1 Chapter 10: Special Partnership Issues

2 SPECIAL PARTNERSHIP ISSUES (1 of 2) nNonliquidating distributions n§751 assets nLiquidating distributions nSale of partnership interest nRetirement or death of a partner nExchange of a partnership interest

3 SPECIAL PARTNERSHIP ISSUES (2 of 2) nTermination of a partnership nMergers and consolidations nDivision of a partnership nOptional basis adjustments nSpecial forms of partnerships nElecting large partnerships

4 Nonliquidating Distributions nGeneral rules nPrecontribution gain (loss) nBasis effects of distributions nHolding period and character of distributed property

5 General Rules nNo gain or loss by either partner or partnership n“Money” distributions in excess of partner’s basis triggers capital gain recognition by partner n“Money” includes cash, reduction of partner’s liabilities, FMV of securities

6 Precontribution Gain (Loss) (1 of 2) nPrecontribution gain (loss) definition –Contributed property w/FMV > tax basis (< for loss) on date transferred to partnership

7 Precontribution Gain (Loss) (2 of 2) nGain or loss recognized by contributing partner w/in seven 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

8 Basis Effects of Distributions nGeneral rule –Partnership’s basis in distributed property carries over to partner nPartner’s basis in partnership reduced by –Money received and –Basis of other property received

9 Holding Period and Character of Distributed Property nPartner’s holding period includes partnership’s holding period nCharacter 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

10 §751 Assets n§751 assets –Property likely to produce ordinary income when sold or collected nUnrealized receivables nSubstantially appreciated inventory nSignificance of §751

11 Unrealized Receivables nUnrealized 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)

12 Substantially Appreciated Inventory (1 of 2) nSubstantially appreciated inventory includes all assets EXCEPT –Cash –Capital assets –§1231 assets

13 Substantially Appreciated Inventory (2 of 2) nAppreciation test 1.Exclude cash, §1231 & capital assets 2.Total basis of remaining assets 3.Multiply sum by Compare result of #3 w/FMV of assets 5.If FMV larger, appreciation exists

14 Significance of §751 nIf §751 assets exist, certain distributions reclassified as a SALE between partnership & partner nWhat appears to be a tax-free distribution could be a taxable event nSee Example C10-12 and Table C10-1

15 Liquidating Distributions nGain or loss recognition by partner nBasis of assets received nHolding period carries over to partner n§751 applies to liquidating distributions nEffects of distribution on partnership –No gain or loss unless §751 deemed sale occurs

16 Gain or Loss Recognition by Partner (1 of 2) nGain recognized if money received (and deemed received) exceeds partner’s basis in partnership

17 Gain or Loss Recognition by Partner (2 of 2) nLoss 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

18 Basis of Assets Received (1 of 2) nBasis of unrealized receivables and inventory same as for partnership –Never increased when distributed from partnership partner

19 Basis of Assets Received (2 of 2) nAfter 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

20 Sale of Partnership Interest (1 of 2) nImpact on Partner –General rule »Capital gain or loss recognized –Partnership liabilities »Relief of liabilities increases the amount realized on the sale

21 Sale of Partnership Interest (2 of 2) nImpact 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 nNo impact on partnership

22 Retirement or Death of a Partner nSale of partnership interest to outside party is a “sale” nSurrender 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)

23 Exchange of a Partnership Interest (1 of 2) nExchange for another partnership interest not a like-kind exchange –Exception: exchanges of interests within a single partnership nExchange for corporate stock –May qualify for §351 treatment »Partnership interest is property under §351

24 Exchange of a Partnership Interest (2 of 2) nIncorporation –Tax consequences depend on how incorporation is accomplished nFormation of an LLC or LLP –If LLC elects to be taxed as a corp, treatment same as for incorporation –If LLP, same tax-free treatment as partnership-to-partnership transfer

25 Termination of a Partnership (1 of 2) nIRC & state laws treat terminations differently nTermination events –No business operated as a partnership –Sale or exchange of  50% interest w/in 12 month period –If a partner completely liquidates, the partnership tax year closes for that partner

26 Termination of a Partnership (2 of 2) nEffects of termination –Tax year closes upon termination –Could cause short tax year to fall in same calendar year as regular 12- month tax year

27 Mergers and Consolidations nTwo or more partnerships join to form a new partnership nIf 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

28 Division of a Partnership nOne partnership divided into two or more partnerships nNew partnerships whose partners own collectively > 50% of interests in old partnerships are considered a continuation of the old partnership

29 Optional Basis Adjustments (1 of 3) nNew partner’s outside basis –Purchase price plus new partner’s share of partnership liabilities nNew partner’s inside basis likely different than outside basis

30 Optional Basis Adjustments (2 of 3) n§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

31 Optional Basis Adjustments (3 of 3) nExample –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)

32 Special Forms of Partnerships nTax shelters and limited partnerships nPublicly traded partnerships nLimited Liability Companies (LLC) nLimited Liability Partnerships (LLP)

33 Publicly Traded Partnerships nPTPs are partnerships whose interests are traded on an established securities exchange nPTPs are taxed as a corporation unless  90% of income is “qualifying income” –E.g., Certain interest, dividends, real property rents

34 Limited Liability Companies (LLCs) nMay be taxed as a partnership or a corp (using check-the-box regs) nAllows entity to obtain flow-through and flexibility of partnership allocations while maintaining limited liability of a corp.

35 Limited Liability Partnerships (LLPs) nUsed by many professional organizations nTaxed as a partnership nPartners not liable for failures in work of other partners or people supervised by other partners

36 Electing Large Partnerships nELP Qualifications nELP taxable income nELP: Termination of partnership nELP: Audit rules

37 ELP Qualifications nNon-service partnership nNot engaged in commodity trading nHave at least 100 partners nFile an election to be taxed as a large partnership

38 ELP Taxable Income nMisc. itemized deductions combined & subject to a 70% deduction at partner level –Remaining misc. deductions combined w/other partnership income nCharitable contributions combined and not separately stated by partners n§179 deductions combined

39 ELP: Termination of Partnership nTermination occurs only upon cessation of any business, financial operation or venture nTermination does not occur upon transfer of 50% ownership

40 ELP: Audit Rules nPartners must report all items in same manner as partnership nAudit findings & agreements reached at partnership level binding on all partners nAudit decisions binding on partners who own interest in year of decision, not year of contested transaction

41 Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business