The U.S. Treasury Department and IRS on January 18, 2019, publicly released a version of the final regulations under section 199A (“Original Final Regulations). A new corrected version of the final regulations (“Corrected Final Regulations”) was released on February 1, 2019.
The final regulations [PDF 800 KB] (247 pages) as corrected, were released for publication in the Federal Register on February 4, 2019, and are scheduled to be published in the Federal Register on February 8, 2019.
The following discussion considers a few notable changes in the Corrected Final Regulations.
Changes to unadjusted basis of qualifying property
Of greatest significance in the Corrected Final Regulations is the correction to the rules applicable to section 743(b) basis adjustments.
The Original Final Regulations provide, among other things, a welcomed change from the proposed regulations with regard to the treatment of section 743(b) adjustments for purposes of determining a partner’s “unadjusted basis of qualifying property” (UBIA). The Original Final Regulations provide that an amount equal to the “excess section 743(b) basis adjustment” should be treated as a separate item of qualified property placed in service when the transfer of a partnership interest occurs in certain instances. The intent of the provision is to allow section 743(b) adjustments to be treated as qualified property to the extent the adjustment represents a change in the fair market value of the underlying property, but not to the extent it represents a recapture of depreciation deductions previously allowed. The Original Final Regulations did not properly define the term “excess section 743(b) basis adjustment” to capture this change in value.
The Corrected Final Regulations change the definition of “excess section 743(b) basis adjustment” to properly account for changes in value and to clarify that the excess section 743(b) basis adjustments are computed with respect to all section 743(b) adjustments, including those made as a result of a substantial built-in loss under section 743(d).
More specifically, under the revised rule, a partner’s excess section 743(b) basis adjustment is an amount that is determined with respect to each item of qualified property and is equal to an amount that would represent the partner’s section 743(b) basis adjustment with respect to the same item of qualified property, but calculated as if the adjusted basis of all of the partnership’s property was equal to the UBIA of such property. The absolute value of the excess section 743(b) basis adjustment cannot exceed the absolute value of the total section 743(b) basis adjustment with respect to all qualified property. If the sum of the excess section 743(b) basis adjustments for all qualified property is a negative number, the partner’s share of unadjusted basis for qualified property is reduced, but not below $0.
Assume a 50% partner in a partnership sells its partnership interest for $300. This partner had an adjusted basis of $200 in its partnership interest. Partnership has two properties, each with UBIA of $300. Both properties were subject to depreciation and have a current adjusted basis of $200. Property 1 has risen in value to $450. Property 2 has fallen in value to $150. The section 743(b) basis adjustment to Property 1 would be positive $125 ($225 FMV - $100 AB) and for Property 2 would be negative $25 ($75 - $100). The total section 743(b) basis adjustment would be $100. However, the section 743(b) basis adjustment determined based on UBIA (i.e., the excess section 743(b) basis adjustment) for Property 1 would be positive $75 ($225 FMV - $150 UBIA) and for Property 2 would be negative $75 ($75 - $150 UBIA). Thus, the total excess section 743(b) basis adjustment would be $0, and no part of the 743(b) basis adjustment would represent qualified property.
Correction with respect to UBIA in transactions described in section 168(i)(7)(B)
The Original Final Regulations provide that the transferee’s UBIA in the qualified property is the same as the transferor’s UBIA, decreased by the amount of money received by the transferee in the transaction or increased by the amount of money paid by the transferee to acquire the property. Under the Original Final Regulations, if property and money were contributed together, the contribution of money would have reduced the UBIA of the contributed property in the hands of the transferee.
The Corrected Final Regulations change the reference above to “transferor.” However, it is still not clear how to apply the rule. Based upon informal conversations with the IRS, it is the understanding of KPMG tax professionals that the rule is intended to prevent a taxpayer from retaining UBIA to the extent that cash was received by a transferor of property.
Note that to the extent that the receipt of cash results in a deemed sale of all or part of the property, the transaction may more properly be treated as a purchase of all or part of property. The rule may be directed at transactions such as the receipt by the transferor to a partnership of amounts treated as reimbursement of preformation capital expenditures under Reg. section 1.707-4(d).
Definition of a trade or business under section 162
The preamble to the final regulations generally provides guidance as to the determination of a trade or business for purposes of section 199A by reference to section 162 and section 446 (which provides guidance as to when an entity may use different methods of accounting for separate and distinct trades or businesses).
The preamble to the Corrected Final Regulations revises a reference to section 446 to state that “no trade or business will be considered separate and distinct unless a complete and separable [the preamble to the Original Final Regulations stated “separate”] set of books and records is kept for such trade or business.” The change is favorable in that it confirms that, if the books and records are able to be separated (even if not previously separated), it is possible to have a separate trade or business, so long as other favorable factors are present.
Change to the definition of a disregarded entity
The Original Final Regulations provide that an entity with a single owner that is treated as regarded as an entity separate from its owner under Reg. section 301.7701-3 is disregarded for purposes of section 199A.
The Corrected Final Regulations appropriately expand the rule to include all entities that are disregarded as separate from their owner under any provision of the Code. Thus, the rule disregards for purpose of section 199A not only single member limited liability companies (LLCs) that do not elect to be treated as a corporation, but also grantor trusts, qualified real estate investment trust (REIT) subsidiaries, qualified subchapter S corporation subsidiaries (commonly referred to as Q-subs) and other entities disregarded under the Code.
Excess boot in like-kind exchanges and involuntary conversions
The Original Final Regulations provide that the UBIA of replacement property acquired in a like-kind exchange or involuntary conversion is the same as the UBIA of the relinquished or converted property, decreased by excess boot or increased by the amount of money paid or the fair market value of other property transferred. The Original Final Regulations define excess boot as the amount of money or the fair market value of other property received by the taxpayer reduced by the amount of appreciation in the relinquished or converted property.
The Corrected Final Regulations make a change to this definition by substituting the word “over” for “reduced by,” making clear that the formula cannot produce a negative number that could result in an increase in UBIA.
Although the revisions described above are seen by tax professionals as welcomed changes, there are other provisions in the Corrected Final Regulations that may continue to give rise to questions for professionals. For instance, the Corrected Final Regulations continue to provide that a partner’s share of UBIA is determined in accordance with how the partnership would allocate depreciation among the partners on the last day of the tax year (rather than based upon how the depreciation was allocated over the course of the tax year).
For more information, contact a tax professional with KPMG’s Washington National Tax practice:
Debbie Fields | +1 202 533 4580 | email@example.com
Jim Sowell | +1 202 533 5710 | firstname.lastname@example.org
Beverly Katz | +1 202 533 3820 | email@example.com