Death of a Partner Death of a Partner 17-3

Transcription

1 Death of a Partner 17-2 Tax year closes with respect to deceased partner (not Php). Passive losses may be deducted on final return (reduced by basis step-up). Decedent s IRC sec. 743(b) adjustment disappears at death but beneficiary is entitled to a 743(b) adjustment. Death of a Partner 17-3 Successor s outside basis: FMV of Php. Interest + Debt Share - IRD No deemed termination (IRC sec. 708(b)(1)(B)) on death of a partner because not a sale or exchange.

2 IRC sec. 754 election. Inside basis steps up or down. Mandatory downward IRC sec. 743 adjustment if: Php. asset I.B. > Php asset FMV by > $250,000 No IRC sec. 743 Adj. for IRD Example

3 Example Able Dies in Year 11 Able, Baker, Cindy, and Donna, form the ABCD limited partnership. Able and Baker each contributed $90,000 for a 30% general partnership interest. Cindy and Donna each contributed $60,000 for a 20% limited partnership interest.

4 The agreement contains a gain chargeback provision that allocates gain on the sale of depreciable property to the partners to the extent of the prior allocations of cost recovery deductions. Otherwise, profits and losses are allocated 30%, 30%, 20%, 20% to Able, Baker, Cindy, and Donna respectively. Immediately after formation, the partnership borrowed $600,000, recourse debt, and used the entire $600,000 to purchase a building (on leased land). For simplicity, the building is depreciated over 10 years at $60,000 per year.

5 The recourse debt was allocated $300,000 to Able and $300,000 to Baker (the general partners). None of the debt principal is due until Year 12. The partnership does not make an IRC sec. 754 election. Each year for the first ten years, other than depreciation, the income and expenses were equal; therefore, the partnership lost <$60,000> each year.

6 By the end of year ten, the <$600,000> total losses (all attributed to depreciation) allocated to each partner over the ten year period is: <$240,000> Able (GP) <$240,000> Baker (GP) <$60,000> Cindy (LP) <$60,000> Donna (LP) Note: The LPs capital accounts cannot go negative so Cindy and Donna s losses could not exceed $60,000 each. End of Year 10: 17-6 ABCD Partnership O.B. Tax Basis FMV Cash $300,000 $300,000 Building Cost $600,000 Accum. Depr -$600,000 = Building Adj. Basis $0 $600,000 Total Assets $300,000 $900,000 Recourse Debt $600,000 $600,000 Able (30% GP) <$150,000> $90,000 $150,000 (all debt) Baker (30% GP) <$150,000> $90,000 $150,000 (all debt) Cindy (20% LP) $0 $60,000 $0 Donna (20% LP) $0 $60,000 $0 Total Debt + Capital $300,000 $900,000

7 Year 11, Able Dies Estate s $390,000 Outside Basis: $90,000 FMV of 30% GP Interest. + $300,000 Debt Share - $0 IRD $390,000 Outside Basis No IRC sec. 754 Election: No IRC sec. 743(b) Adjustment

8 With an IRC sec. 754 Election: With IRC sec. 754 Election, $240,000 IRC sec. 743(b) Adjustment: $390,000 Estate s O.B. - $150,000 Estate s I.B.* $240,000 Upward Adj. *<150,000> PTC + $300,000 (Debt Share)

9 Estate/beneficiary will be allocated MACRS depreciation on the $240,000 as if newly placed in service Estate/beneficiary should note the $240,000 adjustment for future years to calculate O.B. using alternate rule.

10 If the Estate/beneficiary is liquidated with a cash distribution of $90,000, any gain? No gain or loss. The estate s amount realized of $390,000 equals the estates outside basis. The Estate s unused $240,000 IRC sec. 743(b) adjustment shifts to the common balance sheet for the continuing partners!

11 With 50% Estate Tax Discount in FMV of Partnership Interest 17-7 Year 11, Able Dies Estate s $345,000 Outside Basis: $45,000 $90,000 x 50% (discount) + $300,000 Debt Share - $0 IRD $345,000 Outside Basis

12 With IRC sec. 754 Election, $195,000 IRC sec. 743(b) Adjustment: $345,000 Estate s O.B. - $150,000 Estate s I.B.* $195,000 Upward Adj. *<150,000> PTC + $300,000 (Debt Share) Estate/beneficiary will be allocated MACRS depreciation on the $195,000 as if newly placed in service

13 17-7 Sale (cap gain except 751(a)) v. Liquidation of Decedent s Successor (invokes IRC sec. 736) Sale 17-7 Per Buy-Sell Agreement

14 Example Partnership liquidates successor for $90,000 After Able s Death (pre-liquidation) ABCD Partnership O.B. Tax Basis FMV Cash $300,000 $300,000 Building Cost $600,000 Accum. Depr -$600,000 = Building Adj. Basis $0 $600,000 Total Assets $300,000 $900,000 Recourse Debt $600,000 $600,000 Estate (30% GP) <$150,000> $90,000 $390,000 Baker (30% GP) <$150,000> $90,000 $150,000 (all debt) Cindy (20% LP) $0 $60,000 $0 Donna (20% LP) $0 $60,000 $0 Total Debt + Capital $300,000 $900,000

15 Impact of Liquidation on Estate: $90,000 Cash + $300,000 Deemed Cash - $390,000 Pre-distribution O.B. $ 0 Gain or Loss (IRC sec. 731) After Liquidation of Able s Estate With IRC sec. 754 Election ABCD Partnership Tax Basis Sch. L Tax Basis FMV Cash $210,000 $210,000 Building Cost $600,000 Accum. Depr -$600,000 = Building Adj. Basis $240,000 $600,000 Total Assets $450,000 $810,000 Estate s 743(b) adjustment shifts to the common balance sheet

16 After Liquidation of Able s Estate Without IRC sec. 754 Election ABCD Partnership Tax Basis Sch. L Tax Basis FMV Cash $210,000 $210,000 Building Cost $600,000 Accum. Depr -$600,000 = Building Adj. Basis $0 $600,000 Total Assets $210,000 $810,000 Compare if the building instead were depreciable personal property and all gain is IRC sec recapture. Without IRC sec. 754 election, ordinary income to estate of $240,000 (and capital loss <$240,000>) per IRC sec. 751(b). But don t miss the IRC sec. 732(d) election which eliminates the IRC sec. 751 exchange. 32

17 17-9 Example 17-4 Other Partner (Baker) buys out successor for $90,000 Estate s Sale to Baker Amount Realized: Cash $90,000 Debt Relief $300,000 Total Amt. Realized $390,000 Outside Basis: Equity $90,000 Debt $300,000 Total Outside Basis -$390,000 Pre-look-through Gain $0

18 Without IRC sec. 754 Election: Estate s capital gain or loss: = Pre-look-through capital gain $0 - Estate s share of section 1250 capital gain = Estate s Residual Long-term capital gain of <loss> -$ 240,000 $240,000 <$240,000> With IRC sec. 754 Election no Sec capital gain Compare if IRC sec Prop. Without IRC sec. 754 Election: B s IRC Sec. 751 Ordinary Income: B s share of Unrealized Rec. $240,000

19 Compare if IRC sec Prop. Without IRC sec. 754 Election: B s IRC Sec. 751 Ord. Income: B s share of Unrealized Rec. $240,000 B s capital gain or loss: Gain realized w/o IRC sec. 751 $0 - IRC sec. 751 Ordinary Inc. - $240,000 Capital gain or <loss> <$240,000> Need a 754 Election; No IRC sec. 732(d) relief is available. Discourage sale. Unique Impact of IRC sec. 754 Election on Successor of Deceased Partner

20 Tax Year of successor closes on liquidation. Successor remains a partner until fully liquidated. IRC sec. 754 election can eliminate unstated goodwill due to IRC sec. 743(b) inside basis increase. Issue: IRC sec. 753 declares that IRC sec. 736(a) payments are IRD (and 1014 denies a basis step up for IRD). If payments for unstated goodwill fall within 736(a), then they are IRD, and clearly no basis step-up for those payments.

21 Agreed, but I argue that the IRC sec. 743(b) inside step-up occurs before the IRC sec. 736(a) payment is established. First: O.B. is increased to DOD FMV and reduced by IRD on Php IRD assets (goodwill is not an IRD asset). Second: Inside basis is adjusted for non-ird assets such as goodwill. Third: Payments are characterized under IRC sec. 736(a) vs. (b) Additional Examples

22 Example 17-5 Stated Goodwill Without IRC sec. 754 Election A personal service partnership 43 Decedent Alice s interest is liquidated for $500,000 per buy out agreement

23 Step One Estate O.B. The Estate s outside basis is $475,000: $500,000 (DOD FMV) minus $25,000 (estate s share of IRD). In my opinion, the estate s outside basis would be the same even if the liquidating payments were for unstated goodwill (not an IRD Pshp. asset). 45 Step Two Sec. 736(a) The $25,000 payment for the unrealized receivables (zero basis trade receivables) for services is a Sec. 736(a) guaranteed payment to the Estate: $25,000 ordinary income to Estate $25,000 deduction to partnership 46

24 Step Three Sec. 751 Exchange $500,000 (total payment) - $ 25,000 Sec. 736(a) payment = $ 475,000 Sec. 736(b) payment $30,000 is disproportionately too much non-751 assets; therefore, the Estate s share of Sec 1245 recapture, $30,000, is deemed sold to the partnership for the $30,000 cash. 47 A Sec. 732(d) election is made; therefore, the Estate has a $30,000 inside basis in the Sec 1245 recapture: no gain!48

25 Step Four The Remaining Actual Distribution $500,000 (total payment) - $ 25,000 Sec. 736(a) payment - $ 30,000 Sec. 751(b) sales proceeds = $ 445,000 Remaining Proportionate Cash Distribution Tax free because the remaining outside basis is also $445,000 (next slide) 49 Estate s Pre-Distribution Outside Basis: $500,000 DOD FMV - $ 25,000 IRD on unrealized receivables - $ 30,000 Estate s inside basis in the Sec 1245 property fictionally distributed under Sec 751(b) = $ 445,000 Remaining Outside Basis 50

26 17-17 Example 17-6 Same as Ex With Sec. 754 Election 51

27 Step One Estate O.B. and Inside Basis The Estate s outside basis is $475,000: $ 500,000 DOD FMV - $ 25,000 estate s share of IRD =$ 475,000 Outside basis The Estate s share of inside basis is $170,000. Sec. 743(b) adjustment = 305,000 ($475, ,000). 53 Step One Sec. 755 Allocation of $305,000 Sec 743(b) Adjustment $275,000--goodwill $30,000--Sec recapture 54

28 Step Two Sec. 736(a) The $25,000 payment for the unrealized receivables for services is a Sec. 736(a) guaranteed payment to the Estate: $25,000 ordinary income to Estate $25,000 deduction to partnership 55 Step Three Sec. 751 Exchange $500,000 (total payment) - $ 25,000 Sec. 736(a) payment = $ 475,000 Sec. 736(b) payment $30,000 is disproportionately too much non-751 assets; therefore, the Estate s share of Sec 1245 recapture, $30,000, is deemed sold to the partnership for the $30,000 cash. 56

29 Due to the Sec. 754 election, the Estate has a $30,000 inside basis in the Sec 1245 recapture: no gain! 57 Step Four The Remaining Actual Distribution $500,000 (total payment) - $ 25,000 Sec. 736(a) payment - $ 30,000 Sec. 751(b) sales proceeds = $ 445,000 Remaining Proportionate Cash Distribution Tax free because the remaining outside basis is also $445,000 58

30 Partnership Common Adjustment: Because the estate cannot use the $275,000 Sec 743(b) adjustment for the goodwill (it remains inside the partnership), Reg (b) allows the partnership to make an adjustment to the common inside basis in the goodwill up $275,000 (and amortizable over 15 years). The continuing partners benefit from the Sec. 754 election Example 17-7 Liquidation where only non-cash asset is IRD Decedent Alice s interest is liquidated for $1,000,000 per buy out agreement with IRC sec. 754 election 60

31 Step One Estate O.B. and Inside Basis The Estate s outside basis is $250,000: $ 1,000,000 DOD FMV - $ 750,000 estate s share of IRD =$ 250,000 Outside basis The Sec. 754 election is irrelevant to the Estate because the only asset is IRD no inside basis adjustment. 62

32 Step Two Sec. 736(a) None Step Three Sec. 751 Exchange None 63 Step Four The Remaining Actual Distribution $ 1,000,000 (total payment) - $ 250,000 (pre-distribution outside basis) = $ 750,000 Sec. 731(a)(1) capital gain The Sec. 754 election allows the continuing partners to make an upward adjustment to the basis in capital gain property by $750,000. The Sec. 754 election benefits the continuing partners. 64

33 17-18 Example 17-8 Impact of Real Estate Bubble on Liquidation Without IRC Sec. 754 Election 65 Before Bill s Death

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35 Alice: Without Section 754 Election $1,500,000 Capital Loss (Sec 731(a)(2)) ($900,000 (payment) - $2,400,000 (outside basis)) Partnership: $1,500,000 Reduction to inside basis of capital gain property (Sec 734(b)(2)(A)) Mandatory Per 2004 Act 69

36 Subsequent Sale of Land for $1,600,000 (basis $100,000): Gain of $1,500,000 ($750,000 per partner). 71

37 17-21 Example 17-9 Purchase Compared to Liquidation Still no Sec. 754 election. 73 Balance Sheet on Date of Sale: Alice s outside basis is $2,400,000:

38 Impact of Sale: Alice: $1,500,000 Capital Loss (Sec 741) ($900,000 (sales price) - $2,400,000 (outside basis)) Carol and Dinah Each partner s outside basis increases by the purchase price ($450,000 each). 75 Example Sec. 754 election on Bill s death rescues the continuing partners following Alice s death (and the liquidation of Alice s estate)

39 Before Bill s Death Alice: With Section 754 Election $1,500,000 Capital Loss (Sec 731(a)(2)) ($900,000 - $2,400,000) Partnership: $1,500,000 Reduction to inside basis of capital gain property (Sec 734(b)(2)(A)) $1,500,000 increase in inside basis of capital assets for Alice s unused Sec 743(b) adjustment in the land. 78