United States

IRS issues proposed regulations on distributions of “hot” assets

TAX ALERT  | 

On Nov. 3, 2014, the U.S. Department of the Treasury and the IRS issued proposed regulations (REG-151416-06) to amend, update and clarify the existing regulations under section 751(b), which provide for the tax consequences of a partnership distribution that changes a partner's interest in the partnership's unrealized receivables and inventory items ("hot assets" or "section 751 property").

The proposed regulations would replace the current "gross value" approach–which measures a change in a partner's interest in hot assets and other assets by reference to the value of the assets–with an approach that measures the extent to which a hypothetical sale of assets would give rise to ordinary income or capital gains, with and without the distribution. The hypothetical sale approach is generally viewed as simpler to apply and better aligned with other rules of Subchapter K, such as the rules governing the treatment of built-in gain property.

Both the existing rules and the new proposed rules are quite complex, and the proposed rules are not mandatory until issued as final regulations. For now, the most important thing to be aware of is the fact that taxpayers have a choice of continuing to apply the old rules–until the new rules are made mandatory through the issuance of final regulations–or electing to apply the new rules. In general, such an election may be made for distributions occurring on or after Nov. 3, 2014. Although it is not entirely free from doubt, it appears that such an election must be applied to all distributions occurring on or after Nov. 3, 2014, or not at all. For example, the taxpayer would not have the right to continue to apply current law, say, for the remainder of calendar 2014 and then to elect to apply the new rules in 2015.

Taxpayers considering transactions involving distributions that could trigger the application of section 751(b) should discuss with their advisors the possible ramifications of these highly complex proposed regulations, including the option of applying them before they are issued as final regulations.

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