§ 1.721(c)-7 — Examples.

26 CFR § 1.721(c)-7

• Title: Title 26: Internal Revenue
• Part: Part 1: Income Taxes
• Source: eCFR (current through Mar 20, 2026)

Text

§ 1.721(c)-7 Examples.

(a) Presumed facts. For purposes of the examples in paragraph (b) of this section, assume that there are no other transactions that are related to the transactions described in the examples and that all partnership allocations have substantial economic effect under section 704(b). For definitions that apply for purposes of this section, see § 1.721(c)-1(b). Except where otherwise indicated, the following facts are presumed—

(1) USP and USX are domestic corporations that each use a calendar taxable year. USX is not a related person with respect to USP.

(2) CFC1, CFC2, FX, and FY are foreign corporations.

(3) USP wholly owns CFC1 and CFC2. Neither FX nor FY is a related person with respect to USP or with respect to each other.

(4) PRS1, PRS2, and PRS3 are foreign entities classified as partnerships for U.S. tax purposes. A partnership interest in PRS1, PRS2, and PRS3 is not described in section 475(c)(2).

(5) A taxable year is referred to, for example, as year 1.

(6) A partner in a partnership has the same percentage interest in income, gain, loss, deduction, and capital of the partnership.

(7) No property is described in section 197(f)(9) in the hands of a contributing partner.

(8) No partnership is a controlled partnership solely under the facts and circumstances test in § 1.721(c)-1(b)(4).

(b) Examples. The application of the rules stated in §§ 1.721(c)-1 through 1.721(c)-6 may be illustrated by the following examples:

(1) Example 1: Determining if a partnership is a section 721(c) partnership—(i) Facts. In year 1, USP and CFC1 form PRS1 as equal partners. CFC1 contributes cash of $1.5 million to PRS1, and USP contributes three properties to PRS1: A patent with a book value of $1.2 million and an adjusted tax basis of zero, a security (within the meaning of section 475(c)(2)) with a book value of $100,000 and an adjusted tax basis of $20,000, and a machine with a book value of $200,000 and an adjusted tax basis of $600,000.

(ii) Results. (A) Under § 1.721(c)-1(b)(18)(i), USP is a U.S. transferor because USP is a U.S. person and not a domestic partnership. Under § 1.721(c)-1(b)(2), the patent has built-in gain of $1.2 million. The patent is not excluded property under § 1.721(c)-1(b)(6). Therefore, under § 1.721(c)-1(b)(15)(i), the patent is section 721(c) property because it is property, other than excluded property, with built-in gain that is contributed by a U.S. transferor, USP.

(B) Under § 1.721(c)-1(b)(2), the security has built-in gain of $80,000. Under § 1.721(c)-1(b)(6)(ii), the security is excluded property because it is described in section 475(c)(2). Therefore, the security is not section 721(c) property.

(C) The tax basis of the machine exceeds its book value. Under § 1.721(c)-1(b)(6)(iii), the machine is excluded property and therefore is not section 721(c) property.

(D) Under § 1.721(c)-1(b)(12), CFC1 is a related person with respect to USP, and under § 1.721(c)-1(b)(11), CFC1 is a related foreign person. Because USP and CFC1 collectively own at least 80 percent of the interests in the capital, profits, deductions, or losses of PRS1, under § 1.721(c)-1(b)(14)(i), PRS1 is a section 721(c) partnership upon the contribution by USP of the patent.

(E) The de minimis exception described in § 1.721(c)-2(c) does not apply to the contribution because during PRS1's year 1 the sum of the built-in gain with respect to all section 721(c) property contributed in year 1 to PRS1 is $1.2 million, which exceeds the de minimis threshold of $1 million. As a result, under § 1.721(c)-2(b), section 721(a) does not apply to USP's contribution of the patent to PRS1, unless the requirements of the gain deferral method are satisfied.

(2) Example 2: Determining if partnership interest is section 721(c) property—(i) Facts. In year 1, USP and FX form PRS2. USP contributes a security (within the meaning of section 475(c)(2)) with a book value of $100,000 and an adjusted tax basis of $20,000 and a building located in country X with a book value of $30,000 and an adjusted tax basis of $8,000 in exchange for a 40-percent interest. FX contributes a machine with a book value of $195,000 and an adjusted tax basis of $250,000 in exchange for a 60-percent interest.

(ii) Results. PRS2 is not a section 721(c) partnership because FX is not a related person with respect to USP. USP's contributions to PRS2 are not subject to § 1.721(c)-2(b).

(iii) Alternative facts and results. (A) The facts are the same as in paragraph (b)(2)(i) of this section (the facts in Example 2). In addition, USP and CFC1 form PRS1 as equal partners. CFC1 contributes cash of $130,000 to PRS1, and USP contributes its 40-percent interest in PRS2.

(B) PRS2's property consists of a security and a machine that are excluded property, and a building with built-in gain in excess of $20,000. Under § 1.721(c)-1(b)(6)(iv), because more than 90 percent of the value of the property of PRS2 consists of excluded property described in § 1.721(c)-1(b)(6)(i) through (iii) (the security and the machine), any interest in PRS2 is excluded property. Therefore, the 40-percent interest in PRS2 contributed by USP to PRS1 is not section 721(c) property. Accordingly, USP's contribution of its interest in PRS2 to PRS1 is not subject to § 1.721(c)-2(b).

(3) Example 3: Assets-over tiered partnerships—(i) Facts. In year 1, USP and CFC1 form PRS1 as equal partners. USP contributes a patent with a book value of $300 million and an adjusted tax basis of $30 million (USP contribution). CFC1 contributes cash of $300 million. Immediately thereafter, PRS1 contributes the patent to PRS2 in exchange for a two-thirds interest (PRS1 contribution), and CFC2 contributes cash of $150 million in exchange for a one-third interest. The patent has a remaining recovery period of 5 years out of a total of 15 years. With respect to all contributions described in § 1.721(c)-2(b), the de minimis exception does not apply, and the gain deferral method is applied. Thus, the partnership agreements of PRS1 and PRS2 provide that the partnership will make allocations under section 704(c) using the remedial allocation method under § 1.704-3(d).

(ii) Results: USP contribution. PRS1 is a section 721(c) partnership as a result of the USP contribution.

(iii) Results: PRS1 contribution. (A) For purposes of determining whether PRS2 is a section 721(c) partnership as a result of the PRS1 contribution, under § 1.721(c)-2(d)(1), USP is treated as contributing to PRS2 its share of the patent that PRS1 actually contributes to PRS2. USP and CFC1 are each one-third indirect partners in PRS2. Taking into account the one-third interest in PRS2 directly owned by CFC2, USP, CFC1, and CFC2 collectively own at least 80 percent of the interests in PRS2. Thus, PRS2 is a section 721(c) partnership as a result of the PRS1 contribution.

(B) Under § 1.721(c)-2(b), section 721(a) does not apply to PRS1's contribution of the patent to PRS2, unless the requirements of the gain deferral method are satisfied. Under § 1.721(c)-3(b), the gain deferral method must be applied with respect to the patent. In addition, under § 1.721(c)-3(d)(2), because PRS1 is a controlled partnership with respect to USP, the gain deferral method must be applied with respect to PRS1's interest in PRS2, and, solely for purposes of applying the consistent allocation method, PRS2 must treat PRS1 as the U.S. transferor. As stated in paragraph (b)(3)(i) of this section (the facts in Example 3), the gain deferral method is applied. PRS2 is a controlled partnership with respect to USP. Under § 1.721(c)-5(c)(5)(i), the PRS1 contribution is a successor event with respect to the USP contribution.

(iv) Results: application of remedial allocation method. (A) Under § 1.704-3(d)(2), in year 1, PRS2 has $24 million of book amortization with respect to the patent ($6 million ($30 million of book value equal to adjusted tax basis divided by the 5-year remaining recovery period) plus $18 million ($270 million excess of book value over tax basis divided by the new 15-year recovery period)). PRS2 has $6 million of tax amortization. Under the PRS2 partnership agreement, PRS2 allocates $8 million of book amortization to CFC2 and $16 million of book amortization to PRS1. Because of the application of the ceiling rule, PRS2 allocates $6 million of tax amortization to CFC2 and $0 of tax amortization to PRS1. Because the ceiling rule would cause a disparity of $2 million between CFC2's book and tax amortization, PRS2 must make a remedial allocation of $2 million of tax amortization to CFC2 and an offsetting remedial allocation of $2 million of taxable income to PRS1.

(B) PRS1's distributive share of each of PRS2's items with respect to the patent is $16 million of book amortization, $0 of tax amortization, and $2 million of taxable income from the remedial allocation from PRS1. Under § 1.704-3(a)(9), PRS1 must allocate its distributive share of each of PRS2's items with respect to the patent in a manner that takes into account USP's remaining built-in gain in the patent. Therefore, PRS1 allocates $2 million of taxable income to USP. Under § 1.704-3(a)(13)(ii), PRS1 treats its distributive share of each of PRS2's items of amortization with respect to PRS2's patent as items of amortization with respect to PRS1's interest in PRS2. Under the PRS1 partnership agreement, PRS1 allocates $8 million of book amortization and $0 of tax amortization to CFC1, and $8 million of book amortization and $0 of tax amortization to USP. Because the ceiling rule would cause a disparity of $8 million between CFC1's book and tax amortization, PRS1 must make a remedial allocation of $8 million of tax amortization to CFC1. PRS1 must also make an offsetting remedial allocation of $8 million of taxable income to USP. USP reports $10 million of taxable income ($2 million of remedial income from PRS2 and $8 million of remedial income from PRS1).

(4) Example 4: Section 721(c) partnership ceases to have a related foreign person as a partner—(i) Facts. In year 1, USP and CFC1 form PRS1. USP contributes a trademark with a built-in gain of $5 million in exchange for a 60-percent interest, and CFC1 contributes other property in exchange for the remaining 40-percent interest. With respect to all contributions described in § 1.721(c)-2(b), the de minimis exception does not apply, and the gain deferral method is applied. On day 1 of year 4, CFC1 sells its entire interest in PRS1 to FX. There is no plan for a related foreign person with respect to USP to subsequently become a partner in PRS1 (or a successor).

(ii) Results. (A) PRS1 is a section 721(c) partnership.

(B) With respect to year 4, under § 1.721(c)-5(b)(5), the sale is a termination event because, as a result of CFC1's sale of its interest, PRS1 will no longer have a partner that is a related foreign person, and there is no plan for a related foreign person to subsequently become a partner in PRS1 (or a successor). Thus, under § 1.721(c)-5(b)(1), the trademark is no longer subject to the gain deferral method.

(5) Example 5: Transfer described in section 367 of section 721(c) property to a foreign corporation—(i) Facts. In year 1, USP, CFC1, and USX form PRS1. USP contributes a patent with a built-in gain of $5 million in exchange for a 60-percent interest, CFC1 contributes other property in exchange for a 30-percent interest, and USX contributes cash in exchange for a 10-percent interest. With respect to all contributions described in § 1.721(c)-2(b), the de minimis exception does not apply, and the gain deferral method is applied. In year 3, when the patent has remaining built-in gain, PRS1 transfers the patent to FX in a transaction described in section 351.

(ii) Results. (A) PRS1 is a section 721(c) partnership.

(B) With respect to year 3, the transfer of the patent to FX is a transaction described in section 367(d). Therefore, under § 1.721(c)-5(e), the patent is no longer subject to the gain deferral method. Under §§ 1.367(d)-1T(d)(1) and 1.367(a)-1T(c)(3)(i), for purposes of section 367(d), USP and USX are treated as transferring their proportionate share of the patent actually transferred by PRS1 to FX. Under § 1.721(c)-5(e), to the extent USP and USX are treated as transferring the patent to FX, the tax consequences are determined under section 367(d) and the regulations under section 367(d). With respect to the remaining portion of the patent, if any, which is attributable to CFC1, USP must recognize an amount of gain equal to the remaining built-in gain that would have been allocated to USP if PRS1 had sold that portion of the patent immediately before the transfer for fair market value. Under § 1.721(c)-4(c)(1), USP must increase the basis in its partnership interest in PRS1 by the amount of gain recognized by USP and under § 1.721(c)-4(c)(2), immediately before the transfer, PRS1 must increase its basis in the patent by the same amount. The stock in FX received by PRS1 is not subject to the gain deferral method.

(6) Example 6: Limited remedial allocation method for anti-churning property with respect to related partners—(i) Facts. USP, CFC1, and FX form PRS1. On January 1 of year 1, USP contributes intellectual property (IP) with a book value of $600 million and an adjusted tax basis of $0 in exchange for a 60-percent interest. The IP is a section 197(f)(9) intangible (within the meaning of § 1.197-2(h)(1)(i)) that was not an amortizable section 197 intangible in USP's hands. CFC1 contributes cash of $300 million in exchange for a 30-percent interest, and FX contributes cash of $100 million in exchange for a 10-percent interest. The IP is section 721(c) property, and PRS1 is a section 721(c) partnership. The gain deferral method is applied. The partnership agreement provides that PRS1 will make allocations under section 704(c) with respect to the IP using the remedial allocation method under § 1.704-3(d)(5)(iii). All of PRS1's allocations with respect to the IP satisfy the requirements of the gain deferral method. On January 1 of year 16, PRS1 sells the IP for cash of $900 million to a person that is not a related person. During years 1 through 16, PRS1 earns no income other than gain from the sale of the IP in year 16, has no expenses or deductions other than from amortization of the IP, and makes no distributions.

(ii) Results: Year 1. Under § 1.704-3(d)(5)(iii)(B), PRS1 must recover the excess of the book value of the IP over its adjusted tax basis at the time of the contribution ($600 million) using any recovery period and amortization method that would have been available to PRS1 if the property had been newly purchased property from an unrelated party. Thus, under section 197(a), PRS1 must amortize $600 million of the IP's book value ratably over 15 years for book purposes, and PRS1 will have $40 million of book amortization per year without any tax amortization. Under the partnership agreement, in year 1, PRS1 allocates book amortization of $24 million to USP, $12 million to CFC1, and $4 million to FX. Because in year 1 the ceiling rule would cause a disparity between FX's allocations of book and tax amortization, PRS1 makes a remedial allocation of tax amortization of $4 million to FX and an offsetting remedial allocation of $4 million of taxable income to USP. In year 1, the ceiling rule would also cause a disparity between CFC1's allocations of book and tax amortization. However, § 1.197-2(h)(12)(vii)(B) precludes PRS1 from making a remedial allocation of tax amortization to CFC1. Instead, pursuant to § 1.704-3(d)(5)(iii)(C), PRS1 increases the adjusted tax basis in the IP by $12 million, and pursuant to § 1.704-3(d)(5)(iii)(D), that basis adjustment is solely with respect to CFC1. Pursuant to § 1.704-3(d)(5)(iii)(C), PRS1 also makes an offsetting remedial allocation of $12 million of taxable income to USP.

(iii) Results: Years 2-15. At the end of year 15, PRS1 has book basis and adjusted tax basis of $0 in the IP. PRS1 has amortized $600 million for book purposes by allocating total book amortization deductions of $360 million to USP, $180 million to CFC1, and $60 million to FX. For U.S. tax purposes, by the end of year 15, PRS1 has made remedial allocations of $60 million of tax amortization to FX and increased the adjusted tax basis in the IP by $180 million solely with respect to CFC1. PRS1 has also made total remedial allocations of $240 million of taxable income to USP (attributable to $60 million of remedial tax amortization to FX and $180 million of tax basis adjustments with respect to CFC1). With respect to their partnership interests in PRS1, USP has a capital account and an adjusted tax basis of $240 million, CFC1 has a capital account of $120 million and an adjusted tax basis of $300 million, and FX has a capital account and an adjusted tax basis of $40 million.

(iv) Results: Sale of property in year 16. PRS1's sale of the IP for cash of $900 million on January 1 of year 16 results in $900 million of book and tax gain ($900 million−$0). PRS1 allocates the book and tax gain 60 percent to USP ($540 million), 10 percent to FX ($90 million), and 30 percent to CFC1 ($270 million). However, under § 1.704-3(d)(5)(iii)(D)(3), CFC1's tax gain is $90 million, equal to its share of PRS1's gain ($270 million), minus the amount of the tax basis adjustment ($180 million). After the sale, PRS1's only property is cash of $1.3 billion. With respect to their partnership interests in PRS1, USP has a capital account and an adjusted tax basis of $780 million, CFC1 has a capital account and an adjusted tax basis of $390 million, and FX has a capital account and an adjusted tax basis of $130 million.

[T.D. 9891, 85 FR 3849, Jan. 23, 2020]