As you probably know, a taxpayer realizes gain when the taxpayer transfers appreciated property in exchange for other property. There are exceptions to this general rule. One of those exceptions is defined in Internal Revenue Code Section 721. Section 721 governs when a taxpayer contributes property to a partnership in exchange for a partnership interest. As usual in tax law, this exception is defined to eliminate transactions that don’t fit the intent of the provision. As a consequence, some taxpayers will realize gain when they contribute property to a partnership in exchange for a partnership interest.
One of those exceptions is Code Section 721(c). Under Section 721(c), a U.S. taxpayer will realize gain when that taxpayer contributes “section 721(c) property” to a “section 721(c) partnership.” Section 721(c) property is, generally, appreciated property. A section 721(c) partnership is a partnership in which the U.S. taxpayer and one or more related foreign persons own 50% or more of the partnership interests.
Section 721(c) also provides an out for partnerships that adopt a “gain deferral method”. That method requires the partnership to, among other things, use the remedial allocation method for the contributed property.
The final regulations generally explain the mechanics of Section 721(c) and the gain deferral method. The final regulations also tweak the definition of a section 721(c) partnership. As noted above, a section 721(c) partnership is a partnership as to which the contributing U.S. taxpayer and one or more foreign persons own 80% or more of partnership interests. A taxpayer owns interests that it actually and constructively owns. The taxpayer’s constructive ownership is determined under Code Section 267.
The final regulations state that Section 267 will be applied without reference to Section 267(c)(3). As a consequence, some foreign persons will not be deemed to own interests in a partnership held by a corporation the shares of which are held by a partnership of which the foreign person is a partner. Yes, it’s complicated.
Click to view the Federal Register website page containing the text of the final Section 721(c) regulations.
