Partnership Mergers & Divisions

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [TD 8925] RIN 1545-AX32

TITLE: Partnership Mergers and Divisions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations on the tax
consequences of partnership mergers and divisions. The final
regulations affect partnerships and their partners.

DATES: Effective Date: These regulations are effective January 4,
2001. Applicability Date: For dates of applicability of these
regulations, see §§1.708-1(c)(7), 1.708-1(d)(7), and
1.752-5(a).

FOR FURTHER INFORMATION CONTACT: Mary Beth Collins or Dan Carmody,
(202) 622-3080 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document amends sections 708 and 752 of the Income Tax
Regulations (26 CFR part 1) regarding partnership mergers and
divisions.

On January 11, 2000, a notice of proposed rulemaking and a notice of
public hearing (REG-111119-99, 2000-5 I.R.B. 455) were published in
the Federal Register (65 FR 1572) regarding sections 708, 743, and
752 of the Internal Revenue Code. No one requested to speak at the
public hearing. Accordingly, the public hearing scheduled for May 4,
2000, was canceled in the Federal Register (65 FR 24897) on April
28, 2000. Comments responding to the proposed regulations were
received. After consideration of the comments, the proposed
regulations are adopted as revised by this Treasury decision.

I. Partnership Mergers

Section 708(b)(2)(A) provides that in the case of a merger or
consolidation of two or more partnerships, the resulting partnership
is, for purposes of section 708, considered the continuation of any
merging or consolidating partnership whose members own an interest
of more than 50 percent in the capital and profits of the resulting
partnership. Section 1.708-1(b)(2)(i) of the Income Tax Regulations
provides that if the resulting partnership can be considered a
continuation of more than one of the merging partnerships, the
resulting partnership is the continuation of the partnership that is
credited with the contribution of the greatest dollar value of
assets to the resulting partnership. If the members of none of the
merging partnerships own more than a 50 percent interest in the
capital and profits of the resulting partnership, all of the merged
partnerships are considered terminated, and a new partnership
results. The taxable years of the merging partnerships that are
considered terminated are closed under section 706(c).

II. Partnership Divisions

Section 708(b)(2)(B) provides that, in the case of a division of a
partnership into two or more partnerships, the resulting
partnerships (other than any resulting partnership the members of
which had an interest of 50 percent or less in the capital and
profits of the prior partnership) are considered a continuation of
the prior partnership. Section 1.708-1(b)(2)(ii) provides that any
other resulting partnership is not considered a continuation of the
prior partnership but is considered a new partnership. If the
members of none of the resulting partnerships owned an interest of
more than 50 percent in the capital and profits of the prior
partnership, the prior partnership is terminated. Where members of a
partnership that has been divided do not become members of a
resulting partnership that is considered a continuation of the prior
partnership, such members' interests are considered liquidated as of
the date of the division.

Explanation of Revisions and Summary of Comments

I. Assets-Up Form for Partnership Mergers and Divisions

The proposed regulations provide that the form of a partnership
merger or division accomplished under laws of the applicable
jurisdiction will be respected if the partnership undertakes the
steps of one of two prescribed forms. Generally, for partnership
mergers, a terminating partnership contributes its assets and
liabilities to the resulting partnership in exchange for interests
in the resulting partnership, and. immediately thereafter, the
terminated partnership distributes interests in the resulting
partnership to its partners in liquidation of the terminating
partnership (Assets-Over Form). Alternatively, for partnership
mergers, the terminating partnership liquidates by distributing its
assets and liabilities to its partners who then contribute the
assets and liabilities to the resulting partnership (Assets-Up
Form). The default rule for partnership mergers is the Assets-Over
Form, so that if a transaction is not characterized under the
Assets-Up Form, it will be characterized under the Assets-Over Form
regardless of whether that form is followed.

In general, for partnership divisions, a prior partnership transfers
certain assets and liabilities to a resulting partnership in
exchange for interests in the resulting partnership, and immediately
thereafter, the prior partnership distributes the resulting
partnership interests to partners who are designated to receive
interests in the resulting partnership (Assets-Over Form).
Alternatively, for partnership divisions, the prior partnership
distributes certain assets and liabilities to some or all of its
partners who then contribute the assets and liabilities to a
resulting partnership in exchange for interests in the resulting
partnership (Assets-Up Form). As with partnership mergers, the
default rule for partnership divisions is the Assets-Over Form, so
that if a transaction is not characterized under the Assets-Up Form,
it will be characterized under the Assets-Over Form regardless of
whether that form is. followed.

One commentator expressed concern that where the assets of an
operating business are distributed to the partners as joint owners,
and the partners continue to operate the business, the owners of the
assets may be considered to remain partners for federal income tax
purposes. Under the proposed regulations, it was intended that the
Assets-Up Form would be respected where the assets are conveyed to
the partners under the laws of the applicable jurisdiction and then
reconveyed to the resulting partnership. An example has been added
to the final regulations to confirm this result. The example also
confirms that a partnership can use the Assets-Up Form for
partnership mergers and divisions regardless of whether the partners
could otherwise generally hold certain assets, such as undivided
interests in goodwill, outside of a partnership.

The same commentator suggested that the Assets-Up Form should be
respected if, rather than actually conveying ownership of the assets
under applicable jurisdictional law, the partners assign their
rights to receive title to the assets in liquidation of the
partnership, or direct the partnership to transfer title to the
assets to the resulting partnership. In providing that the Assets-Up
Form would be respected in accomplishing partnership mergers and
divisions, the IRS and Treasury did not intend to establish a regime
whereby partners essentially could elect between the Assets-Up Form
and the Assets-Over Form by creating different documents that have
the same legal effect.

The IRS and Treasury believe that if the Assets-Up Form is to be
respected, a partnership must actually undertake the steps that are
necessary, under the laws of the applicable jurisdiction, to convey
ownership of the assets that are distributed to the partners. For
most types of assets, this will not require the actual transfer and
recording of a deed or certificate of title. While the IRS and
Treasury believe that it should be necessary for a partnership to
actually convey ownership of the partnership's assets to its
partners in order to follow the Assets-Up Form, it should not be
necessary for the partners to actually assume the liabilities of the
partnership in order to follow such form. Pursuant to section 752
and the regulations thereunder, a partner essentially is deemed to
have directly incurred a share of the partnership's liabilities.
Requiring the partners to actually assume debt that they already are
deemed to have incurred is unnecessary. Such a requirement also
could create a trap for the unwary. If a partner momentarily assumes
an amount of the partnership's debt that is less than the partner's
share of such debt under section 752 (and other partners momentarily
assume an amount of debt in excess of their shares), the partner
could inappropriately recognize gain as a result of the deemed
distribution.

II. Bifurcation of Assets-Over Form and Assets-Up Form

The proposed regulations provide that the form of a partnership
merger or division accomplished under laws of the applicable
jurisdiction will be respected if the partnership. undertakes the
steps of either the Assets-Over Form or the Assets-Up Form. One
commentator recommended that a single partnership merger or division
be respected if the partnership undertakes the steps of the Assets-
Over Form with respect to some assets and the Assets-Up Form with
respect to others. For example, in a partnership merger, the
terminating partnership could distribute some assets to certain
partners who then contribute the assets to the resulting partnership
in exchange for interests in the resulting partnership (Assets-Up
Form), and simultaneously, the terminating partnership could
transfer the remaining assets to the resulting partnership in
exchange for interests in the resulting partnership and then
distribute the interests to the remaining partners in liquidation of
their interests in the terminating partnership (Assets-Over Form).
In the preamble to the proposed regulations, the IRS and Treasury
recognized that there are numerous transactions that may be
undertaken pursuant to local jurisdictional law to accomplish the
result of a partnership merger or division. The rules set forth in
the proposed regulations were not intended to provide unlimited
flexibility among the various structural alternatives for
accomplishing these transactions. Instead, the proposed regulations
were intended to provide a set of administrable rules that taxpayers
and the IRS could apply in characterizing these transactions.

In view of this purpose, the IRS and Treasury do not believe it is
appropriate for a partnership merger to be accomplished. using both
the Assets-Over Form and the Assets-Up Form when all the assets and
liabilities of the terminated partnership are transferred to a
single resulting partnership. While a partnership merger may be
accomplished by using any number of transactional structures, the
result is a single transaction that combines two partnerships. In
the two alternatives set forth in the proposed regulations, and
adopted in these final regulations, each partner must participate
(or will be deemed to participate) in the partnership merger in the
same manner (with the exception of those partners who are subject to
the buy-out rule).

Therefore, if the partners wish for a partnership merger to be
characterized under the Assets-Up Form, the terminated partnership
must undertake the steps of the Assets-Up Form for all of its assets
when it distributes the assets to its partners. Otherwise, the
transaction will be characterized under the Assets-Over Form.
However, where more than two partnerships are combined, each
combination will be viewed as a separate merger so that the
characterization of a merger of one partnership into the resulting
partnership under the Assets-Over Form will not prevent a
simultaneous merger of another partnership into the same resulting
partnership from being characterized under the Assets-Up Form.

For the same reasons, with respect to partnership divisions, the IRS
and Treasury believe that it is appropriate to require consistency
in applying either the Assets-Over Form or the Assets-Up Form to
characterize a transfer of assets to a. resulting partnership.
However, where a single partnership is divided in a transaction that
involves a transfer of assets (either actual or deemed) to multiple
partnerships, the transfer to each resulting partnership should be
viewed separately. As with mergers involving more than two
partnerships, it is consistent with the purposes of these
regulations, in the context of divisions, to allow the transfer to
one resulting partnership to be characterized under the Assets-Over
Form while characterizing the transfer to another resulting
partnership under the Assets-Up Form. The proposed regulations
provided an example that illustrates when such a division
accomplished under both the Assets-Over Form and the Assets-Up Form
will be respected. The final regulations do not change the example.
See §1.708-1(d)(5) Example 7 of the final regulations. The
final regulations also add an example to illustrate when a division
accomplished under both the Assets-Over Form and the Assets-Up Form
will not be respected.

III. Clarification of Partnership Merger Buy-out Rule

The proposed regulations contain a special buy-out rule that allows
a resulting partnership in a merger to fund the purchase of one or
more partners' interests in a terminating partnership without
triggering the disguised sale rules, which otherwise would cause all
of the partners in the terminating partnership to recognize gain or
loss as a result of the purchase.

Specifically, the proposed regulations provide that if the merger
agreement (or similar document) specifies that the resulting.
partnership is purchasing the exiting partner's interest in the
terminating partnership and the amount paid for the interest, the
transaction will be treated as a sale of the exiting partner's
interest to the resulting partnership.

Because the transaction described in the proposed regulations is
treated as a sale of a partnership interest, the resulting
partnership inherits the exiting partner's capital account in the
terminating partnership and any section 704(c) liability of the
exiting partner. Additionally, if the terminating partnership has an
election in effect under section 754 (or makes an election under
section 754), the resulting partnership will have a special basis
adjustment regarding the terminating partnership's property under
section 743. The proposed regulations provide that the resulting
partnership's basis adjustments under section 743 must be allocated
solely to the partners who were partners in the resulting
partnership immediately before the merger.

Commentators questioned whether the exiting partner must be a party
to the merger agreement in order to obtain the benefit of the
special buy-out rule contained in the proposed regulations. Another
commentator asked whether the exiting partner must consent to the
sale treatment. The commentator explained that it may be difficult
to receive consent from small investors in a large partnership whose
interests are being sold to the resulting partnership.

The IRS and Treasury believe that the exiting partner does. not have
to be a party to the merger agreement in order to obtain the benefit
of the special buy-out rule. However, to ensure that all partners to
the transaction treat the transaction consistently when filing their
returns, the final regulations require that, prior to or
contemporaneous with the transfer, the exiting partner must consent
to the sale treatment provided in the special rule.

Commentators noted that the resulting partnership's basis
adjustments under section 743 should not be allocated solely to the
partners who were partners in the resulting partnership immediately
before the merger. As indicated in §1.708-1(c)(4) Example 4 of
the proposed regulations, where the resulting partnership has
acquired an interest in the terminating partnership in accordance
with the special buy-out rule, the terminating partnership, as part
of the merger, distributes assets to the resulting partnership in
liquidation of the resulting partnership's interest in the
terminating partnership. Accordingly, the resulting partnership
should take an exchanged basis in the distributed assets under
section 732(b), rather than a transferred basis that includes the
basis adjustment under section 743(b). In response to these
comments, the IRS and Treasury have removed the proposed regulations
under section 743 and have clarified the example to indicate that
the basis rules under section 732(b) apply.

Commentators also asked whether a partnership termination under
section 708(b)(1)(B) occurs immediately before a merger if. exiting
partners sell 50 percent or more of the total interests in the
terminating partnership under the buy-out provision. Although not
discussed in the final regulations, it follows from treating the
buyout as occurring immediately prior to the merger that, if exiting
partners sell 50 percent or more of the total interest in the
terminating partnership's capital and profits as part of a merger,
then a partnership termination under section 708(b)(1)(B) will occur
immediately before the merger.

IV. Partnership Division Tax Consequences

The proposed regulations provide that the resulting partnership that
is regarded as continuing shall file a return for the taxable year
of the partnership that has been divided. Commentators requested
that the final regulations clarify the tax consequences of a
partnership that is regarded as continuing. For instance,
commentators asked how a partnership files a return and which
partnership retains the prior partnership's employer identification
number (EIN) when more than one resulting partnership is considered
a continuation of the prior partnership. Additionally, commentators
asked whether subsequent elections by one resulting partnership that
is regarded as continuing binds all resulting partnerships that are
regarded as continuing.

In response to these comments, the final regulations clarify certain
tax consequences that follow from a partnership division when more
than one resulting partnership is regarded as continuing.
Specifically, the final regulations provide that. when more than one
resulting partnership is regarded as continuing, the resulting
partnership that is treated as the divided partnership will file a
return for the taxable year of the partnership that has been divided
and retain the EIN of the prior partnership. All other resulting
partnerships that are regarded as continuing and all new
partnerships (i.e., resulting partnerships that are not considered
continuing) will file separate returns for the taxable year
beginning on the day after the date of the division with new EINs
for each partnership. The final regulations also provide that all
resulting partnerships that are continuing partnerships are subject
to preexisting elections that were made by the prior partnership.
However, a post-division election that is made by a resulting
partnership will not bind any of the other resulting partnerships.

V. Definition of Partnership Mergers and Divisions

The proposed regulations do not define what constitutes a
partnership merger or division. Some commentators have requested
that these terms be defined in the final regulations. Other
practitioners have stated that the selectivity that would be created
by attempting to draw lines in such definitions could lead to
planning opportunities that would be adverse to the government's
interest. The IRS and Treasury have decided not to provide
comprehensive definitions of what is a partnership merger or
division in these final regulations.

In addition to requesting guidance as to the general. definitions of
a partnership merger and division, some commentators have asked more
narrowly whether a partnership division can occur when only one
partner from the prior partnership is a partner in a resulting
partnership. Consider the following example: ABC partnership owns X
business and Y business. A and B each own a 20-percent interest, and
C owns a 60-percent interest in the ABC partnership. C does not want
to continue in the partnership with A and B and would like to
operate X business with D. Accordingly, ABC partnership distributes
X business to C in liquidation of C's interest in partnership ABC.
Subsequently, C forms a partnership with D and contributes X
business to the CD partnership. After the distribution and
contribution of X business, AB partnership owns Y business and CD
partnership owns X business.

The IRS and Treasury believe that the above transaction does not
constitute a division. To have a division, at least two members of
the prior partnership must be members of each resulting partnership
that exists after the transaction. In the above example, C is the
only member of the ABC partnership in the CD partnership.
Accordingly, this transaction would not be treated as a division for
Federal income tax purposes. The final regulations modify the
proposed regulations to clarify this result.

VI. Application of Sections 704(c) and 737 in Partnership Divisions

In the preamble to the proposed regulations, the IRS and Treasury
requested comments as to whether expanded exceptions. under sections
704(c)(1)(B) and 737 would be appropriate in the context of
partnership divisions. Most commentators agreed that it would not be
wise to expand the current exceptions. In a related point, some
commentators stated that the contribution of assets in a division
should not create new section 704(c) property or section 737 net
precontribution gain.

To the extent that a partnership division merely affects a
restructuring of the form in which the partners hold property (that
is, each partner's overall interest in each partnership property
does not change), the IRS and Treasury agree that a partnership
division should not create new section 704(c) property or section
737 net precontribution gain. However, it is not clear that this
result is necessarily appropriate where a division is non-pro rata
as to the partners, where some property is extracted from or added
to the partnerships in connection with the division, or where new
partners are added to the ownership group in connection with the
division. The IRS and Treasury intend to study this issue and
request comments in this regard. VII. Effective Date

The proposed regulations apply to mergers and divisions occurring on
or after the date final regulations are published in the Federal
Register. Commentators requested that the final regulations allow
partnerships to apply the regulations to mergers and divisions
occurring on or after January 11, 2000, (the date the proposed
regulations were published in the Federal Register). The
commentators explained that the regulations. provide needed clarity
in an area that has lacked guidance.

The IRS and Treasury believe it is appropriate to allow partnerships
to apply the final regulations retroactively to the publication date
of the proposed regulations. Therefore, the final regulations apply
to mergers and divisions occurring on or after January 4, 2001.
However, a partnership may apply the rules in the final regulations
for mergers and divisions occurring on or after January 11, 2000.

Special Analyses

It has been determined that this Treasury decision 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, and
because these regulations do not impose on small entities a
collection of information requirement, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply. Therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Internal Revenue Code, the notice of proposed rulemaking that
preceded these regulations was submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its
impact on small business.

Drafting Information

The principal author of these regulations is Mary Beth Collins,
Office of Chief Counsel (Passthroughs and Special Industries).
However, other personnel from the IRS and Treasury. participated in
their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements. Adoption of
Amendments to the Regulations Accordingly, 26 CFR part 1 is 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 1.708-1 is amended as follows:

1. Paragraph (b) is amended by removing paragraph (b)(2) and by
redesignating each paragraph listed in the first column of the
following table as the paragraph listed in the second column as
indicated in the following table:

Old Paragraph Redesignated Paragraph

(b)(1)(i) (b)(1)

(b)(1)(i)(a) (b)(1)(i)

(b)(1)(i)(b) (b)(1)(ii)

(b)(1)(ii) (b)(2)

(b)(1)(iii) (b)(3)

(b)(1)(iii)(a) (b)(3)(i)

(b)(1)(iii)(b) (b)(3)(ii)

(b)(1)(iv) (b)(4)

(b)(1)(v) (b)(5)

2. Paragraphs (c) and (d) are added to read as follows:
§1.708-1 Continuation of partnership.

* * * * *

(c) Merger or consolidation--(1) General rule. If two or more
partnerships merge or consolidate into one partnership, the
resulting partnership shall be considered a continuation of the
merging or consolidating partnership the members of which own an
interest of more than 50 percent in the capital and profits of the
resulting partnership. If the resulting partnership can, under the
preceding sentence, be considered a continuation of more than one of
the merging or consolidating partnerships, it shall, unless the
Commissioner permits otherwise, be considered the continuation
solely of that partnership which is credited with the contribution
of assets having the greatest fair market value (net of liabilities)
to the resulting partnership. Any other merging or consolidating
partnerships shall be considered as terminated. If the members of
none of the merging or consolidating partnerships have an interest
of more than 50 percent in the capital and profits of the resulting
partnership, all of the merged or consolidated partnerships are
terminated, and a new partnership results.

(2) Tax returns. The taxable years of any merging or consolidating
partnerships which are considered terminated shall be closed in
accordance with the provisions of section 706(c) and the regulations
thereunder, and such partnerships shall file their returns for a
taxable year ending upon the date of termination, i.e., the date of
merger or consolidation. The resulting partnership shall file a
return for the taxable year of. the merging or consolidating
partnership that is considered as continuing. The return shall state
that the resulting partnership is a continuation of such merging or
consolidating partnership, shall retain the employer identification
number (EIN) of the partnership that is continuing, and shall
include the names, addresses, and EINs of the other merged or
consolidated partnerships. The respective distributive shares of the
partners for the periods prior to and including the date of the
merger or consolidation and subsequent to the date of merger or
consolidation shall be shown as a part of the return.

(3) Form of a merger or consolidation--

(i) Assets-over form. When two or more partnerships merge or
consolidate into one partnership under the applicable jurisdictional
law without undertaking a form for the merger or consolidation, or
undertake a form for the merger or consolidation that is not
described in paragraph (c)(3)(ii) of this section, any merged or
consolidated partnership that is considered terminated under
paragraph (c)(1) of this section is treated as undertaking the
assets-over form for Federal income tax purposes. Under the assets-
over form, the merged or consolidated partnership that is considered
terminated under paragraph (c)(1) of this section contributes all of
its assets and liabilities to the resulting partnership in exchange
for an interest in the resulting partnership, and immediately
thereafter, the terminated partnership distributes interests in the
resulting partnership to its partners in liquidation of the
terminated partnership.

(ii) Assets-up form. Despite the partners' transitory ownership of
the terminated partnership's assets, the form of a partnership
merger or consolidation will be respected for Federal income tax
purposes if the merged or consolidated partnership that is
considered terminated under paragraph (c)(1) of this section
distributes all of its assets to its partners (in a manner that
causes the partners to be treated, under the laws of the applicable
jurisdiction, as the owners of such assets) in liquidation of the
partners' interests in the terminated partnership, and immediately
thereafter, the partners in the terminated partnership contribute
the distributed assets to the resulting partnership in exchange for
interests in the resulting partnership.

(4) Sale of an interest in the merging or consolidating partnership.
In a transaction characterized under the assets-over form, a sale of
all or part of a partner's interest in the terminated partnership to
the resulting partnership that occurs as part of a merger or
consolidation under section 708(b)(2)(A), as described in paragraph
(c)(3)(i) of this section, will be respected as a sale of a
partnership interest if the merger agreement (or another document)
specifies that the resulting partnership is purchasing interests
from a particular partner in the merging or consolidating
partnership and the consideration that is transferred for each
interest sold, and if the selling partner in the terminated
partnership, either prior to or contemporaneous with the
transaction, consents to treat the transaction as a sale of the
partnership interest. See section 741 and §1.741-1 for
determining the selling partner's gain or loss on the sale or
exchange of the partnership interest.

(5) Examples. The following examples illustrate the rules in
paragraphs (c)(1) through (4) of this section:

Example 1. Partnership AB, in whose capital and profits A and B each
own a 50-percent interest, and partnership CD, in whose capital and
profits C and D each own a 50-percent interest, merge on September
30, 1999, and form partnership ABCD. Partners A, B, C, and D are on
a calendar year, and partnership AB and partnership CD also are on a
calendar year. After the merger, the partners have capital and
profits interests as follows: A, 30 percent; B, 30 percent; C, 20
percent; and D, 20 percent. Since A and B together own an interest
of more than 50 percent in the capital and profits of partnership
ABCD, such partnership shall be considered a continuation of
partnership AB and shall continue to file returns on a calendar year
basis. Since C and D own an interest of less than 50 percent in the
capital and profits of partnership ABCD, the taxable year of
partnership CD closes as of September 30, 1999, the date of the
merger, and partnership CD is terminated as of that date.
Partnership ABCD is required to file a return for the taxable year
January 1 to December 31, 1999, indicating thereon that, until
September 30, 1999, it was partnership AB. Partnership CD is
required to file a return for its final taxable year, January 1
through September 30, 1999.

Example 2.

(i) Partnership X, in whose capital and profits A owns a 40-percent
interest and B owns a 60-percent interest, and partnership Y, in
whose capital and profits B owns a 60- percent interest and C owns a
40-percent interest, merge on September 30, 1999. The fair market
value of the partnership X assets (net of liabilities) is $100X, and
the fair market value of the partnership Y assets (net of
liabilities) is $200X. The merger is accomplished under state law by
partnership Y contributing its assets and liabilities to partnership
X in exchange for interests in partnership X, with partnership Y
then liquidating, distributing interests in partnership X to B and
C.

(ii) B, a partner in both partnerships prior to the merger, owns a
greater than 50-percent interest in the resulting partnership
following the merger. Accordingly, because the fair market value of
partnership Y's assets (net of liabilities) was greater than that of
partnership X's, under paragraph (c)(1) of this section, partnership
X will be considered to terminate in the merger. As a result, even
though, for state law purposes, the transaction was undertaken with
partnership Y contributing its assets and liabilities to partnership
X and distributing interests in partnership X to its partners,
pursuant to paragraph (c)(3)(i) of this section, for Federal income
tax purposes, the transaction will be treated as if partnership X
contributed its assets to partnership Y in exchange for interests in
partnership Y and then liquidated, distributing interests in
partnership Y to A and B.

Example 3.

(i) The facts are the same as in Example 2, except that partnership
X is engaged in a trade or business and has, as one of its assets,
goodwill. In addition, the merger is accomplished under state law by
having partnership X convey an undivided 40-percent interest in each
of its assets to A and an undivided 60-percent interest in each of
its assets to B, with A and B then contributing their interests in
such assets to partnership Y. Partnership Y also assumes all of the
liabilities of partnership X.

(ii) Under paragraph (c)(3)(ii) of this section, the form of the
partnership merger will be respected so that partnership X will be
treated as following the assets-up form for Federal income tax
purposes.

Example 4.

(i) Partnership X and partnership Y merge when the partners of
partnership X transfer their partnership X interests to partnership
Y in exchange for partnership Y interests. Immediately thereafter,
partnership X liquidates into partnership Y. The resulting
partnership is considered a continuation of partnership Y, and
partnership X is considered terminated.

(ii) The partnerships are treated as undertaking the assets-over
form described in paragraph (c)(3)(i) of this section because the
partnerships undertook a form that is not the assets-up form
described in paragraph (c)(3)(ii) of this section. Accordingly, for
Federal income tax purposes, partnership X is deemed to contribute
its assets and liabilities to partnership Y in exchange for
interests in partnership Y, and, immediately thereafter, partnership
X is deemed to have distributed the interests in partnership Y to
its partners in liquidation of their interests in partnership X.

Example 5.

(i) A, B, and C are partners in partnership X. D, E, and F are
partners in Partnership Y. Partnership X and partnership Y merge,
and the resulting partnership is considered a continuation of
partnership Y. Partnership X is considered terminated. Under state
law, partnerships X and Y undertake the assets-over form of
paragraph (c)(3)(i) of this section to accomplish the partnership
merger. C does not want to become a partner in partnership Y, and
partnership X does not have the resources to buy C's interest before
the merger. C, partnership X, and partnership Y enter into an
agreement specifying that partnership Y will purchase C's interest
in partnership X for $150 before the merger, and as part of the
agreement, C consents to treat the transaction in a manner that is
consistent with the agreement. As part of the merger, partnership X
receives from partnership Y $150 that will be distributed to C
immediately before the merger, and interests in partnership Y in
exchange for partnership X's assets and liabilities.

(ii) Because the merger agreement satisfies the requirements of
paragraph (c)(4) of this section and C provides the necessary
consent, C will be treated as selling its interest in partnership X
to partnership Y for $150 before the merger. See section 741 and
§1.741-1 to determine the amount and character of C's gain or
loss on the sale or exchange of its interest in partnership X.

(iii) Because the merger agreement satisfies the requirements of
paragraph (c)(4) of this section, partnership Y is considered to
have purchased C's interest in partnership X for $150 immediately
before the merger. See §1.704-1(b)(2)(iv)(l) for determining
partnership Y's capital account in partnership X.

Partnership Y's adjusted basis of its interest in partnership X is
determined under section 742 and §1.742-1. To the extent any
built-in gain or loss on section 704(c) property in partnership X
would have been allocated to C (including any allocations with
respect to property revaluations under section 704(b) (reverse
section 704(c) allocations)), see section 704 and §1.704-3(a)
(7) for determining the built-in gain or loss or reverse section
704(c) allocations apportionable to partnership Y. Similarly, after
the merger is completed, the built-in gain or loss and reverse
section 704(c) allocations attributable to C's interest are
apportioned to D, E, and F under section 704(c) and §1.704-
3(a)(7).

(iv) Under paragraph (c)(3)(i) of this section, partnership X
contributes its assets and liabilities attributable to the interests
of A and B to partnership Y in exchange for interests in partnership
Y; and, immediately thereafter, partnership X distributes the
interests in partnership Y to A and B in liquidation of their
interests in partnership X. At the same time, partnership X
distributes assets to partnership Y in liquidation of partnership
Y's interest in partnership X. Partnership Y's bases in the
distributed assets are determined under section 732(b).

(6) Prescribed form not followed in certain circumstances.

(i) If any transactions described in paragraph (c)(3) or (4) of this
section are part of a larger series of transactions, and the
substance of the larger series of transactions is inconsistent with
following the form prescribed in such paragraph, the Commissioner
may disregard such form, and may recast the larger series of
transactions in accordance with their substance.

(ii) Example. The following example illustrates the rules in
paragraph (c)(6) of this section: Example. A, B, and C are equal
partners in partnership ABC. ABC holds no section 704(c) property. D
and E are equal partners in partnership DE. B and C want to exchange
their interests in ABC for all of the interests in DE. However,
rather than exchanging partnership interests, DE merges with ABC by
undertaking the assets-up form described in paragraph (c)(3)(ii) of
this section, with D and E receiving title to the DE assets and then
contributing the assets to ABC in exchange for interests in ABC. As
part of a prearranged transaction, the assets acquired from DE are
contributed to a new partnership, and the interests in the new
partnership are distributed to B and C in complete liquidation of
their interests in ABC. The merger and division in this example
represent a series of transactions that in substance are an exchange
of interests in ABC for interests in DE. Even though paragraph (c)
(3)(ii) of this section provides that the form of a merger will be
respected for Federal income tax purposes if the steps prescribed
under the assets-up form are followed, and paragraph (d)(3)(i) of
this section provides a form that will be followed for Federal
income tax purposes in the case of partnership divisions, these
forms will not be respected for Federal income tax purposes under
these facts, and the transactions will be recast in accordance with
their substance as a taxable exchange of interests in ABC for
interests in DE.

(7) Effective date. This paragraph (c) is applicable to partnership
mergers occurring on or after January 4, 2001. However, a
partnership may apply paragraph (c) of this section to partnership
mergers occurring on or after January 11, 2000.

(d) Division of a partnership--(1) General rule. Upon the division
of a partnership into two or more partnerships, any resulting
partnership (as defined in paragraph (d)(4)(iv) of this section) or
resulting partnerships shall be considered a continuation of the
prior partnership (as defined in paragraph (d)(4)(ii) of this
section) if the members of the resulting partnership or partnerships
had an interest of more than 50 percent in the capital and profits
of the prior partnership. Any other resulting partnership will not
be considered a continuation of the prior partnership but will be
considered a new partnership. If the members of none of the
resulting partnerships owned an interest of more than 50 percent in
the capital and profits of the prior partnership, none of the
resulting partnerships will be considered a continuation of the
prior partnership, and the prior partnership will be considered to
have terminated. Where members of a partnership which has been
divided into two or more partnerships do not become members of a
resulting partnership which is considered a continuation of the
prior partnership, such members' interests shall be considered
liquidated as of the date of the division.

(2) Tax consequences--

(i) Tax returns. The resulting partnership that is treated as the
divided partnership (as defined in paragraph (d)(4)(i) of this
section) shall file a return for the taxable year of the partnership
that has been divided and retain the employer identification number
(EIN) of the prior partnership. The return shall include the names,
addresses, and EINs of all resulting partnerships that are regarded
as continuing. The return shall also state that the partnership is a
continuation of the prior partnership and shall set forth separately
the respective distributive shares of the partners for the periods
prior to and including the date of the division and subsequent to
the date of division. All other resulting partnerships that are
regarded as continuing and new partnerships shall file separate
returns for the taxable year beginning on the day after the date of
the division with new EINs for each partnership. The return for a
resulting partnership that is regarded as continuing and that is not
the divided partnership shall include the name, address, and EIN of
the prior partnership.

(ii) Elections. All resulting partnerships that are regarded as
continuing are subject to preexisting elections that were made by
the prior partnership. A subsequent election that is made by a
resulting partnership does not affect the other resulting
partnerships.

(3) Form of a division--

(i) Assets-over form. When a partnership divides into two or more
partnerships under applicable jurisdictional law without undertaking
a form for the division, or undertakes a form that is not described
in paragraph (d)(3)(ii) of this section, the transaction will be
characterized under the assets-over form for Federal income tax
purposes.

(a) Assets-over form where at least one resulting partnership is a
continuation of the prior partnership. In a division under the
assets-over form where at least one resulting partnership is a
continuation of the prior partnership, the divided partnership (as
defined in paragraph (d)(4)(i) of this section) contributes certain
assets and liabilities to a recipient partnership (as defined in
paragraph (d)(4)(iii) of this section) or recipient partnerships in
exchange for interests in such recipient partnership or
partnerships; and, immediately thereafter, the divided partnership
distributes the interests in such recipient partnership or
partnerships to some or all of its partners in partial or complete
liquidation of the partners' interests in the divided partnership.

(b) Assets-over form where none of the resulting partnerships is a
continuation of the prior partnership. In a division under the
assets-over form where none of the resulting partnerships is a
continuation of the prior partnership, the prior partnership will be
treated as contributing all of its assets and liabilities to new
resulting partnerships in exchange for interests in the resulting
partnerships; and, immediately thereafter, the prior partnership
will be treated as liquidating by distributing the interests in the
new resulting partnerships to the prior partnership's partners.

(ii) Assets-up form--(A) Assets-up form where the partnership
distributing assets is a continuation of the prior partnership.
Despite the partners' transitory ownership of some of the prior
partnership's assets, the form of a partnership division will be
respected for Federal income tax purposes if the divided partnership
(which, pursuant to §1.708-1(d)(4)(i), must be a continuing
partnership) distributes certain assets (in a manner that causes the
partners to be treated, under the laws of the applicable
jurisdiction, as the owners of such assets) to some or all of its
partners in partial or complete liquidation of the partners'
interests in the divided partnership, and immediately thereafter,
such partners contribute the distributed assets to a recipient
partnership or partnerships in exchange for interests in such
recipient partnership or partnerships. In order for such form to be
respected for transfers to a particular recipient partnership, all
assets held by the prior partnership that are transferred to the
recipient partnership must be distributed to, and then contributed
by, the partners of the recipient partnership.

(b) Assets-up form where none of the resulting partnerships are a
continuation of the prior partnership. If none of the resulting
partnerships are a continuation of the prior partnership, then
despite the partners' transitory ownership of some or all of the
prior partnership's assets, the form of a partnership division will
be respected for Federal income tax purposes if the prior
partnership distributes certain assets (in a manner that causes the
partners to be treated, under the laws of the applicable
jurisdiction, as the owners of such assets) to some or all of its
partners in partial or complete liquidation of the partners'
interests in the prior partnership, and immediately thereafter, such
partners contribute the distributed assets to a resulting
partnership or partnerships in exchange for interests in such
resulting partnership or partnerships. In order for such form to be
respected for transfers to a particular resulting partnership, all
assets held by the prior partnership that are transferred to the
resulting partnership must be distributed to, and then contributed
by, the partners of the resulting partnership. If the prior
partnership does not liquidate under the applicable jurisdictional
law, then with respect to the assets and liabilities that, in form,
are not transferred to a new resulting partnership, the prior
partnership will be treated as transferring these assets and
liabilities to a new resulting partnership under the assets-over
form described in paragraph (d)(3)(i)(B) of this section.

(4) Definitions--

(i) Divided partnership. For purposes of paragraph (d) of this
section, the divided partnership is the continuing partnership which
is treated, for Federal income tax purposes, as transferring the
assets and liabilities to the recipient partnership or partnerships,
either directly (under the assets-over form) or indirectly (under
the assets-up form). If the resulting partnership that, in form,
transferred the assets and liabilities in connection with the
division is a continuation of the prior partnership, then such
resulting partnership will be treated as the divided partnership. If
a partnership divides into two or more partnerships and only one of
the resulting partnerships is a continuation of the prior
partnership, then the resulting partnership that is a continuation
of the prior partnership will be treated as the divided partnership.
If a partnership divides into two or more partnerships without
undertaking a form for the division that is recognized under
paragraph (d)(3) of this section, or if the resulting partnership
that had, in form, transferred assets and liabilities is not
considered a continuation of the prior partnership, and more than
one resulting partnership is considered a continuation of the prior
partnership, the continuing resulting partnership with the assets
having the greatest fair market value (net of liabilities) will be
treated as the divided partnership.

(ii) Prior partnership. For purposes of paragraph (d) of this
section, the prior partnership is the partnership subject to
division that exists under applicable jurisdictional law before the
division.

(iii) Recipient partnership. For purposes of paragraph (d) of this
section, a recipient partnership is a partnership that is treated as
receiving, for Federal income tax purposes, assets and liabilities
from a divided partnership, either directly (under the assets-over
form) or indirectly (under the assets-up form).

(iv) Resulting partnership. For purposes of paragraph (d) of this
section, a resulting partnership is a partnership resulting from the
division that exists under applicable jurisdictional law after the
division and that has at least two partners who were partners in the
prior partnership. For example, where a prior partnership divides
into two partnerships, both partnerships existing after the division
are resulting partnerships.

(5) Examples. The following examples illustrate the rules in
paragraphs (d)(1), (2), (3), and (4) of this section: Example 1.
Partnership ABCD is in the real estate and insurance businesses. A
owns a 40-percent interest, and B, C, and D each owns a 20-percent
interest, in the capital and profits of the partnership. The
partnership and the partners report their income on a calendar year.
On November 1, 1999, they separate the real estate and insurance
businesses and form two partnerships. Partnership AB takes over the
real estate business, and partnership CD takes over the insurance
business.

Because members of resulting partnership AB owned more than a 50-
percent interest in the capital and profits of partnership ABCD (A,
40 percent, and B, 20 percent), partnership AB shall be considered a
continuation of partnership ABCD. Partnership AB is required to file
a return for the taxable year January 1 to December 31, 1999,
indicating thereon that until November 1, 1999, it was partnership
ABCD. Partnership CD is considered a new partnership formed at the
beginning of the day on November 2, 1999, and is required to file a
return for the taxable year it adopts pursuant to section 706(b) and
the applicable regulations.

Example 2.

(i) Partnership ABCD owns properties W, X, Y, and Z, and divides
into partnership AB and partnership CD. Under paragraph (d)(1) of
this section, partnership AB is considered a continuation of
partnership ABCD and partnership CD is considered a new partnership.
Partnership ABCD distributes property Y to C and titles property Y
in C's name. Partnership ABCD distributes property Z to D and titles
property Z in D's name. C and D then contribute properties Y and Z,
respectively, to partnership CD in exchange for interests in
partnership CD. Properties W and X remain in partnership AB.

(ii) Under paragraph (d)(3)(ii) of this section, partnership ABCD
will be treated as following the assets-up form for Federal income
tax purposes.

Example 3.

(i) The facts are the same as in Example 2, except partnership ABCD
distributes property Y to C and titles property Y in C's name. C
then contributes property Y to partnership CD. Simultaneously,
partnership ABCD contributes property Z to partnership CD in
exchange for an interest in partnership CD. Immediately thereafter,
partnership ABCD distributes the interest in partnership CD to D in
liquidation of D's interest in partnership ABCD.

(ii) Under paragraph (d)(3)(i) of this section, because partnership
ABCD did not undertake the assets-up form with respect to all of the
assets transferred to partnership CD, partnership ABCD will be
treated as undertaking the assets-over form in transferring the
assets to partnership CD. Accordingly, for Federal income tax
purposes, partnership ABCD is deemed to contribute property Y and
property Z to partnership CD in exchange for interests in
partnership CD, and immediately thereafter, partnership ABCD is
deemed to distribute the interests in partnership CD to partner C
and partner D in liquidation of their interests in partnership ABCD.

Example 4.

(i) Partnership ABCD owns three parcels of property: property X,
with a value of $500; property Y, with a value of $300; and property
Z, with a value of $200. A and B each own a 40-percent interest in
the capital and profits of partnership ABCD, and C and D each own a
10 percent interest in the capital and profits of partnership ABCD.
On November 1, 1999, partnership ABCD divides into three
partnerships (AB1, AB2, and CD) by contributing property X to a
newly formed partnership (AB1) and distributing all interests in
such partnership to A and B as equal partners, and by contributing
property Z to a newly formed partnership (CD) and distributing all
interests in such partnership to C and D as equal partners in
exchange for all of their interests in partnership ABCD. While
partnership ABCD does not transfer property Y, C and D cease to be
partners in the partnership. Accordingly, after the division, the
partnership holding property Y is referred to as partnership AB2.

(ii) Partnerships AB1 and AB2 both are considered a continuation of
partnership ABCD, while partnership CD is considered a new
partnership formed at the beginning of the day on November 2, 1999.
Under paragraph (d)(3)(i)(A) of this section, partnership ABCD will
be treated as following the assets-over form, with partnership ABCD
contributing property X to partnership AB1 and property Z to
partnership CD, and distributing the interests in such partnerships
to the designated partners.

Example 5.

(i) The facts are the same as in Example 4, except that partnership
ABCD divides into three partnerships by operation of state law,
without undertaking a form.

(ii) Under the last sentence of paragraph (d)(4)(i) of this section,
partnership AB1 will be treated as the resulting partnership that is
the divided partnership. Under paragraph (d)(3)(i)(A) of this
section, partnership ABCD will be treated as following the assets-
over form, with partnership ABCD contributing property Y to
partnership AB2 and property Z to partnership CD, and distributing
the interests in such partnerships to the designated partners.

Example 6.

(i) The facts are the same as in Example 4, except that partnership
ABCD divides into three partnerships by contributing property X to
newly-formed partnership AB1 and property Y to newly-formed
partnership AB2 and distributing all interests in each partnership
to A and B in exchange for all of their interests in partnership
ABCD.

(ii) Because resulting partnership CD is not a continuation of the
prior partnership (partnership ABCD), partnership CD cannot be
treated, for Federal income tax purposes, as the partnership that
transferred assets (i.e., the divided partnership), but instead must
be treated as a recipient partnership. Under the last sentence of
paragraph (d)(4)(i) of this section, partnership AB1 will be treated
as the resulting partnership that is the divided partnership. Under
paragraph (d)(3)(i)(A) of this section, partnership ABCD will be
treated as following the assets-over form, with partnership ABCD
contributing property Y to partnership AB2 and property Z to
partnership CD, and distributing the interests in such partnerships
to the designated partners.

Example 7.

(i) Partnership ABCDE owns Blackacre, Whiteacre, and Redacre, and
divides into partnership AB, partnership CD, and partnership DE.
Under paragraph (d)(1) of this section, partnership ABCDE is
considered terminated (and, hence, none of the resulting
partnerships are a continuation of the prior partnership) because
none of the members of the new partnerships (partnership AB,
partnership CD, and partnership DE) owned an interest of more than
50 percent in the capital and profits of partnership ABCDE.

(ii) Partnership ABCDE distributes Blackacre to A and B and titles
Blackacre in the names of A and B. A and B then contribute Blackacre
to partnership AB in exchange for interests in partnership AB.
Partnership ABCDE will be treated as following the assets-up form
described in paragraph (d)(3)(ii)(B) of this section for Federal
income tax purposes.

(iii) Partnership ABCDE distributes Whiteacre to C and D and titles
Whiteacre in the names of C and D. C and D then contribute Whiteacre
to partnership CD in exchange for interests in partnership CD.
Partnership ABCDE will be treated as following the assets-up form
described in paragraph (d)(3)(ii)(B) of this section for Federal
income tax purposes.

(iv) Partnership ABCDE does not liquidate under state law so that,
in form, the assets in new partnership DE are not considered to have
been transferred under state law. Partnership ABCDE will be treated
as undertaking the assets-over form described in paragraph (d)(3)(i)
(B) of this section for Federal income tax purposes with respect to
the assets of partnership DE. Thus, partnership ABCDE will be
treated as contributing Redacre to partnership DE in exchange for
interests in partnership DE; and, immediately thereafter,
partnership ABCDE will be treated as distributing interests in
partnership DE to D and E in liquidation of their interests in
partnership ABCDE. Partnership ABCDE then terminates.

(6) Prescribed form not followed in certain circumstances. If any
transactions described in paragraph (d)(3) of this section are part
of a larger series of transactions, and the substance of the larger
series of transactions is inconsistent with following the form
prescribed in such paragraph, the Commissioner may disregard such
form, and may recast the larger series of transactions in accordance
with their substance.

(7) Effective date. This paragraph (d) is applicable to partnership
divisions occurring on or after January 4, 2001. However, a
partnership may apply paragraph (d) of this section to partnership
divisions occurring on or after January 11, 2000. Par. 3. Section
1.752-1 is amended as follows:

1. A sentence is added to the end of paragraph (f).

2. The current Example in paragraph (g) is redesignated as Example
1.

3. Example 2 is added in paragraph (g). The additions read as
follows: §1.752-1 Treatment of partnership liabilities.

* * * * *

(f) * * * When two or more partnerships merge or consolidate under
section 708(b)(2)(A), as described in §1.708-1(c)(3)(i),
increases and decreases in partnership liabilities associated with
the merger or consolidation are netted by the partners in the
terminating partnership and the resulting partnership to determine
the effect of the merger under section 752.

(g) * * *

Example 1. * * *

Example 2. Merger or consolidation of partnerships holding property
encumbered by liabilities.

(i) B owns a 70 percent interest in partnership T. Partnership T's
sole asset is property X, which is encumbered by a $900 liability.
Partnership T's adjusted basis in property X is $600, and the value
of property X is $1,000. B's adjusted basis in its partnership T
interest is $420. B also owns a 20 percent interest in partnership
S. Partnership S's sole asset is property Y, which is encumbered by
a $100 liability. Partnership S's adjusted basis in property Y is
$200, the value of property Y is $1,000, and B's adjusted basis in
its partnership S interest is $40.

(ii) Partnership T and partnership S merge under section 708(b)(2)
(A). Under section 708(b)(2)(A) and §1.708-1(c)(1), partnership
T is considered terminated and the resulting partnership is
considered a continuation of partnership S.

Partnerships T and S undertake the form described in
§1.708-1(c)(3)(i) for the partnership merger. Under
§1.708-1(c)(3)(i), partnership T contributes property X and its
$900 liability to partnership S in exchange for an interest in
partnership S. Immediately thereafter, partnership T distributes the
interests in partnership S to its partners in liquidation of their
interests in partnership T. B owns a 25 percent interest in
partnership S after partnership T distributes the interests in
partnership S to B.

(iii) Under paragraph (f) of this section, B nets the increases and
decreases in its share of partnership liabilities associated with
the merger of partnership T and partnership S. Before the merger,
B's share of partnership liabilities was $650 (B had a $630 share of
partnership liabilities in partnership T and a $20 share of
partnership liabilities in partnership S immediately before the
merger). B's share of S's partnership liabilities after the merger
is $250 (25 percent of S's total partnership liabilities of $1,000).
Accordingly, B has a $400 net decrease in its share of S's
partnership liabilities. Thus, B is treated as receiving a $400
distribution from partnership S under section 752(b). Because B's
adjusted basis in its partnership S interest before the deemed
distribution under section 752(b) is $460 ($420 + $40), B will not
recognize gain under section 731. After the merger, B's adjusted
basis in its partnership S interest is $60.

* * * * *

Par. 4. In §1.752-5, paragraph (a) is amended by adding two
sentences after the third sentence.

§1.752-5 Effective dates and transition rules.

(a) In general. * * * In addition, §1.752-1(f) last sentence
and (g) Example 2, do not apply to any liability incurred or assumed
by a partnership prior to January 4, 2001. Nevertheless,
§1.752-1(f) last sentence and (g) Example 2, may be relied on
for any liability incurred or assumed by a partnership prior to
January 4, 2001 and, unless the partnership makes an election under
paragraph (b)(1) of this section, on or after December 28, 1991,
other than a liability incurred or assumed by the partnership
pursuant to a written binding contract in effect prior to December
28, 1991 and at all times thereafter. * * *

* * * * *

David A. Mader
Acting Deputy Commissioner of Internal Revenue

Approved: 12-20-00

Jonathan Talisman
Acting Assistant Secretary of the Treasury

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