Section. 754 Election. With Distributions

Transcription

1 Section 754 Election With Distributions Election Activates Sec. 743 Sales, Exchanges, Deaths Sec. 734 Distributions 2

2 Two Upward Adjustment Triggers in Sec ) Distributee recognizes sec. 731(a) gain. Sec

3 Gain on Distrib. w/754 Elect. Linda s predistribution O.B. is $100,000 $120,000 of money is distributed to her. Linda s recognizes gain of $20,000 (Sec. 731(a)) Partnership adjusts the common B.S. basis in capital gain property by $20,000 6

4 2) Partnership inside basis of distributed property exceeds the distributee s basis in the property Sec IB > OB with 754 Election Linda s predistribution O.B. is $100,000 Land with I.B. of $120,000 is distributed to her. Linda s basis in the land is $100,000.

5 Partnership adjusts the common B.S. basis in capital gain property by $20,000 9 Return to Sec Prop. Reg. Example On Page 19 Observation #

6 Partner D Dies And C Inherits D s PSP Interest 11 Immediately After DOD Assets In Thousands Tax Basis FMV O.B. Building 0 10,000 Total 0 10,000 Assets NR Debt 2,000 2,000 Capital: Ann (25%) <500> 2,000 0 Bo (25%) <500> 2,000 0 C (50%) <1,000> 4,000 5,000 Debt + Capital 0 10,000 12

7 Section 754 Election is Made 13 $5,000,000 sec. 743(b) adjustment for C ($5 million (O.B.) - $0 (I.B.) ) 14

8 For simplicity, assume no depreciation is claimed on the $5 mil. sec. 743(b) adjustment. 15 The value of the building appreciates from $10 mil. to $14 Mi. 16

9 Balance Sheet Before Buy-Out Assets Tax FMV (In Thousands) Basis Building 0 14,000 O.B. Total 0 14,000 Assets NR Debt 2,000 2,000 Capital: Ann <500> 3,000 0 Bo <500> 3,000 0 C <1,000> 6,000 5,000 Debt + Capital 0 14, C is liquidated: $ 6 mil. cash* + $ 1 mil. debt shift $ 7 mil. money distrib. *Funded with new recourse debt 18

10 C s unused 743(b) adjustment of $5 mil. increases the common balance sheet basis in the building (See reg (b)). 19 C s sec. 731 capital gain: $7 Mil. Distribution -$5 Mil. O.B. =$2 Mil. Cap. Gain 20

11 The sec. 1.1(h) sec lookthru rules for sales do not apply to liquidations. 21 C s sec. 731(a) capital gain increases the common balance sheet basis in the building by $2 mil. (Sec. 734) 22

12 Here, the 754 election primarily benefited the continuing partners 23 Debits: $7,000,000 Building Credits: $1,000,000 C Cap. $6,000,000 Rec.Debt 24

13 After C is Redeemed Assets Tax FMV Basis Building 7,000 14,000 Total Assets 7,000 14,000 O.B. NR Debt 2,000 2,000 Recourse Debt 6,000 6,000 Capital: Ann <500> 3,000 3,500 Bo <500> 3,000 3,500 Debt +Capital 7,000 14, Two 77 Downward Adjustment Triggers (Sec. 734) 26

14 The two downward triggers only occur with liquidating distributions 27 1) Distributee recognizes sec. 731(a)(2) loss. Sec

15 Loss Rec. with 754 Elect. Linda s predistribution O.B. is $100,000 $90,000 liquidating distribution of money to Linda. Linda recognizes a capital loss of <$10,000> Partnership adjusts the common B.S. basis in cold assets by <$10,000> 30

16 If the downward adjustment exceeds $250,000, then a deemed section 754 Election 31 Ex. of Deemed 754 Election Linda s predistribution O.B. is $500,000 $240,000 liquidating distribution of money to Linda. Linda recognizes a capital loss of <$260,000>

17 Mandatory partnership adjustment to common B.S. basis in capital gain property by <$260,000> 33 2) Distributee partner s basis in cold assets exceeds the partnership s inside basis. Sec

18 Cold Asset with 754 Elect. Linda s predistribution O.B. is $100,000 Invest. Land with I.B. of $90,000 is distributed in liquidation. Linda s basis in the land is $100,000. Partnership adjusts the common B.S. basis in capital gain property by <$10,000> 36

19 If the downward adjustment exceeds $250,000, then a deemed (mandatory) section 754 Election 37 Above example Modified 38

20 Same pattern and analysis as example 7 on page 83 Tax Disaster 39 Partner D Dies. Child C inherits D s partnership interest in P. The building was purchased for $8 mil. 40

21 Assets In Thousands Pre-Death Balance Sheet Tax Basis FMV O.B. Building 0 10,000 Total 0 10,000 Assets NR Debt 2,000 2,000 Capital: Ann (25%) <500> 2,000 0 Bo (25%) <500> 2,000 0 D (50%) <1,000> 4,000 0 Debt + Capital 0 10,000 D's interest in P is reported by the Estate on [IRS Form 8971 Schedule A] at $4 million (no discount). No 754 Election is made. 42

22 Post-Death Balance Sheet Assets Tax FMV O.B. Basis (In Thousands) Building 0 10,000 Total 0 10,000 Assets NR Debt 2,000 2,000 Capital: Ann <500> 2,000 0 Bo <500> 2,000 0 C <1,000> 4,000 5,000 Debt + Capital 0 10, Absent the section 754 election, C is stuck with an excess of O.B. > I.B. of $5 million for the remaining life of the partnership. (Zero Depreciation) 44

23 Assets In Thousands Post Death Balance Sheet Tax Basis FMV O.B. Building 0 10,000 Total 0 10,000 Assets NR Debt 2,000 2,000 Capital: Ann (25%) <500> 2,000 0 Bo (25%) <500> 2,000 0 C (50%) <1,000> 4,000 5,000 Debt + Capital 0 10,000 If the building were sold for $10 mil., C is taxed on $5 mil (50%) of the sale gain, shooting her O.B. to $10 mil. $4 mil. would be 1250 cap. gain taxed at 25% max. 46

24 Post Sale Balance Sheet Assets (In Thousands) Tax Basis FMV O.B. Cash 10,000 10,000 Total 0 10,000 Assets NR Debt 2,000 2,000 Capital: Ann (25%) 2,000 2,000 2,500 Bo (25%) 2,000 2,000 2,500 C (50%) 4,000 4,000 10,000 Debt + Capital 10,000 10,000 If, in the following year, C is liquidated: $ 5 mil. (cash $4 + debt relief $1) - 10 mil. O.B. <$ 5 mil.> capital loss (731(a)(2)) 48

25 Summary of tax impact on C: 5 mil Cap Gain Year of Sale -<5 mil.> Cap. Loss Year of Liquidation 49 The partnership must make a mandatory downward adjustment to capital gain property of <$5 mil.> when acquired (deemed 754 election) 50

26 Both C and the continuing partners were hurt by the failure to make a section 754 election 51 Can the partnership somehow justify a section 754 election before the building is sold? 52

27 A 754 election applies to all property distributions and transfers of partnership interests taking place in the partnership taxable year for which the election is made (Reg (a)) 53 Section 743(b) also applies to substituted basis transactions (after June 9, 2003) Reg (b)(5) 54

28 For Example: Contributed PSP interest to a partnership (sec. 721) Contribute PSP interest to a corporation (sec. 351). 55 C could contribute C s PSP interest to UTP (sec. 721 tax free) and UTP (the transferee PTR) will be eligible for a sec 743(b) adjustment of $5 mil. (Compare Example (8) on Page 85) 56

29 A B C PSP Building 57 A B C C UTP D E PSP Building 58

30 or 59 A B C 100% New S Corp. C PSP Building 60

31 31 The up/down section 755 basis allocation process does not apply to substituted basis transactions 61 TMCT, LLC Right to Make Section 754 Election. The Tax Matters Member may make or revoke, on behalf of the Company, all elections in accordance with Section 754 of the Code, so as to adjust the basis of Company property in the case of a distribution of property within the meaning of Section 734 of the Code, and in the case of a transfer of a Company interest within the meaning of Section 743 of the Code. Each Member shall, upon request of the Tax Matters Member, supply the information necessary to give effect to such an election. 62

32 [Partner X] has the right to require the Tax Matters Member to make a Section 754 election. 63 Florida Asset Resolution The Company shall make an election in accordance with Section 754 of the Code, so as to adjust the basis of Company property in the case of a distribution of property within the meaning of Section 734 of the Code and in the case of a transfer of a Company interest within the meaning of Section 743 of the Code, and the Company shall not apply for permission from the Commissioner of the Internal Revenue Service to revoke such election without the prior written consent of each Member (not to be unreasonably withheld).. 64

33 Each of the Members shall, upon request of the Tax Matters Partner, supply the information necessary to give effect to such an election. 65 Section 751(b) Examples 95 With Liquidating Distributions 66

34 95 Examples 19 and 20 compare the current regs. with proposed regs. for a liquidating distribution. 67 Examples 19 Current Regs. Jack is liquidated for: $1 mil. Cash $1 mil. Inventory 754 Election 95 68

35 Not a Service Partnership 69 JJJ Partnership Before Tax Book FMV (In Thousands) Basis Basis Cash 1,000 1,000 1,000 Accounts Rec ,000 Inventory ,000 Land (Capital ,000 Asset) Total Assets 2,000 2,000 4,000 O.B. Jack (50%) 1,000 1,000 2,000 1,000 Jill (25%) , Jane (25%) , Debt + Capital 2,000 2,000 4,000

36 Book capital accounts are (optionally) revalued. 71 Proportionate Under Current Regs No sec. 751(b) distribution Jack is receiving his 50% share of hot asset gross value ($1 mil.)

37 Impact on Jack: $1,000,000 cash is a tax free recovery of $1,000,000 O.B. $1,000,000 of inventory has zero basis to Jack Impact on PSP Upward $400,000 sec. 734 adjustment for the inventory I.B. that disappeared.

38 Debits: Tax Basis $1,000,000 Jack s Cap. $400,000 A/R (734(b)(1)(B) Credits: $1 mil. cash $400,000 inventory 75 After JJJ Partnership (In Thousands) Tax Book FMV Basis Basis Accounts Rec ,000 1,000 Land (Cap. Asset) 600 1,000 1,000 Total Assets 1,000 2,000 4, O.B. Jill (50%) 500 1,000 1, Jane (50%) 500 1,000 1, Debt + Capital 1,000 2,000 4,000 Section 754 Election Benefits Existing Partners

39 Tax Basis Debits and Credits Are challenging without a Sec. 754 Election 77 Example 20 Same Facts 2014 Prop. Regs. Jack is liquidated for: $1 mil. Cash $1 mil. Inventory 754 Election 96 78

40 JJJ Partnership Before Tax Book FMV (In Thousands) Basis Basis Cash 1,000 1,000 1,000 Accounts Rec ,000 Inventory ,000 Land (Capital ,000 Asset) Total Assets 2,000 2,000 4,000 O.B. Jack (50%) 1,000 1,000 2,000 1,000 Jill (25%) , Jane (25%) , Debt + Capital 2,000 2,000 4,000 Jack s Share of Unrealized 751(b) gain Before: $800K (50% x $1.6 mil.) Jack s Share of Unrealized 751(b) gain After: $1 mil. (zero basis Inv.) Thus no section 751 distribution. 80

41 After but Before 751(b) JJJ Partnership (In Thousands) Tax Book FMV Basis Basis Accounts Rec ,000 1,000 Land (Cap. Asset) 600 1,000 1,000 Total Assets 1,000 2,000 4, O.B. Jill (50%) 500 1,000 1, Jane (50%) 500 1,000 1, Debt + Capital 1,000 2,000 4,000 Jill s Share of Unrealized 751(b) gain Before: $400K (25% x 1.6 Mil.) Jill s Share of Unrealized 751(b) gain After: $300K (50% x $600K) Thus a section 751 distribution of $100K 82

42 Jane s consequences match Jill Ord. Inc. of $100,000 each Termination by Discontinuance 84

43 Example 2 Liquidation and Termination with Debt and Negative Capital Accounts Jack and Jill are general partners in the JJ equal partnership, an active business. The partnership terminates: ceases operations, sells all of its noncash assets, and distributes the remaining cash to the partners. Pre-liquidation balance sheet:

44 JJ Balance Sheet Assets Tax Basis FMV Cash $100,000 $100,000 Accounts Receivable $0 $100,000 Inventory $40,000 $100,000 Land $60,000 $100,000 Total Assets $200,000 $400,000 Partner s Outside Basis 102 Debt $600,000 $600,000 Capital Jack <$200,000> <$100,000> $100,000 Jill <$200,000> <$100,000> $100,000 Total Capital <$400,000> <$200,000> Debt + Equity $200,000 $400,000 Sale of assets generates $200,000 of taxable gain which is allocated equally between Jack and Jill $100,000 each. Increases Jack and Jill s O.B., each to $200,000 ($100,000 + $100,000) and tax basis capital to <$100,000> each.

45 After Asset Sales (In Thousands) Assets In Thousands Tax Basis FMV O.B. Cash Debt Capital: Jack (50%) <100> <100> 200 Jill (50%) <100> <100> 200 Debt + Capital The $400,000 of cash is used to pay $400,000 of the $600,000 debt.

46 After $400K of Debt is Paid Assets In Thousands Tax Basis FMV O.B. Cash 0 0 Debt Capital: Jack (50%) <100> <100> 0 Jill (50%) <100> <100> 0 Debt + Capital 0 0 The debt reduction of $200K each (deemed cash distribution) reduces each partner s O.B. to zero (Sec. 752)

47 J and J each contribute $100,000 to pay their deficit restoration obligations After $100K Contributions by J & J Assets In Thousands Tax Basis FMV Cash O.B. Debt Capital: Jack (50%) Jill (50%) Debt + Capital 0 0

48 Liquidation Loss of $100,000 each? No Before the $200K debt is paid, J &J each have an O.B. of $100K The debt repayment (deemed dist.) reduces their O.B. to zero.

49 Zero Loss on Liquidation 103 Example 3 Business Bad Debt for Right of Contribution

50 Same facts as Example 2, but general partner Jack is insolvent so general partner Jill pays the entire $200,000 debt balance of the JJ partnership prior to termination 103 After $400K of Debt is Paid (In Thousands) Assets In Thousands Tax Basis FMV Cash 0 0 O.B. Debt Capital: Jack (50%) <100> <100> 0* Jill (50%) <100> <100> 0* Debt + Capital 0 0 *200,000 (Beg. O.B.) minus $200,000 (Deemed Cash from Debt Reduction)

51 After $200K Debt Balance is Paid Assets In Thousands Tax Basis FMV Cash 0 0 O.B. Debt Capital: Jack (50%) <100> 0 0 Jill (50%) Debt + Capital 0 0 Jack owes Jill $100K but Jack is insolvent.

52 Jill s state law right of contribution from 50% partner Jack, upon dissolution of the partnership, becomes a $100,000 debt of Jack to Jill. 103 As a result, if the debt is uncollectible, Jill can claim a $100K business bad debt deduction (see Rev. Rul and PLR ).

53 Note: business bad debt treatment (ordinary business loss) is superior to the treatment of a liquidating distribution loss pursuant to IRC sec. 731(a)(2), which is a capital loss. 86 More Strategy on the Death of a Partner Exs. 9 thru

54 Return to facts of prop. reg (e) example but assume that the only asset is goodwill and the PSP is a law firm 107 Pre-Retirement Balance Sheet Assets Tax FMV O.B. (In Thousands) Basis Unst. Goodwill 0 10,000 Total Assets 0 10,000 NR Debt 2,000 2,000 Capital: Ann (25%) <500> 2,000 0 Bo (25%) <500> 2,000 0 D (50%) <1,000> 4,000 0 Debt + Capital 0 10,

55 The partnership makes a Sec. 754 election 109 D does not die! D retires and is bought-out for net asset value of $4 mil plus $1 mil. of debt share 110

56 A Leveraged Buy-out of D The PSP borrows $4 mil. recourse (all allocated to A & B) and distributes it to D and $1 mil. of old debt shifts to A & B. 111 Liquidating Distribution of $5 mil. to D (actual $4 mil. + deemed $1 mil.) D s pre-distribution O.B. is Zero 112

57 Post-Liquidation Assets Tax FMV (In Thousands) Basis Goodwill 0 10,000 Total Assets 0 10,000 O.B. Old NR Debt 2,000 2,000 New Debt 4,000 4,000 Capital: Ann <3,000> 2,000 0 Bo <3,000> 2,000 0 Debt +Capital 0 10, Does D have $5 mil. capital gain (secs. 736(b) and 731))? or $5 mil. of ordinary income + SE tax (Sec. 736(a))? 114

58 The partnership agreement declares that the liquidation payment is a section 736(a) payment and that goodwill is zero. 115 The agreement, in effect, refutes the existence of goodwill (Tolmach) 116

59 Like Ex. 12 & 13 Pg. 88 The partnership agreement will be respected based upon sec. 736 regs. and Tolmach (no payment for goodwill so no sec. 736(b) payment) 117 For the purposes of section 736(b), payments made to a retiring partner or to a successor in interest of a deceased partner in exchange for the interest of such partner in partnership property shall not include any amount paid for the partner's share of good will of the partnership in excess of its partnership basis, 118

60 including any special basis adjustments for it to which such partner is entitled, except to the extent that the partnership agreement provides for a reasonable payment with respect to such good will. (Reg (b)(3)) 119 Generally, the valuation placed upon good will by an arm's length agreement of the partners, whether specific in amount or determined by a formula, shall be regarded as correct. (Reg (b)(3)) 120

61 A $5 mil. fixed section 736(a) payment is a guaranteed payment (O.I.+ SE tax) to D. 121 The $5 mil. guaranteed payment is deductible by the partnership (net loss of <$5 mil.>). 122

62 Will Ann and Bo have sufficient O.B. to claim the <$5 mil.> loss (50% each) for the guaranteed payment? Yes! 123 They each have O.B. from $2 mil. of the new debt + $500K of old debt from D 124

63 Pre-Distribution Balance Sheet After $4 mil. is borrowed Assets Tax Basis FMV O.B. Cash 4,000 4,000 Unst. Goodwill 0 10,000 Total Assets 4,000 14,000 NR Debt 2,000 2,000 New Rec. Debt 4,000 4,000 Capital: Ann (25%) <500> 2,000 2,000 Bo (25%) <500> 2,000 2,000 D (50%) <1,000> 4,000 0 Debt + Capital 4,000 14, Debit: $5 mil. Guar. Pyt. (deduction allocated to A and B) Credit: $4 mil. Cash $1 mil. D s Cap. 126

64 Post-Liquidation Assets Tax FMV (In Thousands) Basis Goodwill 0 10,000 Total Assets 0 10,000 O.B. Old NR Debt 2,000 2,000 New Debt 4,000 4,000 Capital: Ann <3,000> 2,000 0 Bo <3,000> 2,000 0 Debt +Capital 0 10, Modification of Prior Example Same as above except the PSP agreement states that the $5 mil. is all for PSP goodwill 128

65 The $5 mil. liquidating distribution is a section 736(b) payment thus all sec. 731(a)(1) capital gain to D. (no SE tax) 129 Because the PSP makes a sec. 754 election, D s 731(a)(1) gain increases the common balance sheet basis in the goodwill 130

66 Pre-Distribution Balance Sheet After $4 mil. is borrowed Assets Tax Basis FMV O.B. Cash 4,000 4,000 Unst. Goodwill 0 10,000 Total Assets 4,000 14,000 NR Debt 2,000 2,000 New Rec. Debt 4,000 4,000 Capital: Ann (25%) <500> 2,000 2,000 Bo (25%) <500> 2,000 2,000 D (50%) <1,000> 4,000 0 Debt + Capital 4,000 14, Debit: $ 5 mil. Goodwill (15 Year Amortization) Credit: $4 mil. Cash $1 mil. D s Cap. 132

67 Assets (In Thousands) Tax Basis FMV Goodwill 5,000 10,000 Total Assets 0 10,000 Old NR Debt 2,000 2,000 New Debt 4,000 4,000 Capital: Post-Liquidation O.B. Ann <500> 2,000 2,500 Bo <500> 2,000 2,500 Debt +Capital 0 10, The partners were free to agree that goodwill was $4 mil., $3 mil, $1 mil., etc. 134

68 Generally, the valuation placed upon good will by an arm's length agreement of the partners, whether specific in amount or determined by a formula, shall be regarded as correct. (Reg (b)(3)) 135 Modification of Original Buy-Out Example Where D dies 136

69 D dies, and C inherits and then C is redeemed for $5 mil. per the pre-existing buy-out agreement (funded with debt) 137 The partnership agreement declares that the $5 mil. liquidation payment is a section 736(a) payment and that goodwill is zero. 138

70 The continuing partners want the entire $5 mil. to be a deductible guaranteed payment 139 No Sec. 754 Election 140

71 Despite the absence of a section 754 election, C s O.B. is stepped up to $5 mil. 141 Pre-Liquidation Balance Sheet Assets Tax FMV O.B. (In Thousands) Basis Unst. Goodwill 0 10,000 Total Assets 0 10,000 NR Debt 2,000 2,000 Capital: Ann (25%) <500> 2,000 0 Bo (25%) <500> 2,000 0 C (50%) <1,000> 4,000 5,000 Debt + Capital 0 10,

72 Beneficiary O.B. 16 FMV of PSP interest on DOD ( 1014(a)(1)) + Share of PSP debt ( 752/742) - Value of PSP interest attributable to IRD ( 1014(c)) (Reg ) 143 The adjustment to O.B. is controversial: One argument: Sec. 753 says that all section 736(a) payments are IRD, so no outside basis step up for the unstated goodwill. 144

73 Argument in Alice article: Sec. 736 is independent of the outside basis determination in sec. 742 and Goodwill (unlike say zero basis accounts receivable) is not an IRD asset so DOD FMV is not reduced under sec Therefore, per Alice article, C s O.B. is $5 mil. (no 743(b) adjustment because no 754 election) 146

74 A $5 mil. liquidating distribution is a section 736(a) guaranteed payment (O.I.+ SE tax) to C. Deductible by the PSP 147 Pre-Distribution Balance Sheet After $4 mil. is borrowed Assets Tax Basis FMV O.B. Cash 4,000 4,000 Unst. Goodwill 0 10,000 Total Assets 4,000 14,000 NR Debt 2,000 2,000 New Rec. Debt 4,000 4,000 Capital: Ann (25%) <500> 2,000 2,000 Bo (25%) <500> 2,000 2,000 D (50%) <1,000> 4,000 5,000 Debt + Capital 4,000 14,

75 Debit: $5 mil. Guar. Pyt. (deduction allocated to A and B) Credit: $4 mil. Cash $1 mil. D s Cap. 149 Post-Liquidation Assets Tax FMV (In Thousands) Basis Goodwill 0 10,000 Total Assets 0 10,000 O.B. Old NR Debt 2,000 2,000 New Debt 4,000 4,000 Capital: Ann <3,000> 2,000 0 Bo <3,000> 2,000 0 Debt +Capital 0 10,

76 Any other tax consequence for C? Recall that C s preredemption O.B. was $5 mil. so C has a sec. 731(a)(2) loss of $5 mil. 151 Summary of C s tax consequences: $5 mil. ordinary income <$5 mil. > capital loss 152

77 Any additional impact on the PSP? 153 The partnership must make a mandatory sec. 734 downward adjustment to partnership capital gain property of <$5 mil.> when acquired. (mandatory because sec. 731(a) loss exceeds 250K) 154

78 Post-Liquidation Assets Tax FMV (In Thousands) Basis Goodwill 0 10,000 Total Assets 0 10,000 O.B. Old NR Debt 2,000 2,000 New Debt 4,000 4,000 Capital: Ann <3,000> 2,000 0 Bo <3,000> 2,000 0 Debt +Capital 0 10, Post-Liquidation Assets Tax FMV (In Thousands) Basis Goodwill 0 10,000 Total Assets 0 10,000 Subject to downward O.B. Old NR Debt 2,000 2,000 adjustment to basis of New Debt 4,000 4,000 Capital: <$5 mil.> Ann for newly <3,000> acquired 2,000 0 Bo <3,000> 2,000 0 capital gain property Debt +Capital 0 10,

79 Modified Example Same as prior Example but the PSP makes a section 754 Election Like Example 14 on page Pre-Liquidation Balance Sheet Assets Tax FMV O.B. (In Thousands) Basis Unst. Goodwill 0 10,000 Total Assets 0 10,000 NR Debt 2,000 2,000 Capital: Ann (25%) <500> 2,000 0 Bo (25%) <500> 2,000 0 C (50%) <1,000> 4,000 5,000 Debt + Capital 0 10,

80 First, C would be eligible for a $5,000, (b) adjustment ($5 million (O.B.) - $0 (I.B.) ) Arguably, sec. 743 and 755 are also independent of 736 so no IRD. 159 The 743(b) adjustment would all be allocated to the goodwill - $5 mil. amortizable basis (sec. 755 residual method). 160

81 Regardless, based upon Tolmach, the liquidating payment is still a section 736(a) payment 161 The $5 mil. fixed section 736(a) payment is a guaranteed payment (O.I.+ SE tax) to C. 162

82 Summary of C s tax consequences: $5 mil. ordinary income <$5 mil. > capital loss 163 The $5 mil. guaranteed payment is deductible by the partnership (net loss of <$5 mil.>). 164

83 Because C has an unused 743(b) adjustment of $5 mil., it shifts to the common balance sheet (sec. 734 regs.) 165 Offset By 166

84 The partnership must make a mandatory sec. 734 downward adjustment to partnership capital gain property (the goodwill) of <$5 mil.> (mandatory because C s sec. 731(a) loss exceeds 250K) 167 Post-Liquidation Assets Tax FMV (In Thousands) Basis Goodwill 0 10,000 Total Assets 0 10,000 O.B. Old NR Debt 2,000 2,000 New Debt 4,000 4,000 Capital: Ann <3,000> 2,000 0 Bo <3,000> 2,000 0 Debt +Capital 0 10,

85 The section 754 election is clearly a better deal for the continuing partners 169 Section 732(d) Unilateral sec. 743(b) adj. on narrow facts (common with PTPs) 170

86 Ex. 17, but using 94 sec recapture instead of zero basis A/R (no material difference) 171 Pre-Liquid. Balance Sheet (In Thousands) Tax Basis FMV Cash 2,000 2, Recapture 0 2,000 Total Assets 2,000 4,000 O.B. John (50%) 1,000 2,000 2,000 Jill (25%) 500 1, Jane (25%) 500 1, Debt + Capital 2,000 4,000

87 The partnership is not a service partnership 173 John, who recently purchased his interest, is liquidated within 2 years of purchase, for $2 mil. cash. 174

88 The partnership does not make a section 754 election. 175 Pre-Liquid. Balance Sheet (In Thousands) Tax Basis FMV Cash 2,000 2, Recapture 0 2,000 Total Assets 2,000 4,000 O.B. John (50%) 1,000 2,000 2,000 Jill (25%) 500 1, Jane (25%) 500 1, Debt + Capital 2,000 4,000

89 Due to the absence of a section 754 election, it appears that John has sec. 751(b) hot asset ordinary inc. of $1 mil. 177 If we ignore section 751(b), the entire $2 mil. distribution is a sec. 736(b) payment that is a tax-free recovery of John s $2 mil. O.B. 178

90 But sec. 751(b) causes John to recognize $1 mil. of O.I. for the fictionally distributed and sold hot asset. Unless John makes a section 732(d) election! 179 John can unilaterally elect section 732(d) and thus eliminate the section 751(b) gain by creating a $1 mil. sec. 743 adjustment on the hot asset. 180