SALES AND EXCHANGES OF PARTNERSHIP INTERESTS
I.
SECTION 741.
Code §741 sets forth the basic rules with respect to the sale or exchange of a partnership
interest. Section 741 treats gains and losses on sale of a partnership interest as sales or exchanges
of capital assets.
A.
From the seller's perspective, an amount realized and an adjusted basis need to be
determined in measuring gain/loss under §1001.
B.
From the buyer's view, an initial outside basis and capital account must be
established.
II.
SELLING PARTNER.
A.
General Rules.
1.
First, in determining amount realized per §1001, the partner must include
his share of partnership debt as a part of the amount received from the purchasing partner.
2.
Second, in determining his adjusted basis, the selling partner must include
his share of partnership income or loss as a basis adjustment up to the time of sale.
B.
Closing the Tax Year of the Selling Partner. Although outside basis for income
and loss is not generally adjusted prior to the close of a tax year under §705, per §706( c), the
sale or exchange of an entire interest closes the tax year of a partnership (only) with respect to a
selling partner, thereby authorizing and requiring such a basis adjustment for tax purposes.
1.
§706( c) does not authorize the closing of the partnership's tax year with
respect to a partner who sells or exchanges less than his entire interest. In such a case, the
varying interest rules of §706(d)(1) kick in, requiring the partnership and the partner to
appropriately account for the impact such a sale or change in interest has on basis, capital
account, income sharing, etc.
III.
"HOT ASSETS."
To the extent the partnership holds inventory or unrealized receivables (collectively
referred to as "Hot Assets"), a selling partner's capital gain or loss may be recharacterized as
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1
ordinary income to the extent of the Hot Assets under §751(a). The rule that a sale or exchange
of a partnership interest results in capital gain under §741 is expressly overridden by §751.
IV.
SELLING PARTNERS - INSTALLMENT SALES TREATMENT.
Partnership interests, like other capital assets, may be sold, with gains thereon reported on
the installment method under §453. Under this method of accounting (assuming adequate stated
interest), otherwise taxable capital gains are reported as and when principal payments are
received on the note on the basis of a gross profit ratio. This method of accounting permits
selling partners the opportunity to pay tax on capital gains as and when payments are received.
The interest portion is, of course, taxed on a non-installment sales method (usually the accrual
method). However, gains on sale of an interest subject to §751(a) recapture items, per §453(i)(2),
may not be subject to installment sales reporting. (See also, Rev. Rul. 89-108 (denying §453
treatment to the extent of § 751(a) substantially appreciated inventory items)
V.
EXCHANGES OF PARTNERSHIP INTERESTS.
Since 1984, §1031(a)(2)(D) has clearly disallowed like-kind exchange treatment for
swaps of partnership interests. This statutory provision repealed the favorable case law taxpayers
were relying upon. However, conversions of a partner's interest in a single partnership (general
to limited and vice versa) may still be accomplished tax free. (See Rev. Rul. 84-52.) Watch out,
however, for liability allocation shifts which may trigger §752(b) deemed cash distributions
resulting in §731(a)(1) gains. A partnership may, however, opt out of Subchapter K under IRC
§761 and the partners are then treated as cotenants whose interests can be exchanged.
VI.
BUYING PARTNER.
A.
Adjusted Basis. The rules applicable to the purchasing partner are generally
straightforward. As to outside basis, the purchasing partner acquires a cost basis in the acquired
partnership interest equal to the cash and fair market value of property paid to seller in
consideration of the interest, plus the new partner's allocable share of partnership debt.
B.
§754 Considerations. An important consideration to a purchasing partner whose
purchase price (outside basis) exceeds his underlying share of the assets of the basis of
partnership assets (inside basis) is whether to demand or request that the partnership elect to
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2
adjust its inside asset bases under §754. If a §754 election is already in effect, there's no need for
further action, since the election is only made once.
C.
Interim Income Loss Allocations. Just as the selling partner is concerned as to the
partnership's determination of interim income and loss for allocation and basis purposes, the
incoming partner is also interested in income and loss allocations which take into account the
method of accounting the partnership has selected for dividing up income and loss for the two
deemed short periods.
D.
Capital Account. The buying partner generally takes over the selling partner's
capital account without adjustment.
VII.
THE PARTNERSHIP AND OTHER PARTNERS.
A.
General Rule No Effect. Generally, the sale or exchange of a partner's interest to
a new or existing partner does not trigger any particularly difficult issues for the partnership or
its other partners.
B.
Exception §708 Termination. A "tax termination" is triggered when sales or
exchanges of capital and profits interests aggregate to 50% or more within a 12-month period.
EXAMPLE #1
Straight cash sale-No Partnership Income or Debt. Assume that Alice, a partner
in partnership ABC decides to sell her 1/3 overall interest in the partnership to
Dorothy for $100,000. At the time of sale, the partnership has no income or loss.
At the time of sale, the partnership books reflect the following:
Partnership ABC
Tax Basis
$50,000
160,000
$210,000
$ N/A
70,000
70,000
70,000
$210,000
Cash
Stock
Total Assets:
Liabilities
Alice
Betsy
Charles
Total Liabilities & Capital:
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3
Book Value
$50,000
250,000
$300,000
$ -0100,000
100,000
100,000
$300,000
Taxable gain to Alice per §741:
Amount Realized on Sale:
Alice’s Adjusted Basis:
§ 741 Taxable Capital Gain
$100,000
<70,000>
$30,000
Tax effects to Dorothy per §742:
Dorothy acquires a cost basis of $100,000 and takes over Alice's capital account.
Assuming that the partnership books reflect Alice's capital account at $100,000,
then Dorothy would have a $100,000 capital account.
Taxable effects to Partnership: Generally none.
EXAMPLE #2
Same Facts, But Income That Needs Allocating: Assume the same facts as in
Week 9, Example 1, except that, at the time of sale (6/30/XX), the partnership has
$30,000 ordinary income and at the end of the tax year the partnership has
$120,000 of ordinary income.
Per 706( c) the partnership's tax year closes with respect to Alice only: But, if
the partnership uses the pro rata method of accounting, even though Alice's actual
stub period income through 6/30/XX was $10,000 (1/3 of $30,000 to 6/30/XX)
her income allocation is $20,000 ($120,000 x 1/2 year x 1/3 interest). Per 705,
Alice must adjust her basis upwards by the $20,000, so that:
Amount Realized On Sale: $100,000
Alice's Adjusted Basis: < 90,000> Reflects Basis Adjustment For Income
§ 741 Taxable Capital Gain: $ 10,000
Plus: Alice must report the $20,000 ordinary income that appears on her final
K-1.
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EXAMPLE #3
Assume the same facts as in Example 1, except that the partnership, prior to
A’s sale to D, borrows $60,000. ABC's Balance Sheet is thus revised at time of
sale to show:
Partnership ABC
Tax Basis
$110,000
160,000
$270,000
$60,000
70,000
70,000
70,000
$270,000
Cash
Stock
Total Assets:
Liabilities
Alice
Betsy
Charles
Total Liabilities & Capital:
Book Value
$110,000
250,000
$360,000
$60,000
100,000
100,000
100,000
$360,000
Taxable gain to Alice per §741:
On cash payment of $100,000 by Dorothy to Alice:
Amount Realized On Sale: $120,000 Reflects Adjustment For Debt Relief
Alice's Adjusted Basis: < 90,000>
§741 Taxable Capital Gain $ 30,000
Basis to Dorothy per §§ 742, 722 and 752(a):
Dorothy has paid $100,000 and she receives an allocation of $20,000 debt per
§752. Her basis is $120,000.
Straight cash sale-No Partnership Income or Debt: Sale of Partial Interest.
Assume that Alice, a partner in partnership ABC decides to sell 2 of her 1/3
overall interest in the partnership to Dorothy for $50,000. At the time of sale, the
partnership has no income or loss. At the time of sale, the partnership books
reflect the following:
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5
Partnership ABC
Tax Basis
$50,000
160,000
$210,000
$ N/A
70,000
70,000
70,000
$210,000
Cash
Stock
Total Assets:
Liabilities
Alice
Betsy
Charles
Total Liabilities & Capital:
Book Value
$50,000
250,000
$300,000
$ -0100,000
100,000
100,000
$300,000
Taxable gain to Alice per §741:
Amount Realized On Sale: $ 50,000
Alice's Adjusted Basis: < 35,000>
§741 taxable Capital Gain $ 15,000
Tax effects to Dorothy per §742:
Dorothy acquires a cost basis of $50,000 and a capital account of $50,000
(because its 2 of the transferors capital account, not because Dorothy paid
$50,000).
Taxable effects to Partnership: Generally none.
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6
WEEK 9 --PART II
TAX TERMINATIONS
I.
INTRODUCTION
Code §708 sets forth the basic events which trigger a so-called termination for tax
purposes. Under Subchapter K, absent a termination, a partnership is treated as continuing. This
means that, despite partner changes or shifts in percentage interests in debt, cash flow, profits,
losses and capital, absent a termination, the partnership will continue to be treated as the same
tax entity. In this regard, §708(a) provides that:
"a partnership shall be considered as terminated only if-A.
§708(b)(1)(A) no part of any business, financial operation, or venture of
the partnership continues to be carried on by any of its partners in a
partnership, or
B.
§708(b)(1)(B) within a 12-month period there is a sale or exchange of 50
percent or more of the total interest in partnership capital and profits."
II.
§708(b)(1)(a): NO FURTHER BUSINESS CARRIED ON BY THE PARTNERS IN
A PARTNERSHIP
A.
Explanation of (b)(1)(A) Terminations. Prior to liquidation of the partnership, it's
hard to trigger (b)(1)(A) terminations, because even if a modicum of business is carried on by the
partnership, it will not be deemed terminated. Even mere collection of interest and principal on a
note receivable held by the partnership upon sale of all of its assets will still constitute sufficient
business to avoid termination per (b)(1)(A).
1.
A "(b)(1)(A)" termination can occur when there is only one partner left.
For example, one person in a 2 person partnership sells out to the other.
2.
Upon the death of one partner in a 2-member partnership, the partnership
shall not be considered as terminated if the estate or other successor in interest of the deceased
partner continues to share in the profits or losses of the partnership business. (Treas. Reg. 1.7081(b)(1)(i)(a)).
B.
Dissolution Distinguished. Local law concepts of dissolution and windup, or
liquidation, are not meaningful terms of art in determining whether a tax termination has or will
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7
occur. A dissolution may occur under local law without necessity of a tax termination occurring
and, conversely, a tax termination may arise without a dissolution.
C.
Liquidation. A partnership liquidation takes place when all of the assets are
marshaled, all creditors paid and the assets are distributed to the partners in satisfaction of their
equity interests.
III.
§708(b)(1)(B): SALES OR EXCHANGES OF 50% OR MORE CAPITAL AND
PROFITS INTERESTS WITHIN 12 MONTHS
§708(b)(1)(B) terminating events are based upon the sales or exchanges of partnership
interests. For a termination to occur, there must be a sale or exchange of at least 50% of the
total interests in partnership capital AND profits during a 12 month period. The same
interest sold more than once during the 12 month period is only counted once, although the later
sale rolls forward the 12 month period.
EXAMPLE #4
In partnership ABC, where Alice, Betsy and Charlie each hold an equal 1/3
interest in capital, profits and losses, if Alice sells her 1/3 capital and profits
interest to Xavier on June 1, 20X0, and Xavier sells the same 1/3 interest to Yetta
on September 15, 20X0, no termination arises, since only 33.3% has been sold,
but the 12 month period will run forward to September 15 of the next year.
A.
12 Months Means 12 Months. The 12-month period is not a reference to a
taxable year, but an actual 12-months.
B.
Multiple Sales. Other than the same interest being sold twice, multiple
interest sales are counted within the 12 month period for the 50% test, and, so
long as the sum total of capital and profits interest shifts equals 50% or more
within the 12 month period, a termination occurs under §708(b)(1)(B).
In partnership ABC, where A, B and C each hold an equal 1/3 interest in capital,
profits and losses, if Alice sells her 1/3 capital and profits interest to Xavier on
June 1, 20X0 and Betsy sells her 1/3 capital and profits interest to Yetta on
January 1, 20X1, a termination results. The termination occurs despite the fact
that the second sale by Betsy to Yetta occurred during the following taxable year.
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EXAMPLE #5
Distributions. In partnership ABC, where A, B and C each hold an equal 1/3
interest in capital, profits and losses, if Alice and Betsy each receive a current
distribution from ABC, resulting in their overall interests reduced to 5% each, no
termination occurs because there's no sale or exchange for §708 purposes. This
result would be true under §708 even if Alice and Betsy receive money
distributions in excess of their adjusted basis resulting in §731 gains (treated as
gains from the sale or exchange of an interest).
Contributions. The same result (i.e. no termination) would arise if Charlie alone
contributed additional property/capital, resulting in a 50% or more shift in profits
and capital interest.
IV.
GIFTS AND BEQUESTS
The regulations further provide that other events are not deemed sales or exchanges for
termination purposes, including gifts, bequests, and inheritances.
V.
CLOSING THE TAX YEAR FOR ALL PARTNERS
A.
Date of Closing. For purposes of subchapter K, a partnership taxable year closes
with respect to all partners on the date on which the partnership terminates. See §706(c)(1) and
Treasury Regulation §1.706-1( c)(1). Per the §1.706-1 regs, the date of termination is:
1.
For purposes of Section 708(b)(1)(A), the date on which the winding up of
the partnership affairs is completed.
2.
For purposes of Section 708(b)(1)(B), the date of the sale or exchange of a
partnership interest which, of itself or together with sales or exchanges in the preceding 12
months, transfers an interest of 50 percent or more in both partnership capital and profits.
B.
Effect of Closing.
1.
Create a short year final return.
2.
Require income/loss for the short period to be determined and allocated
and attendant reporting by the partners.
3.
Outside basis adjustments are then required for the income/loss
adjustments per §705.
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9
EXAMPLE #6
Assume that Alice, a partner in partnership ABC decides to sell her entire 1/3
overall interest in the partnership to Dorothy for $100,000 cash. At the time of
sale, June 30, 20X0, the partnership has $30,000 of capital gains income and
$30,000 of dividend income; however, assume that, within 12 months prior to
June 30, 20X0, Betsy acquired her 1/3 interest by purchasing it from Xavier. At
the time of sale to Dorothy, the partnership books reflect the following:
Partnership ABC
Tax Basis
$110,000
160,000
270,000
60,000
70,000
70,000
70,000
$270,000
Cash
Stock
Total Assets:
Liabilities
Alice
Betsy
Charles
Total Liabilities & Capital:
Book Value
$110,000
250,000
360,000
60,000
100,000
100,000
100,000
$360,000
Questions:
Is there a tax termination triggered on Alice's sale of a 1/3interest in ABC to
Dorothy? Yes, there has been a 50% or more capital and profits interest transfer
when considering the earlier transfer of Xavier's interest to Betsy.
Does the partnership tax year close with respect to Alice? Yes, and because it's
a sale triggering a tax termination per §708(b)(1)(B), the Partnership tax year
closes as regards all partners. Note, this would be true even if Alice sold less than
her entire interest, so long as she sold at least 17% which, when added to Xavier's
1/3 interest would total 50%, thereby triggering a termination. Since there is a
termination, the tax year of the partnership closes, and an interim adjustment for
profits and losses would have to be made to compute gain or loss to Alice.
VI.
DEEMED CONTRIBUTION AND DISTRIBUTION
If a tax termination occurs, the partnership is deemed to contribute all of its assets and
liabilities to a new partnership in exchange for an interest in the new partnership; and,
immediately thereafter, the terminated partnership distributes interests in the new partnership to
the purchasing partner and the other remaining partners in proportion to their respective interests
in the terminated partnership in liquidation of the terminated partnership.
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10
EXAMPLE #7
(i)
A and B each contribute $10,000 cash to form AB, a general partnership,
as equal partners. AB purchases depreciable Property X for $20,000. Property X
increases in value to $30,000, at which time A sells its entire 50 percent interest to
C for $15,000 in a transfer that terminates the partnership under Section
708(b)(1)(B). At the time of the sale, Property X had an adjusted tax basis of
$16,000 and a book value of $16,000 (original $20,000 tax basis and book value
reduced by $4,000 of depreciation). In addition, A and B each had a capital
account balance of $8,000 (original $10,000 capital account reduced by $2,000 of
depreciation allocations with respect to Property X).
(ii)
Following the deemed contribution of assets and liabilities by the
terminated AB partnership to a new partnership (new AB) and the liquidation of
the terminated AB partnership, the adjusted tax basis of Property X in the hands
of new AB is $16,000. See Section 723. The book value of Property X in the
hands of new partnership AB is also $16,000 (the book value of Property X
immediately before the termination) and B and C each have a capital account of
$8,000 in new AB (the balance of their capital accounts in AB prior to the
termination). See §1.704-1(b)(2)(iv)(l) (providing that the deemed contribution
and liquidation with regard to the terminated partnership are disregarded in
determining the capital accounts of the partners and the books of the new
partnership). Additionally, new AB retains the taxpayer identification number of
the terminated AB partnership.
(iii)
Property X was not Section 704(c) property in the hands of terminated AB
and is therefore not treated as Section 704(c) property in the hands of new AB,
even though Property X is deemed contributed to new AB at a time when the fair
market value of Property X ($30,000) was different from its adjusted tax basis
($16,000). See §1.704-3(a)(3)(i) (providing that property contributed to a new
partnership under §1.708-1(b)(1)(iv) is treated as Section 704(c) property only to
the extent that the property was Section 704(c) property in the hands of the
terminated partnership immediately prior to the termination).
(iv)
If a partnership is terminated by a sale or exchange of an interest in the
partnership, a Section 754 election (including a Section 754 election made by the
terminated partnership on its final return) that is in effect for the taxable year of
the terminated partnership in which the sale occurs, applies with respect to the
incoming partner. Therefore, the bases of partnership assets are adjusted pursuant
to Sections 743 and 755 prior to their deemed contribution to the new partnership.
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11
VII.
WHAT ABOUT §704(D) SUSPENDED LOSSES IF §708(B)(1)(B) TERMINATION
OCCURS?
It's currently unclear. Under the old termination rules, the suspended losses were lost
irretrievably. Under the new rules, suspended losses should carry over to the new entity.
VIII. WHAT ABOUT §704 (C )(1) (b) GAINS AND §737 GAINS?
A.
Recall that §704(c)(1)(B) requires gain to be recognized by contributing partner if
built-in gain property is distributed to another partner within7 years of contribution. Will
§704(c)(1)(B) deemed distributions rule be triggered if §708(b)(1)(B) termination occurs? No,
per §1.704-4( c)(3).
B.
Recall that §737 requires net pre-contribution gain to be recognized by a
contributing partner if built-in gain property is contributed and distributions are made to the
contributing partner within 7 years of contribution. Will §737 be triggered if §708(b)(1)(B)
termination occurs? No, per §1.737-2(a) no gain is triggered, but the §704( c) partner is still a
§704( c) partner subject to §737 in the new partnership.
IX.
ARE THERE §731 GAINS POSSIBLE IN A TAX TERMINATION UNDER
§708(b)(1)(B)?
A.
Under the old rules, a termination deemed the partnership to distribute all of its
properties in a liquidating distribution to the new and remaining partners, with this group
recontributing such assets (and liabilities) back to the partnership in exchange for their new
interests in the new partnership. Therefore, theoretically, cash could have been distributed in
excess of basis, triggering §731 gains. The new ordering, that is, deeming the old partnership to
contribute assets and liabilities to a new partnership in exchange for the issuance of new interests
in the new partnership to the new partner and continuing partners, does not create this possibility,
since only interests are distributed to the partners. See §1.7321-2(g)(2).
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12
PART III -- MERGERS, CONSOLIDATIONS AND DIVISIONS
I.
SECTION 708(b)(2)
A.
Mergers. Section 708(b)(2) provides special rules regarding partnership mergers,
consolidations and divisions.
1.
Section 708(b)(2)(A) provides that in the case of the merger or
consolidation of two or more partnerships, the Resulting Partnership shall be considered the
continuation of any merging or consolidating partnership whose members own an interest of
more than 50 percent in the capital and profits of the Resulting Partnership.
All other
partnerships terminate.
2.
The regulations provide that if no group of members owns more than 50%,
all of the partnerships terminate.
B.
Divisions.
As to partnership divisions, §708(b)(2)(B) provides that where a
partnership divides into two or more partnerships, the Resulting Partnerships (other than any
Resulting Partnership the members of which had an interest of 50 percent or less in the capital
and profits of the Prior Partnership) shall, for purposes of this section, be considered a
continuation of the Prior Partnership.
C.
Tax Consequences to Terminating Partnership.
In general, all of the tax
consequences outlined above on termination apply in this context.
II.
MERGERS AND CONSOLIDATIONS
A.
Surviving Partnership. Under §708(b)(2)(A), if two or more partnerships merge
or consolidate into a single partnership, the resulting partnership is treated as a continuation of
any merging partnership whose members own more than 50 percent of the capital and profits of
the resulting partnership. The other partnerships are terminated.
B.
Cross-Membership.
If there is a cross-membership among the merging
partnerships and the members of more than one merging partnership own more than 50 percent
of the capital and profits of the resulting partnership, the merging partnership "which is credited
with the contribution of assets having the greatest fair market value (net of liabilities) to the
resulting partnership" is the continuing partnership, and all other partnerships terminate.
C.
No 50% Survivor. If the members of none of the merging partnerships have an
interest of more than 50 percent in the capital and profits of the resulting partnership, all of the
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13
merging partnerships are terminated and a new partnership results. The taxable years of all
terminating partnerships are closed pursuant to the provisions of §706(c)(1) as of the date of the
merger.
D.
Forms of Merger. The Regulations recognize the following merger forms:
1.
The "Assets-Over" form in which terminating partnerships are
treated as transferring their assets and liabilities to the resulting partnership in
exchange for interests in the resulting partnership, which interests; and
2.
The "Assets-Up" form in which terminating partnerships are
treated as distributing their assets and liabilities to their partners in liquidation,
and immediately thereafter the partners are treated as contributing such assets and
liabilities to the resulting partnership in exchange for interests in the resulting
partnership.
E.
Default to Assets Over. The Assets-Up form applies whenever a terminated
partnership distributes its assets to its partners in any manner that causes them to be treated as the
owners of the assets under local law. Under these circumstances, the form is respected despite
the transitory ownership of the distributed assets. The form is also respected even if the transfer
involves assets (e.g., goodwill) that generally could not be held by the partners are undivided
interest holders. However, a transaction case in the Assets-Up form will be recast as an AssetsOver transaction if the terminated partnership is not liquidated under local law. All mergers and
consolidations that are not cast in the Assets-Up form are treated as Assets-Over transactions,
regardless of their form (or lack of form) under local law. If a merger involves multiple
terminating partnerships, each terminating partnership is analyzed separately, so that the AssetsOver form may apply to some transfers and the Assets-Up form to others.
F.
Tax Effects of Choice. The choice between the Assets-Up and Assets-Over forms
controls for all income tax purpose and may have significant repercussions. For example, under
the Assets-Over form, the tax basis of assets contributed to the resulting partnership is
determined under §723, and thus should be generally unaltered by the transaction. By contrast,
under the Assets-Up form, the basis of the assets of a terminating partnership are first determined
under §§732(b) and 732(c) upon distribution to the partners, and then under §723 upon
contribution to the continuing partnership—a process that can lead to significant basis changes,
particularly if the terminating partnership has inside-outside basis differences.
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14
G.
Application of Disguised Sale Rule.
Finally, the choice of form will cause
§§704(c)(1)(B) and 737 to apply in strikingly different ways. Under the Assets-Up form, both
§§704(c)(1)(B) and 737 are applicable if any assets distributed to the partners were previously
contributed to the distributing partnership within seven years of the distribution. By contrast,
neither §704(c)(1)(B) nor §737 applies to a transaction cast in the Assets-Over form. However,
the deemed contribution of assets from a terminating partnership may create a new layer of builtin gain for purposes of those rules.
H.
Effect of Termination. The taxable years of all terminated partnership are closed
under §706(c), so that each terminated partnership must file a short-year return for the period
ending on the date of the merger or consolidation. The resulting partnership files a full-year
return for the taxable year of the partnership that is not terminated. This return should state that
the resulting partnership is a continuation of the non-terminated partnership; retain the employer
identification number (EIN) of the non-terminated partnership; and ;include the names,
addresses, and EINs of the terminated partnerships. The distributive shares of the partners for
periods prior to and including the date of the merger or consolidation, as well as subsequent to
the date of merger or consolidation, are included in this return.
III.
DIVISIONS
A.
Surviving a Partnership. In the event of a division of a partnership into two more
partnerships, any resulting partnership whose members had an interest of more than 50 percent in
the capital and profits of the original partnership is deemed to be a continuation of the original
partnership. Any other resulting partnership is treated as a new partnership.
B.
Termination of Partnership. If no resulting partnership is treated as a continuation
of the original partnership under this rule, the original partnership is treated as terminating.
C.
Effect on Partners. If a member of the original partnership does not become a
member of a partnership deemed to be a continuation of the original partnership, his interest in
the original partnership is considered liquidated as of the date of the division.
D.
Forms of Division. As with mergers, the Regulations delineate two permissible
forms of division:
1.
The "Assets-Over" form in which an existing partnership transfers
some portion of its assets and/or liabilities to a new partnership (which
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15
momentarily has but one partner, a foot-fault that is quickly forgiven by the
Regulations), and immediately thereafter distributes interests in the new
partnership to some or all of its partners; and
2.
The "Assets-Up" form in which an existing partnership distributes
assets and/or liabilities to some or all of its partners, who then contribute them to
a new partnership.
E.
Default to "Assets Over."
1.
As with mergers, the Regulations effectively prefer the Assets-Over form
for divisions. Any transaction that is not clearly in the Assets-Up form is taxed under the AssetsOver form.
2.
The Regulations make it clear that actual state law transfers from the
"Prior Partnership" to its partners and from the partners to a "Resulting Partnership" are required
for the Assets-Up form to be respected. The Supplementary information issued in connection
with the Regulations makes it equally clear that when several Resulting Partnerships are
produced by a single division transaction, some may be formed using the Assets-Up form while
others can be formed using the Assets-Over form.
F.
Reporting Requirements. The Resulting Partnership that is treated as the Divided
Partnership files a return for the taxable year of the partnership that has been divided and retains
the EIN of the Prior Partnership. The return must include the names, addresses, and EINs of all
other Resulting Partnerships that are regarded as continuing. The return must also state that the
partnership is a continuation of the Prior Partnership and set forth separately the distributive
shares of the partners for the periods through the date of the division and subsequent to the date
of division. All other Resulting Partnerships that are treated as continuing and all new
partnerships are required to file separate returns, using new EINs for each partnership, for the
taxable year beginning on the day after the date of the division. The return for any Resulting
Partnership that is regarded as continuing but is not the Divided Partnership must include the
name, address, and EIN of the Prior Partnership. All Resulting Partnerships that are regarded as
continuing are subject to the Prior Partnership's elections. Any subsequent election made by a
Resulting Partnership does not affect the other Resulting Partnerships.
The Regulations include a number of examples. Several of the examples illustrate some
of the planning flexibility afforded partners under these rules.
{09000.BKW / 00932051.DOC.1 }
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EXAMPLE #8
Partnership ABCD owns three properties: X with a value of $500; Y with a value
of $300; and Z with a value of $200. Partners A and B are each for 40% partners,
while partners C and D are each 10% partners. ABCD divides three partnerships
by contributing property X to AB1 and property Z to CD. Old ABCD is renamed
AB2. AB1 is distributed to partners A and B, while CD is distributed to partners
C and D in complete liquidation of their interest in ABCD (new AB20. AB1 and
AB2 are both continuations of ABCD, while CD is a new partnership. The
Assets-Over form applies. ABCD, as the Divided Partnership, is viewed as
contributing properties X and Y to new partnerships AB1 and CD, and then
distributing the interests in AB1 to partners A and B and the interests in CD to
partners C and D.
EXAMPLE #9
The facts are the same as in Example #8, except that the division is accomplished
in a formless division transaction under state law. Now, the Divided Partnership
is AB1, instead of AB2, because the transaction has not been cast in either the
Assets-Up form or the Assets-Over form. Consequently, it does not matter which
partnership in form was the transferor, and AB1 has the larger net fair market
value than AB2. AB1 as the Divided Partnership is viewed as contributing
properties Y and Z to new partnerships AB2 and CD, and then distributing the
interests in the new partnerships as indicated.
EXAMPLE #10
The facts are the same as in Example #8, except that the division is accomplished
by having ABCD contribute property X to AB1 and property Y to AB2. All the
interests in AB1 and AB2 are distributed to partners A and B in complete
liquidation of their interests in ABCD. Because the formal transferor, which is
renamed CD, is not a continuation of ABCD, it cannot be the Divided Partnership.
Instead, AB1 is selected as the Divided Partnership because its net fair market
value is larger than AB2's. As the Divided Partnership, AB1 is viewed as
contributing properties Y and Z to new partnerships AB2 and CD and then
distributing the interests in the new partnerships as indicated.
{09000.BKW / 00932051.DOC.1 }
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