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Chapter 12 Partnership Distributions . Operating or “Current” Distributions. Current distribution - a distribution that does not completely terminate the partner’s interest in the partnership

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operating or current 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
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 cont4
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
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
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
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 cont8
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 cont9
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 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 pre-distribution
gain or loss upon the sale of 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
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 cont14
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
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
  • 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
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 cont18
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 cont19
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,15 and any partnership distributions
ordinary income from the sale of a partnership
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
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 cont22
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 cont23
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
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 cont25
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
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
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
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
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
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
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 cont32
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
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
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 cont35
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
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
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
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 cont39
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
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
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 cont42
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 cont43
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