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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9945]
RIN 1545–BO81

Guidance Under Section 1061
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:

This document contains final
regulations that provide guidance under
section 1061 of the Internal Revenue
Code (Code). Section 1061
recharacterizes certain net long-term
capital gains of a partner that holds one
or more applicable partnership interests
as short-term capital gains. An
applicable partnership interest is an
interest in a partnership that is
transferred to or held by a taxpayer,
directly or indirectly, in connection
with the performance of substantial
services by the taxpayer, or any other
related person, in any applicable trade
or business. These final regulations also
amend existing regulations on holding
periods to clarify the holding period of
a partner’s interest in a partnership that
includes in whole or in part an
applicable partnership interest and/or a
profits interest. These regulations affect
taxpayers who directly or indirectly
hold applicable partnership interests in
partnerships and the passthrough
entities through which the applicable
partnership interest is held.
DATES:
Effective date: These regulations are
effective on January 13, 2021.
Applicability date: For dates of
applicability, see §§ 1.702–1(g), 1.704–
3(f), 1.1061–1(b), 1.1061–2(c), 1.1061–
3(f), 1.1061–4(d), 1.1061–5(g), 1.1061–
6(e), and 1.1223–3(g).
FOR FURTHER INFORMATION CONTACT: Kara
K. Altman or Sonia K. Kothari at (202)
317–6850 or Wendy L. Kribell at (202)
317–5279 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
SUMMARY:

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Background
This document contains final
regulations under section 1061 of the
Code to amend the Income Tax
Regulations (26 CFR part 1). Section
1061 was added to the Code on
December 22, 2017, by section 13309 of
Public Law 115–97, 131 Stat. 2054
(2017), commonly referred to as the Tax
Cuts and Jobs Act (TCJA). Section 1061
applies to taxable years beginning after
December 31, 2017. Section 1061
recharacterizes certain net long-term

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capital gain with respect to applicable
partnership interests (APIs) as shortterm capital gain.
On August 14, 2020, the Department
of the Treasury (Treasury Department)
and the IRS published a notice of
proposed rulemaking (REG–107213–18)
in the Federal Register (85 FR 49754)
containing proposed regulations under
sections 702, 704, 1061, and 1223 of the
Code (proposed regulations). The
Treasury Department and the IRS
received written and electronic
comments responding to the proposed
regulations. No public hearing was
requested or held. All comments are
available at www.regulations.gov or
upon request. After full consideration of
all comments timely received, this
Treasury decision adopts the proposed
regulations with modifications in
response to the comments as described
in the Summary of Comments and
Explanation of Revisions section of this
preamble.
Summary of Comments and
Explanation of Revisions
Most of the comments addressing the
proposed regulations are summarized in
this Summary of Comments and
Explanation of Revisions. However,
non-substantive comments or comments
merely summarizing or interpreting the
proposed regulations, recommending
statutory revisions, or addressing
provisions outside the scope of these
final regulations are not discussed in
this preamble.
The final regulations retain the
structure of the proposed regulations,
with certain revisions. Section 1.1061–
1 provides definitions of the terms used
in §§ 1.1061–1 through 1.1061–6 of
these final regulations (Section 1061
Regulations or final regulations).
Section 1.1061–2 provides rules and
examples regarding APIs and applicable
trades or businesses (ATBs). Section
1.1061–3 provides guidance on the
exceptions to the definition of an API,
including the capital interest exception.
Section 1.1061–4 provides guidance on
the computation of the
Recharacterization Amount and gives
computation examples. Section 1.1061–
5 provides guidance regarding the
application of section 1061(d) to
transfers to certain related parties.
Section 1.1061–6 provides reporting
rules. Because the application of section
1061 requires a clear determination of
the holding period of a partnership
interest that is, in whole or in part, an
API, the final regulations also provide
clarifying amendments to § 1.1223–3.
Additional clarifying amendments to
§§ 1.702–1(a)(2) and 1.704–3(e) are also
provided.

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Part I of this Summary of Comments
and Explanation of Revisions provides
an overview of the statutory provisions
and defined terms used in the proposed
and final regulations. Part II describes
the comments received and revisions
made in response to those comments
with respect to the following four areas
of the proposed regulations: (1) The
capital interest exception; (2) the
treatment of capital interests acquired
with loan proceeds; (3) the Lookthrough
Rule for certain API dispositions; and
(4) transfers of APIs to Section 1061(d)
Related Persons. Part III discusses
additional comments received and
revisions made in other areas of the
proposed regulations. Part IV
summarizes comments received on
issues related to section 1061 that are
beyond the scope of the regulations and
are under study. Part V discusses
applicability dates for the final
regulations. In addition to the revisions
made in response to comments,
clarifying changes have been made
throughout the final regulations.
I. Overview and Defined Terms
A. Section 1061(a): Recharacterization
Amount, Owner Taxpayer, and Related
Concepts
1. Recharacterization Amount
Section 1061(a) recharacterizes as
short-term capital gain the difference
between a taxpayer’s net long-term
capital gain with respect to one or more
APIs and the taxpayer’s net long-term
capital gain with respect to these APIs
if paragraphs (3) and (4) of section 1222,
which define the terms long-term
capital gain and long-term capital loss,
respectively, for purposes of subtitle A
of the Code, are applied using a threeyear holding period instead of a oneyear holding period. The regulations
refer to this difference as the
Recharacterization Amount. This
recharacterization is made regardless of
any election in effect under section
83(b).
2. Owner Taxpayers and Passthrough
Entities
The regulations provide that the
person who is subject to Federal income
tax on the Recharacterization Amount is
required to calculate such amounts and
refer to this person as the Owner
Taxpayer. Although an API can be held
directly by an Owner Taxpayer, it also
may be held indirectly through one or
more passthrough entities (Passthrough
Entities). A Passthrough Entity may be
a partnership, trust, estate, S
corporation, or a passive foreign
investment company (PFIC) with
respect to which the shareholder has a

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qualified electing fund (QEF) election in
effect. An API Holder is any person who
holds an API. The regulations provide a
framework for determining the
Recharacterization Amount when an
API is held through one or more tiers of
Passthrough Entities (tiered structure).

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3. Gains and Losses Subject to Section
1061
Section 1061(a) applies to a taxpayer’s
net long-term capital gain with respect
to one or more APIs held during the
taxable year. The regulations provide
that the determination of a taxpayer’s
net long-term capital gain with respect
to the taxpayer’s APIs held during the
taxable year includes the taxpayer’s
combined net distributive share of longterm capital gain or loss from all APIs
held during the taxable year and the
Owner Taxpayer’s long-term capital
gain and loss from the disposition of
any APIs during the taxable year. The
regulations generally refer to long-term
capital gains and losses recognized with
respect to an API as API Gains and
Losses. However, API Gains and Losses
do not include long-term capital gain
determined under sections 1231 and
1256, qualified dividends described in
section 1(h)(11)(B), and any other
capital gain that is characterized as
long-term or short-term without regard
to the holding period rules in section
1222, such as capital gain characterized
under the identified mixed straddle
rules described in section 1092(b).
Unrealized API Gains and Losses
means, with respect to a Passthrough
Entity’s assets, all unrealized capital
gains and losses that would be realized
if those assets were disposed of for fair
market value in a taxable transaction
and allocated to an API Holder with
respect to its API, taking into account
the principles of section 704(c). In a
tiered structure, API Gains and Losses
and Unrealized API Gains and Losses
retain their character as API Gains and
Losses as they are allocated through the
tiers.
B. Section 1061(c)(1): Definition of an
Applicable Partnership Interest
Section 1061(c)(1) provides that an
API is a partnership interest held by, or
transferred to, a taxpayer, directly or
indirectly, in connection with the
performance of substantial services by
the taxpayer, or by any other related
person, in any ATB. For this purpose,
the regulations define a Related Person
as a person or entity who is treated as
related to another person or entity under
section 707(b) or 267(b). Both section
1061(c)(1) and the regulations provide
that an API does not include certain
partnership interests held by employees

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of entities that are not engaged in an
ATB.
The regulations provide that an API
means any interest in a partnership
which, directly or indirectly, is
transferred to (or is held by) an Owner
Taxpayer or Passthrough Taxpayer in
connection with the performance of
substantial services by the Owner
Taxpayer or by a Passthrough Taxpayer,
or by a Related Person, including
services performed as an employee, in
any ATB unless an exception applies.
There may be one or more Passthrough
Entities between the partnership that
originally issued the API and the
Passthrough Entity in which the Owner
Taxpayer holds its indirect interest in
the API. Each Passthrough Entity in the
tiered structure is treated as holding an
API under the regulations, that is, each
Passthrough Entity is an API Holder as
is the Owner Taxpayer. An API Holder
may be an individual, partnership, trust,
estate, S corporation (as defined in
section 1361(a)(1)), or a PFIC with
respect to which the shareholder has a
QEF election in effect under section
1295.
Section 1061(c)(1), similar to section
1061(a), uses the term ‘‘taxpayer.’’ The
proposed regulations provide that an
Owner Taxpayer is the taxpayer for
purposes of section 1061(a). The
regulations further provide that the
reference to ‘‘taxpayer’’ in section
1061(c)(1) also includes a Passthrough
Taxpayer. A Passthrough Taxpayer is a
Passthrough Entity that is treated as a
taxpayer for the purpose of determining
the existence of an API, regardless of
whether such Passthrough Taxpayer
itself is subject to Federal income tax.
Generally, if an interest in a partnership
is transferred to a Passthrough Taxpayer
in connection with the performance of
its own services, the services of its
owners, or the services of persons
related to either such Passthrough
Taxpayer or its owners, the interest is an
API as to the Passthrough Taxpayer. The
Passthrough Taxpayer’s ultimate owners
will be treated as Owner Taxpayers,
unless otherwise excepted.
A partnership interest is an API if it
was transferred in connection with the
performance of substantial services. The
regulations presume that services are
substantial with respect to a partnership
interest transferred in connection with
services. This presumption is based on
the assumption, for purposes of section
1061, that the parties have economically
equated the services performed or to be
performed with the potential value of
the partnership interest transferred. The
regulations provide that, subject to
certain exceptions, once a partnership

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interest is an API, it remains an API and
never loses its API character.
C. Section 1061(c)(2): Definition of an
Applicable Trade or Business
Under section 1061, for an interest in
a partnership to be an API, the interest
must be held or transferred in
connection with the performance of
substantial services in an ATB. An ATB
is defined in section 1061(c)(2) as any
activity conducted on a regular,
continuous, and substantial basis
consisting, in whole or in part, of raising
or returning capital, and either (i)
investing in (or disposing of) specified
assets (or identifying specified assets for
such investing or disposition), or (ii)
developing specified assets. The
regulations refer to these actions,
respectively, as Raising or Returning
Capital Actions and Investing or
Developing Actions (collectively,
Specified Actions). The regulations
provide that an activity is conducted on
a regular, continuous, and substantial
basis if it meets the ATB Activity Test.
The ATB Activity Test is met if the total
level of activity (conducted in one or
more entities) meets the level of activity
required to establish a trade or business
for purposes of section 162.
In applying the ATB Activity Test, the
regulations provide that it is not
necessary for both Raising or Returning
Capital Actions and Investing or
Developing Actions to occur in a single
taxable year. In that regard, the
combined Specified Actions are
considered together to determine if the
ATB Activity Test is met.
Section 1061(c)(3) provides that
specified assets (Specified Assets) are
securities, as defined in section
475(c)(2) (without regard to the last
sentence thereof), commodities, as
defined in section 475(e)(2), real estate
held for rental or investment, cash or
cash equivalents, options or derivative
contracts with respect to any of the
foregoing, and an interest in a
partnership to the extent of the
partnership’s proportionate interest in
any of the foregoing. The definition of
Specified Assets in the regulations
generally tracks the statutory language.
It also includes an option or derivative
contract on a partnership interest to the
extent that the partnership interest
represents an interest in other Specified
Assets.
D. Section 1061(c)(4) and Other
Exceptions to API Treatment
Section 1061 includes four exceptions
to the treatment of a profits interest as
an API and the regulations add an
additional exception.

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First, the statutory definition of an
API in section 1061(c)(1) excludes an
interest held by a person who is
employed by another entity that is
conducting a trade or business (other
than an ATB) and provides services
only to such other entity.
Second, section 1061(c)(4)(A)
provides that an API does not include
any interest in a partnership directly or
indirectly held by a corporation. The
regulations provide that the term
‘‘corporation’’ for purposes of section
1061(c)(4)(A) does not include an S
corporation for which an election under
section 1362(a) is in effect or a PFIC
with respect to which the shareholder
has a QEF election under section 1295
in effect.
Third, section 1061(c)(4)(B) provides
that an API does not include a capital
interest which provides a right to share
in partnership capital commensurate
with (i) the amount of capital
contributed (determined at the time of
receipt of such partnership interest), or
(ii) the value of such interest subject to
tax under section 83 upon the receipt or
vesting of such interest (the capital
interest exception). The regulations
provide that long-term capital gains and
losses with respect to an API Holder’s
capital investment in a Passthrough
Entity, referred to as Capital Interest
Gains and Losses (which can include
allocations and disposition amounts
meeting the requirements), are not
subject to recharacterization under
section 1061. As explained in more
detail in Part II.A. of this Summary of
Comments and Explanation of
Revisions, to meet this exception to API
treatment, the proposed regulations
require allocations to API Holders (or
Passthrough Entities that hold an API in
a lower-tier Passthrough Entity) to be
made in the same manner as to certain
other partners. The final regulations
provide a revised and simplified rule
that looks to whether allocations are
commensurate with capital contributed.
Fourth, section 1061(b) provides that
to the extent provided by the Secretary,
section 1061 will not apply to income
or gain attributable to any asset not held
for portfolio investment on behalf of
third party investors.
Finally, the regulations provide that
an interest in a partnership that was an
API in the hands of the seller will not
be treated as an API in the hands of the
purchaser if the interest is acquired by
a bona fide purchaser who (i) does not
provide services in the Relevant ATB to
which the acquired interest relates, (ii)
is unrelated to any service provider, and
(iii) acquired the interest for fair market
value.

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E. Section 1061(d): Transfer of API to a
Section 1061(d) Related Person
Section 1061(d)(1) provides that if a
taxpayer transfers an API, directly or
indirectly, to a related person described
in section 1061(d)(2), the taxpayer must
include in gross income (as short term
capital gain) the excess of so much of
the taxpayer’s long term capital gains
with respect to such interest for the
taxable year attributable to the sale or
exchange of any asset held for not more
than 3 years as is allocable to such
interest over any amount treated as
short term capital gain under section
1061(a).
A related person for purposes of
section 1061(d)(2) (a Section 1061(d)
Related Person) is defined more
narrowly than a related person for
purposes of section 1061(c)(1) and
includes only members of the taxpayer’s
family within the meaning of section
318(a)(1), the taxpayer’s colleagues
(those who provided services in the
ATB during certain time periods) and,
under the regulations, a Passthrough
Entity to the extent that a member of the
taxpayer’s family or a colleague is an
owner.
F. Section 1061(e): Reporting
Section 1061(e) provides that the
Secretary ‘‘shall require such reporting
(at the time and in the manner
prescribed by the Secretary) as is
necessary to carry out the purposes of
[section 1061].’’ The regulations set
forth the reporting requirements and
include rules for providing information
required to compute the
Recharacterization Amount when there
is a tiered structure.
G. Regulatory Authority
Section 1061(f) provides that the
Secretary ‘‘shall issue such regulations
or other guidance as is necessary or
appropriate to carry out the purposes of
[section 1061].’’ The legislative history
indicates that such guidance is to
address the prevention of abuse of the
purposes of the provision. See H.R.
Conf. Rep. No. 115–466 at 422 (2017)
(Conference Report); see also Joint
Committee on Taxation, General
Explanation of Public Law 115–97, JCS–
1–18, at 203 (2017) (Blue Book). The
Conference Report and the Blue Book
also state that the guidance is to address
the application of the provision to tiered
structures of entities. See id.
II. Primary Changes to the Proposed
Regulations
The majority of comments received on
the proposed regulations relate to four
areas: (1) The capital interest exception;
(2) the treatment of capital interests

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acquired with loan proceeds; (3) the
Lookthrough Rule for certain API
dispositions; and (4) transfers of APIs to
Section 1061(d) Related Persons. After
considering these comments, the
Treasury Department and the IRS have
determined that changes in approach
are required for each of these sections of
the final regulations. The remainder of
this section generally describes the
comments received in these areas and
the changes made in response. While all
comments timely received were
considered, comments are not described
in detail to the extent that the ancillary
concerns raised by the commenter were
resolved by the changes made to the
final regulations.
A. Capital Interest Exception
Section 1061(c)(4)(B) provides that an
API does not include certain capital
interests. The proposed regulations
implement the capital interest exception
by excepting from recharacterization
long-term capital gains and losses that
represent a return on an API Holder’s
capital invested in a Passthrough Entity.
The proposed regulations refer to these
amounts as Capital Interest Gains and
Losses, and include in that definition
Capital Interest Allocations,
Passthrough Interest Capital
Allocations, and Capital Interest
Disposition Amounts that meet the
requirements of proposed § 1.1061–
3(c)(3) through (6).
The majority of comments received
regarding the capital interest exception
suggested that the rules in the proposed
regulations are too rigid and do not
reflect many common business
arrangements, resulting in many capital
interest holders being denied eligibility
for the exception. Commenters
described a variety of concerns, detailed
in this Part II.A.
The final regulations provide a
revised and simplified rule that looks to
whether allocations are commensurate
with capital contributed. An allocation
will be considered a Capital Interest
Allocation if the allocation to the API
Holder with respect to its capital
interest is determined and calculated in
a similar manner to the allocations with
respect to capital interests held by
similarly situated Unrelated NonService Partners who have made
significant aggregate capital
contributions.
1. Capital Interest Allocations, in
General
Proposed § 1.1061–3(c)(3) provides
that for an allocation to be treated as a
Capital Interest Allocation or a
Passthrough Interest Capital Allocation,
the allocation must be one made in the

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same manner to all partners. As
described further in part II.A.2. of this
Summary of Comments and Explanation
of Provisions, proposed § 1.1061–3(c)(4)
further provides, in part, that Capital
Interest Allocations are allocations of
long-term capital gain or loss make to an
API Holder and to Unrelated NonService Partners based on their
respective capital account balances
where the Unrelated Non-Service
Partners have a significant aggregate
capital account balance equal to five
percent or more of the aggregate capital
account balance of the partnership are
the time the allocations are made. The
proposed regulations also indicate that
in general, an allocation will be deemed
to satisfy the ‘‘same manner’’
requirement if, under the partnership
agreement, the allocation is based on the
relative capital accounts of the partners
(or Passthrough Entity owners) who are
receiving the allocation in question and
the terms, priority, type and level of
risk, rate of return, and rights to cash or
property distributions during the
partnership’s operations and on
liquidation are the same. Allocations to
an API Holder may be subordinated to
allocations to Unrelated Non-Service
Partners or reduced by the cost of
services provided by such API Holder or
a Related Person. Under proposed
§ 1.1061–3(c)(3)(ii), in the case of a
partnership that maintains capital
accounts under § 1.704–1(b)(2)(iv), the
allocation must be tested based on that
partner’s capital account. In the case of
a Passthrough Entity that is not a
partnership (or a partnership that does
not maintain capital accounts under
§ 1.704–1(b)(2)(iv)), if the Passthrough
Entity maintains and determines
accounts for its owners using principles
similar to those provided under § 1.704–
1(b)(2)(iv), those accounts will be
treated as a capital account for purposes
of the proposed regulations.
Several commenters noted that
requiring allocations be made in
accordance with partners’ overall
section 704(b) capital accounts in a fund
does not comport with the commercial
reality of how most venture capital,
private equity funds, and hedge funds
make their allocations, and would
preclude API Holders from ever
utilizing the capital interest exception.
One commenter noted that many bona
fide partnerships use targeted
allocations and questioned whether it is
fair to exclude partnerships that do not
maintain section 704(b) capital or
similar accounts from the capital
interest exception when those capital
accounts lack economic significance in
the business arrangement. The

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commenter asked the same question
about partnerships that maintain capital
accounts using generally accepted
accounting principles (GAAP).
Several commenters objected to the
‘‘same manner’’ requirement on the
grounds that it did not properly
implement section 1061(c)(4)(B), which
provides, in part, that an API ‘‘shall not
include any capital interest in the
partnership which provides the
taxpayer with a right to share in
partnership capital commensurate with
. . . the amount of capital contributed’’
by such partner. Commenters explained
that while fund managers may earn an
economic return on both their capital
investment and their APIs, they
generally do not have the same
economic rights with respect to their
capital investment that the limited
partners in the fund have with respect
to their capital investment. For example,
commenters indicated that an API
Holder may be entitled to tax
distributions, may have different
allocations of expenses, may be subject
to regulatory allocations (for example,
minimum gain chargeback, as described
in § 1.704–2), and may have different
withdrawal or liquidity rights, which
might be more or less favorable than
those provided to Unrelated NonService Partners. Commenters indicated
there could be varying liquidity rights
between Unrelated Non-Service Partners
and noted that API Holders’ capital may
be subject to more risk than Unrelated
Non-Service Partners’ capital in that API
Holders may bear the first risk of loss.
In the case of hedge funds, commenters
noted that limited partners may invest
at different times and, as such, earn a
return that may not be comparable to
other limited partners’ returns.
In addition, several commenters
explained that economic rights and
allocations in private equity and venture
capital funds are frequently determined
and made on a deal-by-deal basis,
including allocations made in a tiered
structure by an API Holder that is a
Passthrough Entity, and that funds may
have multiple classes of interests with
different rights and obligations, meaning
that economic rights and allocations are
rarely, if ever, aligned with respect to all
partners based on the partners’ section
704(b) capital accounts.
For the aforementioned reasons,
several commenters recommended that
the ‘‘same manner’’ requirement be
eliminated and replaced with a rule that
permits distributions and allocations to
an API Holder, who contributes capital
to a fund, to be ‘‘commensurate’’ with
capital contributed by Unrelated NonService partners. Similarly, one
commenter suggested that the only

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requirement be that an allocation to an
API Holder be calculated and
determined in a similar manner as the
allocations to similarly situated
Unrelated Non-Service Partners. Several
commenters suggested that funds
should be able to establish that they
satisfied the ‘‘commensurate’’ standard
using any reasonable method.
Commenters also recommended that
the scope of the term ‘‘cost of services’’
as used in the proposed regulations be
further explained, noting that situations
where API Holders’ capital investments
are not subject to management fees,
while other investors’ interests are
subject to management fees, should not
prevent the API Holders’ capital
interests from qualifying for the capital
interest exception. Commenters
recommended that the final regulations
clarify the meaning of the term ‘‘cost of
services’’ and specify that an API
Holder’s capital investment that is not
subject to incentive payments or to
management fees may still be eligible
for the capital interest exception.
Because private equity and hedge
funds operate differently, commenters
suggested that there should be separate
rules, tailored to each structure, with
respect to the capital interest exception.
The commenters alluded to the notion
that, although private equity and hedge
funds each operate within a certain
blueprint, there are many variations.
The Treasury Department and the IRS
generally agree with commenters that
under the test in the proposed
regulations, it might be difficult for
some common business arrangements to
meet the capital interest exception and
that a partner comparison, based on
capital contributed rather than the
partners’ section 704(b) capital
accounts, would be more accurate in
determining whether an interest
qualifies for the capital interest
exception. Accordingly, the final
regulations provide that Capital Interest
Allocations must be commensurate with
capital contributed in order to qualify
for the capital interest exception. The
final regulations replace the
requirement that allocations be made to
all partners in the same manner with a
requirement that an allocation to an API
Holder with respect to its capital
interest must be determined and
calculated in a similar manner as the
allocations with respect to capital
interests held by similarly situated
Unrelated Non-Service Partners who
have made significant aggregate capital
contributions. In this regard, the
allocations and distribution rights with
respect to API Holders’ capital interests
and the capital interests of Unrelated
Non-Service Partners who have made

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significant aggregate capital
contributions must be reasonably
consistent. The similar manner test may
be applied on an investment-byinvestment basis or on the basis of
allocations made to a particular class of
interests. The final regulations retain the
factors used in the proposed regulations
to determine whether allocations and
distribution rights are made in a similar
manner among partners: The amount
and timing of capital contributed, the
rate of return on capital contributed, the
terms, priority, the type and level of risk
associated with capital contributed, and
the rights to cash or property
distributions during the partnership’s
operations and on liquidation. The final
regulations maintain the rule that an
allocation to an API Holder will not fail
to qualify solely because the allocation
is subordinated to allocations made to
Unrelated Non-Service Partners or
because an allocation to an API Holder
is not reduced by the cost of services
provided by the API Holder or a Related
Person to the partnership. The final
regulations also clarify the meaning of
cost of services for this purpose. The
fact that API Holders are not charged
management fees on their capital or that
their capital is not subject to allocations
of API items will not prevent the API
Holder’s capital interest from being
eligible for the capital interest
exception. Similarly, an allocation to an
API Holder will not fail if an API Holder
has a right to receive tax distributions
while Unrelated Non-Service Partners
do not have such a right, where such
distributions are treated as advances
against future distributions.
The final regulations extend these
concepts to allocations made through
tiered structures. The final regulations
remove the terms Passthrough Capital
Allocation, Passthrough Interest Capital
Allocation, and Passthrough Interest
Direct Investment Allocation, and
instead provide that an allocation made
to a Passthrough Entity that holds an
API in a lower-tier Passthrough Entity
will be considered a Capital Interest
Allocation if made in accordance with
the principles applicable in determining
Capital Interest Allocations. Under the
final regulations, Capital Interest
Allocations retain their character when
allocated to an upper-tier partnership so
long as they are allocated among the
partners in the upper-tier partnership
with respect to such partners’ capital
interests in a manner that is respected
under section 704(b) (taking the
principles of section 704(c) into
account).
Because the revised rules provide
sufficient flexibility for all structures,
the final regulations do not adopt the

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suggestion to provide a separate set of
rules for private equity and hedge funds.
The Treasury Department and the IRS
continue to study other issues raised by
the commenters, including the
application of the similar manner
requirement to S corporations and the
application of the capital interest
exception to co-invest vehicles.
The Treasury Department and the IRS
request any additional comments on the
application of the capital interest
exception in the final regulations.
2. Unrelated Non-Service Partner
Requirement
As discussed in the prior section,
proposed § 1.1061–3(c)(4) provides
additional guidance on Capital Interest
Allocations. Under the proposed
regulations, Capital Interest Allocations
are allocations of long-term capital gain
or loss made under the partnership
agreement to an API Holder and to
Unrelated Non-Service Partners based
on their respective capital accounts and
which meet other requirements.
Unrelated Non-Service Partners are
defined in proposed § 1.1061–1(a) as
partners who have not provided services
to the Relevant ATB and who are not,
and have never been, related to any API
Holder in the partnership or any person
who provides, or has provided, services
in the Relevant ATB. Proposed
§ 1.1061–3(c)(4) specifies that Capital
Interest Allocations must be made in the
same manner to API Holders and to
Unrelated Non-Service Partners with a
significant aggregate capital account
balance (defined as five percent or more
of the aggregate capital account balance
of the partnership at the time the
allocations are made). Proposed
§ 1.1061–3(c)(4)(iii) provides that the
allocations to the API Holder and the
Unrelated Non-Service Partners must be
clearly identified both under the
partnership agreement and on the
partnership’s books and records as
separate and apart from allocations
made to the API Holder with respect to
its API. The partnership agreement and
the partnership books and records must
also clearly demonstrate that the
requirements for an allocation to be
considered a Capital Interest Allocation
have been met.
For allocations made on a deal-bydeal or class-by-class basis, commenters
noted that it is unclear if the
requirement that allocations be made in
the same manner to API Holders and
Unrelated Non-Service Partners with a
significant aggregate capital account
balance applies to each deal or class, or
if it applies only to a fund generally.
One commenter suggested that as an
alternative to a strict percentage test,

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funds should also be able to satisfy the
test by establishing that the return on a
class of equity was determined at arm’s
length. Another commenter noted that a
specific number or percentage of
Unrelated Non-Service Partners must
comprise the test group to prevent easy
avoidance of the statute but questioned
whether the five percent threshold for
the test group is the appropriate
threshold. The commenter also asked
for clarification on the effect of the rule
in proposed § 1.1061–3(c)(3)(ii)(C) that a
capital account, for these purposes, does
not include the contribution of amounts
attributable to loans made by other
partners or the partnership when
comparing the allocations made to API
Holders and Unrelated Non-Service
Partners.
One commenter stated that many
funds would be unable to meet the
requirement that allocations to the API
Holder and the Unrelated Non-Service
Partners be clearly identified in the
partnership agreement because their
agreements use liquidating distributions
to govern an API Holder’s rights with
respect to its API rather than
allocations. The commenter
recommended that the requirement be
considered satisfied if the distribution
provision clearly identified capital
interest distributions separate and apart
from distributions with respect to APIs.
Several other commenters suggested
that the rule requiring the allocations to
be clearly identified both under the
partnership agreement and on the
partnership’s books and records be
disjunctive, that is, that the allocations
be clearly demarcated in either the
partnership agreement or on the
partnership’s books and records.
Commenters noted that in order to meet
the partnership agreement reporting
requirement, a fund would have to
update its partnership agreements,
which could be done only by
negotiating with the Unrelated NonService Partners. Initiating those
negotiations could cause partners to
want to negotiate other partnership
items, which could take time and alter
the agreements. These commenters thus
suggested grandfathering existing
partnership agreements or providing a
transition period for funds to update
their agreements to comply with this
requirement.
The final regulations retain the
requirement that Capital Interest
Allocations to an API Holder be
compared to Capital Interest Allocations
made to Unrelated Non-Service
Partners, as well as the requirement that
Capital Interest Allocations be made to
Unrelated Non-Service Partners with a
significant capital account balance,

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including the five percent threshold.
The Treasury Department and the IRS
considered a number of alternatives and
determined that the five percent
threshold adequately insures that there
is a significant comparison to meet the
statutory exception that an API does not
include a capital interest which
provides the API Holder with a right to
share in partnership capital
commensurate with the amount of
capital contributed. In accordance with
the provision that the similar manner
test in the final regulations may be
applied on an investment-by-investment
or class-by-class basis, the final
regulations specify that the Unrelated
Non-Service Partner requirement can
also be applied on an investment-byinvestment basis, or on a class-by-class
basis. The final regulations move the
definition of Capital Interest Allocations
to the definition section of the final
regulations but retain the requirement
that allocations with respect to, and
corresponding to, contributed capital be
clearly identified under both the
partnership agreement and in the
partnership’s books and records as
separate and apart from allocations
made to the API Holder with respect to
its API, and specify that the books and
records must be contemporaneous.
Documenting the allocations in the
partnership agreement and in
contemporaneous books and records is
a necessary corollary to the rule
requiring Capital Interest Allocations to
be made in a similar manner between
API Holders and Unrelated Non-Service
Partners with a significant interest,
because it shows that the partnership’s
Unrelated Non-Service Partners
considered these allocations a valid
return on their contributed capital.
The final regulations do not include a
rule that would grandfather existing
partnership agreements or provide a
transition period for partnerships to
update their agreements. Because the
final regulations more closely align the
capital interest exception to standard
industry practice, the number of
partnership agreements that will need to
be amended is reduced. Allocations
made to an API Holder that do not meet
the requirements of these final
regulations will not be considered
Capital Interest Allocations. Finally, due
to the revisions made to the capital
interest exception in these final
regulations, the Treasury and the IRS
have determined that it is not necessary
to clarify the effect that the rule
disregarding contributions made with
the proceeds of loans by other partners
or by the partnership has on the
comparison of the allocation made to

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API Holders and Unrelated Non-Service
Partners.
3. Capital Interest Disposition Amounts
If an owner disposes of an interest in
a Passthrough Entity that is composed of
a capital interest and an API, proposed
§ 1.1061–3(c)(6) provides a mechanism
for the owner to determine the portion
of long-term capital gain or loss
recognized on the disposition that is
treated as a Capital Interest Disposition
Amount and thus, a Capital Interest
Gain or Loss.
The final regulations clarify the
determination of an API Holder’s
Capital Interest Disposition Amount
when the API Holder transfers a
Passthrough Entity interest that is
comprised of both an API and a capital
interest at a gain and would be allocated
only capital loss as a Capital Interest
Allocation if all of the assets of the
Passthrough Entity had been sold for
their fair market value in a fully taxable
transaction immediately before the
interest transfer. In such an instance, the
final regulations provide that all of the
long-term capital gain attributable to the
interest transfer is API Gain. Conversely,
if such API Holder recognizes long-term
capital loss on the transfer of a
Passthrough Entity interest and would
be allocated only capital gain as a
Capital Interest Allocation if all of the
assets of the Passthrough Entity had
been sold for their fair market value in
a fully taxable transaction immediately
before the interest transfer, the final
regulations provide that all of the longterm capital loss attributable to the
interest transfer is API Loss. The final
regulations provide additional rules
where a transferred Passthrough Entity
interest results in a gain and the
transferor would have been allocated
both Capital Interest Gain and API Gain
as well as where a transferred
Passthrough Entity interest results in a
loss and the transferor would have been
allocated both Capital Interest Loss and
API Loss. In such instances, a fraction
is used to determine the portion of the
transferred interest gain or loss
characterized as a Capital Interest
Disposition Amount.
Commenters noted a concern that
Example 5 in proposed regulation
§ 1.1061–3(c)(7)(v), did not adequately
address basis proration upon a partial
interest sale where a partner holds a
partnership interest comprised of both
an API and a capital interest.
Specifically, one commenter noted that
Example 5’s reliance on the equitable
apportionment approach of § 1.61–6(a)
could lead to a situation where the
characterization of the gain or loss
attributable to the sale of a portion of

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the partner’s partnership interest differs
from the characterization of that
partner’s distributive share of asset gain
or loss if all of the assets of the
Passthrough Entity were sold for their
fair market value in a fully taxable
transaction. Another commenter
suggested applying the specific
identification rules in § 1.1223–3
applicable to publicly traded
partnership units to transfers of private
interests. These commenters noted that
because the issue illustrated in Example
5 has ramifications beyond section
1061, further study should occur before
proceeding with the position stated in
Example 5.
The Treasury Department and the IRS
continue to study the issue noted with
respect to Example 5 and have removed
the example in the interim as many of
the concerns raised on the sale of a
partial partnership interest extend
beyond section 1061.
4. Unrealized API Gains and Losses
Proposed § 1.1061–1(a) defines
Unrealized API Gains and Losses as all
unrealized capital gains and losses,
including both short-term and longterm, that would be allocated to an API
Holder with respect to its API if all
relevant assets were disposed of for fair
market value in a taxable transaction on
the relevant date. Proposed § 1.1061–
2(a)(1)(ii) provides rules for the
treatment of Unrealized API Gains and
Losses, including the requirement to
determine Unrealized API Gains and
Losses in tiered structures. Proposed
§ 1.1061–3(c)(3)(iii) provides that
Capital Interest Allocations and
Passthrough Interest Capital Allocations
do not include amounts treated as API
Gains and Losses or Unrealized API
Gains and Losses.
A commenter stated that the
requirement to determine Unrealized
API Gains and Losses in tiered
structures is not reasonable because an
upper-tier Passthrough Entity would not
be able to require every uncontrolled
lower-tier Passthrough Entity in the
chain to revalue its assets under the
principles of § 1.704–1(b)(2)(iv)(f). The
commenter recommended that the
mandatory section 1061 revaluation
rules be eliminated. The commenter
requested instead that the existing rules
for revaluations under the section 704(b)
and 704(c) regulations govern
Unrealized API Gains and Losses.
Alternatively, the commenter suggested
that anti-abuse regulations be written to
address revaluations in chains of
controlled tiered partnerships.
The final regulations remove the
mandatory revaluation rules and adopt
the commenter’s suggestion that

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Unrealized API Gains and Losses be
determined according to the existing
rules governing unrealized gains and
losses, including section 704(c)
principles. Accordingly, the final
regulations provide that the term
Unrealized API Gains and Losses
means, with respect to a Passthrough
Entity’s assets, all unrealized capital
gains and losses that would be (i)
realized if those assets were disposed of
for fair market value in a taxable
transaction on the relevant date, and (ii)
allocated to an API Holder with respect
to its API, taking into account the
principles of section 704(c).
Because the proposed regulations
provide that Capital Interest Allocations
are made based on partners’ relative
section 704(b) capital accounts, several
commenters questioned whether
Unrealized API Gains and Losses that
are reflected in an API Holder’s capital
account could generate Capital Interest
Allocations, including book Capital
Interest Allocations, before these
amounts are recognized. Commenters
explained that these issues are
particularly relevant for hedge funds
and described their operations and
incentive structure. When an API
Holder in a hedge fund receives
incentive allocations with respect to the
API, its capital account is increased by
the amount of the incentive allocation,
and Unrelated Non-Service Partners’
capital accounts are decreased. This
increase is coupled with allocations of
taxable income and gain and also
allocations of unrealized gain (reverse
section 704(c) allocations). Commenters
also requested additional guidance on
the treatment of realized and unrealized
gains from an API which are contributed
to, or reinvested in, a partnership.
The final regulations continue to
provide that Unrealized API Gains and
Losses are not included in Capital
Interest Gains and Losses. In response to
comments, the final regulations clarify
that if an API Holder is allocated API
Gain by a Passthrough Entity, to the
extent that an amount equal to the API
Gain is reinvested in Passthrough Entity
by the API Holder (either as the result
of an actual distribution and
recontribution of the API Gain amount
or the retention of the API Gain amount
by the Passthrough Entity), the amount
will be treated as a contribution to the
Passthrough Entity for a capital interest
that may produce Capital Interest
Allocations for the API Holder,
provided such allocations otherwise
meet the requirements to be a Capital
Interest Allocation.

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B. Capital Contributions Made With the
Proceeds of Partnership or Partner
Loans
Proposed § 1.1061–3(c)(3)(ii)(C)
provides that for purposes of proposed
§§ 1.1061–1 through 1.1061–6, a capital
account does not include the
contribution of amounts directly or
indirectly attributable to any loan or
other advance made or guaranteed,
directly or indirectly, by any other
partner, the partnership, or a Related
Person with respect to any other partner
or the partnership. Repayments on the
loan are included in capital accounts as
those amounts are paid by the partner,
provided that the loan is not repaid with
the proceeds of another similarly
sourced loan. Id.
Several commenters criticized this
treatment, suggesting that the exclusion
of these amounts from the partner’s
capital account inhibits common and
reasonable business practices, and
creates barriers to entry for service
partners, particularly those who are less
represented based on age, gender, or
race or do not have ready access to
capital. One commenter noted that it is
typical for fund managers to either
extend loans to their employees, or to
guarantee loans issued to such
employees by third parties, so that
employees may invest in the manager’s
own investment funds. Similarly,
another commenter stated that the
proposed regulations would introduce a
substantial impediment to raising
capital for commercial real estate
investment by creating a disincentive
for general partners to finance or
support the financing of the
participation of its employees in its
commercial real estate investments. The
commenter claimed that contributions
made in this manner are a significant
source of capital available for real estate
investment and also an important factor
in attracting third party capital because
they create an alignment of interest
between the limited partners and the
general partner and its employees.
Commenters noted that neither the
statute nor the legislative history
indicates that the use of loan proceeds
to make a capital contribution precludes
the interest from being included in a
partner’s capital account and contended
that adding such a rule is not justified
by the commensurate with capital
statutory language of the capital interest
exception. To the contrary, commenters
argued that the authors of the TCJA
were familiar with prior proposals
regarding profits interests that contained
exceptions for loaned capital and their
decision not to include such an
exception in section 1061 is an

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indication that the choice was
intentional. Instead, one commenter
maintained that Congress addressed any
concerns through the rule that a service
provider’s rights with respect to its
contributed capital must match the
rights of other non-service partners with
respect to their shares of contributed
capital.
Some commenters recognized that the
exclusion from capital accounts of
contributions attributable to partner or
partnership loans is an attempt to
control the perceived abuse of limited
partners loaning the general partner of
the partnership an amount of capital
that entitles the general partner to a
portion of the partnership’s profits in
order to avoid the application of section
1061 and fit within the capital interest
exception. Commenters noted that
section 1061(f) provides the Secretary
with authority to issue guidance as is
necessary or appropriate to carry out the
purposes of section 1061 and that the
legislative history indicates that such
guidance is to address the prevention of
abuse of the purposes of the provision.
Other commenters, suggesting that the
policy behind the capital interest
exception is to ensure a partner has
capital at risk to qualify for the
exception, acknowledged that there are
fact patterns in which a partner might
be considered less at risk. One
commenter pointed to the at-risk
limitation on losses under section 465,
noting that a service provider would not
be considered at-risk with respect to
contributed capital that is financed
through a loan from another partner,
even if the loan were fully recourse to
the service provider. By contrast, a
partner is considered at-risk when an
investment is funded by a third-party
loan for which the partner has personal
liability. Another commenter noted that
the proposed regulations’ treatment of a
capital interest funded through a loan
from the issuing partnership is
consistent with the treatment of
partnership loans under other areas of
Subchapter K. The commenter pointed
out that the contribution of a partner’s
own promissory note generally does not
increase the partner’s basis in its
partnership interest under section 722.
Similarly, pursuant to § 1.704–
1(b)(2)(iv)(d)(2), the partner’s capital
account will be increased with respect
to the promissory note only when there
is a taxable disposition of the note by
the partnership or when the partner
makes principal payments on such note,
provided that the note is not readily
tradable on an established securities
market.
Despite recognizing these concerns
regarding abuse, commenters

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maintained that the loan proceeds
exclusion should be eliminated because
general income tax principles, such as
those in sections 83 and 7872, are
sufficient to determine whether a loanfinanced arrangement should not
qualify for the capital interest exception.
Other commenters suggested that if
limitations must be imposed, the rule
should be narrowly tailored,
recommending that only loans that are
nonrecourse or lack substantial security
be excluded from the capital interest
exception. Commenters also suggested
that guarantees should not be treated in
the same manner as a loan, particularly
in the context of a recourse loan or a
loan from a third-party bank. Another
commenter suggested that if the loan or
guarantee operates under normal armslength standards, it should be eligible to
support a capital contribution. Another
commenter noted that the proposed
regulations are silent on loans that are
fully secured with partnership assets.
The Treasury Department and the IRS
remain concerned that capital
contributions made with the proceeds of
loans made or guaranteed by another
partner, the partnership, or a Related
Person with respect to such partner or
partnership could lead to abuse of the
capital interest exception. Therefore, the
final regulations do not adopt the
suggestions to remove the rule.
However, the Treasury Department and
the IRS agree with commenters that the
potential for abuse is reduced when a
loan or advance is made by another
partner (or Related Person with respect
to such other partner, other than the
partnership) to an individual service
provider if the individual service
provider is personally liable for the
repayment of such loan or advance.
Accordingly, the final regulations
provide that an allocation will be
treated as a Capital Interest Allocation if
the allocation is attributable to a
contribution made by an individual
service provider that, directly or
indirectly, results from, or is attributable
to, a loan or advance from another
partner in the partnership (or any
Related Person with respect to such
lending or advancing partner, other than
the partnership) to such individual
service provider if the individual
service provider is personally liable for
the repayment of such loan or advance
as described in the final regulations.
The final regulations apply a similar
approach with respect to loans or
advances made by a partner in the
partnership (or a Related Person to such
partner, other than the partnership) to a
wholly owned entity that is disregarded
as separate from an individual service

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provider where the individual service
provider that owns such disregarded
entity is personally liable for the
repayment of any borrowed amounts
that are not repaid by the disregarded
entity. The final regulations provide that
an individual service provider is
personally liable for the repayment of a
loan or advance made by a partner (or
any Related Person, other than the
partnership) if (i) the loan or advance is
fully recourse to the individual service
provider; (ii) the individual service
provider has no right to reimbursement
from any other person; and (iii) the loan
or advance is not guaranteed by any
other person. The Treasury Department
and the IRS continue to study the
treatment of guarantees generally in
light of questions about who the
borrower is for Federal tax purposes.
A commenter noted that the proposed
regulations’ treatment of loans, together
with the section 704(b) capital account
approach being taken with respect to the
capital interest exception, could mean
that a partner who borrows from a
related person to make even a small
portion of his or her capital contribution
might be denied the capital interest
exception with respect to his or her
entire capital interest. A few
commenters recommended that if the
treatment of related party loans is
retained in the final regulations,
adjustments should be made to ensure
that partners are able to receive
appropriate credit for capital
contributions they make that are not
attributable to loans. Another
commenter stated that the proposed
regulations did not provide a tracing
regime to connect loan proceeds with
capital contributions. One commenter
suggested that final regulations clarify
how to treat a partner that fully funded
a capital contribution with loan
proceeds but repaid such amounts
before there was a capital interest
allocation, including whether a
revaluation would change the answer.
The commenter recommended that it
would be appropriate to treat the
partner’s capital account as funded at
the time of actual contribution. Finally,
the commenter recommended that final
regulations include a transition rule
related to related party loans made,
advanced, guaranteed, or repaid before
final regulations are issued. The
Treasury Department and the IRS
considered these comments and believe
that the concerns raised in them are
resolved by the commensurate with
capital approach to the capital interest
exception taken in the final regulations
because this approach does not rely on
a comparison of allocations based on the

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partners’ overall section 704(b) capital
accounts.
C. Lookthrough Rule for Certain API
Dispositions
Proposed § 1.1061–4(b)(9) provides a
limited Lookthrough Rule that may
apply to the sale of an API where capital
gain is recognized and the holding
period of the API is more than three
years. In the case of a disposition of a
directly held API with a holding period
of more than three years, the proposed
Lookthrough Rule applies if the assets of
the partnership in which the API is held
meet the Substantially All Test. The
Substantially All Test is met if 80
percent or more of the assets of the
partnership in which the API is held,
based on fair market value, are assets
that would produce capital gain or loss
that is not described in proposed
§ 1.1061–4(b)(6) if disposed of by the
partnership, and that have a holding
period of three years or less. In the case
of a tiered structure in which an API
Holder holds its API through one or
more Passthrough Entities, the
Lookthrough Rule applies if the API
Holder disposes of a Passthrough
Interest held for more than three years
and recognizes capital gain, and either:
(i) The Passthrough Entity through
which the API is directly or indirectly
held has a holding period in the API
that is three years or less, or (ii) the
Passthrough Entity through which the
API is held has a holding period in the
API of more than three years and the
assets of the partnership in which the
API is held meet the Substantially All
Test.
The Treasury Department and the IRS
received several comments stating that,
although the application of the
Lookthrough Rule for directly-held APIs
is reasonable, the application of the
Lookthrough Rule for indirectly-held
APIs is punitive and imposes an
unreasonable and significant
administrative burden. The commenters
recommended that the scope of the
Lookthrough Rule for indirectly-held
APIs be limited, particularly in the case
of indirectly-held APIs where the
relevant taxpayer does not control a
partnership that issued the API. Another
commenter questioned the authority for
the Lookthrough Rule but noted that it
is consistent with partnership tax
principles and that the proposed
regulation would be easily manipulated
without the rule.
Commenters suggested that the
proposed regulations be amended in one
or more of the following ways: (i) Limit
the Lookthrough Rule to situations in
which a Passthrough Entity controls all
of the relevant lower-tier Passthrough

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Entities (or only applying it to lower-tier
Passthrough Entities that it controls); (ii)
limit the Lookthrough Rule for
indirectly held APIs to situations in
which the API is held by a lower-tier
Passthrough Entity for three years or
less; (iii) limit the application of the
Lookthrough Rule to situations in which
assets that produce capital gain or loss
of a type taken into account under
section 1061 are a material amount
(greater than 50 percent) of the value of
the underlying assets of the partnership;
(iv) eliminate the Substantially All Test
in the context of tiered structures (that
is, determine the applicability of the
Substantially All Test with respect to
the assets held by the partnership whose
interest was sold); (v) amend the
Substantially All Test so that a
transferring taxpayer who has held its
interest for more than three years will be
required to look through to the
underlying assets’ character only if 80
percent or more of the assets held
directly or indirectly by the Passthrough
Entity have a holding period of three
years or less; (vi) make information
reporting related to the Lookthrough
Rule mandatory for partnerships and S
corporations and for required PFIC
annual information statements
regardless of whether a Passthrough
Entity has issued or holds an API; (vii)
provide a de minimis rule by which an
upper-tier partnership holding a five
percent or less interest in the lower-tier
partnership would be allowed to use its
holding period in the lower-tier
partnership; and (viii) as a part of the de
minimis rule, not require revaluations of
lower-tier partnerships when an Owner
Taxpayer disposes of an upper-tier
interest that holds five percent or less of
a lower-tier partnership. A commenter
recommended that the Lookthrough
Rule approach calculations in tiered
structures from the lower-tier entities
up, aligning with the approach to tiered
structures elsewhere in the proposed
regulations, and allowing the rule to
appropriately accommodate lower-tier
gains from assets whose sale proceeds
are treated as capital gains without
regard to section 1222(3) and (4).
After considering the comments, the
Treasury Department and the IRS agree
that the Lookthrough Rule as proposed
could be difficult for Owner Taxpayers
and Passthrough Entities to apply,
particularly in the context of tiered
structures. However, the Treasury
Department and the IRS remain
concerned that taxpayers could avoid
section 1061 by transferring assets to,
and issuing APIs from, existing
partnerships. Accordingly, the final
regulations retain the Lookthrough Rule,

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but instead of applying the Lookthrough
Rule to the disposition of an API held
for more than three years and where the
Substantially All Test is met, the final
regulations limit the application of the
Lookthrough Rule to situations where,
at the time of disposition of an API held
for more than three years, (1) the API
would have a holding period of three
years or less if the holding period of
such API were determined by not
including any period prior to the date
that an Unrelated Non-Service Partner is
legally obligated to contribute
substantial money or property directly
or indirectly to the Passthrough Entity
to which the API relates (this rule does
not apply to the disposition of an API
to the extent that the gain recognized
upon the disposition of the API is
attributable to any asset not held for
portfolio investment on behalf of third
party investors); or (2) a transaction or
series of transactions has taken place
with a principal purpose of avoiding
potential gain recharacterization under
section 1061(a). The Lookthrough Rule
similarly applies with respect to a
Passthrough Interest issued by an S
corporation or a PFIC to the extent the
Passthrough Interest is treated as an
API. The final regulations also simplify
the method for applying the
Lookthrough Rule.
Commenters also stated that the
Lookthrough Rule raises a concern that
going concern value in a lower-tier
entity might be subject to ordinary
income rates if an upper-tier partnership
interest is sold, the Lookthrough Rule
applies, and the upper-tier partnership
owns a lower-tier partnership interest.
These commenters recommended that
gain associated with goodwill or
enterprise value retain the holding
period of the partnership interest itself,
as opposed to the underlying assets, and
that the Lookthrough Rule apply only to
the gain associated with the
hypothetical liquidation of the
underlying assets. The Treasury
Department and the IRS continue to
study this issue and may address it in
future guidance.
One commenter requested
clarification that the phrase ‘‘total net
capital gain’’ in proposed § 1.1061–
4(b)(9)(ii)(C)(1) refers to ‘‘net long-term
capital gain’’ and that short- and longterm capital gains and losses cannot be
netted against each other. The final
regulations do not include this
language. The Treasury Department and
the IRS believe that the concerns raised
by the commenter are alleviated by the
simplified Lookthrough Rule adjustment
in the final regulations.

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D. Section 1.1061–5: Transfers to
Related Parties
Proposed § 1.1061–5(a) provides that
if an Owner Taxpayer transfers any API,
or any Distributed API Property, directly
or indirectly, to a Section 1061(d)
Related Person, or if a Passthrough
Entity in which an Owner Taxpayer
holds an interest, directly or indirectly,
transfers an API to a Section 1061(d)
Related Person, regardless of whether
gain is otherwise recognized on the
transfer under the Code, the Owner
Taxpayer must include in gross income
as short-term capital gain, the excess of:
(1) The Owner Taxpayer’s net long-term
capital gain with respect to such interest
for such taxable year determined as
provided in proposed § 1.1061–5(c),
over (2) any amount treated as shortterm capital gain under proposed
§ 1.1061–4 with respect to the transfer of
such interest (that is, any amount
included in the Owner Taxpayer’s API
One Year Disposition Gain Amount and
not in the Owner Taxpayer’s Three Year
Disposition Gain Amount with respect
to the transferred interest). Proposed
§ 1.1061–5(b) provides that for purposes
of section 1061(d), the term transfer
includes contributions, distributions,
sales and exchanges, and gifts.
Several commenters addressed
whether section 1061(d) should be
interpreted as an acceleration provision
or merely a recharacterization provision.
With certain exceptions, the proposed
regulations require that gain be
accelerated on the transfer of an API to
a Section 1061(d) Related Person,
regardless of whether the transfer is
otherwise a taxable transaction for
Federal income taxes or whether gain is
otherwise realized or recognized under
the Code on the transfer. One
commenter supported this treatment,
noting that section 1061(d)(1) is literally
worded as an income acceleration
provision while acknowledging that
others have viewed the language as a
recharacterization provision, such as
section 751(a). Another commenter
noted that neither the text nor the
legislative history shed any light on its
purpose and stated that the provision’s
language is susceptible to numerous
different readings. The commenter
noted that section 1061(d) could be read
as a narrow recharacterization
lookthrough provision similar to section
751, a recharacterization and
assignment of income provision that
provides for nonrecognition transfers
and requires the transferor rather than
the transferee to include API Gain when
ultimately realized, a recharacterization
and acceleration provision, or a
proration provision. The commenter did

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not provide a recommendation, but
noted that the proposed regulations
create many traps for the unwary. The
commenter stated that the broad
definition of transfer in the proposed
regulations combined with the
overriding of nonrecognition treatment
could lead to significant, adverse tax
impacts on transferors as well as
otherwise uninvolved, passive interest
holders in a variety of transactions. The
commenter suggested that the Treasury
Department and the IRS carefully
consider whether the effect of the
proposed regulations is appropriate and
aligns with section 1061(d)’s language,
function, and origins.
Other commenters argued that
applying section 1061(d) to transactions
where gain is not otherwise recognized
is inconsistent with the statutory
language. One commenter stated that
section 1061(d) itself does not refer to
any nonrecognition provisions, nor does
it contain any express statement of
intent to override nonrecognition
treatment. This commenter and others
noted that section 1061(d) operates by
reference to the taxpayer’s long-term
capital gains, which as defined in
section 1223(3) include only gains that
are recognized for U.S. Federal income
tax purposes. Consequently, these
commenters argued that the statute by
its terms does not apply to situations in
which the taxpayer has no actual longterm capital gain with respect to such
interest. Commenters also noted that the
legislative history does not provide
support for treating section 1061(d) as
an acceleration provision. Previous
carried interest provisions included
language that explicitly overrode nonrecognition; section 1061 as enacted
contains no such language.
One commenter stated that it is not
necessary to accelerate gain on the
transfer of an API to a Section 1061(d)
Related Person, noting that the API in
the hands of the transferee is still
subject to section 1061(a) because an
API includes interests held by or
transferred to the taxpayer in
connection with the performance of a
substantial service by the taxpayer or a
related person.
Commenters also raised a variety of
concerns about the proposed
regulation’s definition of transfer.
Commenters recommended that the
term transfer be further defined to
address potential cases involving
indirect transfers of an API, such as the
admission of new partners into the
partnership, the withdrawal of old
partners from the partnership, the
transfer of an employee between teams,
or an award to a high performer. One
commenter explained that, in these

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circumstances, because there is no
change in the relative economic position
between fund managers and third-party
investors, there should be no
requirement for the fund manager or
employees of the fund manager to
recognize unrealized built-in gain.
Commenters also recommended that the
final regulations consider whether a
forfeiture of an API is a transfer for
purposes of section 1061(d) but stated
that such an interpretation would be
overbroad. One commenter noted that
forfeiture and reallocations involve
circumstances in which the partners’
legal and economic interests in the
partnership’s Unrealized API Gains are
contingent rather than fixed. Where a
partner’s interest in Unrealized API
Gains is contingent, the commenter
argued that it is not appropriate to tax
a partner on a reduction in that interest
under section 1061(d).
Another commenter asked for
clarification that the distribution of an
API by a direct API Holder to an Owner
Taxpayer (indirect API Holder) would
be exempt from the application of
section 1061(d). The commenter noted
that section 1061(a) would continue to
apply to the distributed API and that
this treatment would be consistent with
the rules related to Distributed API
Property in § 1.1061–4. Under those
rules, a distribution of property by a
Passthrough Entity to an API Holder is
not subject to recharacterization under
section 1061 but the Distributed API
Property continues to be subject to
section 1061. The commenter argued
that this rule would also treat similarly
situated taxpayers the same, rather than
treating distributees of Distributed API
Property differently from Owner
Taxpayers who receive a distribution of
an API from a partnership.
Another commenter asked for
clarification that the definition of gift
refers to transfers which are gifts for
income tax purposes (rather than for gift
tax purposes). The commenter noted
that many common estate planning
techniques involve transfers of assets to
grantor trusts with the transferor as the
grantor and the grantor’s family
members as beneficiaries of the trust,
and that these types of transfers often
result in a completed gift for gift tax
purposes but do not constitute a transfer
of ownership for income tax purposes.
Commenters also recommended that
the final regulations exclude specific
nonrecognition transactions, including
(i) transfers resulting from the death of
an Owner Taxpayer; (ii) gifts to a nongrantor trust by an Owner Taxpayer; and
(iii) transfers resulting from a change in
tax status of a grantor trust. One
commenter noted that, in light of

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section 1061(d)’s specific reference to
section 318(a)(1), and not to section
318(a)(2), a gift to a non-grantor trust for
the benefit of a taxpayer’s spouse,
children, grandchildren or parents
should not be considered an ‘‘indirect
transfer’’ that would trigger the
application of section 1061(d). The
commenter noted that Congress’s use of
the phrase ‘‘directly or indirectly’’ does
not warrant disturbing the conclusion
that a transfer to a non-grantor trust
does not constitute an acceleration
event for purposes of section 1061(d).
This commenter suggested in the
alternative that if a transfer to a nongrantor trust is an acceleration event for
purposes of section 1061(d), only upon
a subsequent distribution of the API out
of the non-grantor trust should the
acceleration event occur.
After considering the comments, the
Treasury Department and the IRS have
determined that while section 1061(d)
can reasonably be interpreted as an
acceleration provision, in the absence of
clear language to the contrary, it is more
appropriate to apply section 1061(d)
only to transfers in which long-term
capital gain is recognized under chapter
1 of the Code. Interpreting section
1061(d) as only a recharacterization
provision is consistent with the
statutory language that looks to so much
of the taxpayer’s long-term capital gain
with respect to such interest for such
taxable year as is attributable to the sale
or exchange of any asset held. This
treatment also prevents the acceleration
of gain in the many non-abusive
nonrecognition transactions described
by commenters. Furthermore, it is not
necessary to accelerate gain on the
transfers of an API to a Section 1061(d)
Related Person in a non-taxable
transaction because the API will remain
an API in the hands of the transferee
under § 1.1061–2(a). Accordingly, the
final regulations provide that the
Section 1061(d) Recharacterization
Amount includes only long-term capital
gain that the Owner Taxpayer
recognizes under chapter 1 of the Code
upon a transfer through a sale or
exchange of an API to a Section 1061(d)
Related Person.
Proposed § 1.1061–5(c) provides a
formula for calculating the Owner
Taxpayer’s short-term capital gain upon
a transfer of an API to a Section 1061(d)
Related Person based upon a
hypothetical sale of all of the
partnership’s property in a fully taxable
transaction. A commenter noted that
because the calculation is not based on
the Recharacterization Amount under a
hypothetical liquidation, it includes
amounts excluded from the
Recharacterization Amount, such as

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capital interest gains and losses. The
commenter recommended that the
formula be amended so that it is based
upon the Recharacterization Amount in
a hypothetical partnership liquidation,
and that the final regulations contain an
exception from taxation for transactions
in which the Owner Taxpayer’s deemed
distributions with respect to the Owner
Taxpayer’s API on a hypothetical
liquidation basis are the same
immediately before and after the
transaction (not including any deemed
distributions due to changes in debt
allocations). Another commenter
suggested that, in order to avoid doublecounting in a tiered structure, there
should be a cap on the amount that
would be taxed equal to the gain that
would be realized if the directly
transferred API were sold for its fair
market value by the Owner Taxpayer.
Another commenter noted that the
proposed regulations provide that
section 1061(d) applies to transfers of
APIs by Passthrough Entities and to
transfers of Distributed API Property by
Owner Taxpayers, but that the rules do
not provide guidance on how to
calculate the amount to be included.
The commenter suggested that, in the
case of a transfer of an API by a
Passthrough Entity, the inclusion
amount should be the amount that
would be allocated to each of the
Passthrough Entity’s direct or indirect
Owner Taxpayers in a deemed taxable
sale of assets by the lower-tier entity in
which the Passthrough Entity holds its
API, and that the amounts that such
Passthrough Entity includes in the API
One Year Distributive Share Amount,
but not in the API Three Year
Distributive Share Amount, for each
Owner Taxpayer should be subtracted
from the aforementioned amounts to
calculate an Owner Taxpayer’s
recharacterization amount under section
1061(d). In the case of a transfer of
Distributed API Property by an Owner
Taxpayer, the commenter suggested that
the inclusion amount should be the
amount of long-term capital gain that
the Owner Taxpayer would have
recognized on a taxable sale for cash at
the Distributed API Property’s fair
market value.
The Treasury Department and the IRS
appreciate these thoughtful suggestions.
The final regulations have revised and
simplified the computation of the
inclusion amount in § 1.1061–5(c) and
have added the term Section 1061(d)
Recharacterization Amount. The final
regulations provide that, if section
1061(d) applies, an Owner Taxpayer’s
Section 1061(d) Recharacterization
Amount is the Owner Taxpayer’s share
of the amount of net long-term capital

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gain from assets held for three years or
less that would have been allocated to
the Owner Taxpayer with respect to the
transferred API if the partnership had
sold all of its property in a fully taxable
transaction for cash in an amount equal
to the fair market value of such property
immediately prior to the Owner
Taxpayer’s transfer of the API (or a
portion of such gain if only a portion of
the API is transferred).
A commenter requested clarification
as to whether ‘‘capital gain recognized’’
on an otherwise taxable transfer in
proposed § 1.1061–5(c)(2) means that
the amount recharacterized under
section 1061(d) includes only gain that
would otherwise be treated as long-term
gain or whether it sets the total amount
of short-term gain on the transfer. The
final regulations provide that the longterm gain that is recharacterized to
short-term under section 1061(d) is the
lesser of (i) the amount of net long-term
capital gain recognized by the Owner
Taxpayer upon the transfer of such
interest, or (ii) the Section 1061(d)
Recharacterization Amount as
computed under § 1.1061–5(c). Thus,
only gain that would otherwise be
treated as long-term gain is
recharacterized under section 1061(d).
Proposed § 1.1061–5(d) provides that
the basis of a transferred API or
transferred Passthrough Interest (in the
case of a transferred Indirect API) is
increased by the additional gain
recognized. A commenter requested that
the rule be revised to explicitly
coordinate with section 743 so that the
basis adjustments will be allocated to
the assets that result in the gain
recognition. The concerns raised in this
comment are resolved because the final
regulations limit the application of
section 1061(d) to transactions in which
gain is recognized.
Another commenter recommended
that the final regulations explicitly
exclude amounts that would be subject
to the Capital Interest Exception. The
final regulations do not adopt this
comment because the Capital Interest
Exception is an exception to the
definition of an API. Therefore, such a
rule is not needed. Commenters also
recommended that the final regulations
explicitly exclude amounts specified in
proposed § 1.1061–4(b)(6) (designated as
§ 1.1061–4(b)(7) in the final regulations)
from the calculation of the Section
1061(d) Recharacterization Amount.
One commenter noted that the scope of
section 1061(d)(1) is broader than the
tax result that would occur if the
partnership had actually sold all its
property, noting that neither the statute
nor the proposed regulations exclude
section 1231 gains (and other excluded

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gains such as those under section 1256)
from the Section 1061(d)
Recharacterization Amount. Another
commenter argued that section 1061(d)
should not recharacterize section 1231
gain, stating that while the statutory
language in section 1061(d) provides
arguable authority for including section
1231 gains in the computation of the
Section 1061(d) Recharacterization
Amount, the approach is hard to justify
from a policy perspective. The
commenter argued that because section
1061(d) is aimed at preventing an API
Holder from circumventing section
1061(a), the regulations should not
impose on taxpayers a result under
section 1061(d) that is worse than if
section 1061(a) had applied to assets
sold by the partnership. The commenter
recommended that ‘‘long-term capital
gains’’ should be interpreted
consistently for purposes of section
1061(a) and section 1061(d), and that
long-term capital gain recognized with
respect to section 1231 assets should not
be recharacterized under either
paragraph.
The final regulations adopt these
comments and provide that the Section
1061(d) Recharacterization Amount
does not include amounts not taken into
account for purposes of section 1061
under § 1.1061–4(b)(7).
Proposed § 1.1061–5(c)(1) provides
that if an Owner Taxpayer transfers an
Indirect API and is subject to section
1061(d), the computation of the Section
1061(d) Recharacterization Amount
must be applied at the level of any
lower-tier Passthrough Entities. One
commenter recommended that this rule
be aligned with the rules for tiered
partnerships elsewhere in the proposed
regulations, such as the Lookthrough
Rule, which explicitly states that it
applies only to the ‘‘assets of the
partnership in which the API is held.’’
A commenter recommended that the
final regulations clarify whether the
transfer of a distributed asset held, or
deemed to be held, by the partnership
for three years or less is subject to
section 1061(d). Another commenter
noted that there is no principled reason
for not applying section 1061(d) in
tiered partnerships to transfers of
Distributed API Property by Passthrough
Entities to Section 1061(d) Related
Persons of the ultimate Owner
Taxpayer.
Under the final regulations, the
Section 1061(d) Recharacterization
Amount is computed by the Owner
Taxpayer. The transfer of a distributed
asset held, or deemed to be held, by a
Passthrough Entity for three years or
less is subject to section 1061(d). The
final regulations clarify that for

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purposes of section 1061(d), an Owner
Taxpayer will be treated as transferring
the Owner Taxpayer’s share of any
Indirect API or Distributed API Property
if the Indirect API or Distributed API
Property is transferred by the API
Holder to a person that is a Section
1061(d) Related Person with respect to
the Owner Taxpayer. The final
regulations also provide that the rules
for determining the Section 1061(d)
Recharacterization Amount also apply
to the transfer of a Passthrough Interest
issued by an S corporation or PFIC to
the extent the Passthrough Interest is
treated as an API.
Proposed § 1.1061–5(e) defines a
Section 1061(d) Related Person as: (i) A
person that is a member of the
taxpayer’s family within the meaning of
section 318(a)(1); (ii) a person that
performed a service within the current
calendar year or the preceding three
calendar years in a Relevant ATB to the
API transferred by taxpayer; or (iii) a
Passthrough Entity to the extent that a
person described in paragraph (e)(1)(i)
or (ii) owns an interest, directly or
indirectly. One commenter
recommended that the definition of
Section 1061(d) Related Person be
amended to exclude a Passthrough
Entity to the extent that a member of the
taxpayer’s family or colleague is an
owner, noting that language is not in the
statute and is not discussed in the
legislative history. The final regulations
do not adopt this comment. Section
1061(d)(1) provides that the inclusion
required by section 1061(d) applies if a
taxpayer transfers any API, directly or
indirectly, to a person related to the
taxpayer.
III. Additional Comments Received and
Revisions Made

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A. Sections 1.1061–1 and 1.1061–2:
Definitions, Operational Rules, and
Examples
1. Definitions, In General
A commenter expressed the view that
the interrelated new terms and
definitions make the proposed
regulations difficult to read and
comprehend in some places. The final
regulations largely retain the terms and
definitions provided in § 1.1061–1(a)
but simplify many of the computational
rules and concepts used to determine
the Recharacterization Amount and the
Section 1061(d) Recharacterization
Amount. The terms and definitions
provide a helpful roadmap to the
regulations and are also needed to
provide Owner Taxpayers, Passthrough
Entities, and the IRS with a common
vocabulary that can be used to describe
the necessary computations and

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reporting requirements. The final
regulations make clarifying changes
throughout the definitions, including
providing that a Passthrough Entity can
also be a trust or estate. Terms have also
been added and removed in accordance
with the revisions discussed elsewhere
in this Summary of Comments and
Explanation of Revisions.
A commenter noted that the preamble
to the proposed regulations provides
that ‘‘taxpayer’’ means Owner Taxpayer
in sections 1061(a) and (d), and both
Owner Taxpayer and Passthrough
Taxpayer in section 1061(c)(1). The
commenter further noted that the
proposed regulations use the definition
of ‘‘person’’ as that term is generally
used under section 7701(a)(1). The
commenter requested that the final
regulations provide explicit definitions
of ‘‘taxpayer’’ and ‘‘person’’ in each
relevant part because the terms have
different meanings in different contexts.
The final regulations do not adopt this
comment because defining taxpayer and
person in different ways in each
relevant section would introduce
unnecessary complexity. However, the
use of these terms has been modified in
certain places in the final regulations to
alleviate confusion.
2. Operational Rules
a. Definition of API; An API Remains an
API
Proposed § 1.1061–1(a) provides that
API means any interest in a partnership
which, directly or indirectly, is
transferred to (or is held by) an Owner
Taxpayer or Passthrough Taxpayer in
connection with the performance of
substantial services by the Owner
Taxpayer or by a Passthrough Taxpayer,
or by any Related Person, including
services performed as an employee, in
any ATB unless an exception applies,
and that for purposes of this definition,
an interest in a partnership also
includes any financial instrument or
contract, the value of which is
determined in whole or in part by
reference to the partnership (including
the amount of partnership distributions,
the value of partnership assets, or the
results of partnership operations.)
A commenter expressed concern that
defining an interest in a partnership to
include a financial instrument or
contract, the value of which is
determined in whole or in part by
reference to the partnership, could
include investment management
contracts that provide for a fee based on
the assets of a fund partnership and not
a carried interest or other performance
allocation, creating a risk that the sale
of a management company or indirect

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sale of a management contract could be
subject to section 1061. This in turn
could cause the enterprise value of the
management company to be taxed at
ordinary income rates. The commenter
recommended that the definition of API
be modified to exclude financial
instruments or contracts that merely
reference the value of partnership assets
or that provide for fee income that is
subject to ordinary income tax
treatment.
Because financial instruments can
replicate the performance of a
partnership interest, the inclusion of
such items in the definition of an API
is necessary for purposes of
implementing section 1061.
Accordingly, the final regulations do not
adopt this comment. As stated in Part IV
of this Summary of Comments and
Explanation of Revisions, the Treasury
Department and the IRS continue to
study the impact of section 1061 on the
taxation of enterprise value related to
the transfer or exchange of partnership
interests and management contracts.
Proposed § 1.1061–2(a)(1)(i) provides
that once a partnership interest qualifies
an API, the partnership interest remains
an API unless and until the
requirements of one of the exceptions to
qualification of a partnership interest as
an API are satisfied. A commenter
questioned whether this provision is
valid given that it is not explicit in the
statute, but reasoned that the rule is
implicit in the statutory scheme and is
necessary to prevent avoidance of the
statute.
The Treasury Department and the IRS
agree with the commenter that this rule
is implicit in the statutory scheme.
Neither the statute nor the legislative
history provide a time limit or other
means of ending API treatment beyond
the exceptions to qualification as an
API. Consequently, no modifications
have been made to § 1.1061–2(a)(1)(i).
b. Presumption That Services are
Substantial
Proposed § 1.1061–2(a)(1)(iv) provides
that if a partnership interest is
transferred to or held by an Owner
Taxpayer, Passthrough Taxpayer, or any
Related Person in connection with the
performance of services, the Owner
Taxpayer, the Passthrough Taxpayer, or
the Related Person is presumed to have
provided substantial services for
purposes of section 1061. Commenters
suggested that presuming all services to
be substantial is overbroad and
recommended that the presumption be
removed. In addition, one commenter
recommended the inclusion of nonexclusive safe harbors that service
partners could rely on to determine that

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partnership interests they hold or that
have been transferred to them are not in
connection with the performance of
substantial services. Another
commenter recommended adding a
means to rebut the presumption that the
services are substantial.
The final regulations retain the
proposed rule’s presumption that all
services provided for a partnership
interest are substantial services for
purposes of section 1061. However, the
Treasury Department and the IRS will
continue to study and consider possible
circumstances under which the
presumption might be rebutted as well
as the possibility of providing safe
harbors for circumstances under which
the presumption will not apply. These
considerations may be addressed in
future guidance.
c. Application of the ATB Activity Test
i. In General, ATB
Proposed § 1.1061–1(a) provides that
applicable trade or business (ATB)
means any activity for which the ATB
Activity Test with respect to Specified
Actions is met, and includes all
Specified Actions taken by Related
Persons, including combining activities
occurring in separate partnership tiers
or entities as one ATB. Proposed
§ 1.1061–1(a) defines an Owner
Taxpayer as the person subject to
Federal income tax on net gain with
respect to an API or an Indirect API
during the taxable year, including an
owner of a Passthrough Taxpayer unless
the owner of the Passthrough Taxpayer
is a Passthrough Entity itself or is
excepted under proposed § 1.1061–3(a),
(b), or (d).

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ii. ATB Activity Test
Proposed § 1.1061–2(b)(1) provides
that the ATB Activity Test is satisfied if
Specified Actions are conducted by one
or more Related Persons and the total
level of activity, including the combined
activities of all Related Persons, satisfies
the level of activity that would be
required to establish a trade or business
under section 162. Proposed § 1.1061–
1(a) provides that Specified Actions
means Raising or Returning Capital
Actions and Investing or Developing
Actions. Raising or Returning Capital
Actions means actions involving raising
or returning capital but does not include
Investing or Developing Actions.
Investing or Developing Actions means
actions involving either (i) investing in
(or disposing of) Specified Assets (or
identifying Specified Assets for such
investing or disposition), or (ii)
developing Specified Assets.

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Commenters requested clarification
that joint ventures of a real estate
developer involving a single stand-alone
project at a single location will not
satisfy the ATB Activity Test. One of
these commenters recommended that
the definition of Raising or Returning
Capital should be refined so that it
includes only raising or returning
capital activities in which the business
earns compensation based on either
capital committed, capital contributed,
or capital invested. Another commenter
noted that additional guidance may be
needed to make the statute more
administrable because real estate held
for rental or investment is a Specified
Asset but holding the property may not
constitute a trade or business under
section 162.
The final regulations do not adopt
these comments. Whether a single
project or raising of capital involves the
level of activity needed to constitute a
trade or business under section 162 is
dependent on the facts and
circumstances unique to the project or
raising of capital. Furthermore,
guidance under section 162 is beyond
the scope of these regulations.
Example 6 of proposed § 1.1061–
2(b)(2)(vi) describes a situation in which
A manages a hardware store that
Partnership owns. A is issued a profits
interest in Partnership in connection
with A’s services. Partnership owns the
building in which the hardware store
operates. The example notes that the
building is held by Partnership not for
rental or investment, but to conduct
Partnership’s hardware business and,
thus, the building is not a Specified
Asset. The example provides that the
partnership maintains and manages a
certain amount of working capital for its
business, but notes that working capital
is not taken into account for the purpose
of determining whether the ATB
Activity Test is met. A commenter
suggested that another example should
be added to analyze how to apply the
ATB Activity Test where the facts are
changed so that the business is held in
a C corporation, the partnership only
holds the C corporation stock, and the
holding partnership is held by an
investment partnership. The commenter
stated that the ATB Activity Test should
not be met by the holding partnership
and the manager should not be an API
Holder.
The final regulations do not adopt this
comment. Depending on the specific
facts and circumstances of the situation,
the Treasury and the IRS believe that
the ATB Activity Test could be met by
such a holding partnership and the
manager might be an API Holder.

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A commenter requested clarification
regarding what activities occurring in
separate partnership tiers or entities will
be considered combined and treated as
one ATB, and recommended that the
regulations be amended to include an
example illustrating how the ATB and
API rules work in this situation. The
commenter recommended that the
application of section 1061 be limited to
an Owner Taxpayer solely with respect
to partnership interests that serve as
compensation for services relating to
Specified Assets. Another commenter
requested simplifying safe harbors for
activities conducted in multiple entities
either in the same chain or in a brothersister chain.
The Treasury Department and the IRS
continue to study these issues and may
consider providing future guidance on
these matters. However, the Treasury
Department and the IRS note the
definition of ATB includes any and all
activities, no matter how minimal,
conducted by entities that are Related
Persons to each other, for purposes of
determining whether the ATB Activity
Test is met, and if that test is met, then
each such participating entity is
considered to be engaged in an ATB.
Another commenter requested
clarification that businesses that do not
both raise or return capital and engage
in either investment or development
activities do not satisfy the ATB
Activity Test, and that the regular,
continuous, and substantial standard
applies independently to each prong of
the ATB Activity Test. The commenter
suggested that because the proposed
regulations aggregate activities of one or
more entities and related parties, the
final regulations should not include the
statement that the fact that either
Raising or Returning Capital Actions or
Investing or Developing Actions are
only infrequently taken does not
preclude the test from being satisfied if
the combined Specified Actions meet
the test. The commenter expressed
concern that this language combined
with the rule that Raising or Returning
Capital Actions and Investing or
Developing Actions are not required to
be taken in each taxable year could
cause the activities of a fund sponsor’s
affiliates to satisfy the raising or
returning capital prong with respect to
any of the sponsored funds.
The final regulations do not adopt this
comment. It is necessary for both the
Raising or Returning Capital Actions
and Investing or Developing Actions to
be present for the ATB Activity Test to
be satisfied. The aggregation rule and
the language regarding infrequent
actions are necessary to prevent abuse of
section 1061. Without these rules,

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activities could be spread among
multiple related entities with the intent
of not satisfying the ATB Activity Test.

1061 is necessary to prevent the
circumvention of, and compliance with,
section 1061.

iii. Definition of Specified Assets
Proposed § 1.1061–1(a) defines
Specified Assets as: (i) Securities,
including interests in partnerships
qualifying as securities (as defined in
section 475(c)(2) without regard to the
last sentence thereof); (ii) commodities
(as defined in section 475(e)(2)); (iii)
real estate held for rental or investment;
(iv) cash or cash equivalents; (v) an
interest in a partnership to the extent
that the partnership holds Specified
Assets; and, (vi) options or derivative
contracts with respect to any of the
foregoing.
Commenters requested additional
guidance on the treatment of
partnerships that engage in the
production, storage, transportation,
processing, or marketing of physical
commodities in the ordinary course of
business (including hedges with respect
to the commodities). The commenters
requested that such partnerships not be
treated as engaged in Investing and
Developing Actions as a result of such
activities, and that Specified Assets only
include commodities that are
themselves actually actively traded on
an established financial market, not
merely commodities of the same type as
commodities that are or can be actively
traded on an established financial
market.
The final regulations do not adopt this
comment; however, the Treasury
Department and the IRS continue to
study this issue and may address it in
future guidance.
Another commenter noted that it is
unclear whether the rule treating a
derivative contract with respect to a
partnership interest as a partnership
interest for purposes of applying section
1061 is needed to appropriately
administer section 1061. The
commenter noted that the proposed
regulation’s position regarding such a
derivative injects unnecessary
complexity into the tax system, and
stated that because payments made
before termination of a swap are almost
always ordinary income, it may not
make economic or tax sense to use such
a financial instrument in lieu of a
partnership interest in an attempt to
avoid section 1061.
The final regulations do not adopt this
comment. While the use of a derivative
contract in this circumstance may be
rare, the Treasury and the IRS are
concerned that the potential for abuse
exists. Consequently, the treatment of a
derivative contract as a partnership
interest for purposes of applying section

B. Section 1.1061–3: Exceptions to the
Definition of API

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1. Corporate Exception
Section 1061(c)(4)(A) provides that an
API ‘‘shall not include any interest in a
partnership directly or indirectly held
by a corporation.’’ In implementing this
exception, proposed § 1.1061–3(b)(2)
provides that a corporation does not
include an entity for which an election
was made to treat the entity as a
Passthrough Entity, and that therefore,
an S corporation for which an election
under 1362(a) is in effect and a PFIC
with respect to which the shareholder
has a QEF election under section 1295
in effect (such entity is a QEF with
respect to the shareholder), are not
treated as corporations for purposes of
section 1061. One commenter approved
of this decision, noting that section
1061(f) provides ample authority for
excluding S corporations and PFICs
from the term corporation. The
commenter noted that allowing such
structures to benefit from the corporate
exception would allow section 1061 to
be entirely circumvented. Another
commenter, discussing PFICs subject to
QEF elections, noted that the exclusion
of QEFs from the definition of
corporation for purposes of section 1061
is consistent with section 1(h)(9) and
(h)(10).
One commenter disagreed regarding
authority, noting that the ability to treat
QEFs and S corporations as subject to
section 1061 is subject to substantial
doubt and contrary to the plain text of
the statute. The commenter also noted
that Notice 2018–18, 2018–2 I.R.B. 443,
and the provision’s legislative history
offer no reason why S corporations
should, or should not, qualify for the
exception. Another commenter said that
a legislative clarification should be
sought prior to including a rule in the
final regulations providing that S
corporations are subject to section 1061.
The Treasury Department and the IRS
agree with commenters that the
exclusion of S corporations and QEFs
from the corporate exception is
necessary to avoid circumvention of
section 1061. Accordingly, no change
has been made to this section of the
final regulations. As explained in the
preamble to the proposed regulations,
section 1061(f) provides that the
Secretary has authority to issue
regulations or other guidance as is
necessary or appropriate to carry out the
purposes of section 1061. Both the
Conference Report and the Blue Book

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further direct the Treasury Department
and the IRS to issue regulations to
address the prevention of abuse of the
purposes of the provision. The grant of
authority in section 1061(f) is sufficient
to issue regulations providing that the
exception in section 1061(c)(4)(A) does
not include S corporations and PFICs
with respect to which shareholders have
QEF elections in effect. See also section
1(h)(9) and (10).
2. Unrelated Purchaser Exception
Proposed § 1.1061–3(d) provides that
if a taxpayer acquires an interest in a
partnership (target partnership) by
taxable purchase for fair market value
that, but for the exception in § 1.1061–
3(d), would be an API, the taxpayer will
not be treated as acquiring an API if,
immediately before the purchase (1) the
taxpayer is not related within the
meaning of section 267(b) or 707(b) to
any person who provides services in the
Relevant ATB, or any service providers
who provide services to or for the
benefit of the target partnership or a
lower-tier partnership in which the
target partnership holds a direct or
indirect interest; (2) section 1061(d)
does not apply to the transaction (as
provided in § 1.1061–5); and (3) the
taxpayer has not provided in the past,
does not then provide, and does not
anticipate providing services in the
future to, or for the benefit of, the target
partnership, directly or indirectly, or
any lower-tier partnership in which the
target partnership holds a direct or
indirect interest.
A few commenters stated that the
proposed regulations are unclear as to
whether the exception applies only to
an API that is directly acquired or
whether it also applies to an API in
which the buyer acquired an indirect
interest through an upper-tier
partnership. One commenter
recommended that final regulations
provide that the exception applies to
both APIs purchased directly as well as
an APIs purchased indirectly, noting
that the unrelated purchaser might not
be able to rely on Rev. Rul. 87–115,
1987–2 C.B. 163, to adjust the basis of
the underlying fund assets to prevent
the recognition of built-in gain, as fund
sponsors generally do not make section
754 elections at the fund level. Further,
the commenter suggested that the final
regulations provide that the exception
applies regardless of whether the lowertier partnership interest is acquired after
the third-party purchases the interest in
the upper-tier partnership or acquires
the upper-tier partnership interest by
contribution. Another commenter
suggested that the exception be

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extended to interests in other
Passthrough Entities.
The final regulations do not adopt
these comments because of the
complexity of administering the
unrelated purchaser exception through
tiers of Passthrough Entities. The final
regulations make non-substantive
clarifying changes to the rule.
The preamble to the proposed
regulations provides that the exception
does not apply to an Unrelated NonService Partner who becomes a partner
by making a contribution to a
Passthrough Entity that holds an API
and in exchange receives an interest in
the Passthrough Entity’s API, stating
that, in this case, allocations to the
Unrelated Non-Service Partner with
respect to the API are API Gains and
Losses and retain their character as API
Gains and Losses. One commenter noted
that this exception to the unrelated
purchaser exception is not explained in
the proposed regulations’ preamble and
suggested that the exception to the
exception is most likely intended to
refer to a situation in which an investor
makes a contribution in form to an
upper-tier partnership, which then
distributes an API with respect to a
lower-tier partnership to the
contributing upper-tier partner. The
commenter notes that these transfers
might be a purchase of the API by the
investor from the upper-tier partnership.
The Treasury Department and the IRS
intend that the third-party purchaser
exception be limited to API purchases
and not apply when a third party
contributes cash or property to a
Passthrough Entity holding an API in a
transaction qualifying for
nonrecognition under section 721(a), or
any similar provision, resulting in the
contributor receiving allocations
attributable to the transferee
Passthrough Entity’s API.

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C. Section 1.1061–4: Computing the
Recharacterization Amount
1. Computation of the
Recharacterization Amount
Proposed § 1.1061–4(a)(1) provides
that the Recharacterization Amount
equals the Owner Taxpayer’s One Year
Gain Amount less the Owner Taxpayer’s
Three Year Gain Amount. The Owner
Taxpayer’s One Year Gain Amount is
the sum of the Owner Taxpayer’s
combined net API One Year Distributive
Share Amount from all APIs held during
the taxable year and the Owner
Taxpayer’s API One Year Disposition
Amount. An Owner’s Taxpayer’s Three
Year Gain Amount is equal to the
Owner Taxpayer’s combined net API
Three Year Distributive Share Amount

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from all APIs held during the taxable
year and the Owner Taxpayer’s API
Three Year Disposition Amount. The
API One Year and Three Year
Distributive Share Amounts exclude
Capital Interest Gains and Losses.
Capital Interest Disposition Amounts
are not included in the computation of
the API One Year and Three Year
Disposition Amounts because they
relate to the disposition of a Capital
Interest rather than an API.
Proposed § 1.1061–4(a)(3)(i) provides
that the API One Year Distributive Share
Amount equals the API Holder’s
distributive share of net long-term
capital gain from the partnership for the
taxable year, including capital gain or
loss on the disposition of all or a part
of an API, with respect to the
partnership interest held by the API
Holder calculated without the
application of section 1061 less, to the
extent included in the amount
determined under proposed § 1.1061–
4(a)(3)(i)(A), the aggregate of amounts
that are excluded from section 1061
under proposed § 1.1061–4(b)(6), the
API Holder’s Transition Amount for the
taxable year; and Capital Interest Gains
and Losses as determined under
proposed § 1.1061–3(c)(2).
One commenter stated that the
definition of API One Year Distributive
Share Amount does not allow for this
amount to be a loss. For example, if an
Owner Taxpayer holds two APIs and
one partnership allocates the taxpayer a
loss and the other a gain, the loss does
not offset the gain because the API One
Year Distributive Share Amount for the
partnership that allocated the taxpayer a
loss will be zero. The commenter
recommended allowing the API One
Year Distributive Share Amount to be
less than zero. The final regulations
adopt this suggestion by revising the
computation for the API One Year
Distributive Share Amount to include
both capital gain and loss. In addition,
the commenter suggested that the final
regulations provide that if each of the
API One Year Distributive Share
Amount and the API Three Year
Distributive Share Amount is greater
than zero but the API One Year
Distributive Share Amount is less than
the API Three Year Distributive Share
Amount, no portion of the API One Year
Distributive Share Amount is
recharacterized as short-term capital
gain. The final regulations adopt this
suggestion by providing that if the One
Year Gain Amount and the Three Year
Gain Amount are both greater than zero
but the One Year Gain Amount is less
than the Three Year Gain Amount, none
of the One Year Gain Amount is
included in the Recharacterization

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Amount for the taxable year. In addition
to adopting this comment, the final
regulations make minor clarifying
changes to the computation rules.
Commenters raised several additional
concerns related to the computation
rules. One commenter recommended
that regulations provide guidance on
how losses limited by section 1211
affect the Recharacterization Amount.
Another commenter noted that the
proposed regulations do not address
how net capital gain is computed or the
order of steps in doing so under section
1(h)(1). The commenter stated that
because section 1061(a) recharacterizes
what would have been long-term capital
gain as short-term capital gain, it is
apparent that section 1061(a) must be
applied somewhere in the process
before the application of section 1(h).
Further, the proposed regulations do not
address § 1.1(h)–1, which provides a
look-through rule when a partnership
interest is sold, to determine what
portion of the gain on sale will be
treated as collectibles gain or section
1250 capital gain. The commenter also
noted that, although section 1231 and
section 1256 gains are excluded from
section 1061 by the proposed
regulations, a sale of a partnership
interest holding such assets is not
excluded, and all the gain is subject to
section 1061(a) unless section 751(a)
applies. Finally, the commenter stated
that there is no provision in the
proposed regulations addressing
suspension of the holding period of an
API when an API owner seeks to obtain
a more-than-three-year holding period
without undertaking additional risk—
that is, the hedging of the API. The
commenter recommended that an
express rule be provided, such as the
rule provided in § 1.1400Z2(a)–1(b) for
interests in partnerships self-certified as
qualified opportunity funds.
The Treasury Department and the IRS
continue to study the issues raised by
these comments in regard to the
computation rules and may address
them in future guidance.
2. Distributed API Property
Proposed § 1.1061–1(a) provides that
Distributed API Property means
property distributed by a Passthrough
Entity to an API Holder with respect to
the API if the holding period, as
determined under sections 735 and
1223, in the API Holder’s hands is three
years or less at the time of disposition
of the property by the API Holder.
A commenter questioned whether the
Treasury Department and the IRS have
the authority to treat Distributed API
Property as subject to section 1061(a).
The commenter further stated that in

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order for the rule to be a valid exercise
of regulatory authority, distributed
property for this purpose should
exclude property that, if sold by the
partnership, would be excluded from
section 1061, such as property that
would generate 1231 and 1256 gains.
The final regulations continue to treat
Distributed API Property as subject to
section 1061(a) under the authority of
section 1061(f). However, the Treasury
Department and the IRS agree with the
commenter that long-term capital gain
from the disposition of Distributed API
Property that, if sold by the partnership,
would be excluded from section 1061,
such as 1231 and 1256 gain, qualified
dividends described in section
1(h)(11)(B), and any other capital gain
that is characterized as long-term or
short-term without regard to the holding
period rules in section 1222, should not
be recharacterized under section
1061(a). The final regulations clarify
this point by excluding these items from
the calculation of the API One Year
Disposition Amount. Additionally,
because a Passthrough Entity does not
calculate an API One Year Disposition
Amount, the final regulations clarify
that for purposes of calculating the API
One Year Distributive Share Amount, an
API Holder’s distributive share of net
long-term capital gain from the
partnership includes capital gain or loss
on the disposition of Distributed API
Property or all or part of an API by an
API Holder that is a Passthrough Entity.
Another commenter suggested that
the final regulations explicitly provide
rules for the treatment of Distributed
API Property when the Distributed API
Property is distributed from one
Passthrough Entity to another and the
upper-tier entity disposes of the
Distributed API Property. The
commenter also requested confirmation
in the final regulations that partnerships
should subtract capital gain or loss from
property that had been Distributed API
Property but no longer is at the time of
disposition when calculating the API
One Year Distributive Share Amount
because such gain is excluded from the
calculation of the Recharacterization
Amount.
The final regulations partially adopt
this comment by revising the
computation of the One Year
Distributive Share Amount to explicitly
include dispositions of API Distributed
Property by a partnership or other
Passthrough Entity. The final
regulations do not adopt the suggestion
to explicitly provide that partnerships
should subtract capital gain or loss from
property that had been Distributed API
Property but no longer is at the time of
disposition when calculating the API

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One Year Distributive Share Amount.
The definition of Distributed API
Property provides that it only applies to
property with a holding period of three
years or less on the date of disposition
by an API Holder. Any property with a
greater than three-year holding period is
therefore not Distributed API Property.
A special rule for Distributed API
Property distributed to an upper-tier
entity by a lower-tier entity is
unnecessary because the definition of
API Holder includes a Passthrough
Entity.
Commenters noted that the proposed
regulations are unclear as to how the
Distributed API Property rules apply
where an API Holder owns both a
profits interest and a capital interest in
a partnership, and recommended that
the final regulations clarify that a
distribution to a partner is not
Distributed API Property to the extent
that it is distributed with respect to the
portion of the partner’s interest
qualifying for the Capital Interest
Exception. One commenter suggested
that such guidance should also address
how to apply the recommended rule in
the context of tiered structures.
The Treasury Department and the IRS
continue to study this issue and may
address it in future guidance.
3. Special Rules for Capital Gain
Dividends From Regulated Investment
Companies (RICs) and Real Estate
Investment Trusts (REITs)
The preamble to the proposed
regulations recognizes that long-term
capital gain treatment should be
available for a capital gain dividend
paid by a RIC or REIT to the extent that
the capital gain dividend is attributable
to assets held for more than three years
or is attributable to assets that are not
subject to section 1061. Proposed
§ 1.1061–4(b)(4) facilitates this
treatment by allowing a RIC or REIT to
disclose two additional amounts based
on modified computations of the RIC’s
or REIT’s net capital gain. First, the RIC
or REIT may disclose the amount of the
capital gain dividend that is attributable
to the RIC’s or REIT’s net capital gain
excluding any amounts not taken into
account for purposes of section 1061
under proposed § 1.1061–4(b)(6) from
the computation. Second, the RIC or
REIT may disclose the amount of the
capital gain dividend that is attributable
to the RIC’s or REIT’s net capital gain
both (1) excluding any amounts not
taken into account for purposes of
section 1061 under proposed § 1.1061–
4(b)(6) from the computation, and (2)
substituting three years for one year in
applying section 1222. The proposed
regulations allow a RIC or REIT to

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disclose these two additional amounts
in writing to its shareholders with its
section 852(b)(3)(C)(i) capital gain
dividend statement or section
857(b)(3)(B) capital gain dividend
notice.
One commenter suggested that it
would be extremely rare for a RIC to
have shareholders for whom this
provision is relevant and stated that
requiring this additional reporting
would be unnecessarily burdensome as
it creates a third type of capital gain that
RICs would need to track and report.
Consequently, the commenter requested
that final regulations continue to permit,
but not require, RICs to report this
information if they have a shareholder
for whom such amounts are relevant. In
addition, the commenter noted that
most funds will not calculate this
information at the time capital gain
dividends are reported on Forms 1099–
DIV. The commenter requested that
final regulations allow reporting on a
written statement furnished to the
applicable shareholder on request,
without tying the reporting of such
amounts to the reporting of capital gain
dividends.
Another commenter suggested that
RICs and REITs should be permitted to
disclose these additional amounts, upon
request by a shareholder, and report the
One Year Amounts Disclosure and
Three Year Amounts Disclosure (as
those terms are defined in proposed
§ 1.1061–6(c)) until the extended due
date of their returns.
The final regulations retain the rules
as proposed but designate them as
§ 1.1061–4(b)(5). As suggested by these
commenters, the final regulations retain
the option to disclose to shareholders
the two additional amounts (that is the
final regulations do not make disclosure
mandatory). The final regulations do not
adopt the suggestion to allow RICs and
REITs to disclose these additional
amounts only upon the request of a
shareholder because such treatment may
allow a RIC or REIT to choose to provide
information only to certain shareholders
but not to other shareholders. The
Treasury Department and the IRS
continue to study comments suggesting
that the disclosure of this information
be separated from the reporting of
capital gain dividends and may issue
guidance in the future. In the interim,
the final regulations retain the rule that
the disclosures are to be provided with
the section 852(b)(3)(C)(i) capital gain
dividend statement or section
857(b)(3)(B) capital gain dividend
notice.

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4. Computation of the
Recharacterization Amount for Owner
Taxpayers With Interests in QEFs
The proposed regulations provide
special rules for Owner Taxpayers that
hold their APIs indirectly through PFICs
for which they have made a QEF
election. Specifically, under proposed
§ 1.1061–4(b)(5), the API One and Three
Year Distributive Share Amounts
include an Owner Taxpayer’s section
1293(a)(1) inclusions from QEFs,
reduced by amounts that are excluded
from section 1061(a) if the QEF
complies with the reporting rules under
§ 1.1061–6(d). These reporting rules
provide that QEFs may provide
information to allow Owner Taxpayers
to compute their Recharacterization
Amount. If a QEF fails to provide such
information, an Owner Taxpayer
includes its entire pro rata share of the
QEF’s net capital gain in its API One
Year Distributive Share Amount and no
portion of its pro rata share of the QEF’s
net capital gain is ultimately included
in its API Three Year Distributive Share
Amount. One commenter made several
suggestions regarding the computation
of an Owner Taxpayer’s API One Year
Distributive Share Amount and API
Three Year Distributive Share Amount
with respect to a QEF’s net capital gain.
Broadly, the commenter expressed a
concern that the corporate-level capital
gain netting rules applicable to QEFs are
not consonant with the requirement that
the Recharacterization Amount be
computed at the Owner Taxpayer level.
A QEF determines its net capital gain at
the corporate level, and may do so in
one of three ways: First, the QEF may
calculate and report the amount of each
category of long-term capital gain
described in section 1(h) of the Code;
second, the QEF may report its net
capital gain for the year and state that
it is subject it to the highest capital gain
rate of tax applicable to the shareholder;
or third, the QEF may determine its
current earnings and profits (E&P) and
report the entire amount as ordinary
earnings. Section 1.1293–1(a)(2). A
QEF’s net capital gain is limited to its
current E&P, regardless of how it
computes such amount under § 1.1293–
1(a)(2) (QEF E&P limitation). Section
1293(e)(2). The commenter had several
suggestions on how to clarify or
improve the rules under section 1061
applicable to QEFs.
First, the commenter suggested that
the three year QEF net capital gain
provision was not entirely clear,
particularly in regard to the API Three
Year Distributive Share Amount. The
commenter recommended that the final
regulations clarify that an Owner

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Taxpayer includes in its API Three Year
Distributive Share Amount the same
base amount as determined for the API
One Year Distributive Share Amount (as
adjusted to reflect only net long-term
capital gains and losses calculated by
substituting a greater-than-three-year
holding period for a greater-than-oneyear holding period).
The Treasury Department and the IRS
confirm that an Owner Taxpayer’s API
Three Year Distributive Share Amount
is based on the amount computed for its
API One Year Distributive Share
Amount and adjusted to include only
items that would be treated as a longterm gain or loss if three years were
substituted for one year in paragraphs
(3) and (4) of section 1222 if the QEF
satisfies certain reporting obligations.
See § 1.1061–6(d). However, the final
regulations revise proposed § 1.1061–
4(b)(5) (designated as § 1.1061–4(b)(6) in
the final regulations) to more precisely
identify the inputs for computing an
Owner Taxpayer’s API One and Three
Year Distributive Share Amounts and
illustrate an Owner Taxpayer’s API
Three Year Distributive Share Amount
computation with respect to a QEF.
Specifically, § 1.1061–4(b)(6)(i) provides
that an Owner Taxpayer’s inclusion
under section 1293(a)(1)(B) that is taken
into account in determining the API
One Year Distributive Share Amount
with respect to a QEF is limited to the
QEF’s E&P by section 1293(e)(2) and
that the section 1293(a)(1)(B) inclusion
may be reduced by the Owner
Taxpayer’s share of the excess (if any)
of the Capital Interest Gain over Capital
Interest Loss with respect to the QEF as
well as amounts not taken into account
for purposes of section 1061 pursuant to
§ 1.1061–4(b)(7). In either case,
however, § 1.1061–4(b)(6)(i) permits
such reductions only if a QEF has
provided an Owner Taxpayer with the
relevant information necessary for the
Owner Taxpayer to determine those
amounts.
Additionally, § 1.1061–4(b)(6)(ii) of
the final regulations provides that the
minuend of an Owner Taxpayer’s API
Three Year Distributive Share Amount
computation (under § 1.1061–4(a)(3)(ii))
includes its entire amount determined
under § 1.1061–4(b)(6)(i) (one year QEF
net capital gain). The final regulations
further provide that if the QEF does not
provide the Owner Taxpayer with
information necessary under § 1.1061–
6(d) to determine the amount of its
section 1293(a)(1)(B) inclusion (less any
allowed reductions) with respect to the
QEF that would be included in its API
One and Three Year Distributive Share
Amounts, then the entire amount of the
Owner Taxpayer’s one year QEF net

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capital gain (less any allowed
reductions) is also included in the
subtrahend of its API Three Year
Distributive Share Amount formula
(under § 1.1061–4(a)(3)(ii)(A)). This
results in an Owner Taxpayer’s entire
section 1293(a)(1)(B) inclusion (less any
allowed reductions) being treated as
short-term capital gain. However, if the
QEF provides the Owner Taxpayer with
the additional necessary information,
then the Owner Taxpayer includes only
the amount of its one year QEF net
capital gain amount that would not be
treated as long-term capital gain
substituting a greater-than-three-year
holding period in applying paragraphs
(3) and (4) of section 1222 in the
subtrahend of this formula (under
§ 1.1061–4(a)(3)(ii)(A)). This can result
in a portion of an Owner Taxpayer’s
section 1293(a)(1)(B) inclusion being
characterized as long-term capital gain
with the balance being treated as shortterm capital gain.
To illustrate, assume an Owner
Taxpayer owns an interest in a QEF that
holds an API; the Owner Taxpayer owns
no other API directly or indirectly. The
QEF generates both long- and short-term
capital gain in its taxable year, none of
which are amounts described in
§ 1.1061–4(b)(7) or Capital Interest
Gains; the Owner Taxpayer’s pro rata
share of the QEF’s long-term capital gain
is $100, $70 of which would not be
long-term capital gain if a greater-thanthree-year holding period were used in
applying paragraphs (3) and (4) of
section 1222, and its share of the QEF’s
short-term capital gain (determined
without regard to section 1061) is $15.
Before applying section 1061, under
§ 1.1293–1(a)(2), the Owner Taxpayer’s
pro rata share of the QEF’s net capital
gain is $100. Under § 1.1061–4(b)(6)(i),
with respect to the QEF, the Owner
Taxpayer’s one year QEF net capital
gain amount, and thus its API One Year
Distributive Share Amount, is $100. In
its API Three Year Distributive Share
Amount computation with respect to
the QEF, this $100 is the minuend
(under § 1.1061–4(a)(3)(ii)). If the QEF
does not provide the Owner Taxpayer
with information to determine how
much of its pro rata share of the QEF’s
net capital gain would constitute longterm capital gain if a greater-than-threeyear holding period were used in
applying paragraphs (3) and (4) of
section 1222, the Owner Taxpayer
would include all $100 under § 1.1061–
4(a)(3)(ii)(A) in the subtrahend of its
computation. This results in an API
Three Year Distributive Share Amount
of $0 with respect to the QEF (that is:
$100 under § 1.1061–4(a)(3)(ii)

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introductory text, minus $100 under
§ 1.1061–4(a)(3)(ii)(A)) and a
Recharacterization Amount of $100 (that
is, $100 API One Year Distributive
Share Amount minus $0 API Three Year
Distributive Share Amount). However, if
the QEF does provide the Owner
Taxpayer with this information, the
Owner Taxpayer includes $70 in the
subtrahend of its API Three Year
Distributive Share Amount computation
with respect to the QEF under § 1.1061–
4(a)(3)(ii)(A). This results in an API
Three Year Distributive Share Amount
of $30 (that is: $100 under § 1.1061–
4(a)(3)(ii) introductory text, minus $70
under § 1.1061–4(a)(3)(ii)(A)) and a $70
Recharacterization Amount (that is:
$100 API One Year Distributive Share
Amount minus $30 API Three Year
Distributive Share Amount).
Additionally, the commenter asked
that the final regulations harmonize the
QEF reporting rules with the reporting
rules applicable to other Passthrough
Entities. Specifically, the commenter
requested that if a QEF does not report
relevant information, then QEF
shareholders that are Owner Taxpayers
should be able to substantiate amounts
included in the API One Year
Distributive Share Amount and Three
Year Distributive Share Amount, as well
as items excluded from section 1061(a),
through alternative means.
The Treasury Department and the IRS
have concluded that, when coupled
with § 1.1061–6(d), the QEF reporting
rules in § 1.1295–1(g) provide a
sufficiently comprehensive framework
for information reporting and no
additional rule for section 1061 is
necessary. Under § 1.1295–1(g)(1), for a
PFIC to be treated as a QEF by its
shareholders it must provide either an
annual statement including the
shareholder’s pro rata share of the QEF’s
net capital gain for the year or a
statement that it has granted its
shareholders access to its books and
records (or other documents) for the
purpose of determining those amounts;
under § 1.1295–1(g)(3), the same
information must be reported to indirect
PFIC shareholders on an intermediary
statement. Under § 1.1295–1(g)(2), in
‘‘rare and unusual circumstances,’’ a
PFIC can provide alternative
documentation if it obtains a private
letter ruling from, and enters into a
closing agreement with, the IRS. In
addition to these reporting
requirements, § 1.1061–6(d) permits (but
does not require) a QEF to provide its
shareholders that are Owner Taxpayers
with additional information for the
purpose of determining the Owner
Taxpayer’s API One Year Distributive

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Share Amount and Three Year
Distributive Share Amount.
The Treasury Department and the IRS
have determined that the reporting
mechanisms under §§ 1.1295–1(g) and
1.1061–6(d) provide sufficient avenues
for an Owner Taxpayer to obtain
information from a QEF to determine its
API One Year Distributive Share
Amount and Three Year Distributive
Share Amount. A special rule allowing
Owner Taxpayers to substantiate QEF
information through alternative means
for purposes of section 1061 would also
run counter to § 1.1295–1(g), which
generally requires a QEF, and not its
shareholders, to report information for
purposes of section 1293. As a result, to
reconcile the optional nature of QEF
reporting as compared with reporting
requirements of other Passthrough
Entities, the final regulations revise
§ 1.1061–6(b)(2)(ii) to provide that a
Passthrough Entity from which
information is requested must provide
such information, but only to the extent
the information is necessary for the
requesting Passthrough Entity to meet
its reporting and filing requirements
under § 1.1061–6. The final regulations
also revise § 1.1061–6(d) to provide that
Owner Taxpayers are not permitted to
separately substantiate amounts with
respect to a QEF under § 1.1061–6(a)(2).
Accordingly, the comments suggesting
changes to the QEF reporting rules
under section 1061 are not adopted.
The commenter also suggested that
the final regulations should provide
guidance on how to apportion the QEF
E&P limitation for purposes of section
1061. Specifically, the commenter
suggested that the QEF E&P limitation
should be apportioned according to the
shareholder’s relative share of the API
One Year Distributive Share Amount
and the API Three Year Distributive
Share Amount with respect to the QEF.
The commenter also suggested that
consideration be given to bypassing
netting at the PFIC level, with guidance
to be provided on how to allocate the
QEF E&P limitation at the Owner
Taxpayer level.
The QEF E&P limitation is imposed
by section 1293(e)(2) and is taken into
account in determining a shareholder’s
pro rata share of the net capital gains of
a QEF that is required to be included in
a shareholder’s income pursuant to
section 1293(a)(1). Netting of losses
must therefore be carried out before
determining the net capital gain of a
QEF that is required to be included by
a shareholder. The Treasury Department
and the IRS recognize the complexity
regarding apportioning the QEF E&P
limitation for purposes of section 1061.
This issue is particularly acute in light

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of the different types of capital gain and
loss relevant for purposes of section
1061 that may be included in a QEF’s
net capital gain, including one- and
three-year capital gains and losses, and
amounts excluded from section 1061
under § 1.1061–4(b)(7) or under the
capital interest exception. Further
complication arises from the fact that a
loss may arise either from a QEF’s
ordinary business operations, or from
one or more of the four categories listed
in the prior sentence.
In this regard, the Treasury
Department and the IRS considered
several possible ways of apportioning
the QEF E&P limitation. One possibility
would be to adopt an approach that
apportions the QEF E&P limitation
between the relevant types of capital
gains for purposes of section 1061 on a
pro rata basis, which the Treasury
Department and the IRS determined
would be appropriate in many
circumstances, though not all. For
example, if a loss arises from a QEF’s
ordinary business operations while its
capital gain income is derived from an
API, there may be no direct link
between the ordinary loss and the APIderived capital gain. In such a case a pro
rata approach may be appropriate.
Alternatively, for other circumstances,
the Treasury Department and the IRS
considered apportioning a QEF’s E&P
limitation based on more specific
ordering rules. For example, if a loss
were related to one or more categories
of capital gain, allocation first to those
categories might be appropriate.
Another possible approach would be to
allocate the loss giving rise to the E&P
limitation in the manner that most
closely approximates how an Owner
Taxpayer would be permitted to allocate
the loss if the QEF’s gains and losses
were derived directly by the Owner
Taxpayer and the Owner Taxpayer’s
income was limited to otherwise-longterm capital gain income. In light of the
complexity regarding the different
scenarios under which a pro rata
approach or an alternative approach
would be more appropriate, the
Treasury Department and the IRS have
determined that this issue warrants
further study and welcome comments in
this regard. Until the Treasury
Department and the IRS issue further
guidance on this issue, taxpayers may
adopt any reasonable method for
apportioning the QEF E&P limitation for
purposes of section 1061 taking into
account these considerations.
Finally, the commenter requested that
the Treasury Department and the IRS
provide a rule that would identify an
Owner Taxpayer’s distributive share of
a QEF’s net capital gain from a

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Passthrough Entity attributable to the
Owner Taxpayer’s qualifying capital
interest and API. The Treasury
Department and the IRS continue to
study this issue and may address it in
future guidance.
5. Items Not Taken Into Account for
Purposes of Section 1061
Proposed § 1.1061–4(b)(6) provides
that certain items of long-term capital
gain and loss are excluded from the
calculation of the API One Year
Distributive Share Amount and the API
Three Year Distributive Share Amount.
Specifically, long-term capital gain and
long-term capital loss determined under
section 1231 or 1256, qualified
dividends included in net capital gain
for purposes of section 1(h)(11)(B), and
capital gains or losses that are
characterized as long-term or short-term
without regard to the holding period
rules in section 1222 are excluded from
these calculations.
Two commenters questioned the
exclusion of long-term capital gain
determined under section 1231 from
recharacterization under section 1061.
Those commenters discussed the
discrepancies in language between
section 1061(a)(1) and 1061(a)(2), noting
that only section 1061(a)(2) refers to
section 1222. Both commenters
suggested that the treatment of section
1231 gains in the proposed regulations
is contrary to the statutory text of
section 1061. The first commenter stated
that section 1061(a)(1) applies to net
long-term capital gain and noted that
other portions of section 1061 indicate
that it is supposed to apply to gains that
are taxed at favorable rates for
disposition of investment assets. This
commenter argued that the reference to
section 1222 in section 1061(a)(2) can be
read as excluding certain section 1222
gains from the reach of section 1061(a),
rather than limiting section 1061(a) to
such gains by implication. The
commenter noted that if a determination
is made that section 1061(a) does apply
to section 1231, then regulations need to
address the holding periods of section
1231 and how the netting rules of
section 1231 interact with section 1061.
The second commenter suggested
that, under the proposed regulations,
the portion of any net section 1231 gains
attributable to APIs could arguably be
included in the amount described in
section 1061(a)(1). The commenter
stated that this would lead to
nonsensical results if net section 1231
gains are included in the amount
described in section 1061(a)(1) but
excluded from the amount described in
section 1061(a)(2). Because of the
conflicting statutory language in

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sections 1061(a)(1) and 1061(a)(2), the
commenter recommended that the
treatment of section 1231 gains be
reconsidered, suggesting that one
approach would be to include the net
1231 gain attributable to APIs in the
section 1061(a) computation after
recomputing this amount by
substituting 3 years for 1 year.
In contrast, several commenters
supported the proposed regulation’s
treatment of qualified dividends and
long-term capital gains determined
under section 1231 and 1256 as not
subject to recharacterization under
section 1061 and recommended these
provisions be finalized as proposed.
Commenters noted that this treatment
aligns with the clear language of the
statute and is consistent with
Congressional intent. One commenter
stated that section 1256 amounts should
not be subject to section 1061(a) because
they are not gains that are taxed at
favorable rates that arise from the
disposition of assets. Another
commenter noted that the statutory
references to section 1223(3) and (4)
raise the question of section 1061’s
potential effect on other Code
provisions without regard to section
1222. The commenter indicated that
some provisions have their own holding
period, such as section 1231, while
others, such as section 1256, just
mandate tax treatment. The commenter
stated that this results in a haphazard
inclusion or exclusion of items from
section 1061 and noted that because the
section 1061 legislative history is
devoid of guidance on this issue, the
approach taken in the proposed
regulations is reasonable but a technical
correction from Congress would be
welcome.
The final regulations do not adopt
suggestions that section 1231 gain
should be subject to recharacterization
under section 1061(a) and maintain the
rules in proposed § 1.1061–4(b)(6),
which is designated as 1.1061–4(b)(7) in
the final regulations. As stated in the
preamble to the proposed regulations,
section 1231 gains and losses are treated
as long-term based on the operation of
section 1231, and not by reference to
paragraphs (3) and (4) of section 1222.
Similarly, section 1256 provides for
specific character treatment and does
not calculate gain by reference to
section 1222. Accordingly, the Treasury
Department and the IRS have
determined that it is appropriate to
exclude these amounts from both the
One Year and Three Year Gain
Amounts. In contrast, because section
1061(d)(1) looks to the excess of longterm capital gains with respect to the
transferred interest to the sale or

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exchange of any asset held for not more
than three years as is allocable to such
interest over what is otherwise shortterm capital gain under section 1061(a),
and does not reference section 1222,
these amounts are captured in
transactions to which section 1061(d)
applies. The final regulations do not
adopt the suggestion to provide
guidance on section 1231 holding
periods or netting rules because such
guidance would be beyond the scope of
these final regulations.
One commenter suggested that
proposed § 1.1061–4(b), which excludes
certain items from the calculation of the
API One Year and Three Year
Distributive Share Amounts, should be
modified to explicitly reference both
One Year Disposition Gains and One
Year Distributive Share Amounts in
providing for an exclusion of section
1231 property from the scope of section
1061. The commenter suggested that the
Treasury Department and the IRS
should also determine whether a similar
modification is appropriate for the
exclusion for section 1256 property.
The final regulations do not adopt this
comment. The API One Year
Disposition Amount includes long-term
capital gains and losses recognized by
an Owner Taxpayer on the disposition
of all or a portion of an API. Pursuant
to section 741, the sale or exchange of
a partnership interest, including an API,
is the sale or exchange of a capital asset.
Accordingly, the character of the gain is
determined with reference to section
1222. The items listed in § 1.1061–
4(b)(7), including section 1231 gain, are
excluded from the calculation of the API
One Year and Three Year Distributive
Share Amounts because they are not
determined without regard to section
1222. Furthermore, asymmetrical tax
treatment occasionally is a result of the
difference between the sale of a
partnership interest and the sale of
assets by a partnership.
One commenter noted that under
section 197(f), acquired goodwill is
treated as depreciable property, thereby
causing gain recognized on the sale of
acquired goodwill to be treated as
section 1231 gain. By contrast, selfcreated goodwill does not qualify as an
amortizable intangible under section
197; therefore, any gain recognized on
the sale of the self-created goodwill is
not section 1231 gain. Instead, it is
treated as a capital asset giving rise to
capital gain upon a sale or exchange.
Consequently, under the proposed
regulations, gain on the sale of acquired
goodwill is excluded from the
Recharacterization Amount while gain
on the sale of self-created goodwill is
not excluded. The commenter

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recommended that in addition to the
exclusion for section 1231 gain, the
regulations should provide that any gain
recognized on the sale of goodwill held
in connection with the conduct of a
trade or business (whether or not
determined under section 1231) is also
excluded from the Recharacterization
Amount because there is no evidence
Congress intended to subject selfcreated goodwill held in connection
with a trade or business to section 1061.
The final regulations do not adopt this
comment. The disparate treatment of
purchased and self-created goodwill is
prescribed by section 197 and nothing
in section 1061 changes this treatment.
6. Holding Periods
Proposed § 1.1061–4(b)(8) clarifies
that the relevant holding period of
either an asset or an API is determined
under all provisions of the Code or
regulations that are relevant to
determining whether the asset or the
API has been held for the long-term
capital gain holding period by applying
those provisions as if the holding period
were three years instead of one year. For
this purpose, the relevant holding
period is the direct owner’s holding
period in the asset sold.
The final regulations maintain this
rule as proposed. One commenter
requested clarification that the
modification of a partnership agreement
does not itself create a new holding
period for the API. The final regulations
do not adopt this comment as section
1061 does not generally change the
holding period of an asset.

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7. API Holder Transition Amounts and
Partnership Transition Amounts
The proposed regulations provide that
a partnership that was in existence as of
January 1, 2018, could irrevocably elect
to treat all long-term capital gains and
losses recognized from the disposition
of all assets held by the partnership for
more than three years as of January 1,
2018, as Partnership Transition
Amounts. An amount of long-term gain
or loss treated as a Partnership
Transition Amount and included in the
allocation of long-term capital gains and
losses under sections 702 and 704 to an
API Holder with respect to its interest
in a Passthrough Entity was treated as
an API Holder Transition Amount. API
Holder Transition Amounts were not
taken into account for purposes of
determining the Recharacterization
Amount. The preamble to the proposed
regulations also requests comments on
whether a transition rule is needed and
whether the Partnership Transition
Amount rules are useful or whether

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another approach would be more
helpful in easing transition difficulties.
Several commenters questioned the
need for an elective transition rule. One
commenter noted that while they
appreciated the Treasury Department
and the IRS seeking to minimize the
burdens associated with the change in
law, they did not believe the transition
rules would measurably lessen the
recordkeeping burden on funds. The
commenter also noted that whether and
for whom the transition rules would be
beneficial is unpredictable. Another
commenter recommended that final
regulations include an example
illustrating, or otherwise better
explaining, the importance of the API
Holder Transition Amount rules, that is,
what benefits the API Holder Transition
Amount rules are intended to confer on
taxpayers. No commenter provided an
example of the potential applicability of
the API Holder Transition Amount
rules. After considering the comments,
the Treasury Department and the IRS
have determined that the Partnership
Transition Amount rules are
unnecessary. Accordingly, the final
regulations do not include these rules.
D. Section 1.1061–6: Reporting
Requirements
Proposed § 1.1061–6(a) provides filing
and reporting requirements for Owner
Taxpayers and Passthrough Entities.
Proposed § 1.1061–6(a)(1) provides that
an Owner Taxpayer must file such
information with the IRS as the
Commissioner may require in forms,
instructions, or other guidance as is
necessary for the Commissioner to
determine that the Owner Taxpayer is in
compliance with section 1061 and the
regulations. Proposed § 1.1061–6(b)(1)
provides that a Passthrough Entity must
file such information with the IRS as the
Commissioner may require in forms,
instructions, or other guidance as is
necessary for the Commissioner to
determine that the Passthrough Entity
and its partners have complied with
section 1061 and the regulations and
that a Passthrough Entity that has issued
an API must furnish to the API Holder,
including an Owner Taxpayer, such
information at such time and in such
manner as is necessary to determine the
One Year Gain Amount and the Three
Year Gain Amount with respect to the
Owner Taxpayer that directly or
indirectly holds the API.
Proposed § 1.1061–6(a)(2) provides
that if a Passthrough Entity does not
furnish the information that an Owner
Taxpayer needs to determine its
Recharacterization Amount and meet its
reporting requirements, and the Owner
Taxpayer is not able to otherwise

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substantiate all or a part of those
amounts to the satisfaction of the
Secretary, then (i) the negative
adjustments under proposed § 1.1061–
4(a)(3)(i)(B) necessary to calculate the
API One Year Distributive Share
Amount will be deemed to equal zero,
and (ii) the negative adjustment to the
API One Year Distributive Share
Amount for purposes of determining the
API Three Year Distribution Amount
under proposed § 1.1061–4(a)(3)(ii)(B)
will be deemed to equal zero.
Proposed § 1.1061–6(b)(2) provides
that a Passthrough Entity that holds an
interest in a lower-tier entity and needs
information from the lower-tier entity to
meet its reporting obligations under the
proposed regulations must request such
information from that entity by the later
of the 30th day after the close of the
taxable year to which the information
request relates or within 14 days after
the date of a request for information
from an upper-tier Passthrough Entity
and the lower-tier entity must respond
by the due date (including extensions)
of the Schedule K–1 for the taxable year.
Proposed § 1.1061–6(b)(2)(vii) provides
that a Passthrough Entity that fails to
comply with the reporting rules in the
proposed regulations or as further
required in forms, instructions, or other
guidance will be subject to penalties.
One commenter stated that the
reporting rules are based on the
assumption that there will be a limited
number of individuals who are in
control and who have access to all
relevant factual information.
Consequently, the rules are extensive
and smaller partnerships and noncontrolled partnerships may have
difficulty complying without significant
cost and expense. The commenter
suggested this argued in favor of
exempting small partnerships from
these rules.
A few commenters stated that lowertier passthrough entities are not
required to furnish information until the
due date of their returns and that this
deadline does not permit upper-tier
entities sufficient time to incorporate
lower-tier passthrough entity
information into their reporting.
Further, the commenter noted that the
regulations appear to prevent Owner
Taxpayers from excluding anything
from the API One Year Distributive
Share Amount even if only part of the
information cannot be substantiated.
The commenter recommended that for
groups of non-controlled entities, the
requestor should be allowed any
reasonable approach to substantiate the
information and suggested that issues
from non-compliant tiers should be
resolved by having the IRS impose

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failure to furnish penalties on those
tiers. Finally, the commenter
recommended guidance on how to
substantiate unreported amounts.
Several commenters suggested that
the information reporting requirements
are onerous and that denying exclusions
from recharacterization for noncompliance is too harsh a penalty for
Owner Taxpayers and upper-tier
partnerships who are unable to secure
the necessary information from lowertier partnerships, particularly where an
Owner Taxpayer or upper-tier
partnership has no control over whether
the reporting requirements are met by
the lower-tier partnership. One
commenter argued that there is no
indication in the statute or legislative
history that this is what Congress
intended. The commenter noted that the
TCJA conference report indicates that
Congress intended section 6031(b)
penalties to apply to a failure to report
to partners and those penalties are
sufficient to deter non-compliance
while not acting to change the character
of distributive share items.
A few commenters noted that the
reporting requirements will require
significant amendments to partnership
agreements and reporting systems.
These commenters requested that the
effective date for the reporting
requirements and associated penalties
be delayed until at least 12 months after
the year end in which the regulations
are finalized to give funds and API
Holders time to amend their operations
and establish proper information
reporting systems, particularly in light
of the increased reporting requirements
resulting from partner tax capital
account reporting, Forms K–2 and K–3,
the section 163(j) limitation, and other
recent guidance.
One commenter suggested that the
regulations should provide a de minimis
exception to the reporting requirements,
especially in tiered partnership
arrangements. The commenter suggested
that if a limited partner owns less than
five percent of a fund, there should be
limitations on reporting requirements to
those partners, arguing that information
reporting is costly in a tiered fund
context and the lower-tiered funds may
not want to dedicate the resources to
provide the proper reporting for such
small fund interests.
The final regulations do not adopt
these comments. The reporting rules,
including the zero presumptions, are
necessary to effectively administer
section 1061 and the regulations. The
Treasury Department and the IRS note
that the amounts required to be reported
under the reporting rules may be
substantiated by any reasonable means

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if a Passthrough Entity fails to report the
necessary information to the Owner
Taxpayer. Similarly, a de minimis rule
or an exception for small partnerships
would frustrate Owner Taxpayers’
ability to correctly determine the
Recharacterization Amount and the
IRS’s ability to administer the statute.
For these reasons, the Treasury
Department and the IRS also decline to
provide a delay in the applicability date
for the reporting rules.
The final regulations retain the
reporting rules as proposed with minor
clarifying changes, including the
changes discussed in paragraph III.C.4
of this preamble with respect to QEF
reporting. In addition, the final
regulations provide that if an Owner
Taxpayer requires information from a
Passthrough Entity to determine the
Section 1061(d) Recharacterization
Amount, the Owner Taxpayer should
request such information from that
entity. The Passthrough Entity is
required to provide the information to
the extent requested by an API Holder
and necessary to determine the Owner
Taxpayer’s Section 1061(d)
Recharacterization Amount. Finally, the
final regulations substitute
‘‘Commissioner’’ for ‘‘Secretary of the
Treasury’’ in § 1.1061–6(a)(2) to avoid
any misperception that any office or
bureau within the Treasury Department
other than the IRS is responsible for
examining taxpayers’ returns.
E. Securities Partnerships
The proposed regulations include an
amendment to § 1.704–3(e), which
provides that a method for aggregating
gains and losses by a securities
partnership will not be considered
reasonable unless it takes into account
the application of section 1061.
Specifically, the proposed regulations
require partnerships that use the partial
or full netting approaches described in
§ 1.704–3(e) to establish accounts to
track API Holders’ Capital Interest Gains
and Losses, Unrealized API Gains and
Losses, and API Gains and Losses. A
commenter questioned whether these
rules were necessary, given the
likelihood of hedge fund managers to
leave a fund before the three-year
holding period expires. Another
commenter noted that funds would
need to implement sophisticated
tracking mechanisms to distinguish
between Capital Interest Gains and
Losses and API Gains and Losses. The
commenter thought that such tracing
conflicted with the principles of
aggregation provided by § 1.704–3(e).
Another commenter recommended
that the final regulations confirm that
partnerships can change their section

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704(c) aggregation method in order to
address section 1061 in a manner
consistent with the regulations and that
any such change would not violate the
requirement to use the same aggregation
approach once an approach is adopted.
The commenter requested that the final
regulations provide examples
illustrating the intended application of
the creation of separate accounts for
APIs and capital interests.
The final regulations provide a
simplified rule in § 1.704–3(e) that
states that section 1061 must be taken
into account in applying the aggregation
rule for securities partnerships, but does
not provide a specific method for doing
so. The Treasury Department and the
IRS continue to study the comments
received on this issue and may provide
additional guidance in the future.
IV. Additional Areas Under Study
A. Section 1061(b) Exception
Section 1061(b) provides that ‘‘[t]o the
extent provided by the Secretary,
[section 1061(a)] shall not apply to
income or gain attributable to any asset
not held for portfolio investment on
behalf of third party investors.’’ The
proposed regulations reserve with
respect to the application of section
1061(b). The preamble to the proposed
regulations states that the Treasury
Department and the IRS generally
believe that the section 1061(b)
exception is effectively implemented in
the proposed regulations with the
exception to section 1061 for
Passthrough Interest Direct Investment
Allocations. The preamble further
requested comments on the application
of section 1061(b) and whether the
proposed regulations’ exclusion for
Passthrough Interest Direct Investment
Allocations properly implements the
exception.
One commenter suggested that the
Passthrough Interest Direct Investment
Allocations would exempt certain
family offices from section 1061(a) but
stated that the exception is too narrow
to account for all types of family offices.
The commenter noted that section
1061(b) is not intended to cover family
offices managed by a professional
investment manager who is not a family
member and who receives an API
because the family members are thirdparty investors with respect to the
professional investment manager.
Several commenters suggested that
additional guidance under section
1061(b) is needed for family offices,
management companies, and other
partnerships that do not hold assets for
portfolio investment on behalf of thirdparty investors. One commenter argued

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that the Treasury Department and the
IRS should not reserve on section
1061(b) because carried interests as used
in asset management businesses were
the particular focus of Congress as it
contemplated carried interest proposals.
One commenter noted that it had
recommended prior to the issuance of
the proposed regulations that the
authority under section 1061(b) should
be exercised to confirm that section
1061(a) does not apply to recharacterize
income or gain attributable to the value
of intangibles, including goodwill,
created or used in an ATB. The
commenter recognized that the
Passthrough Interest Direct Investment
Allocation rules in the proposed
regulations operate in part to implement
an exception for enterprise value, but
recommended that final regulations
should provide specifically that section
1061(a) does not apply to recharacterize
income or gain attributable to enterprise
value. Furthermore, the commenter
argued that the enterprise value
exception should apply to allocations
through tiers and should not require
allocations in accordance with partner
capital accounts if the intangible asset it
not held for portfolio investment on
behalf of third-party investors.
As discussed in Part II.A. of this
Summary of Comments and Explanation
of Revisions, the final regulations
modify the rules related to the capital
interest exception, including removing
the Passthrough Interest Direct
Investment Allocation rules. As
discussed in Part II.C. of this Summary
of Comments and Explanation of
Revisions, the final regulations provide
that the delayed holding period prong of
the Lookthrough Rule does not apply to
the disposition of an API to the extent
that the gain recognized upon the
disposition is attributable to any asset
not held for portfolio investment on
behalf of third party investors. The
Treasury Department and the IRS
continue to study the comments
regarding section 1061(b) and may
address the application of the provision
in future guidance, including whether
section 1061(a) applies to recharacterize
income or gain attributable to enterprise
value. The Treasury Department and the
IRS request additional comments related
to section 1061(b).
B. Small Partnerships
In the preamble to the proposed
regulations, the Treasury Department
and the IRS requested comments and
suggestions on whether a simplified
method for determining and calculating
the API Gain or Loss should be provided
for small partnerships and if so, the
criteria that should be used to determine

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which partnerships should be eligible to
use the simplified method. One
commenter stated that a small
partnership exception is critically
important to the integrity of the entire
section 1061 regulatory regime. The
commenter also noted that given the
burdensome nature of the reporting
requirements that could apply to small
business taxpayers, a modification of
these requirements for either ‘‘small
partnerships’’ or ‘‘small partners’’
would appear to be justified. As
discussed in the section on reporting
requirements, a commenter also
recommended a de minimis exception
to the reporting requirements for
passthrough entities in which a limited
partner owns five percent, or less, of a
fund. The Treasury Department and the
IRS continue to study this issue and
may address this in future guidance.
The Treasury Department and the IRS
request additional comments and
suggestions on whether a simplified
method for determining and calculating
the API Gain or Loss should be provided
for small partnerships and if so, the
criteria that should be used to determine
which partnerships should be eligible to
use the simplified method.
V. Applicability Dates
The final regulations retain the
applicability dates as proposed.
Accordingly, the final regulations
generally apply to taxable years of
Owner Taxpayers and Passthrough
Entities beginning on or after January
19, 2021. Section 1.1061–3(b)(2)(i)
applies to taxable years beginning after
December 31, 2017. Section 1.1061–
3(b)(2)(ii) applies to taxable years
beginning after August 14, 2020. An
Owner Taxpayer or Passthrough Entity
may choose to apply the final
regulations in their entirety to a taxable
year beginning after December 31, 2017,
provided that they consistently apply
the final regulations in their entirety to
that year and all subsequent years.
With respect to an API in a
partnership with a fiscal year ending
after December 31, 2017, section 706
determines the capital gains and losses
the Owner Taxpayer includes in income
with respect to an API after December
31, 2017. Section 706 provides that the
taxable income of a partner for a taxable
year includes amounts required by
sections 702 and 707(c) with respect to
a partnership based on the income, gain,
loss, deduction, or credit of a
partnership for any taxable year ending
within or with the taxable year of the
partner. Accordingly, if a calendar year
Owner Taxpayer has an API in a fiscal
year partnership whose taxable year
ends after December 31, 2017, section

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1061 applies to the Owner Taxpayer’s
distributive share of long-term capital
gain or loss with respect to the API in
calendar year 2018 regardless of
whether the partnership disposed of the
property giving rise to the gains and
losses in the period prior to January 1,
2018. See § 1.706–1(a).
Special Analyses
I. Regulatory Planning and Review—
Economic Analysis
Executive Orders 12866, 13563, and
13771 direct agencies to assess costs and
benefits of available regulatory
alternatives and, if regulation is
necessary, to select regulatory
approaches that maximize net benefits
(including potential economic,
environmental, public health and safety
effects, distributive impacts, and
equity). Executive Order 13563
emphasizes the importance of
quantifying both costs and benefits, of
reducing costs, of harmonizing rules,
and of promoting flexibility.
These regulations have been
designated as economically significant
under Executive Order 12866 pursuant
to the Memorandum of Agreement
(April 11, 2018) between the Treasury
Department and the Office of
Management and Budget (OMB)
regarding review of tax regulations.
A. Need for Final Regulations
These final regulations provide
certainty and clarity to taxpayers
affected by statutory changes introduced
in section 1061 by TCJA. The Treasury
Department and the IRS have received
questions and comments regarding the
meaning of various provisions in section
1061 and issues not explicitly addressed
in the statute. The Treasury Department
and the IRS have determined that such
comments warrant the issuance of
further guidance.
B. Background
Section 1061 of the Internal Revenue
Code (Code), enacted by TCJA,
characterizes certain long-term capital
gains recognized with respect to an API
as short-term capital gains. Short-term
capital gains are generally taxed at a
higher rate than long-term capital gains.
Section 1061 defines an API as an
interest in a partnership transferred to
or held by the taxpayer in connection
with the performance of substantial
services by the taxpayer, or any other
related person, in any ‘‘applicable trade
or business’’ (ATB). Under section 1061
the term ATB encompasses a range of
financial service activities. Specifically,
an ATB is any activity conducted on a
regular, continuous, and substantial
basis which consists, in whole or in

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part, of raising or returning capital, and
either (i) investing in (or disposing of)
‘‘specified assets’’ (or identifying
specified assets for such investing or
disposition), or (ii) developing specified
assets. ‘‘Specified assets’’ are certain
securities, certain commodities, real
estate held for rental or investment, cash
or cash equivalents, options or
derivative contracts with respect to any
of the foregoing, and an interest in a
partnership to the extent of the
partnership’s proportionate interest in
any of the foregoing.
Prior to the TCJA, the Internal
Revenue Code made no distinction
between capital gains allocated to APIs
versus other partnership interests and
partnership assets. Generally, the
required holding period to obtain the
lower long-term capital gains tax rate
was one year for all partnership
interests and partnership capital assets.
Under the new provision, the required
holding period for an API must be
greater than three years to obtain longterm capital gains treatment.
The Treasury Department and the IRS
previously published proposed
regulations under section 1061
(‘‘proposed regulations’’).
C. Overview of the Final Regulations
The final regulations provide
taxpayers with definitional and
computational guidance regarding the
application of section 1061. In
particular, the final regulations provide
a number of definitions, including the
term ‘taxpayer’ for the purpose of
determining the existence of an API.
Additionally, the regulations clarify the
rules for certain exceptions to section
1061, including the exception for capital
interests, and provide for an additional
exception for bona fide purchases of
APIs by an unrelated party who is not
a service provider. The final regulations
also provide rules for calculating the
recharacterized gain amount.
D. Economic Analysis
1. Baseline

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In this analysis, the Treasury
Department and the IRS assess the
benefits and costs of the final
regulations relative to a no-action
baseline reflecting anticipated Federal
income tax-related behavior in the
absence of these final regulations.
2. Summary of Economic Effects
The final regulations provide
certainty and consistency in the
application of section 1061 by providing
definitions and clarifications regarding
the statute’s terms and rules. An
economically efficient tax system

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generally aims to treat income and
expense derived from similar economic
decisions consistently across taxpayers
and activities in order to reduce
incentives for individuals and
businesses to make choices based on tax
rather than market incentives. In the
absence of the guidance provided in
these final regulations, taxpayers would
bear the burden of interpreting the
statute and the chances that different
taxpayers might interpret the statute
differently would be exacerbated. For
example, two similarly situated
taxpayers might interpret the statutory
provisions pertaining to the definition
of taxpayer or the capital interest
exception differently, causing one to
enter into a partnership that another
comparable taxpayer might decline
because of a different interpretation of
how the income will be treated under
section 1061. If this opportunity did not
go to the more productive taxpayer, this
lack of clarity results in an economically
inefficient pattern of activity. An
economic loss may also arise if all
taxpayers have identical interpretations
of the tax treatment of particular income
streams under the statute but which
differ slightly from the interpretation
that Congress intended for these income
streams. In this case, guidance provides
value by bringing economic decisions
closer in line with the intent and
purpose of the statute.
The final regulations include multiple
substantive changes compared to the
proposed regulations. The Treasury
Department and the IRS view these
changes as favorable to taxpayers,
providing more flexibility and reducing
burden and complexity. In particular,
the final rules governing the capital
interest exception are more flexible to
better accommodate common business
practices, which vary considerably
across industries. Compared to the
proposed regulations, the final
regulations considerably narrow the
range of related party transactions
triggering 1061 recharacterization, and
the associated compliance burden.
Finally, compared to the proposed
regulations, the Lookthrough Rule on
the sale of APIs included in the final
regulations is a more narrowly targeted
anti-abuse rule, only imposing a
compliance burden on taxpayers that
appear to have engaged in abusive
practices with the primary aim of
avoiding section 1061(a)
recharacterization.
The proposed regulations solicited
comments on the economic analysis of
the proposed regulations. No such
comments were received.

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3. Economic Analysis of Specific
Provisions
a. Provisions Not Substantially Revised
From the Proposed Regulations
i. Definition of Taxpayer
The statute requires taxpayers to make
a number of determinations, including
the determination of the existence of an
API, and the calculation of the section
1061 amount, or amount of long-term
gain recharacterized under section 1061.
However, the term ‘‘taxpayer’’ is not
defined in either section 1061 or in the
Conference Report. Comments received
by the Treasury Department and IRS
highlight the importance of the
definition of the term taxpayer for
purposes of section 1061. Without
guidance, taxpayers could use different
approaches to define ‘‘taxpayer,’’
leading otherwise similar taxpayers to
experience different degrees of
complexity, and to report different
recharacterized amounts.
The final regulations include two
definitions of taxpayer to address the
level at which the determination of the
existence of an API is made and the
level at which the calculation of the
section 1061 amount is made. The final
regulations define the Owner Taxpayer
as the person generally required to pay
tax on the gain or loss with respect to
the API. Under the final regulations, the
section 1061 calculation is only
performed by the person (the Owner
Taxpayer) who must pay tax on the
gains and losses recognized with respect
to the API. The final regulations also
introduce the term Passthrough
Taxpayer. A Passthrough Taxpayer is an
entity that does not itself generally pay
tax on capital gains but must determine
when an API exists and allocate income,
gain, deduction and loss to its owners.
Both the Owner Taxpayer and the
Passthrough Taxpayer are treated as
taxpayers for the purpose of
determining whether an API exists.
The Treasury Department and the IRS
considered and rejected two alternative
approaches to the definition of taxpayer
outlined in received comments, the
‘‘aggregate approach’’ and the ‘‘full
entity approach’’. Under the aggregate
approach, a partnership is not treated as
a taxpayer for purposes of section 1061.
Instead, section 1061 is applied solely to
the partners that are ultimately subject
to tax on the partnership’s items of
capital gain and loss. A concern with
using this approach for the purpose of
determining whether an API exists is
that it could incentivize partners to use
tiered ownership structures to avoid
section 1061 recharacterization. For
example, an upper tier partnership may

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receive an interest in a lower-tier fund
in connection with the upper-tier
partnership’s performance of services in
an ATB. Partners of the upper-tier
partnership may contend that they did
not receive their interest in the uppertier partnership in connection with the
services performed by the upper-tier
partnership. Stopping such avoidance
strategies would require complex rules
and potentially burdensome reporting
requirements when tiered ownership
structures are involved.
Under the ‘‘full entity approach’’, the
partnership is treated as a taxpayer for
purposes of both determining the
existence of an API and calculating the
section 1061 recharacterization amount.
Treating the partnership as a taxpayer
for purposes of calculating the section
1061 recharacterization amount was
found to be more burdensome than the
approach taken in the final regulations
for three reasons. First, using the full
entity approach for determining the
section 1061 recharacterization amount
may lead to increased recharacterization
of gains under section 1061 because
individuals would not be able to net
gains and losses across multiple APIs.
Second, the administrative burden on
both the taxpayer and the IRS would be
increased in cases of tiered ownership.
Under the full entity approach, a
separate section 1061 calculation would
be required at each level at which an
API is held in a tiered partnership
structure. Finally, the full entity
approach may add complexity and
burden in cases in which an exception
to section 1061 applies, such as if a
corporation is a direct or indirect
partner. Because corporations are
excluded from section 1061, any
amount recharacterized at the
partnership level would need to be
tracked as it is allocated to partners to
ensure that corporate or other excepted
partners are not subject to the three-year
holding period under section 1061.
The Treasury and the IRS have
concluded that the chosen alternative,
incorporating the concepts of Owner
Taxpayer and Passthrough Taxpayer, is
less burdensome than other alternatives
and provides helpful certainty to
taxpayers.
ii. Clarification of the Treatment of an
API Purchased by an Unrelated Party
The statute states that capital gain or
loss recognized by a taxpayer on the sale
of an API held for more than one year
is subject to section 1061. The statute
also provides guidance for ongoing
treatment under section 1061 when the
API is purchased by, or transferred to,
a related party or another service
provider. However, the statute does not

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provide guidance for the taxpayer who
purchases an API and is neither a
service provider to the relevant ATB,
nor related to the seller of the API. The
final regulations add an exception to
section 1061 and provide that the term
API does not include an interest in a
partnership that would be treated as an
API but is held by a bona fide purchaser
of the interest who does not currently
and has never provided services in the
relevant ATB and who is not related to
a person who provides services
currently or has provided services in the
past. By clarifying the treatment of an
API that is sold at arm’s length, the final
regulations reduce uncertainty and
compliance burdens for taxpayers
entering into these transactions. The
Treasury Department and the IRS have
determined that this exception is
consistent with the purpose of section
1061, which applies to service providers
and persons related to service providers
and which is not meant to apply to bona
fide purchasers of a partnership interest
who do not provide services.
The Treasury Department and the IRS
considered not providing this exception.
However, it was determined that failure
to provide this exception would treat
unrelated purchasers of an API in an
inequitable fashion, and that continued
treatment of the partnership interest as
an API would be inconsistent with the
purpose of section 1061 because
unrelated purchasers did not receive
their interest in connection with the
performance of substantial services.
b. Provisions Substantially Revised
From the Proposed Regulations
i. Capital Interest Exception
Section 1061(c)(4)(B) provides that
the definition of an API does not
include ‘‘any capital interest in the
partnership which provides the
taxpayer with a right to share in
partnership capital commensurate
with—(i) the amount of capital
contributed (determined at the time of
receipt of such partnership interest) or
(ii) the value of the interest included in
income under section 83 upon the
receipt or vesting of such interest.’’
However, the statute does not provide
guidance on what it means for a right to
share in partnership capital to be
‘‘commensurate’’ with the amount of
capital contributed.
The final regulations clarify that
allocations are deemed commensurate
with capital contributed if, under the
partnership agreement, the allocation to
an API Holder is calculated in a similar
manner as the allocations to similarly
situated Unrelated Non-Service
Partners. This may be determined on an

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5475

investment-by-investment or class-byclass basis. To qualify as a benchmark
for comparison, the Unrelated NonService Partners must hold a significant
investment, defined as at least five
percent of the partnership. In the
absence of these regulations, taxpayers
might face confusion, along with
substantial compliance cost, in
calculating their qualifying capital
interest. Further, partners with realized
gains would be incentivized to engage
in a series of inefficient transactions in
order to minimize tax.
The Treasury Department and the IRS
considered alternative interpretations of
‘‘commensurate with capital
contributed.’’ In particular, the
proposed regulations provide that an
allocation is ‘‘commensurate with
capital’’ if the allocation is based on the
relative section 704(b) capital accounts
of the partners under the partnership
agreement. The proposed regulations
then provide multiple rules for
calculating an API holder’s capital
account, including a rule disallowing
unrealized API capital gains in
calculating the API holder’s capital
account, and a rule for determining the
capital account when an API is held
through another partnership. In light of
numerous comments, the Treasury
Department and the IRS have
determined that the proposed
regulations were too rigid and were not
well suited to the wide variety of
common business practices regarding
ownership structure, accounting
conventions, and compensation
arrangements. Specifically, many
partnerships subject to section 1061 do
not maintain section 704(b) capital
accounts. For many other partnerships,
the capital account of one partner may
relate to economic rights associated
with multiple separate investments held
by a partnership, while the capital
account of another partner may relate to
economic rights associated with a
separate set of investments held by a
partnership. For these reasons, the
Treasury Department and the IRS have
determined that the section 704(b)
capital accounts of partners provide a
poor means of measuring commensurate
economic capital interest rights.
The proposed regulations also
prohibited use of the capital interest
exception if a capital contribution was
funded with related party loan
proceeds. Commenters noted that it is a
common business practice in industries
subject to Section 1061 for employees to
require new partners to make
substantial capital contributions, which
are often acquired through a loan. This
arrangement, designed not to avoid tax
but to align the incentives of general

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partners and limited partners, would be
unduly penalized under the proposed
regulations, incentivizing firms to
choose a less efficient ownership and
governance structure. The final
regulations amend the rule to allow an
individual service provider’s capital
contributions to be funded with loan
proceeds from partners and persons
related to partners if the individual
service provider is personally liable for
the loan, meaning the loan is fully
recourse to the individual service
provider, the individual service
provider has no right to be reimbursed
by any person, and no person has
guaranteed the individual service’s
provider’s loan. The Treasury
Department and the IRS believe the final
rules address abusive avoidance
strategies, while imposing less burden
on taxpayers engaged in standard
business practices relative to not
allowing any contributions from
proceeds from related part loans to be
eligible for the capital interest
exception.
ii. Lookthrough Rule on Sale of APIs
Section 1061(a) provides that if one or
more APIs are held by a taxpayer at any
time during the taxable year, the excess
(if any) of (1) the taxpayer’s net longterm capital gain with respect to such
interests for such taxable year, over (2)
the taxpayer’s net long-term capital gain
with respect to such interests for that
taxable year computed by applying
paragraphs (3) and (4) of sections 1222
by substituting ‘‘3 years’’ for ‘‘1 year,’’
must be treated as short-term capital
gain, notwithstanding section 83 or any
election in effect under section 83(b).
The House Report explains that section
1061 ‘‘imposes a three-year holding
period (not the generally applicable oneyear holding period) in the case of longterm capital gain from applicable
partnership interests.’’ Neither section
1061 nor the Reports, however,
explicitly provides what the relevant
holding period is for purposes of section
1061(a) for the sale of an API with assets
of different holding periods.
The final regulations include a
Lookthrough Rule that is triggered if a
transaction or series of transactions has
taken place with a principal purpose of
avoiding potential gain
recharacterization under section
1061(a). Under this Lookthrough Rule,
all gain not attributable to assets held
for more than three years is subject to
recharacterization under section
1061(a). Additionally, the Lookthrough
Rule applies if the API disposition
would be subject to Section 1061(a)
recharacterization using a holding
period not beginning until the date that

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Unrelated Non-Service Partners legally
commit to contribute substantial capital
to the applicable partnership. Without
this rule, fund managers might attempt
to avoid the recharacterization of gains
by establishing partnerships and leaving
them inactive for three years before
attracting investment from limited
partners, thereby circumventing Section
1061.
The Treasury Department and the IRS
considered and rejected alternative
approaches, including applying a
simple interest approach, an alternative
lookthrough rule (as provided in the
proposed regulations), and an
underlying assets approach. The simple
interest approach looks solely to the
holding period in the API, regardless of
the length of time the partnership has
engaged in substantive investment. This
approach might allow taxpayers to
avoid section 1061 characterization for
long-term capital gains on assets that are
not held for the more than three years
by the partnership. This result would
encourage distortive behavior in
investment funds, which might look to
create partnerships for different
investors solely for tax purposes,
relative to the approach adopted in the
final regulations. That is, the partners of
that investment partnership would not
be subject to section 1061 if they had
owned their APIs for more than three
years, irrespective of how long the
investment partnership had been active
and attracting capital from outside
investors.
Alternatively, the underlying asset, or
full lookthrough, approach looks solely
to the holding period in the underlying
asset (or assets) of the partnership,
regardless of whether the underlying
asset is sold by the partnership or the
API is sold by its owner. The underlying
asset approach would be more difficult
(and burdensome) for taxpayers to apply
(relative to the provision provided in
the final regulations) as it would require
a determination of the unrealized gain
for each asset held by the partnership,
even in cases in which a relatively small
share of assets by value have a holding
period of three years or less.
The proposed regulations included an
alternative lookthrough rule applied to
the sale of an API if 80% or more of the
value of the assets held by the
partnership at the time of the API
disposition were assets held for three
years or less that would produce capital
gain or loss subject to section 1061 if
disposed of by the partnership. If the
lookthrough rule in the proposed
regulations applied, a portion of the
capital gain on the disposition of the
API attributable partnership assets held
for three or fewer years would be

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recharacterized as short-term capital
gain. This alternative was rejected in the
final regulations because the
calculations required by the proposed
lookthrough rule would impose
unnecessary compliance burden on
individual taxpayers selling an API
without any accompanying general
economic benefit. The rules requiring
partnerships to furnish taxpayers with
the relevant information to perform the
calculations would also impose undue
additional burden on the relevant
partnerships. The lookthrough rule
provided in the final regulations applies
in more limited circumstances,
narrowly targeting taxpayers that appear
to be engaged in abusive practices to
avoid section 1061(a) recharacterization.
Therefore, the final regulations provide
helpful guidance and certainty for
taxpayers, while imposing minimal
compliance burden relative to the noaction baseline or alternative regulatory
approaches.
iii. Treatment of API Transfers to
Related Parties
Section 1061(d) recharacterizes
certain long-term capital gain as shortterm capital gain when a taxpayer
transfers an API to a related person.
While the statute provides a definition
of a related person and a general
description of the recharacterization
amount, numerous commenters
expressed uncertainty regarding the
scope of transfers subject to section
1061(d), pointing out that although the
statutory language of section 1061(d)
refers to the transfer of an API, it refers
to income inclusion associated with an
API transfer that is related to the sale or
exchange of partnership assets held for
three years of less. Based on the
statutory language, commenters
expressed the view that section 1061(d)
transfers should be limited to taxable
transfers.
Although one read of the text of
section 1061(d) suggests that the
provision can be broadly applied to
capture all API transfers, including gifts
and other nonrecognition transfer, the
Treasury Department and the IRS
considered and rejected applying
section 1061(d) to nontaxable transfers.
Applying section 1061(d) to nontaxable
transfers would impose income
recognition on gifts including an API,
where no income recognition is
imposed on otherwise similar gifts,
creating a tax disadvantage for gifts
including an API. Instead, the Treasury
and the IRS have determined that the
section 1061(d) statute is better read as
a recharacterization provision that looks
to how much of the taxpayer’s long-term
capital gain upon the sale of an API is

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attributable to the sale or exchange of
any asset held for three years or less and
that the provision’s use of the word
‘‘transfer’’ does not supersede
application of the sale or exchange
requirement in the statute.
II. Paperwork Reduction Act
A. Collection of Information in § 1.1061–
6(a) on the Owner Taxpayer is on
Existing Forms
The collection of information in
§ 1.1061–6(a) requires an Owner
Taxpayer to file such information with
the IRS as the Commissioner may
require in forms, instructions and other
published guidance as is necessary for
the IRS to determine that the taxpayer
has properly complied with section
1061 and the Section 1061 Regulations.
This information is necessary for the
IRS to determine that the Owner
Taxpayer has properly complied with
section 1061. In general, the Owner
Taxpayer is an individual and the
Owner Taxpayer’s Recharacterization
Amount and Section 1061(d)
Recharacterization Amount will be
required to be reported to the IRS as
short-term capital gain on Schedule D,
‘‘Capital Gains and Losses,’’ of the Form
Form

Type of filer
Individual (NEW Model) ..........

1545–0074

Form 1041 (Including Schedule D).

Trusts and Estates (Legacy
Model).

1545–0092

1. Passthrough Entities
The collection of information in
§ 1.1061–6(b) requires a Passthrough
Entity that has issued an API to furnish
to the API Holder, including the Owner
Taxpayer, such information at such time
and in such manner as the
Commissioner may require in forms,
instructions, and other published
guidance as is necessary to determine
the One Year Gain amount and the
Three Year Gain Amount with respect to
an Owner Taxpayer. This includes: (i)
The API One Year Distributive Share
Amount and the API Three Year
Distributive Share Amount (as
determined under § 1.1061–4); (ii)
Capital gains and losses allocated to the
API Holder that are excluded from
section 1061 under § 1.1061–4(b)(7); (iii)

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Status
Published in the Federal Register on 9/30/19. Comment period closed on 11/29/19. 84 FR 51712. Thirty-day notice
published on 12/18/19. 84 FR 69458. Approved by the Office of Information and Regulatory Affairs (OIRA) on 1/30/
20.
Published in the Federal Register on 4/4/2018. 83 FR
14552. Public comment period closed 6/4/2018. Thirty-day
notice published on 9/27/18. 83 FR 48894. Approved by
OIRA on 5/8/19.

Capital Interest Gains and Losses
allocated to the API Holder (as
determined under § 1.1061–3(c)); (iv) In
the case of a disposition by the API
Holder of an interest in the Passthrough
Entity during the taxable year, any
information required by the API Holder
to properly take the disposition into
account under section 1061, including
information necessary to apply the
Lookthrough Rule and to determine its
Capital Interest Disposition Amount and
any information necessary to determine
an Owner Taxpayer’s Section 1061(d)
Recharacterization Amount. The
regulations seek to minimize the
information that a Passthrough Entity is
required to automatically furnish
annually. In some cases, an upper-tier
Passthrough Entity may be an API
Holder in a lower-tier Passthrough
Entity, and the information furnished by
the lower-tier Passthrough Entity to the
upper-tier Passthrough Entity may not

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time, including all other forms and
schedules for trusts and estates of 307.8
million hours and total estimated
monetized costs of $9.95 billion (in
2016 dollars). These amounts are
aggregate amounts that relate to all
information collections associated with
the applicable OMB control numbers,
and will in the future include, but not
isolate, the estimated burden of Owner
Taxpayers as a result of the information
collections in the regulations. No
burden estimates specific to the final
regulations are currently available. The
Treasury Department and IRS have not
estimated the burden, including that of
any new information collections, related
to the requirements under the final
regulations. Those estimates would
capture both changes made by the TCJA
and those that arise out of discretionary
authority exercised in the regulations.
The Treasury Department and the IRS
request comments on all aspects of
information collection burdens related
to the collection of information
applicable to the Owner Taxpayer in
these regulations. In addition, when
available, drafts of IRS forms are posted
for comment at www.irs.gov/draftforms.

OMB No.(s)

Form 1040 (Including Schedule D).

B. Collection of Information on
Passthrough Entities in § 1.1061–6(b)
and (c) on Existing Forms

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1040, ‘‘U.S. Individual Income Tax
Return.’’ Less frequently, the Owner
Taxpayer is a trust and the Owner
Taxpayer’s Recharacterization Amount
and Section 1061(d) Recharacterization
Amount will be required to be reported
to the IRS as short-term capital gain on
Schedule D, ‘‘Capital Gains and Losses,’’
of the Form 1041, ‘‘U.S. Income Tax
Return for Estates and Trusts.’’
The current status of the Paperwork
Reduction Action submission related to
§ 1.1061–6(a) is provided in the
following table. The burdens associated
with the collection of information from
the Owner Taxpayer to comply with
section 1061 are included in the
aggregate burden estimates for Form
1040 under OMB control number 1545–
0074 and Form 1041 under OMB control
number 1545–0092. The overall burden
estimates provided in OMB Control
Number 1545–0074 represents a total
estimated burden time, including all
other related forms and schedules for
individuals, of 1.784 billion hours and
total estimated monetized costs of
$31.74 billion (in 2017 dollars). The
overall burden estimates provided in
OMB Control Number 1545–0092
represents a total estimated burden

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5477

be sufficient for the upper-tier
Passthrough Entity to meet its reporting
obligations under the regulations. In this
case, the regulations require the lowertier Passthrough Entity to furnish
information to the upper-tier
Passthrough Entity if requested. Thus, if
an upper-tier Passthrough Entity in a
tiered entity structure holds an interest
in a lower-tier Passthrough Entity and it
needs information from the lower-tier
Passthrough Entity to comply with its
obligation to furnish information under
the regulations, it must request
information from the lower-tier entity
and the lower-tier entity must furnish
the requested information. This passing
of information upon request between
the tiers of entities is necessary to
minimize the quantity of information
required to be annually furnished by a
Passthrough Entity and because each
Passthrough Entity in a tiered entity
arrangement is the only entity that has

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access to the information that is
required to be furnished. The collection
of information in the regulations is
necessary to ensure that the Owner
Taxpayer receives information sufficient
to correctly calculate its
Recharacterization Amount under
section 1061.
2. RICs and REITs
Section 1.1061–6(c) permits a RIC or
a REIT that reports or designates all or
a part of a dividend as a capital gain
dividend, to disclose additional
information to their shareholders for
purposes of section 1061. The
furnishing of this information may
allow a Passthrough Entity to include a
portion of the capital gain dividend in
the API Three Year Distributive Share
amount furnished to API Holders and
may ultimately enable an Owner
Taxpayer to reduce its
Recharacterization Amount under the
regulations.
3. Table for Collections of Information
in § 1.1061–6(b) and (c)
The collection of information with
respect to § 1.1061–6(b) and (c) is
provided in the following table. In the
case of a Passthrough Entity that is a
partnership, the information will be
required to be furnished as an
attachment to the Schedule K–1,
‘‘Partner’s Share of Income, Deduction,
Credit, Etc.’’ of Form 1065, ‘‘U.S. Return
of Partnership Income.’’ In the case of a
Passthrough Entity that is an S
corporation, the information will be
required to be furnished as an
attachment to the Schedule K–1,
‘‘Shareholder’s Share of Income,
Deductions, Credit, Etc.,’’ of Form 1120–
S, ‘‘U.S. Income Tax Return for an S
Corporation.’’ The burdens associated
with the collection of information from

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Form

the Passthrough Entities will be
included in the aggregate burden
estimates for the Form 1065 and the
Form 1120S under OMB control number
1545–0123. The overall burden
estimates provided in OMB Control
Number 1545–0123 represents a total
estimated burden time, including all
others related forms and schedules, of
3.344 billion hours and total estimated
monetized costs of $61.558 billion (in
2019 dollars). The burden estimates
provided in OMB Control Number
1545–0123 are aggregate amounts that
relate to all information collections
associated with the applicable OMB
control number, and will in the future
include, but not isolate, the Passthrough
Entities’ estimated burden as a result of
the information collections in the
proposed regulations.
In the case of a Passthrough Entity
that is a trust or estate, the information
will be required to be furnished as an
attachment to the Schedule K–1,
‘‘Beneficiary’s Share of Income,
Deductions, Credit, Etc.,’’ of Form 1041,
‘‘U.S. Income Tax Return for Estates and
Trusts.’’ The burdens associated with
the collection of information from a
Passthrough Entity that is a trust or
estate will be included in the aggregate
burden estimates for the Form 1041
OMB control number 1545–0092. The
overall burden estimates provided in
OMB Control Number 1545–0092
represents a total estimated burden
time, including all other forms and
schedules for trusts and estates of 307.8
million hours and total estimated
monetized costs of $9.95 billion (in
2016 dollars). The burden estimates
provided in OMB Control Number
1545–0092 are aggregate amounts that
relate to all information collections
associated with the applicable OMB

Type of filer

OMB No.(s)

Form 1041 (including Schedule K–1).

Trusts and Estates (Legacy
Model).

1545–0092

Form 1065 (including Schedule K–1).

Business (NEW Model) ..........

1545–0123

Form 1120S (Including Schedule K–1).

Business (New Model) ............

1545–0123

Form 1099–DIV .......................

(Legacy Model) .......................

1545–0110

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control number, and will in the future
include, but not isolate, the Passthrough
Entities’ estimated burden as a result of
the information collections in the
regulations.
In the case of RICs and REITs the
information will be furnished in
connection with the Form 1099–DIV,
‘‘Dividends and Distributions.’’ The
burden estimates associated with the
collection of information from RICs and
REITs will be included in the aggregate
burden estimated for the Form 1099–
DIV under OMB Control Number 1545–
0110. The overall burden estimates
provided in OMB Control Number
1545–0110 represents a total estimated
burden time of 32,119,195 hours and
total estimated monetized costs of $ 1.64
billion (in 2016 dollars). The burden
estimates provided in OMB Control
Number 1545–0110 relate to all
information collections associated with
the applicable OMB Control Number,
and will in the future include, but not
isolate, the RIC and REIT estimated
burden as a result of the information
collections in the regulations.
The Treasury Department and IRS
have not estimated the burden,
including that of any new information
collections, related to the requirements
under the regulations. Those estimates
would capture both changes made by
the TCJA and those that arise out of the
discretionary authority exercised in the
regulations. The Treasury Department
and the IRS request comments on all
aspects of information collection
burdens related to the collection of
information applicable to the
Passthrough Entities in the regulations.
In addition, when available, drafts of
IRS Forms and the applicable
instructions are posted for comment at
https://www.irs.gov/pub/irs-dft/.

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Status
Published in the Federal Register on 4/4/2018. 83 FR
14552. Public comment period closed 6/4/2018. Thirty-day
notice published on 9/27/18. 83 FR 48894. Approved by
OIRA on 5/8/19.
Sixty-day notice published in the Federal Register on 9/30/
19. Public Comment period closed on 11/29/19. 84 FR
51718. Thirty-day notice published in the Federal Register
on 12/19/19. Public Comment period closed on 1/21/20. 84
FR 69825. Approved by OIRA on 1/30/20.
Sixty-day notice published in the Federal Register on 9/30/
19. Public Comment period closed on 11/29/19. 84 FR
51718. Thirty-day notice published in the Federal Register
on 12/19/19. Public Comment period closed on 1/21/20. 84
FR 69825. Approved by OIRA on 1/30/20.
Sixty-day notice published in the Federal Register on 9/19/
19. Public comment period closed 11/18/19. 84 FR 49379.
Thirty-day notice published in the Federal Register on 12/
20/19. 84 FR 70269.

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Form

Type of filer

OMB No.(s)

5479

Status

Link: https://www.federal register.gov/documents/2018/05/23/2018-10981/proposed-collection-comment-requestfor-form-1099-div.

C. Chart Showing Number of
Respondents Regarding Existing Forms

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The following chart shows the
estimated number of returns that are
expected to have attachments providing
additional information with respect to
section 1061. As noted previously,
Owner Taxpayers will be required to
provide section 1061 information on an
attachment to Schedules D for Forms
1040 and 1041. Passthrough Taxpayers
will be required to report section 1061
on Forms 1041, 1065, and 1120S to the
IRS and to furnish information to their
API Holders on attachments to the
respective K–1s. RICs and REITs may
voluntarily report additional
information at an attachment to Form
1099–DIV.

Books and records related to the
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.

III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibility
Act (5 U.S.C. chapter 6), it is hereby
certified that these final regulations will
not have a significant economic impact
on a substantial number of small entities
within the meaning of section 601(6) of
the Regulatory Flexibility Act. These
regulations generally only impact
investment funds that have capital gains
and losses that derive from the
disposition of assets that have a holding
Schedule D Form 1040 ........
20,475 period of more than one year but not
Schedule D Form 1041 ........
2,275 more than three years. Investment funds
Schedule K Form 1065 ........
28,500 are considered small business if they
Schedule K–1s Form 1065 ...
57,000 have annual average receipts of $41.5
Schedule K Form 1120S ......
1,500 million or less (13 CFR part 121). The
Schedule K–1s Form 1120 ...
1,000 rule may affect a substantial number of
Form 1099–DIV filed by
small entities, but data are not readily
REITs ................................
836 available to assess how many entities
Form 1099–DIV filed by
will be affected.
RICs ..................................
3,880
The Treasury Department and the IRS
received no actionable comments on the
D. Voluntary Collection of Information
impact that the proposed regulations
in § 1.1061–6(d) on PFIC Shareholder
would have on small entities. Although
Will Be Added to Existing OMB Control
certain commenters requested that
Number for PFIC Information Retention partnerships with an unspecified
amount of limited assets be excepted
Section 1.1061–6(d) permits a PFIC
from the application of the statutory
with respect to which the shareholder is rules of section 1061, these commenters
an API Holder who has a QEF election
did not provide any data to demonstrate
is in effect for the taxable year to
that any burden would be significant.
provide additional information to the
Similarly, a commenter requested an
shareholder to determine the amount of exception to the reporting requirements
the shareholder’s inclusion that would
for passthrough entities in which a
be included in the API One Year
limited partner owns 5 percent or less
Distributive Share Amount and the API
of a fund but did not quantify the
Three Year Distributive Share Amount.
burden. In addition, the final
If the PFIC furnishes this information to regulations adopt other comments that
the shareholder, the shareholder must
limit the general burden of the
retain a copy of this information along
regulations to all entities, including
with the other information required to
small entities.
be retained under § 1.1295–1(f)(2)(ii).
Even if a substantial number of small
The burden associated with retaining
entities are affected, the economic
this additional information will be
impact of these regulations on small
included in the aggregate burden
entities is not significant. The
estimates for § 1.1295–1(f) under OMB
regulations provide taxpayers with
Control Number 1545–1555. An agency
definitional and computational
may not conduct or sponsor, and a
guidance regarding the application of
person is not required to respond to, a
section 1061. The impact of the
collection of information unless it
regulations is to impose an additional
displays a valid control number
reporting obligation that applies only
assigned by the Office of Management
with respect to the sale of assets held for
and Budget.
more than one year but not more than

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three years. The Treasury Department
and the IRS recognize that this reporting
obligation may increase, at least to some
extent, the tax preparation burden for
affected taxpayers beyond that imposed
by the statute. This reporting obligation
generally will only apply to a minority
of the asset dispositions by an entity.
The entity will also have a reporting
obligation in certain circumstances
regarding the disposition of an API, but
the extent of the reporting obligation
depends on the number of assets
disposed by the entity and their holding
periods. The information reported is
readily available to taxpayers and
reported on forms already in use
beginning with the 2019 taxable year
such as Schedule D to IRS Form 1065.
Finally, some taxpayers may find they
need an initial investment of time to
read and understand these regulations at
an approximate cost of $95/hour and an
estimated time of ten hours.
Accordingly, the Secretary certifies that
these regulations will not have a
significant economic impact on a
substantial number of small entities.
Pursuant to section 7805(f), the notice
of proposed rulemaking preceding this
regulation was submitted to the Chief
Counsel for the Office of Advocacy of
the Small Business Administration for
comment on its impact on small
businesses. No comments were received
from the Chief Counsel for the Office of
Advocacy of the Small Business
Administration.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded
Mandates Reform Act of 1995 requires
that agencies assess anticipated costs
and benefits and take certain other
actions before issuing a final rule that
includes any Federal mandate that may
result in expenditures in any one year
by a state, local, or tribal government, in
the aggregate, or by the private sector, of
$100 million in 1995 dollars, updated
annually for inflation. This rule does
not include any Federal mandate that
may result in expenditures by state,
local, or tribal governments, or by the
private sector in excess of that
threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled
‘‘Federalism’’) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on

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state and local governments, and is not
required by statute, or preempts state
law, unless the agency meets the
consultation and funding requirements
of section 6 of the Executive order. This
rule does not have federalism
implications and does not impose
substantial direct compliance costs on
state and local governments or preempt
state law within the meaning of the
Executive order.

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VI. Congressional Review Act
The Administrator of the Office of
Information and Regulatory Affairs of
the Office of Management and Budget
has determined that this Treasury
decision is a major rule for purposes of
the Congressional Review Act (5 U.S.C.
801 et seq.). Under 5 U.S.C. 801(a)(3), a
major rule takes effect 60 days after the
rule is published in the Federal
Register.
Notwithstanding this requirement, 5
U.S.C. 808(2) allows agencies to
dispense with the requirements of 5
U.S.C. 801 when the agency for good
cause finds that such procedure would
be impracticable, unnecessary, or
contrary to the public interest and the
rule shall take effect at such time as the
agency promulgating the rule
determines. Pursuant to 5 U.S.C. 808(2),
the Treasury Department and the IRS
find, for good cause, that a 60-day delay
in the effective date is contrary to the
public interest.
Following the enactment of section
1061 by the TCJA, the Treasury
Department and the IRS published the
proposed regulations to provide
certainty to taxpayers. In particular, as
demonstrated by the wide variety of
public comments in response to the
proposed regulations received,
taxpayers continue to express
uncertainty regarding the proper
application of the statutory rules under
section 1061. This is especially the case
for taxpayers in the trade or business of
operating investment funds, which may
be unwilling to engage in certain
commercial transactions without the
additional clarity provided by these
final regulations. Additionally, various
rules contained within these regulations
attempt to curb certain abusive
transactions designed to avoid the
application of section 1061 and an
earlier effective date is necessary to
address these abusive transactions.
Accordingly, the Treasury Department
and the IRS have determined that the
rules in this Treasury decision will take
effect on the date of filing for public
inspection in the Federal Register.

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Statement of Availability of IRS
Documents
Notice 2018–18, 2018–2 I.R.B. 443 (in
addition to any other revenue
procedures or revenue rulings, etc. cited
in this preamble) is published in the
Internal Revenue Bulletin (or
Cumulative Bulletin) and is available
from the Superintendent of Documents,
U.S. Government Publishing Office,
Washington, DC 20402, or by visiting
the IRS website at http://www.irs.gov.
Drafting Information
The principal authors of these
regulations are Kara K. Altman, Sonia K.
Kothari, and Wendy L. Kribell of the
Office of Associate Chief Counsel
(Passthroughs and Special Industries).
However, other personnel from the
Treasury Department and the IRS
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Amendment to the Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding entries
for §§ 1.1061–0, 1.1061–1, 1.1061–2,
1.1061–3, 1.1061–4, 1.1061–5, and
1.1061–6 in numerical order to read in
part as follows:

■

Authority: 26 U.S.C. 7805 * * *
Section 1.1061–0 added under 26 U.S.C.
1061(f).
Section 1.1061–1 added under 26 U.S.C.
1061(f).
Section 1.1061–2 added under 26 U.S.C.
1061(f).
Section 1.1061–3 added under 26 U.S.C.
1(h)(9) and 1061(f).
Section 1.1061–4 added under 26 U.S.C.
1061(f).
Section 1.1061–5 added under 26 U.S.C.
1061(f).
Section 1.1061–6 added under 26 U.S.C.
1061(f).

*

*
*
*
*
■ Par. 2. Section 1.702–1 is amended by
adding a sentence at the end of
paragraph (a)(2) and adding paragraph
(g) to read as follows.
§ 1.702–1

Income and credits of partner.

(a) * * *
(2) * * * Each partner subject to
section 1061 must take into account
gains and losses from sales of capital
assets held for more than one year as
provided in section 1061 and §§ 1.1061–
1 through 1.1061–6.
*
*
*
*
*

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(g) Applicability date. The last
sentence of paragraph (a)(2) of this
section applies for the taxable years
beginning on or after January 19, 2021.
■ Par. 3. Section 1.704–3 is amended
by:
■ 1. In paragraph (e)(3)(vi)(B), remove
the word ‘‘and’’ at the end of the
paragraph;
■ 2. Redesignating paragraph
(e)(3)(vi)(C) as paragraph (e)(3)(vi)(D);
■ 3. Adding new paragraph (e)(3)(vi)(C);
and
■ 4. Revising the heading and first
sentence of paragraph (f) and adding a
sentence to the end of paragraph (f).
The additions and revisions read as
follows:
§ 1.704–3

Contributed property.

*

*
*
*
*
(e) * * *
(3) * * *
(vi) * * *
(C) With respect to any person who
directly or indirectly holds an
Applicable Partnership Interest, as
defined in § 1.1061–1(a)(1), take into
account the application of section 1061
with respect to such interest in an
appropriate manner; and
*
*
*
*
*
(f) Applicability dates. With the
exception of paragraphs (a)(1), (a)(8)(ii)
and (iii), (a)(10) and (11), and
(e)(3)(vi)(C) of this section, and of the
last sentence of paragraph (d)(2) of this
section, this section applies to
properties contributed to a partnership
and to revaluations pursuant to § 1.704–
1(b)(2)(iv)(f) or (s) on or after December
21, 1993.
* * * Paragraph (e)(3)(vi)(C) of this
section applies to taxable years
beginning on or after January 19, 2021.
*
*
*
*
*
■ Par. 4. Sections 1.1061–0 through
1.1061–6 are added before the
undesignated center heading ‘‘Changes
to Effectuate F.C.C. Policy’’ to read as
follows:
Sec.

*

*

*

*

*

1.1061–0 Table of contents.
1.1061–1 Section 1061 definitions.
1.1061–2 Applicable partnership interests
and applicable trades or businesses.
1.1061–3 Exceptions to the definition of an
API.
1.1061–4 Section 1061 computations.
1.1061–5 Section 1061(d) transfers to
related persons.
1.1061–6 Reporting rules.

*

*

§ 1.1061–0

*

*

*

Table of contents.

This section lists the captions that
appear in §§ 1.1061–1 through 1.1061–
6.

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§ 1.1061–1 Section 1061 definitions.
(a) Definitions.
(b) Applicability date.
§ 1.1061–2 Applicable partnership interests
and applicable trades or businesses.
(a) API rules and examples.
(1) Rules.
(i) An API remains an API.
(ii) Application of section 1061 to
Unrealized API Gains and Losses.
(iii) API Gains and Losses retain their
character.
(iv) Substantial services by the Owner
Taxpayer, Passthrough Taxpayer or any
Related Person.
(v) Grantor trusts and entities disregarded
as separate from their owners.
(2) Examples.
(b) Application of the ATB Activity Test.
(1) In general.
(i) Rules for applying the ATB Activity
Test.
(A) Aggregate Specified Actions taken into
account.
(B) Raising or Returning Capital Actions
and Investing or Developing Actions are not
both required to be taken in each taxable
year.
(C) Combined conduct by multiple related
entities taken into account.
(ii) Developing Specified Assets.
(iii) Partnerships.
(2) Examples.
(c) Applicability date.
§ 1.1061–3 Exceptions to the definition of
an API.
(a) A partnership interest held by an
employee of another entity not conducting an
ATB.
(b) Partnership interest held by a
corporation.
(1) In general.
(2) Treatment of interests held by an S
corporation or a qualified electing fund.
(c) Capital Interest Gains and Losses.
(1) In general.
(2) Capital Interest Gains and Losses
defined.
(3) General rules for determining Capital
Interest Allocations.
(i) Commensurate with capital contributed.
(ii) In a similar manner.
(A) Relevant factors.
(B) Clear identification requirement.
(iii) Reinvestment of API Gain.
(iv) Unrelated Non-Service Partner
requirement.
(v) Proceeds of certain loans not taken into
account for Capital Interest Allocation
purposes.
(A) General rule.
(B) Recourse liability.
(vi) Items that are not included in Capital
Interest Allocations.
(4) Capital Interest Disposition Amounts.
(i) In general.
(ii) Determination of the Capital Interest
Disposition Amount.
(5) Capital Interest Allocations made by a
Passthrough Entity that is an API Holder.
(6) Examples.
(d) Partnership interest acquired by
purchase by an unrelated person.
(1) Acquirer not a Related Person.
(2) Section 1061(d) not applicable.

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(3) Acquirer not a service provider.
(e) [Reserved]
(f) Applicability date.
(1) General rule.
(2) Partnership interest held by an S
corporation.
(3) Partnership interest held by a PFIC with
respect to which the shareholder has a QEF
election in effect.
§ 1.1061–4 Section 1061 computations.
(a) Computations.
(1) Recharacterization Amount.
(2) One Year Gain Amount and Three Year
Gain Amount.
(i) One Year Gain Amount.
(ii) Three Year Gain Amount.
(3) API One Year Distributive Share
Amount and API Three Year Distributive
Share Amount.
(i) API One Year Distributive Share
Amount.
(ii) API Three Year Distributive Share
Amount.
(4) API One Year Disposition Amount and
API Three Year Disposition Amount.
(i) API One Year Disposition Amount.
(ii) API Three Year Disposition Amount.
(b) Special rules for calculating the One
Year Gain Amount and the Three Year Gain
Amount.
(1) One Year Gain Amount equals zero or
less.
(2) Three Year Gain Amount equals zero or
less.
(3) One Year Gain Amount less than Three
Year Gain Amount.
(4) Installment sale gain.
(5) Special rules for capital gain dividends
from regulated investment companies (RICs)
and real estate investment trusts (REITs).
(i) API One Year Distributive Share
Amount.
(ii) API Three Year Distributive Share
Amount.
(iii) Loss on sale or exchange of stock.
(6) Pro rata share of qualified electing fund
(QEF) net capital gain.
(i) One year QEF net capital gain.
(ii) Three year QEF net capital gain
adjustment.
(7) Items not taken into account for
purposes of section 1061.
(8) Holding period determination.
(i) Determination of holding period for
purposes of the Three Year Gain Amount.
(ii) Relevant holding period.
(9) Lookthrough Rule for certain API
dispositions.
(i) Determination that the Lookthrough
Rule applies.
(A) In general.
(B) Determination that the Lookthrough
Rule applies to the disposition of a
Passthrough Interest.
(ii) Application of the Lookthrough Rule.
(10) Section 83.
(c) Examples.
(1) Recharacterization rules.
(2) Special rules examples.
(d) Applicability date.
§ 1.1061–5 Section 1061(d) transfers to
related persons.
(a) In general.
(b) Transfer.
(c) Section 1061(d) Recharacterization
Amount.

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(d) Special rules.
(e) Section 1061(d) Related Person.
(f) Examples.
(g) Applicability date.
§ 1.1061–6 Reporting rules.
(a) Owner Taxpayer filing requirements.
(1) In general.
(2) Failure to obtain information.
(b) Passthrough Entity filing requirements
and reporting.
(1) Requirement to file information with
the IRS and to furnish information to API
Holder.
(2) Requirement to request, furnish, and
file information in tiered structures.
(i) Requirement to request information.
(ii) Requirement to furnish and file
information.
(iii) Timing of requesting and furnishing
information.
(A) Requesting information.
(B) Furnishing information.
(iv) Manner of requesting information.
(v) Recordkeeping requirement.
(vi) Passthrough Entity is not furnished
information to meet its reporting obligations
under paragraph (b)(1) of this section.
(vii) Filing requirements.
(viii) Penalties.
(c) Regulated investment company (RIC)
and real estate investment trust (REIT)
reporting.
(1) Section 1061 disclosures.
(i) One Year Amounts Disclosure.
(ii) Three Year Amounts Disclosure.
(2) Pro rata disclosures.
(3) Report to shareholders.
(d) Qualified electing fund (QEF) reporting.
(e) Applicability date.
§ 1.1061–1

Section 1061 definitions.

(a) Definitions. The following
definitions apply solely for purposes of
this section and §§ 1.1061–2 through
1.1061–6.
API Gains and Losses are any longterm capital gains and capital losses
with respect to an API and include:
(i) The API One Year Distributive
Share Amount as defined in § 1.1061–
4(a)(3)(i);
(ii) The API Three Year Distributive
Share Amount as defined in § 1.1061–
4(a)(3)(ii);
(iii) The API One Year Disposition
Amount as defined in § 1.1061–
4(a)(4)(i);
(iv) The API Three Year Disposition
Amount as defined in § 1.1061–
4(a)(4)(ii); and
(v) Capital gains or losses from the
disposition of Distributed API Property.
API Holder is a person who holds an
API.
Applicable Partnership Interest (API)
means any interest in a partnership
which, directly or indirectly, is
transferred to (or is held by) an Owner
Taxpayer or Passthrough Taxpayer in
connection with the performance of
substantial services by the Owner
Taxpayer or by a Passthrough Taxpayer,

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or by any Related Person, including
services performed as an employee, in
any ATB unless an exception in
§ 1.1061–3 applies. For purposes of
defining an API under this section and
section 1061 of the Internal Revenue
Code (Code), an interest in a partnership
also includes any financial instrument
or contract, the value of which is
determined in whole or in part by
reference to the partnership (including
the amount of partnership distributions,
the value of partnership assets, or the
results of partnership operations). An
Owner Taxpayer and a Passthrough
Taxpayer can hold an API directly or
indirectly through one or more
Passthrough Entities.
Applicable Trade or Business (ATB)
means any activity for which the ATB
Activity Test with respect to Specified
Actions is met, and includes all
Specified Actions taken by Related
Persons, including combining activities
occurring in separate partnership tiers
or entities as one ATB.
ATB Activity Test has the meaning
provided in § 1.1061–2(b)(1).
Capital account means a capital
account maintained under § 1.704–
1(b)(2)(iv) or similar principles.
Capital Interest Allocations means,
with respect to a partnership,
allocations of long-term capital gain or
loss made under the partnership
agreement to an API Holder and to
Unrelated Non-Service Partners based
on such partners’ capital contributed
with respect to the partnership to the
extent such allocations otherwise meet
the requirements of § 1.1061–3(c). With
respect to other Passthrough Entities,
the principles of this definition apply.
Capital Interest Disposition Amount
has the meaning provided in § 1.1061–
3(c)(4).
Capital Interest Gains and Losses has
the meaning provided in § 1.1061–
3(c)(2).
Distributed API Property means
property distributed by a Passthrough
Entity to an API Holder with respect to
an API if the holding period, as
determined under sections 735 and
1223, in the API Holder’s hands is three
years or less at the time of disposition
of the property by the API Holder.
Indirect API means an API that is held
through one or more Passthrough
Entities.
Investing or Developing Actions
means actions involving either—
(i) Investing in (or disposing of)
Specified Assets (or identifying
Specified Assets for such investing or
disposition); or
(ii) Developing Specified Assets (see
§ 1.1061–2(b)(1)(ii)).

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Lookthrough Rule means the
recharacterization rule described in
§ 1.1061–4(b)(9).
One Year Gain Amount has the
meaning provided in § 1.1061–4(a)(2)(i).
Owner Taxpayer means the person
subject to Federal income tax on net
gain with respect to an API or an
Indirect API during the taxable year,
including an owner of a Passthrough
Taxpayer unless the owner of the
Passthrough Taxpayer is a Passthrough
Entity itself or is excepted under
§ 1.1061–3(a), (b), or (d).
Passthrough Entity means a
partnership, trust, estate, S corporation
described in § 1.1061–3(b)(2)(i), or
passive foreign investment company
described in § 1.1061–3(b)(2)(ii).
Passthrough Interest means an
interest in a Passthrough Entity that
represents in whole or in part an API.
Passthrough Taxpayer means a
Passthrough Entity that is treated as a
taxpayer for the purpose of determining
the existence of an API.
Raising or Returning Capital Actions
means actions involving raising or
returning capital but does not include
Investing or Developing Actions.
Recharacterization Amount has the
meaning provided in § 1.1061–4(a)(1).
Related Person means a person or
entity who is treated as related to
another person or entity under sections
707(b) or 267(b).
Relevant ATB means the ATB in
which services were provided and in
connection with which an API is held
or was transferred.
Section 1061(d) Recharacterization
Amount has the meaning provided in
§ 1.1061–5(c).
Section 1061(d) Related Person has
the meaning provided in § 1.1061–5(e).
Section 1061 Regulations means the
provisions of this section and
§§ 1.1061–2 through 1.1061–6.
Specified Actions means the
combination of Raising or Returning
Capital Actions and Investing or
Developing Actions.
Specified Assets means—
(i) Securities, including interests in
partnerships qualifying as securities (as
defined in section 475(c)(2) without
regard to the last sentence thereof);
(ii) Commodities (as defined in
section 475(e)(2));
(iii) Real estate held for rental or
investment;
(iv) Cash or cash equivalents; and
(v) An interest in a partnership to the
extent that the partnership holds
Specified Assets. See § 1.1061–
2(b)(1)(iii).
(vi) Specified Assets include options
or derivative contracts with respect to
any of the items provided in paragraphs
(i) through (v) of this definition.

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Three Year Gain Amount has the
meaning provided in § 1.1061–
4(a)(2)(ii).
Unrealized API Gains and Losses
means, with respect to a Passthrough
Entity’s assets, all unrealized capital
gains and losses that would be:
(i) Realized if those assets were
disposed of for fair market value in a
taxable transaction on the relevant date;
and
(ii) Allocated to an API Holder with
respect to its API, taking into account
the principles of section 704(c).
Unrelated Non-Service Partners
means partners who do not (and did
not) provide services in the Relevant
ATB and who are not (and were not)
Related Persons with respect to any API
Holder in the partnership or any person
who provides or has provided services
in the Relevant ATB.
(b) Applicability date. The provisions
of this section apply to taxable years of
Owner Taxpayers and Passthrough
Entities beginning on or after January
19, 2021. An Owner Taxpayer or
Passthrough Entity may choose to apply
this section to a taxable year beginning
after December 31, 2017, provided that
they consistently apply the Section 1061
Regulations in their entirety to that year
and all subsequent years.
§ 1.1061–2 Applicable partnership
interests and applicable trades or
businesses.

(a) API rules and examples—(1)
Rules—(i) An API remains an API. Once
a partnership interest qualifies as an
API, the partnership interest remains an
API unless and until the requirements of
one of the exceptions to qualification of
a partnership interest as an API, set
forth in § 1.1061–3, are satisfied.
(ii) Application of section 1061 to
Unrealized API Gains and Losses.
Unrealized API Gains and Losses are
API Gains and Losses subject to section
1061 when the gains and losses are
realized and recognized. Unrealized API
Gains and Losses do not lose their
character as such until they are
recognized.
(iii) API Gains and Losses retain their
character. API Gains and Losses retain
their character as API Gains and Losses
as they are allocated from one
Passthrough Entity to another
Passthrough Entity and then to the
Owner Taxpayer.
(iv) Substantial services by an Owner
Taxpayer, Passthrough Taxpayer, or any
Related Person. If an interest in a
partnership is transferred to or held by
an Owner Taxpayer, Passthrough
Taxpayer, or any Related Person in
connection with the performance of
services, the Owner Taxpayer, the

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Passthrough Taxpayer, or the Related
Person is presumed to have provided
substantial services for purposes of
section 1061.
(v) Grantor trusts and entities
disregarded as separate from their
owners. A trust wholly described in
subpart E, part I, subchapter J, chapter
1 of the Internal Revenue Code (that is,
a grantor trust), a qualified subchapter S
subsidiary described in section
1361(b)(3), and an entity with a single
owner that is treated as disregarded as
an entity separate from its owner under
any provision of the Internal Revenue
Code or any part of 26 CFR (including
§ 301.7701–3 of this chapter) are
disregarded for purposes of the Section
1061 Regulations.
(2) Examples. The following examples
illustrate the provisions of this
paragraph (a).
(i) Example 1: API. (A) A is the
general partner of PRS, a partnership,
and provides services to PRS. A is
engaged in an ATB as defined in
§ 1.1061–1(a). PRS transfers a PRS
profits interest to A in connection with
A’s performance of substantial services
with respect to PRS’s ATB. A’s interest
in PRS is an API.
(B) After 6 years, A retires and is no
longer engaged in an ATB and does not
perform any services with respect to its
ATB and with respect to PRS. However,
A retains the API in PRS. PRS continues
to acquire new capital assets and to
allocate gain to A from the disposition
of those assets. Under paragraph (a)(1)(i)
of this section, A’s interest in PRS
remains an API after A retires.
(ii) Example 2: Contribution of an API
to a partnership. Individuals A, B, and
C each directly hold APIs in PRS, a
partnership. A and B form a new
partnership, GP, and contribute their
APIs in PRS to GP. Following the
contribution, each of A and B holds an
Indirect API because each of A and B
now indirectly holds an API in PRS
through GP, a Passthrough Entity. Each
of A’s and B’s interests in GP is a
Passthrough Interest because each of A’s
and B’s interest in GP represents an
Indirect API.
(iii) Example 3: Passthrough Interest,
Indirect API, Passthrough Taxpayer.
Each of A, B, and C provides services to,
and is an equal partner in, GP. GP is
engaged in an ATB as defined in
§ 1.1061–1(a), is the general partner of
PRS, and provides substantial
management services to PRS. In
connection with GP’s performance of
substantial services in an ATB, PRS
issues a profits interest to GP. Because
GP’s PRS interest was received in
connection with GP’s providing services
in an ATB, GP is a Passthrough

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Taxpayer and GP’s interest in PRS is an
API. Because A, B, and C are partners
in GP, they each hold a Passthrough
Interest in GP and an Indirect API in
PRS. Each of A, B, and C is treated as
an Owner Taxpayer because each is a
partner in GP and because each holds an
Indirect API in PRS in connection with
the performance of its services to GP’s
ATB.
(iv) Example 4: S corporation,
Passthrough Interest, Indirect API, and
Passthrough Taxpayer. A owns all of the
stock of S Corp, an S corporation. S
Corp is engaged in an ATB, as defined
in § 1.1061–1(a). S Corp is the general
partner of PRS, a partnership, and
provides substantial management
services to PRS. A provides substantial
services in S Corp’s ATB. In connection
with S Corp providing substantial
services to PRS, PRS issues a profits
interest to S Corp. S Corp’s interest in
PRS is its only asset. Because S Corp’s
profits interest in PRS was issued to S
Corp in connection with substantial
services in an ATB, S Corp is a
Passthrough Taxpayer and its interest in
PRS is an API. Because A is a
shareholder in S Corp, A holds a
Passthrough Interest in S Corp and an
Indirect API in PRS as a result of S
Corp’s API in PRS. A is treated as an
Owner Taxpayer because A holds an
interest in S Corp, a Passthrough
Taxpayer, and also indirectly holds an
API in PRS in connection with A’s
services in S Corp’s ATB.
(v) Example 5: Indirect API, Related
Person, and Passthrough Taxpayer.
Each of A, B, and C is an equal partner
in partnership GP, the general partner of
PRS. GP’s Specified Actions do not
satisfy the ATB Activity Test under
§ 1.1061–1(a) and as a result, GP’s
actions do not establish an ATB.
Management Company is a Related
Person with respect to GP within the
meaning of sections 267(b) and 707(b),
is engaged in an ATB, and provides
substantial management services to PRS
that are sufficient to satisfy the ATB
Activity Test. Management Company’s
actions are attributed to GP under
paragraphs (a)(1)(iv) and (b)(1)(i)(C) of
this section because Management
Company is a Related Person to GP. In
connection with Management
Company’s services to PRS, PRS issues
a profits interest to GP. Because its PRS
profits interest is issued to GP in
connection with services provided by
Management Company, a Related
Person, GP is a Passthrough Taxpayer
and its interest in PRS is an API. Unless
an exception described in § 1.1061–3
applies, because A, B, and C are
partners in GP, they each hold a
Passthrough Interest in GP and an

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Indirect API in PRS. A, B, and C are
treated as Owner Taxpayers because
they hold an interest in GP, a
Passthrough Taxpayer.
(b) Application of the ATB Activity
Test—(1) In general. The ATB Activity
Test is satisfied if both Raising and
Returning Actions and Investing or
Developing Actions are conducted by an
Owner Taxpayer, Passthrough Taxpayer,
or one or more Related Persons with
respect to an Owner Taxpayer or
Passthrough Taxpayer, and the total
level of activity, including the combined
activities of all Related Persons, satisfies
the level of activity that would be
required to establish a trade or business
under section 162.
(i) Rules for applying the ATB Activity
Test—(A) Aggregate Specified Actions
taken into account. The determination
of whether the ATB Activity Test is
satisfied is based on the combined
activities conducted that qualify as
either Raising or Returning Capital
Actions and Investing or Developing
Actions. The fact that either Raising or
Returning Capital Actions or Investing
or Developing Actions are only
infrequently taken does not preclude the
test from being satisfied if the combined
Specified Actions meet the test.
(B) Raising or Returning Capital
Actions and Investing or Developing
Actions are not both required to be
taken in each taxable year. Raising or
Returning Capital Actions and Investing
or Developing Actions are not both
required to be taken in each taxable year
in order to satisfy the ATB Activity Test.
For example, the ATB Activity Test will
be satisfied if Investing or Developing
Actions are not taken in the current
taxable year, but sufficient Raising or
Returning Capital Actions are taken in
anticipation of future Investing or
Developing Actions. Additionally, the
ATB Activity Test will be satisfied if no
Raising or Returning Capital Actions are
taken in the current taxable year, but
have been taken in a prior taxable year
(regardless of whether the ATB Activity
Test was met in the prior year), and
sufficient Investing or Developing
Actions are undertaken by the taxpayer
in the current taxable year.
(C) Combined conduct by multiple
related entities taken into account—(1)
Related Entities. If a Related Person(s)
(within the meaning of § 1.1061–1(a))
solely or primarily performs Raising or
Returning Capital Actions and one or
more other Related Person(s) solely or
primarily performs Investing or
Developing Actions, the combination of
the activities performed by these
Related Persons will be taken into
account in determining whether the
ATB Activity Test is satisfied.

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(2) Actions taken by an agent or
delegate. Specified Actions taken by an
agent or a delegate in its capacity as an
agent or a delegate of a principal will be
taken into account by the principal in
determining whether the ATB Activity
Test is satisfied with respect to the
principal. These Specified Actions are
also taken into account in determining
whether the ATB Activity test is
satisfied with respect to the agent or the
delegate.
(ii) Developing Specified Assets.
Developing Specified Assets takes place
if it is represented to investors, lenders,
regulators, or other interested parties
that the value, price, or yield of a
portfolio business may be enhanced or
increased in connection with choices or
actions of a service provider. Merely
exercising voting rights with respect to
shares owned or similar activities do not
amount to developing Specified Assets.
(iii) Partnerships. Investing or
Developing Actions directly conducted
with respect to Specified Assets held by
a partnership are counted towards the
ATB Activity Test. Additionally, a
portion of the Investing or Developing
Actions conducted with respect to the
interests in a partnership that holds
Specified Assets is counted towards the
ATB Activity Test. This portion is the
value of the partnership’s Specified
Assets over the value of all of the
partnership’s assets. Actions taken to
manage a partnership’s working capital
will not be taken into account in
determining the portion of Investing or
Developing Actions conducted with
respect to the interests in the
partnership.
(2) Examples. The following examples
illustrate the application of the ATB
Activity Test described in paragraph
(b)(1) of this section.
(i) Example 1: Combined activities of
Raising or Returning Capital Actions
and Investing or Developing Actions.
During the taxable year, B takes a small
number of actions to raise capital for
new investments. B takes numerous
actions to develop Specified Assets. B’s
actions with respect to raising capital
and B’s actions with respect to
developing Specified Assets are
combined for the purpose of
determining whether the ATB Activity
Test is satisfied. These actions
cumulatively rise to the level required
to establish a trade or business under
section 162. Thus, B satisfies the ATB
Activity Test.
(ii) Example 2: Combining Specified
Actions in multiple entities. GP, a
partnership, conducts Raising or
Returning Capital Actions. Management
Company, a partnership that is a Related
Person to GP, conducts Investing or

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Developing Actions. When GP’s and
Management Company’s activities are
combined, the ATB Activity Test is
satisfied. Accordingly, both GP and
Management Company are engaged in
an ATB, and services performed by
either GP or Management Company are
performed in an ATB under paragraph
(b)(1) of this section.
(iii) Example 3: Investing or
Developing Actions taken after Raising
or Returning Capital Actions that do not
meet the ATB Activity Test. In year 1,
PRS engaged in Raising or Returning
Capital Actions to fund PRS’s
investment in Specified Assets.
However, PRS’ Specified Actions during
year 1 did not satisfy the ATB Activity
Test because they did not satisfy the
level of activity required to establish a
trade or business under section 162.
Therefore, PRS was not engaged in an
ATB in year 1. In year 2, PRS engaged
in significant Investing or Developing
Actions but did not engage in any
Raising or Returning Capital Actions. In
year 2, PRS’s Investing or Developing
Actions rise to the level required to
establish a trade or business under
section 162. Because PRS has
cumulatively engaged in both Investing
or Developing Actions and Raising or
Returning Capital Actions and because
the Specified Actions rise to the level of
activity required to establish a trade or
business under section 162, PRS is
engaged in an ATB in year 2.
(iv) Example 4: Raising or Returning
Capital Actions taken in anticipation of
Investing or Developing Actions. In year
1, A only conducted Raising or
Returning Capital Actions. A’s Raising
or Returning Capital Actions were
undertaken to raise capital to invest in
Specified Assets with the goal of
increasing their value through Investing
or Developing Actions and rise to the
level of activity required to establish a
trade or business under section 162. A
did not take Investing or Developing
Actions during the taxable year. A’s
Raising or Returning Capital Actions
satisfy the ATB Activity Test because
they were undertaken in anticipation of
also engaging in Investing or Developing
Actions. Therefore, the ATB Activity
Test is satisfied, and A is engaged in an
ATB in year 1.
(v) Example 5: Attribution of
delegate’s actions. GP is the general
partner of PRS. GP is responsible for
providing management services to PRS.
GP contracts with Management
Company to provide management
services on GP’s behalf to PRS. GP and
Management Company are not Related
Persons. The Specified Actions taken by
Management Company on behalf of GP
are attributed to GP for purposes of the

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ATB Activity Test because the
Management Company is operating as a
delegate of GP. Additionally, those
Specified Actions are taken into account
by Management Company for purposes
of the ATB Activity Test and whether it
is engaged in an ATB.
(vi) Example 6: ATB Activity Test not
satisfied. A is the manager of a hardware
store. Partnership owns the hardware
store, including the building in which
the hardware business is conducted. In
connection with A’s services as the
manager of the hardware store, a profits
interest in Partnership is transferred to
A. Partnership’s business involves
buying hardware from wholesale
suppliers and selling it to customers.
The hardware is not a Specified Asset.
Although real estate is a Specified Asset
if it is held for rental or investment
purposes, Partnership holds the
building for the purpose of conducting
its hardware business and not for rental
or investment purposes. Therefore, the
building is not a Specified Asset as to
Partnership. Partnership also maintains
and manages a certain amount of
working capital for its business, but
actions with respect to working capital
are not taken into account for the
purpose of determining whether the
ATB Activity Test is met. Partnership is
not a Related Person with respect to any
person who takes Specified Actions.
Partnership is not engaged in an ATB
because the ATB Activity Test is not
satisfied. Although Partnership raises
capital, its Raising or Returning Capital
Actions alone do not satisfy the ATB
Activity Test. Further, Partnership takes
no Investing or Developing Actions
because it holds no Specified Assets
other than working capital. Partnership
is not in an ATB and the profits interest
transferred to A is not an API.
(c) Applicability date. The provisions
of this section apply to taxable years of
Owner Taxpayers and Passthrough
Entities beginning on or after January
19, 2021. An Owner Taxpayer or
Passthrough Entity may choose to apply
this section to a taxable year beginning
after December 31, 2017, provided that
they apply the Section 1061 Regulations
in their entirety to that year and all
subsequent years.
§ 1.1061–3
an API.

Exceptions to the definition of

(a) A partnership interest held by an
employee of another entity not
conducting an ATB. An API does not
include any interest transferred to a
person in connection with the
performance of substantial services by
that person as an employee of another
entity that is conducting a trade or
business (other than an ATB) and the

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person provides services only to such
other entity.
(b) Partnership interest held by a
corporation—(1) In general. An API
does not include any interest directly or
indirectly held by a corporation.
(2) Treatment of interests held by an
S corporation or a qualified electing
fund. For purposes of this section, a
corporation does not include an entity
for which an election was made to treat
the entity as a Passthrough Entity. Thus,
the following entities are not treated as
corporations for purposes of section
1061—
(i) An S corporation for which an
election under section 1362(a) is in
effect; and
(ii) A passive foreign investment
company (PFIC) with respect to which
the shareholder has a qualified electing
fund (QEF) election under section 1295
in effect.
(c) Capital Interest Gains and
Losses—(1) In general. Capital Interest
Gains and Losses are not subject to
section 1061 and, therefore, are not
included in calculating an Owner
Taxpayer’s Recharacterization Amount.
(2) Capital Interest Gains and Losses
defined. For purposes of paragraph
(c)(1) of this section, Capital Interest
Gains and Losses are Capital Interest
Allocations that meet the requirements
of paragraph (c)(3) of this section and
Capital Interest Disposition Amounts
that meet the requirements of paragraph
(c)(4) of this section.
(3) General rules for determining
Capital Interest Allocations—(i)
Commensurate with capital contributed.
An allocation will be considered a
Capital Interest Allocation if the
allocation to the API Holder with
respect to its capital interest is
determined and calculated in a similar
manner as the allocations with respect
to capital interests held by similarly
situated Unrelated Non-Service Partners
who have made significant aggregate
capital contributions as described in
paragraph (c)(3)(iv) of this section. For
purposes of this paragraph (c)(3), a
capital interest is an interest that would
give the holder a share of the proceeds
if the partnership’s assets were sold at
fair market value at the time the interest
was received and the proceeds were
then distributed in a complete
liquidation of the partnership.
(ii) In a similar manner. For purposes
of paragraph (c)(3)(i) of this section, a
Capital Interest Allocation to an API
Holder will be treated as made in a
similar manner if allocations and
distribution rights with respect to the
capital contributed by an API Holder to
which the API Holder’s Capital Interest
Allocation relates are reasonably

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consistent with allocation and
distribution rights with respect to
capital contributed by Unrelated NonService Partners where the Unrelated
Non-Service Partner requirement is met.
For purposes of this paragraph (c)(3)(ii),
allocation and distribution rights for an
API Holder that are limited to a
particular class of partnership capital
interests or that are determined with
respect to capital contributions invested
in a particular partnership investment
will be considered as made in a similar
manner to allocations and distribution
rights of Unrelated Non-Service Partners
where the Unrelated Non-Service
Partner requirement is met for the
applicable interest class or partnership
investment.
(A) Relevant factors. For purposes of
this paragraph (c)(3)(ii), the following
factors are not exclusive, but are
relevant factors in determining whether
allocation and distribution rights with
respect to capital contributed by an API
Holder are reasonably consistent with
allocation and distribution rights of
persons meeting the Unrelated NonService Partner requirement: The
amount and timing of capital
contributed, the rate of return on capital
contributed, the terms, priority, type
and level of risk associated with capital
contributed, and the rights to cash or
property distributions during the
partnership’s operations and on
liquidation. Accordingly, an allocation
to an API Holder will not fail to qualify
solely because the allocation is
subordinated to allocations made to
Unrelated Non-Service Partners,
because an allocation to an API Holder
is not reduced by the cost of services
provided by the API Holder or a Related
Person to the partnership, where the
cost of services provided includes
management fees or API allocations, or
because an API Holder has a right to
receive tax distributions while
Unrelated Non-Service Partners do not,
where such distributions are treated as
advances against future distributions.
(B) Clear identification requirement.
For purposes of this paragraph (c)(3)(ii),
allocations will be considered made in
a similar manner only if the allocations
to the API Holder and the Unrelated
Non-Service Partners are allocations
with respect to, and corresponding to,
such partners’ contributed capital that
are separate and apart from allocations
made to the API Holder with respect to
its API and where both the partnership
agreement and the partnership’s
contemporaneous books and records
clearly demonstrate that the
requirements of paragraph (c)(3) of this
section have been met.

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5485

(iii) Reinvestment of API Gain. If an
API Holder is allocated API Gain by a
Passthrough Entity, to the extent that an
amount equal to the API Gain is
reinvested in the Passthrough Entity by
the API Holder (either as the result of an
actual distribution and recontribution of
the API Gain amount or the retention of
the API Gain amount by the Passthrough
Entity), the amount will be treated as a
contribution to the Passthrough Entity
for a capital interest that may produce
Capital Interest Allocations for the API
Holder, provided such allocations meet
the requirements of this paragraph
(c)(3).
(iv) Unrelated Non-Service Partner
requirement. For purposes of paragraph
(c)(3) of this section, the Unrelated NonService Partner requirement means that
Unrelated Non-Service Partners must
have made significant aggregate capital
contributions in relation to total capital
contributions of all partners. Unrelated
Non-Service Partners will be treated as
having made significant aggregate
capital contributions provided such
partners possess five percent or more of
the aggregate capital contributed to the
partnership at the time the allocations
are made. With respect to an API Holder
with allocation and distribution rights
that are attributable to a particular
interest class or partnership investment,
the Unrelated Non-Service requirement
must be met with respect to that
particular interest class or partnership
investment.
(v) Proceeds of certain loans not taken
into account for Capital Interest
Allocation purposes—(A) General rule.
For purposes of the Section 1061
Regulations, an allocation is not a
Capital Interest Allocation to the extent
the allocation is attributable to the
contribution of an amount of capital to
a partnership that, directly or indirectly,
results from, or is attributable to, any
loan or other advance made or
guaranteed, directly or indirectly, by the
partnership, a partner in the
partnership, or any Related Person with
respect to such persons, except to the
extent a loan or advance is described in
paragraph (c)(3)(v)(B) of this section.
However, the repayments on a loan
described in the preceding sentence are
taken into account as capital
contributed (and may therefore generate
Capital Interest Allocations) as those
amounts are paid by the partner,
provided that the loan is not repaid with
the proceeds of another loan described
in the preceding sentence.
(B) Recourse liability. Paragraph
(c)(3)(v)(A) of this section does not
apply with respect to an allocation
attributable to a contribution made by
an individual service provider that,

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directly or indirectly, results from, or is
attributable to, a loan or advance from
another partner in the partnership (or
any Related Person with respect to such
lending or advancing partner, other than
the partnership) to such individual
service provider if the individual
service provider is personally liable for
the repayment of such loan or advance.
A contribution made by an individual
service provider includes a contribution
made by an entity that is wholly owned
by, and disregarded as separate from,
the individual service provider as
described in § 1.1061–2(a)(1)(v),
including a contribution attributable to
a loan or advance made to the
disregarded entity by another partner in
the partnership (or any Related Person
with respect to such lending or
advancing partner, other that the
partnership) if the individual service
provider is personally liable for the
repayment of any and all borrowed
amounts that are not repaid by the
disregarded entity. For purposes of this
paragraph (c)(3)(v)(B), an individual
service provider is personally liable for
the repayment of a loan or advance
made by a partner (or any Related
Person, other than the partnership) if—
(1) The loan or advance is fully
recourse to the individual service
provider;
(2) The individual service provider
has no right to reimbursement from any
other person; and
(3) The loan or advance is not
guaranteed by any other person.
(vi) Items that are not included in
Capital Interest Allocations. Capital
Interest Allocations do not include—
(A) Amounts that are treated as API
Gains and Losses and Unrealized API
Gains and Losses; or
(B) Items that are not taken into
account for purposes of section 1061
under § 1.1061–4(b)(7).
(4) Capital Interest Disposition
Amounts—(i) In general. The term
Capital Interest Disposition Amount
means the amount of long-term capital
gain or loss recognized on the sale or
disposition of all or a portion of a
Passthrough Interest that is treated as
Capital Interest Gain or Loss. In general,
long-term capital gain or loss recognized
on the sale or disposition of a
Passthrough Interest is deemed to be
API Gain or Loss unless it is determined
under paragraph (c)(4)(ii) of this section
to be a Capital Interest Disposition
Amount.
(ii) Determination of the Capital
Interest Disposition Amount. If a
Passthrough Interest that includes a
right to allocations of Capital Interest
Gains and Losses is disposed of, the
amount of long-term capital gain or loss

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that is treated as a Capital Interest
Disposition Amount is determined
under the rules provided in this
paragraph (c)(4)(ii).
(A) First, determine the amount of
long-term capital gain or loss that would
be allocated to the Passthrough Interest
(or the portion of the Passthrough
Interest sold) if all the assets of the
Passthrough Entity (including gain or
loss with respect to assets described in
§ 1.1061–4(b)(7)) were sold for their fair
market value in a fully taxable
transaction immediately before the
disposition of the Passthrough Interest
(hypothetical asset sale). For purposes
of this paragraph (c)(4)(ii), the assets of
the Passthrough Entity include any
assets held by a lower-tier Passthrough
Entity in which the Passthrough Entity
has a direct or indirect interest.
(B) Second, determine the amount
from the hypothetical asset sale that
would be allocated to the Passthrough
Interest (or the portion of the
Passthrough Interest sold) as Capital
Interest Allocations under paragraph
(c)(3) of this section.
(C) Third, if the transferor recognized
long-term capital gain upon disposition
of the Passthrough Interest and only net
short-term capital losses, net long-term
capital losses, or both, are allocated to
the Passthrough Interest under
paragraph (c)(4)(ii)(B) of this section
from the hypothetical asset sale, all of
the long-term capital gain is API Gain.
If the transferor recognized long-term
capital loss on the disposition of the
Passthrough Interest and only net shortterm capital gains, net long-term capital
gains, or both, are allocated to the
Passthrough Interest under paragraph
(c)(4)(ii)(B) of this section, then all the
long-term capital loss is API Loss.
(D) If paragraph (c)(4)(ii)(C) of this
section does not apply and long-term
capital gain is recognized on the
disposition of the Passthrough Interest,
the amount of long-term capital gain
that the transferor of the Passthrough
Interest recognizes that is treated as a
Capital Interest Disposition Amount is
determined by multiplying long-term
capital gain recognized on the
disposition of the Passthrough Interest
by a fraction, the numerator of which is
the amount of long-term capital gain
determined under paragraph (c)(4)(ii)(B)
of this section, and the denominator of
which is the amount of long-term
capital gain determined under
paragraph (c)(4)(ii)(A) of this section,
with the percentage represented by the
fraction limited to 100 percent.
Alternatively, if paragraph (c)(4)(ii)(C) of
this section does not apply and longterm capital loss is recognized on the
disposition of the Passthrough Interest,

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the amount of long-term capital loss
treated as a Capital Interest Disposition
Amount is determined by multiplying
the transferor’s capital loss by a fraction,
the numerator of which is the amount
of long-term capital loss determined
under paragraph (c)(4)(ii)(B) of this
section, and the denominator of which
is the amount of long-term capital loss
determined under paragraph (c)(4)(ii)(A)
of this section, with the percentage
represented by the fraction limited to
100 percent.
(E) In applying this paragraph
(c)(4)(ii), allocations of amounts that are
not included in determining the amount
of long-term capital gain or loss
recognized on the sale or disposition of
the Passthrough Interest are not
included. See, for example, section
751(a).
(5) Capital Interest Allocations made
by a Passthrough Entity that is an API
Holder. An allocation made to a
Passthrough Entity that holds an API in
a lower-tier Passthrough Entity will be
considered a Capital Interest Allocation
if it meets the principles set forth in
paragraphs (c)(3) and (4) of this section
(other than paragraph (c)(3)(iv) of this
section). For purposes of applying the
Capital Interest Allocation rules in this
paragraph (c)(5) to a tiered partnership
structure, to the extent that a Capital
Interest Allocation that is made by a
lower-tier partnership to an upper-tier
partnership is properly allocated to the
upper-tier partnership’s partners with
respect to their capital interests in the
upper-tier partnership in a manner that
is respected under 704(b) (taking into
account the principles of section
704(c)), such allocation is a Capital
Interest Allocation.
(6) Examples. The rules of this
paragraph (c) are illustrated by the
following examples.
(i) Example 1: Capital Interest
Allocations—(A) Facts. Each of A, B,
and C contributes $100 to GP and is an
equal partner in GP, a partnership that
is the general partner of PRS, a
partnership. The contributions are not
attributable to loans or advances
described in paragraph (c)(3)(v)(A) of
this section. PRS’s other partners are
Unrelated Non-Service Partners. Each of
GP and PRS makes allocations to its
partners in accordance with its partners’
interests in that partnership, as
described in § 1.704–1(b)(3). GP holds a
20% profits interest in PRS that is an
API that GP received in exchange for
providing substantial services to PRS in
an ATB. GP’s API is an Indirect API to
each of A, B, and C. GP contributes the
$300 of capital contributed by A, B and
C to PRS. GP’s $300 contribution equals
2% of the contributed capital made by

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all of PRS’s partners ($15,000). PRS’s
partnership agreement describes its
partners’ economic distribution rights
with respect to its liquidating proceeds
as follows: First, liquidating proceeds
are proportionately distributed to each
of GP and the Unrelated Non-Service
Partners equal to the amount necessary
to return each of those partners’
unreturned capital; second, liquidating
proceeds are distributed to GP with
respect to its API in PRS; and, finally,
any residual liquidating proceeds are
distributed, proportionately, 98% to the
Unrelated Non-Service Partners and 2%
to GP. During its initial taxable year,
PRS has $10,000 of net capital gain,
causing an increase in PRS’s
distributable proceeds of $10,000. In
accordance with the partners’ economic
rights as described in PRS’s partnership
agreement, PRS allocates $2,160 of net
capital gain to GP (a $2,000 API
allocation plus $160 ($8,000
($10,000¥$2,000) × 2%), with respect
to GP’s contributed capital) and $7,840
of net capital gain to the Unrelated NonService Partners with respect to their
contributed capital. GP allocates $720
($2,160/3) of this net capital gain to
each of A, B, and C in accordance with
their interests in GP.
(B) PRS’s Capital Interest Allocation
Analysis. Because PRS’s partnership
agreement provides for no differences as
to the amount and timing of capital
contributed, the rate of return on capital
contributed, the type and level of risk
associated with capital contributed, or
the rights to cash or property
distributions during the PRS’s
operations and on liquidation, the
allocations and distribution rights with
respect the capital contributed by GP are
reasonably consistent with the
allocation and distribution rights with
respect to capital contributed by
Unrelated Non-Service Partners.
Accordingly, GP’s allocation of $160 is
a Capital Interest Allocation that is
treated as made in a similar manner as
the allocations made to the Unrelated
Non-Service Partners.
(C) GP Capital Interest Allocation
Analysis. GP is allocated $2,160 from
PRS, consisting of a $2,000 API
allocation and a $160 Capital Interest
Allocation. The $160 Capital Interest
Allocation is allocated equally to A, B,
and C based on their capital
contributions to GP. Therefore, they
qualify as Capital Interest Allocations by
GP. See paragraph (c)(5) of this section.
The $2,000 of gain allocated by PRS’s to
GP with respect to GP’s API cannot be
treated as a Capital Interest Allocation
by GP and therefore is subject to section
1061. In summary, A, B, and C are each
allocated $720 of capital gain from PRS

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($2,160/3). Of this amount, $667 is API
Gain ($2,000/3) and $53 is a Capital
Interest Allocation ($160/3).
(ii) Example 2: Sale of a Passthrough
Interest—(A) Facts. In Year 1, A, B, and
C form GP, a partnership. Each of A, B,
and C contributes $100 to GP and is an
equal partner in GP. The contributions
are not attributable to loans or advances
described in paragraph (c)(3)(v)(A) of
this section. GP invests the $300 in
Asset X in Year 1. GP is also the general
partner of PRS, a partnership. PRS’s
other partners are Unrelated NonService Partners. GP holds a 20% profits
interest in PRS that is an API that GP
received in exchange for providing
substantial services to PRS in an ATB.
GP’s API is an Indirect API to each of
A, B, and C. Each of GP and PRS makes
allocations to its partners in accordance
with its partners’ interests in that
partnership, as described in § 1.704–
1(b)(3). In Year 3, A sells A’s interest in
GP to an unrelated third party for $800
and recognizes $700 of capital gain on
the sale. If PRS had sold its assets in a
hypothetical asset sale as required by
paragraph (c)(4)(ii)(A) of this section
and liquidated immediately before A
sold its interest in GP, GP would have
been allocated $1,800 of long-term
capital gain with respect to GP’s API in
PRS, and GP would have allocated $600
of this $1,800 to A. If GP sold Asset X
for its fair market value and liquidated
immediately before A sold its interest in
GP, A would have been allocated $100
of long-term capital gain.
(B) Analysis. GP does not have a
capital interest in PRS. Therefore, its
allocations from PRS are allocations
with respect to its API which are subject
to section 1061. The total gain allocable
to A as a result of the hypothetical
liquidations would be $700. Under
paragraph (c)(4)(ii)(D) of this section,
$100 of the $700 of A’s interest sale gain
is A’s Capital Interest Disposition
Amount, and is not subject to section
1061.
(iii) Example 3: Reinvestment of
Realized API Gain. A, B, and C are
partners in PRS, a partnership. At the
beginning of Year 1, A is issued an API
in PRS in exchange for providing
substantial services to PRS in an ATB.
A has no capital interest in PRS. During
Year 1, PRS’s assets appreciate by $100.
At the end of Year 1, under the terms
of its partnership agreement, if PRS
were to sell all of its assets at their fair
market value and distribute the
proceeds in a complete liquidation, A
would receive $20 with respect to its
API. Thus, at the end of Year 1, A has
$20 of Unrealized API Gain. In Year 2,
PRS sells Asset X, an asset that PRS
owned in Year 1, and allocates $8 of the

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long-term capital gain to A as API Gain.
As a result, $8 of A’s $20 of Unrealized
API Gain becomes API Gain that is
subject to section 1061. A reinvests A’s
share of the proceeds from the Asset X
sale in PRS. As a result, under
paragraph (c)(3)(iii) of this section, A
has an $8 capital interest in PRS and,
provided the requirements of paragraph
(c)(3) of this section are met, A may
receive future Capital Interest
Allocations with respect to the capital
interest.
(d) Partnership interest acquired by
purchase by an unrelated person. If a
person (acquirer) acquires an interest in
a partnership (target partnership) by
taxable purchase for fair market value
that, but for the exception set forth in
this paragraph (d), would be an API, the
transferor of the interest will be treated
as selling an API but the acquirer will
not be treated as acquiring an API if—
(1) Acquirer not a Related Person.
Immediately before the purchase, the
acquirer is not a Related Person with
respect to—
(i) Any person who provides services
in the Relevant ATB; or
(ii) Any service providers who
provide services to, or for the benefit of,
the target partnership or a lower-tier
partnership in which the target
partnership holds an interest, directly or
indirectly.
(2) Section 1061(d) not applicable.
Section 1061(d) does not apply to the
transaction (as provided in § 1.1061–5).
(3) Acquirer not a service provider. At
the time of the purchase, the acquirer
has not provided, does not provide, and
does not anticipate providing, services
in the future, to, or for the benefit of, the
target partnership, directly or indirectly,
or any lower-tier partnership in which
the target partnership directly or
indirectly holds an interest.
(e) [Reserved]
(f) Applicability date—(1) General
rule. Except as provided in paragraphs
(f)(2) and (3) of this section, the
provisions of this section apply to
taxable years of Owner Taxpayers and
Passthrough Entities beginning on or
after January 19, 2021. An Owner
Taxpayer or Passthrough Entity may
choose to apply this section to a taxable
year beginning after December 31, 2017,
provided that they apply the Section
1061 Regulations in their entirety to that
year and all subsequent years.
(2) Partnership interest held by an S
corporation. Paragraph (b)(2)(i) of this
section, which provides that the
exception under section 1061(c)(1) to
the definition of an API does not apply
to a partnership interest held by an S
corporation with an election under
section 1362(a) in effect, applies to

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taxable years beginning after December
31, 2017.
(3) Partnership interest held by a PFIC
with respect to which the shareholder
has a QEF election in effect. Paragraph
(b)(2)(ii) of this section, which provides
that the exception under section
1061(c)(1) to the definition of an API
does not apply to a partnership interest
held by a PFIC with respect to which
the shareholder has a QEF election in
effect under section 1295, applies to
taxable years of an Owner Taxpayer and
Passthrough Entity beginning after
August 14, 2020.

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§ 1.1061–4

Section 1061 computations.

(a) Computations—(1)
Recharacterization Amount. The
Recharacterization Amount is the
amount that an Owner Taxpayer must
treat as short-term capital gain under
section 1061(a). The Recharacterization
Amount equals—
(i) The Owner Taxpayer’s One Year
Gain Amount; less
(ii) The Owner Taxpayer’s Three Year
Gain Amount.
(2) One Year Gain Amount and Three
Year Gain Amount—(i) One Year Gain
Amount. The Owner Taxpayer’s One
Year Gain Amount is the sum of—
(A) The Owner Taxpayer’s combined
net API One Year Distributive Share
Amount from all APIs held during the
taxable year; and
(B) The Owner Taxpayer’s API One
Year Disposition Amount.
(ii) Three Year Gain Amount. The
Owner Taxpayer’s Three Year Gain
Amount is the sum of—
(A) The Owner Taxpayer’s combined
net API Three Year Distributive Share
Amount from all APIs held during the
taxable year; and
(B) The Owner Taxpayer’s API Three
Year Disposition Amount.
(3) API One Year Distributive Share
Amount and API Three Year
Distributive Share Amount—(i) API One
Year Distributive Share Amount. The
API One Year Distributive Share
Amount equals—
(A) The API Holder’s distributive
share of net long-term capital gain or
loss from the partnership for the taxable
year (including capital gain or loss on
the disposition of Distributed API
Property by an API Holder that is a
Passthrough Entity or the disposition of
all or a part of an API by an API Holder
that is a Passthrough Entity), with
respect to the partnership interest held
by the API Holder calculated without
the application of section 1061; less
(B) To the extent included in the
amount determined under paragraph
(a)(3)(i)(A) of this section, the aggregate
of—

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(1) Amounts that are not taken into
account for purposes of section 1061
under paragraph (b)(7) of this section;
and
(2) Capital Interest Gains and Losses
as determined under § 1.1061–3(c)(2).
(ii) API Three Year Distributive Share
Amount. The API Three Year
Distributive Share Amount equals the
API One Year Distributive Share
Amount, less—
(A) Items included in the API One
Year Distributive Share Amount that
would not be treated as a long-term gain
or loss if three years is substituted for
one year in paragraphs (3) and (4) of
section 1222; and
(B) Any adjustments resulting from
the application of the Lookthrough Rule
under paragraph (b)(9)(ii) of this section
when an API is disposed of by an API
Holder that is a Passthrough Entity.
(4) API One Year Disposition Amount
and API Three Year Disposition
Amount—(i) API One Year Disposition
Amount. The API One Year Disposition
Amount is the combined net amount
of—
(A) Long-term capital gains and losses
recognized during the taxable year by an
Owner Taxpayer, including long-term
capital gain computed under the
installment method that is taken into
account for the taxable year, on the
disposition of all or a portion of an API
that has been held for more than one
year, including a disposition to which
the Lookthrough Rule applies;
(B) Long-term capital gain and loss
recognized by an Owner Taxpayer due
to a distribution with respect to an API
during the taxable year that is treated
under section 731(a) as gain or loss from
the sale or exchange of a partnership
interest held for more than one year;
and,
(C) Long-term capital gains and losses
recognized by an Owner Taxpayer on
the disposition of Distributed API
Property (taking into account deemed
exchanges under section 751(b)) during
the taxable year that has a holding
period of more than one year but not
more than three years to the distributee
Owner Taxpayer on the date of
disposition, excluding items described
in paragraph (b)(7) of this section.
(ii) API Three Year Disposition
Amount. The API Three Year
Disposition Amount is the combined net
amount of—
(A) Long-term capital gains and losses
recognized during the taxable year by an
Owner Taxpayer, including long-term
capital gain computed under the
installment method that is taken into
account for the taxable year, on the
disposition of all or a portion of an API
that has been held for more than three

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years and to which the Lookthrough
Rule does not apply;
(B) Long-term capital gains and losses
recognized by an Owner Taxpayer on
the disposition during the taxable year
of all or a portion of an API that has
been held for more than three years in
a transaction to which the Lookthrough
Rule in paragraph (b)(9) of this section
applies, less any adjustments required
under the Lookthrough Rule in
paragraph (b)(9)(ii) of this section; and
(C) Long-term capital gains and losses
recognized on a distribution with
respect to an API during the taxable year
that is treated under sections 731(a) as
gain or loss from the sale or exchange
of a partnership interest held for more
than three years.
(b) Special rules for calculating the
One Year Gain Amount and the Three
Year Gain Amount—(1) One Year Gain
Amount equals zero or less. If an Owner
Taxpayer’s One Year Gain Amount is
zero or results in a loss, the
Recharacterization Amount for the
taxable year is zero and section 1061(a)
does not apply.
(2) Three Year Gain Amount equals
zero or less. If an Owner Taxpayer’s
Three Year Gain Amount is less than or
equal to $0, the Three Year Gain
Amount is zero for purposes of
calculating the Recharacterization
Amount.
(3) One Year Gain Amount less than
Three Year Gain Amount. If the One
Year Gain Amount and the Three Year
Gain Amount are both greater than zero
but the One Year Gain Amount is less
than the Three Year Gain Amount, none
of the One Year Gain Amount is
included in the Recharacterization
Amount for the taxable year.
(4) Installment sale gain. The One
Year Gain Amount under paragraph
(a)(2)(i) of this section and the Three
Year Gain Amount, as determined under
paragraph (a)(2)(ii) of this section
include long-term capital gains from
installment sales. This includes longterm capital gain or loss recognized with
respect to an API after December 31,
2017, with respect to an installment sale
that occurred on or before December 31,
2017. The holding period of the asset
upon the date of disposition is used for
purposes of determining whether capital
gain is included in the taxpayer’s One
Year Gain Amount or the Three Year
Gain Amount.
(5) Special rules for capital gain
dividends from regulated investment
companies (RICs) and real estate
investment trusts (REITs)—(i) API One
Year Distributive Share Amount. If a
RIC or REIT reports or designates a
dividend as a capital gain dividend and
provides the One Year Amounts

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Disclosure as defined in § 1.1061–
6(c)(1)(i), the amount provided in the
One Year Amounts Disclosure is
included in the calculation of an API
One Year Distributive Share Amount. If
the RIC or REIT does not provide the
One Year Amounts Disclosure, the full
amount of the RIC’s or REIT’s capital
gain dividend must be included in the
calculation of an API One Year
Distributive Share Amount.
(ii) API Three Year Distributive Share
Amount. If a RIC or REIT reports or
designates a dividend as a capital gain
dividend and provides the Three Year
Amounts Disclosure as defined in
§ 1.1061–6(c)(1)(ii), the amount
provided in the Three Year Amounts
Disclosure is used for the calculation of
an API Three Year Distributive Share
amount. If the RIC or REIT does not
provide the Three Year Amounts
Disclosure, no amount of the RIC’s or
REIT’s capital gain dividend may be
used for the calculation of an API Three
Year Distributive Share Amount.
(iii) Loss on sale or exchange of stock.
If a RIC or REIT provides the Three Year
Amounts Disclosure as provided in
paragraph (b)(5)(ii) of this section, any
loss on the sale or exchange of shares of
a RIC or REIT held for six months or less
is treated as a capital loss on an asset
held for more than three years, to the
extent of the amount of the Three Year
Amounts Disclosure from that RIC or
REIT.
(6) Pro rata share of qualified electing
fund (QEF) net capital gain—(i) One
year QEF net capital gain. The
calculation of an API One Year
Distributive Share Amount includes an
Owner Taxpayer’s inclusion under
section 1293(a)(1)(B) as limited by
section 1293(e)(2) with respect to a
passive foreign investment company (as
defined in section 1297(a)) for which a
QEF election (as described in section
1295(a)) is in effect for the taxable year.
The amount of the inclusion may be
reduced by the amount of long-term
capital gain that is not taken into
account for purposes of section 1061 as
provided in paragraph (b)(7) of this
section and may be reduced by the
Owner Taxpayer’s share of the excess, if
any, of the Capital Interest Gain over
Capital Interest Loss with respect to the
QEF, provided in each case that the
relevant information is provided by the
QEF. See § 1.1061–6 for reporting rules.
(ii) Three year QEF net capital gain
adjustment. For purposes of calculating
an Owner Taxpayer’s API Three Year
Distributive Share Amount, the entire
amount determined under paragraph
(b)(6)(i) of this section, after any allowed
reduction, is included as an item in
paragraph (a)(3)(ii)(A) of this section

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unless the QEF provides information to
determine the amount of the inclusion
that would constitute net capital gain
(as defined in § 1.1293–1(a)(2), as
limited by section 1293(e)(2)) if the
QEF’s net capital gain for the taxable
year were calculated under section
1222(11) applying paragraphs (3) and (4)
of section 1222 by substituting three
years for one year. If such information
is provided, the amount included as an
item in paragraph (a)(3)(ii)(A) of this
section is the amount determined under
paragraph (b)(6)(i) of this section that
would not be treated as long-term gain
if three years were substituted for one
year in paragraphs (3) and (4) of section
1222. See § 1.1061–6 for reporting rules.
(7) Items not taken into account for
purposes of section 1061. The following
items of long-term capital gain and loss
are excluded from the calculation of the
API One Year Distributive Share
Amount in paragraph (a)(3)(i) of this
section and the API Three Year
Distributive Share Amount in paragraph
(a)(3)(ii) of this section—
(i) Long-term capital gain and longterm capital loss determined under
section 1231;
(ii) Long-term capital gain and longterm capital loss determined under
section 1256;
(iii) Qualified dividends included in
net capital gain for purposes of section
1(h)(11)(B); and
(iv) Capital gains and losses that are
characterized as long-term or short-term
without regard to the holding period
rules in section 1222, such as certain
capital gains and losses characterized
under the mixed straddle rules
described in section 1092(b) and
§§ 1.1092(b)–3T, 1.1092(b)–4T, and
1.1092(b)–6.
(8) Holding period determination—(i)
Determination of holding period for
purposes of the Three Year Gain
Amount. For purposes of computing the
Three Year Gain Amount, the relevant
holding period of either an asset or an
API is determined under all provisions
of the Code or regulations that are
relevant to determining whether the
asset or the API has been held for the
long-term capital gain holding period by
applying those provisions as if the
holding period were three years instead
of one year.
(ii) Relevant holding period. The
relevant holding period is the direct
owner’s holding period in the asset sold.
Accordingly, for purposes of
determining an API Holder’s Taxpayer’s
API One Year Distributive Share
Amount and API Three Year
Distributive Share Amount for the
taxable year under paragraph (a)(3) of
this section, the partnership’s holding

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period in the asset being sold or
disposed of (whether a directly held
asset or a partnership interest) is the
relevant holding period for purposes of
section 1061.
(9) Lookthrough Rule for certain API
dispositions—(i) Determination that the
Lookthrough Rule applies—(A) In
general. The Lookthrough Rule will
apply if, at the time of disposition of an
API held for more than three years—
(1) The API would have a holding
period of three years or less if the
holding period of such API were
determined by not including any period
before the date that an Unrelated NonService Partner is legally obligated to
contribute substantial money or
property directly or indirectly to the
Passthrough Entity to which the API
relates. This paragraph (b)(9)(i)(A) does
not apply to the disposition of an API
to the extent that the gain recognized
upon the disposition of the API is
attributable to any asset not held for
portfolio investment on behalf of third
party investors (as defined in section
1061(c)(5)). Solely for the purpose of
this paragraph (b)(9)(i)(A), a substantial
legal obligation to contribute money or
property is an obligation to contribute a
value that is at least 5 percent of the
partnership’s total capital contributions
as of the time of the API disposition; or
(2) A transaction or series of
transactions has taken place with a
principal purpose of avoiding potential
gain recharacterization under section
1061(a).
(B) Determination that the
Lookthrough Rule applies to the
disposition of a Passthrough Interest.
Paragraph (b)(9)(i)(A) of this section
similarly applies with respect to a
Passthrough Interest issued by an S
corporation or a PFIC to the extent the
Passthrough Interest is treated as an
API.
(ii) Application of the Lookthrough
Rule. If the Lookthrough Rule applies,
for purposes of applying an Owner
Taxpayer’s Recharacterization Amount,
as described in paragraph (a) of this
section—
(A) The Owner Taxpayer must
include the entire amount of capital
gain recognized on the disposition of an
API by the Owner Taxpayer in the
Owner Taxpayer’s API One Year
Disposition Amount; and
(B) The Owner Taxpayer must include
in its Three Year Disposition Amount an
amount equal its One Year Disposition
Amount (determined under paragraph
(b)(9)(ii)(A) of this section) reduced by
the Owner Taxpayer’s share of the
amount of any gain, directly or
indirectly, from assets held for three
years or less that would have been

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allocated to the Owner Taxpayer (to the
extent attributable to the transferred
API) by the partnership if the
partnership had sold all of its property
in a fully taxable transaction for cash in
an amount equal to the fair market value
of such property (taking into account
section 7701(g)) immediately prior to
the Owner Taxpayer’s transfer of the
API.
(C) In the case of an API disposition
by an API Holder that is a Passthrough
Entity and not an Owner Taxpayer, the
principles set forth in paragraph
(b)(9)(ii)(A) of this section must be
applied to determine the amount to
include in the Owner Taxpayer’s One
Year Distributive Amount and in
paragraph (b)(9)(ii)(B) of this section to
determine the amounts included in the
Owner Taxpayer’s Three Year
Distributive Share Amount.
(10) Section 83. Except with respect to
any portion of the interest that is a
capital interest under § 1.1061–3(c), this
section applies regardless of whether an
Owner Taxpayer or Passthrough Entity
has made an election under section
83(b) or included amounts in gross
income under section 83.
(c) Examples—(1) Recharacterization
rules. The rules of paragraph (a) of this
section are illustrated by the following
examples. Unless otherwise stated, all
gains and losses are long-term capital
gains and losses, none of the long-term
capital gain or loss in this section is
capital gain or loss not taken into
account for purposes of section 1061
under paragraph (b)(7) of this section,
and neither the Lookthrough Rule nor
section 751 is applicable.
(i) Example 1: Determination of API
One Year and Three Year Distributive
Share Amounts—(A) Facts. A holds an
API in PRS but has no capital interest
in PRS and is not entitled to a Capital
Interest Allocation with respect to PRS.
During the taxable year, PRS allocates to
A $20 of long-term capital gain from the
sale of capital asset X (which had been
held by PRS for two years) and $40 of
long-term capital gain from the sale of
capital asset Y (which had held by PRS
for five years). A has no other items of
long-term capital gain or loss with
respect to its interest in PRS during the
taxable year. A has no other long-term
capital gains or losses with respect to
any other API during the taxable year.
(B) Determination of A’s API One
Year Distributive Share Amount. Under
paragraph (a)(3)(i) of this section, A has
an API One Year Distributive Share
Amount of $60. This amount is the sum
of the $20 of the long-term capital gain
allocated to A from PRS’s sale of capital
asset X and the $40 of long-term capital

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gain allocated to A from PRS’s sale of
capital asset Y.
(C) Determination of A’s API Three
Year Distributive Share Amount. (1)
Under paragraph (a)(3)(ii) of this
section, A’s API Three Year Distributive
Share Amount is equal to A’s API One
Year Distributive Amount, $60, less the
sum of:
(i) The items included in the API One
Year Distributive Share Amount that
would not be treated as a long-term gain
or loss if three years is substituted for
one year in paragraphs (3) and (4) of
section 1222, $20; and
(ii) Adjustments resulting from the
application of the Lookthrough Rule
under paragraph (b)(9)(ii) of this section,
which under the facts in paragraph
(c)(1)(i)(A) of this section, is
inapplicable.
(2) Thus, A’s Three Year API
Distributive Share Amount is $40.
(D) Determination of A’s
Recharacterization Amount. Under
paragraph (a)(2)(i) of this section, A’s
One Year Gain amount is equal to A’s
API One Year Distributive Share
Amount, $60. A’s Three Year Gain
Amount is equal to A’s API Three Year
Distributive Share Amount, $40. Under
paragraph (a)(1) of this section, A’s
Recharacterization Amount is A’s One
Year Gain Amount, minus A’s Three
Year Gain Amount, or $20.
(ii) Example 2: API One Year and
Three Year Disposition Amounts—(A)
Facts. During the taxable year, A
disposes of an API that A has held for
four years for a $100 gain. Additionally,
A sells Distributed API Property for a
$300 gain at a time when A has a twoyear holding period in such property. A
has no other items of long-term capital
gain or loss with respect to any API in
the year.
(B) Determination of A’s API One
Year and Three Year Disposition
Amounts. Under paragraph (a)(4)(i) of
this section, A’s API One Year
Disposition Amount is $400. This
amount is the sum of A’s $300 of longterm capital gain on A’s disposition of
the Distributed API Property and A’s
$100 of long-term capital gain on the
disposition of the API. Under paragraph
(a)(4)(ii) of this section, A’s Three Year
Disposition Amount is $100, which is
the amount of long-term capital gain
that A recognized upon disposition of
the API held for more than three years.
Under paragraph (a)(2) of this section,
A’s One Year Gain Amount is $400 and
A’s Three Year Gain Amount is $100.
(C) Determination of A’s
Recharacterization Amount. Under
paragraph (a)(1) of this section, A’s
Recharacterization Amount is $300,
which is the difference between A’s One

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Year Gain Amount and Three Year Gain
Amount.
(iii) Example 3: Determination of One
Year Gain Amount, Three Year Gain
Amount, and Recharacterization
Amount—(A) Facts. A holds an API in
each of PRS1 and PRS2. With respect to
PRS1, A’s API One Year Distributive
Share Amount is $100 and A’s API
Three Year Distributive Share Amount
is ($200). With respect to PRS2, A’s API
One Year Distributive Share Amount is
$600 and A’s API Three Year
Distributive Share Amount is $300.
During the taxable year, A also has an
API One Year Disposition Amount of
$200 of gain. A has no other items of
long-term capital gain or loss with
respect to an API for the taxable year.
(B) Determination of A’s One Year
Gain Amount. Under paragraph (a)(2) of
this section, A’s One Year Gain Amount
is $900, which is an amount equal to A’s
$100 API One Year Distributive Share
Gain from PRS1 and A’s $600 API One
Year Distributive Share from PRS2 (a
combined net API One Year Distributive
Share Amount of $700) plus A’s $200
API One Year Disposition Amount.
(C) Determination of A’s Three Year
Gain Amount. Under paragraph (a)(2) of
this section, A’s Three Year Gain
Amount is $100, which is equal to A’s
combined net API Three Year
Distributive Share Amount for the
taxable year (A’s $200 API Three Year
Distributive Share Amount loss from
PRS1 plus A’s API Three Year
Distributive Share Amount Gain of $300
from PRS2). A does not have an API
Three Year Disposition Amount.
(D) Determination of A’s
Recharacterization Amount. Under
paragraph (a)(1) of this section, A’s
Recharacterization Amount is $800. (A’s
One Year Gain Amount of $900 less A’s
Three Year Gain Amount of $100.)
(2) Special rules examples. The
principles of paragraph (b) of this
section are illustrated by the following
examples.
(i) Example 1: Lookthrough Rule. On
July 1, 2021, A and B form partnership
PRS. At the time of PRS’s formation, A
agrees to provide substantial services to
PRS in exchange for a 20% profits
interest in PRS, and B, a partner that is
an Unrelated Non-Service Partner,
contributes $1 million in exchange for
an interest in PRS and PRS immediately
uses the capital to purchase marketable
securities. On July 1, 2023, C, another
Unrelated Non-Service Partner becomes
legally obligated to contribute capital to
PRS ($75 million) for the purposes of
investing in and developing Specified
Assets and is admitted into PRS. On
July 3, 2023, and after C makes a
contribution of $75 million, PRS uses

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this capital to acquire stock in portfolio
company Z. On July 1, 2025, when Z
has a value of $500 million and the
value of the marketable securities is $2
million, A sells its API in PRS for $85.2
million. As a result of this sale, the
Lookthrough Rule applies because B’s
contribution was non-substantial under
paragraph (b)(9)(i)(A)(1) of this section.
Therefore, A includes $85.2 million in
its API One Year Disposition Amount
and under paragraph (b)(9)(ii)(B) of this
section, $200,000 (20% share of $1
million gain in marketable securities) in
its API Three Year Disposition Amount.
Accordingly, under paragraph (a)(1) of
this section, A’s Recharacterization
Amount is $85 million.
(ii) Example 2: Installment sale gain.
On December 22, 2021, A disposed of
A’s API in an installment sale. At the
time of the disposition, A had held its
API for two years. A received a payment
with respect to the installment sale
during A’s 2022 taxable year causing A
to recognize $200 of long-term capital
gain. The $200 long-term capital gain
recognized in 2022 is subject to section
1061 because it is recognized after
December 31, 2017. Accordingly, the
$200 of long-term capital gain
recognized by A in 2022 is included in
A’s API One Year Disposition Amount.
The $200 of long-term capital gain is not
in A’s API Three Year Disposition
Amount because the API was not held
for more than three years at the time of
its disposition.
(iii) Example 3: REIT capital gain
dividend. During the taxable year, A
holds an API in PRS. PRS holds an
interest in REIT. During the taxable
year, REIT distributes a $1,000 capital
gain dividend to PRS of which 50% is
allocable to A’s API. Part of the capital
gain dividend for the year results from
section 1231 gain. In accordance with
§ 1.1061–6(c)(1)(i), REIT discloses to
PRS the One Year Amounts Disclosure
of $400, which is the $1000 capital gain
dividend reduced by the $600 of section
1231 capital gain dividend included in
that amount. Part of the One Year
Amounts Disclosure for the year results
from gain from property held for three
years or less. In accordance with
§ 1.1061–6(c)(1)(ii), REIT also discloses
the Three Year Amounts Disclosure of
$150, which is the $400 One Year
Amounts Disclosure reduced by the
$250 of gain attributable to property
held for three years or less. PRS
includes a $200 gain in determining A’s
API One Year Distributive Share
Amount and a $75 gain in determining
A’s API Three Year Distributive Share
Amount. See paragraphs (b)(5)(i) and (ii)
of this section.

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(d) Applicability date. The provisions
of this section apply to taxable years of
Owner Taxpayers and Passthrough
Entities beginning on or after January
19, 2021. An Owner Taxpayer or
Passthrough Entity may choose to apply
this section to a taxable year beginning
after December 31, 2017, provided that
they apply the Section 1061 Regulations
in their entirety to that year and all
subsequent years.
§ 1.1061–5 Section 1061(d) transfers to
related persons.

(a) In general. If an Owner Taxpayer
transfers any API or Distributed API
Property, directly or indirectly, to a
Section 1061(d) Related Person (as
defined in paragraph (e) of this section),
the Owner Taxpayer must include in
gross income as short-term capital gain,
an amount equal to—
(1) The short-term capital gain
recognized upon the API transfer
without regard to this paragraph (a); and
(2) The lesser of—
(i) The amount of net long-term
capital gain recognized by the Owner
Taxpayer upon the transfer of such
interest; or
(ii) The amount treated as short-term
capital gain under paragraph (c) of this
section (Section 1061(d)
Recharacterization Amount).
(b) Transfer. For purposes of this
section, the term transfer means a sale
or exchange in which gain is recognized
by the Owner Taxpayer under chapter 1
of the Internal Revenue Code.
(c) Section 1061(d) Recharacterization
Amount. To the extent an Owner
Taxpayer recognizes long-term capital
gain upon a transfer of an API to a
Section 1061(d) Related Person, the
Owner Taxpayer’s Section 1061(d)
Recharacterization Amount is the
amount of net long-term capital gain
(excluding amounts not taken into
account for purposes of section 1061
under § 1.1061–4(b)(7)) from assets held
for three years or less that would have
been allocated to the Owner Taxpayer
(to the extent attributable to the
transferred API) by the partnership if
the partnership had sold all of its
property in a fully taxable transaction
for cash in an amount equal to the fair
market value of such property (taking
into account section 7701(g))
immediately prior to the Owner
Taxpayer’s transfer of the API. If only a
portion of an Owner Taxpayer’s API is
transferred, this paragraph (c) shall
apply with respect to the portion of gain
attributable to the transferred interest.
(d) Special rules. For purposes of this
section, the following rules are
applicable.

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(1) An Owner Taxpayer will be
treated as transferring the Owner
Taxpayer’s share of any Indirect API or
Distributed API Property if the Indirect
API or Distributed API Property is
transferred by the API Holder to a
person that is a Section 1061(d) Related
Person with respect to the Owner
Taxpayer.
(2) The rules set forth in paragraphs
(a), (b), and (c) of this section apply
upon the transfer of a Passthrough
Interest issued by an S corporation or
PFIC to the extent the Passthrough
Interest is treated as an API.
(e) Section 1061(d) Related Person.
For purposes of this section, the term
Section 1061(d) Related Person means—
(1) A person that is a member of the
taxpayer’s family within the meaning of
section 318(a)(1);
(2) A person that performed a service
within the current calendar year or the
preceding three calendar years in a
Relevant ATB to the API transferred by
taxpayer; or
(3) A Passthrough Entity to the extent
that a person described in paragraph
(e)(1) or (2) of this section owns an
interest, directly or indirectly.
(f) Examples. The following examples
illustrate the rules of this section.
(1) Example 1: Transfer to child by
gift. A, an individual, performs services
in an ATB and has held an API in
connection with those services for 10
years. The API has a fair market value
of $1,000 and a tax basis of $0, and no
debt is associated with the API. A
transfers all of the API to A’s daughter
as a gift. A’s daughter is a section
1061(d) Related Person but A’s gift is
not a transfer as described in paragraph
(b) of this section thus section 1061(d)
does not apply to A’s gift. However, the
API remains an API in the hands of A’s
daughter under § 1.1061–2(a)(1)(i).
(2) Example 2: Transfer of an API to
a partnership owned by Section 1061(d)
Related Persons—(i) Facts. A, B, and C
are equal partners in GP, a partnership.
GP holds only one asset, an API in PRS1
which is an Indirect API as to each A,
B, and C. A, B, and C each provides
services in the ATB in connection with
which GP was transferred its API in
PRS1. A and B contribute their interests
in GP to PRS2 in a Section 721(a)
exchange for interests in PRS2.
(ii) Application of section 1061(d).
Because the contribution by A and B of
their interest in GP to PRS2 is an
exchange in which no gain is recognized
by either A or B, the contribution is not
a transfer as described in paragraph (b)
of this section thus section 1061(d) does
not apply to A and B’s contribution.
However, the API remains an API in the
hands of PRS2 under § 1.1061–2(a)(1)(i).

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(3) Example 3: Transfer of an API to
a Section 1061(d) Related Person. A
holds an API in GP, a partnership which
A has owned for four years. A transfers
the API to a Section 1061(d) Related
Person described in paragraph (e) of this
section in exchange for $100 of cash,
resulting in A recognizing long-term
capital gain of $100. Because this is a
transfer described in paragraph (b) of
this section, section 1061(d) applies to
the transfer of A’s API and A must
determine its Section 1061(d)
Recharacterization Amount under
paragraph (c) of this section. If,
immediately prior to A’s transfer of the
API, the partnership had sold all of its
assets in a fully taxable transaction for
cash equal of the fair market value of the
assets, A’s share of the net long-term
capital gain (excluding amounts not
taken into account for purposes of
section 1061 under § 1.1061–4(b)(7))
from assets held for three years or less
would have been $120. Thus, A’s
Section 1061(d) Recharacterization
Amount is $120. As a result, A’s $100
long-term capital gain is recharacterized
as short-term capital gain under
paragraph (a) of this section. The API
remains an API in the hands of the
Section 1061(d) Related Person under
§ 1.1061–2(a)(1)(i).
(g) Applicability date. The provisions
of this section apply to taxable years of
Owner Taxpayers and Passthrough
Entities beginning on or after January
19, 2021. An Owner Taxpayer or
Passthrough Entity may choose to apply
this section to a taxable year beginning
after December 31, 2017, provided that
they apply the Section 1061 Regulations
in their entirety to that year and all
subsequent years.

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§ 1.1061–6

Reporting rules.

(a) Owner Taxpayer filing
requirements–(1) In general. An Owner
Taxpayer must file such information
with the IRS as the Commissioner of
Internal Revenue or the Commissioner’s
delegate (Commissioner) may require in
forms, instructions, or other guidance as
is necessary for the Commissioner to
determine that the Owner Taxpayer has
properly complied with section 1061
and the Section 1061 Regulations. If an
Owner Taxpayer requires information
from a Passthrough Entity to determine
the Capital Interest Disposition Amount
or the Section 1061(d)
Recharacterization Amount, the Owner
Taxpayer must request such information
from that entity.
(2) Failure to obtain information.
Paragraph (b)(1) of this section requires
certain Passthrough Entities to furnish
an Owner Taxpayer with certain
amounts necessary to determine its

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Recharacterization Amount and meet its
reporting requirements under paragraph
(a)(1) of this section. To the extent that
an Owner Taxpayer is not furnished the
information required to be furnished
under paragraph (b)(1) of this section in
such time and in such manner as
required by the Commissioner and the
Owner Taxpayer is not otherwise able to
substantiate all or a part of these
amounts to the satisfaction of the
Commissioner, then if the information
with respect to the determination of
the—
(i) API One Year Distributive Share
Amount under § 1.1061–4(a)(3)(i) is not
furnished, the API One Year
Distributive Share Amount will not be
reduced by—
(A) Amounts not taken into account
for purposes of section 1061 under
§ 1.1061–4(b)(7); or
(B) Capital Interest Gains and Losses
as determined under § 1.1061–3(c)(2).
(ii) API Three Year Distributive Share
Amount determined under § 1.1061–
4(a)(3)(ii) is not furnished, all items
included in the API One Year
Distributive Share Amount are treated
as items that would not be treated as
long-term capital gain or loss, if three
years is substituted for one year in
paragraphs (3) and (4) of section 1222.
(b) Passthrough Entity filing
requirements and reporting—(1)
Requirement to file information with the
IRS and to furnish information to API
Holder. A Passthrough Entity must file
such information with the IRS as the
Commissioner may require in forms,
instructions, or other guidance as is
necessary for the Commissioner to
determine that it and its partners have
complied with section 1061 and the
Section 1061 Regulations. A
Passthrough Entity that has issued an
API must furnish to the API Holder,
including an Owner Taxpayer, such
information at such time and in such
manner as the Commissioner may
require in forms, instructions, or other
guidance as is necessary to determine
the One Year Gain Amount and the
Three Year Gain Amount with respect to
an Owner Taxpayer that directly or
indirectly holds the API. A Passthrough
Entity that has furnished information to
the API Holder must file such
information with the IRS, at such time
and in such manner as the
Commissioner may require in forms,
instructions, or other guidance. This
information includes:
(i) The API One Year Distributive
Share Amount and the API Three Year
Distributive Share Amount (as
determined under § 1.1061–4);
(ii) Capital gains and losses allocated
to the API Holder that are excluded

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from section 1061 under § 1.1061–
4(b)(7);
(iii) Capital Interest Gains and Losses
allocated to the API Holder (as
determined under § 1.1061–3(c)); and
(iv) In the case of a disposition by an
API Holder of an interest in the
Passthrough Entity during the taxable
year, upon the request of an API Holder,
any information required by the API
Holder to properly take the disposition
into account under section 1061,
including—
(A) Information necessary to apply the
Lookthrough Rule and to determine the
API Holder’s Capital Interest
Disposition Amount; and
(B) Information necessary to
determine an Owner Taxpayer’s Section
1061(d) Recharacterization Amount.
(2) Requirement to request, furnish,
and file information in tiered
structures—(i) Requirement to request
information. If a Passthrough Entity
requires information to meet its
reporting and filing requirements under
this section (in addition to any
information required to be furnished to
the Passthrough Entity under paragraph
(b)(1) of this section) from a lower-tier
entity in which it holds an interest, the
Passthrough Entity must request such
information from that entity.
(ii) Requirement to furnish and file
information. If information is requested
of a Passthrough Entity under paragraph
(b)(2)(i) of this section, the Passthrough
Entity must furnish the requested
information to the person making the
request but only to the extent the
information is necessary for the
requesting Passthrough Entity to meet
its reporting and filing requirements
under this section or is required by the
Commissioner in forms, instructions, or
other guidance. If the person requesting
the information is an API Holder in the
Passthrough Entity, the information is
furnished under paragraph (b)(1) of this
section. If the Passthrough Entity
requesting the information is not an API
Holder, the Passthrough Entity must
furnish the information to the
requesting Passthrough Entity as
required by the Commissioner in forms,
instructions, or other guidance.
(iii) Timing of requesting and
furnishing information—(A) Requesting
information. A Passthrough Entity
described in paragraph (b)(2)(i) of this
section must request information under
paragraph (b)(2)(i) of this section by the
later of the 30th day after the close of
the taxable year to which the
information request relates or 14 days
after the date of a request for
information from an upper-tier
Passthrough Entity.

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(B) Furnishing information—(1) In
general. Except as provided in
paragraph (b)(2)(iii)(B)(2) of this section,
requested information must be
furnished by the date on which the
entity is required to furnish information
under section 6031(b) or under section
6037(b), as applicable.
(2) Late requests. Information with
respect to a taxable year that is
requested by an upper-tier Passthrough
Entity after the date that is 14 days prior
to the due date for a lower-tier
Passthrough Entity to furnish and file
information under section 6031(b) or
section 6037(b), as applicable, must be
furnished and filed in the time and
manner prescribed by forms,
instructions and other guidance.
(iv) Manner of requesting information.
Information may be requested
electronically or in any manner that is
agreed to by the parties.
(v) Recordkeeping requirement. Any
Passthrough Entity receiving a request
for information must retain a copy of the
request and the date received in its
books and records.
(vi) Passthrough Entity is not
furnished information to meet its
reporting obligations under paragraph
(b)(1) of this section. If an upper-tier
Passthrough Entity holds an interest in
a lower-tier Passthrough Entity and it is
not furnished the information described
in paragraph (b)(1) of this section, or,
alternatively, if it has not been
furnished information after having
properly requested the information
under this paragraph (b)(2), the uppertier Passthrough Entity must take
actions to otherwise determine and
substantiate the missing information. To
the extent that the upper-tier
Passthrough Entity is not able to
otherwise substantiate and determine
the missing information to the
satisfaction of the Commissioner, the
upper-tier Passthrough Entity must treat
these amounts as provided under
paragraph (a)(2) of this section. The
upper-tier Passthrough Entity must
provide notice to the API Holder and
the IRS regarding the application of this
paragraph (b)(2) to the information
being reported as required in forms,
instructions, and other guidance.
(vii) Filing requirements. Both the
Passthrough Entity requesting the
information and the Passthrough Entity
furnishing the information must file all
information with the IRS as the
Commissioner may require in forms,
instructions, or other guidance.
(viii) Penalties. In addition to the
requirement in section 1061(e) that the
Secretary shall require reporting (at the
time and in the manner prescribed by
the Secretary) as is necessary to carry

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out the purposes of this section, the
information required to be furnished
under this paragraph (b) is also required
to be furnished under sections 6031(b)
and 6037(b). Failure to report as
required under this paragraph (b) will
be subject to penalties under section
6722.
(c) Regulated investment company
(RIC) and real estate investment trust
(REIT) reporting—(1) Section 1061
disclosures. A RIC or REIT that reports
or designates a dividend, or part thereof,
as a capital gain dividend, may, in
addition to the information otherwise
required to be furnished to a
shareholder, disclose two amounts for
purposes of section 1061—
(i) One Year Amounts Disclosure. The
One Year Amounts Disclosure of a RIC
or REIT is a disclosure by the RIC or
REIT of an amount that is attributable to
a computation of the RIC’s or REIT’s net
capital gain excluding capital gain and
capital loss not taken into account for
purposes of section 1061 under
§ 1.1061–4(b)(7). The aggregate amounts
provided in the One Year Amounts
Disclosures with respect to a taxable
year of a RIC or REIT must equal the
lesser of the RIC’s or REIT’s net capital
gain, excluding any capital gains and
capital losses not taken into account for
purposes of section 1061 under
§ 1.1061–4(b)(7), for the taxable year or
the RIC’s or REIT’s aggregate capital
gain dividends for the taxable year.
(ii) Three Year Amounts Disclosure.
The Three Year Amounts Disclosure of
a RIC or REIT is a disclosure by the RIC
or REIT of an amount that is attributable
to a computation of the RIC’s or REIT’s
One Year Amounts Disclosure
substituting ‘‘three years’’ for ‘‘one year’’
in applying section 1222. The aggregate
amounts provided in the Three Year
Amounts Disclosures with respect to a
taxable year of a RIC or REIT must equal
the lesser of the aggregate amounts
provided in the RIC’s or REIT’s One
Year Amounts Disclosures substituting
‘‘three years’’ for ‘‘one year’’ in applying
section 1222 for the taxable year or the
RIC’s or REIT’s aggregate capital gain
dividends for the taxable year.
(2) Pro rata disclosures. The One Year
Amounts Disclosure and Three Year
Amounts Disclosure made to each
shareholder of a RIC or REIT must be
proportionate to the share of capital gain
dividends reported or designated to that
shareholder for the taxable year.
(3) Report to shareholders. A RIC or
REIT that provides the section 1061
disclosures described in paragraphs
(c)(1)(i) and (ii) of this section must
provide those section 1061 disclosures
in writing to its shareholders with the
statement described in section

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852(b)(3)(C)(i) or the notice described in
section 857(b)(3)(B) in which the capital
gain dividend is reported or designated.
(d) Qualified electing fund (QEF)
reporting. A passive foreign investment
company with respect to which the
shareholder has a QEF election (as
described in section 1295(a)) in effect
for the taxable year that determines net
capital gain as provided in § 1.1293–
1(a)(2)(i)(A), as limited by section
1293(e)(2), may provide some or all of
the information listed in paragraph
(b)(1) of this section (and any other
relevant information) to its shareholders
to enable API Holders to determine the
amount of their inclusion under section
1293(a)(1) that would be included in the
API One Year Distributive Share
Amounts and API Three Year
Distributive Share Amounts. To the
extent that such information is not
provided, paragraph (a)(2) of this
section will apply except that Owner
Taxpayers are not permitted to
separately substantiate the information.
An API Holder who receives the
additional information described in this
paragraph (d) must retain such
information as required by § 1.1295–
1(f)(2)(ii).
(e) Applicability date. The provisions
of this section apply to taxable years of
Owner Taxpayers and Passthrough
Entities beginning on or after January
19, 2021. An Owner Taxpayer or
Passthrough Entity may choose to apply
this section to a taxable year beginning
after December 31, 2017, provided that
they apply the Section 1061 Regulations
in their entirety to that year and all
subsequent years.
■ Par. 5. Section 1.1223–3 is amended
by:
■ 1. Redesignating paragraph (b)(5) as
paragraph (b)(6);
■ 2. Adding a new paragraph (b)(5);
■ 3. Designating Examples 1 through 8
of paragraph (f) as paragraphs (f)(1)
through (8);
■ 4. Adding paragraphs (f)(9) and (10);
and
■ 5. Revising the heading and adding a
sentence at the end of paragraph (g).
The additions and revision read as
follows:
§ 1.1223–3 Rules relating to the holding
periods of partnership interests.

*

*
*
*
*
(b) * * *
(5) Divided holding period if
partnership interest comprises in whole
or in part one or more profits interests—
(i) In general. If a partnership interest is
comprised in whole or in part of one or
more profits interests (as defined in
paragraph (b)(5)(ii) of this section), then,
for purposes of applying paragraph

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(b)(1) of this section, the portion of the
holding period to which a profits
interest relates is determined based on
the fair market value of the profits
interest upon the disposition of all, or
part, of the interest (and not at the time
that the profits interest is acquired).
Paragraph (b)(1) of this section
continues to apply to the extent that a
partner acquires portions of a
partnership interest that are not
comprised of a profits interest and the
value of the profits interest is not
included for purposes of determining
the value of the entire partnership
interest under paragraph (b)(1).
(ii) Definition of capital interest and
profits interest. For purposes of this
paragraph (b)(5), a profits interest is a
partnership interest other than a capital
interest. A capital interest is an interest
that would give the holder a share of the
proceeds if the partnership’s assets were
sold at fair market value at the time the
interest was received and then the
proceeds were distributed in a complete
liquidation of the partnership. A profits
interest, for purposes of this paragraph
(b)(5), is received in connection with the
performance of services to or for the
benefit of a partnership in a partner
capacity or in anticipation of being a

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partner, and the receipt of the interest
is not treated as a taxable event for the
partner or the partnership under
applicable Federal income tax guidance.
*
*
*
*
*
(f) * * *
(9) Example 9. On June 1, 2020, GP
contributes $10,000 to PRS for a
partnership interest in PRS. On June 30,
2023, GP receives a 20% interest in the
profits of PRS that is an Applicable
Partnership Interest (API) as defined in
§ 1.1061–1(a). On June 30, 2025, GP
sells its interest in PRS for $30,000. At
the time of GP’s sale of its interest, the
API has a fair market value of $15,000.
GP has a divided holding period in its
interest in PRS; 50% of the partnership
interest has a holding period beginning
on June 1, 2020, and 50% has a holding
period that begins on June 30, 2023.
(10) Example 10. Assume the same
facts as in paragraph (f)(9) of this section
(Example 9), except that on June 30,
2024, GP contributes an additional
$5,000 cash to GP prior to GP’s sale of
its interest in 2025. Immediately after
the contribution of the $5,000 on June
30, 2024, GP’s interest in PRS has a
value of $15,000, not taking into
account the value of GP’s profits interest
in PRS. GP calculates its holding period

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in the portions not comprised by the
profits interest and two-thirds of its
holding period runs from June 30, 2020,
and one-third runs from June 30, 2024.
On June 30, 2025, GP sells its interest
for $30,000 and the API has a fair
market value of $15,000. Accordingly,
on the date of disposition, one-third of
GP’s interest has a five year holding
period from its interest received in 2020
for its $10,000 contribution, one-half of
GP’s interest has a two year holding
period from the profits interest issued
on June 30, 2023, and one-sixth of GP’s
interest has a one year holding period
from the contribution of the $5,000.
(g) Applicability dates. * * *
Paragraphs (b)(5) and (f)(9) and (10) of
this section apply to taxable years
beginning on or after January 19, 2021.
Sunita Lough,
Deputy Commissioner for Services and
Enforcement.
Approved: January 5, 2021.
David J. Kautter,
Assistant Secretary of the Treasury (Tax
Policy).
[FR Doc. 2021–00427 Filed 1–13–21; 4:15 pm]
BILLING CODE 4830–01–P

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