Td 9137

Federal Register / Vol. 69, No. 136 / Friday, July 16, 2004 / Rules and Regulations
approved by the Manager, Seattle ACO, or
per data meeting the type certification basis
of the airplane approved by a Boeing
Company Designated Engineering
Representative who has been authorized by
the Manager, Seattle ACO, to make such
findings. For a repair method to be approved,
the approval must specifically reference this
AD.
Alternative Methods of Compliance
(e) In accordance with 14 CFR 39.19, the
Manager, Seattle ACO, is authorized to
approve alternative methods of compliance
for this AD.
Incorporation by Reference
(f) Unless otherwise specified in this AD,
the actions shall be done in accordance with
Boeing Alert Service Bulletin 767–53A0105,
dated April 10, 2003; or Boeing Alert Service
Bulletin 767–53A0106, dated April 10, 2003;
as applicable. This incorporation by
reference was approved by the Director of the
Federal Register in accordance with 5 U.S.C.
552(a) and 1 CFR part 51. Copies may be
obtained from Boeing Commercial Airplanes,
P.O. Box 3707, Seattle, Washington 98124–
2207. Copies may be inspected at the FAA,
Transport Airplane Directorate, 1601 Lind
Avenue, SW., Renton, Washington; or at the
National Archives and Records
Administration (NARA). For information on
the availability of this material at NARA, call
(202) 741–6030, or go to: http://
www.archives.gov/federal_register/
code_of_federal_regulations/
ibr_locations.html.
Effective Date
(g) This amendment becomes effective on
August 20, 2004.
Issued in Renton, Washington, on July 1,
2004.
Kalene C. Yanamura,
Acting Manager, Transport Airplane
Directorate, Aircraft Certification Service.
[FR Doc. 04–15759 Filed 7–15–04; 8:45 am]
BILLING CODE 4910–13–P

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9137]
RIN 1545–BA81

Partnership Transactions Involving
Long-Term Contracts
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:

SUMMARY: This document contains final
regulations relating to partnership
transactions involving contracts
accounted for under a long-term
contract method of accounting. The
regulations are necessary to resolve

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issues that were reserved in final
regulations under section 460 that were
published in the Federal Register on
May 15, 2002, addressing other midcontract changes in taxpayer engaged in
completing such contracts. The effect of
the regulations is to explain the tax
consequences of these partnership
transactions.
DATES: Effective Date: These regulations
are effective July 16, 2004.
Applicability Date: These regulations
apply to transactions on or after May 15,
2002.
FOR FURTHER INFORMATION CONTACT:
Richard Probst at (202) 622–3060 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
Section 460 of the Internal Revenue
Code generally requires that taxpayers
determine taxable income from a longterm contract using the percentage-ofcompletion method (PCM). Under
regulations finalized in 2001 (TD 8929,
2001–1 C.B. 756), a taxpayer using the
PCM generally includes a portion of the
total contract price in income for each
taxable year that the taxpayer incurs
contract costs allocable to the long-term
contract. More specifically, to determine
the income from a long-term contract,
the taxpayer first computes the
completion factor for the contract,
which is the percentage of the estimated
total allocable contract costs that the
taxpayer has incurred (based on the all
events test of section 461, including
economic performance, regardless of the
taxpayer’s method of accounting)
through the end of the taxable year.
Second, the taxpayer computes the
amount of cumulative gross receipts
from the contract by multiplying the
completion factor by the total contract
price, which is the amount that the
taxpayer reasonably expects to receive
under the contract. Third, the taxpayer
computes the amount of current-year
gross receipts, which is the difference
between the cumulative gross receipts
for the current taxable year and the
cumulative gross receipts for the
immediately preceding taxable year.
This difference may be a loss (a negative
number) based on revisions to estimates
of total allocable contract costs or total
contract price. Fourth, the taxpayer
takes into account both the current-year
gross receipts and the amount of
allocable contract costs actually
incurred during the taxable year. To the
extent any portion of the total contract
price has not been included in taxable
income by the completion year, section
460(b)(1) and the regulations require the
taxpayer to include that portion in

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42551

income for the taxable year following
the completion year.
A long-term contract or a portion of a
long-term contract that is exempt from
the PCM may be accounted for under
any permissible method, including the
completed contract method (CCM).
Under the CCM, a taxpayer does not
take into account the gross contract
price and allocable contract costs until
the contract is complete, even though
progress payments are received in years
prior to completion.
A taxpayer generally must allocate
costs to a contract subject to section
460(a) in the same manner as direct and
indirect costs are capitalized to property
produced by a taxpayer under section
263A. The regulations provide
exceptions, however, that reflect the
differences in the cost allocation rules of
sections 263A and 460.
Section 460(h) directs the Secretary to
prescribe regulations to the extent
necessary or appropriate to carry out the
purpose of section 460, including
regulations to prevent a taxpayer from
avoiding section 460 by using related
parties, pass-through entities,
intermediaries, options, and other
similar arrangements.
On May 15, 2002, final regulations
under section 460 were issued to
address a mid-contract change in
taxpayer engaged in completing a
contract accounted for under a longterm contract method of accounting (TD
8995; 2002–23 I.R.B. 1070). The
regulations divide the rules regarding a
mid-contract change in taxpayer into
two categories—constructive
completion transactions and step-in-theshoes transactions.
In a constructive completion
transaction, the taxpayer that originally
accounted for the long-term contract
(old taxpayer) must recognize income
from the contract as of the time of the
transaction. The contract price used to
determine the amount of income
recognized by the taxpayer is the
amount realized from the transaction,
reduced by any amounts paid by the old
taxpayer to the taxpayer subsequently
accounting for the long-term contract
(new taxpayer) that are allocable to the
contract. Similarly, the new taxpayer in
a constructive completion transaction is
treated as though it entered into a new
contract as of the date of the transaction.
The new taxpayer’s contract price is the
amount that the new taxpayer
reasonably expects to receive under the
contract, reduced by the price paid by
the new taxpayer for the contract, and
increased by any amounts paid by the
old taxpayer to the new taxpayer that
are allocable to the contract. In contrast,
in a step-in-the-shoes transaction, the

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old taxpayer’s obligation to account for
the contract terminates on the date of
the transaction and is assumed by the
new taxpayer. The new taxpayer must
assume the old taxpayer’s methods of
accounting for the contract, with both
the contract price and allocable contract
costs based on amounts taken into
account by both parties.
The final section 460 regulations
provide that a contribution to a
partnership in a transaction described in
section 721(a), a transfer of a
partnership interest, and a distribution
by a partnership to which section 731
applies (other than a distribution of a
contract accounted for under a longterm contract method of accounting) are
step-in-the-shoes transactions. In a
notice issued concurrently with the
final regulations, Notice 2002–37 (2002–
23 I.R.B. 1095), the Treasury
Department and IRS announced their
intention to publish regulations setting
forth the special rules that apply to
these partnership transactions and
described many of these rules. The
notice further provided that these
regulations would apply to
contributions, transfers, and
distributions occurring on or after May
15, 2002. On August 6, 2003, a notice
of proposed rulemaking (REG–128203–
02) relating to partnership transactions
involving contracts accounted for under
a long-term contract method of
accounting was published in the
Federal Register (68 FR 46516).
Comments were received from the
public in response to the notice of
proposed rulemaking. No public hearing
was requested or held. After
consideration of all comments, the
proposed regulations are adopted as
amended by this Treasury decision.
Explanation and Summary of Contents
The regulations proposed on August
6, 2003 provide that the constructive
completion rules do not apply to a
transfer by a partnership (transferor
partnership) of all of its assets and
liabilities to a second partnership
(transferee partnership) in an exchange
described in section 721, followed by a
distribution of the interest in the
transferee partnership in liquidation of
the transferor partnership, under
§ 1.708–1(b)(4) (relating to terminations
under section 708(b)(1)(B)) or § 1.708–
1(c)(3)(i) (relating to certain partnership
mergers). One commentator suggested
clarifying that the constructive
completion rules apply to other
distributions of an interest in a
partnership (lower-tier partnership)
holding one or more contracts
accounted for under a long-term
contract method of accounting by

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another partnership (upper-tier
partnership). This comment has been
adopted.
One commentator suggested that the
final regulations clarify the application
of the constructive completion rules if a
partnership that holds a contract
accounted for under a long-term
contract method of accounting
terminates under section 708(b)(1)(A)
because the number of its owners is
reduced to one. In response to this
comment, the final regulations provide
that the entire contract will be treated as
being distributed from the partnership
for purposes of the constructive
completion rules, because the
partnership ceases to exist for tax
purposes. In addition, the final
regulations provide that the partnership
must apply the constructive completion
rules immediately prior to the
transaction or transactions resulting in
the termination of the partnership.
Consistent with § 1.706–1(c)(2)(ii), the
proposed regulations generally provide
that upon the transfer or liquidation of
an interest in a partnership holding a
contract accounted for under a longterm contract method of accounting, the
step-in-the-shoes rules apply to a
contract accounted for under a longterm contract method of accounting
only if the partnership’s books are
properly closed with respect to that
contract under section 706. The
proposed regulations provide that if the
partnership’s books are not closed with
respect to the contract, the partnership
shall compute its income or loss from
each contract accounted for under a
long-term contract method of
accounting for the period that includes
the date of the transfer or liquidation as
though no change in taxpayer had
occurred with respect to that contract,
and may pro rate income from the
contract under a reasonable method
complying with section 706. The
proposed regulations also provide
similar rules for distributions of
property (other than a contract
accounted for under a long-term
contract method of accounting) from a
partnership holding a long-term
contract, and for contributions of
property (other than a contract
accounted for under a long-term
contract method of accounting) to a
partnership holding a contract
accounted for under a long-term
contract method of accounting.
The proposed regulations requested
comments regarding whether similar
rules should be provided with respect to
transfers of stock in an S corporation
holding a contract accounted for under
a long-term contract method of
accounting. Under section 1377(a)(1)

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and § 1.1377–1(a), each shareholder’s
pro rata share of any S corporation item
for any taxable year is generally the sum
of the amounts determined with respect
to the shareholder by assigning an equal
portion of the item to each day of the
S corporation’s taxable year, and then
dividing that portion pro rata among the
shares outstanding on that day. Under
section 1377(a)(2) and § 1.1377–1(b), an
S corporation may elect to close its
books if a shareholder’s entire interest
in an S corporation is terminated during
the S corporation’s taxable year, and the
corporation and all affected
shareholders agree. No comments were
received.
The Treasury Department and IRS
have concluded that similar rules
should be provided for transfers of S
corporation stock and conversions to
and from S corporation status. Thus, the
final regulations generally provide that
upon the transfer of stock in an S
corporation holding a contract
accounted for under a long-term
contract method of accounting, or the
conversion to or from S corporation
status by a corporation holding such a
contract, the step-in-the-shoes rules
apply to the contract only if the S
corporation’s books are closed under
section 1362(e)(3), section 1362(e)(6)(C),
section 1362(e)(6)(D), section 1377(a)(2),
or § 1.1502–76. If the S corporation’s
books are not closed, the S corporation
computes its income or loss from the
contract for the period that includes the
date of the transfer as though no change
in taxpayer had occurred with respect to
the contract, and must pro rate income
from the contract in accordance with the
rules generally applicable to such
transfers or conversions.
In Rev. Rul. 73–301 (1973–2 C.B. 215),
the IRS ruled that the progress payments
described in the ruling did not
constitute a liability within the meaning
of section 752. See also Rev. Rul. 81–
241 (1981–2 C.B. 146) (citing and
following Rev. Rul. 73–301). The
proposed regulations requested
comments regarding whether there are
circumstances under which the receipt
of progress payments under a contract
accounted for under a long-term
contract method of accounting could
give rise to a liability under section 752,
and, if so, how the regulations would
need to be revised to account for such
liabilities. No written comments were
received. However, if a contract
accounted for under a long-term
contract method of accounting is
contributed to a partnership, then, to the
extent that progress payments give rise
to a liability, section 752(b) would
require the transferring partner to
reduce its basis in its partnership by the

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Federal Register / Vol. 69, No. 136 / Friday, July 16, 2004 / Rules and Regulations
amount of that liability, either when the
contract is contributed (to the extent
that the liability is allocated to other
partners) or when the liability is
extinguished. Thus, because the
proposed regulations require the partner
to reduce the partner’s basis in its
partnership interest by the amount of
progress payments received, the
proposed regulations could require two
reductions in basis for the same
payments.
Ordinarily, progress payments do not
give rise to liabilities within the
meaning of section 752 and the
regulations thereunder. However, to the
extent that there is a case in which a
progress payment gives rise to such a
liability, the Treasury Department and
IRS agree that taxpayers should not be
required to reduce their basis twice for
the same progress payment, and believe
that a similar rule should be provided
for transfers to corporations.
Accordingly, upon a contribution of a
contract accounted for under a longterm contract method of accounting to a
partnership or corporation, the final
regulations provide that the required
reduction in basis for progress payments
received does not apply to the extent
that such progress payments give rise to
a liability (other than a liability
described in section 357(c)(3)).
Finally, one commentator suggested
that the regulations clarify that the fair
market value of a contract contributed to
a partnership does not necessarily equal
the full amount of expected remaining
profit on the contributed contract. The
Treasury Department and IRS believe
that it is sufficiently clear under the
proposed regulations that the fair
market value of the contributed contract
is determined under general tax
principles. Thus, this comment has not
been adopted.
Special Analyses
It has been determined that this
Treasury Decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations, and because the
regulations do not impose a collection
of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue
Code, these regulations were submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for
comment on its impact on small
businesses.

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Drafting Information
The principal authors of these
regulations are Matthew Lay and
Richard Probst of the Office of the
Associate Chief Counsel (Passthroughs
and Special Industries). However,
personnel from other offices of the
Treasury Department and IRS
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.

(C) Definition of old taxpayer and new
taxpayer for certain partnership
transactions.
(D) Exceptions to step-in-the-shoes rules for
S corporations.
(v) Special rules relating to certain
partnership transactions.
(A) Section 704(c).
(1) Contributions of contracts.
(2) Revaluations of partnership property.
(3) Allocation methods.
(B) Basis adjustments under sections 743(b)
and 734(b).
(C) Cross reference.
(D) Exceptions to step-in-the-shoes rules.

Adoption of Amendments to the
Regulations

*

Accordingly, 26 CFR part 1 is amended
as follows:

*

■

PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read, in part, as
follows:

■

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.460–0 is amended as
follows:
■ 1. Revising the entry for paragraph
1.460–4(k)(2)(iv).
■ 2. Adding entries for § 1.460–
4(k)(2)(iv)(A) through (E).
■ 3. Revising the entry for § 1.460–
4(k)(3)(iv).
■ 4. Revising the entry for § 1.460–
4(k)(3)(iv)(A)(2) and adding entries for
§ 1.460–4(k)(3)(iv)(C) and (D).
■ 5. Revising the entry for § 1.460–
4(k)(3)(v).
■ 6. Adding entries for § 1.460–
4(k)(3)(v)(A) through (D).
■ 7. Adding entries for § 1.460–
6(g)(3)(ii)(D)(1) and (2).
The revisions and additions read as
follows:
■

§ 1.460–0 Outline of regulations under
section 460.

*

*

*

*

*

§ 1.460–4 Methods of accounting for longterm contracts.

*

*

*

*

*

(k) * * *
(2) * * *
(iv) Special rules relating to distributions of
certain contracts by a partnership.
(A) In general.
(B) Old taxpayer.
(C) New taxpayer.
(D) Basis rules.
(E) Section 751.
(1) In general.
(2) Ordering rules.
(3) * * *
(iv) Special rules related to certain corporate
and partnership transactions.
(A) * * *
(2) Basis adjustment in excess of stock or
partnership interest basis.

*

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*

*

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*

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42553

*

§ 1.460–6

*

*

*

*

Look-back method.

*

*

*

(g) * * *
(3) * * *
(ii) * * *
(D) * * *
(1) In general.
(2) Special rules for certain pass-through
entity transactions.

*

*
*
*
*
Par. 3. Section 1.460–4 is amended as
follows:
■ 1. Revising the sixth sentence in
paragraph (k)(1).
■ 2. Revising paragraph (k)(2)(iv).
■ 3. Removing the first word ‘‘The’’ in
paragraph (k)(3)(i), adding in its place
‘‘Except as otherwise provided in
paragraph (k)(3)(v)(D) of this section,
the’’.
■ 4. Revising paragraph (k)(3)(i)(I).
■ 5. Redesignating paragraphs (k)(3)(i)(J),
(K) and (L) as paragraphs (k)(3)(i)(K), (L)
and (M), respectively.
■ 6. Adding a new paragraph (k)(3)(i)(J).
■ 7. Revising newly designated
paragraph (k)(3)(i)(K).
■ 8. Revising paragraph (k)(3)(iv).
■ 9. Revising paragraph (k)(3)(v).
■ 10. Adding paragraph (k)(5) Example 9
through Example 13.
■ 11. Revising the first sentence in
paragraph (k)(6).
The additions and revisions read as
follows.
■

§ 1.460–4 Methods of accounting for longterm contracts.

*

*
*
*
*
(k) * * *
(1) * * * Special rules relating to the
treatment of certain partnership
transactions are provided in paragraphs
(k)(2)(iv) and (k)(3)(v) of this section.
* * *
(2) * * *
(iv) Special rules relating to
distributions of certain contracts by a
partnership—(A) In general. The
constructive completion rules of
paragraph (k)(2) of this section apply
both to the distribution of a contract
accounted for under a long-term
contract method of accounting by a

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partnership to a partner and to the
distribution of an interest in a
partnership (lower-tier partnership)
holding (either directly or through other
partnerships) one or more contracts
accounted for under a long-term
contract method of accounting by
another partnership (upper-tier
partnership). Notwithstanding the
previous sentence, the constructive
completion rules of paragraph (k)(2) of
this section do not apply to a transfer by
a partnership (transferor partnership) of
all of its assets and liabilities to a
second partnership (transferee
partnership) in an exchange described
in section 721, followed by a
distribution of the interest in the
transferee partnership in liquidation of
the transferor partnership, under
§ 1.708–1(b)(4) (relating to terminations
under section 708(b)(1)(B)) or § 1.708–
1(c)(3)(i) (relating to certain partnership
mergers). If a partnership that holds a
contract accounted for under a longterm contract method of accounting
terminates under section 708(b)(1)(A)
because the number of its owners is
reduced to one, the entire contract will
be treated as being distributed from the
partnership for purposes of the
constructive completion rules, and the
partnership must apply paragraph (k)(2)
of this section immediately prior to the
transaction or transactions resulting in
the termination of the partnership.
(B) Old taxpayer. The partnership that
distributes the contract is treated as the
old taxpayer for purposes of paragraph
(k)(2)(ii) of this section. For purposes of
determining the total contract price (or
gross contract price) under paragraph
(k)(2)(ii) of this section, the fair market
value of the contract is treated as the
amount realized from the transaction.
For purposes of determining each
partner’s distributive share of
partnership items, any income or loss
resulting from the constructive
completion must be allocated among the
partners of the old taxpayer as though
the partnership closed its books on the
date of the distribution.
(C) New taxpayer. The partner
receiving the distributed contract is
treated as the new taxpayer for purposes
of paragraph (k)(2)(iii) of this section.
For purposes of determining the total
contract price (or gross contract price)
under paragraph (k)(2)(iii) of this
section, the new taxpayer’s basis in the
contract (including the uncompleted
property, if applicable) after the
distribution (as determined under
section 732) is treated as consideration
paid by the new taxpayer that is
allocable to the contract. Thus, the total
contract price (or gross contract price) of
the new contract is reduced by the

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partner’s basis in the contract (including
the uncompleted property, if applicable)
immediately after the distribution.
(D) Basis rules. For purposes of
determining the new taxpayer’s basis in
the contract (including the uncompleted
property, if applicable) under section
732, and the amount of any basis
adjustment under section 734(b), the
partnership’s basis in the contract
(including the uncompleted property, if
applicable) immediately prior to the
distribution is equal to—
(1) The partnership’s allocable
contract costs (including transaction
costs);
(2) Increased (or decreased) by the
amount of cumulative taxable income
(or loss) recognized by the partnership
on the contract through the date of the
distribution (including amounts
recognized as a result of the
constructive completion); and
(3) Decreased by the amounts that the
partnership has received or reasonably
expects to receive under the contract.
(E) Section 751—(1) In general.
Contracts accounted for under a longterm contract method of accounting are
unrealized receivables within the
meaning of section 751(c). For purposes
of section 751, the amount of ordinary
income or loss attributable to a contract
accounted for under a long-term
contract method of accounting is the
amount of income or loss that the
partnership would take into account
under the constructive completion rules
of paragraph (k)(2) of this section if the
contract were disposed of for its fair
market value in a constructive
completion transaction, adjusted to
account for any income or loss from the
contract that is allocated under section
706 to that portion of the taxable year
of the partnership ending on the date of
the distribution, sale, or exchange.
(2) Ordering rules. Because the
distribution of a contract accounted for
under a long-term contract method of
accounting is the distribution of an
unrealized receivable, section 751(b)
may apply to the distribution. A
partnership that distributes a contract
accounted for under a long-term
contract method of accounting must
apply paragraph (k)(2)(ii) of this section
before applying the rules of section
751(b) to the distribution.
(3) * * *
(i) * * *
(I) Contributions of contracts
accounted for under a long-term
contract method of accounting to which
section 721(a) applies;
(J) Contributions of property (other
than contracts accounted for under a
long-term contract method of
accounting) to a partnership that holds

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a contract accounted for under a longterm contract method of accounting;
(K) Transfers of partnership interests
(other than transfers which cause the
partnership to terminate under section
708(b)(1)(A));
*
*
*
*
*
(iv) Special rules related to certain
corporate and partnership
transactions—(A) Old taxpayer—basis
adjustment—(1) In general. Except as
provided in paragraph (k)(3)(iv)(A)(2) of
this section, in the case of a transaction
described in paragraph (k)(3)(i)(D), (E),
or (I) of this section, the old taxpayer
must adjust its basis in the stock or
partnership interest of the new taxpayer
by—
(i) Increasing such basis by the
amount of gross receipts the old
taxpayer has recognized under the
contract; and
(ii) Reducing such basis by the
amount of gross receipts the old
taxpayer has received or reasonably
expects to receive under the contract
(except to the extent such gross receipts
give rise to a liability other than a
liability described in section 357(c)(3)).
(2) Basis adjustment in excess of stock
or partnership interest basis. If the old
and new taxpayer do not join in the
filing of a consolidated Federal income
tax return, the old taxpayer may not
adjust its basis in the stock or
partnership interest of the new taxpayer
under paragraph (k)(3)(iv)(A)(1) of this
section below zero and the old taxpayer
must recognize ordinary income to the
extent the basis in the stock or
partnership interest of the new taxpayer
otherwise would be adjusted below
zero. If the old and new taxpayer join
in the filing of a consolidated Federal
income tax return, the old taxpayer
must create an (or increase an existing)
excess loss account to the extent the
basis in the stock of the new taxpayer
otherwise would be adjusted below zero
under paragraph (k)(3)(iv)(A)(1) of this
section. See § 1.1502–19 and 1.1502–
32(a)(3)(ii).
(3) Subsequent dispositions of certain
contracts. If the old taxpayer disposes of
a contract in a transaction described in
paragraph (k)(3)(i)(D), (E), or (I) of this
section that the old taxpayer acquired in
a transaction described in paragraph
(k)(3)(i)(D), (E), or (I) of this section, the
basis adjustment rule of this paragraph
(k)(3)(iv)(A) is applied by treating the
old taxpayer as having recognized the
amount of gross receipts recognized by
the previous old taxpayer under the
contract and any amount recognized by
the previous old taxpayer with respect
to the contract in connection with the
transaction in which the old taxpayer

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acquired the contract. In addition, the
old taxpayer is treated as having
received or as reasonably expecting to
receive under the contract any amount
the previous old taxpayer received or
reasonably expects to receive under the
contract. Similar principles will apply
in the case of multiple successive
transfers described in paragraph
(k)(3)(i)(D), (E), or (I) of this section
involving the contract.
(B) New taxpayer—(1) Contract price
adjustment. Generally, payments
between the old taxpayer and the new
taxpayer with respect to the contract in
connection with the transaction do not
affect the contract price.
Notwithstanding the preceding sentence
and paragraph (k)(3)(iii)(B) of this
section, however, in the case of
transactions described in paragraph
(k)(3)(i)(B), (D), (E), or (I) of this section,
the total contract price (or gross contract
price) must be reduced to the extent of
any amount recognized by the old
taxpayer with respect to the contract in
connection with the transaction (e.g.,
any amount recognized under section
351(b) or section 357 that is attributable
to the contract and any income
recognized by the old taxpayer pursuant
to the basis adjustment rule of
paragraph (k)(3)(iv)(A) of this section).
(2) Basis in contract. The new
taxpayer’s basis in a contract (including
the uncompleted property, if applicable)
acquired in a transaction described in
paragraphs (k)(3)(i)(A) through (E) or
paragraph (k)(3)(i)(I) of this section will
be computed under section 362, section
334, or section 723, as applicable. Upon
a new taxpayer’s completion (actual or
constructive) of a CCM or a PCM
contract acquired in a transaction
described in paragraphs (k)(3)(i)(A)
through (E) or paragraph (k)(3)(i)(I) of
this section, the new taxpayer’s basis in
the contract (including the uncompleted
property, if applicable) is reduced to
zero. The new taxpayer is not entitled
to a deduction or loss in connection
with any basis reduction pursuant to
this paragraph (k)(3)(iv)(B)(2).
(C) Definition of old taxpayer and new
taxpayer for certain partnership
transactions. For purposes of
paragraphs (k)(3)(ii), (iii) and (iv) of this
section, in the case of a transaction
described in paragraph (k)(3)(i)(I) of this
section, the partner contributing the
contract to the partnership is treated as
the old taxpayer, and the partnership
receiving the contract from the partner
is treated as the new taxpayer.
(D) Exceptions to step-in-the-shoes
rules for S corporations. Upon a transfer
described in paragraph (k)(3)(i)(F) of
this section or a conversion described in
paragraph (k)(3)(i)(G) of this section,

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paragraphs (k)(3)(ii) and (iii) of this
section apply to a contract accounted for
under a long-term contract method of
accounting only if the S corporation’s
books are closed under section
1362(e)(3), section 1362(e)(6)(C), section
1362(e)(6)(D), section 1377(a)(2), or
§ 1.1502–76 on the date of the transfer
or conversion. In these cases, the
corporation is treated as both the old
taxpayer and the new taxpayer for
purposes of paragraphs (k)(3)(ii) and (iii)
of this section. In all other cases
involving these transfers, the
corporation shall compute its income or
loss from each contract accounted for
under a long-term contract method of
accounting for the period that includes
the date of the transaction as though no
change in taxpayer had occurred with
respect to the contract, and must
allocate the income or loss from the
contract for that period in accordance
with the rules generally applicable to
transfers of S corporation stock and
conversions to or from S corporation
status. This paragraph (k)(3)(iv)(D) is
applicable for transactions on or after
July 16, 2004. In addition, this
paragraph (k)(3)(iv)(D) may be relied
upon for transactions on or after May
15, 2002.
(v) Special rules relating to certain
partnership transactions—(A) Section
704(c)—(1) Contributions of contracts.
The principles of section 704(c)(1)(A),
section 737, and the regulations
thereunder apply to income or loss with
respect to a contract accounted for
under a long-term contract method of
accounting that is contributed to a
partnership. The amount of built-in
income or built-in loss attributable to a
contributed contract that is subject to
section 704(c)(1)(A) is determined as
follows. First, the contributing partner
must take into account any income or
loss required under paragraph
(k)(3)(ii)(A) of this section for the period
ending on the date of the contribution.
Second, the partnership must determine
the amount of income or loss that the
contributing partner would take into
account if the contract were disposed of
for its fair market value in a constructive
completion transaction. This calculation
is treated as occurring immediately after
the partner has applied paragraph
(k)(3)(ii)(A) of this section, but before
the contribution to the partnership.
Finally, this amount is reduced by the
amount of income, if any, that the
contributing partner is required to
recognize as a result of the contribution.
(2) Revaluations of partnership
property. The principles of section
704(c) and § 1.704–3 apply to
allocations of income or loss with
respect to a long-term contract that is

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42555

revalued by a partnership under
§ 1.704–1(b)(2)(iv)(f). The amount of
built-in income or built-in loss
attributable to such a contract is equal
to the amount of income or loss that
would be taken into account if, at the
time of the revaluation, the contract
were disposed of for its fair market
value in a constructive completion
transaction.
(3) Allocation methods. In the case of
a contract accounted for under the CCM,
any built-in income or loss under
section 704(c) is taken into account in
the year the contract is completed. In
the case of a contract accounted for
under a long-term contract method of
accounting other than the CCM, any
built-in income or loss under section
704(c) must be taken into account in a
manner that reasonably accounts for the
section 704(c) income or loss over the
remaining term of the contract.
(B) Basis adjustments under sections
743(b) and 734(b). For purposes of
§§ 1.743–1(d), 1.755–1(b), and 1.755–
1(c), the amount of ordinary income or
loss attributable to a contract accounted
for under a long-term contract method
of accounting is the amount of income
or loss that the partnership would take
into account under the constructive
completion rules of paragraph (k)(2) of
this section if, at the time of the sale of
a partnership interest or the distribution
to a partner, the partnership disposed of
the contract for its fair market value in
a constructive completion transaction. If
all or part of the transferee’s basis
adjustment under section 743(b) or the
partnership’s basis adjustment under
section 734(b) is allocated to a contract
accounted for under a long-term
contract method of accounting, the basis
adjustment shall reduce or increase, as
the case may be, the affected party’s
income or loss from the contract. In the
case of a contract accounted for under
the CCM, the basis adjustment is taken
into account in the year in which the
contract is completed. In the case of a
contract accounted for under a longterm contract method of accounting
other than the CCM, the portion of that
basis adjustment that is recovered in
each taxable year of the partnership
must be determined by the partnership
in a manner that reasonably accounts for
the adjustment over the remaining term
of the contract.
(C) Cross reference. See paragraph
(k)(2)(iv)(E) of this section for rules
relating to the application of section 751
to the transfer of an interest in a
partnership holding a contract
accounted for under a long-term
contract method of accounting.
(D) Exceptions to step-in-the-shoes
rules. Upon a contribution described in

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paragraph (k)(3)(i)(J) of this section, a
transfer described in paragraph
(k)(3)(i)(K) of this section, or a
distribution described in paragraph
(k)(3)(i)(L) of this section, paragraphs
(k)(3)(ii) and (iii) of this section apply to
a contract accounted for under a longterm contract method of accounting
only if the partnership’s books are
properly closed with respect to that
contract under section 706. In these
cases, the partnership is treated as both
the old taxpayer and the new taxpayer
for purposes of paragraphs (k)(3)(ii) and
(iii) of this section. In all other cases
involving these transactions, the
partnership shall compute its income or
loss from each contract accounted for
under a long-term contract method of
accounting for the period that includes
the date of the transaction as though no
change in taxpayer had occurred with
respect to the contract, and must
allocate the income or loss from the
contract for that period under a
reasonable method complying with
section 706.
*
*
*
*
*
(5) * * *
Example 9. Constructive completion—
PCM—distribution of contract by partnership
—(i) Facts. In Year 1, W, X, Y, and Z each
contribute $100,000 to form equal
partnership PRS. In Year 1, PRS enters into
a contract. The total contract price is
$1,000,000 and the estimated total allocable
contract costs are $800,000. In Year 1, PRS
incurs costs of $600,000 and receives
$650,000 in progress payments under the
contract. Under the contract, PRS performed
all of the services required in order to be
entitled to receive the progress payments,
and there was no obligation to return the
payments or perform any additional services
in order to retain the payments. PRS properly
accounts for the contract under the PCM. In
Year 2, PRS distributes the contract to X in
liquidation of X’s interest. PRS incurs no
costs and receives no progress payments in
Year 2 prior to the distribution. At the time
of the distribution, PRS’s only asset other
than the long-term contract and the partially
constructed property is $450,000 cash
($400,000 initially contributed and $50,000
in excess progress payments). The fair market
value of the contract is $150,000. Pursuant to
the distribution, X assumes PRS’s contract
obligations and rights. In Year 2, X incurs
additional allocable contract costs of $50,000.
X correctly estimates at the end of Year 2 that
X will have to incur an additional $75,000 of
allocable contract costs in Year 3 to complete
the contract (rather than $150,000 as
originally estimated by PRS). Assume that X
properly accounts for the contract under the
PCM, that PRS has no income or loss other
than income or loss from the contract, and
that PRS has an election under section 754
in effect in Year 2.
(ii) Tax consequences to PRS. For Year 1,
PRS reports receipts of $750,000 (the
completion factor multiplied by total contract

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price ($600,000/$800,000 × $1,000,000)) and
costs of $600,000, for a profit of $150,000,
which is allocated equally among W, X, Y,
and Z ($37,500 each). Immediately prior to
the distribution of the contract to X in Year
2, the contract is deemed completed. Under
paragraph (k)(2)(iv)(B) of this section, the fair
market value of the contract ($150,000) is
treated as the amount realized from the
transaction. For purposes of applying the
PCM in Year 2, the total contract price is
$800,000 (the sum of the amounts received
under the contract and the amount treated as
realized from the transaction ($650,000 +
$150,000)) and the total allocable contract
costs are $600,000. Thus, in Year 2 PRS
reports receipts of $50,000 (total contract
price minus receipts already reported
($800,000 ¥ $750,000)), and costs incurred
in Year 2 of $0, for a profit of $50,000. Under
paragraph (k)(2)(iv)(B) of this section, this
profit must be allocated among W, X, Y, and
Z as though the partnership closed its books
on the date of the distribution. Accordingly,
each partner’s distributive share of this
income is $12,500.
(iii) Tax consequences to X. X’s basis in its
interest in PRS immediately prior to the
distribution is $150,000 (X’s $100,000 initial
contribution, increased by $37,500, X’s
distributive share of Year 1 income, and
$12,500, X’s distributive share of Year 2
income). Under paragraph (k)(2)(iv)(D) of this
section, PRS’s basis in the contract (including
the uncompleted property, if applicable)
immediately prior to the distribution is equal
to $150,000 (the partnership’s allocable
contract costs, $600,000, increased by the
amount of income recognized by PRS on the
contract through the date of the distribution
(including amounts recognized as a result of
the constructive completion), $200,000,
decreased by the amounts that the
partnership has received or reasonably
expects to receive under the contract,
$650,000). Under section 732, X’s basis in the
contract (including the uncompleted
property) after the distribution is $150,000.
Under paragraph (k)(2)(iv)(C) of this section,
X’s basis in the contract (including the
uncompleted property) is treated as
consideration paid by X that is allocable to
the contract. X’s total contract price is
$200,000 (the amount remaining to be paid
under the terms of the contract less the
consideration allocable to the contract
($350,000–$150,000)). For Year 2, X reports
receipts of $80,000 (the completion factor
multiplied by the total contract price
[($50,000/$125,000) x $200,000]) and costs of
$50,000 (the costs incurred after the
distribution of the contract), for a profit of
$30,000. For Year 3, X reports receipts of
$120,000 (the total contract price minus
receipts already reported ($200,000 ¥
$80,000)) and costs of $75,000, for a profit of
$45,000.
(iv) Section 734(b). Because X’s basis in the
contract (including the uncompleted
property) immediately after the distribution,
$150,000, is equal to PRS’s basis in the
contract (including the uncompleted
property) immediately prior to the
distribution, there is no basis adjustment
under section 734(b).
Example 10. Constructive completion—
CCM—distribution of contract by partnership

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—(i) Facts. The facts are the same as in
Example 9, except that PRS and X properly
account for the contract under the CCM.
(ii) Tax consequences to PRS. PRS reports
no income or costs from the contract in Year
1. Immediately prior to the distribution of the
contract to X in Year 2, the contract is
deemed completed. Under paragraph
(k)(2)(iv)(B) of this section, the fair market
value of the contract ($150,000) is treated as
the amount realized from the transaction. For
purposes of applying the CCM in Year 2, the
gross contract price is $800,000 (the sum of
the amounts received under the contract and
the amount treated as realized from the
transaction ($650,000 + $150,000)) and the
total allocable contract costs are $600,000.
Thus, in Year 2 PRS reports profits of
$200,000 ($800,000 ¥ $600,000). This profit
must be allocated among W, X, Y, and Z as
though the partnership closed its books on
the date of the distribution. Accordingly,
each partner’s distributive share of this
income is $50,000.
(iii) Tax consequences to X. X’s basis in its
interest in PRS immediately prior to the
distribution is $150,000 ($100,000 initial
contribution, increased by $50,000, X’s
distributive share of Year 2 income). Under
paragraph (k)(2)(iv)(D) of this section, PRS’s
basis in the contract (including the
uncompleted property, if applicable)
immediately prior to the distribution is equal
to $150,000 (the partnership’s allocable
contract costs, $600,000, increased by the
amount of cumulative taxable income
recognized by PRS on the contract through
the date of the distribution (including
amounts recognized as a result of the
constructive completion), $200,000,
decreased by the amounts that the
partnership has received or reasonably
expects to receive under the contract,
$650,000). Under section 732, X’s basis in the
contract (including the uncompleted
property) after the distribution is $150,000.
Under paragraph (k)(2)(iv)(C) of this section,
X’s basis in the contract is treated as
consideration paid by X that is allocable to
the contract. Under the CCM, X reports no
gross receipts or costs in Year 2. For Year 3,
the completion year, X reports its gross
contract price of $200,000 (the amount
remaining to be paid under the terms of the
contract less the consideration allocable to
the contract ($350,000 ¥ $150,000)) and its
total allocable contract costs of $125,000 (the
allocable contract costs that X incurred to
complete the contract ($50,000 + $75,000)),
for a profit of $75,000.
(iv) Section 734(b). The results under
section 734(b) are the same as in Example 9.
Example 11. Step-in-the-shoes—PCM—
contribution of contract to partnership —(i)
Facts. In Year 1, X enters into a contract that
X properly accounts for under the PCM. The
total contract price is $1,000,000 and the
estimated total allocable contract costs are
$800,000. In Year 1, X incurs costs of
$600,000 and receives $650,000 in progress
payments under the contract. Under the
contract, X performed all of the services
required in order to be entitled to receive the
progress payments, and there was no
obligation to return the payments or perform
any additional services in order to retain the

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payments. In Year 2, X contributes the
contract (including the uncompleted
property) with a basis of $0 and $125,000 of
cash to partnership PRS in exchange for a
one-fourth partnership interest. X incurs
costs of $10,000, and receives no progress
payments in Year 2 prior to the contribution
of the contract. X and the other three partners
of PRS share equally in its capital, profits,
and losses. The parties determine that, at the
time of the contribution, the fair market value
of the contract is $160,000. Following the
contribution in Year 2, PRS incurs additional
allocable contract costs of $40,000. PRS
correctly estimates at the end of Year 2 that
it will have to incur an additional $75,000 of
allocable contract costs in Year 3 to complete
the contract (rather than $150,000 as
originally estimated by PRS).
(ii) Tax consequences to X. For Year 1, X
reports receipts of $750,000 (the completion
factor multiplied by the total contract price
($600,000/$800,000 × $1,000,000)) and costs
of $600,000, for a profit of $150,000. Because
the mid-contract change in taxpayer results
from a transaction described in paragraph
(k)(3)(i)(I) of this section, X is not treated as
completing the contract in Year 2. Under
paragraph (k)(3)(ii)(A) of this section, for
Year 2, X reports receipts of $12,500 (the
completion factor multiplied by the total
contract price ($610,000/$800,000 ×
$1,000,000, or $762,500), decreased by
receipts already reported, $750,000) and
costs of $10,000, for a profit of $2,500. Under
section 722, X’s initial basis in its interest in
PRS is $125,000. Pursuant to paragraph
(k)(3)(iv)(A)(1) of this section, X must
increase its basis in its interest in PRS by the
amount of gross receipts X recognized under
the contract, $762,500, and reduce its basis
by the amount of gross receipts X received
under the contract, the $650,000 in progress
payments. Accordingly, X’s basis in its
interest in PRS is $237,500.
(iii) Tax consequences to PRS. Because the
mid-contract change in taxpayer results from
a step-in-the-shoes transaction, PRS must
account for the contract using the same
methods of accounting used by X prior to the
transaction. The total contract price is the
sum of any amounts that X and PRS have
received or reasonably expect to receive
under the contract, and total allocable
contract costs are the allocable contract costs
of X and PRS. For Year 2, PRS reports
receipts of $134,052 (the completion factor
multiplied by the total contract price
[($650,000/$725,000) ¥ $1,000,000],
$896,552, decreased by receipts reported by
X, $762,500) and costs of $40,000, for a profit
of $94,052. For Year 3, PRS reports receipts
of $103,448 (the total contract price minus
prior year receipts ($1,000,000 × $896,552))
and costs of $75,000, for a profit of $28,448.
(iv) Section 704(c). The principles of
section 704(c) and § 1.704–3 apply to
allocations of income or loss with respect to
the contract contributed by X. In this case,
the amount of built-in income that is subject
to section 704(c) is the amount of income or
loss that the contributing partner would take
into account if the contract were disposed of
for its fair market value in a constructive
completion transaction. This calculation is
treated as occurring immediately after the

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partner has applied paragraph (k)(3)(ii)(A) of
this section, but before the contribution to
the partnership. In a constructive completion
transaction, the total contract price would be
$810,000 (the sum of the amounts received
under the contract and the amount realized
in the deemed sale ($650,000 + $160,000)). X
would report receipts of $47,500 (total
contract price minus receipts already
reported ($810,000 ¥ $762,500)) and costs of
$0, for a profit of $47,500. Thus, the amount
of built-in income that is subject to section
704(c) is $47,500. The partnership must
apply section 704(c) to this income in a
manner that reasonably accounts for the
income over the remaining term of the
contract. For example, in Year 2, PRS could
allocate $26,810 to X under section 704(c)
(the amount of built-in income, $47,500,
multiplied by a fraction, the numerator of
which is the completion factor for the year,
$650,000/725,000, less the completion factor
for the prior year, $610,000/$800,000, and
the denominator of which is 100 percent
reduced by the completion factor for the
taxable year preceding the event creating the
section 704(c) income or loss, $610,000/
$800,000). The remaining $67,242 would be
allocated equally among all of the partners.
In Year 3, the completion year, PRS could
allocate $20,690 to X under section 704(c)
($47,500 × [($725,000/$725,000 ¥$650,000/
$725,000) / (100 percent ¥ $610,000/
$800,000)]). The remaining $7,758 would be
allocated equally among all the partners.
Example 12. Step-in-the-shoes—CCM—
contribution of contract to partnership —(i)
Facts. The facts are the same as in Example
11, except that X and PRS properly account
for the contract under the CCM, and X has
a basis of $610,000 in the contract (including
the uncompleted property).
(ii) Tax consequences to X. X reports no
income or costs from the contract in Years 1
or 2. X is not treated as completing the
contract in Year 2. Under section 722, X’s
initial basis in its interest in PRS is $735,000
(the sum of $125,000 cash and X’s basis of
$610,000 in the contract (including the
uncompleted property)). Pursuant to
paragraph (k)(3)(iv)(A)(1)(ii) of this section, X
must reduce its basis in its interest in PRS
by the amount of gross receipts X received
under the contract, or $650,000. Accordingly,
X’s basis in its interest in PRS is $85,000.
(iii) Tax consequences to PRS. PRS must
account for the contract using the same
methods of accounting used by X prior to the
transaction. Under the CCM, PRS reports no
gross receipts or costs in Year 2. For Year 3,
the completion year, PRS reports its gross
contract price of $1,000,000 (the sum of any
amounts that X and PRS have received or
reasonably expect to receive under the
contract), and total allocable contract costs of
$725,000 (the allocable contract costs of X
and PRS), for a profit of $275,000.
(iv) Section 704(c). In this case, the amount
of built-in income that is subject to section
704(c) is the amount of income or loss that
the contributing partner would take into
account if the contract were disposed of for
its fair market value in a constructive
completion transaction. This calculation is
treated as occurring immediately after the
partner has applied paragraph (k)(3)(ii)(A) of

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42557

this section, but before the contribution to
the partnership. In a constructive completion
transaction, X would report its gross contract
price of $810,000 (the sum of the amounts
received under the contract and the amount
realized in the deemed sale ($650,000 +
$160,000)) and its total allocable contract
costs of $610,000, for a profit of $200,000.
Thus, the amount of built-in income that is
subject to section 704(c) is $200,000. Out of
PRS’s income of $275,000, in Year 3,
$200,000 must be allocated to X under
section 704(c), and the remaining $75,000 is
allocated equally among all of the partners.
Example 13. Step-in-the-shoes—PCM—
transfer of a partnership interest —(i) Facts.
In Year 1, W, X, Y, and Z each contribute
$100,000 to form equal partnership PRS. In
Year 1, PRS enters into a contract. The total
contract price is $1,000,000 and the
estimated total allocable contract costs are
$800,000. In Year 1, PRS incurs costs of
$600,000 and receives $650,000 in progress
payments under the contract. Under the
contract, PRS performed all of the services
required in order to be entitled to receive the
progress payments, and there was no
obligation to return the payment or perform
any additional services in order to retain the
payments. PRS properly accounts for the
contract under the PCM. In Year 2, W
transfers W’s interest in PRS to T for
$150,000. Assume that $10,000 of PRS’s Year
2 costs are incurred prior to the transfer,
$40,000 are incurred after the transfer; and
that PRS receives no progress payments in
Year 2. Also assume that the fair market
value of the contract on the date of the
transfer is $160,000, that PRS closes its books
with respect to the contract under section
706 on the date of the transfer, and that PRS
correctly estimates at the end of Year 2 that
it will have to incur an additional $75,000 of
allocable contract costs in Year 3 to complete
the contract (rather than $150,000 as
originally estimated by PRS).
(ii) Income reporting for period ending on
date of transfer. For Year 1, PRS reports
receipts of $750,000 (the completion factor
multiplied by total contract price ($600,000/
$800,000 × $1,000,000)) and costs of
$600,000, for a profit of $150,000. This profit
is allocated equally among W, X, Y, and Z
($37,500 each). Under paragraph (k)(3)(ii)(A)
of this section, for the part of Year 2 ending
on the date of the transfer of W’s interest,
PRS reports receipts of $12,500 (the
completion factor multiplied by the total
contract price ($610,000/$800,000 ×
$1,000,000) minus receipts already reported
($750,000)) and costs of $10,000 for a profit
of $2,500. This profit is allocated equally
among W, X, Y, and Z ($625 each).
(iii) Income reporting for period after
transfer. PRS must continue to use the PCM.
For the part of Year 2 beginning on the day
after the transfer, PRS reports receipts of
$134,052 (the completion factor multiplied
by the total contract price decreased by
receipts reported by PRS for the period
ending on the date of the transfer [($650,000/
$725,000 × $1,000,000)—$762,500]) and costs
of $40,000, for a profit of $94,052. This profit
is shared equally among T, X, Y, and Z
($23,513 each). For Year 3, PRS reports
receipts of $103,448 (the total contract price

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minus prior year receipts ($1,000,000 ¥
$896,552)) and costs of $75,000, for a profit
of $28,448. The profit for Year 3 is shared
equally among T, X, Y, and Z ($7,112 each).
(iv) Tax Consequences to W. W’s amount
realized is $150,000. W’s adjusted basis in its
interest in PRS is $138,125 ($100,000
originally contributed, plus $37,500, W’s
distributive share of PRS’s Year 1 income,
and $625, W’s distributive share of PRS’s
Year 2 income prior to the transfer).
Accordingly, W’s income from the sale of W’s
interest in PRS is $11,875. Under paragraph
(k)(2)(iv)(E) of this section, for purposes of
section 751(a), the amount of ordinary
income attributable to the contract is
determined as follows. First, the partnership
must determine the amount of income or loss
from the contract that is allocated under
section 706 to the period ending on the date
of the sale ($625). Second, the partnership
must determine the amount of income or loss
that the partnership would take into account
under the constructive completion rules of
paragraph (k)(2) of this section if the contract
were disposed of for its fair market value in
a constructive completion transaction.
Because PRS closed its books under section
706 with respect to the contract on the date
of the sale, this calculation is treated as
occurring immediately after the partnership
has applied paragraph (k)(3)(ii)(A) of this
section on the date of the sale. In a
constructive completion transaction, the total
contract price would be $810,000 (the sum of
the amounts received under the contract and
the amount realized in the deemed sale
($650,000 + $160,000)). PRS would report
receipts of $47,500 (total contract price
minus receipts already reported ($810,000 ¥
$762,500)) and costs of $0, for a profit of
$47,500. Thus, the amount of ordinary
income attributable to the contract is
$47,500, and W’s share of that income is
$11,875. Thus, under § 1.751–1(a), all of W’s
$11,875 of income from the sale of W’s
interest in PRS is ordinary income.
(v) Tax Consequences to T. T’s adjusted
basis for its interest in PRS is $150,000.
Under § 1.743–1(d)(2), the amount of income
that would be allocated to T if the contract
were disposed of for its fair market value
(adjusted to account for income from the
contract for the portion of PRS’s taxable year
that ends on the date of the transfer) is
$11,875. Under § 1.743–1(b), the amount of
T’s basis adjustment under section 743(b) is
$11,875. Under paragraph (k)(3)(v)(B) of this
section, the portion of T’s basis adjustment
that is recovered in Year 2 and Year 3 must
be determined by PRS in a manner that
reasonably accounts for the adjustment over
the remaining term of the contract. For
example, PRS could recover $6,703 of the
adjustment in Year 2 (the amount of the basis
adjustment, $11,875, multiplied by a fraction,
the numerator of which is the excess of the
completion factor for the year, $650,000/
$725,000, less the completion factor for the
prior year, $610,000/$800,000, and the
denominator of which is 100 percent reduced
by the completion factor for the taxable year
preceding the transfer, $610,000/$800,000).
T’s distributive share of income in Year 2
from the contract would be adjusted from
$23,513 to $16,810 as a result of the basis

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adjustment. In Year 3, the completion year,
PRS could recover $5,172 of the adjustment
($11,875 × [($725,000/$725,000 ¥$650,000/
$725,000) / (100 percent ¥ $610,000/
$800,000)]). T’s distributive share of income
in Year 3, the completion year, from the
contract would be adjusted from $7,112 to
$1,940 as a result of the basis adjustment.

*

*
*
*
*
(6) Effective date. Except as provided
in paragraph (k)(3)(iv)(D) of this section,
this paragraph (k) is applicable for
transactions on or after May 15, 2002.
* * *
■ Par. 4. Section 1.460–6 is amended by
revising paragraphs (g)(3)(ii)(D) and
(g)(4) to read as follows:
§ 1.460–6

Look-back method.

*

*
*
*
*
(g) * * *
(3) * * *
(ii) * * *
(D) Information old taxpayer must
provide—(1) In general. Except as
provided in paragraph (g)(3)(ii)(D)(2) of
this section, in order to help the new
taxpayer to apply the look-back method
with respect to pre-transaction taxable
years, any old taxpayer that accounted
for income from a long-term contract
under the PCM or PCCM for either
regular or alternative minimum tax
purposes is required to provide the
information described in this paragraph
to the new taxpayer by the due date (not
including extensions) of the old
taxpayer’s income tax return for the first
taxable year ending on or after a stepin-the-shoes transaction described in
§ 1.460–4(k)(3)(i). The required
information is as follows—
(i) The portion of the contract
reported by the old taxpayer under PCM
for regular and alternative minimum tax
purposes (i.e., whether the old taxpayer
used PCM, the 40/60 PCCM method, or
the 70/30 PCCM method);
(ii) Any submethods used in the
application of PCM (e.g., the simplified
cost-to-cost method or the 10-percent
method);
(iii) The amount of total contract price
reported by year;
(iv) The numerator and the
denominator of the completion factor by
year;
(v) The due date (not including
extensions) of the old taxpayer’s income
tax returns for each taxable year in
which income was required to be
reported;
(vi) Whether the old taxpayer was a
corporate or a noncorporate taxpayer by
year; and
(vii) Any other information required
by the Commissioner by administrative
pronouncement.
(2) Special rules for certain passthrough entity transactions. For

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purposes of paragraph (g)(3)(ii)(D)(1) of
this section, in the case of a transaction
described in § 1.460–4(k)(3)(i)(I), the
contributing partner is treated as the old
taxpayer, and the partnership is treated
as the new taxpayer. In the case of
transactions described in § 1.460–
4(k)(3)(i)(F), (G), (J), (K), or (L), the old
taxpayer is not required to provide the
information described in paragraph
(g)(3)(ii)(D)(1) of this section, because
information necessary for the new
taxpayer to apply the look-back method
is provided by the pass-through entity.
This paragraph (g)(3)(ii)(D) is applicable
for transactions on or after August 6,
2003.
*
*
*
*
*
(4) Effective date. Except as provided
in paragraph (g)(3)(ii)(D) of this section,
this paragraph (g) is applicable for
transactions on or after May 15, 2002.
*
*
*
*
*
■ Par. 5. In § 1.704–3, a sentence is
added at the end of paragraph (a)(3)(ii) to
read as follows:
§ 1.704–3

Contributed property.

(a) * * *
(3) * * *
(ii) * * * See § 1.460–4(k)(3)(v)(A) for
a rule relating to the amount of built-in
income or built-in loss attributable to a
contract accounted for under a longterm contract method of accounting.
*
*
*
*
*
■ Par. 6. Section 1.722–1 is amended by
adding a sentence between the sixth and
seventh sentences to read as follows:
§ 1.722–1
interest.

Basis of contributing partner’s

* * * See § 1.460–4(k)(3)(iv)(A) for
rules relating to basis adjustments
required where a contract accounted for
under a long-term contract method of
accounting is transferred in a
contribution to which section 721(a)
applies.
*
*
*
*
*
■ Par. 7. A sentence is added at the end
of § 1.723–1 to read as follows:
§ 1.723–1 Basis of property contributed to
partnership.

* * * See § 1.460–4(k)(3)(iv)(B)(2) for
rules relating to adjustments to the basis
of contracts accounted for using a longterm contract method of accounting that
are acquired in certain contributions to
which section 721(a) applies.
Par. 8. In § 1.732–1, a sentence is
added at the end of paragraph (c)(1)(i) to
read as follows:

■

§ 1.732–1 Basis of distributed property
other than money.

*

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Federal Register / Vol. 69, No. 136 / Friday, July 16, 2004 / Rules and Regulations
(c) * * *
(1) * * *
(i) * * * See § 1.460–4(k)(2)(iv)(D) for
a rule determining the partnership’s
basis in a long-term contract accounted
for under a long-term contract method
of accounting.
*
*
*
*
*
■ Par. 9. In § 1.734–1, the undesignated
paragraph immediately following
paragraph (b)(1)(ii) is revised to read as
follows:

accounted for under a long-term
contract method of accounting.
*
*
*
*
*
■ Par. 12. Section 1.755–1 is amended as
follows.
■ 1. Adding a sentence at the end of
paragraph (b)(1)(ii).
■ 2. Paragraph (c)(5) is redesignated as
paragraph (c)(6).
■ 3. New paragraph (c)(5) is added.
The additions read as follows:

§ 1.734–1 Optional adjustment to basis of
undistributed partnership property.

*

*

*
*
*
*
(b) * * *
(1) * * *
(ii) * * *
See § 1.460–4(k)(2)(iv)(D) for a rule
determining the partnership’s basis in a
long-term contract accounted for under
a long-term contract method of
accounting. The provisions of this
paragraph (b)(1) are illustrated by the
following examples:
*
*
*
*
*
■ Par. 10. Section 1.743–1 is amended as
follows:
■ 1. A sentence is added at the end of
paragraph (d)(2).
■ 2. A sentence is added at the end of
paragraph (j)(2).
The additions read as follows:
§ 1.743–1 Optional adjustment to basis of
partnership property.

*

*
*
*
*
(d) * * *
(2) * * * See § 1.460–4(k)(3)(v)(B) for
a rule relating to the computation of
income or loss that would be allocated
to the transferee from a contract
accounted for under a long-term
contract method of accounting as a
result of the hypothetical transaction.
*
*
*
*
*
(j) * * *
(2) * * * See § 1.460–4(k)(3)(v)(B) for
rules relating to the effect of a basis
adjustment under section 743(b) that is
allocated to a contract accounted for
under a long-term contract method of
accounting in determining the
transferee’s distributive share of income
or loss from the contract.
*
*
*
*
*
■ Par. 11. In § 1.751–1, a sentence is
added at the end of paragraph (a)(2) to
read as follows:
§ 1.751–1 Unrealized receivables and
inventory items.

(a) * * *
(2) * * * See § 1.460–4(k)(2)(iv)(E) for
rules relating to the amount of ordinary
income or loss attributable to a contract

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§ 1.755–1

Rules for allocation of basis.

*
*
*
*
(b) * * *
(1) * * *
(ii) * * * See § 1.460–4(k)(3)(v)(B) for
a rule relating to the computation of
income or loss that would be allocated
to the transferee from a contract
accounted for under a long-term
contract method of accounting as a
result of the hypothetical transaction.
*
*
*
*
*
(c) * * *
(5) Cross reference. See § 1.460–
4(k)(3)(v)(B) for a rule relating to the
computation of unrealized appreciation
or depreciation in a contract accounted
for under a long-term contract method
of accounting.
*
*
*
*
*
■ Par. 13. Section 1.1362–3 is amended
by adding a sentence at the end of
paragraph (a) to read as follows:
§ 1.1362–3
year.

Treatment of S termination

(a) * * * See § 1.460–4(k)(3)(iv)(D) for
rules relating to the computation of the
S corporation’s income or loss from a
contract accounted for under a longterm contract method of accounting in
the S termination year.
*
*
*
*
*
■ Par. 14. Section 1.1377–1 is amended
by adding a sentence is at the end of
paragraph (a)(1) to read as follows:
§ 1.1377–1

Pro rata share.

(a) * * *
(1) * * * See § 1.460–4(k)(3)(iv)(D)
for rules relating to the computation of
the shareholders’ pro rata share of S
corporation’s income or loss from a
contract accounted for under a longterm contract method of accounting.
*
*
*
*
*
Mark E. Matthews,
Deputy Commissioner for Services and
Enforcement.
Approved: July 1, 2004.
Gregory Jenner,
Acting Assistant Secretary of the Treasury.
[FR Doc. 04–15833 Filed 7–15–04; 8:45 am]
BILLING CODE 4830–01–P

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42559

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9138]
RIN 1545–BD12

Transitional Rule for Vested Accrued
Vacation Pay
Internal Revenue Service (IRS),
Treasury.
ACTION: Removal of temporary
regulation.
AGENCY:

SUMMARY: This document removes a
temporary regulation that provides a
rule for an election to deduct vested
accrued vacation pay for the first taxable
year ending after July 18, 1984. The
repeal of the underlying code section in
1987 has rendered the temporary
regulation obsolete. The removal of this
regulation will not affect taxpayers.
DATE: This Treasury decision is effective
on July 15, 2004.
FOR FURTHER INFORMATION CONTACT:
Jamie J. Kim at (202) 622–4950 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:

Background
Prior to repeal in 1987, section 463 of
the Internal Revenue Code (Code)
permitted taxpayers to elect to deduct
reasonable additions to a reserve
account for vacation pay, including
amounts earned by employees before
the close of the taxable year that,
because of contingencies, would not be
deductible under section 162(a) as an
accrued expense. In connection with the
enactment of the economic performance
rules under section 461(h), section 91(i)
of the Tax Reform Act of 1984, Public
Law 98–369 (98 Stat. 494, 609),
provided a transitional rule under
which certain taxpayers could make an
election under section 463 for the first
taxable year ending after July 18, 1984.
On February 4, 1986, the IRS and
Treasury published temporary
regulation § 1.463–1T (TD 8073) in the
Federal Register (51 FR 4312), as
amended on April 2, 1986, (51 FR
11302), to provide guidance on making
the election under section 463 pursuant
to the transitional rule. The repeal of
section 463 by section 10201(a) of the
Revenue Act of 1987, Public Law 100–
203 (101 Stat. 1330–382, 1330–387), has
rendered temporary regulation § 1.463–
1T obsolete.
Special Analyses
It has been determined that the
removal of this regulation is not a

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