What are the WAYS a partner can liquidate a partnership interest?
- Complete Withdrawal (liquidating distribution)
- Sales (disposition) of partnership interest
- Retirement or Death
On a complete withdrawal (liquidating distribution)…
When would you recognize a taxable gain?
Only to the extent that MONEY/CASH received exceeds the partner’s basis in the partnership interest.
On a complete withdrawal (liquidating distribution)…
When would you recognize a taxable loss?
If money, unrealized receivables (for cash basis), or inventory are the only assets received and if the partner’s basis in the partnership is MORE than the partnership’s basis in the assets received.
On a complete withdrawal (liquidating distribution) OR sale of partnership interest…
What is the character of the gain or loss?
The partner would recognize a CAPITAL gain or loss.
A partnership interest is a CAPITAL asset to the partner
During a liquidation distribution of inventory or unrealized receivables for cash basis…
Do you use the FMV or NBV when determining the distribution amount towards BASIS
NBV is used (not the FMV). These are considered HOT ASSETS!
The basis transfers to the partner. Can generate a loss or gain at liquidation if no other property.
Not the same for property (it would be remaining basis)
HOT ASSETS - DETERMINING THE TRANSFERRED BASIS AT LIQUIDATION
When the partner’s basis in the partnership interest is MORE than the partnership’s basis in the hot assets distributed (and no property distributed)
The BASIS assigned to EACH hot asset, is the SAME as the basis in the hands of the partnership.
Then the partnership recognizes a LOSS because they didn’t receive the FULL amount of their basis. (Or remaining is assigned to property)
Property/assets - DETERMINING THE TRANSFERRED BASIS AT LIQUIDATION (cash, hot, property)
When the partner’s basis in the partnership interest is LESS than the partnership’s basis in the assets distributed
Three step process to determine the basis…
- List ALL assets and assign a basis to EACH equal to the partnership’s basis in the assets.
- Divide them out by CASH, HOT ASSETS, PROPERTY.
> (take the partner basis minus the partnership basis = additional amount)
- Adjust basis of any assets that have depreciated in value down to FMV. (If FMV is LESS than book value, decrease that asset’s basis by that amount change)
> Take the additional amount minus the decreased/depreciated amount = final additional amount.
- Allocate remaining basis to PROPERTY remaining based on % (after decreasing depreciated values)
PROPERTY/ASSETS - DETERMINING THE TRANSFERRED BASIS AT LIQUIDATION
When the partner’s basis in the partnership interest is MORE than the partnership’s basis in the property distributed
Three step process to determine the basis…
- List ALL property and assign a basis to EACH equal to the partnership’s basis in the property.
- Divide them out by CASH, HOT ASSETS, PROPERTY.
> (take the partner basis minus the partnership basis = deficit amount)
- Adjust basis of any assets that have appreciated in value up to FMV. (If FMV is MORE than book value, increase that asset’s basis by that amount change)
> Take the deficit amount minus the appreciated amount = final deficit amount.
- Allocate remaining basis to PROPERTY remaining based on % (after increasing appreciated values) of FMV
For a NONLIQUIDATING distribution…
What is the basis of the property received?
The adjusted basis of the property in the partnership…
Adjusted basis to ZERO if NO basis in the partnership.
For a LIQUIDATING distribution…
What is the basis of the property received?
The partnership interest (basis) is assigned to the property
Must Zero Out the basis account!
At the partnership level… how are gains and losses taxed for liquidation?
There are no gains or losses at the PARTNERSHIP level. Any gain or loss recognition on liquidating distributions is made at the partner level.
Terminating a Partnership - When is the final tax return due?
This would be a short tax year!
The period runs from the beginning of the tax year through the date of the termination. (Tax year ends on date of termination)
Due on the 15th day of the third month AFTER the date of termination.
Terminating a partnership - when does a partnership end?
When all the operations of the business are discontinued and no part of the business is continued by ANY of the partners in the partnership.
How do you calculate gain or loss during the Sale/Transfer of a partnership interest
Beginning Capital Account
+ Share of income(loss) up to sale
= Capital Account at sale Date
+ Share of partnership liabilities
= Adjusted basis in partnership interest
- Amount Realized (Cash Received, FMV of property received, or Relief from share of partnership liabilities)
= CAPITAL gain or loss on sale
When a partner sells their partnership interest in the middle of a tax year…
How are the partnership income, losses, deductions, etc. distributed to the seller and buyer?
Allocated pro rata between the selling partner and the buying partner based on the number of days of ownership during the year.
When would a gain/loss from the sale of a partnership NOT be considered a capital gain/loss?
If it represents HOT ASSETS - then it would be an ordinary gain or loss.
Retirement or Death of a partner - how are payments taxed?
IF payments are for “interest in partnership” they result in a capital gain or loss
IF payments are for partnership income, they are treated as ordinary income
What is Section 754 Election?
A basis adjustment used when a partner transfers a partnership interest…
But the new partner’s share of inside basis doesn’t equal outside basis.
When can the Section 754 Election be made?
When there is a difference between:
> A partner’s share of inside basis in the partnership assets
> The partner’s outside basis in his or her partnership interest
If a partnership elects’ section 754 due to a sale or exchange… what follows?
A Section 743(b) basis adjustment
Which equals the difference between…
- The value of the outside basis to the transferee partner (purchase price)
- The partner’s share of the partnership’s inside basis of the assets
> It is prorated over the partnership assets under the rules set forth in Section 755
How does Section 754 affect EACH partner?
It only affects the new partner. No effect on existing partners
It ONLY adjusts the INSIDE basis.
How long does Section 754 Election remain in effect?
It remains in effect for all future transactions…
It can only be revoked with permission from the IRS
When does the IRS mandate a 743(b) adjustment?
When there is a substantial built-in loss at the time of purchase (inside basis exceeds outside basis by $250,000 or more)
Otherwise, it’s not required to make inside and outside match!
Example - how do you calculate the Section 743(b) adjustment
- Oscar buys 25% for $500,000
- Asset NBV is $1,200,000
- Asset FMV is $2,000,000
HOW DOES THE ADJUSTMENT CHANGE THE CURRENT INSIDE BASIS (NBV)
HOW WILL IT AFFECT A FUTURE SALE OF THE ASSET?
What is the inside basis?
> NBV of property * % Interest = 300K
What is the Outside basis (Purchase price)?
> $500,000
What is the difference/adjustment that needs to be made?
> $200,000 (entirely to Oscar)
The new inside basis = $1,400,000
> Oscar’s = $500K
> Other partners (75% of original basis) = $900K
IF THERE IS A SALE - YOU WOULD DIVIDE THAT SALE PRICE BY THE PERCENTAGE FOR EACH PARTNER… SUBTRACT THEIR INDIVIDUAL BASIS TO KNOW WHAT THEIR GAIN/LOSS IS RECOGNIZED
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Tax Forms63
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U1 - M1 Business Entity Types99
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U1 - M2 Reporting Requirements and Compliance64
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U2 - M1 Partnership Overview63
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U2 - M2 Partnership Formation and Other Considerations32
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U2 - M3 Partnership Dissolution24
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U4 - M1 Business Income55
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U4 - M3 Qualified Business Income18
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U4 - M4 Business Assets: Basis & Holding Period20
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U4 - M5 Business Assets: Cost Recovery72
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U4 - M6 Business Assets: Dispositions45
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U4 - M7 Analysis of Financial Records42
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