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The partnership is an effective and efficient method of organization for many businesses including professionals. However, special tax rules exist for many transactions, transfers, and disbursements that may involve the partners or partnership. Many of these tax rules have been motivated by Congress’s and the IRS’s belief that partnership entities open the door for specific types of tax fraud and abuse. As such, the IRS recently announced a final rule regarding disguised property sales involving partnerships.  

A California tax lawyer at the NewPoint Law Group is proud to provide high-quality tax services to California businesses and individuals. We can provide up-to-date guidance regarding IRS and California FTB changes to the tax code. To schedule a confidential tax consultation at our Folsom or Roseville law offices, call 1-800-358-0305 or contact our tax law team online.

What Is a Disguised Partnership Sale?

Most members of a partnership are aware that ordinary transfers of unencumbered property or money from the individual to the partnership entity typically do not result in a recognition of loss or gain per the non-recognition rule set forth in § 721. But, the non-recognition rule does not apply when the contribution to the partnership involved a sale. Often, a disguised sale is preceded by a transfer of property from one of the partners to the partnership. The partner then receives a disbursement of cash from the partnership entity. When certain circumstances are present, this sequence of events may be characterized as a disguised partnership property sale.

When all of the following factors and circumstances apply, the final rule regarding disguised property sales to a partnership is likely to be operative:

  • The transfer of the money to the partner was contingent upon receipt of property from the partner.
  • The transfer of property and money occurred in a series so that the transactions were not simultaneous.

There are numerous other factors and circumstances the IRS will assess to determine whether the transactions should be characterized as a disguised sale. Disguised transfers can occur when transfers are made between or among partners, when transfers to the partnership are made, and when transfers to the partners are made.

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How Will the Final Rule Affect Disguised Partnership Property Sales?

The final rule recently announced by the IRS, T.D. 9787, finalizes most of the proposed rules that were originally set forth in REG-119305-11 in 2014. T.D. 9787 finalizes rules addressing a substantial number of issues and concerns regarding disguised sales. However, due to some concerns expressed during the comment period, one section of the rule has yet to be finalized. That is, the rules contained within. Regs. Sec. 707-5(a)(2) have not yet been finalized and temporary regulations will continue to govern the interpretation of this section.

The overall goal of the final disguised sale rule is to reduce the probability that a partner will be able to improperly obtain tax benefits by mischaracterizing the transfer. Essentially, the IRS was concerned about partners who would mischaracterize a sale of property to a partnership as a contribution to the entity. By mischaracterizing the transfer a partner would be able to improperly delay or even avoid taxation.

There are several scenarios where the revised, final disguised property sale rules will not apply. For instance, debt-financed-distributions are exempted from the final rule. Payments or transfers that constitute a reasonable guarantee to a partner may also be excluded from the operation of this rule.

The final regulations set forth under §707 will apply to covered transactions conducted starting on October 5, 2016. Final regulations applicable under §752 relating to partnership liabilities are also slated to take effect on October 5.

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Work with Experienced Sacramento Tax Attorney for Partnership Tax Concerns

If you have concerns about how IRS or California FTB partnership rules apply to your business, a California tax attorney of the NewPoint Law Group may be able to provide clear guidance. To discuss how our tax law firm can assist your company or organization in maintaining its tax compliance, call 1-800-358-0305 or contact our firm online.