Chapter C10
Special Partnership Issues
Discussion Questions
C10-1 A current distribution is a distribution which does not terminate the partner's interest in the
partnership nor is the payment one of a series of payments which is intended to terminate the
partner's interest in the partnership. A liquidating distribution is made with the intention of
terminating the partner's entire interest in the partnership either with this payment or with a planned
series of payments including this one. The January distribution to Javier is the first in a series of
distributions which will terminate his interest in the partnership and, therefore, is a liquidating
distribution. p. C10-2.
C10-2 The basis of property in the hands of the distributee partner is generally a carryover of the
property's adjusted basis in the partnership's hands immediately before the distribution. However,
the basis of all property distributed to a partner cannot exceed the distributee partner's basis in his
partnership interest immediately before the distribution reduced by any cash or deemed cash
payments (liability reduction) which she received as part of the distribution. Lia's basis will be
$40,000 if the partnership's basis in the land prior to the distribution was $40,000 or more. Lia will
take a carryover basis from the partnership's books if the partnership's basis for the parcel of land
prior to the distribution was less than $40,000. pp. C10-4 through C10-7.
C10-3 The basis of a single asset received in a liquidating distribution is determined by two factors:
the basis of the distributed property in the partnership's hands and the distributee partner's basis in his
partnership interest prior to the distribution. The total basis to the distributee partner of the assets
received will generally equal the partner's basis in the partnership interest immediately prior to the
distribution. Mariel's basis will be $60,000 in the land regardless of what the partnership's basis in
the land was prior to its distribution. pp. C10-12 through C10-15.
C10-4 Cindy's basis for the property she receives will be reduced to $4,000 from its $4,500 basis to
the CDE Partnership since it is limited to Cindy's basis in her partnership interest before the
distribution. Even though the property will be held as an investment by Cindy, the sale of the
inventory would generate ordinary income for five years from the date of the distribution. The sale
of the capital asset would generate long-term capital gain that is to most individual taxpayers taxed at
a maximum 20% marginal tax rate. pp. C10-2 through C10-8.
C10-5 The partnership's accounts receivable are probably not unrealized receivables because the
partnership uses the accrual method of accounting. However, recapture potential under Secs. 1245
and 1250 are also unrealized receivables. The partnership has Sec. 1245 recapture potential on the
machines used to produce the inventory (and presumably also from other machinery, furniture and
equipment which the partnership owns). Whether the building has Sec. 1250 recapture potential, and
C10-1
therefore additional unrealized receivables, depends on the method of depreciation used for the
building. pp. C10-8 and C10-9.
C10-6 a, b, c, e. p. C10-8.
C10-7 The inventory has a $100,000 FMV. This $100,000 amount must be greater than 120% of
the inventory's basis so the basis must be less that $83,333.33. pp. C10-8 and C10-9.
C10-8 For Sec. 751 to come into play in a current distribution, the distributing partnership must
have both Sec. 751 assets (unrealized receivables and/or substantially appreciated inventory) and
non-Sec. 751 assets. In addition, the distributee partner must have given up some of his interest in
one of the two classes of assets in exchange for an increased interest in the other class of assets. p.
C10-9.
C10-9 A partner can recognize a loss on a distribution only if the distribution is a liquidating
distribution which consists of money, unrealized receivables, and inventory. A loss is recognized if
the amount of money and the carryover basis of the receivables and inventory are less than the
partner's pre-distribution basis in his partnership interest. pp. C10-12 and C10-13.
C10-10 The basis of unrealized receivables and inventory received by a distributee partner in a
nonliquidating or liquidating distribution cannot be greater to the partner than to the partnership. If
the partner receives only money, unrealized receivables, and inventory as part of a liquidating
distribution, and the carryover basis of the receivables and inventory is less than the partner's
predistribution basis in the partnership interest (reduced by money received or deemed to have been
received in the distribution), the partner can not step-up the basis in the receivables or inventory but
must instead recognize a loss.
If the partner's pre-distribution basis in the partnership interest is smaller than the sum of money
received and the carryover basis for the receivables and inventory, the basis of the receivables and
inventory to the distributee partner is reduced. The basis to be allocated between the unrealized
receivables and inventory equals the pre-distribution basis for the partnership interest reduced by any
money or deemed money received in the distribution. pp. C10-12 through C10-14.
C10-11 A partner must divide the sale of a partnership interest into two transactions if the
partnership has Sec. 751 assets. There is a sale by the partner of his share of Sec. 751 assets for their
FMV with their adjusted basis to the partner being the basis that the Sec. 751 assets would have had
if the partner had received them in a current distribution. The remaining sales proceeds and the
remaining adjusted basis are then considered to be the amounts to be reported from the sale of the
remainder of the partnership interest (non-Sec. 751 assets). It is entirely possible that one part of the
transaction would generate a loss while the other part would generate a gain. pp. C10-16 through
C10-19.
C10-2
C10-12 a.
When Tyra's interest in the partnership is terminated, she will be deemed to have
received a money distribution in the amount of her interest in partnership liabilities. Since she has a
zero basis, she must report gain equal to the money distribution. Any other property she receives in
the distribution will, of course, have a zero basis. p. C10-12.
b.
The amount realized will equal the sum of the money received and any liabilities
assumed by the purchaser. Since her basis is zero she will report a large gain. pp. C10-16 through
C10-19.
C10-13 If the entire partnership is terminated, the Sec. 736 provisions do not apply at all. Rather
each partner is taxed under the liquidating distribution rules. Section 736 applies if one or more
partners (but fewer than all the partners) dies or are retiring. Accordingly, Sec. 736 applies to the
payments to Tom. pp. C10-24 and C10-25.
C10-14 There are two kinds of Sec. 736 payments. Section 736(b) payments are payments for a
partner's interest in partnership property and these payments are taxed under the rules for liquidating
distributions. Capital gain is recognized if the partner receives money in excess of basis in her
partnership interest, so Lucia will report a capital gain of $3,000 ($23,000 - $20,000) on the payment
she receives for partnership assets.
Section 736(a) payments will be taxed as a guaranteed payment (ordinary income) if the
distribution is not based on partnership income. If the payment is based on partnership income, the
partner will be taxed on a distributive share of partnership income with the character of the income
determined at the partnership level. Accordingly, Lucia will report her share of partnership income
as a distributive share. pp. C10-19 and C10-20.
C10-15 The advantages of terminating a partnership include the termination of tax accounting
elections which may be disadvantageous and the possibility of a step-up in the basis of partnership
assets. If a partner has a basis for his/her partnership interest that is greater than his share of the
partnership's basis in the assets deemed distributed to him, the assets which are not money,
receivables or inventory will take a stepped-up basis.
The disadvantages of a termination may include loss of a favorable tax year, the bunching of
income for the partners, and a potential decline in asset basis. If a partner's basis for his partnership
interest is smaller than his pro rata share of the partnership's basis for its assets (other than money),
the assets may have their basis reduced by the deemed distribution. pp. C10-22 through C10-26.
C10-16 A publicly traded partnership (PTP) is defined as a partnership whose interests are either
traded on an established securities exchange or are traded in a secondary market or the equivalent
thereof. Two groups of PTPs are not taxed as corporations. A PTP which was in existence on
December 17, 1987, and which has not added a substantial new line of business was not taxed as a
corporation until tax years beginning after December 31, 1997. These partnerships, which were
grandfathered under the 1987 law for 10 years, were granted a new election in the Taxpayer Relief
Act of 1997 (TRA of 1997). The TRA of 1997 allows these PTPs to continue to be taxed as
C10-3
partnerships if they elect to do so and agree to pay an annual tax of 3.5% of gross income from the
partnership’s trade or business. Partnerships which have 90% or more of the their gross income
being "qualifying income" (interest, dividends, real property rents, etc.) continue to be taxed as
partnerships. pp. C10-27 and C10-28.
C10-17 From a legal standpoint, all the owners of a Limited Liability Company (LLC) have limited
liability for the firms debts. In a limited partnership, all general partners have significant liability for
firm debts. With the check-the-box rules, a LLC can choose whether to be taxed as a partnership or
as an association taxed as a corporation. If the LLC chooses partnership taxation, there is virtually
no difference between the taxation of the LLC and the limited partnership. pp. C10-28 and C10-29.
C10-18 An Electing Large Partnership is a partnership which is not a service partnership, is not
engaged in commodity trading, has at least 100 partners, and files and election to be taxed as an
electing large partnership. The primary advantage to the partnership of electing to be an Electing
Large Partnership is that the reporting of income to the large number of partners is much simpler.
Relatively few items are separately stated so that the reporting process is more difficult than a
corporation but easier than a non-electing partnership. pp. C10-29 through C10-32.
Issue Identification Questions
C10-19 ·
·
·
·
·
Does Kayla recognize a gain or loss on the current distribution?
What is Kayla's basis in the office equipment?
When does Kayla's holding period commence for the property?
Does any depreciation recapture carryover to Kayla from the partnership?
What is Kayla's basis in her partnership interest following the distribution?
Kayla recognizes no gain or loss on the distribution. Her basis for the equipment would be a
carryover basis from the partnership ($35,000) if that was possible, but it is limited to her basis in her
partnership interest prior to the distribution ($30,000). Kayla's holding period for the office
equipment includes the holding period that the partnership had for the property. Her basis in the
partnership interest is zero following the distribution. pp. C10-2 through C10-8.
C10-20 Joel must determine:
· How much is his distribution?
· Does the partnership have Sec. 751 assets?
· If the partnership has Sec. 751 assets, did Joel exchange any interest in Sec. 751
assets for cash?
· How much ordinary income must Joel recognize if he exchanges Sec. 751 assets for
cash?
· How must Joel treat any cash distribution received that is in excess of the amount
deemed to be part of the Sec. 751 exchange?
C10-4
The amount of the distribution includes both the cash and the relief from liabilities which he received
when his interest in the partnership changed from 1/3 to 1/4. It is likely that the partnership has Sec.
751 assets since we know the partnership inventory is substantially appreciated. Further, it is likely
that the cash basis partnership has accounts receivable which are unrealized and the partnership may
have recapture potential if it has any depreciable personalty. Again, it is very likely that an exchange
of Sec. 751 assets for cash occurred since he only received cash and probably gave up a portion of
his interest (from 1/3 to 1/4) in each Sec. 751 asset. The amount of ordinary income is the difference
between the amount of cash Joel is deemed to have received for the Sec. 751 assets and the adjusted
basis that Joel would have had in the Sec. 751 assets had the Sec. 751 assets been distributed to Joel
immediately before the deemed Sec. 751 sale (usually a carryover from the partnership's basis in
these Sec. 751 assets). Any cash or deemed cash in excess of the amount deemed to be part of the
Sec. 751 exchange is simply treated as a current distribution. The current distribution will reduce his
basis in his partnership interest. If the current distribution is greater than his basis in the partnership
interest, Joel will recognize gain because he receives cash in excess of his basis. pp. C10-7 through
C10-11.
C10-21 ·
·
Does the partnership have Sec. 751 assets?
What is the amount and character of the gain on the sale of Scott's partnership
interest?
There are no unrealized receivables, but the partnership does have inventory. Scott's gain is
calculated as follows:
Amount realized
Minus: Adjusted basis
Recognized gain
Assets
Total
$40,000
(35,000)
$ 5,000
Sec. 751
$7,000
(4,000)
$3,000
Other
$33,000
(31,000)
$ 2,000
The gain attributable to the Sec. 751 assets is ordinary while the remainder of the gain is
capital.
pp. C10-16 through C10-19.
C10-22 Drew and Dana should consider the following:
·
The sale as contemplated will terminate the partnership. Is termination of the
partnership desirable for Drew and Dana?
··
Will either individual have to recognize gain? The recognition of gain is
unlikely unless Drew and Dana has a small basis relative to the cash held by
the partnership and deemed distributed in the liquidating distribution.
··
What will be the basis for each of the assets? Under current regulations, the
termination is assumed to result in a liquidating distribution to Drew and
Dana followed by Drew and Dana contributing the old partnership's property
C10-5
·
to the new partnership. Some asset basis adjustments will result and the
adjustments are likely to be increases. This could be beneficial for Drew and
Dana. However, under proposed regulations, the termination will be deemed
to result in the old partnership contributing the property directly to the new
partnership so that no adjustment to asset bases is likely to occur.
··
Will income be bunched into a single tax year if the partnership terminates?
Termination of the partnership closes a tax year. If the partnership has the
same tax year-end as Drew and Dana there will be no bunching of income. If
their tax years differ, some bunching will occur.
··
When the partnership terminates, all elections are lost. Are there advantages
or disadvantages from losing all existing elections. There are a few
advantageous tax year-ends for old partnerships which were grandfathered
when the rules about required partnership tax year-ends were enacted. The
loss of this tax benefit would be a significant disadvantage.
Would liquidation by the partnership be more advantageous than a sale to the other
partners?
··
Liquidation by the partnership cannot terminate the partnership.
David should consider:
·
How much of his gain from the sale would be considered sale from his interest in
Sec. 751 assets and, therefore, taxed as ordinary income?
··
His sale will result in ordinary income to the extent that the FMV of Sec. 751
assets exceeds the adjusted basis in those assets that David would have had if
the assets had been distributed to David just before he sold his interest in the
partnership.
·
Will the sale cause a bunching of income from the partnership for David?
··
Since the sale of the entire partnership interest closes the partnership tax year
for the selling partner, the sale will cause bunching of income if David's tax
year-end is different from DDD's tax year-end.
·
Could the transaction be structured in such a way that a liquidation by the partnership
would be more beneficial to David? Possibly. If Drew and Dana really do not want
the partnership to terminate, they may be willing to pay David more in a liquidating
distribution than they were willing to pay for an outright purchase. pp. C10-16
through C10-19, C10-22 through C10-24.
C10-23 ·
·
Does the partnership terminate for tax purposes?
If so, when does the termination occur?
The partnership terminates since there will be only one partner left. The partnership
terminates when the final Sec. 736 payment is made. pp. C10-22 through C10-25.
C10-6
C10-24 ·
Is this gift going to make Haley a partner in the HotWheels LLC for tax purposes?
·
If Alex restructures the gift so that Haley has true control over the interest, how will
the LLC's income be allocated between Alex and Haley?
Haley will probably not be a partner. For Haley to be considered a partner, she must have
control of the interest. For a minor, control includes the situation when the interest is placed
in trust for the benefit of the minor but only if the trustee is someone who will act in the best
interest of the trust beneficiary. It is not clear that Alex is giving up any control over this
interest since he will continue to control the 15% share that he placed into Haley's trust.
Haley is unlikely to be considered a partner. A two-step allocation process will be used to
allocate partnership income. First, Alex must be allocated a FMV salary. His current salary
is described as small, and it may be too small to be considered equal to the FMV of his
services. Once Alex is allocated a FMV salary, all other income allocated to Alex and
Haley must be divided on a per capita basis. Alex must receive three-fourths and Haley
must receive one-fourth. In effect, the family partnership income allocation rules override
the special allocation to Alex.
C10-25 ·
Should Krypton choose to be taxed as a partnership or as a corporation?
··
How much will be kept in the business for growth and how much will be
distributed to the owners each year? The larger the percentage of earnings
which will be distributed the more advantageous a flow-through entity such
as a partnership can be.
··
What is the marginal tax rate for Jeff, Susan and Richard? If Jeff, Susan, and
Richard have lower marginal tax rates than Krypton, there are advantages to
partnership status.
·
How should Jeff's pay for operating the business be structured? If the business is
taxed as a corporation, a generous but reasonable salary will decrease the amount of
income subject to double taxation. If the business is structured as a partnership, the
partners need to decide whether to structure the payment as distributive share, as an
outright guaranteed payment, or whether to establish a guaranteed minimum which
may be some combination of the two.
C10-26 What method should XYZ Limited Partnership choose to use to operate under the publicly
traded partnership rules?
·
·
·
Pay the annual 3.5% of gross income tax and continue to be taxed as a publicly
traded partnership?
Buy back enough interests (or restrict opportunities for trading) so that the
partnership is no longer publicly traded
Incorporate the entity and be taxed as a regular (C) corporation.
C10-7
The best alternative will be a function of the amount of gross income, amount of taxable
income, the tax rates of the partners, the amount of profits that the firm wants to retain, and costs of
buying back partnership interests, and/or restricting trading, or incorporating.
If the XYZ Limited Partnership chooses to continue as a partnership, should it elect to come
under the Electing Large Partnership rules?
·
The election reduces the partnership’s annual cost of providing information to
partners but will require some start-up cost to make the change. The election also has
the advantage of making it more difficult to accidentally terminate the partnership
because of trades. However, the election significantly reduces the partners’ reporting
and audit options.
pp. C10-27 and C10-28.
Problems
C10-27 a.
Partnership interest basis:
Beginning basis
Minus: Cash received
Land basis
Ending basis
$ 25,000
( 4,000)
( 14,000)
$ 7,000
No gain or loss recognized by Lisa. The basis of the land is $14,000.
b.
Partnership interest basis:
Beginning basis
Minus: Deemed cash distribution
Tentative basis
$ 18,000
( 20,000)
($ 2,000)
Ending partnership interest basis: Greater of $0 or tentative basis ($2,000) = $0. Therefore,
a $2,000 capital gain is recognized because the deemed cash distribution is in excess of the
remaining basis of the partnership interest (-0-).
c.
Partnership interest basis
Beginning basis
Minus: Cash received
Receivables basis
Inventory basis
Ending basis
$ 32,000
( 20,000)
( -0- )
( 10,000)
$ 2,000
Ending though Kara receives only cash, receivables, and inventory, no gain or loss
recognized by the partner since the distribution is not a liquidating distribution.
C10-8
pp. C10-2 through C10-8.
C10-28
a.
Gain/Loss
-0-
b.
-0-
c.
$9,000
d.
-0-
Partner's
Post-distribution
Basis
basis
Property
to Partner
$7,000
Land
$4,000
Machinery
3,000
$4,000
Land
6,000
Inventory
7,000
-0Land - Parcel 1
-0Land - Parcel 2
-0$14,000
Land - Parcel 1
4,000
Land - Parcel 2
6,000
Land - Parcel 3
4,000
pp. C10-2 through C10-8.
C10-29 a.
Because Mario does not receive cash in excess of his partnership basis, he recognizes
no gain under the current distribution rules of Sec. 731. However, Sec. 737 requires an additional
step when some precontribution gain remains unrecognized. Mario must recognize gain equal to the
lesser of:
(1) Remaining precontribution gain ($8,000 = $18,000 - $10,000) or
(2) The excess of the FMV of the property distributed over the adjusted basis of the
partnership interest immediately preceding the distribution ($3,000 = $23,000 $20,000 partnership basis).
Under Sec. 737 Mario must recognize a $3,000 gain which takes its character from the land Mario
contributed to the partnership having the precontribution gain.
b.
Under Sec. 731, his basis in his partnership interest is reduced by the carryover basis
of the property distributed to him.
Mario's basis in partnership interest before
the distribution
Plus: Sec. 737 gain recognized on the distribution
Minus: Carryover basis of property distributed
Remaining basis in partnership interest after
the distribution
$20,000
3,000
(15,000)
$ 8,000
Because Mario recognized gain under Sec. 737, he must increase the basis of his partnership
interest by the $3,000 amount of the Sec. 737 gain. His basis is increased before reducing the basis
for the distribution.
c.
Because $3,000 of gain is recognized by Mario under Sec. 737, the partnership must
increase its basis in the property related to the precontribution gain recognized. The partnership's
C10-9
basis in the land is increased to $13,000 ($10,000 carryover basis from Mario at the time of the
contribution + $3,000 Sec. 737 gain recognized on this distribution).
Students may note that there remains $5,000 of precontribution gain related to this land
which could be recognized under Sec. 737 if Mario receives other distributions which trigger the
recognition of this gain within seven years of the original contribution of the land to the partnership
[if the property is contributed after June 8, 1997]. pp. C10-2 through C10-8.
C10-30 a.
Andrew must recognize the gain which would have been allocated to him if the
partnership had sold the land for its FMV instead of distributing it to Bob.
Amount deemed realized
Minus: Adjusted basis
Capital gain on deemed sale
$21,000
(18,000)
$ 3,000
b. and c. All $3,000 of the gain would have been allocated to Andrew since his precontribution gain was $4,000, so Andrew must recognize a $3,000 gain. He increases his basis in the
partnership interest by the $3,000 gain he recognizes to $24,000. Bob's basis in his partnership
interest in not affected by the gain recognition. The partnership's basis in the land is deemed
increased by the $3,000 gain to $21,000 immediately before the land is distributed. Accordingly, the
basis of the land to Bob is $21,000 and Bob's basis in his partnership interest is reduced to $9,000
($30,000 - $21,000) by the distribution. Andrew's basis in his partnership interest is not affected by
the distribution. pp. C10-2 through C10-8.
C10-31 First, precontribution gains on the distributed property must be recognized.
1.
Land: Amount deemed realized
Minus: Adjusted basis
Gain on deemed sale
$10,000
( 4,000)
$ 6,000
The precontribution gain allocated to Beth on the deemed sale is $4,000 ($8,000 FMV - $4,000 basis
at contribution). Beth's basis in her partnership interest after the deemed sale is $19,000 ($15,000 +
$4,000 gain recognized). The land's basis to the partnership immediately before the distribution is
$8,000 ($4,000 basis + $4,000 gain recognized).
2.
Inventory: Amount deemed realized
Minus: Adjusted basis
Gain on deemed sale
$10,000
( 1,000)
$ 9,000
The precontribution gain allocated to Cathy on the deemed sale is $3,000 ($4,000 FMV - $1,000
basis at contribution). Cathy's basis in the partnership interest after the deemed sale is $21,000
($18,000 + $3,000 gain recognized). The inventory's basis to the partnership immediately before the
distribution is $4,000 ($1,000 + $3,000 gain recognized).
C10-10
Then the current distributions must be analyzed using the normal rules.
Alonzo's distribution:
Basis in partnership interest before distribution
Minus: Carryover basis in land (see 1 above)
Basis in partnership interest after distribution
$19,000
( 8,000)
$11,000
Beth's distribution:
Basis in partnership interest before distribution
(see 1 above)
Minus: Carryover basis in inventory (see 2 above)
Basis in partnership interest after distribution
$19,000
( 4,000)
$15,000
Cathy's distribution:
Basis in partnership interest before distribution
(see 2 above)
Minus: Cash received in distribution
Basis in partnership interest after distribution
$21,000
(10,000)
$11,000
pp. C10-2 through C10-8.
C10-32 a.
Accounts receivable and depreciation recapture on the equipment.
b.
Yes, the inventory's $76,000 FMV ($16,000 + $52,000 + $1,500 equipment
depreciation recapture + $6,500) exceeds 120% of its adjusted basis [1.20 x ($0 + $50,000 + $0 +
$6,000) = $67,200].
c.
Beginning
Partnership
Amount
(1)
Kay's Interest
Before
Distributiona
(1/3)
(2)
Kay's Interest
After
Distributiona
(1/4)
(3)
Fictional
Proportionate
Distributiona
(3)=(1)-(2)
(4)
(5)
Actual
Distribution
Differenceb
(5)=(4)-(3)
Sec. 751
Assets
Receivables
Inventory
Supplies
Recapture
Total
$16,000
52,000
6,500
1,500
$76,000
$ 5,333
17,333
2,167
500
$25,333
$ 4,000
13,000
1,625
375
$19,000
$ 1,333
4,333
542
125
$ 6,333
-0-0-0-0-0-
($1,333)
( 4,333)
( 542)
( 125)
($6,333)
Other
Assets
Cash
Equipment
Land
Total
$ 30,000
9,000
65,000
$104,000
$10,000
3,000
21,667
$34,667
$ 2,500
2,250
16,250
$21,000
$ 7,500
750
5,417
$13,667
$20,000
-0-0$20,000
$12,500
( 750)
( 5,417)
$ 6,333
C10-11
Kay's sale:
Amount realized
Minus: Adjusted basis
Recognized gain
$ 6,333
( 4,666)a
$ 1,667 Ordinary Income
Non-Sec. 751 distribution:
Beginning basis
Minus: Sec. 751 transaction:
Inventory
Supplies
Basis after Sec. 751 transaction
Minus: Non-Sec. 751 distribution
Ending partnership interest basis
$33,750
( 4,166)
( 500)
$29,084
(13,667)b
$15,417
a
(-0- receivables + $4,166 inventory + $500 supplies + -0- depreciation recapture)
$20,000 total - $6,333 Sec. 751 exchange.
b
pp. C10-8 through C10-12.
C10-33 a.
Sec. 1245 recapture on machinery.
b.
Yes, the inventory's $86,000 FMV ($12,000 + $24,000 + $50,000 machinery
depreciation recapture) exceeds 120% of its adjusted basis [1.20 x ($12,000 + $21,000 + -0-) =
$39,600].
c.
Beginning
Partnership
Amount
(1)
Jack's
Interest Before
Distributiona
(1/3)
(2)
Jack's Interest
After
Distributiona
(1/4)
(3)
Fictional
Proportionate
Distributiona
(3)=(1)-(2)
Sec. 751
Assets
Receivables
Inventory
Recapture
Total
$12,000
24,000
50,000
$86,000
$ 3,000
6,000
12,500
$21,500
$ 2,400
4,800
10,000
$17,200
$ 600
1,200
2,500
$4,300
Other
Assets
Cash
Machinery
Land
Total
$ 48,000
190,000
76,000
$314,000
$12,000
47,500
19,000
$78,500
$ 4,600
38,000
15,200
$57,200
$ 7,400
9,500
3,800
$20,700
Jack's sale:
Amount realized
Minus: Adjusted basis
Recognized gain
(4)
(5)
Actual
Distribution
Differenceb
(5)=(4)-(3)
-0-0-0-0-
($ 600)
( 1,200)
( 2,500)
($4,300)
$25,000
-0-0$25,000
$17,600
( 9,500)
( 3,800)
$ 4,300
$ 4,300
( 1,650)a
$ 2,650 Ordinary Income
C10-12
Partner's basis in partnership:
Beginning basis
Minus: Sec. 751 transaction
Accounts receivable
Inventory
Basis after Sec. 751 transaction
Minus: Non-Sec. 751 distribution
Ending partnership interest basis
$76,875
( 600)
( 1,050)
$75,225
(20,700)b
$54,525
a
$600 receivables + $1,050 inventory + -0- recapture.
$25,000 total - $4,300 Sec. 751 exchange.
b
pp. C10-8 through C10-12.
C10-34
a.
Partner's
Post-distribution
Gain/Loss
Basis
-0None
b.
-0-
None
c.
$9,000
None
d.
-0-
None
Property
Land
Machinery
Land
Inventory
Land - 1
Land - 2
Land - 1
Land - 2
Land - 3
Basis
to Partner
$10,417
3,583
10,000
7,000
-0-06,460
10,769
10,769
pp. C10-12 through C10-16.
C10-35 Even though Marinda does not receive her proportionate share of each partnership asset in
the liquidating distribution, there are no Sec. 751 implications because the partnership does not have
Sec. 751 assets. Marinda is deemed to have received $110,000 in cash or deemed cash ($100,000
cash + $10,000 release from liability). Accordingly, she must recognize capital gain of $30,000
($110,000 received - $80,000 basis). The partnership recognizes no gain. pp. C10-12 through C1016.
C10-13
C10-36
Alison
Basis before liability reduction
Minus: Liability reduction
Basis before distribution
Minus: Cash
Allocable basis
Minus: Basis allocable to
Inventory
Receivables
Amount allocable to land and building
Land
Building
Ending basis in partnership interest
Bob
$110,000
( 50,000)
$ 60,000
( 20,000)
$ 40,000
$180,000
( 50,000)
$130,000
( 20,000)
$110,000
( 32,195)a
( 7,805)b
-0( -0- )
( -0- )
-0-
( 33,000)
( 10,000)
$ 67,000
( 15,000)b
( 52,000)
-0-
Allison’s allocation
a
FMV of asset
Minus: Partnership’s basis for the asset
Difference
Step 1: Give each asset the partnership’s basis
for the asset
Minus: Allison’s basis to allocate
Decrease to allocate
Step 2: Asset basis after Step 1
Allocate the decrease first to assets
which have declined in value
Adjusted basis at this point in the
calculation
Step 3: Allocate $1,000 remaining decrease
based on relative adjusted basis at this
point in the calculation
Allison’s basis in the assets
a
Inventory
Receivables
$35,000
(33,000)
$ 2,000
$ 8,000
(10,000)
($2,000)
$43,000
(43,000)
$ -0-
$33,000
$10,000
$33,000
$10,000
$43,000
(40,000)
$ 3,000
$43,000
-0-
( 2,000)
( 2,000)
$33,000
$ 8,000
$41,000
805)a
$32,195
( 195)
$ 7,805
( 1,000)
$40,000
(
$33,000/($33,000 + $8,000) x $1,000 remaining decrease to be allocated.
C10-14
Total
b
Bob’s allocation
Land
FMV of asset
Minus: Partnership’s basis for the asset
Difference
Step 1: Give each asset the partnership’s basis
for the asset
Minus: Bob’s basis to allocate
Increase to allocate
Step 2: Allocate the $12,000 increase first to
assets which have appreciated in value
Bob’s basis in the asset
Building
Total
$10,000
(15,000)
($5,000)
$60,000
(40,000)
$20,000
$70,000
(55,000)
$15,000
$15,000
$40,000
$55,000
(67,000)
$12,000
-0$15,000
12,000
$52,000
12,000
$67,000
The basis in each asset received is the number used above to reduce the partner’s basis in the
partnership interest. Note that Alison's basis in the inventory and receivables is smaller than a
carryover basis from the partnership while Bob's basis in the building is larger than a carryover basis.
There is no gain or loss recognized by either partner or by the partnership. pp. C10-12 through C1016.
C10-37 a.
Kelly's January 1 basis
Plus: Share of January income
Kelly's February 1 basis
$35,000
7,000
$42,000
b.
The partnership has inventory. Accordingly, the sales transaction must be analyzed as
the sale of Sec. 751 assets and the sale of the remainder of the partnership interest.
Sec. 751
Assets
Total
Sales pricea
Minus: Adjusted basis
Realized gain
$65,000
(42,000)
$23,000
a
$40,000b
(20,000)c
$20,000
Remaining
Interest
$25,000
(22,000)
$ 3,000
$45,000 cash + $20,000 liabilities = $65,000.
One-third of the FMV of inventory.
c
The basis that the inventory would have in Kelly's hands had she received it in a distribution made
just before the sale. The gain on the sale of the Sec. 751 assets is ordinary income to Kelly. The
remainder of the gain is capital gain.
b
pp. C10-16 through C10-19.
C10-15
C10-38 a.
Amount realized = $90,000 = $80,000 cash + $10,000 liabilities.
Total
Amount realized
Minus: Adjusted basis
Recognized gain or loss
Character
b.
c.
$90,000
(60,000)
$30,000
N/A
Sec. 751
$31,667
(20,000)
$11,667
Ordinary income
Other
$58,333
(40,000)
$18,333
Capital gain
$90,000 = $80,000 + $10,000 liabilities
Unchanged from the basic facts.
pp. C10-16 through C10-19.
C10-39 a.
Total
Amount realized
Minus: Adjusted basis
Recognized gain or loss
Character
$90,000
(48,000)a
$42,000
N/A
Sec. 751
$18,000
( 9,000)
$ 9,000
Ordinary income
Other
$72,000
(39,000)
$33,000
Capital gain
a
Remaining basis = $96,000 x 0.50 = $48,000 since Clay sold one-half of his partnership
interest.
b.
Steve's basis is his purchase price of $75,000 cash paid plus $15,000 in liabilities
assumed.
c.
The partnership's basis will not be affected unless at least an additional 20% of
partnership capital and profits interest was sold within 12 months of this sale.
d.
If Clay sold his entire interest to Steve, the partnership would terminate on the date of
the sale. Clay's gain is twice the amounts shown in part a ($18,000 ordinary income and $66,000
capital gain). Steve's basis in the partnership interest is $180,000 ($150,000 cash paid plus $30,000
in liabilities assumed). When the partnership terminates, there is a deemed distribution to Steve of
60% of each asset. The basis of the assets to Steve will be as follows:
Steve's beginning basis
Minus: Cash (0.60 x $50,000)
Inventory (0.60 x $60,000)
Land (0.60 x $190,000)
Steve's ending basis
$180,000
( 30,000)
( 36,000)
(114,000)
-0-
C10-16
The deemed recontribution of Steve's 60% interest in each asset will result in an increase in the
partnership's basis in the individual assets. Likewise, there is a deemed distribution and
recontribution for the other partners in the partnership. The effect on the basis of the individual
assets will depend on the other partners' basis in their partnership interests. pp. C10-16 through C1019.
C10-40 a.
Suzanne's share of partnership assets is $135,000 (0.333 x $405,000). Therefore
$135,000 of the $150,000 she receives ($130,000 cash + $20,000 release from liabilities) is a Sec.
736(b) payment. The Sec. 736(b) payment is treated like a distribution so Suzanne must recognize a
$30,000 gain (cash distribution of $135,000 in excess of $105,000 basis). The gain is capital gain if
Suzanne held the partnership interest as a capital asset. The remaining $15,000 payment does not
represent a payment for property. Since the payment is not determined based on partnership income,
it is a guaranteed payment. The $15,000 payment is ordinary income to Suzanne.
b.
There is no impact except that Suzanne's capital account will be removed. There are
no partnership deductions for the payments taxed as Sec. 736(b) payments but the partnership can
deduct the guaranteed payment of $15,000. The remaining partners' basis in the partnership must be
increased to reflect the additional amount of liability each is allocated when Suzanne is no longer a
partner. pp. C10-19 through C10-21.
C10-41 a.
Brian's interest in Sec. 736(b) property is $49,600 (0.40 x $124,000 assets).
Amount received
$49,600a
Minus: Sec. 736(b) payment
(49,600)
Sec. 736(a) payment
$ -0a
$41,600 cash + $8,000 liability
Sec. 736(b) payment
Minus: Basis in partnership
Gain or loss
$ 49,600
( 40,000)
$ 9,600
The Sec. 736(a) payment is taxed as a guaranteed payment to the partner and can be
deducted by the partnership.
b.
Brian's interest in the Sec. 736(b) property is $49,600 (0.40 x $124,000).
a
Amount received
Minus: Sec. 736(b) payment
Sec. 736(a) payment
$58,000a
(49,600)
$ 8,400
Sec. 736(b) payment
Minus: Basis in partnership
Capital gain
$49,600
(40,000)
$ 9,600
$50,000 cash + $8,000 liability
C10-17
The Sec. 736(a) payment is taxed as a guaranteed payment to the partner and can be
deducted by the partnership. pp. C10-19 through C10-21.
C10-42 a.
Amount realized
Minus: Sec. 736(b)
payment
Sec. 736(a) payment
$90,000
($65,000 cash + $25,000 liabilities)
( 90,000)
$ -0-
(FMV of property interest)
Sec. 736(b) payments
Minus: Basis in partnership
Recognized gain
$90,000
(75,000)
$15,000
The character of the gain is capital since partnership has no unrealized receivables or
substantially appreciated inventory.
b.
Amount realized
Minus: Sec. 736(b)
payment
Sec. 736(a) payment
$100,000
($75,000 cash + $25,000 liabilities)
( 90,000)
$ 10,000
(FMV of property interest)
Sec. 736(b) payments
Minus: Basis in partnership
Recognized gain
$90,000
(75,000)
$15,000
The character of the gain is capital gain since the partnership has no Sec. 751 assets. The
Sec. 736(a) payment is treated as a guaranteed payment since it is determined without reference to
partnership income. It is ordinary income to Kim and deductible by the partnership. pp. C10-19
through C10-21.
C10-43 a.
The FMV of Jerry's partnership interest is $160,000 (0.40 x $400,000) at the date of
his death. His estate will receive payments totaling $250,000 ($220,000 cash + $30,000 release from
liabilities) during the two-year period following death. Up to the FMV of his share of the assets
($160,000), the payments are Sec. 736(b) payments. The basis of his partnership interest to his
successor-in-interest is its FMV on the date of Jerry's death ($160,000). Accordingly, the first
$160,000 of payments are taxed as liquidating distributions and will generate no gain. The
remaining payments ($90,000) are Sec. 736(a) payments which are not tied to partnership income
and therefore are taxed as guaranteed payments to the successor-in-interest. These will be taxed as
ordinary income to the successor-in-interest.
b.
There is no deduction to the partnership for the Sec. 736(b) payments but the Sec.
736(a) payments can be deducted by the partnership. Because this was a two-person partnership, the
partnership will continue only until the last payment is made to Jerry's successor-in-interest. At the
C10-18
time the last payment is made, the partnership will terminate unless a new partner(s) had been
admitted. pp. C10-19 through C10-21.
C10-44 a.
Amount realized
$150,000
($130,000 cash + $20,000 liabilities)
Minus: Adjusted basis (150,000)
(FMV at date of death)
Realized gain
$ -0b.
10% of partnership income is treated as Bruce's successor-in-interest's distributive
share in each of the next three years.
c.
When the final payment is made.
pp. C10-19 through C10-21.
C10-45 a.
The solution to Question C10-45 omits the Sec. 751 implications because there are
not any Sec. 751 assets and therefore no Sec. 751 exchange takes place. Sec. 751 assets include
substantially appreciated inventory but this inventory isn’t appreciated at all. The adjusted basis of
items included in the definition of inventory are equal to the FMV of those items. The unrealized
receivables are also Sec. 751 assets, but with a basis equal to their FMV, so these receivables are
clearly not unrealized. Outside of the Sec. 736 context, depreciation recapture would be considered
an unrealized receivable but the Code (Sec. 751(c)) specifically excludes recapture items from the
definition of unrealized receivables for purposes of Sec. 736.
John's sales: Each of the two sales (one to John and one to Andrew) is analyzed as follows:
Total Sec. 751
Non-Sec. 751
Amount realized
$220,800a
$105,300
$115,500
b
Minus: Adjusted basis (165,600)
(
57,600)
( 108,000)
Recognized gain
$ 55,200
$ 47,700
$ 7,500
Ordinary income Capital gain
a
$184,800 + $36,000 release from liabilities = $220,800.
$129,600 + $36,000 release from liabilities = $165,600.
b
John's total gain from the two sales is $110,400, $95,400 ($47,700 x 2) of ordinary income and
$15,000 ($7,500 x 2) of capital gain..
The sale of a 60% interest terminates the JAS Partnership. If Andrew and Stephen continue to
operate as a partnership, there is a deemed liquidating distribution and recontribution to a new
partnership. The new partnership must make all necessary elections such as taxable year and
accounting methods. The termination has the following results.
Tax result for Andrew or Stephen continuing:
Beginning basis in existing partnership
interest ($86,400 + $24,000 liabilities)
Basis in partnership interest purchased
from John ($184,800 + $36,000 liabilities)
C10-19
$110,400
220,800
Basis before deemed distribution
Minus: Liquidating distribution of:
Deemed cash
Receivables
Inventory
Basis allocable to equipment and land
Minus: Liquidating distribution of:
Equipmenta
Landb
Basis after liquidating distribution
$331,200
( 80,000)
( 30,000)
( 18,000)
$203,200
(127,000)
( 76,200)
-0Land
FMV of asset
Minus: Partnership’s basis for the asset
Difference
Step 1: Give each asset the partnership’s basis
for the asset
Minus: Partner’s basis to allocate
Increase to allocate
Step 2: Asset basis after Step 1
Allocate the increase first to assets
which have appreciated in value
Partner’s basis in asset
Step 3: Allocate $59,200 remaining increase
based on relative FMVs at this point
in the calculation
Partner’s basis in the assets
Equipment
Total
$54,000
(28,800)
$25,200
$ 90,000
( 60,000)
($ 30,000)
$144,000
( 88,800)
$ 55,200
$28,800
$ 60,000
$28,800
$ 60,000
$ 88,800
(203,200)
$114,400
$ 88,800
25,200
$54,000
30,000
$ 90,000
( 55,200)
$144,000
(22,200)a
$76,200
37,000b
$127,000
$ 59,200
$203,200
a
$54,000/($54,000 + $90,000) x $59,200 = $22,200 remaining increase to be allocated to land.
$59,200 - $22,200 = $37,000.
b
No gain or loss is recognized by Andrew or Stephen on the deemed liquidation.
When the new partnership is formed by recontributions from Andrew and Stephen, the assets will
have carryover bases from the partners as follows:
Cash
Receivables
Inventory
Equipment
Land
$160,000
60,000
36,000
254,000
152,400
C10-20
b.
John's distributions are Sec. 736(b) distributions. He receives a pro rata share of each
asset so there is no Sec. 751 exchange, and he will recognize no gain or loss on the distribution. His
basis in each asset is determined as follows:
Beginning basis in partnership interest
($259,200 + $72,000)
Minus: Cash
Deemed cash
Receivables
Inventory
Basis for remaining allocations
Minus: Equipmenta
Landa
Ending basis in partnership interest
$331,200
( 96,000)
( 72,000)
( 36,000)
( 21,600)
$105,600
( 71,351)
( 34,249)
-0Land
FMV of asset
Minus: Partnership’s basis for the asset
Difference
Step 1: Give each asset the partnership’s basis
for the asset
Minus: Partner’s basis to allocate
Decrease to allocate
Step 2: Adjusted basis after Step 1
Allocate the decrease first to assets
which have appreciated in value
Partner’s basis in asset
Step 3: Allocate $72,000 remaining decrease
based on relative bases at this point
in the calculation
Partner’s basis in the assets
Equipment
Total
$108,000
( 57,600)
$ 50,400
$180,000
(120,000)
$ 60,000
$288,000
(177,600)
$110,400
$ 57,600
$120,000
$ 57,600
$120,000
$177,600
(105,600)
$ 72,000
$177,600
( -0- )
$57,600
( -0- )
$120,000
( -0- )
$177,600
(23,351)a
$34,249
( 48,649)b
$ 71,351
($ 72,000)
$105,600
a
$54,000/($54,000 + $90,000) x $59,200 = $23,351 remaining decrease to be allocated to land.
$72,000 - $23,351 = $48,649.
b
His basis is $36,000 in receivables, $21,600 in inventory, $71,351 in the equipment, and $34,249 in
the land.
The partnership does not terminate. Andrew and Stephen adjust their outside basis for the change in
their liability.
C10-21
Note that under the proposed regulations for termination of a partnership, Andrew and Stephen
would each have a $331,200 basis in the new partnership, and the partnership would have a
carryover basis from the old partnership in each asset.
pp. C10-12 and C10-19 and C10-22 through C10-25.
C10-46 a.
Sec. 736(b) property:
Cash
Land
Receivables
$ 60,000
100,000
$ 20,000
$180,000
The amount realized equals $160,000 cash + $20,000 release from liabilities which is
allocated all to the Sec. 736(b) property.
Amount realized
Minus: Adjusted basis
Recognized gain or loss
$180,000
(120,000)
$ 60,000
The character of the gain is capital gain since the partnership has no Sec. 751 assets.
b.
Amount realized
Minus: Adjusted basis
Recognized gain or loss
$180,000
(120,000)
$ 60,000
The character of the gain is capital since the partnership has no Sec. 751 assets. Thus, in
total, the results are the same in part b as in part a.
pp. C10-12 through C10-19.
C10-47 a.
A taxable transaction occurs.
determined as follows:
The recognized gains for Josh and Diana are
Josh: Amount realized
Minus: Adjusted basis
Recognized gain
$60,000
(40,000)
$20,000
Diana:
$60,000
(20,000)
$40,000
Amount realized
Minus: Adjusted basis
Recognized gain
C10-22
b.
An exchange of a partner's general partnership interest for a limited partnership
interest in the same partnership is treated much like a corporate recapitalization and is likely to be
nontaxable. pp. C10-21 and C10-22.
C10-48 Juanita: Amount realized (cash + liability release)
Minus: Adjusted basis
Recognized gain
$60,000
(42,000)
$18,000
Juanita's gain is a capital gain if she has held the partnership interest as a capital asset. Juanita's sale
terminates the partnership. The hypothetical liquidating distribution would be received by Carrie,
Robert and Molly as follows:
Beginning basis in pshp. int.
Minus: cash and deemed cash
inventory
Basis to be allocated to land
Carrie (30%)
Robert (10%)
$23,000*
( 6,000)
( 5,400)
$11,600
$ 7,000
(2,000)
(1,800)
$3,200
Molly (60%)
$60,000
(12,000)
(10,800)
$37,200
None of the partners nor the partnership recognizes any gain or loss on the hypothetical liquidation.
The deemed recontribution gives each asset the basis which is the total of the amounts calculated
above for the liquidation: cash $10,000 (deemed cash is the $10,000 liability), inventory $18,000 and
land $52,000. No gain is recognized on the recontribution. The new partnership must make all new
accounting method elections and tax year elections. pp. C10-22 through C10-26.
*Note that Carrie's outside basis ($23,000) is not equal to her share of liabilities plus her capital
account. This is often true. The difference could occur, for example, if Carrie has bought her
interest after the partnership formation.
C10-49 a.
No, only 40% is treated as having changed hands.
b.
No, liquidating distributions don't terminate a partnership.
c.
Yes, only one member of the partnership continues as owner.
d.
Yes, the partnership terminates on 6/1 of the current year.
e.
The ABC Partnership terminates on 12/30 of the current year. The WXY Partnership
is treated as having continued.
f.
The WXY Partnership terminates on 1/1 of the current year.
pp. C10-22 through C10-26.
C10-23
C10-50 a.
The KL Partnership continues while the MN Partnership terminates.
b.
The ABC Partnership continues while the CD Partnership terminates.
c.
The YZ and WX Partnerships both terminate.
d.
The DE Partnership is a continuation of the DEFG Partnership. The FG Partnership
is a new partnership.
e.
The HIJK Partnership terminates.
pp. C10-28 through C10-29.
$100,005a
( -0- )
$100,005
C10-51 Amount realized
Minus: Adjusted basis
Recognized gain
a
$5 cash + release from $100,000 liability.
pp. C10-16 through C10-19, C10-22 through C10-24.
C10-52 a.
The ABC Company (an LLC) will be taxed as a partnership. Alex will report his onethird share of each income item reported by the LLC.
Ordinary income
Short-term capital gain
Long-term capital loss
$10,000
4,000
( 2,000)
The distribution is not taxable since it does not exceed Alex's basis in his ABC Company
interest.
b.
Beginning basis
Plus: Share of:
Ordinary income
Capital loss
Minus: Distribution
Ending basis
$40,000
14,000
( 2,000)
(12,000)
$40,000
pp. C10-28 and C10-29.
C10-53 a.
Ordinary income:
Ordinary income before adjustments
Minus: Charitable contributions
Plus: Net short-term capital gain
Ordinary income
C10-24
$5,200,000
( 164,000)
390,300a
$5,426,300
a
$827,400 STCG - $437,100 LTCL = $390,300
b.
Separately stated items:
Rental loss - passive
C10-54 a.
$2,000,000
Ordinary income:
Ordinary income before adjustments
Minus: Sec. 1231 loss
Net loss
a
Sec. 1231 gains
Minus: Sec. 1231 losses
Net loss
b.
$700,000
(107,800)a
$592,200
$ 27,000
( 134,800)
($107,800)
Separately stated items:
Passive income
Long-term capital gains
General business tax credits
$3,000,000
437,600
43,000
Case Study Problems
C10-55 (See Instructor's Guide)
C10-56 (See Instructor's Guide)
Tax Research Problems
C10-57 (See Instructor's Guide)
C10-58 (See Instructor's Guide)
C10-59 (See Instructor's Guide)
C10-25