US tax regs require gain recognition on transfer to partnership with related foreign partners

The US IRS on January 19 issued temporary (TD 9811) and proposed (REG-127203-15) regulations that require US persons to recognize gain on the transfer of appreciated property in exchange for an interest in partnership which has foreign partners that are related to the transferor.

In the regulations, the IRS has exercised its grant of regulatory authority in section 721(c) to override section 721(a), providing that income or gain attributable to the appreciation in property at the time of the contribution will be taken into account by the transferor either immediately or over time.

The IRS said it is appropriate to exercise its authority in circumstances in which gain, when ultimately recognized, would be includible in the gross income of a related foreign person.

The regulations provide for a gain deferral method which generally must be applied to avoid the immediate recognition of gain.

The IRS had announced of its intent to issue the temporary regulations in Notice 2015-54, issued August 6, 2015. The temporary regulations apply to property contributions made after the date of the notice and to contributions made before that date that result from an entity classification election under reg. section 301.7701-3 made after that date.

The temporary regulations adopt rules described in the notice with some modifications.

A significant change is that unlike the notice, the temporary regulations provide that the gain deferral method is applied on a property-by-property basis instead of imposing a unified application requirement.

As such, under the regulations, a failure to comply with one of the requirements of the gain deferral method with respect to any section 721(c) property would not cause an acceleration event for all section 721(c) property.

The IRS said it is still working on regulations under sections 482 and 6662 to ensure the appropriate valuation of controlled transactions involving partnerships.

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