10 August 2020 Key implications of the IRC Section 1061 carried interest proposed regulations for passthroughs, including private equity and alternative funds On July 31, 2020, the IRS issued carried interest proposed regulations under IRC Section 1061 and other related partnership and holding period provisions (REG-107213-18; hereafter the "Regulations"). IRC Section 1061, enacted in the Tax Cuts and Jobs Act of 2017, generally imposes a three-year holding period requirement for certain carried interest arrangements, including carried interests in many private equity and alternative asset funds (i.e., hedge, real estate, energy, infrastructure and fund of funds), to qualify for tax-favored long-term capital gains (LTCGs) treatment. Where it applies, IRC Section 1061 recharacterizes gains arising from the sale of capital assets held for one to three years, otherwise eligible for taxation at LTCG rates, as short-term capital gains (STCGs), typically taxed at the rates applicable to ordinary income.
In addition, the IRS cautions taxpayers regarding carry waivers but does not impose new restrictions or guidelinesin the Regulations. Subject to limited exceptions related to profit interests held by S Corporations and certain PFICs (discussed below), the Regulations would apply to tax years beginning on or after the date final regulations are published in the Federal Register. Taxpayers generally may rely on the Regulations before they are published in final form, provided they follow the Regulations in their entirety and in a consistent manner. Taxpayers may rely on the Regulations' rules on Partnership Transition Amounts and API Holder Transition Amounts for tax years beginning in 2020 (and subsequent tax years) even without consistently following all the requirements of the Regulations. IRC Section 1061(a) applies to taxpayers that hold "applicable partnership interests" (APIs). An API is defined as a partnership interest that is transferred to, or held by, a taxpayer in connection with the performance of substantial services by the taxpayer or any related person in an "applicable trade or business" (ATB). A partnership interest includes any financial instrument or contract, the value of which is determined in whole or in part by reference to the partnership (including the amount of partnership distributions, the value of partnership assets, or the results of partnership operations). Once a partnership interest qualifies as an API, it generally retains that status unless and until an exception from API treatment applies (such as the bona fide third-party purchaser exception, discussed below). Thus, even if an individual API holder retires and ceases to provide any services, the carried interest retains its API status and IRC Section 1061 will continue to apply. Gains and losses with respect to an API retain their character as such when they are allocated through the tiers in a chain of passthrough entities. If a taxpayer acquires a partnership interest in connection with the performance of services, the services provided are presumed to be substantial for purposes of the API requirement. "Unrealized API Gains and Losses" generally retain their character as such, and they must be tested under IRC Section 1061 when they are realized and recognized. Unrealized API Gains and Losses include (i) built-in gain or loss in an API that is contributed to an upper-tier partnership (UTP) and (ii) unrealized capital gains or losses allocated to an API holder with respect to an API in connection with a revaluation of partnership property (commonly referred to as a "book-up") under Treas. Reg. Section 1.704-1(b)(2)(iv)(f). Where such transactions occur in a tiered partnership context, the Regulations require a UTP to look through the tiers of entities to any capital assets held in lower-tier partnerships (LTPs) — a requirement that (i) could prove administratively burdensome and (ii) could be difficult or even impossible for a UTP to comply with where the UTP has no access to information concerning the assets on a LTP's balance sheet. Where Unrealized API Gains and Losses are subsequently recognized, they must be allocated through the tiers to the API holder under the principles of Treas. Reg. Section 1.704-3(a)(9). The preamble to the Regulations (the Preamble) states that a partnership interest may be treated as an API regardless of whether the receipt of the interest satisfies the requirements of Revenue Procedure 93-27, which sets forth an administrative safe harbor for the tax-free receipt of profits interests/carried interests. An ATB is defined by statute as any activity conducted on a regular, continuous and substantial basis which, regardless of whether the activity is conducted in one or more entities, consists, in whole or in part, of — (i) investing in (or disposing of) specified assets (or identifying "specified assets" for such investing or disposition), or The Regulations provide guidance on several aspects of the determination of whether an ATB exists (referred to herein as the "ATB Activity Test"). First, for the ATB Activity Test to be satisfied, the level of activity must be sufficient to establish a trade or business under IRC Section 162. The test is applied based on the combined level of the Raising or Returning Capital Actions and Investing or Developing Actions. It appears that, consistent with the statutory language, both Raising or Returning Capital Actions and Investing or Developing Actions are required for the ATB Activity Test to be met. However, both types of activities need not be present in the same year. For example, if (i) in Year 1 a taxpayer conducts Raising or Returning Capital Actions in anticipation of conducting Investing or Developing Actions in a future year, (ii) in Year 2 the taxpayer conducts Investing or Developing Actions, and (iii) collectively the Year 1 and Year 2 activities are sufficient to establish a trade or business under IRC Section 162, then the ATB Activity Test is met in Year 2. Certain attribution rules apply for purposes of the ATB Activity Test. All activities conducted by persons related to the taxpayer are attributed to the taxpayer for purposes of the test. A "related person" means a person who is related to the taxpayer for purposes of IRC Section 267(b) or IRC Section 707(b). In addition, actions taken by a delegate or agent are attributed to the principal for purposes of the ATB Activity Test. For example, if the general partner of a partnership is contractually obligated to manage a partnership and hires a management company to provide management services on the general partner's behalf, then the management company's activities will be attributed to the general partner for purposes of the ATB Activity Test, even if the management company is unrelated to the general partner. Developing "Specified Assets" (as defined below) occurs when it is represented to investors, lenders, regulators or other interested parties that the value, price, or yield of a portfolio business may be enhanced or increased in connection with choices or actions of a service provider. However, merely exercising voting rights with respect to shares owned, or similar activities, does not amount to developing Specified Assets. "Specified Assets" include stock, securities, options and derivatives. A partnership interest constitutes a "Specified Asset" if the interests in the partnership are publicly traded or widely held, or to the extent the partnership's assets consist of Specified Assets. The Regulations clarify that an option or derivative contract on a partnership interest is included in the definition of Specified Assets to the extent the partnership interest represents an interest in other Specified Assets. Real estate is also a Specified Asset if it is held for rental or investment purposes. (Although real estate is a Specified Asset, IRC Section 1231 gains are not subject to recharacterization as STCG under IRC Section 1061.) any capital interest in the partnership which provides the taxpayer with a right to share in partnership capital commensurate with —
The Regulations provide that, to qualify for the capital interest exception, allocations must be based on the partners' relative capital accounts, and the terms, priority, type and level of risk, rate of return, and rights to cash or property distributions during the partnership's operations and on liquidation must be the same. An allocation to an API holder will not fail to qualify solely because the allocation is subordinated to allocations made to unrelated non-service partners. Further, an allocation to an API holder will not fail to qualify because it is not reduced by the cost of services provided by the API holder or a related person to the partnership. In addition, for allocations to qualify for the capital interest exception, the partnership generally must make allocations on the same terms to unrelated non-service partners with a significant aggregate capital account balance. An aggregate capital account balance equal to 5% or more of the aggregate capital account balance of the partnership at the time the allocations are made will be treated as significant. The taxpayer's capital account does not include any contributed amounts directly or indirectly attributable to any loan or other advance made, or guaranteed, directly or indirectly, by any other partner or the partnership. However, in general, repayments on the loan are included in the taxpayer's capital account as those repayments are made. Unrealized capital gains cannot be converted into gains that qualify for the capital interest exception. The Preamble states that transactions that give rise to a deemed contribution, such as a partnership division or recapitalization, cannot be used to convert API gains and losses into capital interest gains and losses. Gain on the disposition of a capital interest does not necessarily qualify for the capital interest exception from IRC Section 1061. Determining whether the gain is eligible for the exception requires a multi-step process that involves a determination of whether gain or losses allocable to the partner from the hypothetical liquidation of the partnership (and any LTPs) would be eligible for the capital interest exception. If gain on the disposition of a capital interest does not qualify for the capital interest exception, it is treated as API gain. Under the statute, APIs held directly or indirectly by corporations are not subject to IRC Section 1061 (the corporation exception). Consistent with Notice 2018-18, the Regulations provide that an S corporation is not considered a corporation for purposes of the corporation exception. The Regulations provide that the S corporation exclusion applies to tax years beginning after December 31, 2017. The Regulations also exclude APIs held by PFICs for which a QEF election was made from the corporation exception. The rule for a QEF holding an API is effective from the date the Regulations are published in the Federal Register. (Practice Note: Certain funds, such as credit funds that generate significant ordinary income or that qualify for the trading safe harbor, may hold their carried interests in C corporations — such interests are not treated as APIs.) The Regulations track statutory language in regard to the exception for employees of entities that are not engaged in an ATB. (Practice Note: This exception has been interpreted to cover persons receiving profits interests for providing services to portfolio companies engaged in operating trades or businesses.) The Regulations create a new exception to IRC Section 1061, which provides that an API will cease to be treated as an API if it is purchased by a person who does not currently and has never provided services in the relevant ATB, is unrelated to any service provider, and acquires the interest for fair market value. (Practice Note: This exception is generally expected to permit certain unrelated institutional investors to acquire interests in the General Partner without any adverse consequences under IRC Section 1061, subject to the discussion below under Fund-specific industry implications.) IRC Section 1061(b) provides that, "[t]o the extent provided by the Secretary, [Section 1061](a) shall not apply to income or gain attributable to any asset not held for portfolio investment on behalf of third-party investors." The Regulations reserve on this exception. The Preamble notes that many comments suggested that this exception was intended to apply to family offices; significantly, the Preamble also states that the Treasury Department and the IRS generally agree with those comments and believe that the IRC Section 1061(b) exception effectively is implemented as part of the Regulation's provisions under the capital interest exception. However, the Regulations do not mention this family office exception, and it is not entirely clear whether the Regulation's capital interest exception provisions will exempt most, or all family office structures. Hopefully, this exception will be clarified when regulations are finalized. The Regulations adopt a hybrid approach to allocations made with respect to APIs, referred to as the "Partial Entity Approach." This approach treats partnerships and other passthrough entities as taxpayers for purposes of determining the existence of an API; however, the "Recharacterization Amount" (generally defined as the amount of capital gain that is recharacterized as STCG) is determined not at the partnership level, but only at the level of the ultimate owners (individuals, estates or trusts). To implement this approach, the Regulations introduce the concepts of an "Owner Taxpayer" and a "Passthrough Taxpayer." The term "Owner Taxpayer" refers to the person (i.e., an individual, estate or trust) that is subject to federal income tax on net gain with respect to a directly or indirectly held API during the tax year. The term "Passthrough Taxpayer" refers to a passthrough entity that is treated as a taxpayer for the purpose of determining the existence of an API. Passthrough Taxpayers generally are required to make certain computations with respect to their API-related income and to pass such income through to their owners. Any API-related income generally retains its character as such as it passes through tiers of passthrough entities and up to the Owner Taxpayers, who then take such income into account in determining the Recharacterization Amount. In applying IRC Section 1061 to gain on the sale or exchange of an asset, the holding period of the asset disposed of generally controls. For example, if a fund sells stock of a portfolio company, the relevant holding period is the fund's holding period in the portfolio company stock — not the GP entity's holding period in its carried interest in the fund, or an individual carry partner's holding period in its interest in the GP entity. Conversely, if a partner recognizes gain from the sale or exchange an API (including gain due to an excess distribution under IRC Section 731(a)), the relevant holding period is generally the partner's holding period in the API; however, this rule is subject to important exceptions under the Lookthrough Rule and IRC Section 1061(d) (both discussed below). As stated above, in general, the relevant holding period under the Regulations is the holding period of the asset disposed of. However, the Regulations include a limited look-through rule (the Lookthrough Rule), which could recharacterize greater-than-three-year capital gain on an API disposition to one-to-three-year capital gain. If, in a taxable transaction, an API Holder disposes of a directly held API with a holding period that is greater than three years, the Lookthrough Rule will generally recharacterize all or part of the gain as one-to-three-year capital gain if the "Substantially All" test is met. Generally, the "Substantially All" test is met if 80% or more of the partnership's assets (i) are assets that would produce capital gain or loss that is not excluded from IRC Section 1061 (e.g., under the exclusion for IRC Section 1231 gain) if disposed of by the partnership and (ii) have a holding period of three years or less. The determination is made based on the fair market values of the assets. Cash, cash equivalents, and IRC Section 751 unrealized receivables and inventory items are not taken into account. If an upper-tier partnership has a greater-than-three-year holding period in its interest in a lower-tier partnership, the upper-tier partnership must treat the interest as having a one-to-three-year holding period to the extent the lower-tier partnership's assets consist of capital assets with a one-to-three year holding period. The Lookthrough Rule will also apply when an API holder disposes of an indirectly held API in a taxable transaction if either (i) the passthrough entity, through which the API is directly or indirectly held, has held the API for three years or less, or (ii) the assets of the partnership meet the above-described Substantially All test. This is true even if the API Holder has held the passthrough entity interest for longer than three years. The Regulations provide guidance on certain types of income that are not subject to recharacterization under IRC Section 1061. These items include IRC Section 1231 gains, IRC Section 1256 gains, and qualified dividend income. In addition, certain gains that are characterized as short- or long-term without regard to holding period rules under IRC Section 1222 (e.g., capital gains and losses identified as mixed straddles under IRC Section 1092(b) and certain regulations promulgated thereunder) are excluded from IRC Section 1061. Installment sale gains may be subject to IRC Section 1061, even where the sale took place prior to IRC Section 1061's effective date. The Regulations contain a special rule for property distributed with respect to an API interest. Under this rule, the distribution does not accelerate gain recognition under IRC Section 1061 or the Regulations, but a gain or loss from a subsequent sale or exchange of such property will be taken into account under IRC Section 1061, if at the time of the disposition the distributee partner's holding period in the property is not greater than three years. For example, if a fund distributes stock with a two-year holding period to a partner, the distributee partner will generally take the same two-year holding period in that stock under IRC Section 735(b). If the distributee partner receives the distribution with respect to an API in the fund and sells the distributed stock within a year of receiving it, the gain is nevertheless tainted as API gain, despite the fact that such gain was not directly derived from an API. REIT or RIC capital gain dividends and LTCG inclusions for PFICs for which a QEF election has been made may be eligible for LTCG treatment under IRC Section 1061, to the extent that such income either is attributable to (i) the REIT's, RIC's or PFIC's disposition of a capital asset held for longer than three years or (ii) income of the REIT, RIC or QEF that is not subject to recharacterization under IRC Section 1061 (e.g., IRC Section 1231 gain). However, such eligibility is conditioned on the satisfaction of certain reporting requirements. If the REIT, RIC or QEF does not satisfy the reporting requirements, the entire capital gain dividend or QEF capital gain inclusion would be treated as one-to-three-year capital gain for purposes of IRC Section 1061. QEF inclusions are treated as greater-than-three-year gain for purposes of IRC Section 1061 if (i) the capital gain would qualify as long term capital gain using a three-year holding period and (ii) the QEF provides the information needed to make that determination. (Practice Note: Nothing requires the PFIC to provide the information needed for otherwise qualified greater-than-three year gains to receive favorable treatment; see our recommendations below under "Fund-specific industry implications.") Generally speaking, IRC Section 1061 and the Regulations do not supplant the existing rules for determining a partnership's holding or tax basis in its partnership interest. A partner generally has a single, unitary basis in its partnership interest and a single IRC Section 704(b) book capital account, even though the partner may hold multiple different classes of interest in the partnership. Where a partner disposes of only part of its partnership interest, the partner must equitably apportion the tax basis of the entire interest between the portion of the interest that is disposed of and the portion of the interest that is retained. In addition, where a partner acquires multiple interests in a partnership at different times (or in exchange for the contribution of assets with different holding periods), the partner may have a split holding period in its partnership interest. If a partner has a split holding period in its partnership interest and the partner disposes of only part of its interest, then, unless the partnership is a publicly-traded partnership, the portion of the interest disposed of and the portion of the interest retained will each have a split holding period. The Regulations generally leave the above-described regime undisturbed, except for a proposed modification to the regulations under IRC Section 1223 that would apply for purposes of determining the holding period of a partnership interest that consists in whole or in part of one or more profits interests. Under this rule, the portion of the holding period to which a profits interest relates is determined based on the fair market value of the profits interest at the time that all or part of the partnership interest is disposed of. The Preamble notes that one commenter asked whether a capital interest can be disposed of separately from an API for purposes of IRC Section 1061(a). The Preamble clarifies that the disposition of a capital interest will be respected as such for purposes of IRC Section 1061, provided that the interest being disposed of is clearly identified as a capital interest. However, because of the special unitary basis and holding period rules described above, the fact that a partner disposed of a capital interest and retained an API may not determine the tax consequences of the transaction from a tax basis or holding period perspective. Prop. Treas. Reg. Section 1.1061-3(c)(7), Example, 6, illustrates a fact pattern in which a partner holds an API and a capital interest and disposes of the capital interest. Grandfathered transition amounts excluded for purposes of computing the recharacterization amount (Partnership Transition Amount Rule) The Regulations provide an election to carve out from IRC Section 1061 certain more-than-three-year assets. Under the Regulations, partnerships that were in existence as of January 1, 2018, may irrevocably elect to treat as Partnership Transition Amounts all LTCG and LTCL recognized from the disposition of all assets held by the partnership for more than three years as of January 1, 2018. The election is made by attaching a statement to the fund's (or in certain limited cases, the GP's) tax return in the first year the fund (or GP, as appropriate) treats amounts as "Partnership Transition Amounts." The Preamble indicates that this exception is intended to alleviate the burden of certain taxpayers who, prior to the enactment of IRC Section 1061, had no reason to track what portion of the unrealized appreciation in partnership assets was attributable to capital interests (relevant for purposes of the capital exception) and therefore, may lack the historical data to do so. The API Holder Transition Amount is defined as the API holder's allocable share of Partnership Transition Amounts; these amounts are eligible for LTCG treatment and are excluded when calculating the Recharacterization Amount. If an Owner Taxpayer transfers an API, or property distributed with respect to an API with a holding period of not more than three years, to a "related person," the proposed regulations under IRC Section 1061(d) apply. "Related person" is generally more narrowly defined than for purposes of IRC Section 1061(c)(1) and is limited to family members and certain family partnerships, and colleagues described below. These rules may (i) turn a transaction otherwise eligible for nonrecognition into a taxable transaction and/or (ii) result in the recharacterization of LTCG into STCG. "Transfer" for this purpose include contributions, distributions, sales, exchanges and gifts. This aspect of the Regulations may impact some wealth planning strategies.
A tax-free contribution of an API by an API holder to a partnership (under IRC Section 721(a)) is not subject to IRC Section 1061(d). Instead, any associated API gains must be tracked and allocated back to the API Holder when recognized under IRC Section 704(c) principles. Passthrough Entities (including funds of funds, funds and fund GPs) must report IRC Section 1061 information to Owner Taxpayers on an attachment to the Schedule K-1, including:
Penalties will apply if a Passthrough Entity fails to timely comply (e.g., IRC Section 6698, Failure to File Partnership Returns, and IRC Section 6722, Failure to Furnish Correct Payee Statements). A Passthrough Entity that owns a lower-tier partnership (LTP) will need information from LTP to satisfy reporting obligations. The Passthrough Entity must request information from LTP by the later of (1) the 30th day of the close of the calendar year or (2) within 14 days of receiving a request for information from an API Holder. The LTP must respond by the due date (including extensions) of the Schedule K-1 for the tax year. A RIC or REIT must provide certain IRC Section 1061 disclosures in order for its RIC or REIT dividends, ordinarily eligible for capital gains rates, to qualify for favorable treatment in the Recharacterization Amount calculation. If certain required QEF income disclosures are not provided, an API holder must include all amounts of LTCG from the QEF in its API One-Year Distributive Share Amounts (and no amounts in its API Three-Year Distributive Share). The Regulations have implications for funds and the managers and general partners of such funds. Funds may find certain aspects of the new rules challenging, such as the capital interest definition, the reporting requirements and the Lookthrough Rule. The Preamble mentions tax planning techniques commonly referred to as "carry waivers." A "carry waiver" generally refers to a transaction in which a carried interest holder waives its right to a carried interest distribution, and the accompanying allocation of taxable income, in exchange for the right to receive a potential future distribution and allocation of income from the partnership, contingent on the fund's earning sufficient future income to make the allocation. The income waived is generally of a character disadvantageous to the carried interest holder, such as gain from the sale of a capital asset held for not more than three years. The Preamble cautions that carry waiver strategies may be challenged under various grounds, including the partnership anti-abuse rule in Treas. Reg. Section 1.707-2 and the economic substance doctrine. However, the Regulations do not include new rules on carry waivers. The general partner of a fund may earn a limited-partner-like economic return on its partnership capital account attributable to prior carried interest allocations (sometimes referred to as a return on "proprietary capital"). This arrangement is particularly common in the hedge fund industry. The statute appears to predicate the applicability of the capital interest exception on a prior capital contribution or IRC Section 83 income inclusion. Accordingly, it was unclear whether a general partner's return on its proprietary capital would be eligible for the capital interest exception. The Regulations suggest that it is. The portion of the Regulations dealing with the capital interest exception does not require a capital contribution or IRC Section 83 income inclusion, but instead focuses on the manner in which partnership allocations are made. The Regulations' requirement that allocations be made "in the same manner" to all partners to qualify under the capital interest exception may raise questions regarding common arrangements in the asset management industry. Frequently, capital interests held by the general partner or its affiliates do not receive allocations identical to the allocations made to unrelated investors. For example, the general partner and affiliates typically do not owe management fees or carried interest. Moreover, many funds utilize side pockets, or in certain cases may have transfers of interests that result in variations in allocations between API holders and non-API holders in a tax year (e.g., IRC Section 706). In addition, the liquidity rights and other economic terms may differ in some respects. In such cases, it is not clear that allocations to the general partner and affiliates will meet the requirements of the capital interest exception set forth in the Regulations. In particular, the Regulations state that allocations must be made "in the same manner to all partners" and that "allocations will be considered to be made in the same manner if, under the partnership agreement, the allocations are based on the relative capital accounts of the partners … and the terms, priority, type and level of risk, rate of return, and rights to cash or property distributions during the partnership's operations and on liquidation are the same." The only exceptions set forth in the Regulations are that allocations to an API holder may be subordinated to allocations to unrelated non-service partners and that an allocation to an API holder need not be reduced by the cost of services provided by the API holder or a related person to the partnership. The apparent strictness of these requirements raises the possibility that capital interest allocations to service providers in many funds may fail the capital interest exception. The rule in the Regulations providing that a partner's capital account for purposes of the capital interest exception does not include any contributions funded by proceeds of a loan made or guaranteed by any other partner, the partnership, or a person related thereto, is likely to impact many partners. Where a deal professional receives a carried interest and commits capital in exchange for a capital interest, but uses a loan that is guaranteed by the fund to finance this capital contribution, such capital interest is excluded from the definition of capital interest. The partner may obtain a qualified capital account by paying down the loan, unless such payments are funded by another disqualified loan. Investment professionals who fund their capital commitments through disqualified loans should consider alternative funding arrangements to address the implications of the Regulations. As discussed above, the Regulations create an exception to API treatment where an unrelated non-service-provider purchases an API in a fully taxable transaction. However, it is not totally clear how this exception applies in a tiered partnership structure. For example, it is unclear whether, if a third-party buyer acquires an API in a tiered partnership structure, the exception will apply not only to the API directly acquired by the buyer, but also to the buyer's share of any APIs in any lower-tier passthrough entities. Similarly, the Regulations do not specify whether the exception will also apply to any indirect interests in APIs that are acquired after the purchase (for example, if a buyer purchases an interest in a general partner entity and, after the purchase, a new fund is formed and issues a carried interest to the general partner entity). QEF LTCG inclusions may be eligible for LTCG treatment under IRC Section 1061, provided that the QEF satisfies certain reporting requirements. However, the QEF is not statutorily required to report such information to its owners or the IRS. Funds or other persons planning to invest, directly or indirectly, in PFICs should consider negotiating for the contractual right (including for investors in certain funds or fund of funds, in their side letters) to receive the additional information needed to comply with IRC Section 1061, and thereby avoid converting IRC Section 1061 exempt greater-than-three-year capital gains into one-to-three-year capital gains. Fund managers often seek to gift carried interests as part of their wealth and estate transfer planning. However, the related person transfer rules in the Regulations cause gain to be accelerated — and taxed at STCG rates — upon a transfer to certain related persons (e.g., family members, certain family partnerships), even where the transfer would otherwise qualify as a nonrecognition transaction. This trap for the unwary may adversely impact carried interest gift planning and may require careful structuring to avoid. The Regulations do not provide guidance on split holding periods related to add-on investments in portfolio companies structured as C corporations or partnerships. When making add-on investments, Funds should carefully analyze the tax consequences of different potential structures to avoid or mitigate potentially adverse holding period consequences that could result in additional STCG under IRC Section 1061. A partnership may irrevocably elect to treat all LTCGs and LTCLs from the disposition of all assets held by the partnership for more than three years as of January 1, 2018, as Partnership Transition Amounts (subject to certain limitations). This would generally cause such amounts to be excluded from the determination of the Recharacterization Amount to the extent they are allocated to Owner Taxpayers. It appears that such an election may have at least three effects on partnerships and API Holders. First, it will likely simplify the calculation of the Recharacterization Amount in that certain amounts that might otherwise need to be included in the calculation can be excluded in the grounds that the assets in question were held for more than three years as of January 1, 2018. Second, it appears that, in certain fact patterns, the election may impact an Owner Taxpayer's Recharacterization Amount by removing certain items of LTCG and/or LTCL from the netting calculation. It appears that the impact may be favorable or unfavorable, depending on the particular facts. Third, if greater-than-three-year LTCG or LTCL from the disposition of an interest in a passthrough entity is excluded from the calculation of the Recharacterization Amount because a transition amount election is made, it appears that such LTCG or LTCL should not be subject to potential recharacterization as one-to-three-year capital gain or loss under the Lookthrough Rule.
Document ID: 2020-2026 | |||||||||||||||||||
