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Partnership Terminations: Sale or Abandonment of an Interest,

Retirement or Death of Partner, and Closing the Entity

WEDNESDAY, FEBRUARY 12, 2020, 1:00-2:50 pm Eastern

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February 12, 2020

Partnership Terminations: Sale or Abandonment of an Interest, Retirement or Death of Partner, and Closing the Entity

Joseph C. Mandarino, Partner

Smith Gambrell & Russell

[email protected]

Faye Tannenbaum, CPA, Partner

Mazars USA

[email protected]

Notice

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© 2019 Smith, Gambrell & Russell, LLP, All Rights Reserved © 2019 Smith, Gambrell & Russell, LLP, All Rights Reserved

Partnership Terminations

Joseph Mandarino

February 12, 2020

Smith, Gambrell & Russell, LLP

Promenade II, Suite 3100

1230 Peachtree Street, N.E.

Atlanta, Georgia 30309

www.sgrlaw.com

5

http://www.balch.com/

© 2019 Smith, Gambrell & Russell, LLP, All Rights Reserved

Disclaimer

IRS CIRCULAR 230 DISCLOSURE:

Unless explicitly stated to the contrary, this outline, the presentation to which it relates and any other documents or attachments are not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

6


Repeal of Technical Terminations

7


Partnership Termination Rules

• Under old Code Section 708, a partnership was treated as terminated in two situations:

• no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership, or

• within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits

• The latter situation is the so-called “technical termination.”

8



• Under a technical termination, there is a deemed contribution of all the partnership’s assets and liabilities to a new partnership in exchange for an interest in the new partnership, followed by a deemed distribution of interests in the new partnership to the purchasing partners and the other remaining partners.

• The three main consequences of this are:

• the partnership’s taxable year closes, potentially resulting in short taxable years,

• partnership-level elections generally cease to apply following a technical termination, and

• a technical termination generally results in the restart of partnership depreciation recovery periods.

9



• Because of these vexsome consequences, it was common to structure transactions around this rule (e.g., transfer 49% today and the balance in 12 months and a day).

• The TCJA repeals the so-called technical terminations rule.

• The change is effective for partnership tax years beginning after 2017.

10


Termination by Liquidating Distribution

A. General Rules

B. Outside Basis

C. Basis Adjustments

11


Liquidating Distributions – General

12


Liquidating Distributions

• In general, a liquidating distribution can be analogized to

a stock redemption.

• The partner receives a distribution from the partnership in

exchange for or liquidation of his or her interest in the

partnership.

• Can be a single or series of distributions.

13



• The tax treatment of a liquidating distribution varies

depending on what type of property is distributed.

• cash – gain/loss recognized

• “marketable securities” – treated same as cash

• all other property – generally no gain/loss – instead

take the property with a carryover basis.

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• Cash includes “deemed” cash distributions from relief of

liabilities.

• “Marketable securities” are financial instruments and

foreign currencies that are actively traded – these are

treated as cash substitutes and the same tax

consequences attend them.

• “financial instruments” defined as stocks and other

equity interests, debt, options, forward or futures

contracts, notional principal contracts, and derivatives

15



• If cash or marketable securities are received, and the total

exceeds the partner’s outside tax basis, then the

difference is recognized as gain.

• Loss can be recognized but only if the to the extent the

distribution consists solely of cash or §751 assets (aka

“hot assets”).

• Receipt of other property generally will not result in gain

or loss. Instead, the partner’s outside tax basis will be

spread over the received property.

16


Retirement Payments

• An exception to the general rules on liquidating

distributions applies in highly specific circumstances.

• §736 governs payments to retiring partners. Payments

are separated into two classes:

• payments for the partner’s interest in partnership

property (“§736(b) payments”), and

• all other payments (“§736(a) payments”).

17


Outside Basis

18

• As noted, the tax consequences of a liquidating

distribution often depend on the liquidated partner’s

outside basis.

• A partnership's tax basis in its assets is referred to as

“inside” basis.

• A partner’s tax basis in its partnership interest is referred

to as “outside” basis.

• Often, there is a difference between inside and outside

basis.


Outside Basis

19

• Recall, that a partner’s outside basis is the computed as

follows:

• add the amount of cash and tax basis of any

contributed property (not the FMV of property)

• add any income allocated to the partner

• Subtract any losses allocated to the partner

• Subtract any distributions to the partner

• Note that any partnership liabilities allocated to the

partner are treated as a contribution of cash, while a

reduction in allocated partnership liabilities is treated as a

distribution of cash.


Basis Adjustments for Liquidating Distributions

20


Basic Problem

• In many instances, there can be a significant difference between inside and outside basis.

• Inside basis is the tax basis of a member’s share of the LLC’s assets. Outside basis is the member’s tax basis in his or her LLC interest.

• Differences between inside and outside basis can create tax problems.

21


Example

• Smith, Jones and Dewey form Newco, LLC, by contributing $100,000 each. They each hold equal shares in Newco. Newco uses the cash to buy property that later increases in value to $600,000.

• Barlow pays $200,000 to Smith to buy his interest in Newco.

• Immediately after the purchase, Barlow has a $200,000 basis in his interest in Newco.

• Assume that shortly after the sale, Newco sells its sole asset for $600,000.

• Newco recognizes gain of $300,000 (purchase price of $600,000 less tax basis of $300,000). The gain is allocated equally to each member. Thus, $100,000 is allocated to Barlow.

22


Example

• Newco then distributes the $600,000 purchase price in equal shares to its members and liquidates. Thus, Barlow receives a $200,000 cash distribution.

• At the end of the day, then, Barlow receives a $100,000 allocation of income. This increases his outside tax basis from $200,000 to $300,000. He then receives a $200,000 cash distribution, which reduces his outside tax basis from $300,000 to $100,000. Because Newco liquidates, the remaining basis is treated as a capital loss.

23


Example

• Barlow, then has a $100,000 phantom gain (because there was no increase in value in Newco between the time Barlow purchased his interest and the time Newco sold its asset), and a $100,000 phantom loss. It is possible that these will offset each other, but if the gain is ordinary income, Barlow may mot be able to net it against the $100,000 capital loss.

• Another inefficiency arises if the asset is depreciable. Barlow paid $200,000 but at most will receive only $100,000 in cost recovery deductions.

• The Code contains a special elective regime to address these problems.

24


Section 754 Election

• Code section 754 provides for a special tax election that permits a tax basis increase in certain situations that will ameliorate differences between inside and outside tax basis.

• In the foregoing example, if Newco had a section 754 election in place, then the tax basis of Barlow’s share of the Newco asset would be increased from $100,000 to $200,000.

• Thus, Barlow would have no gain or loss on the sale described in the above example. Furthermore, to the extent the asset was depreciable, Barlow would be entitled to depreciation deductions based on the higher tax basis.

• If an LLC member dies, then the basis of his LLC interest increases to FMV. If there is a 754 election in place, the tax basis of the share of the LLC’s assets represented by such interest is stepped up to reflect the new outside basis.

26


Built-In Loss Adjustment

• Although the basis adjustments described above are voluntary, the Code also contains a mandatory basis adjustment.

• If there is a “substantial” built-in loss and there is a transfer of a partnership interest, then a mandatory basis reduction is required under Code section 743.

• For these purposes, a built-in loss is “substantial” if the LLC’s tax basis in its assets exceeds the FMV by more than $250,000.

• This provision is intended to prevent a partnership that has suffered a significant drop in value from selling off or trafficking in its unusually high inside basis.

27


Adjustments Related to Distributions

• Although basis adjustments can be triggered by the transfer of an LLC interest, distributions of property by the LLC can trigger gain or loss and therefore may create basis adjustment opportunities.

• Section 734 permits or requires the LLC to adjust the basis of its property as a result of certain distribution events. Like section 743, section 734 provides for a mandatory basis reduction in certain circumstances.

• The following paragraphs describe the four scenarios in which distributions can create opportunities for basis adjustments:

28


Scenario 1: Gain on Distribution

• Gain is recognized by an LLC member upon a distribution if the member receives money or marketable securities in an amount that is greater than the member’s outside basis.

• If the LLC has a 754 election in place, it is permitted to increase the basis of its remaining assets by the amount of gain recognized in such a distribution.


29


Scenario 2: Lost Basis

• If an LLC member receives a distribution of property other than cash, the member generally takes a basis in such property equal to the basis of the LLC. However, if that basis exceeds the member’s outside basis, a portion of the asset’s basis disappears (i.e., it is reduced to come within the cap of the member’s outside basis).

• If the LLC has a 754 election in place, it can increase the tax basis of its remaining assets by the amount of the disappearing basis.


30


Scenario 3: Loss on Liquidating Distribution

• If an LLC member receives a liquidating distribution of only cash or hot assets (or some combination of the same), then the member can recognize a loss to the extent the member’s outside basis exceeds the amount of the cash and the basis of the hot assets.

• If the LLC has a 754 election in place, it must decrease the tax basis of its remaining assets by the amount of loss so recognized in such a distribution.


31


Scenario 4: Additional Basis

• As noted, if an LLC member receives a distribution of property other than cash, the member generally takes a basis in such property equal to the basis of the LLC. However, in the case of a liquidating distribution, if the member’s outside basis is greater than the LLC’s basis in such property, the member’s basis in such property is increased to equal his or her outside basis.

• If the LLC has a 754 election in place, it is required to decrease the tax basis of its remaining assets by the amount of this additional basis.


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• Scenarios 3 and 4 occur only if a liquidating distribution occurs. If a section 754 election is in place, either scenario will require the LLC to decrease the tax basis of its remaining assets.

• However, even if there is no 754 election in place, if these scenarios give rise to “substantial” reductions, then the LLC much reduce the tax basis of its assets.

• For these purposes, “substantial” means

• in the case of scenario 3, that a member recognizes a loss of more than $250,000 upon the liquidating distribution, or

• in the case of scenario 4, that a member increases the basis of property received by more than $250,000.

Mandatory Basis Adjustments

33


Mechanics of the Election

• The 754 election is made by attaching a written statement to the LLC tax return.

• The election must be filed no later than the legal due date of the return (including extensions).

• The election applies to all transactions occurring in the period covered by the tax return.

• After an LLC has made a 754 election it is binding for all subsequent periods.

• An election can only be revoked with the approval of the IRS.

34


Mechanics of Basis AdjustmentsSection 743 Adjustments (Basis Adjustments Associated with Transfer of Partnership Interests)

• The process of allocating a basis adjustment in the case of section 743 requires several steps.

• First, the basis adjustment is allocated between ordinary income and capital gain assets in accordance with the amount of gain or loss that would be allocated to the LLC member in a hypothetical distribution.

• Second, within each category, the basis adjustment as determined is allocated to individual assets in accordance with the amount of gain or loss that would be allocated to the LLC member in a hypothetical distribution.

• Note that this often results in negative and positive adjustments if there are assets with built in gain or loss, notwithstanding an overall positive or negative adjustment.

35


Mechanics of Basis Adjustments

Section 734 Adjustments (Basis Adjustments Associated with Distributions)

• Scenario 1: Gain on Distribution

• positive adjustments are allocated only to capital gain assets

• Scenario 2: Lost Basis

• positive adjustments are allocated only to assets of the same class as those distributed

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• Scenario 3: Loss on Liquidating Distribution

• negative adjustments are allocated only to capital gain assets

• however, the adjustment is limited to the basis of such assets

• if the adjustment exceeds that basis, the difference is deferred until further assets are acquired

37



• Scenario 4: Additional Basis

• negative adjustments are allocated only to assets of the same class as those distributed

• however, the adjustment is limited to the basis of such assets

• if the adjustment exceeds that basis, the difference is deferred until further assets are acquired

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Death or Retirement

39


Death of a Member• Outside Basis Adjustment -- If a member dies, his or her interest will

pass to the member’s estate or successor, depending on the arrangements (if any) made by the member. The successor of the member takes a tax basis in the member’s LLC interest equal the FMV of such interest as of the date of death.

• Inside Basis Adjustment -- In addition, the transfer of the LLC interest to the member’s estate or successor is a transfer to which Code section 743 applies. Therefore, if the LLC has a section 754 election in place, the tax basis of the estate’s or successor’s share of the LLC’s property is adjusted so that it is equal to the estate’s new outside basis.

• Closing of Tax Year -- Once a member’s interest in an LLC terminates (by death or when liquidation payments are completed), the LLC’s tax year with respect to such member closes. As discussed above, the parties can elect to a pro-rata allocation of income or an actual closing of the books.

40


Liquidating Payments to aWithdrawing Member

• Code section 736 contains special rules that govern the treatment of payments made in liquidation of a dead or retiring member (a “withdrawing” member). They attempt to differentiate between payments for such a member’s interest in the LLC’s property and payments that are associated with the LLC’s income.

• The 736 rules apply to:

• payments by the LLC

• in liquidation of the entire interest

• of a retiring or deceased member.

41


Liquidating Payments for aWithdrawing Member

• The 736 rules do not apply to partial liquidation, but do apply to a series of payments over several years so long as the member’s entire interest is eventually liquidated.

• The member must be dead or must have ceased to be a member for local law purposes at the time of the payment. However, for tax purposes a member remains a partner for tax purposes until his or her interest is completely liquidated (i.e., until the final payment).

42


Liquidating Payments for aWithdrawing Member

• If a partner dies and his or her estate continues as a member of the LLC, the 736 rules do not apply to payments to the estate because there is no termination of the LLC interest.

• Note that the 736 rules apply regardless of how the member withdraws. Although this outline uses the terms “retiring” and “retired,” the rules also apply to liquidation payments in the case of an expelled member, or in the case of other voluntary and involuntary withdrawals.

• It is not clear whether the 736 rules apply to in-kind distributions rather than all-cash distributions. However, the rules do apply in the case of deemed cash distributions (i.e., because of a reduction in a member’s share of the LLC’s liabilities).

43


Section 736 Rules – Structure• Payments subject to section 736 are classified into

two different categories, each of which has slightly different tax results. The two types of payments are as follows:

• payments in exchange for the retiring member’s share of LLC property (referred to as section 736(b) payments), and

• all other payments (referred to as section 736(a) payments).

• In general, section 736(b) payments are taxed as if they were redemption payments. Thus, the rules discussed above that apply to liquidating distributions generally apply to section 736(b) payments.

44


Section 736 Rules – Structure• Section 736(a) payments are treated as not made in

respect of the member’s interest in the LLC’s property.

• In effect, they are viewed as proxies for income associated with the member.

• As a result, section 736(a) payments are classified as either:

• payments treated as a distributive share of LLC income or

• guaranteed payments.

• In either case, these payments offset or reduce the income that would otherwise be allocated to the remaining members.

45


Section 736 Rules – Structure

• Generally, the parties are permitted to come up with a reasonable allocation of liquidation payments between section 736(a) and section 736(b). This is because parties will often have adverse interests.

• For example, gain from section 736(b) payment will often be capital gain, which would be beneficial to the withdrawing member, while section 736(a) payments will often be ordinary income.

• The remaining members may prefer section 736(a) payments because such payments divert or offset income, while a section 736(b) payment generally must be capitalized (although depreciation or amortization deductions may be permitted with respect to the capitalized amount).

46


Section 736(b) Payments

If section 736(b) applies, then payments made to a withdrawing member are treated as made in exchange for his or her interest in the LLC’s property. While the LLC recognizes no gain or loss, there are several different tax consequences to the withdrawing member, depending on the facts of the payment.

1. Substantially Appreciated Inventory

• Section 736(b) payments allocable to a member’s share of the LLC’s substantially appreciated inventory are subject to the hot asset rules. Thus, any gain attributable to such assets is usually taxed as ordinary income, rather than capital gain.

47



2. Unrealized Receivables

Unless the special rule below applies, section 736(b) payments allocable to a member’s share of the LLC’s unrealized receivables are subject to the hot asset rules. Thus, any gain attributable to such assets is taxed as ordinary income.

3. All Other Property

Unless the special rule below applies, section 736(b) payments allocable to a member’s share of the LLC’s other property are taxed under the regular rules. Thus, a withdrawing partner has gain to the extent the amount of a cash distribution exceeds his or her outside basis (and has a loss to the extent his or her outside basis exceeds the amount of the cash distribution). Such gain or loss is usually taxed as capital gain or loss.

48



4. Special Rule

The foregoing rules for section 736(b) payments are subject to a complex exception. In order for the special rule to apply, the following conditions must be met:

• the withdrawing member is a general partner, and

• capital is not a material income-producing factor with respect to the partnership

49



• Although the term “general partner” is not defined, it could be argued that a member of an LLC would not qualify on the basis that members of an LLC are not liable for the debts of the LLC.

• However, it could also be argued that a manager-member of an LLC is analogous to the general partner of a limited partnership. The IRS has not issued any direct guidance on this issue.

• If the special rule applies, then payments to a member that are attributable to the LLC’s unrealized receivables and goodwill are classified as section 736(a) payments instead of section 736(b) payments.

50


Section 736(a) Payments

• If a liquidating payment to a withdrawing member is not treated as a section 736(a) payment (discussed above), then it is governed by section 736(a).

• Recall that a section 736(a) payment is treated as a distributive share of LLC income or a guaranteed payments. In addition, under the special rule described above, certain portions of what would otherwise be a section 736(b) payment to a withdrawing partner may be re-characterized as a section 736(a) payment.

51



• The tax consequences of section 736(a) payments are as follows:

• If section 736(a) payment is determined without regard to the LLC’s income, then it is treated as a guaranteed payment.

• NB: generally a guaranteed payment is taxable to the recipient as ordinary income and is deductible by the LLC.

52



• All other section 736(a) payments are treated as a distributive share of the LLC’s income.

• As a result, the payment is included in the income of the withdrawing member and the allocable income of the remaining members is reduced.

• Typically, the payment would be treated as ordinary income, but the character will depend on the character of the LLC’s income.

• Note that in both cases, a section 736(a) payment diverts income from the remaining members, either because the payment is deductible or because it reduces the other members’ distributive shares.

53


Mixed Payments

• A distribution to a withdrawing partners can consist of both section 736(a) and section 736(b) payments.

• If payments are fixed, then the portion of any payment that is treated as a section 736(b) payment is determined by multiplying the payment by a fraction, the numerator of which is the agreed value of the total payments for the member’s interest in the LLC’s property under section 736(b), and the denominator of which is the total amount of fixed payments.

• If payments are not fixed, the payments are first treated as section 736(b) payments to the extent of the value of the member’s interest in the LLC’s property. Subsequent payments (if any) are treated as section 736(a) payments.

55


Forms and Compliance

56

• Most of the specific compliance/reporting rules for terminations of partnership interests flow from section 751 and appear to be driven by concerns that partnerships and partners correctly re-characterize gain (or loss) under the hot asset rules.


Sale/Exchange vs. Redemption• Section 6050K sets up a reporting regime that requires

notices by various parties to termination of a partnership interest and typically requires the filing of IRS Form 8308.

• Note that Section 6050K is triggered by an exchange described in Section 751(a), which contemplates a transfer of a partnership interest by one partner to another partner or a buyer, not a redemption.

• Note that distributions are addressed in Section 751(b). Accordingly, it appears that the various requirements described in the following slides are not triggered by, for example, a liquidating distribution.

57


Notice by Partner to Partnership• The regulations under Section 6050K specify that a

selling partner has to notify the partnership within 30 days of a sale/exchange.

• The notice has to be in writing and has to list:

• The names and addresses of the transferor and transferee in the section 751(a) exchange;

• The taxpayer identification numbers of the transferor and, if known, of the transferee; and

• The date of the exchange.

• As a practical matter, the partnership may be unaware of the sale/exchange, so this is the first step to put the partnership on notice and start the process of producing the IRS Form 8308.

58


Issuance of Form 8038

• The regulations under Section 6050K specify that provided the partnership has received notice of a section 751(a) exchange, then it must prepare an IRS Form 8308 with respect to each such exchange.

• Note that Form 8308 contains only bare bones information: The names, addresses, and taxpayer identification numbers of the transferee and transferor in the exchange and of the partnership filing the return, and the date of the exchange.

• Note that the partnership and the partner will need detailed information as to 751 assets and how much of the gain/loss on the sale/exchange is re-characterized, but this is not contained in Form 8308.

59


Section 751(a) Statements

• The regulations under Section 751 require that the partner in a 751(a) or a 751(b) transaction (i.e., a sale/exchange or a distribution) must file a special statement with its tax return.

• In the case of a 751(a) transaction, the statement must list:

• the date of the sale or exchange;

• the amount of any gain or loss attributable to the section 751 property, and

• the amount of any gain or loss attributable to capital gain or loss on the sale of the partnership interest.

60


Section 751(b) Statements

• In the case of a 751(b) transaction, the statement must show the computation of any income, gain, or loss to the partner, as well as information similar to that required in the section 751(a) statement.

• Finally, the partnership itself is required to with respect to every 751(b) transaction to submit with its return for the year of the distribution a statement showing the computation of any income, gain, or loss to the partnership under the provisions of section 751(b).

61


Partnership/Partner Friction• Sometimes, a partnership may resist collecting and

sharing the information necessary for the departing partner to do its 751 analysis.

• While it appears that in the case of 751(b) transaction the partnership is required to file a statement with such information, it is not clear that it is similarly required to file such a statement in the case of a 751(a) transaction. The partnership may resist or demand a fee for the extra work involved.

• These disputes can be difficult to resolve, so it is best practice to incorporate into the redemption agreement some language requiring the partnership to provide all information reasonably necessary for the partner to compute its taxes.

62

© 2019 Smith, Gambrell & Russell, LLP, All Rights Reserved © 2019 Smith, Gambrell & Russell, LLP, All Rights Reserved

Thanks!

Joseph Mandarino

February 12, 2020

Smith, Gambrell & Russell, LLP

Promenade II, Suite 3100

1230 Peachtree Street, N.E.

Atlanta, Georgia 30309

www.sgrlaw.com

63

http://www.balch.com/

Centralized Partnership Audit Rules

64


• Under the new rules, any changes determined by the IRS in the course of an audit of apartnership will be made at the partnership level and the changes will be assessed to thepartnership in the year that the audit or a judicial review is completed.

•The amount of the tax will be calculated at the highest marginal rate for individuals orcorporations. The taxpayer representative will have an opportunity to try and demonstrateto the IRS that some or all of the assessment should be at a lower rate.

•This process will be administered by the IRS unless the partnership elects out of theserules. Electing out of the application of these rules can only be done by partnerships whichhave 100 partners or less and only have partners who are (i) individuals, (ii) estates, (iii) Ccorporations, (iv) S corporations, or (v) foreign entities that would be C corporations ifthey were domestic entities.

•The partnership must make the election out of the centralized audit regime on a timelyfiled return and include information regarding all partners on a new form.

65


• A push out election can be made upon examination, where the partnership would send

amended K-1s to all the former partners. Note that the partnership, not the IRS, must send out

amended K-1s. Partnerships wishing to make this election must do so within 45 days of

receipt of the notice of a partnership adjustment.

• The taxpayer representative replaces the Tax Matters Partner (TMP). The taxpayer

representative takes on a much greater role than the traditional TMP. Partners, other than the

taxpayer representative, will no longer have the right to participate in a partnership audit or

judicial proceeding. Partners will not even be notified by the IRS that the partnership is being

audited and will not be able to assist in the partnership’s defense.

• The taxpayer representative does not have to be a partner in the partnership and is selected

annually.

66

Centralized Partnership Audit Rules – Items to

Consider upon Termination

• Adjustments will burden partners with fiduciary responsibility for audits of prior years. Ifpartnership has terminated, election would definitely burden partners who no longer havecapital accounts.

• Lack of capital in partnership could cause issues regarding payment of assessment.

• Items may need to be reported on amended returns when no other partnership items of incomeor expense would be available to offset such adjustments.

• Taxpayer representative indemnities and limitations should be outlined in all agreements andshould consider what will happen if the partnership no longer exists.

• Documentation of applicable tax rates for partners should be gathered contemporaneously, asissues may arise in gathering such documentation if the partnership no longer exists.

• Documentation of partner information prior to a termination and mechanism for obtainingfuture contact information is critical in order to be able to contact former partners at the time ofan audit.

67

Transfer of Interests

68

Transfer of Interest

69

• Gain or loss recognized on a sale of a partnership interest is

considered capital gain/loss, unless such amount relates to

unrealized receivables or inventory.

• Unrealized receivables includes any right to payment for

goods (to the extent that the income would be ordinary) or

services.

• Inventory would include property primarily held for sale to

customers in the ordinary course of business.

Calculation of Gain

70

• Determine the overall gain realized

• Carve out any ordinary gain (valuation is extremely

important in this process)

• Residual gain is considered capital

Example

o Cash with a FMV of 2,000 and a basis of 2,000

o Land with a FMV of 10,000 and a basis of 8,000

o Unrealized receivables with a FMV of 5,000

71

• Partner sells a 50 percent partnership interest for $15,000 with the following balance

sheet:

• Liabilities equal $2,000

• Gain = $16,000 (cash plus liabilities assumed) – $5,000 (basis of 50 percent interest) =

$11,000

• $2,500 of gain relates to unrealized receivables and is ordinary gain

Other Items to Consider upon Termination

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• Generally, a negative “tax basis capital” exists when a partnership allocates taxdeductions or losses or makes distributions to a partner in excess of the partner’s taxbasis equity in the partnership.

• It can also arise when a partner contributes property subject to debt in excess of theproperty’s adjusted tax basis to a partnership.

• Schedule K-1 requires a partnership that does not report tax basis capital accounts to itspartners to report the amount of such partner’s tax basis capital both at the beginning ofthe year and at the end of the year if either amount is negative (note: applicable in Form8865 as well).

• This will provide the IRS with a roadmap for recapture of negative tax basis upontermination.

Negative Tax Basis Capital

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• IRC 163(j) limits deductions for business interest expense.

• While the prior version of IRC 163(j) applied almost exclusively to U.S. corporations with non-U.S.

parents, the current version of IRC 163(j) applies to taxpayers engaged in business in any form, with

limited exceptions.

• IRC 163(j) generally limits a taxpayer’s interest expense deductions for a taxable year to the sum of 30

percent of adjusted taxable income plus its business interest income. Taxpayers with average gross

receipts of less than $25 million over the preceding three taxable years are generally excluded from the

application of section 163(j) as are certain trades or businesses.

• A significant portion of current IRC 163(j) now deals with the interest expense of partnerships, as a result

of the complexity associated with Congress’ decision to treat partnerships as separate entities for certain

aspects of section 163(j) and as aggregates of their partners for others.

Partnership Basis Issues Resulting from Section 163J

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• The section 163(j) limitation is generally calculated in the first instance at the

partnership level. However, most of the remaining aspects of section 163(j) apply at the

partner level.

• Carryforwards of disallowed business interest expense are generally calculated at the

partner level. A partnership’s “excess business interest” and “excess taxable income”

are both allocated among the partners in the same manner as the partnership’s non-

separately stated taxable income or loss. “Excess taxable income” is defined as the

excess (if any) of 30 percent of the partnership’s adjusted taxable income over the

partnership’s business interest expense. The law adopted this partner-level carryforward

mechanism to take into account the fact that partners’ relative interests in their

partnerships are not necessarily fixed from year to year.


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• Partners must adjust the basis in their partnership interests to account for various aspects of the application of

section 163(j). Specifically, a partner must reduce its basis in the partnership for “excess business interest” (but

not to less than zero), even though the interest expense is disallowed. However, this basis reduction will be

subsequently reversed to the extent “excess business interest” is not used under the carryforward rules before

the partner sells or exchanges its partnership interest in either a taxable or tax-free transaction.

• To the extent that the basis reduction is reversed, neither the transferor nor the transferee will be permitted to

utilize the “excess business interest” that resulted in the initial basis reduction. A partner that has had its basis

in a partnership reduced as a result of the operation of section 163(j) will need to be cautious regarding certain

transactions that can ordinarily flow from a partner not having basis in its partnership interest. For instance,

the partner could find itself unable to take into account its distributive share of partnership losses or recognize

gain as a result of a distribution from the partnership in excess of basis.


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Other Filing Issues

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• Repeal of technical terminations

• Termination due to death/sale by partner with only one

remaining partner

• Conversion to disregarded entity and EINs

• Final tax returns and potential short year returns

• Recovery of deferred income items

• Previously disallowed losses

CONTACT

Follow us on:

Visit us at: www.mazarsusa.com

Faye Tannenbaum Partner, Mazars USA LLP

(P) 212.375.6713

(E) [email protected]

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http://www.weisermazars.com/

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Documents

Partnership Terminations: Sale or Abandonment of an …media.straffordpub.com/products/partnership-terminations...2020/02/12 · February 12, 2020 Partnership Terminations: Sale or