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There is uncertainty in evaluatingwhether a transaction is a disguised sale of partnership interests due to the lack of IRS guidance.
Contributions of money or other property to a partnership in exchange for an interest in the partnership are generally nontaxable under Section 721. Similarly, Section 731 allows for nontaxable distributions of money or other property from a partnership to a partner to the extent that the money distributed does not exceed the partner's entire basis in his or her partnership interest. Section 707(a)(2)(B), however, provides that, under regulations prescribed by the Treasury, certain related partnership contributions and distributions may be recharacterized as disguised sales between the partner and partnership (disguised sales of property) or between partners (disguised sales of partnership interests).
The statute directs the Treasury to prescribe regulations determining when related contributions and distributions are properly viewed as a disguised sale of property or a disguised sale of a partnership interest. In 1992, Treasury published final rules addressing the disguised sale of property (the property regulations).1 Additionally, in 2004 the Treasury published proposed regulations providing rules for determining a disguised sale of a partnership interest (the partnership interest regulations).2 The partnership interest regulations, however, were withdrawn in 2009 and have not been re-proposed.
Issuance of the property regulations has provided clarity with respect to disguised sales of property between a partner and partnership under Section 707(a)(2)(B). However, in the absence of regulations uncertainty remains in determining whether purported contributions and distributions are more properly viewed as disguised sales of partnership interests under Section 707(a)(2)(B).
Some commentators have articulated a position that in the absence of regulations disguised sales of partnership interests cannot occur.3 Although arguments exist that Section 707(a)(2)(B) is not self-executing in the absence of regulations, the IRS has consistently stated that until regulations are issued it will apply the statute based on the legislative history. As will be discussed further, case law appears to support the IRS's position that Section 707(a)(2)(B) may result in a disguised sales of a partnership interest notwithstanding the absence of regulations.
Given the lack of regulatory guidance, uncertainty exists in evaluating whether any given transaction falls within the legislative purpose of the statute and may be recast as a disguised sale of partnership interests. In...