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made in a similar manner as the allocations made to the Unrelated Non-Service
Partners.
(C) GP Capital Interest Allocation Analysis. GP is allocated $2,160 from PRS,
consisting of a $2,000 API allocation and a $160 Capital Interest Allocation. The $160
Capital Interest Allocation is allocated equally to A, B, and C based on their capital
contributions to GP. Therefore, they qualify as Capital Interest Allocations by GP. See
paragraph (c)(5) of this section. The $2,000 of gain allocated by PRS’s to GP with
respect to GP’s API cannot be treated as a Capital Interest Allocation by GP and
therefore is subject to section 1061. In summary, A, B, and C are each allocated $720
of capital gain from PRS ($2,160/3). Of this amount, $667 is API Gain ($2,000/3) and
$53 is a Capital Interest Allocation ($160/3).
(ii) Example 2: Sale of a Passthrough Interest--(A) Facts. In Year 1, A, B, and C
form GP, a partnership. Each of A, B, and C contributes $100 to GP and is an equal
partner in GP. The contributions are not attributable to loans or advances described in
§1.1061-3(c)(3)(v)(A). GP invests the $300 in Asset X in Year 1. GP is also the general
partner of PRS, a partnership. PRS’s other partners are Unrelated Non-Service
Partners. GP holds a 20% profits interest in PRS that is an API that GP received in
exchange for providing substantial services to PRS in an ATB. GP’s API is an Indirect
API to each of A, B, and C. Each of GP and PRS makes allocations to its partners in
accordance with its partners’ interests in that partnership, as described in §1.704-
1(b)(3). In Year 3, A sells A’s interest in GP to an unrelated third party for $800 and
recognizes $700 of capital gain on the sale. If PRS had sold its assets in a hypothetical
asset sale as required by paragraph (c)(4)(ii)(A) of this section and liquidated
immediately before A sold its interest in GP, GP would have been allocated $1,800 of
long-term capital gain with respect to GP’s API in PRS, and GP would have allocated
$600 of this $1,800 to A. If GP sold Asset X for its fair market value and liquidated
immediately before A sold its interest in GP, A would have been allocated $100 of long-
term capital gain.
(B) Analysis. GP does not have a capital interest in PRS. Therefore, its
allocations from PRS are allocations with respect to its API which are subject to section
1061. The total gain allocable to A as a result of the hypothetical liquidations would be
$700. Under §1.1061-3(c)(4)(ii)(D), $100 of the $700 of A’s interest sale gain is A’s
Capital Interest Disposition Amount, and is not subject to section 1061.
(iii) Example 3: Reinvestment of Realized API Gain. A, B, and C are partners in
PRS, a partnership. At the beginning of Year 1, A is issued an API in PRS in exchange
for providing substantial services to PRS in an ATB. A has no capital interest in PRS.
During Year 1, PRS’s assets appreciate by $100. At the end of Year 1, under the terms
of its partnership agreement, if PRS were to sell all of its assets at their fair market
value and distribute the proceeds in a complete liquidation, A would receive $20 with
respect to its API. Thus, at the end of Year 1, A has $20 of Unrealized API Gain. In
Year 2, PRS sells Asset X, an asset that PRS owned in Year 1, and allocates $8 of the
long-term capital gain to A as API Gain. As a result, $8 of A’s $20 of Unrealized API