Chapter 10: Special Partnership Issues

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Chapter 10:Special Partnership

Issues

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SPECIAL PARTNERSHIPSPECIAL PARTNERSHIPISSUESISSUES (1 of 2) (1 of 2)

Nonliquidating distributions§751 assetsLiquidating distributionsSale of partnership interestRetirement or death of a partnerExchange of a partnership interest

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SPECIAL PARTNERSHIPSPECIAL PARTNERSHIPISSUESISSUES (2 of 2) (2 of 2)

Termination of a partnershipMergers and consolidationsDivision of a partnershipOptional basis adjustmentsSpecial forms of partnershipsElecting large partnerships

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Nonliquidating Nonliquidating DistributionsDistributions

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

distributed property

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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

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Precontribution Gain (Loss)(1 of 2)

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

basis (< for loss) on date transferred to partnership

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Precontribution Gain (Loss)(2 of 2)

Gain or loss recognized by contributing partner w/in seven years of contribution if– Distribution of contributed property to any

OTHER partner or

– Any property distribution to contributing partner if FMV of property > partner’s basis»Gain recognition only

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Basis Effects of Distributions

General rule– Partnership’s basis in distributed property

carries over to partner

Partner’s basis in partnership reduced by – Money received and– Basis of other property received

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Holding Period and Character of Distributed Property

Partner’s holding period includes partnership’s holding period

Character of gain/loss when property sold– Generally same as for partnership– Ordinary income/loss treatment for

»Unrealized receivables» Inventory sold w/in 5 years of distribution

• After, character determined at partner level

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§751 Assets§751 Assets

§751 assets – Property likely to produce ordinary

income when sold or collected

Unrealized receivablesSubstantially appreciated inventorySignificance of §751

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Unrealized Receivables

Unrealized receivables include– Accounts receivable for cash basis

partnership

– Ordinary income recapture items »§§1245 or 1250 (depreciation)

»§§617(d) (mining properties)

»§§1252 (farmland)

»§§1254 (oil, gas and geothermal)

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Substantially Appreciated Inventory (1 of 2)

Substantially appreciated inventory includes all assets EXCEPT– Cash

– Capital assets

– §1231 assets

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Substantially Appreciated Inventory (2 of 2)

Appreciation test1. Exclude cash, §1231 & capital assets

2. Total basis of remaining assets

3. Multiply sum by 1.20

4. Compare result of #3 w/FMV of assets

5. If FMV larger, appreciation exists

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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

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Liquidating DistributionsLiquidating 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

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Gain or Loss Recognition by Partner (1 of 2)

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

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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

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Basis of Assets Received(1 of 2)

Basis of unrealized receivables and inventory same as for partnership– Never increased when distributed from

partnership partner

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Basis of Assets Received(2 of 2)

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

(increasing) the basis in the property distributed

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Sale of Partnership InterestSale of Partnership Interest(1 of 2)(1 of 2)

Impact on Partner– General rule

»Capital gain or loss recognized

– Partnership liabilities»Relief of liabilities increases the amount

realized on the sale

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Sale of Partnership InterestSale of Partnership Interest(2 of 2)(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

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Retirement or Death of a Retirement or Death of a PartnerPartner

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

Surrender of interest to partnership– Payments for property taxed as liquidating

distributions– Other payments treated as either guaranteed

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

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Exchange of a PartnershipExchange of a PartnershipInterestInterest (1 of 2) (1 of 2)

Exchange for another partnership interest not a like-kind exchange– Exception: exchanges of interests within a

single partnership

Exchange for corporate stock– May qualify for §351 treatment

»Partnership interest is property under §351

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Exchange of a PartnershipExchange of a PartnershipInterestInterest (2 of 2) (2 of 2)

Incorporation– Tax consequences depend on how incorporation

is accomplished

Formation 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

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Termination of a Termination of a PartnershipPartnership (1 of 2) (1 of 2)

IRC & state laws treat terminations differently

Termination events – No business operated as a partnership– Sale or exchange of 50% interest w/in 12

month period– If a partner completely liquidates, the

partnership tax year closes for that partner

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Termination of a Termination of a PartnershipPartnership (2 of 2) (2 of 2)

Effects of termination– Tax year closes upon termination

– Could cause short tax year to fall in same calendar year as regular 12-month tax year

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Mergers andMergers andConsolidationsConsolidations

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 continued– All other old partnerships deemed to terminate

»Possible that no old partnership continues

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Division of a PartnershipDivision 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

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Optional Basis Optional Basis AdjustmentsAdjustments (1 of 3) (1 of 3)

New partner’s outside basis– Purchase price plus new partner’s

share of partnership liabilities

New partner’s inside basis likely different than outside basis

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Optional Basis Optional Basis AdjustmentsAdjustments (2 of 3) (2 of 3)

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

partner

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Optional Basis Optional Basis AdjustmentsAdjustments (3 of 3) (3 of 3)

Example– If §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)

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Special Forms of Special Forms of PartnershipsPartnerships

Tax shelters and limited partnershipsPublicly traded partnershipsLimited Liability Companies (LLC)Limited Liability Partnerships (LLP)

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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

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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.

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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

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Electing Large Electing Large PartnershipsPartnerships

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

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ELP Qualifications

Non-service partnershipNot engaged in commodity tradingHave at least 100 partnersFile an election to be taxed as a

large partnership

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ELP Taxable Income

Misc. itemized deductions combined & subject to a 70% deduction at partner level– Remaining misc. deductions combined

w/other partnership incomeCharitable contributions combined and not

separately stated by partners§179 deductions combined

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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

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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

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

Kenneth W. Monfort College of Businessrichard.newmark@PhDuh.com