10-1 ©2011 Pearson Education, Inc. Publishing as Prentice Hall.

10-1©2011 Pearson Education, Inc. Publishing as Prentice Hall

10-2

SPECIALPARTNERSHIP ISSUES

Nonliquidating distributions§751 assetsTerminating a partnership

interestOptional and mandatory basis

adjustmentsSpecial forms of partnershipsTax planning considerations©2011 Pearson Education, Inc. Publishing as

Prentice Hall

10-3

Nonliquidating Distributions

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

distributed property

©2011 Pearson Education, Inc. Publishing as Prentice Hall

10-4

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


10-5

Precontribution Gain (Loss)(1 of 2)

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

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


10-6

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©2011 Pearson Education, Inc. Publishing as

Prentice Hall

10-7

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


10-8

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


10-9

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

forUnrealized receivablesInventory sold w/in 5 years of

distributionAfter, character determined at partner

level


10-10

§751 Assets

§751 assets Property likely to produce ordinary

income when sold or collectedUnrealized receivablesSubstantially appreciated

inventorySignificance of §751


10-11

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)


10-12

Substantially Appreciated Inventory (1 of 2)

Substantially appreciated inventory includes all assets EXCEPTCashCapital assets§1231 assets


10-13

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, substantial

appreciation exists©2011 Pearson Education, Inc. Publishing as Prentice Hall

10-14

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


10-15

Terminating a Partnership Interest (1 of 2)

Liquidating distributionsSale of partnership interestRetirement or death of a partnerExchange of a partnership

interestIncome recognition and transfers

of a partnership interest©2011 Pearson Education, Inc. Publishing as

Prentice Hall

10-16

Terminating a Partnership Interest (2 of 2)

Termination of a partnershipMergers and consolidationsDivision of a partnership


10-17

Liquidating Distributions

Gain or loss recognition by partner

Basis of assets receivedHolding period carries over to

partner§751 applies to liquidating

distributionsEffects of distribution on

partnershipNo gain or loss unless §751 deemed

sale occurs


10-18

Gain or Loss Recognition by Partner

(1 of 2)

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


10-19

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


10-20

Basis of Assets Received(1 of 2)

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

from partnership partner


10-21

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


10-22

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


10-23

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©2011 Pearson Education, Inc. Publishing as

Prentice Hall

10-24

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)


10-25

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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

10-26

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 or LLLP, same tax-free treatment as partnership-to-partnership transfer


10-27

Termination of a Partnership

(1 of 3)

IRC & state laws treat terminations differently

Termination events (IRC)No business operated as a

partnershipSale or exchange of 50% interest

w/in 12 month period


10-28


(2 of 3)

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

same calendar year as regular 12-month tax year


10-29


(3 of 3)

If termination occurs because of sale of >50% ownership interest“Old” ptrshp contributes assets to

“new” ptrshp in exchange for 100% of new ptrshp

Basis and holding period of assets in new ptrshp same as in old ptrshp

Old ptrshp distributes new ptrshp interests to partners and liquidates

Partners’ basis in new ptrshp unchanged


10-30

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


10-31

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


10-32

Optional and MandatoryBasis Adjustments (1 of 4)

Adjustments on transfersNew partner’s outside basis

Purchase price plus new partner’s share of partnership liabilities

New partner’s inside basis likely different than outside basis


10-33


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

new partner


10-34


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)


10-35


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©2011 Pearson Education, Inc. Publishing as

Prentice Hall

10-36

Special Forms of Partnerships

Tax shelters and limited partnerships

Publicly traded partnershipsElecting large partnershipsLimited Liability Companies

(LLC)Limited Liability Partnerships

(LLP) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

10-37

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©2011 Pearson Education, Inc. Publishing as Prentice Hall

10-38

Limited Liability Companies(LLCs)

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

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


10-39

Limited Liability Partnerships

(LLPs)

Used by many professional orgsIncluding all Big 4 & many nat’l CPA

firmsTaxed as a partnershipPartners not liable for failures in

work of other partners or people supervised by other partnersNon-liable partners can still suffer

E.g., demise of Arthur Andersen©2011 Pearson Education, Inc. Publishing as Prentice Hall

10-40

Limited Liability LimitedPartnership

Allowed by some statesFormed under state’s limited

partnership lawsGeneral partners have limited

liabilityLLLP potentially useful in states

where PSCs cannot be LLCs


10-41

Electing Large Partnerships

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


10-42

ELP Qualifications

Non-service partnershipNot engaged in commodity

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

large partnership


10-43

ELP Taxable Income

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

combined w/other partnership income

Charitable contributions combined and not separately stated by partners

§179 deductions combined©2011 Pearson Education, Inc. Publishing as

Prentice Hall

10-44

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


10-45

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


10-46

Tax Planning Considerations

Tax treatments of partner withdrawal1. Liquidating distribution OR

Partnership increases basis in §751 assets

xfer of >50% interest ptrshp not terminated

2. Sale of partnership interest to partnership xfer of >50% interest terminates

ptrshpOptional basis adjustments affect

each option differently


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

Kenneth W. Monfort College of [email protected]

10-47©2011 Pearson Education, Inc. Publishing as Prentice Hall

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