rr-24-14.pdf

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Part I

Section 7701(o).--Clarification of economic substance doctrine
(Also §§ 732, 734, 743, 754, 755)

Rev. Rul. 2024-14

ISSUE

Does the economic substance doctrine apply to disallow tax benefits associated with
a series of transactions involving a related-party partnership, through which the parties
first generate a disparity between inside basis and outside basis and then trigger a
basis adjustment to property under § 732(b), § 734(b), or § 743(b),
1
which generates
increased cost recovery deductions with respect to the property or reduced gain (or
increased loss) upon a sale of the property?

FACTS

1
Unless otherwise specified, all “Section” or “§” references are to sections of the Code or the Income Tax
Regulations (26 CFR part 1).

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C is a domestic corporation engaged in operating a trade or business, including
through several subsidiary entities commonly managed by C or in which C directly or
indirectly holds controlling financial interests (C Subsidiaries) such that C is related to
each of the C Subsidiaries under § 267(b) or § 707(b)(1). The C Subsidiaries include,
among other entities, Sub 1, Sub 2, Sub 3, Partnership A, Partnership B, Partnership C,
and Partnership D, each of which is indirectly owned by C through one or more C
Subsidiaries. The C Subsidiaries own various depreciable or amortizable assets used
in, and have incurred various liabilities as part of, the conduct of C’s trade or business.
C issues financial statements for its trade or business that report these assets and
liabilities of the C Subsidiaries (C Financial Statements).
Situation 1. C indirectly owns more than 50 percent of the stock of each of Sub 1,
Sub 2, and Sub 3, all domestic corporations. Sub 1 and Sub 2 are the only partners in
Partnership A with each holding a 50 percent interest in the capital, profits, and losses
of Partnership A. Sub 1 and Sub 3 are the only partners in Partnership B with each
holding a 50 percent interest in the capital, profits, and losses of Partnership B.
Prior to Date 1, Partnership A had a valid election in place under § 754. Also prior to
Date 1, Sub 1’s share of the adjusted tax basis of Partnership A’s property (that is,
Sub 1’s share of Partnership A’s inside basis) was equal to $20x and the adjusted tax
basis of Sub 1’s interest in Partnership A (that is, Sub 1’s outside basis) was $100x.
This $80x disparity between Sub 1’s share of Partnership A’s inside basis and Sub 1’s
outside basis in Partnership A prior to Date 1 resulted from Sub 1 and Sub 2 making
contributions to Partnership A, and Partnership A making distributions to Sub 1 and

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Sub 2, of property with specific Federal income tax attributes, and the allocation of
Federal income tax items in accordance with § 704(b) and (c). Such contributions,
distributions, and allocations were undertaken with a view to creating a disparity
between Sub 1’s share of Partnership A’s inside basis and Sub 1’s outside basis in
Partnership A.
On Date 1, Sub 1 transfers its interest in Partnership A to Partnership B in a
contribution that qualifies for nonrecognition of gain or loss under § 721(a) (Sub 1
Contribution). The stated business purpose for the Sub 1 Contribution is to achieve
cost savings for C and the C Subsidiaries by cleaning up intercompany accounts,
reducing administrative complexity, and achieving other administrative efficiencies.
Immediately after the Sub 1 Contribution, Partnership B’s outside basis in its interest
in Partnership A is $100x under § 723 while its share of Partnership A’s inside basis is
$20x (without regard to § 743(b)). Under § 743(b), Partnership A increases the
adjusted basis of its property by $80x (the excess of Partnership B’s $100x outside
basis over its $20x proportionate share of inside basis) with respect to Partnership B
only.
2
Partnership A allocates substantially all of this $80x basis increase to its
depreciable or amortizable property (Basis-Adjusted Property) under § 755 and § 1.755-
1(b)(5). The Sub 1 Contribution on Date 1 was undertaken with a view to exploiting the
disparity between Sub 1’s share of Partnership A’s inside basis and Sub 1’s outside
basis in Partnership A created before Date 1 and increasing Partnership B’s share of

2
This section shows a mechanical application of the rules of subchapter K of chapter 1 of the Code
(subchapter K). The tax effect will be disregarded if the economic substance doctrine applies. Later
sections of this revenue ruling address whether the economic substance doctrine applies.

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Partnership A’s inside basis in the depreciable or amortizable property.
The cost savings resulting from the Sub 1 Contribution are insubstantial in relation to
the reduction in the aggregate Federal income tax liability of the C Subsidiaries resulting
from the $80x increase in Partnership A’s basis in the Basis-Adjusted Property, which
results in Partnership B being allocated increased amounts of deductions for
depreciation or amortization or reduced amounts of gain (or increased amounts of loss)
upon the sale of the Basis-Adjusted Property. C reports the relatively small cost
savings in the C Financial Statements.
Situation 2. C indirectly owns more than 50 percent of the stock of Sub 1 and Sub 2,
both domestic corporations. Sub 1 and Sub 2 are the only partners in Partnership C
with each having a 50 percent interest in the capital, profits, and losses of
Partnership C. Partnership C owns 100 percent of the stock of Sub 3, a domestic
corporation, a depreciable asset, and $100x of money deposited in a bank account.
Prior to Date 2, Partnership had a valid election in place under § 754. Also prior to
Date 2, Partnership C held the Sub 3 stock with an adjusted basis of $90x and fair
market value of $100x and held the depreciable asset with an adjusted basis of $10x
and fair market value of $100x. Also, Sub 1’s outside basis in Partnership C was $100x
and Sub 2’s outside basis in Partnership C was $10x as a result of Sub 1 and Sub 2
making contributions to Partnership C, and Partnership C making distributions to Sub 1
and Sub 2, of property with specific Federal income tax attributes, and the allocation of
Federal income tax items in accordance with § 704(b) and (c). Such contributions,
distributions, and allocations were undertaken with a view to creating a disparity

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between Sub 2’s outside basis and Partnership C’s inside basis in the Sub 3 stock.
On Date 2, Partnership C distributes all of the Sub 3 stock to Sub 2 other than in
liquidation of Sub 2’s interest in Partnership C (Sub 3 Stock Distribution). The stated
business purpose for the Sub 3 Stock Distribution is to achieve costs savings for C and
the C Subsidiaries by cleaning up intercompany accounts, reducing administrative
complexity, and achieving other administrative efficiencies.
Immediately after the Sub 3 Stock Distribution, Sub 2’s adjusted basis in the Sub 3
stock is $10x under § 732(a)(2), the same as Sub 2’s outside basis in Partnership C
prior to the Sub 3 Stock Distribution. In addition, the Sub 3 Stock Distribution reduces
Sub 2’s outside basis in Partnership C from $10x to zero under § 733(2). Following the
Sub 3 Stock Distribution, Partnership C increases the inside basis of its assets by $80x
under § 734(b)(1)(B). Under § 755 and § 1.755-1(c)(2)(i), Partnership C increases the
adjusted basis of its remaining depreciable asset from $10x to $90x.
3
The Sub 3 stock
Distribution on Date 2 was undertaken with a view to exploiting the disparity between
Sub 2’s outside basis in Partnership C and Partnership C’s inside basis in the Sub 3
stock created before Date 2 and transferring basis from nondepreciable Sub 3 stock to
Partnership C’s remaining depreciable asset.
The cost savings resulting from the Sub 3 Stock Distribution are insubstantial in

3
The distribution of Sub 3 stock (controlled corporation) to Sub 2 (corporate partner) meets the
requirements of § 732(f) because Partnership C’s adjusted basis in the Sub 3 stock prior to the Sub 3
Stock Distribution exceeds the adjusted basis of the stock in the hands of the corporate partner (Sub 2).
Under § 732(f), the aggregate adjusted bases of Sub 3’s property must be reduced by $80x, subject to
the limitations in § 732(f)(3). Additionally, this revenue ruling does not address the application of § 751(b)
to the facts of Situations 2 and 3.

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relation to the reduction in the aggregate Federal income tax liability of the
C Subsidiaries resulting from the $80x increase in Partnership C’s inside basis in the
remaining depreciable asset, which results in Sub 1 and Sub 2 being allocated
increased amounts of deductions for depreciation or reduced amounts of gain (or
increased amounts of loss) upon the sale of Partnership C’s remaining depreciable
asset. C reports the relatively small cost savings in the C Financial Statements.
Situation 3. C indirectly owns more than 50 percent of the stock of Sub 1 and Sub 2,
both domestic corporations. Sub 1 and Sub 2 are the only partners in Partnership D
with each having a 50 percent interest in the capital, profits, and losses of
Partnership D.
Prior to Date 3, Partnership D owned two assets: a depreciable asset with an
adjusted basis of $20x and a fair market value of $100x and nondepreciable land with
an adjusted basis of $90x and fair market value of $100x. Also prior to Date 3, Sub 1’s
outside basis in Partnership D was $100x, and Sub 2’s outside basis in Partnership D
was $20x as a result of Sub 1 and Sub 2 making contributions to Partnership D, and
Partnership D making distributions to Sub 1 and Sub 2, of property with specific Federal
income tax attributes, and the allocation of Federal income tax items in accordance with
§ 704(b) and (c). Such contributions, distributions, and allocations were undertaken
with a view to creating a disparity between Partnership D’s inside basis in the
depreciable asset and Sub 1’s outside basis in Partnership D.
On Date 3, Partnership D liquidates by distributing the depreciable asset to Sub 1
and the nondepreciable land to Sub 2 (Partnership D Liquidation). The stated business

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purpose for the Partnership D Liquidation is to achieve cost savings for C and the
C Subsidiaries by cleaning up intercompany accounts, reducing administrative
complexity, and achieving other administrative efficiencies.
Immediately after the Partnership D Liquidation, Sub 1’s adjusted basis in the
depreciable asset is $100x under § 732(b), the same as Sub 1’s outside basis in
Partnership D prior to the Partnership D Liquidation, reflecting an increase of $80x to
the adjusted basis of the depreciable asset in the hands of Sub 1. Also immediately
after the Partnership D Liquidation, Sub 2’s adjusted basis in the nondepreciable land is
$20x under § 732(b), the same as Sub 2’s outside basis in Partnership D prior to the
Partnership D Liquidation, reflecting a decrease of $70x to the adjusted basis of the
nondepreciable land in the hands of Sub 2. The distribution of the depreciable asset to
Sub 1 as part of the Partnership D Liquidation on Date 3 was undertaken with a view to
exploiting the disparity between Partnership D’s inside basis in the depreciable asset
and Sub 1’s outside basis in Partnership D created before Date 3 and transferring basis
from nondepreciable land distributed to Sub 2 to the depreciable asset distributed to
Sub 1.
The cost savings resulting from the Partnership D Liquidation are insubstantial in
relation to the reduction in the aggregate Federal income tax liability of the
C Subsidiaries resulting from the $80x increase in Sub 1’s adjusted basis in the
depreciable asset, which results in increased deductions for depreciation or reduced
amounts of gain (or increased amounts of loss) upon the sale of the depreciable asset
for Sub 1. C reports the relatively small cost savings in the C Financial Statements.

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LAW
Section 267(a) generally disallows deductions in respect of any loss from the sale or
exchange of property, directly or indirectly, between persons specified in any of the
paragraphs of § 267(b), other than any loss of a distributing corporation (or the
distributee) in the case of a distribution in complete liquidation. Section 267(b)(3)
provides that two corporations that are members of the same controlled group (as
defined in § 267(f)) have a relationship referred to in § 267(a). Section 267(f)(1)
provides that a controlled group has the meaning given by § 1563(a), except that “more
than 50 percent” is substituted for “at least 80 percent” each place it appears in
§ 1563(a), and the determination is made without regard to § 1563(a)(4) and (e)(3)(C).
In addition, § 267(b)(10) provides that a corporation and a partnership owned by the
same persons have a relationship referred to in § 267(a) if the same persons own more
than 50 percent of both the value of the outstanding stock of the corporation and the
capital interest, or the profits interest, in the partnership.
Section 707(b)(1)(A) disallows any deduction for losses from sales or exchanges of
property (other than an interest in the partnership) directly or indirectly, between a
partnership and a partner owning, directly or indirectly, more than 50 percent of the
capital interest, or the profits interest, in such partnership. Section 707(b)(1)(B)
disallows any deduction for losses from sales or exchanges of property (other than an
interest in the partnership) directly or indirectly, between two partnerships in which the
same persons own, directly or indirectly, more than 50 percent of the capital interests or

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profits interests.
Section 721(a) provides that no gain or loss is recognized to a partnership or to any
of its partners on the contribution of property to the partnership in exchange for an
interest in the partnership. Section 723 provides that the basis of property contributed
to a partnership by a partner is the adjusted basis of such property to the contributing
partner at the time of the contribution increased by the amount of gain (if any)
recognized under § 721(b) to the contributing partner at such time.
Section 731(b) provides that no gain or loss is recognized to a partnership on the
distribution to a partner of property, including money. Section 732(a)(1) generally
provides that the basis of property (other than money) distributed by a partnership to a
partner other than in liquidation of the partner’s interest is its adjusted basis to the
partnership immediately before the distribution. However, § 732(a)(2) limits the basis to
the distributee partner to the adjusted basis of that partner’s interest in the partnership
reduced by any money distributed in the same transaction. Section 732(b) provides that
the basis of property (other than money) distributed by a partnership to a partner in
liquidation of the partner’s interest equals the adjusted basis of the partner’s interest in
the partnership reduced by any money distributed in the same transaction. Section
732(c) provides rules for the allocation of basis among properties received in a
distribution to which § 732(a)(2) or § 732(b) applies.
Section 733 provides that the adjusted basis of a distributee partner’s interest in a
partnership following a non-liquidating distribution is reduced (but not below zero) by
(1) the amount of any money distributed to the partner, and (2) the adjusted basis of

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distributed property (other than money), as determined under § 732.
Section 734(a) provides that the basis of partnership property is not adjusted as the
result of a distribution of property to a partner unless an election provided in § 754 is in
effect or there is a substantial basis reduction (as defined in § 734(d)) with respect to
such distribution. Section 734(b) provides that a partnership, with respect to which an
election provided in § 754 is in effect or with respect to which there is a substantial basis
reduction, increases or decreases the adjusted basis of partnership property to take into
account the gain or loss recognized by a distributee partner under § 731(a) or changes
in the basis of distributed property under § 732. Under § 734(b)(1)(B), in the case of
distributed property to which § 732(a)(2) applies, the amount of increase includes the
excess of the adjusted basis of the distributed property immediately before the
distribution over the basis of the distributed property to the distributee. If § 734(b) is
applicable, § 734(c) provides that the allocation of basis among partnership properties is
made in accordance with the rules provided in § 755. Section 734(d) provides that
there is a substantial basis reduction with respect to a distribution if, had an election
provided in § 754 been in effect, there would be a negative net basis adjustment to
partnership property of more than $250,000.
Section 743(a) provides that the basis of partnership property is not adjusted as the
result of a transfer of an interest in a partnership by sale or exchange or on the death of
a partner unless an election provided in § 754 is in effect or there is a substantial built-in
loss (as defined in § 743(d)) immediately after such transfer. Section 743(b) provides
that, in the case of a transfer of an interest in a partnership by sale or exchange or upon

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the death of a partner, a partnership with respect to which an election provided in § 754
is in effect or a partnership that has a substantial built-in loss immediately after such
transfer, increases the adjusted basis of the partnership property by the excess of the
basis to the transferee partner of the transferee partner’s interest in the partnership over
such partner’s proportionate share of the adjusted basis of the partnership property, or
decreases the adjusted basis of the partnership property by the excess of the transferee
partner's proportionate share of the adjusted basis of the partnership property over the
basis of such partner’s interest in the partnership. Section 743(b) further provides that,
under regulations prescribed by the Secretary of the Treasury or her delegate
(Secretary), such increase or decrease constitutes an adjustment to the basis of
partnership property with respect to the transferee partner only. If § 743(b) is
applicable, § 743(c) provides that the allocation of basis among partnership properties is
made in accordance with the rules provided in § 755.
Section 754 provides, in part, that if a partnership files an election, in accordance
with the regulations prescribed by the Secretary, the basis of partnership property is
adjusted, in the case of a distribution of property, in the manner provided in § 734, and,
in the case of a transfer of a partnership interest, in the manner provided in § 743. A
§ 754 election applies with respect to all distributions of property by the partnership and
to all transfers of interests in the partnership during the taxable year with respect to
which the election was filed and all subsequent taxable years.
Section 755(a) provides that a basis adjustment under § 734(b) or § 743(b) is
allocated among partnership properties in a manner that reduces the difference

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between the fair market values and adjusted bases of those properties or in any other
manner permitted by the regulations prescribed by the Secretary. Section 755(b)
provides that in applying the allocation rules of § 755(a), increases or decreases in the
adjusted basis of partnership property arising from a distribution of, or a transfer of an
interest attributable to, capital assets and property described in § 1231(b), or any other
property of the partnership, are allocated to partnership property of like character. The
allocation of basis adjustments under §§ 743(b) and 734(b) among partnership property
is provided in § 1.755-1(b) and (c), respectively.
Section 7701(o)(1) provides that, in the case of any transaction to which the
economic substance doctrine is relevant, the transaction is treated as having economic
substance only if (i) the transaction changes in a meaningful way (apart from Federal
income tax effects) the taxpayer’s economic position, and (ii) the taxpayer has a
substantial purpose (apart from Federal income tax effects) for entering into such
transaction. For this purpose, achieving a financial accounting benefit is not taken into
account as a purpose for entering into a transaction if the origin of such financial
accounting benefit is a reduction of Federal income tax. Section 7701(o)(4).
Section 7701(o)(5)(A) provides that the “economic substance doctrine” means the
common law doctrine under which tax benefits under subtitle A of the Code with respect
to a transaction are not allowable if the transaction does not have economic substance
or lacks a business purpose.
Section 7701(o)(5)(C) provides that the determination of whether the economic
substance doctrine is relevant to a transaction is made in the same manner as if

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§ 7701(o) had never been enacted.
Section 7701(o)(5)(D) provides that the term “transaction” includes a series of
transactions.
Section 7701(o)(2)(A) provides that if a taxpayer relies on profit potential to help
prove that a transaction has economic substance, profit potential will only be taken into
account if the present value of the reasonably-expected pretax profit of that transaction
is substantial in relation to the present value of the expected net tax benefits of the
transaction that would be allowed if the Federal income tax effects of the transaction
were not disregarded.
Section 6662(b)(6) provides that a 20 percent penalty applies to an underpayment
attributable to a transaction lacking economic substance under § 7701(o) or failing to
meet the requirements of any similar rule of law. Under § 6662(i), the penalty is
increased to 40 percent or any portion of an underpayment that is attributable to one or
more nondisclosed noneconomic substance transactions. Under § 6664(c)(2), there is
no reasonable cause exception to the penalties described in § 6662(b)(6) or (i).

ANALYSIS
The basis adjustment rules under §§ 732(b), 734(b), and 743(b) are intended to
reduce disparities between inside and outside basis that would otherwise result from a
distribution of property or transfer of a partnership interest. In each of Situations 1-3,
however, the parties engaged in a concerted effort to create disparities between inside
and outside basis through various methods, such as the contribution or distribution of

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property with specific Federal income tax attributes or the allocation of Federal income
tax items in accordance with § 704(b) and (c). They then exploited the created
disparities by engaging in transfers resulting in basis adjustments under the mechanical
rules of § 732(b), 734(b), or 743(b) to inappropriately reduce taxable income through
increased deductions or reduced gain (or increased loss).
In Situation 1, the actions of the parties creating a disparity between Sub 1’s outside
basis and share of Partnership A’s inside basis, the transfer of Sub 1’s interest in
Partnership A to Partnership B in the Sub 1 Contribution, and the resulting positive
basis adjustment to Partnership B’s share of inside basis of Partnership A’s property
under § 743(b) were undertaken with a view to increasing Partnership B’s share of
Partnership A’s inside basis in depreciable or amortizable property by $80x while
avoiding recognition of gain or loss under § 721(a) through a nonrecognition
transaction. Additionally, the $80x basis increase was relatively large in amount
compared to the cost savings to C and the C Subsidiaries.
In Situation 2, the actions of the parties creating a disparity between Sub 2’s outside
basis and Partnership C’s inside basis in the Sub 3 stock, the distribution of Sub 3 stock
(a high-inside basis asset) to Sub 2 (a partner with a low outside basis in its partnership
interest) and the resulting adjustment to the inside basis of Partnership C’s remaining
property were undertaken with a view to transferring $80x of basis from nondepreciable
Sub 3 stock to Partnership C’s remaining depreciable asset while avoiding recognition
of gain or loss under § 731 through a nonrecognition distribution. Additionally, the $80x
basis increase was relatively large in amount compared to the cost savings.

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In Situation 3, the actions of the parties creating a disparity between Sub 1’s outside
basis and Partnership D’s adjusted basis in the depreciable asset, the liquidating
distribution of the depreciable asset (a low-inside basis asset) to Sub 1 (a partner with a
high outside basis in its partnership interest) in the Partnership D Liquidation and the
resulting adjustment to the adjusted basis of the depreciable asset to Sub 1 under
§ 732(b) were undertaken with a view to transferring basis from nondepreciable land
distributed to Sub 2 to the depreciable asset distributed to Sub 1 while avoiding
recognition of gain or loss under § 731 through a nonrecognition distribution.
Additionally, the $80x basis increase was relatively large in amount compared to the
cost savings to C and the C Subsidiaries.
Situations 1-3 all involve persons related to each other under § 267(b) or § 707(b)(1).
A transaction among related parties to avoid Federal income tax by generating inflated
basis adjustments falls outside the plain intent of §§ 732(b), 734(b), 743(b), and 754.
While the differing economic interests of unrelated parties generally make it less likely
that unrelated partners will engage in transactions such as those in Situations 1-3,
partnerships composed of related partners have no such disincentive.
4

Congress intended that the provisions of subchapter K apply to transactions between
partnerships and their partners to preserve parity between inside and outside basis “so
as to prevent any unintended tax benefit or detriment to the partners.” H.R. Rep. No.
1337, 83d Cong., 2d Sess. A225 (1954); S. Rep. No. 1622, 83d Cong., 2d Sess. 384

4
This revenue ruling does not address the application of § 7701(o) to transactions among unrelated
partners. Depending on the specific facts, § 7701(o) may apply to transactions among unrelated
partners.

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(1954). Congress also expressed its desire to prevent related parties from exploiting
the rules of subchapter K to avoid tax “through the realization of fictitious losses or
increasing the basis of property for purposes of depreciation.” H.R. Rep. No. 1337, at
A226; S. Rep. No. 1622, at 386-87.
Congress did not intend that taxpayers be able to avoid or indefinitely defer taxation
altogether by creating basis disparities through contributions or distributions of property
or through allocations of tax items by reason of a § 743(b) basis adjustment after a
nonrecognition transaction, such as the Sub 1 Contribution in Situation 1; by reason of a
§ 734(b) basis adjustment after distribution of property, such as the Sub 3 Stock
Distribution in Situation 2; or by reason of a § 732(b) basis adjustment after a liquidating
distribution of property, such as the Partnership D Liquidation in Situation 3. The
shared economic interests of related parties make them more likely than unrelated
parties to attempt to generate such tax benefits in a manner not intended by Congress
by entering into transactions with no meaningful economic change.
Unless a “meaning plainly appears” that Congress intended a provision to grant a
tax benefit to transactions without economic substance or business purpose, such an
intent “will not [be] attribute[d] to Congress.” Knetsch v. United States, 364 U.S. 361,
367-69 (1960). The economic substance doctrine is intended to apply “despite literal
compliance with the statute.” Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1354
(Fed. Cir. 2006); see Gregory v. Helvering, 293 U.S. 465, 470 (1935). The economic
substance doctrine was developed to address transactions such as these, which follow
the literal words of the Code but lie outside of Congress’s plain intent. Gregory, 293

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U.S. at 469-470.
Each series of transactions described in Situations 1-3 lacks economic substance.
In each of those situations, the economic substance doctrine is applied to basis
adjustments generated by the following series of connected transactions involving
related parties, which may occur over the course of several taxable years: (i) the parties
generate basis disparities through various methods, such as contributions of property
with specific Federal income tax attributes to the partnership, the allocation of Federal
income tax items in accordance with § 704(b) and (c), or distributions of property with
specific attributes to the partners, and (ii) either (1) a partner transfers its partnership
interest in a nonrecognition transaction while there exists an inside/outside basis
disparity, or (2) the partnership distributes property with specific Federal income tax
attributes (for example, high inside basis) to one or more partners with specific Federal
income tax attributes (for example, low outside basis) in a current or liquidating
distribution. The resulting basis adjustments, if allowed, would permit the parties to shift
basis in a manner that enables the parties to claim increased cost recovery deductions
or reduced gain (or increased loss) upon the sale of the basis-adjusted property.
In applying the conjunctive test of § 7701(o)(1), each of two prongs must be met for
the transactions described in Situations 1-3 to have economic substance. First, under
§ 7701(o)(1)(A), the transaction must change in a meaningful way (apart from Federal
income tax effects) the taxpayer’s economic position. Second, under § 7701(o)(1)(B),
the taxpayer must have had a substantial purpose (apart from Federal income tax
effects) for entering into the transaction.

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With respect to the first prong under § 7701(o)(1)(A), the transactions in Situations 1-
3 have a negligible effect on C’s economic position because the transactions shift
ownership of property among commonly controlled entities without “effect[ing] any real
change in the ‘flow of economic benefits,’ or provid[ing] any real ‘opportunity to make a
profit’ . . . .” Coltec, 454 F.3d at 1360; see Reddam v. Commissioner, 755 F.3d 1051,
1060-62 (9th Cir. 2014). The transactions fail to “appreciably affect the [taxpayer’s]
beneficial interest except to reduce . . . tax”; that is, the transactions do not appreciably
affect C’s beneficial interests in the C Subsidiaries or their assets, except to reduce the
aggregate Federal income tax liability of the related persons involved. Knetsch, 364
U.S. at 366 (quoting Gilbert v. Commissioner, 248 F.2d 399, 411 (2d Cir. 1957)
(Learned Hand, J., dissenting)) (emphasis added). The only potential economic gains
are derived from purported cost savings from cleaning up intercompany accounts
between the C Subsidiaries, reducing administrative complexity, and achieving
administrative efficiencies. However, any such cost savings do not change C and the
C Subsidiaries’ economic position in a meaningful way because any economic benefits
attributable to purported cost savings (apart from the Federal income tax effects) are
insubstantial compared to the $80x in Federal income tax benefits from the basis
adjustments attributable to these transactions. The basis increases of $80x resulting
from the transactions in Situations 1-3 can be used to reduce taxable income of the
C Subsidiaries through depreciation, amortization, or other deductions or reduce gain
recognized upon the sale of the property. The transactions were “designed to generate”
basis increases, and those basis increases “would always . . . have overshadowed” the

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economic gain, including gain derived from cost savings. Reddam, 755 F.3d at 1061-
62. Even if there had been “some prospect of profit” from transferring a partnership
interest or partnership property among related parties, the calculable Federal income
tax benefits would have “far exceeded any independent potential for economic return.”
Bank of New York Mellon Corp. v. Commissioner, 801 F.3d 104, 117-18, 120 (2d Cir.
2015); Salem Fin., Inc. v. United States, 786 F.3d 932, 949 (Fed. Cir. 2015) (citing
Knetsch, 364 U.S. at 365-66). Thus, any change in economic position (apart from the
Federal income tax effects) in the transactions described in Situations 1-3 is not
meaningful within the meaning of § 7701(o)(1)(A).
With respect to the second prong of the conjunctive test under § 7701(o)(1)(B), the
transactions described in Situations 1-3 demonstrate a lack of any substantial purpose
(apart from Federal income tax effects) to enter into these transactions. The stated
business purpose of achieving cost savings from cleaning up intercompany accounts
between the C Subsidiaries, reducing administrative complexity, and achieving
administrative efficiencies may be a legitimate nontax economic purpose. However,
any such business purpose is not substantial compared to the Federal income tax
purposes the transactions were designed to carry out. See Reddam, 755 F.3d at 1061.
Many of the facts in these transactions demonstrating a lack of meaningful change in
economic position (apart from Federal income tax effects) also demonstrate a lack of
substantial purpose (apart from Federal income tax effects) for these related parties to
enter into these transactions. Reasonable inferences into a taxpayer’s purpose for
entering a transaction can be drawn from the facts and circumstances surrounding such

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transaction, including results from a transaction that the taxpayer could have reasonably
anticipated as well as results from a transaction that were by design. The fact that the
cost savings were insubstantial compared to relatively large basis increases of $80x,
that there was no appreciable effect on the parties’ economic ownership of the property
allocated the basis increases, and that the transactions were structured to guarantee
basis increases of $80x to depreciable or amortizable property while carrying a de
minimis risk of economic loss compared to the designed Federal income tax benefit,
Altria Grp., 658 F.3d at 290-91, “indicate[] that the taxpayer’s true motivation for the
transaction is tax avoidance.” See Bank of New York Mellon Corp. v. United States,
140 T.C. 15, 38 (2013). Therefore, C lacked a substantial purpose (apart from Federal
income tax effects) for causing its subsidiaries to enter into the transactions described in
Situations 1-3 within the meaning of § 7701(o)(1)(B).
If a transaction or series of transactions lacks economic substance, it may be
disregarded for Federal income tax purposes. See Gregory, 293 U.S. 465; Coltec, 454
F.3d at 1352; ACM P’ship v. Commissioner, 157 F.3d 231, 247-48 (3d Cir. 1998). While
a transaction might meet the literal requirements of the Code, courts will not recognize a
transaction that is not within the intent of the Code. Gregory, 293 U.S. at 469-70. The
series of transactions described in Situations 1-3—related-party contributions or
distributions of property or allocations of tax items and the subsequent transfer of a
partnership interest or distribution of property to generate a basis adjustment to property
that is eligible for cost recovery (or is held for future sale)—failed both prongs under
§ 7701(o)(1) and, therefore, lack economic substance. As a result, their Federal income

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tax effects must be disregarded. The transactions did not change in a meaningful way
(apart from Federal income tax effects) the economic position of C or the C Subsidiaries
within the meaning of § 7701(o)(1)(A), and C lacked a substantial business or other
purpose (apart from Federal income tax effects) for causing the C Subsidiaries to enter
into these transactions within the meaning of § 7701(o)(1)(B).
In addition, under § 6662(b)(6), the transactions described in Situations 1-3 give rise
to a 20 percent penalty applicable to an underpayment attributable to a transaction
lacking economic substance under § 7701(o). The penalty is increased to 40 percent
on any portion of the underpayment attributable to one or more nondisclosed
noneconomic substance transactions. See § 6662(i). Under § 6664(c)(2), a reasonable
cause exception to the penalties described in § 6662(b)(6) and (i) may not be asserted.
The series of transactions described in Situations 1-3 may also be subject to the
partnership anti-abuse rule under § 1.701-2 or the § 704(c) anti-abuse rule under
§ 1.704-3(a)(10). Other anti-abuse doctrines including, but not limited to, the
substance-over-form doctrine and step-transaction doctrine may apply, depending on
the facts and circumstances of a specific transaction or series of transactions.

HOLDING(S)
5

(1) The series of transactions in Situations 1-3 lack economic substance under

5
This revenue ruling makes no interpretations regarding which audit procedures (for example, the
application of subchapter C of chapter 63 of the Code) might apply to effectuate the substantive
interpretations of the Holdings section. Any such interpretations would require facts that are outside the
scope of this revenue ruling.

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§ 7701(o). The transactions did not change the economic position of C or the
C Subsidiaries in a meaningful way (aside from the Federal income tax effects).
Additionally, neither C nor the C Subsidiaries had a substantial purpose for entering the
transactions (aside from Federal income tax effects).
(2) In Situation 1, the basis adjustment under § 743(b) is disregarded. As a result,
Partnership B is not entitled to an increase of $80x in its share of the inside basis of
Partnership A’s assets, and Partnership B’s share of the inside basis of Partnership A’s
assets remains $20x.
(3) In Situation 2, the basis adjustment under § 734(b) is disregarded. As a result,
Partnership C is not entitled to an increase of $80x to the inside basis of the remaining
depreciable asset, and the inside basis of the depreciable asset remains $10x.
(4) In Situation 3, the basis adjustment to Sub 1 under § 732(b) is disregarded. As a
result, Sub 1 is not entitled to an increase of $80x to the adjusted basis of the
depreciable asset, and the adjusted basis of Sub 1’s depreciable asset remains $20x.
(5) C and/or the C Subsidiaries, as applicable, are subject to the 20 percent penalty
under § 6662(b)(6) or the 40 percent penalty under § 6662(i) for a nondisclosed
noneconomic substance transaction, as applicable.
DRAFTING INFORMATION
The principal author of this revenue ruling is Anthony P. Sacco of the Office of
Associate Chief Counsel (Passthroughs and Special Industries). For further information
regarding this revenue ruling, contact Anthony P. Sacco at (202) 317-5805.