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Chapter 7: Sales of Partnership Interests

Chapter 7: Sales of Partnership Interests. Overview. Entity vs. aggregate treatment Entity: transferor treated as selling PS interest, not undivided interest in each asset capital gain or loss under § 741 except to the extent that § 751(a) applies

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Chapter 7: Sales of Partnership Interests

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  1. Chapter 7: Sales of Partnership Interests

  2. Overview • Entity vs. aggregate treatment • Entity: transferor treated as selling PS interest, not undivided interest in each asset • capital gain or loss under § 741 except to the extent that § 751(a) applies • transferor’s gain equals AR (cash plus liabilities relieved) less OB

  3. § 751(a): collapsible PS provision • § 751(a) applies a modified “look-through approach” • transferor recognizes ordinary income or loss equal to her share of the PS’s “§ 751(a) assets” • defined as unrealized receivables and inventory, see § 751(c),(d) • 1997 amend: all assets that would generate ordinary income or loss will be treated as § 751(a) assets (full look-through approach)

  4. Collins-Ledoux Partnership Ledoux p. int. others Ledoux buyer $800K (5 x current earnings) 25% (20-yr right to operate track owned by another, for $200K/yr)

  5. Blank

  6. Mechanics of § 751(a) • Reg. § 1.751-1(a)(2) provides three-step approach for determining transferor’s gain or loss • Step One: determine overall gain or loss (AR less OB) • Step Two: determine transferor’s share of ordinary G/L on a hypothetical sale of PS’s § 751(a) assets for fair market value • Step Three: determine transferor’s capital G/L by subtracting the net Step Two amount from the Step One amount • N.B. a negative step two amount increases a positive step one amount or reduces a negative step one amount

  7. Unrealized Receivables • § 751(c): unrealized receivables include any right to payment for delivery of non-capital goods or rendition of services, except to extent that PS has already taken such items into account (i.e., under accrual method) • UR also includes depreciation recapture from § 1245 or § 1250 property • such prop treated as two separate assets: (1) zero-basis § 751(a) asset with FMV equal to recapture amount and (2) leftover non-§ 751(a) asset

  8. Inventory • § 751(d): inventory includes § 1221(a)(1) items (i.e., property held for sale to customers) and any other asset that would not be considered a capital asset (or § 1231 quasi-capital asset) if sold by PS • 1997 Act eliminated “substantial appreciation” test for inventory for purpose of § 751(a), but left test intact for purposes of § 751(b) • creates a new disparity between sale of a PS interest and a cash liquidating distribution • N.B. § 751(c) UR are also included in definition of § 751(d) inventory (but taxed only once under § 751(c))

  9. Problem 7-1(a)

  10. Blank

  11. Problem 7-1(b) *Includes $30 of depreciation recapture.

  12. Consequences to the Transferee • Transferee takes a cost basis in PS interest under 742 • transferee’s basis includes her share of PS liabilities • inside basis remains unchanged; transferee inherits transferor’s CA. • Exception if PS elects to adjust IB under 743(b)/754 • transferee receives a special inside basis adjustment (SBA) intended to eliminate her share of inside gain or loss • SBA affects only the transferee (not an adjustment to the common basis of PS prop)

  13. Example 7-1

  14. Amount of § 743(b) Adjustment • § 743(b) adjustment equals excess of transferee’s OB over her share of IB. • SBA is negative if OB<IB. • Purchasing partner’s share of IB is generally equal to her tax CA (inherited from transferor) plus her share of PS liab.

  15. § 743(b) Hypothetical Transaction • § 743 regs define a partner’s share of IB as the sum of her share of “previously taxed capital” plus her share of PS liab. • § 743 regs posit a hypothetical transaction in which PS deemed to sell all of its assets for FMV • Purchasing partner’s share of previously taxed capital is equal to: (i) cash she would receive on liquidation following hypo trans, (ii) increased by her share of tax loss on hypo trans, and (iii) decreased by her share of tax gain on hypo trans

  16. Problem 7-2(a)

  17. Problem 7-2(c)

  18. Allocation of Inside Basis Adjustments • Allocation of SBA determined under § 755. • § 755 divides PS assets into two classes: (i) capital assets (including § 1231 quasi-capital assets) and (ii) ordinary income assets (all other assets) • § 743(b) adjustment is allocated first (i) between two classes (capital and ordinary) and (ii) among particular assets within each class • Allocations based on hypo sale for FMV, i.e., according to purchasing partner’s distributive share of tax gain or loss (including any remedial allocations under § 1.704-3(d))

  19. § 755 Net Adjustment • § 755 is a net adjustment, i.e., may be positive for one class and negative for another. • Within each class, § 755 adj may increase basis of some assets and decrease basis of other assets. • Revised regs eliminate flaw under the prior regs which prohibited “two-way adjustments” • Net result: transferee should generally wind up with a FMV basis in each and every PS asset (i.e., her share of the asset’s IB plus her SBA with respect to the particular asset).

  20. Problem 7-3 * Includes $30 of depreciation recapture.

  21. Problem 7-3 (contin.) * includes $6 recapture

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