Partnership Liquidation 731 & 732

1. Partnership Liquidation 731 & 732 731: No gain or loss recognized to partner unless: - Gain to extent money distributed exceeds partner’s basis in partnership interest. - Loss recognized if only money and unrealized receivables and inventory distributed to extent basis in partner’s interest exceeds amount of money distributed and partnership’s basis in receivables and inventory. - Any recognized gain or loss is from sale or exchange of partnership interest. 732(b): If property distributed to partner in liquidation of partnership interest, basis in property shall equal partner’s interest in partnership less money receives in distribution. 751(b) Game: Applied full tilt. Note: 736 Roadmap not applicable on complete liquidation. Corporate & Partner Tax Instructor: Dwight Drake

2. Complete Liquidation: Impact on Partnership General Rule: No gain or loss to partnership on distributions of property to liquidate a partner’s interest in partnership. 731(b) 751(b) Impact: To extent of 736(b) payments not reflect partner’s proportionate share of unrealized receivables and inventory, deemed distribution of additional receivables and inventory to partner followed by partners sales to partnership for cash. Impact is ordinary income to partner and increased basis in such assets to partnership (result of deemed by back). Partnership’s Assets Basis: No change per 734(a) unless 754 election made. If 754 election, basis in capital or 1231 assets (1) increased by gain recognized by distributee partner and excess of partnership basis in distributed property over basis to distributee under 732 and (d) decreased by loss recognized by distributee and excess of distributee basis over partnership’s basis. 708 Termination: Liquidation terminates partnership. Also deemed termination if 50% or more of partners’ interest in profits and capital sold within 12 month period. Old partnership terminated and new partnership formed. Complete carryovers, but tax year closed out and new elections. Corporate & Partner Tax Instructor: Dwight Drake

3. Problem 340 Basic Facts: AB balance sheet. A.B. FMV A.B. FMV Cash 20k 20k A Capital 35k 60k AR 0 20k Inventory 20k 40k B Capital 35k 60k Capital Asset 30k 40k Total 70k 120k 70k 120k AB liquidate. A receives AR plus capital asset. B receives cash and inventory. Issue is application of 751(b) for inventory and receivables. A receives 20k and B 40k. If equal, each would get 30k. Two Options: Corporate & Partner Tax Instructor: Dwight Drake

4. Problem 340 Option 1: Deemed 10k inventory distribution to A, followed by sale back to AB for 10k of capital asset. - A outside basis reduced 5k (basis of inventory) on distribution and A have 5k ordinary income on inventory sale back. - AB partnership have 2.5k LTCG on sale of 10l capital asset for inventory (excess of 10k over 7.5 basis). Gain allocated to B. After deemed distribution, sale back, AB inventory basis is 25k (up 5k), AB capital asset basis is 22.5k (down 7.5k), A outside basis down 5k to 30k and B outside basis up 2.5k to 37.5k. - No gain or loss to A on distribution of 20k ARs and remaining 30k capital asset per 731(a). Per 732, 30k outside basis allocated 0 to ARs (AB’s basis) and 30k to capital asset. Thus total capital asset basis is 40k. - No gain or loss to B on distribution of 20k cash and 40k inventory per 731(a). Per 732, cash reduces basis to 17.5k, all of which allocated to inventory. B basis in inventory 17.5k. No gain or loss to partnership per 731(b). Corporate & Partner Tax Instructor: Dwight Drake

5. Problem 340 Option 2: Deemed 10k inventory distribution to A, 10k capital asset distribution to B and then exchange of assets by A and B. - A outside basis reduced 5k (basis of inventory) on deemed distribution to A and B outside basis reduced 7.5k (25% of 40k) on deemed distribution to B. - B have 2.5k LTCG on deemed exchange of 10k capital asset for inventory (excess of 10k over 7.5 basis), and A have 5k ordinary income. After deemed distributions, AB inventory basis is 15k (down 5k), AB capital asset basis is 22.5k (down 7.5k), A outside basis down 5k to 30k and B outside basis down 7.5k to 27.5k. A & B both have 10k basis in deemed exchange asset. - No gain or loss to A on distribution of 20k ARs and remaining 30k capital asset per 731(a). Per 732, 30k outside basis allocated 0 to ARs (AB’s basis) and 30k to capital asset. Thus total capital asset basis is 40k. (30k plus 10k) - No gain or loss to B on distribution of 20k cash and remaining 30k inventory per 731(a). Per 732, cash reduces basis to 7.5k, all of which allocated to inventory. B basis in inventory 17.5k (7.5k plus 10k). No gain or loss to partnership per 731(b). Corporate & Partner Tax Instructor: Dwight Drake

6. Problem 346 Basic Facts: AC balance sheet. A.B. FMV A.B. FMV Inventory 80k 100k A Capital 60k 100k Capital Asset 40k 100k C Capital 100k 100k Total 120k 200k 160k 200k AC to be converted to corporation. Three options: Option 1: AC distributes assets in complete liquidation, and then A & C contribute to corp in 351 exchange. Basis in assets becomes 160k on AB liquidation (Partner’s outside basis) per 732, which becomes corp’s basis in assets per 362 and A & C basis in stock per 358. Option 2: A & C transfer partnership interests to corp, which then liquidates AB partnership. A & C stock basis is 160k per 358, corp’s basis in partnership interests 160k per 362. On partnership liquidation, corp’s basis in assets becomes 160k per 732. Same result as Option 1. Corporate & Partner Tax Instructor: Dwight Drake

7. Problem 346 Basic Facts: AC balance sheet. A.B. FMV A.B. FMV Inventory 80k 100k A Capital 60k 100k Capital Asset 40k 100k C Capital 100k 100k Total 120k 200k 160k 200k AC to be converted to corporation. Three options: Option 3: AC contributes assets to corp for stock and then liquidates by distributing stock to A & C. Now corp basis in assets 120k, but A & C basis in stock still 160k per 732. Thus, Option 3 produce lower asset basis - not good. Plus, no S election possible in year 1 and no 1244 stock treatment available on loss (shareholder must be original issuee). Corporate & Partner Tax Instructor: Dwight Drake

8. Problem 361 Basic Facts: ABCD balance sheet. A.B. FMV A.B. FMV Cash 4k 4k A Capital 4k 6k AR 8k 8k B Capital 4k 6k Inventory 8k 12k E Capital 6k 6k F Capital 6k 6k Total 20k 24k 20k 24k No election. Since 50% interests in partnership sold in 12 months, termination of old partnership under 708(b)(1)(B). Old partnership deemed to have contributed assets to new partnership with carryover basis and partners A,B,E,F each get interest in new partnership and keep old basis. Balance sheet of new partnership is above. 754 election: E & F each entitled to 1k inside adjustment in asset basis (excess of 6k paid over 5k (1/4 of 20k) share of inside basis. Adjustment allocated to inventory, only asset with appreciation. Balance sheet as follows: Corporate & Partner Tax Instructor: Dwight Drake

9. Problem 361 (b) balance sheet. A.B. FMV A.B. FMV Cash 4k 4k A Capital 4k 6k AR 8k 8k B Capital 4k 6k Inventory 10k 12k E Capital 6k 6k F Capital 6k 6k Total 22k 24k 20k 24k c) No 754 election, but 732(d) invoked by E & F. Same answer as (a). 732(d) of no consequence because no distribution of property to E or F by new partnership. Corporate & Partner Tax Instructor: Dwight Drake

10. S Corp Complete Liquidation – Shareholder Impact General Rule: Per 331, complete liquidation treated as sale or exchange of stock, producing capital gain or loss equal to difference between cash and FMV of property received and shareholder’s basis in stock. Note, shareholder stock basis increased by corporate gain, so often little or no tax due. Timing Issues: - 453 installment sales treatment applies when liquidating distributions over time. Open transaction treatment very risky; appears trumped by 453. - 453 installment treatment permitted even as to installment obligations acquired by non-public corp in asset sell-off and distributed to shareholders. To qualify under 453, corp sale that created obligation must be with 12 month period after liquidation plan adopted and liquidation must be completed within same period. Inventory and “dealer” qualify only if part of bulk sale of assets. Corporate & Partner Tax Instructor: Dwight Drake

11. S Corp Complete Liquidation – Corporation Impact General Rule: Per 336, Corp recognizes gain or loss on property distributed or sold as part of complete liquidation. 267 related-party loss limitations not apply in complete liquidation. Gain or loss passed thru to shareholders. (d)(1) Related Party Exception: No loss at all on distribution to related party (per 267) in complete liquidation if: - Distribution note pro rata, or - Distributed property acquired by corp in 351 transaction or as contribution to capital within 5 yrs of distribution (“Disqualified Property”). (d)(2) Tax Avoidance Exception: No built-in loss (loss at time of acquisition) disallowed if property acquired in 351 transaction or contribution to capital and principal purpose was to recognize loss on liquidation. If acquired within 2 yrs of plan of liquidation, bad purpose a done deal unless there is “clear and substantial relationship” between property and conduct of business and solid explanation. If outside 2yr window, probably safe except in “most rare” cases. Corporate & Partner Tax Instructor: Dwight Drake