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(3) any allocation of partnership income or gain. A partner’s
capital account is decreased by the amount of partnership losses
and deductions allocated to such partner. The capital account is
further reduced by the fair market value of property distributed to
the partner, net of any liability that the partner assumes or to
which the property is subject. See sec. 1.704-1(b)(2)(iv), Income
Tax Regs.
The regulations governing the economic effect of special
allocations contain three tests that essentially serve as “safe
harbors”. Special allocations are deemed to have economic effect
if they meet the requirements of any one of these safe harbor
tests.
(1) The Basic Test of Economic Effect
The basic test for economic effect (with respect to special
allocations) is set forth in section 1.704-1(b)(2)(ii)(b), Income
Tax Regs. The test provides, in general, that a special allocation
will have economic effect if the partnership agreement contains
provisions that require: (1) The determination and maintenance of
partners’ capital accounts be in accordance with the rules of
section 1.704-1(b)(2)(iv), Income Tax Regs.; (2) upon liquidation
of the partnership, the proceeds of liquidation be distributed in
accordance with the partners’ positive capital account balances;
and (3) upon liquidation of the partnership, all deficit capital
accounts be restored to zero.
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