[Federal Register: July 15, 2004 (Volume 69, Number 135)]
[Proposed Rules]
[Page 42370-42379]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr15jy04-18]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-150562-03]
RIN 1545-BC67
Section 1045 Application to Partnerships
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations relating to the
application of section 1045 of the Internal Revenue Code (Code) to
partnerships and their partners. These regulations provide rules
regarding the deferral of gain on a partnership's sale of qualified
small business stock and deferral of gain on a partner's sale of
qualified small business stock distributed by a partnership. The
proposed regulations affect partnerships that invest in qualified small
business stock and their partners. This document also provides notice
of a public hearing on the proposed regulations.
DATES: Written or electronic comments and requests to speak and
outlines of topics to be discussed at the public hearing scheduled for
Tuesday, November 2, 2004, at 10 a.m. must be received by October 11,
2004.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-150562-03), Room
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
150562-03), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC, or sent electronically, via the IRS
Internet site at: http://www.irs.gov/regs or via the Federal eRulemaking
Portal at http://www.regulations.gov (IRS and REG-150562-03). The public
hearing will be held in the IRS Auditorium, Internal Revenue Building,
1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Charlotte Chyr, (202) 622-3070, or Jian H. Grant, (202) 622-3050;
concerning submissions, the hearing, and/or placement on the building
access list to attend the hearing, Sonya Cruse, (202) 622-4693 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)). Comments on the collection of information should be
sent to the Office of Management and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP
Washington, DC 20224. Comments on the collection of information should
be received no later than September 13, 2004. Comments are specifically
requested concerning:
Whether the proposed collection of information is necessary for the
proper performance of the functions of the Internal Revenue Service,
including whether the information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collection of information (see below);
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collection of
information can be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
The collection of information in this proposed regulation is in
Sec. 1.1045-
[[Page 42371]]
1(b)(4)(ii). This information is required to inform the IRS of
partnerships and partners making the section 1045 election. The
collection of information is required to obtain a benefit, that is, to
elect to apply section 1045 treatment for qualified small business
stock that is sold by the partnership. This information will be used by
the partner to permit the partner to defer its allocable share of gain
on the partnership's sale of qualified small business stock and by
partnerships to make necessary adjustments to the basis of replacement
qualified small business stock. The likely respondents are individuals,
businesses or other for-profit institutions, and small businesses or
organizations.
The estimated burden for the collection of information in Sec.
1.1045-1(b)(4)(ii) is as follows:
Estimated total annual reporting burden: 1,000 hours.
The estimated annual burden per respondent varies from 45 to 75
minutes, depending on individual circumstances, with an estimated
average of 1 hour.
Estimated number of respondents: 1000.
Estimated annual frequency of responses: On occasion.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid OMB control number assigned by the Office
of Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
Section 1045 and section 1202 both provide for special treatment of
gain on the sale of QSB stock held by non-corporate taxpayers. Under
section 1202 of the Internal Revenue Code (Code), a taxpayer other than
a corporation (a non-corporate taxpayer) excludes 50 percent of gain on
the sale of qualified small business (QSB) stock (as defined in section
1202(c)) from gross income if the taxpayer holds the stock for more
than five years. Section 1045 permits a non-corporate taxpayer that
holds QSB stock (relinquished QSB stock) for more than six months and
sells it after August 5, 1997, to elect to defer recognizing gain on
the sale. To qualify for such deferral, the taxpayer must purchase QSB
stock (replacement QSB stock) within a 60-day period beginning on the
date of the sale of the relinquished QSB stock. Any gain not recognized
reduces the cost basis of the replacement QSB stock. Section
1045(b)(3). The taxpayer recognizes gain to the extent the amount
realized on the sale of the relinquished QSB stock exceeds the cost
basis of the replacement QSB stock. Section 1045(a). Section 1045 does
not apply to any gain treated as ordinary income. Id.
Section 6005(f)(2) of the Internal Revenue Service Restructuring
and Reform Act of 1998, Public Law 105-206 (112 Stat. 6005(f)(2)), July
22, 1998, (the 1998 Act) added section 1045(b)(5). That section
provides that rules similar to the rules in section 1202 (f), (g), (h),
(i), (j), and (k) apply for purposes of section 1045. The legislative
history accompanying the 1998 Act provides that the benefit of deferred
recognition of gain with respect to the sale of QSB stock by a
partnership will flow through to a partner who is not a corporation if
the partner held the partnership interest at all times the partnership
held the QSB stock. See H.R. Conf. Rep. 105-599, 105th Cong., 2d Sess.
339 (1998). The legislative history further provides that there are no
limitations on the types of partners that a partnership may have in
order for the benefits of section 1045 to apply. Id. at 340.
Under section 1202(g), a non-corporate taxpayer applies section
1202 to the taxpayer's share of a passthrough entity's gain from the
sale of QSB stock if two requirements are met. First, the passthrough
entity must have held the QSB stock for more than five years. Second,
the taxpayer must have held an interest in the passthrough entity on
the date the passthrough entity acquired the QSB stock and at all times
thereafter before the disposition of the stock. For purposes of section
1202, passthrough entities include partnerships, S corporations,
regulated investment companies (RICs), and common trust funds. Section
1202(g)(4).
QSB stock must generally be acquired by the taxpayer at its
original issue. However, section 1202(h) provides that, in the case of
certain transfers of QSB stock, the transferee is treated as having
acquired such stock in the same manner as the transferor and as having
held such stock during any continuous period immediately preceding the
transfer during which it was held by the transferor. Section 1202(h)
applies to transfers from a partnership to a partner of stock with
respect to which requirements similar to the requirements of section
1202(g) are met at the time of the transfer (without regard to the 5-
year holding period requirement) as well as to transfers by gift or at
death.
The committee reports underlying the enactment of section 1202
explain that, under section 1202(h),
[q]ualified small business stock * * * may be distributed by a
partnership to one or more of its partners, as long as (1) all
eligibility requirements with respect to qualified small business
stock are met, and (2) the partner held its interest in the
partnership on the date the partnership acquired the stock and at
all times thereafter and before the disposition of the stock. In
addition, a partner cannot treat stock distributed by a partnership
as qualified small business stock to the extent that the partner's
share of the stock distributed by the partnership exceeded the
partner's interest in the partnership at the time the partnership
acquired the stock.
H.R. Rep. No. 103-111, 103d Cong., lst Sess. 602 (1993).
The committee report goes on to explain that transferees in cases
not described in section 1202(h) are not eligible for partial exclusion
of gain under section 1202(a). Thus, for example, if qualified small
business stock is transferred to a partnership and the partnership
disposes of the stock, any gain from the disposition will not be
eligible for the exclusion. Id.
Rev. Proc. 98-48 (1998-2 C.B. 367) generally provides procedures
for taxpayers (including passthrough entities and individuals holding
interests in a passthrough entity) to elect to apply section 1045. The
background section of the revenue procedure explains that, under
section 1045(b)(5), a passthrough entity that sells QSB stock held for
more than 6 months may make a section 1045 election if the entity
purchases replacement QSB stock during the 60-day period beginning on
the date of the sale. Section 2.03, Rev. Proc. 98-48. The benefit of
the section 1045 election flows through to a non-corporate taxpayer
that held an interest in the passthrough entity for as long as the
entity held the QSB stock. The background section of the revenue
procedure also explains that, under section 1045(b)(5), if a
passthrough entity sells QSB stock held for more than six months, a
non-corporate taxpayer who has held an interest in the entity during
the period in which the entity held the QSB stock and who purchases
replacement QSB stock during the 60-day statutory period may elect to
apply section 1045 to the non-corporate taxpayer's share of any gain on
the sale that the entity does not defer under section 1045. Section
2.03, Rev. Proc. 98-48.
Since Rev. Proc. 98-48 was published, the IRS and Treasury
[[Page 42372]]
Department have received inquiries regarding the application of section
1045 to partnerships and their partners. In response to these
inquiries, the proposed regulations provide rules relating to sales and
purchases of interests in a partnership that owns QSB stock,
partnership dispositions of QSB stock, partnership distributions of QSB
stock, and contributions of QSB stock to a partnership. Partners and
partnerships wishing to elect section 1045 must continue to follow the
procedures of Rev. Proc. 98-48 for rules regarding the time and manner
for making the election, the scope of the election, and revocation of
the election.
Explanation of Provisions
A. General Rules and Definitions
1. QSB Stock
Section 1045(b)(1) provides that the term QSB stock has the same
meaning given such term by section 1202(c). Section 1202(c) provides
that the term QSB stock is any stock in a C corporation that is
originally issued after the date of the enactment of the Revenue
Reconciliation Act of 1993, if (A) as of the date of issuance, the
corporation is a qualified small business, and (B) except as provided
in section 1202(f) and (h), the stock is acquired by the taxpayer at
its original issue in exchange for money or other property (not
including stock), or as compensation for services provided to the
corporation.
Some taxpayers have asked if a partner may treat a sale of a
partnership interest as a sale of QSB stock or an acquisition of a
partnership interest as an acquisition of QSB stock. Sections 1045 and
1202 do not adopt a look-though approach to the sale and acquisition of
partnership interests. Under the plain language of section 1202(c), an
investment in a partnership that holds or purchases QSB stock is not
treated as an investment in QSB stock. This plain language
interpretation is further supported by the structure of sections 1045
and 1202. Congress clearly contemplated partnership transactions when
enacting section 1202, as several of its provisions address such
transactions. In light of this, Congress's failure to provide for
section 1202(a) treatment for acquisitions and dispositions of
partnership interests appears to have been intentional. Such a decision
by Congress would be consistent with the approach taken by section
1202(g). That section allows partners to qualify for section 1202(a)
treatment with respect to gain recognized by reason of holding a
partnership interest only if the partner held the interest in the
partnership on the date of the partnership's acquisition of QSB stock
and at all times thereafter before the disposition of the stock by the
partnership. If a partner were to sell its partnership interest while
the partnership still held QSB stock, then the partner would not have
held the partnership interest from the date of the acquisition of that
stock until the date of the disposition of the stock by the
partnership. For these reasons, the proposed regulations provide that
the term QSB stock does not include an interest in a partnership that
holds or purchases QSB stock.
2. Eligible Partner
Under the proposed regulations, only an eligible partner may defer
gain recognized by a partnership on the sale of QSB stock. Consistent
with section 1202(g) and (h), the proposed regulations define an
eligible partner as a non-corporate partner who held an interest in the
partnership at all times that the partnership held the QSB stock or a
non-corporate partner who acquired an interest in a partnership from an
existing eligible partner by gift or death.
The proposed regulations provide special rules for determining
eligible partners if a partnership (upper-tier partnership) holds an
interest in a partnership (lower-tier partnership) that holds QSB
stock. The proposed rules disregard the upper-tier partnership's
ownership of the lower-tier partnership and treat each partner of the
upper-tier partnership as owning the interest in the lower-tier
partnership directly. A partner of the upper-tier partnership is
treated as owning an interest in the lower-tier partnership during the
period in which both the partner of the upper-tier partnership held an
interest in the upper-tier partnership and the upper-tier partnership
held an interest in the lower-tier partnership.
The IRS and the Treasury Department are concerned that, although
the current look-through treatment for tiered partnerships may be the
simplest approach, the application of the proposed rules presents the
following potential problems: (1) The proposed rules prohibit an upper-
tier partnership from making a section 1045 election at the partnership
level; (2) the eligible partners of the upper-tier partnership may not
have the necessary information to benefit from the proposed rules; and
(3) notification from the lower-tier partnership to the upper-tier
partnerships and their partners and vice versa may be difficult if
multiple tiers of partnerships are involved. Accordingly, the IRS and
Treasury Department request comments specifically on the application of
the proposed rules with respect to tiered partnerships.
3. Nonrecognition Limitation
Under the proposed regulations, the amount of gain that an eligible
partner may defer under section 1045 (whether the election to apply
section 1045 is made at the partnership or the partner level) may not
exceed: (A) The partner's smallest percentage interest in the
partnership's income, gain, or loss with respect to the relinquished
QSB stock, multiplied by (B) the partnership's realized gain from the
sale of such stock. For this purpose, the partnership's realized gain
from the sale of the QSB stock is determined without regard to any
basis adjustment under section 734(b) or 743(b). This rule follows
section 1202(g)(2) and (3) by ensuring that the partner can defer
recognition of only the gain that relates to the partner's continuous
economic interest in the relinquished QSB stock.
B. Partnership Election Under Section 1045
1. General Rule
Consistent with Rev. Proc. 98-48, the proposed regulations allow a
partnership to elect to apply section 1045 if the partnership held QSB
stock for more than six months, sold such QSB stock, and purchased
other QSB stock (replacement QSB stock) within 60 days of the sale. If
the partnership makes an election under section 1045, all eligible
partners of the partnership must defer their distributive shares of the
partnership section 1045 gain from the partnership's sale of the QSB
stock. No separate election is required of the partners. Partnership
section 1045 gain equals the partnership's gain from the sale of the
QSB stock reduced by the greater of: (A) The gain from the sale of the
QSB stock that is treated as ordinary income, or (B) the excess of the
amount realized by the partnership on the sale over the cost of any
replacement QSB stock purchased by the partnership during the 60-day
period beginning on the date of the sale.
2. Election Procedures and Notification
The proposed regulations require the partnership to make the
section 1045 election on the partnership's timely filed return
(including extensions) for the taxable year during which the
partnership sells the QSB stock. In addition, the partnership must
follow the procedures of Rev. Proc. 98-48.
When a partnership makes the election, the proposed regulations
require the partnership to notify all
[[Page 42373]]
partners that it has made the election, and separately state each
partner's distributive share of the partnership section 1045 gain under
section 702. Each partner must determine if it is an eligible partner
and report the partner's distributive share of gain, including gain not
recognized, on Schedule D of the partner's Federal income tax return.
C. Partner Election Under Section 1045
1. General Rule
Also consistent with Rev. Proc. 98-48, the proposed regulations
allow an eligible partner to make a section 1045 election with respect
to the partner's share of gain from the partnership's sale of QSB stock
if the partnership does not make a section 1045 election or purchase
replacement QSB stock within the statutory time period. The election
may be made if the partnership either replaces none of the relinquished
QSB stock or replaces some but not all of the relinquished QSB stock.
For example, relinquished QSB stock can be partially replaced by the
partnership and partially replaced by the partner if section 1045
elections are made by both the partnership and the partner. If a
partner makes a section 1045 election, the partner recognizes its
distributive share of the gain from the sale of the relinquished QSB
stock only to the extent of the greater of: (1) The gain that is
treated as ordinary income, or (2) the excess of the partner's share of
the amount realized by the partnership on the sale of the QSB stock
over the cost of any replacement QSB stock purchased by the partner
during the 60-day statutory period.
A partnership that has sold QSB stock should promptly notify its
partners when it does not intend to make a section 1045 election with
respect to the sale. Prompt notification will allow partners who intend
to make separate section 1045 elections time to purchase replacement
QSB stock within 60 days of the sale of the relinquished QSB stock and
to make timely section 1045 elections. However, the proposed
regulations do not impose a requirement on partnerships to provide such
notification. The IRS and Treasury Department believe that it is more
appropriate for the partners to decide (for example, in the partnership
agreement) whether, and to what extent, the partnership must provide
such notification.
2. Election Procedures
The proposed regulations provide that a partner making an election
under section 1045 with respect to its distributive share of gain on
the partnership's sale of QSB stock must do so on the partner's timely
filed federal income tax return (including extensions) for the taxable
year in which such gain is taken into account. In addition, the partner
must follow the procedures of Rev. Proc. 98-48.
D. Basis Adjustments
The proposed regulations provide rules regarding adjustments to the
eligible partner's basis in the partnership interest and the
partnership's basis in the replacement QSB stock. Under these rules, if
the partnership makes a section 1045 election, then the eligible
partner may not increase its outside basis by the amount of gain that
is not recognized under section 1045. In addition, the partnership is
required to reduce its basis in the replacement QSB stock by the amount
of gain that is not recognized by its partners. The adjustment to the
partnership's inside basis in the replacement QSB stock is similar to a
basis adjustment under section 743(b). These rules are necessary to
preserve (in the replacement QSB stock and the partnership interest)
the deferred gain on the sale of the relinquished QSB stock.
As explained above, a partner's basis in a partnership interest is
not increased by any gain that is deferred by reason of a partnership
section 1045 election. In contrast, a partner's basis in a partnership
interest is increased by any gain that is deferred by reason of a
partner section 1045 election. A partner must reduce the basis of any
replacement QSB stock the partner purchases by the amount of gain that
is not recognized by reason of a partner section 1045 election.
To allow the partnership to make the appropriate adjustments to the
basis of the replacement QSB stock, the proposed regulations require
any partner who recognizes all or part of the partner's distributive
share of partnership section 1045 gain to notify the partnership of the
amount of the partnership section 1045 gain that was recognized. In the
absence of notification, the partnership must presume that the partner
deferred recognition of the partnership section 1045 gain and decrease
its basis in the replacement QSB stock by the partner's distributive
share of partnership section 1045 gain until such time as the partner
provides notification of the amount recognized by the partner. However,
if the partnership knows that one of its partners was, during any
period in which the partnership held the QSB stock, classified as a
corporation for federal tax purposes, then the partnership may presume
that the partner did not defer recognition of the partnership section
1045 gain even in the absence of a notification by the partner.
E. Distribution of QSB Stock
Consistent with section 1202(h) and the legislative history
underlying that section, the proposed regulations provide that, if a
partnership distributes QSB stock to an eligible partner, then the
eligible partner is treated as having acquired such stock in the same
manner as the partnership and having held such stock during any
continuous period immediately preceding the distribution during which
it was held by the partnership. However, the amount of gain on the sale
of such distributed QSB stock that the partner can defer cannot exceed
the distribution nonrecognition limitation. For this purpose, the
distribution nonrecognition limitation is equal to the partner's
section 1045 amount realized, reduced by the partner's section 1045
adjusted basis. The proposed regulations provide rules for determining
the partner's section 1045 amount realized and the partner's section
1045 adjusted basis in the case of a liquidating distribution, a
nonliquidating distribution of all of the QSB stock (of the same type),
and other nonliquidating distributions.
These rules follow the legislative history's directive that a
partner may not treat stock distributed by a partnership as QSB stock
to the extent that the partner's share of the distributed stock exceeds
the partner's interest in the partnership at the time the partnership
acquired the stock. Under the proposed regulations, the amount of gain
that a distributee partner may defer on the sale of distributed QSB
stock will be no more than (but in the case of QSB stock received in
certain nonliquidating distributions may be less than) the amount of
gain that the partner would have been able to defer in the absence of
the distribution.
The IRS and Treasury Department considered an alternative approach
for determining the distribution nonrecognition limitation for sales of
QSB stock following a nonliquidating distribution to a partner. Under
this alternative approach, the distribution nonrecognition limitation
would be determined by reference to the maximum amount of gain that the
partner would have been able to defer if the partnership had not
distributed any QSB stock of the type sold, but instead had sold all of
that QSB stock for a per share price equal to the per share price
received on the actual sale of the distributed QSB stock by the
[[Page 42374]]
partner. Due to the complexity of this alternative approach, it was
rejected and is not included in the proposed regulations. The IRS and
Treasury Department request comments on the extent to which refinements
of the distribution nonrecognition limitation applicable to sales of
distributed QSB stock are appropriate.
F. Contribution of QSB Stock
The proposed regulations provide that a contribution of QSB stock
to a partnership in a transaction to which section 721(a) applies does
not cause the contributing partner to recognize any gain that was
previously deferred under section 1045. However, the QSB stock, once
contributed, is no longer QSB stock in the hands of the partnership
because the partnership has not acquired the stock at original issue
within the meaning of section 1202(c)(1)(B). See also H.R. Rep. No.
103-111, 103d Cong., 1st Sess. 602 (1993).
G. Proposed Effective Date
The regulations are proposed to apply to sales of QSB stock on or
after the date final regulations are published in the Federal Register.
Effect on Other Documents
The following publication will be amplified for partners and
partnerships beginning on or after the date these regulations are
published as final regulations in the Federal Register:
Rev. Proc. 98-48 (1998-2 C.B. 367).
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations. It is hereby
certified that the collection of information in these regulations will
not have a significant economic impact on a substantial number of small
entities. This certification is based upon the fact that QSB stock is
not held by a substantial number of small entities and that the time
required to make the election is estimated to average 1 hour.
Therefore, a Regulatory Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to
section 7805(f) of the Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written (a signed original and eight
(8) copies) or electronic comments that are submitted timely to the
IRS. The IRS and Treasury Department request comments on the clarity of
the proposed rules and how they can be made easier to understand. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for Tuesday, November 2, 2004,
at 10 a.m. in the IRS Auditorium, Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the Constitution Avenue entrance. In
addition, all visitors must present photo identification to enter the
building. Because of access restrictions, visitors will not be admitted
beyond the immediate entrance area more than 15 minutes before the
hearing starts. For information about having your name placed on the
building access list to attend the hearing, see the FOR FURTHER
INFORMATION CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who
wish to present oral comments at the hearing must submit written or
electronic comments and an outline of the topics to be discussed and
the time to be devoted to each topic (signed original and eight (8)
copies) by October 11, 2004. A period of 10 minutes will be allotted to
each person for making comments. An agenda showing the scheduling of
the speakers will be prepared after the deadline for receiving outlines
has passed. Copies of the agenda will be available free of charge at
the hearing.
Drafting Information
The principal authors of these regulations are Charlotte Chyr and
Jian H. Grant, Office of the Associate Chief Counsel (Passthroughs and
Special Industries). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income
taxes, Penalties, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read,
in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.1045-1 is added to read as follows:
Sec. 1.1045-1 Application to partnerships.
(a) General rules--(1) Definition of QSB stock--In general. For
purposes of section 1045 and this section, qualified small business
stock (QSB stock) has the meaning provided in section 1202(c). For
purposes of section 1045 and this section, the term QSB stock does not
include an interest in a partnership that purchases or holds QSB stock.
(For further guidance, see Example 1 and Example 2 of paragraph (g) of
this section.)
(2) Eligible partner--(i) In general. For purposes of this section,
an eligible partner with respect to QSB stock is a taxpayer other than
a corporation who holds an interest in a partnership on the date the
partnership acquires the QSB stock and at all times thereafter before
the partnership sells or distributes the QSB stock.
(ii) Acquisition by gift or at death. For purposes of this section,
a taxpayer who acquires from an eligible partner by gift or at death an
interest in a partnership that holds QSB stock is treated as having
held the acquired interest in the partnership during the period the
eligible partner held the interest in the partnership. (For further
guidance, see Example 6 of paragraph (g) of this section.)
(iii) Tiered partnership--(A) Generally. If a partnership (upper-
tier partnership), holds an interest in another partnership (lower-tier
partnership) that holds QSB stock, then, for purposes of this paragraph
(a)(2), the upper-tier partnership's ownership of the lower-tier
partnership is ignored and each partner of the upper-tier partnership
is treated as owning the interest in the lower-tier partnership
directly. The partner of the upper-tier partnership is treated as
owning the interest in the lower-tier partnership during the period in
which both--
(1) The partner of the upper-tier partnership held an interest in
the upper-tier partnership; and
(2) The upper-tier partnership held an interest in the lower-tier
partnership. (For further guidance, see Example 3 of paragraph (g) of
this section.)
[[Page 42375]]
(B) Multiple tiers of partnership. Principles similar to those
described in paragraph (a)(2)(iii)(A) of this section apply where a
taxpayer holds the interest in the lower-tier partnership through
multiple tiers of partnerships.
(3) Nonrecognition limitation--(i) In general. For purposes of this
section, the amount of gain that an eligible partner does not recognize
under paragraphs (b)(1) and (c)(1) of this section cannot exceed the
nonrecognition limitation. For this purpose, the nonrecognition
limitation is equal to the product of--
(A) The partnership's realized gain from the sale of the QSB stock,
determined without regard to any basis adjustment under section 734(b)
or 743(b) (other than basis adjustments described in paragraph
(b)(3)(ii) of this section); and
(B) The eligible partner's smallest percentage interest in the
partnership's income, gain, or loss with respect to the QSB stock that
was sold. (For further guidance, see Example 4 of paragraph (g) of this
section.)
(ii) Eligible partner's smallest percentage interest. In
determining an eligible partner's smallest percentage interest in the
partnership's income, gain, or loss with respect to QSB stock,
reductions in the partner's interest that occur solely as a result of a
distribution of QSB stock to the partner are not taken into account.
(b) Partnership election--(1) General rule. A partnership that
holds QSB stock for more than six months, sells such QSB stock, and
purchases other QSB stock (replacement QSB stock), within 60 days
beginning on the date of the sale may elect to apply section 1045. For
purposes of this paragraph (b)(1), a purchase of replacement QSB stock
by a partner is not treated as a purchase of replacement QSB stock by
the partnership. If the partnership elects to apply section 1045, then,
subject to the provisions of paragraph (a)(3) of this section, each
eligible partner does not recognize the partner's distributive share of
any partnership section 1045 gain. For this purpose, partnership
section 1045 gain equals the partnership's gain from the sale of the
QSB stock reduced by the greater of--
(i) The amount of the gain from the sale of the QSB stock that is
treated as ordinary income; or
(ii) The excess of the amount realized by the partnership on the
sale over the cost of any replacement QSB stock purchased by the
partnership during the 60-day period beginning on the date of the sale
(excluding the cost of any replacement QSB stock that is otherwise
taken into account under section 1045).
(2) Partner's share of partnership section 1045 gain. A partnership
must allocate partnership section 1045 gain to the partners in the same
proportion as the partnership's entire gain from the sale of the QSB
stock is allocated to the partners. For this purpose, the partnership's
gain from the sale of QSB stock and the partner's distributive share of
that gain are determined without regard to basis adjustments under
section 743(b) and paragraph (b)(3)(ii) of this section.
(3) Basis adjustments--(i) Partner's interest in a partnership.
Notwithstanding section 705(a)(1), the adjusted basis of a partner's
interest in a partnership is not increased by gain from a partnership's
sale of QSB stock that is not recognized by the partner under paragraph
(b)(1) of this section.
(ii) Partnership's replacement QSB stock. The basis of a
partnership's replacement QSB stock is reduced (in the order acquired)
by the amount of gain from the partnership's sale of QSB stock that is
not recognized by an eligible partner. The basis adjustment with
respect to any amount described in this paragraph (b)(3)(ii)
constitutes an adjustment to the basis of the partnership's replacement
QSB stock with respect to that partner only. The effect of such a basis
adjustment is determined under the principles of Sec. 1.743-1(g), (h),
and (j). For purposes of this paragraph (b)(3)(ii), the partnership
must presume that a partner did not recognize that partner's
distributive share of QSB gain until such time as the partner provides
to the partnership the notification described in paragraph (b)(4)(ii)
of this section. However, if the partnership knows that a particular
partner is classified, for Federal tax purposes, as a corporation
during any period in which the partnership held the QSB stock, then the
partnership may presume that the partner did not defer recognition of
the partnership section 1045 gain, even in the absence of a
notification by the partner.
(4) Notice requirements--(i) Partnership notification to partners.
A partnership that makes the election described in paragraph (b)(1) of
this section must notify all of its partners of the election in
accordance with the applicable forms and instructions and separately
state each partner's distributive share of gain from the sale of QSB
stock under section 702. Each partner shall determine whether the
partner is an eligible partner within the meaning of paragraph (b)(1)
of this section and report the partner's distributive share of gain
from the partnership's sale of QSB stock, including gain not
recognized, on Schedule D of the partner's federal income tax return.
(ii) Partner notification to partnership. Any partner that must
recognize all or part of the partner's distributive share of
partnership section 1045 gain must notify the partnership, in writing,
of the amount of partnership section 1045 gain that is recognized by
the partner. (For further guidance concerning paragraph (b) of this
section, see Example 4 through Example 7 of paragraph (g) of this
section.)
(c) Partner election--(1) In general. If an eligible partner of a
partnership that sells QSB stock purchases replacement QSB stock during
the 60-day period beginning on the date of the partnership's sale of
the QSB stock, then the partner may elect to apply section 1045. For
purposes of this paragraph (c)(1), a purchase of replacement QSB stock
by the partnership is not treated as a purchase of replacement QSB
stock by a partner. An eligible partner that elects to apply section
1045 must recognize its distributive share of gain from the
partnership's sale of QSB stock only to the extent of the greater of--
(i) The amount of the partner's distributive share of the gain from
the sale of the QSB stock that is treated as ordinary income; or
(ii) The excess of the partner's share of the amount realized by
the partnership on the sale of the QSB stock (excluding any QSB stock
that was replaced by the partnership) over the cost of any replacement
QSB stock purchased by the partner during the 60-day period beginning
on the date of the partnership's sale of the QSB stock (excluding the
cost of any replacement QSB stock that is otherwise taken into account
under section 1045).
(2) Partner's share of amount realized by partnership. The
partner's share of the amount realized by the partnership shall bear
the same proportion to the amount realized by the partnership on the
sale of the QSB stock (excluding the cost of any replacement QSB stock)
as the partner's distributive share of the partnership's realized gain
from the sale of the QSB stock bears to the partnership's realized gain
on the sale of the QSB stock. For this purpose, the partnership's
realized gain from the sale of QSB stock and the partner's distributive
share of that gain are determined without regard to basis adjustments
under section 743(b) and paragraph (b)(3)(ii) of this section.
(3) Basis adjustments--(i) Partner's interest in a partnership.
Under section 705(a)(1), the adjusted basis of a partner's interest in
a partnership is increased by the amount of gain that is not recognized
by an eligible partner
[[Page 42376]]
pursuant to paragraph (c)(1) of this section.
(ii) Partner's replacement QSB stock. A partner's basis in any
replacement QSB stock that is purchased by the partner during the 60-
day period described in paragraph (c)(1) of this section must be
reduced (in the order acquired) by the partner's distributive share of
the gain on the sale of the partnership's QSB stock that is not
recognized by the partner pursuant to paragraph (c)(1) of this section.
(For further guidance concerning this paragraph (c), see Example 8
through Example 10 of paragraph (g) of this section.)
(d) Partnership distribution of QSB stock to an eligible partner--
(1) In general. Subject to paragraphs (d)(2) and (3) of this section,
in the case of a partnership distribution of QSB stock to an eligible
partner within the meaning of paragraph (a)(2) of this section, the
eligible partner shall be treated as--
(i) Having acquired such stock in the same manner as the
partnership; and
(ii) Having held such stock during any continuous period
immediately preceding the distribution during which it was held by the
partnership. (For further guidance concerning this paragraph (d), see
Example 11 and Example 12 of paragraph (g) of this section.)
(2) Eligibility under section 1202(c). Paragraph (d)(1) of this
section does not apply unless all eligibility requirements with respect
to the QSB stock as defined in section 1202(c) are met by the
distributing partnership with respect to its investment in the QSB
stock.
(3) Distribution nonrecognition limitation--(i) Generally. The
amount of gain that an eligible partner does not recognize on the sale
of QSB stock (the relinquished QSB stock) that was distributed by the
partnership to the partner cannot exceed the distribution
nonrecognition limitation. For this purpose, the nonrecognition
limitation is--
(A) The partner's section 1045 amount realized; reduced by
(B) The partner's section 1045 adjusted basis.
(ii) Section 1045 amount realized--(A) QSB stock received in
liquidation of partner's interest and in certain nonliquidating
distributions. If a partner receives relinquished QSB stock from the
partnership in a distribution in liquidation of the partner's interest
in the partnership or as part of a series of related distributions by
the partnership in which the partnership distributes all of the
partnership's QSB stock of a particular type, then the partner's
section 1045 amount realized is the partner's amount realized from the
sale of the relinquished QSB stock, multiplied by a fraction--
(1) The numerator of which is the partner's smallest percentage
interest (prior to the distribution) in the partnership's income, gain,
or loss with respect to the type of QSB stock sold by the partner; and
(2) The denominator of which is the partner's percentage interest
in that type of partnership QSB stock immediately after the
distribution (determined under paragraph (d)(3)(iv) of this section).
(B) QSB stock received in other distributions. If a partner
receives relinquished QSB stock in a distribution from the partnership
that is not described in paragraph (d)(3)(ii)(A) of this section, the
partner's section 1045 amount realized is the partner's amount realized
from the sale of the relinquished QSB stock multiplied by the partner's
smallest interest (prior to the distribution) in the partnership's
income, gain, or loss with respect to such stock.
(iii) Section 1045 adjusted basis--(A) QSB stock received in
liquidation of partner's interest and in certain nonliquidating
distributions. If a partner receives relinquished QSB stock from the
partnership in a distribution in liquidation of the partner's interest
in the partnership or as part of a series of related distributions by
the partnership in which the partnership distributes all of the
partnership's QSB stock of a particular type, then the partner's
section 1045 adjusted basis is the product of--
(1) The partnership's basis in all of the QSB stock of the type
distributed (without regard to basis adjustments under section 734(b)
or 743(b), other than basis adjustments described in paragraph
(b)(3)(ii) of this section);
(2) The partner's smallest interest (prior to the distribution) in
the partnership's income, gain, or loss with respect to such stock; and
(3) The proportion of the distributed QSB stock that was sold by
the partner.
(B) QSB stock received in other distributions. If a partner
receives relinquished QSB stock in a distribution from the partnership
that is not described in paragraph (d)(3)(iii)(A) of this section, the
partner's section 1045 adjusted basis is the product of--
(1) The partnership's basis in the QSB stock sold by the partner
(without regard to basis adjustments under section 734(b) or 743(b),
other than basis adjustments described in paragraph (b)(3)(ii) of this
section); and
(2) The partner's smallest interest (prior to the distribution) in
the partnership's income, gain, or loss with respect to such stock.
(iv) Partner's percentage interest in distributed QSB stock. For
purposes of this paragraph (d)(3), a partner's percentage interest in a
type of QSB stock immediately after a partnership distribution is the
value (as of the date of the distribution) of the QSB stock distributed
to the partner divided by the value (as of the date of the
distribution) of all of that type of QSB stock that was acquired by the
partnership.
(v) QSB stock of the same type. For purposes of this paragraph
(d)(3), QSB stock will be of the same type as the distributed QSB stock
if it has the same issuer and the same rights and preferences as the
distributed QSB stock and was acquired by the partnership at its
original issue.
(e) Contribution of QSB stock or replacement QSB stock to a
partnership. Section 721 applies to a contribution of QSB stock to a
partnership by a taxpayer other than a corporation. Except as provided
in section 721(b), any gain that was not recognized by the taxpayer
under section 1045 is not recognized when the taxpayer contributes QSB
stock to a partnership in exchange for a partnership interest in the
hands of the taxpayer. Stock that is contributed to a partnership is
not QSB stock in the hands of the partnership because the partnership
did not acquire the stock at original issue. (For further guidance, see
Example 13 of paragraph (g) of this section.)
(f) Time and manner of making election. A partnership making an
election under section 1045 (as described under paragraph (b)(1) of
this section) must do so on the partnership's timely filed (including
extensions) return for the taxable year during which the sale of QSB
stock occurs. A partner making an election under section 1045 (as
described under paragraph (c)(1) of this section) must do so on the
partner's timely filed (including extensions) Federal income tax return
for the taxable year during which the partner's distributive share of
the partnership's gain from the sale of the QSB stock is taken into
account under section 706. In addition, a partnership or partner making
an election under section 1045 must follow the administrative
procedures issued for making such elections. (For further guidance, see
Rev. Proc. 98-48 (1998-2 C.B. 367) and Sec. 601.601(d)(2)(ii)(b) of
this chapter.)
(g) Examples. The provisions of this section are illustrated by the
following examples:
Example 1. Acquisition of a partnership interest as replacement
property. On January
[[Page 42377]]
1, 2006, A, an individual, X, a corporation, and Y, a corporation,
form PRS, a partnership. A, X, and Y each contribute $25 to PRS and
agree to share all partnership items equally. PRS purchases QSB
stock on February 1, 2006, and subsequently sells the QSB stock on
November 4, 2006, for $150. PRS realizes $75 of gain from the sale
of the QSB stock (none of which is treated as ordinary income) and
allocates $25 of gain to each of A, X, and Y. On November 30, 2006,
A contributes $50 to ABC, a partnership, in exchange for an interest
in ABC (instead of purchasing QSB stock). ABC then purchases QSB
stock for $50 on December 1, 2006. A's acquisition of the additional
partnership interest is not treated as a purchase of replacement QSB
stock for purposes of section 1045.
Example 2. Sale of a partnership interest. The facts are the
same as in Example 1, except that PRS does not sell its QSB stock.
Instead, on November 4, 2006, A sells the PRS interest for $50x,
realizing $25 of capital gain. On November 30, 2006, A purchases $50
of new QSB stock. Under paragraph (a)(1) of this section, the sale
of an interest in a partnership that holds QSB stock is not treated
as a sale of QSB stock. Therefore, A may not elect to apply section
1045 with respect to A's $25 of gain from the sale of the PRS
interest.
Example 3. Eligible and non-eligible partners of tiered
partnership. On January 1, 2006, A, an individual, and B, an
individual, contribute cash to UTP, (upper-tier partnership) for
equal partnership interests. On February 1, 2006, UTP and C, an
individual, contribute cash to LTP, (lower-tier partnership) for
equal partnership interests. On March 1, 2006, LTP purchases QSB
stock. On April 1, 2006, D, an individual, joins UTP by contributing
cash to UTP for a 1/3 interest in UTP. On December 1, 2006, LTP
sells the QSB stock. Under paragraph (a)(2)(iii) of this section, A,
B, and D are treated as owning an interest in LTP during the period
in which each of the partners held an interest in UTP and UTP held
an interest in LTP. Therefore, under paragraph (a)(2)(i) of this
section, A and B are eligible partners, and D is not an eligible
partner.
Example 4. Partnership sale of QSB stock and purchase and sale
of replacement QSB stock. (i) Assume the same facts as in Example 1,
except that PRS purchases replacement QSB stock for $135 on December
15, 2006. On its timely filed return for the taxable year during
which the sale of the relinquished QSB stock occurs, PRS makes an
election to apply section 1045. PRS knows that X and Y are
corporations. On March 30, 2007, PRS sells the replacement QSB stock
for $165. PRS realizes $30 of capital gain from the sale of the
replacement QSB stock and allocates $10 of gain to each of A, X, and
Y.
(ii) Under paragraph (b)(1) of this section, the partnership
section 1045 gain is $60 ($75 gain less $15 ($150 amount realized on
the sale of the relinquished QSB stock less $135 cost of the
replacement QSB stock)). This amount must be allocated among the
partners in the same proportions as the entire gain from the sale of
the QSB stock is allocated to the partners, \1/3\ ($20) to A, \1/3\
($20) to X, and \1/3\ ($20) to Y.
(iii) Because neither X nor Y are eligible partners under
paragraph (a)(2) of this section, X and Y must each recognize its
$25 distributive share of partnership gain from the sale of the QSB
stock. Because A is an eligible partner under paragraph (a)(2) of
this section, and because A is bound by the election by PRS to apply
section 1045, A defers recognition of A's $20 distributive share of
partnership section 1045 gain. A is not required to separately elect
to apply section 1045. A must recognize A's remaining $5
distributive share of the partnership's gain from the sale of the
QSB stock.
(iv) Under section 705(a)(1)(A), the adjusted bases of X's and
Y's interests in PRS are each increased by $25. Under section
705(a)(1)(A) and paragraph (b)(3)(i) of this section, the adjusted
basis of A's interest in PRS is not increased by the $20 of
partnership section 1045 gain that was not recognized by A, but is
increased by A's remaining $5 distributive share of gain.
(v) PRS must decrease its basis in the replacement QSB stock by
the $20 of partnership section 1045 gain that was allocated to A.
This basis reduction is a reduction with respect to A only. PRS then
adjusts A's distributive share of gain from the sale of the
replacement QSB stock to reflect the effect of A's basis adjustment
under paragraph (b)(3)(ii) of this section. In accordance with the
principles of Sec. 1.743-1(j)(3), the amount of A's gain from the
sale of the replacement QSB stock in which A has a $20 negative
basis adjustment equals $30 (A's share of PRS's gain from the sale
of the replacement QSB stock ($10), increased by the amount of A's
negative basis adjustment for the replacement stock ($20)).
Accordingly, upon the sale of the replacement QSB stock, A
recognizes $30 of gain, and X and Y each recognize $10 of gain.
Example 5. Sale of partnership interest while partnership holds
QSB stock. Assume the same facts as in Example 4, except that A
sells A's interest in PRS to B, an individual, on March 1, 2006. B
is not an eligible partner under paragraph (a)(2)(i) of this
section, because B did not hold an interest in PRS on the date PRS
originally acquired the QSB stock. Therefore, B must recognize B's
distributive share of partnership section 1045 gain.
Example 6. Death of partner while partnership holds QSB stock.
Assume the same facts as in Example 4, except that A dies on March
1, 2006, and B inherits A's interest in PRS. Under paragraph
(a)(2)(ii) of this section, B is treated as holding the interest in
PRS during the period that A held the interest in PRS. Therefore, B
is an eligible partner under paragraph (a)(2)(i) of this section.
Accordingly, B defers recognition of B's distributive share of the
partnership section 1045 gain on the sale of the QSB stock.
Example 7. Partnership sale of QSB stock and partner purchase of
replacement QSB stock. (i) Assume the same facts as in Example 4,
except that PRS does not make an election under section 1045 with
respect to the sale of the QSB stock. On November 30, 2006, A, an
eligible partner under paragraph (a)(2) of this section, purchases
replacement QSB stock for $50. A elects to apply section 1045 on A's
timely filed return for the taxable year that A is required to
include A's distributive share of PRS's gain from the sale of the
relinquished QSB stock.
(ii) Under paragraph (c)(2) of this section, A's share of the
amount realized from PRS's sale of the QSB stock is $50 (the amount
which bears the same proportion to the total amount realized by the
partnership on the sale of the QSB stock ($150) as A's share of the
gain from the sale of the QSB stock ($25) bears to the total gain
realized by the partnership on the sale of the QSB stock ($75)).
Because A purchased, within 60 days of PRS's sale of the QSB stock,
replacement QSB stock for a cost equal to A's share of the
partnership's amount realized on the sale of the QSB stock, and
because A made a valid election to apply section 1045, A defers
recognition of A's $25 distributive share of gain from PRS's sale of
the QSB stock. Under section 705(a)(1) and paragraph (c)(3)(i) of
this section, the adjusted basis of A's interest in PRS is increased
by $25. Under paragraph (c)(3)(ii) of this section, A's basis in the
replacement QSB stock is $25 ($50 cost minus $25 nonrecognition
amount).
Example 8. Election by partner; replacement by partnership.
Assume the same facts as in Example 7, except that PRS purchases
replacement QSB stock on December 31, 2006, but does not make an
election to apply section 1045. A makes an election to apply section
1045, but does not purchase any replacement QSB stock during the 60-
day period beginning on the date of PRS's sale of the QSB stock.
Because the requirements of neither paragraph (b)(1) nor paragraph
(c)(1) of this section has been satisfied, A must recognize all of
A's distributive share of the gain from PRS's sale of the QSB stock.
Example 9. Partial replacement by partnership; partial
replacement by partner. (i) On January 1, 2006, A, an individual,
and X, a corporation, form PRS, a partnership. A and X each
contribute $50 to PRS and agree to share all partnership items
equally. PRS purchases QSB stock on February 1, 2006, for $100 and
subsequently sells the QSB stock on January 31, 2008, for $300. PRS
realizes $200 of gain from the sale of the QSB stock (none of which
is treated as ordinary income) and allocates $100 of gain to each of
A and X. On February 10, 2008, PRS purchases replacement QSB stock
for $220. On March 20, 2008, A purchases replacement QSB stock for
$40. Both A and PRS make valid elections to apply section 1045.
(ii) Under paragraph (b)(1) of this section, partnership section
1045 gain is $120 ($200 less $80 ($300 amount realized on the sale
of the relinquished QSB stock minus $220 cost of the replacement QSB
stock)). This amount is allocated among the partners in the same
proportions as the entire gain from the sale of the QSB stock is
allocated to the partners, \1/2\ to A ($60), and \1/2\ to X ($60).
Because A is an eligible partner, A defers recognition of A's $60
distributive share of partnership section 1045 gain.
(iii) A also made a valid section 1045 election and purchased,
within 60 days of
[[Page 42378]]
PRS's sale of the QSB stock, replacement QSB stock. Therefore, under
paragraph (c)(1) of this section, A may defer a portion of A's
distributive share of the remaining gain from the partnership's sale
of the QSB stock. A must recognize that remaining gain, however, to
the extent that A's share of the amount realized by PRS on the sale
of the QSB stock (excluding the QSB stock that was replaced by PRS)
exceeds the cost of the replacement QSB stock purchased by A during
the 60-day period following the sale of the QSB stock. The amount
realized by PRS on the sale of the QSB stock (excluding the QSB
stock that was replaced by PRS) is $80 ($300 minus $220). Under
paragraph (c)(2) of this section, A's share of that amount realized
is $40 (50/100 (A's share of the gain from the sale of the QSB
stock) multiplied by $80). Because the replacement QSB stock
purchased by A cost $40, A defers recognition of all of the
remaining gain from the sale of the QSB stock.
(iv) The adjusted basis of A's interest in PRS is not increased
by the gain that was not recognized pursuant to paragraph (b)(1) of
this section, $60, but is increased by the gain that was not
recognized pursuant to paragraph (c)(1) of this section, $40. See
paragraphs (b)(3)(i) and (c)(3)(i) of this section. PRS must
decrease its basis in the replacement QSB stock by the $60 of
partnership section 1045 gain that was allocated to A. See paragraph
(b)(3)(ii) of this section. A must decrease A's basis in the
replacement QSB stock purchased by A by the $40 not recognized
pursuant to paragraph (c)(1) of this section. See paragraph
(c)(3)(ii) of this section.
Example 10. Change in partner's interest in partnership while
partnership holds QSB stock. (i) Assume the same facts as in Example
9, except that, on August 2, 2006, A sells a 25 percent interest in
PRS to Z. On July 10, 2007, A repurchases the 25 percent interest
from Z for $50. Assume that PRS makes a timely election under
section 754 for the taxable year during which A purchases Z's PRS
interest and that, under section 743(b), A has a positive basis
adjustment of $25.
(ii) PRS allocates the $200 of realized gain from the sale of
the QSB stock $100 to A and $100 to X. However, A has a positive
basis adjustment of $25; therefore, A's share of the gain is reduced
to $75. Because A is an eligible partner under paragraph (a)(2) of
this section, A may defer recognition of A's distributive share of
gain from the sale of the QSB stock subject to the nonrecognition
limitation described in paragraph (a)(3) of this section. The
smallest interest that A held in PRS during the time that PRS held
the QSB stock is 25 percent. Under the nonrecognition limitation, A
may not defer more than 25 percent of the partnership gain realized
from the sale of the QSB stock (determined without regard to any
basis adjustment under section 734(b) or section 743(b), other than
a basis adjustment described in paragraph (b)(3)(ii) of this
section). Because the partnership's realized gain determined without
regard to A's basis adjustment under section 743(b) is $200, A may
defer recognition of $50 (25% of $200) of the gain from the sale of
the QSB stock. A must recognize the remaining $25 of that gain.
Example 11. Sale by partner of QSB stock received in a
liquidating distribution. (i) On January 1, 2006, A, an individual,
and X, a corporation, form PRS, a partnership. A and X each
contribute $150 to PRS and agree to share all partnership items
equally. PRS purchases QSB stock on February 1, 2006, for $300. On
May 1, 2006, when the QSB stock has appreciated in value to $400, A
contributes $100 to PRS, increasing A's interest in PRS's income,
gains, losses, deductions, and credits to 60 percent. On June 1,
2009, when the QSB stock is still worth $400, PRS makes a
liquidating distribution of $300 worth of QSB stock to A. Under
section 732, A's basis in the distributed QSB stock is $250. A sells
the QSB stock on August 4, 2009, for $600, realizing a gain of $350
(none of which is treated as ordinary income). A purchases
replacement QSB stock on August 30, 2009, for $550, and makes a
valid election under section 1045 with respect to the QSB stock.
(ii) A is an eligible partner under paragraph (a)(2)(i) of this
section. Therefore, under paragraph (d)(1) of this section, A is
treated as having acquired the distributed QSB stock in the same
manner as PRS and as having held the QSB stock since February 1,
2006, its original issue date. Because A purchased, within 60 days
of A's sale of the QSB stock, replacement QSB stock, A is eligible
to defer a portion of A's gain from the sale of the QSB stock. A
must recognize gain, however, to the extent that A's amount realized
on the sale of the QSB stock, $600, exceeds the cost of the
replacement QSB stock purchased by A during the 60-day period
beginning on the date of the sale of the relinquished QSB stock,
$550. Accordingly, A must recognize $50 of the gain from the sale of
the QSB stock. A defers recognition of the remaining $300 of gain to
the extent that such gain does not exceed the distribution
nonrecognition limitation.
(iii) Under paragraph (d)(3)(ii) of this section, A's
nonrecognition limitation with respect to the sale of the QSB stock
is A's section 1045 amount realized with respect to the stock,
reduced by A's section 1045 adjusted basis with respect to the
stock. A's amount realized from the sale is the product of A's
amount realized from the sale, $600; and a fraction:
(1) the numerator of which is A's smallest percentage interest
in PRS's income, gain, or loss with respect to such stock, 50%; and
(2) the denominator of which is A's percentage interest in that
type of partnership QSB stock immediately after the distribution,
75% (the value of the stock distributed to A, $300, divided by the
value of all QSB stock of that type acquired by PRS, $400).
Therefore, A's section 1045 amount realized is $400 ($600
multiplied by 50/75). Because PRS distributed the QSB stock to A in
liquidation of A's interest in PRS, A's section 1045 adjusted basis
is the product of PRS's basis in all of the QSB stock of the type
distributed, $300; A's smallest interest (prior to the distribution)
in PRS's income, gain, or loss with respect to QSB stock of the type
distributed, 50%; and the percentage of the distributed QSB stock
that was sold by A, 100%. Therefore, A's section 1045 adjusted basis
is $150 (the product of $300, 50%, and 100%)) and A's nonrecognition
limitation amount on the sale of the QSB stock is $250 ($400 section
1045 amount realized minus $150 section 1045 adjusted basis).
Accordingly, A defers recognition of $250 of the remaining $300 gain
from the sale of the QSB stock.
(iv) A's basis in the replacement QSB stock is $300 (cost of the
replacement stock, $550, reduced by the gain not recognized under
section 1045, $250).
Example 12. Sale by partner of QSB stock received in a
nonliquidating distribution. (i) The facts are the same as in
Example 11, except that, on June 1, 2009, PRS distributes only $200
of the QSB stock to A, reducing A's interest in PRS from 60% to 33%.
PRS's basis in the distributed QSB stock is $150. On November 1,
2009, A sells for $250 the QSB stock distributed by PRS to A and
purchases, within 60 days of the date of sale of the relinquished
QSB stock, replacement QSB stock for $250. On December 1, 2009, PRS
sells all of its QSB stock for $250 and purchases, within 60 days of
the date of the sale of the relinquished QSB stock, replacement QSB
stock for $250. A makes a timely election to apply section 1045 with
respect to its sale of the distributed QSB stock and PRS makes a
timely election to apply section 1045 with respect to its sale of
the QSB stock.
(ii) Under section 732, A's basis in the distributed QSB stock
is $150. Therefore, A realizes a gain on the sale of the distributed
QSB stock of $100. Because A made a valid election to apply section
1045 to the sale, and because A purchased, within 60 days of A's
sale of the QSB stock, replacement QSB stock at a cost equal to the
amount realized on the sale of the distributed QSB stock, A defers
recognition of the gain from the sale of the QSB stock to the extent
that such gain does not exceed the distribution nonrecognition
limitation.
(iii) Under paragraph (d)(3) of this section, the nonrecognition
limitation with respect to A's sale of the QSB stock is A's section
1045 amount realized reduced by A's section 1045 adjusted basis.
Because PRS did not distribute all of a particular type of QSB stock
and the distribution of the QSB stock to A was not in liquidation of
A's interest in PRS, A's section 1045 amount realized is $125 (A's
amount realized from the sale of the distributed QSB stock, $250,
multiplied by A's smallest percentage interest (prior to the
distribution) in PRS's income, gain, or loss with respect to such
stock, 50%). A's section 1045 adjusted basis is the product of the
partnership's basis in the QSB stock sold by the partner, $150, and
A's smallest percentage interest (prior to the distribution) in the
partnership's income, gain, or loss with respect to such stock, 50%.
Therefore, A's section 1045 adjusted basis is $75 (50% of $150), and
A's nonrecognition limitation amount on the sale of the QSB stock is
$50 ($125 section 1045 amount realized minus $75 section 1045
adjusted basis). As this amount is less than the amount of gain that
A is eligible to defer under section 1045, $100, A defers
recognition of only $50 of the gain from the sale of the QSB stock.
A must recognize the remaining $50 of that gain.
[[Page 42379]]
(iv) The partnership realizes gain of $100 ($250 amount realized
minus $150 remaining basis in QSB stock) on the sale of its QSB
stock. Because the partnership reinvested its entire amount realized
in new QSB stock and because the partnership made a timely election
to apply section 1045, the partnership may treat all of this gain as
section 1045 gain. A's share of the partnership section 1045 gain is
$50 (50% of $100). Because A is an eligible partner under paragraph
(a)(2) of this section, A can defer recognition of this gain subject
to the nonrecognition limitation described in paragraph (a)(3) of
this section. The smallest percentage interest that A held in PRS
during the time that PRS held the QSB stock (determined without
regard to the reduction that occurred as a result of PRS's
distribution of QSB stock to A) is 50%. See paragraph (a)(3)(ii) of
this section. Therefore, under the nonrecognition limitation, A can
defer recognition of all $50 (50% of $100) of the gain allocated to
A.
Example 13. Contribution of replacement QSB stock to a
partnership. (i) On January 1, 2006, A, an individual, B, an
individual, and X, a corporation, form PRS, a partnership. A, B, and
X each contribute $25 to PRS and agree to share all partnership
items equally. On February 1, 2006, PRS purchases Stock 1, which is
QSB stock in the hands of the partnership. PRS sells Stock 1 on
November 4, 2006, for $150. PRS realizes $75 of gain from the sale
of Stock 1 (none of which is treated as ordinary income) and
allocates $25 of gain to each of its partners. PRS informs the
partners that it does not intend to make an election under section
1045 with respect to the sale of Stock 1. Each partner's share of
the amount realized from the sale of Stock 1 is $50. On November 30,
2006, A, an eligible partner within the meaning of paragraph (a)(2)
of this section, purchases Stock 2, which is also QSB stock, for $50
and makes a valid section 1045 election under paragraph (c)(1) of
this section. Subsequently, A transfers Stock 2 to ABC, a
partnership.
(ii) Because A purchased, within 60 days of PRS's sale of Stock
1, replacement QSB stock for a cost equal to A's share of the
partnership's amount realized on the sale of Stock 1, and because A
made a valid election to apply section 1045 with respect to A's
share of the gain from PRS's sale of Stock 1, A does not recognize
A's $25 distributive share of the gain from PRS's sale of Stock 1.
Before the contribution of Stock 2 to ABC, A's adjusted basis in
Stock 2 is $25 ($50 cost minus $25 nonrecognition amount). Upon the
contribution of Stock 2 to ABC, A's basis in the ABC partnership
interest is $25, and ABC's basis in Stock 2 is $25. However, Stock 2
does not qualify as QSB stock in ABC's hands because it was not
acquired at original issue. Neither A nor ABC will be eligible for
section 1045 treatment on a subsequent sale of Stock 2.
(h) Effective date. This section applies to sales of QSB stock on
or after the date final regulations are published in the Federal
Register.
Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-15964 Filed 7-14-04; 8:45 am]
BILLING CODE 4830-01-P