Precontribution gain on a partnership's technical termination.

• Author: Ellentuck, Albert B.
• Position: Case study

Facts: Moon and Peterson formed the Good Morning Partnership (GMP) on Jan. 1,1996. They are equal partners. Moon contributed a building with a $520,000 fair market value (FMV) and a $390,000 adjusted tax basis, and Peterson contributed $520,000 cash. GMP purchased several parcels of land with $360,000 of the contributed cash. The building was depreciated by the partnership based on a 39-year life, using the straight-line method. GMP has made Sec. 704(c) allocations for precontribution gain on the building using the traditional method. * During each year of partnership operations, operating income equaled expenses net of depreciation. Therefore, the loss recognized by GMP each year equaled its depreciation expense. * On Dec. 31, 1998, Moon sold his interest to Lee for $540,000, triggering a technical termination. Lee and Peterson agree to continue the business, calling it Good Day Partnership (GDP). GMP's balance sheet on the termination date was as follows:

Good Morning Partnership Adjusted basis FMV Cash $160,000 $160,000 Building 360,000 520,000 Land 360,000 400,000 Total $880,000 $1,080,000 Adjusted basis FMV Capital: Moon $380,000 $540,000 Peterson 500,000 540,000 Total $880,000 $1,080,000 Issue: Under the technical termination regulations, what are the effects on the precontribution gain?

Analysis

The sale of Moon's interest to Lee triggers a technical termination. Under Regs. Secs. 1.708-1(b)(1)(iv) and 1.761-1(e), a technical termination no longer results in a deemed distribution of the partnership's assets. Instead, the partnership is treated as transferring its assets and liabilities to a new partnership in return for interests in that partnership. The interests in the "new" partnership are then deemed distributed to the partners who either continue the partnership or dissolve it and wind up its affairs. Thus, for example, a technical termination no longer has the potential for triggering gain to the partners if their share of the partnership's cash exceeds the basis of their partnership interests.

The new regulations simplify the interaction of the technical termination rules with the following Code provisions:

1. Sec. 704(c)(1)(A)--that requires a property's built-in gain or loss (the difference between its basis and FMV at the time it is contributed to a partnership) to be allocated to the contributing partner through depreciation, depletion, etc., adjustments and, to the extent necessary, through a special gain or loss...