Partnership Distributions: An Introduction

• Pages: 213-231
• Author: James R. Repetti,William H. Lyons,Charlene D. Luke

213

Chapter Eleven

PARTNERSHIP DISTRIBUTIONS:

AN INTRODUCTION

One might think that the tax treatme nt of a partnership’s

transferring money or property to one or more partners should be

fairly simple—as simple, for instance, as the treatment of

distributions by S corporations having no accumulated earnings and

profits. Unfortunately, partnership distributions are subject to some

of the most difficult Code provisions eve r written. One of the most

confusing, § 736, which we w ill explore in Chapter 13, attempts just

one task—that of classifying payments to partners leaving the

partnership (so-called “retiring” partners) and payments to

successors of deceased partners. The late Judge Arnold Raum of the

Tax Court questioned whether § 736 is “reasonably comprehensible

. . . even to the average tax expert who has not given special attention

and extended study to the tax problems of partners.”

1

The statutory

provisions in this area were drafted by people with a marvelous

willingness to tolerate complexity.

This Chapter will present the fundamental rules for recognizing

gain or loss and for determining basis when a partnership distributes

money or property to a partner. Learning these rules by heart will

not in itself put you in a position to advise anyone about even the

simplest transaction. There are three complicating factors. First,

payments by a partnership to a partner may take several forms. For

example, § 736 provides that payments to a retiring partner or to a

deceased partner’s successor may be guaranteed payments (see

Chapter 9), distributions of distributive shares (see Chapter 5), or

liquidating distributions to partners leaving the partnership (see

Chapter 13). Second, the usual rules for taxing distributions are often

overridden by § 751(b), which, as will be discussed in Chapter 12,

treats some distributions as consisting of “constructive”

distributions, followed by taxable exchanges of the constructively

distributed money or property between the partner and the

partnership. Third, distributions can trigger inside basis

adjustments if a § 754 election is in effect or if certain other

circumstances discussed i n Chapter 14 exist. Accur ate advice about

the tax treatment o f distributions can be given only by one who has

learned the workings of several complex Code provisions well enough

to think about how they interact with each other in specific cases.

1

Foxman v. Commissioner, 41 T.C. 535, 551 n.9 (1964) (acq., 1966–2 C.B. 3, 4),

aff’d, 352 F.2d 466 (3d Cir. 1965).

214

Partnership Distributions: An Introduction

Ch. 11

The cases in this chapter have been kept unrealistically simple

to avoid having to consider two or more sets of rules at the same time.

Later chapters will begin to approach real-life situations.

A. The General Principle of Nonrecognition

1. General Rule of Nonrecognition and Basis

Preservation

Section 731 states the general rule that neither the partner nor

the partnership recognizes gain or loss on a distribution of money or

property in a liquidating distribution (one that eliminates the

partner’s interest in the partnership

2

) or in a nonliquidating

distribution (one that does not eliminate the partner’s interest in the

partnership).

3

Under § 731, a partner recognizes gain only when the

partnership distributes cash in excess of the partner’s outside basis

and only recognizes losses in rare circumstances.

4

As usual with

nonrecognition transactions, the basis rules preserve for future

recognition whatever gains or losses went unrecogn ized when the

distribution took place.

Example 11-1: Horatio, a 20% partner in HIJ, receives a

distribution of property from the partnership. The receipt

of this distribution reduces Horatio’s partnership interest

to 10%, and therefore, the distribution is nonliquidating

since Horatio retains an interest in the partnership. The

distributed property is a capital asset worth $50,000, which

had a basis in the partnership’s hands of $40,000. Horatio’s

outside basis just before the distribution was $95,000.

Under § 731(a) and (b), neither Horatio nor the

partnership recognizes gain or loss on this nonliquidating

distribution of property. Section 732(a) provides that, as a

general rule, the basis of the property in the partner’s

hands is the same as i ts basis in the partnership’s hands.

In this example, Horatio would take the pro perty with a

basis of $40,000. To make things work out right in the long

run, the basis of Horatio’s partnership interest is reduced

by the basis (to him) of the distributed property. § 733.

Horatio’s new outside basis therefore becomes $55,000

($95,000 minus $40,000). Horatio ends up with the same

2

Reg. § 1.761–1(d) defines liquidating distribution as a distribution or series of

distributions that terminate the partner’s entire interest in the partnership.

3

Nonliquidating distributions are also often called “current distributions” o r

“operating distributions.”

4

The circumstances in which partners recognize gains or losses under § 731 are

discussed in § B.1–2 of this chapter. A partner may also recognize gain o r loss in

certain other situations under § 704(c) and § 737, which are described in § B.4 and

§ B.5 of this chapter, and under § 751(b), which is described in Chapter 12.