Chapter 11: Partnerships: Distributions, Transfers of Interests, and Terminations"
Skip L.O. 5 and L.O. 7 through L.O. 11
Two main transactions we will discuss: distributions from PS to partner and the sale of a partnership interest
Proportionate/disproportionate distributions:

Proportionate distribution: the partner receiving a distribution receives the partner's proportionate share of ordinary income assets. [This type is our primary focus.]

Disproportionate distribution: the partner receiving a distribution does not receive the partner's proportionate share of ordinary income assets. [This concept also applies when a partner sells a PS interest to a third party.]
Liquidating/nonliquidating distributions:

A nonliquidating distribution occurs when a partner is still a partner in the continuing PS.

When consider liquidating distributions, distinguish between two scenarios o the PS is liquidating, or o the PS is not liquidating, but a partner's interest is being liquidated.
Proportionate Nonliquidating Distributions
See Concept Summary 11-1.
General rule: nonrecognition
Partner reduces AB of PS interest by the amount of the distribution, but the AB of the PS interest cannot be negative.
General rule for measurement of property distributions: The dollar amount of the distribution is the PS's AB of the asset. The partner reduces the AB of PS interest by that amount, and the partner's AB of the property is carryover.
Example:
1

Complications:

Cash distribution > AB of PS interest

Property distributions when AB of property > AB of PS interest
Cash distribution > AB of PS interest (departure from general rule)
The excess amount of cash is taxed as a gain - normally capital gain.
A decrease in a partner's share of liabilities could also trigger an equivalent gain because technically the decrease in the liabilities is treated as a distribution.
The AB of the PS interest will be zero.
Property distributions when AB of property > AB of PS interest (departure from general rule)
If the only thing distributed is a single piece of property, the property will take a substitute basis
= the AB of the PS interest. The AB of the PS interest will be zero.
Example:
If cash is also distributed or more than one piece of property is distributed, there are ordering rules that must be taken into account. The rules prescribe the order in which the items are deemed to be distributed and how much AB in the PS interest is assigned to those properties.
(The AB of the PS interest will be zero.) The order is as follows:
1.
Cash
2.
Unrealized receivables and inventory
3.
All other assets
The AB of the PS interest will be "used up" and then equal to zero.
20, 17
There are also rules for allocating the AB of the PS interest within categories if necessary. The rules use the following three steps to reduce the sum of the AB of the assets to the AB of the PS interest:
1.
Each asset starts with carryover basis
2.
Reduce Step 1 amounts by relative amounts of decline in value of assets; basis cannot go below FMV in this step
3.
Reduce Step 2 amounts prorata based on the Step 2 “AB so far” numbers
19 HW 15, 16
2

Proportionate Liquidating Distributions - PS is liquidated
See Concept Summary 11-2.
General rule: nonrecognition
Ramifications of general rule: The partner's entire AB in the partnership interest will substitute for the AB of the assets in the hands of the partner.
1.
AB of PS interest < sum of AB of assets distributed
Example: The sum of the AB of assets of the PS distributed to a partner = 50,000. FMV of the assets = $100,000. Partner’s AB of the PS interest = 40,000.
General rule answer:
Departure from general rule: Gain is recognized if cash distribution > AB of the PS interest. Character is capital. Any other assets received by the partner would have AB = zero.
2.
AB of PS interest > sum of AB of asset distributed
Example: Same as above except the partner’s AB of the PS interest = 60,000.
General rule answer:
Departure from general rule: Loss is recognized if cash, unrealized receivables, or inventory are the only assets distributed to the partner (i.e., no category 3 assets are distributed to the partner). The assets come out with carryover basis, and the excess is the amount of the loss. (The AB of these assets cannot be increased - that's why there is loss recognition.)
Like the prior rules, the order in which assets are deemed distributed are cash, unrealized receivables and inventory, and all other assets.
23, 28
3

Like the prior rules, when there is more than one asset in a class, there are rules for allocating basis within the class.

If the AB of the PS interest < sum of the AB of the assets within the class, use the rules above. Recall, the rules are designed to reduce the AB of the assets.

If the AB of the PS interest > sum of the AB of the assets in the "other" category, use these rules [these rules will be increasing the AB of the assets, which can only be done for the "other" category]:
1.
Each asset starts with carryover basis
2.
Increase Step 1 amounts by relative amounts of appreciation; basis cannot go above
FMV in this step
3.
Increase Step 2 amounts prorata based on FMV of the assets
27 HW 24 (except part e), 25, 26
Property Distributions with Special Tax Treatment
Disguised sales (in Chapter 10 too)
A property distribution soon after the contribution of appreciated property could be a disguised sale.
Marketable securities
A distribution of marketable securities is generally treated as a cash distribution = FMV of the securities.
Precontribution (built-in) gains
In some cases, precontribution gains will be recognized by the contributing partner when there are property distributions. (In Chapter 10, there were allocation rules for precontribution gains and losses when an asset was sold by the PS.) These rules combat nontaxable trading of assets using a partnership.
The two situations in which the contributing partner recognizes precontribution gain:

If the contributed property is distributed to another partner within 7 years of the contribution date. The AB of the property distributed is increased by the recognized gain
(the property is in the hands of another partner).

If the partnership distributes other non-cash property to the partner who contributed the precontribution property within 7 years of the contribution date. Gain recognized = lesser of 1) built-in gain or 2) excess of FMV of property over partner's AB in PS interest at the time of the distribution. The AB of the precontribution property is increased by the recognized gain (the property is still in the PS).
29 HW 30
4

Disproportionate Distributions (same idea applies to sale of PS interest)
A distribution is disproportionate if it changes the partner's interest in certain ordinary assets.
The ordinary assets are inventory, unrealized receivables, and depreciation recapture. These assets are defined in §751(b) and sometimes are referred to hot assets. (Sometimes the inventory is included only if it is “substantially appreciated” – it depends on the transaction.)
Example: A, B, and C are equal partners with AB in PS interest = 1,200 each.
The assets on the balance sheet of ABC Partnership are the following:
Adjusted Basis FMV (this really is FMV – not book value)
Cash
Inventory
1,500
900
1,500
1,500
Investment in land 1,200 1,500
Total 3,600 4,500
Consider a liquidating distribution WITHOUT THE SEC. 751 RULES in which each partner receives one of the assets and look at the different characters of income.
What the SEC. 751 rules will do:
Types of transactions that could alter the partners’ interests in ordinary income assets: nonliquidating distributions, liquidating distributions when the PS is liquidated, a partner’s PS is liquidated by making a distribution of assets, sale of PS interest.
Sale of a Partnership Interest
General rule: recognition
When measuring Amount Realized (AR) and AB of PS interest, liabilities must be considered.
AR includes relief from liabilities, which is why AR increases for the liability relief. The AB of the PS interest includes the liabilities too.
Character will be capital unless the PS holds hot assets - then there will be some ordinary income or loss. Hot assets are unrealized receivables, inventory, and depreciation recapture potential. A loss is possible because inventory does not have to be “substantially appreciated.”
The rules do not affect the amount of the gain or loss, only the character.
Examples:
35 part a only, 33 parts a through d HW 37 part a only, 38 part a only
5