Chapter 20 Partnerships— Distributions, Sales and Exchanges ©2008 CCH. All Rights Reserved W. Peterson Ave. Chicago, IL

CCH Federal Taxation Comprehensive Topics 2 of 47 Distributions—General Rules Code Sections 731 to 733 The rules indicated below assume that the partnership DOES NOT make a disproportionate distribution of the Code Sec. 751 “hot” assets. What is a distribution? A distribution is a transfer of value from the P/S to a partner in reference to his interest in the partnership. A distribution may be in the form of money, debt relief, or other property. Any decrease in a partner’s allocable share of P/S debt is treated as a distribution of money. This can result from payment of principal by the P/S on its debt. Also, a draw against a partner’s share of partnership income is a distribution. Chapter 20, Exhibit 2a

Partnership Distributions Generally tax free to partner and partnership Partner only recognizes gain if cash is received in excess of the partner’s tax basis. Current vs. liquidating distribution CCH Federal Taxation Comprehensive Topics 3 of 51

Partnership Distrib. – Current/Cash Gain only recognized by partner if cash is distributed in excess of partner’s basis. “Draws” are treated as if withdrawn on the last day of the taxable year. Distribution treatment dramatically different from corporate tax. CCH Federal Taxation Comprehensive Topics 4 of 51

Partnership Dist. – Current/Property Partner takes carry-over basis in the property Partner’s basis reduced by the basis of the property received Limitation – partner cannot take a basis in the property greater than the partner’s basis in the partnership. CCH Federal Taxation Comprehensive Topics 5 of 51

Partnership Dist. – Cash/Property Cash is assumed to have been received first. Gain is recognized to the extent cash received is greater than the partner’s basis. Distributions must be at the same time for these rules to qualify. CCH Federal Taxation Comprehensive Topics 6 of 51

Partnership Dist. - Liquidating Gain only recognized if cash is received in excess of the partner’s basis Loss can be recognized unlike current dist. Basis of property received is calculated differently than for current distributions. CCH Federal Taxation Comprehensive Topics 7 of 51

Partnership Dist. – Gain/Loss Gain only recognized if cash is received in excess of the partner’s basis Loss recognized if:  Distribution is for complete liquidation  Distribution consists solely of cash and/or ordinary income assets (A/R, inventory, etc.)  Basis in partnership exceeds basis of assets rec’d CCH Federal Taxation Comprehensive Topics 8 of 51

Partnership Dist. – Liquidating Basis Entire partnership interest must be written off Current dist – partner takes the carryover basis in property distributed and reduces partnership interest accordingly. Liquidating – partner writes off entire partnership interest and replaces with the distributed property CCH Federal Taxation Comprehensive Topics

Effect of Liabilities Transfers of indebtedness to a partner are treated as contributions to the partnership. Alternatively, a reduction in the partner’s share of liabilities is treated as a cash distribution. CCH Federal Taxation Comprehensive Topics

Hot Assets – Disproportionate Dist. When a distribution changes the recipient partner’s interest in partnership “hot assets” (unrealized receivables or significantly appreciated inventory), Section 751(b) triggers recognition of gain or income to the partner, the partnership or both. CCH Federal Taxation Comprehensive Topics

Sale of a Partner’s Interest Sale of an interest to an outside buyer is fully taxable. Gain/loss measured as difference between amount realized from the sale and the partner’s tax basis.  Amount realized is total selling price = cash received + value of any other property received + selling partner’s share of partnership debt being assumed by the buyer. CCH Federal Taxation Comprehensive Topics

Sale of a Partner’s Interest – cont’d If partnership interest exchanged for property, gain is recognized in an amount equal to the difference between the value of such property rec’d and the tax basis of the partnership interest. Partial sale – tax basis is apportioned between the interest sold and the interest retained. CCH Federal Taxation Comprehensive Topics

14 of 47 Death or Retirement of a Partner Code Sec. 736 – Consequences depend on nature of payments to retiree or deceased partner’s successor in interest  Payments for partner’s share of partnership “property” are treated as distributions and subject to same rules as other distributions  Payments in excess of partner’s share of p/s property treated as guaranteed payments or distributive shares of partnership income (and thus deductible by partnership or allocated away from existing partners) Chapter 20, Exhibit 12a

CCH Federal Taxation Comprehensive Topics 15 of 47 What constitutes partnership “property” under Code Sec. 736?  Is capital a material income-producing factor for partnership?  Yes – property is everything except unrealized receivables  No – property is everything except unrealized receivables and goodwill  Exception – goodwill is treated as property if required in partnership agreement Chapter 20, Exhibit 12b Death or Retirement of a Partner

CCH Federal Taxation Comprehensive Topics 16 of 47 Income in Respect of a Decedent Code Sec. 736(b) payments received by deceased partner’s beneficiary will generally be nontaxable to recipient due to Code Sec stepped-up basis rules. Code Sec. 736(a) payments, in contrast, are generally treated as income in respect of a decedent and will be fully taxable to recipient. Chapter 20, Exhibit 13