Partnerships
Partnership Basis Concepts
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Adjusted basis of a partnership
interest held by a partner
Adjusted basis of assets held by the
partnership
Significance of Partner’s Basis
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Significant whenever the interest is
transferred or liquidated
Used in determining consequences of
nonliquidating partnership distributions
under § § 731 and 732.
Entity vs. Aggregate Approach
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Entity Approach - Basis in interest is
separate and apart from share of the
basis of each underlying partnership
asset
Aggregate Approach – Basis of interest
is increased or decreased by partner’s
share of partnership income, loss,
distributions, etc. (§705(a))
§705
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The aggregate of the partners’ adjusted
bases in their partnership interest
generally equals the aggregate of the
adjusted bases of partnership assets.
§705(b) – Provides for the determination
of a partner’s basis in this interests by
reference to partner’s proportionate share
of the basis of partnership assets
Example Exception to
§705’s Generality
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§743(a) – Upon the sale of a
partnership interest, purchaser’s initial
basis is cost, but purchaser’s share of
the partnership’s basis is not adjusted
to reflect the cost of the interest
§743(b) – Provides an elective method
of retaining basis equality in such
situations
Initial Basis
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§722 – Result of a contribution to the
partnership
§742 – Acquired by means other than
the contribution of money or property
to the partnership
Initial Basis (continued)
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Generally determined by cost method
Exceptions:
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Acquired from decedent – value on the date of
death or the alternative valuation date
Acquired by gift – donor’s adjusted basis, increased
by federal gift tax paid
Acquired in connection with performance of services
– the amount of taxable income realized by the
performer in connection with the receipt of the
interest
Adjustments to Basis - §705(a)
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Increased by distributive share of:
Partnership taxable income
 Tax-exempt income of partnership
 Excess of deductions for depletion over the
basis of the property subject to depletion
Also increased by:
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Amount of any cash contributed, or
adjusted basis of property contributed
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Adjustments to Basis §705(a) – con’t
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Decreased (not below zero) by:
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Amount of cash distributed
Basis to partner of any property distributed
to the partner by the partnership
Depletion deduction
Distributive share of partnership losses and
nondeductible expenditures of the
partnership
When Basis Computation
is Necessary
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Only if necessary to determine tax
liability when:
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End of partnership year during which it
suffered a loss, to determine deductibility
of partner’s share
Upon liquidation or disposition of partner’s
interest, to determine gain or loss
Upon the non-liquidating distribution of
cash or property to a partner, to find the
basis of the distributed property
Purpose of Basis Computations
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Keep track of a partner’s “tax
investment”
Prevents double-taxation or exclusion
from taxation
Less Common Basis
Adjustments
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Tax-Exempt Income §705 (a)(1)(B)
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Gifts – tax free to the extent of the carryover
basis, but tax-deferred to extent of market value
over basis. Tax-deferred income does not
affect basis.
Discharged debts – Income to the extent debt is
discharged. Exception - If an insolvent debtor
(at the partner level), then recognize income
only to extent that discharge creates solvency
Less Common Basis
Adjustments (con’t)
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Nondeductible Expenditures §705(a)(2)(B)
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Amounts not deductible in computing its
taxable income and not properly chargeable
to capital account
Prohibition Against
Negative Basis
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§ §705(a)(2) and 705 (a)(3) - prohibits
reduction of a partner’s basis below
zero
§732(a)(2) – limits the basis of
distributed property (other than money)
to the partner’s basis for his partnership
interest
Prohibition Against
Negative Basis (continued)
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§731(a)(1) – Requires a distributeepartner to recognize gain to the extent
money distributed to him exceeds the
basis of his partnership interest.
Ordering of Basis Adjustments
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Increased and decreased by all adjustments
under 705(a), except for losses of the
taxable year and losses previously disallowed
Reduced by any money distributions and
distributions that includes both money and
other property
Any other adjustments relating to separate
distributions of property made in the order
distributions are made
Including Partnership
Liabilities in Basis - §752
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Increases in a partner’s share of partnership
liabilities are treated as cash contributions by
him (includes assumption of partnership liability
by a partner) – Increases partner’s basis as a
contribution to the partnership
Decreases in his share of partnership liabilities
are treated as cash distributions to him (includes
assumption of partner’s liability by the
partnership) – Decreases partner’s basis to
extent of basis, then treated as taxable
distribution
Allocation of Liabilities
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Recourse Debt – Allocated among the
partners in the proportions that they bear the
“economic risk of loss” for such liabilities
Non-recourse Debt – Allocated in proportion
to and to the extent of the partner’s shares of
partnership minimum gain and §704(c)
minimum gain, and then according to the
partner’s interest in partnership profits
Contributions of Property
Subject to a Liability
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The liability is passed to the partnership
Three simultaneous basis adjustments occur to
contributing partner, the partner’s basis is:
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Increased by the full basis in the contributed property
Increased by any resulting increase in his share of
partnership liabilities
Decreased by the entire amount of the liability that the
partnership takes in property subject to the liability.
All other partners have an increase in basis for
their proportion of the assumed liability
Current Distributions of
Property Subject to a Liability
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Mirror image of contribution adjustments
Distributee’s basis is:
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Increased by liabilities encumbering his property
Decreased by his share of the resulting reduction in
partnership liabilities
Decreased by the basis of the distributed property to
him
All other partners have an decrease in basis for
their proportion of the distributed liability
Liability adjustments are given effect prior to
computing the basis of the property distributed
Liquidating Distributions of
Property Subject to a Liability
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It is not necessary to adjust the basis of
the distributee-partner’s interest
following a liquidating distribution
By definition, the distribution results in
the termination of the distributee’s
entire partnership interest.
Sale and Exchange of
Partnership Interests
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Upon the sale or exchange of a
partnership interest, liabilities are treated
in the same manner as upon the sale or
exchange of non-partnership property
The “amount realized” upon the sale or
exchange of a partnership interest
includes the transferor’s share of
partnership liabilities
Alternative Rule for
Determining Basis §705(b)
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Partner’s basis may be determined “by
reference to his proportionate share of
the adjusted basis of partnership
property upon a termination of the
partnership”
In short, the percentage a partner
would receive if the partnership
liquidated
Situations Where Alternative
Rule is Allowed
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If a partner cannot practicably apply the
general rule set forth in §705(a)
If in the opinion of the Commissioner, it
is reasonable to conclude that the result
produced will not vary substantially
from the result obtainable under the
general rule
Basis vs. Capital Account
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In many cases, a partner’s basis is equal to
the sum of the §704(b) capital account and
his share of partnership liabilities.
Exception – for §704(b) purposes,
partnership property is sometimes required or
permitted to be reflected on the partnership’s
books at a value that differs from tax basis.
Note – While a negative basis is not possible,
a negative amount is possible in a capital
account
Chapter 7
Definition of Liability
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For §752 purposes, a liability should include
any obligation of the partnership or a
partner to the extent that incurring or
holding it results in the creation of, or an
increase in, the basis of any property owned
by the obligor; a deduction taken into
account in computing taxable income; or a
nondeductible, noncapitalizable expenditure.
Do Not Qualify as
§752 Liabilities
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Cash-Method Payables
Unpaid Expenditures – until they become
deductible under the all events and economic
performance rules
Deferred compensation expenses – until they
become deductible
Contingent Obligations
Options to purchase partnership property in
exchange for cash premiums
Identifying Liabilities
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Once a nonrecourse obligation is
recognized as a liability for purposes of
the income tax laws in general and
§752 in particular, it will continue to be
treated as a liability until it is paid or
until some intervening event justifies a
reassessment of the obligation
“Wrapped” Liabilities
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“Wrapped” refers to when an
encumbered property is sold or
transferred to or by a partnership,
pursuant to a contract under which the
transferor purports to retain the primary
and ultimate obligation to pay the
encumbrance.
“Wrapped” Liabilities
(continued)
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§752(c) issue – whether the “wrapped”
liability that continues to encumber the
transferred property is treated as
assumed by the transferree or whether
the transferor’s obligation to continue to
service the indebtedness causes the
obligation to remain an obligation of the
transferor for basis purposes
“Wrapped” Liabilities-continued
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If a partnership is the transferor and its
continuing obligation to service the wrapped
indebtedness does not prevent §752(c) from
applying, the transfer results in the liability
ceasing to be a partnership liability and is
reflected in each partner’s basis
Conversely, if §752(c) is prevented from
applying, it is a partnership liability and the
partners receive no change in basis until the
liability is paid down
Partner Loans as Partnership
Liabilities
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Recourse loans – partnership liability
and allocated among all the partners
Nonrecourse loans – partnership
liability, but entire liability is allocated
solely to the lender-partner
FMV Limitation on
Nonrecourse Liabilities
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§752(c) – A liability to which property is subject is
considered a liability of the owner of the property
“to the extent of the FMV of such property.”
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Only affects liabilities that the owner of the property
does not expressly assume
If a partnership has a nonrecourse liability that is
secured by property having a value less than the
liability, a partner who sells an interest in the
partnership is treated as realizing his full share of the
liability, without regard to the value limitation
FMV Limitation on
Nonrecourse Liabilities (con’t)
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If property subject to a liability is
contributed to, or distributed by, a
partnership, the transferee is treated
as having assumed the liability, to the
extent that the amount of the
liability does not exceed the FMV of
the property at the time of contribution
or distribution.
Limitation Timing
Consideration
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The limitation applies only at the time
property is transferred.
Liability Assumptions
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A person is considered to assume a liability
only to the extent that:
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The assuming person is personally obligated to
pay the liability
If a partner assumes a liability, the person to
whom the liability is owed knows of the
assumption and can directly enforce the
partner’s obligation for the liability, and no
other partner would bear the economic risk of
loss for the liability immediately after the
assumption