Limited Partnerships

June 21, 2024

7755 / How does a limited partner treat the amount realized on a sale of a partnership interest?

<div class="Section1"> If the amount the partner realizes (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7754">7754</a>) exceeds the partner’s adjusted basis in the partnership interest, the gain is capital gain except that if part of the amount realized (whether it is more or less than the basis) is attributable to a share of certain ordinary income property (i.e., partnership assets which, if sold, would result in ordinary gain), part of the amount realized (not just part of the gain) will generally have to be treated as ordinary income.<a href="#_ftn1" name="_ftnref1">1</a> The IRC uses the terms “unrealized receivables” and “inventory items of the partnership” to identify the kinds of ordinary income property.<a href="#_ftn2" name="_ftnref2">2</a> These items are also often called “hot assets” or “IRC Section 751 property.” In effect, a sale of a partnership interest is treated as two transactions, a sale of “IRC Section 751 property” and a sale of other property. <hr> Planning Point: In fact, although this situation is not common, the transaction may have to be further broken up, into as many as four transactions, to the extent the partnership’s assets, if sold, would generate collectibles gain (taxed at a maximum 28 percent rate) and unrecaptured section 1250 gain (taxed at a maximum 25 percent rate), as well as the more traditional capital gain and ordinary income.<a href="#_ftn3" name="_ftnref3">3</a> <hr> In order to determine the gain or loss on each sale, the total amount realized by the partner on sale of the interest and the partner’s adjusted basis in the interest must each be allocated between the share of the partnership’s IRC Section 751 property and the share of other property.<a href="#_ftn4" name="_ftnref4">4</a> IRC Section 751 property includes much more than the term “unrealized receivables,” on its face, suggests. In order to prevent the conversion of ordinary income on certain items of partnership property to capital gain, Congress has frequently used the term “unrealized receivables” as a catch-all for various items generating ordinary income. Thus, for example, the term includes potential depreciation recapture computed as if the property had been sold by the partnership at its fair market value at the time the partnership interest is sold, and amounts that would be treated as ordinary income attributable to market discount if the partnership had sold market discount bonds (issued after July 18, 1984) or short term obligations it held.<a href="#_ftn5" name="_ftnref5">5</a> (See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7645">7645</a> regarding market discount bonds, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7626">7626</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7628">7628</a> address short term obligations.) The term “inventory items” includes property held primarily for sale to customers and other property that would not be considered a capital asset or “IRC Section 1231” property.<a href="#_ftn6" name="_ftnref6">6</a> The amount realized by a partner upon the sale or exchange of an interest in IRC Section 751 property is the amount of income or loss from IRC Section 751 property that would have been allocated to the partner if the partnership had sold all of its property in a taxable transaction in an amount equal to the fair market value of the property immediately before the partner’s transfer of the interest in the partnership. Any gain or loss recognized that is attributable to IRC Section 751 property is ordinary gain or loss. The difference between the amount of capital gain or loss that the partner would realize in the absence of these rules and the amount of ordinary income or loss determined under these rules is the partner’s capital gain or loss on the sale of the partnership interest.<a href="#_ftn7" name="_ftnref7">7</a> It is possible to have ordinary income attributable to the sale of the interest in IRC Section 751 property and a capital loss attributable to the sale of the interest in the other property. Example. Partner B sells a one-half interest in partnership AB, when the balance sheet is: <table align="center" style="border-collapse: collapse;"> <tbody> <tr> <td colspan="3" width="246">Assets</td> <td colspan="3" width="237">Liabilities and Capital</td> </tr> <tr> <td width="91" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="63" style="border: 1px solid #3b3b3b;padding: 5px;">basis</td> <td width="92" style="border: 1px solid #3b3b3b;padding: 5px;">market value</td> <td width="82" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="69" style="border: 1px solid #3b3b3b;padding: 5px;">book value</td> <td width="86" style="border: 1px solid #3b3b3b;padding: 5px;">market value</td> </tr> <tr> <td width="91" style="border: 1px solid #3b3b3b;padding: 5px;">Cash</td> <td width="63" style="border: 1px solid #3b3b3b;padding: 5px;">$ 3,000</td> <td width="92" style="border: 1px solid #3b3b3b;padding: 5px;">$ 3,000</td> <td width="82" style="border: 1px solid #3b3b3b;padding: 5px;">Liabilities</td> <td width="69" style="border: 1px solid #3b3b3b;padding: 5px;">$ 2,000</td> <td width="86" style="border: 1px solid #3b3b3b;padding: 5px;">$ 2,000</td> </tr> <tr> <td width="91" style="border: 1px solid #3b3b3b;padding: 5px;">Capital</td> <td width="63" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="92" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="82" style="border: 1px solid #3b3b3b;padding: 5px;">Capital</td> <td width="69" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="86" style="border: 1px solid #3b3b3b;padding: 5px;"></td> </tr> <tr> <td width="91" style="border: 1px solid #3b3b3b;padding: 5px;">Assets</td> <td width="63" style="border: 1px solid #3b3b3b;padding: 5px;">17,000</td> <td width="92" style="border: 1px solid #3b3b3b;padding: 5px;">15,000</td> <td width="82" style="border: 1px solid #3b3b3b;padding: 5px;">A</td> <td width="69" style="border: 1px solid #3b3b3b;padding: 5px;">9,000</td> <td width="86" style="border: 1px solid #3b3b3b;padding: 5px;">15,000</td> </tr> <tr> <td width="91" style="border: 1px solid #3b3b3b;padding: 5px;">Unrealized</td> <td width="63" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="92" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="82" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="69" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="86" style="border: 1px solid #3b3b3b;padding: 5px;"></td> </tr> <tr> <td width="91" style="border: 1px solid #3b3b3b;padding: 5px;">receivables</td> <td width="63" style="border: 1px solid #3b3b3b;padding: 5px;">0</td> <td width="92" style="border: 1px solid #3b3b3b;padding: 5px;">14,000</td> <td width="82" style="border: 1px solid #3b3b3b;padding: 5px;">B</td> <td width="69" style="border: 1px solid #3b3b3b;padding: 5px;">9,000</td> <td width="86" style="border: 1px solid #3b3b3b;padding: 5px;">15,000</td> </tr> <tr> <td width="91" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="63" style="border: 1px solid #3b3b3b;padding: 5px;">$20,000</td> <td width="92" style="border: 1px solid #3b3b3b;padding: 5px;">$32,000</td> <td width="82" style="border: 1px solid #3b3b3b;padding: 5px;"></td> <td width="69" style="border: 1px solid #3b3b3b;padding: 5px;">$20,000</td> <td width="86" style="border: 1px solid #3b3b3b;padding: 5px;">$32,000</td> </tr> </tbody> </table>     B receives $16,000 for his one-half interest ($15,000 in cash and $1,000 in reduction of partnership liabilities). B’s interest in partnership property includes his one-half interest in unrealized receivables worth $7,000. Thus, $7,000 of the $16,000 realized is considered received in exchange for his interest in unrealized receivables and is therefore ordinary income. B’s basis for his partnership interest is $10,000. The difference between the amount of capital gain or loss that the partner would realize in the absence of IRC Section 751 ($16,000 - $10,000 = $6,000) and the amount of ordinary income or loss determined above ($7,000) is B’s capital gain or loss on the sale of its partnership interest. In this case, B will recognize a $1,000 capital loss.<a href="#_ftn8" name="_ftnref8">8</a> On sale of an interest in an upper tier partnership, a proportionate share of the lower tier partnership’s “unrealized receivables” and “inventory items” will be deemed sold.<a href="#_ftn9" name="_ftnref9">9</a> Regulations require a statement relating to the sale.<a href="#_ftn10" name="_ftnref10">10</a> The partner’s distributive shares of partnership gains and losses are included in the return for the year of sale, and are not part of the sale proceeds (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7753">7753</a>). Any such income increases basis. If the partner fails to consider this when selling the partnership interest, the partner may realize ordinary income from operations instead of gain on the sale. Gain or loss from sale of a partnership interest is generally treated as passive for purposes of the “passive loss” rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8010">8010</a> through Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8021">8021</a>) if the activity is passive with respect to the partner (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8011">8011</a>). Partnership interests in different partnerships are not eligible for non-recognition treatment under the like-kind exchange rules.<a href="#_ftn11" name="_ftnref11">11</a> (See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="710">710</a> regarding the like-kind exchange rules generally, and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7839">7839</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7840">7840</a> regarding like-kind exchanges of real estate. Note that like-kind exchange treatment under IRC Section 1031 is now only available for exchanges of real property.) The installment sales rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="667">667</a>) are applied to the sale of a partnership interest in the same manner that the rules would be applied to a direct sale of the underlying assets. Thus, for example, the installment method cannot be used to report income from the sale of a partnership interest to the extent that the sales proceeds represent income attributable to the partnership’s inventory items, which would not qualify for installment treatment if sold directly.<a href="#_ftn12" name="_ftnref12">12</a> Similarly, the installment method cannot be used to report gain on the sale of a partnership interest attributable to depreciation recapture, which is an unrealized receivable for these purposes,<a href="#_ftn13" name="_ftnref13">13</a> and it is generally assumed that the same rule applies to gain attributable to any other unrealized receivable as well. The underlying principle is that the installment method can be used to defer recognition of capital gain, but not of ordinary income. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.      IRC § 741. <a href="#_ftnref2" name="_ftn2">2</a>.      IRC § 751. <a href="#_ftnref3" name="_ftn3">3</a>.      See Treas. Reg. § 1.1(h)-1. <a href="#_ftnref4" name="_ftn4">4</a>.      IRC §§ 741, 751. <a href="#_ftnref5" name="_ftn5">5</a>.      IRC § 751(c). <a href="#_ftnref6" name="_ftn6">6</a>.      IRC § 751(d). <a href="#_ftnref7" name="_ftn7">7</a>.      Treas. Reg. § 1.751-1(a)(2). <a href="#_ftnref8" name="_ftn8">8</a>.      Treas. Reg. § 1.751-1(g)(Ex. 1). <a href="#_ftnref9" name="_ftn9">9</a>.      Madorin v. Comm., 84 TC 667 (1985); IRC § 751(f). <a href="#_ftnref10" name="_ftn10">10</a>.    Treas. Reg. § 1.751-1(a)(3). <a href="#_ftnref11" name="_ftn11">11</a>.    IRC § 1031(a)(2)(D). <a href="#_ftnref12" name="_ftn12">12</a>.    IRC § 453(b)(2)(B); Rev. Rul. 89-108, 1989 CB 100. <a href="#_ftnref13" name="_ftn13">13</a>.    IRC §§ 751(c), 453(i). </div></div>

March 13, 2024

7767 / What is the Subchapter K (partnership) anti-abuse rule?

<div class="Section1"> Subchapter K provides rules governing the formation of partnerships to conduct business transactions without incurring an entity-level tax. The partnership must be bona fide, and transactions must be entered into for a substantial business purpose. The transactions must be respected under substance over form principles, and the tax consequences of the transactions must accurately reflect the partners’ economic agreement and clearly reflect the partner’s income.<a href="#_ftn1" name="_ftnref1">1</a> The anti-abuse rule provides that if a partnership is involved in a transaction with a principal purpose of substantially reducing the present value of the partners’ aggregate tax liability in a manner that is inconsistent with the intent of subchapter K, the IRS can recast the transaction for federal tax purposes to achieve tax results that are consistent with subchapter K.<a href="#_ftn2" name="_ftnref2">2</a> The anti-abuse rule applies only to income taxes, which are governed under IRC subtitle A. It does not apply to transfer taxes, such as estate and gift taxes, which are governed under IRC subtitle B.<a href="#_ftn3" name="_ftnref3">3</a> The determination as to whether a partnership has violated the anti-abuse rule will be based on an analysis of all of the facts and circumstances, including a comparison of the purported business purpose of the transaction and the claimed tax benefits resulting therefrom. Factors to be considered include whether: (1) the present value of the partners’ aggregate federal tax liability is substantially less than (a) if the assets were owned and business conducted directly, or (b) if separate transactions were integrated and treated as a single transaction; (2) necessary partners either have a nominal interest in the partnership, are substantially protected from any risk of loss from the partnership’s activities, or have little or no participation in the profits from the partnership’s activities other than a preferred return; (3) substantially all of the partners are related to one another, either directly or indirectly; (4) partnership items are allocated in compliance with Treasury Regulation Sections 1.704-1 and 1.704, but the results are inconsistent with the purpose of IRC Section 704(b) and these regulations (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7740">7740</a>); (5) the benefits and burdens of ownership of partnership property are either substantially retained by the contributing partner or substantially shifted to a distributee partner.<a href="#_ftn4" name="_ftnref4">4</a> These regulations generally apply to transactions occurring after May 11, 1994.<a href="#_ftn5" name="_ftnref5">5</a> Further, the regulations allow the IRS to treat a partnership as an aggregate of its partners, unless IRC provisions prescribe the treatment of a partnership as an entity and that treatment and resulting tax implications are clearly contemplated by those IRC provisions.<a href="#_ftn6" name="_ftnref6">6</a> This provision is effective for transactions occurring after December 28, 1994.<a href="#_ftn7" name="_ftnref7">7</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 1.701(a). <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 1.701(b). <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.701(h). <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.701(c). <a href="#_ftnref5" name="_ftn5">5</a>. Treas. Reg. § 1.701(g). <a href="#_ftnref6" name="_ftn6">6</a>. Treas. Reg. § 1.701(e). <a href="#_ftnref7" name="_ftn7">7</a>. Treas. Reg. § 1.701(g). </div></div>

March 13, 2024

7766 / What is the effect of a partnership not electing to adjust the basis of partnership property on the sale or exchange of a partnership interest or on the death of a limited partner?

<div class="Section1"> Large syndicated limited partnerships generally state that they will not elect to adjust the partnership basis in property on the sale or exchange of an interest or on the death of a partner. Failure to make the election can have unfavorable tax consequences for an individual who purchases or succeeds to an interest. Generally, a partner’s adjusted basis in a partnership interest reflects the partner’s proportionate share of the partnership’s basis in its property. However, this is not necessarily true of a person who buys or succeeds to a partnership interest from another partner. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7757">7757</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7765">7765</a>. Example. A, B, and C are partners in a partnership having $3,000 in cash, and real property with an adjusted basis of $24,000. Each partner’s adjusted basis in his partnership interest is $9,000. C sells his 1/3 interest in the partnership to D for $15,000, at a time when the fair market value of the land is $42,000. The balance sheet of the partnership at the date of sale shows the following: <table align="center"> <tbody> <tr> <td width="49"></td> <td colspan="2" width="204">Assets</td> <td width="24"></td> <td colspan="2" width="206">Capital</td> </tr> <tr> <td width="49">Assets</td> <td width="105">adjusted basis</td> <td width="99">market value</td> <td width="24"></td> <td width="105">adjusted basis</td> <td width="101">market value</td> </tr> <tr> <td width="49">cash</td> <td width="105">$ 3,000</td> <td width="99">$ 3,000</td> <td width="24">A</td> <td width="105">$ 9,000</td> <td width="101">$15,000</td> </tr> <tr> <td width="49">land</td> <td width="105">24,000</td> <td width="99">42,000</td> <td width="24">B</td> <td width="105">9,000</td> <td width="101">15,000</td> </tr> <tr> <td width="49"></td> <td width="105">$27,000</td> <td width="99">$45,000</td> <td width="24">C</td> <td width="105">9,000</td> <td width="101">15,000</td> </tr> </tbody> </table> Following the sale, the partnership’s adjusted basis in its property remains at $27,000 and each partner’s share of partnership basis remains at $9,000, but D’s basis in his partnership interest is $15,000, its cost to D. If the land is sold in 2024 for $42,000, its fair market value, the partnership will realize a capital gain of $18,000. Each partner must report a capital gain of $6,000 as the partner’s distributive share of the partnership gain. In effect, D is now realizing gain and paying tax on $6,000 of appreciation that was already included in the purchase price paid to C (and that was taxed to C at that time). Assume the partnership terminates in 2025, distributing $15,000 to each partner in liquidation of his or her 1/3 interest. D has an adjusted basis of $21,000 in the partnership interest ($15,000 purchase price plus $6,000 distributive share of capital gain) and so will have a $6,000 capital loss in 2024 on the liquidation of the interest. However, D’s capital loss in 2025 will not make D whole for the capital gain in 2024. D’s $6,000 loss may be of limited use in 2025, and D will have lost use of the amount paid in taxes in 2024. In acknowledgement of the unfair results (of course, if these would be the results, D should probably not have paid $15,000 for the interest in the first place), the IRC permits the partnership to elect to adjust the partnership’s basis in partnership property with respect to a partner to whom an interest in a partnership is transferred by sale or exchange or on the death of a partner. (Adjustment is not made in the case of a gift.) Furthermore, for transfers after October 22, 2004, a basis adjustment is required if the partnership has a built-in loss of more than $250,000 immediately after the transfer. The adjustment decreases or increases the partnership’s basis in partnership assets by the amount by which the purchasing or succeeding partner’s basis in the interest exceeds or is less than the partner’s proportionate share of the adjusted basis of partnership property. The effect of the adjustment is limited to the particular partner.<a href="#_ftn1" name="_ftnref1">1</a> If a partnership is terminated by a sale of an interest in the partnership, an election under IRC Section 743 that is in effect for the year the sale occurs applies to the incoming partner. The bases of property are adjusted before their deemed contribution to the new partnership.<a href="#_ftn2" name="_ftnref2">2</a> Example. Under the facts in the above example, if the election had been in effect with respect to C’s transfer to D, A’s share of partnership basis would have continued to be $9,000, B’s share of partnership basis would have continued to be $9,000 and D’s share would have been adjusted to $15,000. Thus on sale of the property in 2024, D’s account would not reflect a share of the gain: <table align="center"> <tbody> <tr> <td width="166"></td> <td width="93">Partnership</td> <td width="74">A’s share</td> <td width="73">B’s share</td> <td width="78">D’s share</td> </tr> <tr> <td width="166">Sale price of land</td> <td width="93">$42,000</td> <td width="74">$14,000</td> <td width="73">$14,000</td> <td width="78">$14,000</td> </tr> <tr> <td width="166">Less adjusted basis</td> <td width="93"></td> <td width="74"></td> <td width="73"></td> <td width="78"></td> </tr> <tr> <td width="166">common basis</td> <td width="93">24,000</td> <td width="74">8,000</td> <td width="73">8,000</td> <td width="78">8,000</td> </tr> <tr> <td width="166">adjustment to</td> <td width="93"></td> <td width="74"></td> <td width="73"></td> <td width="78"></td> </tr> <tr> <td width="166">partnership basis</td> <td width="93"></td> <td width="74"></td> <td width="73"></td> <td width="78"></td> </tr> <tr> <td width="166">for D </td> <td width="93">6,000</td> <td width="74">0</td> <td width="73">0</td> <td width="78">6,000</td> </tr> <tr> <td width="166">Total adjusted basis</td> <td width="93">$30,000</td> <td width="74">$8,000</td> <td width="73">$8,000</td> <td width="78">$14,000</td> </tr> <tr> <td width="166">Taxable gain from sale</td> <td width="93">$12,000</td> <td width="74">$ 6,000</td> <td width="73">$ 6,000</td> <td width="78">$ 0</td> </tr> </tbody> </table> If, instead of selling the interest, C dies in 2024 and D succeeds to C’s interest, D’s basis would be stepped up to the fair market value on date of death.<a href="#_ftn3" name="_ftnref3">3</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7763">7763</a>. Therefore, D would have a problem similar to that of the purchaser of an interest, if the partnership does not make the election. An incoming partner of an upper-tier partnership (UTP) is entitled to an adjustment in his or her share of the lower-tier partnership’s (LTP) adjusted basis in the LTP’s partnership property, if and only if, the election has been made by both the UTP and the LTP.<a href="#_ftn4" name="_ftnref4">4</a> Regulations require that the election be filed with the partnership return for the taxable year during which the transfer occurs.<a href="#_ftn5" name="_ftnref5">5</a> In the case of an electing large partnership, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7733">7733</a>. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 743. <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 1.708-1(b)(5). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 1014(a). <a href="#_ftnref4" name="_ftn4">4</a>. Rev. Rul. 87-115, 1987 CB 163. <a href="#_ftnref5" name="_ftn5">5</a>. Treas. Reg. § 1.754-1(b)(1). </div></div>

March 13, 2024

7765 / What is the basis of the estate or other successor in interest in a limited partnership?

<div class="Section1">The estate or other successor in interest has a basis in the partnership interest “stepped up” (or down) to the fair market value of the interest on the date of death, or alternative valuation date used for estate tax purposes, increased by the estate’s (or successor’s) share of partnership liabilities on that date, and reduced to the extent the value is attributable to items of income in respect of a decedent.<a href="#_ftn1" name="_ftnref1">1</a> A modified carryover basis may replace stepped up basis for property acquired from a decedent dying in 2010. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="692">692</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="747">747</a>. For partnership tax years beginning after 1997, the partnership tax year ends with respect to a partner who dies (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7763">7763</a>). For partnership tax years beginning before 1998, the distributive share attributable to the period ending with the date of death which was taxable to the estate or successor was income in respect of a decedent, not part of the basis.<a href="#_ftn2" name="_ftnref2">2</a><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 1.742-1. <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. §§ 1.753-1(b), 1.706-1(c)(2). </div></div>

March 13, 2024

7764 / Does a limited partner realize gain or loss on his partnership interest at death?

<div class="Section1">No. The transfer of assets to an estate on the death of a taxpayer is not considered a taxable sale or exchange.</div>

March 13, 2024

7753 / What is a partner's distributive share of partnership income and loss in the year he or she sells, exchanges, or liquidates an entire partnership interest?

<div class="Section1"> A partner includes the distributive share of partnership items up to the time of sale, exchange, or liquidation. The taxable year of the partnership closes with respect to the partner when the partner sells or exchanges his or her entire interest in the partnership, or if the interest is liquidated, but does not close with respect to any other partner<a href="#_ftn1" name="_ftnref1">1</a> (unless the sale causes the partnership to terminate).<a href="#_ftn2" name="_ftnref2">2</a> A partnership is considered terminated only if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners. Thus, the distributive share of income or loss for the short partnership year resulting from the disposition is included in the tax year in which the sale is made, because that is the year in which the short partnership year ends as to the partner leaving the partnership. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7736">7736</a>.If the partnership and partner have different years (i.e., the partnership is on a fiscal year and the individual uses a calendar tax year), it is possible that both a regular full partnership year and the short partnership year will end in the same year of the individual. Consequently, there can be a bunching of more than one year’s partnership income (or loss) in one year’s return of the individual. The partner’s distributive share of partnership income for the part of the partnership year that ends when he or she sells, exchanges, or liquidates the interest may be determined under the method used to determine a new partner’s share, as discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7746">7746</a>. The partnership year does not end as to a partner who disposes of less than his or her entire interest<a href="#_ftn3" name="_ftnref3">3</a> (again assuming the disposition does not cause a termination of the partnership). A liquidation is a termination of a partner’s interest by a distribution or a series of distributions to the partner from the partnership. The entire interest of a partner is not liquidated until the final distribution of a series is made. Thus, the partnership year does not close with respect to a liquidating partner until the final distribution.<a href="#_ftn4" name="_ftnref4">4</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 706(c). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 708(b)(1)(B) (note that the 2017 tax reform legislation eliminated the technical termination rule for tax years beginning after 2017, which previously provided for termination if, within a 12-month period, 50 percent or more of the total interest in partnership capital and profits had been sold or exchanged). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 706(c)(2)(B). <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.706-1(c). </div></div>

March 13, 2024

7757 / What is an individual's basis in a partnership interest that is purchased from a limited partner?

<div class="Section1">The initial basis of a purchased interest is its cost basis and thereafter it is adjusted, as explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7737">7737</a>.<a href="#_ftn1" name="_ftnref1">1</a><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 1.742-1. </div></div>

March 13, 2024

7759 / Does a limited partner report partnership income and losses in the year a gift is made of a limited partnership interest?

<div class="Section1">A partner includes the distributive share of partnership items up to the time of the gift of the interest. The taxable year of the partnership closes with respect to the partner when the partner gives away his or her entire interest in the partnership, but does not close with respect to any other partner.<a href="#_ftn1" name="_ftnref1">1</a> Thus, the distributive share of income or loss for the short partnership year resulting from the gift is included in the tax year in which the gift is made, because that is the year in which the short partnership year ends as to the donor partner. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7736">7736</a>. <hr> Planning Point: If the partnership and partner have different years (i.e., the partnership is on a fiscal year and the individual uses a calendar tax year), it is possible that both a regular full partnership year and the short partnership year will end in the same year of the individual. Consequently, there can be a bunching of more than one year’s partnership income (or loss) in one year’s return of the individual. The partnership year does not end as to a partner who terminates less than the entire interest.<a href="#_ftn2" name="_ftnref2">2</a> <hr> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 706(c). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 706(c)(2)(B). </div></div>

March 13, 2024

7761 / Does the grantor of a grantor trust that owns a partnership interest realize gain when the grantor renounces retained powers and the trust ceases to be treated as a grantor trust?

<div class="Section1">The IRS and the Tax Court take the position that there is gain. They reason that where a grantor of a trust retains certain powers, and as a result is treated as owner of the trust for tax purposes, the grantor is considered, for tax purposes, owner of a partnership interest purchased by the trust. As owner, the grantor reports the distributive share of partnership income, gains, losses, deductions, and credits allocable to the trust. When the grantor renounces the retained powers that resulted in the trust’s being classified as a grantor trust, the grantor is no longer considered owner of the trust’s assets. In effect, the grantor has transferred ownership of the partnership interest to the trust. On the transfer, the grantor is deemed to receive a share of partnership liabilities.<a href="#_ftn1" name="_ftnref1">1</a> The amount realized is taxable as proceeds of a sale, as discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7755">7755</a>. The fair market value of the interest in excess of the liability is a gift to the trust. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7760">7760</a>.<div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. Madorin v. Comm., 84 TC 667 (1985); Treas. Reg. § 1.1001(c)(Ex. 5); Rev. Rul. 77-402, 1977 CB 222. </div></div>

March 13, 2024

7763 / Is partnership income and loss included in a deceased partner's final return? In the return of his successor in interest?

<div class="Section1"> The taxable year of a partnership will close with respect to a limited partner whose entire interest in the partnership terminates for any reason, including the death of the limited partner.<a href="#_ftn1" name="_ftnref1">1</a> A decedent’s own tax year also ends on the date of death and is ordinarily a short year.<a href="#_ftn2" name="_ftnref2">2</a> Thus, since the partnership tax year and the decedent’s tax year will end on the same day, partnership income or loss will be included in the decedent’s final return. If the successor sells or exchanges its entire interest, or its interest is liquidated, the partnership year will end as to the selling successor at the date of sale. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7753">7753</a>. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 706(c)(2)(A). <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 1.443-1(a)(2). </div></div>