The Finalized Disclosure Requirements for Partnership Basis-Shifting Transactions: Slightly Less Onerous, but Still Premature
On January 14, 2025, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) published final regulations (the “Final Regulations”) addressing reporting obligations with respect to certain related-party, basis-shifting transactions involving partnership distributions and transfers of partnership interests.1 The Final Regulations followed the general approach of the proposed regulations that the Treasury and the IRS published on June 18, 2024 (the “Proposed Regulations”), which target the government’s perceived abuse resulting from basis shifting among related and certain other persons in partnerships. However, the Final Regulations do take limited steps to scale back the scope of transactions to which reporting obligations apply.
What is most surprising about the Final Regulations is their timing, having been issued just days before President Joe Biden’s term expired. Moreover, the Final Regulations are predicated on the view that a partnership basis-shifting transaction among related persons is abusive, yet Treasury and IRS have not even issued the proposed regulations that were described in Notice 2024-54. Setting aside the government’s weak position on the economic substance doctrine set forth in Rev. Rul. 2024-14, which was issued in conjunction with the Proposed Regulations, current law therefore does not apply the basis shifting rules in Subchapter K differently depending on whether the partners and partnerships are related or unrelated.
The government is putting the cart before the horse by imposing substantial reporting burdens on taxpayers—together with the threat of penalties for noncompliance—on related-party transactions before final regulations addressing those transactions are issued. In response to a comment that the Proposed Regulations should be withdrawn and reproposed after the proposed regulations described in Notice 2024-54 are finalized, Treasury and IRS claim the Final Regulations are justified at this time because “sound tax administration” requires that the government “gather this information now” in order to determine “which further examination or further guidance may be warranted.”2
If sound tax administration requires taxpayers to submit detailed information under the threat of penalties before there is even a clear legal path for the government to challenge these transactions, there would be no limit to the government using this “come forward and tell us now” approach to any number of possible issues. And, given the Trump Administration’s policies against issuing “regulations that are based on anything other than the best reading of the underlying statutory authority or prohibition,”3 it is far from clear whether the proposed regulations described in Notice 2024-54 (and, later, final regulations) will be issued in the next four years. It would appear that Treasury tried to do what it could to discourage taxpayers from engaging in or benefitting from basis shifting transactions in anticipation of a new administration that would be hostile to the issuance of the proposed regulations contemplated by the Notice.
Burdens Imposed by Proposed Regulations
In the Proposed Regulations, the IRS targeted distributions of property from partnerships or transfers of partnership interests as a result of which one or more partners may be entitled to claim additional depreciation for property held or distributed by a partnership or reduced gain in connection with a sale of that property. Such transactions generally involve tax-free transactions in which the tax basis of assets is increased and corresponding adjustments are made to decrease the basis of other assets. The Proposed Regulations generally proposed to require partnerships, partners, and their material advisors to report certain basis-shifting transactions that meet a certain threshold and involve related or unrelated but tax-indifferent parties.
The Proposed Regulations generally treated the following transactions as reportable “transactions of interest” under Section 6011:4 (1) a partnership distribution in which there are two or more directly or indirectly related partners5 that results in a related partner or the partnership receiving an increase in basis of at least $5 million, and (2) a partner transferring a partnership interest to a transferee partner when the transferee is related to the transferor or another partner and when the transferee partner is entitled to an increase in the basis of its share of the underlying partnership’s assets of at least $5 million. The Proposed Regulations also required that “substantially similar” transactions be reported, which included those involving unrelated but tax-indifferent partners,6 or transfers of partnership interests to related transferees in a gain recognition transaction that results in at least $5 million increase in asset basis.
Limited Relief Provided by Final Regulations
The Treasury and the IRS received comments on the Proposed Regulations, some of which are reflected in the Final Regulations. The Final Regulations are narrower in scope than the Proposed Regulations, but they still impose reporting obligations by requiring partnerships, partners, and their material advisors to disclose “transactions of interest,” including with respect to many transactions that occurred prior to the Final Regulations being issued. Transactions of interest include similar transactions that the Proposed Regulations addressed, involving related-party basis shifting over a certain threshold. The following is a summary of some of the key differences between the Proposed Regulations and the Final Regulations.
- The Final Regulations increased the dollar threshold for a basis increase in a transaction of interest from $5 million to (i) $10 million for tax years from 2025, and (ii) $25 million for tax years before 2025. A further helpful clarification is that, with respect to basis adjustments that result from a distribution, the $10 million threshold only includes tax basis increases to the extent the offsetting tax basis decrease affects related partners (and, in certain circumstances, tax-indifferent partners). These changes should decrease the number of routine transactions that are subject to these reporting rules.
- The Final Regulations have also added a six-year lookback period, requiring disclosure of applicable transactions that occurred within 72 months preceding the first month of the taxpayer’s most recent tax year beginning before January 14, 2025. Therefore, taxpayers will be required to review transactions that they participated7 in within such period and make disclosures within 180 days from the Final Regulations’ publication date. Nevertheless, this rule is an improvement from the Proposed Regulations, which applied to all transactions occurring prior to the effective date as long as tax benefits from the transaction remained (i.e., whether an increase in tax basis was still relevant for depreciation or gain determinations). Even though the retroactive nature of these reporting obligations was not eliminated, having a specific look-back period provides some relief. However, the application of these rules to transactions entered into before the effective date of the Final Regulations still imposes significant administrative burdens on taxpayers and in some cases may make full compliance impossible.
- The Proposed Regulations required disclosures of historic transactions within 90 days of the Final Regulations’ publication date, whereas the Final Regulations have extended the deadline to July 14, 2025. In addition, material advisors have an additional 90 days beyond the regular first calendar quarter reporting deadline to file their disclosure statements (i.e., July 29, 2025).
- The Final Regulations narrowed the scope to only apply to tax-free transfers of partnership interests between “related” parties, as opposed to the approach taken by the Proposed Regulations which also covered a tax-free transfers of partnership interest between an “unrelated” transferee and transferor, even if the transferee is related to one or more existing partners. Moreover, the Final Regulations limited the definition of a “related partner” to a direct partner of the partnership, thereby excluding any indirect partners.
- In response to a number of comments criticizing the expansion of the reporting obligations to transactions involving tax-indifferent parties8 including routine transactions involving investment funds with tax-exempt or non-US limited partners, the IRS has amended the definition of tax-indifferent party so that it now applies to parties whose tax status is known or should have been known to the other person participating in the transaction or the other partners in the partnership. The Final Regulations generally exclude partnerships and S corporations from treatment as tax-indifferent parties, given that these entities are not generally liable to tax, and the tax status of their partners or shareholders could be diverse. Nevertheless, the Final Regulations include an anti-avoidance rule if a principal purpose of the use of such entities is to avoid the tax-indifferent party rules.
- Commentators had noted that the Proposed Regulations may have required disclosure in connection with a taxable transfer of partnership interests yielding a tax basis step-up as a result of a Section 754 election having been made that was followed by a nonrecognition transfer of such acquired partnership interest to a related party (without an increase in such step-up). The Final Regulations clarified that disclosure is only required in connection with such a subsequent nonrecognition transaction if the step-up associated with the transferred partnership interest increases.
- The Final Regulations excluded basis adjustments involving transfers of or distributions with respect to partnership interests in a publicly traded partnership from treatment as related-party basis adjustment transactions. Transfers of partnership interests on the death of a partner were also excluded. In addition, the Final Regulations excluded Section 743(b) adjustments acquired through an arm’s length transaction to which a related transferee succeeds.
Taxpayers involved in partnership transactions should assess their activities to determine if they fall within the scope of these rules, as non-compliance can result in significant penalties (up to $50,000 per transaction for each participation). Participants must provide the information required under Treasury Regulations Section 1.6011-4(d) and the Instructions to Form 8886, Reportable Transaction Disclosure Statement, in the manner described in Treasury Regulations Section 1.6011-4(e), for each taxable year in which the participant participated in a transaction of interest.
Could Congress Disapprove the Final Regulations under the Congressional Review Act, or Could the Trump Administration Rescind the Rules?
The Congressional Review Act9 requires that the Final Regulations be submitted to both the House and Senate for review before such rules can take effect. Any member of the House or Senate can put forward a joint resolution of disapproval of the regulations within 60 days of the submission of such rules. Only a simple majority is required to approve the disapproval resolution before moving to the next chamber, and then to the president for signature. Most importantly, a resolution of disapproval that is considered by the Senate—within 60 session days of the date the rule is submitted or the date it is published in the Federal Register, whichever is later—is not subject to the Senate’s filibuster rules. If the president signs the resolution, then Treasury and IRS cannot reissue a substantially similar rule.
President Donald Trump’s February 19, 2025 executive order, called “Ensuring Lawful Governance and Implementing the President’s ‘Department of Government Efficiency’ Deregulatory Initiative,” may provide another alternative for forcing a withdrawal of the Final Regulations. This order requires agency heads, within 60 days of February 19, to identify certain classes of regulations, including “regulations that are based on anything other than the best reading of the underlying statutory authority or prohibition.” The agency heads shall then provide these lists to the Administrator of the Office of Information and Regulatory Affairs, which will “develop a Unified Regulatory Agenda that seeks to rescind or modify these regulations as appropriate.”
We can only hope that some action to withdraw the Final Regulations is initiated pursuant to either the Congressional Review Act or the president’s executive order. But until then taxpayers must do what they can to comply with these immediately effective reporting requirements with deadlines starting as soon as July 14, 2025.
1 T.D. 10028, 90 Fed. Reg. 2958 (Jan. 14, 2025).
2 T.D. 10028, Preamble, 90 Fed. Reg. 2958, 2963 (Jan. 14, 2025).
3 See the executive order dated Feb. 19, 2025, entitled “Ensuring Lawful Governance and Implementing the President’s ‘Department of Government Efficiency’ Deregulatory Initiative.”
4 References to “Section” are to sections of the Internal Revenue Code of 1986, as amended.
5 Related partners are defined in Sections 267(b) and 707(b)(1).
6 A tax-indifferent party would be defined as a person that is exempt from federal income tax or for which gain would not result in a tax liability for the year in which it is recognized.
7 A taxpayer “participates” in a transaction if the transaction actually occurred in such year or if the taxpayer filed a tax return for such year.
8 A tax-indifferent party is defined as a person that is exempt from federal income tax or for which gain would not result in a tax liability for the year in which it is recognized and whose status as a tax-indifferent party is known or should be known to any other person that participates in the transaction or the other partners in the partnership.
