Treasury recently finalized regulations imposing significant reporting obligations on persons involved in what the regulations describe as “related party basis adjustment transactions.” These regulations designate such transactions as “transactions of interest,” a form of reportable transactions.[1] Reporting obligations can apply to transactions completed prior to the date of these regulations and also may extend many, many years after the transaction that resulted in the applicable basis adjustment. The purpose of this writing is to summarize the relevant transactions and the reporting obligations that apply.
Transactions of Interest
Regulations describe five categories of “reportable transactions” for which certain disclosure, record keeping, and penalties for failure to comply will be applicable.[2] Those categories are: (1) listed transactions; (2) confidential transactions; (3) transactions with contractual protection; (4) loss transactions; and (5) transactions of interest.[3] Compliance requirements are also triggered by transactions which are “substantially similar” to any listed transaction or transaction of interest.[4]
When a transaction is designated as a “transaction of interest,”[5] the taxpayer is required to attach IRS Form 8886,[6] Reportable Transaction Disclosure Statement, to their income tax return for the relevant year and also submit Form 8886 to the Office of Tax Shelter Analysis (“OTSA”).[7] When transactions already undertaken for which the taxpayer’s income tax return has been filed are later designated as transactions of interest, the taxpayer must file Form 8886 with OTSA within 90 calendar days after the date on which the transaction was so designated, provided the statute of limitations for assessment of tax remains open for such year.[8] In addition, there are recordkeeping requirements obligating taxpayers to retain materials and documents related to the reportable transaction as long as the statute of limitations on assessment remains open.[9]
Beyond just taxpayers, any “material advisor”[10] with respect to the transaction of interest also has certain disclosure and recordkeeping requirements.[11] Material advisors must submit IRS Form 8918,[12] Material Advisor Disclosure Statement, to OTSA. Notably, Form 8918 requires material advisors to identify other parties providing material assistance (even if not necessarily meeting the definition of material advisor). Form 8918 must be filed on or before the last day of the month following the end of the calendar quarter in which the person first became a material advisor with respect to the transaction.[13] Material advisors also are obligated to maintain lists identifying each person with whom the advisor has served as a material advisor along with certain other required information.[14]
Taxpayers who are required to disclose transactions of interest, or substantially similar transactions, but fail to disclose such transactions are subject to penalties.[15] The amount of the penalty is 75% of the decrease in tax shown on the return as a result of the reportable transaction, or which would have resulted from such transaction if such transaction were respected for Federal tax purposes, subject to minimum and maximum penalty amounts.[16] The minimum penalty amount is $5,000 in the case of a natural person and $10,000 in any other case. For a transaction of interest, the maximum penalty amount is $10,000 in the case of a natural person and $50,000 in any other case.[17] In addition, there is a 20% accuracy-related penalty on any understatement attributable to an adequately disclosed reportable transaction [18] which is increased to 30% if the transaction is not properly disclosed.[19]
A material advisor who fails to file a timely disclosure, or files an incomplete or false disclosure statement, is subject to a penalty of $50,000.[20] A material advisor may be subject to a penalty for failing to maintain the required information list and failing to make the list available upon written request of the Secretary within 20 business days after the date of such request.[21] The penalty for failing to provide such list is $10,000 per day for the failure to provide such list after the 20th day.[22] No penalty will be imposed on material advisors with respect to the failure on any day if such failure is due to reasonable cause.[23]
Related Party Basis Adjustment Transactions
The following transactions are those to which the regulations apply:[24]
- A partnership with two or more related partners[25]:
- distributes property to one of the related partners in a current or liquidating distribution where the partnership increases the basis of one or more of its remaining properties due to a section 734(b) adjustment;
- distributes property to related partner in liquidation of the person’s partnership interest, causing the basis of one or more distributed properties to be increased due to application of section 732(b); or
- distributes property to a related partner, the basis of one or more of the distributed properties is increased under section 732(d), the distributee acquired all or part of its interest in the partnership in a transaction that would have been described below if the partnership had a section 754 election in effect for the year of the transfer; to another partner (in a transaction which would be described in (2) below) causing the basis of one or more distributed properties to be increased as a result of a section 732(d) election;
- A partner transfers all or part of a partnership interest to a related partner in a nonrecognition transfer[26] and the basis of one or more partnership properties in increased under section 743(b); and
- A partner receives an interest in a recognition transaction, the basis of one or more partnership properties is increased under section 743(b), and subsequently the partner transfers the partnership interest to a person related to the transferor in a transaction that would have otherwise been a transaction of interest under (2) above.[27]
All of these transactions are limited to those transactions for which an applicable threshold has been met. There are two primary threshold amounts (although calculations of these amounts are modified in certain situations):
- Other than transactions subject to the “six year lookback period,”[28] the applicable threshold will be met if the sum of all basis increases resulting from all such transactions during the taxable year (without netting for any basis decrease in the same transaction or another transaction) exceeds by at least $10 million the gain recognized from such transactions during the same taxable year by any of the related partners who are a party to such transactions; or
- For transactions during the “six year lookback period” the same definition applies as above, substituting $25 million for $10 million.
For distributions resulting in a section 734(b) adjustment, a basis increase is only counted towards the appliable threshold to the extent of a related partner’s share of the basis increase.[29] For distributions resulting in an adjustment to the basis of distributed property in a liquidating distribution, the applicable threshold calculation excludes any increase that corresponds to a decrease to the basis of property distributed to unrelated partners other than tax-indifferent parties or a decrease in such parties’ share of any decrease in basis of the partnership’s property under section 734(b).[30]
The regulations clarify that transactions failing to meet the applicable threshold will not be considered “substantially similar” for purposes of triggering a reporting obligation.[31]
Exception for Transfers at Death
An important exception to applicability of these rules relates to a “transfer on the death of a partner.”[32] That term is defined in the regulations to mean “a transfer of a partnership interest from a partner to the partner’s estate or a deemed transfer from a grantor trust owned by the partner to a trust that becomes a separate entity for Federal income tax purposes by reason of the partner’s death.”[33]
This exception avoids treating as transactions of interest basis adjustments that occur by reason of a section 1014 basis adjustment to the partner’s interest in the partnership and corresponding inside basis adjustment to the assets of the partnership under section 743(b) for partnerships with a section 754 election in place for the year of the partner’s death. Likewise, it avoids treating a deemed transfer from a grantor trust to a non-grantor trust, even absent any section 1014 basis adjustment,[34] from constituting a transaction of interest.
It is important to note that, while these exceptions are important, this is not a broad exception for all transfers resulting from the death of a partner. For example, if a section 754 election is not applicable in the year of the partner’s death, subsequent transactions resulting in basis adjustments will not be excepted. These transactions could include distributions of partnership property to the estate or transfers of partnership interests from the estate to beneficiaries. Further, other transactions applying by virtue of the death of a partner, including those occurring during estate and trust administration such as termination of a non-grantor trust in distribution to remainder beneficiaries, will also not be excepted. As such, care should be taken in administering trusts and estates following the death of a partner to determine what transactions will be excepted and which will not.
Reporting Obligations
While the general reporting obligations for transactions of interest are described above, there are some specifics to reporting with respect to related party basis adjustment transactions. In addition to filing Form 8886 for each taxable year in which a participant engaged in a transaction described in the regulations,[35] a participating partnership, participating partner, or related subsequent transferee[36] is deemed under the regulations to have participated in a listed transaction in any taxable year in which its tax return reflects the tax consequences of a basis increase.[37] As such, should the property receiving the basis adjustment constitute depreciable property, each year depreciation deductions are taken with respect to the basis increase is a year in which a transaction of interest has been undertaken. Should property subject to a basis increase be sold many years later, that sale is deemed to be a transaction of interest.
All is not bad news, however. Especially given the substantial burden of determining transactions which may require reporting during the six-year lookback period, the regulations provide certain relief. First, taxpayers will be treated as having met their filing obligations as long as they file their disclosure with OTSA by July 14, 2025.[38] Second, the regulations provide material advisors who have made a tax statement[39] before January 14, 2025, are provided an additional 90 days beyond the generally applicable deadline to report to OTSA.[40]
Conclusion
These regulations became valid as of January 14, 2025. As such, any of the transactions of interest (or substantially similar transactions) identified in the regulations either after that date, or in a previous period for which the statute of limitations on assessment for the relevant year remains open, will be subject to reporting obligations. Given the ubiquity of closely-held partnerships involving family members, these reporting obligations are likely to have an effect on a large number of taxpayers and their advisors (i.e. “material advisors” for purposes of reportable transactions). Failure to report has significant consequences. As such, it is important that taxpayers and their advisors understand what transactions are covered, whether they have engaged in any transaction during any open year and be vigilant to properly report any future transaction of interest.
While comments to the previously proposed regulations requested many aspects of relief from these onerous filing obligations, Treasury only adopted changes with respect to certain of those comments. Thankfully, the applicable threshold amount was raised and the calculation adjusted generally only to capture the effect among related parties. However, many other requests, such as to eliminate these filing requirements and replace them with a new line on the partnership’s income tax return, were not adopted.
In an almost shocking lack of awareness of how this will affect closely-held partnerships, Treasury stated that “the identification of the transactions described in these final regulations should not impact small business owners” and “if a taxpayer is engaging in one or more of the complex transactions identified by these final regulations with a related party that results in positive basis adjustments in a single taxable year that exceed the applicable threshold amounts of $10 million or more (or $25 million for later identified transactions), the taxpayer is not likely a small business owner and the reporting obligations outlined in these final regulations should not be unduly burdensome.” The lack of netting in calculating threshold amounts and the fact that many closely-held family partnerships may hold real property valued well above these amounts (even if the equity, net of debt, is much less) will capture many small business owners. The is exacerbated by the ongoing obligation to report in each year where there is tax benefit from the basis adjustment (for example, 27 years for depreciable residential property and potentially longer for property sold decades after the basis adjustment) along with the significant penalty exposure for failure to comply.
Taxpayers and their advisors should pay close attention to these new regulations. Compliance is important to avoid penalties and may extend many decades into the future. An understanding of when these new regulations may apply will now be important for closely-held family partnerships.
[1] Note that the IRS formerly attempted to identify certain reportable transactions by Notice. Due to litigation with the IRS over compliance with the Administrative Procedures Act, this practice has been eliminated in favor of requiring reportable transactions to be handled by regulations. We have written about the cases initially addressing this issue in Parker Durham, “Notice 2017-10’s Demise May be Imminent: Current Litigation Involving the Controversial IRS Rule,” Nov. 9, 2022, https://esapllc.com/2017-10-demise-litigation-review-2022/; and Joshua W. Sage, “Goodbye Notice 2017-10,” Nov. 15, 2022, https://www.esapllc.com/goodbye-notice-2017-10/.
[2] Treas. Reg. § 1.6011-4.
[3] Id.
[4] Treas. Reg. § 1.6011-4(b)(2) and (6). For a definition of substantially similar, see Treas. Reg. § 1.6011-4(c)(4) which definition is intentionally broad, in order to be “broadly construed in favor of disclosure.”
[5] The scope of this writing is limited to transactions of interest as covering the recently issued final regulations designating “related party basis adjustment transactions” as such.
[6] https://www.irs.gov/forms-pubs/about-form-8886
[7] Treas. Reg. § 1.6011-4(d)(1).
[8] Treas. Reg. § 1.6011-4(d)(2).
[9] Treas. Reg. § 1.6011-4(g).
[10] A person is a “material advisor” if “the person provides any material aid, assistance, or advice with respect to organizing, managing, promoting, selling, implementing, insuring, or carrying out any reportable transaction, and directly or indirectly derives gross income in excess of” regulatory threshold amounts. Treas. Reg. § 301.6111-3(b).
[11] IRC § 6111 and Treas. Reg. § 301.6111-3.
[12] https://www.irs.gov/forms-pubs/about-form-8918
[13] Treas. Reg. § 301.6111-3(e).
[14] IRC § 6112 and Treas. Reg. § 301.6112-1. Per Rev. Proc. 2008-20, this requirement may be satisfied using IRS Form 13976 although use of that form is not required provided the required information is properly maintained.
[15] IRC § 6707A.
[16] IRC § 6707A(b).
[17] Id.
[18] IRC § 6662A(b)(1).
[19] IRC § 6662A(c).
[20] Section 6707(a).
[21] IRC § 6708.
[22] IRC § 6708(a)(1).
[23] IRC § 6708(a)(2).
[24] Treas. Reg. § 1.6011-18(c)(1) and (2).
[25] The term “related partner” is defined in Treas. Reg. § 1.6011-18(b)(9). I do not specifically address treatment of “tax-indifferent parties” as defined in Treas. Reg. § 1.6011-18(b)(12) in this writing, but similar concepts apply as described here with respect to “related partners” subject to certain limited differences (for example, knowledge qualifier and alterations in the calculation of the threshold amount).
[26] The term “nonrecognition transaction” is defined in Treas. Reg. § 1.6011-18(b)(2) as defined in IRC § 7701(a)(45) being “a transaction in which gain or loss is not recognized in whole or in part for purposes of subtitle A.”
[27] For this transaction, the applicable threshold, discussed below, is calculated pursuant to a special rule that limits the amount of the basis adjustment counting towards the appliable threshold amount. See Treas. Reg. § 1.6011-18(c)(2)(ii).
[28] The “six year lookback period” is the period 72 months immediately preceding the first month of the taxpayer’s most recent taxable year that began before January 14, 2025.
[29] Treas. Reg. § 1.6011-18(c)(3)(iii).
[30] Treas. Reg. § 1.6011-18(c)(3)(iv).
[31] Treas. Reg. § 1.6011-18(d)
[32] Treas. Reg. § 1.6011-18(c)(4).
[33] Treas. Reg. § 1.6011-18(b)(13).
[34] See Rev. Rul. 2023-2.
[35] There is an exception for reporting by tax-indifferent parties of substantially similar transactions for years in which the tax-indifferent party is not otherwise required to file an income tax return. Treas. Reg. § 1.6011-18(f)(1).
[36] All defined in Treas. Reg. § 1.6011-18(b).
[37] Treas. Reg. § 1.6011-18(e)(5). There is an exception for transactions completed prior to the six year lookback period. Treas. Reg. § 1.6011-18((f)(2). See also Treas. Reg. § 1.6011-18(g), Ex. 6.
[38] Treas. Reg. § 1.6011-18((h)(1).
[39] A “tax statement” is generally any statement, oral or written, that relates to a tax aspect of a reportable transaction. Treas. Reg. § 301.6111-3(b)(2)(ii).
[40] Treas. Reg. § 1.6011-18(h)(2).