Chapter 11A.Partnership.

Distributions.

C10-Chp-11-1A-Ptshp-Distributions-2010Edited 2010-0221

Howard Godfrey, Ph.D., CPAProfessor of Accounting

Copyright 2010

Note to student:

This chapter has some very important basic rules which are pretty simple and easy to learn, as well as some more complex rules.

The key is to first learn the basic rules and then add the others as you can.

This chapter can be overwhelming. You can avoid being overwhelmed by concentrating on the simple stuff and mastering it first. (Homework)

1. Determine the amount and character of gain or loss a partner recognizes in a nonliquidating partnership distribution.

2. Determine the partner’s basis of assets received in a nonliquidating partnership distribution.

3. Identify the partnership's Sec. 751 assets.

4. Determine the tax implications of a sale or a cash distribution when the partnership has Sec. 751 assets.

5. Determine the amount and character of gain or loss a partner recognizes in a liquidating partnership distribution.

6. Determine the partner’s basis of assets received in a liquidating distribution.

7. Determine the amount and character of the gain or loss recognized when a partner retires from a partnership or dies.

8. Determine whether a partnership has terminated for tax purposes.

9. Understand the effect of optional and mandatory basis adjustments.

10. Determine the appropriate reporting for the income of an electing large partnership.

1. Determine the amount and character of gain or loss a partner recognizes in a nonliquidating partnership distribution.

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A liquidating distribution is one distribution or a series of distributions that terminates a partner's entire interest in the partnership.

All other distributions, including those that substantially reduce a partner's interest, are governed by the non-liquidating distribution rules. [i.e. current distribution]

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Recognition of Gain. A current distribution that does not involve Sec. 751 assets results in no recognition of loss by Ptshp. Partners recognize gain only if they receive money in excess of basis. Here, money includes cash, deemed cash from reductions in a partner's share of liabilities and the FMV of marketable securities if the securities.

See Sec. 731(a),(b),(c)

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Nonliquidating Distributions.While a current distribution causes gain or loss to be recognized only in the conditions listed above, the distribution may trigger recognition of previously unrecognized pre-contribution gain or loss. This recognition of the remaining precontribution gain or loss can occur if contributed asset is distributed to any partner (other than contributing partner) within 7 yrs. It also may occur if the contributing partner receives a distribution with a FMV in excess of his adjusted basis in his partnership interest. In this case, the remaining pre-contribution gain on any asset he contributed to the partnership in the preceding 7 years may have to be recognized. (Sec. 704(c))

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Nonliquidating Distributions.

Contributing partner must recognize the pre-contribution gain or loss when property is distributed to any other partner within 7 years of the contribution.

Amount of gain recognized is the amount that would have been allocable to the contributing partner if the property had been sold for FMV on distribution date.

Partner's basis in partnership interest and the partnership's basis in the property immediately before the distribution are adjusted for any recognized gain or loss.

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Property distributions to a partner may force the partner to recognize his remaining pre-contribution gain if the FMV of distributed property exceeds the partner's basis in the partnership interest immediately prior to the property distribution. The gain to be recognized under Sec. 737 is the lesser of (1) remaining pre-contribution net gain or (2) the excess of the FMV of distributed property over the adjusted basis of the partnership interest immediately before the property distribution (but after reduction for any money distributed at the same time).

If gain is recognized under Sec. 737, the partner's basis in his partnership interest is increased by the recognized gain. Partnership's basis in the property which was the source of the precontribution gain is increased by the recognized gain.

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Nonliquidating Distributions

Distributions reduce the partner’s basis–Reduce basis first for cash received.

then for basis of other property distributed (partner takes partnership’s basis for property)(However, you cannot assign basis to cash and other property distributed in excess of the partner’s outside basis before the distribution.)– If cash distribution exceeds partner’s basis,

the partner recognizes gain for the excess.–Loss is never recognized on nonliquidating

distributions.

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Partnership Distributions-1Partner X, a 1/3 partner in XYZ Partnership, needs a distribution from partnership for some unexpected bills.

The partnership, however, does not have any extra cash to distribute. It will distribute to the partner land that has a value of $30,000 and a basis to the partnership of $25,000. X’s basis in his partnership interest is $45,000.

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Partnership Distributions-2

a. How will this distribution be treated for tax purposes?

b. Assume alternatively, that the partnership sells the land for its fair market value and distributes the cash to Partner X. What are the tax consequences of the sale and distribution?

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Partnership Distributions-3a. There is no gain or loss recognized on the distribution of the land to Partner X. Instead, Partner X has a basis of $25,000 in the land and the distribution reduces his basis in his partnership interest to $20,000 ($45,000 - $25,000). Any gain on a subsequent sale will be recognized only by Partner X.

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Partnership Distributions-4b. The partnership will have a realized and recognized gain of $5,000 ($30,000 - $25,000) on the sale of the land. The gain will be allocated one-third to each of the partners increasing Partner X’s basis by $1,667 ($5,000 x 1/3) to $46,667. Partner X receives $30,000 cash, which reduces his basis in his partnership interest to $16,667 ($46,667 – $30,000).

2. Determine the partner’s basis of assets received in a nonliquidating partnership distribution.

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Basis Effects of “Current” Distribution.

Partner's basis in property distributed by the partnership carries over from the partnership.

Partner's basis is reduced by the amount of money received plus the basis claimed for the distributed property. Total bases of all distributed property in the partner’s hands are limited to the partner's pre-distribution basis in his partnership interest plus gain recognized on the distribution under Sec. 737.

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Order of allocating partnership basis to the individual properties.

First, cash and deemed cash distributions reduce the partner's basis.

Next, the remaining basis is allocated first to unrealized receivables and inventory, and

then any remaining basis to all other property.

Where there are several assets distributed in each category, the basis allocated to that category is allocated to the individual assets in proportion to their relative bases in the hands of the partnership and their FMV.

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Holding Period and Character of Distributed Property.

Partner's holding period for property distributed in a current distribution includes partnership's holding period for the property. If property that was an unrealized receivable in the partnership's hands is sold by the distributee partner, the income or loss that is recognized is ordinary income or loss.

This treatment will occur regardless of the character of the property in the hands of the distributee partner or the length of time the property is held by such partner.

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Holding Period and Character of Distributed Property. If inventory is distributed, a subsequent sale of the inventory by the distributee partner results in ordinary income or loss if the sale occurs within five years of the distribution date.

If the sale occurs more than 5 years after the distribution date, the character of any gain or loss is determined by the character of the property in the partner's hands.

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Note on the next few slides that a partner receiving a non-liquidating distribution of property other than cash, has a carryover basis for that property (the partnership’s basis) unless that exceeds the partner’s outside basis.

If the partner’s outside basis is less, that is the basis assigned to the property distributed.

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Liquidation computations are much simpler if the partnership has no hot asset (Sec. 751) or if such assets are distributed on a proportionate basis. With this simplifying assumption, there is no gain unless cash distributed exceeds basis of partnership interest. Otherwise, we have to pretend the partner took a proportionate distribution and then traded assets with the partnership.

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1 Partner's outside basis (Include debt)

2 Less: cash distributed to Partner

3 Gain recognized by Ptnr (Ln 2-Ln 1)

4 Ptnr's remain. outside basis (Ln 1-Ln 2)

5 Pthp's inside basis - Other prop. dist.

6 Ptnr's basis for other prop (< Ln 4 or 5)

7 Partner's outside basis (Ln 4 - Ln 6)

Non-liquidating Distributions - Sec. 731-33(No Unrealized Receivables distributed)

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1 Partner's outside basis (Include debt)

2 Less: cash distributed to Partner

3 Gain recognized by Ptnr (Ln 2-Ln 1)

4 Ptnr's remain. outside basis (Ln 1-Ln 2)

5 Basis assigned to Unreal. Receivables

(< of Ptshp basis for receivales or Ln. 4)

6 Ptnr's basis avail. for other Prop (Ln 4-5)

7 Pthp's inside basis - Other prop. Dist.

8 Ptnr's basis for other prop (< ln 6 or 7)

9 Partner's remaining outside basis

Non-liquidating Distributions - Sec. 731-33

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The adjusted basis of Jody's partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and land with an adjusted basis to the partnership of $40,000 and a FMV of $35,000. What amount of taxable gain must Jody report as a result of this distribution?a. $0 b. $5,000 c. $10,000 d. $20,000 CPA 11-93

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The adjusted basis of Jody's partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and land with an adjusted basis to the partnership of $40,000 and a FMV of $35,000.

What is Jody's basis in the land ?

a. $0 b. $30,000 c. $35,000

d. $40,000 CPA 11-93

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The adjusted basis of Jody's partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and land with an adjusted basis to the partnership of $40,000 and a FMV of $35,000. What is Jody's basis in her partnership interest after this distribution?a. $0 b. $30,000 c. $35,000 d. $40,000 CPA 11-93

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1 Partner's outside basis (Include debt) 50,000$

2 Less: cash distributed to Partner 20,000

3 Gain recognized by Ptnr (Ln 2-Ln 1)

Gain only if cash exceeds outside basis

4 Ptnr's remain. outside basis (Ln 1-Ln 2)

5 Pthp's inside basis - Other prop. dist.

6 Ptnr's basis for other prop (< Ln 4 or 5)

7 Partner's outside basis (Ln 4 - Ln 6)

Non-liquidating Distributions - Sec. 731-33Solution for Jody's Partnership Dist.

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1 Partner's outside basis (Include debt) 50,000$

2 Less: cash distributed to Partner 20,000

3 Gain recognized by Ptnr (Ln 2-Ln 1) -

Gain only if cash exceeds outside basis

4 Ptnr's remain. outside basis (Ln 1-Ln 2) 30,000

5 Pthp's inside basis - Other prop. dist. 40,000

6 Ptnr's basis for other prop (< Ln 4 or 5) 30,000

7 Partner's outside basis (Ln 4 - Ln 6) -

Non-liquidating Distributions - Sec. 731-33Solution for Jody's Partnership Dist.

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The adjusted basis of Mr. X's partnership interest in ABC partnership is $8,000. X received a non-liquidating distribution of $2,500 cash and property that had an adjusted basis to the partnership of $6,200 (fair market value $7,000).

X's recognized gain on this liquidation is:a. $0 b. $1,500 c. $2,500 d. $8,000 e. $9,500

X's basis for the distributed property (other than cash) is:a. $5,500 b. $6,200 c. $7,000 d. $8,000 e. $8,700

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1 Partner's outside basis (Include debt) 8,000$

2 Less: cash distributed to Partner 2,500

3 Gain recognized by Ptnr (Ln 2-Ln 1)

Gain only if cash exceeds outside basis

4 Ptnr's remain. outside basis (Ln 1-Ln 2)

5 Pthp's inside basis - Other prop. dist.

6 Ptnr's basis for other prop (< Ln 4 or 5)

7 Partner's outside basis (Ln 4 - Ln 6)

Non-liquidating Distributions - Sec. 731-33Solution for Mr. X's Partnership Dist.

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1 Partner's outside basis (Include debt) 8,000$

2 Less: cash distributed to Partner 2,500

3 Gain recognized by Ptnr (Ln 2-Ln 1) 0

Gain only if cash exceeds outside basis

4 Ptnr's remain. outside basis (Ln 1-Ln 2) 5,500

5 Pthp's inside basis - Other prop. dist. 6,200

6 Ptnr's basis for other prop (< Ln 4 or 5) 5,500

7 Partner's outside basis (Ln 4 - Ln 6) 0

Non-liquidating Distributions - Sec. 731-33Solution for Mr. X's Partnership Dist.

3. Identify the partnership's Sec. 751 assets.

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Nonliquidating Distributions With Sec. 751.

Section 751 Assets Defined.

Sec. 751 assets include unrealized receivables and inventory. These two categories include all property that is likely to generate ordinary income when sold or collected.

Unrealized Receivables.

Unrealized receivables are certain rights to payments to be received by a partnership that have not already been recognized as income. The term also includes most potential ordinary income recapture items (e.g., Sec. 1245 gains).

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Nonliquidating Distributions With Sec. 751.

Inventory includes items held for sale in the normal course of business, other property which if sold by the partnership would not be considered a capital asset or Sec. 1231 asset, and any other property which if held by the distributee partner would be one of the two previous types of property.

For purposes of calculating the impact of Sec. 751 on distributions (but not sales), inventory is only considered a Sec. 751 asset if the inventory is substantially appreciated. The test to determine whether inventory is substantially appreciated is mechanical. Inventory is substantially appreciated if its FMV exceeds 120% of its adjusted basis to the partnership. For purposes of testing whether inventory is substantially appreciated, inventory also includes unrealized receivables.

4. Determine the tax implications of a sale, or a cash distribution, when the partnership has Sec. 751 assets.

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Nonliquidating Distributions With Sec. 751.Exchange of Sec. 751 Assets and Other Property. A current distribution receives treatment under Sec. 751 only if:

(1) the partnership has Sec. 751 assets and

(2) there is an exchange of Sec. 751 property for non-Sec. 751 property.

Analyzing a transaction to determine what property is involved in the Sec. 751 distribution is best done in an orderly step-by-step analysis.

5. Determine the amount and character of gain or loss a partner recognizes in a liquidating distribution

Terminating an Interest In a Partnership.A liquidating distribution is a distribution or series of distributions that terminates a partner's interest in a partnership. Gain is recognized only if the money distributed (including money deemed distributed to the partner from a liability reduction or the FMV of marketable securities that are treated like money) exceeds the partner's pre-distribution basis in his partnership interest.Loss is recognized only if the distribution consists of money (including money deemed distributed), unrealized receivables, and inventory, but no other property. The amount of the loss that is recognized is the difference between the partner's basis and the money plus the partnership's basis in the receivables and inventory received.

6. Determine the

partner’s basis of assets received in a liquidating distribution.

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Liquidating Distributions.

Basis in Assets Received.

The basis in unrealized receivables and inventory is generally the same as the basis in the partnership's hands.

In some instances these bases may be reduced because the partner's basis in the partnership interest is smaller than the basis of the distributed property in the hands of the partnership.

In this case, the remaining basis in the partnership interest must be allocated between the assets received based first on their decline in value and then on their relative bases as adjusted to reflect the decline in value.

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Liquidating Distributions.

Holding Period in Distributed Assets. The distributee partner's holding period for any assets received in a liquidating distribution includes the partnership's holding period for such property.

If a contributing partner held the property, the holding period will also include the holding period of the contributing partner.

1 Partner's outside basis (Include debt)

2 Less: cash distributed to Partner

3 Gain recognized by Ptnr (Ln 2-Ln 1)

4 Ptnr's remain. outside basis (Ln 1-Ln 2)

5 Ptnr's basis for other property Line 4

6 Partner's loss on distribution (Line 5)(Positive amount on line 5 is the loss, if no property distributed other than cash,unrealized receivables and inventory.)

7 Remaining Outside Basis $-0-

Liquidating Distributions - Sec. 731-33(No Unrealized Receivables distributed)

1 Partner's outside basis (Include debt)

2 Less: cash distributed to Partner

3 Gain recognized by Ptnr (Ln 2-Ln 1)

4 Ptnr's remain. outside basis (Ln 1-Ln 2)

5 Ptnr's basis in Unreal. Rec. & Inventory

(< Ptshp's inside basis of asset or line 4)

6 Ptnr's basis for other prop. Ln 4 - Ln 5.

7 Partner's loss on distribution (Line 6)

(Positive amount on line 6 is the loss,

if no property distributed other than cash,

unrealized receivables and inventory.)

8 Remaining outside basis $-0-

Liquidating Distributions - Sec. 731-33

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Note that with liquidating distributions, there is no remaining outside basis in the partnership interest because the partner is liquidated – terminated – no longer a partner.

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Jody is a partner in the Success Partnership.

The adjusted basis of Jody's partnership interest was $75,000 immediately before

Jody received a liquidating distribution of $20,000 cash and land with an adjusted basis to the partnership of $40,000 and a fair market value of $50,000.

What amount of taxable loss is reported by Jody as a result of this distribution?a. $0 b. $5,000 c. $10,000 d. $15,000 CPA 11-93

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Jody is a partner in the Success Partnership.

The adjusted basis of Jody's partnership interest was $75,000 immediately before

Jody received a liquidating distribution of $20,000 cash and land with an adjusted basis to the partnership of $40,000 and a fair market value of $50,000.

What amount of taxable loss is reported by Jody as a result of this distribution?

a. $0 b. $5,000 c. $10,000 d. $15,000 CPA 11-93

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Brody is a partner in the Success Partnership.

The adjusted basis of Brody's partnership interest was $25,000 immediately before Brody received a liquidating distribution of $20,000 cash and land with an adjusted basis to the partnership of $40,000 and a fair market value of $50,000.

What is Brody’s basis in the land received this distribution?a. $0 b. $5,000 c. $10,000 d. $15,000 CPA 11-93

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1 Partner's outside basis (Include debt) 25,000

2 Less: cash distributed to Partner

3 Gain recognized by Ptnr (Ln 2-Ln 1)

4 Ptnr's remain. outside basis (Ln 1-Ln 2)

5 Ptnr's basis for other property Line 4

6 Partner's loss on distribution (Line 5)(Positive amount on line 5 is the loss, if no property distributed other than cash,unrealized receivables and inventory.)

7 Remaining Outside Basis $-0-

Liquidating Distributions - Sec. 731-33Distribution to Brody

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1 Partner's outside basis (Include debt) 25,000

2 Less: cash distributed to Partner 20,000

3 Gain recognized by Ptnr (Ln 2-Ln 1)

4 Ptnr's remain. outside basis (Ln 1-Ln 2) 5,000

5 Ptnr's basis for other property Line 4 5,000

6 Partner's loss on distribution (Line 5)(Positive amount on line 5 is the loss, if no property distributed other than cash,unrealized receivables and inventory.)

7 Remaining Outside Basis $-0-

Liquidating Distributions - Sec. 731-33Distribution to Brody

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The

End