Howard E. Abrams

Sell the partnership interest
 Sections 741, 751(a), 743(b)

Receive a liquidating distribution of cash
 Sections 731, 751(b), 734(b)

Receive a liquidating distribution of property
 Sections 751(b), 732, 734(b)
Note: You cannot do a like-kind exchange with a
partnership interest.
Gain or loss is recognized based on a comparison of
the sale price to outside basis.
 The ordinary income component equals the exiting
partner’s distributive share of the ordinary income
inside the partnership. Note that this can exceed the
total gain on the sale.
 The capital gain component equals the total gain on
the sale less the ordinary income component.

The purchasing partner takes a cost basis in the
partnership interest.
 Under section 743(b), the purchasing partner takes
a cost-basis in each of the purchased assets.
 If the purchasing partner pays more or less than
liquidation value, the capital assets will take a greater
or lesser basis.
 Note: the purchasing partner’s capital account is
carried-over from the selling partner. (The purchase
of a partnership interest is not a book-up event.)

Gain or Loss is Recognized to the Distributing
Partner.
 The Exiting Partner’s Share of Ordinary Income Is
Captured Under Section 751(b).

 Inventory is Captured only if “Substantially Appreciated”
 No look-Thru on Capital Gain: Rate Equals 15%
Inside Basis Is Adjusted Under Section 734(b) for
Exiting Partner’s Gain Or Loss.

No Gain or Loss on Distribution
Outside Basis is Pushed into Distributed Assets
Inventory Items Remain Ordinary Income Assets
for 5 Years After Distribution; Unrealized Receivables
Remain Ordinary Income Assets Forever



A condominium development ends badly, with the
final unsold units distributed to the partners. One of
the partners holds the unit for two years and then
sells it. Any gain or loss on the sale is ordinary
because the unit was inventory in the hands of the
partnership.
 To convert the gain into capital gain, the
partnership must change its holding of the property
prior to distribution.

X and Y are 50% partners. XY owns cash of $120 and
a capital asset with basis of $80 and fair market value
of $300. Each partner has a capital account and
outside basis of $100.The cash is distributed to X.

 X recognizes a capital gain of $20 on the distribution.
 The partnership increases its inside basis from $80 to $100.
 If the partnership then sells its asset, there will be a gain of
only $200, allocable half to X and half to Y.
 The partnership now owns cash of $300. X has been taxed on
$120 and Y has been taxed on $100. The total is correct, but X
has been overtaxed and Y has been undertaxed.
Gain or loss from the sale or exchange of a
partnership interest or triggered by a distribution of
cash from the partnership will be long-term or shortterm depending on the partner’s holding period in
the partnership interest.
 A partner now can have a bifurcated holding period
in his partnership interest. That is, gain or loss can be
both long-term and short-term.

When property is contributed to a partnership,
holding period carries over from the contributed
property into the partnership interest.
 If multiple assets are contributed, a proportion of
the partnership interest will receive a holding period
from each contributed asset in proportion to the
relative fair market value of each contributed
property.

X contributes cash of $1,000, capital asset #1 with
value of $2,000 and a sixth-month holding period,
and capital asset #2 with value of $3,000 and a
holding period in excess of one year.
 X will have a new holding period as to one-sixth of
the partnership interest, a six-month holding period
as to one-third of the partnership interest, and a
long-term holding period as to one-half of the
partnership interest.

If a partner contributes cash or property to the
partnership, a portion of the holding period will be
redetermined in proportion to the value of the
contribution as compared with the value of the
partnership interest.
 Example: X owns a partnership interest with value
of $500 and a long-term holding period. X contributes
cash of $250. As a result of the contribution, X has a
new holding period in one-third of the partnership
interest.

In general, the distribution of cash or property
does not affect the holding period of the distributee
partner in the partnership interest.
 However, cash (but not property) distributed from
the partnership up to 12 months prior to recognition
of gain from sale (or deemed sale) of the partnership
interest is netted against any contributed cash (but
not property) to reduce the amount of gain treated
as short-term.

While contributing cash or property will convert a
portion of the partnership interest into short-term
property, such contributions have no affect on the
partnership’s holding period with respect to assets it
already owns.
 Accordingly, the sale of assets by the partnership
will be unaffected by the bifurcation rule applicable
to partnership interests.

To avoid gain to the distributee partner, distribute
property rather than cash. Note: marketable
securities are treated much like cash.
 Can the distributee partner go shopping with the
partnership’s money similar to a Starker exchange
under §1031? In ILM 200650014, the Service
determined that, at least when no other partner
would at any time have an economic interest in the
property, the answer is no.

If a partner exits a partnership that own loss
inventory via a cash distribution, the partner’s share
of the loss will be recognized as a capital loss
because §751(b) speaks only to inventory that is
“substantially appreciated.” But if the partner exits
via a sale of the interest, the loss will be ordinary
under §751(a). If the inventory is distributed in kind,
the loss will be preserved in the inventory and, when
it is sold, the loss will be ordinary under §735(a)(2).
If a partner exits a partnership owning loss capital
assets, the exiting loss will be capital if the partner
exits by sale, exchange, or liquidating distribution.
 Abandonment of the interest will convert the loss
into an ordinary loss so long as the exiting partner has
no share of partnership liabilities.
 Abandonment requires the subjective intention to
abandon plus an affirmative act of abandonment.
 Abandonment of the assets by the partnership is an
alternative strategy.

If a partner exits the venture in exchange for a cash
distribution, capital loss recognized by the exiting
partner will reduce the partnership’s inside basis if a
§754 election is in effect or the basis reduction is
“substantial.” Here, “substantial” means that the
basis reduction exceeds $250,000.
 If the partners sells his partnership interest, a
“substantial” basis reduction means that the
partnership’s assets have a net loss in excess of
$250,000. The adjustment is only the exiting partner’s
share of that loss.

The P partnership has assets with value of $500,000
and inside basis of $800,000. X, owning a 0ne-tenth
interest in P with an outside basis of $80,000,
receives a liquidating distribution of $50,000. X
recognizes a capital loss of $30,000. If no election
under §754 is in effect, the partnership does not
adjust inside basis.
 If X instead sells her interest for $50,000, there is
again a capital loss to X of $30,000 but now an
equivalent inside basis adjustment is mandatory.

If a new partner will replace an exiting partner, the
new partner can purchase an interest in the venture
or can contribute cash for a new interest.
 If the new partner purchases an interest in the
venture, the incoming partner takes the exiting
partner’s capital account, potentially limiting
subsequent loss allocations. But if the incoming
partner contributes cash, capital account equals the
amount of cash contributed.
 Disguised sale of a partnership interest challenge?

A partner who sells an interest in a partnership
owning depreciated real estate is subject to the 25%
capital gain rate applicable to “unrecaptured §1250
gain.”
 But an exit in exchange for a liquidating
distribution is not subject that this higher rate. And
an election under §754 will eliminate the exiting
partner’s share of the higher-rate gain permanently.
 Note: this strategy has no effect on gain actually
recaptured by §1250 (or by §1245).

EO and TO each contribute $100 to the partnership in
exchange for a 50% interest in profits, losses, and
capital. The partnership purchases two capital assets
for $100 each. CA #1 increases in value to $200 while
CA #2 increases in value to $190. CA #2 is distributed
to EO and CA #1 is sold for cash. How do the books of
the venture read?
EO
CA
TO
OB
CA
Explanation
OB
$ 100
$ 100
$ 100
$100 Contributions
45
0
45
0 Book-Up of #2
(190)
(100)
0
0 Distribution
50
50
50
50 Sale of CA #1
5
50
195
150 Totals
Y has a 50% interest in the XY partnership (the other
partners collectively are referred to as “X”). XY owns
an asset with cost basis of $200 and current value of
$1,000. Y must receive cash of $500 by liquidation,
sale of the interest, or combination of the two.
 XY can borrow $500, guaranteed by X. A liquidating
distribution of cash to Y will produce a capital gain of
$400 and an inside basis increase of the same
amount. A sale of the asset will then produce a
capital gain to X of $400 as well. Each partner is
taxed properly.

______X______
CA
OB
$ 100
$ 100
0
490
400
0
0
0
$ 500
$ 590
Assets
Property
Value
$ 1000
______Y______
CA
OB
$ 100
$ 100
0
0
400
0
( 490) ( 490)
$ 10
$
0
Basis
$ 590
Debt
($ 490)
______X______
CA
OB
$ 500
$ 590
0
205
0
( 490)
$ 500
$ 305
______Y______
CA
OB
$ 10
$
0
0
205
0
0
$ 10
$ 205
Assets
Cash
Basis
$ 510
Value
$ 510
Debt
-0-
______X______
CA
OB
$ 500
$ 590
0
205
0
( 490)
0
0
$ 500
$ 305
______Z______
CA
OB
$ 10
$ 10
0
205
0
0
0
( 205)
$ 10
$ 10
Assets
Cash
Basis
$ 510
Value
$ 510
Debt
-0-
Howard E. Abrams