The Repeal of the Technical Termination Rule

A technical termination was an event under former U.S. tax law where a partnership was considered closed for tax purposes following a significant change in ownership, even if the business continued its operations. The trigger was the sale or exchange of 50% or more of the total interests in partnership capital and profits within a 12-month period. This rule, found in Internal Revenue Code Section 708, created a legal fiction where the old partnership ceased to exist for tax accounting and a new one was instantly formed.

The rule’s primary function was to address substantial shifts in partnership ownership. Even if a partnership’s name, location, and business activities remained identical, its tax identity was forced to reset. The termination was “technical” and did not mean the partnership had legally dissolved or liquidated its assets. It was a tax-driven event with significant compliance and financial consequences for the partners.

The Repeal of the Technical Termination Rule

The Tax Cuts and Jobs Act of 2017 (TCJA) repealed the technical termination rule. This legislative action eliminated the clause triggering a termination upon the sale or exchange of 50% or more of its interests. The repeal was effective for partnership taxable years beginning after December 31, 2017, meaning partnerships no longer face automatic termination for tax purposes due to a major ownership change.

This change simplifies partnership tax law. Before the TCJA, the rule created administrative burdens and adverse financial outcomes that were not aligned with the business’s continuation. The repeal means a partnership’s existence for tax purposes continues uninterrupted unless it ceases to carry on any business, aligning the tax treatment more closely with economic reality.

The elimination of this rule was a favorable development for partnerships and investors. It removed a layer of complexity that often led to compliance issues. Now, the focus after a large ownership transfer shifts from the entity’s survival to the tax attributes of the buying and selling partners, providing more certainty.

Consequences Under the Former Rule

Under the former rule, a technical termination triggered a series of mandatory tax events. The most immediate consequence was the forced closure of the partnership’s taxable year on the date of the ownership change. This required the partnership to file a final Form 1065 for the short taxable year, often resulting in two tax filings within a single calendar year.

Following the tax year’s close, regulations prescribed a “deemed” transaction with significant implications. The terminated partnership was treated as if it had distributed all its assets and liabilities to its partners. Immediately after, those same partners were treated as recontributing the assets and liabilities into a new partnership, a sequence that was a legal fiction for tax purposes.

A substantial negative consequence was the impact on depreciation. When assets were deemed recontributed to the new partnership, their tax basis for depreciation was reset. Depreciable property, such as buildings or equipment, had to be treated as newly placed in service. This reset resulted in less favorable depreciation deductions, as the new partnership could not continue the schedules established by the old one.

This process also meant any tax elections made by the old partnership became void, requiring the new partnership to make new elections. The administrative burden of tracking these deemed transactions, filing short-year returns, and establishing new depreciation schedules was considerable. Understanding these historical rules remains relevant for any partnership that underwent such an event before 2018 or is facing an audit.

Current Partnership Treatment After a Major Ownership Change

With the repeal, a partnership’s tax year no longer closes for the entity following a major ownership change. The partnership continues its tax year uninterrupted, and its asset depreciation schedules and tax elections remain in place. This provides stability and removes previous administrative burdens. The partnership files a single Form 1065 for its full tax year, regardless of ownership transfers.

The tax consequences of a large ownership transfer now focus on the partners involved in the sale. The partnership’s tax year closes only for the selling partner, who must report their share of partnership items up to the sale date. The partnership allocates these items between the selling and purchasing partners using either an “interim closing method” or a “proration method.”

A Section 754 election has become a more prominent tool for addressing ownership changes. If a partnership has this election in effect, the purchasing partner can receive a Section 743(b) basis adjustment. This adjustment steps up the new partner’s share of the inside basis of the partnership’s assets to reflect their purchase price. This allows for larger depreciation deductions for that specific partner without affecting others.