IRS issues new version of foreign currency regulations

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Partnership rules

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The proposed regulations maintain the aggregate approach to Section 987 aggregate partnerships (partnerships wholly owned by related persons) in the final regulations. However, for all other partnerships in scope of the proposed regulations, they apply a “hybrid approach to entity theory.” This approach is intended to prevent a partner from transferring its share of net unrecognized Section 987 gain or loss to another partner. A partnership that owns a Section 987 QBU would determine its unrecognized Section 987 gain or loss at the partnership level and then allocate to each partner their share of the unrecognized Section 987 gain or loss for the year. At the partner level, each partner would translate its share of the unrecognized Section 987 gain or loss into its functional currency at the yearly average exchange rate and calculate its net unrecognized Section 987 gain or loss with respect to each Section 987 QBU of the partnership based on this share. In effect, the Section 987 pools, as applicable, are maintained as the partner level.

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Recognized Section 987 gains or losses follow a similar approach to unrecognized Section 987 gains or losses. Each partner would recognize (or suspend) Section 987 gain or loss based on the proportionate size of the remittance to the partnership. For example, if a Section 987 QBU remits 50% of its gross assets to the partnership, each partner with net unrecognized Section 987 gain or loss would recognize (or suspend) 50% of the net unrecognized Section 987 gain or loss. In general, the loss-to-the-extent-of-gain rule is also applied at the partner level.  

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The proposed regulations provide a framework for adjusting a partner’s basis in its partnership interest based on the principles of Section 705 when a partner recognizes Section 987 gain or loss, defers Section 987 gain or loss, or suspends section 987 loss attributable to a partnership.

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The proposed regulations would also provide that an upper-tier partnership (UTP) adjusts its basis in a lower-tier partnership (LTP) solely with respect to a partner of UTP that either recognizes Section 987 gain or loss, defers Section 987 gain or loss, or suspects Section 987 loss attributable to the LTP.

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The IRS requested comments on the coordination of the partner capital account maintenance rules in the Section 704(b) regulations with these proposed regulations, as well as the appropriate currency in which Section 743(b) basis adjustments allocated to assets in a Section 987 QBU should be maintained. Additionally, the IRS continues to study the application of entity theory and aggregate theory to partnerships in the Section 987 context, including whether it would be appropriate to apply a hybrid approach to entity theory to all partnerships, regardless of whether the partners are related parties.

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The proposed regulations would treat S corporations in the same manner as partnerships. 

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Partnership rules

The proposed regulations maintain the aggregate approach to Section 987 aggregate partnerships (partnerships wholly owned by related persons) in the final regulations. However, for all other partnerships in scope of the proposed regulations, they apply a “hybrid approach to entity theory.” This approach is intended to prevent a partner from transferring its share of net unrecognized Section 987 gain or loss to another partner. A partnership that owns a Section 987 QBU would determine its unrecognized Section 987 gain or loss at the partnership level and then allocate to each partner their share of the unrecognized Section 987 gain or loss for the year. At the partner level, each partner would translate its share of the unrecognized Section 987 gain or loss into its functional currency at the yearly average exchange rate and calculate its net unrecognized Section 987 gain or loss with respect to each Section 987 QBU of the partnership based on this share. In effect, the Section 987 pools, as applicable, are maintained as the partner level.

Recognized Section 987 gains or losses follow a similar approach to unrecognized Section 987 gains or losses. Each partner would recognize (or suspend) Section 987 gain or loss based on the proportionate size of the remittance to the partnership. For example, if a Section 987 QBU remits 50% of its gross assets to the partnership, each partner with net unrecognized Section 987 gain or loss would recognize (or suspend) 50% of the net unrecognized Section 987 gain or loss. In general, the loss-to-the-extent-of-gain rule is also applied at the partner level.  

The proposed regulations provide a framework for adjusting a partner’s basis in its partnership interest based on the principles of Section 705 when a partner recognizes Section 987 gain or loss, defers Section 987 gain or loss, or suspends section 987 loss attributable to a partnership.

The proposed regulations would also provide that an upper-tier partnership (UTP) adjusts its basis in a lower-tier partnership (LTP) solely with respect to a partner of UTP that either recognizes Section 987 gain or loss, defers Section 987 gain or loss, or suspects Section 987 loss attributable to the LTP.

The IRS requested comments on the coordination of the partner capital account maintenance rules in the Section 704(b) regulations with these proposed regulations, as well as the appropriate currency in which Section 743(b) basis adjustments allocated to assets in a Section 987 QBU should be maintained. Additionally, the IRS continues to study the application of entity theory and aggregate theory to partnerships in the Section 987 context, including whether it would be appropriate to apply a hybrid approach to entity theory to all partnerships, regardless of whether the partners are related parties.

The proposed regulations would treat S corporations in the same manner as partnerships.