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Chapter 11

Chapter 11. Partnerships: Distributions, Transfer of Interests, and Terminations. Distributions from a Partnership (slide 1 of 4). A payment from a partnership to a partner is not necessarily treated as a distribution

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Chapter 11

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  1. Chapter 11 Partnerships: Distributions, Transfer of Interests, and Terminations

  2. Distributions from a Partnership(slide 1 of 4) • A payment from a partnership to a partner is not necessarily treated as a distribution • e.g., Partnership may pay interest or rent to a partner, make a guaranteed payment, or purchase property from a partner • If a payment is treated as a distribution, it will fall into one of two categories: • Liquidating distributions • Nonliquidating distributions • Depends on whether the partner remains a partner in the partnership after the distribution

  3. Distributions from a Partnership (slide 2 of 4) • A liquidating distribution occurs when either: • Partnership itself liquidates and distributes all its property to the partners, or • Ongoing partnership redeems interest of one of its partners • e.g., Partner retires

  4. Distributions from a Partnership (slide 3 of 4) • A nonliquidating distribution is any distribution from a continuing partnership to a continuing partner • Two types of nonliquidating distributions • Draw • Distribution of partner’s share of current or accumulated profits • Partial liquidation • Reduces partner’s interest in partnership capital but does not liquidate partner’s interest

  5. Distributions from a Partnership(slide 4 of 4) • Distributions from a partnership may be either: • Proportionate—Partner receives his or her share of certain ordinary income-producing assets • Disproportionate—Partner’s share of certain ordinary income-producing assets increases or decreases

  6. Proportionate Nonliquidating Distributions (slide 1 of 3) • In general, neither partner nor partnership recognizes gain or loss on proportionate nonliquidating distributions • Partner usually takes a carryover basis in assets distributed • Basis in partnership interest is reduced by amount of cash and basis of property distributed

  7. Proportionate Nonliquidating Distributions (slide 2 of 3) • Partner recognizes gain to extent cash received exceeds partner’s adjusted basis (outside basis) in partnership interest • Reduction in partner’s share of partnership debt is treated as a distribution of cash • First reduces partner’s basis in partnership • Any reduction in excess of partner’s basis in partnership results in taxable gain to the partner • Partner cannot recognize loss on a proportionate nonliquidating distribution

  8. Proportionate Nonliquidating Distributions (slide 3 of 3) • Property distributions • In general, no gain recognized on a property distribution • If inside basis of property distributed exceeds partner’s outside basis in partnership interest, distributed asset takes substituted basis • Assets are deemed distributed and basis applied in a certain order

  9. Ordering Rules • 1. Cash • 2. Unrealized receivables and inventory • 3. All other assets • Basis is allocated to assets within a category based on adjusted basis to partnership

  10. Bill’s basis in partnership interest: $30,000 Proportionate nonliquidating distributions (independent fact situations): Assets Distributed A B C . Cash $15,000 $15,000 $ 5,000 Land—basis N/A $ 6,000 N/A (Fair mkt value) N/A $10,000 N/A Accts rec—basis N/A N/A -0- (Fair mkt value) N/A N/A $16,000 Proportionate Nonliquidating Distribution Examples (slide 1 of 6)

  11. A B C. Basis in interest $30,000 $30,000 $30,000 Cash distributed ( 15,000)(15,000)(5,000) Basis after cash 15,000 15,000 25,000 Acct. rec. distrib. N/A N/A (-0-) Basis after A.R. 15,000 15,000 25,000 Land Distrib. N/A ( 6,000) N/A Basis after all dist. $15,000 $ 9,000 $25,000 Proportionate Nonliquidating Distribution Examples (slide 2 of 6)

  12. A B C . Basis in p’ship int. $15,000 $9,000 $25,000 Basis in cash 15,000 15,000 5,000 Basis in land N/A 6,000 N/A Basis in A/R N/A N/A -0- Total basis $30,000 $30,000 $30,000 Sale of non-cash assets at FMV: Selling price N/A $10,000 $16,000 Basis N/A (6,000) (-0-) Gain N/A $4,000 $16,000 Proportionate Nonliquidating Distribution Examples (slide 3 of 6)

  13. Bill’s basis in partnership interest: $30,000 Proportionate nonliquidating distributions (independent fact situations): Assets DistributedD E F . Cash $40,000 N/A $20,000 Relief of liabilities N/A 40,000 N/A Land-basis N/A N/A $30,000 (Fair mkt value) N/A N/A $50,000 Proportionate Nonliquidating Distribution Examples (slide 4 of 6)

  14. D E F . Basis in interest $30,000 $30,000 $30,000 Cash distributed (40,000) N/A (20,000) Relief of liabilities N/A (40,000) N/A Gain recognized 10,000 10,000 N/A . Basis after cash (and deemed cash) dist. -0- -0- 10,000 Land distrib. N/A N/A (10,000) Basis after all distrib. -0- -0- -0- Proportionate Nonliquidating Distribution Examples (slide 5 of 6)

  15. D E F. Basis in p'ship int. -0- -0- -0- Basis in cash 40,000 N/A 20,000 Liabilities relieved N/A 40,000 N/A Basis in land N/A N/A 10,000 Gain recognized (10,000)(10,000) N/A . Original basis 30,000 30,000 30,000 Sale of non-cash assets at FMV: Selling price N/A N/A $50,000 Basis N/A N/A (10,000) Gain N/A N/A $40,000 Proportionate Nonliquidating Distribution Examples (slide 6 of 6)

  16. Effect of Liquidating Distribution • In general: • No gain or loss is recognized by partnership • Partner reduces basis in partnership interest by basis in property received at each level using Ordering Rules • Partner’s entire basis in interest will be absorbed by distributed assets

  17. Exceptions to Liquidating Distribution Rules (slide 1 of 2) • Gain is recognized if: • Cash distributed exceeds partner’s basis • Precontribution gain exceptions • Disproportionate distribution

  18. Exceptions to Liquidating Distribution Rules (slide 2 of 2) • Loss is recognized only if: • Assets received include only cash, unrealized receivables and inventory, and • Outside basis exceeds partnership’s inside basis in distributed property

  19. Bill’s basis in partnership interest: $30,000 Proportionate liquidating distributions (partnership also liquidates) (independent fact situations): G H I. Cash $50,000 $10,000 $10,000 Unrealized rec. N/A -0- -0- (Fair mkt value) N/A $16,000 $16,000 Filing cabinet (1231) N/A N/A 300 (Fair mkt value) N/A N/A 300 Proportionate Liquidating Distribution Examples (slide 1 of 4)

  20. G H I . Basis in interest $30,000 $30,000 $30,000 Cash distribution (50,000)(10,000)(10,000) Gain recognized 20,000 N/A N/A Basis after cash -0- 20,000 20,000 A/R distrib. N/A -0- -0- Loss recognized N/A (20,000) N/A Basis after A/R -0- -0- 20,000 Filing cabinet N/A N/A (20,000) Ending basis $ -0- $ -0- $ -0- Proportionate Liquidating Distribution Examples (slide 2 of 4)

  21. G H I. Basis in p’ship int. $ -0- $ -0- $ -0- Basis in cash 50,000 10,000 10,000 Basis in A/R N/A -0- -0- Basis in filing cabinet N/A N/A 20,000 Capital (Gain)/loss (20,000) 20,000 N/A . Original basis $30,000 $30,000 $30,000 Proportionate Liquidating Distribution Examples (slide 3 of 4)

  22. Sale of non-cash assets at FMV: Example H: A/R Fil.Cab. Total. Selling price $16,000 N/A $16,000 Basis -0- N/A -0- . Gain/(loss) $16,000 N/A $16,000 (Ordinary) Example I: Selling price $16,000 $ 300 $16,300 Basis -0- 20,000 20,000 Gain/(loss) $16,000 ($19,700) ($3,700) (Ordinary) (May be ord) Proportionate Liquidating Distribution Examples (slide 4 of 4)

  23. Property Distributions with Special Tax Treatment (slide 1 of 4) • Disguised sales • Contribution of appreciated property to partnership followed by a cash distribution to the contributing party may be treated as a disguised sale • Treated as a sale of property resulting in gain recognition • Partnership’s basis in the asset is cost

  24. Property Distributions with Special Tax Treatment (slide 2 of 4) • Marketable securities • FMV of marketable securities distributed to a partner is treated as a cash distribution • Some or all of excess of FMV of securities distributed over partner’s outside basis is taxable gain • Marketable securities include most actively traded debt or equity interests, options, futures, and derivatives • Exceptions apply

  25. Property Distributions with Special Tax Treatment (slide 3 of 4) • Precontribution gain property • Contributing partner recognizes gain on distribution of precontribution gain property in two situations: • 1. If property is distributed to another partner within 7 years of contribution date, contributing partner recognizes remaining precontribution gain • Partner’s basis in partnership and basis of distributed property is increased by gain recognized

  26. Property Distributions with Special Tax Treatment (slide 4 of 4) • Precontribution gain property • Contributing partner recognizes gain on distribution of precontribution gain property in two situations (cont’d): • 2. If partnership distributes any property other than cash to a partner within 7 years after that partner contributes appreciated property, the partner recognizes the lesser of: • Remaining net precontribution gain • Excess of FMV of distributed property over partner’s basis in partnership interest

  27. Disproportionate Distributions(slide 1 of 3) • Occurs when partnership distributes cash or property to a partner which increases or decreases the partner’s share of ordinary income-producing assets (hot assets)

  28. Disproportionate Distributions(slide 2 of 3) • If partner receives less than proportionate share of hot assets, then treated as if: • Partnership distributed some of the assets, and • Partner sold these hot assets back to partnership • Partner recognizes ordinary income on sale of the hot assets; Partnership’s basis in hot assets is cost

  29. Disproportionate Distributions(slide 3 of 3) • Hot assets include: • Substantially appreciated inventory • Inventory includes all assets other than cash, capital and §1231 assets • Substantially appreciated means FMV > 120% of partnership’s adjusted basis in inventory • Unrealized receivables • Rights to receive future amounts that will result in ordinary income recognition

  30. §736: Liquidating Distribution Where P’ship Does Not Liquidate (slide 1 of 3) • §736(a) income payment: • Treated as distributive share of partnership income or guaranteed payment to partner • Certain items if partnership is service-provider and retiring partner is a general partner: • Unrealized receivables (except depreciation recapture) • Goodwill (unless provided for in partnership agreement) • §736(b) property payment: • Payments made for liquidated partner’s share of partnership’s assets

  31. §736: Liquidating Distribution Where P’ship Does Not Liquidate (slide 2 of 3) • §736(a) income payment: • Partner has: • Ordinary income (guaranteed payment), or • Distributive share of income • Partnership has: • Guaranteed payment (deductible) if determined without regard to partnership profits • Distributive share if based on profits

  32. §736: Liquidating Distribution Where P’ship Does Not Liquidate (slide 3 of 3) • §736(b) property payment: • Disproportionate distribution to extent of partner’s share of hot assets • Return of basis (and capital gain (loss) for remainder)

  33. Sale of Partnership Interest (slide 1 of 4) • Generally, results in gain or loss recognition by selling partner • Gain (loss) = amount realized less partner’s basis in partnership interest • Partnership liabilities assumed by purchasing partner are treated as part of consideration paid for the partnership interest

  34. Sale of Partnership Interest (slide 2 of 4) • Partnership tax year closes for selling partner on sale date • Partner’s share of income through sale date is calculated • Can prorate annual income or use interim closing of the books • Taxed to selling partner and increases basis in partnership interest

  35. Sale of Partnership Interest (slide 3 of 4) • Effect of hot assets • Hot assets include: • Unrealized receivables (same as for disproportionate distributions) • Inventory • Includes all partnership property except money, capital assets, and §1231 assets

  36. Sale of Partnership Interest (slide 4 of 4) • Effect of hot assets (cont’d) • Must allocate sales price of partnership interest between “hot” (ordinary income) assets and “nonhot” (capital gain) components • Selling partner’s gain is classified as a capital gain or loss portion and an ordinary income or loss amount related to the hot assets

  37. Other Dispositions of Partnership Interests (slide 1 of 8) • Transfer of a partnership interest to a controlled corporation • Tax free if §351 requirements are met • If 50% or more of the total interest in capital and profits of the partnership are transferred, the partnership terminates

  38. Other Dispositions of Partnership Interests (slide 2 of 8) • Incorporating a partnership • At least three methods available: • 1. Transfer each partner’s interest to the corp in exchange for stock • Partnership terminates • Corp becomes owner of all partnership assets • Corp has substituted basis in assets; Old partners have substituted basis in stock

  39. Other Dispositions of Partnership Interests (slide 3 of 8) • Incorporating a partnership (cont’d) • 2. Transfer partnership assets to corp in exchange for stock and assumption of partnership liabilities • Partnership distributes stock to partners in liquidating distribution • Corp has carryover basis in assets; Old partners have substituted basis in stock

  40. Other Dispositions of Partnership Interests (slide 4 of 8) • Incorporating a partnership (cont’d) • 3. Partnership distributes all assets and liabilities pro rata to partners in complete liquidation of partnership • Partners transfer assets and liabilities to corp in exchange for stock under §351 • Corp has substituted basis for assets; Partners have substituted basis for stock

  41. Other Dispositions of Partnership Interests (slide 5 of 8) • Incorporating a partnership (cont’d) • All three methods of incorporating a partnership are tax-free • Exception: if liabilities of partnership exceed basis of transferred assets

  42. Other Dispositions of Partnership Interests (slide 6 of 8) • Nontaxable like-kind exchange rules do not apply to the exchange of interests in different partnerships

  43. Other Dispositions of Partnership Interests (slide 7 of 8) • Generally, the gift of a partnership interest is tax-free • Partnership income, loss, etc. is prorated between donor and donee

  44. Other Dispositions of Partnership Interests (slide 8 of 8) • Death of a partner • Taxable year of partnership closes with respect to that partner on date of death • Compute deceased partner’s share of partnership income or loss to that date and report on partner’s final Form 1040

  45. §754 Election • Adjusts partnership’s basis in assets to reflect: • The difference in the amount paid by the purchasing partner and his share of the inside basis of partnership assets • The adjustment can be positive or negative • The adjustment affects the basis of partnership property with respect to the transferee partner only • Gain or loss recognized by partner receiving distribution from partnership • Once made, election remains in effect for all future years unless election revoked with IRS consent

  46. Termination of Partnership(slide 1 of 3) • Partnership terminates when either of the following events occur: • No part of the business continues to be carried on by any partners • Within a 12-month period, 50% or more of the partnership’s capital and profits interests are sold or exchanged

  47. Termination of Partnership (slide 2 of 3) • Partnership terminates and its tax year closes when: • The partnership incorporates • One partner in a two-party partnership buys out the other partner • A termination also occurs when the partnership ceases operations and liquidates

  48. Termination of Partnership (slide 3 of 3) • Partnership tax year usually does not close: • Upon the death of a partner • Entry of a new partner • Liquidation of a partner’s interest in other than a two-party partnership • Sale or exchange of a less than 50% partnership interest

  49. Family Partnerships (slide 1 of 3) • Owned and controlled primarily by members of the same family • Often formed to save taxes by funneling some of parent’s income to the children • Often difficult to establish for tax purposes

  50. Family Partnerships (slide 2 of 3) • Family member will be recognized as a partner if: • Capital is a material income-producing factor and partnership interest is acquired in a bona fide transaction where ownership and control are received • Can be acquired by gift or purchase from another family member • Capital is not a material income-producing factor, but family member contributes substantial or vital services

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