The IRS has released a draft version of Form 7217, Partner’s Report of Property Distributed by a Partnership, which partners must use starting with the 2024 tax year to report their tax basis in property distributed to them by partnerships. This new requirement aims to enhance transparency by requiring partners to disclose details such as the partnership’s predistribution basis in the property and its fair market value (FMV).

While Form 7217 does not introduce new reporting obligations for partnerships distributing property, it is part of a broader IRS initiative to facilitate partnership audits through enhanced disclosure requirements.

Understanding Partnership Distributions and Basis Computations

Under Section 731(a), most partnership distributions of money or property are tax-free, except in certain situations. A partner must recognize gain if the cash and marketable securities received exceed their predistribution basis in the partnership interest. Additionally, distributions involving unrealized receivables (Sec. 751(c)) or substantially appreciated inventory (Sec. 751(d)) can result in taxation under Section 751(b). Transactions that involve the return of previously contributed property may also be considered taxable sales under Section 707(a)(2)(B).

Section 732 provides the rules for determining a partner’s basis in distributed property. The basis computation depends on whether the distribution is nonliquidating or liquidating:

• Nonliquidating Distribution: The partner generally takes a carryover basis from the partnership’s predistribution basis in the property, limited to the partner’s remaining basis in the partnership interest after accounting for cash received.
• Liquidating Distribution: The partner’s basis in the property is equal to their entire remaining basis in the partnership interest, reduced by any cash received.

If a partner receives multiple properties in the same distribution, basis allocation rules apply:

• Basis is first allocated to unrealized receivables and inventory items.
• Any remaining basis is assigned to other distributed properties, ensuring that decreases are first applied to properties with unrealized depreciation.
• In the case of a liquidating distribution, additional basis is allocated based on unrealized appreciation and FMV.

Additionally, partnerships that have made a Section 754 election can adjust the basis of their remaining assets under Section 734(b). Partners who acquired their interests through purchase may also have Section 743(b) basis adjustments, impacting their basis in distributed property.

New Reporting Requirements on Form 7217

Beginning with 2024 tax filings, partners receiving property distributions must file Form 7217 with their annual tax return. Each distribution date requires a separate form. Distributions involving only cash do not trigger a filing requirement.

Form 7217 Structure

• Part I: General details about the distribution, including whether it was liquidating and whether gain was recognized under Sections 731(a) or 751(b). It also requires partners to report their predistribution basis in their partnership interest—a new disclosure requirement.
• Part II: Detailed, property-specific basis computations, including:
  • Asset descriptions and IRS asset class codes (from Publication 946)
  • The partnership’s predistribution basis in the property (from Schedule K-1)
  • Any basis adjustments under Sections 732(d), 732(f), 734(b), or 743(b)
  • FMV of the property and the partner’s final basis after applying Section 732

Though Form 7217 does not require partners to show a full basis calculation, the level of detail required will allow the IRS to verify whether the Section 732 rules are being properly applied.

IRS Efforts to Monitor Basis-Shifting Transactions

The IRS and Treasury have increased scrutiny of basis-shifting transactions, particularly those involving related-party partners. In June 2024, the IRS issued Notice 2024-54, proposed regulations REG-124593-23, and Revenue Ruling 2024-14, targeting transactions that manipulate basis to create tax advantages.

Two key basis-shifting strategies are under IRS scrutiny:

1. Shifting Basis from Nondepreciable to Depreciable Assets: A partnership distributes high-basis property to a low-basis partner, allowing the partnership to increase the basis of its remaining assets.
2. Stepped-Up Basis in Liquidating Distributions: A partner with a high basis in their interest receives low-basis property in liquidation, claiming an immediate basis step-up to the full amount of their partnership interest.

Form 7217 enables the IRS to identify potential basis-shifting transactions by requiring partners to disclose:

• Any basis step-ups in liquidating distributions
• Asset class codes, which help flag high-basis allocations to properties with favorable tax treatment

Conclusion

While Form 7217 does not change the fundamental rules of Section 732, it introduces a new level of transparency in partnership distributions. By requiring detailed partner-level basis reporting, the IRS aims to improve compliance and detect tax avoidance strategies related to basis shifting. Partners and tax professionals should familiarize themselves with these new reporting obligations to ensure accurate tax filings and avoid potential IRS scrutiny.