Senate Finance Committee Chair Ron Wyden (D-Ore.) is working on a draft of legislation that would substantially change some tax rules on partnerships. The National Association of Home Builders has come out against the legislation, arguing that the changes "would restrict the ability of partnerships to allocate income and deductions unless those allocations are in line with the partners' ownership percentages."

The new proposal is in line with many others coming from either Democrats in Congress or the Biden White House. They include eliminating step-up basis, the additional 20% deduction for pass-through businesses, carried interest, and the 1031 exchange break as well as increasing the capital gains tax rate.

The following "examples of partnership tax loopholes" and the suggested change come from committee document:

  • Contributions and distributions of appreciated (or depreciated) property are generally tax free. Partnerships are supposed to allocate built-in gains and losses on contributed property in a way that limits abuse, but they get to choose among three or more allocation methods. Only one—the "remedial method"—actually prevents tax from being shifted between the partners. The discussion draft would require partnerships to use the remedial method making sure gain, and the related tax liability, cannot be shifted. 
  • Upon a change in the interests of the partners, a partnership can elect—but is not required—to revalue its assets to prevent the shifting of built-in gain and loss. The discussion draft would require such revaluations. 
  • The partnership tax rules afford tremendous flexibility in the allocation of partnership income and losses among partners. The discussion draft would remove optionality and in doing so, simplify administration and curtail abuse. For certain related-party partnerships, the discussion draft would require all income and loss to be allocated pro-rata.

"The draft proposal would remove the Substantial economic effect of safe harbor and generally require most partnership allocations to be made based on Partners' interest in the partnership," John Blake, a partner in the real estate and construction group of accounting and advisory firm Klatzkin, tells GlobeSt.com. "This would undoubtedly simplify partnership filings, but it would remove some of the flexibility afforded commercial real estate partnerships in the past."

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