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Bonus Reg Package Leaves Some Partnership Issues Open

Posted on Sep. 18, 2019

Practitioners are calling for clarity on what happens under the bonus depreciation rules if all a partnership’s interests are purchased and the sole buyer wants to write off the full amount of the assets.

Treasury and the IRS didn’t directly address the issue in the first round of proposed bonus depreciation regulations in August 2018, or in final (T.D. 9874) and proposed regulations (REG-106808-19) released September 13. Before the release of the latest round of rules, some practitioners were concerned that partners contemplating purchasing all the other partners’ interests in a partnership might be required to keep the entity alive to take advantage of 100 percent depreciation on qualified assets.

That fact pattern is laid out in Rev. Rul. 99-6, 1999-1 C.B. 432, which describes a scenario in which one existing partner purchases all the interests of the other partners, and another in which a third party purchases all the partnership’s interests. In both scenarios, the partnership that filed annual tax returns would turn into a disregarded entity with one owner, meaning an entity-level informational tax return would no longer be filed.

But the new regs don’t explicitly reference Rev. Rul. 99-6.

New Prior Depreciable Interest Rule

The Tax Cuts and Jobs Act increased bonus depreciation under section 168(k) to 100 percent for qualified property and expanded the property that qualifies by allowing used property new to the taxpayer to qualify. In the proposed regulations released in 2018 (REG-104397-18), the IRS and Treasury allowed basis adjustments under section 743(b) to qualify for bonus depreciation, provided other requirements were met.

Under section 743(b), if a section 754 election is made, a partner purchasing an interest in a partnership from another partner will receive a stepped-up basis in partnership property to eliminate disparities between that partner’s inside and outside basis. For purposes of determining whether the section 743(b) basis adjustment qualifies for bonus depreciation, each partner is treated as having owned and used the partner’s proportionate share of partnership property.

However, some real-life scenarios, such as the fact patterns under Rev. Rul. 99-6, were left unresolved.

Practitioners said it seems that a third party that purchased all the interests of a partnership could get a cost basis that would qualify for bonus depreciation if that party wasn’t related to the selling partners and the third party didn’t have a prior depreciable interest in the property.

But according to Jason Dexter of KPMG LLP, if an existing partner bought out the other partners, the extent to which the buyer’s capital outlay is entitled to immediate expensing is unclear. The proposed regs from 2018 didn’t shed light on when a partner was considered to have had a prior depreciable interest in partnership property for purposes other than section 743(b), he noted.

The September 13 proposed regs describe more broadly when a partner is deemed to have had a prior depreciable interest in partnership property. The proposed rules added language stating that a partner is treated as having had a prior depreciable interest in a portion of property equal to the partner’s total share of depreciation deductions related to the property as a percentage of the total depreciation deductions allocated to all partners regarding the property.

Partners should apply that rule during the current calendar year and the five-year period immediately before the partnership’s placed-in-service year of the property, the regs state.

“For this purpose, only the portion of the current calendar year and previous 5-year period during which the partnership owned the property and the person was a partner is taken into account,” the government said. “The Treasury Department and the IRS believe that this provides an accurate reflection of the partner’s prior depreciable interest in the property.”

Still Unclear

According to Dexter, the new prior depreciable interest rule seems intended to look to the five years leading up to the transaction in which the partner bought partnership property. “But a literal reading of the language, which refers to the current placed-in-service date of the partnership — rather than the partner — suggests that the partner may have to look back to the five-year period before the partnership placed the property in service, which may have been longer than five years ago,” he said.

Richard Blumenreich, also of KPMG, said that when applied to a transaction described in situation 1 of Rev. Rul. 99-6, the new rule in the proposed regs doesn’t clarify whether the buyer is treated as acquiring only the share of partnership property in which it didn’t have a prior depreciable interest, or a pro rata share of everything.

For example, Blumenreich said, assume that A and B each own 50 percent of a limited liability company, and the LLC owns qualified property with a fair market value of $100 and an adjusted basis of zero. If B purchases A’s 50 percent interest in the LLC, then under situation 1 of Rev. Rul. 99-6, the LLC is treated as making a liquidating distribution of all its property to A and B. Following this distribution, B is treated as acquiring the portion of LLC’s property deemed to have been distributed to A, he explained.

“If B’s prior share of the total depreciation deductions with respect to LLC’s property is 50 percent, it’s unclear from the proposed regulations whether the property deemed to have been distributed to A, and purchased by B, includes only that property in which B did not have a prior depreciable interest,” Blumenreich said. “In that scenario, B is entitled to $50 of bonus depreciation, or a mixture of the two, in which case B is entitled to only $25 of bonus depreciation.”

Dexter said that if the intent of the new prior depreciable interest rule is to be consistent with the approach taken for section 743(b) basis adjustments, as the preamble to the proposed regs states, then it seems that B ought to be treated as purchasing only A’s “vertical slice” ownership interest.

“This approach would be in accordance with B’s capital investment, and also align the tax and economic consequences that follow from a similar situation in which B buys all but 1 percent of A’s interest in LLC,” Dexter said. “That would result in full expensing of B’s stepped-up basis under section 743(b), and in this example, where B buys all of A’s interest in LLC.”

Blumenreich added that while the new prior depreciable interest rule is intended to clarify how to apply the no-prior-use requirement to partnership transfers, there’s still some uncertainty whether reference to a partner’s share of total depreciation deductions is intended to be book or tax, for instance, and whether this rule imposes new information collection and tracking requirements regarding a partner’s prior depreciable interest in partnership property.

Rev. Rul. 99-5

Although the IRS and Treasury didn’t explicitly reference Rev. Rul. 99-6 in the new regulations, they did cite to and address the fact pattern in situation 1 of Rev. Rul. 99-5, 1999-1 C.B. 434, in which a taxpayer wholly owns a business that places property in service and a third party purchases an interest in the entity, turning it into a partnership in the same tax year.

The final regs state that in that scenario, the contributing partner is deemed to have placed the property in service before contributing it to the new partnership, so that same partner can deduct the entire first-year depreciation. The contributing partner is treated as having contributed the property to the partnership with a zero basis, and the property is considered section 704(c) property in the hands of the partnership.

“I suspect that that rule will be the source of much study and use in the years to come,” Eric B. Sloan of Gibson, Dunn & Crutcher LLP said of the government’s approach in the final regs.

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