Thought-provokinganalysis and opinion on federal tax issues

AICPA Comments On IRS Negative Tax Capital Reporting

September 19, 2020

by Monte A. Jackel

The AICPA recently released a comment letter it sent to the IRS on the tax basis negative capital proposed reporting regime.

1. The purpose of this reporting regime, as I understand it, is to ensure that a partner reports the recapture of the excess of his share of debt over his tax basis when a triggering event occurs (sale, redemption, maybe death). Nothing more, nothing less. The IRS claims these amounts are under-reported or are buried into UPREIT roll ups. Regardless, since none of the methods either proposed or suggested (including the last IRS notice and the AICPA letter) will get to the actual real number of negative capital, reporting some number on the return is, to me, completely meaningless except to tell the IRS that you had minimum gain at some point in time and either still have it or it should have been recaptured already. That item can be a PRI (partnership related item under the BBA audit regime) if the partner recapture relates to a partnership item, such as in a liquidation but not, generally, sales of interests (but could be sales of partnership assets). So I thought that saying that the negative basis as reported is not a PRI, as stated in the AICPA report, is somewhat misleading. 

2. I would posit that all the IRS needs is a statement on the return that you think you were negative at either the beginning or end of the year (or both) and that you can use any reasonable method that is specified but you don’t report the actual number ever. Nothing else makes any sense to me.

3. The regulations under section 6011-1(a) tell you that you prepare a tax return based on regulations or forms (which includes instructions). FAQs are not counted. Neither are notices. I feel very strongly that the IRS must first issue regulations (could only be one sentence) that mandates the reporting. I would not go forward without it.

4. The section 734(b) conundrum set forth in the AICPA report has gone on for many years and there is much literature on it. Regardless of the distortions caused by the basis adjustment applying for all partners, there is a vast preponderance of what is out there that says section 734(b) adjustments cannot be limited to the distributee only. The only way to “get it right” is to legislate that there can be partial partnership redemptions. Doing that, along with some clean up amendments, will solve the problem. So I don’t agree with the AICPA example’s conclusion in the appendix on that point. The only time I have seen section 734(b) being partner specific is where there is a less than full redemption of a section 704(c) partner and where the section 734(b) basis adjustment must attach to the contributed asset of that distributee partner. See this link. In all other cases, you need a legislative change to target the adjustment solely to a single partner even though it creates problems for tax capital reporting and so on. 

5. The IRS proposal that you report the aggregate net section 704(c) amount is a silly proposal. I also frankly do not agree with the AICPA recommendation on this point. Section 704(c) is generally asset by asset, separate forwards and reverses (if you believe the 2014 proposed regulation section 751(b) preamble and related preambles where the no netting of forwards and reverses is set forth). The current rules, returns and instructions do not tell you how to adopt a section 704(c) method either. 

6. What is essential is section 704(c) reporting on the return on a property by property basis with full disclosure of the method adopted and how it was computed. I would even contemplate requiring the taxpayer to state why the anti-abuse rule of regulation section 1.704-3(a)(10) was not applicable. Any other approach makes zero sense to me.