IRC 704(c) for Tax Counsel: Structuring Partnership Agreements for Contributions of Built-In Gain or Loss Property

An often difficult and frequently overlooked challenge for tax counsel and partnership advisers is negotiating the Section 704(c) contribution rules. Section 704(c) operates to prevent the shifting of tax liabilities associated with built in gains and losses among/between partners when a partner or member contributes property that has a fair market value different from the basis the partnership would take in the contributed property. Tax counsel must ensure that partnership agreements and contribution structures consider the provisions of Section 704(c) to avoid costly tax consequences.

The key provision to Section 704(c) requires contributing partners to recognize gain or loss on the partnership sale of built-in gain/loss property within seven years of the contribution. Section 704(c)(1)(B) works in tandem with Section 737, which requires recognition of precontribution gain by a contributing partner in case of certain distributions. The goals of the Sections are to prevent contributing partners from shifting built-in gains to another partner.

Tax counsel must not only understand the rules but also the practical implications of Section 704(c) in negotiating and drafting partnership agreements. Failure to take the anti-abuse rules into account when structuring contributions result in unnecessary tax issues for the individual partners.

Listen as our authoritative panel of tax advisers guides counsel through the basis adjustment rules, discusses the impact of the Section 754 election on individual partners and the partnership, and provides best practices for avoiding potential pitfalls of the election.

1. Key aspects of Sect. 704(c)
   1. Applies whenever a partner contributes appreciated or depreciated property to a partnership, or when a new partner is admitted
   2. Income, gain, loss or deduction for property contributed must be shared among partners
   3. Parties must account for any variance between basis of property and fair market value at time of contribution over the life of the partnership
   4. If property is depreciable or subject to depletion, then taxpayers are granted broad authority to determine how to account for this variance over the life of the partnership
   5. Simple Traditional Method Example
   6. Ceiling Rule Limit
   7. Simple Traditional with Curatives Example
   8. Simple Remedial Example
2. Forward and reverse allocations under Sect. 704(c)
   1. Elections available to choose allocation method
   2. Forward allocations
      1. Book vs. tax basis
      2. Traditional, curative, remedial methods
   3. Reverse allocations
      1. Issues with revaluation of capital accounts
      2. Aggregation elections
3. Structuring and drafting partnership operating documents to conform to Section 704(c) rules
   1. Timing of Making Forward 704(c) Election and Possible State law issues
      1. Should you select a method in the agreement upon inception?
      2. Should you give someone (manager, BOD, etc.) power to select a method later?
      3. State law breach of fiduciary duties issues with “2”
   2. Timing of Making Reverse Section 704(c) Election and Possible State law issues
      1. Should you elect to revalue?
      2. Should you grant someone (manager, BOD, etc.) the power to elect to revalue later?
      3. Do the regulations allow the drafter to grant someone the power to elect to revalue at later time (or must the drafter either elect to revalue or not at the time of inception)?

The panel will discuss these and other important topics:

• Preparing partnership and operating agreements with specific language to conform with Sect. 704(c) allocation restrictions
• Identifying various elections to adopt an appropriate allocation method
• What are the specific events and conditions under which a reverse revaluation is allowed under Section 704(c)
• Understanding reverse 704(c) revaluations in the context of partnership termination/reformation

Learning Objectives

After completing this course, you will be able to:

• Identify property contribution transactions that fall under the rules of Section 704(c)
• Distinguish the specific types of allocations allowed under Section 704(c)
• Determine available elections to determine when an allocation method permitted by Section 704(c) is appropriate
• Select specific drafting language to preserve flexibility in operating documents while conforming with 704(c) anti-abuse provisions
• Recognize issues with capital account revaluations in reverse allocations

• Field of Study: Taxes
• Level of Knowledge: Intermediate
• Advance Preparation: None
• Teaching Method: Seminar/Lecture
• Delivery Method: Group-Internet (via computer)
• Attendance Monitoring Method: Attendance is monitored electronically via a participant's PIN and through a series of attendance verification prompts displayed throughout the program
• Prerequisite: Three years+ business or public firm experience at mid-level within the organization, drafting complex partnership agreements and schedules, supervising other attorneys or tax advisers. Specific knowledge and understanding of partnership structure, operating agreements and liquidation, including partner capital accounts, allocation and distributions; familiarity with the economic effect test; safe-harbor and non-safe harbor partnership agreements according to IRC 704.

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IRS Approved Provider

Strafford is an IRS-approved continuing education provider offering certified courses for Enrolled Agents (EA) and Tax Return Preparers (RTRP).