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)

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

Liquidating Distributions (Cont.)

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

Chapter 11Sale of a Partnership

Interest

Gain or Loss on the Sale of a 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 on the Sale of a 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 on the Sale of a 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 the 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 the 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 the 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 the 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

Adjusted Basis in the Partnership Interest (Cont.)

Adjustments to Basis for Changes in Partner’s Share of Liabilities Under historical approach:

Any increase or decrease in the share of partnership debt is looked as a deemed money contribution or distribution

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

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

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

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