's
assets as of the date of disposition of the API.
(2) Applying the Substantially All Test in tiered arrangements. In
applying the Substantially All Test, if a partnership has held an
interest in a lower-tier Passthrough Entity for more than three years,
the partnership must increase the amount calculated for the numerator
under paragraph (b)(9)(i)(C)(1)(i) of this section by the partnership's
share of the value of the assets held by the lower-tier Passthrough
Entity that would be included in the numerator under paragraph
(b)(9)(i)(C)(1)(i) of this section by the lower-tier Passthrough
Entity, if the lower-tier Passthrough Entity was calculating the
numerator under paragraph (b)(9)(i)(C)(1)(i) of this section.
(ii) Application of the Lookthrough Rule. If the Lookthrough Rule
applies--
(A) The Owner Taxpayer must include the entire amount of capital
gain recognized on the sale of the API in the API One Year Disposition
Amount (see paragraph (a)(4)(i)(A) of this section) and in the case of
an API Holder that is a Passthrough Entity and not an Owner Taxpayer,
the entire amount of the capital gain recognized on the sale is
included in the One Year Distributive Share Amount determined with
respect to the API Holders of the Passthrough Entity (see paragraph
(a)(3)(i)(A) of this section); and
(B) The Owner Taxpayer must include the amount of gain included in
the API One Year Disposition Amount with respect to the disposition of
the API reduced by the adjustment determined under paragraph
(b)(9)(ii)(C) of this section (see paragraph (a)(4)(ii)(B) of this
section) in the API Three Year Disposition Amount, and in the case of
an API Holder that is a Passthrough Entity and not an Owner Taxpayer,
the API Three Year Distributive Share Amount is reduced by the
adjustment determined under paragraph (b)(9)(ii)(C) of this section as
provided in paragraph (a)(3)(ii)(B) of this section.
(C) Adjustment required by the Lookthrough Rule. The adjustment
required by the Lookthough Rule equals--
(1) If the Lookthrough Rule applies under paragraph (b)(9)(i)(A) or
paragraph (b)(9)(i)(B)(2) of this section, the adjustment is equal to
the capital gain recognized on the disposition of the API that is
attributable to assets included in the numerator under paragraph
(b)(9)(i)(C)(1)(i) of this section. This amount is calculated by
multiplying the capital gain recognized on the sale of the API by a
fraction, expressed as a percentage. The numerator of the fraction is
equal to the total net capital gain the partnership would recognize if
the partnership disposed of the assets the value of which was included
in the numerator under paragraph (b)(9)(i)(C)(1)(i) of this section for
fair market value immediately before the disposition of the API. The
denominator is equal to the total net capital gain the partnership
would recognize if the partnership disposed of the assets the value of
which was included in the denominator under paragraph
(b)(9)(i)(C)(1)(ii) of this section for fair market value immediately
prior to the disposition of the API. If the numerator is zero or less,
the adjustment in this paragraph (b)(9)(ii)(C) is zero. If the
numerator is greater than zero and the denominator is zero or less, the
adjustment is the entire amount of gain recognized on the sale of the
API.
(2) If the Lookthrough Rule applies under paragraph (b)(9)(i)(B)(1)
of this section, the adjustment is equal to the gain attributable to
the API directly or indirectly held by the Passthrough Entity.
(10) Section 83. Except with respect to any portion of the interest
that is a capital interest under Sec. 1.1061-3(c), this section
applies regardless of whether an Owner Taxpayer has made an election
under section 83(b) or included amounts in gross income under section
83.
(c) Examples--(1) Computation examples. The rules of paragraph (a)
of this section are illustrated by the following examples. Unless
otherwise stated, none of the long-term capital gain or loss in this
section is capital gain or loss not taken into account for purposes of
section 1061, as provided in paragraph (b)(6) of this section.
(i) Example 1. Calculation of the API One Year Distributive Share
Amount and the API Three Year Distributive Share Amount--(A) Facts. A
holds an API in PRS. A does not have a capital account in PRS for
purposes of Sec. 1.1061-3(c)(3)(ii). During the taxable year, A is
allocated $20 of long-term capital gain recognized by PRS on the sale
of capital asset X held by PRS for two years. A is allocated $40 of
long-term capital gain from the sale of capital asset Y held by PRS for
five years. Assume A has no other items of long-term capital gain or
loss with respect to its interest in PRS during the taxable year.
Accordingly, A is allocated $60 of long-term capital gain from PRS
under Sec. 1.702-1(a)(2) for the taxable year. A has no other long-
term capital gains or losses with respect to an API during the taxable
year.
(B) Calculation of A's API One Year Distributive Share Amount. A
has an API One Year Distributive Share Amount for PRS of $60 of long-
term capital gain. This amount is equal to A's $60 distributive share
from PRS under Sec. 1.702-1(a)(2) because no items that are described
in paragraph (b)(6) or (7) of this section reduce that amount.
(C) Calculation of A's API Three Year Distributive Share Amount. A
has an API Three Year Distributive Share Amount of $40 of long-term
capital gain. A calculates this amount by subtracting the $20 allocated
to A from the sale of capital asset X from the API One Year
Distributive Share Amount of $60 calculated in paragraph (B) of this
Example 1. A subtracts the gain allocated to A as a result of the sale
of capital asset X because PRS had only held capital asset X for two
years prior to its disposition and this gain would not be treated as
long-term capital gain if three years were substituted for one year in
paragraphs (3) and (4) of section 1222. Only the $40 gain allocated to
A on the sale of capital asset Y which was held by PRS for five years
prior to its disposition is included in A's API Three Year Distributive
Share Amount.
(D) Calculation of A's Recharacterization Amount. A's One Year Gain
amount equals $60 (A's API One Year Distributive Share Amount, plus an
API One Year Disposition Amount of $0). A's Three Year Gain Amount
equals $40 (A's API Three Year Distributive Share Amount, plus an API
Three Year Disposition Amount of $0). A's Recharacterization Amount is
$20, the difference between A's One Year Gain Amount of $60, and A's
Three Year Gain Amount of $40.
(ii) Example 2. Calculation of the API One Year Distributive Share
amount when Capital Interest Allocations are present--(A) Facts. A
holds a Passthrough Interest in PRS. A holds an API in PRS and, under
the terms of the partnership agreement, is entitled to Capital Interest
Allocations from PRS. During the taxable year, A receives a $130
allocation of long-term capital gain under Sec. 1.702-1(a)(2) with
respect to its interest in PRS as a result of the sale of asset X that
PRS had held for 5 years. Of this amount, $50 is treated as a Capital
Interest Allocation described in Sec. 1.1061-3(c)(4). A has no other
long-term capital gains and losses with
[[Page 49789]]
respect to an API during the taxable year.
(B) Calculation. A's distributive share of long-term capital gain
from PRS is $130. A's API One Year Distributive Share Amount is $80.
This is calculated by subtracting A's $50 Capital Interest Allocation
from A's distributive share of long-term capital gain determined for
purposes of Sec. 1.702-1(a)(2). A's API Three Year Distributive Share
Amount is also $80 because the $80 would be treated as long-term
capital gain if three years were substituted for one year in paragraphs
(3) and (4) of section 1222.
(C) Recharacterization Amount. A has a One Year Gain Amount of $80
(A's $80 API One Year Distributive Share Amount, plus a One Year
Disposition Amount of $0). A has a Three Year Gain Amount of $80 (A's
$80 API Three Year Distributive Share Amount, plus a Three Year
Disposition Amount of $0). Accordingly, A's Recharacterization Amount
is $0, the difference between A's One Year Gain Amount and Three Year
Gain Amount.
(iii) Example 3. API One Year Disposition Amount--(A) Facts. During
the taxable year, A disposes of an API that A has held for four years
as of the date of disposition for a $100 gain. The Lookthrough Rule is
not applicable to the sale. Additionally, A sells Distributed API
Property at a $300 gain when such property had a two year holding
period in A's hands. A has no other items of long-term capital gain or
loss with respect to an API in that year.
(B) Calculation of A's API One Year Disposition Amount. A's API One
Year Disposition Amount is $400. This amount equals A's $300 long-term
capital gain on A's disposition of its Distributed API Property and
$100 long-term capital gain on the disposition of A's API. A's Three
Year Disposition Amount is $100, the amount of long-term capital gain A
recognized upon disposition of A's API held for more than three years.
(C) Calculation of A's Recharacterization Amount. A's One Year Gain
Amount is $400. A's Three Year Gain Amount is $100. A's
Recharacterization Amount is $300, the difference between A's One Year
Gain Amount and Three Year Gain Amount.
(iv) Example 4. Calculation of One Year Gain Amount, Three Year
Gain Amount, and Recharacterization Amount--(A) Facts. During the
taxable year, A held an API in PRS1 and an API in PRS2 for the entire
year. With respect to PRS1, A's API One Year Distributive Share Amount
is $100 of long-term capital gain and A's API Three Year Distributive
Share Amount is ($200) of long-term capital loss. With respect to PRS2,
A's API One Year Distributive Share Amount is $600 of long-term capital
gain and A's API Three Year Distributive Share Amount is $300 of long-
term capital gain. For the taxable year, A also has an API One Year
Disposition Amount of $200 of gain. A has no other items of long-term
capital gain or loss with respect to an API for the taxable year.
(B) Calculation of A's One Year Gain Amount. A's One Year Gain
Amount is $900. This amount is calculated by combining A's $100 API One
Year Distributive Share Gain from PRS1, the $600 API One Year
Distributive Share from PRS2 (for a combined net API One Year
Distributive Share Amount of $700 of long-term capital gain), and the
$200 API One Year Disposition Amount.
(C) Calculation of A's Three Year Gain Amount. A's Three Year Gain
Amount is $100. This amount is calculated by first determining A's
combined net API Three Year Distributive Share Amount for the taxable
year. This amount is arrived at by combining and netting A's $200 API
Three Year Distributive Share Amount loss from PRS1 with A's API Three
Year Distributive Share Amount Gain of $300 from PRS2. A's combined net
Three Year Distributive Share Amount is $100 of long-term capital gain.
Because A does not have an API Three Year Disposition Amount, the Three
Year Gain Amount is equal to A's API Three Year Distributive Share
Amount of $100 of gain.
(D) Calculation of A's Recharacterization Amount. A's
Recharacterization Amount is $800, which is the amount by which A's One
Year Gain Amount of $900 exceeds A's Three Year Gain Amount of $100.
(2) Special rules examples. The principles of paragraph (b) of this
section are illustrated by the following examples.
(i) Example 1. Lookthrough rule--(A) Facts. A is a partner in GP.
GP is a partnership and holds an API in PRS, which GP has held for 2
years. A's interest in GP includes both an indirect interest in GP's
API in PRS and a capital account in GP that entitles A to Capital
Interest Gains and Losses from GP. A has held its interest in GP for 4
years. During the taxable year, A sold its interest in GP for a $200
gain in a transaction to which section 1061(d) did not apply. After the
application of Sec. 1.1061-3(c)(6), A determined that $100 of A's
capital gain on the disposition of its interest in GP is a Capital
Interest Disposition Amount and $100 of A's capital gain is API Gain.
(B) Determination of Whether the Lookthrough Rule Applies. A's
disposition of an interest in GP is a disposition of a Passthrough
Interest held for more than three years with respect to which A
recognized capital gain. GP is the Passthrough Entity in which A holds
its Passthrough Interest and GP has a two year holding period in its
API in PRS. Thus, under paragraph (b)(9)(i)(B)(1) of this section, the
Lookthrough Rule applies to A's disposition of A's Indirect API.
(C) Effect of the Application of the Lookthrough Rule. A is an
Owner Taxpayer. Under paragraph (b)(9)(ii)(A) of this section, A must
include the $100 of API Gain in A's One Year Disposition Amount. Under
paragraph (b)(9)(ii)(B) of this section, the amount A includes in the
Three Year Disposition Amount is the amount A included in the One Year
Disposition Amount, reduced by the adjustment required under paragraph
(b)(9)(ii)(C)(2) of this section. This amount is A's gain attributable
to the sale of its Indirect API, or $100. Therefore, A includes none of
the $100 of API Gain from the sale of A's Indirect API in A's Three
Year Disposition Amount.
(ii) Example 2. Lookthrough Rule-(A) Facts. Assume the same facts
as Example 1 except that GP has held its API in PRS for 4 years and all
of the assets of PRS are securities that are subject to an election
under section 475.
(B) Determination of whether the Lookthrough Rule applies. A's
disposition of an interest in GP is a disposition of a Passthrough
Interest held for more than three years with respect to which A
recognized capital gain. GP is the Passthrough Entity in which A holds
its Passthrough Interest and GP has a four year holding period in its
API. Thus, under paragraph (b)(9)(i)(B)(2) of this section, the
Lookthrough Rule will apply if the assets of PRS meet the Substantially
All Test in paragraph (b)(9)(i)(C) of this section. The determination
of whether the test is met is made by dividing the aggregate fair
market value of the assets of PRS that would produce capital gain or
loss not described in paragraph (b)(6) of this section if disposed of
by PRS as of the date of disposition of the API and that have a holding
period of three years or less (the numerator as determined under
paragraph (b)(9)(i)(C)(1)(i) of this section); by, the aggregate fair
market value of all of the partnerships assets as of the date of
disposition (the denominator as determined under paragraph
(b)(9)(i)(C)(1)(ii) of this section). Because all of the assets of the
partnership are assets subject to an election under section 475 and
thus would produce ordinary income or loss on disposition, the
numerator as
[[Page 49790]]
determined under paragraph (b)(9)(i)(C)(1)(i) of this section is 0. As
a result, the Substantially All Test is not met, and the Lookthrough
Rule does not apply.
(iii) Example 3.--(A) Facts. Assume that same facts in Example 2,
except that GP disposed of its API in PRS for a capital gain of $480.
GP's API entitles it to 20% of PRS' net profits. A is allocated $120 of
gain from the sale. At the time of GP's disposition of its interest in
PRS, PRS held the following assets--
(1) $1,000 cash;
(2) Asset X, an asset that would produce capital gain or loss that
is not described in paragraph (b)(6) of this section if disposed of by
PRS, which has a fair market value of $100, a basis of $100, and a
holding period of 4 years;
(3) Asset Y, an asset that would produce capital gain or loss that
is not described in paragraph (b)(6) of this section if disposed of by
PRS, which has a fair market value of $1,600, a basis of $1,000, and a
holding period of 2 years;
(4) Asset Z, an asset that would produce capital gain or loss that
is described in paragraph (b)(6) of this section if disposed of by PRS,
which has a value of $300, a basis of $100, and a holding period of 2
years; and
(5) A 20% interest in the profits and capital of partnership PRS2.
The total fair market value of PRS2 is $10,000. The interest PRS holds
in PRS 2 has a fair market value of $2,000, a basis of $400, and a
holding period of 4 years.
(6) PRS2 holds two assets that would produce capital gain or loss
that is not described in paragraph (b)(6) of this section if disposed
of by PRS2, Asset S and Asset T. Asset S has a fair market value of
$8,000, a basis of $1,000, and a holding period of 2 years. Asset T has
a fair market value of $2,000, a basis of $1,000, and a holding period
of 4 years.
(B) Determination of Whether the Lookthrough Rule Applies--(1) In
general. Because GP recognized capital gain on the disposition of an
API that GP held directly that had a holding period of more than three
years, paragraph (b)(9)(i)(A) of this section governs whether the
Lookthrough Rule applies. To determine whether the Lookthrough Rule
applies under paragraph (b)(9)(i)(A) of this section, it must be
determined whether the assets of PRS meet the Substantially All Test in
paragraph (b)(9)(i)(C) of this section. To make this determination, the
numerator under paragraph (b)(9)(i)(C)(1)(i) of this section and the
denominator under paragraph (b)(9)(i)(C)(1)(ii) of this section of the
fraction described in paragraph (b)(9)(i)(C)(1) of this section must be
determined. The value of cash, cash equivalents, unrealized receivables
described in section 751(c), and inventory items described in section
751(d) is excluded from this determination.
(2) Calculation of the denominator under paragraph
(b)(9)(i)(C)(1)(ii) of this section. The denominator under paragraph
(b)(9)(i)(C)(1)(ii) of this section is equal to the aggregate fair
market value of the assets of PRS on the date of disposition of the API
and is $4,000 ($100 (Asset X) + $1,600 (Asset Y) + $300 (Asset Z) +
$2,000 (PRS2)).
(3) Calculation of the numerator under paragraph (b)(9)(i)(C)(1)(i)
of this section. The numerator in paragraph (b)(9)(i)(C)(1)(i) of this
section equals the aggregate fair market value of assets of PRS that
would produce capital gain or loss that is not described in paragraph
(b)(6) of this section if disposed of by PRS as of the date GP disposes
of its API in PRS and that have a holding period of three years or less
to PRS. Based on the following, this amount is equal to $3,200 (the
value of Asset Y ($1,600) and PRS's share of the value of Asset S
($1,600) held by PRS2).
(i) The $1000 of cash is not taken into account for purposes of the
Substantially All Test.
(ii) The fair market value of Asset X is excluded from the
calculation of the numerator under paragraph (b)(9)(i)(C)(i)(1) of this
section because it has a 4 year holding period to PRS.
(iii) Asset Y would produce capital gain or loss that is not
described in paragraph (b)(6) of this section if disposed of by PRS and
Asset Y has a holding period of 2 years. Accordingly, the $1,600 fair
market value of asset Y is included in calculating the numerator under
the paragraph (b)(9)(i)(C)(1)(i) of this section.
(iv) Although Asset Z has a holding period of 2 years to GP,
capital gain or loss on the disposition of Asset Z is described
paragraph (b)(6) of this section so its value is not included in
calculating the numerator under paragraph (b)(9)(i)(C)(1)(i) of this
section.
(v) PRS holds a 20% capital and profits interest in PRS2 and has a
holding period of 4 years in its interest. Under paragraph
(b)(9)(i)(C)(2) of this section, PRS's share of the fair market value
of the assets held by PRS2 for three years or less is included in the
GP's calculation of the amount under paragraph (b)(9)(i)(C)(1)(i) of
this section. Asset S has a holding period of 2 years and a value of
$8,000. PRS's share of the $8,000 is $1,600 ($8,000 x 20% = $1,600).
Asset T has a holding period of more than 3 years and is not included
in the amount determined under paragraph (b)(9)(i)(C)(1)(i) of this
section. The amount included in the calculation under paragraph
(b)(9)(i)(C)(2) of this section with respect to the interest PRS holds
in PRS2 is $1,600, PRS' share of the fair market value of Asset S.
(4) Fraction. Because $3,200 (the amount calculated under paragraph
(b)(9)(i)(C)(1)(i) of this section) divided by $4,000, expressed as a
percentage, is equal to 80%, the Lookthrough Rule applies.
(C) Effect of application of the Lookthrough Rule--(1) In general.
The API Holder is GP, which is a Passthrough Entity and not an Owner
Taxpayer. Thus, the application of the Lookthrough Rule affects the
calculation of the API One Year Distributive Share Amount and API Three
Year Distributive Share Amounts of GP's API Holders.
(2) Calculation of the API One Year Distributive Share Amount. All
of GP's gain is API Gain and GP must include the entire $480 of GP's
long-term capital gain in the API One Year Distributive Share Amount of
its API Holders. For A, this amount is $120.
(3) Calculation of the adjustment to the API Three Year
Distributive Share Amount--(i) Adjustment calculation. To determine the
amount by which the API Three Year Distributive Share Amount calculated
under paragraph (a)(3)(ii)(B) of this section is reduced as a result of
the application of the Lookthrough Rule, the adjustment described in
paragraph (b)(9)(ii)(C) of this section must be determined. The
adjustment is equal to the capital gain recognized on the disposition
of the API in PRS by GP that is attributable to assets included in the
numerator under paragraph (b)(9)(i)(C)(1)(i) of this section. This
amount is calculated by multiplying the capital gain recognized on the
sale by a fraction, expressed as a percentage. The numerator of the
fraction is equal to total net capital gain that would be generated by
the assets included in calculating the numerator under paragraph
(b)(9)(C)(1)(i) of this section if PRS disposed of the assets for fair
market immediately before the disposition of the API. The denominator
of the fraction is equal to the total net capital gain that would be
attributable to the assets included in the denominator under paragraph
(b)(9)(C)(1)(ii) of this section if PRS disposed of all of its assets
for fair market value immediately before the disposition of the API.
(ii) Total net gain that would be recognized on a hypothetical sale
of the assets included in the denominator under paragraph
(b)(9)(i)(C)(1)(ii) of this
[[Page 49791]]
section. The total amount of capital gain that would be recognized on a
hypothetical disposition of the assets that were included in the
denominator under paragraph (b)(9)(i)(C)(1)(ii) of this section is
$2,400 ($0 gain on Asset X + $600 gain on Asset Y + $200 gain on Asset
Z and $1,600 gain on the interest in PRS2).
(iii) Total net gain that would be recognized on a hypothetical
sale of the assets included in the numerator under paragraph
(b)(9)(i)(C)(1)(i) of this section. The full fair market value of Asset
Y and PRS's 20% share of the fair market value Asset S held by PRS2
were included in the amount determined under paragraph (b)(9)(C)(1)(i)
of this section. Asset Y has been held for 2 years and would produce
$600 of gain if sold immediately before GP's disposition of its API in
PRS. If Asset S were disposed of immediately before GP disposed of its
interest in PRS, GP would be allocated gain of $1,400 ($8,000 fair
market value less $1,000 basis equals gain of $7,000 and 20% of $7,000
equals $1,400). Accordingly, the amount of gain that would be
recognized on the disposition of the assets included in paragraph
(b)(9)(i)(C)(1)(i) of this section is $2,000.
(iv) Adjustment. The amount of the adjustment is calculated by
multiplying $480, the amount of gain recognized on the disposition of
the API by a fraction, expressed as a percentage. The numerator of the
fraction is $2,000, the amount of gain attributable to assets included
in the computation under paragraph (b)(9)(i)(C)(1)(i) of this section.
The denominator of the fraction is equal to $2,400, the amount of gain
that would be recognized on the hypothetical sale of PRS's assets
included in the denominator under paragraph (b)(9)(ii)(C)(1)(ii) of
this section. The fraction is equal to $2000 divided by $2,400,
expressed as a percentage, or 83.3 percent. The capital gain recognized
by GP on the sale, $480 is multiplied by 83.3 percent to arrive at the
gain attributable to the assets included in paragraph
(b)(9)(i)(C)(1)(i) of this section or $399.84. A's share of the gain is
$99.96. To compute A's API Three Year Distributive Share Amount, A's
API Three Year Distributive Share Amount calculated under paragraph
(a)(3)(ii) of this section is reduced by $99.96 as a result of the
application of the Lookthrough Rule.
(iv) Example 4. Installment sale gain. On December 22, 2017, A
disposed of A's API in an installment sale. At the time of the
disposition, A had held its API for two years. A received a payment
with respect to the installment sale during A's 2018 taxable year
causing A to recognize $200 of long-term capital gain. The $200 long-
term capital gain recognized in 2018 is subject to section 1061 because
it is recognized after December 31, 2017. Accordingly, the $200 of
long-term capital gain recognized by A in 2018 is included in A's API
One Year Disposition Amount. The $200 of long-term capital gain is not
in A's API Three Year Disposition Amount because the API was not held
for more than three years at the time of its disposition.
(v) Example 5. Partnership Transition Amounts and API Holder
Transition Amounts--(A) Facts. A and B formed GP on January 1, 2012, by
contributing $150 each. GP contributed the $300 to PRS. GP has a
calendar taxable year. GP's capital contribution to PRS is equal to 10%
of the aggregate capital account balance of GP which is $3,000. In
2012, PRS also issued GP an API in PRS. Under the terms of the
partnership agreement, GP is allocated 20% of all net capital gain or
loss earned by PRS with respect to its API. GP also earns a pro rata
allocation of the remaining 80% of net capital gain or loss. In 2012,
PRS acquired Asset X and Asset Y for $1,500 each. Following a
revaluation event, PRS increased the capital accounts of A and B to
reflect a revaluation of the partnership property as of that date under
Sec. 1.704-1(b)(2)(iv)(f). As of January 1, 2018, PRS continued to
hold Asset X and Asset Y. PRS also purchases Asset U for $1,000 on
December 31, 2019. GP's capital account balance continues to equal 10%
of the aggregate capital account balance of PRS. As of the due date of
PRS's federal income tax return for the 2021 taxable year, the first
year PRS treats amounts as Partnership Transition Amounts, PRS elected
to treat the long-term capital gain or loss recognized on the
disposition of all of PRS's assets held for more than three years as of
January 1, 2018, as Partnership Transition Amounts. PRS identified
Asset X and Asset Y as assets held for more than three years as of
January 1, 2018, and subject to the election. PRS retained sufficient
records to demonstrate that Asset X and Asset Y had been held for more
than three years as of January 1, 2018.
(B) Calculation of Partnership Transition Amounts. On December 31,
2021, when its holding period in Asset U was two years, PRS disposed of
Asset U for a gain of $2,000. PRS also disposed of Asset X for a gain
of $2,000 and Asset Y for a gain of $3,000 on the same date. PRS did
not dispose of any other assets during the calendar year. Thus, PRS
recognized a total of $7,000 of net long-term capital gain from the
sale of Asset U, Asset X, and Asset Y ($2,000 + $2,000 + $3,000).
Because Asset X and Asset Y are assets identified by PRS as having been
held for three years as of January 1, 2018, the long-term gain from the
disposition of these assets is treated as a Partnership Transition
Amount by PRS pursuant to its election. Based on its API, GP is
entitled to 20% of the total net long-term capital gain of $7,000, or
$1,400. The remainder of the gain, $5,600, is split between the
partners according to their partnership interests. GP is entitled to
10% of the $5,600. GP's distributive share of long-term capital gain
for 2019 from PRS is $1,960 ((20% x $7,000) + (10% x $5,600)). Of this
amount, $1,400 is attributable to gain from Asset X ((20% x $2,000) +
(10% x $1,600)) and Asset Y ((20% x $3,000) + (10% x $2,400)), and is
treated as an API Holder Transition Amount as to GP. After the $1,960
allocated to GP is reduced by the $1,400, $560 of the original
distributive share of long-term capital gain to GP remains. Of this
amount, $160 is a Capital Interest Allocation from PRS to GP with
respect to the capital account GP holds in PRS. This amount is also
subtracted from the amount of the original distributive share, leaving
a $400 API One Year Distributive Share Amount for the taxable year.
Because PRS has only held Asset U for two years, the API Three Year
Distributive Share Amount for the taxable year is 0. GP, in allocating
the API Holder Transition Amounts allocated to GP by PRS to A and B,
must allocate those amounts to A and B consistently with the
partnership agreement in effect for GP as of March 15, 2018, for the
year ending December 31, 2017. Because A and B have always been 50%
partners, 50% of the API Holder Transition Amount allocated to GP by
PRS can be allocated by GP to each A and B.
(vi) Example 6. REIT capital gain dividend. During the taxable
year, A holds an API in PRS. PRS holds an interest in REIT. During the
taxable year, REIT designates a $1,000 capital gain dividend to PRS of
which 50% is allocable to A's API. Part of the capital gain dividend
for the year results from section 1231 gain. In accordance with Sec.
1.1061-6(c)(1)(i), REIT discloses to PRS the One Year Amounts
Disclosure of $400 which is the $1000 capital gain dividend reduced by
the $600 of section 1231 capital gain dividend included in that amount.
Part of the One Year Amounts Disclosure for the year results from gain
from property held for less than three years. In accordance with Sec.
1.1061-6(c)(1)(ii), REIT also discloses
[[Page 49792]]
the Three Year Amounts Disclosure of $150, which is the $400 One Year
Amounts Disclosure reduced by the $250 of gain attributable to property
held for less than three years. PRS includes a $200 gain in determining
A's API One Year Distributive Share Amount and a $75 gain in
determining A's API Three Year Distributive Share Amount. See paragraph
(b)(4)(i) and (ii) of this section.
(d) Applicability date. The provisions of this section apply to
taxable years of Owner Taxpayers and Passthrough Entities beginning on
or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL
REGISTER].
Sec. 1.1061-5 Section 1061(d) transfers to related persons.
(a) In general. If an Owner Taxpayer transfers any API, or any
Distributed API Property, directly or indirectly, or if a Passthrough
Entity in which an Owner Taxpayer holds an interest, directly or
indirectly, transfers an API to a Section 1061(d) Related Person, as
defined in paragraph (e) of this section, regardless of whether gain is
otherwise recognized on the transfer under the Internal Revenue Code,
the Owner Taxpayer shall include in gross income as short-term capital
gain, the excess (if any) of--
(1) The Owner Taxpayer's net long-term capital gain with respect to
such interest for such taxable year determined as provided in paragraph
(c) of this section, over
(2) Any amount treated as short-term capital gain under Sec.
1.1061-4 with respect to the transfer of such interest (that is, any
amount included in the Owner Taxpayer's API One Year Disposition Gain
Amount and not in the Owner Taxpayer's Three Year Disposition Gain
Amount with respect to the transferred interest).
(b) Transfer. For purposes of section 1061(d), the term transfer
includes, but is not limited to, contributions, distributions, sales
and exchanges, and gifts.
(c) Application of paragraph (a) of this section--(1) Determination
of amounts included in paragraph (a)(1) of this section.--(A) In
general. An Owner Taxpayer's net long-term capital gain with respect to
a transferred API for the taxable year for the purpose of paragraph
(a)(1) of this section is the amount of net long-term capital gain from
assets held for three years or less (including any remedial allocations
under Sec. 1.704-3(d)) that would have been allocated to the partner
(to the extent attributable to the transferred API) if the partnership
had sold all of its property in a fully taxable transaction for cash in
an amount equal to the fair market value of such property (taking into
account section 7701(g)) immediately prior to the partner's transfer of
the API. If the amount calculated pursuant to this paragraph (c) is
negative or zero, then the amount calculated under paragraph (a) of
this section shall be zero, and section 1061(d) shall not apply. If
only a portion of a partnership interest is so transferred, then only
the portion of gain attributable to the transferred interest shall be
included in gross income.
(B) Tiered entities. If the Owner Taxpayer transfers an Indirect
API and is subject to this section, the computation described in
paragraph (c)(1) of this section must be applied at the level of any
lower-tier Passthrough Entities.
(2) Application to an otherwise taxable transfer. In the case of a
transfer that is otherwise a taxable event, paragraph (a) of this
section characterizes the capital gain recognized on the transfer as
short-term capital gain to the extent that the gain is required to be
included in gross income as short-term capital gain under paragraph (a)
of this section. If the amount of capital gain otherwise recognized on
the transfer is less than the amount that is required to be included
under paragraph (a) of this section, the Owner Taxpayer must include in
gross income the difference between the amount of gain otherwise
recognized and the gain required to be included under paragraph (a) of
this section as short term capital gain.
(d) Basis of transferred interest increased by additional gain
recognized. If the basis of a transferred API or, in the case of a
transfer of an Indirect API, the basis of a transferred Passthrough
Interest in the transferee's hands is determined, in whole or in part,
by reference to the basis of the transferred API or Passthrough
Interest in the transferor's hands before application of this section,
and capital gain is required to be recognized because of the
application of this section, then, immediately before the transfer, the
basis of the API or Passthrough Interest shall (before any increase
permitted under section 1015(d), if applicable) be increased by the
capital gain the transferor included in gross income solely by reason
of this section.
(e) Section 1061(d) Related Person--(1) In general. For purposes of
this section, the term Section 1061(d) Related Person means--
(i) A person that is a member of the taxpayer's family within the
meaning of section 318(a)(1);
(ii) A person that performed a service within the current calendar
year or the preceding three calendar years in a Relevant ATB to the API
transferred by taxpayer; or
(iii) A Passthrough Entity to the extent that a person described in
paragraph (e)(1)(i) or (ii) of this section owns an interest, directly
or indirectly.
(2) Exception. A contribution under section 721(a) to a partnership
is not a transfer to a Section 1061(d) Related Person under this
paragraph (e) because, as provided in Sec. 1.1061-2(a)(1)(ii)(B), for
purposes of section 1061 the principles of section 704(c) and
Sec. Sec. 1.704-1(b)(2)(iv)(f) and 1.704-3(a)(9) apply to allocate all
applicable Unrealized API Gains and Losses subject to section 1061(a)
at the time of transfer to the API Holder contributing the interest.
(f) Examples. The following examples illustrate the rules of this
section.
(1) Example 1. Transfer to child by gift. A, an individual,
performs services in an ATB and has held an API in connection with
those services for 10 years. The API has a fair market value of $1,000
and a tax basis of $0. A transfers all of the API to A's daughter as a
gift. A's daughter is a Section 1061(d) Related Person. Immediately
before the gift, if the partnership that issued the API had sold all of
its assets for fair market value, A would have been allocated $700 of
net long-term capital gain from assets held by the partnership for
three years or less. Therefore, the amount described in (a)(1) of this
section is $700. A did not recognize any gain on the transfer for
federal income tax purposes before application of this section, which
means that the amount described in (a)(2) of this section is $0. A
includes the difference between the amounts described in (a)(1) and
(a)(2) of this section, or $700 and $0, in gross income as short-term
capital gain. A includes $700 in gross income as short-term capital
gain. A's daughter increases her basis in the API by the $700 of gain
recognized by A on the transfer under paragraph (d) of this section.
(2) Example 2. Taxable transfer to child for fair market value. The
facts are the same as in Example 1, except that A sells the API to A's
daughter for $1,000, the API's fair market value and recognizes $1,000
of capital gain. A's API One Year Disposition Amount and API Three Year
Disposition Amount are both $1,000. Therefore, the amount described in
(a)(2) of this section is $0. The amount described in (a)(1) is $700.
The difference between the amount described in (a)(1) of this section
($700) and the amount described in (a)(2) of this section ($0) is $700.
Because A
[[Page 49793]]
recognized gain greater than the amount required under paragraph (a) of
this section, there is no gain to accelerate and up to $700 of A's
long-term capital gain will be recharacterized as short-term gain.
Three hundred dollars of A's gain is not recharacterized under section
1061(d). The balance of $700 of long-term capital gain is entirely
recharacterized as short-term capital gain. Accordingly, A includes
$300 of gain in gross income as long-term capital gain and $700 as
short-term capital gain. Because A's daughter does not determine her
basis in the API by reference to A's basis, paragraph (d) of this
section does not apply.
(3) Example 3. Contribution of an API to a Passthrough Entity owned
by Section 1061(d) Related Persons--(i) Facts. A, B, and C are equal
partners in GP. GP holds only one asset, an API in PRS1 which is an
indirect API as to each A, B, and C. A, B, and C each provide services
in the ATB in connection with which GP was transferred its API in PRS1.
A and B contribute their interests in GP to PRS2 in exchange for
interests in PRS2. Under the terms of the partnership agreement of
PRS2, all Unrealized API Gain or Loss allocable to A and B in the
property held by GP and PRS1 as of the date of the contribution by A
and B when recognized will continue to be allocated to each A and B by
PRS2. As provided in Sec. 1.1061-2(a)(1)(ii)(B), as a result of the
contribution by A and B of their interests in GP to PRS2, PRS1 and GP
must revalue their assets under the principles of Sec. 1.704-
1(b)(2)(iv)(f).
(ii) Application of section 1061(d). The contribution by A and B of
their interest in GP to PRS2 is a potential transfer to a Section
1061(d) Related Person as to both A and B under paragraph (e)(1)(iii)
of this section to the extent that the other is an owner of PRS2.
However, because paragraph (e)(2) of this section provides that a
contribution under section 721(a) to a partnership is not a transfer to
a Section 1061(d) Related Person for purposes of this section, section
1061(d) does not apply to A and B's contribution.
(g) Applicability date. The provisions of this section apply to
taxable years of Owner Taxpayers and Passthrough Entities beginning on
or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL
REGISTER].
Sec. 1.1061-6 Reporting rules.
(a) Owner Taxpayer Filing Requirements-(1) In general. An Owner
Taxpayer must file such information with the IRS as the Commissioner
may require in forms, instructions, or other guidance as is necessary
for the Commissioner to determine that the Owner Taxpayer has properly
complied with section 1061 and Sec. Sec. 1.1061-1 through 1.1061-6.
(2) Failure to obtain information. Paragraph (b)(1) of this section
requires Passthrough Entities to furnish an Owner Taxpayer with certain
amounts necessary to determine its Recharacterization Amount and meet
its reporting requirements under paragraph (a)(1) of this section. To
the extent that an Owner Taxpayer is not furnished the information
required to be furnished under paragraph (b)(1) of this section in such
time and in such manner as required by the Commissioner and the Owner
Taxpayer is not otherwise able to substantiate all or a part of these
amounts to the satisfaction of the Secretary of the Treasury or his
delegate (Secretary), then--
(i) With respect to the determination of the API One Year
Distributive Share Amount under Sec. 1.1061-4(a)(3)(i) if not
furnished, the amount calculated under Sec. 1.1061-4(a)(3)(i)(B) does
not include--
(A) Amounts excluded from section 1061 under Sec. 1.1061-4(b)(6);
(B) API Holder Transition Amounts; and
(C) Capital Interest Gains and Losses as determined under Sec.
1.1061-3(c)(2).
(ii) With respect to the determination of the API Three Year
Distributive Share Amount determined under Sec. 1.1061-4(a)(3)(ii) if
not furnished, items included in the API One Year Distributive Share
amount are treated as items that would not be treated as long-term
capital gain or loss, if three years is substituted for one year in
paragraphs (3) and (4) of section 1222.
(b) Passthrough Entity Filing Requirements and Reporting--(1)
Requirement to file information with the IRS and to furnish information
to API Holder. A Passthrough Entity must file such information with the
IRS as the Commissioner may require in forms, instructions, or other
guidance as is necessary for the Commissioner to determine that it and
its partners have complied with the section 1061 and Sec. Sec. 1.1061-
1 through 1.1061-6. A Passthrough Entity that has issued an API must
furnish to the API Holder, including an Owner Taxpayer, such
information at such time and in such manner as the Commissioner may
require in forms, instructions or other guidance as is necessary to
determine the One Year Gain Amount and the Three Year Gain Amount with
respect to an Owner Taxpayer that directly or indirectly holds the API.
A Passthrough Entity that has furnished information to the API Holder
must file such information with the IRS, at such time and in such
manner as the Commissioner may require in forms, instructions or other
guidance. This information includes:
(i) The API One Year Distributive Share Amount and the API Three
Year Distributive Share Amount (as determined under Sec. 1.1061-4);
(ii) Capital gains and losses allocated to the API Holder that are
excluded from section 1061 under Sec. 1.1061-4(b)(6);
(iii) Capital Interest Gains and Losses allocated to the API Holder
(as determined under Sec. 1.1061-3(c));
(iv) API Holder Transition Amounts (as determined under Sec.
1.1061-4(b)(7)); and
(v) In the case of a disposition by an API Holder of an interest in
the Passthrough Entity during the taxable year, any information
required by the API Holder to properly take the disposition into
account under section 1061, including information to apply the
Lookthrough Rule and to determine its Capital Interest Disposition
Amount.
(2) Requirement to request, furnish, and file information in tiered
structures--(i) Requirement to request information. If Passthrough
Entity requires information to meet its reporting and filing
requirements under this Sec. 1.1061-6 (in addition to any information
required to be furnished to the Passthrough Entity under paragraph
(b)(1) of this section) from a lower tier entity in which it holds an
interest, the Passthrough Entity must request such information from
that entity.
(ii) Requirement to furnish and file information. If information is
requested of a Passthrough Entity under paragraph (b)(2)(i) of this
section, the Passthrough Entity must furnish the requested information
to the person making the request. If the person requesting the
information is an API Holder in the Passthrough Entity, the information
is furnished under paragraph (b)(1) of this section. If the Passthrough
Entity requesting the information is not an API Holder, the Passthrough
Entity must furnish the information to the requesting Passthrough
Entity as required by the Commissioner in forms, instructions, or other
guidance. Additionally, the Passthrough Entity must file the requested
information with the IRS as the Commissioner may require in forms,
instructions, or other guidance.
(iii) Timing of requesting and furnishing information--(A)
Requesting information. A Passthrough Entity described in paragraph
(b)(2)(i) of this section must request information under paragraph
(b)(2)(i) of this section by the later of the 30th day after the close
of
[[Page 49794]]
the taxable year to which the information request relates or 14 days
after the date of a request for information from an upper tier
Passthrough Entity.
(B) Furnishing information--(1) In general. Except as provided in
paragraph (b)(2)(iii)(B)(2) of this section, requested information must
be furnished by the date on which the entity is required to furnish
information under section 6031(b) or under section 6037(b), as
applicable.
(2) Late requests. Information with respect to a taxable year that
is requested by an upper tier Passthrough Entity after the date that is
14 days prior to the due date for a lower tier Passthrough Entity to
furnish and file information under section 6031(b) or section 6037(b),
as applicable, must be furnished and filed in the time and manner
prescribed by forms, instructions and other guidance.
(iv) Manner of requesting information. Information may be requested
electronically or in any manner that is agreed to by the parties.
(v) Recordkeeping Requirement. Any Passthrough Entity receiving a
request for information must retain a copy of the request and the date
received in its books and records.
(vi) Passthrough Entity is not Furnished Information to meet its
Reporting Obligations under paragraph (b)(1) of this section. If an
upper-tier Passthrough Entity holds an interest in a lower-tier
Passthrough Entity and it is not furnished the information described in
paragraph (b)(1) of this section, or, alternatively, if it has not been
furnished information after having properly requested the information
under this paragraph (b)(2), the upper-tier Passthrough Entity must
take actions to otherwise determine and substantiate the missing
information. To the extent that the upper-tier Passthrough Entity is
not able to otherwise substantiate and determine the missing
information to the satisfaction of the Secretary, the upper-tier
Passthrough Entity must treat these amounts as provided under paragraph
(a)(2) of this section. The upper-tier Passthrough Entity must provide
notice to the API Holder and the IRS regarding the application of this
paragraph (b)(2) to the information being reported as required in
forms, instructions, and other guidance.
(vii) Penalties. In addition to the requirement to section 1061(e),
the information required to be furnished under this paragraph (b) is
also required to be furnished under sections 6031(b) and 6037(b), and
failure to report as required under this paragraph (b) will be subject
to penalties under section 6722.
(c) Regulated investment company (RIC) and real estate investment
trust (REIT) reporting--(1) Section 1061 disclosures. A RIC or REIT
that reports or designates a dividend, or part thereof, as a capital
gain dividend, may, in addition to the information otherwise required
to be furnished to a shareholder, disclose two amounts for purposes of
section 1061--
(i) One Year Amounts Disclosure. The One Year Amounts Disclosure of
a RIC or REIT is a disclosure by the RIC or REIT of an amount that is
attributable to a computation of the RIC's or REIT's net capital gain
excluding capital gain and capital loss not taken into account for
purposes of section 1061 under Sec. 1.1061-4(b)(6). The aggregate
amounts provided in the One Year Amounts Disclosures with respect to a
taxable year of a RIC or REIT must equal the lesser of the RIC's or
REIT's net capital gain, excluding any capital gains and capital losses
not taken into account for purposes of section 1061 under Sec. 1.1061-
4(b)(6), for the taxable year or the RIC's or REIT's aggregate capital
gain dividends for the taxable year.
(ii) Three Year Amounts Disclosure. The Three Year Amounts
Disclosure of a RIC or REIT is a disclosure by the RIC or REIT of an
amount that is attributable to a computation of the RIC's or REIT's One
Year Amounts Disclosure substituting ``three years'' for ``one year''
in applying section 1222. The aggregate amounts provided in the Three
Year Amounts Disclosures with respect to a taxable year of a RIC or
REIT must equal the lesser of the aggregate amounts provided in the
RIC's or REIT's One Year Amounts Disclosures substituting ``three
years'' for ``one year'' in applying section 1222 for the taxable year
or the RIC's or REIT's aggregate capital gain dividends for the taxable
year.
(2) Pro rata disclosures. The One Year Amounts Disclosure and Three
Year Amounts Disclosure made to each shareholder of a RIC or REIT must
be proportionate to the share of capital gain dividends reported or
designated to that shareholder for the taxable year.
(3) Report to shareholders. A RIC or REIT that provides the section
1061 disclosures described in paragraphs (c)(1)(i) and (ii) of this
section must provide those section 1061 disclosures in writing to its
shareholders with the statement described in section 852(b)(3)(C)(i) or
the notice described in section 857(b)(3)(B) in which the capital gain
dividend is reported or designated.
(d) Qualified electing fund (QEF) reporting. A passive foreign
investment company with respect to which the shareholder has a QEF
election (as described in section 1295(a)) in effect for the taxable
year that determines net capital gain as provided in Sec. 1.1293-
1(a)(2)(A) may provide additional information to its shareholders to
enable API Holders to determine the amount of their inclusion under
section 1293(a)(1) that would be included in the API One Year
Distributive Share Amounts and API Three Year Distributive Share
Amounts. If such information is not provided, an API Holder must
include all amounts of long-term capital gain from the QEF in its API
One Year Distributive Share Amounts and no amounts in its API Three
Year Distributive Share Amount. An API Holder who receives the
additional information described in this paragraph (d) must retain such
information as required by Sec. 1.1295-1(f)(2)(ii).
(e) Applicability date. The provisions of this section apply to
taxable years of Owner Taxpayers and Passthrough Entities beginning on
or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL
REGISTER].
0
Par. 5. Section 1.1223-3 is amended by:
0
1. Redesignating paragraph (b)(5) as paragraph (b)(6);
0
2. Adding new paragraph (b)(5);
0
3. Designating Example 1 through Example 8 of paragraph (f) as
paragraphs (f)(1) through (f)(8);
0
4. Adding paragraphs (f)(9) and (10); and
0
5. Adding a sentence at the end of paragraph (g).
The additions read as follows:
Sec. 1.1223-3 Rules relating to the holding periods of partnership
interests.
* * * * *
(b) * * *
(5) Divided holding period if partnership interest comprises in
whole or in part one or more profits interests--(i) In general. If a
partnership interest is comprised in whole or in part of one or more
profits interests (as defined in paragraph (b)(5)(ii) of this section),
then, for purposes of applying paragraph (b)(1) of this section, the
portion of the holding period to which a profits interest relates is
determined based on the fair market value of the profits interest upon
the disposition of all, or part, of the interest (and not at the time
that the profits interest is acquired). Paragraph (b)(1) of this
section continues to apply to the extent that a partner acquires
portions of a partnership interest that are not comprised of a profits
interest and the value of the profits interest is not included for
purposes of determining
[[Page 49795]]
the value of the entire partnership interest under that paragraph.
(ii) Definition of profits interest. For purposes of this paragraph
(b)(5), a profits interest is a partnership interest other than a
capital interest. A capital interest is an interest that would give the
holder a share of the proceeds if the partnership's assets were sold at
fair market value at the time the interest was received and then the
proceeds were distributed in a complete liquidation of the partnership.
A profits interest, for purposes of this paragraph (b)(5), is received
in connection with the performance of services to or for the benefit of
a partnership in a partner capacity or in anticipation of being a
partner, and the receipt of the interest is not treated as a taxable
event for the partner or the partnership under applicable federal
income tax guidance.
* * * * *
(f) * * *
(9) Example 9. On June 1, 2020, GP contributes $10,000 to PRS for a
partnership interest in PRS. On June 30, 2023, GP received a 20%
interest in the profits of PRS that is an applicable partnership
interest (API), as defined in Sec. 1.1061-1, in PRS. On June 30, 2025,
GP sells its interest in PRS for $30,000. At the time of GP's sale of
its interest, the API has a fair market value of $15,000. GP has a
divided holding period in its interest in PRS; 50% of the partnership
interest has a holding period beginning on June 1, 2020, and 50% has a
holding period that begins on June 30, 2023.
(10) Example 10. Assume the same facts as in Example 9, except that
on June 30, 2024, GP contributes an additional $5,000 cash to GP prior
to GP's sale of its interest in 2025. Immediately after the
contribution of the $5,000 on June 23, 2024, GP's interest in PRS has a
value of $15,000, not taking into account the value of GP's profits
interest in PRS. GP calculates its holding period in the portions not
comprised by the profits interest and two-thirds of its holding period
runs from June 30, 2020, and one-third runs from June 30, 2024. On June
30, 2025, GP sells its interest for $30,000 and the API has a fair
market value of $15,000. Accordingly, on the date of disposition, one-
third of GP's interest has a five year holding period from its interest
received in 2020 for its $10,000 contribution, one-half of GP's
interest has a two year holding period from the profits interest issued
on June 30, 2023, and one-sixth of GP's interest has a one year holding
period from the contribution of the $5,000.
(g) * * * Paragraph (b)(5), (f)(9), and (f)(10) of this section
apply to taxable years beginning on or after [DATE OF PUBLICATION OF
THE FINAL RULE IN THE FEDERAL REGISTER].
Sunita Lough,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2020-17108 Filed 8-6-20; 4:15 pm]
BILLING CODE 4830-01-P
