1. 10-1 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

2. 10-2 SPECIAL PARTNERSHIP ISSUES  Nonliquidating distributions  §751 assets  Terminating a partnership interest  Optional and mandatory basis adjustments  Special forms of partnerships  Tax planning considerations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

3. 10-3 Nonliquidating Distributions  General rules  Precontribution gain (loss)  Basis effects of distributions  Holding period and character of distributed property ©2011 Pearson Education, Inc. Publishing as Prentice Hall

4. 10-4 General Rules  No gain or loss by either partner or partnership  “Money” distributions in excess of partner’s basis triggers capital gain recognition by partner  “Money” includes cash, reduction of partner’s liabilities, FMV of securities ©2011 Pearson Education, Inc. Publishing as Prentice Hall

5. 10-5 Precontribution Gain (Loss) (1 of 2)  Precontribution gain (loss) definition  Contributed property w/FMV > tax basis (< for loss) on date transferred to partnership ©2011 Pearson Education, Inc. Publishing as Prentice Hall

6. 10-6 Precontribution Gain (Loss) (2 of 2)  Gain or loss recognized by contributing partner w/in 7 years of contribution if  Distribution of contributed property to any OTHER partner or  Any property distribution to contributing partner if FMV of property > partner’s basis  Gain recognition only ©2011 Pearson Education, Inc. Publishing as Prentice Hall

7. 10-7 Basis Effects of Distributions (1 of 2)  General rule  Partnership’s basis in distributed property carries over to partner  Partner’s basis in partnership reduced in the following order  Money received,  Basis of other property received ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8. 10-8 Basis Effects of Distributions (2 of 2)  Basis in new property if partnership’s basis in property > partner’s basis in partnership after adjusting for money received and preconribution gain partner’s remaining basis x partnership’s basis in asset partnership’s basis in total assets distributed ©2011 Pearson Education, Inc. Publishing as Prentice Hall

9. 10-9 Holding Period and Character of Distributed Property  Partner’s holding period includes partnership’s holding period  Character of gain/loss when property sold  Generally same as for partnership  Ordinary income/loss treatment for  Unrealized receivables  Inventory sold w/in 5 years of distribution  After, character determined at partner level ©2011 Pearson Education, Inc. Publishing as Prentice Hall

10. 10-10 §751 Assets  §751 assets  Property likely to produce ordinary income when sold or collected  Unrealized receivables  Substantially appreciated inventory  Significance of §751 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

11. 10-11 Unrealized Receivables  Unrealized receivables include  Accounts receivable for cash basis partnership  Ordinary income recapture items  §§1245 or 1250 (depreciation)  §§617(d) (mining properties)  §§1252 (farmland)  §§1254 (oil, gas and geothermal) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

12. 10-12 Substantially Appreciated Inventory (1 of 2)  Substantially appreciated inventory includes all assets EXCEPT  Cash  Capital assets  §1231 assets ©2011 Pearson Education, Inc. Publishing as Prentice Hall

13. 10-13 Substantially Appreciated Inventory (2 of 2)  Appreciation test 1. Exclude cash, §1231 & capital assets 2. Total basis of remaining assets 3. Multiply sum by 1.20 4. Compare result of #3 w/FMV of assets 5. If FMV larger, substantial appreciation exists ©2011 Pearson Education, Inc. Publishing as Prentice Hall

14. 10-14 Significance of §751  If §751 assets exist, certain distributions reclassified as a SALE between partnership & partner  What appears to be a tax-free distribution could be a taxable event  See Example C10-12 and Table C10-1 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

15. 10-15 Terminating a Partnership Interest (1 of 2)  Liquidating distributions  Sale of partnership interest  Retirement or death of a partner  Exchange of a partnership interest  Income recognition and transfers of a partnership interest ©2011 Pearson Education, Inc. Publishing as Prentice Hall

16. 10-16 Terminating a Partnership Interest (2 of 2)  Termination of a partnership  Mergers and consolidations  Division of a partnership ©2011 Pearson Education, Inc. Publishing as Prentice Hall

17. 10-17 Liquidating Distributions  Gain or loss recognition by partner  Basis of assets received  Holding period carries over to partner  §751 applies to liquidating distributions  Effects of distribution on partnership  No gain or loss unless §751 deemed sale occurs ©2011 Pearson Education, Inc. Publishing as Prentice Hall

18. 10-18 Gain or Loss Recognition by Partner (1 of 2)  Gain recognized if money received (and deemed received) exceeds partner’s basis in partnership ©2011 Pearson Education, Inc. Publishing as Prentice Hall

19. 10-19 Gain or Loss Recognition by Partner (2 of 2)  Loss recognized if  Only money, unrealized receivables & inventory are only assets received AND  Basis in partnership > sum of money plus partnership’s basis in unrealized receivables and inventory received ©2011 Pearson Education, Inc. Publishing as Prentice Hall

20. 10-20 Basis of Assets Received (1 of 2)  Basis of unrealized receivables and inventory same as for partnership  Never increased when distributed from partnership partner ©2011 Pearson Education, Inc. Publishing as Prentice Hall

21. 10-21 Basis of Assets Received (2 of 2)  After reducing partner’s basis for money received, remaining basis in partnership is allocated to remaining property distributed  Gain (loss) is deferred by reducing (increasing) the basis in the property distributed ©2011 Pearson Education, Inc. Publishing as Prentice Hall

22. 10-22 Sale of Partnership Interest (1 of 2)  Impact on Partner  General rule  Capital gain or loss recognized  Partnership liabilities  Relief of liabilities increases the amount realized on the sale ©2011 Pearson Education, Inc. Publishing as Prentice Hall

23. 10-23 Sale of Partnership Interest (2 of 2)  Impact on partner (continued)  §751 property  All inventory and unrealized receivables are considered §751 property  Hypothetical asset sale approach used by Treasury Regs. Under §751 to determine ordinary income or loss  No impact on partnership ©2011 Pearson Education, Inc. Publishing as Prentice Hall

24. 10-24 Retirement or Death of a Partner  Sale of partnership interest to outside party is a “sale”  Surrender of interest to partnership  Payments for property taxed as liquidating distributions  Other payments treated as either guaranteed payment (ordinary income) or distributive share (retain character) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

25. 10-25 Exchange of a Partnership Interest (1 of 2)  Exchange for another partnership interest not a like-kind exchange  Exception: exchanges of interests within a single partnership  Exchange for corporate stock  May qualify for §351 treatment  Partnership interest is property under §351 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

26. 10-26 E xchange of a Partnership Interest (2 of 2)  Incorporation  Tax consequences depend on how incorporation is accomplished  Formation of an LLC or LLP  If LLC elects to be taxed as a corp, treatment same as for incorporation  If LLP or LLLP, same tax-free treatment as partnership-to-partnership transfer ©2011 Pearson Education, Inc. Publishing as Prentice Hall

27. 10-27 Termination of a Partnership (1 of 3)  IRC & state laws treat terminations differently  Termination events (IRC)  No business operated as a partnership  Sale or exchange of  50% interest w/in 12 month period ©2011 Pearson Education, Inc. Publishing as Prentice Hall

28. 10-28 Termination of a Partnership (2 of 3)  Effects of termination  Tax year closes upon termination  Could cause short tax year to fall in same calendar year as regular 12-month tax year ©2011 Pearson Education, Inc. Publishing as Prentice Hall

29. 10-29 Termination of a Partnership (3 of 3)  If termination occurs because of sale of >50% ownership interest  “Old” ptrshp contributes assets to “new” ptrshp in exchange for 100% of new ptrshp  Basis and holding period of assets in new ptrshp same as in old ptrshp  Old ptrshp distributes new ptrshp interests to partners and liquidates  Partners’ basis in new ptrshp unchanged ©2011 Pearson Education, Inc. Publishing as Prentice Hall

30. 10-30 Mergers and Consolidations  Two or more partnerships join to form a new partnership  If partners of “Old 1” own > 50% of New partnership, then Old 1 partnership is deemed to be continued  All other old partnerships deemed to terminate  Possible that no old partnership continues ©2011 Pearson Education, Inc. Publishing as Prentice Hall

31. 10-31 Division of a Partnership  One partnership divided into two or more partnerships  New partnerships whose partners own collectively > 50% of interests in old partnerships are considered a continuation of the old partnership ©2011 Pearson Education, Inc. Publishing as Prentice Hall

32. 10-32 Optional and Mandatory Basis Adjustments (1 of 4)  Adjustments on transfers  New partner’s outside basis  Purchase price plus new partner’s share of partnership liabilities  New partner’s inside basis likely different than outside basis ©2011 Pearson Education, Inc. Publishing as Prentice Hall

33. 10-33 Optional and Mandatory Basis Adjustments Adjustments (2 of 4)  Optional §754 adjustment allows partnership to adjust basis of partnership assets for new partner’s share of partnership assets  Basis adjustment belongs only to new partner ©2011 Pearson Education, Inc. Publishing as Prentice Hall

34. 10-34 Optional and Mandatory Basis Adjustments (3 of 4)  Example  If §754 adjustment is $30,000 and new partner is 1/3 partner, then new partner’s inside basis increases by $10,000 ($30,000 x 1/3) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

35. 10-35 Optional and Mandatory Basis Adjustments (4 of 4)  Mandatory basis adjustment for substantial built-in loss  Substantial if Built-in loss > $250K,  Exchange of partnership interest, AND  No §754 optional basis adjustment election in effect ©2011 Pearson Education, Inc. Publishing as Prentice Hall

36. 10-36 Special Forms of Partnerships  Tax shelters and limited partnerships  Publicly traded partnerships  Electing large partnerships  Limited Liability Companies (LLC)  Limited Liability Partnerships (LLP) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

37. 10-37 Publicly Traded Partnerships  PTPs are partnerships whose interests are traded on an established securities exchange  PTPs are taxed as a corporation unless  90% of income is “qualifying income”  E.g., Certain interest, dividends, real property rents ©2011 Pearson Education, Inc. Publishing as Prentice Hall

38. 10-38 Limited Liability Companies (LLCs)  May be taxed as a partnership or a corp using check-the-box regs  Allows entity to obtain pass-through and flexibility of partnership allocations while maintaining limited liability of a corp. ©2011 Pearson Education, Inc. Publishing as Prentice Hall

39. 10-39 Limited Liability Partnerships (LLPs)  Used by many professional orgs  Including all Big 4 & many nat’l CPA firms  Taxed as a partnership  Partners not liable for failures in work of other partners or people supervised by other partners  Non-liable partners can still suffer  E.g., demise of Arthur Andersen ©2011 Pearson Education, Inc. Publishing as Prentice Hall

40. 10-40 Limited Liability Limited Partnership  Allowed by some states  Formed under state’s limited partnership laws  General partners have limited liability  LLLP potentially useful in states where PSCs cannot be LLCs ©2011 Pearson Education, Inc. Publishing as Prentice Hall

41. 10-41 Electing Large Partnerships  ELP Qualifications  ELP taxable income  ELP: Termination of partnership  ELP: Audit rules ©2011 Pearson Education, Inc. Publishing as Prentice Hall

42. 10-42 ELP Qualifications  Non-service partnership  Not engaged in commodity trading  Have at least 100 partners  File an election to be taxed as a large partnership ©2011 Pearson Education, Inc. Publishing as Prentice Hall

43. 10-43 ELP Taxable Income  Misc. itemized deductions combined & subject to a 70% deduction at partner level  Remaining misc. deductions combined w/other partnership income  Charitable contributions combined and not separately stated by partners  §179 deductions combined ©2011 Pearson Education, Inc. Publishing as Prentice Hall

44. 10-44 ELP: Termination of Partnership  Termination occurs only upon cessation of any business, financial operation or venture  Termination does not occur upon transfer of 50% ownership ©2011 Pearson Education, Inc. Publishing as Prentice Hall

45. 10-45 ELP: Audit Rules  Partners must report all items in same manner as partnership  Audit findings & agreements reached at partnership level binding on all partners  Audit decisions binding on partners who own interest in year of decision, not year of contested transaction ©2011 Pearson Education, Inc. Publishing as Prentice Hall

46. 10-46 Tax Planning Considerations  Tax treatments of partner withdrawal 1. Liquidating distribution OR  Partnership increases basis in §751 assets  xfer of >50% interest ptrshp not terminated 2. Sale of partnership interest to partnership  xfer of >50% interest terminates ptrshp  Optional basis adjustments affect each option differently ©2011 Pearson Education, Inc. Publishing as Prentice Hall

47. Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard.newmark@PhDuh.com 10-47 ©2011 Pearson Education, Inc. Publishing as Prentice Hall