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(2) The Comparative Liquidation Test
Pursuant to section 1.704-1(b)(3)(iii), Income Tax Regs., a
partner’s interest in the partnership is determined by the
“comparative liquidation test”. When a partner’s special
allocation is consistent with the comparative liquidation test, the
special allocation is deemed to be in accordance with the partners’
interests in the partnership. This test applies only when a
partnership’s special allocations lack economic effect under the
alternative test for economic substance set forth in section 1.704-
1(b)(2)(ii), Income Tax Regs.
To satisfy the comparative liquidation test, the partnership
agreement must meet the first two parts of the basic test for
economic effect. That is, the partnership agreement must provide
that (1) capital accounts are to be properly maintained, and (2)
liquidating distributions will be made only to partners with
positive capital account balances. When both conditions are
satisfied, 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 partner would have received
in a hypothetical liquidation at the end of the prior year.
Specifically:
the partner’s interests in the partnership with respect
to the portion of the allocation that lacks economic
effect will be determined by comparing the manner in
which distributions (and contributions) would be made if
all partnership property were sold at book value and the
partnership were liquidated immediately following the end
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