[Code of Federal Regulations]
[Title 26, Volume 8]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.707-3]

[Page 470-475]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
Determination of Tax Liability--Table of Contents
 
Sec. 1.707-3  Disguised sales of property to partnership; general rules.

    (a) Treatment of transfers as a sale--(1) In general. Except as 
otherwise provided in this section, if a transfer of property by a 
partner to a partnership and one or more transfers of money or other 
consideration by the partnership to that partner are described in 
paragraph (b)(1) of this section, the transfers are treated as a sale of 
property, in whole or in part, to the partnership.
    (2) Definition and timing of sale. For purposes of Sec. Sec. 1.707-
3 through 1.707-5, the use of the term sale (or any variation of that 
word) to refer to a transfer of property by a partner to a partnership 
and a transfer of consideration by a partnership to a partner means a 
sale or exchange of that property, in whole or in part, to the 
partnership by the partner acting in a capacity other

[[Page 471]]

than as a member of the partnership, rather than a contribution and 
distribution to which sections 721 and 731, respectively, apply. A 
transfer that is treated as a sale under paragraph (a)(1) this section 
is treated as a sale for all purposes of the Internal Revenue Code 
(e.g., sections 453, 483, 1001, 1012, 1031 and 1274). The sale is 
considered to take place on the date that, under general principles of 
Federal tax law, the partnership is considered the owner of the 
property. If the transfer of money or other consideration from the 
partnership to the partner occurs after the transfer of property to the 
partnership; the partner and the partnership are treated as if, on the 
date of the sale, the partnership transferred to the partner an 
obligation to transfer to the partner money or other consideration.
    (3) Application of disguised sale rules. If a person purports to 
transfer property to a partnership in a capacity as a partner, the rules 
of this section apply for purposes of determining whether the property 
was transferred in a disguised sale, even if it is determined after the 
application of the rules of this section that such person is not a 
partner. If after the application of the rules of this section to a 
purported transfer of property to a partnership, it is determined that 
no partnership exists because the property was actually sold, or it is 
otherwise determined that the contributed property is not owned by the 
partnership for tax purposes, the transferor of the property is treated 
as having sold the property to the person (or persons) that acquired 
ownership of the property for tax purposes.
    (4) Deemed terminations under section 708. In applying the rules of 
this section, transfers resulting from a termination of a partnership 
under section 708(b)(1)(B) are disregarded.
    (b) Transfers treated as a sale--(1) In general. A transfer of 
property (excluding money or an obligation to contribute money) by a 
partner to a partnership and a transfer of money or other consideration 
(including the assumption of or the taking subject to a liability) by 
the partnership to the partner constitute a sale of property, in whole 
or in part, by the partner to the partnership only if based on all the 
facts and circumstances--
    (i) The transfer of money or other consideration would not have been 
made but for the transfer of property; and
    (ii) In cases in which the transfers are not made simultaneously, 
the subsequent transfer is not dependent on the entrepreneurial risks of 
partnership operations.
    (2) Facts and circumstances. The determination of whether a transfer 
of property by a partner to the partnership and a transfer of money or 
other consideration by the partnership to the partner constitute a sale, 
in whole or in part, under paragraph (b)(1) of this section is made 
based on all the facts and circumstances in each case. The weight to be 
given each of the facts and circumstances will depend on the particular 
case. Generally, the facts and circumstances existing on the date of the 
earliest of such transfers are the ones considered in determining 
whether a sale exists under paragraph (b)(1) of this section. Among the 
facts and circumstances that may tend to prove the existence of a sale 
under paragraph (b)(1) of this section are the following:
    (i) That the timing and amount of a subsequent transfer are 
determinable with reasonable certainty at the time of an earlier 
transfer;
    (ii) That the transferor has a legally enforceable right to the 
subsequent transfer;
    (iii) That the partner's right to receive the transfer of money or 
other consideration is secured in any manner, taking into account the 
period during which it is secured;
    (iv) That any person has made or is legally obligated to make 
contributions to the partnership in order to permit the partnership to 
make the transfer of money or other consideration;
    (v) That any person has loaned or has agreed to loan the partnership 
the money or other consideration required to enable the partnership to 
make the transfer, taking into account whether any such lending 
obligation is subject to contingencies related to the results of 
partnership operations;
    (vi) That a partnership has incurred or is obligated to incur debt 
to acquire

[[Page 472]]

the money or other consideration necessary to permit it to make the 
transfer, taking into account the likelihood that the partnership will 
be able to incur that debt (considering such factors as whether any 
person has agreed to guarantee or otherwise assume personal liability 
for that debt);
    (vii) That the partnership holds money or other liquid assets, 
beyond the reasonable needs of the business, that are expected to be 
available to make the transfer (taking into account the income that will 
be earned from those assets);
    (viii) That partnership distributions, allocation or control of 
partnership operations is designed to effect an exchange of the burdens 
and benefits of ownership of property;
    (ix) That the transfer of money or other consideration by the 
partnership to the partner is disproportionately large in relationship 
to the partner's general and continuing interest in partnership profits; 
and
    (x) That the partner has no obligation to return or repay the money 
or other consideration to the partnership, or has such an obligation but 
it is likely to become due at such a distant point in the future that 
the present value of that obligation is small in relation to the amount 
of money or other consideration transferred by the partnership to the 
partner.
    (c) Transfers made within two years presumed to be a sale--(1) In 
general. For purposes of this section, if within a two-year period a 
partner transfers property to a partnership and the partnership 
transfers money or other consideration to the partner (without regard to 
the order of the transfers), the transfers are presumed to be a sale of 
the property to the partnership unless the facts and circumstances 
clearly establish that the transfers do not constitute a sale.
    (2) Disclosure of transfers made within two years. Disclosure to the 
Internal Revenue Service in accordance with Sec. 1.707-8 is required 
if--
    (i) A partner transfers property to a partnership and the 
partnership transfers money or other consideration to the partner with a 
two-year period (without regard to the order of the transfers);
    (ii) The partner treats the transfers other than as a sale for tax 
purposes; and
    (iii) The transfer of money or other consideration to the partner is 
not presumed to be a guaranteed payment for capital under Sec. 1.707-
4(a)(1)(ii), is not a reasonable preferred return within the meaning of 
Sec. 1.707-4(a)(3), and is not an operating cash flow distribution 
within the meaning of Sec. 1.707-4(b)(2).
    (d) Transfers made more than two years apart presumed not to be a 
sale. For purposes of this section, if a transfer of money or other 
consideration to a partner by a partnership and the transfer of property 
to the partnership by that partner are more than two years apart, the 
transfers are presumed not to be a sale of the property to the 
partnership unless the facts and circumstances clearly establish that 
the transfers constitute a sale.
    (e) Scope. This section and Sec. Sec. 1.707-4 through 1.707-9 
apply to contributions and distributions of property described in 
section 707(a)(2)(A) and transfers described in section 707(a)(2)(B) of 
the Internal Revenue Code.
    (f) Examples. The following examples illustrate the application of 
this section.

    Example 1. Treatment of simultaneous transfers as a sale. A 
transfers property X to partnership AB on April 9, 1992, in exchange for 
an interest in the partnership. At the time of the transfer, property X 
has a fair market value of $4,000,000 and an adjusted tax basis of 
$1,200,000. Immediately after the transfer, the partnership transfers 
$3,000,000 in cash to A. Assume that, under this section, the 
partnership's transfer of cash to A is treated as part of a sale of 
property X to the partnership. Because the amount of cash A receives on 
April 9, 1992, does not equal the fair market value of the property, A 
is considered to have sold a portion of property X with a value of 
$3,000,000 to the partnership in exchange for the cash. Accordingly, A 
must recognize $2,100,000 of gain ($3,000,000 amount realized less 
$900,000 adjusted tax basis ($1,200,000 multiplied by $3,000,000/
$4,000,000)). Assuming A receives no other transfers that are treated as 
consideration for the sale of the property under this section, A is 
considered to have contributed to the partnership, in A's capacity as a 
partner, $1,000,000 of the fair market value of the property with an 
adjusted tax basis of $300,000.
    Example 2. Treatment of transfers at different times as a sale. (i) 
The facts are the same as

[[Page 473]]

in Example 1, except that the $3,000,000 is transferred to A one year 
after A's transfer of property X to the partnership. Assume that under 
this section the partnership's transfer of cash to A is treated as part 
of a sale of property X to the partnership. Assume also that the 
applicable Federal short-term rate for April, 1992, is 10 percent, 
compounded semiannually.
    (ii) Under paragraph (a)(2) of this section, A and the partnership 
are treated as if, on April 9, 1992, A sold a portion of property X to 
the partnership in exchange for an obligation to transfer $3,000,000 to 
A one year later. Section 1274 applies to this obligation because it 
does not bear interest and is payable more than six months after the 
date of the sale. As a result, A's amount realized from the receipt of 
the partnership's obligation will be the imputed principal amount of the 
partnership's obligation to transfer $3,000,000 to A, which equals 
$2,721,088 (the present value on April 9, 1992, of a $3,000,000 payment 
due one year later, determined using a discount rate of 10 percent, 
compounded semiannually). Therefore, A's amount realized from the 
receipt of the partnership's obligation is $2,721,088 (without regard to 
whether the sale is reported under the installment method). A is 
therefore considered to have sold only $2,721,088 of the fair market 
value of property X. The remainder of the $3,000,000 payment ($278,912) 
is characterized in accordance with the provisions of section 1272. 
Accordingly, A must recognize $1,904,761 of gain ($2,721,088 amount 
realized less $816,327 adjusted tax basis ($1,200,000 multiplied by 
$2,721,088/$4,000,000)) on the sale of property X to the partnership. 
The gain is reportable under the installment method of section 453 if 
the sale is otherwise eligible. Assuming A receives no other transfers 
that are treated as consideration for the sale of property under this 
section, A is considered to have contributed to the partnership, in A's 
capacity as a partner, $1,278,912 of the fair market value of property X 
with an adjusted tax basis of $383,673.
    Example 3. Operation of presumption for transfers within two years. 
(i) C transfers undeveloped land to the CD partnership in exchange for 
an interest in the partnership. The partnership intends to construct a 
building on the land. At the time the land is transferred to the 
partnership, it is unencumbered and has an adjusted tax basis of 
$500,000 and a fair market value of $1,000,000. The partnership 
agreement provides that upon completing construction of the building the 
partnership will distribute $900,000 to C.
    (ii) If, within two years of C's transfer of land to the 
partnership, a transfer is made to C pursuant to the provision requiring 
a distribution upon completion of the building, the transfer is presumed 
to be, under paragraph (c) of this section, part of a sale of the land 
to the partnership. C may rebut the presumption that the transfer is 
part of a sale if the facts and circumstances clearly establish that--
    (A) The transfer to C would have been made without regard to C's 
transfer of land to the partnership; or
    (B) The partnership's obligation or ability to make this transfer to 
C depends, at the time of the transfer to the partnership, on the 
entrepreneurial risks of partnership operations.
    (iii) For example, if the partnership will be able to fund the 
transfer of cash to C only to the extent that permanent loan proceeds 
exceed the cost of constructing the building, the fact that excess 
permanent loan proceeds will be available only if the cost to complete 
the building is significantly less than the amount projected by a 
reasonable budget would be evidence that the transfer to C is not part 
of a sale. Similarly, a condition that limits the amount of the 
permanent loan to the cost of constructing the building (and thereby 
limits the partnership's ability to make a transfer to C) unless all or 
a substantial portion of the building is leased would be evidence that 
the transfer to C is not part of a sale, if a significant risk exists 
that the partnership may not be able to lease the building to that 
extent. Another factor that may prove that the transfer of cash to C is 
not part of a sale would be that, at the time the land is transferred to 
the partnership, no lender has committed to make a permanent loan to 
fund the transfer of cash to C.
    (iv) Facts indicating that the transfer of cash to C is not part of 
a sale, however, may be offset by other factors. An offsetting factor to 
restrictions on the permanent loan proceeds may be that the permanent 
loan is to be a recourse loan and certain conditions to the loan are 
likely to be waived by the lender because of the creditworthiness of the 
partners or the value of the partnership's other assets. Similarly, the 
factor that no lender has committed to fund the transfer of cash to C 
may be offset by facts establishing that the partnership is obligated to 
attempt to obtain such a loan and that its ability to obtain such a loan 
is not significantly dependent on the value that will be added by 
successful completion of the building, or that the partnership 
reasonably anticipates that it will have (and will utilize) an 
alternative source to fund the transfer of cash to C if the permanent 
loan proceeds are inadequate.
    Example 4. Operation of presumption for transfers within two years. 
E is a partner in the equal EF partnership. The partnership owns two 
parcels of unimproved real property (parcels 1 and 2). Parcels 1 and 2 
are unencumbered. Parcel 1 has a fair market value of $500,000, and 
parcel 2 has a fair market value of $1,500,000. E transfers additional

[[Page 474]]

unencumbered, unimproved real property (parcel 3) with a fair market 
value of $1,000,000 to the partnership in exchange for an increased 
interest in partnership profits of 66\2/3\ percent. Immediately after 
this transfer, the partnership sells parcel 1 for $500,000 in a 
transaction not in the ordinary course of business. The partnership 
transfers the proceeds of the sale $333,333 to E and $166,667 to F in 
accordance with their respective partnership interests. The transfer of 
$333,333 to E is presumed to be, in accordance with paragraph (c) of 
this section, a sale, in part, of parcel 3 to the partnership. However, 
the facts of this example clearly establish that $250,000 of the 
transfer to E is not part of a sale of parcel 3 to the partnership 
because E would have been distributed $250,000 from the sale of parcel 1 
whether or not E had transferred parcel 3 to the partnership. The 
transfer to E exceeds by $83,333 ($333,333 minus $250,000) the amount of 
the distribution that would have been made to E if E had not transferred 
parcel 3 to the partnership. Therefore, $83,333 of the transfer is 
presumed to be part of a sale of a portion of parcel 3 to the 
partnership by E.
    Example 5. Operation of presumption for transfers more than two 
years apart. (i) G transfers undeveloped land to the GH partnership in 
exchange for an interest in the partnership. At the time the land is 
transferred to the partnership, it is unencumbered and has an adjusted 
tax basis of $500,000 and a fair market value of $1,000,000. H 
contributes $1,000,000 in cash in exchange for an interest in the 
partnership. Under the partnership agreement, the partnership is 
obligated to construct a building on the land. The projected 
construction cost is $5,000,000, which the partnership plans to fund 
with its $1,000,000 in cash and the proceeds of a construction loan 
secured by the land and improvements.
    (ii) Shortly before G's transfer of the land to the partnership, the 
partnership secures commitments from lending institutions for 
construction and permanent financing. To obtain the construction loan, H 
guarantees completion of the building for a cost of $5,000,000. The 
partnership is not obligated to reimburse or indemnify H if H must make 
payment on the completion guarantee. The permanent loan will be funded 
upon completion of the building, which is expected to occur two years 
after G's transfer of the land. The amount of the permanent loan is to 
equal the lesser of $5,000,000 or 80 percent of the appraised value of 
the improved property at the time the permanent loan is closed. Under 
the partnership agreement, the partnership is obligated to apply the 
proceeds of the permanent loan to retire the construction loan and to 
hold any excess proceeds for transfer to G 25 months after G's transfer 
of the land to the partnership. The appraised value of the improved 
property at the time the permanent loan is closed is expected to exceed 
$5,000,000 only if the partnership is able to lease a substantial 
portion of the improvements by that time, and there is a significant 
risk that the partnership will not be able to achieve a satisfactory 
occupancy level. The partnership completes construction of the building 
for the projected cost of $5,000,000 approximately two years after G's 
transfer of the land. Shortly thereafter, the permanent loan is funded 
in the amount of $5,000,000. At the time of funding the land and 
building have an appraised value of $7,000,000. The partnership 
transfers the $1,000,000 excess permanent loan proceeds to G 25 months 
after G's transfer of the land to the partnership.
    (iii) G's transfer of the land to the partnership and the 
partnership's transfer of $1,000,000 to G occurred more than two years 
apart. In accordance with paragraph (d) of this section, those transfers 
are presumed not to be a sale unless the facts and circumstances clearly 
establish that the transfers constitute a sale of the property, in whole 
or part, to the partnership. The transfer of $1,000,000 to G would not 
have been made but for G's transfer of the land to the partnership. In 
addition, at the time G transferred the land to the partnership, G had a 
legally enforceable right to receive a transfer from the partnership at 
a specified time an amount that equals the excess of the permanent loan 
proceeds over $4,000,000. In this case, however, there was a significant 
risk that the appraised value of the property would be insufficient to 
support a permanent loan in excess of $4,000,000 because of the risk 
that the partnership would not be able to achieve a sufficient occupancy 
level. Therefore, the facts of this example indicate that at the time G 
transferred the land to the partnership the subsequent transfer of 
$1,000,000 to G depended on the entrepreneurial risks of partnership 
operations. Accordingly, G's transfer of the land to the partnership is 
not treated as part of a sale.
    Example 6. Rebuttal of presumption for transfers more than two years 
apart. The facts are the same as in Example 5, except that the 
partnership is able to secure a commitment for a permanent loan in the 
amount of $5,000,000 without regard to the appraised value of the 
improved property at the time the permanent loan is funded. Under these 
facts, at the time that G transferred the land to the partnership the 
subsequent transfer of $1,000,000 to G was not dependent on the 
entrepreneurial risks of partnership operations, because during the 
period before the permanent loan is funded, the permanent lender's 
obligation to make a loan in the amount necessary to fund the transfer 
is not subject to the contingencies related to the risks of partnership 
operations, and after the permanent loan is funded, the partnership 
holds liquid assets sufficient to make the

[[Page 475]]

transfer. Therefore, the facts and circumstances clearly establish that 
G's transfer of the land to the partnership is part of a sale.
    Example 7. Operation of presumption for transfers more than two 
years apart. The facts are the same as in Example 6, except that H does 
not guarantee either that the improvements will be completed or that the 
cost to the partnership of completing the improvements will not exceed 
$5,000,000. Under these facts, if there is a significant risk that the 
improvements will not be completed, G's transfer of the land to the 
partnership will not be treated as part of a sale because the lender is 
required to make the permanent loan if the improvements are not 
completed. Similarly, the transfers will not be treated as a sale to the 
extent that there is a significant risk that the cost of constructing 
the improvements will exceed $5,000,000, because, in the absence of a 
guarantee of the cost of the improvements by H, the $5,000,000 proceeds 
of the permanent loan might not be sufficient to retire the construction 
loan and fund the transfer to G. In either case, the transfer of cash to 
G would be dependent on the entrepreneurial risks of partnership 
operations.
    Example 8. Rebuttal of presumption for transfers more than two years 
apart. (i) On February 1, 1992, I, J, and K form partnership IJK. On 
formation of the partnership, I transfers an unencumbered office 
building with a fair market value of $50,000,000 and an adjusted tax 
basis of $20,000,000 to the partnership, and J and K each transfer 
United States government securities with a fair market value and an 
adjusted tax basis of $25,000,000 to the partnership. Substantially all 
of the rentable space in the office building is leased on a long-term 
basis. The partnership agreement provides that all items of income, 
gain, loss, and deduction from the office building are to be allocated 
45 percent to J, 45 percent to K, and 10 percent to I. The partnership 
agreement also provides that all items of income, gain, loss, and 
deduction from the government securities are to be allocated 90 percent 
to I, 5 percent to J, and 5 percent to K. The partnership agreement 
requires that cash flow from the office building and government 
securities be allocated between partners in the same manner as the items 
of income, gain, loss, and deduction from those properties are allocated 
between them. The partnership agreement complies with the requirements 
of Sec. 1.704-1(b)(2)(ii)(b). It is not expected that the partnership 
will need to resort to the government securities or the cash flow 
therefrom to operate the office building. At the time the partnership is 
formed, I, J, and K contemplated that I's interest in the partnership 
would be liquidated sometime after January 31, 1994, in exchange for a 
transfer of the government securities and cash (if necessary). On March 
1, 1995, the partnership transfers cash and the government securities to 
I in liquidation of I's interest in the partnership. The cash 
transferred to I represents the excess of I's share of the appreciation 
in the office building since the formation of the partnership over J's 
and K's share of the appreciation in the government securities since 
they are acquired by the partnership.
    (ii) I's transfer of the office building to the partnership and the 
partnership's transfer of the government securities and cash to I 
occurred more than two years apart. Therefore, those transfers are 
presumed not to be a sale unless the facts and circumstances clearly 
establish that the transfers constitute a sale. Absent I's transfer of 
the office building to the (partnership, I would not have received the 
government securities from the partnership. The facts including the 
amount and nature of partnership assets) indicate that, at the time that 
I transferred the office building to the partnership, the timing of the 
transfer of the government securities to I was anticipated and was not 
dependent on the entrepreneurial risks of partnership operations. 
Moreover, the facts indicate that the partnership allocations were 
designed to effect an exchange of the burdens and benefits of ownership 
of the government securities in anticipation of the transfer of those 
securities to I and those burdens and benefits were effectively shifted 
to I on formation of the partnership. Accordingly, the facts and 
circumstances clearly establish that I sold the office building to the 
partnership on February 1, 1992, in exchange for the partnership's 
obligation to transfer the government securities to I and to make 
certain other cash transfers to I.

[T.D. 8439, 57 FR 44978, Sept. 30, 1992]