Sale or Liquidation of Partnership Interest

Question 1

What code section governs payments to retiring partners?

Answer 1

736

Question 2

What is a “liquidation” of a partnership interests?

Answer 2

A termination of a partner’s entire interest in the partnership by means of a distribution, or series of distributions, to the partner by the partnership. 761(b).

Question 3

What is a service partnership?

Answer 3

A partnership where capital is not a material income-producing factor (such as a partnership of doctors, lawyers, architects, or accountants)

Question 4

What is Code Section 736(a)

Answer 4

It governs payments to retiring partners in service partnerships

Question 5

What is Code Section 736(b)

Answer 5

It governs payments to retiring partners in partnerships other than service partnerships

Question 6

What does Code Section 736(b) provide?

Answer 6

It provides that payments to retiring partners in liquidation of their interests will be treated as distributions

Question 7

How is a payment made to a retiring partner treated?

Answer 7

As a distribution. 736(b).

Gain is only recognized if cash is received in excess of outside basis. 731(a)(1).

Loss is recognized if only cash, 751(c) unrealized receivables, and 751(d)(2) inventory items are distributed.

In that situation, loss is recognized to extent partner’s outside basis exceeds sum of money distributed and partner’s transferred basis in unrealized receivables and inventory.

The loss is considered as arising from the sale/exchange of partnership interest and thus a capital loss.

Question 8

Whose job is it to compute outside basis?

Answer 8

The partner’s. The partnership does not track this.

Question 9

Why does outside basis matter?

Answer 9

Ability to claim losses
Taxability of distributions of cash.
Basis of property distributed.
Gain or loss on disposition of partnership interest.

Question 10

Section 741?

Answer 10

A sale of a partnership interest will be a sale of a capital asset, except as provided

(This supports the entity view of the partnership)

Question 11

Section 751(a)

Answer 11

Converts sale of partnership interest into ordinary income to extent of amounts attributable to

(i) unrealized receivables, and
(ii) inventory

Question 12

Section 751(b)

Answer 12

Provides that the same re-characterization for hot assets applies if there’s a distribution of hot assets in redemption of a portion of a partnership interest.

Question 13

How is a partner treated on the sale of a partnership interest?

Answer 13

Seller recognizes gain or loss equal to difference between amount realized and outside basis. The character of the gain is capital (Section 741), except to the extent attributable to hot assets (Section 751).

Question 14

How is the buyer of a partnership interest treated?

Answer 14

Buyer takes a cost basis in the partnership interest. The buyer inherits seller’s capital accounts (both tax and book) and share of inside basis, unless the partnership makes a 754 election.

Question 15

What are “look-through” capital gains?

Answer 15

There are different rates for capital gains. Under 1(h), capital gains from collectibles are taxed at 28%, and Section 1250 capital gains are at a maximum of 25%. A seller of a partnership interest has to look through to partnership assets to determine if any part of her 741 capital gain is allocable to these so that the appropriate rate can be applied.

Question 16

Is a sale of a partnership interest eligible for installment sale treatment under 453?

Answer 16

Yes, with one exception. Gain attributable to the seller’s share of 751(a) property that, if sold directly, would not have been eligible for 453 treatment, must be reported immediately. The rest is eligible.

Question 17

What is the effect of a Section 754 election?

Answer 17

The partnership must make special basis adjustments whenever an interest in it is transferred (under 743) and following certain distributions (under 734). Once the partnership makes the election with respect to one transaction (either a transfer of distribution), it remains in effect with respect to all future transactions and can only be revoked with consent of IRS.

Section 755 provides rules for allocating the Section 743(b) adjustment among the partnership’s asset (the goal being to give buying partner a cost basis in her share of each asset). These basis adjustments are only made with respect to the transferee partner; the common basis of the partnership’s assets remains unchanged.

Question 18

What does Section 755 provide?

Answer 18

Section 755 provides rules for allocating the 743(b) adjustment among the partnership’s asset (the goal being to give buying partner a cost basis in her share of each asset).