-20-
impact. Accordingly, the regulations provide that an examination
of a partner's interest in the partnership "shall be made by taking
into account all facts and circumstances relating to the economic
arrangement of the partners." Sec. 1.704-1(b)(3)(i), Income Tax
Regs. There is, however, a specific provision in the regulations
on which petitioner and respondent both rely to demonstrate the
correctness of their respective positions in this case. To this
provision we now turn.
3. Special Rules for Determining Partners' Interests
The "partners' interest" regulations contain a special
provision for "certain determinations" in ascertaining the
partner's interest in the partnership. This special provision
applies only when a partnership's allocations lack economic effect
under section 1.704-1(b)(2)(ii), Income Tax Regs. To satisfy this
special provision, the partnership agreement must meet the first
two parts of the basic test for economic effect. That is, the
agreement must provide both that capital accounts are to be
properly maintained and that liquidating distributions will be made
only to partners with positive capital accounts. When these
conditions are met, the special provision may be applied to
determine whether the allocations are in accordance with
partnership interests.
Under the special provision, a partner's interest is measured
by comparing the amount the partner would receive in a hypothetical
liquidation at the end of the current year with the amount the
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