assignment of partnership interest tax consequences

Marcum Announces Acquisition Agreement to Join CBIZ Learn More

• Newsletters
• Client Portal
• Make Payment
• (855) Marcum1

Search our Services and Industries

Tax issues to consider when a partnership interest is transferred.

By Colleen McHugh - Co‑Partner‑in‑Charge, Alternative Investments

There can be several tax consequences as a result of a transfer of a partnership interest during the year. This article discusses some of those tax issues applicable to the partnership.

Adjustments to the Basis of Partnership Property Upon a transfer of a partnership interest, the partnership may elect to, or be required to, increase/decrease the basis of its assets. The basis adjustments will be for the benefit/detriment of the transferee partner only.

• If the partnership has a special election in place, known as an IRS Section 754 election, or will make one in the year of the transfer, the partnership will adjust the basis of its assets as a result of the transfer. IRS Section 754 allows a partnership to make an election to “step-up” the basis of the assets within a partnership when one of two events occurs: distribution of partnership property or transfer of an interest by a partner.
• The partnership will be required to adjust the basis of its assets when an interest in the partnership is transferred if the total adjusted basis of the partnership’s assets is greater than the total fair market value of the partnership’s assets by more than $250,000 at the time of the transfer.

Ordinary Income Recognized by the Transferor on the Sale of a Partnership Interest Typically, when a partnership interest is sold, the transferor (seller) will recognize capital gain/loss. However, a portion of the gain/loss could be treated as ordinary income to the extent the transferor partner exchanges all or a part of his interest in the partnership attributable to unrealized receivables or inventory items. (This is known as “Section 751(a) Property” or “hot” assets).

• Unrealized receivables – includes, to the extent not previously included in income, any rights (contractual or otherwise) to payment for (i) goods delivered, or to be delivered, to the extent the proceeds would be treated as amounts received from the sale or exchange of property other than a capital asset, or (ii) services rendered, or to be rendered.
• Property held primarily for sale to customers in the ordinary course of a trade or business.
• Any other property of the partnership which would be considered property other than a capital asset and other than property used in a trade or business.
• Any other property held by the partnership which, if held by the selling partner, would be considered of the type described above.

Example – Partner A sells his partnership interest to D and recognizes gain of $500,000 on the sale. The partnership holds some inventory property. If the partnership sold this inventory, Partner A would be allocated $100,000 of that gain. As a result, Partner A will recognize $100,000 of ordinary income and $400,000 of capital gain.

The partnership needs to provide the transferor with sufficient information in order to determine the amount of ordinary income/loss on the sale, if any.

Termination/Technical Termination of the Partnership A transfer of a partnership interest could result in an actual or technical termination of the partnership.

• The partnership will terminate on the date of transfer if there is one tax owner left after the transfer.
• The partnership will have a technical termination for tax purposes if within a 12-month period there is a sale or exchange of 50% or more of the total interest in the partnership’s capital and profits.

Example – D transfers its 55% interest to E. The transfer will result in the partnership having a technical termination because 50% or more of the total interest in the partnership was transferred. The partnership will terminate on the date of transfer and a “new” partnership will begin on the day after the transfer.

Allocation of Partnership Income to Transferor/Transferee Partners When a partnership interest is transferred during the year, there are two methods available to allocate the partnership income to the transferor/transferee partners: the interim closing method and the proration method.

• Interim closing method – Under this method, the partnership closes its books with respect to the transferor partner. Generally, the partnership calculates the taxable income from the beginning of the year to the date of transfer and determines the transferor’s share of that income. Similarly, the partnership calculates the taxable income from the date after the transfer to the end of the taxable year and determines the transferee’s share of that income. (Note that certain items must be prorated.)

Example – Partner A transfers his 10% interest to H on June 30. The partnership’s taxable income for the year is $150,000. Under the interim closing method, the partnership calculates the taxable income from 1/1 – 6/30 to be $100,000 and from 7/1-12/31 to be $50,000. Partner A will be allocated $10,000 [$100,000*10%] and Partner H will be allocated $5,000 [$50,000*10%].

• Proration method – this method is allowed if agreed to by the partners (typically discussed in the partnership agreement). Under this method, the partnership allocates to the transferor his prorata share of the amount of partnership items that would be included in his taxable income had he been a partner for the entire year. The proration may be based on the portion of the taxable year that has elapsed prior to the transfer or may be determined under any other reasonable method.

Example – Partner A transfers his 10% interest to H on June 30. The partnership’s taxable income for the year is $150,000. Under the proration method, the income is treated as earned $74,384 from 1/1 – 6/30 [181 days/365 days*$150,000] and $75,616 from 7/1-12/31 [184 days/365 days*$150,000]. Partner A will be allocated $7,438 [$74,384*10%] and Partner H will be allocated $7,562 [$75,616*10%]. Note that this is one way to allocate the income. The partnership may use any reasonable method.

Change in Tax Year of the Partnership The transfer could result in a mandatory change in the partnership’s tax year. A partnership’s tax year is determined by reference to its partners. A partnership may not have a taxable year other than:

• The majority interest taxable year – this is the taxable year which, on each testing day, constituted the taxable year of one or more partners having an aggregate interest in partnership profits and capital of more than 50%.

Example – Partner A, an individual, transfers his 55% partnership interest to Corporation D, a C corporation with a year-end of June 30. Prior to the transfer, the partnership had a calendar year-end. As a result of the transfer, the partnership will be required to change its tax year to June 30 because Corporation D now owns the majority interest.

• If there is no majority interest taxable year or principal partners, (a partner having a 5% or more in the partnership profits or capital) then the partnership adopts the year which results in the least aggregate deferral.

Change in Partnership’s Accounting Method A transfer of a partnership interest may require the partnership to change its method of accounting. Generally, a partnership may not use the cash method of accounting if it has a C corporation as a partner. Therefore, a transfer of a partnership interest to a C corporation could result in the partnership being required to change from the cash method to the accrual method.

As described in this article, a transfer of a partnership interest involves an analysis of several tax consequences. An analysis should always be done to ensure that any tax issues are dealt with timely.

If you or your business are involved in a transfer described above, please contact your Marcum Tax Professional for guidance on tax treatment.

Related Insights & News

Presidential Election 2024: What Trump vs. Harris Could Mean for Federal Business Taxes

The outcome of the upcoming presidential election may significantly affect the changes in federal income taxes on businesses.

Clearing the Fog: Anticipating the Impact of the 2025 Tax Cliff

Maximize savings and sustainability: exploring the ira’s comprehensive energy incentives, employee retention tax credit (ertc) claims under scrutiny: key irs developments explained, irs update: ertc claim processing amid moratorium and increased scrutiny, upcoming events.

Path to Prosperity: Preparing Your Business for the Future

Providence, RI

Innovate for Impact

Philadelphia, PA

Smart Selections: Enhancing Business Operations with the Right IT Systems

Wrigley Cyber Classic

Chicago, IL

Mission Possible: Nonprofits in the Age of Digital Finance

Washington, DC

Synergy in Security and Operations: The Top Ten Benefits of Consolidating IT Providers for NOC and SOC Services

Open Enrollment for Employee Benefits – Things to Consider

Marcum Women’s Initiative: Coffee and Conversations

Nashville, TN

Cyber Threats and Prevention: A Growing Concern for Businesses

Burlington, MA

Robotic Process Automation and AI: The Next Frontier in Finance Transformation

Building Hope: Mental Health and Suicide Prevention in the Construction Industry

Building Success: Navigating Contracts, Legal Landscapes, and Accounting Matters 

Marcum New England Life Science & Biotech Summit

New Haven, CT

Marcum New England Construction Summit

Marcum Manufacturing Forum

Cleveland, OH

Marcum Mid-South Construction Summit

Marcum Ohio Construction Summit

Warrensville Heights, OH

Economic & Market Update

Marcum Women’s Initiative: Floral Arrangement Class

South Portland, ME

Marcum Tech Top 40

Client Kickoff: Hawkeye Tailgate & Game Day 

Iowa City, IA

Dental Transition Services Social

Ballwin, MO

Foundations of Estate Planning – Wills, Trusts and other Essentials

Related service.

Tax & Business

Have a Question? Ask Marcum

The New Equation

Executive leadership hub - What’s important to the C-suite?

Tech Effect

Shared success benefits

Loading Results

No Match Found

Withholding and information reporting on the transfer of private partnership interests

November 2020

Treasury and the IRS released on October 7 Final Regulations (the Final Regulations ) under Sections 1446(f) and 864(c)(8). Section 1446(f), added to the Code by the 2017 tax reform legislation, provides rules for withholding on the transfer or disposition of a partnership interest. Proposed Regulations were issued in May 2019, which laid the framework for guidance on withholding and reporting obligations under Section 1446(f) (the Proposed Regulations). The Proposed Regulations also addressed information reporting under Section 864(c)(8); these rules were finalized in September 2020. The Final Regulations retain the basic structure and guidance of the Proposed Regulations, but with various modifications. 

The Final Regulations apply to both publicly traded partnerships (PTPs) and private partnerships. This insight summarizes some of the changes applicable to PTPs but primarily focuses on private partnerships. A separate detailed Insight will be circulated with respect to PTPs. 

The Final Regulations generally are applicable to transfers occurring on or after the date that is 60 days after their publication in the Federal Register. However, the backstop withholding rules only apply to transfers that occur on or after January 1, 2022.

PTPs . Significantly, beginning January 1, 2022, the Final Regulations will require withholding under Section 1446(f) on both dispositions of and distributions by PTPs. This is a significant evolution of these rules, which to date have not been extended to PTPs due to the informational and operational challenges associated with imposing withholding taxes in respect of publicly traded securities. As will be discussed in more detail in the separate alert, these challenges result from the expansion of withholding obligations to new parties (e.g., executing brokers) that traditionally may not have been withholding agents and a substantial expansion of the qualified intermediary (QI) obligations. 

Other partnerships . The Final Regulations retain the presumption that withholding is required unless an applicable certification is provided. However, they now provide a limitation on the transferee’s liability to the extent the transferee can establish the transferor had no tax liability under Section 864(c)(8). The Final Regulations also include new or expanded exceptions to the withholding requirements. These include the ability to rely on a valid Form W-9 to prove US status as well as a new exception from withholding for partnerships that are not engaged in a US trade or business.

Download the full publication Withholding and information reporting on the transfer of private partnership interests

The takeaway.

The Final Regulation package retains the basic approach and structure of the Proposed Regulations, with some modifications. Taxpayers (particularly minority partners and taxpayers in tiered structures) who are intending to either eliminate or reduce the withholding tax should be mindful of the time restrictions in order to be compliant with a reduction or elimination of withholding and the potential difficulty in obtaining information from a partnership and should plan accordingly.

• Final Regulations modify treatment of gain or loss on sale of partnership interest by foreign partner (October 21, 2020)
• PwC Client Comments re Section 1446(f) Proposed Regulations (July 12, 2019)
• Proposed regulations address tax withholding, information reporting on partnerships with US trade or business (May 31, 2019)

Our insights. Your choices.

Subscribe to receive our tax insights.

Related content

Tax services.

Delivering tax services, insights and guidance on US tax policy, tax reform, legislation, registration and tax law.

Sightline is a tax platform that makes the entire tax process more collaborative and insightful. Built by tax professionals for tax professionals.

2024 Tax Policy Outlook: Defining the choices ahead

The stakes rarely have been higher as business leaders seek to manage operations and plan investments in an environment of uncertain tax policy and tax changes....

Policy on Demand

Policy on Demand is a news platform that provides in-depth insights and analysis on tax policy, legislative and regulatory developments that impact your...

Krishnan Chandrasekhar

US Tax Leader, PwC US

© 2017 - 2024 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details.

• Data Privacy Framework
• Cookie info
• Terms and conditions
• Site provider
• Your Privacy Choices

Selling Your Partnership Interest? Form 8308, and New Penalty Relief, May Apply

by Shawn Smith, Jeffrey McMichael

Beginning with tax year 2023, partnerships that sell or exchange partnership interests must report additional information to the IRS, both on Form 8308 “Report of a Sale or Exchange of Certain Partnership Interests” and on their Schedule K-1 disclosures. The additional information is intended to help partners determine their tax liability when selling or exchanging their interests.  In October 2023, the IRS released a revised version of Form 8308 that adds a new part IV requiring calculations of gain or loss on the sale or exchange of certain partnership interests. The completed Form 8308, including the new part IV, must be sent to the transferor and transferee partners by January 31, 2024. Commentators have expressed concern to the IRS because, in many cases, partnerships will not have all of the information required to complete part IV of Form 8308 by the January 31, 2024, deadline.  As a result, in mid-January 2024 IRS Notice 2024-19 granted penalty relief for taxpayers who are unable to furnish a completed copy of Form 8308 to the transferor and transferee partners by the January 31 deadline. However, the completed form is still due to the IRS on that date. Below offers guidance on Form 8308 and the new penalty relief.

What Information Is Needed on Form 8308 When a Partnership Sells or Exchanges an Interest?

Partnerships must generally file Form 8308 to report the sale or exchange by a partner of all of part of their partnership interest where any money or other property received in the sale or exchange is attributable to unrealized receivables or inventory items as defined in Section 751(a), more commonly referred to as “hot assets.” The partnership must attach the completed Form 8308 to its timely filed tax return (including extensions) and furnish copies to the transferor and transferee partners of the transaction. The October 2023 revision to Form 8308 affects transfers occurring on or after January 1, 2023, and has expanded the reporting requirements of parts I and II, and added new parts III and IV: 

• Parts I-III require the partnership to disclosure more information about the transferor and transferee partners, the record holder and beneficial owner of the partnership interest immediately before and after the transaction, and the date and type of transfer. 
• Section 751(a) for “hot assets,” taxed at ordinary rates up to 37%;
• Section 1(h)(5) for collectibles, taxed at higher capital gain rates up to 28%; and
• Unrecaptured 1250 gain for real property, taxed at 25%.

In addition, the partnership must disclose the above gains on the transferor partner’s 2023 Schedule K-1 that is filed with the partnership’s Form 1065 tax return. The amounts are disclosed in Boxes 20AB, 20AC and 20AD, respectively. If a partnership is required to file Form 8308 due to a sale or exchange described in Section 751(a) and its regulations, the partnership must furnish a statement to the transferor and transferee involved in the transaction by the later of:

• January 31 of the year following the calendar year in which the exchange occurred, or
• 30 days after the partnership has received notice of the exchange. 

Generally, a partnership must use a completed Form 8308 as the required statement. However, the partnership can also furnish a separate statement to the transferor and transferee that includes the required information to be shown on Form 8308 with respect to the Section 751(a) transaction.

What Type of Penalty Relief Does Notice 2024-19 Provide for Form 8308?

Notice 2024-19 acknowledges the concerns taxpayers have with being able to timely furnish the information required in part IV of Form 8308 to the transferor and transferee partners. Therefore, the IRS will not impose penalties under Section 6722 for failure to furnish a completed Form 8308 to the transferor and transferee partners of a Section 751(a) exchange by the January 31, 2024, due date.  However, keep in mind this penalty relief applies only to the partnership furnishing the Form 8308 to the transferor and transferee partners , not to attaching a completed Form 8308 to the partnership’s timely filed tax return (including extensions).

How Does My Partnership Qualify for Relief Under Notice 2014-19?

To qualify for relief under Notice 2024-19, the partnership must do the following:

• Timely and correctly furnish the transferor and transferee partners a copy of Form 8308 with parts I, II and III completed, or a statement that includes the same information, by the later of January 31, 2024, or 30 days after the partnership is notified of the Section 751(a) exchange; and
• Provide the transferor and transferee partners a copy of the complete Form 8308, including part IV, or a statement that includes the same information, by the later of the due date of the partnership’s Form 1065 (including extensions) or 30 days after the partnership is notified of the Section 751(a) exchange.

Taxpayers that were involved in a sale or exchange of their partnership interest should notify their tax professional of the transaction and determine if filing Form 8308 is required, then discuss next steps to comply with the new reporting requirements for tax year 2023. Contact Shawn Smith at [email protected] , Jeffrey McMichael at [email protected] or a member of your service team to discuss this topic further. Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.

About the Authors

Shawn smith, cpa, jeffrey mcmichael, jd, related insights, new calculation method may result in fewer employee benefit plan audits moving forward, irs recommits to scrutiny of limited partners providing services to private funds, what entities are required to collect and report beneficial ownership information.

Receive insights from our team of private company specialists directly to your inbox as they go live in our online Knowledge Center.

Trending News

Related Practices & Jurisdictions

• Administrative Regulatory
• All Federal

The US Department of the Treasury and Internal Revenue Service (IRS) recently issued  final regulations under section 1446(f) , a provision enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA) that generally imposes a withholding obligation on transfers of certain partnership interests (Note: All references to “section” are to the Internal Revenue Code of 1986, as amended (the “Code”) unless otherwise indicated). That provision, in conjunction with the enactment of section 864(c)(8) also under the TCJA, imposes a new statutory scheme in response to the ruling of the Tax Court in  Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner , 149 TC No. 3 (2017), aff’d, 926 F.3d 819 (DC Cir. June 11, 2019). The final regulations largely retained the rules set forth in the proposed regulations, with some additions and modifications. The following discusses some of the noteworthy provisions in the regulations.

SECTIONS 864(C)(8) AND 1446(F): IN GENERAL

Section 864(c)(8) generally provides that gain or loss derived by a nonresident individual or foreign corporation from the sale or exchange (or other disposition) of an interest in a partnership engaged in a US trade or business is treated as effectively connected income (ECI) to the same extent as such partner’s portion of distributive share of gain or loss that would have been ECI if the partnership had sold all of its assets at their fair market value as of the date of the partner’s sale or exchange. Section 864(c)(8) further provides that withholding is not required to the extent a transferor provides a nonforeign affidavit to the transferee, or if other regulatory exceptions are adopted (as discussed below).

Section 1446(f) generally requires a transferee of a partnership interest described in section 864(c)(8) to withhold 10% of the amount realized by the transferor. Moreover, if the transferee fails to withhold such amount, the partnership is required to deduct and withhold from distributions to the transferee a tax equal to the amount the transferee failed to withhold plus interest.

EFFECTIVE DATES

Generally, the final regulations apply to transfers of partnership interests occurring on or after 60 days after the final regulations are published in the Federal Register ( i.e. , December 2020). However, a partnership’s requirement to withhold amounts not withheld by the transferee applies to transfers that occur on or after January 1, 2022.

AMOUNT TO WITHHOLD

Amount realized.

The final regulations retained the definition of “amount realized” set forth in the proposed regulations, namely, that it generally includes (i) consideration paid by the transferee and (ii) the transferor’s share of partnership liabilities (determined under section 752 and the regulations promulgated thereunder). Thus, the amount realized includes any reduction in the transferor’s share of partnership liabilities. One commentator suggested the inclusion of any reduction to a transferor’s share of partnership liabilities could cause liquidity concerns when the amount of liabilities assumed exceeds the cash or other property exchanged in the transfer. Treasury and the IRS concluded that it was inappropriate to exclude a reduction in a transferor’s share of partnership liabilities from the amount realized, citing that such concerns are addressed in regulation 1.1446(f)-2(c)(3).

For purposes of determining the amount realized, the final regulations retain the look-through rule set forth in the proposed regulations for situations involving a transfer by a foreign partnership transferor that has a direct or indirect partner not subject to tax on gain from such transfer as a result of an applicable US income tax treaty. Specifically, the final regulations provide that a treaty-eligible partner is not a presumed foreign taxable person for purposes of determining the modified amount realized. A foreign partnership that provides a certification of modified amount realized must include, in addition to IRS Form W-8IMY ( Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding and Reporting ) and a withholding statement, the certification of treaty benefits (on IRS Form W-8BEN ( Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals) ) or Form W-8BEN-E ( Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities) ), as applicable from each direct or indirect partner that is not a presumed foreign taxable person.

Certification of Maximum Tax Liability

The final regulations adopt the procedure in the proposed regulations limiting the withholding amount based on the maximum tax liability the transferor would be required to pay on the gain attributable to the partnership interest transfer. Specifically, the procedure allows a transferee to withhold based on a certification received from the transferor containing certain information relating to the transferor and the transfer, including the transferor’s maximum tax liability. A transferee may rely on a certification received from a transferor that is a foreign corporation, a nonresident alien individual or a foreign partnership regarding the transferor’s maximum tax liability. In addition, the final regulations permit transferors that are foreign trusts to use the maximum tax liability procedure to reduce the amount otherwise required to be withheld. Similar to the approach taken with respect to foreign partnerships, such rules treat the foreign trust as a nonresident alien individual for purposes of computing its maximum tax liability.

OBLIGATION TO WITHHOLD

In general, as noted earlier, the transferee of a partnership interest must withhold a tax equal to 10% of the amount realized by the transferor on any transfer of a partnership interest unless an applicable exception applies (as discussed below).

The final regulations maintain this broad presumption, despite comments to the proposed regulations noting that such presumption may impose a withholding obligation on  any  transfer of a partnership interest, regardless of whether the partnership in question has assets in, or a connection to, the United States. Treasury and the IRS justified this broad approach in the final regulations by noting that a transferee will not know whether a transfer results in tax on gain without information from the transferor or the partnership. Therefore, the transferee must presume that a transfer is subject to withholding unless it obtains a certification establishing otherwise.

Given the broad application of the final regulations, even non-US partners in non-US partnerships may be caught up in the withholding requirements of partnership interest transfers. This can be a trap for the unwary because it is not always obvious whether a non-US entity or investment vehicle is, by default, classified as a partnership for US income tax purposes. For example, in the absence of a US entity classification election confirming its US income tax classification, the US income tax classification of Brazilian funds, such as FIMs ( fundos de investimento multimercado ) and FIPs ( fundos de investimento em participações ), depends on certain peculiarities of the given entity’s governing documents. Thus, investors and their advisors should be careful to consider the impact of the final regulations not only on US partnerships but also on non-US partnerships and investment vehicles.

The final regulations provide that a partnership is permitted to determine that it does not have a withholding obligation under the final regulations if it possesses a valid IRS Form W-9 ( Request for Taxpayer Identification Number and Certification)  for the transferor to establish the transferor’s non-foreign status, even if the transferee does not provide a withholding certificate to the partnership.

LIABILITY FOR FAILING TO WITHHOLD

As noted above, if a transferee fails to withhold any amount required to be withheld, the partnership must deduct and withhold from distributions to the transferee a tax in an amount equal to the amount the transferee failed to withhold, plus interest. A partnership may determine its withholding obligation by relying on information provided in a certification received from the transferee ( i.e. , a withholding certificate). Generally, a transferee is required to provide a partnership with a certification that it has complied with its partnership interest transfer withholding obligation, including whether it is relying upon an exemption from such withholding. The final regulations add a provision that any person required to withhold is not liable for failure to withhold, including any interest or penalties resulting therefrom, if such person establishes to the satisfaction of the IRS that the transferor had no effectively connected gain subject to tax on the transfer of the partnership interest. However, it may be difficult for the withholding agent to convince the IRS that no such taxable gain exists without cooperation from the transferor.

Because partnerships can become liable for deducting and withholding tax (and interest) that a transferee failed to withhold from a transferor, partnerships should consider reviewing their partnership agreements and due diligence requirements related to transfers of partnership interests. For instance, a partnership may include provisions in its partnership agreement that a transfer of a partnership interest may only be permitted if (among other customary requirements) a transferee provides a valid certificate establishing an exception to withholding or certifies that it will withhold on the transfer (accompanied by proof of such actual withholding).

RELIANCE ON CERTIFICATIONS PROVIDED BY TRANSFEROR, TRANSFEREE AND PARTNERSHIP

In order not to withhold or to withhold a reduced amount, a transferee is permitted to rely on a certification it receives from a transferor or the partnership unless it has actual knowledge that the certification is incorrect or unreliable. Moreover, the partnership may rely on a certification received from the transferee unless the partnership knows or has reason to know it is incorrect or unreliable. Such “reason to know” standard requires the partnership to review the certification to confirm that it does not have information suggesting the certificate is incorrect or unreliable. On that basis, transferees might consider including a pre-closing condition (and other relevant contractual provisions) in a purchase agreement that the partnership will confirm the certification from the transferor and/or the partnership will itself provide a certification.

WITHHOLDING EXCEPTIONS

The final regulations generally retain the withholding exceptions of the proposed regulations with certain modifications. Importantly, the transferor’s distributive share of ECI exception no longer requires effectively connected income or loss in a given tax year, and a new no trade or business exception has been adopted.

The final regulations do not include any withholding exceptions for: (i) disguised sales; (ii) transferors that are “withholding foreign partnerships” and “withholding foreign trusts” if they enter into a withholding agreement with the IRS; and (iii) earnout payments entitling the transferor to future payments based on specific goals or metrics.

Non-Foreign Status

The transferor may provide a certificate to a transferee certifying as to its non-foreign status. For that purpose, a certification of non-foreign status includes a valid IRS Form W-9. Moreover, a transferee may rely on a valid Form W-9 it already possesses from the transferor provided it meets the certification requirement as set forth in the final regulations.

The transferor may provide a certification that no gain will be realized by the transferor. Importantly, the transferor must certify that ordinary income attributable to property described in Code section 751 (“hot assets”) utilized in or attributable to a US trade or business would not be recognized in connection with the transfer.

Deemed Sale

A transferee (other than a partnership that is a transferee because it makes a distribution) may rely on a certification from the partnership that if the partnership sold all of its assets on the “determination date,” either: (1) the partnership would have no effectively connected gain, or if the partnership would have a net amount of such gain, the amount of the partnership’s net gain that would have been effectively connected gain would be less than 10% of the total net gain; or (2) the transferor would not have a distributive share of net gain from the partnership that would be ECI, or if the transferor would have a distributive share of ECI, the transferor’s allocable share of the partnership’s net ECI would be less than 10% of the transferor’s distributive share of the total net gain from the partnership. For this purpose, and generally, the “determination date” is the transfer date or any day that is no more than 60 days before the date of the transfer.

No US Trade or Business

Addressing comments to the proposed regulations, Treasury and the IRS included a new exception from withholding not included in the proposed regulations. Specifically, a transferee (other than a partnership that is a transferee because it makes a distribution) may rely on a certification from the partnership that it was not engaged in a US trade or business during the partnership’s tax year, up to and including the date of the transfer. Partnerships that invest in assets that do not give rise to ECI ( e.g. , corporations, real estate investment trusts, etc.) should find this exception useful.

Transferor’s Distributive Share of ECI

A transferee (other than a partnership that is a transferee because it makes a distribution) may rely on a certification from the transferor stating that: (a) it has held its partnership interest for the prior three tax years (the “look-back period”); (b) the transferor’s (and its related partners’ within the meaning of sections 267(b) and 707(b)) distributive share of gross ECI in each of the taxable years within the look-back period was less than $1 million in the aggregate; (C) the transferor’s distributive share of gross ECI in each of the years within the look-back period is less than 10% of its total distributive share of gross partnership income; and (D) the transferor’s share of ECI was timely reported on its tax return and all US taxes on such ECI were timely paid.

Notably, a transferor may only provide a certificate pursuant to that exception if it has received a Schedule K-1 from the partnership reflecting distributable gross income for each of the years within the look-back period. Importantly, unlike the proposed regulations, the final regulations do not require that the transferor have received an IRS Form 8805 ( Foreign Partner’s Information Statement of Section 1446 Withholding Tax ) and have effectively connected gain or loss, thus making this exception available for partners of partnerships without ECI. Practically, the use of this exception may be limited because some partnerships do not provide K-1s to their foreign partners unless and until the partnership derives ECI.

Certification of Nonrecognition by Transferor

A transferee may rely on a certification from the transferor stating that by reason of the operation of a nonrecognition provision of the Code, the transferor is not required to recognize any gain or loss with respect to the transfer of the partnership interest. The final regulations also contain a partial nonrecognition exception that may apply in certain circumstances.

Treaty Claims

A transferor may provide a certification to the transferee that it is not subject to tax on any gain upon transfer of the partnership interest because of an applicable tax treaty limiting the ability of the United States to tax income that does is not attributable to a permanent establishment. To avail itself of that exception, the transferor must make the certification on a valid IRS Form W-8BEN, or Form W-8BEN-E. In addition, the transferee must mail a copy of the certification to the IRS within 30 days of the transfer. Before making such certification for purposes of invoking the treaty claim exception, a transferor should consider other factors that may give rise to a permanent establishment, including whether the US office of the partnership constitutes a fixed place of business as defined by the applicable treaty.

The IRS indicated its intention to revise the instructions to Forms W-8BEN and W-8BEN-E to describe the information required to be provided for making a treaty benefits claim for purposes of section 1446(f), including a treaty claim made with respect to a transfer of a publicly traded partnership (PTP) interest.

Current Public Notices

Current legal analysis, more from mcdermott will & emery, upcoming legal education events.

Sign Up for e-NewsBulletins

• Frost Brown Todd

Sale or Redemption of a Partnership Interest – Is There a Difference?

Jul 27, 2023

Categories:

Blogs Tax Law Defined™ Blog

Martin E. Mooney

Partners in a partnership and members of a limited liability company that is taxed as a partnership (both referred to as a “Partnership”) often face the issue of handling the retirement or other departure of an equity owner (referred to as a “Partner”). A question to address is whether it is better for the Partnership to redeem the outgoing Partner’s interest or for each of the Partners to purchase a proportionate share of the equity interest of the outgoing Partner. From an economic perspective, in general, the remaining Partners will be in the same position regardless of whether they each purchase their respective proportionate interests from the outgoing partner or the partnership redeems the interest.

For example, assume a Partnership has four equal Partners, and one is retiring. From an economic perspective, the three remaining Partners will each end up with a one-third interest in the Partnership regardless of whether the Partnership redeems the interest of the outgoing Partner, or each Partner purchases one third of the equity interest of the outgoing Partner (possibly using funds provided by the Partnership). The issue to consider is whether there are any differences between the tax consequences of a redemption of the interest or a sale of the interest. As the examples below illustrate, there can be significant differences.

Example 1 – Retiring Partner in a Service Business

Assume our retiring partner is an attorney in an equally owned four-person legal practice that operates as a limited liability partnership (LLP).  The LLP has negligible liabilities and typically pays out all profits to its Partners, so the basis of the outgoing Partner in the LLP is nominal and will be treated as zero for ease of illustration. The LLP operates on a cash basis. When the Partner retires, the LLP has two assets: unrealized receivables of $600,000 and goodwill of $2,000,000. The outgoing Partner will receive $650,000 either from the LLP as a redemption distribution or as a payment of $216,666.67 from each of the other three Partners. What are the tax implications?

The tax consequences of the sale are straightforward. Pursuant to Section 741, [1] gain or loss from the sale of a partnership interest is treated as gain or loss from the sale or exchange of a capital asset, except as otherwise provided in section 751. In general, Section 751 requires the portion of the amount realized from the sale of a partnership interest attributable to unrealized receivables and inventory items of the partnership to be treated as ordinary income. In our example, the outgoing Partner will realize and recognize a gain of $650,000, with $150,000 of the gain attributable to the outgoing Partner’s share of unrealized receivables and taxed as ordinary income, and $500,000 attributable to goodwill and taxed as long-term capital gain. If the LLP makes a Section 754 election on its return for the year of the sale, or has made one previously, then the remaining Partners will each get a basis increase under Section 743 of $50,000 for the unrealized receivables, which can offset receivables income as it is collected, and $166,666.67 for goodwill, which can be amortized over 15 years.

The tax consequences of the redemption payment depend on how the Partners agree to treat the payments. The portion of the redemption payment of $650,000 attributable to unrealized receivables will be ordinary income to the outgoing Partner, just as it would be in a sale. For the remaining Partners, Sections 736(a)(2) [2] and Sections 736(b)(2) and (3) [3] permit the LLP to deduct the portion of the payment attributable to unrealized receivables. In the sale alternative, the Section 743 adjustment to the outgoing Partner’s share of unrealized receivables means no income is realized by the other Partners on the collection of that portion of the receivables. Although there is no basis adjustment to the outgoing Partner’s share of unrealized receivables in a redemption, the ability to deduct the portion of the payment attributable to the outgoing Partner’s share of unrealized receivables gives a timing advantage to the continuing Partners because the LLP will likely be able to deduct the Section 736(a) payments before the corresponding income is collected.

Because capital is not a material income-producing factor for the LLP, and the retiring Partner was a general partner, Section 736 would also permit the LLP to deduct the portion of the payment to the outgoing Partner attributable to goodwill, but the outgoing Partner must treat the payment as ordinary income and self-employment income. Such treatment is permitted as long as the LLP’s agreement does not provide for a payment with respect to goodwill, which is in the complete control of the Partners. If the LLP’s agreement permitted a payment for goodwill, the outgoing Partner would recognize long-term capital gain on the portion of the redemption payment attributable to goodwill, and the LLP would get to adjust its basis in goodwill by $500,000 and amortize the goodwill over fifteen years pursuant to the rules of Section 734, provided the LLP makes a Section 754 election on its return for the year of the sale, or has made one previously.

Example 2: Partnership with Real Estate

Assume we again have a Partnership with four equal Partners who each have held their respective equity interests for several years. In our simple case, the Partnership has no liabilities, and its sole assets consists of real estate that was acquired by the Partnership for $10,000,000 with capital contributions made equally by the Partners. At the time of purchase, the land was valued at $1,000,000, and the depreciable portion of the real estate was valued at $9,000,000. The real estate has been fully depreciated by the Partnership and it has appreciated in value to $20,000,000. Each Partner has a remaining basis in the Partner’s equity interest of $250,000. One of the Partners is about to retire and will receive a total payment of $5,000,000. How would a sale to each of the other three Partners of one-third of his equity interest for $1,666,666,67 differ from a redemption of the equity interest by the Partnership for $5,000,000?

Like Example 1, the tax consequences of a sale are straightforward. The outgoing Partner would recognize total gain of $4,750,000 ($5,000,000 total sale price less basis of $250,000), with $2,250,000 of the gain taxed at the rate of 25% applicable to unrecaptured Section 1250 gain and $2,500,000 taxed at the 20% rate applicable to long-term capital gain. If the Partnership makes a Section 754 election on its return for the year of the sale, or has made one previously, then the remaining Partners would each get a basis increase under Section 743 of $1,583333.33 allocated between land and building based on the fair market value of each. The increase in the basis of the depreciable real estate would be recovered by each Partner over the appropriate recovery period.

Also, like Example 1, things are more complicated if the transaction is structured as a redemption. A redemption would trigger total gain to the outgoing partner of $4,750,000, just like a sale, but it appears that all of the gain would be taxed as long-term capital gain at a 20% rate and none as unrecaptured 1250 gain taxable at a 25% rate thereby providing a tax saving of $112,500 to the outgoing partner (5% x $2,250,000) compared with a sale. The Treasury Regulations under Section 1(h) provide that the rules that permit a portion of the gain from the sale of a partnership interest to be taxed at a 25% rate applies only to a sale of a partnership interest, but not to “a transaction that is treated, for Federal income tax purposes, as a redemption of a partnership interest.” [4] As a result, the redemption allows the outgoing partner to escape the 25% rate applied to unrecaptured 1250 gain, which is a great result for the outgoing partner. The problem, however, is that there is uncertainty regarding the impact on the remaining Partners regarding their liability for the unrecaptured section 1250 gain the outgoing Partner has escaped. It is a distinct possibility the remaining Partners may be liable for the unrecaptured Section 1250 gain of the outgoing Partner. At a minimum, the remaining Partners would want to factor that potential liability into the redemption price paid to the outgoing Partner.

Example 3 – Timing of Gain Recognition in a Deferred Payment Transaction

Assume we again have a four-person Partnership with each Partner owning a 25% interest in the Partnership. Assume further that the balance sheet has no liabilities, and it has three assets: (i) unrealized receivables with a basis of zero and a current fair market value of $4,000,000; (ii) fully depreciated machinery and equipment that was originally acquired for $5,000,000, with a current value of $2,000,000; and goodwill with a basis of zero and a current fair market value of $6,000,000. One of the Partners desires to retire. The Partners agree that he can retire and receive $3,000,000 for his equity interest in a lump sum payment on the third anniversary date of the sale. What would the tax differences between a redemption payment of $3,000,000 from the Partnership in three years and a payment of $1,000,000 from each of the other three Partners in three years?

If the transaction were structured as a purchase by the other three Partners, it would qualify as an installment sale under Section 453. In general, that would mean the retiring Partner could delay reporting recognition of income until the payments for the equity interest are received. There are, however, important exceptions to that general rule. Section 453(i) requires “recapture income” to be recognized in the year of sale. [5] Consequently, proceeds that would be treated as being attributable to depreciation recapture items under Section 751(a) must be reported as income in the year of sale by Section 453(i). Also, receivables cannot be reported under the installment sale rules. There had been limited authority regarding whether installment reporting was available for the portion of the sale price of a Partnership equity interest attributable to underlying cash-basis accounts receivable. In a Tax Court decision that was affirmed on appeal by the Fifth Circuit, the court held installment reporting was not available to the deferred portion of the sale price of a partnership interest attributable to the cash-basis accounts receivable of a personal service partnership. [6] It is not completely clear whether cash-basis receivables for the sale of goods would be treated the same way. At a minimum, there would be risk that installment sale treatment would not apply to the deferred portion of the sale price attributable to those receivables. In our case, the retiring Partner could be taxable in the year of sale on as much as $1,500,000 of the gain, all of which would be ordinary income. More importantly, the retiring Partner would not receive any cash for three years and would have to come up with funds to pay tax on the income recognized in the year of sale.

Another consideration for a transaction structured as a sale is that interest will be imputed to the amount paid under the rules of Sections 1274 and 1274A, thereby converting a portion of the price paid from purchase price to interest, which would be ordinary income to the retiring Partner and deductible by the purchasing Partners. Because the purchase price paid by each of the other Partners would be less than $2,000,000, the purchaser and seller could elect to report interest on the cash method instead of using the original issue discount rules. [7] The purchasers would get an immediate step up in the receivables, the equipment, and the goodwill if the Partnership makes a Section 754 election in the year of sale, or has previously made the election.

In contrast, if the transaction were structured as a redemption, the installment sale rules would not apply. Instead, under Section 731, the retiring Partner would recognize income in the year the Partner receives payment. Under the rules of Section 751(b), $1,000,000 of the purchase price attributable to the receivables, and $500,000 attributable to depreciation recapture would be taxed as ordinary income. The $1,500,000 balance of the gain attributable to goodwill would be long-term capital gain. The key point is that no income would be reported until the retiring Partner receives cash for the redeemed equity interest, which means the Partner will have cash in hand from the transaction to pay the tax. Also, the imputed interest rules would not apply to the retiring Partner if the retiring Partner’s equity interest is being redeemed by the Partnership rather than sold to the other Partners.

The remaining Partners would have to wait until year three when payment is made and the outgoing Partner recognizes income until basis adjustments are made to the receivables and the depreciable equipment under Section 751(b) and the goodwill under Section 734, if the Partnership makes a Section 754 election in the year of sale, or has previously made the election.

Example 4 – Holding Period Considerations

Assume the same facts as in Example 3 except that early in the year all four Partners each contribute $1,000,000 to the Partnership. Prior to the end of the year, the Partner retires. Instead of receiving a $3,000,000 for his equity interest, the Partner will receive a payment of $4,000,000. The $1,000,000 contribution would cause the retiring Partner’s basis in his equity interest to increase to $1,000,000, so the total gain recognized by the Partner remains at $3,000,000. Besides the differences between a purchase and a redemption described in Example 3, would the facts of Example 4 create any other differences?

In a purchase transaction, the retiring Partner would have to deal with the holding period rules for equity interests. Specifically, Section 1.1223-3(b)(1) of the Treasury Regulations provides, “ The portion of a partnership interest to which a holding period relates shall be determined by reference to a fraction, the numerator of which is the fair market value of the portion of the partnership interest received in the transaction to which the holding period relates, and the denominator of which is the fair market value of the entire partnership interest (determined immediately after the transaction) .” Applying our facts, 75% of the equity interest would have a long-term holding period ($3 million/$4 million), but the remaining 25% of the interest attributable to the $1,000,000 capital contribution made earlier in the year of sale would have a short-term holding period. As a result, for the $1,500,000 portion of the gain treated as capital gain (reduced by any imputed interest), 75% would be long-term capital gain taxed at a 20% rate and 25% of the gain would be short-term capital gain taxed at a 37% rate.

Section 1.1223-3(b)(1) of the Treasury Regulations sets forth a special rule to avoid the surprising and seemingly unfair result described in the preceding paragraph. [8] If the Partnership makes a distribution to a Partner in the same year a cash contribution is made, the Partner can reduce the amount of the cash capital contributions by the amount of distributions in applying the holding period rule. On our facts, the holding period problem could be eliminated entirely if the retiring Partner received a cash distribution of $1,000,000 from the Partnership in the year of sale, which would reduce the price paid for the retiring Partner’s interest from $4,000,000 to $3,000,000, and the retiring Partner’s basis in the equity interest from $1,000,000 to zero. On those facts, all of the capital gain recognized by the retiring Partner would be long-term capital gain.

If the transaction were structured as a redemption, the holding period issue would not be a problem. The taxable event to the retiring Partner would occur in year three when the retiring Partner receives payment, the portion of the payment not attributable to Section 751 assets would be taxed as gain from the sale of the retiring Partner’s equity interest. By then, all of the retiring Partner’s equity interest would have a long-term holding period, so all of the capital gain recognized by the retiring partner would be long-term capital gain.

As the examples above illustrate, the tax consequences can be dramatically different depending on whether the buy-out of a retiring Partner’s interest is structured as a cross-purchase or redemption. The parties need to understand these differences in order to achieve the desired after-tax outcomes and avoid unwanted surprises. For more information, contact the author of this article. You can also visit our  Tax Law Defined® Blog  for more insight into the latest developments in federal, state and local tax planning and tax administration.

[1] References to “sections” are to section of the Internal Revenue Code of 1986, as amended. This article addresses federal income tax consequences and does not address state and local tax consequences.

[2] Section 736(a)(2) of the Code states:

“Payments made in liquidation of the interest of a retiring partner or a deceased partner shall, except as provided in subsection (b), be considered—

(2) as a guaranteed payment described in section 707(c) if the amount thereof is determined without regard to the income of the partnership.”

[3] Sections 736(b)(2) and (3) of the Code state:

“(2) Special rules. For purposes of this subsection, payments in exchange for an interest in partnership property shall not include amounts paid for—

(A) unrealized receivables of the partnership (as defined in section 751(c) ), or

(B) good will of the partnership, except to the extent that the partnership agreement provides for a payment with respect to good will.

(3) Limitation on application of paragraph (2).

Paragraph (2) shall apply only if—

(A) capital is not a material income-producing factor for the partnership, and

(B) the retiring or deceased partner was a general partner in the partnership.

[4] See Treas, Reg. §1.1(h)-1(b)(3)(ii).

[5] Section 453(i) of the Code states:

(i) Recognition of recapture income in year of disposition.

(1) In general. In the case of any installment sale of property to which subsection (a) applies—

(A) notwithstanding subsection (a) , any recapture income shall be recognized in the year of the disposition, and

(B) any gain in excess of the recapture income shall be taken into account under the installment method.

(2) Recapture income. For purposes of paragraph (1) , the term “recapture income” means, with respect to any installment sale, the aggregate amount which would be treated as ordinary income under section 1245 or 1250 (or so much of section 751 as relates to section 1245 or 1250 ) for the taxable year of the disposition if all payments to be received were received in the taxable year of disposition.

[6] Lori M. Mingo TC Memo 2013-149 (2013), aff’d 114 AFTR 2d 2014-6886 (2014, CA5).

[7] See Section 1274A(c) of the Code.

[8] Treas. Reg. Section 1,1223-3(b)(2) states,

(2) Special rule. For purposes of applying paragraph (b)(1) of this section to determine the holding period of a partnership interest (or portion thereof) that is sold or exchanged (or with respect to which gain or loss is recognized upon a distribution under section 731), if a partner makes one or more contributions of cash to the partnership and receives one or more distributions of cash from the partnership during the one-year period ending on the date of the sale or exchange (or distribution with respect to which gain or loss is recognized under section 731), the partner may reduce the cash contributions made during the year by cash distributions received on a last-in-first-out basis, treating all cash distributions as if they were received immediately before the sale or exchange (or at the time of the distribution with respect to which gain or loss is recognized under section 731).

Before you send us any information, know that contacting us does not create an attorney-client relationship. We cannot represent you until we know that doing so will not create a conflict of interest with any existing clients. Therefore, please do not send us any information about any legal matter that involves you unless and until you receive a letter from us in which we agree to represent you (an "engagement letter"). Only after you receive an engagement letter will you be our client and be properly able to exchange information with us. If you understand and agree with the foregoing and you are not our client and will not divulge confidential information to us, you may contact us for general information.

Tax Implications on Sale of a Partnership Interest

In determining gain or loss on sale of a partnership interest, taxpayers are often surprised to find they have a taxable gain..

For income tax purposes gain or loss is the difference between the amount realized and adjusted basis of the partnership interest in the hands of the partner.

Amount Realized

Examples of Amount Realized:

Example 1 – Sale of Partnership interest with no debt:

Amy is a member in ABC, LLC which has no outstanding liabilities. Amy sells her entire interest to Dave for $30,000 of cash and property that has a fair market value of $70,000. Amy’s amount realized is $100,000.

Example 2 – Sale of partnership interest with partnership debt:

Amy is a member of ABC, LLC and has a $23,000 basis in her interest. Amy’s membership interest is 1/3 of the LLC. When Amy sells her 1/3 interest for $100,000 the partnership has a liability of $9,000. Amy’s amount realized would be $103,000 ($100,000 + ($9,000 x 1/3).

Gain Realized

Generally, a partner selling his partnership interest recognizes capital gain or loss on the sale. The amount of the gain or loss recognized is the difference between the amount realized and the partner’s adjusted tax basis in his partnership interest.

Example 1 (from above)- Sale of Partnership interest with no debt:

Assume Amy’s basis was $40,000. Amy would realize a gain of $60,000 ($100,000 – $40,000).

Example 2 (from above) – Sale of partnership interest with partnership debt:

Amy’s basis was $23,000. Amy would realize a gain of $80,000 ($103,000 realized less $23,000 basis).

Character of Gain

Partnership taxation establishes the general rule that gain on sale a partnership interest receives favorable capital gain treatment.  However, gains attributable to so-called “hot assets,” which include inventory, depreciation recapture, and accounts receivable of a cash basis partnership are taxed at less favorable ordinary income rates.

To the extent that a sale is attributable to the selling partner’s share of the hot assets, the resulting gain or loss is taxed at ordinary income rates. When real estate is sold to the extent the gain on sale is attributable to depreciation deductions, the resulting gain is treated as unrecaptured IRC §1250 section gain. §1250 gain is taxed at a flat 25% rate.

Like-Kind Exchange

It is important to note that in IRC §1031 (like-kind exchange), non-recognition treatment does not apply to exchanges of partnership interests.

We’ve Got Your Back

If you’re selling your partnership interest, we can help you plan the sale so that you pay no more tax than necessary. Contact Simon Filip,  the Real Estate Tax Guy , at  [email protected]  or 201.655.7411 today.

You are using an unsupported browser ×

You are using an unsupported browser. This web site is designed for the current versions of Microsoft Edge, Google Chrome, Mozilla Firefox, or Safari.

Site Feedback

The Office of the Federal Register publishes documents on behalf of Federal agencies but does not have any authority over their programs. We recommend you directly contact the agency associated with the content in question.

If you have comments or suggestions on how to improve the www.ecfr.gov website or have questions about using www.ecfr.gov, please choose the 'Website Feedback' button below.

If you would like to comment on the current content, please use the 'Content Feedback' button below for instructions on contacting the issuing agency

Website Feedback

• Incorporation by Reference
• Recent Updates
• Recent Changes
• Corrections
• Reader Aids Home
• Using the eCFR Point-in-Time System
• Understanding the eCFR
• Government Policy and OFR Procedures
• Developer Resources
• My Subscriptions
• Sign In / Sign Up

Hi, Sign Out

The Electronic Code of Federal Regulations

Enhanced content :: cross reference.

Enhanced content is provided to the user to provide additional context.

Navigate by entering citations or phrases (eg: suggestions#fillExample" class="example badge badge-info">1 CFR 1.1 suggestions#fillExample" class="example badge badge-info">49 CFR 172.101 suggestions#fillExample" class="example badge badge-info">Organization and Purpose suggestions#fillExample" class="example badge badge-info">1/1.1 suggestions#fillExample" class="example badge badge-info">Regulation Y suggestions#fillExample" class="example badge badge-info">FAR ).

Choosing an item from citations and headings will bring you directly to the content. Choosing an item from full text search results will bring you to those results. Pressing enter in the search box will also bring you to search results.

Background and more details are available in the Search & Navigation guide.

• Title 26 —Internal Revenue
• Chapter I —Internal Revenue Service, Department of the Treasury
• Subchapter A —Income Tax
• Part 1 —Income Taxes
• Transfers of Interests in a Partnership

Enhanced Content - Table of Contents

§ 1.741-1 § 1.742-1 § 1.743-1 Enhanced Content - Details 26 U.S.C. 7805 , unless otherwise noted. Section 1.1(h)-1 also issued under 26 U.S.C. 1(h) ; Section 1.21-1 also issued under 26 U.S.C. 21(f) ; See Part 1 for more T.D. 6500, 25 FR 11402 , Nov. 26, 1960; 25 FR 14021 , Dec. 21, 1960; T.D. 9989, 89 FR 17606 , Mar. 11, 2024, unless otherwise noted. T.D. 6500, 25 FR 11402 , Nov. 26, 1960; 25 FR 14021 , Dec. 21, 1960, unless otherwise noted. T.D. 6500, 25 FR 11402 , Nov. 26, 1960; 25 FR 14021 , Dec. 31, 1960, T.D. 9381, 73 FR 8604 , Feb. 15, 2008, unless otherwise noted. See Part 1 for more Enhanced Content - Print (approximately 25+ pages) " href="#">Generate PDF (approximately 25+ pages) This content is from the eCFR and may include recent changes applied to the CFR. The official, published CFR, is updated annually and available below under "Published Edition". You can learn more about the process here . Enhanced Content - Display Options The eCFR is displayed with paragraphs split and indented to follow the hierarchy of the document. This is an automated process for user convenience only and is not intended to alter agency intent or existing codification. A separate drafting site is available with paragraph structure matching the official CFR formatting. If you work for a Federal agency, use this drafting site when drafting amendatory language for Federal regulations: switch to eCFR drafting site . Enhanced Content - Subscribe Subscribe to: 26 CFR Part 1 - Transfers of Interests in a Partnership Enhanced Content - Timeline 9/24/2019 view on this date view change introduced   1/24/2017 view on this date view change introduced compare to most recent Enhanced Content - Go to Date Enhanced content - compare dates, enhanced content - published edition. View the most recent official publication: View Title 26 on govinfo.gov View the PDF for 26 CFR Part 1 - Transfers of Interests in a Partnership These links go to the official, published CFR, which is updated annually. As a result, it may not include the most recent changes applied to the CFR. Learn more . Enhanced Content - Developer Tools This document is available in the following developer friendly formats: Hierarchy JSON - Title 26 Content HTML - this subject group Content XML - this subject group Information and documentation can be found in our developer resources . eCFR Content The Code of Federal Regulations (CFR) is the official legal print publication containing the codification of the general and permanent rules published in the Federal Register by the departments and agencies of the Federal Government. The Electronic Code of Federal Regulations (eCFR) is a continuously updated online version of the CFR. It is not an official legal edition of the CFR. Enhanced Content Transfers of interests in a partnership, § 1.741-1 recognition and character of gain or loss on sale or exchange.. ( a ) The sale or exchange of an interest in a partnership shall, except to the extent section 751(a) applies, be treated as the sale or exchange of a capital asset, resulting in capital gain or loss measured by the difference between the amount realized and the adjusted basis of the partnership interest, as determined under section 705. For treatment of selling partner's distributive share up to date of sale, see section 706(c)(2). Where the provisions of section 751 require the recognition of ordinary income or loss with respect to a portion of the amount realized from such sale or exchange, the amount realized shall be reduced by the amount attributable under section 751 to unrealized receivables and substantially appreciated inventory items, and the adjusted basis of the transferor partner's interest in the partnership shall be reduced by the portion of such basis attributable to such unrealized receivables and substantially appreciated inventory items. See section 751 and § 1.751-1 . ( b ) Section 741 shall apply whether the partnership interest is sold to one or more members of the partnership or to one or more persons who are not members of the partnership. Section 741 shall also apply even though the sale of the partnership interest results in a termination of the partnership under section 708(b). Thus, the provisions of section 741 shall be applicable ( 1 ) to the transferor partner in a 2-man partnership when he sells his interest to the other partner, and ( 2 ) to all the members of a partnership when they sell their interests to one or more persons outside the partnership. ( c ) See section 351 for nonrecognition of gain or loss upon transfer of a partnership interest to a corporation controlled by the transferor. ( d ) For rules relating to the treatment of liabilities on the sale or exchange of interests in a partnership see §§ 1.752-1 and 1.1001-2 . ( e ) For rules relating to the capital gain or loss recognized when a partner sells or exchanges an interest in a partnership that holds appreciated collectibles or section 1250 property with section 1250 capital gain, see § 1.1(h)-1 . This paragraph (e) applies to transfers of interests in partnerships that occur on or after September 21, 2000. ( f ) For rules relating to dividing the holding period of an interest in a partnership, see § 1.1223-3 . This paragraph (f) applies to transfers of partnership interests and distributions of property from a partnership that occur on or after September 21, 2000. [T.D. 6500, 25 FR 11814 , Nov. 26, 1960; 25 FR 14021 , Dec. 31, 1960, as amended by T.D. 7741, 45 FR 81745 , Dec. 12, 1980; T.D. 8902, 65 FR 57099 , Sept. 21, 2000] § 1.742-1 Basis of transferee partner's interest. ( a ) In general. The basis to a transferee partner of an interest in a partnership shall be determined under the general basis rules for property provided by part II (section 1011 and following), Subchapter O, Chapter 1 of the Internal Revenue Code. Thus, the basis of a purchased interest will be its cost. Generally, the basis of a partnership interest acquired from a decedent is the fair market value of the interest at the date of his death or at the alternate valuation date, increased by his estate's or other successor's share of partnership liabilities, if any, on that date, and reduced to the extent that such value is attributable to items constituting income in respect of a decedent (see section 753 and §§ 1.706-1(c)(3)(v) and 1.753 -1(b)) under section 691. See section 1014(c). However, the basis of a partnership interest acquired from a decedent is determined under section 1022 if the decedent died in 2010 and the decedent's executor elected to have section 1022 apply to the decedent's estate. For basis of contributing partner's interest, see section 722. The basis so determined is then subject to the adjustments provided in section 705. ( b ) Effective/applicability date. This section applies on and after January 19, 2017. For rules before January 19, 2017, see § 1.742-1 as contained in 26 CFR part 1 revised as of April 1, 2016. [T.D. 9811, 82 FR 6239 , Jan. 19, 2017] § 1.743-1 Optional adjustment to basis of partnership property. ( a ) Generally. The basis of partnership property is adjusted as a result of the transfer of an interest in a partnership by sale or exchange or on the death of a partner only if the election provided by section 754 (relating to optional adjustments to the basis of partnership property) is in effect with respect to the partnership. Whether or not the election provided in section 754 is in effect, the basis of partnership property is not adjusted as the result of a contribution of property, including money, to the partnership. ( b ) Determination of adjustment. In the case of the transfer of an interest in a partnership, either by sale or exchange or as a result of the death of a partner, a partnership that has an election under section 754 in effect— ( 1 ) Increases the adjusted basis of partnership property by the excess of the transferee's basis for the transferred partnership interest over the transferee's share of the adjusted basis to the partnership of the partnership's property; or ( 2 ) Decreases the adjusted basis of partnership property by the excess of the transferee's share of the adjusted basis to the partnership of the partnership's property over the transferee's basis for the transferred partnership interest. ( c ) Determination of transferee's basis in the transferred partnership interest. In the case of the transfer of a partnership interest by sale or exchange or as a result of the death of a partner, the transferee's basis in the transferred partnership interest is determined under section 742 and § 1.742-1 . See also section 752 and §§ 1.752-1 through 1.752-5 . ( d ) Determination of transferee's share of the adjusted basis to the partnership of the partnership's property — ( 1 ) Generally. A transferee's share of the adjusted basis to the partnership of partnership property is equal to the sum of the transferee's interest as a partner in the partnership's previously taxed capital, plus the transferee's share of partnership liabilities. Generally, a transferee's interest as a partner in the partnership's previously taxed capital is equal to— ( i ) The amount of cash that the transferee would receive on a liquidation of the partnership following the hypothetical transaction, as defined in paragraph (d)(2) of this section (to the extent attributable to the acquired partnership interest); increased by ( ii ) The amount of tax loss (including any remedial allocations under § 1.704-3(d) ), that would be allocated to the transferee from the hypothetical transaction (to the extent attributable to the acquired partnership interest); and decreased by ( iii ) The amount of tax gain (including any remedial allocations under § 1.704-3(d) ), that would be allocated to the transferee from the hypothetical transaction (to the extent attributable to the acquired partnership interest). ( 2 ) Hypothetical transaction defined. For purposes of paragraph (d)(1) of this section, the hypothetical transaction means the disposition by the partnership of all of the partnership's assets, immediately after the transfer of the partnership interest, in a fully taxable transaction for cash equal to the fair market value of the assets. See § 1.460-4(k)(3)(v)(B) for a rule relating to the computation of income or loss that would be allocated to the transferee from a contract accounted for under a long-term contract method of accounting as a result of the hypothetical transaction. ( 3 ) Examples. The provisions of this paragraph (d) are illustrated by the following examples: (i) A is a member of partnership PRS in which the partners have equal interests in capital and profits. The partnership has made an election under section 754, relating to the optional adjustment to the basis of partnership property. A sells its interest to T for $22,000. The balance sheet of the partnership at the date of sale shows the following: Assets Adjusted basis Fair market value Cash $5,000 $5,000 Accounts receivable 10,000 10,000 Inventory 20,000 21,000 Depreciable assets 20,000 40,000 Total 55,000 76,000 Liabilities and Capital Adjusted per books Fair market value Liabilities $10,000 $10,000 Capital: A 15,000 22,000 B 15,000 22,000 C 15,000 22,000 Total 55,000 76,000 (ii) The amount of the basis adjustment under section 743(b) is the difference between the basis of T's interest in the partnership and T's share of the adjusted basis to the partnership of the partnership's property. Under section 742, the basis of T's interest is $25,333 (the cash paid for A's interest, $22,000, plus $3,333, T's share of partnership liabilities). T's interest in the partnership's previously taxed capital is $15,000 ($22,000, the amount of cash T would receive if PRS liquidated immediately after the hypothetical transaction, decreased by $7,000, the amount of tax gain allocated to T from the hypothetical transaction). T's share of the adjusted basis to the partnership of the partnership's property is $18,333 ($15,000 share of previously taxed capital, plus $3,333 share of the partnership's liabilities). The amount of the basis adjustment under section 743(b) to partnership property therefore, is $7,000, the difference between $25,333 and $18,333. A, B, and C form partnership PRS, to which A contributes land (Asset 1) with a fair market value of $1,000 and an adjusted basis to A of $400, and B and C each contribute $1,000 cash. Each partner has $1,000 credited to it on the books of the partnership as its capital contribution. The partners share in profits equally. During the partnership's first taxable year, Asset 1 appreciates in value to $1,300. A sells its one-third interest in the partnership to T for $1,100, when an election under section 754 is in effect. The amount of tax gain that would be allocated to T from the hypothetical transaction is $700 ($600 section 704(c) built-in gain, plus one-third of the additional gain). Thus, T's interest in the partnership's previously taxed capital is $400 ($1,100, the amount of cash T would receive if PRS liquidated immediately after the hypothetical transaction, decreased by $700, T's share of gain from the hypothetical transaction). The amount of T's basis adjustment under section 743(b) to partnership property is $700 (the excess of $1,100, T's cost basis for its interest, over $400, T's share of the adjusted basis to the partnership of partnership property). ( e ) Allocation of basis adjustment. For the allocation of the basis adjustment under this section among the individual items of partnership property, see section 755 and the regulations thereunder. ( f ) Subsequent transfers. Where there has been more than one transfer of a partnership interest, a transferee's basis adjustment is determined without regard to any prior transferee's basis adjustment. In the case of a gift of an interest in a partnership, the donor is treated as transferring, and the donee as receiving, that portion of the basis adjustment attributable to the gifted partnership interest. The provisions of this paragraph (f) are illustrated by the following example: (i) A, B, and C form partnership PRS. A and B each contribute $1,000 cash, and C contributes land with a basis and fair market value of $1,000. When the land has appreciated in value to $1,300, A sells its interest to T1 for $1,100 (one-third of $3,300, the fair market value of the partnership property). An election under section 754 is in effect; therefore, T1 has a basis adjustment under section 743(b) of $100. (ii) After the land has further appreciated in value to $1,600, T1 sells its interest to T2 for $1,200 (one-third of $3,600, the fair market value of the partnership property). T2 has a basis adjustment under section 743(b) of $200. This amount is determined without regard to any basis adjustment under section 743(b) that T1 may have had in the partnership assets. (iii) During the following year, T2 makes a gift to T3 of fifty percent of T2's interest in PRS. At the time of the transfer, T2 has a $200 basis adjustment under section 743(b). T2 is treated as transferring $100 of the basis adjustment to T3 with the gift of the partnership interest. ( g ) Distributions — ( 1 ) Distribution of adjusted property to the transferee — ( i ) Coordination with section 732. If a partnership distributes property to a transferee and the transferee has a basis adjustment for the property, the basis adjustment is taken into account under section 732. See § 1.732-2(b) . ( ii ) Coordination with section 734. For certain adjustments to the common basis of remaining partnership property after the distribution of adjusted property to a transferee, see § 1.734-2(b) . ( 2 ) Distribution of adjusted property to another partner — ( i ) Coordination with section 732. If a partner receives a distribution of property with respect to which another partner has a basis adjustment, the distributee does not take the basis adjustment into account under section 732. ( ii ) Reallocation of basis. A transferee with a basis adjustment in property that is distributed to another partner reallocates the basis adjustment among the remaining items of partnership property under § 1.755-1(c) . ( 3 ) Distributions in complete liquidation of a partner's interest. If a transferee receives a distribution of property (whether or not the transferee has a basis adjustment in such property) in liquidation of its interest in the partnership, the adjusted basis to the partnership of the distributed property immediately before the distribution includes the transferee's basis adjustment for the property in which the transferee relinquished an interest (either because it remained in the partnership or was distributed to another partner). Any basis adjustment for property in which the transferee is deemed to relinquish its interest is reallocated among the properties distributed to the transferee under § 1.755-1(c) . ( 4 ) Coordination with other provisions. The rules of sections 704(c)(1)(B), 731, 737, and 751 apply before the rules of this paragraph (g) . ( 5 ) Example. The provisions of this paragraph (g) are illustrated by the following example: (i) A, B, and C are equal partners in partnership PRS. Each partner originally contributed $10,000 in cash, and PRS used the contributions to purchase five nondepreciable capital assets. PRS has no liabilities. After five years, PRS's balance sheet appears as follows: Assets Adjusted basis Fair market value Asset 1 $10,000 $10,000 Asset 2 4,000 6,000 Asset 3 6,000 6,000 Asset 4 7,000 4,000 Asset 5 3,000 13,000 Total 30,000 39,000 Capital Adjusted per books Fair market value Partner A $10,000 $13,000 Partner B 10,000 13,000 Partner C 10,000 13,000 Total 30,000 39,000 (ii) A sells its interest to T for $13,000 when PRS has an election in effect under section 754. T receives a basis adjustment under section 743(b) in the partnership property that is equal to $3,000 (the excess of T's basis in the partnership interest, $13,000, over T's share of the adjusted basis to the partnership of partnership property, $10,000). The basis adjustment is allocated under section 755, and the partnership's balance sheet appears as follows: Assets Adjusted basis Fair market value Basis adjustment Asset 1 $10,000 $10,000 $0.00 Asset 2 4,000 6,000 666.67 Asset 3 6,000 6,000 0.00 Asset 4 7,000 4,000 (1,000.00) Asset 5 3,000 13,000 3,333.33 Total 30,000 39,000 3,000.00 Capital Adjusted per books Fair market value Special basis Partner T $10,000 $13,000 $3,000 Partner B 10,000 13,000 0 Partner C 10,000 13,000 0 Total 30,000 39,000 3,000 (iii) Assume that PRS distributes Asset 2 to T in partial liquidation of T's interest in the partnership. T has a basis adjustment under section 743(b) of $666.67 in Asset 2. Under paragraph (g)(1)(i) of this section, T takes the basis adjustment into account under section 732. Therefore, T will have a basis in Asset 2 of $4,666.67 following the distribution. (iv) Assume instead that PRS distributes Asset 5 to C in complete liquidation of C's interest in PRS. T has a basis adjustment under section 743(b) of $3,333.33 in Asset 5. Under paragraph (g)(2)(i) of this section, C does not take T's basis adjustment into account under section 732. Therefore, the partnership's basis for purposes of sections 732 and 734 is $3,000. Under paragraph (g)(2)(ii) of this section, T's $3,333.33 basis adjustment is reallocated among the remaining partnership assets under § 1.755-1(c) . (v) Assume instead that PRS distributes Asset 5 to T in complete liquidation of its interest in PRS. Under paragraph (g)(3) of this section, immediately prior to the distribution of Asset 5 to T, PRS must adjust the basis of Asset 5. Therefore, immediately prior to the distribution, PRS's basis in Asset 5 is equal to $6,000, which is the sum of (A) $3,000, PRS's common basis in Asset 5, plus (B) $3,333.33, T's basis adjustment to Asset 5, plus (C) ($333.33), the sum of T's basis adjustments in Assets 2 and 4. For purposes of sections 732 and 734, therefore, PRS will be treated as having a basis in Asset 5 equal to $6,000. ( h ) Contributions of adjusted property — ( 1 ) Section 721(a) transactions. If, in a transaction described in section 721(a), a partnership (the upper tier) contributes to another partnership (the lower tier) property with respect to which a basis adjustment has been made, the basis adjustment is treated as contributed to the lower-tier partnership, regardless of whether the lower-tier partnership makes a section 754 election. The lower tier's basis in the contributed assets and the upper tier's basis in the partnership interest received in the transaction are determined with reference to the basis adjustment. However, that portion of the basis of the upper tier's interest in the lower tier attributable to the basis adjustment must be segregated and allocated solely to the transferee partner for whom the basis adjustment was made. Similarly, that portion of the lower tier's basis in its assets attributable to the basis adjustment must be segregated and allocated solely to the upper tier and the transferee. A partner with a basis adjustment in property held by a partnership that terminates under section 708(b)(1)(B) will continue to have the same basis adjustment with respect to property deemed contributed by the terminated partnership to the new partnership under § 1.708-1(b)(1)(iv) , regardless of whether the new partnership makes a section 754 election. ( 2 ) Section 351 transactions — ( i ) Basis in transferred property. A corporation's adjusted tax basis in property transferred to the corporation by a partnership in a transaction described in section 351 is determined with reference to any basis adjustments to the property under section 743(b) (other than any basis adjustment that reduces a partner's gain under paragraph (h)(2)(ii) of this section). ( ii ) Partnership gain. The amount of gain, if any, recognized by the partnership on a transfer of property by the partnership to a corporation in a transfer described in section 351 is determined without reference to any basis adjustment to the transferred property under section 743(b). The amount of gain, if any, recognized by the partnership on the transfer that is allocated to a partner with a basis adjustment in the transferred property is adjusted to reflect the partner's basis adjustment in the transferred property. ( iii ) Basis in stock. The partnership's adjusted tax basis in stock received from a corporation in a transfer described in section 351 is determined without reference to the basis adjustment in property transferred to the corporation in the section 351 exchange. A partner with a basis adjustment in property transferred to the corporation, however, has a basis adjustment in the stock received by the partnership in the section 351 exchange in an amount equal to the partner's basis adjustment in the transferred property, reduced by any basis adjustment that reduced the partner's gain under paragraph (h)(2)(ii) of this section. ( iv ) Example. The following example illustrates the principles of this paragraph (h)(2) : (i) A, B, and C are equal partners in partnership PRS. The partnership's only asset, Asset 1, has an adjusted tax basis of $60 and a fair market value of $120. Asset 1 is a nondepreciable capital asset and is not section 704(c) property. A has a basis in its partnership interest of $40, and a positive section 743(b) adjustment of $20 in Asset 1. In a transaction to which section 351 applies, PRS contributes Asset 1 to X, a corporation, in exchange for $15 in cash and X stock with a fair market value of $105. (ii) Under paragraph (h)(2)(ii) of this section, PRS realizes $60 of gain on the transfer of Asset 1 to X ($120, its amount realized, minus $60, its adjusted basis), but recognizes only $15 of that gain under section 351(b)(1). Of this amount, $5 is allocated to each partner. A must use $5 of its basis adjustment in Asset 1 to offset A's share of PRS's gain. Under paragraph (h)(2)(iii) of this section, PRS's basis in the stock received from X is $60. However, A has a basis adjustment in the stock received by PRS equal to $15 (its basis adjustment in Asset 1, $20, reduced by the portion of the adjustment which reduced A's gain, $5). Under paragraph (h)(2)(i) of this section, X's basis in Asset 1 equals $90 (PRS's common basis in the asset, $60, plus the gain recognized by PRS under section 351(b)(1), $15, plus A's basis adjustment under section 743(b), $20, less the portion of the adjustment which reduced A's gain, $5). ( i ) [Reserved] ( j ) Effect of basis adjustment — ( 1 ) In general. The basis adjustment constitutes an adjustment to the basis of partnership property with respect to the transferee only. No adjustment is made to the common basis of partnership property. Thus, for purposes of calculating income, deduction, gain, and loss, the transferee will have a special basis for those partnership properties the bases of which are adjusted under section 743(b) and this section. The adjustment to the basis of partnership property under section 743(b) has no effect on the partnership's computation of any item under section 703. ( 2 ) Computation of partner's distributive share of partnership items. The partnership first computes its items of income, deduction, gain, or loss at the partnership level under section 703. The partnership then allocates the partnership items among the partners, including the transferee, in accordance with section 704, and adjusts the partners' capital accounts accordingly. The partnership then adjusts the transferee's distributive share of the items of partnership income, deduction, gain, or loss, in accordance with paragraphs (j)(3) and (4) of this section, to reflect the effects of the transferee's basis adjustment under section 743(b). These adjustments to the transferee's distributive shares must be reflected on Schedules K and K-1 of the partnership's return (Form 1065). These adjustments to the transferee's distributive shares do not affect the transferee's capital account. See § 1.460-4(k)(3)(v)(B) for rules relating to the effect of a basis adjustment under section 743(b) that is allocated to a contract accounted for under a long-term contract method of accounting in determining the transferee's distributive share of income or loss from the contract. ( 3 ) Effect of basis adjustment in determining items of income, gain, or loss — ( i ) In general. The amount of a transferee's income, gain, or loss from the sale or exchange of a partnership asset in which the transferee has a basis adjustment is equal to the transferee's share of the partnership's gain or loss from the sale of the asset (including any remedial allocations under § 1.704-3(d) ), minus the amount of the transferee's positive basis adjustment for the partnership asset (determined by taking into account the recovery of the basis adjustment under paragraph (j)(4)(i)(B) of this section) or plus the amount of the transferee's negative basis adjustment for the partnership asset (determined by taking into the account the recovery of the basis adjustment under paragraph (j)(4)(ii)(B) of this section). ( ii ) Examples. The following examples illustrate the principles of this paragraph (j)(3) : A and B form equal partnership PRS. A contributes nondepreciable property with a fair market value of $50 and an adjusted tax basis of $100. PRS will use the traditional allocation method under § 1.704-3(b) . B contributes $50 cash. A sells its interest to T for $50. PRS has an election in effect to adjust the basis of partnership property under section 754. T receives a negative $50 basis adjustment under section 743(b) that, under section 755, is allocated to the nondepreciable property. PRS then sells the property for $60. PRS recognizes a book gain of $10 (allocated equally between T and B) and a tax loss of $40. T will receive an allocation of $40 of tax loss under the principles of section 704(c). However, because T has a negative $50 basis adjustment in the nondepreciable property, T recognizes a $10 gain from the partnership's sale of the property. A and B form equal partnership PRS. A contributes nondepreciable property with a fair market value of $100 and an adjusted tax basis of $50. B contributes $100 cash. PRS will use the traditional allocation method under § 1.704-3(b) . A sells its interest to T for $100. PRS has an election in effect to adjust the basis of partnership property under section 754. Therefore, T receives a $50 basis adjustment under section 743(b) that, under section 755, is allocated to the nondepreciable property. PRS then sells the nondepreciable property for $90. PRS recognizes a book loss of $10 (allocated equally between T and B) and a tax gain of $40. T will receive an allocation of the entire $40 of tax gain under the principles of section 704(c). However, because T has a $50 basis adjustment in the property, T recognizes a $10 loss from the partnership's sale of the property. A and B form equal partnership PRS. PRS will make allocations under section 704(c) using the remedial allocation method described in § 1.704-3(d) . A contributes nondepreciable property with a fair market value of $100 and an adjusted tax basis of $150. B contributes $100 cash. A sells its partnership interest to T for $100. PRS has an election in effect to adjust the basis of partnership property under section 754. T receives a negative $50 basis adjustment under section 743(b) that, under section 755, is allocated to the property. The partnership then sells the property for $120. The partnership recognizes a $20 book gain and a $30 tax loss. The book gain will be allocated equally between the partners. The entire $30 tax loss will be allocated to T under the principles of section 704(c). To match its $10 share of book gain, B will be allocated $10 of remedial gain, and T will be allocated an offsetting $10 of remedial loss. T was allocated a total of $40 of tax loss with respect to the property. However, because T has a negative $50 basis adjustment to the property, T recognizes a $10 gain from the partnership's sale of the property. ( 4 ) Effect of basis adjustment in determining items of deduction — ( i ) Increases — ( A ) Additional deduction. The amount of any positive basis adjustment that is recovered by the transferee in any year is added to the transferee's distributive share of the partnership's depreciation or amortization deductions for the year. The basis adjustment is adjusted under section 1016(a)(2) to reflect the recovery of the basis adjustment. ( B ) Recovery period — ( 1 ) In general. Except as provided in paragraph (j)(4)(i)(B)( 2 ) of this section, for purposes of section 168, if the basis of a partnership's recovery property is increased as a result of the transfer of a partnership interest, then the increased portion of the basis is taken into account as if it were newly-purchased recovery property placed in service when the transfer occurs. Consequently, any applicable recovery period and method may be used to determine the recovery allowance with respect to the increased portion of the basis. However, no change is made for purposes of determining the recovery allowance under section 168 for the portion of the basis for which there is no increase. The partnership is allowed to deduct the additional first year depreciation under section 168(k) and § 1.168(k)-2 for an increase in the basis of qualified property, as defined in section 168(k) and § 1.168(k)-2 , under section 743(b) in a class of property, as defined in § 1.168(k)-2(f)(1)(ii)(A) through (F) , even if the partnership made the election under section 168(k)(7) and § 1.168(k)-2(f)(1) not to deduct the additional first year depreciation for all other qualified property of the partnership in the same class of property, as defined in § 1.168(k)-2(f)(1)(ii)(A) through (F) , and placed in service in the same taxable year, provided the section 743(b) basis adjustment meets all requirements of section 168(k) and § 1.168(k)-2 . Further, the partnership may make an election under section 168(k)(7) and § 1.168(k)-2(f)(1) not to deduct the additional first year depreciation for an increase in the basis of qualified property, as defined in section 168(k) and § 1.168(k)-2 , under section 743(b) in a class of property, as defined in § 1.168(k)-2(f)(1)(ii)(A) through (F) , and placed in service in the same taxable year, even if the partnership does not make that election for all other qualified property of the partnership in the same class of property, as defined in § 1.168(k)-2(f)(1)(ii)(A) through (F) , and placed in service in the same taxable year. In this case, the section 743(b) basis adjustment must be recovered under a reasonable method. ( 2 ) Remedial allocation method. If a partnership elects to use the remedial allocation method described in § 1.704-3(d) with respect to an item of the partnership's recovery property, then the portion of any increase in the basis of the item of the partnership's recovery property under section 743(b) that is attributable to section 704(c) built-in gain is recovered over the remaining recovery period for the partnership's excess book basis in the property as determined in the final sentence of § 1.704-3(d)(2) . Any remaining portion of the basis increase is recovered under paragraph (j)(4)(i)(B)( 1 ) of this section. The first sentence of this paragraph (j)(4)(i)(B)( 2 ) does not apply to a partnership that is not a publicly traded partnership within the meaning of section 7704(b) with respect to any basis increase under section 743(b) that is recovered using the additional first year depreciation deduction under section 168(k). ( C ) Examples. The provisions of this paragraph (j)(4)(i) are illustrated by the following examples: (i) A, B, and C are equal partners in partnership PRS, which owns Asset 1, an item of depreciable property that has a fair market value in excess of its adjusted tax basis. C sells its interest in PRS to T while PRS has an election in effect under section 754. PRS, therefore, increases the basis of Asset 1 with respect to T. (ii) Assume that in the year following the transfer of the partnership interest to T, T's distributive share of the partnership's common basis depreciation deductions from Asset 1 is $1,000. Also assume that, under paragraph (j)(4)(i)(B) of this section, the amount of the basis adjustment under section 743(b) that T recovers during the year is $500. The total amount of depreciation deductions from Asset 1 reported by T is equal to $1,500. (i) A and B form equal partnership PRS. A contributes property with an adjusted basis of $100,000 and a fair market value of $500,000. B contributes $500,000 cash. When PRS is formed, the property has five years remaining in its recovery period. The partnership's adjusted basis of $100,000 will, therefore, be recovered over the five years remaining in the property's recovery period. PRS elects to use the remedial allocation method under § 1.704-3(d) with respect to the property. If PRS had purchased the property at the time of the partnership's formation, the basis of the property would have been recovered over a 10-year period. The $400,000 of section 704(c) built-in gain will, therefore, be amortized under § 1.704-3(d) over a 10-year period beginning at the time of the partnership's formation. (ii)(A) Except for the depreciation deductions, PRS's expenses equal its income in each year of the first two years commencing with the year the partnership is formed. After two years, A's share of the adjusted basis of partnership property is $120,000, while B's is $440,000: Capital accounts A B Book Tax Book Tax Initial Contribution $500,000 $100,000 $500,000 $500,000 Depreciation Year 1 (30,000) (30,000) (20,000) Remedial 10,000 (10,000) 470,000 110,000 470,000 470,000 Depreciation Year 2 (30,000) (30,000) (20,000) Remedial 10,000 (10,000) 440,000 120,000 440,000 440,000 (B) A sells its interest in PRS to T for its fair market value of $440,000. A valid election under section 754 is in effect with respect to the sale of the partnership interest. Accordingly, PRS makes an adjustment, pursuant to section 743(b), to increase the basis of partnership property. Under section 743(b), the amount of the basis adjustment is equal to $320,000. Under section 755, the entire basis adjustment is allocated to the property. (iii) At the time of the transfer, $320,000 of section 704(c) built-in gain from the property was still reflected on the partnership's books, and all of the basis adjustment is attributable to section 704(c) built-in gain. Therefore, the basis adjustment will be recovered over the remaining recovery period for the section 704(c) built-in gain under § 1.704-3(d) . ( ii ) Decreases — ( A ) Reduced deduction. The amount of any negative basis adjustment allocated to an item of depreciable or amortizable property that is recovered in any year first decreases the transferee's distributive share of the partnership's depreciation or amortization deductions from that item of property for the year. If the amount of the basis adjustment recovered in any year exceeds the transferee's distributive share of the partnership's depreciation or amortization deductions from the item of property, then the transferee's distributive share of the partnership's depreciation or amortization deductions from other items of partnership property is decreased. The transferee then recognizes ordinary income to the extent of the excess, if any, of the amount of the basis adjustment recovered in any year over the transferee's distributive share of the partnership's depreciation or amortization deductions from all items of property. ( B ) Recovery period. For purposes of section 168, if the basis of an item of a partnership's recovery property is decreased as the result of the transfer of an interest in the partnership, then the decrease is recovered over the remaining useful life of the item of the partnership's recovery property. The portion of the decrease that is recovered in any year during the recovery period is equal to the product of— ( 1 ) The amount of the decrease to the item's adjusted basis (determined as of the date of the transfer); multiplied by ( 2 ) A fraction, the numerator of which is the portion of the adjusted basis of the item recovered by the partnership in that year, and the denominator of which is the adjusted basis of the item on the date of the transfer (determined prior to any basis adjustments). ( C ) Examples. The provisions of this paragraph (j)(4)(ii) are illustrated by the following examples: (i) A, B, and C are equal partners in partnership PRS, which owns Asset 2, an item of depreciable property that has a fair market value that is less than its adjusted tax basis. C sells its interest in PRS to T while PRS has an election in effect under section 754. PRS, therefore, decreases the basis of Asset 2 with respect to T. (ii) Assume that in the year following the transfer of the partnership interest to T, T's distributive share of the partnership's common basis depreciation deductions from Asset 2 is $1,000. Also assume that, under paragraph (j)(4)(ii)(B) of this section, the amount of the basis adjustment under section 743(b) that T recovers during the year is $500. The total amount of depreciation deductions from Asset 2 reported by T is equal to $500. (i) A and B form equal partnership PRS. A contributes property with an adjusted basis of $100,000 and a fair market value of $50,000. B contributes $50,000 cash. When PRS is formed, the property has five years remaining in its recovery period. The partnership's adjusted basis of $100,000 will, therefore, be recovered over the five years remaining in the property's recovery period. PRS uses the traditional allocation method under § 1.704-3(b) with respect to the property. As a result, B will receive $5,000 of depreciation deductions from the property in each of years 1-5, and A, as the contributing partner, will receive $15,000 of depreciation deductions in each of these years. (ii) Except for the depreciation deductions, PRS's expenses equal its income in each of the first two years commencing with the year the partnership is formed. After two years, A's share of the adjusted basis of partnership property is $70,000, while B's is $40,000. A sells its interest in PRS to T for its fair market value of $40,000. A valid election under section 754 is in effect with respect to the sale of the partnership interest. Accordingly, PRS makes an adjustment, pursuant to section 743(b), to decrease the basis of partnership property. Under section 743(b), the amount of the adjustment is equal to ($30,000). Under section 755, the entire adjustment is allocated to the property. (iii) The basis of the property at the time of the transfer of the partnership interest was $60,000. In each of years 3 through 5, the partnership will realize depreciation deductions of $20,000 from the property. Thus, one third of the negative basis adjustment ($10,000) will be recovered in each of years 3 through 5. Consequently, T will be allocated, for tax purposes, depreciation of $15,000 each year from the partnership and will recover $10,000 of its negative basis adjustment. Thus, T's net depreciation deduction from the partnership in each year is $5,000. (ii) Assume that in the year following the transfer of the partnership interest to T, T's distributive share of the partnership's common basis depreciation deductions from Asset 2 is $500. PRS allocates no other depreciation to T. Also assume that, under paragraph (j)(4)(ii)(B) of this section, the amount of the negative basis adjustment that T recovers during the year is $1,000. T will report $500 of ordinary income because the amount of the negative basis adjustment recovered during the year exceeds T's distributive share of the partnership's common basis depreciation deductions from Asset 2. ( 5 ) Depletion. Where an adjustment is made under section 743(b) to the basis of partnership property subject to depletion, any depletion allowance is determined separately for each partner, including the transferee partner, based on the partner's interest in such property. See § 1.702-1(a)(8) . For partnerships that hold oil and gas properties that are depleted at the partner level under section 613A(c)(7)(D), the transferee partner (and not the partnership) must make the basis adjustments, if any, required under section 743(b) with respect to such properties. See § 1.613A-3(e)(6)(iv) . ( 6 ) Example. The provisions of paragraph (j)(5) of this section are illustrated by the following example: A, B, and C each contributes $5,000 cash to form partnership PRS, which purchases a coal property for $15,000. A, B, and C have equal interests in capital and profits. C subsequently sells its partnership interest to T for $100,000 when the election under section 754 is in effect. T has a basis adjustment under section 743(b) for the coal property of $95,000 (the difference between T's basis, $100,000, and its share of the basis of partnership property, $5,000). Assume that the depletion allowance computed under the percentage method would be $21,000 for the taxable year so that each partner would be entitled to $7,000 as its share of the deduction for depletion. However, under the cost depletion method, at an assumed rate of 10 percent, the allowance with respect to T's one-third interest which has a basis to him of $100,000 ($5,000, plus its basis adjustment of $95,000) is $10,000, although the cost depletion allowance with respect to the one-third interest of A and B in the coal property, each of which has a basis of $5,000, is only $500. For partners A and B, the percentage depletion is greater than cost depletion and each will deduct $7,000 based on the percentage depletion method. However, as to T, the transferee partner, the cost depletion method results in a greater allowance and T will, therefore, deduct $10,000 based on cost depletion. See section 613(a). ( k ) Returns — ( 1 ) Statement of adjustments — ( i ) In general. A partnership that must adjust the bases of partnership properties under section 743(b) must attach a statement to the partnership return for the year of the transfer setting forth the name and taxpayer identification number of the transferee as well as the computation of the adjustment and the partnership properties to which the adjustment has been allocated. ( ii ) Special rule. Where an interest is transferred in a partnership which holds oil and gas properties that are depleted at the partner level under section 613A(c)(7)(D), the transferee must attach a statement to the transferee's return for the year of the transfer, setting forth the computation of the basis adjustment under section 743(b) which is allocable to such properties and the specific properties to which the adjustment has been allocated. ( iii ) Example. The provisions of paragraph (k)(1)(ii) of this section are illustrated by the following example: (i) Partnership XYZ owns a single section 613A(c)(7)(D) domestic oil and gas property (Property) and other non-depletable assets. A, a partner in XYZ with an adjusted tax basis in Property of $100 (excluding any prior adjustments under section 743(b)), sells its partnership interest to B for $800 cash. Under § 1.613A-3(e)(6)(iv) , A's adjusted basis of $100 in Property carries over to B. (ii) Under section 755, XYZ determines that Property accounts for 50% of the fair market value of all partnership assets. The remaining 50% of B's purchase price ($400) is attributable to non-depletable property. XYZ must provide a statement to B containing the portion of B's adjusted basis attributable to non-depletable property ($400). Under this paragraph (k)(1) , XYZ must report basis adjustments under section 743(b) to non-depletable property. B must report basis adjustments under section 743(b) to Property. ( 2 ) Requirement that transferee notify partnership — ( i ) Sale or exchange. A transferee that acquires, by sale or exchange, an interest in a partnership with an election under section 754 in effect for the taxable year of the transfer, must notify the partnership, in writing, within 30 days of the sale or exchange. The written notice to the partnership must be signed under penalties of perjury and must include the names and addresses of the transferee and (if ascertainable) of the transferor, the taxpayer identification numbers of the transferee and (if ascertainable) of the transferor, the relationship (if any) between the transferee and the transferor, the date of the transfer, the amount of any liabilities assumed or taken subject to by the transferee, and the amount of any money, the fair market value of any other property delivered or to be delivered for the transferred interest in the partnership, and any other information necessary for the partnership to compute the transferee's basis. ( ii ) Special rule. A transferee that acquires, on the death of a partner, an interest in a partnership with an election under section 754 in effect for the taxable year of the transfer, must notify the partnership, in writing, within one year of the death of the deceased partner. The written notice to the partnership must be signed under penalties of perjury and must include the names and addresses of the deceased partner and the transferee, the taxpayer identification numbers of the deceased partner and the transferee, the relationship (if any) between the transferee and the transferor, the deceased partner's date of death, the date on which the transferee became the owner of the partnership interest, the fair market value of the partnership interest on the applicable date of valuation set forth in section 1014 or section 1022, the manner in which the fair market value of the partnership interest was determined, and the carryover basis as adjusted under section 1022 (if applicable). ( iii ) Nominee reporting. If a partnership interest is transferred to a nominee which is required to furnish the statement under section 6031(c)(1) to the partnership, the nominee may satisfy the notice requirement contained in this paragraph (k)(2) by providing the statement required under § 1.6031(c)-1T , provided that the statement satisfies all requirements of § 1.6031(c)-1T and this paragraph (k)(2) . ( 3 ) Reliance. In making the adjustments under section 743(b) and any statement or return relating to such adjustments under this section, a partnership may rely on the written notice provided by a transferee pursuant to paragraph (k)(2) of this section to determine the transferee's basis in a partnership interest. The previous sentence shall not apply if any partner who has responsibility for federal income tax reporting by the partnership has knowledge of facts indicating that the statement is clearly erroneous. ( 4 ) Partnership not required to make or report adjustments under section 743(b) until it has notice of the transfer. A partnership is not required to make the adjustments under section 743(b) (or any statement or return relating to those adjustments) with respect to any transfer until it has been notified of the transfer. For purposes of this section, a partnership is notified of a transfer when either— ( i ) The partnership receives the written notice from the transferee required under paragraph (k)(2) of this section; or ( ii ) Any partner who has responsibility for federal income tax reporting by the partnership has knowledge that there has been a transfer of a partnership interest. ( 5 ) Effect on partnership of the failure of the transferee to comply. If the transferee fails to provide the partnership with the written notice required by paragraph (k)(2) of this section, the partnership must attach a statement to its return in the year that the partnership is otherwise notified of the transfer. This statement must set forth the name and taxpayer identification number (if ascertainable) of the transferee. In addition, the following statement must be prominently displayed in capital letters on the first page of the partnership's return for such year, and on the first page of any schedule or information statement relating to such transferee's share of income, credits, deductions, etc.: “RETURN FILED PURSUANT TO § 1.743-1(k)(5) .” The partnership will then be entitled to report the transferee's share of partnership items without adjustment to reflect the transferee's basis adjustment in partnership property. If, following the filing of a return pursuant to this paragraph (k)(5) , the transferee provides the applicable written notice to the partnership, the partnership must make such adjustments as are necessary to adjust the basis of partnership property (as of the date of the transfer) in any amended return otherwise to be filed by the partnership or in the next annual partnership return of income to be regularly filed by the partnership. At such time, the partnership must also provide the transferee with such information as is necessary for the transferee to amend its prior returns to properly reflect the adjustment under section 743(b). ( l ) Effective/applicability date. The provisions in this section apply to transfers of partnership interests that occur on or after December 15, 1999. The provisions of this section relating to section 1022 are effective on and after January 19, 2017. The last three sentences of paragraph (j)(4)(i)(B)( 1 ) of this section, and the last sentence of paragraph (j)(4)(i)(B)( 2 ) of this section, apply to transfers of partnership interests that occur on or after September 24, 2019. However, a partnership may choose to apply the last three sentences in paragraph (j)(4)(i)(B)(1) of this section, and the last sentence of paragraph (j)(4)(i)(B)(2) of this section, for transfers of partnership interests that occur on or after September 28, 2017. A partnership may rely on the last three sentences in paragraph (j)(4)(i)(B)(1) of this section in regulation project REG-104397-18 (2018-41 I.R.B. 558) (see § 601.601(d)(2)(ii)(b) of this chapter ) for transfers of partnership interests that occur on or after September 28, 2017, and ending before September 24, 2019. [T.D. 8847, 64 FR 69909 , Dec. 15, 1999; 65 FR 9220 , Feb. 24, 2000, as amended by T.D. 9137, 69 FR 42559 , July 16, 2004; T.D. 9811, 82 FR 6239 , Jan. 19, 2017; T.D. 9874, 84 FR 50150 , Sept. 24, 2019] Reader Aids Information. About This Site Legal Status Accessibility No Fear Act Continuity Information Check out Future CPA's sample client Annual Performance Report offering unparalleled insights into financials. Interested in elevating your finances with a futuristic finance team on your side? Fill this form to get started. Navigating partnership interests and tax consequences. Introduction Partnerships are a common business structure, and understanding the taxation of partnership interests is essential for partners and investors. A partnership interest is a complex property for income tax purposes, similar to owning shares in a corporation. In this guide, we will explore the concept of partnership interests and delve into their taxation through practical examples. The Concept of Partnership Interest What is a partnership interest. A partnership interest comprises the rights of a partner in a partnership. These rights include participation in profits and losses of the partnership and an ownership stake in partnership assets, especially during dissolution. Similar to owning stock in a corporation, a partnership interest is considered a property for income tax purposes. Taxation of Partnership Interests Typically, a partnership interest is regarded as non-depreciable capital property held to earn business or property income. Consequently, disposing of a partnership interest usually results in a capital gain or loss. Acquiring a Partnership Interest New partnership. When forming a new partnership, determining the adjusted cost base (ACB) of the partnership interest is straightforward. The ACB equals the fair value of assets contributed to the partnership. If non-monetary assets are involved, appraisals may be necessary, but this doesn't alter the basic concept. Admission to an Existing Partnership Admission to an existing partnership can occur through two methods: buying an interest directly from a partner or acquiring an interest from the partnership by transferring assets. Purchasing an Interest from a Partner When purchasing an interest directly from an existing partner, the cost equals the purchase price. For instance, if Mr. Kim acquires Mr. Boland's one-third interest for $90,000, both Mr. Kim's cost and Mr. Boland's proceeds of disposition would be $90,000. Purchasing an Interest from the Partnership using Assets In cases where the partnership interest is acquired by transferring assets directly to the partnership, no tax consequences occur for existing partners. No disposition of their interest occurs, and therefore, no capital gain is recorded. The new partner's interest is recorded at the cost of the assets transferred, e.g., $90,000. Let's understand admission of a new partner with an example below. Real World Example Consider an existing partnership named ABC Enterprises that has three equal partners: Sarah, Mike, and Emily. Each of them has made a capital contribution of $20,000. They would like to bring in a new equal partner, Mr. Johnson, with the goal of ensuring that each partner retains a 25 percent interest in the organization. Mr. Johnson agrees to pay $40,000 to each of the existing partners for one-quarter of their one-third interest. This arrangement ensures that each partner maintains a 25 percent interest [(75%)(1/3) = 25%]. ‍ Mr. Johnson would have an Adjusted Cost Base (ACB) of $120,000, which represents the consideration given up for the 25 percent interest. Each of the original partners (Sarah, Mike, and Emily) would have a capital gain calculated as follows: Proceeds Of Disposition To Each Partner: $40,000 ACB of Part Interest [(25%)($20,000)]: ($5,000) Capital Gain For Each Partner: $35,000 The capital accounts in the accounting records of the partnership and the partners' ACB will be as follows: Sarah's Capital Before Admitting Mr. Johnson: $20,000 Mike's Capital Before Admitting Mr. Johnson: $20,000 Emily's Capital Before Admitting Mr. Johnson: $20,000 Mr. Johnson's Contribution: $120,000 Adjustment For Admission Of Mr. Johnson: Sarah: ($5,000) Mike: ($5,000) Emily: ($5,000) Mr. Johnson: $15,000 Ending Capital Accounts: Sarah: $15,000 Mike: $15,000 Emily: $15,000 ACB Of Partnership Interest: Mr. Johnson: $120,000 Note that while the accounting values for the interests of the original three partners are equal to their ACBs, this is not the case for Mr. Johnson. In contrast to his accounting value of $15,000, his ACB would be his cost of $120,000 [(3)($40,000)]. In this example, we have only considered situations where assets were given to specific partners in return for the new partner’s acquired interest. There are also situations in which the new partner makes a payment directly to the partnership in return for his or her interest. If Mr. Johnson had paid the $120,000 directly to the partnership, there would be no tax consequences for the existing partners (Sarah, Mike, and Emily). No disposition of any part of their interest would have occurred, and as a consequence, no capital gain would be recorded, and the ACBs of their interests would remain at $20,000. Mr. Johnson's interest would be recorded at $120,000 for both tax and accounting purposes. Adjusted Cost Base (ACB) The adjusted cost base (ACB) of a partnership interest is crucial for tax purposes. ACB is determined by starting with the ACB of the preceding year and adjusting it for various items, including income allocations, drawings, capital contributions, dividends, and more. Timing of Adjustments Adjustments for income allocations, drawings, and dividends are made on the first day of the following fiscal period. Let's explore these adjustments. Adjustments for Income Allocations Partnership income is allocated based on the partnership agreement. The allocated income, whether business income or capital gains/losses, is added to or subtracted from the partner's ACB on the first day of the following fiscal period. Example: In a partnership with four equal partners and a December 31, 2019 year end, each partner initially contributed $2,000. In 2020, they earned $20,000 in gross service revenue. Each partner's share of business income ($5,000 each) would be added to their ACB on January 1, 2021. Adjustments for Capital Contributions and Drawings Net capital contributions increase the ACB, while drawings decrease it. These adjustments occur when the contributions or drawings take place. Example: If Mr. A's partnership interest has an ACB of $20,450 at January 1, 2020, and he contributes $8,200 in March 2020 while making withdrawals of $2,000 in May, August, and November 2020, his ACB would be calculated as $22,650. Adjustments for Dividends Dividends, whether eligible, non-eligible, or capital, are allocated based on the partnership agreement. The full amount of dividends is added to the ACB on the first day of the following fiscal period. Negative ACB A negative adjusted cost base (ACB) can occur when withdrawals exceed the initial ACB and positive adjustments. Special provisions allow general partners to carry forward a negative ACB until they dispose of their interest. This deferral is beneficial for tax purposes and is also applicable in cases of deemed disposition at death. Limited Partnerships and Limited Partners In a limited partnership, there are limited partners who have limited liability and active general partners who manage the business. Taxation rules for limited partners differ from those for general partners. Disposition of a Partnership Interest When a partner disposes off their interest in a partnership, it can have significant tax implications. Disposition typically occurs through two main scenarios: selling the interest to an arm's length party or withdrawing from the partnership. Sale to an Arm's Length Party If a partnership interest is sold to a party that is not related to the seller (an arm's length party), the tax consequences are relatively straightforward. The calculation involves subtracting the adjusted cost base (ACB) of the partnership interest from the proceeds resulting from the sale. If the result is positive, it represents a capital gain. One-half of this gain will be taxed in the hands of the partner. If the result is negative, one-half of the amount becomes an allowable capital loss, which can be deducted by the partner to offset any current year taxable capital gains. Any unused capital loss can be carried over to previous and subsequent years for deduction. Example: Suppose Partner A sells their partnership interest to an unrelated third party for $120,000, and the ACB of their interest is $90,000. In this case, Partner A would realize a capital gain of $30,000 ($120,000 - $90,000). They would include $15,000 (one-half of the gain) in their taxable income. Withdrawal from the Partnership When a partner withdraws from a partnership, it's essentially a disposition of their interest. The most common scenario involves the remaining partner(s) buying out the withdrawing partner's interest. Here's how it works: Example: Consider the ABC Partnership with three partners: A, B, and C. C decides to retire and withdraws from the partnership. In return, A and B each pay C $175,000 for C's interest. Partner C would incur a taxable capital gain, which is calculated by comparing the proceeds received from A and B to the ACB of C's partnership interest. For A and B, there are no immediate tax consequences. However, their ACB for their remaining interests would increase by the amount paid to C. This process ensures that the tax implications are fair for both the withdrawing partner and the remaining partners. Understanding partnership interests and their adjusted cost base is essential for tax planning in partnerships. These concepts play a vital role in determining capital gains or losses when disposing of partnership interests and can significantly impact a partner's tax liability. Proper tracking and accounting are crucial to ensure compliance with tax regulations and optimize tax outcomes in partnership arrangements. If you’d like to learn more or would need help with a similar tax issue, please reach out to us at [email protected] . Share this article Disclaimer: The information provided on this website is for general informational purposes only and should not be considered professional advice. While we strive to ensure accuracy, accounting and financial regulations are subject to change, and it is recommended to consult a qualified professional before making any financial decisions. The use of futurecpa.ca does not create a client relationship, and we do not endorse or guarantee the accuracy of third-party content. We value confidentiality but cannot guarantee the security of transmitted information. The content on futurecpa.ca may change without notice. By using this website, you agree to these terms and conditions. For personalized advice, please contact us by filling our contact form or reach out to us at [email protected] . Thank you for visiting futurecpa.ca. We hope you find our content helpful. Related articles Still not sure? Let us help you find answers. Privacy Policy Terms of Service Email: [email protected] 12877 76 Avenue Surrey BC V3W 1E6, Canada © 2023 Future CPA Inc. All rights reserved.             2022-1087 IRS properly denied charitable deduction for partnership interest given to private foundation absent appropriate contemporaneous written acknowledgement Granting partial summary judgment for the government, the U.S. District Court for the Northern District of Texas has held that the IRS properly denied a charitable deduction stemming from a couple's donation of a 4% limited partnership interest to a private foundation to establish a DAF, so the couple was not entitled to a refund for the resulting tax paid ( Kevin M. Keefer, et ux. v. United States ). Kevin Keefer was a limited partner in Burbank HHG Hotel, LP (Burbank), which owned and operated a single hotel. On April 23, 2015, Burbank and the Apple Hospitality REIT (Apple) exchanged a nonbinding letter of intent (LOI) for Apple to purchase Burbank. Burbank had not signed the LOI and continued courting potential buyers. On June 18, 2015, Keefer assigned to Pi Foundation a 4% limited partner interest in Burbank to establish a DAF. Although Burbank had tentatively agreed to sell the hotel to Apple for $54m, the sales contract had not been signed, and Apple had not yet reviewed the property or associated records. The parties signed a sales contract on July 2, 2015, and the sale closed on August 11, 2015. The Keefers commissioned an appraisal of the donated interest as of June 18, 2015, which: Described the appraiser's qualifications Did not include the appraiser's tax identification numbers Included a "Statement of Limiting Conditions," stating that Keefer and Pi had agreed that Pi "would only share in the net proceeds from the Seller's Closing Statement [and] not in Other Assets of the Partnership not covered in the sale" The appraisal concluded the fair market value of the donated interest was $1.257m. Pi sent Keefer a 12-page packet of documents related to establishing the DAF (DAF Packet), which he signed on June 8, 2015. In early September 2015, Pi sent Keefer a brief letter acknowledging the donation (Acknowledgment Letter). In their timely filed joint federal income tax return for 2015, the Keefers claimed a $1.257m charitable contribution deduction for the donation to the DAF. Their Form 1040 provided their appraiser's tax identification number, the appraisal, the DAF Packet, and the Acknowledgement Letter. The IRS issued a deficiency notice in July or August 2019, denying the charitable deduction and increasing the Keefers' 2015 tax liability by $423,304 plus penalties and accruing interest. The IRS asserted that (1) the Keefers did not have a CWA from the donee showing the DAF "has exclusive legal control over the assets contributed" and (2) their appraisal did not include the appraiser's identifying number. The Keefers paid the additional tax and filed a refund claim in November 2019, which the IRS denied in March 2020 as untimely. In November 2019, the Keefers filed the instant refund action in district court. District court refund claim Both parties moved for summary judgment. The Keefers made four claims: Claim 1 : The IRS erred in denying their deduction and refund request Alternative Claim 2 : If the court finds the contribution was actually an anticipatory assignment of income, the Keefers are nonetheless entitled to a refund of tax, interest and penalties Alternative Claim 3 : If the court disallows the charitable contribution deduction, the IRS should be required to recalculate the Keefers' basis in the contributed asset and refund resulting overpaid taxes, penalties and interest Claim 4 : The court should grant summary judgment denying the IRS's defense of variance to the Keefers' two alternative claims The government asserted that (1) the defense of variance barred the Keefers' two alternative claims and (2) the Keefers' were not entitled to any refund. Ultimately, the court concluded that: The Keefers' refund claim was timely The Doctrine of Variance did not bar the taxpayers' claims The donation was an anticipatory assignment of income The IRS properly denied the Keefers' charitable deduction because their CWA did not meet the requirements of IRC Section 170(f)(8) and (18) The taxpayers were not entitled to a refund of their 2015 taxes A discussion of the last three points follows. Assignment of income Noting that a taxpayer may not escape tax on earned income by assigning that income to another party, the court stated, "[T]he critical question is whether the [donated] asset itself, or merely the income from it, has been transferred." The Keefers argued that their donation of the 4% interest met both prongs of the test established in Humacid Co. v. Commissioner , 42 T.C. 894 (1964), which provided that courts will respect the form of a donation of appreciated stock if the donor donates the property and title to it completely before the property produces income from a sale. Specifically, the Keefers contended that the hotel's sale to Apple remained uncertain when they assigned to Pi the 4% partnership interest, including all rights and interest pertaining to the interest. The government contended that the hotel's sale was "practically certain" at the time of the donation and "the Keefers carved out and retained a portion of the partnership asset by oral agreement." When the Keefers signed the agreement to assign the partnership interest to Pi on June 18, 2015, the court concluded, the hotel was not yet under contract. The contract to sell the hotel was signed on July 2, 2015, and Apple had 30 days to review the property and potentially back out of the contract. Absent a binding obligation to close the sale, "the deal was not 'practically certain' to go through," the court found. The pending sale of the hotel, "even if very likely to occur considering the presence of backup offers and as reflected in the appraiser's estimate that the risk of no sale was only 5% — does not render this donation an anticipatory assignment of income," the court stated. Turning back to the first Humacid prong, however, the court concluded that the Keefers had carved out a partial interest in the 4% partnership interest when they donated it, and thus did not give the entire interest to Pi. The Keefers asserted that their assignment of the 4% interest subject to an oral agreement that Pi would receive the net proceeds from the sale of the hotel, as opposed to other partnership assets not covered in the sale, "is not a 'carving out' from the 4% partnership interest to Pi any more than the partnership paying a liability for a pre-existing light bill is a 'carving out' from some partnership interest." The government argued that the oral agreement showed the taxpayers "did not donate a true partnership interest [but gave] away 4% of the net cash from the sale of one of the Partnership's assets [that] the Keefers would otherwise have received from the sale of the hotel. This is a classic assignment of income." The court rejected the Keefers' light-bill analogy, noting that the funds held back in the Keefers' transfer to Pi were funds that the general partner (1) chose to maintain to comply with loan agreements and (2) had the discretion to withhold from partner distributions. The taxpayers had not made a complete donation of the 4% interest, the court concluded, finding no genuine issue of material fact that they had carved out part of the 4% partnership interest before donating it to Pi. Thus, the anticipatory assignment of income doctrine applied. Insufficient CWA The court found that the CWA the Keefers received from Pi did not meet the requirements of IRC Section 170(f)(8) and (18). The Keefers argued that the Acknowledgement Letter and DAF Packet together constitute a statutorily compliant CWA. The government contended that multiple documents cannot be combined to constitute a CWA unless the documents include a merger clause, and neither document in this case stated that Pi had "exclusive legal control" over the donated assets. The court concluded that the CWA was not statutorily compliant; therefore, the IRS properly denied the charitable deduction. The court based this conclusion on its finding that (1) the DAF Packet did not constitute a CWA; and (2) the Acknowledgement Letter cannot supplement the DAF Packet. Specifically, the court found that the June 8, 2015 "DAF Packet did not complete the donation or legally obligate Kevin to donate the interest to Pi." The September 9, 2015 Acknowledgement Letter constituted the CWA in this case but did not meet the necessary statutory requirements because it did not "reference the Keefer DAF or otherwise affirm Pi's exclusive legal control, as required by [IRC Section] 170(f)(8)," which requires "strict compliance." Implications Taxpayers contemplating making a transfer to a DAF should consider the court's discussion on CWAs. As a general matter, the donee is not required to record or report the information provided on a CWA to the IRS, so the burden falls on the donor to ensure that proper documentation is received for the charitable organization. The court noted that the CWA requirements, under IRC Section 170(f)(8), required strict compliance; thus, IRC Section 170(f)(18) must also require strict compliance because it supplements and cross references IRC Section 170(f)(8): "The taxpayer obtains a [CWA] (determined under rules similar to the rules of [IRC Section 170(f)(8)(C)] from the sponsoring organization (as so defined) of such [DAF] that such organization has exclusive legal control over the assets contributed" (citing Averyt v. Commissioner , T.C. Memo. 2012-198 (internal citations omitted)). The court noted that the specific language included in IRC Section 170(f)(18) ("exclusive legal control") was not required. Given the lack of guidance in this area, however, failure to make clear that the donee organization had exclusive legal control may result in denial of the donor's charitable deduction. Absent subsequent guidance, a more conservative approach may be for donors to DAFs to request CWAs that contain such language (e.g., "exclusive legal control of contributed assets was held by the [DAF]"). Another small, but important nuance, is that the court in Keefer rejected the government's position that the court should apply the Ninth Circuit's expanded view of the assignment of income doctrine, whereby a deal that is "practically certain to proceed" would cause the assignment of income doctrine to apply ( Ferguson v. Commissioner , 174 F.3d 997, 1003 (9th Cir. 1999)). Given the differences in approach, taxpayers should consult their tax advisor to ensure the proper precedent is being considered pursuant to any charitable contribution. ——————————————— For additional information concerning this Alert, please contact:   ( ) ( ) ( ) ( ) ( ) The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Ernst & Young LLP or other tax professional prior to taking any action based upon this information. Ernst & Young LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein. Copyright © 1996 – 2024, Ernst & Young LLP All rights reserved. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. EY US Tax News Update Master Agreement | EY Privacy Statement Global (EN) Albania (en) Algeria (fr) Argentina (es) Armenia (en) Australia (en) Austria (de) Austria (en) Azerbaijan (en) Bahamas (en) Bahrain (en) Bangladesh (en) Barbados (en) Belgium (en) Belgium (nl) Bermuda (en) Bosnia and Herzegovina (en) Brasil (pt) Brazil (en) British Virgin Islands (en) Bulgaria (en) Cambodia (en) Cameroon (fr) Canada (en) Canada (fr) Cayman Islands (en) Channel Islands (en) Colombia (es) Costa Rica (es) Croatia (en) Cyprus (en) Czech Republic (cs) Czech Republic (en) DR Congo (fr) Denmark (da) Denmark (en) Ecuador (es) Estonia (en) Estonia (et) Finland (fi) France (fr) Georgia (en) Germany (de) Germany (en) Gibraltar (en) Greece (el) Greece (en) Hong Kong SAR (en) Hungary (en) Hungary (hu) Iceland (is) Indonesia (en) Ireland (en) Isle of Man (en) Israel (en) Ivory Coast (fr) Jamaica (en) Jordan (en) Kazakhstan (en) Kazakhstan (kk) Kazakhstan (ru) Kuwait (en) Latvia (en) Latvia (lv) Lebanon (en) Lithuania (en) Lithuania (lt) Luxembourg (en) Macau SAR (en) Malaysia (en) Mauritius (en) Mexico (es) Moldova (en) Monaco (en) Monaco (fr) Mongolia (en) Montenegro (en) Mozambique (en) Myanmar (en) Namibia (en) Netherlands (en) Netherlands (nl) New Zealand (en) Nigeria (en) North Macedonia (en) Norway (nb) Pakistan (en) Panama (es) Philippines (en) Poland (en) Poland (pl) Portugal (en) Portugal (pt) Romania (en) Romania (ro) Saudi Arabia (en) Serbia (en) Singapore (en) Slovakia (en) Slovakia (sk) Slovenia (en) South Africa (en) Sri Lanka (en) Sweden (sv) Switzerland (de) Switzerland (en) Switzerland (fr) Taiwan (en) Taiwan (zh) Thailand (en) Trinidad and Tobago (en) Tunisia (en) Tunisia (fr) Turkey (en) Turkey (tr) Ukraine (en) Ukraine (ru) Ukraine (uk) United Arab Emirates (en) United Kingdom (en) United States (en) Uruguay (es) Uzbekistan (en) Uzbekistan (ru) Venezuela (es) Vietnam (en) Vietnam (vi) Zambia (en) Zimbabwe (en) Financial Reporting View Women's Leadership Corporate Finance Board Leadership Executive Education Fresh thinking and actionable insights that address critical issues your organization faces. Insights by Industry Insights by Topic KPMG's multi-disciplinary approach and deep, practical industry knowledge help clients meet challenges and respond to opportunities. Advisory Services Audit Services Tax Services Services to meet your business goals Technology Alliances KPMG has market-leading alliances with many of the world's leading software and services vendors. Helping clients meet their business challenges begins with an in-depth understanding of the industries in which they work. That’s why KPMG LLP established its industry-driven structure. In fact, KPMG LLP was the first of the Big Four firms to organize itself along the same industry lines as clients. Our Industries How We Work We bring together passionate problem-solvers, innovative technologies, and full-service capabilities to create opportunity with every insight. What sets us apart Careers & Culture What is culture? Culture is how we do things around here. It is the combination of a predominant mindset, actions (both big and small) that we all commit to every day, and the underlying processes, programs and systems supporting how work gets done. Relevant Results Sorry, there are no results matching your search., gain recognized on sale of partnership interest attributable to inventory not u.s.-source income subject to u.s. tax. A D.C. Circuit decision concerning gain recognized on sale of partnership interest. The U.S. Court of Appeals for the District of Columbia Circuit today reversed a previous decision of the Tax Court and held that gain recognized by a nonresident alien individual partner on a sale of her interest in a U.S. partnership, which was attributable to inventory items, could not be treated as U.S.-source income subject to U.S. tax. The case is:  Indu Rawat v. Commissioner,  No. 23-1142 (D.C. Cir. July 23, 2024). Read the D.C. Circuit’s  decision The taxpayer, a nonresident alien individual, acquired a 29.2% interest in a U.S. partnership that sold the popular energy drink 5-Hour Energy. In 2008 the taxpayer sold her partnership interest in exchange for a promissory note worth approximately $438 million. At the time of the transaction, the partnership held inventory valued at $6.4 million that it later sold for a profit of $22.4 million. All agreed that of the $438 million the taxpayer received for her partnership interest, $6.5 million was attributable to a gain on the partnership’s sale of inventory. The IRS took the position that the inventory gain should be taxed as though the taxpayer had sold actual inventory and was therefore subject to U.S.-source taxable income. The taxpayer challenged the IRS assessment in the Tax Court. The Tax Court agreed with the IRS, holding that under section 751(a), the taxpayer must be taxed as though she sold the inventory that gave rise to the section 751(a) gain. Thus, under the section 865 sourcing rules governing the sale of inventory, income from the sale could be considered U.S.-source (and taxable) depending on the particulars.  The taxpayer appealed to the D.C. Circuit, which examined the statutory language of section 751(a) alongside its “companion provision” section 741, and concluded that a proper reading of section 751(a) and its legislative history does not treat inventory gain as gain from the actual sale of inventory. Section 751(a) converts the taxpayer’s gain on her partnership interest from capital gain to ordinary income, but goes no further. As a result, the inventory gain realized by the taxpayer when she sold her partnership interest must be treated as foreign-source income not subject to U.S. tax. The KPMG name and logo are trademarks used under license by the independent member firms of the KPMG global organization. KPMG International Limited is a private English company limited by guarantee and does not provide services to clients. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 3712, 1801 K Street NW, Washington, DC 20006. Thank you for contacting KPMG. We will respond to you as soon as possible. Contact KPMG By submitting, you agree that KPMG LLP may process any personal information you provide pursuant to KPMG LLP's Privacy Statement . Job seekers Visit our careers section or search our jobs database. Use the RFP submission form to detail the services KPMG can help assist you with. Office locations International hotline You can confidentially report concerns to the KPMG International hotline Press contacts Do you need to speak with our Press Office? Here's how to get in touch. Practical Law Disposal and acquisition of partnership interests: tax Practical law uk practice note 3-556-6906  (approx. 24 pages), get full access to this document with a free trial. Try free and see for yourself how Practical Law resources can improve productivity, efficiency and response times. About Practical Law This document is from Thomson Reuters Practical Law, the legal know-how that goes beyond primary law and traditional legal research to give lawyers a better starting point. We provide standard documents, checklists, legal updates, how-to guides, and more. 650+ full-time experienced lawyer editors globally create and maintain timely, reliable and accurate resources across all major practice areas. 83% of customers are highly satisfied with Practical Law and would recommend to a colleague. 81% of customers agree that Practical Law saves them time. Joint Ventures Partnerships and LLPs Insurance and taxation Structuring projects Disposal and acquisition of partnership interests: tax Practical law uk practice note 3-556-6906  (approx. 24 pages), get full access to this document with practical law. Try free and see for yourself how Practical Law resources can enhance productivity, increase efficiency, and improve response times. About Practical Law This document is from Thomson Reuters Practical Law, the legal know-how that goes beyond primary law and traditional legal research to give lawyers a better starting point. We provide standard documents, checklists, legal updates, how-to guides, and more. Increase efficiency Enhance productivity Improve response time Joint Ventures 1 Scope of this note 2 Nature of interest in partnership Disposal consideration Connected parties and transactions not at arm's length Chargeable gain Business asset disposal relief, rollover relief and hold-over relief Intangible fixed asset regime: corporate partners Resignation of outgoing partner and admission of new partner Resignation of outgoing partner and increase in existing partners' interests Admission of new partner and reduction of existing partners' interests Change in capital sharing ratio between existing partners Outgoing partner assigns interest to new partner Change in capital sharing ratio following revaluation of assets Sale of asset by partnership following change in capital sharing ratio 5 Tax on income: basis period rules 6 Stamp duty and SDRT 7 Stamp duty land tax and land transaction tax VAT on transfer of partnership interest VAT registration and notifying HMRC of change in partners This site uses cookies to store information on your computer. Some are essential to make our site work; others help us improve the user experience. By using the site, you consent to the placement of these cookies. Read our  privacy policy  to learn more. GAINS & LOSSES Taxing the Transfer of Debts Between Debtors and Creditors C Corporation Income Taxation NOL & Other Tax Attributes Individual Income Taxation   EXECUTIVE SUMMARY   T he frequent transfer of cash between closely held businesses and their owners is very common. If the owner works in the business, the transfer is likely to be either a salary to a shareholder/employee or a Sec. 707(c) guaranteed payment to a partner. Alternatively, the transfer may be a loan. As long as the true substance of the transaction is a loan, it will be respected for tax purposes. 1 The cash flow is not exclusively from the businesses to the owner. Many owners prefer to capitalize their closely held business with a combination of equity and debt. Once again, these loans will be respected and not reclassified as equity if they are bona fide loans. In the normal course of business, these loans are repaid. The receipt of the repayment will be tax free except to the extent it is interest. However, in difficult economic conditions, many of these loans are not repaid. To the extent that the creditor cancels the obligation, the debtor has cancellation of debt (COD) income under Sec. 61(a)(12). This income is taxable unless the taxpayer qualifies for an exclusion under Sec. 108. In other cases, the debt is transferred between the parties either as an independent transaction or part of a larger one. This article reviews these transactions. Two basic types of transfers have created significant tax issues. In the first, the debtor transfers the debt to the creditor. If the debtor is the owner of a business and the business is a creditor, the transfer appears to be a contribution. If the business is the debtor and the owner is the creditor, the transfer can be a distribution, liquidation, or reorganization. The other type of transfer is from the creditor to the debtor. Again, the transaction can take the form of a contribution if the creditor is the owner, or it can take the form of a distribution, liquidation, or reorganization if the creditor is the business. Debtor-to-Creditor Transfers Corporations. The two seminal cases that established the framework for analyzing the transfer of a debt obligation from a debtor to a creditor are Kniffen 2 and Edwards Motor Transit Co. 3 Arthur Kniffen ran a sole proprietorship and owned a corporation. The sole proprietorship borrowed money from the corporation. For valid business reasons, Kniffen transferred the assets and liabili ties of the proprietorship to the corporation in exchange for stock of the corporation, thereby transferring a debt from the debtor to the creditor. The transaction met the requirements of Sec. 351. The government argued that the transfer of the debt to the creditor was in fact a discharge or cancellation of the debt (a single step), which should have been treated as the receipt of boot under Sec. 351(b) and taxed currently. The taxpayer argued that the transfer was an assumption of the debt and, based on Sec. 357(a), should not be treated as boot. The Tax Court acknowledged that the debt was canceled by operation of law. However, it did not accept the government’s argument as to the structure of the transaction. Instead, it determined that two separate steps occurred. First, the corporation assumed the debt. This assumption was covered by Sec. 357(a). After the assumption, the interests of the debtor and creditor merged and the debt was extinguished. Since the transfer was not for tax avoidance purposes, Sec. 357(b) did not apply. The result was a tax-free Sec. 351 transaction, except to the extent that the assumed debt exceeded the bases of the assets transferred, resulting in gain under Sec. 357(c). This decision established the separation of the debt transfer from its extinguishment. Edwards Motor Transit Co. cites, and is considered to have adopted, the approach in Kniffen . For valid business reasons, the owners of Edwards created The Susquehanna Co., a holding company, and transferred Edwards’ stock to it under Sec. 351. Susquehanna borrowed money from Edwards to meet certain financial obligations. To eliminate problems that arose from having a holding company owning the stock of an operating company, the owners merged Susquehanna into Edwards under Sec. 368(a)(1)(A). The government acknowledged that the basic transaction was a nontaxable merger. However, the government wanted the company to recognize income as a result of the cancellation or forgiveness of the debt. The Tax Court ruled for the taxpayer, on the grounds that the debt transfer (from debtor to creditor) was not a cancellation of the debt. The ruling cited Kniffen as authority for this conclusion. On its surface, Edwards Motor Transit affirmed the decision and reasoning in Kniffen . The Tax Court stated, “The transfer by the parent corporation of its assets to Edwards [its subsidiary] . . . constituted payment of the outstanding liabilities . . . just as surely as if Susquehanna had made payment in cash.” This statement relied on both Kniffen and Estate of Gilmore. 4 In Gilmore , a liquidating corporation transferred a receivable to its shareholder who happened to be the debtor. In that case, the court ruled the transaction was an asset transfer and not a forgiveness of debt. The court based its conclusion in large part on the fact that no actual cancellation of the debt occurred. The statement in Edwards Motor Transit quoted above, however, is inapposite to the conclusion in Kniffen . A payment is not a transfer and assumption of a liability. Since Susquehanna was deemed to have used assets to repay the debt, the Tax Court should have required Susquehanna to recognize gain to the extent that the value of the assets used to repay the debt exceeded their bases. The conclusions in Kniffen and Edwards are consistent only in their holdings that these debt transfers were not cancellations of debts that would result in COD income. In Kniffen, the court ruled that the debt was assumed and then extinguished. In Edwards, the court ruled that the extinguishment of the debt constituted repayment. It is possible that the Tax Court reached the correct outcome in Edwards Motor Transit but for the wrong reason. In Rev. Rul 72-464, 5 a debtor corporation merged into the creditor corporation in a tax-free A reorganization under Sec. 368(a)(1)(A). The ruling concluded that the debtor corporation did not recognize any gain or loss on the extinguishment of the debt within the acquiring corporation. General Counsel Memorandum (GCM) 34902 6 provided the detailed analysis behind the conclusion. The GCM cited both Kniffen and Edwards 7 and adopted their underlying rationale. Specifically, it concluded that the basic transaction (the reorganization) results in a transfer of the debt to the acquiring corporation. It is after the transfer that the debt is extinguished by the statutory merger of interests. The transfer is an assumption of debt, which is nontaxable under Sec. 357(a). Therefore, the transferor (debtor corporation) recognizes no gain or loss. This is exactly what happened in Ed wards . The debt was assumed, not repaid. Therefore, the Tax Court should have reached the conclusion that the transaction was nontaxable under Sec. 357(a) and not have relied on the questionable authority of Estate of Gilmore 8 or concluded that the debt was repaid. Liquidations The transactions discussed up to this point have been either tax-free corporate formations (Sec. 351) or tax-free reorganizations (Sec. 361). In a different transaction that is likely to occur, the creditor/shareholder liquidates the debtor corporation. If the transaction is not between a parent and its subsidiary, taxability is determined by Secs. 331 and 336. Prior to 1986, the outcome might have been determined by Kniffen and Edwards . With the repeal that year of the General Utilities 9 doctrine (tax-free corporate property distributions) and the enactment of current Sec. 336, the outcome is straightforward. Under Sec. 336, the debtor corporation that is liquidated recognizes its gains and losses. Whether the liquidated corporation is treated as using assets to satisfy a debt requiring the recognition of gain or is treated as distributing assets in a taxable transaction under Sec. 336, all the gains and losses are recognized. The taxation of the shareholder is a little more complex. First, the shareholder must determine how much it received in exchange for the stock. The most reasonable answer is that the shareholder received the value of the assets minus any debt assumed and minus the face amount of the debt owed to it by the liquidated corporation. This amount is used to determine the gain or loss that results from the hypothetical sale of stock under Sec. 331. Second, the shareholder must determine what was received for the debt, whether assets or the debt itself. The amount received in payment of the liquidated corporation’s debt is a nontaxable return of capital. If the shareholder is deemed to have received the debt itself, then the debt is merged out of existence. The basis of all the assets received should be their fair market value (FMV) under either Sec. 334(a) or general basis rules. If the liquidated corporation is a subsidiary of the creditor/shareholder, the results change. Under Sec. 337, a subsidiary recognizes neither gain nor loss on the transfer of its assets in liquidation to an 80% distributee (parent). Sec. 337(b) expands this rule to include distributions in payment of debts owed to the parent corporation. Therefore, the subsidiary/debtor does not recognize any gain or loss. The parent corporation (creditor) recognizes no gain or loss on the liquidation of its subsidiary under Sec. 332. The basis of the transferred property in the hands of the parent is carryover basis. 10 This carry­over basis rule also applies to property received as payment of debt if the subsidiary does not recognize gain or loss on the repayment. 11 In other words, the gain or loss is postponed until the assets are disposed of by the parent corporation. One important exception to the nonrecognition rule is applied to the parent corporation. Under Regs. Sec. 1.332-7, if the parent’s basis in the debt is different from the face amount of the debt, the parent recognizes the realized gain or loss (face amount minus basis) that results from the repayment. Since this regulation does not mention any exception to the rules of Sec. 334(b)(1), the parent corporation is required to use carryover basis for all the assets received without adjustment for any gain or loss recognized on the debt. This discussion of liquidations assumes that the liquidated corporation is solvent. If it is insolvent, the answer changes. The transaction cannot qualify under Secs. 332 and 337. The shareholder is not treated as receiving any property in exchange for stock; therefore, a loss is allowed under Sec. 165(g). The taxation of the debt depends on the amount, if any, received by the shareholder as a result of the debt. Partnerships The taxation of debt transfers involving partnerships is determined, in large part, by Secs. 731, 752, and 707(a)(2)(B). Specifically, the taxation of transfers by debtor partners to the creditor/partnership is determined by the disguised sale rules of Sec. 707(a)(2)(B), whereas transfers by debtor partnerships to a creditor/partner fall under Secs. 731 and 752. Sec. 707(a)(2)(B) provides that a transfer of property by a partner to a partnership and a related transfer of cash or property to the partner is treated as a sale of property. The regulations specify the extent to which the partnership’s assumption of liabilities from the partner is treated as the distribution of the sale price. Regs. Sec. 1.707-5 divides assumed liabilities into either qualified liabilities or unqualified liabilities. A qualified liability 12 is one that: Was incurred more than two years before the assumption; Was incurred within two years of the assumption, but was not incurred in anticipation of the assumption; Was allocated to a capital expenditure related to the property transferred to the partnership under Temp. Regs. Sec. 1.163-8T; or Was incurred in the ordinary course of business in which it was used, but only if all the material assets of that trade or business are transferred to the partnership. The amount of qualified recourse liabilities is limited to the FMV of the transferred property reduced by senior liabilities. Any additional recourse liabilities are treated as nonqualified debt. If a transfer of property is not otherwise treated as part of a sale, the partnership’s assumption of a qualified liability in connection with a transfer of property is not treated as part of a sale. The assumption of nonqualified liabilities is treated as sale proceeds to the extent that the assumed liability exceeds the transferring partner’s share of that liability (as determined under Sec. 752) immediately after the partnership assumes the liability. If no money or other consideration is transferred to the partner by the partnership in the transaction, the assumption of qualified liabilities in a transaction treated as a sale is also treated as sales proceeds to the extent of the transferring partner’s share of that liability immediately after the partnership assumes the liability. 13 Following the assumption of the liability, the interests of the debtor and creditor merge, thereby extinguishing the debt. The result is that generally the full amount of these assumed liabilities are part of the sale proceeds. 14 The assumed liabilities that are not treated as sale proceeds still fall under Sec. 752. Since the transaction results in a reduction of the transferor’s personal liabilities, the taxpayer is deemed to have received a cash distribution equal to the amount of the debt assumed under Sec. 752(b). Given that the debt is immediately extinguished, no amount is allocated to any partner. The end result is that the transferor must recognize gain if the liability transferred exceeds the transferor’s outside basis before the transaction, increased by the basis of any asset transferred to the partnership as part of the transaction. A partnership may have borrowed money from a partner and then engaged in a transaction that transfers the debt to the creditor/partner. The first question is whether the initial transaction is a loan or capital contribution. Sec. 707(a) permits loans by partners to partnerships. The evaluation of the transaction is similar to one to determine whether a shareholder has loaned money to a corporation or made a capital contribution. The factors laid out in Sec. 385 and Notice 94-47 15 should be considered in this analysis. Assuming the debt is real and it alone is transferred to the creditor/partner, the outcome is straightforward. The partner is treated as having made a cash contribution to the partnership under Sec. 752(a) to the extent that the amount of debt exceeds the amount allocated to the partner under the Sec. 752 regulations. If part of the debt is allocated to other partners, these other partners are treated as receiving a deemed cash distribution. If the transfer is part of a larger transaction, then the analysis is a little more complex. The transfer of the other assets is governed by Secs. 737, 731, and 751. Sec. 737 requires a partner to recognize gain if, during the prior seven years, the partner had contributed property with built-in gain to the partnership and the current FMV of the distributed property exceeds the partner’s outside basis. The partner is treated as recognizing gain in an amount equal to the lesser of (1) the excess (if any) of the FMV of property (other than money) received in the distribution over the adjusted basis of such partner’s interest in the partnership immediately before the distribution reduced (but not below zero) by the amount of money received in the distribution, or (2) the net precontribution gain of the partner. The outside basis is increased by the amount of the deemed contribution because the partner assumed a partnership liability. After any gain under Sec. 737 is determined, the general distribution rules of Secs. 731 and 751(b) apply to the transaction. In effect, the transfer to a creditor/partner of a partnership debt owed to the partner is treated the same as any liability assumed by the partner. The extinguishment of the debt should not result in additional tax consequences. Creditor-to-Debtor Transfers In addition to debtor-to-creditor transfers, there are creditor-to-debtor transfers. The outcome of these transactions is determined by the two-step analysis in Kniffen . The creditor is treated as having transferred an asset to the debtor/owner. After the transfer, the interests of the debtor and creditor merge, resulting in the extinguishment of the debt. This extinguishment is generally nontaxable since the basis of the debt and the face amount are equal. 16 The result changes if the basis in the hands of the creditor and the adjusted issue price of the debtor are not equal. 17 One of the initial pieces of guidance that addressed this question was Rev. Rul. 72-464. 18 In this ruling, the debt was transferred in a nontaxable transaction. Consequently, the recipient (the debtor) had a carryover basis in the debt. Since this basis was less than the face amount, gain equal to the difference was recognized. This ruling did not explain the reasoning behind the gain recognition or the potential impact if the value of the debt was different from its basis. 19 These items were addressed in Rev. Rul. 93-7. 20 Rev. Rul. 93-7 analyzed a transaction between a partnership and a partner, here designated P and A , respectively. A was a 50% partner. This percentage allowed A to not be a related party to P under Sec. 707(b). P also had no Sec. 751 assets, and A had no share of P ’s liabilities under Sec. 752. These were excluded because they did not affect the reasoning behind the taxation of debt transfers. A issued a debt with a face amount of $100 for $100. P acquired the debt for $100. When the debt was worth $90, it was distributed to A in complete redemption of its interest, which had an FMV of $90 and outside basis of $25. In other words, a creditor/partnership distributed debt to the debtor/partner. The debt was an asset, a receivable, in the hands of P . When it was distributed to A , P determined its taxation under Sec. 731(b), which provides that no gain or loss is recognized by a partnership on the distribution of property. The application of Sec. 731(b) in this transaction followed directly from Kniffen , which treated the transfer of a debt as a separate transaction from any extinguishment that follows the transfer. Under Sec. 732, A ’s basis in the transferred debt was $25. 21 The basis rules of Sec. 732 assume that a built-in gain or loss on distributed property is realized and recognized when the recipient disposes of the property. In this situation, the distributed debt was extinguished, and therefore no future event would generate taxable gain or loss. Consequently, this extinguishment became a taxable event. In this specific case, A recognized gain of $65 ($90 FMV – $25 basis) and COD income of $10 ($100 face − $90 FMV.) The ruling did not spell out the reasoning for the recognition of both gain and COD income. It is the correct outcome based on Regs. Sec. 1.1001-2. Under that regulation, when property is used to satisfy a recourse obligation, the debtor has gain equal to the difference between the value of the property and its basis, and COD income equal to the difference between the amount of debt and the value of the property used as settlement. The distributed debt is property at the time of the distribution, and the rules of Regs. Sec. 1.1001-2 should apply. In Rev. Rul. 93-7, the value of the debt was less than the face amount. A debt’s value could exceed its face amount. In that case, the revenue ruling indicated, a deduction for the excess value may be available to the partner as a result of the deemed merger. In Letter Ruling 201105016, 22 the IRS ruled that a taxpayer was entitled to a deduction when it reacquired its debt at a premium as part of a restructuring plan. Rev. Rul. 93-7 cited Regs. Sec. 1.163-4(c)(1), and Letter Ruling 201105016 cited Regs. Sec. 1.163-7(c). Both regulations state that the reacquisition of debt at a premium results in deductible interest expense equal to the repurchase amount minus the adjusted issue price. Regs. Sec. 1.163-4(c)(1) applies to corporate taxpayers, while Regs. Sec. 1.163-7(c) expanded this treatment to all taxpayers. Based on these regulations and the treatment of the distribution as an acquisition of a debt, an interest expense deduction should be permitted when the value exceeds the amount of debt, whereas COD income is recognized when the value is less than the amount of the debt. In Rev. Rul. 93-7, the partnership was the creditor, and the debt was transferred to a debtor/partner. The reverse transaction can occur, in which a creditor/partner transfers debt to the debtor/partnership in exchange for a capital or profits interest. Sec. 721 applies to the creditor/partner. Therefore, no gain or loss is recognized. However, Sec. 108(e)(8)(B) applies to the debtor/partnership. Sec. 108(e)(8)(B) provides that the partnership recognizes COD income equal to the excess of the debt canceled over the value of the interest received by the creditor. This income is allocated to the partners that owned interests immediately before the transfer. The partnership does not recognize gain or loss (other than the COD income) as a result of this transaction. 23 The value of the interest generally is determined by the liquidation value of the interest received. 24 If the creditor receives a profits interest, the liquidation value is zero, and therefore the partnership recognizes COD income equal to the amount of debt transferred. Corporate Transactions Debt transfers between corporations and shareholders are just as likely as transfers between partners and partnerships. If the transferor is a shareholder or becomes a shareholder as a result of the transaction, Secs. 1032, 118, and 351 provide basic nontaxability. However, Sec. 108 overrules these sections in certain cases. If the shareholder transfers the debt to the corporation as a contribution to capital, Sec. 108(e)(6) may result in the recognition of COD income by the corporation. Under Sec. 108(e)(6), the corporation is treated as having satisfied the indebtedness with an amount of money equal to the shareholder’s adjusted basis in the indebtedness. Therefore, the corporation has COD income amount equal to the excess of the face amount of the debt over the transferor’s basis in the debt immediately prior to the transfer. In most cases, the face and basis are equal, and no COD income is recognized. If the transfer is in exchange for stock, Sec. 108(e)(8)(A) provides that the corporation is treated as having satisfied the indebtedness with an amount of money equal to the FMV of the stock. Therefore, the corporation recognizes COD income equal to the excess of the face value of the debt over the value of the stock received. In many cases, the value of the stock is less than the debt canceled, and therefore COD income is recognized. Sec. 351 provides that 80% creditor/shareholders recognize neither gain nor loss if the debt is evidenced by a security. If Sec. 351 does not apply, the creditor/shareholder may be able to claim a loss or bad-debt deduction. Rev. Rul. 2004-79 25 provides a detailed analysis of the transfer of debt from a creditor corporation to a debtor shareholder. The analysis is similar to the one for partnership distributions covered by Rev. Rul. 93-7, discussed previously. Modifying the facts of Rev. Rul. 2004-79, assume that a shareholder borrows money from his corporation. The face amount of the debt is $1,000, and the issue price is $920. The original issue discount (OID) of $80 is amortized by both the corporation and the shareholder. At a time when the adjusted issue price and basis are $950 but the FMV is only $925, the corporation distributes the debt to the shareholder as a dividend. From the corporation’s point of view, this is a property dividend. Rev. Rul. 2004- 79 cites Rev. Rul. 93-7, but it could just as easily have cited Kniffen . As a property dividend, the transaction’s taxa tion to the corporation is governed by Sec. 311. Since the value in the revenue ruling was less than the basis, the corporation recognized no gain or loss. If the value had appreciated, the corporation would have recognized gain equal to the appreciation. The shareholder receives a taxable dividend equal to the value of the debt; consequently, the debt has a basis equal to its FMV of $925. Since the debt is automatically extinguished, the shareholder is treated as having satisfied an obligation in the amount of $950 with a payment of $925. Therefore, the shareholder must recognize $25 of COD income. A second fact pattern in the revenue ruling is the same, except the value of the distributed debt is $1,005. Under these facts, the shareholder would be entitled to an interest expense deduction under Regs. Sec. 1.163-4 or 1.163-7 in the amount of $55 ($1,005 − $950). In other words, the shareholder is deemed to have reacquired its own debt for a payment equal to the basis that the distributed debt obtains in the transaction. The conclusions of Rev. Rul. 2004-79 are consistent with those in Rev. Rul. 93-7. They follow the reasoning of Kniffen . Another transaction that could occur involving shareholder debt is a liquidation of the corporation, resulting in a distribution of the debt to the debtor/shareholder. The results should be similar to those in Rev. Rul. 2004-79. The corporation that distributes the debt is taxed under Sec. 336. Therefore, the corporation recognizes gain or loss depending on the basis of the debt and its FMV. This is the same result as in the dividend case, except that the loss is recognized under Sec. 336 instead of being denied under Sec. 311. The shareholder’s basis in the debt is its FMV under Sec. 334(a). The shareholder recognizes COD income or interest expense, depending on whether the basis is less than or greater than the adjusted issue price of the debt. These results flow from the regulations under Secs. 61 and 163 and are consistent with the conclusions in the above revenue rulings. The results change slightly if the liquidation qualifies under Secs. 332 and 337. The IRS discussed these results in Chief Counsel Advice 200040009. 26 Sec. 332 shields the parent from recognition of income on the receipt of the debt. Sec. 337 shields the liquidating corporation from recognizing gain or loss on the transfer of the debt to its parent corporation. The basis is carryover basis under Sec. 334(b). Then, because the debt is extinguished, the parent recognizes either COD income or interest expense on the extinguishment of the debt. As in the prior revenue rulings and Kniffen , the extinguishment has to be a taxable event because the elimination of the carryover basis prevents the parent corporation from having a taxable transaction in the future involving this debt. These results are consistent with prior decisions. The results discussed for a parent/subsidiary liquidation should also apply if the debtor/corporation acquires a corporation that owns its debt in a nontaxable asset reorganization. In this case, Sec. 361 replaces Secs. 332 and 337. The extinguishment of the debt is a separate transaction that should result in recognition of income or expense. Acquired Debt So far, this article has discussed transactions between the debtor and creditor. Now it turns to how the holder of the debt acquired it. In many cases, the holder acquired the debt directly from the debtor, and the acquisition is nontaxable. In other situations, the debt is outstanding and in the hands of an unrelated party. The holder acquires the debt from this unrelated party. In these cases, Sec. 108(e)(4) may create COD income. Under Sec. 61, if a debtor reacquires its debt for less than its adjusted issue price, the debtor has COD income. Sec. 108(e)(4) expands on this rule: If a party related to the debtor acquires the debt, the debtor is treated as acquiring the debt, with the resulting COD income recognized. Related parties are defined in Secs. 267(b) and 707(b)(1). The regulations provide that the acquisition can be either direct or indirect. A direct acquisition is one by a person related to the debtor at the time the debt is acquired. 27 An indirect acquisition occurs when the debtor acquires the holder of the debt instrument, where the holder of the debt acquired it in anticipation of becoming related to the debtor. 28 The determination of whether the holder acquired the debt in anticipation of becoming related is based on all the facts and circumstances. 29 However, if the holder acquires the debt within six months before the holder becomes related to the debtor, the acquisition by the holder is deemed to be in anticipation of becoming related to the debtor. 30 In the case of a direct acquisition, the amount of COD income is equal to the adjusted issue price minus the basis of the debt in the hands of the related party. In the case of indirect acquisitions, the calculation depends on whether the debt is acquired within six months of being acquired. 31 If the holder acquired the debt within six months of being acquired, the COD income is calculated as if it were a direct acquisition. If the holder acquired the debt more than six months before being acquired, the COD income is equal to the adjusted issue price minus the FMV of the debt instrument on the date that the holder is acquired. When a debtor reacquires its own debt, in addition to reporting COD income, the debtor has the debt extinguished as a result of the merger of interests. When a related party acquires the debt, the debtor has COD income, but the debt remains outstanding. In these cases, the debtor is treated as issuing a new debt instrument immediately following the recognition of the COD income for an amount equal to the amount used to calculate the COD income (adjusted basis or FMV 32 ). If this issue price is less than the stated redemption price at maturity of the debt (as defined in Sec. 1273(a)(2), the difference is OID that is subject to the amortization rules of Sec. 1272. Rev. Rul. 2004-79 provides a simple example of this transaction. In the ruling, a parent corporation, P , issued $10 million of debt for $10 million. After issuance, S , a subsidiary of P , purchased the debt for $9.5 million. Under Regs. Sec. 1.108-2(f), P had to recognize $500,000 of COD income ($10 million face − $9.5 million basis to S ). After this recognition, P was treated as having issued the debt to S for $9.5 million. Therefore, $500,000 of OID was amortizable by P and S . If S later transfers the debt to P , the previously discussed rules determine the taxation of the transfer using S ’s basis ($9.5 million + amortized OID). Secs. 61 and 108(e)(4) apply only if the debt is acquired for less than the adjusted issue price. If the acquisition price is greater than the adjusted issue price, the acquiring party treats this excess as premium and amortizes it, thereby reducing the amount of interest income recognized by the holder. Installment Obligations An installment obligation differs from other obligations in that the holder recognizes income when cash is collected in payment of the obligation. The rules describing the taxation of installment obligations were rewritten as part of the Installment Sales Revision Act of 1980, P.L. 96-471. Under old Sec. 453(d) (new Sec. 453B(a)), if the holder of an installment obligation distributes, transmits, or disposes of the obligation, the taxpayer is required to recognize gain or loss equal to the difference between the basis in the obligation and the FMV of the obligation. There is an exception to this rule for distributions in liquidation of a subsidiary that are exempt from taxation under Sec. 337. Prior to the Code revision, the regulations permitted the transfer of installment obligations without gain recognition if the transaction was covered by either Sec. 721 or 351. 33 Although the regulations have not been revised for the Code change, the IRS continues to treat Secs. 721 and 351 as overriding the gain recognition provision. 34 If the transaction results in transfer of the obligation either from the creditor to the debtor or from the debtor to the creditor, the tax result changes. The seminal case is Jack Ammann Photogrammetric Engineers, Inc. 35 In it, the taxpayer created a corporation to which he contributed $100,000 in return for 78% of the corporation’s stock. He then sold his photogrammetry business to the corporation for $817,031. He received $100,000 cash and a note for $717,031. He reported the sale under the installment method. When he was still owed $540,223 on the note, he transferred it to the corporation for stock of the corporation worth $540,223. He reported this as a disposition under Sec. 453(d) and recognized the deferred gain. Later, he filed a claim for refund, arguing that Sec. 351 prevented recognition of the deferred gain. After allowing the refund, the IRS assessed a deficiency against the corporation, arguing that the corporation came under Sec. 453(d). The corporation argued that, under Sec. 1032, it was not taxable. The Tax Court ruled for the IRS. The Fifth Circuit reversed the decision. The underlying reasoning was that the disposition by the shareholder and the extinguishment of the debt in the hands of the corporation were separate transactions. The extinguishment did not fall under Sec. 453(d). The court indicated that the IRS should have assessed the tax against the shareholder. Following this case, the IRS issued Rev. Rul. 73-423. 36 In this ruling, a shareholder transferred an installment obligation from Corporation X back to the corporation in a transaction described in Sec. 351. The ruling concluded that the transfer was a satisfaction of the installment agreement at other than face value under Sec. 453(d)(1)(A) and that the shareholder was required to recognize gain without regard to Sec. 351. The corporation had no gain or loss under Sec. 1032 and Ammann . Sec. 453(d) is now Sec. 453B(a), and the rule has not changed. Therefore, if a creditor transfers an installment obligation to the debtor in an otherwise tax-free transaction, the obligation is treated as satisfied at other than its face value, and the creditor is required to recognize gain or loss as discussed in Rev. Rul. 73-423. 37 New Sec. 453B(f) covers transactions in which installment obligations become unenforceable. This section covers the extinguishment of an installment debt through a merger of the rights of a debtor and creditor. The Code treats these transactions as dispositions of the obligation with gain or loss recognized. When the debtor and creditor are related, the disposition is at FMV but no less than the face amount. If the debtor of an installment obligation engages in a transaction in which the creditor assumes the debt, the results are consistent with those of transactions involving obligations other than installment notes. The debtor is deemed to have received cash equal to the amount of the debt. This is fully taxable unless exempted by Sec. 357, 721, or a similar provision. The creditor falls under Sec. 453B(f), with the extinguishment treated as a taxable disposition of the obligation for its FMV (which for related parties is no less than the face amount). Business entities often incur debts to their owners, and, conversely, the owners incur liabilities to their business entities. In numerous transactions these obligations are canceled for consideration other than simple repayment of the debt. Based on Kniffen , these transactions are treated as a transfer of consideration followed by an extinguishment of the debt. If a shareholder’s debt to his or her controlled corporation is transferred to that corporation along with assets, the transaction may be tax free under Secs. 351 and 357(a). If a shareholder/creditor receives the related corporate debt in a distribution or liquidation, Sec. 311 or 336 determines the corporation’s taxation. The cancellation of a partner’s debt to the partnership is generally governed by the distribution rules, including the constructive sale or compensation rules of Sec. 707(a)(2). When a partner cancels the partnership’s debt, the partner has made a contribution to capital. This can have consequences to all partners since the total liabilities are decreased and the partners’ bases are decreased under Sec. 752. In most cases the merger of debtor and creditor interests is nontaxable. However, if the basis of the debt or receivable does not equal the face amount of the debt, income or loss is recognized. The exact amount and character of the income or loss depends on factors discussed in this article. It is important for the tax adviser to identify those cases in which the debt transfer is not tax free. 1 Invalid loans to shareholders have been reclassified as dividends. 2 Kniffen , 39 T.C. 553 (1962). 3 Edwards Motor Transit Co. , T.C. Memo. 1964-317. 4 Estate of Gilmore , 40 B.T.A. 945 (1939). 5 Rev. Rul. 72-464, 1972-2 C.B. 214. 6 GCM 34902 (6/8/72). The GCM also refers to Sec. 332, which will be dis cussed later. 7 As the GCM points out, by using Sec. 357(a), taxpayers could achieve the same outcome in C reorganizations. 8 See Chief Counsel Advice 200040009 (10/6/00), which suggests Estate of Gilmore ’s requirement of a formal cancellation of debt before COD income is recognized may no longer be valid. 9 General Utilities & Operating Co. v. Helvering , 296 U.S. 200 (1935). 10 Sec. 334(b)(1). 12 Regs. Sec. 1.707-5(a)(6). 13 If the partnership transfers money or other consideration in the transaction, the amount treated as sales proceeds may be limited under Regs. Sec. 1.707-5(a)(5)(i)(B). 14 Under Regs. Sec. 1.707-5(a)(3)(ii), a partner’s share of liabilities is reduced by liabilities assumed that are anticipated to be reduced. Based on Kniffen and Edwards , the reduction will be anticipated. 15 Notice 94-47, 1994-1 C.B. 357. 16 See, e.g., IRS Letter Ruling 8825048 (3/23/88). 17 The transaction that gives rise to the difference and the taxation that results are discussed later. 18 Rev. Rul. 72-464, 1972-2 C.B. 214. Although this is a debtor-to-creditor transfer, the result is the same. 19 See GCM 34902 (6/8/72). 20 Rev. Rul. 93-7, 1993-1 C.B. 125. 21 If the partnership makes a Sec. 754 election, the partnership has a Sec. 734 adjustment of $75 ($100 inside basis – $25 basis after distribution). 22 IRS Letter Ruling 201105016 (2/4/11). 23 Regs. Sec. 1.108-8, effective Nov. 17, 2011. 24 See the Regs. Sec. 1.108-8(b)(2) safe-harbor rule. 25 Rev. Rul. 2004-79, 2004-2 C.B. 106. 26 CCA 200040009 (10/6/00). 27 Regs. Sec. 1.108-2(b). 28 Regs. Sec. 1.108-2(c)(1). 29 Regs. Sec. 1.108-2(c)(2). 30 Regs. Sec. 1.108-2(c)(3). 31 Regs. Secs. 1.108-2(f)(1) and (2). 32 Regs. Sec. 1.108-2(g). 33 Regs. Sec. 1.453-9(c)(2). 34 See IRS Letter Rulings 8824044 (3/22/88) and 8425042 (3/19/84). 35 Jack Ammann Photogrammetric Engineers, Inc. , 341 F.2d 466 (5th Cir. 1965), rev’g 39 T.C. 500 (1962). 36 Rev. Rul. 73-423, 1973-2 C.B. 161. 37 Although this revenue ruling involved a corporation, the IRS believes the same rule applies to partnerships. Treasury is currently working on a revision of the regulations to clarify the results. See the preamble to Regs. Sec. 1.108-8, T.D. 9557 (11/17/11).   EditorNotes Edward Schnee is the Hugh Culverhouse Professor of Accounting at the University of Alabama in Tuscaloosa, Ala. Eugene Seago is the R.B. Pamplin Professor of Accounting at Virginia Tech University in Blacksburg, Va. For more information about this article, please contact Prof. Schnee at . A trust is not always a trust for federal income tax purposes Advances between affiliated entities: an uphill but winnable battle for loan characterization, foreign partnership reporting requirements, sec. 163(j) planning considerations, bitcoin etfs: the known and unknown. TAX PRACTICE MANAGEMENT To get through the rigors of tax season, CPAs depend on their tax preparation software. Here's how they rate the leading professional products. EMPLOYEE BENEFITS & PENSIONS The 2022 act affected a wide array of retirement fund and pension plan provisions. This article highlights many of the most noteworthy ones, along with relevant IRS guidance and congressional plans for technical corrections. 416 IMAGES assignment of partnership interest template Doc Template Gifts of Partnership Interests PPT Assignment of Partnership Interest partnership assignment pdf Doc Template Chapter 6 VIDEO Journal Entries Incentive Stock Options And How They Affect Your Tax Obligations Tax Administration For Individual in Malaysia Tax, Budget Assignment Discussion Part-2 INTEREST ON DRAWING Retirement of a Partner.(Revaluation of Assets & Reassessment of Liabilities). Basic Enteries COMMENTS Tax Issues to Consider When a Partnership Interest is Transferred Therefore, a transfer of a partnership interest to a C corporation could result in the partnership being required to change from the cash method to the accrual method. As described in this article, a transfer of a partnership interest involves an analysis of several tax consequences. Tax Treatment of Liquidations of Partnership Interests Redemption of a Partnership Interest. Redemptions of a partner's entire partnership interests are governed by IRC section 736. That section does not affect the amount of income, gain, or loss that will be reported by the retiring partner; instead, it determines whether the income will be a capital gain (or loss) or ordinary income, and whether the remaining partners will be able to deduct a ... Reporting on the transfer of partnership interests: PwC Treasury and the IRS released on October 7 Final Regulations (the Final Regulations) under Sections 1446 (f) and 864 (c) (8). Section 1446 (f), added to the Code by the 2017 tax reform legislation, provides rules for withholding on the transfer or disposition of a partnership interest. Proposed Regulations were issued in May 2019, which laid ... Selling Your Partnership Interest? Form 8308, and New Penalty Relief In October 2023, the IRS released a revised version of Form 8308 that adds a new part IV requiring calculations of gain or loss on the sale or exchange of certain partnership interests. The completed Form 8308, including the new part IV, must be sent to the transferor and transferee partners by January 31, 2024. IRS Issues Partnership Interest Transfer Regulations The US Department of the Treasury and Internal Revenue Service (IRS) recently issued final regulations under section 1446 (f), a provision enacted as part of the Tax Cuts and Jobs Act of 2017 ... Sale or Redemption of a Partnership Interest Sale or Redemption of a Partnership Interest - Is There a ... Publication 541 (03/2022), Partnerships An executor and a beneficiary of an estate. A partnership and a person owning, directly or indirectly, 80% or more of the capital or profits interest in the partnership. Two partnerships if the same persons directly or indirectly own 80% or more of the capital or profits interests. Property subject to a liability. Tax Implications on Sale of a Partnership Interest Example 2 - Sale of partnership interest with partnership debt: Amy is a member of ABC, LLC and has a $23,000 basis in her interest. Amy's membership interest is 1/3 of the LLC. When Amy sells her 1/3 interest for $100,000 the partnership has a liability of $9,000. Amy's amount realized would be $103,000 ($100,000 + ($9,000 x 1/3). Termination of a Partnership Interest Termination of a Partnership Interest. This item explores the two main methods used when terminating a partnership interest: purchase and liquidation. A terminating partner may sell his or her interest to one or more of the remaining partners, or the partnership may liquidate his or her interest. The tax issues associated with these two methods ... Gifts of Partnership Interests The gift of a partnership interest generally does not result in the recognition of gain or loss by the donor or the donee. A gift is, however, subject to gift tax unless the gift qualifies for the annual gift tax exclusion or reduces the donor's lifetime gift tax applicable exclusion amount. (Since the lifetime gift tax exclusion for 2016 is $5 ... Special Issues Related to Distributions of Partnership Interests by Sec. 761 (e) Sec. 761 (e) provides that any distri-bution of an interest in a partnership that is not otherwise treated as a sale or ex change, as discussed above, will still be treated as a sale or exchange for purposes of Secs. 708 and 743. While the legislative history of this provision indicates that the IRS might issue regulations ... eCFR :: 26 CFR Part 1 A sells its partnership interest to T for $100. PRS has an election in effect to adjust the basis of partnership property under section 754. T receives a negative $50 basis adjustment under section 743 (b) that, under section 755, is allocated to the property. The partnership then sells the property for $120. PDF Publication 541 (Rev. March 2022) An executor and a beneficiary of an estate. A partnership and a person owning, di-rectly or indirectly, 80% or more of the cap-ital or profits interest in the partnership. Two partnerships if the same persons di-rectly or indirectly own 80% or more of the capital or profits interests. Property subject to a liability. Assignment of Partnership Interest (US) Form To avoid such tax consequences, and preserve individual tax treatment for the partners, the partnership agreement might prohibit assignments of partnership interest may be sold to any such business entity. ... To create an Assignment of Partnership Interest, there should be a drafted document that records the transfer of rights and benefits ... Navigating Partnership Interests and Tax Consequences In cases where the partnership interest is acquired by transferring assets directly to the partnership, no tax consequences occur for existing partners. No disposition of their interest occurs, and therefore, no capital gain is recorded. The new partner's interest is recorded at the cost of the assets transferred, e.g., $90,000. Selling LLC Interests: The Tax Consequences May Not Be What You Expected However, such transactions introduce a number of new issues, particularly if the LLC makes a noncash distribution to effectuate the redemption, which can create unintended consequences. Conclusion. Tax issues are messy. No one would hold up the tax consequences of buying and selling stock of corporations as a model of simplicity and clarity. Trusts Owning Partnership Interests The trust is worth $2 million, including $500,000 of marketable securities (with a total cost basis of $503,000) and a limited partnership interest worth $1.5 million. The securities generate $18,000 of dividend income and the partnership reports the trust's share of partnership taxable income of $200,000, but the partnership makes no ... IRS properly denied charitable deduction for partnership interest ... The Keefers asserted that their assignment of the 4% interest subject to an oral agreement that Pi would receive the net proceeds from the sale of the hotel, as opposed to other partnership assets not covered in the sale, "is not a 'carving out' from the 4% partnership interest to Pi any more than the partnership paying a liability for a pre ... Gain recognized on sale of partnership interest attributable to ... At the time of the transaction, the partnership held inventory valued at $6.4 million that it later sold for a profit of $22.4 million. All agreed that of the $438 million the taxpayer received for her partnership interest, $6.5 million was attributable to a gain on the partnership's sale of inventory. Assignment Of Partnership Interest Tax Consequences When you are searching for a Assignment Of Partnership Interest Tax Consequences and don't have the time to commit trying to find the right and updated version, the procedures may be stress filled. A robust online form catalogue might be a gamechanger for everyone who wants to manage these situations effectively. Current developments in partners and partnerships During the period of this update (Nov. 1, 2019, through Nov. 30, 2020), the IRS issued guidance on the law known as the Tax Cuts and Jobs Act (TCJA), 1 which was enacted at the end of 2017 and made several changes that affect partners and partnerships. The IRS also provided guidance for taxpayers regarding other changes made to Subchapter K over the past few years. Disposal and acquisition of partnership interests: tax Interests in partnerships may change in a number of ways, including the retirement of an existing partner, the admission of a new partner, a transfer or assignment of an interest in a partnership, or a change in the capital sharing ratio of a partnership. This practice note considers the tax on chargeable gains, stamp duty, SDLT, land transaction tax and VAT implications of these changes. Disposal and acquisition of partnership interests: tax Interests in partnerships may change in a number of ways, including the retirement of an existing partner, the admission of a new partner, a transfer or assignment of an interest in a partnership, or a change in the capital sharing ratio of a partnership. This practice note considers the tax on chargeable gains, stamp duty, SDLT, land transaction tax and VAT implications of these changes. Taxing the Transfer of Debts Between Debtors and Creditors This article reviews these transactions. Two basic types of transfers have created significant tax issues. In the first, the debtor transfers the debt to the creditor. If the debtor is the owner of a business and the business is a creditor, the transfer appears to be a contribution. If the business is the debtor and the owner is the creditor ... assignment essay homework paper phd report resume review speech thesis