Disposition of a Partnership Interest

1. 1 Disposition of a Partnership Interest

2. 2 Today’s Agenda  General rules governing the transfer of a partnership interest Rules regarding Section 751 assets Taxable vs. Nontaxable Transfers Section 743(b) Basis Adjustment Payments to Retiring Partners under Section 736

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4. 4 Disposition of a Partnership Interest – Some Examples Sell to another person or the partnership Gift Retirement Liquidation of the partnership Incorporation of the partnership Charitable contribution The instructor should quickly go over some of the ways to dispose of a partnership interest including selling it to another person or the partnership, making a gift of the partnership interest to someone, retiring, liquidating the partnership, incorporating the partnership and giving the partnership interest to a charity. The instructor should quickly go over some of the ways to dispose of a partnership interest including selling it to another person or the partnership, making a gift of the partnership interest to someone, retiring, liquidating the partnership, incorporating the partnership and giving the partnership interest to a charity.

5. 5 Disposition of a Partnership Interest The most common way to dispose of a partnership interest is to sell it to either another partner, the partnership or an unrelated third party. Code Section 741 governs the treatment of a sale of a partnership interest. The most common way to dispose of a partnership interest is to sell it to another partner, the partnership or to an unrelated third party. Code Section 741 governs the treatment of the sale of a partnership interest. The general rule of Section 741 is that the partner will have a gain or loss on the sale of a capital asset.The most common way to dispose of a partnership interest is to sell it to another partner, the partnership or to an unrelated third party. Code Section 741 governs the treatment of the sale of a partnership interest. The general rule of Section 741 is that the partner will have a gain or loss on the sale of a capital asset.

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8. 8 Answers Economically, the partner that is disposing of his partnership interest will have the same amount of property whether he sells the interest or receives a distribution from the partnership. However, the Code and the courts distinguish between a sale and a distribution We should emphasize that there is no economic difference between selling the partnership interest to the partnership and getting a liquidating distribution from the partnership. However, the tax implication for a sale are not the same as for a distribution. The courts distinguish between a sale and a contribution/distribution. If there is a contribution/distribution Section 707(a)(2)(B) will apply. The court cases which distinguish between the two types of transaction place a heavy reliance on from versus substance. Therefore, it very important that we help the partner and partnership structure the transaction correctly. We should emphasize that there is no economic difference between selling the partnership interest to the partnership and getting a liquidating distribution from the partnership. However, the tax implication for a sale are not the same as for a distribution. The courts distinguish between a sale and a contribution/distribution. If there is a contribution/distribution Section 707(a)(2)(B) will apply. The court cases which distinguish between the two types of transaction place a heavy reliance on from versus substance. Therefore, it very important that we help the partner and partnership structure the transaction correctly.

9. 9 General Rules – Section 741 In a sale of a partnership interest the partner will recognize a gain or loss on the sale of a capital asset. Amount of gain or loss = Amount received minus Adjusted basis of partnership interest If a partner sells his partnership interest Section 741 characterizes it as a sale of a capital asset. The amount of gain or loss that a partner will have to recognize is the difference between the amount he is deemed to have received and his adjusted basis in his partnership interest. The adjusted basis in this calculation is the partner’s outside basis. The amount received or realized is calculated the same as in any sale of an asset. (Cash received + the FMV of any property received + any debt assumed by the buyer – any debt assumed by the seller – selling expenses).If a partner sells his partnership interest Section 741 characterizes it as a sale of a capital asset. The amount of gain or loss that a partner will have to recognize is the difference between the amount he is deemed to have received and his adjusted basis in his partnership interest. The adjusted basis in this calculation is the partner’s outside basis. The amount received or realized is calculated the same as in any sale of an asset. (Cash received + the FMV of any property received + any debt assumed by the buyer – any debt assumed by the seller – selling expenses).

10. 10 Go over the question to make sure there are no questions.Go over the question to make sure there are no questions.

11. 11 Answer The amount realized on the sale of a partnership interest must always include the partner’s share of liabilities. In this case the amount realized is the $100,000 cash received from Tom plus the relief of Peter’s share of partnership liabilities of $6,000. Therefore, the gain is $106,000 – $36,000 = $70,000 Peter will have a $70,000 gain. The amount realized on the sale was $106,000 which included the $100,000 cash he got plus the $6,000 of liabilities Tom assumed. You must always remember that the amount received on a sale of a partnership interest includes the partner’s share of liabilities. The liabilities are also included in the partner’s outside basis as well.Peter will have a $70,000 gain. The amount realized on the sale was $106,000 which included the $100,000 cash he got plus the $6,000 of liabilities Tom assumed. You must always remember that the amount received on a sale of a partnership interest includes the partner’s share of liabilities. The liabilities are also included in the partner’s outside basis as well.

12. 12 Important Issues What interest is being sold? Must check to see if the complete interest or only a partial interest is being sold Must also check what type of interest is being sold if the partner is both a general partner and a limited partner In this case the partner has a single capital account and basis must be prorated between the two types of interest Another issue that must be considered when selling a partnership interest is what interest is being sold. We must check to see if the complete interest is being sold or if it is only a partial interest. We also must check to see what type of interest is being sold if the partner owns both a general and a limited partnership interest. If a partner owns both a general and a limited interest he will only have on e capital account. The capital account must be prorated between the two interests. The capital account is prorated based on relative FMVs of the two interest. However, the relative FMVs must be adjusted for liabilities. Because of the differences in the rules concerning allocating liabilities to general and limited partners the partner may end up with a negative capital account for one of the interests. In this event, the pro ration must be based on before and after liabilities. There are several older revenue rulings that show how to make the proper pro ration between interests. Another issue that must be considered when selling a partnership interest is what interest is being sold. We must check to see if the complete interest is being sold or if it is only a partial interest. We also must check to see what type of interest is being sold if the partner owns both a general and a limited partnership interest. If a partner owns both a general and a limited interest he will only have on e capital account. The capital account must be prorated between the two interests. The capital account is prorated based on relative FMVs of the two interest. However, the relative FMVs must be adjusted for liabilities. Because of the differences in the rules concerning allocating liabilities to general and limited partners the partner may end up with a negative capital account for one of the interests. In this event, the pro ration must be based on before and after liabilities. There are several older revenue rulings that show how to make the proper pro ration between interests.

13. 13 Important Issues A sale of a partnership interest can cause a Section 708 termination of the partnership if more than 50% of the profits and capital interest is transferred within a 12-month period A sale always terminates the partnership’s year for the selling partner The partner must adjust his basis in the partnership interest by his share of the partnership’s income or loss to the date of sale A sale of a partnership interest can cause a termination under Section 708 if 50% or more of the capital and profits of the partnership have been exchanged in a taxable transaction in the last twelve months. So after any sale the partnership needs to make sure that there has not been a technical termination under section 7080. The partnership terminates as to the partner that is selling his or her interest. The partner must include in income his share of the partnership’s income or loss up to the point of sale. You also need to examine any disallowed losses under Section 465 and 469. To determine that amount of income or loss at the date of sale, Section 708 says the partnership’s books must be closed at this date to determine income. A sale of a partnership interest can cause a termination under Section 708 if 50% or more of the capital and profits of the partnership have been exchanged in a taxable transaction in the last twelve months. So after any sale the partnership needs to make sure that there has not been a technical termination under section 7080. The partnership terminates as to the partner that is selling his or her interest. The partner must include in income his share of the partnership’s income or loss up to the point of sale. You also need to examine any disallowed losses under Section 465 and 469. To determine that amount of income or loss at the date of sale, Section 708 says the partnership’s books must be closed at this date to determine income.

14. 14 Go over the problem briefly.Go over the problem briefly.

15. 15 Answer According to Section 708, the partnership’s books should be closed at the date of the sale to determine the partnership’s income. Therefore, Kate should increase her basis by $60,000. However, the practical answer in many cases is to prorate income. If income were prorated Kate would only increase her basis by $26,250. Kate’s basis will be $100,000. According to Section 708 the partnership’s books must be closed as of the date of sale to determine her share of income or loss at that time. Kate’s share of income for the first seven months is $60,000 (1/4 of $240,000). She must add that amount to her basis of $40,000 to get her adjusted basis. If the partnership does not close its books but just prorates the income based on the number of days or months she owned the interest her share of partnership income would only be $26,250. This is a difference of $33,750. Kate would report the same amount of total income on her return however, in this case she would probably have less ordinary income and more capital gains which would reduce her tax liability. Kate’s basis will be $100,000. According to Section 708 the partnership’s books must be closed as of the date of sale to determine her share of income or loss at that time. Kate’s share of income for the first seven months is $60,000 (1/4 of $240,000). She must add that amount to her basis of $40,000 to get her adjusted basis. If the partnership does not close its books but just prorates the income based on the number of days or months she owned the interest her share of partnership income would only be $26,250. This is a difference of $33,750. Kate would report the same amount of total income on her return however, in this case she would probably have less ordinary income and more capital gains which would reduce her tax liability.

16. 16 Other Issues to Consider - Seller In determining a partner’s adjusted basis in his or her partnership interest any loss limitations under Code Sections 704(d), 465, and 469 must be considered A sale of a partnership interest does not create basis for Section 704(d), but it does for Section 465. Gain on a sale of a partnership interest that produced passive income is considered passive as well. The instructor should just briefly go over this slide reminding the students about the difference in the rules for Section 704(d) and Section 465.The instructor should just briefly go over this slide reminding the students about the difference in the rules for Section 704(d) and Section 465.

17. 17 Other Issues to Consider - Buyer The new partner’s basis in the partnership interest is equal to the amount paid for the interest plus the share of liabilities assumed. If the old partner was subject to Section 704(c), the new partner is the successor to the old partner and will be subject to Section 704(c). The new partner is also the successor to the old partner’s Section 704(b) capital account Factors that the new partner should consider is that his outside basis in his partnership interest is the amount he paid for the interest plus the liabilities he assumed from the old partner. In addition, the new partner should be aware that if the old partner had contributed property with a built-in gain or loss to the partnership and that built-in gain or loss had not been recognized the new partner is subject to the rules under Section 704(c). In many cases the partner will have to recognize more gain than he expects. A partner should be aware of this problem before purchasing an interest with built-in gain or loss included. The new partner is also the successor to the old partner’s capital account. Factors that the new partner should consider is that his outside basis in his partnership interest is the amount he paid for the interest plus the liabilities he assumed from the old partner. In addition, the new partner should be aware that if the old partner had contributed property with a built-in gain or loss to the partnership and that built-in gain or loss had not been recognized the new partner is subject to the rules under Section 704(c). In many cases the partner will have to recognize more gain than he expects. A partner should be aware of this problem before purchasing an interest with built-in gain or loss included. The new partner is also the successor to the old partner’s capital account.

18. 18 Facilitation note: Because we are asking three questions, we should ask for a separate volunteer for each of the three questions. Because debrief exposes answers which might help answer subsequent question, the debrief/answer slide follows participant response. Suggestion: Let volunteer respond, then ask clarifying questions, perhaps leading them to a better answer. When finished with facilitating their response, do not tip your hand by saying “Yes”, “Right” or for that matter. “Wrong”. Simply thank the participant for their response (to encourage others to volunteer). At the end of the exercise, change to the answer slide and explain correct answer… if possible, noting where volunteer’s responses were on the right track.Facilitation note: Because we are asking three questions, we should ask for a separate volunteer for each of the three questions. Because debrief exposes answers which might help answer subsequent question, the debrief/answer slide follows participant response. Suggestion: Let volunteer respond, then ask clarifying questions, perhaps leading them to a better answer. When finished with facilitating their response, do not tip your hand by saying “Yes”, “Right” or for that matter. “Wrong”. Simply thank the participant for their response (to encourage others to volunteer). At the end of the exercise, change to the answer slide and explain correct answer… if possible, noting where volunteer’s responses were on the right track.

19. 19 Answer Susan has a gain of $22,000 on the sale of her partnership interest. The amount received on the sale was $58,000 consisting of the $50,000 in cash from Kim and the $8,000 relief of liabilities. Her adjusted basis was $36,000 consisting of her beginning basis of $40,000 less her share of the partnership’s loss up to the date of sale of $4,000. Go over the answer to the first question “How much gain or loss will Susan have on the sale?” by explaining how much the deemed sales price is and how her basis was adjusted before the sale.Go over the answer to the first question “How much gain or loss will Susan have on the sale?” by explaining how much the deemed sales price is and how her basis was adjusted before the sale.

20. 20 Facilitation note: Because we are asking three questions, we should ask for a separate volunteer for each of the three questions. Because debrief exposes answers which might help answer subsequent question, the debrief/answer slide follows participant response. Suggestion: Let volunteer respond, then ask clarifying questions, perhaps leading them to a better answer. When finished with facilitating their response, do not tip your hand by saying “Yes”, “Right” or for that matter. “Wrong”. Simply thank the participant for their response (to encourage others to volunteer). At the end of the exercise, change to the answer slide and explain correct answer… if possible, noting where volunteer’s responses were on the right track.Facilitation note: Because we are asking three questions, we should ask for a separate volunteer for each of the three questions. Because debrief exposes answers which might help answer subsequent question, the debrief/answer slide follows participant response. Suggestion: Let volunteer respond, then ask clarifying questions, perhaps leading them to a better answer. When finished with facilitating their response, do not tip your hand by saying “Yes”, “Right” or for that matter. “Wrong”. Simply thank the participant for their response (to encourage others to volunteer). At the end of the exercise, change to the answer slide and explain correct answer… if possible, noting where volunteer’s responses were on the right track.

21. 21 Answer Kim’s basis in her partnership interest would be $58,000 which consists of the $50,000 she paid for the interest plus the $8,000 of liabilities she assumed from Susan. The new partner’s (Kim) outside basis is the amount she paid for the interest ($50,000) plus the liabilities she assumed from Susan, the old partner ($8,000). So Kim’s original outside basis will be $58,000.The new partner’s (Kim) outside basis is the amount she paid for the interest ($50,000) plus the liabilities she assumed from Susan, the old partner ($8,000). So Kim’s original outside basis will be $58,000.

22. 22 Agenda  General rules governing the transfer of a partnership interest Rules regarding Section 751 assets Taxable vs. Nontaxable Transfers Payments to Retiring Partners under Section 736

23. 23 Sale of a Partnership Interest with Section 751 assets Section 751(a) applies to gain attributable to Section 751 assets Section 751(a) prevents a partner from converting his share of ordinary income into capital gains. If Section 751(a) applies, then gain on the sale of a partnership interest can be part ordinary income and part capital gain If a partnership has Section 751 assets, part of the gain or loss on the sale of a partnership interest may not be a capital gain. Section 751(b) applies to distributions from a partnership, while Section 751(a) applies to the gain on the sale of a partnership interest. The two sections never overlap one another. Section 751(a) applies to the gain or loss on the sale of Section 751 assets. The effect of this section is to convert what the partner thinks is a capital gain into ordinary income.If a partnership has Section 751 assets, part of the gain or loss on the sale of a partnership interest may not be a capital gain. Section 751(b) applies to distributions from a partnership, while Section 751(a) applies to the gain on the sale of a partnership interest. The two sections never overlap one another. Section 751(a) applies to the gain or loss on the sale of Section 751 assets. The effect of this section is to convert what the partner thinks is a capital gain into ordinary income.

24. 24 Section 751 Assets Section 751 assets are referred to as “hot assets” “Hot Assets” include unrealized receivables and inventory Included in unrealized receivables are cash basis A/R and depreciation recapture Section 751 property includes unrealized receivables and inventory. These assets are sometimes called “Hot Assets”. Unrealized receivables includes cash basis accounts receivables and depreciation recapture. All other assets including cash and property, plant and equipment are referred to as “Non-Section 751 Property”. Section 751 property includes unrealized receivables and inventory. These assets are sometimes called “Hot Assets”. Unrealized receivables includes cash basis accounts receivables and depreciation recapture. All other assets including cash and property, plant and equipment are referred to as “Non-Section 751 Property”.

25. 25 Question Does Section 751(a) Apply? Libby sells her partnership interest to Susan for $45,000 in cash. The partnership is a service partnership that only has cash and cash basis accounts receivables for assets. Does Section 751(a) apply to this sale? a. Yes b. No Go over the question.Go over the question.

26. 26 Answer Does Section 751(a) apply to the sale? Answer: a. Yes If a partnership has Section 751 assets, Section 751(a) applies to a sale of a partnership interest. In this case the partnership has cash basis accounts receivables which are Section 751 assets If a partnership has Section 751 assets, then Section 751(a) applies to the gain or loss on the sale of those assets. The effect of this section is to convert what would normally be a capital gain into ordinary income. Section 751 assets include unrealized receivables such as cash basis A/R and depreciation recapture and inventory. If a partnership has Section 751 assets, then Section 751(a) applies to the gain or loss on the sale of those assets. The effect of this section is to convert what would normally be a capital gain into ordinary income. Section 751 assets include unrealized receivables such as cash basis A/R and depreciation recapture and inventory.

27. 27 Sale of a Partnership Interest with Section 751 Assets To determine the gain or loss on the sale of a partnership interest the partner must first determine the total gain or loss Then the sale must be bifurcated between Section 751 and non-751 assets. Next the partner must determine the gain or loss on the sale of the Section 751 assets Lastly, the partner must determine the gain or loss under Section 741 To determine the amount of the gain or loss on the sale of a partnership interest that is subject to section 751(a) the partner first determines the overall gain or loss he or she has on the sale of the partnership interest. The second step then is to split the sale price between Section 751 assets and non-Section 751 assets. The sales price for the Section 751 assets is deemed to be the FMV of the Section 751 assets. After the sales price is split the partner can determine the amount of Section 751 gain he or she must recognize. This income or loss will be ordinary. The remaining gain or loss will be reported as a capital gain or loss under Section 741.To determine the amount of the gain or loss on the sale of a partnership interest that is subject to section 751(a) the partner first determines the overall gain or loss he or she has on the sale of the partnership interest. The second step then is to split the sale price between Section 751 assets and non-Section 751 assets. The sales price for the Section 751 assets is deemed to be the FMV of the Section 751 assets. After the sales price is split the partner can determine the amount of Section 751 gain he or she must recognize. This income or loss will be ordinary. The remaining gain or loss will be reported as a capital gain or loss under Section 741.

28. 28 Gain on Sale of Section 751 Assets The amount of Section 751 gain that the partner must report is his share of the gain the partnership would have if it sold all its Section 751 assets for their FMV. The gain on the sale of Section 751 assets is reported as ordinary income. The sales price is split based on FMV. The amount of Section 751 gain or loss that a partner must recognize is his or her share of the gain that the partnership would have to report if it sold all of its Section 751 assets for their FMV. The gain determined under Section 751 is ordinary income.The sales price is split based on FMV. The amount of Section 751 gain or loss that a partner must recognize is his or her share of the gain that the partnership would have to report if it sold all of its Section 751 assets for their FMV. The gain determined under Section 751 is ordinary income.

29. 29 Section 741 Gain The amount of gain or loss under Section 741 is the difference between the total gain or loss and the amount reported under Section 751. The gain or loss under Section 741 is capital. It is possible to have a Section 751 gain and a Section 741 loss or vice versa After the amount of gain or loss under Section 751 is determined the partner can determine his Section 741 gain or loss by taking the difference between the total gain calculated and the amount of gain or loss reported under Section 751. The gain or loss calculated under Section 741 is capital. Based on the new regulations it is possible to have a Section 751 gain and a Section 741 loss or vice versa.After the amount of gain or loss under Section 751 is determined the partner can determine his Section 741 gain or loss by taking the difference between the total gain calculated and the amount of gain or loss reported under Section 751. The gain or loss calculated under Section 741 is capital. Based on the new regulations it is possible to have a Section 751 gain and a Section 741 loss or vice versa.

30. 30 Case Study 1 – Dispositionof a Partnership Interest

31. 31 Case 1 Issues The amount received on the sale of a partnership interest always includes the relief of liabilities. Section 751(a) applies if the partnership has either unrealized receivables or inventory. The gain or loss on Section 751 assets is calculated first and is the partner’s share of the difference between the FMV and the partnership’s basis of those assets. Section 751 gain or loss is ordinary. Section 741 gain is the difference between the total gain or loss on the sale and the Section 751 gain or loss. Section 741 gain or loss is capital. The instructor needs to review the issues and the calculation process when Section 751 is involved.The instructor needs to review the issues and the calculation process when Section 751 is involved.

32. 32 Case 1 – Scenario A Section 751(a) does apply to this transaction because the partnership owns inventory which is a Section 751 asset. Susan’s total gain on the sale is $6,700. Sales Price: Cash $17,200 + Relief of Liabilities $ 7,000 = $24,200 Adjusted Basis: Capital $10,500 + Share of Liabilities $7,000 = $17,500 Total Gain = $24,200 – $17,500 = $6,700 Section 751 does apply to this problem. The first step is to determine Susan’s overall gain or loss on the sale of her partnership interest. Go over the slide and explain how Susan’s overall gain is $6,700Section 751 does apply to this problem. The first step is to determine Susan’s overall gain or loss on the sale of her partnership interest. Go over the slide and explain how Susan’s overall gain is $6,700

33. 33 Case 1 – Scenario A Susan’s Section 751 gain is: FMV of Section 751 Assets $9,600 P’ship basis of Section 751 Assets 7,500 Total Gain $2,100 Susan Share of 751 Gain $700 Susan’s Section 741 Gain = Total Gain – Section 751 Gain $6,700 - $700 = $6,000 The next step is to determine Susan’s Section 751 gain. In this case the total FMV of the Section 751 assets is $9,600. The partnership has a basis in its Section 751 assets of $7,500. If the partnership were to sell its Section 751 assets for their FMV the partnership would have a gain of $2,100. Susan’s 1/3 share of that gain is $700. She will have to report a $700 Section 751 gain as ordinary income. Since her overall gain was $6,700, the difference between that gain and her Section 751 gain is $6,000 which will be a capital gain under Section 741.The next step is to determine Susan’s Section 751 gain. In this case the total FMV of the Section 751 assets is $9,600. The partnership has a basis in its Section 751 assets of $7,500. If the partnership were to sell its Section 751 assets for their FMV the partnership would have a gain of $2,100. Susan’s 1/3 share of that gain is $700. She will have to report a $700 Section 751 gain as ordinary income. Since her overall gain was $6,700, the difference between that gain and her Section 751 gain is $6,000 which will be a capital gain under Section 741.

34. 34 Case 1 – Scenario B Section 751(a) would apply to this transaction because the partnership has cash basis accounts receivable Alice’s amount realized on the sale is Cash of $15,000 + Debt Relief of $1,000 = $16,000 Her adjusted basis is Capital of $9,000 + Share of Debt $1,000 = $10,000 The total gain without Section 751(a) is $6,000. Section 751(a) also applies in Scenario B. The first step is to determine Alice’s total gain on the sale of her partnership interest. Her total gain is $6,000. The instructor needs to go over the slide to explain how we determined her gain was $6,000.Section 751(a) also applies in Scenario B. The first step is to determine Alice’s total gain on the sale of her partnership interest. Her total gain is $6,000. The instructor needs to go over the slide to explain how we determined her gain was $6,000.

35. 35 Case 1 – Scenario B The total Section 751(a) gain would be FMV of A/R $14,000 Basis of A/R 0 Section 751(a) Gain $14,000 Alice’s share of the Section 751(a) gain would be $7000. Alice would have a Section 741 loss of $1,000. Total gain of $6,000 less Section 751(a) gain of $7,000. After determining the total gain, Alice must now determine how much the Section 751(a) gain or loss is. In this case the total FMV of the Section 751 assets is $14,000. The partnership has a basis in its Section 751 assets of $0. If the partnership were to sell its Section 751 assets for their FMV the partnership would have a gain of $14,000. Alice’s share of that gain is $7,000. She will have to report a $7,000 Section 751 gain as ordinary income. Since her overall gain was $6,000, the difference between that gain and her Section 751 gain is ($1,000). Thus, Alice must report a $1,000 capital loss under Section 741. After determining the total gain, Alice must now determine how much the Section 751(a) gain or loss is. In this case the total FMV of the Section 751 assets is $14,000. The partnership has a basis in its Section 751 assets of $0. If the partnership were to sell its Section 751 assets for their FMV the partnership would have a gain of $14,000. Alice’s share of that gain is $7,000. She will have to report a $7,000 Section 751 gain as ordinary income. Since her overall gain was $6,000, the difference between that gain and her Section 751 gain is ($1,000). Thus, Alice must report a $1,000 capital loss under Section 741.

36. 36 Agenda  General rules governing the transfer of a partnership interest Rules regarding Section 751 assets Taxable vs. Nontaxable Transfers Payments to Retiring Partners under Section 736

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38. 38 Answer As long as the requirements of Section 351 are met the transfer of a partnership interest to a corporation would be tax-free. All the other transfers would be taxable. The only transaction in the question that could be tax-free is the transfer to a corporation. All the other transfers are taxable. For the transfer to a corporation to be tax-free all the requirements of Section 351 must be met. Section 1031 does not allow a partnership to be transferred tax-free even if it is the same kind of partnership. However, the partnership can make a like-kind exchange of property inside the partnership. If a partner abandons his partnership interest he will have a gain or loss equal to the difference between his relief of liabilities and his basis in the partnership. If his basis is less than his share of liabilities he will have a gain. The payments a partner receives from a partnership when he retires is also taxable under Codes Section 736. The only transaction in the question that could be tax-free is the transfer to a corporation. All the other transfers are taxable. For the transfer to a corporation to be tax-free all the requirements of Section 351 must be met. Section 1031 does not allow a partnership to be transferred tax-free even if it is the same kind of partnership. However, the partnership can make a like-kind exchange of property inside the partnership. If a partner abandons his partnership interest he will have a gain or loss equal to the difference between his relief of liabilities and his basis in the partnership. If his basis is less than his share of liabilities he will have a gain. The payments a partner receives from a partnership when he retires is also taxable under Codes Section 736.

39. 39 Transfer of a Partnership Interest to a Corporation If a partner transfers his partnership interest to a corporation in exchange for stock in the corporation and all the requirements under Section 351 are met, the transfer will be tax-free When there is a contribution of a partnership interest with liabilities in excess of basis of the interest to a corporation, Section 357(c) will result in gain. For the transfer to a corporation to be tax-free all the requirements of Section 351 must be met. If any of the requirements under Section 351 are not met the partner will have gain. In addition, if the partner’s share of liabilities is in excess of his basis he will have to recognize a gain under Section 357(c).For the transfer to a corporation to be tax-free all the requirements of Section 351 must be met. If any of the requirements under Section 351 are not met the partner will have gain. In addition, if the partner’s share of liabilities is in excess of his basis he will have to recognize a gain under Section 357(c).

40. 40 Converting a Partnership Interest If a general partnership interest is converted into a limited interest or vice versa the conversion is not a disposition. Likewise the conversion of a general or limited partnership into an LLC or an LLP is not a disposition. However, there may be a gain on the conversion because of the change in the partner’s share of debt. If a partner converts his interest from a limited to general interest or vice versa the conversion is not considered a disposition. Likewise if the partnership converts to an LLC or LLP the conversion is not considered a disposition. However, in both of these cases the partner may have a gain if the conversion changes the amount of the partner’s share of debt and the reduction is more than the partner’s basis in his partnership interest because the reduction in debt is treated as a distribution of cash.If a partner converts his interest from a limited to general interest or vice versa the conversion is not considered a disposition. Likewise if the partnership converts to an LLC or LLP the conversion is not considered a disposition. However, in both of these cases the partner may have a gain if the conversion changes the amount of the partner’s share of debt and the reduction is more than the partner’s basis in his partnership interest because the reduction in debt is treated as a distribution of cash.

41. 41 Go over the question briefly with the students.Go over the question briefly with the students.

42. 42 Answer When a partner abandons his partnership interest it is treated as a sale for the amount of debt relief. Therefore Mark is deemed to have sold his interest for $5,000, which results in a loss on the abandonment of $15,000. The loss would be treated as a capital loss. A partner can have a gain on the abandonment of a partnership interest if his or her adjusted basis is less than his or her share of partnership debt. If a partner abandons his partnership interest he will have a gain or loss equal to the difference between his relief of liabilities and his basis in the partnership. If his basis is less than his share of liabilities he will have a gain. If a partner abandons his partnership interest he will have a gain or loss equal to the difference between his relief of liabilities and his basis in the partnership. If his basis is less than his share of liabilities he will have a gain.

43. 43 Like-Kind Exchange of a Partnership Interest Per Code Section 1031(a)(2)(D) the nonrecognition provisions of Section 1031 do not apply to any exchange of interests in a partnership. This is true even though the underlying properties may be identical. Code Section 1031 does not apply to conversions of the type of partnership interest because conversions are not deemed exchanges. Section 1031 does not allow a partnership to be transferred tax-free even if it is the same kind of partnership. However, the partnership can make a like-kind exchange of property inside the partnership. Section 1031 does not allow a partnership to be transferred tax-free even if it is the same kind of partnership. However, the partnership can make a like-kind exchange of property inside the partnership.

44. 44 Case Study 2 – Taxable vs. Nontaxable Transfers

45. 45 Case 2 Issues Abandonment of a partnership interest can result in a gain or loss. The gain or loss is capital. A like-kind exchange of a partnership interest is a taxable transaction. If the requirements of Code Section 351 are met the contribution of a partnership interest to a corporation is nontaxable. An exception applies if liabilities transferred exceed the basis of the partnership interest. The instructor needs to review the tax rule concerning abandonment, like-kind exchanges and incorporations of partnerships.The instructor needs to review the tax rule concerning abandonment, like-kind exchanges and incorporations of partnerships.

46. 46 Case 2 – Scenario A The abandonment of a partnership interest is an exchange of the partnership interest for the deemed cash distribution (relief of liabilities). In this case Debbie would have a $15,000 loss ($25,000 debt relief - $40,000 basis) on the abandonment of her partnership interest. The loss would be a capital loss. In this case the amount of debt relief is more than her basis in the partnership interest. Thus Debbie would have a gain on the abandonment of $15,000 ($25,000 debt relief - $10,000 basis). The gain would be capital. When a partner abandons his partnership interest it is an exchange of the partnership interest in exchange for the relief of the partner’s share of liabilities. In this case the sales price for Debbie’s partnership interest is $25,000. In the first situation, Debbie will have a loss on the abandonment because the sales price is less than her basis. The loss will be capital. In the second situation, Debbie will have a gain of $15,000 because her basis is less than the sales price. The gain will be capital. This situation will occur when a partner has used their share of liabilities to take previous losses.When a partner abandons his partnership interest it is an exchange of the partnership interest in exchange for the relief of the partner’s share of liabilities. In this case the sales price for Debbie’s partnership interest is $25,000. In the first situation, Debbie will have a loss on the abandonment because the sales price is less than her basis. The loss will be capital. In the second situation, Debbie will have a gain of $15,000 because her basis is less than the sales price. The gain will be capital. This situation will occur when a partner has used their share of liabilities to take previous losses.

47. 47 Case 2 – Scenario B The requirements under Section 351 would be met because Bill transferred property (the partnership interest) solely in exchange for stock of the corporation and immediately after the exchange he was in control of the corporation. Because Section 351 is met, Bill would not have to recognize a gain or loss on the transfer. In this case Section 357(c) would create a gain equal to the excess of liabilities transferred over basis. Thus, Bill will recognize a gain of $10,000 ($15,000 debt relief - $5,000 basis). In the first situation all the requirements under Section 351 are met . Therefore, there is no gain or loss on the incorporation of the partnership. In the second situation, the requirements of Section 351 are met so there is no gain or loss at the point. However, the amount liabilities Bill is deemed to have contributed exceeds his basis in his partnership interest. Thus, under Section 357(c) he will have to recognize a gain of the excess. In this case he will have a $10,000 gain.In the first situation all the requirements under Section 351 are met . Therefore, there is no gain or loss on the incorporation of the partnership. In the second situation, the requirements of Section 351 are met so there is no gain or loss at the point. However, the amount liabilities Bill is deemed to have contributed exceeds his basis in his partnership interest. Thus, under Section 357(c) he will have to recognize a gain of the excess. In this case he will have a $10,000 gain.

48. 48 Case 2 – Scenario C Section 1031 does not apply to an exchange of partnership interest based on Section 1031(a)(2)(D). The transfer would be treated as a taxable exchange. Laura would have to recognize a gain of $20,000 on this transfer. The gain is computed by determining the amount realized ($100,000 FMV of property received + $50,000 debt relief - $50,000 assumption of debt =$100,000) less adjusted basis ($30,000 capital + $50,000 share of debt = $80,000). As stated earlier Section 1031(a)(2)(D) does not allow tax deferral treatment for an exchange of partnership interests. Therefore, Laura will have to recognize a gain on her transfer. The transfer is treated as a sale and the gain is calculated in the same manner as any sale of an asset. She is deemed to have received $100,000 made up of the FMV of the property she got plus the liabilities she was relieved of less the additional liabilities she assumed. She will have to report a $20,000 gain on this transaction. (The $100,000 she received less $80,000 her basis in the partnership interest).As stated earlier Section 1031(a)(2)(D) does not allow tax deferral treatment for an exchange of partnership interests. Therefore, Laura will have to recognize a gain on her transfer. The transfer is treated as a sale and the gain is calculated in the same manner as any sale of an asset. She is deemed to have received $100,000 made up of the FMV of the property she got plus the liabilities she was relieved of less the additional liabilities she assumed. She will have to report a $20,000 gain on this transaction. (The $100,000 she received less $80,000 her basis in the partnership interest).

49. 49 Agenda  General rules governing the transfer of a partnership interest Rules regarding Section 751 assets Taxable vs. Nontaxable Transfers Section 754(b) Basis Adjustments Payments to Retiring Partners under Section 736

50. 50 When does it apply? On any distribution or sale that creates a disparity between the partner’s inside and outside basis The disparity is caused by the fact that outside basis is at cost and the transaction has no affect on inside basis

51. 51 Section 754 Election Code allows the partnership to make an election under Section 754 to adjust the basis of the assets Applies to both a step up or step down in basis Once the election is made it is effective for all future transactions

52. 52 Rules for making the Adjustment Sale of a partnership interest – Section 743(b) Liquidating Distribution – Section 734(b)

53. 53 Section 743(b) Partner specific Adjustment not made on the partnership’s books – off balance sheet adjustment

54. 54 Amount of Adjustment Difference between the buyer’s outside basis and share of inside basis If outside basis is higher – positive adjustment If outside basis is lower – negative adjustment

55. 55 Section 743(b) Regulations Define a partner’s inside basis as the sum of their share of previously taxed capital Previously taxed capital = balance in the partner’s tax capital account

56. 56 Section 743(b) Regulations Require a hypothetical sale of all assets at FMV immediately The partner’s share of the gain or loss is the amount of the adjustment

57. 57 Example 1 AB, an equal partnership. A sells her interest to X for $300. Immediately after the transaction the balance sheet is: Book Value Inventory 100 200 Land 100 400 Capital 200 600

58. 58 Adjustment under Section 743(b) Purchase price was $300. Under the hypothetical transaction is as if X bought ½ of each asset Sales Price Cost Gain Inventory 100 50 50 Land 200 50 150

59. 59 Allocating the Adjustment Section 755 governs the allocation Allocated First between two classes of assets Capital (including 1231) Noncapital Does not affect partnership books

60. 60 Example Asset Basis FMV Gain Share Cash 100 100 Stock 100 300 200 100 Machinery 50 100 50 25 Building 200 500 300 150 Inventory 80 140 60 30 A/R 70 60 (10) (5) Goodwill 0 300 300 150

61. 61 Allocation Problem Partner sold 50% interest for $750. Gain on sale is $450. Allocation between capital and non-capital assets based on the income and gain allocated to the partner

62. 62 Allocation Problem Ordinary income is from inventory, accounts receivable and depreciation recapture 30-5+25 = 50. Capital gain is from other assets 100+150+150 = 400

63. 63 Allocation The $50 is allocated between the ordinary income assets The $400 is allocated to the capital assets If basis of depreciable assets are stepped-up, the partner is allowed an annual depreciation deduction

64. 64 Adjustments from Distributions Section 734(b) applies Affect the common partnership property

65. 65 Allocation under Section 755 Based specifically on the event which triggered the adjustment. Amount assigned to a particular class of assets Once assigned to a particular class, it is divided among assets in that class

66. 66 Allocation under Section 755 Positive adjustment First to assets with unrealized appreciation in proportion to their relative appreciation Then based on relative FMV Negative adjustment First to assets with unrealized depreciation in proportion to their relative depreciation Then based on adjusted basis

67. 67 Agenda  General rules governing the transfer of a partnership interest Rules regarding Section 751 assets Taxable vs. Nontaxable Transfers Section 743(b) Basis Adjustments Payments to Retiring Partners under Section 736

68. 68 Payments made to a Retiring Partner Section 736 governs the payments made to a retiring partner Section 736 divides all payments into two classes Section 736(a) – payment not for the partner’s interest in partnership property; and Section 736(b) – payments for the partner’s interest in partnership property Section 736 makes a distinction between distributions to general partners of service partnerships and all other distributions Section 736 governs the payments made to a retiring partner. A retiring partner is one that ceases to be partner under local law. If the partner is not retiring, a liquidating distribution is taxed under Codes Section 731 and 751(b). If the partner is retiring Code Section 736 applies. The general theory of Section 736 is that splits payments to retiring partners between amount received in exchange for the partner’s partnership interest (Section 736(b)) and payments for the partner’s share of partnership income (Section 736(a)). Section 736 says nothing about how payments to retiring partners are taxed; all it does is classify the payments. Once a payment has been classified, you must look to other sections to find the tax treatment. Section 736(b)(3) makes a distinction in the tax treatment for the payment of unrealized receivables and goodwill for general partners in a service partnership. Section 736 governs the payments made to a retiring partner. A retiring partner is one that ceases to be partner under local law. If the partner is not retiring, a liquidating distribution is taxed under Codes Section 731 and 751(b). If the partner is retiring Code Section 736 applies. The general theory of Section 736 is that splits payments to retiring partners between amount received in exchange for the partner’s partnership interest (Section 736(b)) and payments for the partner’s share of partnership income (Section 736(a)). Section 736 says nothing about how payments to retiring partners are taxed; all it does is classify the payments. Once a payment has been classified, you must look to other sections to find the tax treatment. Section 736(b)(3) makes a distinction in the tax treatment for the payment of unrealized receivables and goodwill for general partners in a service partnership.

69. 69 Payments made to a Retiring Partner Section 736(a) payments are taxed as a distributive share or a guaranteed payment depending if the amount depends on partnership income. Section 736(b) payments are taxed as distributions. Section 736(a) payments are taxed as a distributive share of income if the amount of the payment depends upon the partnership’s income or as a guaranteed payment if the amount is fixed. The income is ordinary income to the recipient and the other partners gets the a reduction in the amount of income they must report. Section 736(a) payments are taxable at the end of the partnership’s tax year. Section 736(b) payments are taxed as distribution. The amount of income or loss the partner must recognize is the difference between the amount received and the partner’s basis in his partnership interest. This payment has no effect on the partnership and the other partners. The gain or loss will be capital unless Section 751(b) applies which could make part of the gain ordinary. The partner is taxed on Section 736(b) payment when they are received.Section 736(a) payments are taxed as a distributive share of income if the amount of the payment depends upon the partnership’s income or as a guaranteed payment if the amount is fixed. The income is ordinary income to the recipient and the other partners gets the a reduction in the amount of income they must report. Section 736(a) payments are taxable at the end of the partnership’s tax year. Section 736(b) payments are taxed as distribution. The amount of income or loss the partner must recognize is the difference between the amount received and the partner’s basis in his partnership interest. This payment has no effect on the partnership and the other partners. The gain or loss will be capital unless Section 751(b) applies which could make part of the gain ordinary. The partner is taxed on Section 736(b) payment when they are received.

70. 70 Go over the question briefly.Go over the question briefly.

71. 71 Answer Section 736 does apply to this transaction because the partner is retiring from the partnership. Section 736(a) says all payments to a retiring partner are Section 736(a) payments unless Section 736(b) applies. Section 736(b) says payments made in exchange for the retiring partner’s interest in partnership property are not Section 736(a) payments Because the partner is retiring from the partnership Section 736 will apply. Section 736(a) says that all payments to a retiring partner are Section 736(a) payments unless Section 736(b) applies. Therefore, we begin by treating all payments to retiring partners as being Section 736(a) payments. Then we look to Section 736(b) to see whether that section applies or not. If the payments are made in exchange for the partner’s interest in the partnership’s property the payments are Section 736(b) payments and are treated as distributions.Because the partner is retiring from the partnership Section 736 will apply. Section 736(a) says that all payments to a retiring partner are Section 736(a) payments unless Section 736(b) applies. Therefore, we begin by treating all payments to retiring partners as being Section 736(a) payments. Then we look to Section 736(b) to see whether that section applies or not. If the payments are made in exchange for the partner’s interest in the partnership’s property the payments are Section 736(b) payments and are treated as distributions.

72. 72 Answer In this case, $75,000 was not for the partner’s interest in partnership property, so it is a Section 736(a) payment. Since the amount is fixed in amount it is deemed a guaranteed payment. The remainder, $25,000, is a Section 736(b) payment treated as a distribution. In this case the Section 736(a) payment was $75,000 because it was not for the partner’s interest in partnership property. Because the amount is fixed in nature and did not depend on the partnership’s income the payment is a guaranteed payment. The rest of the payment is for the partner’s interest in partnership property and is taxed as a distribution under Section 736(b).In this case the Section 736(a) payment was $75,000 because it was not for the partner’s interest in partnership property. Because the amount is fixed in nature and did not depend on the partnership’s income the payment is a guaranteed payment. The rest of the payment is for the partner’s interest in partnership property and is taxed as a distribution under Section 736(b).

73. 73 Payments by Service Partnerships to General Partners In this context Section 736 views payments as being for any of five different things: Payment not for the partner’s interest in property – Section 736(a) payment Payment for the partner’s share of unrealized receivables – Section 736(a) payment Payment for the partner’s share of unstated goodwill – Section 736(a) payment Payment for the partner’s share of stated goodwill – Section 736(b) payment and Payment for the partner’s share of other property – Section 736(b) payment Section 736 has two versions, one for distributions to general partners of partnerships in which “capital is not a material producing factor” (service partnerships) and another for all other distributions. In all cases the statue distinguishes between Section 736(a) and Section 736(b) payments by asking whether the payment is for the retiring partner’s interest in the partnership. If the partner is not a general partner in a service partnership that is the only question that must be addressed. However, if the distribution is to a general partner in a service partnership you must determine what the Section 736(b) payment is for. If the payment is for the partner’s interest in either unrealized receivables or in some kinds of goodwill the payment is deemed to not be “for property” and thus, classified as Section 736(a) payments. Section 736 requires us to view payments to general partners of service partnerships as being for any of five different things Payments for the partner’s interest in property - (Section 736(a)). Payment for the partner’s interest in unrealized receivables - (Section 736(a)). Payments for the partner’s share of the partnership’s goodwill that is not provided for in the partnership agreement (unstated goodwill) – (Section 736(a)). Payments for stated goodwill – (Section 736(b)). Payments for any type of property – (Section 736(b)).Section 736 has two versions, one for distributions to general partners of partnerships in which “capital is not a material producing factor” (service partnerships) and another for all other distributions. In all cases the statue distinguishes between Section 736(a) and Section 736(b) payments by asking whether the payment is for the retiring partner’s interest in the partnership. If the partner is not a general partner in a service partnership that is the only question that must be addressed. However, if the distribution is to a general partner in a service partnership you must determine what the Section 736(b) payment is for. If the payment is for the partner’s interest in either unrealized receivables or in some kinds of goodwill the payment is deemed to not be “for property” and thus, classified as Section 736(a) payments. Section 736 requires us to view payments to general partners of service partnerships as being for any of five different things Payments for the partner’s interest in property - (Section 736(a)). Payment for the partner’s interest in unrealized receivables - (Section 736(a)). Payments for the partner’s share of the partnership’s goodwill that is not provided for in the partnership agreement (unstated goodwill) – (Section 736(a)). Payments for stated goodwill – (Section 736(b)). Payments for any type of property – (Section 736(b)).

74. 74 Go over the question briefly.Go over the question briefly.

75. 75 Answer Under Section 736 because the retiring partner is a general partner in a service partnership, the payments for his share of unrealized receivables and for the unstated goodwill will be Section 736(a) payments. The partner will have $15,000 of ordinary income under Section 736(a) and the remaining partners will get a deduction of $15,000. Based on Section 736 since the partner is a general partner in a service partnership any payments made for unrealized receivables or unstated goodwill will be Section 736(a) payments. In this case the Section 736(a) payments will be $15,000. This income will be ordinary in nature and taxed at the end of the partnership’s tax year.Based on Section 736 since the partner is a general partner in a service partnership any payments made for unrealized receivables or unstated goodwill will be Section 736(a) payments. In this case the Section 736(a) payments will be $15,000. This income will be ordinary in nature and taxed at the end of the partnership’s tax year.

76. 76 Answer The rest of the payment ($20,000) is a Section 736(b) payment which is taxed as a distribution. The partner will have a gain or loss equal to the difference between the amount received and his basis in his partnership interest. The rest of the distribution will be a Section 736(b) payment. This distribution will be taxed under Code Section 731. The partner will have a gain or loss equal to the difference between the amount received as a Section 736(b) payment and his basis in his partnership interest.The rest of the distribution will be a Section 736(b) payment. This distribution will be taxed under Code Section 731. The partner will have a gain or loss equal to the difference between the amount received as a Section 736(b) payment and his basis in his partnership interest.

77. 77 Case Study 3 – Payments to Retiring Partners

78. 78 Case 3 Issues Section 736 applies to payments made to retiring partners Payments to retiring partners are either Section 736(a) payments or Section 736(b) payments These payments are taxed differently Payments made to general partners from a service partnership are treated differently than payments made to a partner in a partnership where capital is a material income-producing factor under Section 736(b)(2) The instructor need to review the rules for Section 736(a) and Section 736(b) payments with the students.The instructor need to review the rules for Section 736(a) and Section 736(b) payments with the students.

79. 79 Case 3 – Scenario A Kevin is deemed to have received a payment of $30,000 consisting of the $25,000 cash payment plus the $5,000 debt relief. In this case Kevin has received a total distribution of $30,000. Because he is a retiring partner we must determine how much of the distribution is a Section 736(a) payment and how much is a Section 736(b) payment.In this case Kevin has received a total distribution of $30,000. Because he is a retiring partner we must determine how much of the distribution is a Section 736(a) payment and how much is a Section 736(b) payment.

80. 80 Case 3 – Scenario A Of this amount $14,000 is a Section 736(a) payment. The $14,000 is made up of the excess over his share of partnership assets of $11,000 ($30,000 amount received - $19,000 share of partnership assets), that amount is a Section 736(a) payment because it is not a payment for property; plus $2,000 payment for his share of A/R which is a Section 736(a) payment because of Section 736(b)(2)(A); plus $1,000 payment for his share of unstated goodwill. Because Kevin is a general partner in a service partnership the amounts paid in excess of his share of partnership assets, the amount paid for his share of unrealized receivables and his share of unstated goodwill will be a Section 736(a) payment. The amount he received in excess of his share of partnership assets is $11,000. This amount was determined by taking the $30,000 he was deemed to have received and subtracting his share of assets of $19,000. The amount he got for unrealized receivables is $2,000 and the amount he got for unstated goodwill is $1,000. Thus, his total Section 736(a) payment is $14,000. Because Kevin is a general partner in a service partnership the amounts paid in excess of his share of partnership assets, the amount paid for his share of unrealized receivables and his share of unstated goodwill will be a Section 736(a) payment. The amount he received in excess of his share of partnership assets is $11,000. This amount was determined by taking the $30,000 he was deemed to have received and subtracting his share of assets of $19,000. The amount he got for unrealized receivables is $2,000 and the amount he got for unstated goodwill is $1,000. Thus, his total Section 736(a) payment is $14,000.

81. 81 Case 3 – Scenario A The payment for his interest in the machine’s value in excess of basis is not a payment for an unrealized receivable for Section 736 purposes. The remaining payment of $16,000 is a Section 736(b) payment. The remaining amount of $16,000 will be treated as a Section736(b) payment.The remaining amount of $16,000 will be treated as a Section736(b) payment.

82. 82 Case 3 – Scenario A The Section 736(a) payment will be a guaranteed payment because it does not depend on the partnership’s income. Kevin will have ordinary income of $14,000 under Section 736(a) and the partnership will get a deduction of $14,000. Kevin will have a liquidating distribution of $16,000 under Section 751(a). This distribution will cause him to recognize $8,000 more ordinary income related to the depreciation recapture on the machine and a capital loss of $1,000. Kevin’s Section 736(a) payment will be treated as a guaranteed payment because the amount he got did not depend on the partnership’s income. This income will be taxed as ordinary income and will be taxable to Kevin at the end of the partnership’s tax year. The partnership will get a corresponding deduction for the guaranteed payment. The Section 736(b) payment will be treated as a liquidating distribution. Kevin will have a total gain of $7,000 ($16,000 amount received less his basis of $9,000). However, because the partnership has unrealized receivables Section 751(a) applies. Under Section 751(a) Kevin will have a gain of $8,000 on the deemed sale of the Section 751 asset related to the depreciation recapture on the machine. He will have to report the entire $8,000 gain as ordinary income and then report a $1,000 capital loss. Kevin’s Section 736(a) payment will be treated as a guaranteed payment because the amount he got did not depend on the partnership’s income. This income will be taxed as ordinary income and will be taxable to Kevin at the end of the partnership’s tax year. The partnership will get a corresponding deduction for the guaranteed payment. The Section 736(b) payment will be treated as a liquidating distribution. Kevin will have a total gain of $7,000 ($16,000 amount received less his basis of $9,000). However, because the partnership has unrealized receivables Section 751(a) applies. Under Section 751(a) Kevin will have a gain of $8,000 on the deemed sale of the Section 751 asset related to the depreciation recapture on the machine. He will have to report the entire $8,000 gain as ordinary income and then report a $1,000 capital loss.

83. 83 Case 3 – Scenario B Because Section 736(b)(2) does not apply in this situation, only $11,000 – the payment in excess of the value of Kevin’s interest in partnership property – is a Section 736(a) payment. Section 736(a) gives Kevin $11,000 of ordinary income and the partnership has an $11,000 ordinary deduction. In this scenario Kevin is not a general partner in a service partnership only payments in excess of his share of partnership property will be treated as a Section 736(a) payment. Thus his Section 736(a) payment would be $11,000 which will be a guaranteed payment and is ordinary income. As in the first scenario the partnership will have an $11,000 deduction.In this scenario Kevin is not a general partner in a service partnership only payments in excess of his share of partnership property will be treated as a Section 736(a) payment. Thus his Section 736(a) payment would be $11,000 which will be a guaranteed payment and is ordinary income. As in the first scenario the partnership will have an $11,000 deduction.

84. 84 Case 3 – Scenario B Kevin’s $19,000 Section 736(b) payment is a distribution. Section 751(b) will give Kevin $10,000 more ordinary income related to the depreciation recapture on the machine and the unrealized A/R and the partnership will now have a basis of $2,000 for its unrealized receivables and $12,000 for the machine. Kevin will recognize no capital gain or loss. Kevin’s Section 736(b) distribution is the remaining amount ($19,000). The Section 736(b) payment will be treated as a liquidating distribution. Kevin will have a total gain of $10,000 ($19,000 amount received less his basis of $9,000). However, because the partnership has unrealized receivables Section 751(a) applies. Under Section 751(a) Kevin will have a gain of $10,000 on the deemed sale of the Section 751 asset related to the depreciation recapture on the machine ($8,000) and the unrealized receivables ($2,000). He will have to report the entire $10,000 gain as ordinary income. He will not recognize any capital gain or loss. Kevin’s Section 736(b) distribution is the remaining amount ($19,000). The Section 736(b) payment will be treated as a liquidating distribution. Kevin will have a total gain of $10,000 ($19,000 amount received less his basis of $9,000). However, because the partnership has unrealized receivables Section 751(a) applies. Under Section 751(a) Kevin will have a gain of $10,000 on the deemed sale of the Section 751 asset related to the depreciation recapture on the machine ($8,000) and the unrealized receivables ($2,000). He will have to report the entire $10,000 gain as ordinary income. He will not recognize any capital gain or loss.