IRS vows to put a stop to the use of “basis shifting” transactions that use related-party partnerships to avoid taxes

Today, the IRS and Treasury issued new guidance to prevent the use of partnership rules to inflate asset basis without meaningful economic changes. The Treasury estimates that abusive use of related party basis shifting in partnerships could potentially cost taxpayers more than $50 billion over a 10-year period. High-income taxpayers and corporations have been shifting basis from less beneficial assets to those where it will generate tax benefits, avoiding taxes without altering business economics. These complex transactions often involve multiple steps over several years, using sophisticated tax strategies to strip basis from certain assets and reassign it to others, enabling increased depreciation deductions or reduced gain on asset sales with minimal economic impact.

The target of the new guidance are three types of basis-shifting transactions: transfer, distribution, and liquidation.

1. Transfer of partnership interest to related party in which a partner with low "inside" basis and high "outside" basis transfers their interest tax-free to a related person or to a person who is related to other partners in the partnership, creating a tax-free basis increase for the transferee partner's share of "inside" basis.
2. Distribution of property to a related party in which a partnership with related partners distributes a high-basis asset to a partner with low outside basis. The distributee reduces the asset's basis while the partnership increases the basis of its remaining assets, yielding tax savings for the related parties.
3. Liquidation of related partnership or partner in which a partnership with related partners liquidates and distributes (i) a low-basis asset that is subject to accelerated cost recovery or for which the parties intend to sell to a partner with a high outside basis and (ii) a high-basis property that is subject to longer cost recovery (or no cost recovery at all) or for which the parties intend to hold to a partner with a low outside basis. Under the partnership liquidation rules, the first related partner increases the basis of the property with a shorter life or which is held for sale while the second related partner decreases the basis of the long-lived or non-depreciable property, with the result that the related parties generate or accelerate tax benefits.

Notice 2024-54 announces two sets of regulations: (1) a Revenue Ruling; and (2) proposed regulations. Rev. Rul. 2024-14 alerts taxpayers and advisors using partnerships that engage in the three variations of transactions identified above that the IRS will apply the economic substance doctrine to challenge inappropriate basis adjustments and other aspects of these transactions. The IRS will raise the economic substance doctrine under Rev. Rul. 2024-14 where related parties: (i) create inside/outside basis disparities through various methods, including the use of certain partnership allocations and distributions; (ii) capitalize on the disparity by either transferring a partnership interest in a nonrecognition transaction or making a current or liquidating distribution of partnership property to a partner; and (iii) claim a basis adjustment under Internal Revenue Code sections 732(b), 734(b), or 743(b) resulting from the nonrecognition transaction or distribution. Proposed regulations (REG-124593-23) designate certain partnership related-party basis adjustment transactions and substantially similar transactions as transactions of interest, a type of reportable transaction. Material advisors and certain participants in these transactions would be required to file disclosures with the IRS and would be subject to penalties for failure to disclose. The proposed regulations would affect participants in these transactions as well as material advisors.

As part of its serious focus, the IRS Chief Counsel has announced the creation of a new Associate Office that will focus exclusively on partnerships, S-corporations, trusts and estates.

In addition to the brief summary above, I have provided a direct link to the three pieces of guidance: Notice 2024-54, Rev. Rul. 2024-14 and, Reg-124593-23.