General Rule Capital Gain or Loss Sec. 741 12-3 1 General rule: a sale by a partner generates capital gain or loss. Exception for seller s share of partnership hot asset gains or losses. Same for: Sale to third party Sale to an existing partner. Example 12-1 Sale L sells a limited partnership interest to M. 12-4 Example 12-1 12-4 Amount Realized: Cash From Buyer $10,000 Debt Relief $15,000 Total Amount Realized $25,000 L s outside basis is $20,000 ($15,000 is debt share) M pays $10,000 and assumes L s $15,000 share of debt. Outside Basis: Tax Basis Cap Acct..$5,000 Debt $15,000 Outside Basis. 20,000 Gain Recognized $ 5,000
Example 12-2 Facts 12-4 B gives B s limited partnership interest to charity and the charity takes over B s $9,000 debt share. $9,000 B s outside basis $27,000 B s share of FMV of Php assets $18,000 B s charity deduction Amount Realized: Cash From Charity $0 Debt Relief $9,000 Total Amount Realized $9,000 Can we use B s entire outside basis of $9,000 to compute the sale gain? With a bargain sale to charity the outside basis of the portion sold is: Outside Amount Realized Basis x -------------------------- Fair Market Value Outside basis of the portion sold is: $9,000 $9,000 x ----------- = $3,000 $27,000 ($18,000 + $9,000)
Amount Realized: Cash From Charity $0 Debt Relief $9,000 Total Amount Realized $9,000 Outside Basis: Sec. 1011(b) Basis (33.33%) $3,000 Gain Recognized $6,000 Example 12-3 Facts Same as Ex. 12-2, except the gift is to B s daughter. 12-5 With a bargain sale to an individual, the entire donor basis is allowed to offset the sales price Amount Realized: Cash From Donee $0 Debt Relief $9,000 Total Amount Realized $9,000 Outside Basis: Sec. 1011(b) Basis (100%) $9,000 Gain Recognized $0
12-6 What if prior losses had reduced B s outside basis to zero? $9,000 Gain on Gift Amount Realized: Cash From Donee $0 Debt Relief $9,000 Total Amount Realized $9,000 Outside Basis: Sec. 1011(b) Basis (100%) $0 Gain Recognized $9,000 Example 12-4 Facts Php. P is in a Grantor Trust T: $20,000 T s capital contrib. to P $10,000 T s share of P debt <$29,000> T s share of P s losses. $1,000 outside basis Bargain sale By Grantor To Trust Grantor renounces a power that causes the trust to cease to be a grantor trust (completed gift for income tax purposes).
12-7 Amount Realized: Cash From Trust. $0 Debt Relief $10,000 Total Amount Realized $10,000 Outside Basis: Equity ($20,000 - $20,000) Debt ($10,000 - $9,000) -$1,000 Gain Recognized $9,000 Determination of Partner s Outside Basis Reg. 1.705-1 18 Increases to Outside Basis 12-8 Taxable Income Tax Exempt Income Depletion over basis 19 Decreases to Outside Basis <Distributions> <Losses> <Nondeductible expenditures not capitalized> 20
12-9 Alternate Rule to Determine Outside Basis. Partner s Tax Basis Equity + Partner s Share of Debt +/- Adjustment if necessary = Alternate Rule Outside Basis Reg. 1.705-1(b) 21 22 Example 12-5 ABC Php. Assets Tax Basis Cash $1,000 Depreciable Assets $2,000 Total Assets $3,000 Partner s Outside Basis Capital A $1,000? B $1,000? C $1,000? Total Capital $3,000 12-9 Partner s Outside Basis Assets Tax Basis Cash $1,000 Depreciable Assets $2,000 Total Assets $3,000 Capital A $1,000 $1,000 B $1,000 $1,000 C $1,000 $1,000 Total Capital $3,000 12-92
Example 12-6 A sells to D What is D s O.B.? 12-10 25 Before Sale by A to D for $1,250: BCD Partnership Balance Sheet Partner s Outside Basis Assets Tax Basis FMV Cash $750 $750 Depreciable Assets $1,500 $3,000 Total Assets $2,250 $3,750 Capital B $750 $1,250 $750 C $750 $1,250 $750 A $750 $1,250 $750 Total Capital $1,500 $1,500 26 A s gain on sale $1,250 Selling Price $ 750 A s outside basis $ 500 A s gain on Sale After Sale by A to D for $1,250: BCD Partnership Balance Sheet Assets Tax Basis FMV Cash $750 $750 Depreciable Assets $1,500 $3,000 Total Assets $2,250 $3,750 Capital B $750 $1,250 $750 C $750 $1,250 $750 D $750 $1,250? Partner s O.B. 27 Total Capital $1,500 $1,500 28
BCD Partnership Balance Sheet Partner s O.B. Assets Tax Basis FMV Cash $750 $750 12-11 Depreciable Assets $1,500 $3,000 Total Assets $2,250 $3,750 Capital B $750 $1,250 $750 C $750 $1,250 $750 D $750 $1,250 $1,250 ($750 + $500 adj.) Total Capital $1,500 $1,500 29 D s Alternate Rule Beginning Outside Basis: $ 750 Beg. I.B. + $ 500 Adj. = $ 1,250 30 Example 12-7 12-11 BCD Partnership Balance Sheet Partner s O.B. 10 Years Later, D Plans to Sell Her Partnership Interest What is her outside basis using the alternate rule Assets Tax Basis FMV Cash $3,000 $3,000 Accounts Receivable $4,000 $4,000 Depreciable Assets $5,000 $5,000 Investment Land $18,000 $30,000 Total Assets $30,000 $42,000 Debt $6,000 $6,000 Capital B $8,000 $12,000 $10,000 C $8,000 $12,000 $10,000 D $8,000 $12,000? Debt + Capital $30,000 $42,000 32
What is D s Outside Basis? BCD Partnership Balance Sheet Partner s O.B. 12-11 Assets Tax Basis FMV Cash $3,000 $3,000 Accounts Receivable $4,000 $4,000 Depreciable Assets $5,000 $5,000 Investment Land $18,000 $30,000 Total Assets $30,000 $42,000 Debt $6,000 $6,000 Capital B $8,000 $12,000 $10,000 C $8,000 $12,000 $10,000 D $8,000 $12,000 $10,500 ($10,000 + $500 adj.) Debt + Capital $30,000 $42,000 33 Alternate Rule: $8,000 Cap. basis + $2,000 Debt + $ 500 Adjustment =$10,500 D s O.B. 34 12-12 IRC sec. 751(a) Section 751 Treatment Gain or Loss Attributable 35 Sales proceeds are first allocated to the seller s share of gain or loss on hot assets. Hot assets= Unrealized receivables + Inventory Items
The balance is gain or loss from the sale of a capital asset. Unrealized Receivables 12-12 Right to payment for Goods delivered or to be delivered (not a capital asset). Services rendered or to be rendered. Recapture items 12-13 Inventory Items 12-13 1) Stock in trade or inventory 2) Property other than: Capital assets IRC sec. 1231 Assets 3) Property which would, if held by the selling partner, be an inventory item. Need not be substantially appreciated Calculation of Capital Gain or Loss with Hot Assets Realized Gain or loss Without IRC sec. 751 12-14 - Recognized gain or loss on share of hot assets if sold by the partnership. = Recognized capital gain or loss
Example 12-8 12-15 A and B are equal partners in personal service partnership PRS. B sells to T for $15,000 when PRS's balance sheet is as follows (next slide): Tax Basis FMV Outside Assets: Basis Cash $3,000 $3,000 Loan Rec. $10,000 $10,000 Capital. Assets 7,000 5,000 Unrealized Rec. 0 $14,000 Total Assets $20,000 $32,000 Liabilities: $2,000 $2,000 Capital: A $9,000 $15,000 $10,000 B $9,000 $15,000 $10,000 Debt + Equity $20,000 $32,000 43 Step One 12-16 Example 12-8 Capital Gain Absent IRC sec. 751: Cash from T $15,000 Debt Relief $1,000 Total Amt. Realized $16,000 Outside Basis: Capital $9,000 Debt $1,000 Basis Allocated To Sale -$10,000 Gain Recognized w/o IRC sec. 751 $6,000
Step Two Step Three 12-16 B s IRC Sec. 751 Ordinary Income: B s share of Unrealized Rec. $7,000 B s IRC Sec. 751 Ordinary Income: B s share of Unrealized Rec. $7,000 B s capital gain or loss: Gain realized w/o IRC sec. 751 $6,000 - IRC sec. 751 Ordinary Inc. - 7,000 Capital gain or <loss> <$1,000> B s IRC Sec. 751 Ordinary Income: B s share of Unrealized Rec. $7,000 B s capital gain or loss: Gain realized w/o IRC sec. 751 $6,000 - IRC sec. 751 Ordinary Inc. - 7,000 Capital gain or <loss> <$1,000> Gain realized w/o IRC sec. 751 $6,000 Summary of B s Tax Treatment: Ordinary Income = $7,000 Capital Loss = <$1,000>
Additional Examples Sale of Partnership Interest and Sec. 751(a) 12-17 Example 12-9 Sale with IRC sec. 751 Ordinary Income 49 50 Example 12-9 Sale The NOP Manufacturing Partnership is a calendar year cash basis partnership formed by Norma, Oppie, and Peter on January 1. 30% partner Norma contributes $3,000 30% partner Oppie contributes $3,000 40% partner Peter contributes $4,000 The partnership earns operating income of $100,000 per year every year. In year 2, the partnership purchases land for $110,000. 51 The partnership does not distribute any of its profits to the partners in years 1 and 2. NOP has no debt. At the beginning of year three the partnership assets consist of: Asset Inside Basis FMV Cash $100,000 $100,000 Land 110,000 210,000 A/R for services 0 $690,000 Total Assets $210,000 $1,000,000 52
January 1 of year three, Norma sells her interest for $300,000 to Jay (30% X 1,000,000 = $300,000) Amount Realized $300,000 Beginning Outside Basis $3,000 30% of Year 1 Income 30,000 30% of Year 2 Income 30,000 Norma s Outside Basis. < 63,000> Recognized Gain on Sale $ 237,000 53 Norma s Sec 751 Ordinary Income or Loss: A s Share of the U/R Ordinary Inc. 207,000 Norma s Capital Gain or Loss: Gain Realized W/0 Sec. 751 $237,000 - Share of the U/R Ordinary Inc. $207,000 = Capital Gain $30,000 Summary of Norma s Tax Treatment: Ordinary Income = $ 207,000 Capital Gain = $ 30,000 Example 12-10 Sale at a Discount Example 12-10 Same facts as example 12-9 except Norma sells her 30% interest to Jay at a minority interest discount of 50% of her share of the net asset value of the partnership interest; therefore, the sales price is $150,000 ($300,000 x 50%). 55 56
Amount Realized $150,000 Beginning Outside Basis $3,000 30% of Year 1 Income 30,000 30% of Year 2 Income 30,000 Norma s Outside Basis. < 63,000> Realized Gain on Sale $ 87,000 For purposes determining Sec 751(a) income, the value of the assets are determined at the partnership level regardless of the discount in the value of the partnership interest. 57 58 Norma s Sec 751 Ordinary Income or Loss: A s Share of the U/R Ordinary Inc. 207,000 Norma s Capital Gain or Loss: Gain Realized W/0 Sec. 751 $ 87,000 - Share of the U/R Ordinary Inc. $207,000 = Capital Loss <$120,000> Example 12-11 Sale By Buyer Summary of Norma s Tax Treatment: Ordinary Income = $ 207,000 Capital Loss = <$ 120,000> 60
Example 12-11 Return to Example 1-8. Jay purchased Norma s 30% interest for $300,000. Assume the partnership has not made a Sec 754 election. Jay s outside basis is $300,000 (cost), but Jay is not entitled to change his share of the inside basis in partnership assets. Shortly after Jay s purchase, he sells his partnership interest to Jenny for $300,000: $300,000 Amount Realized $300,000 Outside Basis $0 Gain/Loss Realized 61 62 Jay Sec 751 Ordinary Income or Loss: Jay s Ordinary Inc. 207,000 Jay s Capital Gain or Loss: Gain Realized W/o Sec. 751 $ 0 - Share of the U/R Ordinary Inc. $207,000 = Capital Loss <$207,000> Summary of Jay s Tax Treatment: Ordinary Income = $ 207,000 Capital Loss = <$ 207,000> A Sec 754 election (discussed in Ch. 2) would solve this problem for Jay by allowing him an upward adjustment to his share of the accounts receivable by $207,000 (per Sec. 743). Granted, a purchase and immediate sale are uncommon; however, a sale or liquidation immediately following an inheritance is common. 64
12-34 12-34 Self-Study Problem (5) 65 Alice sells to Debra for $100,000 66 12-34 Draft 2013 Form 1040 67 68
Draft 2013 Form 1040 $5,000 $20,000 Alice materially participates in ABCD 69 70 Partnership NIIIT Category One and Two Income 71 Category One Category Two Category Three Gross Investment Income (before deductions) Gross Income Interest, Dividends, Annuities, Royalties, and Rents that is: Nonbusiness (investment) Passive business income Trading business income Other Gross Income that is: Passive business income or Trading business income Net Gain from the disposition of property that is: Nonbusiness (invest. or personal) Passive business Trading business
Draft Draft Form 8960 Form 1040, Line 17 73 74 Draft 2013 Form 1040 Partnership NIIIT Category Three Investment Income 75 76
12-34 12-34 Alice sells to Debra for $100,000 77 78 Is any of Alice s $25,000 sale gain net investment income subject to the 3.8% NIIT in 2013? 79 Category One Category Two Category Three Gross Investment Income (before deductions) Gross Income Interest, Dividends, Annuities, Royalties, and Rents that is: Nonbusiness (investment) Passive business income Trading business income Other Gross Income that is: Passive business income or Trading business income Net Gain from the disposition of property that is: Nonbusiness (invest. or personal) Passive business Trading business
12-34 IRC Sec. 1411(c)(4): (4) Exception for certain active interests in partnerships and S corporations. In the case of a disposition of an interest in a partnership or S corporation (A) gain from such disposition shall be taken into account under clause (iii) of paragraph (1)(A) only to the extent of the net gain which would be so taken into account by the transferor if all property of the partnership or S corporation were sold for fair market value immediately before the disposition of such interest, and (B) a rule similar to the rule of subparagraph (A) shall apply to a loss from such disposition. Alice sells to Debra for $100,000 81 82 Prop. Reg. Category Three Formula for Sale of Partnership Interest: Prop. Reg. Category Three Formula for Sale of Partnership Interest: Chapter 1 Gain - Net inside gain or loss on chapter 2 nontaxable assets (the adjustment) = Category Three Investment Income 83 $25,000 Chapter 1 Gain - $25,000 Nontaxable inside gain = $ 0 Category Three II 1 $20,000 inventory gain + $25,000 goodwill gain (max. $25,000) 1 84
Draft Form 8960 Form 1040, Lines 13 + 14 $25,000 Adjustment -$25,000 $0 85 86 Draft 2013 Form 1040 $5,000 $20,000 87 Prop. Reg. Sec. 1.1411-7(d) Required statement of adjustment. Any transferor making an adjustment under paragraph (c) of this section must attach a statement to the transferor's return for the year of disposition. The statement must include-- (1) A description of the disposed-of interest; (2) The name and taxpayer identification number of the entity disposed of; (3) The fair market value of each property of the entity; (4) The entity's adjusted basis in each property; (5) The transferor's allocable share of gain or loss with respect to each property of the entity; (6) Information regarding whether the property was held in (or attributable to) a trade or business not described in 1.1411-5; (7) The amount of the net gain under 1.1411-4(a)(1)(iii) on the disposition of the interest; and (8)The computation of the adjustment under paragraph (c) of this 88 section.
If Alice does not materially participate, then her entire gain is NII under IRC sec. 1411 Draft Form 8960 Adjustment $25,000 0 $25,000 89 90 Same prior facts except the investment property has a basis of $80,000 and goodwill has a basis of $100,000 91 ABCD Balance Sheet Assets Tax Basis FMV Cash $100,000 $100,000 Inventory $20,000 $100,000 Investment asset $80,000 $100,000 Goodwill $100,000 $100,000 Total Assets $300,000 $400,000 Alice sells to Debra for $100,000 Partner s Outside Basis Capital Alice $75,000 $100,000 $75,000 Bob $75,000 $100,000 $75,000 Carol $75,000 $100,000 $75,000 Don $75,000 $100,000 $75,000 Total Capital $300,000 $400,000 92
Chapter 1 Income NIIT Chapter 2A Prop. Reg. Category Three Formula for Sale of Partnership Interest: $25,000 Chapter 1 Gain - $20,000 Nontaxable inside gain = $ 5,000 Category Three II 1 1 $20,000 inventory gain 93 94 Draft Form 8960 $25,000 Adjustment -$20,000 $5,000 95 96
Taxpayer friendly ordering rule in proposed regs. ABCD Balance Sheet Sale at a 5% Discount Assets Tax Basis FMV Cash $100,000 $100,000 Inventory $20,000 $100,000 Investment asset $80,000 $100,000 Goodwill $100,000 $100,000 Total Assets $300,000 $400,000 Partner s Outside Basis Capital Alice $75,000 $100,000 $75,000 Bob $75,000 $100,000 $75,000 Carol $75,000 $100,000 $75,000 Don $75,000 $100,000 $75,000 Total Capital $300,000 $400,000 97 Alice sells to Debra for $95,000 98 Chapter 1 Income Gain Realized without $20,000 ($95K - $75K) IRC sec. 751 Sec. 751 Ord. Inc. - $20,000 ($80,000 4) Capital Gain $ 0 IRC Sec. 1411(c)(4): (4) Exception for certain active interests in partnerships and S corporations. In the case of a disposition of an interest in a partnership or S corporation (A) gain from such disposition shall be taken into account under clause (iii) of paragraph (1)(A) only to the extent of the net gain which would be so taken into account by the transferor if all property of the partnership or S corporation were sold for fair market value immediately before the disposition of such interest, and 99 (B) a rule similar to the rule of subparagraph (A) shall apply to a loss from such disposition. 100
Category One Category Two Category Three Gross Investment Income (before deductions) Gross Income Interest, Dividends, Annuities, Royalties, and Rents that is: Nonbusiness (investment) Passive business income Trading business income Other Gross Income that is: Passive business income or Trading business income Net Gain from the disposition of property that is: Nonbusiness (invest. or personal) Passive business Trading business NIIT Chapter 2A Prop Reg. Category Three Formula for Sale of Partnership Interest: $20,000 Chapter 1 Gain - $20,000 Nontaxable inside gain = $ 0 Category Three II 1 $20,000 inventory gain 1 102 Draft Form 8960 $20,000 Adjustment -$20,000 $0 103 104
12-35 12-35 Self-Study Problem (6) 105 106 Chapter 1 Income Gain Realized W/0 751 $335,000 ($500,000 - $165,000) Chapter 1 Income Gain Realized W/0 751 $335,000 ($500,000 - $165,000) IRC sec. 751(a) Ordinary Income - $60,000 ($25,000 A/R and $35,000 1245 recapture) 107 108
Gain Realized W/0 751 $335,000 ($500,000 - $165,000) IRC sec. 751(a) Ordinary Income Chapter 1 Income Capital Gain = 275,000 - $60,000 ($25,000 A/R and $35,000 1245 recapture) 109 If the partnership collected the A/R the day after the sale, Debra would recognize ordinary income of $25,000 absent an IRC sec. 754 election. 110 6(c) 12-35 Chapter 1 Income Gain Realized W/0 751 $135,000 ($300,000 - $165,000) Same facts except Alice sells to Debra for $300,000 instead of $500,000 (a 40% discount) 111 112
Chapter 1 Income Gain Realized W/0 751 $135,000 ($300,000 - $165,000) Chapter 1 Income Gain Realized W/0 751 $135,000 ($300,000 - $165,000) IRC sec. 751(a) Ordinary Income - $60,000 ($25,000 A/R and $35,000 1245 recapture) IRC sec. 751(a) Ordinary Income Capital Gain = 75,000 - $60,000 ($25,000 A/R and $35,000 1245 recapture) 113 114 6(d) 12-36 Chapter 1 Income Gain Realized W/0 751 $435,000 ($600,000 - $165,000) Same facts except Alice sells to Debra for $600,000 instead of $500,000 (a $100,000 premium) 115 116
Chapter 1 Income Gain Realized W/0 751 $435,000 ($600,000 - $165,000) Chapter 1 Income Gain Realized W/0 751 $435,000 ($600,000 - $165,000) IRC sec. 751(a) Ordinary Income - $60,000 ($25,000 A/R and $35,000 1245 recapture) IRC sec. 751(a) Ordinary Income - $60,000 ($25,000 A/R and $35,000 1245 recapture) Capital Gain = $375,000 117 118 Is any of the gain net investment income subject to the 3.5% NIIT in 2013? Assume that Alice materially participates in the partnership. Even if Alice materially participates, her $100,000 premium gain is NII (per the proposed regs). 6(d) Sale for $600,000 (a $100,000 premium) 12-36 119 120
NIIT Chapter 2A Prop Reg. Category Three Formula for Sale of Partnership Interest: $435,000 Chapter 1 Gain - $335,000 Nontaxable inside gain = $100,000 Category Three II 1 1 $25,000 (AR) + $35,000 (1245 Recap.) + $275,000 (goodwill) 121 122 Draft Form 8960 $435,000 IRC Sec. 1411(c)(4): (4) Exception for certain active interests in partnerships and S corporations. In the case of a disposition of an interest in a partnership or S corporation Adjustment -$335,000 $100,000 123 (A) gain from such disposition shall be taken into account under clause (iii) of paragraph (1)(A) only to the extent of the net gain which would be so taken into account by the transferor if all property of the partnership or S corporation were sold for fair market value immediately before the disposition of such interest, and Arguably zero NII based upon the statutory language (B) a rule similar to the rule of subparagraph (A) shall apply to a loss from such disposition. 124
Apply Prop. Regs. and argue that the goodwill is worth $1,500,000 so none of the gain is category three NII Prop. Reg. Sec. 1.1411-7(d) Required statement of adjustment. Any transferor making an adjustment under paragraph (c) of this section must attach a statement to the transferor's return for the year of disposition. The statement must include-- (1) A description of the disposed-of interest; (2) The name and taxpayer identification number of the entity disposed of; (3) The fair market value of each property of the entity; (4) The entity's adjusted basis in each property; (5) The transferor's allocable share of gain or loss with respect to each property of the entity; (6) Information regarding whether the property was held in (or attributable to) a trade or business not described in 1.1411-5; (7) The amount of the net gain under 1.1411-4(a)(1)(iii) on the disposition of the interest; and (8)The computation of the adjustment under paragraph (c) of this section. 125 126 Sale at a Loss ABCD Balance Sheet Sale at a 20% Discount Assets Tax Basis FMV Cash $100,000 $100,000 Investment asset $100,000 $200,000 1231 Asset $200,000 $100,000 Total Assets $400,000 $400,000 Partner s Outside Basis 127 Capital Alice $100,000 $100,000 $100,000 Bob $100,000 $100,000 $100,000 Carol $100,000 $100,000 $100,000 Don $100,000 $100,000 $100,000 Total Capital $400,000 $400,000 Alice sells to Debra for $80,000 128
Alice Materially Participates in the Partnership Chapter 1 Capital Loss of <$20,000> ($80,000 100,000) Assume that Alice also recognizes a capital gain of $20,000 from her sale of Apple Inc. stock in 2013; so her regular tax net capital gain is zero. 129 130 Form 1040 Schedule D: Apple Inc. Sale Gain $20,000 ABCD Php Sale Loss <$20,000> Draft 2013 Form 1040 NIIT Chapter 2A Prop Reg. Category Three Formula for Sale of Partnership Interest: <$20,000> Chapter 1 Loss 1 + $20,000 Net Nontaxable inside loss = $0 Category Three Loss (Bad news) $0 131 1 <$25,000> (1231 asset loss) max. $<20,000> 132
ABCD Balance Sheet Sale at a 20% Discount Assets Tax Basis FMV Cash $100,000 $100,000 Investment asset $100,000 $200,000 1231 Asset $200,000 $100,000 Total Assets $400,000 $400,000 Partner s Outside Basis Capital Alice $100,000 $100,000 $100,000 Bob $100,000 $100,000 $100,000 Carol $100,000 $100,000 $100,000 Don $100,000 $100,000 $100,000 Total Capital $400,000 $400,000 Alice sells to Debra for $80,000 133 134 Draft Form 8960 Adjustment $0 +20,000 $20,000 Impact, the entire $20,000 capital gain from the sale of Apple Inc. is NIIT 135 IRC Sec. 1411(c)(4): (4) Exception for certain active interests in partnerships and S corporations. In the case of a disposition of an interest in a partnership or S corporation (A) gain from such disposition shall be taken into account under clause (iii) of paragraph (1)(A) only to the extent of the net gain which would be so taken into account by the transferor if all property of the partnership or S corporation were sold for fair market value immediately before the disposition of such interest, and (B) a rule similar to the rule of subparagraph (A) shall apply to a loss from such disposition. 136
Prop. Reg. Sec. 1.1411-7(d) Required statement of adjustment. Any transferor making an adjustment under paragraph (c) of this section must attach a statement to the transferor's return for the year of disposition. The statement must include-- (1) A description of the disposed-of interest; (2) The name and taxpayer identification number of the entity disposed of; (3) The fair market value of each property of the entity; (4) The entity's adjusted basis in each property; (5) The transferor's allocable share of gain or loss with respect to each property of the entity; (6) Information regarding whether the property was held in (or attributable to) a trade or business not described in 1.1411-5; (7) The amount of the net gain under 1.1411-4(a)(1)(iii) on the disposition of the interest; and (8)The computation of the adjustment under paragraph (c) of this section. 137 ABCD Balance Sheet Sale at a 40% Discount Assets Tax Basis FMV Cash $100,000 $100,000 Investment asset $100,000 $200,000 1231 Asset $200,000 $100,000 Total Assets $400,000 $400,000 Partner s Outside Basis Capital Alice $100,000 $100,000 $100,000 Bob $100,000 $100,000 $100,000 Carol $100,000 $100,000 $100,000 Don $100,000 $100,000 $100,000 Total Capital $400,000 $400,000 Alice sells to Debra for $60,000 138 Alice Materially Participates in the Partnership Chapter 1 Capital Loss of <$40,000> ($60,000 100,000) Assume that Alice also recognizes a capital gain of $40,000 from her sale of Apple Inc. stock in 2013; so her regular tax net capital gain is zero. 139 140
Form 1040 Schedule D: Apple Inc. Sale Gain $40,000 ABCD Php Sale Loss <$40,000> Draft 2013 Form 1040 NIIT Chapter 2A Prop Reg. Category Three Formula for Sale of Partnership Interest: <$40,000> Chapter 1 Loss 1 + $25,000 Net Nontaxable inside loss = $15,000 Category Three Loss $0 1 <$25,000> (1231 asset loss) 141 142 ABCD Balance Sheet Sale at a 40% Discount Assets Tax Basis FMV Cash $100,000 $100,000 Investment asset $100,000 $200,000 1231 Asset $200,000 $100,000 Total Assets $400,000 $400,000 Partner s Outside Basis Capital Alice $100,000 $100,000 $100,000 Bob $100,000 $100,000 $100,000 Carol $100,000 $100,000 $100,000 Don $100,000 $100,000 $100,000 Total Capital $400,000 $400,000 Alice sells to Debra for $60,000 143 144
Draft Form 8960 Adjustment $0 +25,000 $25,000 $25,000 of the $40,000 capital gain on the sale of the Apple Inc. stock is NIIT. 145 What if Alice Does Not Materially Participate in the Partnership Sale for $80,000 146 ABCD Balance Sheet Sale at a 20% Discount Assets Tax Basis FMV Cash $100,000 $100,000 Investment asset $100,000 $200,000 1231 Asset $200,000 $100,000 Total Assets $400,000 $400,000 Alice sells to Debra for $80,000 Partner s Outside Basis Capital Alice $100,000 $100,000 $100,000 Bob $100,000 $100,000 $100,000 Carol $100,000 $100,000 $100,000 Don $100,000 $100,000 $100,000 Total Capital $400,000 $400,000 147 Form 1040 Schedule D: Apple Inc. Sale Gain $20,000 ABCD Php Sale Loss <$20,000> Draft 2013 Form 1040 $0 148
NIIT Chapter 2A Prop Reg. Category Three Formula for Sale of Partnership Interest: <$20,000> Chapter 1 Loss + $0 Net Nontaxable inside loss = <$20,000> Category Three Loss 149 150 Adjustment $0 +0 $0 Partner and Partnership Reporting 12-19 Impact, the entire $20,000 capital gain from the sale of Apple Inc. is offset by the $20,000 capital loss on the sale of the partnership interest. 151 152
12-19 Selling Partner s IRS Reporting Obligation Pursuant to Reg. 1.751-1(a)(3), a partner selling or exchanging any part of an interest in a partnership that has any section 751 property at the time of sale or exchange must submit with its income tax return the following information The date of the sale ; Partnership Reporting Obligation IRS Form 8308 12-19 The amount of any gain or loss attributable to the section 751 property; and The amount of capital gain or loss. 153 154 12-20 Gain Attributable to Appreciated Collectibles Or Section 1250 Capital Gain. Example 12-12 12-22 Reg. 1.1(h)-1 155
A and B are equal partners in personal service partnership PRS. B sells to T for $15,000 when PRS's balance sheet is as follows (next slide): 28 Tax Basis FMV Outside Assets: 12-22 Basis Cash $3,000 $3,000 Loan Rec. $10,000 $10,000 Collectibles $1,000 $3,000 Other Cap. Assets 6,000 2,000 Unrealized Rec. 0 $14,000 Total Assets $20,000 $32,000 Liabilities: $2,000 $2,000 Capital: A $9,000 $15,000 $10,000 B $9,000 $15,000 $10,000 Debt + Equity $20,000 $32,000 Step One Example 1-11 Capital Gain Absent IRC sec. 751: Cash from T $15,000 Debt Relief $1,000 Total Amt. Realized $16,000 Step Two B s IRC Sec. 751 Ordinary Income: B s share of Unrealized Rec. $7,000 Outside Basis: Capital $9,000 Debt $1,000 Basis Allocated To Sale -$10,000 Gain Recognized w/o IRC sec. 751 $6,000
Step Three B s IRC Sec. 751 Ordinary Income: B s share of Unrealized Rec. $7,000 Step Four B s IRC Sec. 751 Ordinary Income: B s share of Unrealized Rec. $7,000 B s capital gain or loss: Gain realized w/o IRC sec. 751 $6,000 - IRC sec. 751 Ordinary Inc. -7,000 = Pre-look-through cap. gain <loss> <$1,000> B s capital gain or loss: Gain realized w/o IRC sec. 751 $6,000 - IRC sec. 751 Ordinary Inc. -7,000 = Pre-look-through cap. gain <loss> <$1,000> - B s share of Collectible Gain $1,000 $1,000 = B s Residual Long-term capital loss <$2,000> B s IRC Sec. 751 Ordinary Income: B s share of Unrealized Rec. $7,000 B s capital gain or loss: Gain realized w/o IRC sec. 751 $6,000 - IRC sec. 751 Ordinary Inc. -7,000 Summary of B s Tax Treatment: Ordinary Income: $7,000 Collectible Cap Gain @ 28%: $1,000 Residual LT Capital Loss: <$2,000> = Pre-look-through cap. gain <loss> <$1,000> - B s share of Collectible Gain $1,000 $1,000 = B s Residual Long-term capital loss <$2,000> Gain realized w/o IRC sec. 751 $6,000
Sales Not Redemptions 12-21 The look-through treatment for Sec. 1250 capital gain and collectibles does not apply to redemptions of partnership interests. 165 Reporting Requirements Per Reg. 1.1(h)-1(e): 12-24 Reporting rules similar to those that apply to the partners and the partnership under section 751(a) shall apply in the case of sales or exchanges that cause holders to recognize collectibles gain and section 1250 capital gain. See 1.751-1(a)(3). Calculating Gain or Loss When A Portion Is Sold Rev. Rul. 84-53 12-25 Single Basis Rule 167 12-25 A partner has a single basis in the partnership interest, even if such partner is both a general partner and a limited partner of the same partnership (Rev. Rul. 84-52)
Distributions and losses reduce a partner s capital account basis BEFORE debt basis. 169 O.B. on Portion Sold 12-26 1) O.B. exceeds debt share. Excess O.B. allocated per relative FMV (sold v. total interest). + debt assumed by buyer 12-26 Example 12-13
Date/Typo: 2013 Not 2010 12-28 2) Debt exceeds (or equals) O.B. O.B. allocated per the ratio of debt assumed by buyer to seller share of total debt. 12-28 Example 12-14
Installment Sales Mingo, TC Memo 2013-149 PWC Partner Denied Installment Sale Treatment on Share of Partnership Unrealized Receivables Statute of limitations was closed in the year of sale, 2002, so the IRS called it income in 2003. How? 179
Closing of Tax Year on Sale or Death of a Partner 181