Publication 541
taxmap/pubs/p541-007.htm#en_us_publink1000104314The following discussions explain the treatment of gain or loss
from the disposition of an interest in a partnership.
taxmap/pubs/p541-007.htm#en_us_publink1000104315A loss incurred from the abandonment or worthlessness of a partnership
interest is an ordinary loss only if both of the following tests are met.
- The transaction is not a sale or exchange.
- The partner has not received an actual or deemed distribution
from the partnership.
If the partner receives even a de minimis actual or deemed distribution,
the entire loss generally is a capital loss. However, see
Payments for Unrealized Receivables and Inventory Items, later.
For information on how to report an abandonment loss, see the
Instructions for Form 4797. See Revenue Ruling 93-80 for more information on
determining if a loss incurred on the abandonment or worthlessness of a
partnership interest is a capital or an ordinary loss.
taxmap/pubs/p541-007.htm#en_us_publink1000104316Generally, a partnership's basis in its assets is not affected
by a transfer of an interest in the partnership, whether by sale or exchange or
because of the death of a partner. However, the partnership can elect to make an
optional adjustment to basis in the year of transfer.
taxmap/pubs/p541-007.htm#en_us_publink1000104317The sale or exchange of a partner's interest in a partnership
usually results in capital gain or loss. However, see
Payments for Unrealized Receivables and Inventory Items,
later, for certain exceptions. Gain or loss is the difference
between the amount realized and the adjusted basis of the partner's interest in
the partnership. If the selling partner is relieved of any partnership
liabilities, that partner must include the liability relief as part of the
amount realized for his or her interest.
taxmap/pubs/p541-007.htm#en_us_publink1000104318Kumar became a limited partner in the ABC Partnership by contributing
$10,000 in cash on the formation of the partnership. The adjusted basis of his
partnership interest at the end of the current year is $20,000, which includes
his $15,000 share of partnership liabilities. The partnership has no unrealized
receivables or inventory items. Kumar sells his interest in the partnership for
$10,000 in cash. He had been paid his share of the partnership income for the
tax year.
Kumar realizes $25,000 from the sale of his partnership interest
($10,000 cash payment + $15,000 liability relief). He reports $5,000 ($25,000
realized − $20,000 basis) as a capital gain.
taxmap/pubs/p541-007.htm#en_us_publink1000104319The facts are the same as in Example 1, except that Kumar withdraws
from the partnership when the adjusted basis of his interest in the partnership
is zero. He is considered to have received a distribution of $15,000, his relief
of liability. He reports a capital gain of $15,000.
taxmap/pubs/p541-007.htm#en_us_publink1000104320An exchange of partnership interests generally does not qualify
as a nontaxable exchange of like-kind property. This applies regardless of
whether they are general or limited partnership interests or interests in the
same or different partnerships. However, under certain circumstances, such an
exchange may be treated as a tax-free contribution of property to a partnership.
See
Contribution of Property
under
Transactions Between Partnership and Partners, earlier.
An interest in a partnership that has a valid election in effect
under section 761(a) of the Internal Revenue Code to be excluded from the
partnership rules of the Code is treated as an interest in each of the
partnership assets and not as a partnership interest. See
Exclusion From Partnership Rules,
earlier.
taxmap/pubs/p541-007.htm#en_us_publink1000104321A partner who sells a partnership interest at a gain may be able
to report the sale on the installment method. For requirements and other
information on installment sales, see Publication 537.
Part of the gain from the installment sale may be allocable to
unrealized receivables or inventory items. See
Payments for Unrealized Receivables and Inventory Items,
later. The gain allocable to unrealized receivables and inventory
items must be reported in the year of sale. The gain allocable to the other
assets can be reported under the installment method.
taxmap/pubs/p541-007.htm#en_us_publink1000104322If a partner receives money or property in exchange for any part
of a partnership interest, the amount due to his or her share of the
partnership's unrealized receivables or inventory items results in ordinary
income or loss. This amount is treated as if it were received for the sale or
exchange of property that is not a capital asset.
This treatment applies to the unrealized receivables part of
payments to a retiring partner or successor in interest of a deceased partner
only if that part is not treated as paid in exchange for partnership property.
See
Liquidation at Partner's Retirement or Death,
later.
taxmap/pubs/p541-007.htm#en_us_publink1000104323Unrealized receivables include any rights to payment not already
included in income for the following items.
- Goods delivered or to be delivered to the extent the payment
would be treated as received for property other than a capital asset.
- Services rendered or to be rendered.
These rights must have arisen under a contract or agreement that
existed at the time of sale or distribution, even though the partnership may not
be able to enforce payment until a later date. For example, unrealized
receivables include accounts receivable of a cash method partnership and rights
to payment for work or goods begun but incomplete at the time of the sale or
distribution of the partner's share.
The basis for any unrealized receivables includes all costs or
expenses for the receivables that were paid or accrued but not previously taken
into account under the partnership's method of accounting.
taxmap/pubs/p541-007.htm#en_us_publink1000104324Unrealized receivables include potential gain that would be ordinary
income if the following partnership property were sold at its fair market value
on the date of the payment.
- Mining property for which exploration expenses were deducted.
- Stock in a Domestic International Sales Corporation (DISC).
- Certain farm land for which expenses for soil and water conservation
or land clearing were deducted.
- Franchises, trademarks, or trade names.
- Oil, gas, or geothermal property for which intangible drilling
and development costs were deducted.
- Stock of certain controlled foreign corporations.
- Market discount bonds and short-term obligations.
- Property subject to recapture of depreciation under sections
1245 and 1250 of the Internal Revenue Code. Depreciation recapture is discussed
in chapter 3 of Publication 544.
The income or loss realized by a partner upon the sale or exchange
of its interest in unrealized receivables and inventory items, discussed below,
is the amount that would have been allocated to the partner if the partnership
had sold all of its property for cash at fair market value, in a fully taxable
transaction, immediately prior to the partner's transfer of interest in the
partnership. Any gain or loss recognized that is attributable to the unrealized
receivables and inventory items will be ordinary gain or loss.
taxmap/pubs/p541-007.htm#en_us_publink1000104326You are a partner in ABC Partnership. The adjusted basis of your
partnership interest at the end of the current year is zero. Your share of
potential ordinary income from partnership depreciable property is $5,000. The
partnership has no other unrealized receivables or inventory items. You sell
your interest in the partnership for $10,000 in cash and you report the entire
amount as a gain since your adjusted basis in the partnership is zero. You
report as ordinary income your $5,000 share of potential ordinary income from
the partnership's depreciable property. The remaining $5,000 gain is a capital
gain.
taxmap/pubs/p541-007.htm#en_us_publink1000104327Inventory items are not limited to stock-in-trade of the partnership.
They also include the following property.
- Property that would properly be included in the partnership's
inventory if on hand at the end of the tax year or that is held primarily for
sale to customers in the normal course of business.
- Property that, if sold or exchanged by the partnership, would
not be a capital asset or section 1231 property (real or depreciable business
property held more than one year). For example, accounts receivable acquired for
services or from the sale of inventory and unrealized receivables are inventory
items.
- Property held by the partnership that would be considered
inventory if held by the partner selling the partnership interest or receiving
the distribution.
If a partner exchanges a partnership interest attributable to
unrealized receivables or inventory for money or property, he or she must notify
the partnership in writing. This must be done within 30 days of the transaction
or, if earlier, by January 15 of the calendar year following the calendar year
of the exchange. A partner may be subject to a $50 penalty for each failure to
notify the partnership about such a transaction, unless the failure was due to
reasonable cause and not willful neglect.
taxmap/pubs/p541-007.htm#en_us_publink1000104329When a partnership is notified of an exchange of partnership
interests involving unrealized receivables or inventory items, the partnership
must file Form 8308. Form 8308 is filed with Form 1065 for the tax year that
includes the last day of the calendar year in which the exchange took place. If
notified of an exchange after filing Form 1065, the partnership must file Form
8308 separately, within 30 days of the notification.
On Form 8308, the partnership provides its telephone number and
states the date of the exchange and the names, addresses, and taxpayer
identification numbers of the partnership filing the return and the transferee
and transferor in the exchange. The partnership must provide a copy of Form 8308
(or a written statement with the same information) to each transferee and
transferor by the later of January 31 following the end of the calendar year or
30 days after it receives notice of the exchange.
The partnership may be subject to a penalty of up to $100 for
each failure to timely file Form 8308 and a $50 penalty for each failure to
furnish a copy of Form 8308 to a transferor or transferee, unless the failure is
due to reasonable cause and not willful neglect. If the failure is intentional,
a higher penalty may be imposed. See Internal Revenue Code sections 6722, 6723,
and 6724 for details.
taxmap/pubs/p541-007.htm#en_us_publink1000104330If a partner sells or exchanges any part of an interest in a
partnership having unrealized receivables or inventory, he or she must file a
statement with his or her tax return for the year in which the sale or exchange
occurs. The statement must contain the following information.
- The date of the sale or exchange.
- The amount of any gain or loss attributable to the unrealized
receivables or inventory.
- The amount of any gain or loss attributable to capital gain
or loss on the sale of the partnership interest.
In general, any gain or loss on a sale or exchange of unrealized
receivables or inventory items a partner received in a distribution is an
ordinary gain or loss. For this purpose, inventory items do not include real or
depreciable business property, even if they are not held more than 1 year.
taxmap/pubs/p541-007.htm#en_us_publink1000104332Oscar, a distributee partner, received his share of accounts
receivable when his law firm dissolved. The partnership used the cash method of
accounting, so the receivables had a basis of zero. If Oscar later collects the
receivables or sells them, the amount he receives will be ordinary income.
taxmap/pubs/p541-007.htm#en_us_publink1000104333If a distributee partner sells inventory items held for more
than 5 years after the distribution, the type of gain or loss depends on how
they are being used on the date sold. The gain or loss is capital gain or loss
if the property is a capital asset in the partner's hands at the time sold.
taxmap/pubs/p541-007.htm#en_us_publink1000104334Marucia receives, through dissolution of her partnership, inventory
that has a basis of $19,000. Within 5 years, she sells the inventory for
$24,000. The $5,000 gain is taxed as ordinary income. If she had held the
inventory for more than 5 years, her gain would have been capital gain, provided
the inventory was a capital asset in her hands at the time of sale.
taxmap/pubs/p541-007.htm#en_us_publink1000104335If a distributee partner disposes of unrealized receivables or
inventory items in a nonrecognition transaction, ordinary gain or loss treatment
applies to a later disposition of any substituted basis property resulting from
the transaction.
taxmap/pubs/p541-007.htm#en_us_publink1000104336Payments made by the partnership to a retiring partner or successor
in interest of a deceased partner in return for the partner's entire interest in
the partnership may have to be allocated between payments in liquidation of the
partner's interest in partnership property and other payments. The partnership's
payments include an assumption of the partner's share of partnership liabilities
treated as a distribution of money.
For income tax purposes, a retiring partner or successor in interest
of a deceased partner is treated as a partner until his or her interest in the
partnership has been completely liquidated.
taxmap/pubs/p541-007.htm#en_us_publink1000104337Payments made in liquidation of the interest of a retiring or
deceased partner in exchange for his or her interest in partnership property are
considered a distribution, not a distributive share or guaranteed payment that
could give rise to a deduction (or its equivalent) for the partnership.
taxmap/pubs/p541-007.htm#en_us_publink1000104338Payments made for the retiring or deceased partner's share of
the partnership's unrealized receivables or goodwill are not treated as made in
exchange for partnership property if both of the following tests are met.
- Capital is not a material income-producing factor for the
partnership. Whether capital is a material income-producing factor is explained
in the discussion under
Family Partnership near the beginning of this publication.
- The retiring or deceased partner was a general partner in
the partnership.
However, this rule does not apply to payments for goodwill to
the extent that the partnership agreement provides for a reasonable payment to a
retiring partner for goodwill.
Unrealized receivables includes, to the extent not previously
includible in income under the method of accounting used by the partnership, any
rights (contractual or otherwise) to payment for (1) goods delivered, or to be
delivered, to the extent the proceeds therefrom would be treated as amounts
received from the sale or exchange of property other than a capital asset, or
(2) services rendered, or to be rendered.
taxmap/pubs/p541-007.htm#en_us_publink1000104339Generally, the partners' valuation of a partner's interest in
partnership property in an arm's-length agreement will be treated as correct. If
the valuation reflects only the partner's net interest in the property (total
assets less liabilities), it must be adjusted so that both the value of, and the
basis for, the partner's interest include the partner's share of partnership
liabilities.
taxmap/pubs/p541-007.htm#en_us_publink1000104340Upon the receipt of the distribution, the retiring partner or
successor in interest of a deceased partner will recognize gain only to the
extent that any money (and marketable securities treated as money) distributed
is more than the partner's adjusted basis in the partnership. The partner will
recognize a loss only if the distribution is in money, unrealized receivables,
and inventory items. No loss is recognized if any other property is received.
See
Partner's Gain or Loss under
Partnership Distributions, earlier.
taxmap/pubs/p541-007.htm#en_us_publink1000104341Payments made by the partnership to a retiring partner or successor
in interest of a deceased partner that are not made in exchange for an interest
in partnership property are treated as distributive shares of partnership income
or guaranteed payments. This rule applies regardless of the time over which the
payments are to be made. It applies to payments made for the partner's share of
unrealized receivables and goodwill not treated as a distribution.
If the amount is based on partnership income, the payment is
taxable as a distributive share of partnership income. The payment retains the
same character when reported by the recipient that it would have had if reported
by the partnership.
If the amount is not based on partnership income, it is treated
as a guaranteed payment. The recipient reports guaranteed payments as ordinary
income. For additional information on guaranteed payments, see
Transactions Between Partnership and Partners,
earlier.
These payments are included in income by the recipient for his
or her tax year that includes the end of the partnership tax year for which the
payments are a distributive share or in which the partnership is entitled to
deduct them as guaranteed payments.
Former partners who continue to make guaranteed periodic payments
to satisfy the partnership's liability to a retired partner after the
partnership is terminated can deduct the payments as a business expense in the
year paid.
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