Recall that in 2014 Treasury issued Prop. Reg. §1.751-1 that addresses how a partner should measure its interest in a partnership’s unrealized receivables and substantially appreciated inventory items (“hot assets”) under §751(b) (i.e., in a redemption transaction), and the timing of recognizing gain associated with the hot assets in a partial redemption transaction. Very generally, by opting into the proposed regulations, a partially redeemed partner will not immediately recognize gain with respect to its share of the hot assets, but rather, will apply §704(c) principles and remain tax responsible for the hot asset gain that would have been recognized if the partnership sold all its assets for fair market value on the date of the partial redemption. For instance, if 50% of a 20% partner’s interest in the partnership is begin redeemed, under the current regulations that partner will recognize 50% of its “hot asset” responsibility. Under the proposed regulations, if the partnership revalues its assets under §704(b), causing the partially redeemed partner to have §704(c) responsibility for such partner’s full share of hot asset income, there will not be hot asset recapture income to be recognized by reason of the partial redemption.
Prior to enactment (if ever – it’s been 11 years already), a partnership and its partners can choose to apply Prop. Reg. §1.751-1 by reporting on their returns consistently with the rules set forth in the proposed regulation. A specific form or statement is not required. Rather, the preamble instructs the partnership and its partners to “apply each of §1.751-1(a)(2), §1.751-1(b)(2), and §1.751-1(b)(4) of these proposed regulations consistently for all partnership distributions and sales and exchanges, including for any distributions and sales or exchanges the partnership makes after a termination of the partnership under section 708(b)(1)(B).” (REG 151416-06.)