Determining the effects of a sale of deceased partner's interest by the successor in interest.

• Author: Ellentuck, Albert B.

Facts

P. Hawk was a partner in the Bird Partnership. Last month, Hawk was killed in an auto accident. Under the partnership agreement, his successor in interest (S. Hawk) is obligated to sell P. Hawk's interest to the remaining partners for its fair market value (FMV). S. Hawk has come to her tax adviser to evaluate the result of the proposed sale and to determine if there are any tax planning opportunities. The balance sheet assets of Bird Partnership used for the valuation are:

Adjusted basis FMV Cash $ 10,000 $ 10,000 Inventory 20,000 28,000 Equipment 30,000 30,000 Building 60,000 80,000 $120,000 $ 148,000 Issue

What are the effects of the proposed sale?

Analysis

When a partnership interest is sold, the selling partner generally recognizes capital gain or loss from the disposition. However, if the collapsible partnership rules apply, the selling partner may recognize ordinary income.

When S. Hawk inherited the partnership interest, her basis in the interest became its FMV at date of death. Thus, S. Hawk's basis in the partnership interest was $37,000. And there would ordinarily be no gain or loss on the sale of the interest.

However, the collapsible partnership rules require the bifurcation of the amount realized and adjusted basis. The ordinary income portion is determined by looking at the underlying basis and FMV of the partnership's Sec. 751 property. The capital gain or loss is the difference between the remainder of the partner's amount realized and adjusted basis. S. Hawk's interest consists of:

Adjusted basis FMV Inventory $ 5,000 $ 7,000 Other assets 32,000 30,000 $37,000 $37,000 Thus, S. Hawk would have to recognize $2,000 of ordinary income and a $2,000 long-term capital loss from the proposed disposition.

This seemingly nonsensical answer can be avoided if the Bird Partnership makes or has made a Sec. 754 election effective for the year of death. If the Sec. 754 election applies, basis adjustments for the benefit of S. Hawk are made. The overall $7,000 basis...