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Waters and Looney describe the circumstances when current and liquidating partnership distributions of marketable securities are treated as distributions of money that may trigger the recognition of gain and when they are treated as property distributions subject to a carryover basis regime. There is a clear tax advantage to be gained from a distribution of property to a partner. In such a case, no gain is immediately recognized by the distributee partner upon receipt of the property. Unfortunately, the Code significantly limits a partners ability to defer recognition of gain on marketable securities distributed by a partnership to the partner.

When a partner sells a partnership interest, the resulting gain or loss is treated as capital gain or loss, except to the extent that the partnership holds certain items whose sale would result in gain or loss that was not capital. Seemingly, the purpose of this regime is to prevent taxpayers from obtaining more favorable treatment by selling an interest in a partnership than what would result if the partnership were to sell its underlying assets. But given this legislative aim, the existing tax provisions produce results for taxpayers that are both unduly favorable (in that sale of a partnership interest sometimes receives more beneficial treatment than sale of underlying assets) and unduly unfavorable (in that, in other instances, sale of a partnership interest triggers a less beneficial outcome than the sale of underlying assets). The design of the partnership tax rules also necessitates piecemeal reform as taxpayers discover new opportunities to benefit from unduly favorable results produced by the partnership tax regime. Most recently, in December 2017, Congress adopted legislative reform to address one such instance involving the sale of a partnership interest by a non-U.S. person. In addition, the method used by the partnership tax rules requires Congress to update the statute governing sale of a partnership interest to take into account potential ripple effects of unrelated legislative changes. As a result, the design is error prone because, inevitably, Congress overlooks and fails to address these potential ripple effects. Changes enacted by Congress in December 2017 provide at least one example of this phenomenon. In particular, Congress enacted a new restriction on the deductibility of losses incurred in a trade or business. However, Congress did not provide for a corresponding modification to the tax provisions governing sale of an interest in a partnership-creating the potential for another way in which the existing statutory design is unduly favorable. Some of the problems identified by this Article existed long before the adoption of significant tax legislation in December 2017; one of the problems was partially (but incompletely) addressed by that legislation and one of the problems was created by that legislation. To address each of the failings that it identifies, this Article proposes equating the tax treatment of the sale of a partnership interest with the tax treatment of the sale of underlying assets in all cases.

This article discusses \"related-party basis shifting.\" This planning technique has only recently come to light and, typically, involves the use of various provisions of Subchapter K to increase the basis of partnership-related assets without a taxable transaction, an investment, or even a meaningful economic change of position. Basis shifting appears to be most commonly used by affiliated groups and is often abusive, with inappropriate tax savings running into the billions of dollars. The fees practitioners charge are commensurate. In response, in June of 2024, the Internal Revenue Service (the Service) and Treasury issued Notice 2024-54, which gave notice of plans to issue proposed regulations. 1 But the Notice went beyond just giving notice and effectively contains both Proposed Related-Party Basis Adjustment Regulations and Proposed Consolidated Return Regulations. 2 At the same time, the Service also issued Revenue Ruling 2024-14, and Treasury promulgated Proposed Regulations under section 6011. 3 The Proposed Regulations have since been finalized. As a package, they were designed ultimately to restrict or eliminate abusive basis shifting. After the Article was written and edited by The Tax Lawyer, the Notice was withdrawn, and Treasury stated that it intended to go through \"notice and comment\" to withdraw the section 6011 Regulations. 4 But the approach the Notice took remains highly relevant, and the Regulations remain valid. Thus, both are discussed in detail in the article. This Article reviews the area generally and critiques the governmental responses. It argues that the erstwhile Proposed Related-Party Basis Adjustment Regulations were overly broad and unlikely to survive in a post-Loper Bright world and proposes alternatives. But the Article is also skeptical as to whether the Proposed Related-Party Basis Adjustment Regulations are even needed in light of the section 6011 Regulations and (assuming they were finalized) the Proposed Consolidated Return Regulations. While the latter have been withdrawn and the former are proposed to be withdrawn, both represent good policy. The Article argues that these latter two efforts were well-advised and, if fully implemented, likely would be sufficient to address the vast majority of abusive basis shifting transactions. The Article includes a discussion of the relevant, and rather dramatic, developments that occurred in 2025. Finally, it questions whether practitioners are fulfilling their obligation to the tax system when designing many of the basis-shifting strategies and expresses its support for Sen. Wyden's partnership taxation reform proposals.

The American Bar Association Section of Taxation (the \"Section\") released comments (the \"Comments\") on proposed regulations issued by the Treasury and the Service concerning section 751(b), which was included in Subchapter K when first enacted in 1954, and has been amended slightly since then. Section 751(b) applies to a distribution of property from a partnership to a partner if the effect of the distribution is to effect an exchange of the distributee's share of unrealized receivables and substantially appreciated inventory \"in exchange for\" an increased share of other assets, or vice versa. Thus, section 751(b) is directed at distributions that have the effect of shirting ordinary income among partners. Regulations under section 751(b) were promulgated in 1956 and were focused on distributions that shift partners' shares of the value of a partnership's ordinary income assets. The regulations have not been amended since their original promulgation. The examples in those regulations determine a partner's interest in section 751 property by reference to the partner's share of the gross value of the partnership's assets (the \"gross value\" approach), not by reference to the partner's share of the unrealized gain or loss in the property. If a distribution results in a shift between the partner's interest in the partnership's section 751 property and the partnership's other property, those regulations require a deemed asset exchange of both section 751 property and other property between the partner and the partnership to determine the tax consequences of the distribution (the \"asset exchange\" approach). With their focus on value, the 1956 regulations were found to yield results that were both internally inconsistent and inconsistent with the goals of the statute. In response to this well-recognized problem, the government issued Notice 2006-14, proposing a new approach to implementing section 751(b). In the Notice, the government asked for comments on (1) replacing the gross asset value approach with a \"hypothetical sale\" approach for purposes of determining a partner's interest in the partnership's section 751 property and (2) replacing the asset exchange approach with a \"hot asset sale\" approach to determine the tax consequences when it is determined that section 751(b) applies. The proposed 751(b) regulations adopt many of the principles described in Notice 2006-14. The proposed regulations (1) provide rules for determining partners' interests in section 751 property, (2) set forth the test to determine whether section 751 (b) applies to a partnership distribution, including anti-abuse principles that may apply in certain situations in which the test would not otherwise be satisfied, (3) explain the tax consequences of a section 751(b) distribution, and (4) describe certain ancillary issues. The proposed regulations withdraw the asset exchange approach of the current regulations, but do not require the use of a particular approach for determining the tax consequences of a section 751(b) distribution. Rather, the partnership must use a reasonable approach that is consistent with the purpose of section 751(b). The drafters of the proposed regulations signal that the \"hot asset sale\" approach and a \"deemed gain\" approach are reasonable in many or most situations. In the Comments, the Section stated that it strongly supports the general approach adopted in the proposed regulations as compared with the approach taken in the 1956 regulation. Additionally, while supporting the general approach of the proposed regulations, the Section recommended numerous changes and additions, notably with respect to: (1) determining substantial appreciation in inventory; (2) permitting certain special allocations (i.e., synthetic revaluations) to obtain the same results as a revaluation; (3) addressing the overlap of section 751(b) with section 704(b) substantiality; (4) revising certain aspects of the capital gain recognition provisions in the proposed regulation; (5) providing for information reporting by lower tier partnerships to upper tier partnerships; (6) coordinating the interaction of section 751(b) with section 1245; (7) allocating section 734(b) adjustments; (8) illustrating the interaction of section 751(b) and section 1254; (9) clarifying that if the deemed gain approach is adopted, the resulting deemed sale will not be given effect for any other purpose as a partnership-level sale of assets; (10) resolving the interaction of section 751(b) and section 1248; and (11) addressing certain aspects of the anti-abuse rules in the proposed regulations. The comments provide detailed explanations, often with numerical examples, in each of these areas. These comments (\"Comments\") are submitted on behalf of the American Bar Association Section of Taxation (the \"Section\") and have not been approved by the House of Delegates or Board of Governors of the American Bar Association. Accordingly, they should not be construed as representing the position of the American Bar Association. Principal responsibility for preparing these Comments was exercised by Howard E. Abrams and Erich P. Hahn. Substantive contributions were made by Deanna W. Harris, Victoria Louie, and Julie Marion. The Comments were reviewed by Thomas E. Yearout, Chair of the Partnerships and LLCs Committee (the \"Committee\"), and Jeanne M. Sullivan, former Chair of the Committee. The Comments were further reviewed by William H. Caudill for the Sections Committee on Government Submissions, Roberta Mann, Council Director for the Committee, and Peter H. Blessing, the Section's Vice Chair (Government Relations). Although the members of the Section of Taxation who participated in preparing these Comments have clients who might be affected by the federal income tax principles addressed by these Comments, no such member (or the firm or organization to which such member belongs) has been engaged by a client to make a government submission with respect to, or otherwise to influence the development or outcome of, the specific subject matter of these Comments.

Section 1446(f) of the Internal Revenue Code requires the transferee of a partnership interest to withhold 10 percent of the amount realized by the transferor if, among other requirements, the transferor is a non-US person, a gain is recognized on the sale, and such gain is \"effectively connected\" with a US trade or business conducted by the partnership. The author of this article has examined the proposed regulations and other guidance implementing this provision and found them deficient in several respects. He points out that, unfortunately, they disregard the statutory requirements and generally require withholding by all transferees of partnership interests, anywhere in the world, even if the partnership has never conducted any activities within the United States. The proposed regulations and other guidance provide for limited exceptions, but as the author explains, the exceptions are unrealistic and wholly inadequate.

Long-awaited proposed regulations would revise the operation of section 751(b) to reflect modern concepts of partnership taxation. The Treasury should be commended for exercising its regulatory authority to thoroughly overhaul the section 751(b) regulations to achieve the goals of the statute—preventing shifts in unrealized ordinary income—in a more sensible manner. The novel approach under the proposed regulations relies on section 704(c) principles to measure a partner's interest in hot asset gain before and after a distribution of partnership property. Ordinary income tax would be imposed only to the extent a partner's interest in hot asset gain cannot be fully preserved through mandatory revaluations. When a disproportionate distribution reduces (but does not eliminate) a partner's interest in the partnership, revaluations and reverse section 704(c) allocations would permit considerable flexibility to avoid section 751(b) and thus obtain continued deferral. This Article illustrates the hypothetical sale construct and reasonable approaches to determine the existence and consequences of a section 751(b) distribution, as well as the role of mandatory (or elective) capital gain recognition to prevent basis adjustments under sections 732 and 734(b). The Article suggests alternative approaches for reconciling the operation of sections 704(c) and 734(b), including enhanced capital gain recognition and exchanges of reverse section 704(c) hot asset gain. The Article also considers fixes to prevent basisshifting to depreciable assets and the need to curtail deferral when no longer consistent with the purpose of section 751(b). The Article concludes that the proposed regulations could be significantly improved by mandating the deemed gain approach and requiring enhanced gain recognition to allow basis adjustments to function sensibly. Despite their daunting complexity, the proposed regulations should hopefully improve compliance with section 751(b).

Section 704(b) and its Regulations allows partnerships a great deal of flexibility on how items of income and deduction are allocated to partners. This flexibility has been heavily criticized over the years. The article reviews section 704(b) and its Regulations, including the partner's-interest-in-the-partnership test, the substantial-economic-effect safe harbor, and \"target allocations.\" (Target allocations are widely used notwithstanding the lack of clear legal underpinnings). The article discusses the shortcomings of the existing scholarship, argues for a flexible section 704(b) allocation regime, but acknowledges that reform is necessary. The article proposes a new definition of substantiality, limiting section 704(b) to \"bottom-line\" items, and adding a safe harbor for target allocations.

Under Section 1221, a partnership interest or stock in an S Corporation is a capital asset. Per Reg. 1.1221-1(a), \"The term capital assets includes all classes of property not specially excluded under Section 1221. In determining whether property is a capital asset, the period for which held is immaterial.\" Therefore, based upon the Internal Revenue Code and regulations a partnership interest and stock in an S Corporation would be classified as capital assets. Under Section 1221, accounts and notes receivables generated from services or sale of inventory in the ordinary cause of a trade or business are not capital assets. In connection with a sale of a partnership interest, Reg. 1.751-1(a) treats a partner's share of unrealized receivables and inventory as sale of assets other than capital assets. Typically, for an oil and gas partnership that is on the cash method of accounting for income tax purposes, it will have one month of oil sales and possibly two months of gas sales that are uncollected.

Sen. Wyden has proposed dramatic changes to Subchapter K. Probably no change is further reaching than that made to section 752, which provides the rules for allocating partnership debt to partners. At a minimum (the exact scope is unclear), the proposal would radically change the allocation of recourse debt. No longer would the allocation be based on partners' \"economic risk of loss;\" instead, it would be based on partner profit shares. This Article reviews and analyzes current law and the changes the Wyden proposal would make to that law. The Article argues that the Wyden proposal in its current form goes too far but could be viable if an exception for small business is made. If implemented, the proposal might be the biggest single change to Subchapter K since 1954, with large tax consequences to partners and their partnerships. Fair transition rules that would mitigate these consequences would be vital.