Reg. § 1.1045-1 Application to partnerships.
(a) Overview of section A partnership that holds qualified small business stock (QSB stock) (as defined in of this section) for more than 6 months, sells such QSB stock, and purchases replacement QSB stock (as defined in of this section) may elect to apply section . An eligible partner (as defined in of this section) of a partnership that sells QSB stock, may elect to apply section if the eligible partner purchases replacement QSB stock directly or through a purchasing partnership (as defined in of this section). A taxpayer (other than a C corporation) that holds QSB stock for more than 6 months, sells such QSB stock and purchases replacement QSB stock through a purchasing partnership may elect to apply section . A section election is revocable only with the prior written consent of the Commissioner. To obtain the Commissioner's prior written consent, the person who made the section election must submit a request for a private letter ruling. (For further guidance, see Rev. Proc. 2007-1, 2007-1 CB 1 (or any applicable successor) and .) of this section provides rules for partnerships that elect to apply section . of this section provides rules for certain taxpayers other than C corporations and for eligible partners that elect to apply section . of this section provides a limitation on the amount of gain that an eligible partner does not recognize under section . of this section provides rules for partnership distributions of QSB stock to an eligible partner. of this section provides rules for contributions of QSB stock or replacement QSB stock to a partnership. of this section provides definitions of certain terms used in section and this section. of this section provides reporting rules for partnerships and partners that elect to apply section . of this section provides examples illustrating the provisions of this section. of this section contains the effective/applicability date.
(b) Partnership election
(1) Partnership purchase of replacement QSB stock A partnership that holds QSB stock for more than 6 months, sells such QSB stock, and purchases replacement QSB stock may elect in accordance with of this section to apply section . If the partnership elects to apply section , then, subject to the provisions of and of this section, each eligible partner shall not recognize its distributive share of any partnership section gain (as determined under of this section). For this purpose, partnership section gain equals the partnership's gain from the sale of the QSB stock reduced by the greater of—
(i) The amount of the gain from the sale of the QSB stock that is treated as ordinary income; or
(ii) The excess of the amount realized by the partnership on the sale over the total cost of all replacement QSB stock purchased by the partnership (excluding the cost of any replacement QSB stock purchased by the partnership that is otherwise taken into account under section ).
(2) Partner's distributive share of partnership section 1045 gain A partner's distributive share of partnership section gain shall be in the same proportion as the partner's distributive share of the partnership's gain from the sale of the QSB stock. For this purpose, the partnership's gain from the sale of QSB stock and the partner's distributive share of that gain are determined without regard to basis adjustments under section and of this section.
(3) Basis adjustments
(i) Partner's interest in a partnership The adjusted basis of an eligible partner's interest in a partnership shall not be increased under section by gain from a partnership's sale of QSB stock that is not recognized by the partner as the result of a partnership election under of this section.
(ii) Partnership's replacement QSB stock
(A) Rule The basis of a partnership's replacement QSB stock is reduced (in the order acquired) by the amount of gain from the partnership's sale of QSB stock that is not recognized by an eligible partner as a result of the partnership's election under section . The basis adjustment with respect to any amount described in this constitutes an adjustment to the basis of the partnership's replacement QSB stock with respect to that partner only. The effect of such a basis adjustment is determined under the principles of , , and except as modified in this . If a partnership sells QSB stock with respect to which a basis adjustment has been made under this , and the partnership makes an election under of this section with respect to the sale and purchases replacement QSB stock, the basis adjustment shall carry over to the replacement QSB stock except to the extent otherwise provided in this . The basis adjustment that carries over to the replacement QSB stock shall be reduced (but not below zero) by the eligible partner's distributive share of the excess, if any, of the greater of the amount determined under or of this section from the sale of the QSB stock, over the partnership's gain from the sale of the QSB stock (determined without regard to basis adjustments under section or of this section). The excess amount that reduces the basis adjustment shall be accounted for as gain in accordance with . See Example 5 of of this section. For purposes of this , a partnership must presume that a partner did not recognize that partner's distributive share of the partnership section gain as a result of the partnership's section election unless the partner notifies the partnership to the contrary as described in of this section. However, if a partnership knows that a particular partner is classified, for Federal tax purposes, as a C corporation, then the partnership may presume that the partner did not defer recognition of its distributive share of the partnership section gain, even in the absence of a notification by the partner. If a partnership makes an election under section , but an eligible partner opts out of the election under of this section and provides to the partnership the notification required under of this section, no basis adjustments under this are required with respect to that partner as a result of the section election by the partnership.
(B) Tiered-partnership rule If a partnership (upper-tier partnership) holds an interest in another partnership (lower-tier partnership) that makes an election under section , the portion of the lower-tier partnership's basis adjustment as provided in of this section in the replacement QSB stock must be segregated and allocated to the upper-tier partnership and any eligible partner as defined in of this section. Similarly, that portion of the basis of the upper-tier partnership's interest in the lower-tier partnership attributable to the basis adjustment as provided in of this section in the lower-tier partnership's replacement QSB stock must be segregated and allocated solely to any eligible partner as defined in of this section.
(C) Statement of adjustments A partnership that must adjust the basis of replacement QSB stock under this must attach a statement to the partnership return for the taxable year in which the partnership purchases replacement QSB stock setting forth the computation of the adjustment, the replacement QSB stock to which the adjustment has been made, the date(s) on which such QSB stock was acquired by the partnership, and the amount of the adjustment that is allocated to each partner.
(4) Eligible partners may opt out of partnership's section 1045 election An eligible partner may opt out of the partnership's section election with respect to QSB stock either by recognizing the partner's distributive share of the partnership section gain, or by making a partner section election under of this section with respect to the partner's distributive share of the partnership section gain. See of this section for applicable notification requirements. Opting out of a partnership's section election under this does not constitute a revocation of the partnership's election, and such election shall continue to apply to other partners of the partnership.
(5) Notice requirements
(i) Partnership notification to partners A partnership that makes an election under of this section must notify all of its partners of the election and the purchase of replacement QSB stock, in accordance with the applicable forms and instructions, and separately state each partner's distributive share of partnership section gain from the sale of QSB stock under section . Each partner shall determine whether the partner is an eligible partner within the meaning of of this section and report the partner's distributive share of partnership section gain from the partnership's sale of QSB stock, including gain not recognized, in accordance with the applicable forms and instructions.
(ii) Partner notification to partnership Any partner that must recognize all or part of the partner's distributive share of partnership section gain must notify the partnership, in writing, of the amount of partnership section gain that is recognized by the partner. Similarly, an eligible partner that opts out of a partnership's section election under of this section must notify the partnership, in writing, that the partner is opting out of the partnership's section election.
(c) Partner election
(1) In general
(i) Rule An eligible partner of a partnership that sells QSB stock (selling partnership) may elect in accordance with of this section to apply section if replacement QSB stock is purchased by the eligible partner. An eligible partner of a selling partnership may elect in accordance with of this section to apply section if replacement QSB stock is purchased by a partnership in which the taxpayer is a partner (directly or through an upper-tier partnership) on the date on which the partnership acquires the replacement QSB stock (purchasing partnership). A taxpayer other than a C corporation that sells QSB stock held for more than 6 months at the time of the sale may elect in accordance with of this section to apply section if replacement QSB stock is purchased by a purchasing partnership (including a selling partnership).
(ii) Partner purchase of replacement QSB stock Subject to of this section, an eligible partner of a selling partnership that elects to apply section with respect to the eligible partner's purchase of replacement QSB stock must recognize its distributive share of gain from the sale of QSB stock by the selling partnership only to the extent of the greater of—
(A) The amount of the eligible partner's distributive share of the selling partnership's gain from the sale of the QSB stock that is treated as ordinary income; or
(B) The excess of the eligible partner's share of the selling partnership's amount realized (as determined under of this section) on the sale by the selling partnership of the QSB stock (excluding the cost of any replacement QSB stock purchased by the selling partnership) over the cost of any replacement QSB stock purchased by the eligible partner (excluding the cost of any replacement QSB stock that is otherwise taken into account under section ).
(iii) Partnership purchase of replacement QSB stock
(A) Partner of a selling partnership Subject to of this section, an eligible partner that treats its interest in QSB stock purchased by a purchasing partnership as a purchase of replacement QSB stock by the eligible partner and that elects to apply section with respect to such purchase must recognize its total gain (the eligible partner's distributive share of gain from the selling partnership's sale of QSB stock and any gain taken into account under of this section from the sale of replacement QSB stock) only to the extent of the greater of—
(1) The amount of the eligible partner's distributive share of the selling partnership's gain from the sale of the QSB stock that is treated as ordinary income; or
(2) The excess of the eligible partner's share of the selling partnership's amount realized (as determined under of this section) on the sale by the selling partnership of the QSB stock (excluding the cost of any replacement QSB stock purchased by the selling partnership) over the eligible partner's share of the purchasing partnership's cost of the replacement QSB stock, as determined under of this section (excluding the cost of any QSB stock that is otherwise taken into account under section ).
(B) Taxpayer other than a C corporation Subject to of this section, a taxpayer other than a C corporation that treats its interest in QSB stock purchased by a purchasing partnership with respect to which the taxpayer is a partner as a purchase of replacement QSB stock by the taxpayer must recognize its gain from the sale of the QSB stock only to the extent of the greater of—
(1) The amount of gain from the sale of the QSB stock that is treated as ordinary income; or
(2) The excess of the amount realized by the taxpayer on the sale of the QSB stock over the partner's share of the purchasing partnership's cost of the replacement QSB stock, as determined under of this section (excluding the cost of any QSB stock that is otherwise taken into account under section ).
(2) Eligible partner's share of amount realized by partnership
(i) General rule The eligible partner's share of the amount realized by the selling partnership is the amount realized by the partnership on the sale of the QSB stock (excluding the cost of any replacement QSB stock otherwise taken into account under section ) multiplied by the following fraction—
(A) The numerator of which is the eligible partner's distributive share of the partnership's realized gain from the sale of the QSB stock; and
(B) The denominator of which is the partnership's realized gain on the sale of the QSB stock.
(ii) General rule modified for determining eligible partner's share of amount realized by purchasing partnership upon a sale of replacement QSB stock in certain situations
(A) No gain realized or loss realized on sale of replacement QSB stock If a purchasing partnership does not realize a gain or realizes a loss from the sale of replacement QSB stock for which an election under this section was made for purposes of applying of this section, the eligible partner's share of the amount realized is—
(1) The greater of—
(i) The amount determined in of this section from a prior sale of QSB stock (that is not otherwise taken into account under of this section) in which the eligible partner had a distributive share of gain allocated to the eligible partner that was not recognized under of this section; or
(ii) The amount realized by a taxpayer other than a C corporation from a prior sale of QSB stock (that is not otherwise taken into account under of this section) in which the taxpayer realized gain that was not recognized under of this section; less
(2) The eligible partner's distributive share of any loss recognized on the sale of replacement QSB stock, if applicable.
(B) Eligible partner's interest in purchasing partnership is reduced and gain realized on sale of replacement QSB stock If an eligible partner's interest in a purchasing partnership is reduced subsequent to the sale of QSB stock and the purchasing partnership realizes a gain from the sale of the replacement QSB stock, the eligible partner's share of the amount realized upon a sale of replacement QSB stock must be determined under of this section based on the distributive share of the partnership's realized gain that would have been allocated to the eligible partner if the eligible partner's interest in the partnership had not been reduced.
(iii) Eligible partner's share of the amount realized For purposes of determining the eligible partner's share of the amount realized by the partnership, the partnership's realized gain from the sale of QSB stock and the eligible partner's distributive share of that gain are determined without regard to basis adjustments under section and and of this section.
(3) Partner's share of the cost of QSB stock purchased by a purchasing partnership The partner's share of the cost (adjusted basis) of replacement QSB stock purchased by a purchasing partnership is the percentage of the partnership's future income and gain, if any, that is reasonably expected to be allocated to the partner (determined without regard to any adjustment under section ) with respect to the replacement QSB stock that was purchased by the partnership, multiplied by the cost of that replacement QSB stock. The assumptions made by a partnership in determining the reasonably expected allocation of income and gain must be consistent for each partner. For example, a partnership may not treat the same item of income or gain as being reasonably expected to be allocated to more than one partner.
(4) Basis adjustments
(i) Eligible partner's interest in selling partnership Under section , the adjusted basis of an eligible partner's interest in a selling partnership that sells QSB stock is increased by the partner's distributive share of gain without regard to of this section. However, if the selling partnership is also a purchasing partnership, the adjusted basis of an eligible partner's interest in a partnership that sells QSB stock may be reduced under of this section.
(ii) Replacement QSB stock A partner's basis in any replacement QSB stock that is purchased by the partner, as well as the adjusted basis of any replacement QSB stock that is purchased by a purchasing partnership and that is treated as the partner's replacement QSB stock must be reduced (in the order replacement QSB stock is acquired by the partner and purchasing partnership, as applicable) by the partner's distributive share of the gain on the sale of the selling partnership's QSB stock that is not recognized by the partner under of this section, or by the gain on a sale of QSB stock by the partner that is not recognized by the partner under section , as applicable. If replacement QSB stock is purchased by the purchasing partnership, the purchasing partnership shall maintain its adjusted basis in the replacement QSB stock without regard to any basis adjustments required by this . The eligible partner, however, shall in computing its distributive share of income, gain, loss and deduction from the purchasing partnership with respect to the replacement QSB stock take into account the variation between the adjusted basis in the QSB stock as determined under this and the adjusted basis determined without regard to this . A partner must retain records setting forth the computation of this basis adjustment, the replacement QSB stock to which the adjustment has been made, and the date(s) on which such stock was acquired. See Examples 7 and 8 of of this section.
(iii) Partner's basis in purchasing partnership interest A partner that treats the partner's interest in QSB stock purchased by a purchasing partnership as the partner's replacement QSB stock must reduce (in the order replacement QSB stock is acquired) the adjusted basis of the partner's interest in the purchasing partnership by the partner's distributive share of the gain on the sale of the selling partnership's QSB stock that is not recognized by the partner pursuant to of this section, or by the gain on a sale of QSB stock by the partner that is not recognized by the partner under section , as applicable. Similarly, a partner of an upper-tier partnership that treats the partner's interest in QSB stock purchased by a lower-tier purchasing partnership as the partner's replacement QSB stock must reduce (in the order replacement QSB stock is acquired) the adjusted basis of the partner's interest in the upper-tier partnership by the partner's distributive share of the gain on the sale of the selling partnership's QSB stock that is not recognized by the partner pursuant to of this section, or by the gain on a sale of QSB stock by the partner that is not recognized by the partner under section , as applicable.
(iv) Increase in basis on sale of QSB stock by purchasing partnership A partner that recognizes gain under of this section must increase the adjusted basis of the partner's interest in the purchasing partnership under section by the amount of the gain recognized by that partner. Similarly, a partner in an upper-tier partnership that recognizes gain under of this section must increase the adjusted basis of the partner's interest in the upper-tier partnership under section by the amount of the gain recognized by that partner.
(5) Partner recognition of gain At the time that either the partner or the purchasing partnership (whichever applies) sells or exchanges replacement QSB stock, the amount recognized by the partner is determined by taking into account the basis adjustments described in of this section. Similarly, a partner of an upper-tier partnership that owns an interest in a lower-tier partnership that holds replacement QSB stock must take into account the basis adjustments described in of this section in determining the amount recognized by the partner on a sale of the interest in the lower-tier partnership by the upper-tier partnership or the partner's distributive share of gain from the upper-tier partnership. See of this section for rules applicable to certain distributions of replacement QSB stock.
(d) Nonrecognition limitation
(1) In general For purposes of this section, the amount of gain that an eligible partner does not recognize under and of this section cannot exceed the nonrecognition limitation. Except as otherwise provided in of this section, the nonrecognition limitation is equal to the product of—
(i) The partnership's realized gain from the sale of the QSB stock, determined without regard to any basis adjustment under section or section (other than basis adjustments described in of this section); and
(ii) The eligible partner's smallest percentage interest in partnership capital as determined in of this section. See Example 9 of of this section.
(2) Eligible partner's smallest percentage interest in partnership capital An eligible partner's smallest percentage interest in partnership capital is the eligible partner's percentage share of capital determined at the time of the acquisition of the QSB stock as adjusted prior to the time the QSB stock is sold to reflect any reduction in the capital of the eligible partner including a reduction as a result of a disproportionate capital contribution by other partners, a disproportionate capital distribution to the eligible partner or the transfer of an interest by the eligible partner, but excluding income and loss allocations.
(3) Special rule for tiered partnerships For purposes of of this section, if an eligible partner is treated as owning an interest in a lower-tier purchasing partnership through an upper-tier partnership, the eligible partner's percentage interest in the purchasing partnership shall be proportionately adjusted to reflect the eligible partner's percentage interest in the upper-tier partnership.
(e) Partnership distribution of QSB stock to a partner
(1) In general Subject to and of this section, in the case of a partnership distribution of QSB stock to a partner, the partner shall be treated for purposes of this section as—
(i) Having acquired such stock in the same manner as the partnership; and
(ii) Having held such stock during any continuous period immediately preceding the distribution during which it was held by the partnership. See Examples 10 and 11 of of this section.
(2) Eligibility under section 1202(c) of this section does not apply unless all eligibility requirements with respect to QSB stock as defined in section are met by the distributing partnership with respect to its investment in QSB stock.
(3) Distribution nonrecognition limitation
(i) Generally The amount of gain that an eligible partner does not recognize under this section on the sale of QSB stock that was distributed by the partnership to the partner cannot exceed the distribution nonrecognition limitation. For this purpose, the distribution nonrecognition limitation is—
(A) The partner's section amount realized (determined under of this section); reduced by
(B) The partner's section adjusted basis (determined under of this section).
(ii) Section 1045 amount realized
(A) QSB stock received in liquidation of partner's interest and in certain nonliquidating distributions If a partner receives QSB stock from the partnership in a distribution in liquidation of the partner's interest in the partnership or as part of a series of related distributions by the partnership in which the partnership distributes all of the partnership's QSB stock of a particular type, then the partner's section amount realized is the partner's amount realized from the sale of the distributed QSB stock, multiplied by a fraction—
(1) The numerator of which is the partner's smallest percentage interest in partnership capital determined under of this section; and
(2) The denominator of which is the partner's percentage interest in that type of QSB stock immediately after the distribution (determined under of this section).
(B) Partner's smallest percentage interest in partnership capital A partner's smallest percentage interest in partnership capital is the partner's percentage share of capital determined at the time of the acquisition of the QSB stock as adjusted prior to the time the QSB stock is distributed to the partner to reflect any reduction in the capital of the partner including a reduction as a result of a disproportionate capital contribution by other partners, a disproportionate capital distribution to the partner, or the transfer of a capital interest by the partner, but excluding income and loss allocations.
(C) QSB stock received in other distributions If a partner receives QSB stock in a distribution from the partnership that is not described in of this section, the partner's section amount realized is the partner's amount realized from the sale of the distributed QSB stock multiplied by the partner's smallest percentage interest in partnership capital determined under of this section.
(iii) Section 1045 adjusted basis
(A) QSB stock received in liquidation of partner's interest and in certain nonliquidating distributions If a partner receives QSB stock from the partnership in a distribution in liquidation of the partner's interest in the partnership or as part of a series of related distributions by the partnership in which the partnership distributes all of the partnership's QSB stock of a particular type, then the partner's section adjusted basis is the product of—
(1) The partnership's basis in all of the QSB stock of the type distributed (without regard to basis adjustments under section or section , other than basis adjustments described in and of this section);
(2) The partner's smallest percentage interest in partnership capital determined under of this section; and
(3) The proportion of the distributed QSB stock that was sold by the partner.
(B) QSB stock received in other distributions If a partner receives QSB stock in a distribution from the partnership that is not described in of this section, the partner's section adjusted basis is the product of—
(1) The partnership's basis in the QSB stock sold by the partner (without regard to basis adjustments under section or section , other than basis adjustments described in and of this section); and
(2) The partner's smallest percentage interest in partnership capital determined under of this section.
(iv) Partner's percentage interest in distributed QSB stock For purposes of this , a partner's percentage interest in a type of QSB stock immediately after a partnership distribution is the value (as of the date of the distribution) of the QSB stock distributed to the partner divided by the value (as of the date of the distribution) of all of that type of QSB stock that was acquired by the partnership.
(v) QSB stock of the same type For purposes of this , QSB stock will be of the same type as the distributed QSB stock if it has the same issuer and the same rights and preferences as the distributed QSB stock and was acquired by the partnership at original issue.
(4) Distribution of replacement QSB stock to a partner that reduces another partner's interest in the replacement QSB stock For purposes of this section, a partner must recognize gain upon a distribution of replacement QSB stock to another partner that reduces the partner's share of the replacement QSB stock held by a partnership. The amount of gain that the partner must recognize is determined based on the amount of gain that the partner would recognize upon a sale of the distributed replacement QSB stock for its fair market value on the date of the distribution but not to exceed the amount that was previously not recognized by the partner under section with respect to the distributed replacement QSB stock. Any gain recognized by a partner whose interest is reduced must be taken into account in determining the adjusted basis of the partner's interest in the partnership and also taken into account in determining the partnership's adjusted basis in the QSB stock distributed to another partner under of this section.
(f) Contribution of QSB stock or replacement QSB stock to a partnership Section applies to a contribution of QSB stock to a partnership. Except as provided in section , any gain that was not recognized by the taxpayer under section is not recognized when the taxpayer contributes QSB stock to a partnership in exchange for a partnership interest. Stock that is contributed to a partnership is not QSB stock in the hands of the partnership. See Example 12 of of this section.
(g) Definitions For purposes of section and this section, the following terms are defined as follows:
(1) Qualified small business stock The term qualified small business stock (QSB stock) has the meaning provided in section . The term “QSB stock” does not include an interest in a partnership that purchases or holds QSB stock. See Example 1 of of this section.
(2) Replacement QSB stock The term replacement QSB stock is any QSB stock purchased within 60 days beginning on the date of a sale of QSB stock.
(3) Eligible partner
(i) In general Except as provided in , , and of this section, an eligible partner with respect to QSB stock is a taxpayer other than a C corporation that holds an interest in a partnership on the date the partnership acquires the QSB stock and at all times thereafter for more than 6 months until the partnership sells or distributes the QSB stock.
(ii) Acquisition by gift or at death For purposes of of this section, a taxpayer who acquires from a partner (other than a C corporation) by gift or at death an interest in a partnership that holds QSB stock is treated as having held the acquired interest in the partnership during the period the partner (other than a C corporation) held the interest in the partnership.
(iii) Tiered partnership For purposes of of this section, if a partnership (upper-tier partnership) holds an interest in another partnership (lower-tier partnership) that holds QSB stock, then the upper-tier partnership's ownership of the lower-tier partnership is disregarded and each partner of the upper-tier partnership is treated as owning the interest in the lower-tier partnership directly. The partner of the upper-tier partnership is treated as owning the interest in the lower-tier partnership during the period in which both—
(A) The partner of the upper-tier partnership held an interest in the upper-tier partnership; and
(B) The upper-tier partnership held an interest in the lower-tier partnership. See Examples 3 and 4 of of this section.
(iv) Multiple tiers of partnerships Principles similar to those described in of this section apply where a taxpayer holds an interest in a lower-tier partnership through multiple tiers of partnerships.
(4) Month(s) For purposes of this section, the term month(s) means a period commencing on the same numerical day of any calendar month as the day on which the QSB stock is sold and ending with the close of the day preceding the numerically corresponding day of the succeeding calendar month or, if there is no corresponding day, with the last day of the succeeding calendar month.
(h) Reporting and election rules
(1) Time and manner of making election A partnership making an election under section (as described under of this section) must do so on the partnership's timely filed (including extensions) Federal income tax return for the taxable year during which the sale of QSB stock occurs. A partner making an election under section (as described under of this section) must do so on the partner's timely filed (including extensions) Federal income tax return for the taxable year during which the partner's distributive share of the partnership's gain from the sale of the QSB stock is taken into account by such partner under section . In addition, a partnership or partner making an election under section must make such election in accordance with the applicable forms and instructions.
(2) Purchases, distributions, and sales of QSB stock or replacement QSB stock by partnerships A partnership that purchases, distributes to a partner, or sells or exchanges QSB stock or replacement QSB stock must provide information to the Commissioner and to the partnership's partners to the extent provided by the applicable forms and instructions.
(3) Nonrecognition of gain by eligible partners An eligible partner that does not recognize gain under section must provide information to the Commissioner to the extent provided by the applicable forms and instructions.
(i) Examples The provisions of this section are illustrated by the following examples:
Example 1. Sale of a partnership interest. On January 1, 2008, A, an individual, X, a C corporation, and Y, a C corporation, form PRS, a partnership. A, X, and Y each contribute $250 to PRS and agree to share all partnership items equally. PRS purchases QSB stock for $750 on February 1, 2008. On November 4, 2008, A sells A's interest in PRS for $500, realizing $250 of capital gain. Under of this section, an interest in a partnership that holds QSB stock is not treated as QSB stock. Therefore, the sale of an interest in a partnership that holds QSB stock is not treated as a sale of QSB stock, and A may not elect to apply section with respect to A's $250 gain from the sale of A's interest in PRS.
Example 2. Election by partner; replacement by partnership.
(i) Assume the same facts as in Example 1, except that A does not sell A's interest in PRS. Instead, PRS sells the QSB stock (QSB1 stock) for $1,500 on November 3, 2008. PRS realizes $750 of gain from the sale of the QSB1 stock (none of which is treated as ordinary income) and allocates $250 of gain to each of A, X, and Y. PRS does not make a section election. On November 30, 2008, A contributes $500 to ABC, a partnership, in exchange for a 10 percent interest in ABC. ABC then purchases QSB stock (QSB2 stock) for $5,000 on December 1, 2008. ABC has no other assets. A makes an election under of this section and treats A's percentage interest in ABC's QSB2 stock as replacement QSB stock under of this section with respect to the $250 gain PRS allocated to A. Under of this section, A's share of the cost of QSB2 stock purchased by ABC is $500 (A's reasonably expected income and gain with respect to QSB2 stock, or 10 percent multiplied by the cost of the QSB2 stock, $5,000). Under of this section, A will not recognize the $250 gain PRS allocated to A, because A's share of the amount realized by PRS, $500 (the total amount realized by the partnership on the sale of the QSB1 stock ($1,500) multiplied by A's share of the gain from the sale of the QSB1 stock ($250) over the total gain realized by the partnership on the sale of the QSB1 stock ($750)), does not exceed A's share of ABC's cost of the QSB2 stock acquired by ABC, $500. Under of this section, A must reduce A's share of ABC's basis in the QSB2 stock by $250. Under of this section, A must reduce A's basis in A's interest in ABC by $250. Under of this section, A's basis in A's interest in PRS is increased by $250.
(ii) Assume the same facts as in paragraph (i) of this Example 2, except that A does not contribute $500 to ABC in exchange for a partnership interest. Instead, on November 30, 2008, EFG, a partnership in which A has an existing 10 percent partnership interest, purchases QSB stock for $5,000. Under of this section, A may treat A's 10 percent interest in EFG's QSB stock as replacement QSB stock with respect to the $250 of gain PRS allocated to A.
(iii) Assume the same facts as in paragraph (i) of this Example 2, except that ABC owns QSB stock that ABC purchased on November 10, 2008, and ABC does not purchase QSB stock on December 1, 2008. Under of this section, ABC is not a purchasing partnership with respect to A for the QSB stock ABC purchased on November 10, 2008. A may not treat A's percentage interest in ABC's QSB stock as replacement QSB stock to defer the $250 gain PRS allocated to A, because A acquired its interest in ABC after ABC acquired the QSB stock.
(iv) Assume the same facts as in paragraph (i) of this Example 2, except that ABC sells QSB2 stock on July 30, 2009, for $5,000. ABC realizes no gain or loss on the sale of QSB2 stock. A desires to continue to rollover the $250 gain from the sale of QSB1 stock. Under of this section, A's share of the amount realized is $500, which was A's share of the amount realized on the prior sale of QSB1 stock. Accordingly, A must elect to apply section and purchase $500 of replacement QSB stock either directly or through a purchasing partnership to continue to defer the $250 gain from the sale of QSB1 stock.
Example 3. Tiered partnerships; partnership election.
(i) On January 1, 2008, A, an individual, and B, an individual, each contribute $500 to UTP (upper-tier partnership) for equal partnership interests. On February 1, 2008, UTP and C, an individual, each contribute $1,000 to LTP (lower-tier partnership) for equal partnership interests. On March 1, 2008, LTP purchases QSB stock for $500. On April 1, 2008, D, an individual, joins UTP by contributing $500 to UTP for a 1⁄3 interest in UTP. On December 1, 2008, LTP sells the QSB stock for $2,000. Under of this section, A, B, and D are treated as owning an interest in LTP during the period in which each of the partners held an interest in UTP and UTP held an interest in LTP. Therefore, under and of this section, A and B are eligible partners, and D and UTP are not eligible partners with respect to the QSB stock sold by LTP. Under of this section, C is also an eligible partner with respect to the QSB stock sold by LTP.
(ii) Assume the same facts as in paragraph (i) of this Example 3. LTP realizes a gain of $1,500 on the December 1, 2008, sale of QSB stock. LTP allocates $750 of gain to each of UTP and C. UTP, in turn, allocates $250 (of the $750 of gain allocated to UTP) to each of A, B, and D. LTP makes a section election. On January 1, 2009, LTP purchases replacement QSB stock for $2,000. Under of this section, D notifies UTP that it recognizes $250 of gain and UTP notifies LTP. Because A, B, and C are eligible partners with respect to the QSB stock sold by LTP, A and B may each defer $250 of LTP's section gain and C may defer $750 of LTP's section gain. LTP must decrease its basis in the replacement QSB stock by the $750 of partnership section gain that was allocated to C and by $500 of the partnership section gain that was allocated to UTP. These basis reductions are with respect to UTP (A and B) and C only. Under of this section, the basis of UTP's interest in LTP attributable to the LTP's replacement QSB stock must be segregated and allocated to A and B. In addition, A and B each have a $250 negative basis adjustment in their respective interests in UTP. If UTP sells its interest in LTP for $1,250, A and B would each recognize $250 of gain from the sale of the LTP interest. D would not recognize any gain or loss from the sale.
Example 4. Tiered partnerships; partner election.
(i) On January 1, 2008, A, an individual, and X, a C corporation, form UTP, a partnership. A and X each contribute $250 to UTP and agree to share all partnership items equally. Also, on January 1, 2008, UTP and Y, a C corporation, form LTP, a partnership. UTP and Y contribute $500 and $250, respectively, to LTP. UTP and Y agree to share all partnership items equally. LTP purchases QSB stock for $750 on February 1, 2008. On November 3, 2008, LTP sells the QSB stock for $1,500. LTP realizes $750 of gain from the sale of the QSB stock (none of which is treated as ordinary income) and allocates $250 gain to Y and $500 gain to UTP. Of the $500 gain allocated to UTP from the sale of QSB stock, $250 is allocated to A and $250 is allocated to X. LTP purchases replacement QSB stock (replacement QSB1 stock) for $1,350 on December 15, 2008. LTP does not make an election under section . Under the rules provided in of this section, A makes an election under section on its timely filed return for the taxable year for which the distributive share of gain from the sale of QSB stock is taken into account by A under section . Under of this section, A treats A's interest in replacement QSB1 stock as replacement stock with respect to A's distributive share of LTP's section gain. On March 30, 2009, LTP sells replacement QSB1 stock for $1,650. LTP realizes $300 of gain from the sale of replacement QSB1 stock (none of which is treated as ordinary income) and allocates $100 to Y and $200 to UTP.
(ii) Under of this section, A must recognize its distributive share of gain from LTP's sale of QSB stock ($250) only to the extent of the greater of A's distributive share of LTP's gain from the sale of QSB stock that is treated as ordinary income ($0) or the amount by which A's share of the amount realized by LTP's sale of QSB stock exceeds A's share of LTP's cost of the replacement QSB1 stock, $50 (1⁄3 of $1,500, or $500, minus 1⁄3 of $1,350, or $450). Because Y is not an eligible partner of LTP under of this section, Y must recognize its $250 distributive share of partnership gain from the sale of the QSB stock. Also, X is not an eligible partner under of this section, and it must recognize its $250 distributive share of gain from UTP attributable to UTP's distributive share of $500 of LTP's gain from the sale of QSB stock.
(iii) Under section , the adjusted basis of Y's interest in LTP is increased by $250, and the adjusted basis of UTP's interest in LTP is increased by $500. Under section , the adjusted basis of X's interest in UTP is increased by $250, and the adjusted basis of A's interest in UTP is increased by $250. However, under of this section, the adjusted basis of A's interest in UTP is reduced by the $200 of partnership section gain that was not recognized by A.
(iv) Under of this section, the LTP's adjusted basis in replacement QSB1 stock is reduced by the $200 of gain from the sale of QSB stock that is not recognized by A, as a result of A's election under section . A must retain records setting forth the computation of this basis adjustment, the replacement QSB stock to which the adjustment is made, and dates the stock was acquired. LTP's adjusted basis in the replacement QSB1 stock is maintained without regard to the eligible partner's adjustment provided in of this section.
(v) On the sale of replacement QSB1 stock, LTP realizes a gain of $300, $100 of which is allocated to Y and $200 of which is allocated to UTP. UTP allocates $100 of this gain to A. Under of this section, in determining A's amount recognized upon the sale of replacement QSB1 stock by LTP, A must take into account A's basis adjustment of $200. Accordingly, A recognizes a total gain of $300 upon the sale of replacement QSB1 stock, absent an additional section election by A or LTP. Under of this section, the adjusted basis of A's interest in UTP is increased by $300 under section .
(vi) Assume the same facts as in paragraph (i) of this Example 4, except that UTP sells its entire interest in LTP on March 30, 2009, for $1,200. UTP realizes a gain of $200 on the sale of its interest in LTP ($1,200 amount realized less $1,000 adjusted basis) and allocates $100 of this gain to A. Under of this section, in determining A's amount recognized upon the sale of UTP's interest in LTP, A must take into account A's basis adjustment of $200. Accordingly, A recognizes a total gain of $300 upon the sale of the interest in LTP. Under of this section, the adjusted basis in A's interest in UTP is increased by $300 under section .
Example 5. Partnership sale of QSB stock and purchase and sale of replacement QSB stock.
(i) On January 1, 2008, A, an individual, X, a C corporation, and Y, a C corporation, form PRS, a partnership. A, X, and Y each contribute $250 to PRS and agree to share all partnership items equally. PRS purchases QSB stock for $750 on February 1, 2008. On November 3, 2008, PRS sells the QSB stock for $1,500. PRS realizes $750 of gain from the sale of the QSB stock (none of which is treated as ordinary income) and allocates $250 of gain to each of A, X, and Y. PRS purchases replacement QSB stock (replacement QSB1 stock) for $1,350 on December 15, 2008. On its timely filed return for the taxable year during which the sale of the QSB stock occurs, PRS makes an election to apply section . A does not make an election to apply section with respect to the November 3, 2008, sale of QSB stock. PRS knows that X and Y are C corporations. On March 30, 2009, PRS sells replacement QSB1 stock for $1,650. PRS realizes $300 of gain from the sale of replacement QSB1 stock (none of which is treated as ordinary income) and allocates $100 of gain to each of A, X, and Y. A does not make an election to apply section with respect to the March 30, 2009, sale of replacement QSB1 stock.
(ii) Under of this section, the partnership section gain from the November 3, 2008, sale of QSB stock is $600 ($750 gain less $150 ($1,500 amount realized on the sale of QSB stock less $1,350 cost of replacement QSB1 stock)). This amount must be allocated among the partners in the same proportions as the entire gain from the sale of QSB stock is allocated to the partners, 1⁄3 ($200) to A, 1⁄3 ($200) to X, and 1⁄3 ($200) to Y.
(iii) Because neither X nor Y is an eligible partner under of this section, X and Y must each recognize its $250 distributive share of partnership gain from the sale of QSB stock. Because A is an eligible partner under of this section, A may defer recognition of A's $200 distributive share of partnership section gain. A is not required to separately elect to apply section . A must recognize A's remaining $50 distributive share of the partnership's gain from the sale of QSB stock.
(iv) Under section , the adjusted bases of X's and Y's interests in PRS are each increased by $250. Under section and of this section, the adjusted basis of A's interest in PRS is not increased by the $200 of partnership section gain that was not recognized by A, but is increased by A's remaining $50 distributive share of gain.
(v) PRS must decrease its basis in the replacement QSB1 stock by the $200 of partnership section gain that was allocated to A. This basis reduction is a reduction with respect to A only. PRS then adjusts A's distributive share of gain from the sale of replacement QSB1 stock to reflect the effect of A's basis adjustment under of this section. In accordance with the principles of , the amount of A's gain from the March 30, 2009, sale of replacement QSB1 stock in which A has a $200 negative basis adjustment equals $300 (A's share of PRS' gain from the sale of replacement QSB1 stock ($100), increased by the amount of A's negative basis adjustment for replacement QSB1 stock ($200)). Accordingly, upon the sale of replacement QSB1 stock, A recognizes $300 of gain, and X and Y each recognize $100 of gain.
(vi) Assume the same facts as in paragraph (i) of this Example 5, except that PRS purchases replacement QSB stock (replacement QSB2 stock) on April 15, 2009, for $1,150 and PRS makes an election to apply section with respect to the March 30, 2009, sale of replacement QSB1 stock. Under of this section, PRS' $200 basis adjustment in QSB1 stock relating to the November 3, 2008, sale of QSB stock carries over to the basis adjustment for QSB2 stock. This basis adjustment is an adjustment with respect to A only. The $200 basis adjustment is reduced by A's distributive share of the excess of $500 (the greater of the amount determined under paragraph (b)(1)(i), $0, or (ii) of this section, $500 ($1,650 amount realized on the sale of QSB1 stock less $1,150 cost of replacement QSB2 stock)) over $300 (PRS' gain from the sale of QSB1 stock), or $67 ($200 ($500 minus $300) divided by 3). Under paragraph (b)(3)(ii)(A), A must account for the $67 excess amount that reduces PRS' basis adjustment in QSB2 stock as gain in accordance with . Therefore, A now has a $133 negative basis adjustment with respect to replacement QSB2 stock (($200) negative basis adjustment from the November 3, 2008, sale of QSB stock plus $67 positive basis adjustment from the March 30, 2009, sale of QSB1 stock). A also recognizes the $100 of gain allocated by PRS to A from the March 30, 2009, sale of replacement QSB1 stock for total gain recognition of $167 ($100 plus $67).
Example 6. Partnership sale of QSB stock; election by eligible partner; replacement QSB stock purchased by purchasing partnership.
(i) Assume the same facts as in Example 5 except that PRS does not make an election under section with respect to the sale of either the QSB stock on November 3, 2008, or the QSB1 stock on March 30, 2009. However, A makes an election under section with respect to the sale of QSB stock and treats the purchase of QSB1 stock on December 15, 2008, by PRS, as the purchase of replacement QSB stock. Additionally, A makes an election under section with respect to the sale of QSB1 stock and treats the purchase of QSB2 stock on April 15, 2009, by PRS, as the purchase of replacement QSB stock.
(ii) A's distributive share of gain from the November 3, 2008, sale of QSB stock is $250 (A's 1⁄3 interest in $750 of total PRS gain). Under of this section, A must recognize only $50 of A's distributive share of PRS' gain of $250, that is the excess of A's share of the amount realized on the sale of QSB stock, or $500 (the total amount realized by PRS on the sale of QSB stock ($1,500) multiplied by A's share of the gain from the sale of QSB stock ($250) over the total gain realized by PRS on the sale of QSB stock ($750)), minus A's share of PRS' cost of QSB1 stock, or $450 (1⁄3 of $1,350). Under section and of this section, A's adjusted basis in its interest in PRS is increased by $250. However, under of this section, because PRS is a purchasing partnership, A's adjusted basis of its interest in PRS is then reduced by the deferred gain of $200. Also under of this section, PRS' adjusted basis in QSB1 stock is reduced by the gain not recognized of $200 and A must take into account such adjusted basis in computing A's income, gain, loss or deduction with respect to QSB1 stock. A must retain records setting forth the computation of this basis adjustment, the replacement QSB stock to which the adjustment is made, and dates the stock was acquired.
(iii) A's distributive share of gain from the March 30, 2009, sale of QSB1 stock is $100 (A's 1⁄3 interest in $300 of total PRS gain) and under of this section, A must take into account A's $200 basis adjustment with respect to the QSB1 stock that was sold. Accordingly, A's total gain from the sale of QSB1 stock is $300. Under of this section, A must recognize only $167 of A's total gain of $300, that is, the excess of A's share of the amount realized on the sale of QSB1 stock, or $550 (the total amount realized by PRS on the sale of QSB1 stock ($1,650) multiplied by A's share of the gain from the sale of QSB1 stock ($100) over the total gain realized by PRS on the sale of QSB1 stock ($300)) minus A's share of PRS' cost of QSB2 stock, or $383 (1⁄3 of $1,150). Under section , A's adjusted basis in A's interest in PRS is increased by A's $100 distributive share of gain from the sale of QSB1 stock. Under of this section, A's adjusted basis of A's interest in PRS is increased by the additional $67 of gain recognized under of this section. Also, under of this section, PRS' adjusted basis in QSB2 stock is reduced by the gain not recognized of $133 ($300 minus $167) and A must take into account such adjusted basis in computing A's income, gain, loss or deduction with respect to QSB2 stock. A must retain records setting forth the computation of this basis adjustment, the replacement QSB stock to which the adjustment is made, and dates the stock was acquired.
Example 7. Partnership sale of QSB stock and partner purchase of replacement QSB stock.
(i) Assume the same facts as in paragraph (i) of Example 5, except that PRS does not make an election under section with respect to the sale of the QSB stock and does not purchase replacement QSB stock. On November 30, 2008, A, an eligible partner under of this section, purchases replacement QSB stock for $500. A elects pursuant to of this section to apply section on A's timely filed return for the taxable year that A is required to include A's distributive share of PRS' gain from the sale of the QSB stock.
(ii) Under of this section, A's share of the amount realized from PRS' sale of the QSB stock is $500 (the total amount realized by the partnership on the sale of the QSB stock ($1,500) multiplied by A's share of the gain from the sale of the QSB stock ($250) over the total gain realized by the partnership on the sale of the QSB stock ($750)). Because A purchased, within 60 days of PRS' sale of the QSB stock, replacement QSB stock for a cost equal to A's share of the partnership's amount realized on the sale of the QSB stock, and because A made an election pursuant to of this section to apply section , A defers recognition of A's $250 distributive share of gain from PRS' sale of the QSB stock. Under section and of this section, the adjusted basis of A's interest in PRS is increased by $250. Under of this section, A's adjusted basis in the replacement QSB stock is $250 ($500 cost minus $250 nonrecognition amount).
Example 8. Partial replacement by partnership; partial replacement by partner.
(i) On January 1, 2008, A, an individual, and X, a C corporation, form PRS, a partnership. A and X each contribute $500 to PRS and agree to share all partnership items equally. PRS purchases QSB stock on February 1, 2008, for $1,000 and subsequently sells the QSB stock on January 31, 2010, for $3,000. PRS realizes $2,000 of gain from the sale of the QSB stock (none of which is treated as ordinary income) and allocates $1,000 of gain to each of A and X. On February 10, 2010, PRS purchases replacement QSB stock for $2,200. On March 20, 2010, A purchases replacement QSB stock for $400. PRS makes an election to apply section under of this section with respect to the partnership section gain from the sale of QSB stock and A does not opt out of PRS' section election under of this section. Also, A makes an election under of this section with respect to the remaining gain from the sale of the QSB stock.
(ii) Under of this section, partnership section gain is $1,200 ($2,000 less $800 ($3,000 amount realized on the sale of the QSB stock minus $2,200 cost of the replacement QSB stock)). This amount is allocated among the partners in the same proportions as the entire gain from the sale of the QSB stock is allocated to the partners, 1⁄2 to A ($600), and 1⁄2 to X ($600). Because A is an eligible partner, A defers recognition of A's $600 distributive share of partnership section gain.
(iii) A also made an election under section and purchased, within 60 days of PRS' sale of the QSB stock, replacement QSB stock for $400. Therefore, under of this section, A may defer a portion of A's distributive share of the remaining gain from the partnership's sale of the QSB stock. A must recognize that remaining gain to the extent that A's share of the amount realized by PRS on the sale of the QSB stock (excluding the cost of the QSB stock that was replaced by PRS) exceeds the cost of the replacement QSB stock purchased by A during the 60-day period following the sale of the QSB stock. The amount realized by PRS on the sale of the QSB stock (excluding the cost of the QSB stock that was replaced by PRS) is $800 ($3,000 minus $2,200). Under of this section, A's share of that amount realized is $400 ($1,000 (A's share of the realized gain from the sale of the QSB stock) ÷ $2,000 (PRS total realized gain from the sale of the QSB stock) multiplied by $800). Because the replacement QSB stock purchased by A cost $400, A defers recognition of all of the remaining gain from the sale of the QSB stock.
(iv) The adjusted basis of A's interest in PRS is not increased by the $600 gain that was not recognized pursuant to of this section, but is increased by the $400 gain that was not recognized pursuant to of this section. See and of this section. PRS must decrease its basis in the replacement QSB stock by the $600 of partnership section gain that was allocated to A. See of this section. A must decrease A's basis in the replacement QSB stock purchased by A by the $400 not recognized pursuant to of this section. See of this section.
Example 9. Change in partner's interest in partnership while partnership holds QSB stock.
(i) On January 1, 2008, A, an individual, and X, a C corporation, form PRS, a partnership. A and X each contribute $500 to PRS and agree to share all partnership items equally. PRS purchases QSB stock on February 1, 2008, for $1,000. On August 2, 2008, A sells a 25 percent interest in PRS to Z. On July 10, 2009, A repurchases the 25 percent interest from Z for $500. PRS makes a timely election under section for the 2008 taxable year. Under section , A has a positive basis adjustment of $250. On January 31, 2011, PRS sells the QSB stock for $3,000. PRS realizes $2,000 of gain from the sale of the QSB stock (none of which is treated as ordinary income) and allocates $1,000 of gain to each of A and X. On February 10, 2010, PRS purchases replacement QSB stock for $3,000. PRS makes an election to apply section under of this section with respect to the partnership section gain from the sale of QSB stock.
(ii) Of the $2,000 of realized gain from the sale of the QSB stock, PRS allocates $1,000 to A and $1,000 to X. However, A has a positive basis adjustment of $250 under section as a result of the purchase of the 25 percent interest in PRS from Z; therefore, A's share of the gain is reduced to $750. Because A is an eligible partner under of this section, A may defer recognition of A's distributive share of gain from the sale of the QSB stock subject to the nonrecognition limitation described in of this section. The smallest percentage interest that A held in PRS capital during the time that PRS held the QSB stock is 25 percent. Under the nonrecognition limitation, A may not defer more than 25 percent of the partnership gain realized from the sale of the QSB stock (determined without regard to any basis adjustment under section or section , other than a basis adjustment described in of this section). Because the partnership's realized gain determined without regard to A's basis adjustment under section is $2,000, A may defer recognition of $500 (25 percent of $2,000) of the gain from the sale of the QSB stock. A must recognize the remaining $250 of that gain.
Example 10. Sale by partner of QSB stock received in a liquidating distribution.
(i) On January 1, 2008, A, an individual, and X, a C corporation, form PRS, a partnership. A and X each contribute $1,500 to PRS and agree to share all partnership items equally. PRS purchases QSB stock on February 1, 2008, for $3,000. On May 1, 2008, when the QSB stock has appreciated in value to $4,000, A contributes $1,000 to PRS, increasing A's interest in PRS capital to 60 percent. On June 1, 2011, when the QSB stock is still worth $4,000, PRS makes a liquidating distribution of $3,000 worth of QSB stock to A. Under section , A's basis in the distributed QSB stock is $2,500. A sells the QSB stock on August 4, 2011, for $6,000, realizing a gain of $3,500 (none of which is treated as ordinary income). A purchases replacement QSB stock on August 30, 2011, for $5,500, and makes an election under section with respect to the August 4, 2011, sale of QSB stock.
(ii) A is an eligible partner under of this section. Therefore, under of this section, A is treated as having acquired the distributed QSB stock in the same manner as PRS and as having held the QSB stock since February 1, 2008, its original issue date. Because A purchased, within 60 days of A's sale of the QSB stock, replacement QSB stock, A is eligible to defer a portion of A's gain from the sale of the QSB stock. A must recognize gain, however, to the extent that A's amount realized on the sale of the QSB stock, $6,000, exceeds the cost of the replacement QSB stock purchased by A during the 60-day period beginning on the date of the sale of the QSB stock, $5,500. Accordingly, A must recognize $500 of the gain from the sale of the QSB stock. A defers recognition of the remaining $3,000 of gain to the extent that such gain does not exceed the distribution nonrecognition limitation under of this section.
(iii) Under of this section, A's nonrecognition limitation with respect to the sale of the QSB stock is A's section amount realized with respect to the stock, reduced by A's section adjusted basis with respect to the stock. A's amount realized from the sale is the product of A's amount realized from the sale, $6,000; and a fraction—
(1) The numerator of which is A's smallest percentage interest in PRS capital with respect to such stock, 50 percent; and
(2) The denominator of which is A's percentage interest in that type of partnership QSB stock immediately after the distribution, 75 percent (the value of the stock distributed to A, $3,000, divided by the value of all QSB stock of that type acquired by PRS, $4,000).
(iv) Therefore, A's section amount realized is $4,000 ($6,000 multiplied by 50/75). Because PRS distributed the QSB stock to A in liquidation of A's interest in PRS, A's section adjusted basis is the product of PRS' basis in all of the QSB stock of the type distributed, $3,000; A's smallest percentage interest in PRS capital with respect to QSB stock of the type distributed, 50 percent; and the percentage of the distributed QSB stock that was sold by A, 100 percent. Therefore, A's section adjusted basis is $1,500 (the product of $3,000, 50 percent, and 100 percent)) and A's nonrecognition limitation amount on the sale of the QSB stock is $2,500 ($4,000 section amount realized minus $1,500 section adjusted basis). Accordingly, A defers recognition of $2,500 of the remaining $3,000 gain from the sale of the QSB stock and must recognize $500 of the remaining $3,000 gain. Accordingly, A's total gain recognized from the sale of the QSB stock is $1,000.
(v) A's basis in the replacement QSB stock is $3,000 (cost of the replacement QSB stock, $5,500, reduced by the gain not recognized under section , $2,500).
Example 11. Sale by partner of QSB stock received in a nonliquidating distribution.
(i) The facts are the same as in Example 10, except that, on June 1, 2011, PRS distributes only $2,000 of the QSB stock to A, reducing A's interest in PRS capital from 60 percent to 33 percent. PRS' basis in the distributed QSB stock is $1,500. On November 1, 2011, A sells for $2,500 the QSB stock distributed by PRS to A and purchases, within 60 days of the date of sale of the QSB stock, replacement QSB stock for $2,500. A makes a timely election to apply section with respect to A's sale of the distributed QSB stock.
(ii) Under section , A's basis in the distributed QSB stock is $1,500. Therefore, A realizes a gain on the sale of the distributed QSB stock of $1,000. Because A made an election to apply section to the sale, and because A purchased, within 60 days of A's sale of the QSB stock, replacement QSB stock at a cost equal to the amount realized on the sale of the distributed QSB stock, A defers recognition of the gain from the sale of the QSB stock to the extent that such gain does not exceed the distribution nonrecognition limitation.
(iii) Under of this section, the nonrecognition limitation with respect to A's sale of the QSB stock is A's section amount realized reduced by A's section adjusted basis. Because PRS did not distribute all of the particular type of QSB stock and the distribution of the QSB stock to A was not in liquidation of A's interest in PRS, under of this section A's section amount realized is $1,250 (A's amount realized from the sale of the distributed QSB stock, $2,500, multiplied by A's smallest percentage interest in PRS capital with respect to such stock, 50 percent). Under of this section, A's section adjusted basis is the product of the partnership's basis in the QSB stock sold by the partner, $1,500, and A's smallest percentage interest in the partnership capital with respect to such stock, 50 percent. Therefore, A's section adjusted basis is $750 (50 percent of $1,500), and A's nonrecognition limitation amount on the sale of the QSB stock is $500 ($1,250 section amount realized minus $750 section adjusted basis). As this amount is less than the amount of gain that A is eligible to defer under section , $1,000, A defers recognition of only $500 of the gain from the sale of the QSB stock. A must recognize the remaining $500 of that gain.
(iv) A's basis in the replacement QSB stock is $2,000 (cost of the replacement QSB stock, $2,500, reduced by the gain not recognized under section , $500).
Example 12. Contribution of replacement QSB stock to a partnership.
(i) On January 1, 2008, A, an individual, B, an individual, and X, a C corporation, form PRS, a partnership. A, B, and X each contribute $250 to PRS and agree to share all partnership items equally. On February 1, 2008, PRS purchases QSB stock for $750. PRS sells the QSB stock on November 3, 2008, for $1,050. PRS realizes $300 of gain from the sale of the QSB stock (none of which is treated as ordinary income) and allocates $100 of gain to each of its partners. PRS informs the partners that it does not intend to make an election under section with respect to the sale of the QSB stock. Each partner's share of the amount realized from the sale of the QSB stock is $350. On November 30, 2008, A, an eligible partner within the meaning of of this section, purchases replacement QSB stock for $350 and makes a section election under of this section. Subsequently, A transfers the replacement QSB stock to ABC, a partnership, in exchange for an interest in ABC.
(ii) Because A purchased within 60 days of PRS' sale of the QSB stock, replacement QSB stock for a cost equal to A's share of the partnership's amount realized on the sale of the QSB stock, and because A made a valid election to apply section with respect to A's share of the gain from PRS' sale of the QSB stock, A does not recognize A's $100 distributive share of the gain from PRS' sale of the QSB stock. Before the contribution of the replacement QSB stock to ABC, A's adjusted basis in the replacement QSB stock is $250 ($350 cost minus $100 nonrecognition amount). A does not recognize gain upon the contribution of QSB stock to ABC under section . Upon the contribution of the replacement QSB stock to ABC, A's basis in the ABC partnership interest is $250, and ABC's basis in the replacement QSB stock is $250. However, the replacement QSB stock does not qualify as QSB stock in ABC's hands. Neither A nor ABC will be eligible to defer gain under section on a subsequent sale of the replacement QSB stock.
(j) Effective date/applicability—In general This section applies to sales of QSB stock on or after August 14, 2007.
[T.D. 9353, 72 FR 45349, Aug. 14, 2007, as amended by T.D. 9353, 72 FR 57487, Oct. 10, 2007]