T3-M3 Liquidation of a Partnership and an LLC

Question 1

what are the 3 ways a partner may liquidate a partnership interest?

Answer 1

• complete withdrawal (liquidating distribution)
• sale of partnership interest
• retirement or death
• consequences to a partnership:
• partnership does NOT recognize any entity level gain/loss
• any gain/loss on sale of assets and expenses of liquidating the partnership are passed on to the partners.
• liquidation of an LLC and the consequences to its members will be treated the same as either a corp or a partnership, whichever form the LLC elected to take for federal income tax purposes

Question 2

what are tax rules on complete withdrawal liquidating distribution?

Answer 2

• partners recognize capital gain only if money received > partner’s basis
• partners recognize capital loss only if money, unrealized receivables (for cash basis taxpayer), or inventory are the only assets received and if they are < partner’s basis

Question 3

what are tax rules on liquidating distribution of multiple assets?

Answer 3

If multiple assets are distributed, the remaining basis in the partner’s partnership interest must be allocated among the assets distributed

1. distribution with multiple hot assets only: the partner’s basis is allocated to the assets only if the outside basis is LESS than the inside basis
2. outside basis LESS than inside basis: 3 steps
   - assign basis to all assets equal to the partnership’s basis in the assets
   - adjust the basis of any assets in the last property category (other property or hot assets if no other property) that have DEPRECIATED in value down to FMV
   - allocate any basis in the partnership interest remaining after step 2 among all the assets in the last property category based on relative adjusted basis of the assets after the step 2 adjustment
3. outside basis MORE than inside basis: 3 steps
   - assign basis to all assets equal to partnership’s basis in the assets
   - adjust basis of any assets in the last property category that have APPRECIATED in value up to FMV
   - allocate any basis in the partnership interest remaining after step 2 among all the assets in the last property category based on the relative FMV

Question 4

what are tax rules on sale of partnership interest?

Answer 4

• in general, recognize as capital gain or loss. Exception, any gain from “hot assets” is treated as ordinary income.
• allocation of partnership income, gains, losses, and deductions must be allocated pro-rata between seller and buyer based on NUMBER OF DAYS
• formula:
  + beginning capital account
  + share of income/loss up to sale
  + share of partnership liabilities
• cash received
• FMV of property received
• relief from share of partnership liabilities
  = gain or loss

Question 5

what are tax rules on retirement or death of a partner?

Answer 5

• payments for interest in partnership assets result in capital gain or loss
• if payments are measured by partnership income, they are treated as partnership income regardless of the period they are paid, so these payments are taxed as ordinary income to the retired partner

Question 6

what is section 754 election and section 743(b) basis adjustment?

Answer 6

• partnerships have the option to make a section 754 election when there is a transfer of partnership interest by sale/exchange or upon death of a partner AND partner’s outside basis is DIFFERENT from partner’s inside basis
• the, follow by section 743(b) basis adjustment
• even the partnership does not elect sec 754, the IRS mandates sec 743(b) adjustment when there is a substantial built-in loss at the time of purchase (inside basis > outside basis by $250K or more)
• GOAL of this adjustment is to make the transferee have an inside basis in the partnership assets EQUAL to his/her outside basis