CHAPTER 12

PARTNERSHIP DISTRIBUTIONS

OPERATING OR “CURRENT” DISTRIBUTIONS

Current distribution - a distribution that does not completely terminate the partner’s interest in the partnership

Generally a current distribution of either cash or property is a nontaxable transaction to both the recipient partner and the partnership The partnership reduces the recipient partner’s

capital account and recognizes no taxable gain or loss (but would recognize a book gain or loss)

OPERATING OR “CURRENT” DISTRIBUTIONS (CONT.)

The recipient partner generally reduces their outside basis by the basis of property received, takes a carryover basis in the distributed property, and recognizes no gain or loss Limitation: if the partner receives cash

distribution in excess of the tax basis of the partnership interest, the partner is required to recognize taxable capital gain to the extent of the excess

OPERATING OR “CURRENT” DISTRIBUTIONS (CONT.)

Mid-year advances and partner “draws” against the partner’s share of income Distributions of money or property during the

partnership taxable year Treated as distributions made on the last day of

the partnership’s taxable year Deemed money distributions caused by a reduction in

a partner’s share of partnership liabilities also receive draw treatment

PROPERTY DISTRIBUTIONS – CONSEQUENCES TO THE PARTNERSHIP

The partnership takes the property off its books and reduces the partner’s capital account by the FMV of the distribution Book gain or loss recognized No restrictions on the amount by which the

partner’s capital balance can be reduced Unlike tax basis, the partnership can reduce

partner capital to negative

PARTNER’S BASIS IN DISTRIBUTED PROPERTY

General Rule—Carryover Basis The partner takes a carryover basis in the

property received , and reduces his or her outside basis by the same amount

Exception: If the partnership’s basis in the distributed

property exceeds the partner’s outside basis, the outside basis becomes the basis of the property.

The partner’s outside basis is reduced to zero

PARTNER’S BASIS IN DISTRIBUTED PROPERTY (CONT.)

Effect of Prior Partnership-level Basis Adjustments The partner’s basis in the distributed property

includes prior §734(b) basis adjustments (arising from prior distributions), but does not include prior §743(b) basis adjustments (arising from transfers of interests in the partnership)

PARTNER’S BASIS IN DISTRIBUTED PROPERTY (CONT.)

Character and Holding Period of Distributed Property Unrealized appreciation or depreciation inherent

in the distributed property will be taxed to the partner when the property is subsequently disposed

The partner’s holding period for the property includes the partnership’s holding period

PARTNER’S BASIS IN DISTRIBUTED PROPERTY (CONT.) Character and Holding Period of Distributed

Property The character of gain or loss on disposition

Unrealized receivables: ordinary income Depreciation recapture: ordinary income Inventory: ordinary income only for five years following the

distribution After five years, the character depends on how it is held or

used by the distributee partner Other property: depend on the partner’s use of such property

or purpose for holding it

LIQUIDATING DISTRIBUTIONS

Liquidating distribution – a distribution that completely terminates the partner’s interest in partnership capital and profits

General Rule Nontaxable transaction to both the partner and

the partnership The partner takes a tax basis in the distributed

property equal to the partner’s outside basis pre-distribution

CHAPTER 11

SALE OF A PARTNERSHIP INTEREST

GAIN OR LOSS UPON THE SALE OF PARTNERSHIP INTEREST

General rule: A partnership interest is a capital asset, and any

gain or loss on its sale will be a capital gain or loss

Gain or loss realized : the amount realized for the transfer of the partner’s partnership interest less the adjusted basis in the partnership interest (“outside basis”)

GAIN OR LOSS UPON THE SALE OF PARTNERSHIP INTEREST (CONT.)

Exceptions Gain or loss allocable to the share of net

appreciation or depreciation in the partnership’s ordinary income assets is generally taxed as ordinary income or loss The remainder is capital gain or loss

Gain equal to the partner’s share of the partnership’s appreciation of collectibles is treated as collectibles gain

GAIN OR LOSS UPON THE SALE OF PARTNERSHIP INTEREST (CONT.)

Exceptions Long-term gain allocable to the share of the

partnership’s unrecaptured Code Section 1250 depreciation is taxed at maximum 25%

AMOUNT REALIZED

The amount realized on the sale of a partnership interest is the amount of cash and the FMV of any property received, plus the liability relief realized by the selling partner in connection with the transaction

Debt relief usually takes the form of a decreased share of partnership liabilities

ADJUSTED BASIS IN PARTNERSHIP INTEREST

Adjusted basis in partnership interest: the sum of original tax basis on the day acquisition, plus adjustments reflecting operations during holding period

The calculation of the initial basis varies based on the way in which the partner acquired the interest

ADJUSTED BASIS IN PARTNERSHIP INTEREST (CONT.)

General Rule - §705(a) : Also called historical method/approach The beginning adjusted basis:

If obtained through a contribution to the partnership, the initial basis is equal to the amount of cash plus the tax basis of property contributed

If a partner purchased a partnership interest, the partner takes a cost basis in the interest

ADJUSTED BASIS IN PARTNERSHIP INTEREST (CONT.)

General Rule - §705(a) : The beginning adjusted basis:

If a partner obtained the interest by inheritance and got a stepped-up (or stepped-down) basis in the partnership interest, the initial basis is equal to its FMV at the date of the decedent’s death or at the alternative valuation date, increased by his or her share of the partnership’s debt

ADJUSTED BASIS IN PARTNERSHIP INTEREST (CONT.)

General Rule - §705(a) : The beginning adjusted basis is then increased

by the partner’s share of partnership taxable income and tax exempt income, as well as the basis of any further contributions of property

The beginning adjusted basis is decreased by the partner’s share of partnership losses, expenses incurred in producing tax-exempt income, nondeductible/ non-capitalized expenditures,15

and any partnership distributions

ORDINARY INCOME FROM THE SALE OF A PARTNERSHIP

§751(a) states that amount realized on the sale of a partnership interest which is attributable to unrealized receivables or inventory is treated as ordinary income

ORDINARY INCOME FROM THE SALE OF A PARTNERSHIP (CONT.)

Definition of Unrealized Receivables The rights to receive payments for goods and

services provided or to be provided, including: Depreciation recapture Excess depreciation Mining exploration expenses recapture Stock in a D.I.S.C.13 or certain foreign corporations Franchises, trademarks, etc Oil, gas or geothermal property Excess farm loss recapture Market discount bonds and short-term obligations

ORDINARY INCOME FROM THE SALE OF A PARTNERSHIP (CONT.)

Definition of Inventory Three categories of inventory:

First category: true inventory and dealer property held primarily for sale to customers in the ordinary course of the partnership’s business

Second category: property other than capital asset when sold or exchanged by the partnership, including: A/R of cash-basis taxpayer Realized A/R of accrual-basis taxpayer Depreciation recapture, and All unrealized receivable

ORDINARY INCOME FROM THE SALE OF A PARTNERSHIP (CONT.)

Definition of Inventory Three categories of inventory:

Third category: any other partnership property that would be either §1221(1) property, other noncapital assets, or non §1231(b) property if it were held by the selling partner

If selling partner is required to recognize ordinary income that exceeds the total gain on the sale, the partner will recognize a capital loss in the amount of the excess

COLLECTIBLES AND UNRECAPTURED §1250 GAIN (CONT.)

Unrecaptured §1250 Gain Definition: the depreciation that has been taken

on real property, less the depreciation that is recaptured as ordinary income

Under current law, gain will be classified as unrecaptured §1250 gain to the extent of accumulated depreciation deductions on the property

COLLECTIBLES AND UNRECAPTURED §1250 GAIN (CONT.)

Unrecaptured §1250 Gain Unrecaptured §1250 gain cannot exceed the gain

recognized on the sale of the asset Unrecaptured §1250 gains are subject to a

maximum tax rate of 25 percent These rules apply only when a partner has held

the partnership interest for long term

INSTALLMENT SALE OF A PARTNERSHIP INTEREST (CONT.)

Meanwhile, the installment method is not available for the sale of inventory, and the ordinary income attributable to the portion of inventory must be reported in its entirety in the year of sale

ABANDONMENTS AND GIFTS OF A PARTNERSHIP INTEREST (CONT.)

If the gift is to a charity, the amount of the charitable contribution deduction is based upon the type of property held by the partnership The amount of the charitable contribution is

reduced to the extent that the partner would recognize ordinary income had the partnership interest is sold

LIKE-KIND EXCHANGES OF PARTNERSHIP INTERESTS

§1031(a)(2)(D) A partnership interest exchanged for a

partnership interest in the same or another partnership does not qualify for nonrecognition exchange under this section

LIKE-KIND EXCHANGES OF PARTNERSHIP INTERESTS ( CONT.)

§1031(a)(2)(D) As a result,

Exchanges of interests in different partnerships are taxable

Exchanges of interests in the same partnerships are taxable

But changes in status (such as from general partner to limited partner) are not taxable unless collateral rules apply to cause a taxable event

LIQUIDATING DISTRIBUTIONS (CONT.) CHAPTER 12 - CONTINUED

Recognition of Gain or Loss by Distributee Partner If the receipt of cash (including liability relief)

exceeds the partner’s outside basis, the partner must recognize gain in the amount of the excess

In an all-cash liquidating distribution, if cash received (including liability relief) is less than the partner’s tax basis in the partnership interest, the partner recognizes loss

LIQUIDATING DISTRIBUTIONS (CONT.)

Recognition of Gain or Loss by Distributee Partner In an all-cash and/or ordinary income assets

liquidating distribution, if cash plus tax basis of the ordinary income assets received is less than the partner’s outside basis, the partner recognizes a loss

Capital loss

LIQUIDATING DISTRIBUTIONS (CONT.)

Property Distributions and Determination of Basis The partner’s outside basis must be adjusted for

the partner’s share of partnership income or loss This adjusted basis is then reduced by the

amount of cash received The remainder becomes the partner’s tax basis

in property received in the distribution

DISPROPORTIONATE DISTRIBUTIONS

when a distribution changes the partner’s proportionate share of “hot assets”, the distribution is partially recast as a taxable exchange Hot assets: ordinary income assets of

“unrealized receivables and “substantially appreciated inventory”

DISPROPORTIONATE DISTRIBUTIONS (CONT.)

When a partner receives more than his or her share of hot assets (an “excess” share), the partner will report capital gains for his or her “excess” share of the appreciation in capital gain assets that remain in the partnership There is a hypothetical distribution of the

partner’s share of all assets to the partner This is followed by a hypothetical exchange of

capital gain assets to the partnership for the “excess” share of hot assets actually received.

DISPROPORTIONATE DISTRIBUTIONS (CONT.)

The portion of the ordinary income assets received in the deemed “exchange” will have a basis to the distributee equal to their FMV (their “cost” in the exchange)

The remaining ordinary income assets and capital gain assets will have a carryover basis from the partnership

DEFINITION OF UNREALIZED RECEIVABLES

Unrealized receivables - right to receive payments for goods and services provided or to be provided, but also including:

Depreciation recapture Excess depreciation under §1250 Mining exploration expenses recapture Franchises, trademarks Oil, gas or geothermal property Excess farm loss recapture Market discount bonds and short-term obligations Stock in a D.I.S.C. or certain foreign corporations

DEFINITION OF SUBSTANTIALLY APPRECIATED INVENTORY

First, the asset must constitute inventory - §751(d) sets out four categories of inventory items

Second, the inventory must be substantially appreciated Substantially appreciated: the aggregate FMV of

all of the inventory exceeds 120 percent of its aggregate basis

DEFINITION OF SUBSTANTIALLY APPRECIATED INVENTORY (CONT.)

Four categories of inventory: True inventory and dealer property held primarily

for sale to customers in the ordinary course of the partnership’s business

Property other than a capital asset and a §1231(b) asset, including, A/R of a cash-basis taxpayer and an accrual-basis

taxpayer Depreciation recapture, and all other unrealized

receivables

DEFINITION OF SUBSTANTIALLY APPRECIATED INVENTORY (CONT.)

Four categories of inventory: Potential gain from the sale of §1246 stock Any other partnership property that would be

either §1221(1) property, other noncapital assets or non-§1231(b) property, or property giving rise to potential gain from the sale of §1246 stock if it were held by the distributee partner

DISTRIBUTION OF MARKETABLE SECURITIES

The term “money” generally includes “marketable securities”

Thus, a partner recognizes gain to the extent the value of the distributed securities exceeds the partner’s basis in partnership interest

However, a partner can receive marketable securities attributable to his or her share of the net appreciation of the partnership’s marketable securities without recognizing gain

DISTRIBUTION OF MARKETABLE SECURITIES (CONT.)

Non-recognizing gain calculation: reducing the amount of marketable securities treated as money by the excess of The partner’s share of net gain recognized if all

securities of the type distributed held by the partnership immediately before the transaction were sold for FMV, over

The partner’s share of gain recognized if the securities held by the partnership immediately after the transaction had been sold

DISTRIBUTION OF MARKETABLE SECURITIES (CONT.)

As long as a partner’s inside basis in the assets of a partnership are equal to the partner’s outside basis, the partner can withdraw his or her full distributive share of marketable securities without recognizing any gain under §731

DISTRIBUTION OF MARKETABLE SECURITIES (CONT.)

Thus, if the partner forego a non-appreciated interest in other assets in return for the distribution of marketable securities, the partner shall not recognize gain to the extent the partner has outside basis in the partnership interest that matches his or her share of inside basis in such other assets