March 12, 2020

Final regulations: Transfers to partnerships with related foreign partners

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The IRS recently issued final regulations addressing transfers of appreciated property by U.S. persons to partnerships that have partners who are related foreign persons — that is, foreign persons related to the transferor. The regulations generally override the rules providing for non-recognition of gain on a contribution of property to a partnership in exchange for an interest in the partnership under Internal Revenue Code Section 721(a). They also largely finalize the 2017 proposed regulations, with some modifications and clarifications. These regulations are designed to prevent IRS perceived abuse surrounding the contribution of appreciated property to a partnership that has foreign partners that are not subject to U.S. taxation as a means to shift a portion of gain on the property to them.

Definition of a related person

The IRS has determined that a modification to the definition of related person is appropriate to limit the application of these rules in certain situations. Specifically, a new paragraph has been added that provides, for purposes of determining whether a person is a related person with respect to a U.S. transferor, that Sec. 267(b) is applied without regard to Sec. 267(c)(3).This modification to the definition of related person provides relief when certain foreign individual partners of a partnership would be treated as a related person with respect to a domestic corporation because of constructive stock ownership rules under Sec. 267(c)(3).

Consistent allocation method

The regulations provide the requirements that must be met in order for the gain deferral method to apply to such transfers and immediate gain recognition upon contribution to be avoided. Among the requirements, a Sec. 721(c) partnership must adopt the remedial allocation method under Sec. 704(c) and apply the consistent allocation method with respect to Sec. 721(c) property.The consistent allocation method provides that, for each tax year of a Sec. 721(c) partnership in which there’s remaining built-in gain in Sec. 721(c) property, the partnership must allocate each book item of income, gain, deduction and loss with respect to the property to the U.S. transferor in the same percentage for the tax year. However, it doesn’t require the allocations to be in the same percentage among all tax years in which the gain deferral method is applied. The method, therefore, prevents a U.S. transferor from rendering the remedial allocation method ineffective by, for example, having the partnership allocate a higher percentage of book depreciation to the U.S. transferor than the U.S. transferor’s percentage share of income or gain with respect to the Sec. 721(c) property.Upon a variation of a U.S. transferor’s interest in a Sec. 721(c) partnership, book items with respect to Sec. 721(c) property that are allocated under the interim closing method will be treated as allocated in the same percentage for purposes of applying the consistent allocation method in a single tax year. An exception is if the variation results from a transaction undertaken with a principal purpose of avoiding the tax consequences of the gain deferral method.The modification to the consistent allocation method when the interim closing method is applied is intended to clarify that a U.S. transferor continues to comply with the consistent allocation method following certain economic events that don’t close the tax year of the Sec. 721(c) partnership. Given the high thresholds required to be subject to these rules, the IRS has determined that allowing the partnership to choose the proration method is inappropriate for the consistent allocation method. A Sec. 721(c) partnership should have the resources and capabilities to comply with the more precise interim closing method without incurring an undue burden.


The final regulations include the reporting requirements provided in the 2017 proposed regulations regarding both gain deferral contributions and the annual reporting requirements with respect to Sec. 721(c) property to which the gain deferral method applies. The 2017 regulations required much of the reporting to be on statements attached to returns.Since the issuance of the 2017 regulations, however, the IRS has updated and added new schedules to Form 8865, “Return of U.S. Persons With Respect to Certain Foreign Partnerships,” to facilitate compliance with these reporting requirements. The agency has also issued new Form 8838-P, “Consent To Extend the Time To Assess Tax Pursuant to the Gain Deferral Method.” The purpose of these changes is to include the information that previously was reported on the statements. The final regulations require the use of these forms and schedules but provide relief from this requirement for tax returns filed before March 17th, 2020. Taxpayers may report the required information on supplemental statements as previously prescribed in the proposed regulations if the return is filed before that date.The final regulations also clarify the duration for which the U.S. transferor must extend the period of limitations on the assessment of tax. One regulation clarifies the relevant periods to which Form 8838-P applies by measuring each period by the number of months occurring after the relevant date. Accordingly, the final regulations measure each period by a fixed term that’s determinable on the date of contribution.

Technical terminations

Sec. 708(b) generally provides that a partnership will terminate if it ceases to do business. Before the enactment of the Tax Cuts and Jobs Act (TCJA), former Sec. 708(b)(1)(B) provided another way for a partnership to terminate. That is, a partnership could terminate if, within any 12-month period, 50% or more of the total interest in partnership capital and profits was sold or exchanged — commonly referred to as a “technical termination.”The regulations provided that a technical termination results in a deemed contribution of all the terminated partnership’s assets and liabilities to a new partnership in exchange for an interest in the new partnership, followed by a deemed distribution of interests in the new partnership to both the purchasing partners and the remaining partners. However, the TCJA repealed former Sec. 708(b)(1)(B) for all partnership tax years beginning after December 31, 2017; therefore, technical terminations no longer apply.The 2017 regulations provided rules regarding technical terminations in two contexts:

  1. They provided that a partnership won’t be treated as a Sec. 721(c) partnership following a deemed contribution that occurs as a result of a technical termination.
  2. They treated certain technical terminations as successor events for purposes of the acceleration event exceptions provided in the regulations.

The rules in the 2017 regulations regarding technical terminations are retained in the final regulations. Although the TCJA repealed former Sec. 708(b)(1)(B), the applicability date for the final regulations relates back to the applicability date provided in the 2017 regulations, which is before the effective date provided in the TCJA.Accordingly, the rules provided in the final regulations regarding technical terminations will have limited applicability; they’ll apply only to technical terminations occurring on or after the applicability date provided in the 2017 regulations but before the effective date for the repeal of former Sec. 708(b)(1)(B) provided in the TCJA.

Applicability dates

The final regulations generally apply to contributions occurring on or after August 6, 2015, and to contributions occurring before August 6, 2015, that result from an entity classification election filed on or after August 6, 2015. However, various elections may affect applicability. Consult the Elliott Davis team for more information and any other questions you might have about the final regulations.

What about accidental partnerships?

The IRS received a comment with respect to the 2017 regulations that expressed concern that an intercompany transaction between a U.S. person and a foreign person may result in a deemed or “accidental partnership,” despite no intention by the partners to create one and no realization one was created.The agency notes that, when an accidental partnership exists, the filing obligations won’t have been fulfilled and, therefore, the limitations period on assessment under Sec. 6501(c)(8) will remain open until three years after the IRS is provided the required reporting information under Sec. 6038B. Accordingly, a taxpayer that makes a contribution to an accidental partnership could file amended returns applying the gain deferral method, including fulfilling its reporting requirements.

We can help

Contact Elliott Davis for more information on this and other matters related to conducting business internationally.

The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.

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