©2010 Pearson Education, Inc. Publishing as Prentice Hall

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©2010 Pearson Education, Inc. Publishing as Prentice Hall

SPECIAL PARTNERSHIP ISSUES Nonliquidating distributions §751 assets Terminating a partnership interest Optional and mandatory basis adjustments Special forms of partnerships Tax planning considerations ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Nonliquidating Distributions General rules Precontribution gain (loss) Basis effects of distributions Holding period and character of distributed property ©2010 Pearson Education, Inc. Publishing as Prentice Hall

©2010 Pearson Education, Inc. Publishing as Prentice Hall 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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Precontribution Gain (Loss) (1 of 2) Precontribution gain (loss) definition Contributed property w/FMV > tax basis (< for loss) on date transferred to partnership ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Precontribution Gain (Loss) (2 of 2) Gain or loss recognized by contributing partner w/in 7 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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Basis Effects of Distributions (1 of 2) General rule Partnership’s basis in distributed property carries over to partner Partner’s basis in partnership reduced in the following order Money received, Basis of other property received ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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 partnership’s basis in asset partnership’s basis in total assets distributed x ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

©2010 Pearson Education, Inc. Publishing as Prentice Hall §751 Assets §751 assets Property likely to produce ordinary income when sold or collected Unrealized receivables Substantially appreciated inventory Significance of §751 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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) ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Substantially Appreciated Inventory (1 of 2) Substantially appreciated inventory includes all assets EXCEPT Cash Capital assets §1231 assets ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Substantially Appreciated Inventory (2 of 2) Appreciation test Exclude cash, §1231 & capital assets Total basis of remaining assets Multiply sum by 1.20 Compare result of #3 w/FMV of assets If FMV larger, substantial appreciation exists ©2010 Pearson Education, Inc. Publishing as Prentice Hall

©2010 Pearson Education, Inc. Publishing as Prentice Hall 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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Terminating a Partnership Interest (1 of 2) Liquidating distributions Sale of partnership interest Retirement or death of a partner Exchange of a partnership interest Income recognition and transfers of a partnership interest ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Terminating a Partnership Interest (2 of 2) Termination of a partnership Mergers and consolidations Division of a partnership ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Liquidating Distributions Gain or loss recognition by partner Basis of assets received Holding period carries over to partner §751 applies to liquidating distributions Effects of distribution on partnership No gain or loss unless §751 deemed sale occurs ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Gain or Loss Recognition by Partner (1 of 2) Gain recognized if money received (and deemed received) exceeds partner’s basis in partnership ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Basis of Assets Received (1 of 2) Basis of unrealized receivables and inventory same as for partnership Never increased when distributed from partnership partner ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Sale of Partnership Interest (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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Retirement or Death of a Partner 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) ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Exchange of a Partnership Interest (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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Exchange of a Partnership Interest (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 or LLLP, same tax-free treatment as partnership-to-partnership transfer ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Termination of a Partnership (1 of 3) IRC & state laws treat terminations differently Termination events (IRC) No business operated as a partnership Sale or exchange of  50% interest w/in 12 month period ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Termination of a Partnership (2 of 3) 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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Termination of a Partnership (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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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 continued All other old partnerships deemed to terminate Possible that no old partnership continues ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Optional and Mandatory Basis Adjustments (1 of 4) Adjustments on transfers 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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Optional and Mandatory Basis Adjustments (2 of 4) Optional §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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Optional and Mandatory Basis Adjustments (3 of 4) 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) ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Optional and Mandatory Basis Adjustments (4 of 4) Mandatory basis adjustment for substantial built-in loss Substantial if Built-in loss > $250K, Exchange of partnership interest, AND No §754 optional basis adjustment election in effect ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Special Forms of Partnerships Tax shelters and limited partnerships Publicly traded partnerships Electing large partnerships Limited Liability Companies (LLC) Limited Liability Partnerships (LLP) ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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. ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Limited Liability Partnerships (LLPs) Used by many professional organizations Taxed as a partnership Partners not liable for failures in work of other partners or people supervised by other partners ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Limited Liability Limited Partnership Allowed by some states Formed under state’s limited partnership laws General partners have limited liability LLLP potentially useful in states where PSCs cannot be LLCs ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Electing Large Partnerships ELP Qualifications ELP taxable income ELP: Termination of partnership ELP: Audit rules ©2010 Pearson Education, Inc. Publishing as Prentice Hall

©2010 Pearson Education, Inc. Publishing as Prentice Hall ELP Qualifications Non-service partnership Not engaged in commodity trading Have at least 100 partners File an election to be taxed as a large partnership ©2010 Pearson Education, Inc. Publishing as Prentice Hall

©2010 Pearson Education, Inc. Publishing as Prentice Hall ELP Taxable Income Misc. itemized deductions combined & subject to a 70% deduction at partner level Remaining misc. deductions combined w/other partnership income Charitable contributions combined and not separately stated by partners §179 deductions combined ©2010 Pearson Education, Inc. Publishing as Prentice Hall

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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

©2010 Pearson Education, Inc. Publishing as Prentice Hall 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 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Tax Planning Considerations Tax treatments of partner withdrawal Liquidating distribution OR Partnership increases basis in §751 assets xfer of >50% interest ptrshp not terminated Sale of partnership interest to partnership xfer of >50% interest terminates ptrshp Optional basis adjustments affect each option differently ©2010 Pearson Education, Inc. Publishing as Prentice Hall

©2010 Pearson Education, Inc. Publishing as Prentice Hall