Chapter 12
Partnership Distributions
Operating or “Current” Distributions
 Current distribution - a distribution that does not
completely terminate the partner’s interest in the
partnership
 Generally a current distribution of either cash or
property is a nontaxable transaction to both the
recipient partner and the partnership

The partnership reduces the recipient partner’s capital account
and recognizes no taxable gain or loss (but would recognize a
book gain or loss)
Operating or “Current” Distributions (Cont.)
 The recipient partner generally reduces their outside
basis by the basis of property received, takes a
carryover basis in the distributed property, and
recognizes no gain or loss

Limitation: if the partner receives cash distribution in excess of
the tax basis of the partnership interest, the partner is required
to recognize taxable capital gain to the extent of the excess
Operating or “Current” Distributions (Cont.)
 Mid-year advances and partner “draws” against the
partner’s share of income


Distributions of money or property during the partnership
taxable year
Treated as distributions made on the last day of the
partnership’s taxable year

Deemed money distributions caused by a reduction in a partner’s
share of partnership liabilities also receive draw treatment
Property Distributions –
Consequences to the Partnership
 The partnership takes the property off its books and
reduces the partner’s capital account by the FMV of
the distribution



Book gain or loss recognized
No restrictions on the amount by which the partner’s capital
balance can be reduced
Unlike tax basis, the partnership can reduce partner capital to
negative
Partner’s Basis in Distributed Property
 General Rule—Carryover Basis
 The partner takes a carryover basis in the property received ,
and reduces his or her outside basis by the same amount
 Exception:
 If the partnership’s basis in the distributed property exceeds
the partner’s outside basis, the outside basis becomes the basis
of the property.
 The partner’s outside basis is reduced to zero
Partner’s Basis in Distributed Property (Cont.)
 Effect of Prior Partnership-level Basis Adjustments
 The partner’s basis in the distributed property includes prior
§734(b) basis adjustments (arising from prior distributions),
but does not include prior §743(b) basis adjustments (arising
from transfers of interests in the partnership)
 Character and Holding Period of Distributed
Property


Unrealized appreciation or depreciation inherent in the
distributed property will be taxed to the partner when the
property is subsequently disposed
The partner’s holding period for the property includes the
partnership’s holding period
Partner’s Basis in Distributed Property (Cont.)
 Character and Holding Period of Distributed
Property

The character of gain or loss on disposition
Unrealized receivables: ordinary income
 Depreciation recapture: ordinary income
 Inventory: ordinary income only for five years following the
distribution
 After five years, the character depends on how it is held or
used by the distributee partner
 Other property: depend on the partner’s use of such property or
purpose for holding it

Liquidating Distributions
 Liquidating distribution – a distribution that
completely terminates the partner’s interest in
partnership capital and profits
 General Rule


Nontaxable transaction to both the partner and the
partnership
The partner takes a tax basis in the distributed property equal
to the partner’s outside basis pre-distribution
Liquidating Distributions (Cont.)
 Recognition of Gain or Loss by Distributee Partner
 If the receipt of cash (including liability relief) exceeds the
partner’s outside basis, the partner must recognize gain in the
amount of the excess
 In an all-cash liquidating distribution, if cash received
(including liability relief) is less than the partner’s tax basis in
the partnership interest, the partner recognizes loss
Liquidating Distributions (Cont.)
 Recognition of Gain or Loss by Distributee Partner
 In an all-cash and/or ordinary income assets liquidating
distribution, if cash plus tax basis of the ordinary income
assets received is less than the partner’s outside basis, the
partner recognizes a loss
Capital
loss
Liquidating Distributions (Cont.)
 Property Distributions and Determination of Basis
 The partner’s outside basis must be adjusted for the partner’s
share of partnership income or loss
 This adjusted basis is then reduced by the amount of cash
received
 The remainder becomes the partner’s tax basis in property
received in the distribution
Chapter 11
Sale of a Partnership Interest
Gain or Loss on the Sale
of a Partnership Interest
 General rule:
 A partnership interest is a capital asset, and any gain or loss on
its sale will be a capital gain or loss
 Gain or loss realized : the amount realized for the transfer of
the partner’s partnership interest less the adjusted basis in the
partnership interest (“outside basis”)
Gain or Loss on the Sale
of a Partnership Interest (Cont.)
 Exceptions
 Gain or loss allocable to the share of net appreciation or
depreciation in the partnership’s ordinary income assets is
generally taxed as ordinary income or loss


The remainder is capital gain or loss
Gain equal to the partner’s share of the partnership’s
appreciation of collectibles is treated as collectibles gain
Gain or Loss on the Sale
of a Partnership Interest (Cont.)
 Exceptions
 Long-term gain allocable to the share of the partnership’s
unrecaptured Code Section 1250 depreciation is taxed at
maximum 25%
Amount Realized
 The amount realized on the sale of a partnership
interest is the amount of cash and the FMV of any
property received, plus the liability relief realized by
the selling partner in connection with the transaction
 Debt relief usually takes the form of a decreased
share of partnership liabilities
Adjusted Basis in the Partnership Interest
 Adjusted basis in partnership interest: the sum of
original tax basis on the day acquisition, plus
adjustments reflecting operations during holding
period
 The calculation of the initial basis varies based on
the way in which the partner acquired the interest
Adjusted Basis in the Partnership Interest (Cont.)
 General Rule - §705(a) :
 Also called historical method/approach
 The beginning adjusted basis:
If obtained through a contribution to the partnership, the initial
basis is equal to the amount of cash plus the tax basis of property
contributed
 If a partner purchased a partnership interest, the partner takes a
cost basis in the interest

Adjusted Basis in the Partnership Interest (Cont.)
 General Rule - §705(a) :
 The beginning adjusted basis:

If a partner obtained the interest by inheritance and got a
stepped-up (or stepped-down) basis in the partnership interest,
the initial basis is equal to its FMV at the date of the decedent’s
death or at the alternative valuation date, increased by his or her
share of the partnership’s debt
Adjusted Basis in the Partnership Interest (Cont.)
 General Rule - §705(a) :
 The beginning adjusted basis is then increased by the partner’s
share of partnership taxable income and tax exempt income, as
well as the basis of any further contributions of property
 The beginning adjusted basis is decreased by the partner’s
share of partnership losses, expenses incurred in producing
tax-exempt income, nondeductible/ non-capitalized
expenditures, and any partnership distributions
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Adjusted Basis in the Partnership Interest (Cont.)
 Adjustments to Basis for Changes in Partner’s Share
of Liabilities

Under historical approach:

Any increase or decrease in the share of partnership debt is looked
as a deemed money contribution or distribution
Ordinary Income from the Sale of a Partnership
 §751(a) states that amount realized on the sale of a
partnership interest which is attributable to
unrealized receivables or inventory is treated as
ordinary income
Ordinary Income from the Sale
of a Partnership (Cont.)
 Definition of Unrealized Receivables
 The rights to receive payments for goods and services provided
or to be provided, including:
Depreciation recapture
 Excess depreciation
 Mining exploration expenses recapture
 Stock in a D.I.S.C.13 or certain foreign corporations
 Franchises, trademarks, etc
 Oil, gas or geothermal property
 Excess farm loss recapture
 Market discount bonds and short-term obligations

Ordinary Income from the Sale
of a Partnership (Cont.)
 Definition of Inventory
 Three categories of inventory:
First category: true inventory and dealer property held primarily
for sale to customers in the ordinary course of the partnership’s
business
 Second category: property other than capital asset when sold or
exchanged by the partnership, including:
 A/R of cash-basis taxpayer
 Realized A/R of accrual-basis taxpayer
 Depreciation recapture, and
 All unrealized receivable

Collectibles and Unrecaptured §1250 Gain
(Cont.)
 Unrecaptured §1250 Gain
 Definition: the depreciation that has been taken on real
property, less the depreciation that is recaptured as ordinary
income
 Under current law, gain will be classified as unrecaptured
§1250 gain to the extent of accumulated depreciation
deductions on the property
Collectibles and Unrecaptured §1250 Gain
(Cont.)
 Unrecaptured §1250 Gain
 Unrecaptured §1250 gain cannot exceed the gain recognized
on the sale of the asset
 Unrecaptured §1250 gains are subject to a maximum tax rate
of 25 percent
 These rules apply only when a partner has held the
partnership interest for long term
Like-Kind Exchanges of Partnership Interests
 §1031(a)(2)(D)
 A partnership interest exchanged for a partnership interest in
the same or another partnership does not qualify for
nonrecognition exchange under this section
 As a result,
Exchanges of interests in different partnerships are taxable
 Exchanges of interests in the same partnerships are taxable
 But changes in status (such as from general partner to limited
partner) are not taxable unless collateral rules apply to cause a
taxable event
