Highlights
- The U.S. Department of the Treasury and IRS recently proposed rules that would modify the timing of so-called "hot asset" reporting. The change is welcome news for practitioners who were concerned that the timing requirement would make it difficult for partnerships to comply.
- Gain on the sale of a partnership interest attributable to hot assets is taxed as ordinary income and has been the subject of an IRS enforcement campaign. Though the timing of hot asset reporting has changed, the issue remains an area of focus for the IRS. If there was a sale or exchange of a partnership interest during a year under audit, the IRS will likely audit the calculation of ordinary income.
Generally, gain or loss on the sale or exchange of a partnership interest is treated as capital gain or loss except to the extent of so-called "hot assets." Gain attributable to hot assets – generally unrealized receivables and inventory – is ordinary income. The IRS has a current campaign (i.e., an area of focus in enforcement) examining whether the amount of ordinary income reported on the sale of a partnership interest is correct.
A partnership is required to file a Form 8308, Report of a Sale or Exchange of Certain Partnership Interests, if any of the consideration received by the partner was attributable to hot assets. Partnerships are generally required to provide a completed copy of the Form 8308 to the partner that sold its interest (i.e., the transferor partner) and the partner that purchased the interest by Jan. 31 of the year after the sale occurred.
In late 2023, the IRS amended Form 8308 to add Part IV, which required partnerships to include Section 751 gain or loss as well as unrecaptured Section 1250 gain and the transferor partner's share of these amounts. Practitioners commented that many partnerships would be unable to provide the information by the Jan. 31 deadline.
Proposed regulations issued this week would eliminate the requirement that partnerships furnish the information in Part IV by Jan. 31. Partnerships will still provide the information in Parts I-III by Jan. 31. The partnership would then file a completed Form 8308 when it files its partnership tax return. It would also report the information required in Part IV of the Form 8308 on the Schedule K-1 issued to the partners.
This proposed change is a welcome simplification. Given the IRS' continued focus on the calculation of ordinary income on the sale of a partnership interest, partnerships should carefully report ordinary income on the sale of a partnership interest on the Schedule K-1 and Form 8308. Holland & Knight has extensive experience handling tax controversies involving the sale of a partnership interest.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
