Applying the rules governing distributions of marketable securities.

• Author: Ellentuck, Albert B.
• Position: Partnership distributions - Case study

Facts: Chuck, Willie and Harry are equal partners of Royal Monarch Company, a partnership they formed several years ago for joint investments. Through Royal Monarch, the partners purchased land, limited partnership interests and stock of both public and private companies. The partnership has been winding down its activities and Chuck has decided to terminate his involvement. Willie and Harry are agreeable to the separation. Chuck's partnership interest is worth $30,000, and he has a $5,000 basis in that interest. * Among Royal Monarch's assets are 300 shares of IBN-TELco, a publicly traded stock purchased three years ago. The stock is worth $30,000. Royal Monarch's basis in the stock is $3,000 ($10 per share). These are the only marketable securities owned by Royal Monarch. Chuck has asked that these shares be distributed to him in complete liquidation of his partnership interest. He believes the distribution would be a nontaxable property distribution. Issue: What are the tax effects of the proposed distribution of IBN-TELco stock?

Analysis

Before 1994, Chuck's proposal would have been quite beneficial from his standpoint. He would have recognized no gain on the liquidation of his interest in Royal Monarch, because he would have received no money. He would have received the stock with a $5,000 basis (his basis in his partnership interest). Moreover, the stock would have been nearly as liquid as cash, and would have allowed Chuck to determine when he would recognize the gain from the liquidation of his partnership interest.

This is no longer the case, however. Sec. 731(c), added in late 1994, changed the taxation of distributions of marketable securities. Under this provision, to determine (1) whether gain or loss is recognized on a distribution to a partner and (2) the recognition of precontribution gain for distributions to contributing partners, distributions of marketable securities ordinarily will be treated as distributions of money in an amount equal to the fair market value (FMV) of the securities on the distribution date. As a consequence, in general, the distributee will recognize gain to the extent the securities' FMV exceeds the distributee's basis in his partnership interest. Under this general rule, Chuck would recognize $25,000 of gain on this liquidating distribution, the amount by which the "money" distributed--$30,000 (the FMV of the marketable securities)--exceeds his basis in his Royal Monarch interest. Because the stock...