Transcript CHAPTER 12 PARTNERSHIP DISTRIBUTIONS

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 predistribution

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, and
any partnership distributions

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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