US state income tax digest April 2025
The US state income tax digest highlights significant income and business tax legislation, regulatory adoptions, judicial decisions, and administrative guidance.
Guidance designated related party basis adjustment transactions
March 2025
In brief
What happened?
The Treasury Department and the IRS issued final regulations addressing Related-Party Basis Adjustment Disclosure obligations on January 14, 2025 (the RPBA Regulations) identifying certain partnership related-party basis transactions (Covered Transactions) as Transactions of Interest, which must be disclosed to the IRS by participants and material advisors.
Why is it relevant?
Subject to certain exceptions, participants and material advisors now must disclose many common partnership transactions that result in basis adjustments, including current and liquidating distributions of property by a partnership with related partners and non-recognition transfers of partnership interests to a related partner. Disclosure requirements may apply to both current Transactions of Interest and completed Transactions of Interest that occurred during the 72-month period beginning prior to the start of the taxpayer’s most recent tax year that began prior to the publication of the final regulations (the Lookback Period).
Failing to disclose a Transaction of Interest could result in penalties for both participants and material advisors.
Action to consider:
Taxpayers should consider whether they have participated in any transactions involving partnerships that resulted in basis adjustments during the Lookback Period and should consult with their advisors about whether transactions completed during the Lookback Period or currently under consideration are Transactions of Interest that require disclosure under the RPBA Regulations.
In detail
Background
The partnership tax rules generally minimize or eliminate disparities between a partner’s basis in its partnership interest (outside basis) and that partner’s share of the partnership’s basis in partnership assets (inside basis) that can arise on a sale or exchange of a partnership interest or in connection with a partnership distribution. In June 2024, Treasury and the IRS issued three guidance items (the June Related-Party Basis Adjustment Guidance) to address “transactions involving related parties in which basis adjustments were created to artificially generate or regenerate Federal income tax benefits that resulted in significant tax savings without a corresponding economic outlay.”
The June Related-Party Basis Adjustment Guidance included (1) proposed regulations that would treat certain covered transactions as Transactions of Interest required to be disclosed to the IRS by participants and material advisors; (2) Notice 2024-54, which announced that Treasury and the IRS plan to publish proposed regulations with respect to Related-Party Basis Adjustment Transactions as well as proposed regulations with respect to the taxable income and tax liability of a consolidated group whose members own interests in a partnership that, when finalized, would limit the ability of certain partners to benefit from basis adjustments attributable to Transactions of Interest; and (3) Rev. Rul. 2024-14, which holds that the economic substance doctrine applies to disallow tax benefits in three scenarios involving a related-party partnership that engaged in transactions with a view to creating a disparity between inside and outside basis that resulted in a basis adjustment to property that either increased cost recovery deductions with respect to the property or reduced gain or increased loss upon the sale of the property.
The RPBA Regulations officially designate specified transactions as Transactions of Interest that must be disclosed to the IRS by participants and material advisors. Transactions of Interest are a type of reportable transaction that the IRS and Treasury believe “has the potential for tax avoidance or evasion, but [for which the IRS lacks] sufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction.”
Observation: The proposed regulations announced by Treasury and the IRS in Notice 2024-54 have not been published as of the date of this Insight. Thus, there are no new substantive rules with respect to the Transactions of Interest described in the RPBA Regulations.
Transactions of Interest
The RPBA Regulations designate a wide variety of common partnership transactions involving related partners as Transactions of Interest. For this purpose, partners are related if they have a relationship described in either Section 267(b) (without regard to Section 267(c)(3)) or Section 707(b). Critically, the RPBA regulations do not require that the related partners be related to the partnership or require that the related partners own a threshold amount of partnership interests. Thus, even incidental ownership of partnership equity by related persons theoretically could trigger a reporting obligation in common transactions. Transactions designated as Transactions of Interest generally fall into the following four categories:
- A partnership current or liquidating distribution of cash or property to a partner who is a related partner with respect to any other partner and that results in the partnership increasing the basis of one or more of its remaining properties.
- A partnership distribution of property in liquidation of the interest of a partner who is a related partner with respect to any other partner (or as part of the complete liquidation of the partnership) and that results in an increase in the basis of one or more of the distributed properties under Section 732.
- A distribution of property to a partner who is a related partner with respect to any other partner by a partnership that had not elected under Section 754 when that partner acquired its interest and that results in an increase in the basis of one or more of the distributed properties under Section 732(d).
- The transfer of an interest in a partnership to a partner that is related to the transferring partner in a non-recognition transaction that results in a basis increase to one or more partnership properties.
The subsequent realization of tax benefits in any year following an initial Transaction of Interest in which the tax return of the partnership or its partner reflects the tax consequences of a basis increase resulting from that initial Transaction of Interest is itself a Transaction of Interest. While the RPBA Regulations seem primarily focused on subsequent disclosure of step-up amortization or depreciation, or recovery on sale of the adjusted property, disclosure also may be required even in a subsequent year in which none of the adjustment is recovered (e.g., an adjustment to corporate stock) because the adjustment will continue to be reflected annually on the participating partnership’s tax return.
The RPBA Regulations also provide that a transaction that is substantially similar to any of the four categories described above also is a Transaction of Interest. The regulations under Section 6011 require that when assessing similarity, the rules should be construed broadly in favor of disclosure. The RPBA Regulations provide the following two examples of substantially similar Transactions of Interest:
- A partnership distribution of property that would be a Transaction of Interest under either of the first two scenarios described above except that (1) the partners are not related and (2) one or more of the partners is a tax-indifferent party who facilitates a basis increase to any other partner by receiving a reduced basis in distributed property or in its share of partnership property. For this purpose, a partner is a tax-indifferent party if the partner is either not liable for US federal income tax (e.g., a partner with tax-exempt or foreign status) or if any increased gain from the transaction would not result in a federal income tax liability, and whose status as a tax-indifferent party is known or should have been known by the partnership or any of its other partners. (A tax-indifferent party does not include a partnership or S corporation unless formed with a principal purpose of avoiding tax indifferent party status.)
- The transfer of an interest in a partnership to a partner that is related to the transferring partner in a recognition transaction that results in a basis increase to one or more partnership properties.
Observation: The RPBA Regulations designate many common partnership transactions as Transactions of Interest and do not include an intent standard that would limit disclosure to transactions that are within the much narrower list of targeted transactions described in Rev. Rul 2024-54. Thus, a significant number of disclosures are expected under these regulations.
In addition to transactions involving related parties, transactions involving tax-indifferent parties also may be Transactions of Interest to the extent the partnership or partners are or should be aware that the counter-party is tax-exempt or otherwise would not be subject to tax in the year in which gain would ordinarily be recognized.
The RPBA Regulations explicitly exclude the following categories of transaction from the Transaction of Interest definition:
- In the case of a partnership interest acquired in a recognition transaction that resulted in an increase in the basis of partnership property under Section 743(b), the first subsequent transfer of the partnership interest in a non-recognition transaction to the extent the recomputed adjustment does not exceed the original basis adjustment. For example, if Parent purchases a partnership interest from an unrelated person in a transaction that gives rise to a basis adjustment under Section 743(b), and Parent subsequently transfers that interest to Sub in a transaction that causes Sub to have an equivalent basis adjustment under Section 743(b), that transfer is not a Transaction of Interest. (However, if Sub then transfers the partnership interest to Sub2, that transfer could be a Transaction of Interest, because Sub did not acquire the interest in a recognition transaction.)
- Any transaction listed above only becomes a Transaction of Interest if the basis adjustment exceeds the Applicable Threshold (as described below).
Transfers of interests in connection with the death of a partner are not included as Transactions of Interest.
Observation: In many cases, partnerships and their advisors will lack sufficient information to determine whether a distribution or transfer constitutes a Transaction of Interest. For example, a partnership might be unsure whether any partners are related to a distributee partner, or whether any partner knows or should know whether another partner is a tax-indifferent party. Partnerships, partners, and material advisors will need to consider whether a protective disclosure should be filed based on the information available.
Applicable Threshold amount
The RPBA Regulations require disclosure by a partnership only if the sum of all basis increases resulting from Transactions of Interest exceeds the gain recognized from such transactions during the same tax year in which tax is required to be paid by any of the related partners by at least $10 million. For Transactions of Interest that occurred during the Lookback Period, the threshold amount for disclosure is increased to $25 million.
For purposes of computing these amounts, the partnership must sum all positive basis adjustments to property without reduction for any negative adjustments resulting from the same or another transaction. Where a distribution to a partner who is a related partner with respect to any other partner results in the partnership increasing the basis of one or more of its remaining properties, the basis increases count towards the threshold amount only to the extent of a related partner’s share of the increase. Also, where a partnership distributes property in liquidation of the interest of a partner who is a related partner with respect to any other partner resulting in an increase in the basis of one or more of the distributed properties under Section 732, the basis increases are excluded for purposes of computing the threshold amount to the extent they correspond to a decrease to the basis of property distributed to unrelated partners (other than tax-indifferent parties) or to unrelated partners’ (other than tax-indifferent parties’) shares of a corresponding decrease to the basis of the partnership’s remaining property under Section 734(b).
Disclosure requirements for participants in Transactions of Interest
Participants
Any participant in a Transaction of Interest described in the RPBA Regulations must disclose its involvement on Form 8886, Reportable Transaction Disclosure Statement. Participants include both Participating Partnerships and Participating Partners. A partnership is a Participating Partnership if (1) it made a distribution of property to a Participating Partner as part of a Transaction of Interest or (2) interests in the partnership were transferred as part of a Transaction of Interest.
Partners are Participating Partners if they (1) directly received a distribution of property (including money) in a Transaction of Interest or (2) directly transferred or received an interest in a Participating Partnership in a Covered Transaction. A partner who benefits indirectly from a distribution of property to a related partner or tax-indifferent party is not a Participating Partner and is not obligated to file a disclosure. A partner of a publicly-traded partnership is generally excluded from the definition of Participating Partner, and has an obligation to file only if the partner engages in a private transfer (as described in Reg. 1.7704–1(e)), a redemption or repurchase agreement (as described in Reg. 1.7704–1(f)), or a private placement (as described in Reg. 1.7704– 1(h)) of a partnership interest.
A “related subsequent transferee” is subject to the disclosure requirements if the transferee receives a transfer (including a distribution) of property from a related person in a non-recognition transaction if that property was subject to an increase in basis as part of a prior Covered Transaction.
Observation: The RPBA Regulations notably fail to describe the treatment of tiered partnerships for purposes of determining who qualifies as a Participating Partnership or Participating Partner. Indirect partners of a Participating Partnership who hold their interest through one or more tiers of partnerships may be excluded from the Participating Partner definition.
A person required to disclose under the RPBA Regulations must file Form 8866, Reportable Transaction Disclosure Statement with its return for the tax year. That form must describe the transaction in detail including names and identifying details of participating persons, basis adjustment amounts, and US federal income tax consequences resulting from the transaction. For transactions that occurred during the Lookbook Period (and before 2024), the statement must be filed by July 14, 2025 for each open year in which a Covered Transaction took place or the effects of a Covered Transaction are shown on the return.
Observation: Transactions that occurred prior to the Lookback Period are not Transactions of Interest under the RPBA Regulations. Neither the transactions themselves nor the tax consequences arising from such transactions in later years are required to be reported under these rules. Taxpayers are not obligated to disclose a Transaction of Interest that took place in a year during the Lookback Period for which the statute of limitations has closed. However, subsequent years in which the basis consequences from that initial Transaction of Interest are reflected on a tax return in a year for which the statute of limitations remains open must be disclosed as a Transaction of Interest.
Disclosure requirements for material advisors of participants in Transactions of Interest
The RPBA Regulations also require material advisors to disclose all Transactions of Interest for which they made an oral or written statement relating to the tax aspects of a Transaction of Interest. Material advisor disclosures are due by the last day of the month following the end of the calendar quarter in which the advisor becomes a material advisor. For Transactions of Interest that occurred during the Lookback Period, the RPBA Regulations provide a 90-day extension to July 29, 2025.
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