Property Transfer Taxation

IRS Changes Transfer of Property Rules

Temporary IRS Regulations Change Rules for Transfers of Property by U.S. Persons to Partnerships with Related Foreign Partners

Internal Revenue Code (IRC) §721(a) provides, as a general rule, that a taxpayer does not recognize built-in gain on the contribution of appreciated property to a partnership. Rather the partnership assumes a carry-over basis in that property. However, IRC §721(c), allows the Internal Revenue Service (IRS) to issue regulations requiring gain recognition upon the contribution of appreciated property if the gain, when otherwise recognized, would be included in the gross income of a non-U.S. person. For the first time ever the IRS has utilized its statutory authority under IRC §721(c) and crafted temporary regulations addressing the transfer of appreciated property by “U.S. transferor” to partnerships with foreign partners related to the transferor.

The temporary regulations reflect IRS concerns that certain partnerships can over time allocate the deferred gain to related foreign partners not subject to U.S. federal income tax. The remainder of this article will be broken down into two sections: (1) a discussion of definitions necessary to understand the temporary regulations and (2) the specific provisions of the temporary regulations.


The temporary regulations apply to property with a built-in gain at the contribution date (henceforth known as “section721(c) property”). Section 721(c) property excludes cash equivalents, securities as defined under IRC §475(c)(2), and items of tangible property with a built-in gain not exceeding $20,000 or whose adjusted tax bases exceed book values.

Property Transfer TaxationA “U.S. transferor” is a “U.S. person” as defined by IRC §7701(a)(30) other than a domestic partnership. This includes U.S. citizens or residents, domestic corporations and estates, and trusts either under the jurisdiction of a U.S. court or those controlled by one or more U.S. persons.

A “section 721(c) partnership” is a partnership that after the contribution in question has a foreign partner related to the US transferor where together they own (directly or indirectly) 80% or more of the partnership.

The rules under IRC §§267(b) and §707(b)(2) determine whether a foreign partner is related to the U.S. transferor. Related parties include, but are not limited to, members of a family, a corporation in which the individual owns more than 50% of the stock (either direct or indirectly), two corporate members of the same controlled group, a corporation and a partnership if the same person owns 50% or more of both entities, a partnership in which the individual owns more than 50% (either directly or indirectly), and two partnerships in which the same person owns more than 50% of each (either directly or indirectly).


General Rule

The temporary regulations apply when a U.S. transferor contributes section 721(c) property to a section 721(c) partnership.

Example: UST, a U.S. citizen, owns 100% of FC, a controlled foreign corporation. UST contributes appreciated real property to a new partnership in exchange for a 70% interest. FC contributes cash for the remaining 30% interest. The appreciated property constitutes “section 721(c) property.” The partnership qualifies as a “section 721(c) partnership” because UST and FC are related and collectively own 100% of the partnership. Consequently, the non-recognition rules of IRC 721(a) do not apply to UST’s contribution unless one of the exceptions described in this article apply.

The temporary regulations also apply a look-through rule when an upper tier partnership with a U.S. partner contributes appreciated property to a lower-tier partnership. In such cases the rules treat the contribution as if the U.S. partner transferred its share of the contributed property directly to the lower-tier partnership. If the lower-tier partnership qualifies as a section 721(c) partnership, the upper-tier partnership will generally recognize the entire built-in gain because the entire property qualifies as section 721 (c) property. (This rule does not apply in the case of a technical termination.)

Deferral of the Built-in Gain

The transferor can avoid immediate gain recognition on a property-by-property basis by meeting the following requirements:

1.) The section 721(c) partnership adopts the “remedial allocation method” of IRC §704(c) in a manner that satisfies the “consistent allocation method.” The remedial allocation method removes the IRC §704(c) “ceiling rule” that can limit special allocations of depreciation and gain associated with contributed built-in gain property. The consistent allocation method requires a section 721(c) partnership to allocate the same percentage of each book item of income, gain, deduction, or loss attributable to section 721(c) property to the U.S. transferor.

However, the temporary regulations do not require the adoption of the remedial and consistent allocation methods with respect to property that generates “effectively connected income” where the partners do not claim tax treaty relief. In general, “effectively connected income” represents income attributable to a foreign person’s operation of a U.S. trade or business. IRC §875(1) generally treats partnership allocations of U.S.-source trade or business income to a foreign partner as effectively connected income.

2.) The U.S. transferor recognizes gain equal to the partial or remaining built-in gain upon the occurrence of an “acceleration or partial acceleration event.” Acceleration events reduce or defer the amount of built-in gain that a US transferor will otherwise recognize under the gain deferral method absent the occurrence of that event. The regulations do provide several exceptions to this general rule.

3.) Procedural and reporting requirements are satisfied. Note that these requirements are quite extensive and detailed.

4.) The U.S. transferor extends the statutory period of limitations on assessment of tax.

5.) The rules for tiered partnerships are satisfied. For example, all partnerships in the ownership chain must adopt qualifying gain deferral methods such as the IRC §704(c) remedial method. The temporary regulations set forth the specific tiered partnership rules.

The text of the temporary regulations also serve as proposed regulations not yet issued by the IRS. The temporary and proposed regulations became effective on January 18, 2017 with applicability dates for the majority of the regulations dating back to the issuance of the original notice of regulation on or after August 6, 2015.

This article only provides a general overview of these very complex and detailed regulations. Consequently, we recommend that you consult a CPA in Dallas or a business tax professional to determine how these regulations affect your situation.

About The Author

Daniel Quintana

Daniel Quintana of Kurtz & Company, P.C. in Dallas Texas.