Getting Technical With Partnership Termination Rule

Cadwalader, Wickersham & Taft LLP


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The Tax Court recently ruled that a new partnership ("New Shoals") that is deemed to form on a technical termination may use a taxable year that starts...
United States Tax
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The Tax Court recently ruled that a new partnership ("New Shoals") that is deemed to form on a technical termination may use a taxable year that starts on the date of the termination of the old partnership ("Old Shoals"), rejecting the government's argument that a new taxable year begins on the day after the technical termination. At stake was New Shoals' charitable contribution deduction for the donation of an easement, which the government claimed should be disallowed because New Shoals did not donate the easement within its taxable year and therefore failed the substantive and reporting requirements for noncash charitable contribution deductions.

On December 28, 2017, River Club sold its 92% interest in Shoals to Savannah Shoals Investments, LLC ("Investments") for $515,000, triggering a technical termination of Old Shoals and a deemed formation of New Shoals. On the same day, upon the majority vote of Investments' members, a deed granting a conservation easement was executed and recorded. New Shoals claimed an easement deduction on its tax return filed for the remaining period of the taxable year. Savannah Shoals, LLC ("Shoals") and the government agreed that Old Shoals' taxable year ended on December 28, 2017 but disagreed on the start date of New Shoals' taxable year. The Tax Court rejected the government's argument that New Shoals' taxable year must begin the day after the termination of Old Shoals and sided with Shoals that New Shoals' taxable year can begin on the same day as the termination.

Under the pre-2018 Code and Treasury Regulations, a partnership was deemed to terminate and its taxable year end when 50% or more of its total capital and profits interest was sold or exchanged within a 12-month period. Although the Tax Cuts and Jobs Act repealed the technical termination rule for taxable years beginning after December 31, 2017, this rule remains an issue for partnerships with open years before 2018.

In rejecting the government's reasoning, the Court pointed to the plain language in the applicable Treasury Regulation stating that a new partnership is formed "immediately" after the technical termination, which the Court held does not necessarily mean the next day. The Court also referred to a basic partnership tax principle that a partnership comes into existence when it realizes income or incurs an expense. New Shoals began conducting its business on December 28, 2017, when its members voted to donate the easement and the deed was executed and recorded, and thus New Shoals began to exist on December 28 for tax purposes. The Court's conclusion is also consistent with another basic axiom of tax law that an expense is deductible only by the person or persons that incur it. Since the members of New Shoals funded the purchase of a 92% interest in New Shoals, they are correctly entitled to the easement deduction.

The Tax Court gave a common sense reading to the partnership tax rules as taxpayers understand them and, in doing so, rejected overly complex and technical interpretations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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