Question

Walter sells his 40 percent interest in Kennel Kids Playground with a partnership basis interest of $40,000 to George for $60,000. The partnership has the following assets: Cash = $50,000, inventory ($20,000 basis, $60,000 fair market value), and land ($30,000 basis; $40,000 fair market value). What are the tax effects of this sale on Walter’s taxable income?

Answer 1

Tax Effects Due to Sale of Partnership Interest by Walter on his Taxable Income

Partnership Interest : 40%

Walter's Basis in Partnership Interest : $40,000

Proceeds from Sale of Interest : $60,000

Step I :

Partnership Assets
Asset	Adjusted Basis	Fair Market Value
Cash	50,000	50,000
Inventory	20,000	60,000
Land	30,000	40,000
	100,000	150,000

Step II :

Calculation of Tax
Total Gain	20,000	(Sale Price - Partner's Outside Basis)
Ordinary Income	16,000	(Inventory FMV - Adjusted Basis of Inventory) * Partnership Interest
Capital Gain	4,000	(Total Gain - Ordinary Income)

Therefore the above mentioned Transaction will have the Following Tax Effects on Walter's Income:

1. Ordinary Income : $ 16,000

2. Capital Gain : $ 4,000

Explanations;

Sale or Exchange of Partnership Interest results in Capital Gain or Loss computed by:

Amount Realized - Adjusted Basis of Perner's Interest in Partnership

But there are certain Exceptions as well i.e,

" Where a Partner receives any Money or Property in Exchange of any Part of Partnership Interest , the amount due to his/her share of Unrealized Receivables or Inventory Items results in Ordinary Income or Loss.

The Computation of Ordinary Income or Loss will be through the following Formula:

FMV - Adjusted Basis * Partnership Interest