Federal Tax Issues Cont and California Taxation of Partnerships and LLCs BUS 223G PARTNERSHIP DISTRIBUTIONS Distributions The Basics Typically assets paid to a partner by a partnership if not paid in exchange for services or the use of property are classified as partnership distributions Most of the time partnership distributions are made in the form of cash via check wire transfer etc Distributions The Basics There are two main types of distributions 1 Operating also referred to as current or nonliquidating distributions 2 Liquidating Distributions Nonliquidating Operating Distributions These are the most regular and common type of distribution It is a distribution that does not completely terminate the partner s interest in the partnership Generally but with some very important exceptions a current distribution of either cash or property is a nontaxable transaction to both the recipient partner and the partnership The partnership reduces the recipient partner s capital account and recognizes no taxable gain or loss The partner s outside basis is reduced based on the amount of the distribution cash or the ADJUSTED BASIS of the non cash property but not below zero Nonliquidating Distributions Partner generally takes a carryover basis in the assets distributed Example of a non cash nonliquidating distribution Partnership ABC makes a distribution of a computer to a partner Computer FMV of 500 and the partnership inside basis in the computer right before the distribution was 150 The partner normally we will go over an exception later has an initial basis in the computer of 150 carryover basis after it received the computer as a distribution Nonliquidating Distributions Other important impacts to partner 1 The partner s holding period on the assets distributed to them are also carried over from the holding period in the partnership s hands prior to the distribution For example the partnership acquired construction equipment on 7 3 2010 and distributes it to partner on 6 5 2022 Partner s beginning holding period for the equipment is 7 3 2010 NOT on 6 5 22 2 Partner s outside basis in partnership interest is reduced by amount of cash and the basis of the property distributed to them by the partnership Nonliquidating Distributions When Taxable to Partner In certain situations nonliquidating distributions are taxable to the partner Taxable to the extent cash received exceeds partner s adjusted basis outside basis in partnership interest Important reminder a reduction in partner s share of partnership debt is treated as a distribution of cash Nonliquidating CASH Distributions When Taxable to Steps to Calculate Extent of Taxable Nonliquidating CASH Partner Distributions 1 Cash is deemed to be distributed first and it reduces partner s outside basis in partnership 2 Once partner s outside basis reaches zero any additional cash distributions results in taxable gain to the partner Nonliquidating NON CASH Distributions When Taxable to Partner Unlike cash distributions in general there is no gain recognized on a property distribution to a partner remember outside basis is reduced by basis of assets received in the distribution However if the inside basis of property distributed exceeds partner s outside basis in partnership interest the distributed non cash asset takes a substituted basis based on the partner s remaining OUTSIDE basis Example of Noncash Nonliquidating Distribution to Partner Excess of Outside Basis Aries has a 50 000 outside basis in the partnership Partnership distributes land to Aries FMV and Inside Basis of 60 000 Because distribution is non cash no gain recognized by Aries even though inside basis of the asset 60 000 Aries outside basis 50 000 However because of the 10 000 excess inside basis of assets over Aries outside basis Aries takes a basis in the land of only 50 000 not a carryover basis of 60 000 Question What is Aries outside tax basis in the partnership after this distribution Mixture of Cash and Non Cash Distribution If a partner receives a MIX of cash and non cash property in a distribution assets received must be calculated in a specific order Ordering Rules 1 Cash 2 Unrealized receivables and inventory 3 All other assets Basis is allocated to assets within each category above based on adjusted basis to partnership Mixture of Cash and Non cash Distribution Example Joe has an outside basis in a partnership of 20 000 In a regular nonliquidating distribution he receives the following Inside Basis to the Partnership Pre 10 000 0 Distribution Cash A R Inventory 7 500 Equipment 12 000 Total basis of Assets Distributed 29 500 Mixture of Cash and Non cash Distribution Example Joe must handle the distributions IN ORDER Here s how each part of the distribution impacts Joe Impact to Joe s Outside Basis 10 000 Recognized Cash None His remaining 10K in outside basis is allocated to the assets below Reduced from 20K to 10K Gain P ship s Basis 0 A R Inventory 7 500 Equipment 12 000 Joe s Basis in the Asset 0 7 500 2 500 10 000 total basis in assets to Joe Liquidating Distributions A liquidating distribution occurs when either 1 Partnership itself liquidates and distributes all its property to the partners or 2 Ongoing partnership redeems interest of one of its partners For example partner retires from the partnership Liquidating Distributions In general in a liquidating distribution 1 No gain or loss is recognized by partnership 2 Partner reduces outside basis in partnership interest by basis in property received at each level using Ordering Rules see previous slides 3 Partner s entire outside basis in interest will be absorbed by distributed assets However there are exceptions to this general rule Liquidating Distributions Gain is recognized in a liquidating distribution if most common situation Cash distributed exceeds partner s basis Liquidating Distributions Loss is recognized only if 1 Assets received include only cash unrealized receivables and or inventory and 2 The partner s outside basis exceeds partnership s inside basis in distributed property Important note If ANY property other than cash unrealized receivables and inventory are distributed then NO loss may be recognized by the partner on the liquidating distribution Liquidating Distributions Example 1 Liquidating Distributions Example 2 Same facts as in Example 1 but this time Ramon also receives as part of the liquidating distribution a desk with a inside basis to the partnership of 100 Because of the
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