Section 743 basis increases do not produce net consolidated deductions

Plain-English summary

A consolidated group transferred partnership interests through an intercompany section 332 liquidation and section 368 reorganization while section 754 elections were in effect. Chief Counsel concluded that those nonrecognition transfers were exchanges for section 743(b) purposes because section 761(e) treats a partnership-interest distribution as an exchange. The resulting inside-basis adjustments were personal to the transferees and were not subject to reallocation under section 704(b). Even so, the group could not claim the additional depreciation and amortization generated by those adjustments. Under Treasury Regulation section 1.1502-13, those deductions had to be redetermined as noncapital, nondeductible items because divisions of a single corporation would not have obtained a net deduction from the transfers. The section 743(b) adjustments to partnership property did not conflict with sections 362(a) and 334(b)(1), which governed the transferees' carryover basis in the partnership interests themselves.

Ruling snapshot

• Question: How do section 743(b) basis adjustments from intercompany nonrecognition transfers interact with section 704(b), the consolidated intercompany rules, and corporate carryover-basis rules?
• Outcome: advice given
• Key authorities: IRC §§ 332, 334, 362, 368, 704, 743, 754, and 761(e); Treas. Reg. §§ 1.743-1 and 1.1502-13

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           memorandum
           Number: 201726012
           Release Date: 6/30/2017
           CC:PSI:1                                              Third Party Communication: None
           POSTU-101184-15                                       Date of Communication: Not Applicable

 UILC:     743.00-00, 1502.13-00

  date:    March 28, 2017

     to:   Deborah H. Delgado
           Attorney (Austin)
           (Large Business & International)

  from:    David R. Haglund
           Chief, Branch 1
           Office of the Associate Chief Counsel
           (Passthroughs & Special Industries)


subject:   -----------------------------------------


           This Chief Counsel Advice responds to your memorandum dated December 7, 2015. In
           accordance with section 6110(k)(3) of the Internal Revenue Code, this Chief Counsel
           Advice may not be used or cited as precedent.

           LEGEND

           Taxpayer =                 ------------------------------------------------------------
           Parent1 =                  ----------------------------------------------------------------
           Parent2 =                  -------------------------------------
           Partnership1 =             -------------------------------------------------------------------
           Partnership2 =             ------------------------------------------------------------------------
           Corporation1 =             --------------------------------------
           Corporation2 =             --------------------------------------------------
           Corporation3 =             -------------------------
           SubsidiaryA =              ------------------------------------------------------------------------------------------
           ----------------------------------------------------------------------------------------------------------------
           SubsidiaryB =              ----------------------------------
           SubsidiaryC =              ------------------------------------------------------------------------------------------
                                      -------
           SubsidiaryD =              ----------------------------------
POSTU-101184-15                                 2

SubsidiaryE =     -------------------------------------
SubsidiaryF =     --------------------------
SubsidiaryG =     -----------------------------------------------
SubsidiaryH =     ------------------
Business =        -----------------------------------
Brand =           -------------------------
Year1 =           -------
Year2 =           -------
Year3 =           -------
Year4 =           -------
Year5 =           -------
Year6 =           -------
Year7 =           -------
Year8 =           -------
Year9 =           -------
n1 =              ----
n2 =              --------------
n3 =              ----------
n4 =              ----------
n5 =              --------------
n6 =              ----------------
n7 =              ----------------
n8 =              ----
n9 =              ----
n10 =             -------------
n11 =             -------------
n12 =             -----
n13 =             --------
n14 =             --------
n15 =             ------------
n16 =             -------------
n17 =             ------
n18 =             ----
n19 =             --------
n20 =             --------------------
n21 =             --------------------
n22 =             --------------------
n23 =             ----------------------
n24 =             --------------------
n25 =             --------------------
n26 =             ------------------
n27 =             ----------------
n28 =             ----------------
POSTU-101184-15                              3

ISSUES

1. Whether the transfer of a partnership interest in a complete liquidation to which
   § 332(a) applies or a reorganization to which § 368(a)(1)(A) and/or (D) applies is
   considered a transfer by sale or exchange for purposes of § 743(b).
2. Whether § 743(b) adjustments are subject to reallocation under § 704(b).
3. Under the circumstances described below, whether §1.1502-13 permits the
   Taxpayer’s consolidated group (the “Taxpayer Group”) to claim increased
   deductions for depreciation and amortization that are attributable to § 743(b)
   adjustments arising from the transfer of a partnership interest in an intercompany
   reorganization to which § 368 applies and from the distribution of a partnership
   interest in an intercompany liquidation to which § 332(a) applies.1

4. Under the circumstances described below, whether the basis adjustment provisions
   of § 743(b) conflict with the basis provisions of § 362(a) when a partnership interest
   is transferred in an intercompany reorganization to which § 368 applies or with the
   basis provisions of § 334(b)(1) when a partnership interest is distributed in an
   intercompany liquidation to which § 332(a) applies.

CONCLUSIONS

1. The transfer of a partnership interest in a complete liquidation to which § 332(a)
   applies or in a reorganization to which § 368(a)(1)(A) and/or (D) applies is
   considered a transfer by sale or exchange for purposes of § 743(b).

2. Section 743(b) adjustments are not subject to reallocation under § 704(b) because
   they are personal to the transferee and do not affect common basis.

3. Under the circumstances described below, §1.1502-13 does not permit the Taxpayer
   Group to claim increased deductions for depreciation and amortization that are
   attributable to § 743(b) adjustments arising from the transfer of a partnership interest
   in an intercompany reorganization to which § 368 applies and from the distribution of
   a partnership interest in an intercompany liquidation to which § 332(a) applies.

4. Under the circumstances described below, the basis adjustment provisions of
   § 743(b) do not conflict with the basis provisions of § 362(a) when a partnership
   interest is transferred in an intercompany reorganization to which § 368 applies or
   with the basis provisions of § 334(b)(1) when a partnership interest is distributed in
   an intercompany liquidation to which § 332(a) applies.

FACTS

1
POSTU-101184-15                              4


In Year1, Parent1 and Parent2 formed a joint venture to combine the operations of each
of their Business under the Brand name. At the time, Parent1 and Parent2 were
unrelated corporations and each was the common parent of its respective consolidated
group. All subsidiaries mentioned below are domestic. As part of the transaction,
Partnership1 was formed in Year1. SubsidiaryA (which was owned n1% by Parent1
and n1% by Parent2) owned n2% of the membership interests in Partnership1 and
served as the managing member. SubsidiaryB, an indirect subsidiary of Parent2, and
SubsidiaryC, an indirect subsidiary of Parent1, each contributed substantially all of their
Business assets to Partnership1 in exchange for the remaining membership interests in
Partnership1, approximately n3% and n4%, respectively.

In Year2, Parent1 and Parent2, indirectly through Partnership1, acquired the
outstanding stock of unrelated Corporation1 for cash of $n5. The acquisition was
structured as follows. Partnership1 formed Corporation2 as an acquisition vehicle.
SubsidiaryD, an indirect subsidiary of Parent2, and SubsidiaryE, an indirect subsidiary
of Parent1, made cash contributions of $n6 and $n7, respectively, to Partnership1 in
exchange for membership interests in Partnership1. Partnership1 then contributed this
cash to Corporation2 which was used to acquire the outstanding stock of Corporation1,
via a merger of Corporation1 into Corporation2.

Later in Year2, Partnership1 formed a lower-tier partnership, Partnership2, to hold the
combined Business assets of Partnership1 and Corporation2. Partnership1 contributed
substantially all of its operating assets to Partnership2 in exchange for a n8%
membership interest in Partnership2, and Corporation2 contributed substantially all of
its assets (which consisted primarily of stock of subsidiaries) to Partnership2 in
exchange for a n9% membership interest in Partnership2. As a result of the
contributions, Partnership1 and Corporation2 essentially became holding companies.

In Year3, Parent2 acquired Corporation3 for $n10, and Parent2’s name was changed to
Taxpayer. Partnership1, Partnership2, and SubsidiaryA were all renamed at this time.
In Year4, Taxpayer (formerly Parent2) acquired all of the stock of Parent1 in an all-stock
acquisition valued at $n11. Taxpayer continued to be the common parent of the
Taxpayer Group, which now includes Parent 1 and the former members of Parent 1’s
consolidated group. (The Taxpayer Group includes, at all relevant times, all of the
corporations referenced below.)

SubsidiaryD and SubsidiaryE each had a relatively high basis in its membership interest
in Partnership1 as a result of the Year2 cash contributions to Partnership1 that
Partnership1 used to acquire Corporation1 stock for $n5. SubsidiaryB and SubsidiaryC
each had a relatively low basis in its membership interest in Partnership1 as a result of
their contribution of historic Business assets to Partnership1 when the original joint
venture was formed in Year1.
POSTU-101184-15                                       5

In Year6, Partnership1 partially redeemed the membership interests held by
SubsidiaryB and SubsidiaryC. Partnership1 distributed n12% of its Corporation2 stock
to these distributee partners (n13% to SubsidiaryB and n14% to SubsidiaryC). After the
partial redemption, Corporation2 became a member of the Taxpayer Group. At the time
of the partial redemption, both Partnership1 and Partnership2 had § 754 elections in
place. SubsidiaryB and SubsidiaryC had a combined outside basis in Partnership1 of
approximately $n15 prior to the partial redemption. Following the distribution, the
Taxpayer Group claimed a § 734(b) basis adjustment of approximately $n16 derived
from the difference between the excess partnership inside basis in Corporation2 stock
of approximately $n5 and SubsidiaryB’s and SubsidiaryC’s combined outside basis of
approximately $n15. SubsidiaryB and SubsidiaryC took a combined carryover basis of
approximately $n15 in the Corporation2 stock and their outside basis in Partnership1
was reduced to $n17.

Starting in Year2, pursuant to the Partnership1 and Partnership2 partnership
agreements, gains attributable to pre-formation contributions were tracked and allocated
to the contributing partners as required by § 704(c). Additional layers of reverse
§ 704(c) gain were created from revaluations in Year2, Year6, Year7, and Year8. The
§ 704(c) allocations to SubsidiaryB and SubsidiaryC remained unchanged after the
Year6 distribution of Corporation2 stock despite the significant reductions in their
interests in Partnership1’s capital.

In Year9, the Taxpayer Group engaged in another restructuring of its corporate
subsidiaries engaged in Business. At that time, interests in Partnerhip1 were held by
SubsidiaryA, SubsidiaryB, SubsidiaryC, SubsidiaryE, and SubsidiaryF.2 SubsidiaryB
and SubsidiaryC, the two partners that received distributions of Corporation2 stock in
Year6, were merged or liquidated (as described more fully below) into other members of
the Taxpayer Group. As a result of these transactions, SubsidiaryE and SubsidiaryF,
each a direct partner in Partnership1, acquired additional interests in Partnership1.

At the time of the Year9 restructuring, SubsidiaryB was owned n18% by SubsidiaryG
and n19% by SubsidiaryH. SubsidiaryB distributed cash to SubsidiaryG in redemption
of its stock, and then merged upstream into SubsidiaryH in a transaction purported to
qualify as a complete liquidation under § 332. Immediately thereafter, SubsidiaryH
merged sideways into SubsidiaryF in a transaction purported to qualify as a
reorganization under § 368(a)(1)(A) and (D) (the “Reorganization”). Neither
SubsidiaryB nor SubsidiaryH recognized an amount of gain or loss with respect to their
transfers of the interest in Partnership1, and SubsidiaryH and SubsidiaryF took a basis
in the interest equal to that of the respective transferor.

SubsidiaryC, which was wholly owned by SubsidiaryE, merged upstream into
SubsidiaryE in a transaction purported to qualify as a complete liquidation under § 332

2
 Ownership of Partnership1 interests changed during the period spanning Year2 to Year9; however, such changes
are not relevant to the issues at hand.
POSTU-101184-15                                        6

(the “Liquidation”). SubsidiaryC recognized no amount of gain or loss with respect to its
transfer of its interest in Partnership1, and SubsidiaryE took a basis in the interest equal
to that of the transferor, SubsidiaryC.

Finally, SubsidiaryA distributed its interest in Partnership1 to SubsidiaryE, in a
distribution to which §§ 301 and 311(b) applied (the “Distribution”).

Partnership1 and Partnership2 each had § 754 election in place at the time of the Year9
transactions. Accordingly, the Taxpayer Group took the position that the
Reorganization, the Liquidation, and the Distribution resulted in transfers of partnership
interests that are considered transfers by sale or exchange under § 743(b). The
transfers, including those pursuant to the purported nonrecognition transactions,
therefore, triggered a step-up in basis of partnership assets owned by Partnership1 and
its lower-tier partnership, Partnership2. The Taxpayer Group calculated a net § 743(b)
adjustment of $n20 for the transfers of Partnership1 interests pursuant to the
Reorganization3 and the Liquidation; of this amount, $n21 arose from the transfer in the
Reorganization and was allocated solely to SubsidiaryF, and $n22 arose from the
transfer in the Liquidation and was allocated solely to SubsidiaryE. The Taxpayer
Group calculated a net § 743(b) adjustment of $n23 for the indirect transfers of
Partnership2 pursuant to such transactions; of this amount, $n24 arose from the
transfer in the Reorganization and was allocated solely to SubsidiaryF and $n25 arose
from the transfer in the Liquidation and was allocated solely to SubsidiaryE.

For Year9, the § 743(b) basis adjustments associated with the transfers of Partnership1
pursuant to the Reorganization and the Liquidation, and the indirect transfers of
Partnership2 pursuant to such transactions, resulted in additional depreciation and
amortization deductions in the amount of $n26, of which $n27 was allocated solely to
SubsidiaryF and $n28 was allocated solely to SubsidiaryE.

Thus, as a result of the Reorganization and Liquidation, the Taxpayer Group claimed
additional depreciation and amortizations deductions of $n26 on its consolidated federal
income tax return for Year9.

LAW AND ANALYSIS

Issue 1: Whether the transfer of a partnership interest in a complete liquidation to which
§ 332(a) applies or a reorganization to which § 368(a)(1)(A) and/or (D) applies is a
transfer by sale or exchange for purposes of § 743(b).



3
  The § 743(b) basis adjustment for a subsequent transferee of a partnership interest is separately determined by
reference to the common basis of partnership assets without regard to the prior transferee’s § 743(b) basis
adjustment. §1.743-1(f). However, while the § 743(b) basis adjustment for each of SubsidiaryH and SubsidiaryF was
separately determined, the amount of each successive § 743(b) basis adjustment was identical because the interest
in Partnership1 was immediately transferred from SubsidiaryB to SubsidiaryH to SubsidiaryF.
POSTU-101184-15                              7

Section 743(b) provides that in the case of a transfer of an interest in a partnership by
sale or exchange or upon the death of a partner, a partnership with respect to which the
election provided in § 754 is in effect or which has a substantial built-in loss immediately
after such transfer shall (1) increase the adjusted basis of the partnership property by
the excess of the basis to the transferee partner of his interest in the partnership over
his adjusted share of the adjusted basis of the partnership property, or (2) decrease the
adjusted basis of the partnership property by the excess of the transferee’s
proportionate share of the adjusted basis of the partnership property over the basis of
its interest in the partnership.

Sale or exchange is not defined in § 743, the regulations thereunder, or the legislative
history of the provision. Section 743 was enacted to ameliorate the tax consequences
to a transferee partner by giving a partnership the option to eliminate discrepancies
between a transferee partner’s inside and outside basis when the partnership’s inside
basis in its property is not equal to the fair market value of the property. Jt. Comm. On
Taxation, Summary of the New Provisions of the Internal Revenue Code of 1954, at 92
(1955).

General Counsel Memorandum 35921 (July 29, 1974) held that for purposes of
§ 743(b), a transfer of a partnership in a liquidation under former § 333 was not a
transfer of an interest by sale or exchange. As demonstrated by the GCM, whether the
distribution of a partnership interest by a liquidating corporation was a sale or exchange
was considered an open question prior to the Deficit Reduction Act of 1984 (1984 Act).
See, e.g., John S. Pennell and Terence F. Cuff, “Tax Results of Liquidation of Corporate
Partner Still Unclear Despite DRA 1984,” Journal of Taxation, Vol. 62, No. 2 (February
1985).

Section 761(e), enacted as part of the 1984 Act, provides that except as otherwise
provided in regulations, for purposes of (1) § 708 (relating to continuation of
partnership), (2) § 743 (relating to optional adjustment to basis of partnership property),
and (3) any other provision of this subchapter specified in regulations prescribed by the
Secretary, any distribution of an interest in a partnership (not otherwise treated as an
exchange) shall be treated as an exchange.

The regulations under § 761 do not limit the definition of exchange to taxable
exchanges for purposes of § 743. In particular, no provisions limit the definition of an
exchange between related parties or members of a consolidated group. The
transactions at issue here involved the distribution of a partnership interest as part of
the complete liquidation of a corporate partner, and the transfer of a partnership interest
as part of the reorganization of a corporate partner. Consequently, these transactions
constitute an exchange for purposes of § 743 under the provisions of § 761(e).

Issue 2: Whether § 743(b) adjustments are subject to reallocation under § 704(b).
POSTU-101184-15                               8

Section 703(a) provides that the taxable income of a partnership shall be computed in
the same manner as in the case of an individual except for certain enumerated
exceptions, including the requirement that items described in § 702(a) shall be
separately stated.

Section 704(b) provides that a partner’s distributive share of income, gain, loss,
deduction, or credit (or item thereof) shall be determined in accordance with the
partner’s interest in the partnership (determined by taking into account all facts and
circumstances), if (1) the partnership agreement does not provide as to the partner’s
distributive share of income, gain, loss, deduction, or credit (or item thereof), or (2) the
allocation to a partner under the agreement of income, gain, loss, deduction, or credit
(or item thereof) does not have substantial economic effect.

Section 743(b) provides, in relevant part, that in the case of a transfer of an interest in a
partnership by sale or exchange or upon the death of a partner, a partnership with
respect to which the election provided in § 754 is in effect or which has a substantial
built-in loss immediately after such transfer shall (1) increase the adjusted basis of the
partnership property by the excess of the basis to the transferee partner of his interest
in the partnership over his proportionate share of the adjusted basis of the partnership
property, or (2) decrease the adjusted basis of the partnership property by the excess of
the transferee partner’s proportionate share of the adjusted basis of the partnership
property over the basis of his interest in the partnership. Under regulations prescribed
by the Secretary, such increase or decrease shall constitute an adjustment to the basis
of partnership property with respect to the transferee partner only. A partner’s
proportionate share of the adjusted basis of partnership property shall be determined in
accordance with its interest in partnership capital and, in the case of property
contributed to the partnership by a partner, § 704(c) (relating to contributed property)
shall apply in determining such share.

Section 1.704-1(b)(iii) provides, in relevant part, that the determination of a partner’s
distributive share of income, gain, loss, deduction, or credit (or item thereof) under
§ 704(b) is not conclusive as to the tax treatment of a partner with respect to such
distributive share. If a partnership has a § 754 election in effect, a partner’s distributive
share of partnership income, gain, loss, or deduction may be affected as provided in
§1.743-1.

Section 1.704-1(b)(2)(iv)(m)(1) provides that the capital accounts of the partners will not
be considered to be determined and maintained in accordance with the rules of
paragraph (b)(2)(iv) unless, upon adjustment to the adjusted tax basis of partnership
property under § 732, 734, or 743, the capital accounts of the partners are adjusted as
provided in paragraph (b)(2)(iv)(m).

Section 1.704-1(b)(2)(iv)(m)(2) provides, in relevant part, that in the case of a transfer of
all or a part of an interest in a partnership that has a § 754 election in effect for the
partnership taxable year in which the transfer occurs, adjustments to the adjusted tax
POSTU-101184-15                                            9

basis of partnership property under § 743 shall not be reflected in the capital account of
the transferee partner or on the books of the partnership, and subsequent capital
account adjustments for distributions and for depreciation, depletion, amortization, and
gain or loss with respect to such property will disregard the effect of such basis
adjustment.

Section 1.743-1(j)(1) provides that the basis adjustment constitutes an adjustment to the
basis of partnership property with respect to the transferee only. No adjustment is
made to the common basis of partnership property. Thus, for purposes of calculating
income, deduction, gain, and loss, the transferee will have a special basis for those
partnership properties the bases of which are adjusted under § 743(b) and the
regulations. The adjustment to the basis of partnership property under § 743(b) has no
effect on the partnership’s computation of any item under § 703.

Partnership1 and Partnership2 each had a § 754 election in effect for Year9. As
described above, the Year9 transactions are sales or exchanges for purposes of
§ 743(b). Consequently, Partnership1 and Partnership2 are required to adjust the basis
of the partnership property with respect to transferees as required by § 743(b) and the
underlying regulations. Adjustments to the adjusted tax basis of partnership property
under § 743 are not reflected in the capital account of the transferee partner or on the
books of the partnership. §1.704-1(b)(2)(iv)(m)(2). No adjustment is made to the
common basis of partnership property, and the § 743(b) adjustment has no effect on the
partnership’s computation of any item under § 703. §1.743-1(j)(1). Section 743(b)
adjustments are personal to the transferee partners and are not subject to reallocation
under § 704(b).

Issue 3: Whether §1.1502-13 permits the Taxpayer Group to claim increased
deductions for depreciation and amortization that are attributable to § 743(b)
adjustments arising from the transfer of a partnership interest in an intercompany
reorganization to which § 368 applies and from the distribution of a partnership interest
in an intercompany liquidation to which § 332(a) applies.4

Section 1.1502-13 provides rules for taking into account items of income, gain,
deduction, and loss of members from intercompany transactions (“the intercompany
transaction regulations”). The purpose of these regulations is to provide rules to clearly
reflect the taxable income (and tax liability) of the group as a whole by preventing
intercompany transactions from creating, accelerating, avoiding, or deferring
consolidated taxable income (or consolidated tax liability). §1.1502-13(a)(1).

The amount and location of the item (or items) of each member to an intercompany
transaction (intercompany items and corresponding items) are determined on a

4
  We do not address the application of §1.1502-13 to the Distribution (SubsidiaryA’s taxable distribution of its interest
in Partnership1 to SubsidiaryE). We understand that this interest in Partnership1 was negligible, and that the amount
recognized with respect to the Distribution and the amount of any associated §743(b) adjustments, were not
significant.
POSTU-101184-15                             10

separate entity basis (separate entity treatment), but the timing, character, source, and
other attributes of the intercompany items and corresponding items, although initially
determined on a separate entity basis, are redetermined to produce the effect of
transactions between divisions of a single corporation (single entity treatment).
§1.1502-13(a)(2).

An intercompany transaction is a transaction between corporations that are members of
the same consolidated group immediately after the transaction. §1.1502-13(b)(1)(i).
The parties to an intercompany transaction are identified as S, the member transferring
property or providing services, and B, the member receiving the property or services.
§1.1502-13(b)(1)(i). Intercompany transactions include, for example, S’s sale of
property (or other transfer, such as an exchange or contribution) to B, whether or not
gain or loss is recognized; and S’s distribution to B with respect to S stock. §1.1502-
13(b)(1)(i).

S's income, gain, deduction, and loss from an intercompany transaction, whether
directly or indirectly, are its intercompany items. §1.1502-13(b)(2)(i). S's intercompany
items include amounts from an intercompany transaction that are not yet taken into
account under its separate entity method of accounting, and amounts reflected in basis
(or amounts equivalent to basis) under S’s separate entity method of accounting that is
a substitute for income, gain, deduction, or loss from an intercompany transaction.
§1.1502-13(b)(2)(iii).

B's income, gain, deduction, and loss from an intercompany transaction, or from
property acquired in an intercompany transaction, are its corresponding items.
§1.1502-13(b)(3)(i). An item is a corresponding item whether it is directly or indirectly
from an intercompany transaction (or from property acquired in an intercompany
transaction). §1.1502-13(b)(3)(i). B’s corresponding items include amounts that are
permanently disallowed or permanently eliminated, whether directly or indirectly; thus,
for example, corresponding items include an amount not recognized under § 332
(nonrecognition on liquidating distributions). §1.1502-13(b)(3)(ii).

The recomputed corresponding item is the corresponding item that B would take into
account if S and B were divisions of a single corporation and the intercompany
transaction were between those divisions. §1.1502-13(b)(4). For example, if S sells
property with a $70 basis to B for $100, and B later sells the property to a nonmember
for $90, B's corresponding item is its $10 loss, and the recomputed corresponding item
is $20 of gain (determined by comparing the $90 sales price with the $70 basis the
property would have if S and B were divisions of a single corporation). Although neither
S nor B actually takes the recomputed corresponding item into account, it is computed
as if B did take it into account. §1.1502-13(b)(4).

The attributes of an intercompany item or corresponding item are all of the item’s
characteristics (except amount, location, and timing) necessary to determine the item’s
effect on taxable income (and tax liability). §1.1502-13(b)(6). For example, attributes of
POSTU-101184-15                             11

an item include character, source, treatment as excluded from gross income or as a
noncapital, nondeductible amount, and treatment as built-in gain or loss under § 382(h)
or § 384. §1.1502-13(b)(6).

In general, for each consolidated return year, B's corresponding items and S's
intercompany items are taken into account under the rules of §1.1502-13(c). The
separate entity attributes of S’s intercompany items and B’s corresponding items are
redetermined to the extent necessary to produce the same effect on consolidated
taxable income (and consolidated tax liability) as if S and B were divisions of a single
corporation, and the intercompany transaction were a transaction between divisions.
§1.1502-13(c)(1)(i). Thus, the activities of both S and B might affect the attributes of
both intercompany items and corresponding items. §1.1502-13(c)(1)(i).

B takes its corresponding item into account under its accounting method, but the
redetermination of the attributes of a corresponding item might affect its timing.
§1.1502-13(c)(2)(i). For example, if B's sale of property acquired from S is treated as a
dealer disposition because of S's activities, § 453(b) prevents any corresponding
income of B from being taken into account under the installment method. §1.1502-
13(c)(2)(i).

S takes its intercompany item into account to reflect the difference for the year between
B's corresponding item taken into account and the recomputed corresponding item.
§1.1502-13(c)(2)(ii). That is, the amount of S's intercompany item taken into account in
any year equals the hypothetical amount that the single entity would take into account
for that year (the recomputed corresponding item) minus the amount of B's
corresponding item.

As divisions of a single corporation, S and B are treated as engaging in their actual
transaction and owning any actual property involved in the transaction (rather than
treating the transaction as not occurring). §1.1502-13(c)(3). For example, S’s sale of
land to B for cash is not disregarded, but is treated as an exchange of land for cash
between divisions (and B therefore succeeds to S’s basis in the property). §1.1502-
13(c)(3).

Special rules for redetermining and allocating attributes are found in §1.1502-13(c)(4).
Under §1.1502-13(c)(4)(ii), to the extent S's intercompany item and B's corresponding
item do not offset in amount, the attributes redetermined under §1.1502-13(c)(1)(i) must
be allocated to S's intercompany item and B's corresponding item by using a method
that is reasonable in light of all the facts and circumstances, including the purposes of
this section and any other rule affected by the attributes of S's intercompany item and
B's corresponding item.

Section 1.1502-13(c)(6) provides special rules for the treatment of S’s intercompany
items if B’s corresponding items are excluded or nondeductible. Section 1.1502-
13(c)(6)(i) begins with the general statement that, under §1.1502-13(c)(1)(i), S's
POSTU-101184-15                                         12

intercompany item might be redetermined to be excluded from gross income or treated
as a noncapital, nondeductible amount (emphasis added). This general statement is
illustrated by an example in which S's intercompany loss from the sale of property to B
is treated as a noncapital, nondeductible amount if B distributes the property to a
nonmember shareholder at no further gain or loss (because, if S and B were divisions of
a single corporation, the loss would not have been recognized under § 311(a)).

Section 1.1502-13(c)(7)(ii), Example (9) illustrates application of the matching rule to an
intercompany sale of a partnership interest. In the example, S owns a 20% interest in
the capital and profits of a general partnership which has an election under § 754 in
effect. The partnership holds land for investment with a basis equal to its value, and
depreciable assets which have value in excess of basis. S's basis in its partnership
interest equals its share of the adjusted basis of the partnership's land and depreciable
assets. On January 1 of Year 1, S sells its partnership interest to B at a gain. During
Years 1 through 10, the partnership depreciates the operating assets, and B's
depreciation deductions from the partnership reflect the increase in the basis of the
depreciable assets under § 743(b).5 §1.1502-13(c)(7)(ii), Example (9)(a).

In the example, S's gain is taken into account during Years 1 through 10 to reflect the
difference in each year between B's depreciation deductions from the partnership taken
into account and the recomputed depreciation deductions from the partnership. Under
§1.1502-13(c)(1)(i) and §1.1502-13(c)(4)(i), S's gain taken into account is ordinary
income. §1.1502-13(c)(7)(ii), Example (9)(b).

The example also posits an alternative set of facts in which the partnership sells a
portion of its depreciable assets to a third party at a gain on December 31 of Year 4. In
addition to the intercompany gain taken into account as a result of the partnership's
depreciation, S takes intercompany gain into account in Year 4 to reflect the difference
between B's partnership items taken into account from the sale (which reflect the basis
increase under § 743(b)) and the recomputed partnership items. The attributes of S's
additional gain are redetermined to produce the same effect on consolidated taxable
income as if S and B were divisions of a single corporation (recapture income or §
1231). §1.1502-13(c)(7)(ii), Example (9)(c),

The Taxpayer Group has taken the position that the transfers of Partnership1 interests
in the Year9 Reorganization and Liquidation resulted in a step-up in basis of the assets
owned by Partnership1 and Partnership2, pursuant to § 743(b) and the regulations
thereunder. The net § 743(b) basis adjustment for the transfers of interests in
Partnership1 pursuant to the Reorganization and Liquidation was $n20, and the net
§ 743(b) basis adjustment for the indirect transfers of interests in Partnership2 pursuant
to such transactions was $n23. As a result of these adjustments, the transferees,

5
  The depreciation and amortization deductions are corresponding items even though they arise indirectly from the
intercompany sale. An item is a corresponding item whether it is directly or indirectly from an intercompany
transaction (or from property acquired in an intercompany transaction). §1.1502-13(b)(3)(i).
POSTU-101184-15                                           13

SubsidiaryF and Subsidiary E, claimed increased depreciation and amortization
deductions in the amount of $n26 for the Taxpayer Group’s taxable year ending in
Year9. However, because the transfers occurred pursuant to nonrecognition
transactions, the transferors, SubsidiaryH and SubsidiaryC, recognized no
corresponding amount of income or gain.

At issue here is the appropriate treatment, under the intercompany transaction
regulations, of these additional items of depreciation and amortization that are indirectly
attributable to the Reorganization and Liquidation.

The merger of SubsidiaryH into SubsidiaryF (the Reorganization), as well as the
liquidation of SubsidiaryC into SubsidiaryE (the Liquidation), are both intercompany
transactions; each is a transaction between corporations that are members of the
Taxpayer Group immediately after the transaction.6 In the Reorganization, SubsidiaryH
is the ‘selling member’ and SubsidiaryF is the ‘buying member.’ In the Liquidation,
SubsidiaryC is the selling member and SubsidiaryE is the buying member.

S's gain from an intercompany transaction is an intercompany item. §1.1502-13(b)(2)(i).
The selling members (SubsidiaryH and SubsidiaryC) each realized an amount of gain
with respect to their interest in Partnership1, however, such amounts were not
recognized (either under § 337 or § 361). Thus, SubsidiaryH and SubsidiaryC each
have an intercompany item of $0.

B’s deductions, whether directly or indirectly, from an intercompany transaction or from
property acquired in an intercompany transaction are corresponding items. §1.1502-
13(b)(3)(i). Thus, SubsidiaryF’s and SubsidiaryE’s increased depreciation and
amortization deductions that flow through from Partnership1 (and Partnership2) as a
result of their acquisitions of the Partnership1 interests in the Reorganization and
Liquidation, respectively, constitute corresponding items.

An item’s attributes are all of its characteristics (except amount, location, and timing)
necessary to determine the item’s effect on taxable income (and tax liability); such
attributes include treatment as a noncapital, nondeductible amount. §1.1502-13(b)(6).
Under the matching rule, the separate entity attributes of S’s intercompany items and
B’s corresponding items are redetermined to the extent necessary to produce the same
effect on consolidated taxable income (and consolidated tax liability) as if S and B were
divisions of a single corporation, and the intercompany transaction were a transaction




6
  Section 1.1502-13(j)(2)(i) provides that a reference to a person includes, as the context requires, a reference to a
predecessor or successor. For this purpose, a predecessor includes a transferor of assets to a transferee (the
“successor”) in a transaction to which § 381(a) applies. §1.1502-13(j)(2)(i). Thus, although SubsidiaryH and
SubsidiaryC each ceased to exist as a result of the Reorganization and Liquidation, respectively, SubsidiaryF and
SubsidiaryE are ‘successors’ for purposes of applying the rules of §1.1502-13.
POSTU-101184-15                                          14

between divisions. §1.1502-13(c)(1)(i).7 Although the intercompany transaction
regulations most often redetermine the attributes of the seller’s intercompany item, the
regulations specifically provide for redetermination of the buyer’s corresponding item (or
items) in order to achieve the appropriate single-entity result. §1.1502-13(c)(1)(i); see
e.g., §1.1502-13(c)(7)(ii), Example 5(e).

Basis adjustments required by § 743(b) constitute an adjustment to the basis of
partnership property with respect to the transferee only; importantly, such adjustments
are segregated and allocated solely to the transferee partner for whom the adjustment
is made. § 743(b) and §1.743-1(j). Thus, for purposes of calculating income,
deduction, gain, and loss, the transferee has a special basis for those partnership
properties that are adjusted under § 743(b). §1.743-1(j).

SubsidiaryF’s and SubsidiaryE’s corresponding items, consisting of increased
depreciation and amortization deductions that flow through from Partnership1 and
Partnership2, arise solely from the creation of this special basis under § 743(b). This
special basis and its tax treatment is a characteristic of SubsidiaryF’s and SubsidiaryE’s
corresponding items, necessary to determine the items’ effects on taxable income (and
tax liability). Thus, SubsidiaryF’s and SubsidiaryE’s entitlement to the depreciation and
amortization deductions that stem from this special basis, is an attribute to be
considered separate and apart from the items generated in the Reorganization and
Liquidation (but only to the extent necessary to achieve the effect as if the transferors
and transferees were divisions of a single corporation). See §1.1502-13(b)(6) and
§1.1502-13(c)(1)(i).

Under §1.1502-13(c)(1)(i), the attributes of SubsidiaryF’s and SubsidiaryE’s
depreciation and amortization deductions must be redetermined to the extent necessary
to produce the same effect on consolidated taxable income as if the Reorganization and
Liquidation were between divisions of a single corporation. If the respective transferor
members, SubsidiaryH and SubsidiaryC, and the respective transferee members,
SubsidiaryF and SubsidiaryE, were divisions of a single corporation, the transferee
members would succeed to the transferor members’ basis in the Partnership1 interest,
precisely the result accomplished here (pursuant to §§ 334(b) and 362(b)).

However, if SubsidiaryH and SubsidiaryF, and SubsidiaryC and SubsidiaryE,
respectively, were divisions of a single corporation, the transfers of the Partnership1
interests would not result in, and the single corporation would not be entitled to claim, a
net deduction for the increased depreciation and amortization arising from the special
basis adjustments under § 743(b). Thus, to achieve the effect of single entity treatment,
SubsidiaryF’s depreciation and amortization deductions of $n27 and SubsidiaryE’s
depreciation and amortization deductions of $n28 must be redetermined to be treated
as noncapital, nondeductible items (because, as divisions of a single corporation,

7
 As divisions of a single corporation, the intercompany transactions are not ignored; thus, SubsidiaryH and
SubsidiaryC are treated as engaging in an actual transfer of the interests in Partnership1, and SubsidiaryF and
SubsidiaryE are treated as owning the interests in Partnership1. §1.1502-13(c)(3).
POSTU-101184-15                             15

§ 743(b) would not give rise to a net deduction for depreciation and amortization for the
Taxpayer Group). See §1.1502-13(c)(1)(i); see also §1.1502-13(c)(4)(ii) (when the
amounts of S’s intercompany item and B’s corresponding item do not offset, the
redetermined attributes of those items will be allocated to the intercompany item and
corresponding item using a method that is reasonable in light of all of the facts and
circumstances). Effectively, SubsidiaryF and SubsidiaryE are not permitted the special
basis adjustments under §743(b) to the extent their corresponding items produce a
result that is inconsistent with treating the transactions as between divisions of a single
corporation.

Treatment of SubsidiaryF’s and SubsidiaryE’s corresponding items as noncapital,
nondeductible items is consistent with the special rules of §1.1502-13(c)(6) which
address attribute redetermination in the context of intercompany items. Section
§1.1502-13(c)(6)(i) explicitly acknowledges that an intercompany item may be
redetermined to be excluded from gross income or treated as a noncapital,
nondeductible amount under §1.1502-13(c)(1)(i) in order to achieve single entity
treatment. This is illustrated by an example provided therein, in which S’s intercompany
loss from the sale of property to B is treated as a noncapital, nondeductible amount
when B distributes the property to a nonmember shareholder at no further gain or loss.
Redetermination is appropriate because if S and B were divisions of a single
corporation, no loss would have been recognized under § 311(a).

Notably, the example applies the attribute redetermination rule to eliminate S’s
intercompany item entirely. Thus, while the amount of an item is not an attribute, it is
clear that redetermination of an item’s attributes can affect whether the item is taken
into account at all. Moreover, while the example addresses the redetermination of S’s
intercompany items, its conclusion is based upon the application of §1.1502-13(c)(1)(i)
which, by its terms, applies attribute redetermination not only to S’s intercompany items
but also to B’s corresponding items.

Applying a similar analysis to the Reorganization and Liquidation here, SubsidiaryF’s
and SubsidiaryE’s increased depreciation and amortization deductions must be
redetermined to be treated as noncapital, nondeductible items because if each of the
members to the Reorganization and to the Liquidation were divisions of a single
corporation, no net deduction for the increased depreciation and amortization would
have arisen from the application of § 743(b).

This treatment is not inconsistent with the analysis and conclusions of §1.1502-
13(c)(7)(i), Example (9), which illustrates application of the matching rule to a taxable
sale of a partnership interest between members. In the example, the sale of the interest
results in a gain to S (S’s intercompany item). Through the operation of § 743(b), the
sale also results in a corresponding increase to the basis of the partnership’s assets,
which is allocated wholly to B, and an increase to the partnership’s depreciation
deductions, which flow through solely to B (B’s corresponding items). §1.1502-
13(c)(7)(i), Example (9)(a).
POSTU-101184-15                                        16


The example states that S's basis in its partnership interest equals its share of the
adjusted basis of the partnership's land and depreciable assets; that is, there is parity
between S’s share of the inside basis of the partnership’s assets and S’s outside basis
in its partnership interest. As a result of this parity, the amount of gain recognized by S
from its sale of the partnership interest corresponds precisely with the increased
partnership asset basis allocated to B under § 743(b) and, over time, S’s gain can be
matched precisely with B’s increased depreciation deductions. Similar results are
obtained if the partnership sells an asset which reflects the § 743(b) basis increase; a
proportionate amount of S’s gain from its sale of the partnership interest can be
matched precisely with B’s reduced share of the gain or increased share of the loss
from the partnership’s sale of the asset. See §1.1502-13(c)(7)(i), Example (9)(b) and
(c). Because the amount of S’s and B’s items offset (with the result that consolidated
taxable income (and consolidated tax liability) is unaffected), attribute redetermination is
necessary only to the extent of the character of those matching items. The
intercompany sale, in addition to the § 743(b) basis adjustments resulting from that sale,
will have no effect on consolidated taxable income (and consolidated tax liability).

The facts underlying the Reorganization and Liquidation, and the consequences of
these transactions, are distinguishable from those in Example (9). Here, there is no
correspondence between the amount of the items of the transferors (SubsidiaryH and
SubsidiaryC) and those of the respective transferees (SubsidiaryF and SubsidiaryE).
As a result, there is no ability to match the members’ respective intercompany and
corresponding items to achieve the appropriate single entity result. Under these facts,
application of the attribute redetermination rule to treat the increased depreciation and
amortization deductions as noncapital, nondeductible items is not only warranted, but is
compelled, by the fundamental purpose of the intercompany transaction regulations, as
clearly stated therein -- to clearly reflect the taxable income (and tax liability) of the
group as a whole by preventing intercompany transactions from creating, accelerating,
avoiding, or deferring consolidated taxable income (or consolidated tax liability). See
§1.1502-13(a)(1) and (c)(1)(i).8

Thus, we conclude that §1.1502-13 does not permit the Taxpayer Group to claim
increased deductions for depreciation and amortization that are attributable to § 743(b)
adjustments arising from the Reorganization and Liquidation. Such amounts must be
redetermined to be treated as noncapital, nondeductible items.

Issue 4: Whether the basis adjustment provisions of § 743(b) conflict with the basis
provisions of § 362(a) when a partnership interest is transferred in an intercompany
reorganization to which § 368 applies or with the basis provisions of § 334(b)(1) when a


8
 We note that application of the attribute redetermination rule is not a one-way street. Attribute redetermination
would be equally appropriate had the intercompany transactions resulted in decreased depreciation and amortization
deductions flowing through from Partnership1 and Partnership2 as a result of the application of § 743(b).
POSTU-101184-15                             17

partnership interest is distributed in an intercompany liquidation to which § 332(a)
applies.

In the case of property transferred in a reorganization to which § 368 applies, in which
no gain or loss is recognized, the basis of such property in the hands of the transferee
generally is the same as it would be in the hands of the transferor under § 362(a).
Similarly, in the case of property distributed to a corporate parent from a subsidiary in a
complete liquidation to which § 332(a) applies, in which no gain or loss is recognized,
the basis of such property in the hands of the distributee generally is the same as it
would be in the hands of the distributor under § 334(b)(1).

Thus, with respect to the transfer of the Partnership1 interest from SubsidiaryH to
SubsidiaryF in the Reorganization (to which § 368 applies), and the distribution of the
Partnership1 interest from SubsidiaryC to SubsidiaryE in the Liquidation (to which § 332
applies), the transferee’s and distributee’s basis in their Partnership1 interest is the
same as it would be in the hands of the respective transferor and distributor.

Application of § 743(b), by contrast, has no effect on the basis of a partnership interest
transferred in a reorganization or distributed in a complete liquidation. Rather, in such
cases, if the partnership has a § 754 election in effect, § 743(b) provides for an increase
or decrease in the adjusted basis of partnership property.

Thus, with respect to the transfers of Partnership1 interests, there is no conflict between
the basis adjustment provisions of § 743(b) and the applicable carryover basis
provisions of § 362(a) and § 334(b)(1).

CASE DEVELOPMENT, HAZARDS, AND OTHER CONSIDERATIONS
POSTU-101184-15                             18


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