SECTION 2. BACKGROUND

.01 To prevent the shifting of tax consequences among partners with respect to precontribution gain or loss, § 704(c) requires partnerships to allocate income, gain, loss, and deductions with respect to property contributed by a partner so as to take into account any variation between the adjusted tax basis of the property and its fair market value at the time of the contribution. These allocations must be made using a reasonable method that is consistent with the purpose of § 704(c). Similar rules apply to differences between book value and tax basis that are created by a revaluation of partnership assets pursuant to § 1.704–1(b)(2)(iv)(f) (reverse § 704(c) allocations).

.02 Section 1.704–3(a)(10) provides that an allocation method (or combination of methods) is not reasonable if the contribution of property (or event that results in reverse § 704(c) allocations) and the corresponding allocation of tax items with respect to the property are made with a view to shifting the tax consequences of built-in gain or loss among the partners in a manner that substantially reduces the present value of the partners’aggregate tax liability.

.03 Section 1.704–3(a)(2) provides that § 704(c) allocations are generally made on a property-by-property basis. Therefore, built-in gains and losses from different items of contributed or revalued property generally cannot be aggregated.

.04 Section 1.704–3(e)(3) provides a special rule that allows securities partnerships (as defined in § 1.704–3(e)(3)(iii))

to make reverse § 704(c) allocations on an aggregate basis. Specifically, § 1.704–3 (e)(3)(i) provides that, for purposes of making reverse § 704(c) allocations, a securities partnership may aggregate builtin gains and losses from qualified financial assets (as defined in § 1.704–3 (e)(3)(ii)) using any reasonable approach that is consistent with the purpose of § 704(c). This rule, however, only applies to built-in gains and losses from revaluations of partnership property; aggregation of built-in gains and losses from contributed property is only permitted pursuant to published guidance or by letter ruling. Section 1.704–3(e)(4)(iii).

.05 Section 1.704–3(e)(3)(iv) and (v) describe two methods of making § 704(c) allocations on an aggregate basis that are generally reasonable, the partial netting and the full netting approaches, respectively.

.06 Since the regulations under § 704(c) were issued, the Service has received and responded to numerous ruling requests from securities partnerships organized as part of a “Master-Feeder Structure” for permission to aggregate contributed property for purposes of making § 704(c) and reverse § 704(c) allocations.

.07 In a typical Master-Feeder Structure, two or more Feeder Funds or one or more Feeder Funds and an investment advisor, principal underwriter, or manager contribute their assets, consisting primarily of cash or financial investments, to a single Master Portfolio in exchange for beneficial interests in the Master Portfolio. In these cases, each Feeder Fund and the Master Portfolio is registered with the Securities and Exchange Commission under the Investment Company Act of 1940 (1940 Act). The shares of these Feeder Funds are typically publicly offered and widely held by individuals, corporations, and institutional investors. Generally, each Feeder Fund is an openend mutual fund, which continuously offers to sell new shares or redeem existing shares for a price equal to the net asset value of their proportionate interest in the portfolio.

.08 The IRS and Treasury Department have determined that it is in the best interest of sound tax administration to reduce the burden on taxpayers of submitting ruling requests by granting to certain Mas

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(2) Each Feeder Fund contributes only cash and/or a portfolio of diversified stocks and securities that satisfies the 25 and 50 percent tests of § 368(a)(2)(F)(ii) in exchange for beneficial interests in the Master Portfolio;

(3) Each partner in the Master Portfolio that is an investment advisor, principal underwriter, or manager, contributes only cash and/or services in exchange for beneficial interests in the Master Portfolio;

(4) The Master Portfolio is treated as a partnership for federal tax purposes and qualifies as a securities partnership under § 1.704–3(e)(3)(iii);

(5) Each Feeder Fund is a publicly offered regulated investment company, as defined in § 67(c)(2)(B) and § 1.67–2T (g)(3)(iii);

(6) The Master Portfolio is registered as an investment company under the 1940 Act.

(7) The Master Portfolio makes § 704(c) and reverse § 704(c) allocations under the partial netting approach or the full netting approach as described in § 1.704–3(e)(3)(iv) or § 1.704–3(e)(3)(v), respectively, and;

(8) The contributions to the Master Portfolio and the corresponding allocations of tax items with respect to the property contributed to the Master Portfolio are not made with a view to shifting the tax consequences of built-in gain or loss among the partners in a manner that substantially reduces the present value of the partners’ aggregate tax liability.