Prop regs on partnership related party transactions: PwC

In brief

Treasury and the IRS released proposed regulations on November 24 that address the disallowance or deferral of deductions under Sections 267 and 707 for losses and expenses in certain transactions with partnerships and related persons. The proposed rules would update the current regulations, promulgated in 1958, to reflect statutory changes since 1982 and indicated Congressional intent to treat partnerships as an entity rather than as an aggregate of its partners for purposes of applying related-party loss disallowance rules.

Public comments on the proposed regulations are due by February 26, 2024. The regulations are proposed to apply for tax years ending on or after the date of publication of the final regulations in the Federal Register.

Takeaway: The proposed regulations, an item on the IRS priority guidance plan, would resolve uncertainty in a number of areas. If adopted, these changes would conform the regulations with the current statute by applying the loss disallowance rules of Sections 267(a)(1) and 707(b)(1), the gain recharacterization rules of Section 707(b)(2), and the matching rule of Section 267(a)(2) at the partnership level, not the partner level. Taxpayers should evaluate the effect of the proposed rules on transactions with related persons and consider submitting comments.

In detail

Background

In general, certain losses from the sale or exchange of property in transactions involving related parties are disallowed. This is accomplished by imposing a matching rule that disallows certain deductions until the corresponding gross income is recognized under the payee’s method of accounting. As the statutory rules originally were enacted, partnerships were excluded from the list of relationships subject to these loss disallowance rules. However, Treasury promulgated regulations in 1958 that applied the aggregate theory of partnerships to provide that any of these loss transactions that occurs between a partnership and a person other than a partner is considered as occurring between that other person and each of the members of the partnership separately (i.e., treating the partnership as an aggregate of its partners).

The preamble to the current proposed regulations states that statutory changes since 1982 have caused the use of the aggregate theory in the 1958 regulations to be inconsistent with the current statute. Examples of the changes that have been made include the disallowance of a deduction resulting from a transaction between a commonly controlled partnership and an S corporation or a C corporation; the extension of the matching rule to transactions between a partnership and a partner or a person related to a partner; and changes that apply loss disallowance rules and character of gain rules to transactions between a partnership and any person (a partner or non-partner) who directly or indirectly owns more than 50% of the capital or profits interest in the partnership.

Proposed rules

Stating that the statutory changes indicate that Congress intended for a partnership to be viewed as an entity rather than as an aggregation of its partners in applying the related-party loss disallowance rules, Treasury and the IRS have proposed the following changes to conform the regulations with this view and the current statute:

Remove Treas. Reg. sec. 1.267(b)-1(b) that treats a transaction that occurs between a person and a partnership as occurring between the person and each partner.
Amend Treas. Reg. sec. 1.267(a)-1 to disallow losses and defer otherwise deductible amounts at the partnership (entity) level.
Amend Treas. Reg. sec.1.267(a)-1 to (i) reflect the rules in Questions and Answers 1 and 4 in Temp. Reg. sec. 1.267(a)-2T(c) as Treas. Reg. sec. 1.267(a)-1(d)(2) and (3) and (ii) terminate the application of Questions and Answers 2 and 3 in Temp. Reg. sec. 1.267(a)-2T(c).
Amend Treas. Reg. sec. 1.707-1(b)(1) and (b)(2) by replacing the term “partner” with the term “person,” and replacing “80 percent” with “50 percent” in Treas. Reg. sec. 1.707-1(b)(2) to reflect the statute.

Public comments on the proposed regulations are due by February 26, 2024. The proposed regulations are proposed to apply to tax years ending on or after the date the Treasury decision adopting them as final regulations is published in the Federal Register.