Chapter 16. Distributions Treated As Section 751(b) Exchanges

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1 Chapter 16 Distributions Treated As Section 751(b) Exchanges Receipt of Excess Cold Assets 1)If Excess Cold Assets Are Distributed: then the partnership is treated as if it made a hypothetical distribution of the partner's proportionate share of Hot assets followed by a fictional sale of these Hot assets by the partner back to the partnership at fair market value in exchange for the excess Cold assets actually received in the distribution. 2

2 Receipt of Excess Hot Assets 2) If Excess Hot Assets Are Distributed: then the partnership is treated as if it made a hypothetical distribution of the partner's proportionate share of Cold assets followed by a fictional sale of these Cold assets by the partner back to the partnership at fair market value in exchange for the excess Hot assets actually received in the distribution. 3 Example

3 Example 16-1 Jack and Jill Liquidate JJ Partnership Assets Tax Basis FMV Cash To Jack $100, ,000 Accts. Rec. To Jill $0 100,000 Inventory To Jill $40, ,000 Land To Jack $60,000 $100,000 Totals $200,000 $400,000 5 Example

4 Four Steps Step One: Determine the Deemed Distribution a current distribution. Step Two: The Deemed Exchange by the Distributee Partner 7 Step Three: The Deemed Exchange by the Partnership Step Four: The Remaining Proportionate Distribution (current or liquidating). 8

5 Example Partners agree that the inventory is fictionally distributed to Jack in exchange for cash. 9 Jack (excess cold assets): Fictional dist of inventory reduces Jack s O.B. by $40K (to $60K). $60K of O.I. on fictional sale of inventory in exchange for cash. (IRC sec. 751(b)) Jack s basis in the land is $60K (731 and 732) 10

6 Jill (excess hot assets): Fictional dist of cash reduces Jill s O.B. by $100K (to $0). $0 income on fictional purchase of inventory for cash. (IRC sec. 751(b)) Jill s basis in the inventory is $100,000 and A/R is zero. 11 Example 16-3 Not a Service Partnership 16-6 ABC Partnership ABC Partnership January 1, 2005 Partner's Basis FMV Outside Cash $ 26,000 $ 26,000 Basis Accounts Receivable $ - $ 26,000 Total Assets $ 26,000 $ 52,000 Agnes (50%) $ 13,000 $ 26,000 $ 13,000 Bob (25%) $ 6,500 $ 13,000 $ 6,500 Cao (25%) $ 6,500 $ 13,000 $ 6,500 Total Equity $ 26,000 $ 52,000 Four Steps Illustrated 12

7 Example 16-3 $26,000 Cash to Agnes Not a Service Php. So No IRC sec. 736(a) Pyt. 13 Example 16-4 Not a Service Php All A/R to Agnes 16-7 Even if a Service Php. IRC sec. 736(a) is not triggered. 14

8 Disproportionate 16-8 Liquidating Payments to Retiring Partner or Deceased Partner s Successor under IRC sec Example Partner X is liquidated for $25,000 cash (not a service php) 16

9 Example Basis Value Cash $25,000 $25,000 Inventory 15,000 25,000 Land 8,000 25,000 TOTAL $48,000 $75,000 Capital Accounts Partner X $16,000 $25,000 Partner Y 16,000 25,000 Partner Z 16,000 25,000 TOTAL $48,000 $75, Step One: Fictional distribution of $8,333 of inventory (1/3 of inventory) with basis of $5,000 to Ptr X; reduce X s O.B. by $5,000 Step Two: Fictional sale of the inventory in exchange for $8,333 of cash result is O.I. of $3,333. Step Three: Partnership purchases of inventory in fictional exchange. 18

10 Example X s Interest X s Interest Actual Before After Distribution Distribution Distribution FMV of Partnership Assets Fictional Proportionate Distribution 2 3 = 4 Difference 5 4 = 6 Hot Assets: Inventory $25,000 $8,333 $0 $8,333 $0 ($8,333) Cold Assets: Cash $25,000 $8,333 $0 $8,333 $25,000 $16,667 Land $25,000 $8,333 $0 $8,333 $0 ($8,333) Net $8, Step Four: Remaining proportionate distribution to X of $16,667 ($25,000 - $8,333). $11, X s pre-step Four O.B. ($16,000 (Beg.) - $5,000 (Step One)). $5,667 of Capital Gain (Sec. 731) ($16,667 - $11,000) 20

11 Summary of Tax Consequences to Partner X: Ordinary income of $3,333 on the deemed exchange. Capital gain of $5,667 on the proportionate distribution of money. 21 Tax Consequences to Partnership/Continuing Partners: The partnership increases its inside basis in the inventory by $3,333. If a Sec. 754 election were in effect, then the Partnership would increase the inside basis in the Land by $5,667 Partner X s Sec. 731(a)(1) gain. 22

12 Reporting Section 751(b) Exchanges Partner Reporting

13 Distributee Partner Reporting A statement setting forth separately the following information: The date of the sale or exchange; The amount of any gain or loss attributable to the section 751 property [Step Two]; and The amount of any gain or loss attributable to capital gain or loss on the sale of the partnership interest. Reg. sec (a)(3). [Step Four] 16-12

14 The distributee partner shall submit with the partner s return a statement showing the computation of any income, gain, or loss to the partner Partnership Reporting

15 Partnership Reporting A partnership which distributes [disproportionately] shall submit with its return for the year of the distribution a statement showing the computation of any income, gain, or loss to the partnership under the provisions of section 751(b) Partnership Similar Reporting A statement setting forth separately the following information: The date of the sale or exchange; The amount of any gain or loss attributable to the section 751 property [Step Three]; and 16-12