Partnerships

Chapter 11
Partnerships: Distributions,
Transfer of Interests,
and Terminations
Corporations, Partnerships,
Estates & Trusts
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even serious mistakes, you may

have a fresh start any moment
you choose, for this thing we call
"failure" is not the falling down,
but the staying down.
-Mary Pickford
The Big Picture (slide 1 of 4)

In the previous chapter, Josh, Kyle, and Maria created
Beachside Properties, LLC, to own and operate the
Beachsider Cafe and to own, manage, and lease the
remaining properties in the Shorefront Center.
Several years have passed since the LLC was formed.
The LLC interests and the net underlying assets are
currently valued at approximately $10 million (including
$1 million of goodwill for the Beachsider Cafe).
During this period, the LLC has made significant
distributions of cash and property to its members.
3

The area has grown substantially, and it appears to be
a good time to develop the remaining 7 acres of
property.
The cost of development is estimated at $10 million.
Josh wants to manage the expansion.

Kyle and Maria are nearing retirement age.
They would prefer to dispose of their interests (valued at
$9.5 million, or 95% of the net LLC value).
Josh has been approached by a group of developers

who are willing to invest the $19.5 million necessary
to make the improvements and to purchase Kyles
and Marias interests.
4

The transfer of Kyles and Marias interests and the
admission of the new LLC members can be
accomplished in two ways.
First, the LLC could admit the new members for $19.5
million of cash
Use $9.5 million to redeem the interests of Kyle and Maria.
Second, Kyle and Maria could sell their LLC interests

directly to the new members for $9.5 million.
The new members would also contribute $10 million of cash to the
LLC for the expansion.

Although the two alternatives have identical
economic effects, the tax results could differ
substantially.
How are the distributions of cash and property to the LLC
members treated over the years?
What are the tax consequences of admitting the new
members to the LLC and redeeming the interests of Kyle
and Maria?
What are the results if the new members acquire the
interests directly from Kyle and Maria and contribute the
cash for expansion to the LLC?
Read the chapter and formulate your response.

6
The Big Picture Example 1
Distributions From A Partnership

Return to the facts of The Big Picture on p. 11-1.
Assume that Joshs basis in his interest in

Beachside Properties, LLC, is $300,000.
The LLC distributes $50,000 cash to Josh at
the end of the year.
Josh does not recognize any gain on the
distribution and reduces his basis by $50,000 (the
amount of the distribution) to $250,000.
Distributions from a Partnership(slide 1 of 4)

A payment from a partnership to a partner is not necessarily treated as a distribution
e.g., Partnership may pay interest or rent to a partner, make a guaranteed
payment, or purchase property from a partner
If a payment is treated as a DISTRIBUTION, it will fall into two categories:
1. Liquidating distributions- when Partnership itself liquidates or redeems a
partners interest in an ongoing Partnership
2. Nonliquidating distributions- any other distribution from a continuing
partnership to a continuing partner(draw or partial liquidation)
Depends on whether the partner remains a partner in the partnership after the
distribution
Abbreviations: capital P = partnership; small p = partner

8
Distributions from a Partnership

(slide 2 of 4)
A liquidating distribution occurs when either:

1. Partnership itself liquidates and distributes all its
property to the partners, or
2. Ongoing partnership redeems interest of one of its
partners
e.g., Partner retires

A Nonliquidating distribution is any distribution
from a continuing partnership to a continuing
partner
Two types of nonliquidating distributions
1. Draw
1.
Distribution of partners share of current or accumulated profits

that have been taxed to the partner in the current or prior taxable
years.
2. Partial liquidation
1.
Reduces partners interest in partnership capital but does not

liquidate partners interest
10

Distributions from a partnership may be either:
ProportionatePartner receives his or her share of
certain ordinary income-producing assets Hot
Assets (Unrealized AR, Substantially Appreciated
INVENTORY, & DEPRECIATION RECAPTURE) INVENTORY =
ALL ASSETS OTHER THAN CASH, 1221 & 1231
ASSETS.
DisproportionatePartners share of certain ordinary

income-producing assets increases or decreases
Substantially Appreciated Inventory is where FMV
>120% Partnerships basis
11
Proportionate Nonliquidating Distributions (slide 1 of 3)
In general, NEITHER partner nor partnership

recognizes GAIN OR LOSS on proportionate
nonliquidating distributions
1. Partner usually takes a carryover basis, Partnerships
basis, in assets distributed
2. Basis in partnership interest is reduced by amount of
cash and Partnerships basis of property distributed
12

Partner recognizes gain to extent CASH received exceeds
partners adjusted basis (outside basis) in partnership interest.
However, a reduction in partners share of partnership debt is
treated as a cash distribution. If actual cash distribution &
reduction of debt exceeds partners outside basis, gain is
recognized.
1.
2.
First reduces partners basis in partnership

Any reduction in excess of partners basis in partnership results
in taxable gain to the partner
Partner CAN NOT RECOGNIZE LOSS on a proportionate

nonliquidating distribution. Only when interested is liquidated
can a loss be determined. Thus, loss cant be recognized unless
the distribution is a liquidating distribution, or a sale of the
partnership interest.
13
Property distributions
In general, no gain recognized on a property distribution
If inside (Partnerships) basis of property distributed exceeds
partners outside basis in partnership interest, distributed
asset takes substituted basis (the partners outside basis in the
partnership interest.)
There are several exceptions to the general rule. (See slides
addressing Property Distributions with Special Tax
Treatment)
Assets are deemed distributed and basis applied in a certain
order
14
Ordering Rules 1 OF 2
When the inside basis of distributed assets exceeds the
distributee partners outside basis, assets are deemed
distributed in the following order:
1. Cash
2. Unrealized receivables and inventory
3. All other assets
Basis is allocated to assets within a category based on

adjusted basis to partnership
15
Ordering Rules 2 OF 2
Unrealized AR - have value to the P but for which the
related income hasnt been realized & recognized and
which will generate ordinary income when realized &
recognized. E.g. AR for a Cash Based P. Also includes
recapture of deprecation as ordinary income if P sold
assets.
Inventory includes P assets EXCEPT Cash, Capital, or
1231 assets. Thus, ALL AR are considered inventory;
albeit, only cash basis AR are unrealized AR
See Concept 11.1 page 11-9
16
Proportionate Nonliquidating Distribution

Examples (slide 1 of 6)
Bills basis in partnership interest: $30,000
Proportionate nonliquidating distributions
(independent fact situations):
Assets Distributed
A
B
Cash
$15,000 $15,000
Landbasis
N/A
$ 6,000
(Fair mkt value)
N/A
$10,000
Accts recbasis
N/A
N/A
(Fair mkt value)
N/A
N/A
C .
$ 5,000
N/A
N/A
-0$16,000
17

A
Basis in interest
$30,000
$30,000
$30,000
Cash distributed
Basis after cash
Acct. rec. distrib.
Basis after A.R.
Land Distrib.
Basis after all dist.
( 15,000)
15,000
N/A
15,000
N/A
$15,000
(15,000)
15,000
N/A
15,000
( 6,000)
$ 9,000
(5,000)
25,000
(-0-)
25,000
N/A
$25,000
18

Basis in pship int.
Basis in cash
Basis in land
Basis in A/R
Total basis
A
$15,000
15,000
N/A
N/A
$30,000
Sale of non-cash assets

at FMV: Selling price N/A
Basis
N/A
Gain
N/A
B
$9,000
15,000
6,000
N/A
$30,000
C .
$25,000
5,000
N/A
-0$30,000
$10,000
(6,000)
$4,000
$16,000
(-0-)
$16,000
19

Bills basis in partnership interest:
$30,000
Proportionate nonliquidating distributions
(independent fact situations):
Assets Distributed
Cash
Relief of liabilities
Land-basis
(Fair mkt value)
D
$40,000
N/A
N/A
N/A
E
N/A
40,000
N/A
N/A
F
.
$20,000
N/A
$30,000
$50,000
20

Basis in interest
Cash distributed
Relief of liabilities
Gain recognized
Basis after cash (and
deemed cash) dist.
Land distrib.
Basis after all distrib.
D
$30,000
(40,000)
N/A
10,000
E
$30,000
N/A
(40,000)
10,000
F .
$30,000
(20,000)
N/A
N/A .
-0N/A
-0-
-0N/A
-0-
10,000
(10,000)
-021

Basis in p'ship int.
Basis in cash
Liabilities relieved
Basis in land
Gain recognized
Original basis
Sale of non-cash assets
at FMV: Selling price
Basis
Gain
D
-040,000
N/A
N/A
(10,000)
30,000
N/A
N/A
N/A
E
-0N/A
40,000
N/A
(10,000)
30,000
N/A
N/A
N/A
F .
-020,000
N/A
10,000
N/A .
30,000
$50,000
(10,000)
$40,000
22
Effect of Liquidating Distribution

In general:
1. No gain or loss is recognized by partnership
2. Partner reduces basis in partnership interest by
basis in property received at each level using
Ordering Rules
3. Partners entire basis in interest will be absorbed
by distributed assets
23
Exceptions to Liquidating Distribution

Rules (slide 1 of 2)
Gain is recognized if:
1. Cash distributed exceeds partners basis
2. Precontribution gain exceptions
3. Disproportionate distribution
24
Exceptions to Liquidating Distribution

Rules (slide 2 of 2)
Loss is recognized only if:

1. Assets received include ONLY cash, unrealized
receivables and inventory(hot assets), and
2. Outside basis exceeds partnerships inside basis
in distributed property
25
Proportionate Liquidating Distribution

Bills basis in partnership interest: $30,000
Proportionate liquidating distributions (partnership also
liquidates) (independent fact situations):
G
H
I
.
Cash
$50,000
$10,000
$10,000
Unrealized rec.
N/A
-0-0(Fair mkt value)
N/A
$16,000
$16,000
Filing cabinet (1231) N/A
N/A
300
(Fair mkt value)
N/A
N/A
300
26

Basis in interest
Cash distribution
Gain recognized
Basis after cash
A/R distrib.
Loss recognized
Basis after A/R
Filing cabinet
Ending basis
G
$30,000
(50,000)
20,000
-0N/A
N/A
-0N/A
$ -0-
H
$30,000
(10,000)
N/A
20,000
-0(20,000)
-0N/A
$ -0-
I
.
$30,000
(10,000)
N/A
20,000
-0N/A
20,000
(20,000)
$ -0-
27

Basis in pship int.
Basis in cash
Basis in A/R
Basis in filing cabinet
Capital (Gain)/loss
Original basis
$ -050,000
N/A
N/A
(20,000)
$30,000
$ -010,000
-0N/A
20,000
$30,000
$ -010,000
-020,000
N/A .
$30,000
28

Sale of non-cash assets at FMV:
Example H:
A/R
Selling price
$16,000
Basis
-0Gain/(loss)
$16,000
(Ordinary)
Example I:
Selling price
$16,000
Basis
-0Gain/(loss)
$16,000
(Ordinary)
Fil.Cab.
N/A
N/A
N/A
300
20,000
($19,700)
(May be ord)
Total .
$16,000
-0- .
$16,000
$16,300
20,000
($3,700)
29
Property Distributions with Special Tax Treatment (slide 1 of 4)
Disguised sales
1. Contribution of appreciated property to partnership &
soon thereafter (IRS assumes disguised sale if it
occurs within 2 yrs see chapter 10 page 10-12)
followed by a cash or property distribution to the
contributing party may be treated as a disguised sale
2. If so, the initial contribution will be treated as a sale of
property resulting in gain recognition to partner
Partnerships basis in the asset is cost
30

Marketable securities
FMV of marketable securities distributed to a partner is
treated as a cash distribution
Some or all of excess of FMV of securities distributed over
partners outside basis is taxable gain
Marketable securities include most actively traded debt or
equity interests, options, futures, and derivatives
Exceptions apply
a) MS arent treated as cash if contributed by the parnter to
whom these are now distributed.
b) Property wasnt marketable securities when Partnership
acquired these
c) partner is an eligible partner of an investment Partnership
31
Precontribution gain property
Contributing partner recognizes gain on distribution of

precontribution gain property in two situations:
1. If the pre-contribution gain property is distributed to
ANOTHER partner within 7 years of contribution date,
contributing partner recognizes remaining
precontribution gain
Contributing Partners basis in partnership and basis of
distributed property in hands of distributee partner is increased
by gain recognized
32

Precontribution gain property
Contributing partner recognizes gain on distribution of
precontribution gain property in two situations (contd):
2. If partnership distributes ANY property other than cash to a partner
within 7 years after THAT partner contributes appreciated property,
the partner recognizes the lesser of:
a) Remaining net precontribution gain
b) Excess of FMV of distributed property over partners basis in
partnership interest
c) P BASIS IN ORIGINAL PRE-GAIN ASSET IS INCREASED
BY AMOUNT OF GAIN p RECONGIZES AS IS p OUTSIDE
BASIS
Exception- if the partner originally contributed the distributed

property, the P is merely returning property to the original
contributor & p is not required to recognize built-in gain.
33
Disproportionate Distributions (slide 1 of 3)

Occurs when partnership distributes cash or
property to a partner which increases or decreases
the partners share of ordinary income-producing
assets (HOT ASSETS)- the Partner doesnt receive
his proportion share of hot assets.
The Aggregate ( conduit) theory assumes each
partner owns a proportionate share of each of the
Partnerships assets
34
Disproportionate Distributions(slide 2 of 3)
If partner receives less than his proportionate share of hot
assets, then 2 separate events are DEEMED to have
occurred:
1. Partnership distributed some (his share) of the hot
assets to the distributee partner, and
2. The Distributee Partner sold these hot assets back to
partnership at FMV.
As a result, the Partner recognizes ordinary income on sale of the
hot assets back to Partnership (excess of FMV over the
Partnerships inside basis in hot assets). Then Partnerships basis
in hot assets is cost it is deemed to have paid the distributee
partner. See example 21 page 11-15
35
Disproportionate Distributions (slide 3 of 3)

Hot assets include:
Substantially appreciated inventory
Inventory includes all assets other than cash, capital (1221
assets), and 1231 assets, which would include accrual
based AR
Substantially appreciated means FMV > 120% of
partnerships adjusted basis in inventory
Unrealized receivables
Rights to receive future amounts that will result in ordinary
income recognition- cash basis AR
36
736: Liquidating Distribution Where Pship Does Not Liquidate (slide 1 of 3)
736(a) income payment (partners share of Ps going concern

value):
1. Treated as distributive share of partnership income or
guaranteed payment to partner
2. Certain items if partnership is service-provider and retiring
partner is a general partner:
Unrealized receivables (except depreciation recapture)
Goodwill (unless provided for in partnership agreement)
736(b) property payment:

Payments made for liquidated partners share of partnerships
assets
736 classifies payments made by an going Pship in complete
liquidation of a retiring partners interest, or payments made to a
successor of a deceased partner.
37
736: Liquidating Distribution Where Pship Does Not Liquidate (slide 2 of 3)
736(a) income payment:
Partner has:
1. Ordinary income (guaranteed payment THOSE
PAYMENTS NOT REFERENCED TO P PROFITS), or
2. Distributive share of income (allocation of Ps income for
the year taxed to partner according to character to P)
Partnership has:
1. Guaranteed payment (deductible) if determined without
regard to partnership profits
2. Distributive share if based on profits ( reduces income
for the year to be distributed to remaining partners)
38
736: Liquidating Distribution Where

Pship Does Not Liquidate (slide 3 of 3)
736(b) property payment:
Disproportionate distribution to extent of partners
share of hot assets
Return of basis (and capital gain (loss) for
remainder)
39
736(b) Property Payments (slide 1 of 4)

Recall that the members of Beachside Properties,

LLC, are considering two alternatives for its future
expansion.
Assume that they decide to admit new partners for
$19.5 million and use $9.5 million of the cash to
redeem the interests of Kyle and Maria.
Because the LLC itself is not liquidating, the
distribution to Kyle and Maria is classified under
736.
40

The current balance sheet for Beachside Properties,
LLC, is as follows:
41

Capital is a material income-producing
factor for Beachside Properties, LLC.
The entire $9.5 million distribution from the LLC
to Kyle and Maria is a 736(b) payment for their
interests in the partnerships property.
Kyle and Maria will recognize gain to the extent
that this cash distribution (including forgiveness of
their shares of the LLCs debt) exceeds their bases
in the LLC interests.
42

Because Kyle and Maria receive cash in lieu of their
shares of the LLCs unrealized receivables and
inventory, this is a disproportionate distribution.
They will recognize ordinary income to the extent that their
gain relates to these receivables and inventory.
The remaining gain will be a capital gain.

As there are no 736(a) payments, the LLC cannot
claim any deductions.
Absent a 754 election (discussed later), the basis of the
LLCs property will not be affected
43
Sale of Partnership Interest
(slide 1 of 4)
Generally, results in gain or loss recognition by

selling partner
Gain (loss) = amount realized less partners basis in
Partnership liabilities assumed by purchasing partner
are treated as part of consideration paid for the
44
Sale of Partnership Interest (slide 2 of 4)

Partnership tax year closes for selling partner on
sale date
Partners share of income through sale date is calculated
Can prorate annual income or use interim closing of the
books
Taxed to selling partner and increases his basis in

partnership interest. Selling partners Basis is
adjusted for the selling Partners share of Pships
income or loss through date of sale before gain or loss
on sale is calculated
45
Sale of Partnership Interest (slide 3 of 4)

Effect of Hot assets
Hot assets include:
Unrealized receivables & depreciation
recapture (same as for disproportionate
distributions)
Inventory
Includes all partnership property except
money, capital assets, and 1231 assets
46
Sale of Partnership Interest

(slide 4 of 4)
Effect of hot assets (contd)

Must allocate sales price of partnership interest between
hot (ordinary income) assets and nonhot (capital
gain) components
Selling partners gain is classified as a capital gain or loss
portion and an ordinary income or loss amount related
to the hot assets
47
Effect Of Hot Assets (slide 1 of 2)

Return to the facts of The Big Picture on p. 11-1
Recall that the second restructuring option for

Beachside Properties, LLC, is for Kyle and
Maria to sell their interests directly to the new
members of the LLC.
The new members will contribute $10 million of
cash to Beachside Properties and pay $4.75 million
each to Kyle and Maria in exchange for their
interests in the LLC.
48
Effect Of Hot Assets (slide 2 of 2)

Refer back to the balance sheet in Example 27.
Kyle and Maria will receive cash of $9.5 million (total)
plus relief of their shares of the LLCs debt.
Their bases in the LLC interests equal their capital account
balances plus their shares of the LLCs liabilities.
The difference must be recognized as a gain.

The gain is ordinary income to the extent that it relates to
Kyles and Marias shares of the LLCs accounts
receivable, inventory, and depreciation recapture.
The remaining gain is a capital gain.
Absent a 754 election (discussed later), the basis of

the LLCs property will not be affected.
49
Other Dispositions of Partnership

Interests (slide 1 of 8)
Transfer of a partnership interest to a
controlled corporation
Tax free if 351 requirements are met
If 50% or more of the total interest in capital and
profits of the partnership are transferred, the
partnership terminates
50
Other Dispositions of Partnership
Interests (slide 2 of 8)
Incorporating a partnership
At least three methods available:
1. Transfer each partners interest to the corp in
exchange for stock
i. Partnership terminates
ii. Corp becomes owner of all partnership assets
iii. Corp has substituted basis in assets; Old partners have
substituted basis in stock
51
Other Dispositions of Partnership Interests (slide 3 of 8)
Incorporating a partnership (contd)

2. Transfer partnership assets to corp in exchange for
stock and assumption of partnership liabilities
i.
ii.
Partnership distributes stock to partners in liquidating

distribution
Corp has carryover basis in assets; Old partners have
substituted basis in stock
52

3. Partnership distributes all assets and liabilities pro
rata to partners in complete liquidation of
partnership
i.
ii.
Partners transfer assets and liabilities to corp in exchange

for stock under 351
Corp has substituted basis for assets; Partners have
substituted basis for stock
53

All three methods of incorporating a partnership are taxfree
Exception: if liabilities of partnership exceed basis of
transferred assets
Different methods may, however, result in different

inside and outside basis amounts.
Thus, selecting the appropriate incorporation method is crucial
54
Other Dispositions of Partnership Interests

(slide 6 of 8)
Nontaxable like-kind exchange rules do not apply to

the exchange of interests in different partnerships.
Thus, these are fully taxable!
An exchange of interest in the same P is generally
not taxable.
55
Other Dispositions of Partnership Interests

(slide 7 of 8)
Generally, the gift of a partnership interest is taxfree

Partnership income, loss, etc. is prorated between
donor and donee.
Since Ps tax year doesnt end with gift, the donor
reports his share of P income/loss at end of Ps year
end.
56
Death of a partner
Taxable year of partnership closes with respect to that
partner on date of death
Compute deceased partners share of partnership income
or loss to that date and report on partners final Form
1040
57
754 Election 1 of 2
Adjusts partnerships basis in assets to reflect:
1. Purchase/Sale Transaction- The difference in the amount
paid by the purchasing partner and his share of the inside
basis of partnership assets
The adjustment can be positive or negative
The adjustment affects the basis of partnership
property(assets) with respect to the transferee partner
only
A. If Adjustment is positive-Transferee paid more than his share of inside
basis:
P increases basis of it assets.
If a portion of step-up is depreciable property, the step-up amount is
treated as a separate asset & depreciated as a newly acquired.
B. If adjustment is negative- Transferee paid less than his share of inside basis:
P decreases basis in its assets.
Example 39 page 11-29
58
754 Election 2of 2

Adjusts partnerships basis in assets to reflect:
2. Adjustment is made for Partnerships distributions:
a) (+)Gain or ( -) loss recognized by partner receiving
distribution from partnership,
b) (+) Excess of Ps basis in distributed property over the

basis of property in distributees hands
c) (-) Excess of distributees basis in distributed property
over the Ps basis in that property.
See examples 40-42 page 11-30 & 11-31
Once the 754 election is made, the election remains in effect for all future years
unless election revoked with IRS consent
59
754 Election (slide 1 of 2)

For either restructuring option, Beachside Properties could
make a 754 election and reflect an adjustment to the basis of
the LLCs property.
Step-up related to sale of interests
On a sale of the interests to the new LLC members, the step-up would
equal the difference between the $9.5 million paid and Kyles and
Marias share of the inside basis of the LLCs property.
This step-up of approximately $7.6 million [$9.5 million - (95% X $2
million net assets)] would be allocated to the various partnership
properties under the rules of 755 (not discussed in this chapter).
Deductions related to the stepup, such as depreciation, would be
allocated to the new developer group.
60
754 Election (slide 2 of 2)

Step-up related to distribution in liquidation of the LLC
members interests.
If the LLC redeems the interests of Kyle and Maria, the LLC can step
up the bases of its remaining assets by the amount of gain recognized
by Kyle and Maria.
This step-up is approximately $7.8 million [$9.5 million distribution $1.7 million total basis in partnership interests (Kyles basis of
$400,000 + Marias basis of $1.3 million)], and benefits all the
remaining partners in the partnership.
Note that the step-up differs depending on whether there is a

sale or redemption, because Kyles and Marias share of the
basis of the assets differs from their basis in the LLC interests.
61
Termination of Partnership
(slide 1 of 3)
Partnership terminates when either of the following

events occur:
1. No part of the business continues to be carried on by
any partners
2. Within a 12-month period, 50% OR MORE of the
partnerships capital AND (Both must be sold or
exchanged) profits interests are sold or exchanged
62
(slide 2 of 3)
Partnership terminates and its tax year closes when:

1. The partnership incorporates
2. One partner in a two-party partnership buys out the
other partner
A termination also occurs when the partnership

ceases operations and liquidates
63
(slide 3 of 3)
Partnership tax year usually does not close:

1. Upon the death of a partner
2. Entry of a new partner
3. Liquidation of a partners interest in other than a
two-party partnership
4. Sale or exchange of a less than 50% partnership
interest
64
Termination Of A Partnership (slide 1 of 2)

Before the sale or redemption, Kyles and Marias
combined interests equal
95% of the LLCs capital, and
80% of the LLCs profits interests.
If they both sell their interests within a 12-month

period, they will cause a technical termination of the
existing LLC, and a new LLC will be deemed to be
formed.
65
Termination Of A Partnership (slide 2 of 2)

A technical termination would require
redetermination of the LLCs basis in its assets and
reestablishing the (new) LLC as an entity.
Note: The partners could structure the sale so that the
termination did not occur.
For example, have Kyle and Maria sell less than a 50%
interest in the LLC in one year and the remaining interest
more than 12 months later.
If the LLC redeems the interests, there is no sale or

exchange transaction, and no technical termination of
the LLC.
66
Family Partnerships
(slide 1 of 3)
Owned and controlled primarily by members of the

same family
Often formed to save taxes by funneling some of
parents income to the children
Often difficult to establish for tax purposes

704(e)(3) defines family as husband, wife, ancestors, lineal
descendants, and any trust established for the primary benefit of
such persons. BROTHERS/SISTERS ARE NOT INCLUDED
67
Family Partnerships
(slide 2 of 3)
Family member will be recognized as a partner if:

1. Capital is a material income-producing factor and
partnership interest is acquired in a bona fide transaction
where ownership and control are received
a) Can be acquired by gift or purchase from another family member
2. Capital is not a material income-producing factor, but

family member contributes substantial or vital services
68
Family Partnerships (slide 3 of 3)

Kiddy tax may apply to child partner under age 19 (or a
student under age 24) and claimed as a dependent by
parent-partner. However, earned income is not subject to
the kiddy tax
Family member whose interest is acquired by gift from
another family member may only have a portion of
partnership income allocated to them
Donor partner must be allocated income representing
reasonable compensation for services rendered to the
partnership
69
Limited Liability Companies

A LLC with 2 or more owners is taxed as a partnership
LLC members are not personally liable for debts of the entity
Effectively treated as a limited partnership with no general
partners
Results in unusual application of partnership taxation rules in
areas such as
Allocation of liabilities to the LLC members,

Inclusion or exclusion of debt for at-risk purposes,
Passive or active status of a member for passive loss purposes, and
Determination of a members liability for self-employment tax
LLCs are relatively new so there is no established body of case

law available
Makes planning difficult
70
Limited Liability Partnerships

1. Partners are not personally liable for the
malpractice and torts of their partners
2. Taxable as a partnership
3. Conversion of a general partnership into a
LLP is not taxable if:
1. all of the general partners become LLP
partners and
2. hold the same proportionate interest
71
Refocus On The Big Picture (slide 1 of 3)

Two things are happening when the new developers
become members of Beachside Properties, LLC.
The developers are buying out the interests of two existing
LLC members, and
They are providing cash with which to expand the LLCs
operations.
The expansion itself raises no specific tax problems.

An LLC can admit new members with no immediate tax
consequences.
In addition to the issues addressed earlier in the

chapter, the LLCs operating agreement should be
modified to ensure that there is no shift in ownership
rights between Josh and the new LLC members.
72

What If?
Changing the facts, assume the developers
have only $5 million in cash, with good
prospects for receiving an additional $5
million over the next two years, and $9.5
million more in the third year.
The LLC has found a bridge loan and temporary
financing of $10 million to cover costs during this
interim period.
73

What If?
This loan, though, is not large enough to also completely buy
out Kyles and Marias interests.
Thus, they have agreed to accept installment payments for the sale or
redemption of their interests.
Now the buyout of Kyle and Maria can be treated either as an

installment sale or as a redemption under 736 requiring a
series of payments.
While the specific results of these arrangements are beyond the
scope of this chapter, different tax consequences might arise as
to the timing and character of Kyles and Marias gain
recognition.
74
If you have any comments or suggestions concerning this

PowerPoint Presentation for South-Western Federal Taxation,
please contact:
Dr. Donald R. Trippeer, CPA
trippedr@oneonta.edu
SUNY Oneonta
Modified by
Patrick M. Lynch, CPA, CFE, CFF, CrFA, DABFA, CPU, CLU, ChFC
PMLYNCH@LOYNO.EDU
75

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Chapter 11

even serious mistakes, you may

The Big Picture (slide 1 of 4)

The Big Picture (slide 2 of 4)

Josh wants to manage the expansion.

Josh has been approached by a group of developers

The Big Picture (slide 3 of 4)

Second, Kyle and Maria could sell their LLC interests

The Big Picture (slide 4 of 4)

Read the chapter and formulate your response.

The Big Picture Example 1

Distributions From A Partnership

Assume that Joshs basis in his interest in

Distributions from a Partnership(slide 1 of 4)

Abbreviations: capital P = partnership; small p = partner

Distributions from a Partnership

A liquidating distribution occurs when either:

Distributions from a Partnership(slide 3 of 4)

Distribution of partners share of current or accumulated profits

Reduces partners interest in partnership capital but does not

Distributions from a Partnership(slide 4 of 4)

DisproportionatePartners share of certain ordinary

Proportionate Nonliquidating Distributions (slide 1 of 3)

In general, NEITHER partner nor partnership

Proportionate Nonliquidating Distributions (slide 2 of 3)

First reduces partners basis in partnership

Partner CAN NOT RECOGNIZE LOSS on a proportionate

Proportionate Nonliquidating Distributions (slide 3 of 3)

Basis is allocated to assets within a category based on

Proportionate Nonliquidating Distribution

Proportionate Nonliquidating Distribution

Proportionate Nonliquidating Distribution

Sale of non-cash assets

Proportionate Nonliquidating Distribution

Proportionate Nonliquidating Distribution

Proportionate Nonliquidating Distribution

Effect of Liquidating Distribution

Exceptions to Liquidating Distribution

Exceptions to Liquidating Distribution

Loss is recognized only if:

Proportionate Liquidating Distribution

Proportionate Liquidating Distribution

Proportionate Liquidating Distribution

Proportionate Liquidating Distribution

Property Distributions with Special Tax Treatment (slide 1 of 4)

Partnerships basis in the asset is cost

Property Distributions with Special Tax Treatment (slide 2 of 4)

Property Distributions with Special Tax Treatment (slide 3 of 4)

Precontribution gain property

Contributing partner recognizes gain on distribution of

Property Distributions with Special Tax Treatment (slide 4 of 4)

Exception- if the partner originally contributed the distributed

Disproportionate Distributions (slide 1 of 3)

Disproportionate Distributions (slide 3 of 3)

736: Liquidating Distribution Where Pship Does Not Liquidate (slide 1 of 3)

736(a) income payment (partners share of Ps going concern

736(b) property payment:

736: Liquidating Distribution Where Pship Does Not Liquidate (slide 2 of 3)

736(a) income payment:

736: Liquidating Distribution Where

The Big Picture Example 27

736(b) Property Payments (slide 1 of 4)

Recall that the members of Beachside Properties,

The Big Picture Example 27