The IRS Targets Partnership Basis Shifting: New Disclosure Rules and Economic-Substance Risk

What happened

On June 17, 2024, the Treasury Department and IRS released a three-part package targeting related-party partnership basis-shifting transactions. The pieces work together:

• Notice 2024-54 announced two sets of forthcoming proposed regulations addressing the area.
• Proposed regulations (REG-124593-23) would designate certain related-party partnership basis-adjustment transactions as "transactions of interest" — a class of reportable transaction.
• Revenue Ruling 2024-14 applied the economic-substance doctrine under IRC § 7701(o) to several related-party basis-shifting fact patterns, concluding the IRS would disallow the claimed benefits.

The agency also announced a dedicated passthrough working group to develop further partnership guidance, signaling this is the start of sustained attention, not a one-off.

What the IRS is actually targeting

The techniques at issue exploit mechanical features of partnership taxation. Through distributions of property and transfers of partnership interests among related parties — and the basis-adjustment rules under §§ 732, 734(b), and 743(b), often paired with a § 754 election — basis can be moved from assets that generate little tax benefit to assets that are depreciable or amortizable, or shifted to reduce gain on a later sale.

The IRS's objection is not to the existence of these rules. It is to using them among related parties to manufacture basis, and the tax deductions or reduced gain that follow, without a meaningful change in economic position. Revenue Ruling 2024-14 walks through scenarios in which the agency views the non-tax consequences as insubstantial relative to the tax benefit, and states it will invoke § 7701(o) to deny the benefits.

Why "transaction of interest" status matters

Designating a transaction as a transaction of interest pulls it into the reportable-transaction regime, and that carries real consequences:

• both taxpayers and material advisors must disclose the transaction to the IRS on the prescribed forms
• failure to disclose a reportable transaction carries its own penalties under § 6707A, independent of whether the underlying position is ultimately sustained
• the disclosure itself flags the transaction for examination

The proposed regulations describe a threshold tied to the size of the basis increase within the covered category, so the regime is aimed at transactions of consequence rather than ordinary partnership activity. But for structures that fall within it, the obligation to come forward is the immediate change.

The economic-substance overlay raises the stakes

The most serious feature of the package is the economic-substance angle. When the doctrine under § 7701(o) applies and a transaction is found to lack economic substance, the accuracy-related penalty is strict liability — there is no reasonable-cause defense — and it runs at 20 percent of the underpayment, rising to 40 percent if the transaction was not adequately disclosed.

That combination is deliberate. A taxpayer who does not disclose faces both the reportable-transaction penalty and, if the economic-substance doctrine is applied, the higher 40 percent strict-liability penalty. Disclosure mitigates one exposure and reduces the other. The structure of the guidance pushes related-party basis-shifting transactions into the open and attaches a heavy cost to keeping them hidden.

What this means for existing and planned structures

The practical task has two parts: look back and look forward.

Looking back, partnerships and related-party groups that have implemented basis-adjustment transactions should evaluate whether any fall within the described category, what disclosure obligations now attach, and whether the positions can withstand an economic-substance challenge. The reportable-transaction rules can reach transactions already completed, so this is not purely a prospective concern.

Looking forward, any planned transaction that moves basis among related parties to create depreciation or reduce gain should be tested against the economic-substance doctrine before it is executed — not afterward. A transaction that produces a tax benefit far in excess of its non-tax effects is exactly the profile the IRS has described.

Key takeaways

• On June 17, 2024, the IRS issued a three-part package — Notice 2024-54, proposed regulations REG-124593-23, and Revenue Ruling 2024-14 — targeting related-party partnership basis shifting.
• The proposed regulations would make certain of these transactions reportable "transactions of interest," requiring disclosure by taxpayers and advisors.
• Revenue Ruling 2024-14 applies the economic-substance doctrine, which carries a strict-liability penalty of 20 percent, or 40 percent if undisclosed.
• A dedicated passthrough working group signals sustained enforcement attention.

What to do now

1. Review past basis-adjustment transactions for exposure.

Identify related-party transactions within the described category and assess disclosure obligations and economic-substance risk.

2. Test planned transactions before execution.

Any related-party basis shift aimed at depreciation or reduced gain should be evaluated under § 7701(o) in advance.

3. Coordinate taxpayer and advisor disclosure.

Reportable-transaction obligations run to both. Confirm who files what, and on time, to avoid § 6707A penalties.

Bottom line

The IRS has put related-party partnership basis shifting on notice, and it has chosen its tools carefully: mandatory disclosure on one side, a strict-liability economic-substance penalty on the other. For structures that fall within the category, the defensible path is to surface the transaction and stress-test its substance — before the agency does it for you.