Individual Questions Authority for Rule in Business Interest Regs

COMMENTS ON SELECTED PROVISIONS OF THE §163 PROPOSED REGULATIONS: REG-107911-18

September 14, 2020

I. Introduction

1. The proposed regulations contain a “partnership tax basis increase in its properties” rule (inside tax basis adjustment rule) as a complement to the partnership interest disposition rule in section 163(j)(4).

2. It is submitted that this inside tax basis adjustment proposed rule is not within the authority of the Treasury and the IRS Office of Chief Counsel to issue although, but for the authority issue, such a rule would be appropriate tax policy.

3. As stated in the proposed regulation preamble:

While the statute is clear that a partner increases the basis in its partnership interest immediately prior to a disposition by any nondeductible EBIE, it does not specifically state that there must also be a corresponding increase to the basis of partnership assets to account for the nondeductible, capitalized expense (i.e., the nondeductible EBIE). The absence of a corresponding increase to the partnership's basis immediately before the partner's disposition would create distortions that are inconsistent with the intent of both section 163(j) and subchapter K of the Code. . . . For example, the basis increase attributable to nondeductible EBIE immediately before a liquidating distribution results in less gain recognized under section 731(a)(1) (or more loss recognized under section 731(a)(2) for the partner disposing of its partnership interest. Consequently, following a liquidating distribution to a partner with EBIE, section 163(j)(4)(B)(iii)(II) causes a reduced section 734(b) adjustment if the partnership has a section 754 election in effect (versus the partner basis increase not occurring), resulting in basis disparity between the partnership's basis in its assets and the aggregate outside basis of the remaining partners. . . . The Treasury Department and the IRS have determined that basis disparity resulting from the absence of a corresponding inside basis increase, as described earlier, is an inappropriate result. Accordingly, these Proposed Regulations would provide for a corresponding inside basis increase that would serve as the partnership analog of section 163(j)(4)(B)(iii)(II). (Emphasis Added).

II. Analysis

Basic Premise. It is submitted that merely because a result is “inappropriate” does not grant legal authority to create tax basis that does not otherwise exist absent either a statute that provides for that specific result or a statute that expressly provides such regulatory authority to achieve that result. The absence of actual tax realization and recognition under section 1001 and other provisions of law otherwise preclude issuing such a rule.

1. There is no express statutory authority to issue regulations to provide for such a result under section 163(j).

2. Section 7805(a)'s grant of regulatory authority to provide “all needful rules and regulations” cannot include the authority to increase tax basis without either an actual tax realization and recognition event, or a statute that explicitly provides for (or specifically grants regulatory authority to provide for) gain or loss to be taken into account along with a correlative basis adjustment (such as sections 475(a) or 1256(a)).

3. T.D. 8501 issued temporary regulations providing for the remedial allocation method under regulation §1.704-3T(d) (now final regulations). The preamble to those temporary regulations cites sections 704(c) and 7805 as authority to provide for the notional tax items created under such method. The General Explanation Of The Revenue Provisions Of The Deficit Reduction Act of 1984, JCS-41-84, Dec. 31, 1984, at pp. 213-214, expressly grants the Treasury broad authority to provide rules that ameliorate the effects of the so-called “ceiling rule” under those regulations. The ceiling rule¹ is representative of the fundamental principle that the creation of a tax item requires a tax realization and recognition event (absent a specific statute providing for such result in a particular case).²

4. The distortions in tax basis dealt with in the proposed rule is fundamentally caused by the application of section 163(j)(4) at the partnership level rather than at the partner level. This statute does not authorize regulations to adjust inside tax basis in this case. There is simply no grant of authority to deviate from the realization and recognition requirements under the Internal Revenue Code where tax basis is only created when there is a gain or loss realized and recognized (but not necessarily taken into account) under section 1001 and similar provisions of law.

5. If this proposed rule is eliminated, its omission would necessitate a readjustment of the operation of the tiered partnership proposed rules which rely on the same general principle.

Monte A. Jackel
@Jackeltaxlaw
Silver Spring, MD