DISTRIBUTIONS- HOT ASSETS
I.
SCOPE OF §751.
§751 requires recognition of ordinary gain or loss when the partnership owns unrealized
receivables or inventory and there is either:
II.
A.
A sale of a partnership interest; or
B.
There is a DISPROPORTIONATE DISTRIBUTION to a partner.
DIFFERENCES BETWEEN §751(a) AND §751(b).
A.
Sales. §751(a) deals with sales of partnership interests. There is no requirement
that "inventory" be "substantially appreciated."
B.
Distributions. §751(b) deals with DISPROPORTIONATE DISTRIBUTIONS.
§751(b) is a deemed sale provision like §707(b). In the case of a DISPROPORTIONATE
DISTRIBUTION, inventory must be substantially appreciated, whereas under §751(a), there is
no such request.
III.
DEFINITION OF UNREALIZED RECEIVABLES.
A.
The term "unrealized receivables" includes, to the extent not previously includible
in income under the method of accounting used by the partnership, any rights (contractual or
otherwise) to payment for:
1.
Goods delivered, or to be delivered, to the extent the proceeds therefrom
would be treated as amounts received from the sale or exchange of property other than a capital
asset; or
2.
B.
Services rendered, or to be rendered.
For purposes of this section and Sections 731, 736, and 741, such term also
includes Section 1245 property (as described in §1248), Section 1250 property, and other similar
items.
IV.
DEFINITION OF SUBSTANTIALLY APPRECIATED INVENTORY.
A.
Definition of Inventory. The term "inventory items" means:
1.
Property of a partnership of the kind described in Section 1221(1);
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2.
Any other property of the partnership which, on sale or exchange by the
partnership, would be considered property other than capital assets and other than property
described in Section 1231;
3.
any other property of the partnership which, if sold or exchanged by the
partnership, would result in a gain taxable under subsection (a) of Section 1256 (relating to gain
on foreign investment company stock); and
4.
any other property held by the partnership which, if held by the selling or
distributing partner, would be considered property of the type described in subparagraph (1), (2),
or (3).
B.
Definition of Substantially Appreciated. Value of inventory exceeds 120% of
adjusted basis of such inventory. But, inventory will be “disregarded” if the purpose for the
acquisition was to avoid the 120% rule (IRC § 751(b)(3)(B).
V.
SUBSTANTIALLY APPRECIATED INVENTORY ITEM UNREALIZED
RECEIVABLES.
In determining whether the partnership owns substantially appreciated inventory, one
must include accounts receivable, whether or not realized, in applying the 120% test.
VI.
DEFINITION OF DISPROPORTIONATE DISTRIBUTION.
A.
General. Generally, under §751(b) each partner is treated as owning interest in
each partnership asset in proportion to his interest in the partnership. If a partner receives a
distribution for property or money from a partnership which varies (i.e., increases or decreases)
the amount of §751 assets which he was treated as owning immediately prior to the distribution,
then a "DISPROPORTIONATE DISTRIBUTION" has occurred. Under such circumstances,
the partner did not merely receive the amount of §751 assets which he was treated as owning
prior to the distribution, rather he either received an interest in §751 assets in exchange for his
interest in other assets or he received an interest in other assets in exchange for his interest in
§751 assets.
B.
Current or Liquidating. A DISPROPORTIONATE DISTRIBUTION may take
the form of either a current distribution or a liquidating distribution. Reg. §1.751-1(b).
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VII.
§751 ASSETS.
For sake of convenience, unrealized receivables and inventory are referred to as §751
Assets.
VIII. APPROACH TO §751 SALES
EXAMPLE #1
Assume there is an equal 3-person partnership, ABC Co. ABC Co. is:
ASSETS
Type
Accounts Receivable
Basis
-0-
Cash
$15,000
Value
$15,000
15,000
LIABILITIES AND EQUITY
Type
A
Basis
$5,000
Value
$10,000
B
$5,000
$10,000
C
$5,000
$10,000
Assume that A sells his half interest to D for $10,000 in cash. There are $5,000 of
§751 assets, consisting of the unrealized receivables. There is $5,000 of gain, all
of which would be ordinary income.
IX.
APPROACH TO §751 DISTRIBUTIONS.
A.
Are there §751 assets?
B.
Is there a Taxable Transaction?
C.
What is the basis to the partnership of properties?
D.
What is the basis to the partners of the properties?
E.
What are the properties exchanged?
F.
What allocations must be made to determine the total amount of taxable gain or
loss?
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X.
TAXABLE TRANSACTION
Determine the amount involved in the taxable transaction. This is the amount of §751
Assets received or given up by the partner which is greater than or less than the amount of §751
Assets which that partner is treated as owning in a cash basis partnership.
EXAMPLE #2
Assume there is an equal 3-person partnership, ABC Co. ABC Co. is:
ASSETS
Type
Accounts Receivable
Basis
-0-
Cash
$15,000
Value
$15,000
15,000
LIABILITIES AND EQUITY
Type
A
Basis
$5,000
Value
$10,000
B
$5,000
$10,000
C
$5,000
$10,000
Assume that A, in complete liquidation of his interest, receives $10,000 cash. A
received $5,000 more worth of cash than he was entitled to. A gave up a $5,000
interest in the unrealized accounts receivable. Since there was a $5,000 change in
§751 Assets, §751(b) makes this a Taxable Transaction by overriding IRC
§731(b).
A.
Basis to Partner. Under §751(b) a partner is treated as owning an undivided
interest in each partnership assets in proportion to his interest in the partnership. For purposes of
§751(b) the partner's basis in each such undivided interest is equal to the basis such partner
would have had in such interests if he had received them in a current distribution immediately
prior to the DISPROPORTIONATE DISTRIBUTION. [Reg. 1.751-1(b)(2)(iii)]
B.
Basis to Partnership. Determine the adjusted basis of the partnership in each asset
owned by it. [Reg. 1.751-1(b)(2)(ii)]
C.
Properties Exchanged. Determine which properties will be treated as being
exchanged for each other under §751(b).
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1.
If the parties do not designate the property exchanged, this determination
can be made by looking at what the partner would have had, had he received his undivided
interest in all assets owned by the partnership in a current distribution. Then look at the assets
which he in fact received. To the extent he received less than his proportionate interest in any
asset he will be treated as giving up his interest in such asset. To the extent that the partnership
gave him a larger interest in any one asset than its proportionate share, the partnership shall be
treated as exchanging that asset.
2.
The parties can designate the properties exchanged by agreement.
[Reg. 1.751-1(g), ex. 3 and 4.]
D.
Allocations. Since the total value of the properties treated as being exchanged
may be less than or greater than the amount of the taxable transaction, one must make certain
basis and value allocations to determine the tax consequences of the transaction.
EXAMPLE #3
ABC Co. is a three person equal partnership with the following balance sheet:
ASSETS
Basis
Cash
FMV
$15,000
$15,000
$9,000
$9,000
Inventory
$21,000
$30,000
Depreciable Property
(no recapture potential)
$42,000
$48,000
Land
$9,000
$9,000
Total
$96,000
$111,000
Accounts Receivable
LIABILITIES
Current
Basis
$15,000
FMV
$15,000
Long Term
$21,000
$21,000
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CAPITAL
A
Basis
$20,000
FMV
$25,000
B
$20,000
$25,000
C
$20,000
$25,000
A's basis in his partnership interest is $32,000. A receives, in complete liquidation
of his interest, $10,000 cash and $15,000 of depreciable property.
Analysis:
1.
Does ABC Co. have §751 Assets?
a.
Unrealized accounts receivable. No.
b.
Substantial Appreciated Inventory. Yes.
i.
Inventory.
(a)
Accounts receivable $9,000.
(b)
Inventory - basis $21,000 and value $30,000.
(c)
120% test - total basis of inventory (which includes
accounts receivable) is $30,000, 120% of which equals $36,000. $39,000 > $36,000 so 120% test
is satisfied.
2.
Was there a Taxable Transaction because there was a DISPROPORTIONATE
DISTRIBUTION?
A's share of partnership property:
Cash
Basis
$5,000
FMV
$5,000
Accounts Receivable
$3,000
$3,000
Inventory
$7,000
$10,000
$14,000
$16,000
$3,000
$3,000
Depreciable Property
Land
A did not receive any interest in the accounts receivable or inventory with a fair market
value of $13,000. These assets constitute Section 751 Assets and, therefore, this was a
DISPROPORTIONATE DISTRIBUTION in the amount of $13,000 which constitutes a
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Taxable Transaction. A also did not receive his full share of depreciable property which would
have been $16,000. A only received $15,000..
3.
Taxable Transaction - $13,000, see above.
4.
Basis to Partner A in Assets Given Up. Apply §732 as if A received his
proportionate share of partnership assets in a current distribution.
Cash
$5,000
Accounts Receivable
$3,000
Inventory
$7,000
Depreciable Property
$14,000
Land
5.
$3,000
Basis to Partnership in Assets Given Up.
Cash
Liabilities
6.
$5,000
$12,000
Properties Exchanged.
a.
A received the following consideration:
i.
$10,000 cash ($5,000 more than pro rata share)
ii.
$15,000 depreciable property ($1,000 less than his pro rata
iii.
Relief of $12,000 of liability.
share).
b.
A, therefore, gave up his interest in:
i.
$3,000 accounts receivable;
ii.
$10,000 of inventory;
iii.
$1,000 depreciable property; and
iv.
$3,000 land,
for a total of $17,000 in exchange for $5,000 cash and $12,000 relief of liabilities.
Of this $17,000 exchange, $10,000 of inventory and $3,000 of accounts receivable
constitute §751 assets.
7.
Taxation.
a.
To A: A is treated as having sold his interest in §751 assets
consisting of $10,000 of inventory and $3,000 of receivables for cash of $13,000 producing a
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taxable gain of $3,000. Section 751(b) does not apply to the balance of the distribution. Before
the distribution, A's basis for his partnership interest was $32,000 ($20,000 plus $12,000, his
share of partnership liabilities). This basis is reduced by $10,000, the basis attributed to the
Section 751 property treated as distributed to A and sold by him to the partnership. Thus, A has a
basis of $22,000 for the remainder of his partnership interest. Since A received no more than his
share of the depreciable property, none of the depreciable property constitutes proceeds of the
sale under Section 751(b). A did, however, receive more than his share of money. Therefore, the
sale proceeds must, by process of elimination, be the consideration A received in exchange for
his share of §751 Assets. Therefore, out of the total of $22,000 of cash and debt relief, $13,000 is
allocable to the IRC §751(b) transaction and $9,000 is treated as a §731 distribution. In
liquidation of the balance of A's interest, he received depreciable property and $9,000 in money
($22,000 less $13,000). Therefore, no gain or loss is recognized to A on the distribution. Under
Section 732(b), A's basis for the depreciable property is $13,000 (the remaining basis of his
partnership interest, $22,000, reduced by $9,000, the money received in the distribution)
b.
To the Partnership: Since the partnership paid cash for the
inventory and accounts receivable, it gets a cost basis therefor and no gain or loss is recognized
to the partnership.
8.
Character of Gain or Loss. Character of gain or loss under §751 is
determined by reference to the character of the asset in the hands of the party giving it up.
Therefore, A would have to report $3,000 of ordinary income which represents the appreciation
as the value of his share of the inventory.
9.
Allocation of Gain or Loss at Partnership Level. If the partnership had
recognized any gain or loss, the remaining partners of the partnership as then constituted would
have been allocated such gain or loss in accordance with their respective interests
§1.751.1(b)(2)(iii).
XI.
REPORTING REQUIREMENTS (§6050(k).
A.
Code §6050(K). If there is an exchange described in Code §751(a) of any interest
in a partnership during any given calendar year, such partnership shall make a return for such
calendar year stating: (i) the name and address of the transferee and the transferor, and (ii) any
other information the Secretary may prescribe. In the case of any exchange described in
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Paragraph (1) above, the transferor of the partnership interest shall promptly notify the
partnership of such exchange and the partnership shall not be required to make a return until so
notified.
B.
Every partnership making a return under subsection (a) shall furnish to each
person whose name is set forth in such return a written statement showing: (i) the name and
address of the partnership making the return, and (ii) information shown on the return with
respect to such person. Such statement is to be furnished no later than January 31 following the
calendar year in which the exchange was made.
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