IRS Issues Basis Shifting Guidance for Partnerships, Proposes Reporting Requirements

By Meeren Amin

The Internal Revenue Service (IRS) and U.S. Department of Treasury recently issued guidance to curtail what they consider abusive basis shifting by related-party partners and partnerships. That guidance, which was issued June 17, 2024, includes proposed regulations that would make certain basis-shifting transactions “transactions of interest” subject to reporting requirements. This guidance also describe two sets of forthcoming regulations.  

The proposed regulations are concerned with related persons who use partnerships to make basis adjustments under IRC § § 732(b) and (d), 734(b), or 743(b). Generally, these transactions involve related partners increasing basis of partnership assets to allow for additional depreciation or decreased taxable gain or increased taxable loss upon disposition. These transactions occur through distributions of property by the partnership to related partners or liquidations of partnership interests. The transactions may also include transfers of partnership interests from a partner with a low share of inside basis and high outside basis to a related partner who will be able to increase their inside basis. 

Because the partners in these transactions are related parties, the IRS argues that the transactions do not have any meaningful effect on the partnership and therefore lack economic substance.

The IRS seems to have learned its lesson from recent Administrative Procedures Act (APA) cases including Green Valley v. Commissioner by issuing proposed regulations prior to enacting reporting requirements. Once finalized, partners and partnerships that engage in transactions under the regulations, or those substantially similar, that increase basis over $5 million will be required to submit a Form 8886 to the Office of Tax Shelter Analysis (OTSA) within 90 days and then with each subsequent tax return. Each “material advisor” to the transaction must submit a Form 8918 to OTSA disclosing the advice rendered. This would include attorneys, CPAs, and any others that provided material aid, assistance or advice to the partners or partnership. The penalty is up to $50,000 simply for failing to file Forms 8886 or 8918, and additional penalties may also apply to partners and partnerships, along with potentially enhanced scrutiny for material advisors that do not file.

With the announcement that a new IRS office will focus exclusively on pass throughs, it seems the IRS is serious about its scrutiny of partnerships, which highlights the importance of proper reporting. Since the proposed regulations are complex, it is important for partners, partnerships and their advisors to begin planning for the future regulations and determining whether they are subject to reporting requirements. 

For more information, please contact Meeren Amin at [email protected] or another member of the firm’s Taxation & Wealth Planning Department.