ABA Members Comment on Proposed Regs on Disguised Sales of Partnership Interests

Michael J. Desmond, Tax Legislative Counsel (Acting), Treasury

Nicholas J. DeNovio, Deputy Chief Counsel -- Technical, IRS

Heather C. Maloy, Associate Chief Counsel (Passthroughs & Special Industries), IRS

William P. O'Shea, Deputy Associate Chief Counsel (Passthroughs & Special Industries), IRS

Matthew Lay, Acting Attorney Advisor, Tax Legislative Counsel, Treasury

Christine Ellison, Chief, Branch 3, Passthroughs & Special Industries Division, IRS

These comments were prepared by individual members of the Partnerships & LLCs Committee of the Section of Taxation. Principal responsibility was exercised by Glenn Mincey and Eric Sloan. Substantive contributions were made by Patrick Browne, Phillip Gall, Steve Gorin, Steven Klig, Steven Schneider, Todd Smith, and Wayne Strasbaugh. The comments were reviewed by Jim Wreggelsworth, Committee Vice-Chair. The comments were also reviewed by Robert Schachat of the Section's Committee on Government Submissions and by Fred Witt, Supervisory Council Director.

Although the members of the Section of Taxation who participated in preparing these comments have clients who would be affected by the federal income tax rules applicable to the subject matter addressed by these comments, or have advised clients on the application of such rules, no such member (or the firm or organization to which such member belongs) has been engaged by a client to make a government submission with respect to, or otherwise to influence the development or outcome of, the specific subject matter of these comments.

Contacts:

On November 26, 2004, the IRS and Treasury issued proposed regulations on the subject of disguised sales of partnership interests (the "Proposed Regulations").⁵ In an attempt to maintain consistency with the "familiar" rules of the Property Regulations, the IRS and Treasury drafted the Proposed Regulations to follow the form of the Property Regulations.

In the preamble to the Proposed Regulations, the IRS and Treasury requested comments regarding specific issues. We appreciate the opportunity to provide comments both in response to these specific requests from the IRS and Treasury and in response to other provisions in the Proposed Regulations. We also appreciate the IRS's and Treasury's consideration of our past comments.

We reiterate our suggestions from the 2004 Comments that the Proposed Regulations, when promulgated by the IRS and Treasury in final form (the "Final Regulations"), should balance the legitimate interests of the government in defeating abusive tax reduction schemes with two important taxpayer concerns. First, if principles from the Property Regulations are extended directly to the Final Regulations, many legitimate business transactions (in which the parties neither contemplated nor expected a sale between the departing partner and the new partner) might be treated as disguised sales of partnership interests. Second, the government's interest in defeating abusive tax reduction schemes must be balanced against tax complexity.

In addition, we reiterate our suggestion in the 2004 Comments that the Final Regulations should be more narrowly drafted than the Property Regulations. Accordingly, we suggest the Final Regulations treat a transaction as a sale only if the partner's contribution would not have been made but for the distribution to the departing partner, and the distribution to the departing partner would not have been made but for new partner's contribution (a "double but for test").

We recognize the government's unstated concern that economically similar transactions could have different tax consequences without the promulgation of a suitable test to identify transactions more appropriately regarded as sales. In issuing the Proposed Regulations, the IRS and Treasury have made significant progress toward accomplishing the goal of balancing the legitimate interests of the government in defeating abusive tax reduction schemes with these important taxpayer concerns. Nevertheless, as discussed in this letter, if the Proposed Regulations are finalized in their current form, many unintended and unwarranted consequences will arise.

As we discussed in the 2004 Comments, Congress had a narrow focus in enacting section 707(a)(2)(B). Specifically, "Congress was concerned that taxpayers had deferred or avoided tax on sales of property (including partnership interests) by characterizing sales as contributions of property (including money) followed, or preceded, by a related partnership distribution."⁹ That is, Congress sought to prevent transactions in which, even though the parties did not document a transaction as a sale, the intent of the parties was in fact to engage in a sale, and the involvement of the partnership was a mere subterfuge. Stated differently, Congress sought to treat such transactions in a manner consistent with their underlying economic substance.

Consistent with Congressional intent, the IRS and Treasury, in drafting the Property Regulations, determined that, when a partner transfers property to a partnership, nominally as a contribution, the partnership transfers property to the partner, nominally as a distribution, and the combined effect is to allow the transferring partner to withdraw all or a part of his or her equity in the transferred property, the transaction generally should be considered to be a sale of property to the partnership.¹⁰ To discern the intention of the parties to engage in a sale, the Property Regulations ask whether there has been a transfer of property, and whether there has been a related transfer of money or other consideration that would not have been made but for the transfer of property.¹¹

In the 2004 Comments, we suggested that the Proposed Regulations be more narrowly drafted than rules concerning disguised sales of property, a view echoed by other commentators.¹² Moreover, the IRS and Treasury agreed that it was appropriate for the Proposed Regulations to be narrower than the Property Regulations. Nevertheless, in an apparent attempt to maintain consistency with the "familiar" rules of the existing Property Regulations, the IRS and Treasury drafted the Proposed Regulations to follow the form of the Property Regulations. Thus, the Proposed Regulations provide that a transfer of consideration by a partner (the purchasing partner) to a partnership and a transfer of consideration by the partnership to a different partner (the selling partner) constitute a sale of the selling partner's partnership interest only if, based on all of the facts and circumstances, the transfer by the partnership would not have been made but for the transfer to the partnership, and, in cases in which the transfers are not made simultaneously, the subsequent transfer is not dependent upon the entrepreneurial risks of partnership operations.¹³

We reiterate our statements in the 2004 Comments that, although the Property Regulations certainly serve as a useful framework for the IRS and Treasury, we recommend that the Final Regulations be more narrowly drafted than the Property Regulations because (i) disguised sales of partnership interests offer limited potential for tax abuse, and (ii) the Proposed Regulations, if finalized in their current form, would impose a more substantial recharacterization upon a particular transaction than the Property Regulations currently impose.

More importantly, however, we reiterate our suggestion that the Final Regulations apply to recharacterize a transaction as a disguised sale of a partnership interest only when it can be determined that the selling partner and the purchasing partner each agreed to or expected a particular result, or reached a "meeting of the minds" with regard to the sale and purchase of a partnership interest. To make this determination, we suggest the Final Regulations adopt a "double but for test," under which a transaction would be treated as a sale only if the partner's contribution would not have been made but for the distribution to the departing partner, and the distribution to the departing partner would not have been made but for new partner's contribution.

The balance of this letter discusses the Proposed Regulations and the areas with respect to which the IRS and Treasury have requested comments. Specifically, this letter discusses (i) the facts and circumstances relevant to the determination of whether a disguised sale of a partnership interest exists, (ii) presumptions and safe harbors in the Proposed Regulations and Property Regulations, (iii) rules in the Proposed Regulations relating to liabilities, (iv) application of the Proposed Regulations to partnership mergers and divisions, and (v) disclosure rules.

II. Facts and Circumstances

Like the Property Regulations, the Proposed Regulations include a list of ten non-exclusive facts and circumstances that are intended to be relevant to the determination of the existence of a disguised sale of a partnership interest.¹⁵ A number of new facts and circumstances are listed, but many of the facts and circumstances are adopted from the Property Regulations. We question whether the following two factors are relevant to the determination of the existence of a disguised sale of a partnership interest: (i) the transfer of consideration by the partnership to the selling partner is disproportionately large in relationship to the selling partner's general and continuing interest in partnership profits;¹⁶ and (ii) the selling partner has no obligation to return or repay the consideration to the partnership, or has an obligation to return or repay the consideration due at such a distant point in the future that the present value of that obligation is small in relation to the amount of consideration transferred by the partnership to the selling partner.¹⁷

The first factor, whether the transfer of consideration by the partnership to the selling partner is disproportionately large in relationship to the selling partner's general and continuing interest in partnership profits¹⁸ should be considered in determining whether a partner engaged in a disguised sale of property to the partnership, in our view. A transaction in which a purported partner contributes property to a partnership in exchange for minimal continued participation in the entrepreneurial risks associated with such property could indeed be indicative of a disguised sale of such property, because such facts would indicate that the partner has "cashed out" of its equity investment in the property. Nevertheless, it is difficult to see how the relative amount of the reduction of a partner's interest in the partnership as compared to the partner's retained interest is more indicative of a sale of the partner's interest rather than a redemption of such interest.

With respect to the second factor, whether the selling partner has an obligation to return or repay the consideration to the partnership,¹⁹ it is questionable whether this factor is particularly relevant even to the determination of a disguised sale of property. That is, a partner typically does not have an obligation to return a distribution to a partnership nor does a seller of property typically have an obligation to return a transfer of consideration. Regardless of the factor's relevancy with respect to disguised sales of property, we find it particularly difficult to see how this factor is relevant to distinguish a sale of a partner's interest from a redemption of such interest.

III. Presumptions and Safe Harbors

Consistent with our suggestion in the 2004 Comments, the Proposed Regulations include a favorable presumption for transfers of money, including marketable securities that are treated as money under section 731(c)(1), to a partner in complete redemption of a partner's interest.²⁶ Nevertheless, the favorable presumption is subject to a significant limitation. Such a transfer is presumed not to be a sale, in whole or in part, of the selling partner's interest in the partnership to the purchasing partner unless the facts and circumstances clearly establish that the transfer is part of a sale.

Due to the significant limitation, we question the utility of this favorable presumption. Under the Proposed Regulations, the general determination of whether a transaction is a disguised sale of a partnership interest is if, based on all of the facts and circumstances, the transfer by the partnership would not have been made but for the transfer to the partnership. The standard for rebuttal of the presumption in favor of complete redemptions of a partner's interest is explicitly greater than the general standard. That is, the facts and circumstances must clearly establish a disguised sale of a partnership interest rather than simply indicate that one exists. It is easy to see that this analysis will be fraught with uncertainty, perhaps to the point of futility. Moreover, there is no clear indication of what facts and circumstances will be most indicative of disguised sale of partnership interest treatment, or whether differing tax consequences will be considered relevant. Thus, while we believe that this presumption will be favorable to taxpayers, absent clarification, it appears that the qualifying language in this presumption may cause considerable confusion.

In the preamble to the Proposed Regulations, the IRS and Treasury requested comments on whether the Proposed Regulations should include additional safe harbors, and if so, how to appropriately define those categories of partnerships. As we suggested in the 2004 Comments, we believe that another safe harbor should be provided for securities partnerships. Many securities partnerships admit new partners after the formation of the partnership and entirely or partially redeem the interests of other partners on a routine basis. Our experience is that the admission of a new partner to these partnerships typically is unrelated, as a factual matter, to the partial or complete redemption of another partner. Therefore, it seems that such contributions and distributions should not be considered to involve the sale of a partnership interest. Accordingly, we believe that the IRS and Treasury should provide a safe harbor for routine contributions to and distributions from securities partnerships. The Final Regulations could adopt the definition of a securities partnership from the section 704(c) regulations that define the term for purposes of allowing such partnerships to aggregate reverse section 704(c) allocations.²⁹

We also suggested in the 2004 Comments that a safe harbor be provided for staged closings in syndicated offerings. In staged closings, a partnership receives investments from partners at different times, or in stages. In many instances, partners who invested in earlier stages will receive distributions that are funded with contributions from partners who invest in later stages. Often, the partnership requires partners who invest in later stages to include an additional amount in their contribution to represent an interest charge for the delay between the earlier stage and the later stage. That interest charge is distributed to the partners who invested in the earlier stage. Although there has been a contribution by the later stage investor and a distribution to the earlier stage investors, we recommend that this transaction not be considered a disguised sale of a partnership interest.

Finally, in our experience, the parties view staged closings as purely an administrative convenience. If these transactions were treated as sales transactions, it would perhaps be possible to wait to close the offering until all investors had subscribed, but this would be done solely to avoid an adverse tax result. To avoid imposing distortions on real, economically motivated transactions where there is little potential for tax abuse, we believe that it is appropriate for the IRS and Treasury to provide a safe harbor for transfers to and from partnerships involved in staged closings when such transfers represent an interest charge for the delay between stages.

To the extent that other situations arise in which the IRS and Treasury feel that a safe harbor would promote certainty and administrative convenience, the IRS and Treasury should retain the flexibility to provide additional safe harbors and favorable presumptions under the Final Regulations in public guidance similar to the manner in which the IRS and Treasury may provide safe harbors under the Property Regulations³⁰ and additional safe harbors under the Proposed Regulations.³¹

The preamble to the Proposed Regulations provides that the IRS and Treasury intend to address "deficiencies and technical ambiguities" in the Property Regulations. Although changes to the definition of "operating cash flow distributions" (as set forth in Treas. Reg. § 1.707-4(b)(2)(i)) are not specifically mentioned, we reiterate our suggestion that the IRS and Treasury take the opportunity to expand the definition of "operating cash flow distributions" to include partnership taxable income or loss resulting from sales other than in the ordinary course of the partnership's business. A transfer of money is an operating cash flow distribution if it does not exceed the partner's interest in net cash flow, defined by reference to partnership taxable income or loss in the ordinary course of the partnership's business and investment activities.³⁵ This definition does not provide for circumstances under which the partnership obtains distributable cash by selling a significant partnership asset. Thus, although a distribution to the partners of a partnership of cash obtained from the sale of a significant partnership asset would not seem to be appropriately treated as part of a disguised sale transaction, such distribution would not be protected under any safe harbor. Accordingly, we recommend that the IRS and Treasury expand the definition of "operating cash flow distributions" to include partnership taxable income or loss resulting from sales other than in the ordinary course of the partnership's business.

In the 2004 Comments, we recommended that transfers of different property not result in disguised sale of partnership interest treatment.³⁶ Although our prior comments were unheeded on this point, the preamble to the Proposed Regulations requests comments on whether a favorable presumption or safe harbor for such transactions is appropriate.³⁷ We feel very strongly that transfers of different property generally should not result in disguised sale of partnership interest treatment. Although we are mindful of the legitimate concern expressed in the preamble, we believe that such concern can best be addressed with a narrowly tailored anti-abuse rule.

Under the Proposed Regulations, when simultaneous transfers of different property result in disguised sale of partnership interest treatment, the parties and the partnership are treated as if, on the date of the sale, the purchasing partner transferred property to the partnership in exchange for the property to be transferred to the selling partner and then the purchasing partner transferred that property to the selling partner in exchange for the selling partner's interest in the partnership.³⁸ The Proposed Regulations include an example ("Example 3") that illustrates the treatment of transfers of different property:

The Proposed Regulations contain a list of ten non-exclusive facts and circumstances that tend to establish the existence of a sale.⁴¹ Although Example 3 specifically states that no facts rebut the presumption of a disguised sale of a partnership interest, it appears that three of the specified facts and circumstances militate against disguised sale of partnership interest treatment: (i) the same property transferred to the partnership by the purchasing partner is not transferred to the selling partner; (ii) there were no negotiations between the purchasing partner and the selling partner (or between the partnership and each of the purchasing and selling partners with each partner being aware of the negotiations) concerning any transfer of consideration; and (iii) the selling partner and the purchasing partner did not enter into one or more agreements, including an amendment to the partnership agreement (other than for admitting the purchasing partners) relating to the transfers.⁴² Are taxpayers intended to infer that these facts and circumstances are not enough to rebut the presumption that the transfers constitute a disguised sale of a partnership interest under the Proposed Regulations? If Example 3 is retained in the Final Regulations, we believe that the Final Regulations should explain why such facts and circumstances were insufficient to rebut the two-year presumption.

We believe that the application of the Proposed Regulations to transfers of different property exceeds the statutory authority. Section 707(a)(2)(B) provides as follows:

In Example 3, the parties' actual transfers standing alone cannot be characterized as a sale of a partnership interest. When the partnership interest is sold, nothing happens to the partnership. As a result of the actual transfers in Example 3, partnership AB no longer owns an historic asset (Whiteacre) and acquires a new asset (Investment Property). That is not substantively the same as if B had merely sold his partnership interest to C. We do not believe that section 707(a)(2)(B) should be applied to create a series of transactions that never occurred in order to find a transaction that is a taxable sale of a partnership interest.

Our view of section 707(a)(2)(B) is supported by the legislative history. None of the three cases cited in the legislative history involved transfers of different property.⁴³ Furthermore, in each of those cases, the government argued that the substance of what the taxpayers did in two steps could be best characterized as one event -- a sale. The same cannot be said of the transfers in Example 3.

Our reading is supported by the balance of the Proposed Regulations and also by the Property Regulations. In all of the other examples in the Proposed Regulations, and all the examples in the Property Regulations in which a disguised sale is found, two steps are recharacterized as one sale. In Prop. Treas. Reg. § 1.707- 7(l), Ex. 1, for example, the transfer of $500 to the partnership and the transfer of $500 from the partnership are characterized as one sale transaction between selling partner and purchasing partner for $500. Similarly, in Treas. Reg. § 1.707- 3(f), Ex. 1, the transfer of property X to the partnership and the partnership's transfer of $3,000,000 to the same partner are characterized as one sale. Example 3 of the Proposed Regulations, in stark contrast, creates additional steps to find that a disguised sale of a partnership interest has occurred.

We recommend that the application of the Proposed Regulations to transfers of different property also be rejected as a matter of policy because such application would interfere with normal, non- abusive business transactions. For instance, suppose that, in Example 3, C believes that Whiteacre is a poor long-term investment and that the costs of maintaining Whiteacre are not worthwhile. C may make a business decision that he will not join the partnership if it continues to hold Whiteacre. A and B believe that the Investment Property is a good investment and, therefore, are willing to accommodate C's wish that the partnership dispose of Whiteacre. A and B then agree that Whiteacre will be distributed to B (who will suffer appropriate dilution).

We believe it is inconsistent with Congressional intent and sound tax policy to require sale treatment in such circumstances. Section 707(a)(2)(B) was added to the Code to prevent abuses of section 721 and 731. There is no tax abuse occurring in the scenario described, because (i) the transfers are motivated by real business reasons; (ii) the parties are not trying to avoid sale treatment; (iii) there are no cash distributions (i.e., no tax-free "cashing out"); (iv) the property transferred to the partnership is in substance a capital contribution to the partnership; and (v) the property transferred to the "selling partner" is an historic asset of the partnership that is in substance a return of capital. Yet, the taxpayers can avoid sale treatment only if they can "clearly establish" that the transfers do not constitute a sale -- which they will apparently be unable to do, because C would not have made his contribution but for the distribution to B.

Another reason we recommend that the application of the Proposed Regulations to transfers of different property be rejected as a matter of policy is that the effect of the Proposed Regulations is to override substantially sections 721 and 731 without justifiable reason.⁴⁴ Overriding those sections in this context cannot be defended on the ground that the net effect of the transfers of different property involves a sale element. Every property transfer that qualifies under section 721 involves a sale element, because noncontributing partners obtain an indirect interest in the contributed property in exchange for a reduction in their proportionate share of the partnership's assets. Likewise, every property transfer that qualifies under section 731 involves a sale element, because the non-distributee partners increase their interest in the partnership in exchange for relinquishing their indirect interest in the property distributed to the distributee partner and the distributee partner increases its interest in distributed property in exchange for a smaller interest in the partnership. Nonetheless, Congress long ago determined that such transactions should not be treated as taxable events. That policy decision is fundamental to subchapter K and we advise against sweeping it aside lightly. Section 707(a)(2)(B) was not intended to sweep so broadly.

While we believe that a presumption of disguised sale of partnership interest treatment is inappropriate in the case of transfers of different property, we believe that imposing sale treatment on the partnership through the deemed transaction mechanism is particularly inappropriate. In Example 3, it is difficult to discern any compelling reason under section 707(a)(2)(B) for the transfers to cause A to be taxed. A is an innocent bystander with respect to the actual transfers. If the Proposed Regulations are finalized in their current form, then, unless there is a substantial advantage to the partnership from the exchange of Whiteacre for Investment Property, A may view it in his best interest to block the transactions so as to avoid the tax ramifications.

Significantly, self-help is available. For example, faced with the alternative of either doing nothing or being subject to significant taxation, AB may elect to form a new partnership with C and transfer all of its assets except Whiteacre to the new partnership. AB could then distribute Whiteacre to B and operate as an upper-tier partnership. Thus, except for creating a new entity, the parties can accomplish the same economic result and avoid disguised sale of partnership interest treatment under the Proposed Regulations. The administration of the tax laws is not improved by forcing the parties in this scenario to choose between doing nothing, going forward as planned with a strong presumption of multiple instances of taxation, or creating a tiered partnership arrangement. (Moreover, it seems likely that many taxpayers would be unaware of such opportunities, creating the types of disparities upon which sound tax policy frowns.)

In our view, the Proposed Regulations, if finalized in their current form, would needlessly inhibit contributions of property to existing partnerships, because a person considering such a contribution will be forced to protect himself from the potentially dramatic consequences of falling into the deemed transaction mechanism of the Proposed Regulations. He will need to investigate prior distributions by the partnership, obtain assurances from the partnership with respect to future distributions, and be certain that there are no circumstances, such as statements by other partners, that might lead the government to believe that the "but for" test is met. Even if he is reasonably confident that the presumption could be rebutted, he may decide not to contribute to the partnership, because the tax costs of being wrong could be high.⁴⁵

By creating a presumption that results in multiple incidents of sale treatment, the Proposed Regulations interfere with normal, non- abusive business transactions, raising significant obstacles to the accomplishment of fundamental policies underlying subchapter K. Accordingly, we recommend that transfers of different property not be treated as a disguised sale of a partnership interest unless they violate an anti-abuse rule. Such a rule could provide that transfers are treated as a disguised sale of a partnership interest only if (i) the property contributed by the purchasing partner is disposed of by the partnership within a short time (e.g., nine months); (ii) a distribution of property is made to the selling partner within two years of the contribution; and (iii) the distribution was made with the principal purpose of avoiding disguised sale of partnership interest treatment.⁴⁶

IV. Special Rules Relating to Liabilities

As we discussed in the 2004 Comments, the legislative history underlying section 707(a)(2)(B) explains that Congress anticipated that the disguised sale provisions would apply if (i) a transferor partner received the proceeds of a loan related to contributed property and responsibility for the repayment of the loan rested with the partnership or the other partners, or (ii) the partner obtained a loan related to the property in anticipation of the transaction and responsibility for repayment of the loan was transferred to the partnership or the other partners.⁴⁷ The common concern in these two instances is whether the relief of liability involves a shift of economic benefits and burdens to the partnership or the other partners.

The Proposed Regulations generally adopt our suggestion and follow the Property Regulations by providing that only the actual assumption of a liability will be treated as part of a disguised sale of a partnership interest. Specifically, deemed contributions and distributions under section 752 resulting from reallocations of partnership liabilities are not treated as transfers of consideration in determining whether a disguised sale of a partnership interest has occurred.⁵² Nevertheless, the Proposed Regulations do not to exclude explicitly deemed contributions and distributions under section 752 resulting from initial allocations of partnership liabilities from the determination of whether a disguised sale of a partnership interest has occurred.

We understand from informal discussions with government representatives that the Proposed Regulations are intended to apply only when a liability is actually assumed. Thus, we suggest that the Proposed Regulations, if finalized, specifically provide that initial allocations of partnership liabilities under section 752 will not be treated as part of a disguised sale of a partnership interest.

The IRS and Treasury have requested comments regarding whether the Proposed Regulations should include rules similar to those in the Property Regulations for qualified liabilities, and, if so, whether and how those rules should be modified to address issues particular to disguised sales of partnership interests. The Proposed Regulations do not include rules for qualified liabilities because, in contrast to the Property Regulations, "a transfer to a partnership of encumbered property alone would not be subject to recharacterization as a disguised sale of a partnership interest."⁶⁰ Rather, a transfer to a partnership of encumbered property would have to be related to a transfer of consideration by another partner to the partnership to be recharacterized as a disguised sale.

We recommend that the Final Regulations include rules for qualified liabilities. In the event that a transfer to a partnership of encumbered property is either presumptively or circumstantially related to a transfer of consideration by another partner, there may be instances in which the assumption of liabilities by the partnership should not be considered to be part of a disguised sale of a partnership interest. In addition, the Proposed Regulations may apply both to the distributee ("selling") partner's liabilities assumed by the partnership, as well as partnership liabilities incurred directly for the benefit of the distributee partner (because the assumption of a portion of such liability by other partners may be considered a contribution by a "purchasing" partner). In either case, we believe that the IRS and Treasury should adopt the familiar definitions of "qualified liabilities" found in the Property Regulations.⁶¹

If a partner contributes property to a partnership subject to a liability, however, the analysis is more difficult. If the partner is making a contribution to a new partnership, the Proposed Regulations do not attempt to recharacterize the transaction as a disguised sale of a partnership interest; instead, only the Property Regulations are applicable.⁶³ Unfortunately, the Proposed Regulations do not address the contribution by either a new partner or a continuing partner to an existing partnership.

In Example 4, C contributes Asset 1, subject to a $2 million liability, to the partnership. If the partnership's assumption of the liability encumbering Asset 1 is treated as a distribution to C, such distribution could be considered to be part of a disguised sale. Nevertheless, because the $2 million liability was incurred more than two years ago to purchase Asset 1 and has encumbered Asset 1 since such purchase, the liability is a qualified liability for purposes of the Property Regulations.⁶⁵ Therefore, the assumption of such qualified liability by the partnership is not treated as part of a disguised sale of property.⁶⁶

Because the partnership's assumption of the liability encumbering Asset 1 occurred within two years of the contributions by A and B, the Proposed Regulations may apply. Under the overlap rule, to the extent a transfer is treated as part of a sale of property under the Property Regulations, such transfer is not taken into account in applying the Proposed Regulations. Thus, to the extent that a contribution by a partner to an existing partnership of property subject to a liability is considered part of a disguised sale of property, the consideration received by the contributing partner (relief of liability) may not be considered part of a disguised sale of a partnership interest.

Because C's contribution of Asset 1 subject to the liability is not treated as part of a disguised sale of property, however, it appears that such contribution may nevertheless be treated as part of a disguised sale of a partnership interest.⁶⁷ As discussed above, if the liability that is assumed by the partnership constitutes a qualified liability within the meaning of the Property Regulations, the assumption of such liability is not considered part of a disguised sale of property.⁶⁸ Because the liability encumbering Asset 1 was a qualified liability, its assumption was not considered part of a disguised sale of property. Thus, it appears that the overlap rule would not literally exclude the application of the Proposed Regulations.⁶⁹ And because the Proposed Regulations do not include an exception for qualified liabilities, no provision of the Proposed Regulations prevents C's contribution to the partnership of Asset 1 subject to the liability from being considered part of a disguised sale of a partnership interest.⁷⁰

In addition, treating C's contribution to the partnership of Asset 1 subject to the liability as part of a disguised sale of a partnership interest could produce the unexpected and illogical result of C acquiring a partnership interest while simultaneously being treated as having sold a portion of such interest. It is perhaps this illogical result that compelled the IRS and Treasury to include the provision that the Proposed Regulations do not apply if a partner is making an initial contribution to a new partnership.⁷¹ Accordingly, to avoid this illogical result and to provide consistent treatment for partners contributing property subject to a liability to an existing partnership, we recommend that the Final Regulations adopt rules similar to the Property Regulations with respect to qualified liabilities.

V. Timing of the Disguised Sale

With respect to the timing of the sale, the Proposed Regulations provide a rule that appears to be modeled after the Property Regulations. Specifically, under the Property Regulations, a sale is considered to take place on the date that, under general principles of federal income tax law, the partnership is considered the owner of the property.⁷⁴ Similarly, in the Proposed Regulations, the sale in non-simultaneous transfers is considered to take place on the date of the earliest of the transfers by the purchasing partner to the partnership or by the partnership to the selling partner (or if earlier, on the date that the transferor agrees in writing to make the transfer).⁷⁵ The goal of achieving consistency with the Property Regulations and utilizing taxpayers' familiarity with those regulations is certainly appropriate, absent any compelling reason to the contrary. Thus, in evaluating the propriety of the rule of the Proposed Regulations, it is important to examine both the consequences of the timing rule as well as its underlying justification.

A number of commentators have addressed concerns regarding the administrative burden imposed by the timing rule of the Proposed Regulations.⁷⁸ These commentators observe that the recharacterization under the Proposed Regulations of the status of the purchasing partner and the selling partner as partners will complicate and confuse taxpayers and their advisors and will dramatically increase compliance burdens by, for example, requiring amended partnership returns and reallocations of income, gain, deduction, and loss. Moreover, the recharacterization of the status of the partners may cause a number of other consequences, including the reallocation of liabilities among the partners, resulting in potentially unwelcome and unwarranted deemed distributions under section 752.

As the commentators note, the timing rule of the Proposed Regulations seems to present unintended planning opportunities as well. Under the Proposed Regulations, the transaction is deemed to be a sale for all tax purposes. If the contribution by the purchasing partner is made after the distribution to the selling partner, even though the purchasing partner has not transferred any property to the partnership, the purchasing partner is considered to be a partner from the time that the selling partner received the distribution. Thus, any distribution from the partnership to a partner could result in a planning opportunity; if the tax consequences of a sale of the distributee partner's interest became advantageous, the transaction could be converted to such a sale within two years simply upon the contribution to the partnership by a purported "purchasing" partner. For example, a purchaser with net operating losses expiring in the preceding year could contribute property to a partnership that had made a distribution to a partner in the preceding year, thus obtaining an allocable share of partnership profits for the preceding year. In addition, a partner that received a distribution in the preceding year could convert such distribution to a sale by locating an investor who will contribute to the partnership within two years of the distribution.

The same holds true if the contribution by the purchasing partner is made before the distribution to the selling partner. In such case, even though the selling partner has not received any property from the partnership, the purchasing partner again is treated as having acquired the selling partner's partnership interest from the time that the purchasing partner made its contribution. Thus, any contribution to the partnership becomes a planning opportunity; if the tax consequences of a purchase of the selling partner's interest became advantageous, the transaction could be converted to such a sale within two years simply upon the distribution by the partnership to the purported selling partner.

This suggested timing rule is easiest to understand in the context of a contribution by the "purchasing" partner followed by a distribution to the "selling" partner, as in the following example.

The problems with application of this rule become apparent when the distribution to the "selling" partner is followed by a contribution by the "purchasing" partner, as in the following example.

The more common occurrence, however, will involve transactions in which the two-year presumptions cause a determination to be made that a disguised sale of a partnership interest has occurred but the facts and circumstances are not sufficient to rebut the presumption. We believe that such transactions demonstrate a significant difficulty in applying the two-year presumptions to disguised sales of partnership interests. Thus, if the two-year presumptions are retained, we recommend that a second alternative to the timing rule (explained in section V.C below) be adopted in the Final Regulations.

The two-year presumptions, however, have the effect of considering facts and circumstances existing on the date of the latest transfer. When the subsequent transfer (whether to the partnership or to the distributee partner) occurs within the two-year presumptive period, the facts and circumstances as they existed on the date of the earliest transfer, although relevant, are determinative only if they clearly establish that a sale did not occur. Many practitioners may be rightly concerned that the transaction will be retroactively recharacterized in accordance with the two-year presumptions because the facts and circumstances as they existed on the date of the earliest transfer do not rise to a level to clearly establish that a sale did not occur.

The inclusion of the two-year presumptions in the Proposed Regulations and their practical effect in examining the facts and circumstances existing on the date of the latest transfer suggest that the more appropriate rule would be to treat the sale as having occurred upon the latest of the transfers by the purchasing partner to the partnership or by the partnership to the selling partner (the "latest transfer rule"). This rule, however, would allow taxpayers involved in transactions that are in fact disguised sales to defer gain on such sales.

Despite the possibility that the latest transfer rule may result in deferral of taxation, we believe that the rule makes the most practical sense in light of the two-year presumptions. Considering that unwarranted consequences arise with respect to both the timing rule and the selling partner consideration rule, we believe that it would be more appropriate to treat a sale as occurring under the latest transfer rule.

VI. Application to Partnership Mergers and Divisions

In the preamble to the Proposed Regulations, the IRS and Treasury requested comments as to whether the Proposed Regulations should include special rules or exceptions for some or all of the transfers occurring in a partnership merger or division under Treas. Reg. § 1.708-1(c) or (d). As discussed below, we suggest that the Final Regulations apply to partnership mergers only in limited circumstances and generally exempt from their application all transfers incident to partnership divisions.

While Treas. Reg. § 1.708-1(c)(4) permits a special election by the parties to treat a sale of an interest in the terminated partnership in accordance with its form, all other transfers of interests in the terminated partnership in connection with a merger are to be treated under the assets-over form. As a result, there can be no possibility of a disguised sale of an interest in the terminated partnership in connection with a partnership merger.

There remains, however, the possibility of a disguised sale of a partnership interest in the resulting partnership. Application of either the assets-over or assets-up form necessitates the contribution of assets to the resulting partnership in exchange for an interest in the resulting partnership. The contribution of such assets could be related to a distribution in partial or complete redemption of other partners in the resulting partnership.

To the extent distributions are made to former partners of the terminated partnership, we believe that the interests that are reduced should be regarded as relating back to the terminated partnership because the distributee partners were not partners of the resulting partnership prior to the merger. Accordingly, the distribution of assets by the resulting partnership to former partners of the terminated partnership cannot be viewed as part of a disguised sale of the former partners of the terminated partnership's interests because, for the reasons discussed above, interests in the terminated partnership cannot be deemed to be transferred in light of the IRS's and Treasury's rejection of the interests-over form.

On the other hand, to the extent assets of the terminated partnership are distributed by the resulting partnership to former partners of the resulting partnership, such distributions could be regarded as a disguised sale of the interests of former partners of the resulting partnership to former partners of the terminated partnership if a step transaction analysis were applied to connect the merger transaction and the subsequent redemption. The fact that some partners may not wish to have as great an ownership interest in the resulting partnership formed by a merger is as likely (if not more likely) to be attributable to the changed nature of the capital structure and business of the resulting partnership as to a desire to effect a disguised sale of their pre-merger interests. Such partners should be able to have their interests redeemed in a liquidating distribution from the partnership. In other contexts, the IRS and Treasury have recognized that a permanent change in the capital structure of a business entity provides sufficient reason for not applying a step-transaction analysis that would recast the business form.⁸⁷

We believe that there would be relatively few opportunities for taxpayers to abuse such a safe harbor. In that regard, we note that Treas. Reg. § 1.708-1(c)(6) provides the IRS with authority to disregard the form of a merger transaction where it is part of a larger series of transactions and recast the merger in accordance with its substance.

We also recognize that an additional regulatory exception to our proposed safe harbor for transfers incident to partnership mergers may be required for situations in which the nature of the merger transaction is predominantly an acquisition of a partnership interest, such as when substantially all the assets of one of the merging partnerships is distributed to the other.

With respect to a possible disguised sale of an interest in the divided partnership, any consideration furnished to effect a disguised purchase of an existing partner's interest would have to be obtained by the divided partnership from a contribution of property made separately from the partnership division transaction. As we have noted, the divided partnership is treated as a transferor rather than a transferee of assets in a partnership division. Treas. Reg. § 1.708-1 (d)(6) authorizes the IRS and Treasury to recast partnership divisions in accordance with their form where they are part of a larger series of transactions. In the event a partner contributed an asset to the divided partnership before a division with the purpose of causing that asset to be distributed to another partner in reduction of its interest, we believe that Treas. Reg. § 1.708-1 (d)(6) already provides the IRS and Treasury with sufficient power to segregate and recharacterize that portion of the division transaction as a disguised sale of an interest in the divided partnership. Accordingly, we recommend that the Final Regulations include a general safe harbor for transactions incident to partnership divisions (whether involving the divided partnership or a recipient partnership) with an appropriate cross-reference to the IRS's authority under Treas. Reg. § 1.708-1(d)(6).

VII. Disclosure Rules

The Proposed Regulations provide disclosure rules for disguised sales of partnership interests and expand disclosure rules for disguised sales of property. With respect to disguised sales of partnership interests, the Proposed Regulations provide that disclosure is required when a partner transfers consideration to a partnership and the partnership transfers consideration to another partner within a seven-year period (without regard to the order of the transfers), the partners treat the transfers other than as a sale for tax purposes, and a transfer of consideration does not meet certain safe harbor criteria or specific exceptions.⁸⁹

With respect to disguised sales of property, the Proposed Regulations amend Treas. Reg. §§ 1.707-3(c)(2) and 1.707-6(c) to extend the disclosure requirement to transfers occurring within seven years rather than two years. Finally, the Proposed Regulations revise Treas. Reg. § 1.707-8(c) to require disclosure to be made by any person who makes a transfer that is required to be disclosed. That is, under the Proposed Regulations, disclosure would be required not only by the partnership, but also by the contributing and distributee partners.

For several reasons, we respectfully disagree with the proposed expansion of the required disclosure period to seven years. First, the reporting burden suggested by the Proposed Regulations would be particularly onerous. Expanding the reporting burden to encompass transactions that occur within seven years of each other would require that contributions and distributions must be compared to all other contributions and distributions that occur within the seven- year period to determine if any relation exists. It is particularly notable that, because the reporting requirement is imposed without regard to the order of the transfers, a contribution must be compared to all distributions that occurred within the period beginning seven years before and seven years after the contribution. Similarly, a distribution must be compared to all contributions within the period beginning seven years before and seven years after the distribution.

Second, the expansion of the disclosure period to seven years is in our view an excessive response to the Joint Committee's suggestion. The IRS and Treasury's proposed seven-year expansion is based upon the Joint Committee's suggestion that expanding the disclosure period might make a facts and circumstances determination by the IRS both more likely to occur and easier for the IRS to administer.⁹² The Joint Committee's suggestion was made specifically in reference to certain transactions in which partnership contributions and distributions were made within two years and two days, thus avoiding the disclosure requirements. We believe that the intended purpose of the disclosure period is to identify those transactions structured to comply in form but not in substance with the two-year presumptions. Thus, although the IRS and Treasury suggested in the preamble to the Proposed Regulations that the seven-year expansion might make taxpayers more likely to undertake the facts and circumstances determination for transfers that occur more than two years apart, we believe the expansion of the period from two to seven years is excessive in light of its intended purpose.

We are sympathetic to the need to identify transactions structured to comply in form but not in substance with the two-year disguised sale presumptions, but we suggest that the Final Regulations adopt a more balanced approach. An expansion of the disclosure period to three years would balance the intent of the disclosure requirements with the burden placed upon taxpayers, while also identifying transactions that are structured only in form to satisfy the two-year presumptions. As discussed above, both the Property Regulations and the Proposed Regulations provide that transactions that occur more than two years apart are presumed not to be a disguised sale. As we discussed in the 2004 Comments, the two- year presumptions in the Property Regulations were evidently intended to promote taxpayer certainty, and also to be responsive to the legislative history to section 707(a)(2)(B) that noted that a transaction would be treated as a sale when a partner contributed property to a partnership and received a distribution of money or property "within a reasonable period before or after such contribution."⁹³ Even if taxpayers were to structure partnership contributions and distributions to be made just beyond the three-year period, it would be difficult to determine that such transactions should be considered disguised sales.

partner to comply with the reporting rules, each partner would first have to be aware of the need to gather this information from the partnership and then be able to compel the production of such information from the partnership. As we have discussed in numerous examples, neither the contributing partner nor the distributee partner may be aware of any contribution or distribution to the other partner. Thus, the contributing partner and the distributee partner may not be aware even of the duty to report, much less have the necessary information to comply with the reporting requirement.

For the reasons discussed above, we believe that only the partnership should bear the reporting burden for transactions that may be considered disguised sales of partnership interests.

² Unless otherwise indicated, all "section" references are to the Internal Revenue Code of 1986, as amended (the "Code"), and all "Treas. Reg. § " references are to the Treasury Regulations promulgated under the Code.

³ Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 73, 98 Stat. 494, 591, as amended by the Tax Reform Act of 1986, Pub. L. 99-514, § 1805(b), 100 Stat. 2810.

⁴ T.D. 8439, 1992-2 C.B. 126 (Sept. 30, 1992). Proposed regulations were published in the Federal Register in April of 1991. 56 Fed. Reg. 19,055 (Apr. 25, 1991).

⁵ REG-149519-03, 69 Fed. Reg. 68,838 (Nov. 26, 2004).

⁶ Prop. Treas. Reg. § 1.707-7(b)(2)(vi).

⁷ Prop. Treas. Reg. § 1.707-7(b)(2)(vii).

⁸ Prop. Treas. Reg. § 1.707-7(e).

⁹ STAFF OF THE JOINT COMM. ON TAXATION, 98th Cong., GENERAL EXPLANATION OF THE REVENUE PROVISIONS OF THE DEFICIT REDUCTION ACT OF 1984, at 226 (COMM. PRINT 1984); H.R. REP. NO. 98- 432, at 1218 (1984) (the "House Report"); S. REP. NO. 98-169, at 225 (1984) (the "Senate Report").

¹⁰See Preamble to Prop. Treas. Reg. §§ 1.707-0 through 9 (the "preamble to the proposed Property Regulations"), 56 Fed. Reg. 19,055 (Apr. 25, 1991).

¹¹ Treas. Reg. § 1.707-3(b)(1).

¹²See Tax Section of the New York State Bar Association, Report on Disguised Sales of Partnership Interests, 2003 TAX NOTES 44-15 (Feb. 13, 2003) (the "NYSBA Report").

¹³ Prop. Treas. Reg. § 1.707-7(b)(1).

¹⁴ Treas. Reg. § 1.707-3(b)(2).

¹⁵ Prop. Treas. Reg. § 1.707-7(b)(2).

¹⁶ Prop. Treas. Reg. § 1.707-7(b)(2)(vi).

¹⁷ Prop. Treas. Reg. § 1.707-7(b)(2)(vii).

¹⁸ Treas. Reg. § 1.707-3(b)(1)(ix).

¹⁹ Treas. Reg. § 1.707-3(b)(1)(x).

²⁰ Prop. Treas. Reg. § 1.707-7(b)(2).

²¹See Treas. Reg. § 1.707-3(f), Examples 3-8.

²² Prop. Treas. Reg. § 1.707-7(c).

²³ If the transaction is respected as a contribution and subsequent distribution, the rules of section 734(b) will apply, rather than those of section 743(b). Notably, applying the rules of section 734(b) may generally result in a less favorable result for the contributing partner than if the contributing partner had instead purchased an interest and obtained a positive basis adjustment with respect to the partnership's assets under section 743(b).

²⁴ We note that there may be differences between sections 751(a) and (b). While we believe that the IRS and Treasury should minimize such apparent differences in formal guidance, we believe that the different treatment under sections 751(a) and (b) should not be sufficient reason to prevent an exception under the Final Regulations for transactions involving complete redemptions. It is anticipated that formal guidance with respect to section 751 is forthcoming. See Office of Tax Policy and Internal Revenue Service, 2004-2005 Priority Guidance Plan, 2004 TNT 144-23 (July 27, 2004).

²⁵ Treas. Reg. § 1.1(h)-1(b)(3)(ii) (regulations under section 1(h)(6), which would require the allocable share of section 1250 gain to be taken into account in determining unrecaptured section 1250 gain upon the sale of a partnership interest held for more than one year, do not apply to the redemption of a partnership interest).

²⁶ Prop. Treas. Reg. § 1.707-7(e).

²⁷ Prop. Treas. Reg. § 1.707-7(g).

²⁸See section 448(d)(2).

²⁹ Treas. Reg. § 1.704-3(e)(3). The regulations define a securities partnership as a partnership which is either a management company or an investment partnership, and the partnership makes all of its book allocations in proportion to the partners' relative book capital accounts (except for reasonable special allocations to a partner that provides management services or investment advisory services to the partnership). A "management company" is a partnership registered with the Securities and Exchange Commission as a management company under the Investment Company Act of 1940. An "investment partnership" is a partnership that (i) holds, on the date of each capital account restatement, qualified financial assets that constitute at least 90 percent of the fair market value of the partnership's non-cash assets; and (ii) reasonably expects to make revaluations at least annually.

³⁰ Treas. Reg. § 1.707-4(e) (providing that the IRS may provide, by guidance published in the Internal Revenue Bulletin, that certain payments or transfers to a partner are not treated as part of a disguised sale of property).

³¹ Prop. Treas. Reg. § 1.707-7(h).

³² Treas. Reg. § 1.707-4.

³³ Prop. Treas. Reg. § 1.707-7(f).

³⁴ One possible definition for such tax distributions could constitute "distributions not in excess of the product of (i) the total amount of a partner's share of partnership taxable income multiplied by (ii) the maximum federal, state, and local tax rates, to the extent that such distributions exceed the total distributions provided for in Treas. Reg. § 1.707-4(b)."

³⁵ Treas. Reg. § 1.707-4(b)(2)(i).

³⁶See the 2004 Comments, p. 24. See also the NYSBA Report, at 28-29.

³⁷ REG-149519-03, 69 Fed. Reg. at 68,841.

³⁸ Prop. Treas. Reg. § 1.707-7(a)(2)(ii)(B).

³⁹ Prop. Treas. Reg. § 1.707-7(l), Ex. 3(i).

⁴⁰ Prop. Treas. Reg. § 1.707-7(l), Ex. 3(iii).

⁴¹ Prop. Treas. Reg. § 1.707-7(b)(2).

⁴²See Prop. Treas. Reg. § 1.707- 7(b)(2)(iii), (ix), and (x).

⁴³See Otey v. Commissioner, 70 T.C. 312 (1978), aff'd per curiam, 634 F.2d 1046 (6th Cir. 1980); Communications Satellite Corp. v. United States, 625 F.2d 997 (Ct. Cl. 1980); Jupiter Corp. v. United States, 2 Cl. Ct. 58 (1983).

⁴⁴ Section 731 reflects Congressional intent to limit narrowly the area in which gain or loss is recognized upon a distribution so as to remove deterrents to property being moved in and out of partnerships as business reasons dictate. See S. Rep. No. 1622, 83^rd Cong., 2^nd Sess., at 96 (1954).

⁴⁵ In addition, we understand from informal discussions with government representatives that guidance in the form of a private letter ruling would not be available because of the inherently factual nature of such transactions.

⁴⁶ We do not believe a presumption in favor of taxpayers would be sufficient. In the permutation of Example 3 we described above, the "but for" test of the Proposed Regulations would clearly be met despite the transaction being a normal, non-abusive business transaction.

⁴⁷ The House Report, at 1221; the Senate Report, at 231.

⁴⁸ The Senate Report, at 230.

⁴⁹ Only the assumption by a partnership or a partner of liabilities, rather than the mere allocation or reallocation of liabilities, may give rise to a disguised sale. Treas. Reg. § 1.707-5(a)(1).

⁵⁰ This fact is recognized in the section 704(b) regulations, which specifically provide that the allocation or reallocation of liabilities under section 752 does not affect the partner's capital accounts. Treas. Reg. § 1.704- 1(b)(2)(iv)(c).

⁵¹ Treas. Reg. § 1.1223-3(b)(3) (providing that, for purposes of determining the holding period for a partnership interest, deemed contributions and distributions under section 752 are disregarded to the same extent they are disregarded under Treas. Reg. § 1.704-1(b)(2)(iv)(c)).

⁵² Treas. Reg. § 1.707-7(j)(1).

⁵³ Section 752(a); Treas. Reg. § 1.752-1(b).

⁵⁴ Prop. Treas. Reg. § 1.707-7(j)(4)(ii) provides that a partner's share of a nonrecourse liability of the partnership is determined in accordance with Treas. Reg. § 1.752-3(a)(3).

⁵⁵ Prop. Treas. Reg. § 1.707-7(j)(1) would apply, however, to the reallocation of $1 million of the partnership's liabilities to B resulting from B's interest in the partnership presumably being increased to 75 percent.

⁵⁶Compare Plantation Patterns, Inc. v. Commissioner, 462 F.2d 712 (5th Cir. 1972), aff'g 29 T.C.M. 817 (1970) (in a case in which a corporation could not have borrowed without the guarantee of its shareholder, shareholder treated as true borrower for tax purposes, and treated as subsequently contributing the proceeds of the loan to the capital of the corporation).

⁵⁷ H.R. CONF. REP. NO. 98-861, at 862 (1984).

⁵⁸See, e.g., Treas. Reg. § 1.707- 5(b) (the "debt-financed distribution" exception).

⁵⁹ Prop. Treas. Reg. § 1.707-7(j)(6). Under the Proposed Regulations, if a partnership transfers consideration within ninety days of incurring a liability and the transfer of consideration is allocable to such liability, the amount transferred from the partnership that may be treated as part of a disguised sale of a partnership interest is reduced by the partner's share of the liability that is allocable to the money transferred to the partner.

⁶⁰See the preamble to the Proposed Regulations. REG-149519-03, 69 Fed. Reg. 68,838 (Nov. 26, 2004).

⁶¹ Treas. Reg. § 1.707-5(a)(6)(i)(A)-(D).

⁶² Note that this section of this comment letter discusses the assumption of liabilities and not the mere allocation or reallocation of partnership liabilities.

⁶³ Prop. Treas. Reg. § 1.707-7(a)(8).

⁶⁴ Prop. Treas. Reg. § 1.707-7(a)(6).

⁶⁵ Treas. Reg. § 1.707-5(a)(6)(i)(A).

⁶⁶ Treas. Reg. § 1.707-5(a)(5).

⁶⁷ This is the proverbial "out of the frying pan and into the fire."

⁶⁸Id.

⁶⁹ It seems logical that the fact that no gain is recognized under the Property Regulations should not prevent the overlap rule from applying, nevertheless, the Property Regulations explicitly limit the exclusion of the overlap rule to cases in which "the transfer is treated as part of a sale of property." Prop. Treas. Reg. § 1.707-7(a)(6).

⁷⁰ Note that a similar issue exists with respect to the exception for preformation capital expenditures. Although the Proposed Regulations adopt the safe harbor distributions of the Property Regulations (including the exception for preformation capital expenditures), without an explanation of its application, the exception may provide limited benefit.

⁷¹ Prop. Treas. Reg. § 1.707-7(a)(8).

⁷² Treas. Reg. § 1.707-5(b)(1).

⁷³ Treas. Reg. § 1.707-5(a)(6).

⁷⁴ Treas. Reg. § 1.707-3(a)(2).

⁷⁵ Prop. Treas. Reg. § 1.707-7(a)(2)(ii)(A).

⁷⁶ Prop. Treas. Reg. § 1.707-7(a)(2)(ii)(C). Commentators have suggested that the purchasing partner's imputed receipt of the selling partner's consideration in exchange for an obligation to later deliver such consideration to the partnership should implicate section 7872, applicable to below market loans. Such treatment is questionable because the Proposed Regulations provide that the purchasing partner transfers an obligation to the partnership; the Proposed Regulations do not explicitly provide that the purchasing partner has received a loan from the partnership. It should be noted, however, that the Property Regulations provide that section 1274 (applicable to debt instruments issued for property) applies upon a disguised sale of property to a partnership in which the transfer of consideration by the partnership occurs after the transfer of property to the partnership. Treas. Reg. § 1.707- 3(f), Example 2. It seems, however, that section 483, rather than section 1274, is properly applicable in such situations.

⁷⁷ Prop. Treas. Reg. § 1.707-7(a)(2)(ii)(D).

⁷⁸See Philip A. McCarty, Attorney Comments on Proposed Regulations on Disguised Sales of Partnership Interests, 2005 TAX NOTES 10-17 (Jan. 10, 2005); Richard M. Lipton and Todd D. Golub, Comments on Proposed Regulations Regarding the Disguised Sale of Partnership Interests, 2005 TAX NOTES 52-34 (Feb. 25, 2005); Tax Section of the New York State Bar Association, Report on Disguised Sales of Partnership Interests Responding to Reg-149518-03, 2005 TAX NOTES 78-42 (Apr. 22, 2005).

⁷⁹See Helvering v. Horst, 311 U.S. 112, 116-117 (1940); Blair v. Commissioner, 300 U.S. 5, 12 (1937).

⁸⁰Grodt and McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, 1237 (1981); see also Treas. Reg. § 1.861- 7(c) (providing that for purposes of sourcing income, a sale of personal property is consummated at the time when, and the place where, the rights, title, and interest of the seller in the property are transferred to the buyer; where bare legal title is retained by the seller, the sale is deemed to have occurred at the time and place of passage to the buyer of beneficial ownership and risk of loss).

⁸¹Grodt and McKay Realty, Inc. v. Commissioner, 77 T.C. at 1237-1238.

⁸² We noted in the 2004 Comments that, because is was not clear what the two-year presumptions would add to the Proposed Regulations, it was difficult to endorse their inclusion.

⁸³ Prop. Treas. Reg. § 1.707-7(b)(2).

⁸⁴ T.D. 8925 (January 4, 2001).

⁸⁵ Treas. Reg. § 1.708-1(c)(3)(i).

⁸⁶ Treas. Reg. § 1.708-1(c)(3)(ii).

⁸⁷See, e.g., Rev. Rul. 78-330, 1978-2 C.B. 147 (the IRS respected parent corporation's cancellation of indebtedness of subsidiary to avoid application of section 357(c) upon the merger of the subsidiary); Rev. Rul. 77-227, 1977-2 C.B. 120 (the IRS respected the distribution of preferred stock dividend by acquiring corporation immediately prior to reorganization under section 368(a)(1)(A)); Rev. Rul. 69-407, 1969-2 C.B. 50 (the IRS respected a recapitalization immediately prior to section 355 distribution).

⁸⁸ Prop. Treas. Reg. § 1.707-7(a)(8).

⁸⁹ Prop. Treas. Reg. § 1.707-7(k).

⁹⁰See the preamble to the Proposed Regulations. REG-149519-03, 69 Fed. Reg. 68,838 (Nov. 26, 2004).

⁹¹ STAFF OF THE JOINT COMM. ON TAXATION, 108th Cong., REPORT OF INVESTIGATION OF ENRON CORPORATION AND RELATED ENTITIES REGARDING FEDERAL TAX AND COMPENSATION ISSUES, AND POLICY RECOMMENDATIONS, at 206 (COMM. PRINT 2003).

⁹²Id.

⁹³ The House Report, at 1221; the Senate Report, at 231.