IRS Seeks to Close Partnership Basis-Shifting Tax Loopholes
What You Need to Know
These types of transactions create no real economic value apart from tax reduction, the agency contends.
The IRS intends to use additional funding under the Inflation Reduction Act to significantly increase audits and challenge these techniques.
The regulations would deny depreciation deductions in future years even if the relevant transaction occurred before 2024.
The Internal Revenue Service has announced that it intends to propose regulations designed to close certain loopholes used by partnerships to minimize their tax liability through transactions that have no real economic substance.
The guidance focuses on complicated basis-shifting transactions through which taxpayers shift the basis of assets between closely related partners or entities to reduce taxable gain or increase depreciation deductions.
According to the IRS, these types of transactions create no real economic value apart from tax reduction. The IRS announced its intent to provide rules regarding the impact of basis adjustments in certain types of transactions — and also identifies related-party transactions resulting in basis adjustments as reportable transactions of interest.
The IRS intends to use its additional funding under the Inflation Reduction Act to significantly increase audits and challenge these related-party transactions going forward.
Although the new guidance is only in proposed form, the IRS was clear that the regulations would deny depreciation deductions, or reduction in gain on disposition, in future years even if the relevant transaction occurred before 2024. Taxpayers should consult their tax advisors to explore the tax ramifications of these transactions.
Three Types of Transactions
The IRS has identified three specific types of transactions used by partnerships to minimize taxation through basis adjustments: (1) transfer of partnership interests to related parties, (2) distribution of property to a related party, and (3) liquidation of related partnership or partner.
In the first type of transaction, a partner with a low share of the partnership’s “inside” tax basis and a high “outside” tax basis transfers the interest tax-free to a related party. The transfer is valuable to the partnership because it generates a tax-free basis increase to the transferee partner’s share of “inside” basis.
In the second type of transaction, a partnership with related partners distributes a high-basis asset to one of the related partners that has a low outside basis. The recipient then reduces the basis of the distributed asset, and the partnership receives a corresponding increase in the basis of its remaining assets to create tax savings.
