Under the Tax Cuts and Jobs Act (“TCJA”), a taxpayer holding an “applicable partnership interest” is required to recalculate any net long-term capital gain realized “with respect to” the “applicable partnership interest” by applying a three-year holding period (instead of the standard one-year holding period). Internal Revenue Code (“IRC”) § 1061(a). If such calculation results in a lower amount of net long-term capital gain than the amount of net long-term capital gain realized utilizing the standard one-year holding period, the rule recharacterizes such difference as short-term capital gain. IRC § 1061(a) (flush language). Section 1061(a)(2) requires a taxpayer to recalculate its net long-term capital gain by “applying paragraphs (3) and (4) of sections 1222 by substituting ‘3 years’ for ‘1 year.’” IRC § 1061(a)(2).

Section 1061 applies to net long-term gain “with respect to” an applicable partnership interest. IRC §§ 1061(a)(1)-(2). This reference is intended to capture both gain realized on the disposition of the partnership interest and gain realized by the partnership on the disposition of a partnership asset and allocated to the holder of the partnership interest. With respect to gain realized from a disposition of the interest, the applicable holding period is the partner’s holding period in the partnership interest.

The Section 1061 rule  applies with respect to any partnership interest which, directly or indirectly, is transferred to (or is held by) a partner in connection with the performance of substantial services in any “applicable trade or business” by the partner, or any other person related to the partner. IRC § 1061(c)(1). An applicable trade or business is any activity conducted on a regular, continuous, and substantial basis, which (regardless of whether conducted in one or more entities) consists, in whole or in part, of (A) raising or returning capital and (B) either (i) investing in (or disposing of) specified assets (or identifying specified assets for such investing or disposition) or (ii) developing specified assets. IRC § 1061(c)(2). Whether a business is an applicable trade or business, “specified assets” means (i) securities (as defined in IRC § 475(c)(2) without regard to the last sentence thereof), (ii) commodities (as defined in IRC § 475(e)(2)), (iii) real estate held for rental or investment, (iv) cash or cash equivalents, (v) options or derivative contracts with respect to any of the foregoing, and (vi) an interest in a partnership to the extent of the partnership’s proportionate interest in any of the foregoing. IRC § 1061(c)(3).

 Section 1061 contains a number of exceptions. Section 1061 does not apply to:

  • Any partnership interest directly or indirectly held by a corporation. IRC § 1061(c)(4)(A).
  •  Any capital interest in the partnership which provides the partner with the right to share in capital commensurate with either (i) the amount of capital contributed (determined at the time of receipt of the interest), or (ii) the value of the interest subject to tax under IRC § 83 upon the receipt or vesting of the interest (e., as compensation income). IRC § 1061(c)(4)(B).
  • Any interests held by a person employed by another entity conducting a trade or business (which is not an applicable trade or business) and only provides services to such other entity. IRC § 1061(c)(1).
  • Any income or gain attributable to an asset not held for portfolio investment on behalf of third party investors. IRC § 1061(b). For purposes of this exception, a third party investor means a person who (i) holds an interest in the partnership which does not constitute property held in connection with an applicable trade or business, and (ii) is not (and has not been) actively engaged, and is (and was) not related to a person so engaged, in (directly or indirectly) providing “substantial services” for such partnership or any applicable trade or business. IRC § 1061(c)(5).

 If the applicable partnership interest is transferred (directly or indirectly) to a “related person”, the transferor is required to include in gross income as short-term capital gains the excess (if any) of the amount of the transferor’s long-term capital gains with respect to such interest that is attributable to the sale or exchange of any asset held for not more than three years that is allocable to that transferred interest, over the amount treated as short-term capital gain under IRC § 1061(a) relating to the transfer of that interest. IRC § 1061(d)(1). For purposes of this rule, a person is related to the partner if that person either (A) is a member of the partner’s family (within the meaning of IRC § 318(a)(1)), or (B) performed a service within the current, or three preceding, calendar years in any applicable trade or business in which the partner also performed a service. IRC § 1061(d)(2). These TCJA revisions are effective for taxable years beginning after December 31, 2017.


Unless expressly provided that the advice (“the advice”) contained in the above (“this message”) is intended to constitute written tax advice within the meaning of Section 10.37 of IRS Circular 230, this message is intended to communicate general information for discussion purposes only, and you should not, therefore, interpret the advice to be written tax advice.