IRS Issues Final Regulations Requiring Disclosure of Certain “Basis Shifting” Transactions Involving Partnership Distributions and Transfers of Partnership Interests

Alert
January 23, 2025
6 minutes

The U.S. Department of the Treasury (the “Treasury”) and the Internal Revenue Service (the “IRS”) published final regulations on January 14, 2025 (the “Regulations”) requiring taxpayers and their material advisors to disclose certain transactions (including historic transactions) involving partnership distributions and transfers of partnership interests.

Under the Regulations, taxpayers will be required to review quickly a wide scope of partnership transactions, including certain transactions commonly undertaken by private funds, that occurred within a six-year lookback period and prepare required disclosures by July 14, 2025. In addition, the Regulations impose go-forward tax compliance obligations for taxpayers with respect to such transactions. Failure to comply with the reporting requirements may result in the imposition of penalties of up to $50,000 per transaction for each participant.

Members of the Trump Administration and the new Congress have been increasingly vocal about streamlining and reducing regulatory footprints, and thus, it is possible that the Regulations will be overridden or limited. In particular, the new Congress may override the Regulations by enacting a joint resolution of disapproval under the Congressional Review Act. Any such action is uncertain, and given the July 14, 2025 disclosure deadline, taxpayers likely will need to begin assessing their reporting obligations before there is clarity on whether the Regulations will be overridden or modified.

Overview of the Regulations:

The stated purpose of the Regulations is for the Treasury and the IRS to study whether certain partnership transactions facilitate tax avoidance by using technical rules to shift improperly tax basis. However, the Regulations potentially apply to a wide scope of partnership transactions, including certain ordinary course transactions in the private fund space, regardless of intent or tax avoidance outcomes.

The Regulations designate the following as transactions of interest that must be reported by participating partners and partnerships:

  1. certain distributions of cash or property by a partnership that has two or more partners that are related, where the distribution results in a tax basis increase to either distributed or retained property,
  2. certain transfers of a partnership interest by one partner to a related partner where the transferee obtains a tax basis increase with respect to the partnership property, and
  3. “substantially similar transactions” which include, but are not limited to, distributions where the partnership has no related partners but has one or more tax-indifferent partners (such as tax-exempt or non-U.S. investors) (such transactions, “Basis Shifting Transactions”).

Disclosure is only required where the basis increases from all Basis Shifting Transactions of a partnership or partner during a taxable year (reduced dollar-for-dollar by taxable gain recognized in the Basis Shifting Transactions on which tax is required to be paid by any of the related partners or tax-indifferent partners) is at least $10 million (the “applicable threshold”). The Regulations further limit the portion of basis increases taken into account for this purpose by excluding basis increases generated by distributions to, or where there is a corresponding basis decrease to, unrelated partners that are not tax-indifferent.

Of immediate importance, the Regulations require taxpayers to disclose by July 14, 2025, any “participation” in an open tax year (for which a tax return had already been filed as of January 14, 2025) in a Basis Shifting Transaction that occurred within a six-year lookback period (generally, the six years before the taxpayer’s most recent tax year beginning before January 14, 2025). For this purpose, a taxpayer “participates” in a Basis Shifting Transaction if the transaction actually occurred in such year, or if the taxpayer filed a tax return for such year reflecting the basis consequences of such Basis Shifting Transaction. The applicable threshold is $25 million, rather than $10 million, for any Basis Shifting Transaction that occurred in the lookback period.

Participation in a Basis Shifting Transaction in a year for which a tax return had not yet been filed as of January 14, 2025 must be disclosed with the taxpayer’s tax returns for the year of the participation. However, no disclosure is required for Basis Shifting Transactions that occurred before the six-year lookback period.

Failure to comply with the reporting requirements may result in the imposition of penalties of up to $50,000 per transaction per participant.

The Regulations also require material advisors to file disclosures for Basis Shifting Transactions within or since the look back period and going forward. Notably, for transactions going forward, material advisors will generally be required to file disclosures before the taxpayer (generally within one to four months of the relevant transaction), or face their own penalties.

Practical Impact on Private Funds:

Private funds often utilize partnerships in their fund and transaction structures. Depending on the specific facts, some ordinary course transactions may qualify as Basis Shifting Transactions that require disclosure, including: 

  • “Continuation fund” transactions;
  • In-kind distributions of property by a fund;
  • Distributions from so-called “splitter” partnerships (that is, partnerships established below blockers in order to facilitate carried interest) in connection with an exit event;
  • Cash redemptions or distributions of assets to non-U.S. or tax-exempt partners; and
  • Redemptions or distributions in tiered partnership arrangements.

In order to meet the upcoming July 14, 2025 deadline, private funds should consider with their tax advisors whether any of their partners or partnerships have participated in a Basis Shifting Transaction within the six-year lookback period. Such investors may also want to re-evaluate their pending structures or standard structures to determine whether any changes to such structures would reduce the administrative burdens and compliance costs that will result from disclosures required by the Regulations.

Changes from Proposed Regulations:

Although the Regulations largely follow the proposed regulations issued in June 2024 (the “Proposed Regulations”), they did include some taxpayer friendly changes:

  • Increased dollar threshold. Basis Shifting Transactions are only required to be disclosed if the associated basis increase to related partners exceeds by at least $10M (or with respect to retroactive transactions, $25M), the amount of gain recognized in such transaction during the same taxable year on which tax is required to be paid. The Proposed Regulations required disclosure for Basis Shifting Transactions that resulted in basis increases of over $5M to all partners (not just related partners) in connection with retroactive and go-forward transactions.
  • Six-year lookback. While the six-year lookback period is onerous, this represents an improvement from the Proposed Regulations, which covered any transaction that could affect a current year tax liability.
  • Extension of disclosure deadline for six-year lookback transactions. The Proposed Regulations required disclosures of historic transactions within 90 days, whereas the Final Regulations have extended the deadline (by approximately 3 months) to July 14, 2025.
  • Publicly traded partnerships. The Regulations exempt partners in publicly-traded partnerships from the disclosure requirements, except with respect to specific types of distributions or transfers. Publicly traded partnerships are still required to comply with the disclosure obligations.
  • Other technical fixes. The Regulations included some other technical fixes suggested by commentators. For example, the Proposed Regulations may have required disclosure in connection with a taxable transfer of partnership interests yielding a tax basis step-up that was followed by a nonrecognition transfer of such acquired partnership interest to a related party (without an increase in such step-up). The Regulations clarified that disclosure is only required in connection with such a subsequent nonrecognition transaction if the step-up associated with the transferred partnership interest increases.

What’s Next?

The Regulations are technically complex and will require a thorough analysis of relevant historic and go-forward partnership transactions to determine required disclosure obligations. Ropes & Gray is closely analyzing the Regulations and the practical issues that investors will face if they remain in effect. If you have questions regarding the Regulations, please reach out to the Ropes & Gray tax team.