How Tax Works – Episode 43: Allocations Under IRC 704(c)

Host: Matthew Foreman, Co-Chair of Falcon Rappaport & Berkman’s Taxation Practice Group
Release Date: January 5, 2026

Main Theme

Purpose:
This episode provides an accessible yet thorough breakdown of partnership allocations under IRC Section 704(c), focusing mainly on depreciation. Host Matt Foreman demystifies why these rules matter, how allocations work, and details the three primary allocation methods (traditional, curative, remedial) with engaging real-world examples. The episode caters to accountants, lawyers, business owners, and anyone aiming to confidently navigate complex partnership tax issues.

Key Discussion Points & Insights

1. Why Partnership Tax Is So Complex

• Partnerships are extremely flexible, which is beneficial for taxpayers but technically challenging.
• Contributions to a partnership are generally tax-free (Sec. 721), unless:
  • Liabilities exceed the basis
  • The contribution is a disguised sale
  • The partnership is an investment company
• Property contributed carries over its tax characteristics (inside/outside basis).
• Book basis is reset to fair market value at contribution, leading to allocation issues (the 704(c) “problem”).

2. The Core Issue: Depreciation Allocations

• Depreciation: Reflects the economic decline in an asset’s value (“Depreciation ... reflects the decline in an asset's value over ... useful life due to ordinary wear and tear, passage of time, change in capacity or other physical and environmental factors.” [12:16])
• Allocations become complex when contributed assets have built-in gain (FMV > Tax Basis).
• Sec. 704(c) requires that depreciation be allocated “to minimize built-in gain between partners” ([16:57]).

3. Overview of 704(c) Methods

• Four methods allowed by regulation:
  • Traditional
  • Traditional with curative allocations
  • Remedial
  • Any other “reasonable method”
• You must choose one method per item; combination of methods must be reasonable ([20:00]).

a) Traditional Method

• Allocate book depreciation according to the partnership agreement.
• Allocate tax depreciation first to non-contributing partners, up to their book allocation; remainder to contributing partner.
• Example:
  • Alma contributes a printer to Acme Partnership (FMV $500, Basis $300, 10 years left), Barry contributes $500 cash.
  • Tax depreciation: $300 over 10 years → $30/year
  • Book depreciation: $500 over 10 years → $50/year
  • Tax allocations: Barry gets $25, Alma gets $5 per year (even though both receive $25 book allocation).
  • Quote: “... even though she's a $25 book allocation, she's gonna have a $5 tax allocation...” ([23:00])

b) Ceiling Rule

• Limits the total tax depreciation to the total available on the contributed property.
• Can cause a distortion – the non-contributing partner does not receive as much tax depreciation as their book allocation implies.
• Quote: “The ceiling rule ... limits a non-contributing partner’s total tax depreciation to the amount of that partner’s book tax allocation.” ([25:10])

c) Traditional with Curative Allocations

• Fixes ceiling rule “distortion” by reallocating other partnership items of income or loss (“curative allocation”).
• Example: $5 lost depreciation (due to ceiling rule) is “repaired” by allocating $5 of income/revenue to the contributing partner (Alma), which nets out for the non-contributing partner (Barry).
• Quote: “By allocating five extra dollars of income to Alma, it’s the same as giving an extra $5 deduction to Barry.” ([29:45])
• Must be reasonable: Cannot exceed the amount required to offset the ceiling rule distortion.

d) Remedial Method

• Creates notional income and offsetting loss – “out of thin air” – to fix the ceiling rule distortion.
• No need for actual partnership income/revenue to perform the fix.
• Quote: “The remedial method essentially creates an income and offsetting loss ... The income and loss offset each other. So the net effect is actually zero.” ([31:24])

e) Other Reasonable Methods

• While regulations invite “any reasonable method,” in practice the three main methods suffice.
• Quote: “I’m not convinced there’s actually other reasonable methods other than the three ... The overall method or the combination of methods is actually the ‘any reasonable method’.” ([33:30])

Notable Quotes & Memorable Moments

• “This is your world, so I’m just living in it.” ([04:10])
  Matt’s signature lighthearted tone, inviting listener input on future topics.

• On the ceiling rule:
  “The ceiling rule ... is not really a rule, it’s more of a result. I don’t get to choose the names. I promise you, if I did, they’d be much more fun because I’m the kind of guy who calls a podcast ‘How Tax Works’.” ([25:00])

• On the simplicity of using straight line depreciation:
  “I’m going to pretend only straight line exists for two reasons. One, it’s simpler, and, and two, it’s simpler. You might say Matt, those are the same. And I said great, you’re listening.” ([14:30])

• Practical advice:
  “If you’re just a partnership and the partnership’s making a decision, model out what you have to do. Again, you can do it on every asset. That’s different. I generally tell people to pick one and stick with it.” ([36:45])

Timestamps for Important Segments

| Timestamp | Segment | Summary/Key Point | |-----------|----------------------------------------|-------------------------------------------------------------------------------| | 01:00 | Introduction/Overview | Outline of 704(c) allocation issues and episode structure | | 07:00 | Why contributions are tax-free | Nuances of liability, disguised sale, and investment company exceptions | | 12:16 | Depreciation explained | Economic background and relevance | | 14:30 | Depreciation methods (Makers, etc.) | Simplifying to straight-line for examples | | 16:57 | The central problem of 704(c) | Built-in gain and depreciation mismatch | | 20:00 | 704(c) allocation methods intro | Overview and regulatory requirements | | 21:40 | Traditional method, detailed example | Walkthrough of classic allocation math | | 25:10 | The Ceiling Rule explained | How and why allocations are limited | | 29:45 | Traditional with curative allocations | How to "fix" the ceiling rule with partnership income allocations | | 31:24 | Remedial method explained | Notional allocations solve the problem even without actual income | | 33:30 | Other reasonable methods | Discussion on practical application and IRS’s “stick” | | 36:45 | Choosing what method to use | Negotiation and practical guidance | | 38:00 | Closing remarks | Resources, next episode teaser, and New Year wishes |

Tone and Style

• Accessible, witty, and practical.
• Matt frequently cracks jokes (“If I did choose the names, they’d be much more fun”) and offers real-world observations.
• He never loses sight of the practical implications for partnerships, consistently advising listeners to model out scenarios and keep things consistent.

Conclusion

Matt Foreman’s episode on IRC 704(c) allocations is a brisk, lucid tour through one of partnership tax’s gnarliest thickets. With humor and practical wisdom, Matt demystifies the technical mechanics of depreciation allocations, offers a clear analysis of traditional, curative, and remedial methods, and provides sensible advice on choosing the right approach. Accountants, lawyers, and business owners will come away with a far greater confidence in navigating 704(c)—and may even be inspired to check out his webinar for a deeper dive.

Contact:
Questions, comments, or webinar/podcast requests? Email Matt via his FRB Law email address (details on the firm's website).
Next episode: Common mistakes and misconceptions under Section 1202 (Qualified Small Business Stock exclusion).