Identifying a partnership distribution.

AuthorEllentuck, Albert B.

A distribution is a transfer of cash or property by a partnership to a partner with respect to the partner's interest in partnership capital or income. Distributions do not include loans to partners or amounts paid to partners for services or the use of property, such as rent, or guaranteed payments.

A partnership distribution may consist of cash, property, or both. In addition, any reduction of a partner's share of partnership liabilities is treated as an actual distribution of cash (Sec. 752(b)). Transactions that should be carefully reviewed for such potential gain include distributions of encumbered property, distributions in partial liquidation of a partner's interest, and the admission of a new partner.

A like-kind exchange involving encumbered property can also result in a deemed distribution under Sec. 752 to the extent the mortgage assumed in the exchange is less than the mortgage transferred. Regs. Sec. 1.1031(b)-1(c) provides that a net reduction in debt due to the exchange of encumbered property is considered boot, and gain is recognized. Under Rev. Rul. 2003-56, if such a like-kind exchange straddles two tax years, the gain that is recognized due to the receipt of boot that resulted from a net decrease in liabilities is reported in the tax year in which the partnership transfers the relinquished property and not the year in which the partnership receives the replacement property.

Distinguishing Loans From Distributions

In some situations, it may be difficult to distinguish between distributions and partnership loans to partners. Moreover, partners may sometimes attempt to avoid immediate taxation on a distribution by characterizing it as a loan. The substance of the transaction determines whether the transfer of funds is a loan or a distribution. An advance of funds to a partner is characterized as a loan only if there is an unconditional and legally enforceable obligation to repay a sum certain--the amount of the advance--at a determinable date (Regs. Sec. 1.731-l(c)(2)). A mere deficit balance in a partner's capital account does not constitute a loan for this purpose, even if the partner is obligated by law or by the partnership agreement to repay the deficit to the partnership (Rev. Rul. 73-301; Maugham, T.C. Memo. 1980-280; Seay, T.C. Memo. 1992-254). When a loan from a partnership to a partner is intended, there should be a written loan document with commercially reasonable terms that provides a market interest rate.

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