[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1245-1]

[Page 349-356]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1245-1  General rule for treatment of gain from dispositions of 
certain depreciable property.

    (a) General. (1) In general, section 1245(a)(1) provides that, upon 
a disposition of an item of section 1245 property, the amount by which 
the lower of (i) the recomputed basis of the property, or (ii) the 
amount realized on a sale, exchange, or involuntary conversion (or the 
fair market value of the property on any other disposition), exceeds the 
adjusted basis of the property shall be treated as gain from the sale or 
exchange of property which is neither a capital asset nor property 
described in section 1231 (that is, shall be recognized as ordinary 
income). The amount of such gain shall be determined separately for each 
item of section 1245 property. In general, the term recomputed basis 
means the adjusted basis of property plus all adjustments reflected in 
such adjusted basis on account of depreciation allowed or allowable for 
all periods after December 31, 1961. See section 1245(a)(2) and Sec. 
1.1245-2. Generally, the ordinary income treatment applies even though 
in the absence of

[[Page 350]]

section 1245 no gain would be recognized under the Code. For example, if 
a corporation distributes section 1245 property as a dividend, gain may 
be recognized as ordinary income to the corporation even though, in the 
absence of section 1245, section 311(a) would preclude any recognition 
of gain to the corporation. For the definition of section 1245 property, 
see section 1245(a)(3) and Sec. 1.1245-3. For exceptions and 
limitations to the application of section 1245(a)(1), see section 
1245(b) and Sec. 1.1245-4.
    (2) Section 1245(a)(1) applies to dispositions of section 1245 
property in taxable years beginning after December 31, 1962, except 
that:
    (i) In respect of section 1245 property which is an elevator or 
escalator, section 1245(a)(1) applies to dispositions after December 31, 
1963, and
    (ii) In respect of section 1245 property which is livestock 
(described in subparagraph (4) of Sec. 1.1245-3(a)), section 1245(a)(1) 
applies to dispositions made in taxable years beginning after December 
31, 1969, and
    (iii) [Reserved].
    (3) For purposes of this section and Sec. Sec. 1.1245-2 through 
1.1245-6, the term disposition includes a sale in a sale-and-leaseback 
transaction and a transfer upon the foreclosure of a security interest, 
but such term does not include a mere transfer of title to a creditor 
upon creation of a security interest or to a debtor upon termination of 
a security interest. Thus, for example, a disposition occurs upon a sale 
of property pursuant to a conditional sales contract even though the 
seller retains legal title to the property for purposes of security but 
a disposition does not occur when the seller ultimately gives up his 
security interest following payment by the purchaser.
    (4) For purposes of applying section 1245, the facts and 
circumstances of each disposition shall be considered in determining 
what is the appropriate item of section 1245 property. A taxpayer may 
treat any number of units of section 1245 property in any particular 
depreciation account (as defined in Sec. 1.167(a)-7) as one item of 
section 1245 property as long as it is reasonably clear, from the best 
estimates obtainable on the basis of all the facts and circumstances, 
that the amount of gain to which section 1245(a)(1) applies is not less 
than the total of the gain under section 1245(a)(1) which would be 
computed separately for each unit. Thus, for example, if 50 units of 
section 1245 property X, 25 units of section 1245 property Y, and other 
property are accounted for in one depreciation account, and if each such 
unit is sold at a gain in one transaction in which the total gain 
realized on the sale exceeds the sum of the adjustments reflected in the 
adjusted basis (as defined in paragraph (a)(2) of Sec. 1.1245-2) of 
each such unit on account of depreciation allowed or allowable for 
periods after December 31, 1961, all 75 units may be treated as one item 
of section 1245 property. If, however, 5 such units of section 1245 
property Y were sold at a loss, then only 70 of such units (50 of X plus 
the 20 of Y sold at a gain) may be treated as one item of section 1245 
property.
    (5) In case of a sale, exchange, or involuntary conversion of 
section 1245 and non-section 1245 property in one transaction, the total 
amount realized upon the disposition shall be allocated between the 
section 1245 property and the non-section 1245 property in proportion to 
their respective fair market values. In general, if a buyer and seller 
have adverse interests as to the allocation of the amount realized 
between the section 1245 property and the non-section 1245 property, any 
arm's length agreement between the buyer and the seller will establish 
the allocation. In the absence of such an agreement, the allocation 
shall be made by taking into account the appropriate facts and 
circumstances. Some of the facts and circumstances which shall be taken 
into account to the extent appropriate include, but are not limited to, 
a comparison between the section 1245 property and all the property 
disposed of in such transaction of (i) the original cost and 
reproduction cost of construction, erection, or production, (ii) the 
remaining economic useful life, (iii) state of obsolescence, and (iv) 
anticipated expenditures to maintain, renovate, or to modernize.
    (b) Sale, exchange, or involuntary conversion. (1) In the case of a 
sale, exchange, or involuntary conversion of section 1245 property, the 
gain to which

[[Page 351]]

section 1245(a)(1) applies is the amount by which (i) the lower of the 
amount realized upon the disposition of the property or the recomputed 
basis of the property, exceeds (ii) the adjusted basis of the property.
    (2) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. On January 1, 1964, Brown purchases section 1245 property 
for use in his manufacturing business. The property has a basis for 
depreciation of $3,300. After taking depreciation deductions of $1,300 
(the amount allowable), Brown realizes after selling expenses the amount 
of $2,900 upon sale of the property on January 1, 1969. Brown's gain is 
$900 ($2,900 amount realized minus $2,000 adjusted basis). Since the 
amount realized upon disposition of the property ($2,900) is lower than 
its recomputed basis ($3,300, i.e., $2,000 adjusted basis plus $1,300 in 
depreciation deductions), the entire gain is treated as ordinary income 
under section 1245(a)(1) and not as gain from the sale or exchange of 
property described in section 1231.
    Example 2. Assume the same facts as in example (1) except that Brown 
exchanges the section 1245 property for land which has a fair market 
value of $3,700, thereby realizing a gain of $1,700 ($3,700 amount 
realized minus $2,000 adjusted basis). Since the recomputed basis of the 
property ($3,300) is lower than the amount realized upon its disposition 
($3,700), the excess of recomputed basis over adjusted basis, or $1,300, 
is treated as ordinary income under section 1245(a)(1). The remaining 
$400 of the gain may be treated as gain from the sale or exchange of 
property described in section 1231.

    (c) Other dispositions. (1) In the case of a disposition of section 
1245 property other than by way of a sale, exchange, or involuntary 
conversion, the gain to which section 1245(a)(1) applies is the amount 
by which (i) the lower of the fair market value of the property on the 
date of disposition or the recomputed basis of the property, exceeds 
(ii) the adjusted basis of the property. If property is transferred by a 
corporation to a shareholder for an amount less than its fair market 
value in a sale or exchange, for purposes of applying section 1245 such 
transfer shall be treated as a disposition other than by way of a sale, 
exchange, or involuntary conversion.
    (2) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. X Corporation distributes section 1245 property to its 
shareholders as a dividend. The property has an adjusted basis of $2,000 
to the corporation, a recomputed basis of $3,300, and a fair market 
value of $3,100. Since the fair market value of the property ($3,100) is 
lower than its recomputed basis ($3,300), the excess of fair market 
value over adjusted basis, or $1,100, is treated under section 
1245(a)(1) as ordinary income to the corporation even though, in the 
absence of section 1245, section 311(a) would preclude recognition of 
gain to the corporation.
    Example 2. Assume the same facts as in example (1) except that X 
Corporation distributes the section 1245 property to its shareholders in 
complete liquidation of the corporation. Assume further that section 
1245(b)(3) does not apply and that the fair market value of the property 
is $3,800 at the time of the distribution. Since the recomputed basis of 
the property ($3,300) is lower than its fair market value ($3,800), the 
excess of recomputed basis over adjusted basis, or $1,300, is treated 
under section 1245(a)(1) as ordinary income to the corporation even 
though, in the absence of section 1245, section 336 would preclude 
recognition of gain to the corporation.

    (d) Losses. Section 1245(a)(1) does not apply to losses. Thus, 
section 1245(a)(1) does not apply if a loss is realized upon a sale, 
exchange, or involuntary conversion of property, all of which is 
considered section 1245 property, nor does the section apply to a 
disposition of such property other than by way of sale, exchange, or 
involuntary conversion if at the time of the disposition the fair market 
value of such property is not greater than its adjusted basis.
    (e) Treatment of partnership and partners. (1) The manner of 
determining the amount of gain recognized under section 1245(a)(1) to a 
partnership may be illustrated by the following example:

    Example: A partnership sells for $63 section 1245 property which has 
an adjusted basis to the partnership of $30 and a recomputed basis to 
the partnership of $60. The partnership recognizes under section 
1245(a)(1) gain of $30, i.e., the lower of the amount realized ($63) or 
recomputed basis ($60), minus adjusted basis ($30). This result would 
not be changed if one or more partners had, in respect of the property, 
a special basis adjustment described in section 743(b) or had taken 
depreciation deductions in respect of such special basis adjustment.

    (2)(i) Unless paragraph (e)(3) of this section applies, a partner's 
distributive share of gain recognized under section

[[Page 352]]

1245(a)(1) by the partnership is equal to the lesser of the partner's 
share of total gain from the disposition of the property (gain 
limitation) or the partner's share of depreciation or amortization with 
respect to the property (as determined under paragraph (e)(2)(ii) of 
this section). Any gain recognized under section 1245(a)(1) by the 
partnership that is not allocated under the first sentence of this 
paragraph (e)(2)(i) (excess depreciation recapture) is allocated among 
the partners whose shares of total gain from the disposition of the 
property exceed their shares of depreciation or amortization with 
respect to the property. Excess depreciation recapture is allocated 
among those partners in proportion to their relative shares of the total 
gain (including gain recognized under section 1245(a)(1)) from the 
disposition of the property that is allocated to the partners who are 
not subject to the gain limitation. See Example 2 of paragraph 
(e)(2)(iii) of this section.
    (ii)(A) Subject to the adjustments described in paragraphs 
(e)(2)(ii)(B) and (e)(2)(ii)(C) of this section, a partner's share of 
depreciation or amortization with respect to property equals the total 
amount of allowed or allowable depreciation or amortization previously 
allocated to that partner with respect to the property.
    (B) If a partner transfers a partnership interest, a share of 
depreciation or amortization must be allocated to the transferee partner 
as it would have been allocated to the transferor partner. If the 
partner transfers a portion of the partnership interest, a share of 
depreciation or amortization proportionate to the interest transferred 
must be allocated to the transferee partner.
    (C)(1) A partner's share of depreciation or amortization with 
respect to property contributed by the partner includes the amount of 
depreciation or amortization allowed or allowable to the partner for the 
period before the property is contributed.
    (2) A partner's share of depreciation or amortization with respect 
to property contributed by a partner is adjusted to account for any 
curative allocations. (See Sec. 1.704-3(c) for a description of the 
traditional method with curative allocations.) The contributing 
partner's share of depreciation or amortization with respect to the 
contributed property is decreased (but not below zero) by the amount of 
any curative allocation of ordinary income to the contributing partner 
with respect to that property and by the amount of any curative 
allocation of deduction or loss (other than capital loss) to the 
noncontributing partners with respect to that property. A 
noncontributing partner's share of depreciation or amortization with 
respect to the contributed property is increased by the noncontributing 
partner's share of any curative allocation of ordinary income to the 
contributing partner with respect to that property and by the amount of 
any curative allocation of deduction or loss (other than capital loss) 
to the noncontributing partner with respect to that property. The 
partners' shares of depreciation or amortization with respect to 
property from which curative allocations of depreciation or amortization 
are taken is determined without regard to those curative allocations. 
See Example 3(iii) of paragraph (e)(2)(iii) of this section.
    (3) A partner's share of depreciation or amortization with respect 
to property contributed by a partner is adjusted to account for any 
remedial allocations. (See Sec. 1.704-3(d) for a description of the 
remedial allocation method.) The contributing partner's share of 
depreciation or amortization with respect to the contributed property is 
decreased (but not below zero) by the amount of any remedial allocation 
of income to the contributing partner with respect to that property. A 
noncontributing partner's share of depreciation or amortization with 
respect to the contributed property is increased by the amount of any 
remedial allocation of depreciation or amortization to the 
noncontributing partner with respect to that property. See Example 3(iv) 
of paragraph (e)(2)(iii) of this section.
    (4) If, under paragraphs (e)(2)(ii)(C)(2) and (e)(2)(ii)(C)(3) of 
this section, the partners' shares of depreciation or amortization with 
respect to a contributed property exceed the adjustments reflected in 
the adjusted basis of the

[[Page 353]]

property under Sec. 1.1245-2(a) at the partnership level, then the 
partnership's gain recognized under section 1245(a)(1) with respect to 
that property is allocated among the partners in proportion to their 
relative shares of depreciation or amortization (subject to any gain 
limitation that might apply).
    (5) This paragraph (e)(2)(ii)(C) also applies in determining a 
partner's share of depreciation or amortization with respect to property 
for which differences between book value and adjusted tax basis are 
created when a partnership revalues partnership property pursuant to 
Sec. 1.704-1(b)(2)(iv)(f).
    (iii) Examples. The application of this paragraph (e)(2) may be 
illustrated by the following examples:

    Example 1. Recapture allocations. (i) Facts. A and B each contribute 
$5,000 cash to form AB, a general partnership. The partnership agreement 
provides that depreciation deductions will be allocated 90 percent to A 
and 10 percent to B, and, on the sale of depreciable property, A will 
first be allocated gain to the extent necessary to equalize A's and B's 
capital accounts. Any remaining gain will be allocated 50 percent to A 
and 50 percent to B. In its first year of operations, AB purchases 
depreciable equipment for $5,000. AB depreciates the equipment over its 
5-year recovery period and elects to use the straight-line method. In 
its first year of operations, AB's operating income equals its expenses 
(other than depreciation). (To simplify this example, AB's depreciation 
deductions are determined without regard to any first-year depreciation 
conventions.)
    (ii) Year 1. In its first year of operations, AB has $1,000 of 
depreciation from the partnership equipment. In accordance with the 
partnership agreement, AB allocates 90 percent ($900) of the 
depreciation to A and 10 percent ($100) of the depreciation to B. At the 
end of the year, AB sells the equipment for $5,200, recognizing $1,200 
of gain ($5,200 amount realized less $4,000 adjusted tax basis). In 
accordance with the partnership agreement, the first $800 of gain is 
allocated to A to equalize the partners' capital accounts, and the 
remaining $400 of gain is allocated $200 to A and $200 to B.
    (iii) Recapture allocations. $1,000 of the gain from the sale of the 
equipment is treated as section 1245(a)(1) gain. Under paragraph 
(e)(2)(i) of this section, each partner's share of the section 
1245(a)(1) gain is equal to the lesser of the partner's share of total 
gain recognized on the sale of the equipment or the partner's share of 
total depreciation with respect to the equipment. Thus, A's share of the 
section 1245(a)(1) gain is $900 (the lesser of A's share of the total 
gain ($1,000) and A's share of depreciation ($900)). B's share of the 
section 1245(a)(1) gain is $100 (the lesser of B's share of the total 
gain ($200) and B's share of depreciation ($100)). Accordingly, $900 of 
the $1,000 of total gain allocated to A is treated as ordinary income 
and $100 of the $200 of total gain allocated to B is treated as ordinary 
income.
    Example 2. Recapture allocation subject to gain limitation. (i) 
Facts. A, B, and C form general partnership ABC. The partnership 
agreement provides that depreciation deductions will be allocated 
equally among the partners, but that gain from the sale of depreciable 
property will be allocated 75 percent to A and 25 percent to B. ABC 
purchases depreciable personal property for $300 and subsequently 
allocates $100 of depreciation deductions each to A, B, and C, reducing 
the adjusted tax basis of the property to $0. ABC then sells the 
property for $440. ABC allocates $330 of the gain to A (75 percent of 
$440) and allocates $110 of the gain to B (25 percent of $440). No gain 
is allocated to C.
    (ii) Application of gain limitation. Each partner's share of 
depreciation with respect to the property is $100. C's share of the 
total gain from the disposition of the property, however, is $0. As a 
result, under the gain limitation provision in paragraph (e)(2)(i) of 
this section, C's share of section 1245(a)(1) gain is limited to $0.
    (iii) Excess depreciation recapture. Under paragraph (e)(2)(i) of 
this section, the $100 of section 1245(a)(1) gain that cannot be 
allocated to C under the gain limitation provision (excess depreciation 
recapture) is allocated to A and B (the partners not subject to the gain 
limitation at the time of the allocation) in proportion to their 
relative shares of total gain from the disposition of the property. A's 
relative share of the total gain allocated to A and B is 75 percent 
($330 of $440 total gain). B's relative share of the total gain 
allocated to A and B is 25 percent ($110 of $440 total gain). However, 
under the gain limitation provision of paragraph (e)(2)(i) of this 
section, B cannot be allocated 25 percent of the excess depreciation 
recapture ($25) because that would result in a total allocation of $125 
of depreciation recapture to B (a $100 allocation equal to B's share of 
depreciation plus a $25 allocation of excess depreciation recapture), 
which is in excess of B's share of the total gain from the disposition 
of the property ($110). Therefore, only $10 of excess depreciation 
recapture is allocated to B and the remaining $90 of excess depreciation 
recapture is allocated to A. A is not subject to the gain limitation 
because A's share of the total gain ($330) still exceeds A's share of 
section 1245(a)(1) gain ($190). Accordingly, all $110 of the total gain 
allocated to B is treated as ordinary income ($100 share of depreciation 
allocated to B plus $10 of excess depreciation recapture) and $190 of 
the total

[[Page 354]]

gain allocated to A is treated as ordinary income ($100 share of 
depreciation allocated to A plus $90 of excess depreciation recapture).
    Example 3. Determination of partners' shares of depreciation with 
respect to contributed property. (i) Facts.C and D form partnership CD 
as equal partners. C contributes depreciable personal property C1 with 
an adjusted tax basis of $800 and a fair market value of $2,800. Prior 
to the contribution, C claimed $200 of depreciation from C1. At the time 
of the contribution, C1 is depreciable under the straight-line method 
and has four years remaining on its 5-year recovery period. D 
contributes $2,800 cash, which CD uses to purchase depreciable personal 
property D1, which is depreciable over seven years under the straight-
line method. (To simplify the example, all depreciation is determined 
without regard to any first-year depreciation conventions.)
    (ii) Traditional method. C1 generates $700 of book depreciation (\1/
4\ of $2,800 book value) and $200 of tax depreciation (\1/4\ of $800 
adjusted tax basis) each year. C and D will each be allocated $350 of 
book depreciation from C1 in year 1. Under the traditional method of 
making section 704(c) allocations, D will be allocated the entire $200 
of tax depreciation from C1 in year 1. D1 generates $400 of book and tax 
depreciation each year (\1/7\ of $2,800 book value and adjusted tax 
basis). C and D will each be allocated $200 of book and tax depreciation 
from D1 in year 1. As a result, after the first year of partnership 
operations, C's share of depreciation with respect to C1 is $200 (the 
depreciation taken by C prior to contribution) and D's share of 
depreciation with respect to C1 is $200 (the amount of tax depreciation 
allocated to D). C and D each have a $200 share of depreciation with 
respect to D1. At the end of four years, C's share of depreciation with 
respect to C1 will be $200 (the depreciation taken by C prior to 
contribution) and D's share of depreciation with respect to C1 will be 
$800 (four years of $200 depreciation per year). At the end of four 
years, C and D will each have an $800 share of depreciation with respect 
to D1 (four years of $200 depreciation per year).
    (iii) Effect of curative allocations. (A) Year 1. If the partnership 
elects to make curative allocations under Sec. 1.704-3(c) using 
depreciation from D1, the results will be the same as under the 
traditional method, except that $150 of the $200 of tax depreciation 
from D1 that would be allocated to C under the traditional method will 
be allocated to D as additional depreciation with respect to C1. As a 
result, after the first year of partnership operations, C's share of 
depreciation with respect to C1 will be reduced to $50 (the total 
depreciation taken by C prior to contribution ($200) decreased by the 
amount of the curative allocation to D ($150)). D's share of 
depreciation with respect to C1 will be $350 (the depreciation allocated 
to D under the traditional method ($200) increased by the amount of the 
curative allocation to D ($150)). C and D will each have a $200 share of 
depreciation with respect to D1.
    (B) Year 4. At the end of four years, C's share of depreciation with 
respect to C1 will be reduced to $0 (the total depreciation taken by C 
prior to contribution ($200) decreased, but not below zero, by the 
amount of the curative allocations to D ($600)), and D's share of 
depreciation with respect to C1 will be $1,400 (the total depreciation 
allocated to D under the traditional method ($800) increased by the 
amount of the curative allocations to D ($600)). However, CD's section 
1245(a)(1) gain with respect to C1 will not be more than $1,000 (CD's 
tax depreciation ($800) plus C's tax depreciation prior to contribution 
($200)). Under paragraph (e)(2)(ii)(C)(4) of this section, because the 
partners' shares of depreciation with respect to C1 exceed the 
adjustments reflected in the property's adjusted basis, CD's section 
1245(a)(1) gain will be allocated in proportion to the partners' 
relative shares of depreciation with respect to C1. Because C's share of 
depreciation with respect to C1 is $0, and D's share of depreciation 
with respect to C1 is $1,400, all of CD's $1,000 of section 1245(a)(1) 
gain will be allocated to D. At the end of four years, C and D will each 
have an $800 share of depreciation with respect to D1 (four years of 
$200 depreciation per year).
    (iv) Effect of remedial allocations. (A) Year 1. If the partnership 
elects to make remedial allocations under Sec. 1.704-3(d), there will 
be $600 of book depreciation from C1 in year 1. (Under the remedial 
allocation method, the amount by which C1's book basis ($2,800) exceeds 
its tax basis ($800) is depreciated over a 5-year life, rather than a 4-
year life.) C and D will each be allocated one-half ($300) of the total 
book depreciation. As under the traditional method, D will be allocated 
all $200 of tax depreciation from C1. Because the ceiling rule would 
cause a disparity of $100 between D's book and tax allocations of 
depreciation, D will also receive a $100 remedial allocation of 
depreciation with respect to C1, and C will receive a $100 remedial 
allocation of income with respect to C1. As a result, after the first 
year of partnership operations, D's share of depreciation with respect 
to C1 is $300 (the depreciation allocated to D under the traditional 
method ($200) increased by the amount of the remedial allocation 
($100)). C's share of depreciation with respect to C1 is $100 (the total 
depreciation taken by C prior to contribution ($200) decreased by the 
amount of the remedial allocation of income ($100)). C and D will each 
have a $200 share of depreciation with respect to D1.
    (B) Year 5. At the end of five years, C's share of depreciation with 
respect to C1 will be $0 (the total depreciation taken by C prior to 
contribution ($200) decreased, but not

[[Page 355]]

below zero, by the total amount of the remedial allocations of income to 
C ($600)). D's share of depreciation with respect to C1 will be $1,400 
(the total depreciation allocated to D under the traditional method 
($800) increased by the total amount of the remedial allocations of 
depreciation to D ($600)). However, CD's section 1245(a)(1) gain with 
respect to C1 will not be more than $1,000 (CD's tax depreciation ($800) 
plus C's tax depreciation prior to contribution ($200)). Under paragraph 
(e)(2)(ii)(C)(4) of this section, because the partners' shares of 
depreciation with respect to C1 exceed the adjustments reflected in the 
property's adjusted basis, CD's section 1245(a)(1) gain will be 
allocated in proportion to the partners' relative shares of depreciation 
with respect to C1. Because C's share of depreciation with respect to C1 
is $0, and D's share of depreciation with respect to C1 is $1,400, all 
of CD's $1,000 of section 1245(a)(1) gain will be allocated to D. At the 
end of five years, C and D will each have a $1,000 share of depreciation 
with respect to D1 (five years of $200 depreciation per year).

    (iv) Effective date. This paragraph (e)(2) is effective for 
properties acquired by a partnership on or after August 20, 1997. 
However, partnerships may rely on this paragraph (e)(2) for properties 
acquired before August 20, 1997 and disposed of on or after August 20, 
1997.
    (3)(i) If (a) a partner had a special basis adjustment under section 
743(b) in respect of section 1245 property, or (b) on the date he 
acquired his partnership interest by way of a sale or exchange (or upon 
death of another partner) the partnership owned section 1245 property 
and an election under section 754 (relating to optional adjustment to 
basis of partnership property) was in effect with respect to the 
partnership, then the amount of gain recognized under section 1245(a)(1) 
by him upon a disposition by the partnership of such property shall be 
determined under this subparagraph.
    (ii) There shall be allocated to such partner, in the same 
proportion as the partnership's total gain is allocated to him as his 
distributive share under section 704, a portion of (a) the common 
partnership adjusted basis for the property, and (b) the amount realized 
by the partnership upon the disposition, or, if nothing is realized, the 
fair market value of the property. There shall also be allocated to him, 
in the same proportion as the partnership's gain recognized under 
section 1245(a)(1) is allocated under subparagraph (2) of this paragraph 
as his distributive share of such gain, a portion of the adjustments 
reflected in the adjusted basis (as defined in paragraph (a)(2) of Sec. 
1.1245-2) of such property. If on the date he acquired his partnership 
interest by way of a sale or exchange the partnership owned such 
property and an election under section 754 was in effect, then for 
purposes of the preceding sentence the amount of the adjustments 
reflected in the adjusted basis of such property on such date shall be 
deemed to be zero. For special rules relating to the amount of 
adjustments reflected in the adjusted basis of property after 
partnership transactions, see paragraph (c)(6) of Sec. 1.1245-2.
    (iii) The partner's adjusted basis in respect of the property shall 
be deemed to be (a) the portion of the partnership's adjusted basis for 
the property allocated to the partner under subdivision (ii) of this 
subparagraph, (b) increased by the amount of any special basis 
adjustment described in section 743(b)(1) (or decreased by the amount of 
any special basis adjustment described in section 743(b)(2) which the 
partner may have in respect of the property on the date the partnership 
disposed of the property.
    (iv) The partner's recomputed basis in respect of the property shall 
be deemed to be (a) the sum of the partner's adjusted basis for the 
property, as determined in subdivision (iii) of this subparagraph, plus 
the amount of the adjustments reflected in the adjusted basis (as 
defined in paragraph (a)(2) of Sec. 1.1245-2) for the property 
allocated to the partner under subdivision (ii) of this subparagraph, 
(b) increased by the amount by which any special basis adjustment 
described in section 743(b)(1) (or decreased by the amount by which any 
special basis adjustment described in section 743(b)(2)) in respect of 
the property was reduced, but only to the extent such amount was applied 
to adjust the amount of the deductions allowed or allowable to the 
partner for depreciation or amortization of section 1245 property 
attributable to periods referred to in paragraph (a)(2) of Sec. 1.1245-
2. The terms allowed or allowable, depreciation or amortization, and 
attributable to periods shall have the

[[Page 356]]

meanings assigned to these terms in paragraph (a) of Sec. 1.1245-2.
    (4) The application of subparagraph (3) of this paragraph may be 
illustrated by the following example:

    Example: A, B, and C each hold a one-third interest in calendar year 
partnership ABC. On December 31, 1962, the firm holds section 1245 
property which has an adjusted basis of $30,000 and a recomputed basis 
of $33,000. Depreciation deductions in respect of the property for 1962 
were $3,000. On January 1, 1963, when D purchases C's partnership 
interest, the election under section 754 is in effect and a $5,000 
special basis adjustment is made in respect of D to his one-third share 
of the common partnership adjusted basis for the property. For 1963 and 
1964 the partnership deducts $6,000 as depreciation in respect of the 
property, thereby reducing its adjusted basis to $24,000, and D deducts 
$2,800, i.e., his distributive share of partnership depreciation 
($2,000) plus depreciation in respect of his special basis adjustment 
($800). On March 15, 1965, the partnership sells the property for 
$48,000. Since the partnership's recomputed basis for the property 
($33,000, i.e., $24,000 adjusted basis plus $9,000 in depreciation 
deductions) is lower than the amount realized upon the sale ($48,000), 
the excess of recomputed basis over adjusted basis, or $9,000, is 
treated as partnership gain under section 1245(a)(1). D's distributive 
share of such gain is $3,000 (\1/3\ of $9,000). However, the amount of 
gain recognized by D under section 1245 (a)(1) is only $2,800, 
determined as follows:

(1) Adjusted basis:
  D's portion of partnership adjusted basis (\1/      $8,000
   3\ of $24,000)...............................
  D's special basis adjustment as of December          4,200
   31, 1964 ($5,000 minus $800).................
    D's adjusted basis..........................  ..........     $12,200
                                                 ------------
(2) Recomputed basis:
  D's adjusted basis............................      12,200
  D's portion of partnership depreciation for          2,000
   1963 and 1964, i.e., for periods after he
   acquired his partnership interest (\1/3\ of
   $6,000)......................................
  Depreciation for 1963 and 1964 in respect of           800
   D's special basis adjustment.................
      D's recomputed basis......................
                                                 ============
                                                  ..........      15,000
(3) D's portion of amount realized by partnership (\1/3\ of       16,000
 $48,000)...................................................
(4) Gain recognized to D under section 1245(a)(1), i.e., the       2,800
 lower of (2) or (3), minus (1).............................



[T.D. 6832, 30 FR 8576, July 7, 1965, as amended by T.D. 7084, 36 FR 
268, Jan. 8, 1971; T.D. 7141, 36 FR 18793, Sept. 22, 1971; T.D. 8730, 62 
FR 44216, Aug. 20, 1997]