Exchanging IDRs in an MLP
EXCHANGING IDRS IN AN MLP for common units did not trigger income taxes, the IRS said.
The key was the parties structured the exchange so that there was no capital shift among the partners.
The IRS analyzed the exchange in an internal memo written by the national office to the field, or the part of the IRS that audits taxpayers. The memo, released as Chief Counsel Advice 201517006, was made public in late April.
IDRs, short for incentive distribution rights, are a right the general partner of a master limited partnership or yield co retains to an increasing share of cash flow as distributions to investors increase over time. For example, the general partner might be distributed 15% of net cash flow off the top after cash distributions to inves-tors take them above 125% of minimum quarterly distributions and 25% after distributions to investors move past 150%.
The general partner in the case under audit traded incentive distribution rights for new common units and less valuable IDRs with higher thresholds before the general partner would receive more cash and a lower percentage of cash for the general partner at each threshold. The new units were designed to give the general partner the same amount of cash overall as before.
Each partner has a “capital account” that is his claim on the assets if the partnership liquidates.
The partnership assets had appreciated significantly by the time of the exchange. However, the capital accounts had not been adjusted to reflect this appreciation. IRS regulations allow partnerships to “book up,” or adjust capital accounts for appreciation, after certain events, such as when a new partner or existing partner makes a capital contribution in exchange for a partnership interest. According to the IRS, the general partner would have taken a capital account in the new common units it received for the IDRs that was above the capital accounts the investors had in their equivalent common units, making the common units no longer fungible.
Therefore, the general partner made a capital contribution for the new common units, allowing the partnership to book up the investor capital accounts for the appreciation. There was enough appreciation in partnership assets to equalize the capital accounts on the common units without having to reduce anyone’s capital account.
The IRS national office told the field that such a restructuring of the general partner interest was simply an adjustment in the ratio in which the existing partners shared in partnership returns and not a taxable exchange. The memo suggests that the result might have been different if there had been a capital shift from some partners to other partners.
Keith Martin in Washington