Section 2. BACKGROUND

Section 833(c) of the Act requires basis adjustments to be made following certain distributions from partnerships for which no § 754 election is in effect. As amended by § 833(c) of the Act, § 734(a) and (b) requires a partnership to reduce its basis in partnership property upon a distribution of partnership property after October 22, 2004, if there is a “substantial basis reduction.” Under § 734(d), there is a substantial basis reduction if a downward adjustment of more than $250,000 would be made to the basis of partnership assets if a section 754 election were in effect at the time of the distribution. EIPs, like other partnerships, are required to make any basis adjustments that are required under § 734 upon the distribution of partnership property.

Section 833(b) of the Act requires basis adjustments to be made following certain transfers of interests in partnerships for which no § 754 election is in effect. As amended by § 833(b) of the Act, § 743(a) and (b) requires a partnership to reduce the basis of partnership property upon a

transfer after October 22, 2004, of an interest in the partnership by sale or exchange or upon the death of a partner, if, at the time of the relevant transfer, the partnership has a “substantial built-in loss.” Section 743(d)(1) provides that, for purposes of § 743, a partnership has a substantial built-in loss with respect to a transfer of a partnership interest if the partnership’s adjusted basis in the partnership’s property exceeds by more than $250,000 the fair market value of the property.

Section 833(b) of the Act also provides that an EIP is not treated as having a substantial built-in loss, and thus is not required to make basis adjustments to partnership property, with respect to any transfer of a partnership interest occurring while an election to be treated as an EIP is in effect. In lieu of the partnership basis adjustments otherwise required under § 743, a partner-level loss disallowance rule applies. Section 743(e)(2) provides that, in the case of a transfer of an interest in an EIP, the transferee partner’s distributive share of the losses, without regard to gains, from the sale or exchange of partnership property is not allowed, except to the extent that it is established that the losses exceed the loss recognized on the transfer of the partnership interest by the transferor partner (or by a prior transferor to the extent not fully offset by a prior disallowance under § 743(e)(2)). Under § 743(e)(3), losses disallowed under this rule do not decrease the transferee partner’s basis in its partnership interest. Section 743(e) is to be applied without regard to any termination of the partnership under § 708(b)(1)(B). In the case of a basis reduction to property distributed to the transferee partner in a nonliquidating distribution, § 743(e)(5) provides that the amount of the transferor’s recognized loss taken into account under § 743(e)(2) is reduced by the amount of the basis reduction under § 732(a)(2).

Section 743(e)(6), as added by the Act, provides that an EIP means any partnership if (A) the partnership makes an election to have § 743(e) apply, (B) the partnership would be an investment company under section 3(a)(1)(A) of the Investment Company Act of 1940 but for an exemption under paragraph (1) or

(7) of section 3(c) of such Act, (C) the partnership has never been engaged in a trade or business, (D) substantially all of the assets of the partnership are held for investment, (E) at least 95 percent of the assets contributed to the partnership consist of money, (F) no assets contributed to the partnership had an adjusted basis in excess of fair market value at the time of contribution, (G) all partnership interests of the partnership are issued by the partnership pursuant to a private offering before the date which is 24 months after the date of the first capital contribution to the partnership, (H) the partnership agreement of the partnership has substantive restrictions on each partner’s ability to cause a redemption of the partner’s interest, and (I) the partnership agreement of the partnership provides for a term that is not in excess of 15 years. However, in the case of an EIP which is in existence on June 4, 2004, § 743(e)(6)(H) does not apply to the partnership, and § 743(e)(6)(I) is applied by substituting “20 years” for “15 years”.

Section 743(e)(7) provides that the Secretary shall prescribe regulations as may be appropriate to carry out the purposes of § 743(e), including regulations for applying § 743(e) to tiered partnerships.

Section 6031(f) provides that in the case of any EIP, the information required under § 6031(b) to be furnished to any partner to whom § 743(e)(2) applies shall include information as is necessary to enable the partner to compute the amount of losses disallowed under § 743(e).