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Chapter 21

Dispositions of Partnership Interests


and Partnership Distributions

Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Sale of partnership interests


Partners
1.
2.
3.

dispose their interests by:

Selling to a third party;


Selling to another partner;
Transferring the interests back to the
partnership;

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Sales of Partnership Interests


Seller

Issues

Selling partner determines gain or loss as the


difference between the amount realized and
his/her outside basis in partnership
Generally, the gain/loss is capital. A portion of the
gain/loss will be ordinary if a seller realizes any
gain/loss attributable to unrealized receivables or
inventory items (Hot Assets)

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Hot Assets

Include two components: 1) unrealized receivables; 2)


inventory items.
Unrealized receivables include the right to receive payment
for goods delivered, or to be delivered or services rendered,
or to be rendered.

For cash-method taxpayers, unrealized receivables include accounts


receivable.
For accrual-method taxpayers, accounts receivable are not considered
unrealized receivables.

Inventory items include classic inventory and more broadly


any assets that are not capital or 1231 assets

For example: equipment or real estate used in business but held no


more than one-year; accounts receivable

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Sales of Partnership Interests

Process for determining gain or loss


Step 1: Total gain or loss = Amount realized Outside
basis
Step 2: Calculate the partners share of gain or loss
from hot assets as if the partnership sold these assets
at their fair market value. This represents the ordinary
portion of the gain or loss
Capital gain or loss = Step 1 Step 2

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Example 21-1/4
Last year Chanzz Inc. sold Its 30 percent Interest In CCS
on June 30 to Greg Randall. Greg paid Chanzz Inc.
$100,000 for its interest in CCS. Chanzz's share of CCS
liabilities as of June 30 was $24,000. Chanzz Inc.'s basis in
its CCS interest at the sale date was $105,000 (including its
share of CCS's liabilities). 1) What amount of gain did
Chanzz recognize on the sale? What is the character of
Chanzz's gain? (equipment held less than one year)

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Sales of Partnership Interests


Buyer

of partnership interests

For sale transaction, the new investors outside


basis will be equal to his cost of the partnership
interest
To the extent that the new investor shares in the
partnership liabilities, his share of partnership
liabilities increases his outside basis
Buyers basis = Cost of purchase + Share of
liabilities assumed

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Operating Distributions
Usually

paid to distribute the business profits


to the partners but can also reduce a
partners ownership
Operating Distributions of Cash Only

Partners generally do not recognize gain or loss


on the distribution of property or money
One exception is when the distribution is greater
than the partners outside basis. Partners will
recognize gain in this case.
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Operating Distributions
Partner simply reduces his/her (outside) basis in
the partnership interest by the amount of the
distribution
Partnerships basis in its remaining assets
remains unchanged
Partner never recognizes a loss from an
operating distribution

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Liquidating Distributions

Gain or Loss Recognition in Liquidating


Distributions

Generally partners and partnerships do not


recognize gain or loss
Exception

Gain - Partner recognizes gain when partnership


distributes money (includes debt relief) and the amount
exceeds the partners outside basis in the partnership
interest (distribution-outside basis>0)

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Liquidating Distributions

Loss - Partner recognizes loss when two conditions


are met
Distribution consists of only cash and hot assets,
and
Partners outside basis exceeds the sum of the
bases of the distributed assets (outside
basis>inside basis of assets)
Outside basis: a partners basis in the partnership
interest
Inside basis: the partnerships basis in its assets

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Liquidating Distributions
When

to recognize gain/loss in a liquidating


distribution
Inside basis > outside
basis

Inside basis < outside


basis

Money distribution only

Gain recognized

N/A

Money and hot assets


only

N/A

Loss recognized

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Example 21-16
(Outside basis>Inside basis & money and
hot assets)

Suppose Greg has an outside basis of


$334,000, including his share of liabilities of
$66,000. In a liquidating distribution, he
receives $159,000 cash and inventory with a
fair market value and basis of $49,000. Will
Greg recognize a gain or loss?

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Liquidating Distributions
Then

what happens when no gain/loss is


recognized?

The GR: to reallocate partners outside basis to


the distributed assets.

The

GR: allocate the partners entire outside


basis to the assets the partner receives

Use the liquidated partners interests (old) to


replace the basis of assets received (new)

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Liquidating Distributions
How

to allocate the partners entire outside


basis to the assets the partner receives?
Allocation essentially depends on two things

the partnerships bases in distributed assets


relative to the partners outside basis and
the type of property distributedwhether it is
money, hot assets, or other property

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