Publication 541 |
2000 Tax Year |
Disposition of Partner's Interest
The following discussions explain the treatment of gain or loss
from the disposition of an interest in a partnership.
Abandoned or worthless partnership interest.
A loss incurred from the abandonment or worthlessness of a
partnership interest is an ordinary loss only if both of the following
tests are met.
- The transaction is not a sale or exchange.
- The partner has not received an actual or deemed
distribution from the partnership.
If the partner receives even a de minimis actual or deemed
distribution, the entire loss is a capital loss.
Partnership election to adjust basis of partnership property.
Generally, a partnership's basis in its assets is not affected by a
transfer of an interest in the partnership, whether by sale or
exchange or because of the death of a partner. However, the
partnership can elect to make an optional adjustment to basis in the
year of transfer. See Adjusting the Basis of Partnership
Property, later, for information on making the election.
Sale, Exchange,
or Other Transfer
The sale or exchange of a partner's interest in a partnership
usually results in capital gain or loss. However, see Payments
for Unrealized Receivables and Inventory Items, later, for
certain exceptions. Gain or loss is the difference between the amount
realized and the adjusted basis of the partner's interest in the
partnership. If the selling partner is relieved of any partnership
liabilities, that partner must include the liability relief as part of
the amount realized for his or her interest.
Example 1.
Fred became a limited partner in the ABC Partnership by
contributing $10,000 in cash on the formation of the partnership. The
adjusted basis of his partnership interest at the end of the current
year is $20,000, which includes his $15,000 share of partnership
liabilities. The partnership has no unrealized receivables or
inventory items. Fred sells his interest in the partnership for
$10,000 in cash. He had been paid his share of the partnership income
for the tax year.
Fred realizes $25,000 from the sale of his partnership interest
($10,000 cash payment + $15,000 liability relief). He reports $5,000
($25,000 realized - $20,000 basis) as a capital gain.
Example 2.
The facts are the same as in Example 1, except that Fred withdraws
from the partnership when the adjusted basis of his interest in the
partnership is zero. He is considered to have received a distribution
of $15,000, his relief of liability. He reports a capital gain of
$15,000.
Exchange of partnership interests.
An exchange of partnership interests generally does not qualify as
a nontaxable exchange of like-kind property. This applies regardless
of whether they are general or limited partnership interests or
interests in the same or different partnerships. However, under
certain circumstances, such an exchange may be treated as a tax-free
contribution of property to a partnership. See Contribution of
Property under Transactions Between Partnership and
Partners, earlier.
An interest in a partnership that has a valid election in effect
under section 761(a) of the Internal Revenue Code to be excluded from
the partnership rules of the Code is treated as an interest in each of
the partnership assets and not as a partnership interest. See
Exclusion From Partnership Rules, earlier.
Installment reporting for sale of partnership interest.
A partner who sells a partnership interest at a gain may be able to
report the sale on the installment method. For requirements and other
information on installment sales, see Publication 537,
Installment Sales.
The gain from the installment sale is treated as part capital gain
and part ordinary income if the partnership's assets included
unrealized receivables or inventory items. See Payments for
Unrealized Receivables and Inventory Items, later. The gain
allocable to unrealized receivables and inventory items is generally
ordinary income and must be reported in the year of sale. The gain
allocable to the other assets is capital gain and can be reported
under the installment method.
Liquidation at Partner's Retirement or Death
Payments made by the partnership to a retiring partner or successor
in interest of a deceased partner in return for the partner's entire
interest in the partnership may have to be allocated between payments
in liquidation of the partner's interest in partnership property and
other payments. The partnership's payments include an assumption of
the partner's share of partnership liabilities treated as a
distribution of money.
For income tax purposes, a retiring partner or successor in
interest of a deceased partner is treated as a partner until his or
her interest in the partnership has been completely liquidated.
Liquidating payments.
Payments made in liquidation of the interest of a retiring or
deceased partner in exchange for his or her interest in partnership
property are considered a distribution, not a distributive share or
guaranteed payment that could give rise to a deduction (or its
equivalent) for the partnership.
Unrealized receivables and goodwill.
Payments made for the retiring or deceased partner's share of the
partnership's unrealized receivables or goodwill are not treated as
made in exchange for partnership property if both of the following
tests are met.
- Capital is not a material income-producing factor for the
partnership. (Whether capital is a material income-producing factor is
explained in the discussion under Family Partnership near
the beginning of this publication.)
- The retiring or deceased partner was a general partner in
the partnership.
However, this rule does not apply to payments for goodwill to
the extent that the partnership agreement provides for a reasonable
payment to a retiring partner for goodwill.
Payments for unrealized receivables or goodwill are not treated as
made in exchange for partnership property under any circumstance if
the partner retired or died before January 5, 1993 (or retired on or
after that date if a written contract to buy the partner's interest in
the partnership was binding on January 4, 1993, and at all times
thereafter).
Unrealized receivables are defined later under Payments for
Unrealized Receivables and Inventory Items. However, for this
purpose, they do not include the items listed in that discussion under
Other items treated as unrealized receivables.
Partners' valuation.
Generally, the partners' valuation of a partner's interest in
partnership property in an arm's-length agreement will be treated as
correct. If the valuation reflects only the partner's net interest in
the property (total assets less liabilities), it must be adjusted so
that both the value of and the basis for the partner's interest
include the partner's share of partnership liabilities.
Gain or loss on distribution.
Upon the receipt of the distribution, the retiring partner or
successor in interest of a deceased partner will recognize gain only
to the extent that any money (and marketable securities treated as
money) distributed is more than the partner's adjusted basis in the
partnership. The partner will recognize a loss only if the
distribution is in money, unrealized receivables, and inventory items.
No loss is recognized if any other property is received. See
Partner's Gain or Loss under Partnership
Distributions, earlier.
Other payments.
Payments made by the partnership to a retiring partner or successor
in interest of a deceased partner that are not made in
exchange for an interest in partnership property are treated as
distributive shares of partnership income or guaranteed payments. This
rule applies regardless of the time over which the payments are to be
made. It applies to payments made for the partner's share of
unrealized receivables and goodwill not treated as a distribution.
If the amount is based on partnership income, the payment is
taxable as a distributive share of partnership income. The payment
retains the same character when reported by the recipient that it
would have had if reported by the partnership. For more information,
see Partner's Income or Loss, earlier.
If the amount is not based on partnership income, it is treated as
a guaranteed payment. The recipient reports guaranteed payments as
ordinary income. For additional information on guaranteed payments,
see Transactions Between Partnership and Partners, earlier.
These payments are included in income by the recipient for his or
her tax year that includes the end of the partnership tax year for
which the payments are a distributive share or in which the
partnership is entitled to deduct them as guaranteed payments.
Former partners who continue to make guaranteed periodic payments
to satisfy the partnership's liability to a retired partner after the
partnership is terminated can deduct the payments as a business
expense in the year paid.
Payments for Unrealized Receivables and Inventory Items
If a partner receives money or property in exchange for any part of
a partnership interest, the amount due to his or her share of the
partnership's unrealized receivables or inventory items results in
ordinary income or loss. This amount is treated as if it were received
for the sale or exchange of property that is not a capital asset.
This treatment applies to the unrealized receivables part of
payments to a retiring partner or successor in interest of a deceased
partner only if that part is not treated as paid in exchange for
partnership property. See Liquidation at Partner's Retirement or
Death, earlier.
For a sale or exchange of a partnership interest before August 6,
1997, inventory must be substantially appreciated before it generates
ordinary income (rather than capital gain). This also applies to any
sale or exchange under a written contract that is in effect on June 8,
1997, and at all times thereafter before the sale or exchange. For the
definition of "substantially appreciated," see Certain
distributions treated as a sale or exchange under
Partnership Distributions, earlier.
Unrealized receivables.
Unrealized receivables include any rights to payment not already
included in income for the following items.
- Goods delivered or to be delivered to the extent the payment
would be treated as received for property other than a capital
asset.
- Services rendered or to be rendered.
These rights must have arisen under a contract or agreement that
existed at the time of sale or distribution, even though the
partnership may not be able to enforce payment until a later date. For
example, unrealized receivables include accounts receivable of a cash
method partnership and rights to payment for work or goods begun but
incomplete at the time of the sale or distribution of the partner's
share.
The basis for any unrealized receivables includes all costs or
expenses for the receivables that were paid or accrued but not
previously taken into account under the partnership's method of
accounting.
Other items treated as unrealized receivables.
Unrealized receivables include potential gain that would be
ordinary income if the following partnership property were sold at its
fair market value on the date of the payment.
- Mining property for which exploration expenses were
deducted.
- Stock in a Domestic International Sales Corporation
(DISC).
- Certain farm land for which expenses for soil and water
conservation or land clearing were deducted.
- Franchises, trademarks, or trade names.
- Oil, gas, or geothermal property for which intangible
drilling and development costs were deducted.
- Stock of certain controlled foreign corporations.
- Market discount bonds and short-term obligations.
- Property subject to recapture of depreciation under sections
1245 and 1250 of the Internal Revenue Code. Depreciation recapture is
discussed in chapter 3 of Publication 544.
Determining value.
Generally, the sales price of unrealized receivables, or their
value if received in a distribution treated as a sale or exchange, is
determined by any arm's-length agreement between the buyer and the
seller (or between the partnership and the partner receiving the
distribution).
If no agreement exists, the price or value must be determined by
taking into account both the estimated cost to complete performance of
the contract or agreement and the time between the sale or
distribution and the time of payment.
Example.
You are a partner in ABC Partnership. The adjusted basis of your
partnership interest at the end of the current year is zero. Your
share of potential ordinary income from partnership depreciable
property is $5,000. The partnership has no other unrealized
receivables or inventory items. You sell your interest in the
partnership for $10,000 in cash and you report the entire amount as a
gain since your adjusted basis in the partnership is zero. You report
as ordinary income your $5,000 share of potential ordinary income from
the partnership's depreciable property. The remaining $5,000 gain is a
capital gain.
Inventory items.
Inventory items are not just stock-in-trade of the partnership.
They also include the following property.
- Property that would properly be included in the
partnership's inventory if on hand at the end of the tax year or that
is held primarily for sale to customers in the normal course of
business.
- Property that, if sold or exchanged by the partnership,
would not be a capital asset or section 1231 property (real or
depreciable business property held more than one year). For example,
accounts receivable acquired for services or from the sale of
inventory and unrealized receivables are inventory items.
- Property held by the partnership that would be considered
inventory if held by the partner selling the partnership interest or
receiving the distribution.
Notification required of partner.
If a partner exchanges a partnership interest attributable to
unrealized receivables or inventory for money or property, he or she
must notify the partnership in writing. This must be done within 30
days of the transaction or, if earlier, by January 15 of the calendar
year following the calendar year of the exchange. A partner may be
subject to a $50 penalty for each failure to notify the partnership
about such a transaction, unless the failure was due to reasonable
cause and not willful neglect.
Information return required of partnership.
When a partnership is notified of an exchange of partnership
interests involving unrealized receivables or inventory items, the
partnership must file Form 8308, Report of a Sale or
Exchange of Certain Partnership Interests. Form 8308 is filed
with Form 1065 for the tax year that includes the last day of the
calendar year in which the exchange took place. If notified of an
exchange after filing Form 1065, the partnership must file Form 8308
separately, within 30 days of the notification.
On Form 8308, the partnership states the date of the exchange and
the names, addresses, and taxpayer identification numbers of the
partnership filing the return and the transferee and transferor in the
exchange. The partnership must also provide a copy of Form 8308 (or a
written statement with the same information) to each transferee and
transferor by the later of January 31 following the end of the
calendar year or 30 days after it receives notice of the exchange.
The partnership may be subject to a penalty of up to $50 for each
failure to timely file Form 8308 and a $50 penalty for each failure to
furnish a copy of Form 8308 to a transferor or transferee, unless the
failure is due to reasonable cause and not willful neglect. If the
failure is intentional, a higher penalty may be imposed. See the form
instructions for details.
Statement required of partner.
If a partner sells or exchanges any part of an interest in a
partnership having unrealized receivables or inventory, he or she must
file a statement with his or her tax return for the year in which the
sale or exchange occurs. The statement must contain the following
information.
- The date of the sale or exchange, the partner's adjusted
basis for the partnership interest, and the part of the basis that
represents the unrealized receivables or inventory items.
- The money and fair market value of any other property the
partner received or will receive for the interest in the partnership,
and the part for the unrealized receivables or inventory items.
- The statement described earlier in Special adjustment
to basis under Partner's Basis for Distributed Property,
if the partner computes the basis for the unrealized receivables
or inventory items under that provision.
- If the partnership used the optional basis adjustment, the
computation described later under Adjusting the Basis of
Partnership Property and a list of the partnership properties to
which the adjustment has been allocated.
Partner's disposition of distributed unrealized receivables
or inventory items.
In general, any gain or loss on a sale or exchange of unrealized
receivables or inventory items a partner received in a distribution is
an ordinary gain or loss. For this purpose, inventory items do not
include real or depreciable business property, even if they are not
held more than 1 year.
Example.
Mike, a distributee partner, received his share of accounts
receivable when his law firm dissolved. The partnership used the cash
method of accounting, so the receivables had a basis of zero. If Mike
later collects the receivables or sells them, the amount he receives
will be ordinary income.
Exception for inventory items held more than 5 years.
If a distributee partner sells inventory items held for more than 5
years after the distribution, the type of gain or loss depends on how
they are being used on the date sold. The gain or loss is capital gain
or loss if the property is a capital asset in the partner's hands at
the time sold.
Example.
Ann receives, through dissolution of her partnership, inventory
that has a basis of $19,000. Within 5 years, she sells the inventory
for $24,000. The $5,000 gain is taxed as ordinary income. If she had
held the inventory for more than 5 years, her gain would have been
capital gain, provided the inventory was a capital asset in her hands
at the time of sale.
Substituted basis property.
If a distributee partner disposes of unrealized receivables or
inventory items in a nonrecognition transaction, ordinary gain or loss
treatment applies to a later disposition of any substituted basis
property resulting from the transaction.
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