Chapter 7: Sales of Partnership Interests

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Chapter 7 Sales of Partnership Interests
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Overview

• Entity vs. aggregate treatment
• Entity transferor treated as selling PS
  interest, not undivided interest in each asset
• capital gain or loss under 741 except to the
  extent that 751(a) applies
• transferors gain equals AR (cash plus
  liabilities relieved) less OB

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751(a) collapsible PS provision

• 751(a) applies a modified look-through
  approach
• transferor recognizes ordinary income or loss
  equal to her share of the PSs 751(a) assets
• defined as unrealized receivables and inventory,
  see 751(c),(d)
• 1997 amend all assets that would generate
  ordinary income or loss will be treated as
  751(a) assets (full look-through approach)

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Ledoux
p. int.
others
Ledoux
buyer
800K
(5 x current earnings)
25
(20-yr right to operate track owned by another,
for 200K/yr)
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Mechanics of 751(a)

• Reg. 1.751-1(a)(2) provides three-step approach
  for determining transferors gain or loss
• Step One determine overall gain or loss (AR less
  OB)
• Step Two determine transferors share of
  ordinary G/L on a hypothetical sale of PSs
  751(a) assets for fair market value
• Step Three determine transferors capital G/L by
  subtracting the net Step Two amount from the Step
  One amount
• N.B. a negative step two amount increases a
  positive step one amount or reduces a negative
  step one amount

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Unrealized Receivables

• 751(c) unrealized receivables include any
  right to payment for delivery of non-capital
  goods or rendition of services, except to extent
  that PS has already taken such items into account
  (i.e., under accrual method)
• UR also includes depreciation recapture from
  1245 or 1250 property
• such prop treated as two separate assets (1)
  zero-basis 751(a) asset with FMV equal to
  recapture amount and (2) leftover non- 751(a)
  asset

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Inventory

• 751(d) inventory includes 1221(a)(1) items
  (i.e., property held for sale to customers) and
  any other asset that would not be considered a
  capital asset (or 1231 quasi-capital asset) if
  sold by PS
• 1997 Act eliminated substantial appreciation
  test for inventory for purpose of 751(a), but
  left test intact for purposes of 751(b)
• creates a new disparity between sale of a PS
  interest and a cash liquidating distribution
• N.B. 751(c) UR are also included in definition
  of 751(d) inventory (but taxed only once under
  751(c))

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Problem 7-1(a)
Assets Basis FMV Gain/Loss As Share
Capital Asset 30 60 30 10
Inventory 1 15 90 75 25
Inventory 2 90 75 (15) (5)
Total 135 225 90 30
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Problem 7-1(b)
Assets Basis FMV Gain/Loss Es Share
Cash 100 100 NA NA
Securities 100 250 150 30
Equipment 50 80 30 6
Accts Rec. 200 170 (30) (6)
Inventory 300 400 100 20
Total 750 1,000 250 50
Includes 30 of depreciation recapture.
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Consequences to the Transferee

• Transferee takes a cost basis in PS interest
  under 742
• transferees basis includes her share of PS
  liabilities
• inside basis remains unchanged transferee
  inherits transferors CA.
• Exception if PS elects to adjust IB under
  743(b)/754
• transferee receives a special inside basis
  adjustment (SBA) intended to eliminate her share
  of inside gain or loss
• SBA affects only the transferee (not an
  adjustment to the common basis of PS prop)

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Example 7-1
Assets Basis FMV Capital Tax/Book FMV
Capital Asset 30 60 A 45 75
Inventory 1 15 90 B 45 75
Inventory 2 90 75 C/D 45 75
Total 135 225 Total 135 225
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Amount of 743(b) Adjustment

• 743(b) adjustment equals excess of transferees
  OB over her share of IB.
• SBA is negative if OBltIB.
• Purchasing partners share of IB is generally
  equal to her tax CA (inherited from transferor)
  plus her share of PS liab.

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743(b) Hypothetical Transaction

• 743 regs define a partners share of IB as the
  sum of her share of previously taxed capital
  plus her share of PS liab.
• 743 regs posit a hypothetical transaction in
  which PS deemed to sell all of its assets for FMV
• Purchasing partners share of previously taxed
  capital is equal to (i) cash she would receive
  on liquidation following hypo trans, (ii)
  increased by her share of tax loss on hypo trans,
  and (iii) decreased by her share of tax gain on
  hypo trans

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Problem 7-2(a)
Assets Basis FMV Ds share of previously taxed capital (hypo transaction) Ds share of previously taxed capital (hypo transaction)
Capital Asset 30 60 Liquidating distrib. 75
Inventory 1 15 90 Plus tax loss 5
Inventory 2 90 75 Less tax gain (35)
Total 135 225 Ds share of PTC 45
Same as Ds tax capital account Same as Ds tax capital account
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Problem 7-2(c)
Basis Book FMV Tax Book FMV
Assets Liab. 300 300 300
Cash 1,200 1,200 1,200 Capital
Land 100 600 900 A 100 600 700
Sec. 300 300 300 B 600 600 700
Total 1,600 2,100 2,400 C 600 600 700
Total 1,600 2,100 2,400
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Allocation of Inside Basis Adjustments

• Allocation of SBA determined under 755.
• 755 divides PS assets into two classes (i)
  capital assets (including 1231 quasi-capital
  assets) and (ii) ordinary income assets (all
  other assets)
• 743(b) adjustment is allocated first (i)
  between two classes (capital and ordinary) and
  (ii) among particular assets within each class
• Allocations based on hypo sale for FMV, i.e.,
  according to purchasing partners distributive
  share of tax gain or loss (including any remedial
  allocations under 1.704-3(d))

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755 Net Adjustment

• 755 is a net adjustment, i.e., may be positive
  for one class and negative for another.
• Within each class, 755 adj may increase basis
  of some assets and decrease basis of other
  assets.
• Revised regs eliminate flaw under the prior regs
  which prohibited two-way adjustments
• Net result transferee should generally wind up
  with a FMV basis in each and every PS asset
  (i.e., her share of the assets IB plus her SBA
  with respect to the particular asset).

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Problem 7-3
Tax/Book FMV Tax/Book FMV
Liab. 250 250
Assets Capital
Cash 240 240 A 110 150
Securities 10 80 B 110 150
Equip. 50 110 C 110 150
Accts Rec. 200 170 D 110 150
Inventory 300 400 E 110 150
Total 800 1,000 800 1,000
Includes 30 of depreciation recapture.
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Problem 7-3 (contin.)
Assets Fs IB Fs SBA IB SBA FMV Fs G/L
Cash 48 NA 48 48 0
Securities 2 14 16 16 0
Equipment 10 12 22 22 0
Accts Rec. 40 (6) 34 34 0
Inventory 60 20 80 80 0
Total 160 40 200 200 0
includes 6 recapture
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