1 / 45

CCH Federal Taxation Comprehensive Topics Chapter 20 Partnerships—Distributions, Sales, and Exchanges

CCH Federal Taxation Comprehensive Topics Chapter 20 Partnerships—Distributions, Sales, and Exchanges. ©2006 , CCH, a Wolters Kluwer business 4025 W. Peterson Ave. Chicago, IL 60646-6085 800 248 3248 www.CCHGroup.com. Distributions—General Effect on Partners. Chapter 20, Exhibit 1a.

enid
Download Presentation

CCH Federal Taxation Comprehensive Topics Chapter 20 Partnerships—Distributions, Sales, and Exchanges

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. CCH Federal TaxationComprehensive TopicsChapter 20Partnerships—Distributions, Sales, and Exchanges ©2006, CCH, a Wolters Kluwer business 4025 W. Peterson Ave. Chicago, IL 60646-6085 800 248 3248 www.CCHGroup.com

  2. Distributions—GeneralEffect on Partners Chapter 20, Exhibit 1a CCH Federal Taxation Comprehensive Topics

  3. Distributions—GeneralEffect on Partners Chapter 20, Exhibit 1b CCH Federal Taxation Comprehensive Topics

  4. Distributions—General Rules Code Sections 731 to 733 The rules indicated below assume that the partnership DOES NOT make a disproportionate distribution of the Code Sec. 751 “hot” assets. What is a distribution? A distribution is a transfer of value from the P/S to a partner in reference to his interest in the partnership. A distribution may be in the form of money, debt relief, or other property. Any decrease in a partner’s allocable share of P/S debt is treated as a distribution of money. This can result from payment of principal by the P/S on its debt. Also, a draw against a partner’s share of partnership income is a distribution. Chapter 20, Exhibit 3a CCH Federal Taxation Comprehensive Topics

  5. Distributions—General Rules Code Sections 731 to 733 Will the partnership recognize either a gain or loss on the distribution of property to a partner? Generally no. Even distributions of Code Sec. 1245 or Code Sec. 1250 property do not trigger recognition unless Code Sec. 751(b) applies. Exception: Disproportionate distributions. Chapter 20, Exhibit 3b CCH Federal Taxation Comprehensive Topics

  6. Distributions—General Rules Code Sections 731 to 733 Will the partner recognize either a gain or loss on the distribution?Capital gain is recognized only if cash or debt relief received is greater than her outside basis. Loss is never recognized. Code Sec. 731(a); Reg. 1.731-1(a)(1). If the cash received is a draw against profits and the amount received is greater than outside basis, gain is NOT recognized. The reason: A distribution reduces outside basis as shown below. However, the profits implied in a draw against profits increases basis by an equal amount. Thus, a cash draw would have a zero effect on outside basis. What effect does the distribution have on the partner’s outside basis?Her outside basis is reduced by the amount of cash plus the partnership’s inside basis in the distributed asset(s). However, her outside basis cannot be reduced below zero Chapter 20, Exhibit 3c CCH Federal Taxation Comprehensive Topics

  7. Distributions—General Rules Code Sections 731 to 733 What is the basis of the transferred asset(s) to the partner? Follow this step-by-step formula: (1) Reduce her outside basis by the amount of cash received. (2)(a) If her remaining outside basis is sufficient, she will take a basis equal to the partnership’s inside basis in the distributed asset. (2)(b) If her remaining outside basis is NOT sufficient, she will allocate the “step-down” in basis first to assets with a basis in excess of FMV. (2)(c) Any excess of the “step-down” over the amount in (2)(b) is allocated among remaining assets in accordance with their remaining bases. Chapter 20, Exhibit 3d CCH Federal Taxation Comprehensive Topics

  8. Distributions—General Rules Code Sections 731 to 733 What is the holding period and character of assets distributed from a partnership to a partner? The holding period begins on the day after the date that the partnership acquired the asset. The character is determined by the use that the partner makes of the asset. CCH Federal Taxation Comprehensive Topics

  9. Proportionate Distributions—Example FACTS: • On July 1, Y1, ABC Partnership distributes to each of its equal partners $10,000 cash and land with a fair market value (FMV) of $10,000 and basis (AB) of $5,000. • The three parcels of land were acquired by ABC on 12/31/80. • A, B and C have outside bases of $20,000, $10,000, and $5,000 respectively. • The partnership has the following tax/book balance sheet prior to the distribution. Chapter 20, Exhibit 4a CCH Federal Taxation Comprehensive Topics

  10. Proportionate Distributions—Example Chapter 20, Exhibit 4b CCH Federal Taxation Comprehensive Topics

  11. Proportionate Distributions—Example QUESTION 1: What are the tax consequences of the distribution to A, B and C? QUESTION 2: What result to C if he receives the land first and the cash in a subsequent separate distribution on October 1? QUESTION 3: What result to C in QUESTION 2, if the cash distribution on October 1 is a draw against his share of partnership income, which is $20,000 for the year? Chapter 20, Exhibit 4c CCH Federal Taxation Comprehensive Topics

  12. Proportionate Distributions—Example Chapter 20, Exhibit 4d CCH Federal Taxation Comprehensive Topics

  13. Proportionate Distributions—Example Chapter 20, Exhibit 4e CCH Federal Taxation Comprehensive Topics

  14. Proportionate Distributions—Example Chapter 20, Exhibit 4f CCH Federal Taxation Comprehensive Topics

  15. Selling a Partnership Interest—Effect on Selling Partner How is a partner’s initial outside basis in a partnership (P/S) interest determined if purchased from a partner?A partner buying into a P/S takes an outside basis that is the sum of: (a) Purchase price (Code Sec. 742); (b)  Partner’s share of partnership liabilities (Code Sec. 752(d)). Chapter 20, Exhibit 5a CCH Federal Taxation Comprehensive Topics

  16. Selling a Partnership Interest—Effect on Selling Partner What is the character of any gain or loss recognized by the selling partner on the sale of a P/S interest? Code Sec. 741 provides that a sale of a partnership interest generally results in capital gains or losses. However, Code Sec. 741 yields to Code Sec. 751 and gain or loss is ordinary if amounts received by the selling partner are attributable to “hot assets.” Code Sec. 751 defines “hot” assets as the following items: • Unrealized receivables in which no taxable income resulted from the credit sale. Generally cash basis but not accrual basis P/S’s would have unrealized receivables. However in determining the character of gain on sale of a partnership interest, unrealized receivables must include any Code Sec. 1245 or 1250 depreciation recapture potential from Code Sec. 1231 assets! Chapter 20, Exhibit 5b CCH Federal Taxation Comprehensive Topics

  17. Selling a Partnership Interest—Effect on Selling Partner • Appreciated inventory, where aggregate FMV exceeds aggregate basis. For purposes of determining aggregate amounts under Code Sec. 751, inventory includes all partnership property except cash, capital assets and Code Sec. 1231 assets. Thus, for purposes of the “aggregate” computation, inventory includes unrealized receivables! In determining the character of gain on sales of partnership interests the minimum 20% substantial appreciation requirement has been repealed effective August 5, 20x1. However, this 20% substantial appreciation requirement has been retained for inventory distributions (or deemed distribution) by partnerships. • Code Sec. 1245 and 1250 business assets (i.e., long-term business assets with depreciation recapture potential.) A selling partner’s distributive share of any built-in gain on sale of “hot” assets is recognized as ordinary income, even when there is a realized loss on the sale. In such a case, the recognized capital loss would be increased by the ordinary income amount. The combined effect of Code Sec. 741 & 751 may yield surprising results when a partner sells a partnership interest—an ordinary gain under Code Sec. 751 and a capital loss under Code Sec. 741. Chapter 20, Exhibit 5c CCH Federal Taxation Comprehensive Topics

  18. Selling a Partnership Interest—Effect on Partnership What is the tax effect on a partnership’s (P/S’s) inside basis of assets when a partner sells her interest? Without Code Sec. 754 election. Code Sec. 743(a) provides that “the basis of partnership property shall not be adjusted as the result of a transfer of an interest in a partnership by sale ...” However, if the partnership carries “hot assets,” the tax effect is initially quite alarming. Consider the following example. Chapter 20, Exhibit 6 CCH Federal Taxation Comprehensive Topics

  19. Selling a Partnership Interest—Example FACTS: 12/31/x1: Buyer pays $40,000 cash to Seller for a 1/3 interest in a cash method partnership that has as its primary asset $90,000 of accounts receivable with a zero basis and land with a $30,000 fair market value (FMV) and basis. Comments: As indicated earlier, Buyer’s outside basis is cost, or $40,000. In effect, he has paid $30,000 for his 1/3 interest in receivables (1/3 x $90m = $30m) and $10,000 for his 1/3 interest in the land (1/3 x $30m = $10m)] 1/1/x2: $90,000 cash is received by the P/S on the receivables. Chapter 20, Exhibit 7a CCH Federal Taxation Comprehensive Topics

  20. Selling a Partnership Interest—Example QUESTION 1: Does Seller have ordinary income of $30,000? ANSWER 1: Yes, Seller is taxed under Code Sec. 751 on the $30,000 of ordinary income attributable to the receivables when she sells her partnership interest to Buyer. Chapter 20, Exhibit 7b CCH Federal Taxation Comprehensive Topics

  21. Selling a Partnership Interest—Example QUESTION 2: Does the Buyer have ordinary income of $30,000? (i.e., a 1/3 share in the partnership’s income from collections—1/3 x [90m cash – 0 inside basis of P/S] = 30m) ANSWER 2: Yes! Buyer is taxed on his 1/3 share, or $30,000 ordinary income. This result occurs even though (1) Seller already recognizes $30,000 as ordinary income and (2) Buyer pays $30,000 for his share of the receivables and has no real gain on their collection. Comments: Of course, Buyer’s outside basis will increase by his $30,000 share of P/S ordinary income. When he eventually sells his P/S interest, the increased outside basis will reduce capital gain (or increase capital loss) by $30,000. Not much consolation, given the timing (i.e., 20x2) and character (i.e., ordinary) of his taxable income. Chapter 20, Exhibit 7c CCH Federal Taxation Comprehensive Topics

  22. Selling a Partnership Interest—Example QUESTION 3: Is there a way to prevent the Buyer’s dilemma? ANSWER 3: Yes! Read on. With Code Sec. 754 election. To avoid taxing Buyer on the appreciation of his proportionate share of partnership assets prior to the date of purchase, the P/S may elect under Code Sec. 754 to adjust its inside basis of the receivables. In the example above, a Code Sec. 754 election by the P/S gives Buyer a $30,000 inside “cost” basis in his “share” of the receivables. When the receivables are collected, the other partners each will be taxed just as they would be with the Code Sec. 754 election. However, Buyer realizes no income because of the upward adjustment of his “personal” inside basis. Chapter 20, Exhibit 7d CCH Federal Taxation Comprehensive Topics

  23. Selling a Partnership Interest—Example COMMENTS: Code Sec. 754 cuts both ways. If partnership assets had declined in value as of the time of the sale of the partnership interest, a Code Sec. 754 election would create a downward adjustment to the Buyer’s personal inside basis in the partnership assets. Obviously, such an election would be disadvantageous to Buyer. Chapter 20, Exhibit 7e CCH Federal Taxation Comprehensive Topics

  24. Selling a Partnership Interest with Hot Assets—Example FACTS: 1. S sells his 1/3 capital interest to B for $150,000 cash. 2.  The tax/book balance sheet of the partnership (P/S) immediately before the sale is as follows: Chapter 20, Exhibit 8a CCH Federal Taxation Comprehensive Topics

  25. P/S Balance Sheet Immediately Before the Sale Inside Basis FMV Outside Basis FMV Cash $ 30,000 $ 30,000 Capital- S (1/3) $ 30,000 $150,000 Accounts receivable 0 240,000 Capital- S (2/3) 120,000 300,000 Land 150,000 180,000 Total Assets $180,000 $450,000 Total Capital $180,000 $450,000 Selling a Partnership Interest with Hot Assets—Example Chapter 20, Exhibit 8b CCH Federal Taxation Comprehensive Topics

  26. Selling a Partnership Interest with Hot Assets—Example QUESTIONS: What is the amount and character of the gain to S? Indicate how the partnership tax/book balance sheet will appear assuming that a Code Sec. 754 election is NOT in place. Indicate how the partnership tax/book balance sheet will appear assuming that a Code Sec. 754 election IS in place. Chapter 20, Exhibit 8c CCH Federal Taxation Comprehensive Topics

  27. SOLUTION: Amount and character of the gain to S (a) (b) (c) = (a) – (b) (d) = 1/3 x [240m – 0] (e) = (c) – (d) Sales Price Outside Basis of Seller Realized gain OI Capital $150,000 $60,000 $90,000 $80,000 $10,000 Selling a Partnership Interest with Hot Assets—Example Chapter 20, Exhibit 8d CCH Federal Taxation Comprehensive Topics

  28. SOLUTION: Partnership Tax/Book Balance Sheet assuming that a Code Sec. 754 election is NOT in place. P/S Tax/Book Balance Sheet - Without Code Sec. 754 Election: Inside Basis FMV Outside FMV Cash $ 30,000 $ 30,000 Capital-B (1/3) $150,000 $150,000 Accounts receivable 0 240,000 Capital-Z (2/3) 120,000 300,000 Land 150,000 180,000 Total Assets $180,000 $450,000 Total Capital $270,000 $450,000 Selling a Partnership Interest with Hot Assets—Example Chapter 20, Exhibit 8e CCH Federal Taxation Comprehensive Topics

  29. SOLUTION: Partnership Tax/Book Balance Sheet assuming that a Code Sec. 754 election IS in place. P/S Tax/Book Balance Sheet - With Code Sec. 754 Election: Inside Basis FMV Outside FMV $ 30,000 Cash $ 30,000 Capital-B (1/3) $150,000 $150,000 A/R [Inside Basis: 0 + 80m] 80,000 240,000 Capital-Z (2/3) 120,000 300,000 Land [Inside Basis: 150+10] 160,000 180,000 $450,000 Total Assets $270,000 Total Capital $270,000 $450,000 Selling a Partnership Interest with Hot Assets—Example Chapter 20, Exhibit 8f CCH Federal Taxation Comprehensive Topics

  30. Selling a Partnership Interest with Hot Assets—Example Note on the $80,000 step-up of A/R: The $80,000 step-up in P/S’s inside basis of receivables benefits only B, not the other partners. In effect, B gets a “personal inside basis” in P/S’s receivables, which will reduce his share of P/S income when the receivables are collected. Chapter 20, Exhibit 8g CCH Federal Taxation Comprehensive Topics

  31. Basic Partnership Tax Accounting—Outside Basis, Inside Basis and Capital Account Code Sec. 704(d) Outside Basis Definition.This is a partner’s adjusted basis (AB) in the partnership (P/S) capital interest. Purpose.Outside basis is used mainly in computing gain or loss on the sale of a P/S interest, and for determining the deductibility of Code Sec. 702(a)(8) operating losses under the at-risk rules. Chapter 20, Exhibit 10a CCH Federal Taxation Comprehensive Topics

  32. Basic Partnership Tax Accounting—Outside Basis, Inside Basis and Capital Account Inside Basis Definition.This is the P/S’s basis in assets. Purpose.Inside basis is used by the P/S to compute depreciation, or its gain or loss on disposition of the property. Computation.If the assets are acquired through a partner’s contribution, inside basis is generally the partner’s AB at date of contribution. If obtained from a non-partner, inside basis is cost. Chapter 20, Exhibit 10b CCH Federal Taxation Comprehensive Topics

  33. Basic Partnership Tax Accounting—Outside Basis, Inside Basis and Capital Account Capital Account Definition.A capital account is maintained for each partner at the partnership level. It represents a partner’s equity in the P/S. Purpose. At any point in time during the life of a P/S, the capital account generally identifies what each partner would be entitled to receive upon liquidation of her outside basis. Computation.A partner’s initial capital account balance is the FMV (net of debt relief) of the contributed property. It is increased by the partner’s share of P/S profits. It is decreased by the partner’s share of losses, and the amount of cash and the FMV of any property distributed to the partner. Comparison with outside basis.It is different from the partner’s outside basis in that (1) capital arising from property contributions are stated at FMV, not contributing partner’s AB; and (2) it does not include the partner’s share of P/S liabilities as does the outside basis. Chapter 20, Exhibit 10c CCH Federal Taxation Comprehensive Topics

  34. Basic Partnership Tax Accounting—Example 1 (Formation) Chapter 20, Exhibit 12a CCH Federal Taxation Comprehensive Topics

  35. Basic Partnership Tax Accounting—Example 1 (Formation) Chapter 20, Exhibit 12b CCH Federal Taxation Comprehensive Topics

  36. Basic Partnership Tax Accounting—Example 1 (Formation) COMMENTS: “Tax/book” balance sheet means a financial statement that shows (1) the partnership’s inside basis in its assets, (2) the partners’ outside basis in their capital interest, and (3) the partners’ capital accounts as reported on the partnership books. Chapter 20, Exhibit 12c CCH Federal Taxation Comprehensive Topics

  37. Basic Partnership Tax Accounting—Example 2 (Profit Allocation) FACTS: [Use the balance sheet at Example1 as the starting point] Same as above, except that during 20x1, ABC reports $10,000 Code Sec. 702(a)(8) income from cash sales, and sold the land for $40,000 cash. Profits are allocated according to the partners’ capital account balances. Allocate 20x1 Income, reconstruct the P/S Balance Sheet, and identify: (1) Outside Bases (2) Inside Bases and (3) Capital Account Balances Chapter 20, Exhibit 13a CCH Federal Taxation Comprehensive Topics

  38. Basic Partnership Tax Accounting—Example 2 (Profit Allocation) Chapter 20, Exhibit 13b CCH Federal Taxation Comprehensive Topics

  39. Basic Partnership Tax Accounting—Example 2 (Profit Allocation) Chapter 20, Exhibit 13c CCH Federal Taxation Comprehensive Topics

  40. Basic Partnership Tax Accounting—Example 2 (Profit Allocation) COMMENTS: Each partner’s outside basis is increased by the partner’s share of partnership liabilities on the theory that the partners ultimately will be responsible for paying that debt. Code Sec. 752(a). The result is that the borrowed funds become an asset ($30,000 cash) having an inside basis of $30,000 to the partnership, and the resulting liability to repay that cash increases the partners’ outside bases by that same amount in a ratio of 1:6:3, or $3,000 to A, $18,000 to B and $9,000 to C. Note that a partner’s share of partnership liabilities does not increase his or her capital account. Chapter 20, Exhibit 13d CCH Federal Taxation Comprehensive Topics

  41. Basis Adjustments Attributable to Partnership Distributions – Sec. 734(b) • Certain distributions cause differences between inside and outside basis: • Distributions that trigger recognition of gain or loss to recipient partner • Distributions where partner takes different basis in property than partnership had • Current distribution where p/s basis exceeded basis of p/s interest • Liquidating distribution where basis of p/s interest exceeded p/s basis in distributed property CCH Federal Taxation Comprehensive Topics

  42. Basis Adjustments Attributable to Partnership Distributions – Sec. 734(b) • Unlike Adjustments under Sec. 743(b), basis adjustments under Sec. 734(b) are made for benefit of all remaining partners • Basis adjustment is made to same class of property as that resulting in imbalance between inside and outside basis • Adjustments attributable to excess distributions of cash are made to capital assets CCH Federal Taxation Comprehensive Topics

  43. Death or Retirement of a Partner • Code Sec. 736 – Consequences depend on nature of payments to retiree or deceased partner’s successor in interest • Payments for partner’s share of partnership “property” are treated as distributions and subject to same rules as other distributions • Payments in excess of partner’s share of p/s property treated as guaranteed payments or distributive shares of partnership income (and thus deductible by partnership or allocated away from existing partners) CCH Federal Taxation Comprehensive Topics

  44. Death or Retirement of a Partner • What constitutes partnership “property” under Code Sec. 736? • Is capital a material income-producing factor for partnership? • Yes – property is everything except unrealized receivables • No – property is everything except unrealized receivables and goodwill • Exception – goodwill is treated as property if required in partnership agreement CCH Federal Taxation Comprehensive Topics

  45. Income in Respect of a Decedent • Code Sec. 736(b) payments received by deceased partner’s beneficiary will generally be nontaxable to recipient due to Code Sec. 1014 stepped-up basis rules. • Code Sec. 736(a) payments, in contrast, are generally treated as income in respect of a decedent and will be fully taxable to recipient. CCH Federal Taxation Comprehensive Topics

More Related