Partnership Mergers

• December 5, 2023
• Carey M. Heyman, CPA

When two or more partnerships combine, the transaction may be considered a termination of each of the partnerships, except to the extent that the partners of one partnership end up with more than 50% ownership of the capital and profits of the resulting partnership.  If more than one partnership can meet the test because of overlapping partners, the surviving partnership is the merging partnership with the largest net value of assets.

There are two kinds of partnership mergers.

Asset-Over Form of Merger

When a merger involves transferring assets from the merging partnership(s) to the resulting partnership, it is considered the “assets-over” form of merger.  This is the default type of a partnership merger, unless the merger specifically follows the “assets-up” form.  The assets-over form maintains the same asset basis as the old partnership, resulting in the same collateral effects as a partnership termination under former Section 708(b)(1)(B).  The fact that the transferor partnership may temporarily hold interests in the transferee partnership, which could disqualify it as a partnership due to only having one owner, is disregarded. The partners’ capital accounts in the merging partnerships should be combined as their capital accounts in the merged partnership.

Asset-Up Form of Merger

The “assets-up” form of merger is only recognized if the parties actually follow the transaction.  In this form, the merging partnership distributes its assets to its partners in accordance with state law, liquidating their interests. The distributed assets are then contributed by those same partners to a resulting partnership that does not receive any other assets from the prior partnership.  The inside basis to the surviving partnership is determined by the outside basis of the partners’ interests in the merging partnership.  The possibility that the interim holding of assets by the partners may be a continuation of the partnership, particularly if they constitute a business, is disregarded.  If interests in a merging partnership are received by someone other than a partner who contributed Section 704(c) property, gain may be triggered under Section 704(c)(1)(B) or Section 737.  Therefore, it is difficult to see why parties would want to use this form, unless there are significant increases in the basis of partnership assets, most likely because partners had purchased interests when there was no Section 754 election in place.

The Internal Revenue Code does not recognize the “interests-over” form of merger, where partners of the merging partnership contribute their partnership interests to the surviving partnership.  Instead, this transaction is treated as an “assets-over” transaction due to complications in applying Section 704(c)(1)(B) and Section 737 to the partners of the merging partnership.

Some other factors to consider with a partnership merger are:

• Liability increases and decreases in a merger are netted.  Although not addressed in the Internal Revenue Code, changes in shares of Section 751 property and a distribution resulting from a net decrease in liabilities may trigger gain recognition.  A reverse Section 704(c) allocation could help avoid this gain. 
• The merging partnerships do not recognize depreciation recapture.  
• The partnership’s depreciation period and method remain the same as if there had been no transfer, but other accounting aspects, such as inventory method, do not. 
• An anti-abuse provision applies step-transaction and similar principles when the merger is part of a larger transaction, such as a disguised exchange of partnership interests.

Sources: IRS.gov, Bloomberg Tax

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