736 Roadmap

1
736 Roadmap
736(b) Payments in liquidation of partners
interest, to extent in exchange for partners
interest in partnership property, considered at
distributions of property. Thus, - Go
to 731 for gain or loss treatment - Go to
732 for basis treatment 736(a) Kicks in if
(1) premium payment is made in excess of
partners interest in partnership property and
(2) capital not material factor (service
partnership) and there are unrealized receivables
or goodwill not subject to an agreement on
payments for good will. Then, - If
payments based on income, deemed distributed
share of income to partner and income allocated
to other partners reduced. - If payment
not based on income, deemed guaranteed payment
under 707(c), with income to liquidating partner
and deduction to partnership.
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731 732 via 736(b) liquidation
731 No gain or loss recognized to partner
unless - Gain to extent money distributed
exceeds partners basis in partnership interest.
- Loss recognized if only money and
unrealized receivables and inventory distributed
to extent basis in partners interest exceeds
amount of money distributed and partnerships
basis in receivables and inventory. - Any
recognized gain or loss is from sale or exchange
of partnership interest. 732(b) If property
distributed to partner in liquidation of
partnership interest, basis in property shall
equal partners interest in partnership less
money receives in distribution.
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732 Basis Priority Allocation
First Apply partners basis in partnership
interest to inventory and unrealized receivables
equal to partnerships adjusted basis in such
items. If not enough to cover, apply decrease
first pro rata to any built-in losses and, if
more decrease still required, then apply pro rata
to remaining adjusted basis of inventory and
receivables. Second, apply remaining portion
of partners basis to other distributed assets.
- If remaining basis exceeds partnerships
basis in such assets, allocate excess first to
assets with built-in gains to extent of gains.
If still more, allocate balance per FMV of
assets. - If remaining basis less than
partnerships basis in such assets, apply
decrease first pro rata to built-in losses in
such assets to extent of losses. If still more
decrease, allocated decrease pro rata to
remaining basis in assets. Remember
Distributee partner may tack partnerships
holding period per 735(b). Partnerships
ordinary income taint sticks for ever on
receivables and 5 year on inventory. 735(a).
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Impact on Partnership of Partners Liquidation
General Rule No gain or loss to partnership
on distributions of property to liquidate a
partners interest in partnership. 731(b)
731(a) Exception If payments made under 731(a),
partnership gets deduction if guaranteed payments
under 707(c) and allocations to other partners
reduced to extent payments deemed distribution of
income to liquidating partner. 751(b) Impact
To extent of 736(b) payments not reflect
partners proportionate share of unrealized
receivables and inventory, deemed distribution of
additional receivables and inventory to partner
followed by partners sales to partnership for
cash. Impact is ordinary income to partner and
increased basis in such assets to partnership
(result of deemed by back). Partnerships
Assets Basis No change per 734(a) unless 754
election made. If 754 election, basis in capital
or 1231 assets (1) increased by gain recognized
by distributee partner and excess of partnership
basis in distributed property over basis to
distributee under 732 and (d) decreased by loss
recognized by distributee and excess of
distributee basis over partnerships basis.
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Problem 313-1

• Basic Facts ABC balance sheet
• A.B. FMV
  A.B.
  FMV
• Cash 90k 90k
  A Capital 85k
  70k
• Inventory 15k 30k
  B Capital 85k 70k
• Land 150k 90k
  C Capital 85k
  70k
• Total 255k 210k
  255k
  210k
• A receives 1/3 inventory and 60k land in
  liquidation of partnership interest. No gain to
  A under 731because no money in excess of basis.
  No loss under 731(a)(2) to A because property
  other than cash or 751 property distributed. Per
  732(c) A 85k basis first allocated to inventory
  (751 asset) to extent of partnerships basis (5k)
  and other 80k allocated to land. Land basis
  drops from 100k (2/3 of 150k) to 80k. Had 754
  election been made, other partnership land basis
  would be increased by lost 20k basis per
  734(b)(1)(B). No gain or loss to partnership per
  731(b) on inventory gain or land loss.

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Problem 313-1
Basic Facts ABC balance sheet
A.B. FMV
A.B. FMV Cash
90k 90k A
Capital 85k 70k
Inventory 15k 30k
B Capital 85k 70k
Land 150k 90k
C Capital 85k
70k Total 255k 210k
255k
210k (b) A receives 1/3 inventory and 60k
cash in liquidation. Per 732, 5k basis allocated
to inventory (partnerships basis) and 60k
reduces basis to 20k, which is recognized as
capital loss per 731(a)(2). No gain or loss to
partnership, and no adjustment to asset basis.
If 754 election, partnerships land basis would
be reduced by 20k loss recognized by A.
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Problem 313-1
Basic Facts ABC balance sheet
A.B. FMV
A.B. FMV Cash
90k 90k A
Capital 85k 70k
Inventory 15k 30k
B Capital 85k 70k
Land 150k 90k
C Capital 85k
70k Total 255k 210k
255k
210k c) Why 732(a)(2) loss restrictions?
Goal is to defer gain or loss through basis
adjustment. Where partners interest liquidated
and only assets distributed are 751 assets and
cash, no further deferral of loss possible.
Thus, recognized at point of liquidation.
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Problem 313-1
Basic Facts ABC balance sheet - revised
inventory to 120k FMV
A.B. FMV
A.B. FMV Cash
90k 90k A Capital
85k 100k Inventory
15k 120k B Capital
85k 100k Land
150k 90k C
Capital 85k 100k
Total 255k 300k
255k
300k (d) A receive 60k cash and 1/3 inventory in
liquidation. A basis in inventory still 5k, 60k
reduce basis and still 20k loss to A per
731(a)(2). Same result even though gain in
partnership interest. Note, when A sell
inventory for 40k (its FMV), will have 35k
ordinary income - equal to 15k partnership
interest gain and 20k capital loss on
liquidation.
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Problem 313- 2

• If 754 election
• Downward adjustment in partnerships other assets
  only for loss on liquidation or if 732(b) applies
  on liquidation.
• But upward adjustment to partnerships other
  assets for both operating and liquidating
  distributions because 731(a)(1) and 732(a)(2) and
  (b) apply to both types of distributions.

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Problem 325
Basic Facts ABC balance sheet - Capital
material income producing factor
A.B. FMV
A.B. FMV Cash
24k 24k
A Capital 12k 18k AR
0k 9k
B Capital 12k
18k Capital Asset 9k 15k
C Capital 12k
18k Goodwill 3k 6k
Totals
36k 54k
36k 54k
(a) A receive 20k cash in liquidation and no
goodwill provision. Per 736(b), 751(b) phantom
sale applies to AR, producing 3k ordinary income
to A (1/3 of 9k). 2k premium payment 736(a)
guaranteed payment, triggering 2k ordinary income
to A and 162 deduction to partnership. Remaining
15k payment exceed 12k basis for 3k LTCG under
731(a)(1). Partnership has no gain on cash
distribution, but has 2k deduction per above.
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Problem 325
Basic Facts ABC balance sheet - Service
partnership A.B.
FMV
A.B. FMV Cash
24k 24k A Capital
12k 18k AR
0k 9k B Capital
12k 18k Capital Asset
9k 15k C Capital
12k 18k Goodwill
3k 6k
Totals 36k
54k
36k 54k (b) A receive 20k
cash in liquidation and no goodwill provision.
Since service entity, 6k under 736(a) - 3k
receivables, 1k gain in goodwill, 2k premium.
All ordinary income to A and 6k deduction to
partnership. Balance of 14k distribution under
736(b) and exceed outside basis (12k) for 2k LTCG
per 731(a)(1).
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Problem 325
Basic Facts ABC balance sheet - Service
partnership A.B.
FMV
A.B. FMV Cash
24k 24k A Capital
12k 18k AR
0k 9k B Capital
12k 18k Capital Asset
9k 15k C Capital
12k 18k Goodwill
3k 6k
Totals 36k
54k
36k 54k (c) A receive 20k
cash in liquidation - 10k year 1 and 1k next 10
years. Same income and deductions as (b). Issue
is timing. 14k (70) out of 20k total is 736(b)
payment 6k (30) 736(a). Thus, of first yr 10k
payment, 30 or 3k is ordinary income to A with
3k deduction to partnership, and 7k can first be
used to recover 12k basis or basis can be
allocated pro rata to all 736(b) payments. If
latter, 1k LTCG in year 1. For all 1k annual
payments, 300 736(a) ordinary income and 700
736(b).
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Problem 325
Basic Facts ABC balance sheet - Service
partnership A.B.
FMV
A.B. FMV Cash
24k 24k A Capital
12k 18k AR
0k 9k B Capital
12k 18k Capital Asset
9k 15k C Capital
12k 18k Goodwill
3k 6k
Totals 36k
54k
36k 54k (d) Same as c) but
outside basis 16k. Still 30 of all payments
736(a) ordinary income with offsetting deduction
to partnership. 70 736(b) applied against
basis, but here 2k LTCL. Loss could be
recognized in last years of payments or pro rata
over payments. If pro rata, 1k LTCL in year 1
and 100 LTCL in each of next 10 yrs.
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Problem 325
Basic Facts ABC balance sheet - Service
partnership A.B.
FMV
A.B. FMV Cash
24k 24k A Capital
12k 18k AR
0k 9k B Capital
12k 18k Capital Asset
9k 15k C Capital
12k 18k Goodwill
3k 6k
Totals 36k
54k
36k 54k (e) Same as c) but A
receives 10k yr 1 and 10 of profits next 10 yrs.
Profits estimated at 10k per year. Since amount
not fixed, treated as open transaction, with all
736(b) payments first, then excess 736(a). Thus,
year 1 10k applied against 12k basis, along with
yrs 2 3 1k payments. Yrs 4 5 1k payment also
736(b) representing As gain on capital asset and
each yr A has 1k LTCG under 731(a)(1). Next 6
yrs 1k payments all 736(a) - ordinary income to A
and deductible to partnership.
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Problem 325

• Basic Facts ABC balance sheet - Service
  partnership
• A.B. FMV
  A.B.
  FMV
• Cash 24k 24k
  A Capital 12k
  18k
• AR 0k 9k
  B Capital 12k
  18k
• Capital Asset 9k 15k
  C Capital 12k 18k
• Goodwill 3k 6k
  
• Totals 36k 54k
  36k
  54k
• Same as (b) but 2k is received for goodwill per
  agreement. Then appreciation in As goodwill
  share (1k) becomes 736(b) payment, increasing
  736(b) to 15k and reducing 736(a) to 5k. Thus, A
  has 5k ordinary income (instead of 6k) and 3k
  LTCG (instead of 2k).
• A prefers this goodwill treatment because
  converts 1k of ordinary income to LTCG.

16
Problem 334

• Basic Facts ABC balance sheet - Law Firm
• A.B. FMV
  A.B.
  FMV
• Cash 60k 60k
  A Capital 20k
  50k
• Goodwill 0k 90k
  B Capital 20k 50k
• 
  C Capital 20k
  50k
• Totals 60k 150k
  60k
  150k
• B and C pay A 50k for As partnership interest.
  A realizes 50k, against basis of 20k, for 30k
  capital gain. B C each have 25k increase in
  basis. If 754 election, partnership could
  increase basis of goodwill 30k, which could be
  amortized over 15 yrs per section 197.
• Sale to B and C, but partnership pays 50k to A.
  Deemed 25k partnership distribution to B and C,
  followed by their purchase of As interest.
  Purchase transaction result same as in (a).
  Distribution to B C governed by 731(a)(1) and
  each has 5k gain because cash exceeds basis. If
  754 election, inside basis in goodwill increased
  by 10k gain on distribution and 30k gain on
  purchase.

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Problem 334

• Basic Facts ABC balance sheet - Law Firm
• A.B. FMV
  A.B.
  FMV
• Cash 60k 60k
  A Capital 20k
  50k
• Goodwill 0k 90k
  B Capital 20k 50k
• 
  C Capital 20k
  50k
• Totals 60k 150k
  60k
  150k
• Transaction 50k liquidation. If goodwill
  separately stated, all payments 736(b) and A has
  30k capital gain. If goodwill not stated, 20k
  under 736(b) for basis recovery and 30k under
  736(a) - ordinary income to A and deductible by
  partnership. If goodwill separately stated and
  754 election, partnership can increase goodwill
  basis by 30k gain.
• How avoid litigation with IRS. State intentions
  in agreement regoodwill and make certain parties
  file consistent positions per agreement.