§1061 — Partnership interests held in connection with performance of services
Statute Text — 26 U.S.C. §1061
If one or more applicable partnership interests are held by a taxpayer at any time during the taxable year, the excess (if any) of—
the taxpayer’s net long-term capital gain with respect to such interests for such taxable year, over
the taxpayer’s net long-term capital gain with respect to such interests for such taxable year computed by applying paragraphs (3) and (4) of sections
1
1 So in original. Probably should be “section”.
1222 by substituting “3 years” for “1 year”,
shall be treated as short-term capital gain, notwithstanding section 83 or any election in effect under section 83(b).
To the extent provided by the Secretary, subsection (a) shall not apply to income or gain attributable to any asset not held for portfolio investment on behalf of third party investors.
For purposes of this section—
Except as provided in this paragraph or paragraph (4), the term “applicable partnership interest” means any interest in a partnership which, directly or indirectly, is transferred to (or is held by) the taxpayer in connection with the performance of substantial services by the taxpayer, or any other related person, in any applicable trade or business. The previous sentence shall not apply to an interest held by a person who is employed by another entity that is conducting a trade or business (other than an applicable trade or business) and only provides services to such other entity.
The term “applicable trade or business” means any activity conducted on a regular, continuous, and substantial basis which, regardless of whether the activity is conducted in one or more entities, consists, in whole or in part, of—
raising or returning capital, and
either—
investing in (or disposing of) specified assets (or identifying specified assets for such investing or disposition), or
developing specified assets.
The term “specified asset” means securities (as defined in section 475(c)(2) without regard to the last sentence thereof), commodities (as defined in section 475(e)(2)), real estate held for rental or investment, cash or cash equivalents, options or derivative contracts with respect to any of the foregoing, and an interest in a partnership to the extent of the partnership’s proportionate interest in any of the foregoing.
The term “applicable partnership interest” shall not include—
any interest in a partnership directly or indirectly held by a corporation, or
any capital interest in the partnership which provides the taxpayer with a right to share in partnership capital commensurate with—
the amount of capital contributed (determined at the time of receipt of such partnership interest), or
the value of such interest subject to tax under section 83 upon the receipt or vesting of such interest.
The term “third party investor” means a person who—
holds an interest in the partnership which does not constitute property held in connection with an applicable trade or business; and
is not (and has not been) actively engaged, and is (and was) not related to a person so engaged, in (directly or indirectly) providing substantial services described in paragraph (1) for such partnership or any applicable trade or business.
If a taxpayer transfers any applicable partnership interest, directly or indirectly, to a person related to the taxpayer, the taxpayer shall include in gross income (as short term capital gain) the excess (if any) of—
so much of the taxpayer’s long-term capital gains with respect to such interest for such taxable year attributable to the sale or exchange of any asset held for not more than 3 years as is allocable to such interest, over
any amount treated as short term capital gain under subsection (a) with respect to the transfer of such interest.
For purposes of this paragraph, a person is related to the taxpayer if—
the person is a member of the taxpayer’s family within the meaning of section 318(a)(1), or
the person performed a service within the current calendar year or the preceding three calendar years in any applicable trade or business in which or for which the taxpayer performed a service.
The Secretary shall require such reporting (at the time and in the manner prescribed by the Secretary) as is necessary to carry out the purposes of this section.
The Secretary shall issue such regulations or other guidance as is necessary or appropriate to carry out the purposes of this section 22 So in original. Probably should be followed by a period.
Treasury Regulations
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Treas. Reg. §1.1061-0Table of contents
This section lists the captions that appear in §§ 1.1061-1 through 1.1061-6.
(a) Definitions.
(b) Applicability date.
(a) API rules and examples.
(1) Rules.
(i) An API remains an API.
(ii) Application of section 1061 to Unrealized API Gains and Losses.
(iii) API Gains and Losses retain their character.
(iv) Substantial services by the Owner Taxpayer, Passthrough Taxpayer or any Related Person.
(v) Grantor trusts and entities disregarded as separate from their owners.
(2) Examples.
(b) Application of the ATB Activity Test.
(1) In general.
(i) Rules for applying the ATB Activity Test.
(A) Aggregate Specified Actions taken into account.
(B) Raising or Returning Capital Actions and Investing or Developing Actions are not both required to be taken in each taxable year.
(C) Combined conduct by multiple related entities taken into account.
(ii) Developing Specified Assets.
(iii) Partnerships.
(2) Examples.
(c) Applicability date.
(a) A partnership interest held by an employee of another entity not conducting an ATB.
(b) Partnership interest held by a corporation.
(1) In general.
(2) Treatment of interests held by an S corporation or a qualified electing fund.
(c) Capital Interest Gains and Losses.
(1) In general.
(2) Capital Interest Gains and Losses defined.
(3) General rules for determining Capital Interest Allocations.
(i) Commensurate with capital contributed.
(ii) In a similar manner.
(A) Relevant factors.
(B) Clear identification requirement.
(iii) Reinvestment of API Gain.
(iv) Unrelated Non-Service Partner requirement.
(v) Proceeds of certain loans not taken into account for Capital Interest Allocation purposes.
(A) General rule.
(B) Recourse liability.
(vi) Items that are not included in Capital Interest Allocations.
(4) Capital Interest Disposition Amounts.
(i) In general.
(ii) Determination of the Capital Interest Disposition Amount.
(5) Capital Interest Allocations made by a Passthrough Entity that is an API Holder.
(6) Examples.
(d) Partnership interest acquired by purchase by an unrelated person.
(1) Acquirer not a Related Person.
(2) Section 1061(d) not applicable.
(3) Acquirer not a service provider.
(e) [Reserved]
(f) Applicability date.
(1) General rule.
(2) Partnership interest held by an S corporation.
(3) Partnership interest held by a PFIC with respect to which the shareholder has a QEF election in effect.
(a) Computations.
(1) Recharacterization Amount.
(2) One Year Gain Amount and Three Year Gain Amount.
(i) One Year Gain Amount.
(ii) Three Year Gain Amount.
(3) API One Year Distributive Share Amount and API Three Year Distributive Share Amount.
(i) API One Year Distributive Share Amount.
(ii) API Three Year Distributive Share Amount.
(4) API One Year Disposition Amount and API Three Year Disposition Amount.
(i) API One Year Disposition Amount.
(ii) API Three Year Disposition Amount.
(b) Special rules for calculating the One Year Gain Amount and the Three Year Gain Amount.
(1) One Year Gain Amount equals zero or less.
(2) Three Year Gain Amount equals zero or less.
(3) One Year Gain Amount less than Three Year Gain Amount.
(4) Installment sale gain.
(5) Special rules for capital gain dividends from regulated investment companies (RICs) and real estate investment trusts (REITs).
(i) API One Year Distributive Share Amount.
(ii) API Three Year Distributive Share Amount.
(iii) Loss on sale or exchange of stock.
(6) Pro rata share of qualified electing fund (QEF) net capital gain.
(i) One year QEF net capital gain.
(ii) Three year QEF net capital gain adjustment.
(7) Items not taken into account for purposes of section 1061.
(8) Holding period determination.
(i) Determination of holding period for purposes of the Three Year Gain Amount.
(ii) Relevant holding period.
(9) Lookthrough Rule for certain API dispositions.
(i) Determination that the Lookthrough Rule applies.
(A) In general.
(B) Determination that the Lookthrough Rule applies to the disposition of a Passthrough Interest.
(ii) Application of the Lookthrough Rule.
(10) Section 83.
(c) Examples.
(1) Recharacterization rules.
(2) Special rules examples.
(d) Applicability date.
(a) In general.
(b) Transfer.
(c) Section 1061(d) Recharacterization Amount.
(d) Special rules.
(e) Section 1061(d) Related Person.
(f) Examples.
(g) Applicability date.
(a) Owner Taxpayer filing requirements.
(1) In general.
(2) Failure to obtain information.
(b) Passthrough Entity filing requirements and reporting.
(1) Requirement to file information with the IRS and to furnish information to API Holder.
(2) Requirement to request, furnish, and file information in tiered structures.
(i) Requirement to request information.
(ii) Requirement to furnish and file information.
(iii) Timing of requesting and furnishing information.
(A) Requesting information.
(B) Furnishing information.
(iv) Manner of requesting information.
(v) Recordkeeping requirement.
(vi) Passthrough Entity is not furnished information to meet its reporting obligations under paragraph (b)(1) of this section.
(vii) Filing requirements.
(viii) Penalties.
(c) Regulated investment company (RIC) and real estate investment trust (REIT) reporting.
(1) Section 1061 disclosures.
(i) One Year Amounts Disclosure.
(ii) Three Year Amounts Disclosure.
(2) Pro rata disclosures.
(3) Report to shareholders.
(d) Qualified electing fund (QEF) reporting.
(e) Applicability date.
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Treas. Reg. §1.1061-0(a)Owner Taxpayer filing requirements.
Owner Taxpayer filing requirements.
(1) In general.
(2) Failure to obtain information.
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Treas. Reg. §1.1061-0(b)Passthrough Entity filing requirements and reporting.
Passthrough Entity filing requirements and reporting.
(1) Requirement to file information with the IRS and to furnish information to API Holder.
(2) Requirement to request, furnish, and file information in tiered structures.
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Treas. Reg. §1.1061-0(c)Regulated investment company (RIC) and real estate investment trust (REIT) reporting.
Regulated investment company (RIC) and real estate investment trust (REIT) reporting.
(1) Section 1061 disclosures.
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Treas. Reg. §1.1061-0(d)Qualified electing fund (QEF) reporting.
Qualified electing fund (QEF) reporting.
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Treas. Reg. §1.1061-0(e)Applicability date.
Applicability date.
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Treas. Reg. §1.1061-0(f)Examples.
Examples.
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Treas. Reg. §1.1061-0(g)Applicability date.
Applicability date.
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Treas. Reg. §1.1061-0(i)One Year Amounts Disclosure.
One Year Amounts Disclosure.
(ii) Three Year Amounts Disclosure.
(2) Pro rata disclosures.
(3) Report to shareholders.
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Treas. Reg. §1.1061-0(v)Recordkeeping requirement.
Recordkeeping requirement.
(vi) Passthrough Entity is not furnished information to meet its reporting obligations under paragraph (b)(1) of this section.
(vii) Filing requirements.
(viii) Penalties.
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Treas. Reg. §1.1061-1Section 1061 definitions
(a) Definitions. The following definitions apply solely for purposes of this section and §§ 1.1061-2 through 1.1061-6.
API Gains and Losses are any long-term capital gains and capital losses with respect to an API and include:
(i) The API One Year Distributive Share Amount as defined in § 1.1061-4(a)(3)(i);
(ii) The API Three Year Distributive Share Amount as defined in § 1.1061-4(a)(3)(ii);
(iii) The API One Year Disposition Amount as defined in § 1.1061-4(a)(4)(i);
(iv) The API Three Year Disposition Amount as defined in § 1.1061-4(a)(4)(ii); and
(v) Capital gains or losses from the disposition of Distributed API Property.
API Holder is a person who holds an API.
Applicable Partnership Interest (API) means any interest in a partnership which, directly or indirectly, is transferred to (or is held by) an Owner Taxpayer or Passthrough Taxpayer in connection with the performance of substantial services by the Owner Taxpayer or by a Passthrough Taxpayer, or by any Related Person, including services performed as an employee, in any ATB unless an exception in § 1.1061-3 applies. For purposes of defining an API under this section and section 1061 of the Internal Revenue Code (Code), an interest in a partnership also includes any financial instrument or contract, the value of which is determined in whole or in part by reference to the partnership (including the amount of partnership distributions, the value of partnership assets, or the results of partnership operations). An Owner Taxpayer and a Passthrough Taxpayer can hold an API directly or indirectly through one or more Passthrough Entities.
Applicable Trade or Business (ATB) means any activity for which the ATB Activity Test with respect to Specified Actions is met, and includes all Specified Actions taken by Related Persons, including combining activities occurring in separate partnership tiers or entities as one ATB.
ATB Activity Test has the meaning provided in § 1.1061-2(b)(1).
Capital account means a capital account maintained under § 1.704-1(b)(2)(iv) or similar principles.
Capital Interest Allocations means, with respect to a partnership, allocations of long-term capital gain or loss made under the partnership agreement to an API Holder and to Unrelated Non-Service Partners based on such partners' capital contributed with respect to the partnership to the extent such allocations otherwise meet the requirements of § 1.1061-3(c). With respect to other Passthrough Entities, the principles of this definition apply.
Capital Interest Disposition Amount has the meaning provided in § 1.1061-3(c)(4).
Capital Interest Gains and Losses has the meaning provided in § 1.1061-3(c)(2).
Distributed API Property means property distributed by a Passthrough Entity to an API Holder with respect to an API if the holding period, as determined under sections 735 and 1223, in the API Holder's hands is three years or less at the time of disposition of the property by the API Holder.
Indirect API means an API that is held through one or more Passthrough Entities.
Investing or Developing Actions means actions involving either—
(i) Investing in (or disposing of) Specified Assets (or identifying Specified Assets for such investing or disposition); or
(ii) Developing Specified Assets (see § 1.1061-2(b)(1)(ii)).
Lookthrough Rule means the recharacterization rule described in § 1.1061-4(b)(9).
One Year Gain Amount has the meaning provided in § 1.1061-4(a)(2)(i).
Owner Taxpayer means the person subject to Federal income tax on net gain with respect to an API or an Indirect API during the taxable year, including an owner of a Passthrough Taxpayer unless the owner of the Passthrough Taxpayer is a Passthrough Entity itself or is excepted under § 1.1061-3(a), (b), or (d).
Passthrough Entity means a partnership, trust, estate, S corporation described in § 1.1061-3(b)(2)(i), or a passive foreign investment company described in § 1.1061-3(b)(2)(ii).
Passthrough Interest means an interest in a Passthrough Entity that represents in whole or in part an API.
Passthrough Taxpayer means a Passthrough Entity that is treated as a taxpayer for the purpose of determining the existence of an API.
Raising or Returning Capital Actions means actions involving raising or returning capital but does not include Investing or Developing Actions.
Recharacterization Amount has the meaning provided in § 1.1061-4(a)(1).
Related Person means a person or entity who is treated as related to another person or entity under sections 707(b) or 267(b).
Relevant ATB means the ATB in which services were provided and in connection with which an API is held or was transferred.
Section 1061(d) Recharacterization Amount has the meaning provided in § 1.1061-5(c).
Section 1061(d) Related Person has the meaning provided in § 1.1061-5(e).
Section 1061 Regulations means the provisions of this section and §§ 1.1061-2 through 1.1061-6.
Specified Actions means the combination of Raising or Returning Capital Actions and Investing or Developing Actions.
Specified Assets means—
(i) Securities, including interests in partnerships qualifying as securities (as defined in section 475(c)(2) without regard to the last sentence thereof);
(ii) Commodities (as defined in section 475(e)(2));
(iii) Real estate held for rental or investment;
(iv) Cash or cash equivalents; and
(v) An interest in a partnership to the extent that the partnership holds Specified Assets. See § 1.1061-2(b)(1)(iii).
(vi) Specified Assets include options or derivative contracts with respect to any of the items provided in paragraphs (i) through (v) of this definition.
Three Year Gain Amount has the meaning provided in § 1.1061-4(a)(2)(ii).
Unrealized API Gains and Losses means, with respect to a Passthrough Entity's assets, all unrealized capital gains and losses that would be:
(i) Realized if those assets were disposed of for fair market value in a taxable transaction on the relevant date; and
(ii) Allocated to an API Holder with respect to its API, taking into account the principles of section 704(c).
Unrelated Non-Service Partners means partners who do not (and did not) provide services in the Relevant ATB and who are not (and were not) Related Persons with respect to any API Holder in the partnership or any person who provides or has provided services in the Relevant ATB.
(b) Applicability date. The provisions of this section apply to taxable years of Owner Taxpayers and Passthrough Entities beginning on or after January 19, 2021. An Owner Taxpayer or Passthrough Entity may choose to apply this section to a taxable year beginning after December 31, 2017, provided that they consistently apply the Section 1061 Regulations in their entirety to that year and all subsequent years.
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Treas. Reg. §1.1061-1(a)Definitions.
Definitions. The following definitions apply solely for purposes of this section and §§ 1.1061-2 through 1.1061-6.
API Gains and Losses are any long-term capital gains and capital losses with respect to an API and include:
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Treas. Reg. §1.1061-1(b)Applicability date.
Applicability date. The provisions of this section apply to taxable years of Owner Taxpayers and Passthrough Entities beginning on or after January 19, 2021. An Owner Taxpayer or Passthrough Entity may choose to apply this section to a taxable year beginning after December 31, 2017, provided that they consistently apply the Section 1061 Regulations in their entirety to that year and all subsequent years.
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Treas. Reg. §1.1061-1(i)§1.1061-1(i)
Realized if those assets were disposed of for fair market value in a taxable transaction on the relevant date; and
(ii) Allocated to an API Holder with respect to its API, taking into account the principles of section 704(c).
Unrelated Non-Service Partners means partners who do not (and did not) provide services in the Relevant ATB and who are not (and were not) Related Persons with respect to any API Holder in the partnership or any person who provides or has provided services in the Relevant ATB.
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Treas. Reg. §1.1061-1(v)An interest in a partnership to the extent that the partnership holds Specified Assets.
An interest in a partnership to the extent that the partnership holds Specified Assets. See § 1.1061-2(b)(1)(iii).
(vi) Specified Assets include options or derivative contracts with respect to any of the items provided in paragraphs (i) through (v) of this definition.
Three Year Gain Amount has the meaning provided in § 1.1061-4(a)(2)(ii).
Unrealized API Gains and Losses means, with respect to a Passthrough Entity's assets, all unrealized capital gains and losses that would be:
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Treas. Reg. §1.1061-2Applicable partnership interests and applicable trades or businesses
(a) API rules and examples—(1) Rules—(i) An API remains an API. Once a partnership interest qualifies as an API, the partnership interest remains an API unless and until the requirements of one of the exceptions to qualification of a partnership interest as an API, set forth in § 1.1061-3, are satisfied.
(ii) Application of section 1061 to Unrealized API Gains and Losses. Unrealized API Gains and Losses are API Gains and Losses subject to section 1061 when the gains and losses are realized and recognized. Unrealized API Gains and Losses do not lose their character as such until they are recognized.
(iii) API Gains and Losses retain their character. API Gains and Losses retain their character as API Gains and Losses as they are allocated from one Passthrough Entity to another Passthrough Entity and then to the Owner Taxpayer.
(iv) Substantial services by an Owner Taxpayer, Passthrough Taxpayer, or any Related Person. If an interest in a partnership is transferred to or held by an Owner Taxpayer, Passthrough Taxpayer, or any Related Person in connection with the performance of services, the Owner Taxpayer, the Passthrough Taxpayer, or the Related Person is presumed to have provided substantial services for purposes of section 1061.
(v) Grantor trusts and entities disregarded as separate from their owners. A trust wholly described in subpart E, part I, subchapter J, chapter 1 of the Internal Revenue Code (that is, a grantor trust), a qualified subchapter S subsidiary described in section 1361(b)(3), and an entity with a single owner that is treated as disregarded as an entity separate from its owner under any provision of the Internal Revenue Code or any part of 26 CFR (including § 301.7701-3 of this chapter) are disregarded for purposes of the Section 1061 Regulations.
(2) Examples. The following examples illustrate the provisions of this paragraph (a).
(i) Example 1: API. (A) A is the general partner of PRS, a partnership, and provides services to PRS. A is engaged in an ATB as defined in § 1.1061-1(a). PRS transfers a PRS profits interest to A in connection with A's performance of substantial services with respect to PRS's ATB. A's interest in PRS is an API.
(B) After 6 years, A retires and is no longer engaged in an ATB and does not perform any services with respect to its ATB and with respect to PRS. However, A retains the API in PRS. PRS continues to acquire new capital assets and to allocate gain to A from the disposition of those assets. Under paragraph (a)(1)(i) of this section, A's interest in PRS remains an API after A retires.
(ii) Example 2: Contribution of an API to a partnership. Individuals A, B, and C each directly hold APIs in PRS, a partnership. A and B form a new partnership, GP, and contribute their APIs in PRS to GP. Following the contribution, each of A and B holds an Indirect API because each of A and B now indirectly holds an API in PRS through GP, a Passthrough Entity. Each of A's and B's interests in GP is a Passthrough Interest because each of A's and B's interest in GP represents an Indirect API.
(iii) Example 3: Passthrough Interest, Indirect API, Passthrough Taxpayer. Each of A, B, and C provides services to, and is an equal partner in, GP. GP is engaged in an ATB as defined in § 1.1061-1(a), is the general partner of PRS, and provides substantial management services to PRS. In connection with GP's performance of substantial services in an ATB, PRS issues a profits interest to GP. Because GP's PRS interest was received in connection with GP's providing services in an ATB, GP is a Passthrough Taxpayer and GP's interest in PRS is an API. Because A, B, and C are partners in GP, they each hold a Passthrough Interest in GP and an Indirect API in PRS. Each of A, B, and C is treated as an Owner Taxpayer because each is a partner in GP and because each holds an Indirect API in PRS in connection with the performance of its services to GP's ATB.
(iv) Example 4: S corporation, Passthrough Interest, Indirect API, and Passthrough Taxpayer. A owns all of the stock of S Corp, an S corporation. S Corp is engaged in an ATB, as defined in § 1.1061-1(a). S Corp is the general partner of PRS, a partnership, and provides substantial management services to PRS. A provides substantial services in S Corp's ATB. In connection with S Corp providing substantial services to PRS, PRS issues a profits interest to S Corp. S Corp's interest in PRS is its only asset. Because S Corp's profits interest in PRS was issued to S Corp in connection with substantial services in an ATB, S Corp is a Passthrough Taxpayer and its interest in PRS is an API. Because A is a shareholder in S Corp, A holds a Passthrough Interest in S Corp and an Indirect API in PRS as a result of S Corp's API in PRS. A is treated as an Owner Taxpayer because A holds an interest in S Corp, a Passthrough Taxpayer, and also indirectly holds an API in PRS in connection with A's services in S Corp's ATB.
(v) Example 5: Indirect API, Related Person, and Passthrough Taxpayer. Each of A, B, and C is an equal partner in partnership GP, the general partner of PRS. GP's Specified Actions do not satisfy the ATB Activity Test under § 1.1061-1(a) and as a result, GP's actions do not establish an ATB. Management Company is a Related Person with respect to GP within the meaning of sections 267(b) and 707(b), is engaged in an ATB, and provides substantial management services to PRS that are sufficient to satisfy the ATB Activity Test. Management Company's actions are attributed to GP under paragraphs (a)(1)(iv) and (b)(1)(i)(C) of this section because Management Company is a Related Person to GP. In connection with Management Company's services to PRS, PRS issues a profits interest to GP. Because its PRS profits interest is issued to GP in connection with services provided by Management Company, a Related Person, GP is a Passthrough Taxpayer and its interest in PRS is an API. Unless an exception described in § 1.1061-3 applies, because A, B, and C are partners in GP, they each hold a Passthrough Interest in GP and an Indirect API in PRS. A, B, and C are treated as Owner Taxpayers because they hold an interest in GP, a Passthrough Taxpayer.
(b) Application of the ATB Activity Test—(1) In general. The ATB Activity Test is satisfied if both Raising and Returning Actions and Investing or Developing Actions are conducted by an Owner Taxpayer, Passthrough Taxpayer, or one or more Related Persons with respect to an Owner Taxpayer or Passthrough Taxpayer, and the total level of activity, including the combined activities of all Related Persons, satisfies the level of activity that would be required to establish a trade or business under section 162.
(i) Rules for applying the ATB Activity Test—(A) Aggregate Specified Actions taken into account. The determination of whether the ATB Activity Test is satisfied is based on the combined activities conducted that qualify as either Raising or Returning Capital Actions and Investing or Developing Actions. The fact that either Raising or Returning Capital Actions or Investing or Developing Actions are only infrequently taken does not preclude the test from being satisfied if the combined Specified Actions meet the test.
(B) Raising or Returning Capital Actions and Investing or Developing Actions are not both required to be taken in each taxable year. Raising or Returning Capital Actions and Investing or Developing Actions are not both required to be taken in each taxable year in order to satisfy the ATB Activity Test. For example, the ATB Activity Test will be satisfied if Investing or Developing Actions are not taken in the current taxable year, but sufficient Raising or Returning Capital Actions are taken in anticipation of future Investing or Developing Actions. Additionally, the ATB Activity Test will be satisfied if no Raising or Returning Capital Actions are taken in the current taxable year, but have been taken in a prior taxable year (regardless of whether the ATB Activity Test was met in the prior year), and sufficient Investing or Developing Actions are undertaken by the taxpayer in the current taxable year.
(C) Combined conduct by multiple related entities taken into account—(1) Related Entities. If a Related Person(s) (within the meaning of § 1.1061-1(a)) solely or primarily performs Raising or Returning Capital Actions and one or more other Related Person(s) solely or primarily performs Investing or Developing Actions, the combination of the activities performed by these Related Persons will be taken into account in determining whether the ATB Activity Test is satisfied.
(2) Actions taken by an agent or delegate. Specified Actions taken by an agent or a delegate in its capacity as an agent or a delegate of a principal will be taken into account by the principal in determining whether the ATB Activity Test is satisfied with respect to the principal. These Specified Actions are also taken into account in determining whether the ATB Activity test is satisfied with respect to the agent or the delegate.
(ii) Developing Specified Assets. Developing Specified Assets takes place if it is represented to investors, lenders, regulators, or other interested parties that the value, price, or yield of a portfolio business may be enhanced or increased in connection with choices or actions of a service provider. Merely exercising voting rights with respect to shares owned or similar activities do not amount to developing Specified Assets.
(iii) Partnerships. Investing or Developing Actions directly conducted with respect to Specified Assets held by a partnership are counted towards the ATB Activity Test. Additionally, a portion of the Investing or Developing Actions conducted with respect to the interests in a partnership that holds Specified Assets is counted towards the ATB Activity Test. This portion is the value of the partnership's Specified Assets over the value of all of the partnership's assets. Actions taken to manage a partnership's working capital will not be taken into account in determining the portion of Investing or Developing Actions conducted with respect to the interests in the partnership.
(2) Examples. The following examples illustrate the application of the ATB Activity Test described in paragraph (b)(1) of this section.
(i) Example 1: Combined activities of Raising or Returning Capital Actions and Investing or Developing Actions. During the taxable year, B takes a small number of actions to raise capital for new investments. B takes numerous actions to develop Specified Assets. B's actions with respect to raising capital and B's actions with respect to developing Specified Assets are combined for the purpose of determining whether the ATB Activity Test is satisfied. These actions cumulatively rise to the level required to establish a trade or business under section 162. Thus, B satisfies the ATB Activity Test.
(ii) Example 2: Combining Specified Actions in multiple entities. GP, a partnership, conducts Raising or Returning Capital Actions. Management Company, a partnership that is a Related Person to GP, conducts Investing or Developing Actions. When GP's and Management Company's activities are combined, the ATB Activity Test is satisfied. Accordingly, both GP and Management Company are engaged in an ATB, and services performed by either GP or Management Company are performed in an ATB under paragraph (b)(1) of this section.
(iii) Example 3: Investing or Developing Actions taken after Raising or Returning Capital Actions that do not meet the ATB Activity Test. In year 1, PRS engaged in Raising or Returning Capital Actions to fund PRS's investment in Specified Assets. However, PRS' Specified Actions during year 1 did not satisfy the ATB Activity Test because they did not satisfy the level of activity required to establish a trade or business under section 162. Therefore, PRS was not engaged in an ATB in year 1. In year 2, PRS engaged in significant Investing or Developing Actions but did not engage in any Raising or Returning Capital Actions. In year 2, PRS's Investing or Developing Actions rise to the level required to establish a trade or business under section 162. Because PRS has cumulatively engaged in both Investing or Developing Actions and Raising or Returning Capital Actions and because the Specified Actions rise to the level of activity required to establish a trade or business under section 162, PRS is engaged in an ATB in year 2.
(iv) Example 4: Raising or Returning Capital Actions taken in anticipation of Investing or Developing Actions. In year 1, A only conducted Raising or Returning Capital Actions. A's Raising or Returning Capital Actions were undertaken to raise capital to invest in Specified Assets with the goal of increasing their value through Investing or Developing Actions and rise to the level of activity required to establish a trade or business under section 162. A did not take Investing or Developing Actions during the taxable year. A's Raising or Returning Capital Actions satisfy the ATB Activity Test because they were undertaken in anticipation of also engaging in Investing or Developing Actions. Therefore, the ATB Activity Test is satisfied, and A is engaged in an ATB in year 1.
(v) Example 5: Attribution of delegate's actions. GP is the general partner of PRS. GP is responsible for providing management services to PRS. GP contracts with Management Company to provide management services on GP's behalf to PRS. GP and Management Company are not Related Persons. The Specified Actions taken by Management Company on behalf of GP are attributed to GP for purposes of the ATB Activity Test because the Management Company is operating as a delegate of GP. Additionally, those Specified Actions are taken into account by Management Company for purposes of the ATB Activity Test and whether it is engaged in an ATB.
(vi) Example 6: ATB Activity Test not satisfied. A is the manager of a hardware store. Partnership owns the hardware store, including the building in which the hardware business is conducted. In connection with A's services as the manager of the hardware store, a profits interest in Partnership is transferred to A. Partnership's business involves buying hardware from wholesale suppliers and selling it to customers. The hardware is not a Specified Asset. Although real estate is a Specified Asset if it is held for rental or investment purposes, Partnership holds the building for the purpose of conducting its hardware business and not for rental or investment purposes. Therefore, the building is not a Specified Asset as to Partnership. Partnership also maintains and manages a certain amount of working capital for its business, but actions with respect to working capital are not taken into account for the purpose of determining whether the ATB Activity Test is met. Partnership is not a Related Person with respect to any person who takes Specified Actions. Partnership is not engaged in an ATB because the ATB Activity Test is not satisfied. Although Partnership raises capital, its Raising or Returning Capital Actions alone do not satisfy the ATB Activity Test. Further, Partnership takes no Investing or Developing Actions because it holds no Specified Assets other than working capital. Partnership is not in an ATB and the profits interest transferred to A is not an API.
(c) Applicability date. The provisions of this section apply to taxable years of Owner Taxpayers and Passthrough Entities beginning on or after January 19, 2021. An Owner Taxpayer or Passthrough Entity may choose to apply this section to a taxable year beginning after December 31, 2017, provided that they apply the Section 1061 Regulations in their entirety to that year and all subsequent years.
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Treas. Reg. §1.1061-2(a)API rules and examples—(1) Rules—(i) An API remains an API.
API rules and examples—(1) Rules—(i) An API remains an API. Once a partnership interest qualifies as an API, the partnership interest remains an API unless and until the requirements of one of the exceptions to qualification of a partnership interest as an API, set forth in § 1.1061-3, are satisfied.
(ii) Application of section 1061 to Unrealized API Gains and Losses. Unrealized API Gains and Losses are API Gains and Losses subject to section 1061 when the gains and losses are realized and recognized. Unrealized API Gains and Losses do not lose their character as such until they are recognized.
(iii) API Gains and Losses retain their character. API Gains and Losses retain their character as API Gains and Losses as they are allocated from one Passthrough Entity to another Passthrough Entity and then to the Owner Taxpayer.
(iv) Substantial services by an Owner Taxpayer, Passthrough Taxpayer, or any Related Person. If an interest in a partnership is transferred to or held by an Owner Taxpayer, Passthrough Taxpayer, or any Related Person in connection with the performance of services, the Owner Taxpayer, the Passthrough Taxpayer, or the Related Person is presumed to have provided substantial services for purposes of section 1061.
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Treas. Reg. §1.1061-2(b)Application of the ATB Activity Test—(1) In general.
Application of the ATB Activity Test—(1) In general. The ATB Activity Test is satisfied if both Raising and Returning Actions and Investing or Developing Actions are conducted by an Owner Taxpayer, Passthrough Taxpayer, or one or more Related Persons with respect to an Owner Taxpayer or Passthrough Taxpayer, and the total level of activity, including the combined activities of all Related Persons, satisfies the level of activity that would be required to establish a trade or business under section 162.
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Treas. Reg. §1.1061-2(c)Applicability date.
Applicability date. The provisions of this section apply to taxable years of Owner Taxpayers and Passthrough Entities beginning on or after January 19, 2021. An Owner Taxpayer or Passthrough Entity may choose to apply this section to a taxable year beginning after December 31, 2017, provided that they apply the Section 1061 Regulations in their entirety to that year and all subsequent years.
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Treas. Reg. §1.1061-2(i)Example 1: Combined activities of Raising or Returning Capital Actions and Investing or Developing Actions.
Example 1: Combined activities of Raising or Returning Capital Actions and Investing or Developing Actions. During the taxable year, B takes a small number of actions to raise capital for new investments. B takes numerous actions to develop Specified Assets. B's actions with respect to raising capital and B's actions with respect to developing Specified Assets are combined for the purpose of determining whether the ATB Activity Test is satisfied. These actions cumulatively rise to the level required to establish a trade or business under section 162. Thus, B satisfies the ATB Activity Test.
(ii) Example 2: Combining Specified Actions in multiple entities. GP, a partnership, conducts Raising or Returning Capital Actions. Management Company, a partnership that is a Related Person to GP, conducts Investing or Developing Actions. When GP's and Management Company's activities are combined, the ATB Activity Test is satisfied. Accordingly, both GP and Management Company are engaged in an ATB, and services performed by either GP or Management Company are performed in an ATB under paragraph (b)(1) of this section.
(iii) Example 3: Investing or Developing Actions taken after Raising or Returning Capital Actions that do not meet the ATB Activity Test. In year 1, PRS engaged in Raising or Returning Capital Actions to fund PRS's investment in Specified Assets. However, PRS' Specified Actions during year 1 did not satisfy the ATB Activity Test because they did not satisfy the level of activity required to establish a trade or business under section 162. Therefore, PRS was not engaged in an ATB in year 1. In year 2, PRS engaged in significant Investing or Developing Actions but did not engage in any Raising or Returning Capital Actions. In year 2, PRS's Investing or Developing Actions rise to the level required to establish a trade or business under section 162. Because PRS has cumulatively engaged in both Investing or Developing Actions and Raising or Returning Capital Actions and because the Specified Actions rise to the level of activity required to establish a trade or business under section 162, PRS is engaged in an ATB in year 2.
(iv) Example 4: Raising or Returning Capital Actions taken in anticipation of Investing or Developing Actions. In year 1, A only conducted Raising or Returning Capital Actions. A's Raising or Returning Capital Actions were undertaken to raise capital to invest in Specified Assets with the goal of increasing their value through Investing or Developing Actions and rise to the level of activity required to establish a trade or business under section 162. A did not take Investing or Developing Actions during the taxable year. A's Raising or Returning Capital Actions satisfy the ATB Activity Test because they were undertaken in anticipation of also engaging in Investing or Developing Actions. Therefore, the ATB Activity Test is satisfied, and A is engaged in an ATB in year 1.
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Treas. Reg. §1.1061-2(v)Example 5: Attribution of delegate's actions.
Example 5: Attribution of delegate's actions. GP is the general partner of PRS. GP is responsible for providing management services to PRS. GP contracts with Management Company to provide management services on GP's behalf to PRS. GP and Management Company are not Related Persons. The Specified Actions taken by Management Company on behalf of GP are attributed to GP for purposes of the ATB Activity Test because the Management Company is operating as a delegate of GP. Additionally, those Specified Actions are taken into account by Management Company for purposes of the ATB Activity Test and whether it is engaged in an ATB.
(vi) Example 6: ATB Activity Test not satisfied. A is the manager of a hardware store. Partnership owns the hardware store, including the building in which the hardware business is conducted. In connection with A's services as the manager of the hardware store, a profits interest in Partnership is transferred to A. Partnership's business involves buying hardware from wholesale suppliers and selling it to customers. The hardware is not a Specified Asset. Although real estate is a Specified Asset if it is held for rental or investment purposes, Partnership holds the building for the purpose of conducting its hardware business and not for rental or investment purposes. Therefore, the building is not a Specified Asset as to Partnership. Partnership also maintains and manages a certain amount of working capital for its business, but actions with respect to working capital are not taken into account for the purpose of determining whether the ATB Activity Test is met. Partnership is not a Related Person with respect to any person who takes Specified Actions. Partnership is not engaged in an ATB because the ATB Activity Test is not satisfied. Although Partnership raises capital, its Raising or Returning Capital Actions alone do not satisfy the ATB Activity Test. Further, Partnership takes no Investing or Developing Actions because it holds no Specified Assets other than working capital. Partnership is not in an ATB and the profits interest transferred to A is not an API.
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Treas. Reg. §1.1061-3Exceptions to the definition of an API
(a) A partnership interest held by an employee of another entity not conducting an ATB. An API does not include any interest transferred to a person in connection with the performance of substantial services by that person as an employee of another entity that is conducting a trade or business (other than an ATB) and the person provides services only to such other entity.
(b) Partnership interest held by a corporation—(1) In general. An API does not include any interest directly or indirectly held by a corporation.
(2) Treatment of interests held by an S corporation or a qualified electing fund. For purposes of this section, a corporation does not include an entity for which an election was made to treat the entity as a Passthrough Entity. Thus, the following entities are not treated as corporations for purposes of section 1061—
(i) An S corporation for which an election under section 1362(a) is in effect; and
(ii) A passive foreign investment company (PFIC) with respect to which the shareholder has a qualified electing fund (QEF) election under section 1295 in effect.
(c) Capital Interest Gains and Losses—(1) In general. Capital Interest Gains and Losses are not subject to section 1061 and, therefore, are not included in calculating an Owner Taxpayer's Recharacterization Amount.
(2) Capital Interest Gains and Losses defined. For purposes of paragraph (c)(1) of this section, Capital Interest Gains and Losses are Capital Interest Allocations that meet the requirements of paragraph (c)(3) of this section and Capital Interest Disposition Amounts that meet the requirements of paragraph (c)(4) of this section.
(3) General rules for determining Capital Interest Allocations—(i) Commensurate with capital contributed. An allocation will be considered a Capital Interest Allocation if the allocation to the API Holder with respect to its capital interest is determined and calculated in a similar manner as the allocations with respect to capital interests held by similarly situated Unrelated Non-Service Partners who have made significant aggregate capital contributions as described in paragraph (c)(3)(iv) of this section. For purposes of this paragraph (c)(3), a capital interest is an interest that would give the holder a share of the proceeds if the partnership's assets were sold at fair market value at the time the interest was received and the proceeds were then distributed in a complete liquidation of the partnership.
(ii) In a similar manner. For purposes of paragraph (c)(3)(i) of this section, a Capital Interest Allocation to an API Holder will be treated as made in a similar manner if allocations and distribution rights with respect to the capital contributed by an API Holder to which the API Holder's Capital Interest Allocation relates are reasonably consistent with allocation and distribution rights with respect to capital contributed by Unrelated Non-Service Partners where the Unrelated Non-Service Partner requirement is met. For purposes of this paragraph (c)(3)(ii), allocation and distribution rights for an API Holder that are limited to a particular class of partnership capital interests or that are determined with respect to capital contributions invested in a particular partnership investment will be considered as made in a similar manner to allocations and distribution rights of Unrelated Non-Service Partners where the Unrelated Non-Service Partner requirement is met for the applicable interest class or partnership investment.
(A) Relevant factors. For purposes of this paragraph (c)(3)(ii), the following factors are not exclusive, but are relevant factors in determining whether allocation and distribution rights with respect to capital contributed by an API Holder are reasonably consistent with allocation and distribution rights of persons meeting the Unrelated Non-Service Partner requirement: The amount and timing of capital contributed, the rate of return on capital contributed, the terms, priority, type and level of risk associated with capital contributed, and the rights to cash or property distributions during the partnership's operations and on liquidation. Accordingly, an allocation to an API Holder will not fail to qualify solely because the allocation is subordinated to allocations made to Unrelated Non-Service Partners, because an allocation to an API Holder is not reduced by the cost of services provided by the API Holder or a Related Person to the partnership, where the cost of services provided includes management fees or API allocations, or because an API Holder has a right to receive tax distributions while Unrelated Non-Service Partners do not, where such distributions are treated as advances against future distributions.
(B) Clear identification requirement. For purposes of this paragraph (c)(3)(ii), allocations will be considered made in a similar manner only if the allocations to the API Holder and the Unrelated Non-Service Partners are allocations with respect to, and corresponding to, such partners' contributed capital that are separate and apart from allocations made to the API Holder with respect to its API and where both the partnership agreement and the partnership's contemporaneous books and records clearly demonstrate that the requirements of paragraph (c)(3) of this section have been met.
(iii) Reinvestment of API Gain. If an API Holder is allocated API Gain by a Passthrough Entity, to the extent that an amount equal to the API Gain is reinvested in the Passthrough Entity by the API Holder (either as the result of an actual distribution and recontribution of the API Gain amount or the retention of the API Gain amount by the Passthrough Entity), the amount will be treated as a contribution to the Passthrough Entity for a capital interest that may produce Capital Interest Allocations for the API Holder, provided such allocations meet the requirements of this paragraph (c)(3).
(iv) Unrelated Non-Service Partner requirement. For purposes of paragraph (c)(3) of this section, the Unrelated Non-Service Partner requirement means that Unrelated Non-Service Partners must have made significant aggregate capital contributions in relation to total capital contributions of all partners. Unrelated Non-Service Partners will be treated as having made significant aggregate capital contributions provided such partners possess five percent or more of the aggregate capital contributed to the partnership at the time the allocations are made. With respect to an API Holder with allocation and distribution rights that are attributable to a particular interest class or partnership investment, the Unrelated Non-Service requirement must be met with respect to that particular interest class or partnership investment.
(v) Proceeds of certain loans not taken into account for Capital Interest Allocation purposes—(A) General rule. For purposes of the Section 1061 Regulations, an allocation is not a Capital Interest Allocation to the extent the allocation is attributable to the contribution of an amount of capital to a partnership that, directly or indirectly, results from, or is attributable to, any loan or other advance made or guaranteed, directly or indirectly, by the partnership or another partner in the partnership (or any Related Person with respect to such persons), except to the extent a loan or advance is described in paragraph (c)(3)(v)(B) of this section. However, the repayments on a loan described in the preceding sentence are taken into account as capital contributed (and may therefore generate Capital Interest Allocations) as those amounts are paid by the partner, provided that the loan is not repaid with the proceeds of another loan described in the preceding sentence.
(B) Recourse liability. Paragraph (c)(3)(v)(A) of this section does not apply with respect to an allocation attributable to a contribution made by an individual service provider that, directly or indirectly, results from, or is attributable to, a loan or advance from another partner in the partnership (or any Related Person with respect to such other partner, other than the partnership) to such individual service provider if the individual service provider is personally liable for the repayment of such loan or advance. A contribution made by an individual service provider includes a contribution made by an entity that is wholly owned by, and disregarded as separate from, the individual service provider as described in § 1.1061-2(a)(1)(v), including a contribution attributable to a loan or advance made to the disregarded entity by another partner in the partnership (or any Related Person with respect to such other partner, other than the partnership) if the individual service provider is personally liable for the repayment of any and all borrowed amounts that are not repaid by the disregarded entity. For purposes of this paragraph (c)(3)(v)(B), an individual service provider is personally liable for the repayment of a loan or advance made by another partner (or any Related Person with respect to such other partner, other than the partnership) if—
(1) The loan or advance is fully recourse to the individual service provider;
(2) The individual service provider has no right to reimbursement from any other person; and
(3) The loan or advance is not guaranteed by any other person.
(vi) Items that are not included in Capital Interest Allocations. Capital Interest Allocations do not include—
(A) Amounts that are treated as API Gains and Losses and Unrealized API Gains and Losses; or
(B) Items that are not taken into account for purposes of section 1061 under § 1.1061-4(b)(7).
(4) Capital Interest Disposition Amounts—(i) In general. The term Capital Interest Disposition Amount means the amount of long-term capital gain or loss recognized on the sale or disposition of all or a portion of a Passthrough Interest that is treated as Capital Interest Gain or Loss. In general, long-term capital gain or loss recognized on the sale or disposition of a Passthrough Interest is deemed to be API Gain or Loss unless it is determined under paragraph (c)(4)(ii) of this section to be a Capital Interest Disposition Amount.
(ii) Determination of the Capital Interest Disposition Amount. If a Passthrough Interest that includes a right to allocations of Capital Interest Gains and Losses is disposed of, the amount of long-term capital gain or loss that is treated as a Capital Interest Disposition Amount is determined under the rules provided in this paragraph (c)(4)(ii).
(A) First, determine the amount of long-term capital gain or loss that would be allocated to the Passthrough Interest (or the portion of the Passthrough Interest sold) if all the assets of the Passthrough Entity (including gain or loss with respect to assets described in § 1.1061-4(b)(7)) were sold for their fair market value in a fully taxable transaction immediately before the disposition of the Passthrough Interest (hypothetical asset sale). For purposes of this paragraph (c)(4)(ii), the assets of the Passthrough Entity include any assets held by a lower-tier Passthrough Entity in which the Passthrough Entity has a direct or indirect interest.
(B) Second, determine the amount from the hypothetical asset sale that would be allocated to the Passthrough Interest (or the portion of the Passthrough Interest sold) as Capital Interest Allocations under paragraph (c)(3) of this section.
(C) Third, if the transferor recognized long-term capital gain upon disposition of the Passthrough Interest and only net short-term capital losses, net long-term capital losses, or both, are allocated to the Passthrough Interest under paragraph (c)(4)(ii)(B) of this section from the hypothetical asset sale, all of the long-term capital gain is API Gain. If the transferor recognized long-term capital loss on the disposition of the Passthrough Interest and only net short-term capital gains, net long-term capital gains, or both, are allocated to the Passthrough Interest under paragraph (c)(4)(ii)(B) of this section, then all the long-term capital loss is API Loss.
(D) If paragraph (c)(4)(ii)(C) of this section does not apply and long-term capital gain is recognized on the disposition of the Passthrough Interest, the amount of long-term capital gain that the transferor of the Passthrough Interest recognizes that is treated as a Capital Interest Disposition Amount is determined by multiplying long-term capital gain recognized on the disposition of the Passthrough Interest by a fraction, the numerator of which is the amount of long-term capital gain determined under paragraph (c)(4)(ii)(B) of this section, and the denominator of which is the amount of long-term capital gain determined under paragraph (c)(4)(ii)(A) of this section, with the percentage represented by the fraction limited to 100 percent. Alternatively, if paragraph (c)(4)(ii)(C) of this section does not apply and long-term capital loss is recognized on the disposition of the Passthrough Interest, the amount of long-term capital loss treated as a Capital Interest Disposition Amount is determined by multiplying the transferor's capital loss by a fraction, the numerator of which is the amount of long-term capital loss determined under paragraph (c)(4)(ii)(B) of this section, and the denominator of which is the amount of long-term capital loss determined under paragraph (c)(4)(ii)(A) of this section, with the percentage represented by the fraction limited to 100 percent.
(E) In applying this paragraph (c)(4)(ii), allocations of amounts that are not included in determining the amount of long-term capital gain or loss recognized on the sale or disposition of the Passthrough Interest are not included. See, for example, section 751(a).
(5) Capital Interest Allocations made by a Passthrough Entity that is an API Holder. An allocation made to a Passthrough Entity that holds an API in a lower-tier Passthrough Entity will be considered a Capital Interest Allocation if it meets the principles set forth in paragraphs (c)(3) and (4) of this section (other than paragraph (c)(3)(iv) of this section). For purposes of applying the Capital Interest Allocation rules in this paragraph (c)(5) to a tiered partnership structure, to the extent that a Capital Interest Allocation that is made by a lower-tier partnership to an upper-tier partnership is properly allocated to the upper-tier partnership's partners with respect to their capital interests in the upper-tier partnership in a manner that is respected under 704(b) (taking into account the principles of section 704(c)), such allocation is a Capital Interest Allocation.
(6) Examples. The rules of this paragraph (c) are illustrated by the following examples.
(i) Example 1: Capital Interest Allocations—(A) Facts. Each of A, B, and C contributes $100 to GP and is an equal partner in GP, a partnership that is the general partner of PRS, a partnership. The contributions are not attributable to loans or advances described in paragraph (c)(3)(v)(A) of this section. PRS's other partners are Unrelated Non-Service Partners. Each of GP and PRS makes allocations to its partners in accordance with its partners' interests in that partnership, as described in § 1.704-1(b)(3). GP holds a 20% profits interest in PRS that is an API that GP received in exchange for providing substantial services to PRS in an ATB. GP's API is an Indirect API to each of A, B, and C. GP contributes the $300 of capital contributed by A, B and C to PRS. GP's $300 contribution equals 2% of the contributed capital made by all of PRS's partners ($15,000). PRS's partnership agreement describes its partners' economic distribution rights with respect to its liquidating proceeds as follows: First, liquidating proceeds are proportionately distributed to each of GP and the Unrelated Non-Service Partners equal to the amount necessary to return each of those partners' unreturned capital; second, liquidating proceeds are distributed to GP with respect to its API in PRS; and, finally, any residual liquidating proceeds are distributed, proportionately, 98% to the Unrelated Non-Service Partners and 2% to GP. During its initial taxable year, PRS has $10,000 of net capital gain, causing an increase in PRS's distributable proceeds of $10,000. In accordance with the partners' economic rights as described in PRS's partnership agreement, PRS allocates $2,160 of net capital gain to GP (a $2,000 API allocation plus $160 ($8,000 ($10,000−$2,000) × 2%), with respect to GP's contributed capital) and $7,840 of net capital gain to the Unrelated Non-Service Partners with respect to their contributed capital. GP allocates $720 ($2,160/3) of this net capital gain to each of A, B, and C in accordance with their interests in GP.
(B) PRS's Capital Interest Allocation Analysis. Because PRS's partnership agreement provides for no differences as to the amount and timing of capital contributed, the rate of return on capital contributed, the type and level of risk associated with capital contributed, or the rights to cash or property distributions during the PRS's operations and on liquidation, the allocations and distribution rights with respect the capital contributed by GP are reasonably consistent with the allocation and distribution rights with respect to capital contributed by Unrelated Non-Service Partners. Accordingly, GP's allocation of $160 is a Capital Interest Allocation that is treated as made in a similar manner as the allocations made to the Unrelated Non-Service Partners.
(C) GP's Capital Interest Allocation Analysis. GP is allocated $2,160 from PRS, consisting of a $2,000 API allocation and a $160 Capital Interest Allocation. The $160 Capital Interest Allocation is allocated equally to A, B, and C based on their capital contributions to GP. Therefore, they qualify as Capital Interest Allocations by GP. See paragraph (c)(5) of this section. The $2,000 of gain allocated by PRS to GP with respect to GP's API cannot be treated as a Capital Interest Allocation by GP and therefore is subject to section 1061. In summary, A, B, and C are each allocated $720 of capital gain from PRS ($2,160/3). Of this amount, $667 is API Gain ($2,000/3) and $53 is a Capital Interest Allocation ($160/3).
(ii) Example 2: Sale of a Passthrough Interest—(A) Facts. In Year 1, A, B, and C form GP, a partnership. Each of A, B, and C contributes $100 to GP and is an equal partner in GP. The contributions are not attributable to loans or advances described in paragraph (c)(3)(v)(A) of this section. GP invests the $300 in Asset X in Year 1. GP is also the general partner of PRS, a partnership. PRS's other partners are Unrelated Non-Service Partners. GP holds a 20% profits interest in PRS that is an API that GP received in exchange for providing substantial services to PRS in an ATB. GP's API is an Indirect API to each of A, B, and C. Each of GP and PRS makes allocations to its partners in accordance with its partners' interests in that partnership, as described in § 1.704-1(b)(3). In Year 3, A sells A's interest in GP to an unrelated third party for $800 and recognizes $700 of capital gain on the sale. If PRS had sold its assets in a hypothetical asset sale as required by paragraph (c)(4)(ii)(A) of this section and liquidated immediately before A sold its interest in GP, GP would have been allocated $1,800 of long-term capital gain with respect to GP's API in PRS, and GP would have allocated $600 of this $1,800 to A. If GP sold Asset X for its fair market value and liquidated immediately before A sold its interest in GP, A would have been allocated $100 of long-term capital gain.
(B) Analysis. GP does not have a capital interest in PRS. Therefore, its allocations from PRS are allocations with respect to its API which are subject to section 1061. The total gain allocable to A as a result of the hypothetical liquidations would be $700. Under paragraph (c)(4)(ii)(D) of this section, $100 of the $700 of A's interest sale gain is A's Capital Interest Disposition Amount, and is not subject to section 1061.
(iii) Example 3: Reinvestment of Realized API Gain. A, B, and C are partners in PRS, a partnership. At the beginning of Year 1, A is issued an API in PRS in exchange for providing substantial services to PRS in an ATB. A has no capital interest in PRS. During Year 1, PRS's assets appreciate by $100. At the end of Year 1, under the terms of its partnership agreement, if PRS were to sell all of its assets at their fair market value and distribute the proceeds in a complete liquidation, A would receive $20 with respect to its API. Thus, at the end of Year 1, A has $20 of Unrealized API Gain. In Year 2, PRS sells Asset X, an asset that PRS owned in Year 1, and allocates $8 of the long-term capital gain to A as API Gain. As a result, $8 of A's $20 of Unrealized API Gain becomes API Gain that is subject to section 1061. A reinvests A's share of the proceeds from the Asset X sale in PRS. As a result, under paragraph (c)(3)(iii) of this section, A has an $8 capital interest in PRS and, provided the requirements of paragraph (c)(3) of this section are met, A may receive future Capital Interest Allocations with respect to the capital interest.
(d) Partnership interest acquired by purchase by an unrelated person. If a person (acquirer) acquires an interest in a partnership (target partnership) by taxable purchase for fair market value that, but for the exception set forth in this paragraph (d), would be an API, the transferor of the interest will be treated as selling an API but the acquirer will not be treated as acquiring an API if—
(1) Acquirer not a Related Person. Immediately before the purchase, the acquirer is not a Related Person with respect to—
(i) Any person who provides services in the Relevant ATB; or
(ii) Any service providers who provide services to, or for the benefit of, the target partnership or a lower-tier partnership in which the target partnership holds an interest, directly or indirectly.
(2) Section 1061(d) not applicable. Section 1061(d) does not apply to the transaction (as provided in § 1.1061-5).
(3) Acquirer not a service provider. At the time of the purchase, the acquirer has not provided, does not provide, and does not anticipate providing services to, or for the benefit of, the target partnership, directly or indirectly, or any lower-tier partnership in which the target partnership directly or indirectly holds an interest.
(e) [Reserved]
(f) Applicability date—(1) General rule. Except as provided in paragraphs (f)(2) and (3) of this section, the provisions of this section apply to taxable years of Owner Taxpayers and Passthrough Entities beginning on or after January 19, 2021. An Owner Taxpayer or Passthrough Entity may choose to apply this section to a taxable year beginning after December 31, 2017, provided that they apply the Section 1061 Regulations in their entirety to that year and all subsequent years.
(2) Partnership interest held by an S corporation. Paragraph (b)(2)(i) of this section, which provides that the exception under section 1061(c)(1) to the definition of an API does not apply to a partnership interest held by an S corporation with an election under section 1362(a) in effect, applies to taxable years beginning after December 31, 2017.
(3) Partnership interest held by a PFIC with respect to which the shareholder has a QEF election in effect. Paragraph (b)(2)(ii) of this section, which provides that the exception under section 1061(c)(1) to the definition of an API does not apply to a partnership interest held by a PFIC with respect to which the shareholder has a QEF election in effect under section 1295, applies to taxable years of an Owner Taxpayer and Passthrough Entity beginning after August 14, 2020.
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Treas. Reg. §1.1061-3(a)A partnership interest held by an employee of another entity not conducting an ATB.
A partnership interest held by an employee of another entity not conducting an ATB. An API does not include any interest transferred to a person in connection with the performance of substantial services by that person as an employee of another entity that is conducting a trade or business (other than an ATB) and the person provides services only to such other entity.
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Treas. Reg. §1.1061-3(b)Partnership interest held by a corporation—(1) In general.
Partnership interest held by a corporation—(1) In general. An API does not include any interest directly or indirectly held by a corporation.
(2) Treatment of interests held by an S corporation or a qualified electing fund. For purposes of this section, a corporation does not include an entity for which an election was made to treat the entity as a Passthrough Entity. Thus, the following entities are not treated as corporations for purposes of section 1061—
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Treas. Reg. §1.1061-3(c)Capital Interest Gains and Losses—(1) In general.
Capital Interest Gains and Losses—(1) In general. Capital Interest Gains and Losses are not subject to section 1061 and, therefore, are not included in calculating an Owner Taxpayer's Recharacterization Amount.
(2) Capital Interest Gains and Losses defined. For purposes of paragraph (c)(1) of this section, Capital Interest Gains and Losses are Capital Interest Allocations that meet the requirements of paragraph (c)(3) of this section and Capital Interest Disposition Amounts that meet the requirements of paragraph (c)(4) of this section.
(3) General rules for determining Capital Interest Allocations—(i) Commensurate with capital contributed. An allocation will be considered a Capital Interest Allocation if the allocation to the API Holder with respect to its capital interest is determined and calculated in a similar manner as the allocations with respect to capital interests held by similarly situated Unrelated Non-Service Partners who have made significant aggregate capital contributions as described in paragraph (c)(3)(iv) of this section. For purposes of this paragraph (c)(3), a capital interest is an interest that would give the holder a share of the proceeds if the partnership's assets were sold at fair market value at the time the interest was received and the proceeds were then distributed in a complete liquidation of the partnership.
(ii) In a similar manner. For purposes of paragraph (c)(3)(i) of this section, a Capital Interest Allocation to an API Holder will be treated as made in a similar manner if allocations and distribution rights with respect to the capital contributed by an API Holder to which the API Holder's Capital Interest Allocation relates are reasonably consistent with allocation and distribution rights with respect to capital contributed by Unrelated Non-Service Partners where the Unrelated Non-Service Partner requirement is met. For purposes of this paragraph (c)(3)(ii), allocation and distribution rights for an API Holder that are limited to a particular class of partnership capital interests or that are determined with respect to capital contributions invested in a particular partnership investment will be considered as made in a similar manner to allocations and distribution rights of Unrelated Non-Service Partners where the Unrelated Non-Service Partner requirement is met for the applicable interest class or partnership investment.
(A) Relevant factors. For purposes of this paragraph (c)(3)(ii), the following factors are not exclusive, but are relevant factors in determining whether allocation and distribution rights with respect to capital contributed by an API Holder are reasonably consistent with allocation and distribution rights of persons meeting the Unrelated Non-Service Partner requirement: The amount and timing of capital contributed, the rate of return on capital contributed, the terms, priority, type and level of risk associated with capital contributed, and the rights to cash or property distributions during the partnership's operations and on liquidation. Accordingly, an allocation to an API Holder will not fail to qualify solely because the allocation is subordinated to allocations made to Unrelated Non-Service Partners, because an allocation to an API Holder is not reduced by the cost of services provided by the API Holder or a Related Person to the partnership, where the cost of services provided includes management fees or API allocations, or because an API Holder has a right to receive tax distributions while Unrelated Non-Service Partners do not, where such distributions are treated as advances against future distributions.
(B) Clear identification requirement. For purposes of this paragraph (c)(3)(ii), allocations will be considered made in a similar manner only if the allocations to the API Holder and the Unrelated Non-Service Partners are allocations with respect to, and corresponding to, such partners' contributed capital that are separate and apart from allocations made to the API Holder with respect to its API and where both the partnership agreement and the partnership's contemporaneous books and records clearly demonstrate that the requirements of paragraph (c)(3) of this section have been met.
(iii) Reinvestment of API Gain. If an API Holder is allocated API Gain by a Passthrough Entity, to the extent that an amount equal to the API Gain is reinvested in the Passthrough Entity by the API Holder (either as the result of an actual distribution and recontribution of the API Gain amount or the retention of the API Gain amount by the Passthrough Entity), the amount will be treated as a contribution to the Passthrough Entity for a capital interest that may produce Capital Interest Allocations for the API Holder, provided such allocations meet the requirements of this paragraph (c)(3).
(iv) Unrelated Non-Service Partner requirement. For purposes of paragraph (c)(3) of this section, the Unrelated Non-Service Partner requirement means that Unrelated Non-Service Partners must have made significant aggregate capital contributions in relation to total capital contributions of all partners. Unrelated Non-Service Partners will be treated as having made significant aggregate capital contributions provided such partners possess five percent or more of the aggregate capital contributed to the partnership at the time the allocations are made. With respect to an API Holder with allocation and distribution rights that are attributable to a particular interest class or partnership investment, the Unrelated Non-Service requirement must be met with respect to that particular interest class or partnership investment.
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