Special issues related to distributions of partnership interests by estates and trusts.

• Author: Bottiglieri, Tom

With the popularity of family limited partnerships, it is not uncommon to find a partnership interest held by an estate or trust. However, eventually the estate or trust must distribute the partnership interest. The complex rules governing the tax treatment of distributions from estates and trusts are further complicated when a partnership interest is distributed.

General Rule

When an estate or trust distributes cash or property, the distribution is taxed to the beneficiary to the extent that the trust or estate has distributable net income (i.e., generally taxable income not including capital gain) (Sec. 662). This means that the beneficiary, rather than the estate or trust, is taxed on the entity's income up to the amount of the distribution. In the case of property, the distribution amount is the lesser of the property's tax basis or its fair market value (FMV) (Sec. 643(e)(2)). Nevertheless, regardless of how the property distribution is measured, the beneficiary's tax basis in the property will be the same as the estate or trust's cost basis prior to the distribution.

In addition, there are situations in which an estate or trust will recognize gain as a result of the distribution of appreciated property, which will require an adjustment to the property's basis: (1) the property is distributed in satisfaction of a specific pecuniary bequest; (2) the property is subject to liabilities in excess of basis; or (3) the fiduciary elects (under Sec. 643(e)(3)) to treat the distribution as a sale to the beneficiary for the property's FMV. Further, if the property distributed is a partnership interest and the estate or trust has a negative tax capital account (this occurs when the liabilities of the partnership allocable to the interest exceed the estate or trust's share of the partnership basis of its assets), then a gain will be recognized equal to the negative capital as a result of the requirement of Sec. 752(d) to include the partner's liabilities in the amount realized.

Sec. 761(e)

Sec. 761(e) provides that any distribution of an interest in a partnership that is not otherwise treated as a sale or exchange, as discussed above, will still be treated as a sale or exchange for purposes of Secs. 708 and 743.

While the legislative history of this provision indicates that the IRS might issue regulations providing that estates and trusts would not be subject to this provision, no regulations have been issued to date. It seems relatively certain...