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Chapter 10: Special Partnership Issues

Chapter 10: Special Partnership Issues

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Chapter 10: Special Partnership Issues

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  1. Chapter 10:Special Partnership Issues Chapter 10: Special Partnership Issues

  2. SPECIAL PARTNERSHIPISSUES (1 of 2) • Nonliquidating distributions • §751 assets • Liquidating distributions • Sale of partnership interest • Retirement or death of a partner • Exchange of a partnership interest

  3. SPECIAL PARTNERSHIPISSUES (2 of 2) • Termination of a partnership • Mergers and consolidations • Division of a partnership • Optional basis adjustments • Special forms of partnerships • Electing large partnerships

  4. Nonliquidating Distributions • General rules • Precontribution gain (loss) • Basis effects of distributions • Holding period and character of distributed property

  5. 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

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

  7. Precontribution Gain (Loss)(2 of 2) • Gain 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 • General rule • Partnership’s basis in distributed property carries over to partner • Partner’s basis in partnership reduced by • Money received and • Basis of other property received

  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

  10. §751 Assets • §751 assets • Property likely to produce ordinary income when sold or collected • Unrealized receivables • Substantially appreciated inventory • Significance of §751

  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)

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

  13. Substantially Appreciated Inventory (2 of 2) • Appreciation test • Exclude cash, §1231 & capital assets • Total basis of remaining assets • Multiply sum by 1.20 • Compare result of #3 w/FMV of assets • If FMV larger, appreciation exists

  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

  15. 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

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

  17. 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

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

  19. 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

  20. 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

  21. 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

  22. 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)

  23. Exchange of a PartnershipInterest (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

  24. Exchange of a PartnershipInterest (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, same tax-free treatment as partnership-to-partnership transfer

  25. Termination of a Partnership (1 of 2) • IRC & state laws treat terminations differently • Termination 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) • 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

  27. Mergers andConsolidations • 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

  28. 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

  29. Optional Basis Adjustments (1 of 3) • 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

  30. Optional Basis Adjustments (2 of 3) • §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) • 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)

  32. Special Forms of Partnerships • Tax shelters and limited partnerships • Publicly traded partnerships • Limited Liability Companies (LLC) • Limited Liability Partnerships (LLP)

  33. 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

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

  35. Limited Liability Partnerships(LLPs) • Used by many professional organizations • Taxed as a partnership • Partners not liable for failures in work of other partners or people supervised by other partners

  36. Electing Large Partnerships • ELP Qualifications • ELP taxable income • ELP: Termination of partnership • ELP: Audit rules

  37. 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

  38. 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

  39. 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

  40. 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

  41. End of Chapter 10 Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark atUniversity of Northern Colorado’sKenneth W. Monfort College of Businessrichard.newmark@PhDuh.com