10-1 ©2008 Prentice Hall, Inc.. 10-2 ©2008 Prentice Hall, Inc. SPECIAL PARTNERSHIP ISSUES ...

10-1©2008 Prentice Hall, Inc.

©2008 Prentice Hall, Inc. 10-2

SPECIALSPECIALPARTNERSHIP ISSUESPARTNERSHIP ISSUES

Nonliquidating distributions§751 assetsTerminating a partnership

interestBasis adjustmentsSpecial forms of partnerships


Nonliquidating Nonliquidating DistributionsDistributions

General rulesPrecontribution gain (loss)Basis effects of distributionsHolding period and character of

distributed property


General Rules

No gain or loss by either partner or partnership

“Money” distributions in excess of partner’s basis triggers capital gain recognition by partner

“Money” includes cash, reduction of partner’s liabilities, FMV of securities


Precontribution Gain (Loss)(1 of 2)

Precontribution gain (loss) definition Contributed property w/FMV >

tax basis (< for loss) on date transferred to partnership


Precontribution Gain (Loss)(2 of 2)

Gain or loss recognized by contributing partner w/in 7 years of contribution ifDistribution of contributed property to

any OTHER partner orAny property distribution to contributing

partner if FMV of property > partner’s basisGain recognition only


Basis Effects of Distributions

(1 of 2)

General rulePartnership’s basis in distributed

property carries over to partnerPartner’s basis in partnership

reduced in the following order Money received,Basis of other property received


Basis Effects of Distributions

(2 of 2)

Basis in new property if partnership’s basis in property > partner’s basis in partnership after adjusting for money received and preconribution gain

partner’s remaining

basis

x partnership’s basis in asset partnership’s basis in total assets

distributed


Holding Period and Character

of Distributed Property

Partner’s holding period includes partnership’s holding period

Character of gain/loss when property soldGenerally same as for partnershipOrdinary income/loss treatment for

Unrealized receivablesInventory sold w/in 5 years of distribution

After, character determined at partner level


§751 Assets§751 Assets

§751 assets Property likely to produce ordinary

income when sold or collectedUnrealized receivablesSubstantially appreciated

inventorySignificance of §751


Unrealized Receivables

Unrealized receivables includeAccounts receivable for cash basis

partnershipOrdinary income recapture items

§§1245 or 1250 (depreciation)§§617(d) (mining properties)§§1252 (farmland)§§1254 (oil, gas and geothermal)


Substantially Appreciated Inventory (1 of 2)

Substantially appreciated inventory includes all assets EXCEPTCashCapital assets§1231 assets


Substantially Appreciated Inventory (2 of 2)

Appreciation test1. Exclude cash, §1231 & capital

assets2. Total basis of remaining assets3. Multiply sum by 1.204. Compare result of #3 w/FMV of

assets5. If FMV larger, appreciation exists


Significance of §751

If §751 assets exist, certain distributions reclassified as a SALE between partnership & partner

What appears to be a tax-free distribution could be a taxable event

See Example C10-12 and Table C10-1


Terminating a Terminating a Partnership InterestPartnership Interest (1 of 2)(1 of 2)

Liquidating distributionsSale of partnership interestRetirement or death of a partnerExchange of a partnership interestIncome recognition and transfers

of a partnership interest


Terminating a Terminating a Partnership InterestPartnership Interest (2 of 2) (2 of 2)

Termination of a partnershipMergers and consolidationsDivision of a partnership


Liquidating Distributions

Gain or loss recognition by partnerBasis of assets receivedHolding period carries over to partner§751 applies to liquidating distributionsEffects of distribution on partnership

No gain or loss unless §751 deemed sale occurs


Gain or Loss Recognition by Partner

(1 of 2)

Gain recognized if money received (and deemed received) exceeds partner’s basis in partnership


Gain or Loss Recognition by Partner

(2 of 2)

Loss recognized if Only money, unrealized

receivables & inventory are only assets received AND

Basis in partnership > sum of money plus partnership’s basis in unrealized receivables and inventory received


Basis of Assets Received(1 of 2)

Basis of unrealized receivables and inventory same as for partnershipNever increased when distributed

from partnership partner


Basis of Assets Received(2 of 2)

After reducing partner’s basis for money received, remaining basis in partnership is allocated to remaining property distributedGain (loss) is deferred by reducing

(increasing) the basis in the property distributed


Sale of Partnership Interest(1 of 2)

Impact on PartnerGeneral rule

Capital gain or loss recognizedPartnership liabilities

Relief of liabilities increases the amount realized on the sale


Sale of Partnership Interest(2 of 2)

Impact on partner (continued)§751 property

All inventory and unrealized receivables are considered §751 property

Hypothetical asset sale approach used by Treasury Regs. Under §751 to determine ordinary income or loss

No impact on partnership


Retirement or Death of a Partner

Sale of partnership interest to outside party is a “sale”

Surrender of interest to partnershipPayments for property taxed as

liquidating distributionsOther payments treated as either

guaranteed payment (ordinary income) or distributive share (retain character)


Exchange of a Partnership Interest

(1 of 2)

Exchange for another partnership interest not a like-kind exchangeException: exchanges of interests

within a single partnershipExchange for corporate stock

May qualify for §351 treatmentPartnership interest is property under

§351


Exchange of a Partnership Interest

(2 of 2)

IncorporationTax consequences depend on how

incorporation is accomplishedFormation of an LLC or LLP

If LLC elects to be taxed as a corp, treatment same as for incorporation

If LLP, same tax-free treatment as partnership-to-partnership transfer


Termination of a Partnership

(1 of 2)

IRC & state laws treat terminations differently

Termination events No business operated as a

partnershipSale or exchange of 50%

interest w/in 12 month period


Termination of a Partnership

(2 of 2)

Effects of terminationTax year closes upon terminationCould cause short tax year to fall

in same calendar year as regular 12-month tax year


Mergers and Consolidations

Two or more partnerships join to form a new partnership

If partners of “Old 1” own > 50% of New partnership, then Old 1 partnership is deemed to be continuedAll other old partnerships deemed to

terminatePossible that no old partnership continues


Division of a Partnership

One partnership divided into two or more partnerships

New partnerships whose partners own collectively > 50% of interests in old partnerships are considered a continuation of the old partnership


Basis AdjustmentsBasis Adjustments

(1 of 4)(1 of 4)

New partner’s outside basisPurchase price plus new partner’s

share of partnership liabilitiesNew partner’s inside basis likely

different than outside basis



(2 of 4)(2 of 4)

§754 adjustment allows partnership to adjust basis of partnership assets for new partner’s share of partnership assetsBasis adjustment belongs only to

new partner



(3 of 4)(3 of 4)

ExampleIf §754 adjustment is $30,000 and

new partner is 1/3 partner, then new partner’s inside basis increases by $10,000 ($30,000 x 1/3)



(4 of 4)(4 of 4)

Mandatory basis adjustment for substantial built-in lossSubstantial if Built-in loss > $250K,Exchange of partnership interest,

ANDNo §754 optional basis adjustment

election in effect


Special Forms of Special Forms of PartnershipsPartnerships

Tax shelters and limited partnerships

Publicly traded partnershipsElecting large partnershipsLimited Liability Companies (LLC)Limited Liability Partnerships (LLP)


Publicly Traded Partnerships

PTPs are partnerships whose interests are traded on an established securities exchange

PTPs are taxed as a corporation unless 90% of income is “qualifying income”E.g., Certain interest, dividends, real

property rents


Limited Liability Companies(LLCs)

May be taxed as a partnership or a corp using check-the-box regs

Allows entity to obtain flow-through and flexibility of partnership allocations while maintaining limited liability of a corp.


Limited Liability Partnerships

(LLPs)

Used by many professional organizations

Taxed as a partnershipPartners not liable for failures in

work of other partners or people supervised by other partners


Limited Liability LimitedPartnership

Allowed by about 20 statesFormed under state’s limited

partnership lawsGeneral partners have limited

liabilityLLLP potentially useful in states

where PSCs cannot be LLCs


Electing Large Partnerships

ELP Qualifications ELP taxable incomeELP: Termination of partnershipELP: Audit rules


ELP Qualifications

Non-service partnershipNot engaged in commodity

tradingHave at least 100 partnersFile an election to be taxed as a

large partnership


ELP Taxable Income

Misc. itemized deductions combined & subject to a 70% deduction at partner levelRemaining misc. deductions combined

w/other partnership incomeCharitable contributions combined

and not separately stated by partners§179 deductions combined


ELP: Termination of Partnership

Termination occurs only upon cessation of any business, financial operation or venture

Termination does not occur upon transfer of 50% ownership


ELP: Audit Rules

Partners must report all items in same manner as partnership

Audit findings & agreements reached at partnership level binding on all partners

Audit decisions binding on partners who own interest in year of decision, not year of contested transaction

Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark atUniversity of Northern Colorado’s

Kenneth W. Monfort College of [email protected]

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