Question

Lonnie Davis has been a general partner in the Highland Partnership for many years and is also a sole proprietor in a separate business. To spend more time focusing on his sole proprietorship, he plans to leave Highland and will receive a liquidating distribution of $72,000 in cash and land with a fair market value of $135,500 (tax basis of $173,000). Immediately before the distribution, Lonnie’s basis in his partnership interest is $448,000, which includes his $79,500 share of partnership debt. The Highland Partnership does not hold any hot assets.

a. What is the amount and character of any gain or loss to Lonnie?

b. What is Lonnie’s basis in the land?
c. What is the amount and character of Lonnie’s gain or loss if he holds the land for 13 months as investment property and then sells it for $163,000?
d. Assume there are no gains from the sale of other Section 1231 in the same tax year. What is the amount and character of Lonnie’s gain or loss if he places the land into service in his sole proprietorship and then sells it 13 months later for $163,000?

Answer 1

Ans: (a)

	Amount	Character of gain or loss
Neither gain nor loss recognised	$0	None of the above

Lonnie does not recognize a gain because the $72,000 of cash he receives and debt relief of $79,500 are not greater than the tax basis in his interest of $448,000. Further ,Lonnie does not recognise a loss on the liquidating distribution because he receives assets other than cash and/or hot assets in the distribution ( i.e. the land).

Ans: (b)

Basis

$296,500

Lonnie's basis in the land is equal to his basis in his partnership interest of $448,000 reduced by the actual cash distribution of $72,000 and the deemed cash distribution of $79,500 from debt relief leaving a basis of $296,500 in the land.

Ans: (c)

	Amount	Character of gain or loss
Recognised loss	$133,500	$133,500 of capital loss

Lonnie will recognize a long-term capital loss of $133,500 or $ 163,000 less his $296,500 substituted basis in the land. The loss is a long-term capital loss because Lonnie held the land as a capital asset for more than one year.

Ans: (d)

	Amount	Character of gain or loss
Recognised loss	$133,500	$133,500 of Section 1231 loss

Lonnie will recognize a Section 1231 loss of $133,500 ( $ 163,000 less his $296,500 substituted basis in the land). The loss is a section 1231 loss because Lonnie held the land as a trade or business asset for more than one year making the land Section 1231 property. Losses from the sale or exchange of Section 1231 property are treated as ordinary assuming there are no gains from the sale of other Section 1231 in the same year.