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o Allocation Method for Nonamortizable IRC section 197 Intangibles
o Anti-Churning Rules
• Issue: Anti-Abuse Rule
o Issue: Effect of IRC section 704(c) On Partners' Share of Non-Recourse Liabilities
o Issue: "Reverse" 704(c) — Revaluations
o Examination Techniques
o Supporting Law
o Resources
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Introduction
When a partner contributes property to a partnership which has increased or decreased in value, the property
has an inherent built-in gain or built-in loss that arose during the period in which the partner owned the
property outside of the partnership. Thus, at the time of contribution, the property has a tax basis to the
partnership that differs from its fair market value (FMV). As was discussed in Chapter 1, the property's FMV at
the time of contribution is what is called the "book value." Where the "book value" (FMV at contribution) and
the "tax basis" (basis carried over from the contributing partner) differ, the property is referred to as "section
704(c) property."
The goal of IRC section 704(c) is to prevent the shifting of tax consequences (gain, loss, and deductions) with
respect to appreciated or depreciated property contributed by a partner to a partnership. It upholds the
assignment of income principle by requiring the contributing partner to be taxed on the portion of the gain or
loss that arose prior to the property's contribution to the partnership. This chapter will cover:
• IRC section 704(c) in the context of non-depreciable property
• IRC section 704(c) in the context or depreciable property
• IRC section 704(c) in the context of amortizable property
• Impact of IRC section 704(c) on the sharing of non-recourse liabilities
• "Reverse" IRC section 704(c) which addresses re-valuations
• IRC section 704(c)(1)(C) and duplication of built-in losses
• The Anti-Abuse Rule
Overview
Prior to 1984, there was no special rule that a contributing partner had to take into account the gain or loss
inherent in property at the time of contribution. In 1984, Congress took action to prevent partners from shifting
pre-contribution gain or loss among themselves and made IRC section 704(c) mandatory. As a result, gain or
loss inherent in contributed property must be allocated back to the contributing partner. In the case of non-
depreciable property, this can happen all at once when the property is sold. On the other hand, gain or loss
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inherent in depreciable property will be recognized over time as depreciation deductions are allocated to other
partners and away from the contributing partner, thereby increasing the contributing partner's share of
partnership income.
Final regulations for 704(c) were issued on December 21, 1993. These regulations include an anti-abuse rule in
Treas. Reg. section 1.704-3(a)(10). A firm grounding in the basic operation of IRC section 704(c) is critical to
understanding the proper allocation of gain, loss, and cost recovery pertaining to IRC section 704(c) property.
Additionally, IRC section 704(c) principles have an impact on a contributing partner's share of partnership non-
recourse debt.
ISSUE: IRC SECTION 704(c) AND NON-DEPRECIABLE PROPERTY
Example 3-1
Adam and Melvin form an equal partnership in which Adam contributes raw land with a tax basis of $10,000
and a FMV of $50,000. Melvin contributes $50,000 of cash. The land is IRC section 704(c) property because
there is a $40,000 appreciation that occurred prior to its contribution to the partnership. Its book value is
$50,000 and its tax basis is $10,000.
If the partnership were to sell the land for $50,000, the entire gain would be allocated to Adam.
If the land appreciated in the hands of the partnership and it were sold for $100,000, $50,000 of the gain would
be split equally between Adam and Melvin and the built-in gain of $40,000 would be allocated to Adam.
Consistent with the assignment of income principles, Melvin is only allocated a portion of the gain that accrued
during the time that he owned the land via the partnership. All of the built-in gain of ($40,000) that accrued
prior to contribution is allocated back to the contributing partner.
Allocation Methods — Non-depreciable Property
Although straightforward in its aim of upholding the assignment of income principle and allocating to the
contributing partner any built-in gain or loss, IRC section 704(c) becomes more complicated when there has
been a tax gain but a book loss.
Example 3-2
Taking the facts from Example 3-1, if the land decreased in value to $30,000 and was sold, there would be a tax
gain of $20,000 ($30,000 less tax basis of $10,000). Following IRC section 704(c) principles, this gain would
be allocated to Adam. Melvin, on the other hand, has suffered an economic loss but has no accompanying tax
loss. Remember that Melvin bought an undivided interest in a partnership that owned land worth $50,000. The
land had a book value of $50,000 and was sold for $30,000, resulting in a $20,000 book loss. The problem here