On April 17, the IRS announced in Notice 2025-23 that it intends to propose regulations that would withdraw rules requiring partnerships to disclose participation in certain "basis shifting" transactions that the IRS believes may be abusive. This change of course to rules that are only a few months old will be welcome news to businesses daunted by the prospect of identifying participation during a six-year lookback period. Although disclosure filings by July 14 are still technically required until the rules are formally removed, the IRS announcement also provides a waiver to penalties associated with a failure to file disclosure statements.
Background of IRS Campaign Regarding Partnership Basis Shifting Transactions
On June 17, 2024, the IRS announced in Notice 2024-54 that it intended to issue proposed regulations that would crack down on perceived abuses among related parties to certain partnership transactions whereby the related parties effectively "shift" additional tax basis to partnership property eligible for cost recovery.
On that same date, the IRS also issued proposed regulations that would require taxpayers and material advisors to file new information disclosure forms with respect to participation in such a transaction. Final regulations under Reg. §1.6011-18 that identify such a transaction as a new transaction of interest were published in the Federal Register on Jan. 14, 2025.
Notwithstanding the latest development, the final regulations under Reg. §1.6011-18 represent the culmination of those new information disclosure requirements. Note that the other proposed regulations implicated by Notice 2024-54 were never issued. In other words, there are no changes to the way federal tax law actually applies to basis shifting transactions, despite the requirement in the final regulations to disclose participation in such transactions.
Details of Basis Shifting Transactions in the Final Regulations
The types of transactions subject to the reporting requirements of the final regulations are varied and somewhat complex. However, all of the transaction iterations essentially involve the same three key elements when present simultaneously: (1) there are related parties, (2) there is a positive basis adjustment with respect to partnership property, and (3) the positive basis adjustment exceeds the amount of taxable gain recognized in the transaction by a specified threshold amount.
A common way this could be accomplished is when a partnership distributes non-cash property (e.g., land) with a high tax basis to a partner who has a low basis in his or her partnership interest. In that case, the partner must adjust the tax basis of the distributed property down to the amount of the partner's tax basis in his or her partnership interest. When the partnership has a Section 754 election in effect, the partnership is permitted to increase the tax basis of its remaining assets (e.g., depreciable real estate). The result is that the partnership's tax basis in the distributed property is effectively "shifted" to its other retained assets, which often are subject to more favorable cost recovery rules.
As previously noted, the final regulations still technically apply until they are formally withdrawn. Under the final regulations, parties must follow the disclosure rules if they have participated in a basis shifting transaction of interest. These include "participating partners," "participating partnerships," and "related subsequent transferees," if such party's tax return reflects a tax consequence or a tax strategy of the transaction, such as the tax benefits from cost recovery on a basis increase. These parties disclose their participation on Form 8886, Reportable Transaction Disclosure Statement, by attaching the form to their returns and sending a copy to the IRS Office of Tax Shelter Analysis (OTSA).
The threshold referenced under the final regulations refers to the excess of all basis increases over the gain recognized from the transaction during the same taxable year, if such excess is at least $10 million. However, in the case of a transaction of interest that occurred during the six-year lookback period, the excess must be at least is $25 million.
The Fate of the Basis Shifting Campaign and Penalty Relief
Notice 2025-23 provides that the Department of the Treasury and the IRS intend to propose regulations that would remove the final regulations. When that is formalized, it will effectively retroactively eliminate the disclosure requirements.
In the meantime, Notice 2025-23 also provides immediate relief from penalties for failure to file Form 8886 by parties participating in a basis shifting transaction that is described in the final regulations. Similarly, the IRS guidance provides penalty relief to material advisors involved with such transactions as well. The penalty relief in both instances is unconditional.
Additionally, Notice 2025-23 withdraws Notice 2024-54. Recall that the IRS had indicated in Notice 2024-54 an intent to issue other proposed regulations that would make changes to the way federal tax law actually applies to basis shifting transactions. The withdrawal of Notice 2024-54 appears to eliminate any such changes in the future.
With Notice 2025-23 and the removal of Notice 2024-54, early indications about the fate of the basis shifting campaign appear to be that it is no longer an IRS priority. In any case, the penalty waiver provides welcome relief to the disclosure requirements, particularly for parties confronted with significant challenges in identifying participation during the six-year lookback period.
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