Questions and Answers about Technical Terminations, Internal Revenue Code (IRC) Sec. 708

Prior Law

Q1. Under what circumstances did a partnership terminate under prior law (through
December 31, 2017)?

A1. Before enactment of the Tax Cuts and Jobs Act (TCJA), a partnership was considered terminated if either:

  1. No part of the partnership’s activities continued to be carried on by any of its partners in a partnership. For example, the partnership ceases its activities and liquidates.
  2. A sale or exchange of 50 percent or more of the total interests in the partnership’s capital and profits occurred within a twelve-month period. This was considered a technical termination.

New Law

Q2. What changes made by the TCJA relate to partnership terminations?

A2. The TCJA eliminated the rule for technical terminations for partnerships or entities treated as partnerships for tax years beginning after December 31, 2017. So, a partnership may now only terminate by cessation of partnership activities and liquidation, or when the partnership’s business activities no longer continue in partnership form.  

Example 1 – Pre-TCJA

AB partnership was formed on January 1, 2005. On that date, the partnership purchased and placed in service rental real estate properties. On January 5, 2017, sales and exchanges of greater than 50 percent interests in capital and profits occurred within a 12 month period, causing a technical termination.   All of AB’s depreciable assets are considered contributed to a new partnership on January 6, 2017.  The new partnership keeps the same name and taxpayer ID. A Treasury regulation [Reg. § 1.708-1(b)(3)] states that the partnership’s tax year closes for all partners on the date a terminating event takes place. The partnership would file a final return for the short period ending on the partnership termination date, January 5, 2017. The new partnership would file a short-period return beginning January 6, 2017.

Example 2 – Post-TCJA

Assume AB partnership was formed on the same date above and purchased the same assets. But, assume that on January 5, 2018, sales and exchanges of greater than 50 percent of interests in capital and profits occurred within a 12-month period. No technical termination occurred, since the TCJA repealed technical terminations for tax years beginning after December 31, 2017.  The partnership would not file a short-period return for tax year 2018.

Income Allocation

Q3. How is income allocated when a partner leaves the partnership?

A3. When a partner sells or exchanges their entire partnership interest, the partnership’s tax year ends for that partner. The partnership allocates its income or loss for the year between the transferor and transferee partners based on the sale date. If a partner transfers less than their entire interest, the partnership tax year doesn’t close for the selling partner unless the partnership actually terminates.  Still, the partnership must allocate income or loss in a way that recognizes the partners’ varying interests during the tax year. In these situations, the partnership’s distributive share items are allocated among the partners whose interest changed in one of two ways: the interim closing method or the proration method. The proration method can only be used if agreed to by the partners in writing. 

Regulations under IRC Section 706 gives allocation rules for the following situations:

  1. when a partner’s interest in a partnership varies during the year due to a disposition of the entire interest, such as a partner’s death or the sale or exchange of liquidation of a partner’s interest, or
  2. when a disposition is less than the entire interest, including the admission of a new member.

Q4. If a partnership wants to trigger a technical termination as under prior law, may it voluntarily do so?

A4. Generally, no. But, a fiscal year partnership whose tax year began after January 1,2017, and on or before December 31, 2017, may be subject to the technical termination rules for its final fiscal period beginning in 2017.