Untitled Document

The Tax Resource Group: Professional Tax Research Material, Resources, and Consulting

Category: International; Sales & Exchanges; Partnerships & LLCs
Subject: Partnership Interests
Title: Acquisition of Partnership Interests
IRC Sections: 708(b)(1)(B), 704, 752, 482, 267
Filename: 1224.html
Date Produced: 04/95

Background
The taxpayer (TP) is a group of companies configured as follows. SWISSCO is a Swiss corporation and the parent of two other companies, USCO, a U.S. corporation, and AUSTRIACO, an Austrian corporation. SWISSCO is the sole owner of USCO and AUSTRIACO.

The taxpayer wishes to invest in a U.S. commercial building owned by a partnership, ABC. Three individuals, Messrs. A, B, and C own the ABC partnership in approximately equal proportions. Mr. C is the father of Messrs. A and B. The commercial building is worth between $4 and $4.4 million with an outstanding mortgage of $2.6 million.

Mr. C is approximately 81 years of age and does not wish to sell his interest in ABC. Accordingly, the parties have agreed in principle for TP to purchase the interests in ABC held by A and B for a total of $4,375,000. The purchase money will first go to extinguish the existing mortgage on the property. TP will then borrow against the property with SWISSCO providing a loan guarantee. C will remain in place. The parties have also agreed that Mr. C will receive annual cash flow to C of approximately $35,000. The value of C's interest is fixed at $530,400 for liquidation purposes. In essence, irrespective of the ultimate value of the property owned by ABC, Mr. C will never receive more than the agreed upon liquidation value.

USCO is a tenant in the building owned by ABC. (There are other tenants as well.)

TP wants to know how to structure the transaction bearing in mind the following objectives.

-For some reason, the income of ABC partnership must be zeroed out each year by some means.
-TP wishes to acquire all remaining interests in ABC partnership within a period of time not to exceed 15 years.

The purpose of this memorandum is to discuss a possible structure and then identify the potential tax issues.

Discussion
Because Mr. C is unwilling to sell his interest, it is necessary to leave him in place as a partner of ABC. As a result, the form of the transaction is essentially forced into one of purchasing the existing partnership interests held by A and B. The threshold question is which entity or combination thereof should purchase these interests. TP has stated no preference in this matter. It seems to me that for obvious reasons it would be advantageous from the standpoint of simplicity and tax efficiency to confine the transaction entirely to the U.S. by having USCO acquire the partnership interests held by A & B.

Assuming USCO does buy out A and B, the following issues present themselves.

1. Purchase of approximately two-thirds of ABC in one transaction would terminate ABC under Section 708(b)(1)(B). Confirm that no adverse tax consequences would result. We need to look at the partnership returns of ABC and we need to know the outside basis for the partnership interests held by A and B.

2. The inside basis of two-thirds of ABC property would be stepped up to purchase price value as a result of the technical termination and the recontribution of the ABC property to a new tax partnership. This must be confirmed.

3. What is the subsequent effect of Section 704(c) regarding special allocations of depreciation and disposition gain attributable to the step-up in basis?

4. I am concerned that the transaction taken as a whole could be recharacterized by the IRS. At this point, I have no idea what that would mean. A, B, and C are family members, and it seems that the transaction has certain characteristics that might be interpreted in a manner other than the form taken by the transaction. Why is Mr. C's interest frozen? Does the value placed upon C's interest reflect his real interest in the partnership at this moment? What will be the character of the income stream provided to C? Given that C has locked in the value of his interest now, would it be possible for the IRS to recharacterize the transaction with C as an installment sale? If so, how would that affect USCO? What happens if the value of the ABC property declines such that C's one-third interest is worth less than the stated value?

5. Does the shifting of debt, what is in effect a refinancing, affect Partner C in any way? I strongly suspect that C will have phantom gain. Presumably the debt guaranteed by SWISSCO will be allocated under Section 752 entirely to USCO. In effect, C will go from a one-third share of $2.6 million of debt to a zero share of debt as a result of this transaction. It seems to me this could possibly kill the deal entirely. This should be thoroughly explored. Is the bank debt to be guaranteed by SWISSCO nonrecourse either by its terms or by operation of state law? If so, the debt would clearly be allocated 100% to USCO.

6. What is the projected taxable income of the partnership? Why is it desirable/necessary to "zero-out" ABC's income? Would it be possible to set up a related management company to which a management fee could be paid? If so, would Section 482 be a problem?

7. If ABC has no income, how will Partner C be paid the necessary cash flow? The requirements to zero out ABC's income while at the same time providing cash flow to Partner C appear to be fundamentally at odds.

8. Suppose ABC is profitable, but there is special allocation of gross income to C such that the net profit allocated to USCO is zero. Take a simple example. Suppose ABC has $100,000 of gross income and $65,000 of deductions leaving profit of $35,000. Specially allocate $35,000 of gross income to C leaving zero net profit to allocate normally. Could this be justified based on the facts? Would this pass muster under Section 704(b)? How would this affect the concern expressed in Point 4, above?

9. What is the effect (if any) under Sections 267(a)(3) and 163(j) of SWISSCO's plan to guarantee ABC debt?