2009 Pearson Education Inc Publishing as Prentice Hall

SPECIAL PARTNERSHIP ISSUES ® Nonliquidating distributions ® § 751 assets ® Terminating a partnership interest ® Basis adjustments ® Special forms of partnerships ® Tax planning considerations © 2009 Pearson Education, Inc. Publishing as Prentice 10 -2

Nonliquidating Distributions ® General rules ® Precontribution gain (loss) ® Basis effects of distributions ® Holding period and character of distributed property © 2009 Pearson Education, Inc. Publishing as Prentice 10 -3

General Rules ® No gain or loss by either partner or partnership ® “Money” distributions in excess of partner’s basis triggers capital gain recognition by partner ® “Money” includes cash, reduction of partner’s liabilities, FMV of securities © 2009 Pearson Education, Inc. Publishing as Prentice 10 -4

Precontribution Gain (Loss) (1 of 2) ® Precontribution gain (loss) definition Contributed property w/FMV > tax basis (< for loss) on date transferred to partnership © 2009 Pearson Education, Inc. Publishing as Prentice 10 -5

Precontribution Gain (Loss) (2 of 2) ® Gain or loss recognized by contributing partner w/in 7 years of contribution if Distribution of contributed property to any OTHER partner or Any property distribution to contributing partner if FMV of property > partner’s basis ¬Gain recognition only © 2009 Pearson Education, Inc. Publishing as Prentice 10 -6

Basis Effects of Distributions (1 of 2) ® General rule Partnership’s basis in distributed property carries over to partner ® Partner’s basis in partnership reduced in the following order Money received Basis of other property received © 2009 Pearson Education, Inc. Publishing as Prentice 10 -7

Basis Effects of Distributions (2 of 2) ® Basis in new property if partnership’s basis in property > partner’s basis in partnership after adjusting for money received and precontribution gain partner’s remaining basis x partnership’s basis in asset partnership’s basis in total assets distributed © 2009 Pearson Education, Inc. Publishing as Prentice 10 -8

Holding Period and Character of Distributed Property ® Partner’s holding period includes partnership’s holding period ® Character of gain/loss when property sold Generally same as for partnership Ordinary income/loss treatment for ¬Unrealized receivables ¬Inventory sold w/in 5 years of distribution ªAfter, character determined at partner level © 2009 Pearson Education, Inc. Publishing as Prentice 10 -9

§ 751 Assets ® § 751 assets Property likely to produce ordinary income when sold or collected ® Unrealized receivables ® Substantially appreciated inventory ® Significance of § 751 © 2009 Pearson Education, Inc. Publishing as Prentice 10 -10

Unrealized Receivables ® Unrealized receivables include Accounts receivable for cash basis partnership Ordinary income recapture items ¬§§ 1245 or 1250 (depreciation) ¬§§ 617(d) (mining properties) ¬§§ 1252 (farmland) ¬§§ 1254 (oil, gas, and geothermal) © 2009 Pearson Education, Inc. Publishing as Prentice 10 -11

Substantially Appreciated Inventory (1 of 2) ® Substantially appreciated inventory includes all assets EXCEPT Cash Capital assets § 1231 assets © 2009 Pearson Education, Inc. Publishing as Prentice 10 -12

Substantially Appreciated Inventory (2 of 2) ® Appreciation test 1. 2. 3. 4. 5. Exclude cash, § 1231 & capital assets Total basis of remaining assets Multiply sum by 1. 20 Compare result of #3 w/ FMV of assets If FMV larger, substantial appreciation exists © 2009 Pearson Education, Inc. Publishing as Prentice 10 -13

Significance of § 751 ® If § 751 assets exist, certain distributions reclassified as a SALE between partnership & partner ® What appears to be a tax-free distribution could be a taxable event ® See Example C 10 -12 and Table C 10 -1 © 2009 Pearson Education, Inc. Publishing as Prentice 10 -14

Terminating a Partnership Interest (1 of 2) ® Liquidating distributions ® Sale of partnership interest ® Retirement or death of a partner ® Exchange of a partnership interest ® Income recognition and transfers of a partnership interest © 2009 Pearson Education, Inc. Publishing as Prentice 10 -15

Terminating a Partnership Interest (2 of 2) ® Termination of a partnership ® Mergers

Liquidating Distributions ® Gain or loss recognition by partner ® Basis of assets received ® Holding period carries over to partner ® § 751 applies to liquidating distributions ® Effects of distribution on partnership No gain or loss unless § 751 deemed sale 10 -17 occurs © 2009 Pearson Education, Inc. Publishing as Prentice

Gain or Loss Recognition by Partner (1 of 2) ® Gain recognized if money received (and deemed received) exceeds partner’s basis in partnership © 2009 Pearson Education, Inc. Publishing as Prentice 10 -18

Gain or Loss Recognition by Partner (2 of 2) ® Loss recognized if Only money, unrealized receivables, & inventory are assets received AND Basis in partnership > sum of money plus partnership’s basis in unrealized receivables and inventory received © 2009 Pearson Education, Inc. Publishing as Prentice 10 -19

Basis of Assets Received (1 of 2) ® Basis of unrealized receivables and inventory same as for partnership Never increased when distributed from partnership partner © 2009 Pearson Education, Inc. Publishing as Prentice 10 -20

Basis of Assets Received (2 of 2) ® After reducing partner’s basis for money received, remaining basis in partnership is allocated to remaining property distributed Gain (loss) is deferred by reducing (increasing) the basis in the property distributed © 2009 Pearson Education, Inc. Publishing as Prentice 10 -21

Sale of Partnership Interest (1 of 2) ® Impact on Partner General ¬Capital rule gain or loss recognized Partnership liabilities ¬Relief of liabilities increases the amount realized on the sale © 2009 Pearson Education, Inc. Publishing as Prentice 10 -22

Sale of Partnership Interest (2 of 2) ® Impact § 751 on Partner (continued) property ¬All inventory and unrealized receivables are considered § 751 property ¬Hypothetical asset sale approach used by Treasury Regs. Under § 751 to determine ordinary income or loss ® No impact on partnership © 2009 Pearson Education, Inc. Publishing as Prentice 10 -23

Retirement or Death of a Partner ® Sale of partnership interest to outside party is a “sale” ® Surrender of interest to partnership Payments for property taxed as liquidating distributions Other payments treated as either guaranteed payment (ordinary income) or distributive share (retain character) © 2009 Pearson Education, Inc. Publishing as Prentice 10 -24

Exchange of a Partnership Interest (1 of 2) ® Exchange for another partnership interest not a like-kind exchange Exception: exchanges of interests within a single partnership ® Exchange May for corporate stock qualify for § 351 treatment ¬Partnership interest is property under § 351 © 2009 Pearson Education, Inc. Publishing as Prentice 10 -25

Exchange of a Partnership Interest (2 of 2) ® Incorporation Tax consequences depend on how incorporation is accomplished ® Formation of an LLC or LLP If LLC elects to be taxed as a corp, treatment same as for incorporation If LLP or LLLP, same tax-free treatment as partnership-to-partnership transfer © 2009 Pearson Education, Inc. Publishing as Prentice 10 -26

Termination of a Partnership (1 of 4) ® IRC & state laws treat terminations differently ® Termination events (IRC) No business operated as a partnership Sale or exchange of 50% interest w/in 12 -month period © 2009 Pearson Education, Inc. Publishing as Prentice 10 -27

Termination of a Partnership (2 of 4) ® Effects of termination Tax year closes upon termination Could cause short tax year to fall in same calendar year as regular 12 -month tax year © 2009 Pearson Education, Inc. Publishing as Prentice 10 -28

Termination of a Partnership (3 of 4) ® Effects of termination (continued) If termination occurs because of sale of > 50% ownership interest ¬“Old” partnership contributes assets to “new” partnership in exchange for 100% of new partnership ¬Basis and holding period of assets in new partnership same as in old partnership ¬Old partnership distributes new partnership interests to partners and liquidates ¬Partners’ basis in new partnership unchanged 10 -29

Termination of a Partnership (4 of 4) If termination occurs because of sale of > 50% ownership interest ¬“Old” ptrshp contributes assets to “new” ptrshp in exchange for 100% of new ptrshp ¬Basis and holding period of assets in new ptrshp same as in old ptrshp ¬Old ptrshp distributes new ptrshp interests to partners and liquidates ¬Partners’ basis in new ptrshp unchanged © 2009 Pearson Education, Inc. Publishing as Prentice 10 -30

Mergers and Consolidations ® Two or more partnerships join to form a new partnership ® If partners of “Old 1” own > 50% of New partnership, then Old 1 partnership is deemed to be continued All other old partnerships deemed to terminate ¬Possible that no old partnership continues © 2009 Pearson Education, Inc. Publishing as Prentice 10 -31

Division of a Partnership ® One partnership divided into two or more partnerships ® New partnerships whose partners own collectively > 50% of interests in old partnerships are considered a continuation of the old partnership © 2009 Pearson Education, Inc. Publishing as Prentice 10 -32

Basis Adjustments (1 of 4) ® New partner’s outside basis Purchase price plus new partner’s share of partnership liabilities ® New partner’s inside basis likely different than outside basis © 2009 Pearson Education, Inc. Publishing as Prentice 10 -33

Basis Adjustments (2 of 4) ® Optional § 754 adjustment allows partnership to adjust basis of partnership assets for new partner’s share of partnership assets Basis adjustment belongs only to new partner © 2009 Pearson Education, Inc. Publishing as Prentice 10 -34

Basis Adjustments (3 of 4) ® Example If § 754 adjustment is $30, 000 and new partner is 1/3 partner, then new partner’s inside basis increases by $10, 000 ($30, 000 x 1/3) © 2009 Pearson Education, Inc. Publishing as Prentice 10 -35

Basis Adjustments (4 of 4) ® Mandatory basis adjustment for substantial built-in loss Substantial if Built-in loss > $250 K, Exchange of partnership interest, AND No § 754 optional basis adjustment election in effect © 2009 Pearson Education, Inc. Publishing as Prentice 10 -36

Special Forms of Partnerships ® Tax shelters and limited partnerships ® Publicly traded partnerships ® Electing large partnerships ® Limited Liability Companies (LLC) ® Limited Liability Partnerships (LLP) © 2009 Pearson Education, Inc. Publishing as Prentice 10 -37

Publicly Traded Partnerships ® PTPs are partnerships whose interests are traded on an established securities exchange ® PTPs are taxed as a corporation unless 90% of income is “qualifying income” E. g. , Certain interest, dividends, real property rents © 2009 Pearson Education, Inc. Publishing as Prentice 10 -38

Limited Liability Companies (LLCs) ® May be taxed as a partnership or a corp using check-the-box regs ® Allows entity to obtain pass-through and flexibility of partnership allocations while maintaining limited liability of a corp © 2009 Pearson Education, Inc. Publishing as Prentice 10 -39

Limited Liability Partnerships (LLPs) ® Used by many professional organizations ® Taxed as a partnership ® Partners not liable for failures in work of other partners or people supervised by other partners © 2009 Pearson Education, Inc. Publishing as Prentice 10 -40

Limited Liability Limited Partnership ® Allowed by some states ® Formed under state’s limited partnership laws ® General partners have limited liability ® LLLP potentially useful in states where PSCs cannot be LLCs © 2009 Pearson Education, Inc. Publishing as Prentice 10 -41

Electing Large Partnerships ® ELP Qualifications ® ELP taxable income ® ELP: Termination of

ELP Qualifications ® Non-service partnership ® Not engaged in commodity trading ® Have at least 100 partners ® File an election to be taxed as a large partnership © 2009 Pearson Education, Inc. Publishing as Prentice 10 -43

ELP Taxable Income ® Misc. itemized deductions combined & subject to a 70% deduction at partner level Remaining misc. deductions combined w/other partnership income ® Charitable contributions combined and not separately stated by partners ® § 179 deductions combined © 2009 Pearson Education, Inc. Publishing as Prentice 10 -44

ELP: Termination of Partnership ® Termination occurs only upon cessation of any business, financial operation, or venture ® Termination does not occur upon transfer of 50% ownership © 2009 Pearson Education, Inc. Publishing as Prentice 10 -45

ELP: Audit Rules ® Partners must report all items in same manner as partnership ® Audit findings & agreements reached at partnership level binding on all partners ® Audit decisions binding on partners who own interest in year of decision, not year of contested transaction © 2009 Pearson Education, Inc. Publishing as Prentice 10 -46

Tax Planning Considerations ® Tax 1. treatments of partner withdrawal Liquidating distribution OR Partnership increases basis in § 751 assets ¬ xfer of >50% interest ptrshp not terminated ¬ 2. Sale of partnership interest to partnership ¬ xfer of >50% interest terminates ptrshp Optional basis adjustments affect each option differently © 2009 Pearson Education, Inc. Publishing as Prentice 10 -47

Comments or questions about Power. Point Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard. newmark@Ph. Duh. com © 2009 Pearson Education, Inc. Publishing as Prentice Hall 10 -48