Partnership 5 - Sales and Terminations Flashcards
What is the classification of a partnership interest?
Capital asset.
What is the classification of G/L from the sale of a partnership interest? Exception?
Capital in nature.
Except to the extent the partnership has hot assets, gain will be re characterized as ordinary income.
What is the rule of hot asset? What is this rule also called?
Instead of viewing “selling” partnership interest, a partner sells percentage of assets on the balance sheet.
Look though rule.
What does look through rule also affect?
The tax rates applied to a portion of the gain.
What are 2 types of hot assets?
- Unrealized receivables (receivables of a cash basis TP, including depreciation recapture)
- Inventory (anything other than cash, Sec. 1231 assets, capital assets)
What must the selling partner do if the partnership has hot assets at the time of a partnership interest is sold?
He must allocate a portion of the sale proceeds to these assets and recognize ordinary income.
Question:
The personal service partnership had cash basis BS at Dec. 31, Yr 4.
Cash: AB $102,000. FMV $102,000.
Unrealized A/R: AB n/a. FMV $420,000.
C, an equal partner with A and B, sold his interest to D, an outdier for $154,000 cash on Jan 1, Yr 5. D assumed C’s share of the partnership liability.
Liability and capital note payable: AB $60,000. FMV $60,000
Capital accounts:
A: AB $14,000. FMV 154,000
B: 14,000. 154,000.
C: 14,000. 154,000.
What was the total amount and character of the gain recognized by C?
Total amount realized:
Cash (154,000) + Debt relief (20,000) = 174,000 - Adjusted basis (14,000 + 20,000) = Recognized gain ($140,000).
Now apply hot asset rule;
If hot asset is sold, amount realized (FMV 420,000) - Adjusted basis (0) = Ordinary income (420,000) x 1/3 (allocated to C) = 140,000.
Total gain was 140,000 and therefore, the whole amount is recognized as ordinary income.
If the ordinary income allocated to C was $200,000 instead of 140,000, Total gain (140,000) - ordinary income (200,000) = (60,000) capital loss.
What are other 2 assets besides hot assets that could impact the gain from the sale of a partnership asset?
Collectibles (taxed at 28%) or Sec. 1250 assets (ie. buildings. to the extent straight depreciation was taken, it will be taxed at 25%).
What are 2 cases of partnership terminations?
- No part of the business continues by any partner in the partnership form.
- Technical termination: there is a sale or exchange of at least a 50% interest in both capital and profits within a consecutive 12-month period.
What does termination require?
Requires a closing of the partnership tax-year.
What are the 2 assumption would be made when technical termination occur (business and financial operations are continued by other members)?
- A deemed distribution of assets to the remaining partners and the purchaser.
- A hypothetical re-contribution of assets to a new partnership.
What happens to the original partnership when a partnership divides into 2 or more partnerships?
The original partnership is continued in each of the new partnerships which contain partners that controlled 50% or more of the partnership interest in the original partnership.
What happens to the partner’s basis when there is distributive share of partnership income before selling his interest?
The distributive share will increase the basis.
