Question

Partner A owns a one-interest in the ABC cash method, calendar year general partnership, which manufactures and sells inventory. A, B and C, the original partners, each made initial cash contributions of $75,000. All income has been distributed as earned. On January 1^st, A sells his interest in the partnership to D. Consider the tax consequences of the sale to A, assuming he has owned his partnership interest for several years. The balance sheet of the ABC partnership (which is to be used in all parts of this problem unless the facts indicate to the contrary) is as follows:

                Assets                       Partners’ Capital

              A.B.      F.M.V.                 A.B.        F.M.V.

Cash    $45,000   $45,000    A        $75,000    $135,000

Inventory75,000     90,000    B          75,000      135,000

A/R            0        45,000    C          75,000       135,000

CA     105,000    225,000    Total $225,000      $405,000

Total:$225,000 $405,000

Consider the tax consequences to A on his sale in the following alternative situations:

(a) A sells his interest for $135,000 cash.

(b) Each partner originally contributed $150,000 cash (and assume each has an outside basis of $150,000), and the capital asset has a basis to the partnership of $330,000. A sells his interest to D for $135,000 cash.

(c) Each partner originally contributed only $45,000 cash instead of $75,000, and the capital asset was purchased and held subject to a $90,000 liability. A sells his interest to D for $105,000 cash.

(d) The sale occurs on March 31, one quarter of the way through the year, at a time when A’s share of partnership income through March 31 (all ordinary income) is $30,000. It is agreed that D will pay A $165,000 for his interest and also will acquire A’s right to income.

Answer 1

Part A

1. STEP ONE
   1. $135k AR – $75k AB = $60k gain
   2. If there’s no liabilities, tax capital accounts should equal partners’ basis in the partnership
2. STEP TWO(A)
   1. Capital gain (loss) in absence of § 751 = $60k
      1. § 741: gain/loss from sale of a p’ship interest is capital
3. STEP TWO(B)
   1. Hypothetical Sale of § 751 Property

Inventory	Accounts Receivable
AR           $90k AB           ($75k) Gain        $15k	AR           $45k AB           (0) Gain        $45k

1. Total Gain = $60k
2. A’s share = $20k
3. A has § 751 ordinary income of $20k
4. § 741: $60k gain – $20k OI = $40k capital gain
   1. Since A held the p’ship interest for several years, it’s LTCG
5. Note: if A had contributed the accounts receivable, the built-in gain of $45k would be allocated to A in the hypothetical sale under § 704(c)

Part B

1. STEP ONE
   1. $135k AR – $150k AB = $15k loss
2. STEP TWO(A)
   1. Capital gain (loss) in absence of § 751 = $15k
3. STEP TWO(B)
   1. Hypothetical Sale of § 751 Property

Inventory	Accounts Receivable
AR           $90k AB           ($75k) Gain        $15k	AR           $45k AB           (0) Gain        $45k

1. Note: § 751 property does not include capital assets
2. Total Gain = $60k
3. A’s share = $20k
4. A has § 751 ordinary income of $20k
5. § 741: $15k loss – $20k OI = $35k LTCL

Part C

1. STEP ONE
   1. $135k AR – $75k AB = $60k gain
   2. AR
      1. § 1001(b): $105k cash received
      2. § 752(d); Reg. 1.752-1(h): $30k liability relief
   3. AB
      1. § 722: $45k cash contributed
      2. §§ 752; 722: $30k share of liability
2. STEP TWO
   1. Same result as part (a)

Part D

1. STEP ONE
   1. $165k AR – $105k AB = $60k gain
   2. AR
      1. § 1001(b): $165k cash received
   3. AB
      1. $75k original outside basis
      2. $30k income through March 31
         1. § 706(c)(2)(A): p’ship taxable year closes w/ respect to a partner upon sale of her entire interest
         2. Reg. § 1.706-1(c)(2)(ii): where a partner sells her entire interest, the partner shall include . . . his distributive share of items in § 702(a)
            1. § 702(a)(7) includes OI
         3. § 705(a)(1)(A): outside basis is increased by partner’s share of p’ship taxable income
2. STEP TWO
   1. Same result as part (a)