Question

Greg, Yenny, Rachel, and Harry form an equal partnership between partners. It has the following assets: $30,000 in cash, inventory worth $40,000 in which the partnership has a basis of $20,000, and a capital asset worth $20,000 in which the partnership has a basis of $12,000. The partnership distributes $22,500 in cash to Greg in liquidation of Greg's interest in the partnership when Greg has a basis of $15,500. What are the tax consequences? Explain the answer

A. Greg recognizes a capital gain of $7,000. The partnership does not adjust the basis of any of its assets.

B. Greg recognizes an ordinary gain of $5,000 and a capital gain of $2,000. The partnership does not adjust the basis of any of its assets unless an election under Section 754 is in effect.

C.Greg recognizes an ordinary gain of $5,000 and a capital gain of $2,000. The partnership’s overall basis in inventory is increased by $5,000.

D.Greg recognizes a capital gain of $7,000. The partnership increases its basis in property by $7,000 due Greg's recognition of gain.

Answer 1

Part A:

Since the partnership has not adjusted the basis of any of its assets thus, the capital gain recognized by Greg, i.e. $7,000, will be taxed in the hands of Greg. The capital gain of $7,000 will be taxed as per the income tax rules in the country.

Part B:

Again since the partnership has not adjusted the basis of its assets the ordinary gain recognized by Greg, i.e. $5,000, would be considered to compute his taxable income. The capital gain of $2,000 will be taxed in the hands of Greg as capital gain.

Part C:

In this case since the partnership has increased its overall basis in inventory by $5,000 thus, the ordinary income of $5,000 recognized by Greg will not be considered to compute the taxable income of Greg. However, the balance $2,000 will be taxed in the hands of Greg as capital gain.

Part D:

In this case since the partnership has increased its basis in property by $7,000, i.e. the entire gain accrued to Greg, thus, there would be no tax implications to Greg for the gain of $7,000.