Gifts of partnership interests: a donor must be wary of the tax consequences of a gift of a partnership interest, especially if the donor has a negative basis in the partnership interest.

• Author: Ellentuck, Albert B.

The gift of a partnership interest generally does not result in the recognition of gain or loss by the donor or the donee. A gift is, however, subject to gift tax unless the gift qualifies for the annual gift tax exclusion or reduces the donor's lifetime gift tax applicable exclusion amount. (Since the lifetime gift tax exclusion for 2016 is $5.45 million, most gifts will not be taxable.) Practitioners should note that if the general partner has unfettered discretion to make or withhold distributions, any gift of an interest in the partnership may be treated as a gift of a future interest not qualifying for the annual gift tax exclusion (TAM 9751003).

If gift tax is imposed, it is calculated on the fair market value (FMV) of the gifted property less the amount of debt from which the donor is relieved. In the context of a gift of a partnership interest, the FMV involved is the FMV of the donor's interest in partnership property, and the debt involved is the donor's share of partnership liabilities.

If the debt relief exceeds the donor's basis in his partnership interest, the debt relief is treated as an amount realized in a deemed sale transaction, and the donor must recognize gain (Regs. Sec. 1.1001-2(a)). Gain recognition usually occurs when the partner has a negative tax basis capital account. Some of this gain may be ordinary, depending on whether the hot asset rules of Sec. 751 apply. Any capital gain on the deemed sale may be short-term or long-term under the applicable rules.

Example: J is a partner in I Investments Partnership. His tax basis capital account is $(100,000), and his share of the partnership's liabilities is $150,000. The FMV of his interest in partnership assets is $200,000. J approaches his practitioner about gifting the partnership interest to his son, R.J's tax consequences are shown in the exhibit on p. 294.

A partner acquiring an interest by gift generally has a basis equal to the donor's basis plus, in some instances, a portion of the gift tax paid (Secs. 742 and 1015). The increase is equal to the gift tax paid on the net appreciation of the transferred interest, but the basis may not exceed the interest's FMV (Sec. 1015(d); Regs. Sec. 1.1015-5(a)). Net appreciation is the amount by which the FMV of the transferred interest immediately before the gift exceeds the donors basis. Accordingly, the donee increases the basis by the following amount: (Net appreciation * FMV of gift) x gift tax paid.

If the donor...