CHAPTER 12

PARTNERSHIP DISTRIBUTIONS
OPERATING OR CURRENT
DISTRIBUTIONS
Current distribution - a distribution that does
not completely terminate the partners 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 partners
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 partners share of income
Distributions of money or property during the
partnership taxable year
Treated as distributions made on the last day of the
partnerships taxable year
Deemed money distributions caused by a reduction in a
partners 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 partners capital account by the
FMV of the distribution
Book gain or loss recognized
No restrictions on the amount by which the partners
capital balance can be reduced
Unlike tax basis, the partnership can reduce partner
capital to negative
PARTNERS BASIS IN DISTRIBUTED
PROPERTY
General RuleCarryover Basis
The partner takes a carryover basis in the property
received , and reduces his or her outside basis by the
same amount
Exception:
Ifthe partnerships basis in the distributed property
exceeds the partners outside basis, the outside basis
becomes the basis of the property.
The partners outside basis is reduced to zero
PARTNERS BASIS IN DISTRIBUTED
PROPERTY (CONT.)
Effect of Prior Partnership-level Basis
Adjustments
The partners 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)
PARTNERS BASIS IN DISTRIBUTED
PROPERTY (CONT.)
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 partners holding period for the property includes
the partnerships holding period
PARTNERS 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 partners use of such property or

purpose for holding it

LIQUIDATING DISTRIBUTIONS
Liquidating distribution a distribution that
completely terminates the partners 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 partners outside basis pre-
distribution
CHAPTER 11

SALE OF A PARTNERSHIP INTEREST

GAIN OR LOSS UPON THE SALE OF
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 partners partnership interest less the
adjusted basis in the partnership interest (outside
basis)
GAIN OR LOSS UPON THE SALE OF
PARTNERSHIP INTEREST (CONT.)
Exceptions
Gain or loss allocable to the share of net appreciation
or depreciation in the partnerships ordinary income
assets is generally taxed as ordinary income or loss
The remainder is capital gain or loss
Gain equal to the partners share of the partnerships
appreciation of collectibles is treated as collectibles
gain
GAIN OR LOSS UPON THE SALE OF
PARTNERSHIP INTEREST (CONT.)
Exceptions
Long-term gain allocable to the share of the
partnerships 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 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 PARTNERSHIP
INTEREST (CONT.)
General Rule - 705(a) :
Alsocalled 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 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 decedents death or at the alternative valuation date,
increased by his or her share of the partnerships debt
ADJUSTED BASIS IN PARTNERSHIP
INTEREST (CONT.)
General Rule - 705(a) :
The beginning adjusted basis is then increased by the
partners 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
partners share of partnership losses, expenses
incurred in producing tax-exempt income,
nondeductible/ non-capitalized expenditures, and any
15

partnership distributions
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
partnerships 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

ORDINARY INCOME FROM THE
SALE OF A PARTNERSHIP (CONT.)
Definition of Inventory
Three categories of inventory:
Third category: any other partnership property that would
be either 1221(1) property, other noncapital assets, or non
1231(b) property if it were held by the selling partner
Ifselling partner is required to recognize ordinary
income that exceeds the total gain on the sale, the
partner will recognize a capital loss in the amount of
the excess
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
INSTALLMENT SALE OF A
PARTNERSHIP INTEREST (CONT.)
Meanwhile, the installment method is not
available for the sale of inventory, and the
ordinary income attributable to the portion of
inventory must be reported in its entirety in the
year of sale
ABANDONMENTS AND GIFTS OF A
PARTNERSHIP INTEREST (CONT.)
If the gift is to a charity, the amount of the
charitable contribution deduction is based upon
the type of property held by the partnership
The amount of the charitable contribution is reduced
to the extent that the partner would recognize
ordinary income had the partnership interest is sold
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
LIKE-KIND EXCHANGES OF
PARTNERSHIP INTERESTS ( CONT.)
1031(a)(2)(D)
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
LIQUIDATING DISTRIBUTIONS
(CONT.) CHAPTER 12 - CONTINUED
Recognition of Gain or Loss by Distributee
Partner
Ifthe receipt of cash (including liability relief)
exceeds the partners 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
partners 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
partners outside basis, the partner recognizes a loss
Capital loss
LIQUIDATING DISTRIBUTIONS
(CONT.)
Property Distributions and Determination of
Basis
The partners outside basis must be adjusted for the
partners share of partnership income or loss
This adjusted basis is then reduced by the amount of
cash received
The remainder becomes the partners tax basis in
property received in the distribution
DISPROPORTIONATE
DISTRIBUTIONS
when a distribution changes the partners
proportionate share of hot assets, the
distribution is partially recast as a taxable
exchange
Hot assets: ordinary income assets of unrealized
receivables and substantially appreciated inventory
DISPROPORTIONATE
DISTRIBUTIONS (CONT.)
When a partner receives more than his or her
share of hot assets (an excess share), the
partner will report capital gains for his or her
excess share of the appreciation in capital gain
assets that remain in the partnership
There is a hypothetical distribution of the partners
share of all assets to the partner
This is followed by a hypothetical exchange of capital
gain assets to the partnership for the excess share
of hot assets actually received.
DISPROPORTIONATE
DISTRIBUTIONS (CONT.)
The portion of the ordinary income assets
received in the deemed exchange will have a
basis to the distributee equal to their FMV (their
cost in the exchange)
The remaining ordinary income assets and
capital gain assets will have a carryover basis
from the partnership
DEFINITION OF UNREALIZED
RECEIVABLES
Unrealized receivables - right to receive payments for
goods and services provided or to be provided, but also
including:
Depreciation recapture
Excess depreciation under 1250

Mining exploration expenses recapture

Franchises, trademarks

Oil, gas or geothermal property

Excess farm loss recapture

Market discount bonds and short-term obligations

Stock in a D.I.S.C. or certain foreign corporations

DEFINITION OF SUBSTANTIALLY
APPRECIATED INVENTORY
First, the asset must constitute inventory -
751(d) sets out four categories of inventory items
Second, the inventory must be substantially
appreciated
Substantially appreciated: the aggregate FMV of all
of the inventory exceeds 120 percent of its aggregate
basis
DEFINITION OF SUBSTANTIALLY
APPRECIATED INVENTORY (CONT.)
Four categories of inventory:
True inventory and dealer property held primarily for
sale to customers in the ordinary course of the
partnerships business
Property other than a capital asset and a 1231(b)
asset, including,
A/R of a cash-basis taxpayer and an accrual-basis taxpayer
Depreciation recapture, and all other unrealized receivables
DEFINITION OF SUBSTANTIALLY
APPRECIATED INVENTORY (CONT.)
Four categories of inventory:
Potential gain from the sale of 1246 stock
Any other partnership property that would be either
1221(1) property, other noncapital assets or non-
1231(b) property, or property giving rise to potential
gain from the sale of 1246 stock if it were held by the
distributee partner
DISTRIBUTION OF MARKETABLE
SECURITIES
The term money generally includes marketable
securities
Thus, a partner recognizes gain to the extent the
value of the distributed securities exceeds the
partners basis in partnership interest
However, a partner can receive marketable
securities attributable to his or her share of the
net appreciation of the partnerships marketable
securities without recognizing gain
DISTRIBUTION OF MARKETABLE
SECURITIES (CONT.)
Non-recognizing gain calculation: reducing the
amount of marketable securities treated as
money by the excess of
The partners share of net gain recognized if all
securities of the type distributed held by the
partnership immediately before the transaction were
sold for FMV, over
The partners share of gain recognized if the
securities held by the partnership immediately after
the transaction had been sold
DISTRIBUTION OF MARKETABLE
SECURITIES (CONT.)
As long as a partners inside basis in the assets of
a partnership are equal to the partners outside
basis, the partner can withdraw his or her full
distributive share of marketable securities
without recognizing any gain under 731
DISTRIBUTION OF MARKETABLE
SECURITIES (CONT.)
Thus, if the partner forego a non-appreciated
interest in other assets in return for the
distribution of marketable securities, the partner
shall not recognize gain to the extent the partner
has outside basis in the partnership interest that
matches his or her share of inside basis in such
other assets