New Restrictions on Property Transfers to Controlled Partnerships with Foreign Related Partners: Regulations to Require Current Gain Recognition on Certain Transfers of Property to Controlled Partnerships with Foreign Related Partners

Sullivan & Cromwell LLP - August 12, 2015

On August 6, 2015, the Internal Revenue Service (the “IRS”) issued Notice 2015-54 (the “Notice”) announcing the intention to issue regulations (the “Future Regulations”) in response to transactions where taxpayers contribute property to a partnership that allocates income or gain from the contributed property to foreign partners related to the transferor that are not subject to U.S. tax. Although built-in income or gain from contributed property is generally allocated to the contributing partner under generally applicable rules, the IRS believes that taxpayers involved in such transactions use valuation techniques inconsistent with arm’s-length standards and/or improperly allocate the income or gain to foreign partners.

The Future Regulations will generally require U.S. persons (other than domestic partnerships) to recognize gain upon the contribution of built-in gain property (i.e., property with a fair market value in excess of tax basis) to a partnership (whether foreign or domestic) if (i) a related foreign person (or persons) is a direct or indirect partner and (ii) such U.S. persons and related persons own more than 50 percent of the interests in the partnership. Notwithstanding the general rule, current gain recognition will not be required if the taxpayer adopts the “remedial” allocation method (described below) and otherwise satisfies the safe harbor requirements for gain deferral, or the taxpayer satisfies a de minimis exception for property with an aggregate built-in gain of $1 million or less. The Future Regulations will need to be considered with respect to any contribution of property to a partnership with foreign related partners.

When finalized, the Future Regulations will generally be effective for transactions occurring after August 6, 2015 and will contain an anti-abuse rule applying to transactions entered into with a principal purpose of avoiding the application of the rules described in the Notice. New reporting requirements will be effective for taxable years beginning in 2015.