Pope Phft2017 Corp SM 10

Chapter C:10
Special Partnership Issues

Discussion Questions
C:10-1A liquidating distribution. A current distribution is a distribution that does not terminate
the partners interest in the partnership, nor is the payment one of a series of payments intended to
terminate the partners interest in the partnership. A liquidating distribution is made with the
intention of terminating the partners entire interest in the partnership either with this payment or
with a planned series of payments including this one. The January distribution to Javier is the first
in a series of distributions that will terminate his interest in the partnership and, therefore, is a
liquidating distribution. p. C:10-2.
C:10-2 The basis of a single asset received in a liquidating distribution is determined by two
factors: the basis of the distributed property in the partnerships hands and the distributee
partners basis in his or her partnership interest prior to the distribution. However, the total basis
to the distributee partner of the assets received generally will equal the partners basis in the
partnership interest immediately prior to the distribution. Because Mariel received a single asset
that was not money, accounts receivable, or inventory, her basis will be $60,000 in the land
regardless of what the partnerships basis in the land was prior to its distribution. pp. C:10-12
through C:10-14.
C:10-3 Cindys basis for the property she receives will be reduced to $4,000 from its $4,500 basis
to the CDE Partnership because it is limited to Cindys basis in her partnership interest before the
distribution. Even though Cindy will hold the property as an investment, the sale of the inventory
would generate ordinary income for five years from the date of the distribution. The sale of the
capital asset would generate long-term capital gain that is taxed at the applicable capital gains
rate. pp. C:10-4 through C:10-7.
C:10-4 Sec. 1245 depreciation recapture potential. The partnerships accounts receivable probably
are not unrealized receivables because the partnership uses the accrual method of accounting.
However, depreciation recapture potential under Secs. 1245 is treated as an unrealized receivable.
The partnership has Sec. 1245 recapture potential on the machines used to produce the inventory
(and presumably also from other machinery, furniture, and equipment the partnership owns). The
building has no Sec. 1250 recapture potential, and therefore does not produce an additional
unrealized receivable because it was depreciated under MACRS, which requires straight-line
depreciation. The building, however, does have unrecaptured Sec. 1250 gain potential, but
unrecaptured Sec. 1250 gain is not an unrealized receivable. p. C:10-8.
C:10-5 a, b, c, e. In essence, any property that is not a capital asset or Sec. 1231 property (to the
extent exceeding Sec. 1245 and Sec. 1250 elements). p. C:10-8.
C:10-6 For Sec. 751 to come into play in a current distribution, the distributing partnership must
have both Sec. 751 assets (unrealized receivables and/or substantially appreciated inventory) and
non-Sec. 751 assets. In addition, the distributee partner must have given up some of his or her
Copyright 2017 Pearson Education, Inc.
C:10-1
interest in one of the two classes of assets in exchange for an increased interest in the other class
of assets. In other words, the distribution must be disproportionate. p. C:10-9.
C:10-7 Under Sec. 731, a partner can recognize a loss on a distribution only if the distribution is a
liquidating distribution that consists only of money, unrealized receivables, and/or inventory. The
partner recognizes a loss if the amount of money and the carryover basis of the receivables and
inventory are less than the partners predistribution basis in his or her partnership interest. p.
C:10-12.
C:10-8 Yes. In determining the character of gain and/or loss on the sale of a partnership interest,
the partnership is deemed to sell all its assets in a hypothetical sale for their FMV. The selling
partner is then allocated his or her share of the ordinary income or loss from the sale of Sec. 751
assets. The partners residual gain or loss on the sale is capital gain or loss. If the partnership
owns loss assets in addition to Sec. 751 assets, the allocable ordinary income could exceed the
partners total gain, in which case the residual amount would be a capital loss. This result occurs
in Example C:10-20 in the text. pp. C:10-16 through C:10-19.
C:10-9 a. When Tyras interest in the partnership terminates, she will be deemed to have
received a money distribution in the amount of her interest in partnership liabilities. Because she
has a zero basis, she must report gain equal to the money distribution. Any other property she
receives in the distribution will have a zero basis.
b.
The amount realized will equal the sum of the money received and any liabilities
assumed by the purchaser. Because her basis is zero she will report a large gain. pp. C:10-12 and
C:10-16 through C:10-18.
C:10-10 If the entire partnership terminates, the Sec. 736 provisions do not apply at all. Rather
each partner is taxed under the liquidating distribution rules. Section 736 applies if one or more
partners (but fewer than all the partners) dies or retires. Accordingly, Sec. 736 applies to the
payments to Tom. pp. C:10-19 and C:10-20.
C:10-11 Section 736 divides payments into two categories. Section 736(b) payments are for a
partners interest in partnership property, and these payments are taxed under the rules for
liquidating distributions. The partner recognizes capital gain if she receives money exceeding
basis in her partnership interest, so Lucia will report a capital gain of $3,000 ($23,000 - $20,000)
on the payment she receives for partnership assets.
Section 736(a) payments will be taxed as a guaranteed payment (ordinary income) if the
distribution is not based on partnership income. If the payment is based on partnership income,
the partner will be taxed on a distributive share of partnership income with the character of the
income determined at the partnership level. Accordingly, Lucia will report her share of
partnership income as a distributive share. pp. C:10-19 and C:10-20.
C:10-12 The advantages of terminating a partnership include the termination of tax accounting
elections, which also may be disadvantageous, and the possibility of an accelerated loss flow
through when the terminated partnerships year closes. The disadvantages of a termination may
include loss of a favorable tax year and the bunching of income for the partners. The advantage
C:10-2
or disadvantage of changed asset bases no longer exists under current Treasury Regulations. See
Reg. Sec. 1.708-1(b)(1)(iv). pp. C:10-22 through C:10-25.
C:10-13 A publicly traded partnership (PTP) is defined as a partnership whose interests are either
traded on an established securities exchange or are traded in a secondary market or the equivalent
thereof. Two groups of PTPs are not taxed as corporations. A PTP that existed on December 17,
1987, and which has not added a substantial new line of business, was not taxed as a corporation
until tax years beginning after December 31, 1997. These partnerships, which were grandfathered
under the 1987 law for ten years, were granted a new election in the Taxpayer Relief Act of 1997
(TRA of 1997). The TRA of 1997 allows these PTPs to continue to be taxed as partnerships if they
elect to do so and agree to pay an annual tax of 3.5% of gross income from the partnerships trade
or business. Partnerships that have 90% or more of their gross income being qualifying income
(interest, dividends, real property rents, etc.) continue to be taxed as partnerships. pp. C:10-29 and
C:10-30.
C:10-14 From a legal standpoint, all the owners of a limited liability company (LLC) have limited
liability for the firms debts. In a limited partnership, all general partners have significant liability
for firm debts. Under the check-the-box regulations, an LLC can choose whether to be treated as
a partnership or taxed as a corporation. If the LLC chooses partnership treatment, the LLC and
the limited partnership are treated similarly except the limited partnership must have at least one
general partner. p. C:10-30.
C:10-15
An electing large partnership is a partnership that is not a service partnership, is
not engaged in commodity trading, has at least 100 partners, and files an election to be taxed as
an electing large partnership. The primary advantage to the partnership of electing to be an
electing large partnership is that the reporting of income to the large number of partners is
simplified. Relatively few items are separately stated so that the reporting process is more
difficult than for a corporation but easier than for a non-electing partnership. Note: Sec. 775 for
electing large partnerships is repealed for tax years beginning after 2017. Thus, the rules
discussed in this section are applicable only for tax years beginning before 2018. pp. C:10-32
through C:10-34.
Issue Identification Questions

C:10-16
Does Kayla recognize a gain or loss on the current distribution?

What is Kaylas basis in the office equipment?
When does Kaylas holding period begin for the property?
Does any depreciation recapture carryover to Kayla from the partnership?
What is Kaylas basis in her partnership interest following the distribution?
Kayla recognizes no gain or loss on the distribution. Her basis for the equipment would
be a carryover basis from the partnership ($35,000) if that were possible, but it is limited to her
basis in her partnership interest prior to the distribution ($30,000). Kaylas holding period for the
office equipment includes the holding period the partnership had for the property. Her basis in the
partnership interest is zero following the distribution. The depreciation recapture potential is an
unrealized receivable that will generate ordinary income under Sec. 735 (a)(1) when Kayla sells
the property. pp. C:10-2 through C:10-7.
C:10-3
C:10-4
C:10-17
How much is Joels distribution?

Does the partnership have Sec. 751 assets?
If the partnership has Sec. 751 assets, did Joel exchange any interest in Sec. 751
assets for cash?
How much ordinary income must Joel recognize if he exchanges Sec. 751 assets
for cash?
How must Joel treat any cash distribution received that exceeds the amount
deemed to be part of the Sec. 751 exchange?
The amount of the distribution includes both the cash and the relief from liabilities that he
received when his interest in the partnership changed from one-third to one-fourth. The
partnership probably has Sec. 751 assets because the partnership inventory is substantially
appreciated. Furthermore, the cash basis partnership probably has unrealized accounts receivable,
and the partnership may have recapture potential if it has any depreciable personality. Again, an
exchange of Sec. 751 assets for cash probably occurred because Joel received only cash and
probably gave up a portion of his interest (from one-third to one-fourth) in each Sec. 751 asset.
The amount of ordinary income is the difference between the amount of cash Joel is deemed to
have received for the Sec. 751 assets and the adjusted basis that Joel would have had in the Sec.
751 assets had the Sec. 751 assets been distributed to Joel immediately before the deemed Sec.
751 sale (usually a carryover from the partnerships basis in these Sec. 751 assets). Any cash or
deemed cash exceeding the amount deemed to be part of the Sec. 751 exchange is treated as a
current distribution. The current distribution will reduce his basis in his partnership interest. If the
current distribution is greater than his basis in the partnership interest, Joel will recognize gain
because he receives cash exceeding his basis.
Note: The discussion in this chapter pertaining to disproportionate distributions conforms to
existing Treasury Regulations under Sec. 751(b). The Treasury Department has issued proposed
regulations that would alter the method for calculating disproportionate distributions and their tax
consequences. When this textbook went to press, those regulations were still only proposed.
Therefore, this textbook continues to apply the methods contained in existing Treasury
Regulations.
pp. C:10-7 through C:10-11.
C:10-18
Does the partnership have Sec. 751 assets?

What is the amount and character of the gain on the sale of Scotts partnership
interest?
Should the partnership make a Sec. 754 election so Sally can obtain an optional
basis adjustment?
The partnership has no unrealized receivables, but the partnership does have inventory.
The results of the sale are determined as follows:
Application of step 1 yields the following gain on Scotts sale of his partnership interest:
Amount realized on sale
$43,000
Minus: Adjusted basis of partnership interest ( 33,000)
Total gain realized
$10,000
C:10-5
Application of step 2 yields the following allocation to Sec. 751 property:

Deemed Sale of
Assets
Partnership
Gain
Inventory
$9,000
Building
15,000a
Land
6,000
a
$5,400 of which is unrecaptured Sec. 1250 gain.
b
$1,800 of which is unrecaptured Sec. 1250 gain.
Scotts Share
(1/3)
$3,000
5,000b
2,000
Thus, on the sale of his partnership interest, Scott recognizes $3,000 of ordinary income
and $1,800 of unrecaptured Sec. 1250 gain.
Application of step 3 yields the following residual allocation to capital gain:
Total gain realized
Minus:Allocation to ordinary income and unrecaptured Sec. 1250 gain
Capital gain recognized
$10,000
( 4,800)
$ 5,200
In summary, on the sale of his partnership interest, Scott recognizes $3,000 of ordinary income,
$1,800 of unrecaptured Sec. 1250 gain, and a $5,200 capital gain.
If the partnership made a Sec. 754 election, Sallys optional basis adjustment would be
calculated as follows:
Cash purchase price
$43,000
Minus: Sallys share of partnerships
basis in assets (1/3 x $99,000)
( 33,000)
Optional basis adjustment
$ 10,000
The optional basis adjustment would be allocated $3,000 to the inventory, $5,000 to the building,
and $2,000 to the land.
pp. C:10-16 through C:10-19 and C:10-26 through C:10-28.
C:10-19 Drew and Dana should consider the following:
The sale as contemplated will terminate the partnership. Is termination of the

partnership desirable for Drew and Dana?
Will either individual have to recognize gain? The recognition of gain is unlikely
unless Drew and Dana have a small basis relative to the cash held by the
partnership and deemed distributed in the liquidating distribution.
What will be the basis for each of the assets? Under current Treasury Regulations,
the termination will be deemed to result in the old partnership contributing the
property directly to the new partnership so that no adjustment to asset bases is
likely to occur.
Will income be bunched into a single tax year if the partnership terminates?
Termination of the partnership closes a tax year. If the partnership has the same tax
C:10-6
year-end as Drew and Dana, no bunching of income will occur. If their tax years
differ, however, some bunching will occur.
When the partnership terminates, all elections are lost. Are there advantages or
disadvantages from losing all existing elections? A few advantageous tax year-ends
for old partnerships were grand fathered when Congress enacted the rules
imposing required partnership tax year-ends. The loss of this tax benefit would be
a significant disadvantage.
Would liquidation by the partnership be more advantageous than a sale to the other
partners? Liquidation by the partnership does not terminate the partnership.
David should consider:
How much of his gain from the sale would be considered sale from his interest in
Sec. 751 assets and, therefore, taxed as ordinary income? His sale will result in
ordinary income to the extent of his share of ordinary income upon the
hypothetical sale of underlying Sec. 751 assets.
Will the sale cause a bunching of income from the partnership for David?
Because the sale of the entire partnership interest closes the partnership tax
year for the selling partner, the sale will cause bunching of income if Davids tax
year-end is different from DDDs tax year-end.
Could the transaction be structured in such a way that a liquidation by the

partnership would be more beneficial to David? Possibly. If Drew and Dana really
do not want the partnership to terminate, they may be willing to pay David more in
a liquidating distribution than they were willing to pay for an outright purchase.
pp. C:10-16 through C:10-19, C:10-22 through C:10-25.
C:10-20
Does the partnership terminate for tax purposes?

If so, when does the termination occur?
The partnership terminates because only one partner remains. The partnership terminates
when the final Sec. 736 payment occurs. pp. C:10-22 through C:10-25.
C:10-21
Is this gift going to make Haley a partner in the HotWheels LLC for tax purposes?
If Alex restructures the gift so that Haley has true control over the interest, how
will the LLCs income be allocated between Alex and Haley?
Haley probably will not be a partner. For Haley to be considered a partner, she
must have control of the interest. For a minor, control includes the situation where the
interest is placed in trust for the benefit of the minor but only if the trustee is someone
who will act in the best interest of the trust beneficiary. It is not clear that Alex is giving
up any control over this interest since he will continue to control the 15% share he placed
into Haleys trust. Thus, Haley is unlikely to be considered a partner. A two-step
allocation process will be used to allocate partnership income. First, Alex must be
allocated a FMV salary. His current salary is described as small, and it may be too small
to be considered equal to the
FMV of his services. Once Alex is allocated a FMV salary, all other income allocated to
Alex and Haley must be divided on a pro rata basis. Alex must receive three-fourths and
C:10-7
Haley must receive one-fourth. In effect, the family partnership income allocation rules
override the special allocation to Alex. pp. C:9-30, C:9-31, and C:10-30.
C:10-22
Should Krypton choose to be taxed as a partnership or as a corporation?

How much will be kept in the business for growth, and how much will be distributed
to the owners each year? The larger the percentage of earnings that will be
distributed, the more advantageous a flow-through entity such as a partnership can
be.
What is the marginal tax rate for Jeff, Susan, and Richard? If Jeff, Susan, and Richard
have lower marginal tax rates than does Krypton, partnership status has advantages.
How should Jeffs pay for operating the business be structured? If the business is
taxed as a corporation, a generous but reasonable salary will decrease the amount
of income subject to double taxation. However, given the lower capital gains rate
on dividend income, double taxation is not as detrimental as it could be if dividends
were taxed as ordinary income. If the business is structured as a partnership, the
partners need to decide whether to structure the payment as distributive share, as
an outright guaranteed payment, or whether to establish a guaranteed minimum
that may be some combination of the two. pp. C:2-3 through C:2-8 and C:10-31.
C:10-23 What method should XYZ Limited Partnership choose to use to operate under the
publicly traded partnership rules?
Pay the annual 3.5% of gross income tax and continue to be taxed as a publicly
traded partnership?
Buy back enough interests (or restrict opportunities for trading) so the partnership
is no longer publicly traded?
Incorporate the entity and be taxed as a regular C corporation?
If the XYZ Limited Partnership chooses to continue as a partnership, should it
elect to come under the electing large partnership rules?
The best alternative will be a function of the amount of gross income, amount of taxable
income, tax rates of the partners, amount of profits the firm wants to retain, and costs of buying
back partnership interests, and/or restricting trading, or incorporating.
The election reduces the partnerships annual cost of providing information to partners
but will require some start-up cost to make the change. The election also has the advantage of
making it more difficult to accidentally terminate the partnership because of trades. However, the
election significantly reduces the partners reporting and audit options.
pp. C:10-29 and C:10-30.
C:10-8
Problems
C:10-24a.
Ending partnership interest basis is $7,000, determined as follows:

Beginning basis
Minus: Cash received
Land basis
Ending basis
$ 25,000
( 4,000)
( 14,000)
$ 7,000
Lisa recognizes no gain. Her basis in the land is $14,000.

b.
Ending partnership interest basis is zero, determined as follows:

Beginning basis
Basis before distribution of land
Minus: Basis of land to Lisa
Ending basis
$ 25,000
( 4,000)
$ 21,000
( 21,000)
$
-0-
Lisa recognizes no gain. Her basis in the land is limited to $21,000, which is the basis of
her partnership interest reduced by the cash distributed.
c.

Beginning basis
Basis before distribution of land (but not less than zero)
Ending basis
$ 25,000
( 28,000)
$
-0-0$
-0-
Lisa recognizes a $3,000 gain, the amount by which cash distributed exceeds her
partnership basis before the cash distribution. Her basis in the land is limited to zero, which is the
basis of her partnership interest reduced by the cash distributed.
d.

Beginning basis
Basis before distribution of property
Minus: Basis of receivables and inventory
Basis before distribution of land
Ending basis
$ 25,000
( 4,000)
$ 21,000
( 10,000)
$ 11,000
( 11,000)
$
-0-
Lisa recognizes no gain. Her basis in the receivables is zero, and her basis in the
inventory is $10,000. Her basis in the land is limited to $11,000, which is the basis of her
partnership interest reduced by the cash distributed and by the basis of receivables and inventory
distributed.
C:10-9
e.
FMV of land distributed

Minus: Basis of land distributed
Gain recognized by the corporation (Sec. 311(b))
$ 30,000
( 14,000)
$ 16,000
In addition, the corporation increases its E&P by the E&P gain (which also is $16,000),
decreases E&P by taxes on the tax gain, and decreases E&P by the $34,000 ($4,000 cash +
$30,000 FMV of land) dividend distribution to Lisa (Sec. 312).
Lisa recognizes a $34,000 ($4,000 cash + $30,000 FMV of land) dividend (Sec. 301(c)
and Sec. 316). Her basis in the land is its $30,000 FMV (Sec. 301(d)), and her basis in her
corporate stock remains at $25,000.
f.
FMV of land distributed

Minus: Basis of land distributed
Gain recognized by the corporation (Sec. 311(b))
$ 30,000
( 14,000)
$ 16,000
One-half the $16,000 gain passes through to Lisa.

Lisas basis in S corporation stock:
Beginning basis
Plus: Gain pass-through
Basis before distributions
Minus: Distributions excluded from Lisa gross income
Ending basis
$ 25,000
8,000
$ 33,000
( 33,000)
$
-0-
Lisa received a $34,000 ($4,000 cash + $30,000 FMV of land) distribution, which
exceeded her stock basis before the distribution. Thus, in addition to the $8,000 pass-through
gain, Lisa recognizes a $1,000 capital gain on the excess distribution (Sec. 1368(b)(2)). Her basis
in the land is its $30,000 FMV (Sec. 301(d)).
pp. C:10-2 through C:10-7, C:4-2 through C:4-11, and C:11-24 through C:11-28.
C:10-25
Partners
a.
Gain/Loss
-0-
Postdistribution
Basis
$7,000
b.
-0-
$4,000
c.
$9,000
-0-
d.
-0-
$14,000
Property
Land
Machinery
Land
Inventory
Land - Parcel 1
Land - Parcel 2
Land - Parcel 1
Land - Parcel 2
Land - Parcel 3
Basis
to Partner
$4,000
3,000
6,000
7,000
-0-04,000
6,000
4,000

C:10-26a.
$3,000 gain recognized. Because Mario does not receive cash exceeding his
partnership basis, he recognizes no gain under the current distribution rules of Sec. 731.
C:10-10
However, Sec. 737 requires an additional step when some precontribution gain remains
unrecognized. Mario must recognize gain equal to the lesser of:
1.
Remaining precontribution gain ($8,000 = $18,000 - $10,000) or
2.
The excess of the FMV of the property distributed over the adjusted basis of the
partnership interest immediately preceding the distribution ($3,000 = $23,000 $20,000 partnership basis).
Under Sec. 737, Mario recognizes a $3,000 gain, which takes its character from the land Mario
contributed to the partnership having the precontribution gain.
b.
$8,000 basis, determined as follows:
Marios basis in partnership interest before
the distribution
$20,000
Plus: Sec. 737 gain recognized on the distribution
3,000
Minus: Carryover basis of property distributed
(15,000)
Basis in partnership interest after the distribution
$ 8,000
Because Mario recognized gain under Sec. 737, he must increase the basis of his
partnership interest by the $3,000 amount of the Sec. 737 gain. His basis is increased before
reducing the basis for the distribution.
c.
$13,000 basis. Because Mario recognizes $3,000 of gain under Sec. 737, the
partnership must increase its basis in the property related to the precontribution gain that Mario
recognized. The partnerships basis in the land is increased to $13,000 ($10,000 carryover basis
from Mario at the time of the contribution + $3,000 Sec. 737 gain recognized on this
distribution).
Students may note that $5,000 of precontribution gain related to this land remains, which
could be recognized under Sec. 737 if Mario receives other distributions that trigger the
recognition of this gain within seven years of the original contribution of the land to the
partnership. pp. C:10-2 through C:10-7.
C:10-27a.
$3,000 gain by Andrew. Andrew must recognize the gain that would have been
allocated to him had the partnership sold the land for its FMV instead of distributing it to Bob.
Amount deemed realized
$21,000
Minus: Adjusted basis
( 18,000)
Capital gain on deemed sale
$ 3,000
b. and c. Basis in partnership interest: $24,000 for Andrew; $9,000 for Bob. Basis in land
to Bob is $21,000. All $3,000 of the gain would have been allocated to Andrew because his
pre-contribution gain was $4,000, so Andrew must recognize a $3,000 gain. He increases his
basis in the partnership interest by the $3,000 gain he recognizes to $24,000. Bobs basis in his
partnership interest is not affected by the gain recognition. The partnerships basis in the land is
deemed increased by the $3,000 gain to $21,000 immediately before the land is distributed.
Accordingly, the basis of the land to Bob is $21,000, and Bobs basis in his partnership interest is
reduced to $9,000 ($30,000 - $21,000) by the distribution. Andrews basis in his partnership
interest is not affected by the distribution. pp. C:10-2 through C:10-7.
C:10-28 Basis in property after distribution: Land, $8,000; Inventory, $4,000; Cash, $10,000.
C:10-11
Basis in partnership interest after distribution: Alonzo, $11,000; Beth, $15,000; Cathy,
$11,000.
First, Beth and Cathy must recognize precontribution gains on the distributed property.
1.
Land: Amount deemed realized

Gain on deemed sale
$10,000
( 4,000)
$ 6,000
The precontribution gain allocated to Beth on the deemed sale is $4,000 ($8,000 FMV - $4,000
basis at contribution). Beths basis in her partnership interest after the deemed sale is $19,000
($15,000 + $4,000 gain recognized). The lands basis to the partnership immediately before the
distribution is $8,000 ($4,000 basis + $4,000 gain recognized).
2.
Inventory: Amount deemed realized

Gain on deemed sale
$10,000
( 1,000)
$ 9,000
The precontribution gain allocated to Cathy on the deemed sale is $3,000 ($4,000 FMV - $1,000
basis at contribution). Cathys basis in the partnership interest after the deemed sale is $21,000
($18,000 + $3,000 gain recognized). The inventorys basis to the partnership immediately before
the distribution is $4,000 ($1,000 + $3,000 gain recognized).
Then, the current distributions must be analyzed using the normal rules.
Alonzos distribution:
Basis in partnership interest before distribution
Minus: Carryover basis in land (see 1 above)
Basis in partnership interest after distribution
$19,000
( 8,000)
$11,000
Beths distribution:
(see 1 above)
Minus: Carryover basis in inventory (see 2 above)
$19,000
( 4,000)
$15,000
Cathys distribution:
(see 2 above)
Minus: Cash received in distribution
$21,000
( 10,000)
$11,000
C:10-12
C:10-29a.
Accounts receivable and depreciation recapture on the equipment.
b.
Yes. The inventorys $76,000 FMV ($16,000 + $52,000 + $1,500 equipment
depreciation recapture + $6,500) exceeds 120% of its adjusted basis [1.20 x ($0 + $50,000 + $0 +
$6,000) = $67,200]. The $1,500 depreciation recapture arises from the $1,500 built-in gain on
the equipment, all of which would be Sec.1245 because of the $4,000 depreciation taken on the
equipment. Supplies are part of inventory because Sec. 751(d) defines inventory essentially as
anything other than cash, capital assets, and Sec. 1231 property.
c.
Beginning
Partnership
Amount
Sec. 751 Assets:
Receivables
Inventory
Supplies
Recapture
Total
Other Assets:
Cash
Equipment
Land
Total
(1)
Kays Interest
Before
Distribution
(1/3)
(2)
Kays Interest
After
Distribution
(1/4)
(3)
Hypothetical
Proportionate
Distribution
(3)=(1)-(2)
$16,000
52,000
6,500
1,500
$76,000
$ 5,333
17,333
2,167
500
$25,333
$ 4,000
13,000
1,625
375
$19,000
$ 1,333
4,333
542
125
$ 6,333
$ 30,000
9,000
65,000
$104,000
$10,000
3,000
21,667
$34,667
$ 2,500
2,250
16,250
$21,000
$ 7,500
750
5,417
$13,667
Kays sale:
Amount realized
Recognized gain (ordinary income)
Kays basis in partnership interest:
Beginning basis
Minus: Sec. 751 transaction:
Inventory ($50,000/$52,000 x $4,333)
Supplies ($6,000/$6,500 x $542)
Basis after Sec. 751 transaction
Minus: Non-Sec. 751 distribution
Ending partnership interest basis
(4)
(5)
Actual
Distribution
Difference
(5)=(4)-(3)
$-0-0-0-0$-0-
$(1,333)
( 4,333)
( 542)
( 125)
$(6,333)
$20,000
-0-0$20,000
$12,500
( 750)
( 5,417)
$ 6,333
$ 6,333
( 4,666)a
$ 1,667
$33,750
( 4,166)
( 500)
$29,084
(13,667)b
$15,417
$0 receivables + $4,166 inventory + $500 supplies + $0 depreciation recapture.

$20,000 total - $6,333 Sec. 751 exchange.

Regulations.
C:10-13
C:10-30a.
Sec. 1245 recapture on machinery. The receivables are not included because they
have been realized.
b.
Yes. The inventorys $86,000 FMV ($12,000 + $24,000 + $50,000 machinery
depreciation recapture) exceeds 120% of its adjusted basis [1.20 x ($12,000 + $21,000 + $0) =
$39,600]. Realized as well as unrealized receivables are included in the Sec. 751(d) definition of
inventory.
c.
Sec. 751 Assets:

Receivables
Inventory
Recapture
Total
Other Assets:
Cash
Machinery
Land
Total
Beginning
Partnership
Amount
(1)
Jacks
Interest Before
Distribution
(1/4)
(2)
Jacks Interest
After
Distribution
(1/5)
(3)
Hypothetical
Proportionate
Distribution
(3)=(1)-(2)
$12,000
24,000
50,000
$86,000
$ 3,000
6,000
12,500
$21,500
$ 2,400
4,800
10,000
$17,200
$ 600
1,200
2,500
$4,300
$-0-0-0$-0-
$( 600)
( 1,200)
( 2,500)
$(4,300)
$ 48,000
190,000
76,000
$314,000
$12,000
47,500
19,000
$78,500
$ 4,600
38,000
15,200
$57,800
$ 7,400
9,500
3,800
$20,700
$25,000
-0-0$25,000
$17,600
( 9,500)
( 3,800)
$ 4,300
Jacks sale:
Amount realized
Recognized gain (ordinary income)
Jacks basis in partnership interest:
Beginning basis
Minus: Sec. 751 transaction
Accounts receivable
Inventory ($21,000/$24,000 x $1,200)
Basis after Sec. 751 transaction
Minus: Non-Sec. 751 distribution
Ending basis
(4)
(5)
Actual
Distribution
Difference
(5)=(4)-(3)
$ 4,300
( 1,650)a
$ 2,650
$76,875
( 600)
( 1,050)
$75,225
(20,700)b
$54,525
$600 receivables + $1,050 inventory + $0 recapture.

$25,000 total - $4,300 Sec. 751 exchange.

Regulations.
C:10-14
C:10-31
Beginning
Partnership
Amount
Sec. 751 Assets:
Receivables
Inventory
Total
Other Assets:
Cash
(1)
Paulas
Interest Before
Distribution
(1/4)
(2)
Paulas Interest
After
Distribution
(1/5)
(3)
Hypothetical
Proportionate
Distribution
(3)=(1)-(2)
(4)
(5)
Actual
Distribution
Difference
(5)=(4)-(3)
$ 40,000
100,000
$140,000
$86,000
$10,000
25,000
$35,000
$ 8,000
18,000
$26,000
$2,000
7,000
$9,000
$ -010,000
$10,000
$ 20,000
$ 5,000
$ 4,000
$1,000
Deemed cash distribution

Partnerships sale of inventory for cash:
Amount realized
Minus: Adjusted basis of inventory (0.80 x $1,000)
Partnerships recognized gain
-0-
$ (2,000)
3,000
$ 1,000
$(1,000)
($1,000)
$1,000
$1,000
( 800)a
$ 200b
Because the total basis for the inventory is $80,000 and the total FMV is $100,000, the
basis of this portion of the inventory is assumed to be 80% of its FMV.
b
The $200 gain is allocated one-third to each of the other three partners (Reg. Sec. 1.7511(b)(2)(ii)). Thus, each other partner recognizes $67 of ordinary income.
a
Basis in partnership interest:
Beginning basis
Plus: Share of partnership income
Minus: Deemed distribution of cash
Distribution of remaining inventory
(adjusted basis = 0.80 x $9,000)
Ending basis
Paula
Partner Q
Partner R
Partner S
$25,000
$25,000
67
$25,000
67
$25,000
67
_______
$25,067
_______
$25,067
_______
$25,067
(1,000)
( 7,200)
$16,800
Paulas basis in inventory:

Portion deemed purchased from
partnership (cost)
Remaining distribution (adjusted basis)
Total
$1,000
7,200
$8,200

Regulations.
C:10-15
C:10-32 The results of the two types of distributions are compared as follows:
Cleo
Part a
Gain (loss) recognized
Basis in partnership interest
Part b
Gain (loss) recognized
$2,000
Leo
$
-0-
-0-
2,000
2,000
(2,000)
A partner recognizes gain on either type of distribution to the extent cash distributed exceeds the
partners basis in his or her partnership interest before the distribution. A partner recognizes a loss
only with liquidating distributions and then only where the partnership distributes no assets other
than cash, inventory, and/or unrealized receivables. The loss equals the excess of the partners
basis in the partnership interest over the amount of these assets distributed (in this case, cash).
pp. C:10-2, C:10-4, and C:10-12.
C:10-33
Gain/Loss
Partners
Postdistribution
Basis
a.
-0-
None
b.
-0-
None
c.
$9,000
None
d.
-0-
None
Predistribution basis
Less: Cash distribution
Property
Basis
to Partner
Land
Machinery
Land
Inventory
Land - 1
Land - 2
Land - 1
Land - 2
Land - 3
$11,000a
3,000
10,000b
7,000
-0-c
-06,462d
10,769
10,769
$20,000
( 6,000
)
$14,000
Basis to allocate
Basis of property to partners:
Land
First allocate to property basis

Then allocate to property appreciation
Total
$ 4,000
7,000
$11,000
$20,000
( 3,000
)
$17,000
( 7,000
)
Basis to allocate
Less: Allocation to inventory
C:10-16
Machinery
$ 3,000
-0$ 3,000
Allocation to land
$10,000
$26,000
( 35,000
)
$
-0-
Basis to allocate (but not less than zero)

Basis of property to partners:
First allocate to property basis
Balance
Then allocate to property appreciation
Finally allocate on relative FMV
Total
Land 1
Land 2
Land 3
$4,000
$ 6,000
$ 4,000
2,000
462
$6,462
4,000
769
$10,769
6,000
769
$10,769
Basis to
Allocate
$28,000
( 14,000)
$14,000
( 12,000)
(2,000)
$
-0-
pp. C:10-12 through C:10-16.

C:10-34 Marinda: $30,000 capital gain; Partnership: No gain recognized. Even though Marinda
does not receive her proportionate share of each partnership asset in the liquidating distribution,
the transaction has no Sec. 751 implications because the partnership has no Sec. 751 assets.
Marinda is deemed to have received $110,000 in cash or deemed cash ($100,000 cash + $10,000
release from liability). Accordingly, she must recognize capital gain of $30,000 ($110,000
received - $80,000 basis). The partnership recognizes no gain. pp. C:10-12 through C:10-16.
C:10-35
Basis before liability reduction
Minus: Liability reduction (deemed distribution)
Basis before distributions
Minus: Cash distributions
Basis to be allocated
Minus: Basis allocable to inventory
Basis allocable to receivables
Amount allocable to other property
Minus: Basis allocable to land
Basis allocable to building
Ending basis in partnership interest
Alison
$ 110,000
( 50,000)
$ 60,000
( 20,000)
$ 40,000
( 32,195)a
( 7,805)a
$
-0(
-0-)
(
-0-)
$
-0-
C:10-17
Bob
$ 180,000
( 50,000)
$ 130,000
( 20,000)
$110,000
( 33,000)
( 10,000)
$ 67,000
( 15,000)b
( 52,000)b
$
-0-
Allisons allocation:
FMV of asset
Minus: Partnerships basis for the asset
Difference
Step 1: Give each asset the partnerships basis
for the asset
Minus: Allisons basis to be allocated
Decrease to allocate
Step 2: Asset basis after Step 1
Allocate the decrease first to assets
that have declined in value
Adjusted basis at this point in the
calculation
Step 3: Allocate $1,000 remaining decrease
based on relative adjusted basis at this
point in the calculation
Allisons basis in the assets
Inventory
Receivables
$ 35,000
( 33,000)
$ 2,000
$ 8,000
( 10,000)
( $2,000)
$43,000
(43,000)
$
-0-
$ 33,000
$10,000
$ 33,000
$10,000
$ 43,000
( 40,000)
$ 3,000
$43,000
( 2,000)
( 2,000)
$ 33,000
$ 8,000
$41,000
(
805)*
$ 32,195
( 195)
$ 7,805
( 1,000)
$40,000
-0-
Total
*$33,000/($33,000 + $8,000) x $1,000 remaining decrease to be allocated.

b
Bobs allocation:
FMV of asset
Difference
for the asset
Minus: Bobs basis to be allocated
Increase to allocate
Step 2: Allocate the $12,000 increase first to
assets that have appreciated in value
Bobs basis in the asset
Land
Building
Total
$10,000
( 15,000)
($ 5,000)
$60,000
( 40,000)
$20,000
$70,000
( 55,000)
$15,000
$15,000
$40,000
$55,000
( 67,000)
$12,000
-0$15,000
12,000
$52,000
12,000
$67,000
The basis in each asset received is the number used to reduce the partners basis in the partnership
interest. Note that Alisons basis in the inventory and receivables is smaller than a carryover basis
from the partnership while Bobs basis in the building is larger than a carryover basis. Neither the
partners nor the partnership recognize any gain or loss. pp. C:10-12 through C:10-14.
C:10-18
C:10-36 a, b, c, and d. Larrys basis in his partnership interest:

Part a
Part b
Part c
Basis before distribution
$ 40,000 $46,500 $46,500
Minus: Cash distribution
( 2,500) ( 2,500 ( 2,500)
)
Basis to be allocated
$.37,500 $44,000 $44,000
Minus: Basis allocable to inventorya
( 8,000) ( 8,000 ( 8,000)
)
Basis to be allocated to capital assets b $ 29,500 $36,000 $36,000
Part d
$34,500
( 2,500)
$32,000
( 8,000)
$24,000
Inventory is not substantially appreciated. Therefore, Sec. 751 does not apply.
b
See Parts a d below for remaining allocations. Also see summary of bases after Part
d.
a.
Capital Asset 1 Capital Asset 2
Total
$ 15,000
$ 17,500
$ 32,500
( 10,000)
( 15,000)
( 25,000)
$ 5,000
$ 2,500
$ 7,500
FMV of asset
Difference
for the asset
$ 10,000
$15,000
$ 25,000
Minus: Larrys basis to be allocated
( 29,500)
$ 4,500
Step 2: Basis after Step 1
$ 10,000
$15,000
$ 25,000
Allocate the $4,500 increase to assets
that have increased in value*
3,000
1,500
4,500
Larrys basis in the capital assets
$13,000
$16,500
$ 29,500
*Based on relative unrealized appreciation: Capital Asset 1, $5,000/$7,500 x $4,500;
Capital Asset 2, $2,500/$7,500 x $4,500
b.
FMV of asset
Capital Asset 1
$ 15,000
( 10,000)
Capital Asset 2
$ 17,500
( 15,000)
$ 5,000
$ 2,500
$10,000
$15,000
$10,000
$15,000
$25,000
( 36,000
)
$11,000
$25,000
5,000
$15,000
2,500
$17,500
7,500
$32,500
Difference
Step 1: Give each asset the partnerships
basis
for the asset
Allocate the increase to assets
that have increased in valuea
Basis after Step 2
Step 3: Allocate the remaining $3,500
C:10-19
Total
$32,500
( 25,000
)
$ 7,500
increaseb
1,615
$16,615
1,885
$19,385
3,500
$36,000
But not more than the unrealized appreciation.

Based on relative FMV: Capital Asset 1, $15,000/$32,500 x $3,500;
Capital Asset 2, $17,500/$32,500 x $3,500
c.
FMV of asset
Minus: Partnerships basis for the
Capital Asset 1
$15,000
( 10,000)
Capital Asset 2
$17,500
( 20,000)
Total
$32,500
(30,000)
asset
Difference
for the asset
Allocate the increase to assets
that have increased in valuea
Basis after Step 2
increaseb
$ 5,000
($ 2,500)
$ 2,500
$10,000
$20,000
$10,000
$20,000
$30,000
( 36,000)
$ 6,000
$30,000
5,000
$15,000
-0$20,000
5,000
$35,000
462
$15,462
538
$20,538
1,000
$36,000
But not more than the unrealized appreciation.

Based on relative FMV: Capital Asset 1, $15,000/$32,500 x $1,000;
Capital Asset 2, $17,500/$32,500 x $1,000
d.
FMV of asset
Capital Asset 1
$15,000
( 10,000)
Difference
for the asset
$ 5,000
Capital Asset 2
Total
$17,500
$32,500
( 20,000)
( 30,000
)
($ 2,500)
$ 2,500
$10,000
$20,000
$10,000
$ 20,000
-0-
( 2,500)
Decrease to allocate
Allocate the decrease to assets
that have decreased in valuea
Basis after Step 2
$10,000
C:10-20
$ 17,500
$30,000
( 24,000
)
($
6,000)
$30,000
( 2,500
)
$27,500

decreaseb
( 1,273)
( 2,227)
$ 8,727
$ 15,273
( 3,500
)
$24,000
But not more than the unrealized depreciation.

Based on relative adjusted bases after the Step 2 adjustments:
Capital Asset 1, $10,000/$27,500 x ($3,500)
Capital Asset 2, $17,500/$27,500 x ($3,500)
Summary of asset bases:
Part a
$ 2,500
8,000
13,000
16,500
$40,000
Cash
Inventory
Capital Asset 1
Capital Asset 2
Total
Part b
$ 2,500
8,000
16,615
19,385
$46,500
Part c
$ 2,500
8,000
15,462
20,538
$46,500
Part d
$ 2,500
8,000
8,727
15,273
$34,500
pp. C:10-12 through C:10-14.

C:10-37a.
Kellys January 1 basis

Plus: Share of January income [($15,000 + $6,000) x ]
Kellys February 1 basis
$35,000
7,000
$42,000
b.
Kelly recognizes $20,000 of ordinary income, $1,333 of unrecaptured Sec. 1250
gain, and a $1,667 capital gain. The partnership has inventory and Sec. 1250 property .
Accordingly, the sales transaction must be analyzed as follows:
Application of step 1 yields the following gain on Kellys sale of her partnership interest:
($45,000 cash + $20,000 liabilities)
$65,000
Total gain realized
$23,000
Deemed Sale
of Assets
Inventory
Building
Land
Partnership Gain
Kellys Share (1/3)
$60,000
4,000 (all unrecaptured Sec. 1250 gain)
5,000
$20,000
1,333
1,667
Thus, on the sale of her partnership interest, Kelly recognizes ordinary income of
$20,000 and an unrecaptured Sec. 1250 gain of $1,333.
C:10-21

Total gain realized
$23,000
Minus: Allocation to ordinary income and unrecaptured Sec. 1250 gain ( 21,333)
$ 1,667
c.
d.
$65,000 = $45,000 cash paid + $20,000 share of partnership liabilities.

Unchanged from the basic facts. However, Margaret may have a special basis
adjustment in the assets if a Sec. 754 election is in effect.
pp. C:10-16 through C:10-19, C:10-26, and C:10-27.

C:10-38a.
Clay recognizes $9,000 of ordinary income and a $3,000 capital loss. The results
of the sale are determined as follows:
Application of step 1 yields the following gain on Clays sale of his partnership
interest:
Minus: Adjusted basis of partnership interest
($168,000 x 0.50)
Total gain realized
$ 90,000
( 84,000)
$ 6,000

Partnership
Gain (Loss)
Deemed Sale of Assets
Clays Share (60% x 0.50)
Inventory
$ 30,000
$ 9,000
Land
( 10,000)
( 3,000)
Thus, on the sale of his partnership interest, Clay recognizes ordinary income of $9,000.
Application of step 3 yields the following residual allocation to capital loss:
Total gain realized
Minus: Allocation to ordinary income
Capital loss recognized
$ 6,000
( 9,000)
$( 3,000)
Also, Clays ending basis in his remaining partnership interest is $84,000

($168,000 0.50).
b.
Steves basis is $90,000, his purchase price of $75,000 cash paid plus $15,000 in
liabilities assumed.
c.
The partnerships basis will not be affected. However, Steve may have a special
basis adjustment in the assets if a Sec. 754 election is in effect.
C:10-22
d.
If Clay sold his entire interest to Steve, the partnership would terminate on the
date of the sale. Clays gain is twice the amounts shown in Part a ($18,000 ordinary income and
$6,000 capital loss). Steves basis in the partnership interest is $180,000 ($150,000 cash paid +
$30,000 in liabilities assumed).
Under Reg. Sec. 1-708-(b)(iv), the old CAP Partnership is deemed to contribute all its assets
and liabilities to a new partnership (NewCAP) in exchange for an interest in NewCAP. Under Sec.
723, NewCap takes a carryover basis (and holding period) in each of the assets contributed to it. Old
CAP then distributes interests in NewCAP to Steve and the remaining partners. Each partners basis
in the NewCap interest is the same as his or her basis in the old CAP Partnership interest.
C:10-39a.
Alice recognizes $24,000 of ordinary income, $10,000 of unrecaptured Sec. 1250
gain, and a $16,000 capital gain. The result of the sale is determined as follows:
Application of step 1 yields the following gain on Alices sale of her partnership
interest:
$160,000
Total gain realized
$ 50,000
Application of step 2 yields the following allocation of Sec. 751 property:
Receivable
Inventory
Machinery
Building
Land
Investments
Partnership
Gain (Loss)
Alices
Share ()
$21,000
15,000
42,000a
45,000b
( 6,000)
33,000
$ 7,000
5,000
14,000a
15,000b
( 2,000)
11,000
Partnership depreciation is $36,000, and Alices share is $12,000.

Partnership unrecaptured Sec. 1250 gain is $30,000, and Alices share is $10,000.
Thus, on the sale of her partnership interest, Alice recognizes ordinary income of
$24,000 ($7,000 + $5,000 + $12,000 recapture). In addition, Alices unrecaptured Sec. 1250 gain
is $10,000.
C:10-23

Total gain realized
and unrecaptured Sec. 1250 gain
$50,000
(34,000)
$16,000
b.
Darlas basis in her partnership interest is $160,000 ($125,000 cash paid + $35,000
share of liabilities assumed). Also, Darla may have a special basis adjustment in the partnership
assets if a Sec. 754 election is in effect. pp. C:10-16 through C:10-19, C:10-26, and C:10-27.
C:10-40a.
$30,000 capital gain and $15,000 ordinary income. Suzannes share of partnership
assets is $135,000 (1/3 x $405,000). Therefore, $135,000 of the $150,000 she receives ($130,000
cash + $20,000 release from liabilities) is a Sec. 736(b) payment. The Sec. 736(b) payment is
treated as a distribution, so Suzanne must recognize a $30,000 gain (cash distribution of $135,000
exceeding $105,000 basis). The gain is capital gain if Suzanne held the partnership interest as a
capital asset. The remaining $15,000 payment does not represent a payment for property.
Because the payment is not determined based on partnership income, it is a guaranteed payment.
Thus, the $15,000 payment is ordinary income to Suzanne. Note: Because of Suzannes
recognized gain, the partnership could adjust the basis of the land upward by $30,000 if a Sec.
754. election is in effect.
b.
Suzannes capital account will be removed because she is no longer a partner. The
partnership gets no deduction for the payments taxed as Sec. 736(b) payments, but the
partnership can deduct the guaranteed payment of $15,000. The remaining partners bases in the
partnership must be increased to reflect the additional amount of liability each is allocated when
Suzanne is no longer a partner. pp. C:10-19, C:10-20, C:10-28, and C:10-29.
C:10-41a.
$9,600 capital gain, determined as follows:

Amount realized ($41,600 cash + $8,000 liability)
Minus: Sec. 736(b) payment = ($124,000 x 0.40)
Sec. 736(a) payment
Sec. 736(b) payment
Minus: Basis in partnership
Capital gain
b.
$49,600
(49,600)
$
-0$ 49,600
( 40,000)
$ 9,600
$8,400 ordinary income and $9,600 capital gain, determined as follows:

Amount realized ($50,000 cash + $8,000 liability)
$58,000
Minus: Sec. 736(b) payment ($124,000 x 0.40)
( 49,600)
Sec. 736(a) payment (ordinary income)
$ 8,400
Sec. 736(b) payment
Capital gain
$49,600
( 40,000)
$ 9,600
Brian is taxed on the Sec. 736(a) payment as a guaranteed payment, and the partnership
deducts the payment. (Note: The capital gains recognized in Parts a and b could create a basis
C:10-24
adjustment to the land if a Sec. 754 election is in effect.) pp. C:10-19, C:10-20, C:10-28, and C:1029.
C:10-42a.

Amount realized ($65,000 cash + $25,000 liabilities) $90,000
Minus: Sec. 736(b) payment (FMV of property interest)
( 90,000)
$ -0Sec. 736(b) payments
Recognized gain
$90,000
( 75,000)
$15,000
The character of the gain is capital because the partnership has no unrealized receivables
or substantially appreciated inventory.
b.
$10,000 ordinary income and $15,000 capital gain, determined as follows:

Amount realized ($75,000 cash + $25,000 liabilities) $100,000
Minus: Sec. 736(b) payment (FMV of property interest)
( 90,000)
$ 10,000
Sec. 736(b) payments
Recognized gain
$ 90,000
( 75,000)
$ 15,000
The character of the gain is capital gain because the partnership has no Sec. 751 assets.
The Sec. 736(a) payment is treated as a guaranteed payment because it is determined without
reference to partnership income. It is ordinary income to Kim and deductible by the partnership.
(Note: The recognized gains in Parts a and b could create basis adjustment to the land if a Sec.
754 election is in effect.) pp. C:10-19, C:10-20, C:10-28, and C:10-29.
C:10-43a.
$90,000 of ordinary income. The FMV of Jerrys partnership interest at the date of his
death plus his share of partnership liabilities is $160,000 ($130,000 + $30,000). His estate will receive
payments totaling $250,000 ($220,000 cash + $30,000 release from liabilities) during the two-year
period following death. The payments are Sec. 736(b) payments up to the FMV of his partnership
interest plus his share of liabilities for a total of $160,000. See Reg. Sec. 1.736-1(b) (1). The basis of
his partnership interest to his successor-in-interest is $160,000 ($130,000 FMV on the date of Jerrys
death + $30,000 share of liabilities). Accordingly, the first $160,000 of payments is treated as
liquidating distributions and will generate no gain. The remaining payments ($90,000) are Sec. 736(a)
payments, which are not tied to partnership income and therefore are taxed as guaranteed payments to
the successor-in-interest. These payments will be taxed as ordinary income to the successor-ininterest.
b.
The partnership gets no deduction for the Sec. 736(b) payments, but it can deduct
the Sec. 736(a) payments. Because this was a two-person partnership, the partnership will
continue only until the partnership makes the last payment to Jerrys successor-in-interest. At the
time the partnership makes the last payment, the partnership will terminate unless a new partner(s)
is admitted. pp. C:10-19 and C:10-20.
C:10-44a.
Amount realized ($130,000 cash + $20,000 liabilities)

C:10-25
$150,000

($130,000 FMV at date of death + $20,000 liabilities)
Realized gain
(150,000)
$
-0-
b.
10% of partnership income is treated as Bruces successor-in-interests distributive
share in each of the next three years. It is not deductible by the partnership.
c.
When the partnership makes the final payment.
pp. C:10-19 and C:10-20.
C:10-45a.
Because the accounts receivable have a basis equal to their FMV and because the
building has no depreciation recapture potential, the partnership holds no unrealized receivables.
However, the building does have unrecaptured Sec. 1250 gain potential.
Johns sales: Each of the two sales (one to Stephen and one to Andrew) is as follows:
Total
Amount realized
$222,000a
Minus: Adjusted basis ( 166,800)b
Recognized gain
$ 55,200
a
$186,000 + $36,000 release from liabilities
b
($261,600 x 0.50) + $36,000 share of liabilities
Johns total gain from the two sales is $110,400, of which $60,000 is an unrecaptured Sec. 1250
gain subject to the 25% capital gains tax rate, and $50,400 is a capital gain.
The sale of a 60% interest terminates the JAS Partnership. If Andrew and Stephen continue to
operate as a partnership, the old partnership makes a deemed contribution of assets to a new
partnership and liquidating distribution of interests in the new partnership (NewJAS) to Andrew
and Stephen. The NewJAS Partnership must make all necessary elections, such as taxable year
and accounting methods. The termination has the following results:
Tax result for Andrew or Stephen continuing:
Beginning basis in existing partnership
interest ($87,200 + $24,000 liabilities)
Basis in partnership interest purchased
from John ($186,000 + $36,000 liabilities)
Basis before deemed distribution of NewJAS Partnership interest
Basis in NewJAS Partnership interest after deemed distribution
$111,200
222,000
$333,200
$333,200
When the new partnership is formed, the assets will have carryover bases from the old partnership
as follows (the holding periods also carryover):
Cash
$160,000
Receivables
100,000
Building
200,000
Land
96,000
b.
Johns distributions are Sec. 736(b) distributions. For distribution purposes, the
partnership holds no Sec. 751 assets. Thus, no Sec. 751 exchange occurs, and John will
recognize no gain or loss on the distribution. His basis in each asset is determined as follows:
C:10-26
Beginning basis in partnership interest

($261,600 + $72,000 share of liabilities)
Minus: Actual cash
Deemed cash (liability relief)
Receivables
Basis allocable to land and building
Minus: Building
Land
Ending basis in partnership interest
$333,600
( 24,000)
( 72,000)
( 60,000)
$177,600
(120,000)
( 57,600)
$
-0-
John holds the following assets after the distribution:

Adjusted Basis
Cash
Receivables
Building
Land
Total
$ 24,000
60,000
120,000
57,600
$261,600
FMV
$ 24,000
60,000
180,000
108,000
$372,000
Notice that the built-in gain on these assets is $110,400 ($372,000 - $261,600). Thus, Johns
total gain is the same as in Part a, except here the gain is deferred rather than recognized
immediately.
The partnership does not terminate and has the following postdistribution balance sheet:
Partnerships Basis
Assets:
Cash
Receivables
Building
Land
Total
Liabilities and Capital:
Liabilities
Capital - Andrew
- Stephen
Total
FMV
$136,000
40,000
80,000
38,400
$294,400
$136,000
40,000
120,000
72,400
$368,000
$120,000
87,200
87,200
$294,400
$120,000
124,000
124,000
$368,000
Andrew and Stephen each will have an outside basis of $147,200 ($87,200 + $60,000 share of
liabilities). pp. C:10-12 through C:10-19 and C:10-22 through C:10-25.
C:10-46a.

Sec. 736(b) property:
Cash
$ 60,000
Receivables
20,000
Land
100,000
$180,000
C:10-27
The amount realized equals $160,000 cash + $20,000 release from liabilities, which is
allocated all to the Sec. 736(b) property.
Recognized gain or loss
$180,000
( 120,000)
$ 60,000
The character of the gain is capital gain because the partnership has no Sec. 751 assets or
Sec. 1250 property.
b. $60,000 capital gain, determined as follows:
Amount realized ($160,000 cash and $20,000 liabilities) $180,000
( 120,000)
Recognized gain or loss
$ 60,000
The character of the gain is capital because the partnership has no Sec. 751 assets or
Sec. 1250 property. Thus, in total, the results are the same as in Part a. pp. C:10-12 through C:1019.
C:10-47a.
A taxable transaction occurs. The recognized gains for Josh and Diana are
determined as follows:
Josh: Amount realized
Recognized gain
$60,000
(40,000)
$20,000
Diana: Amount realized

Recognized gain
$60,000
(20,000)
$40,000
All or part of the gains might be unrecaptured Sec. 1250 gain if the underlying real property was
subject to depreciation.
b.
An exchange of a partners general partnership interest for a limited partnership
interest in the same partnership is treated much like a corporate recapitalization and is likely to be
nontaxable. See Rev. Rul. 84-52, 1984-1 C.B. 157. Similarly with conversion from a partnership
to an LLC. See Rev. Rul. 95-37, 1995-1 C.B. 130. pp. C:10-20 and C:10-21.
C:10-28
C:10-48a.
No. Only 40% is treated as having changed hands.
b.
No. Liquidating distributions do not terminate a partnership.
c.
Yes. Only one member of the partnership continues as owner.
d.
Yes. The partnership terminates on June 1 of the current year.
e.
The ABC Partnership terminates on December 30 of the current year. The WXY
Partnership is treated as having continued.
f.
The WXY Partnership terminates on January 1 of the current year.
pp. C:10-22 through C:10-25.
C:10-49a.
The KL Partnership continues while the MN Partnership terminates.
b.
The ABC Partnership continues while the CD Partnership terminates.
c.
The YZ and WX Partnerships both terminate.
d.
The DE Partnership is a continuation of the DEFG Partnership.
Partnership is a new partnership.
e.
The HIJK Partnership terminates.
The FG
pp. C:10-25 and C:10-26.

C:10-50Amount realized
$100,005a
(
-0-)
Recognized gain
$100,005
a
$5 cash + release from $100,000 liability.
C:10-51a.
The total optional basis adjustment is $20,000, calculated as follows:

Cash purchase price
Minus: Pattys share of partnerships
basis in assets (1/3 x $240,000)
Optional basis adjustment
b.
$100,000
( 80,000)
$ 20,000
The partnership recognizes a $60,000 ($220,000 - $160,000) gain.
c.
Pattys share of the gain is $20,000. However, she recognizes none of this gain
because of her $20,000 basis adjustment. pp. C:10-26 through C:10-28.
C:10-29
C:10-52 $110,000 loss to Latisha, made up of $90,000 of ordinary income and a $200,000
capital loss. $110,000 downward mandatory basis adjustment to Larry. These results are
determined as follows:
Basis
FMV
Partnership
Gain (Loss)
Latishas
Share
$ 800,000
1,600,000
$2,400,000
$1,070,000
1,000,000
$2,070,000
$ 270,000
(600,000)
$(330,000)
$ 90,000
(200,000)
$(110,000)
Assets
Inventory
Land
Total
Latishas loss recognized:

Cash received
$ 690,000
Minus: Basis of partnership interest
(800,000)
Loss on sale of partnership interest
$(110,000)
Analysis of Latishas loss:

Total loss recognized
$(110,000)
(90,000)
$(200,000)
Summary of loss:
Ordinary income
$ 90,000
Capital loss
(200,000)
Total loss
$(110,000)
Computation of mandatory basis adjustment to Larry:

Larrys cost basis in his partnership interest
$ 690,000
Minus: Larrys share of basis in partnership assets ($2,400,000 x 1/3)

Mandatory downward basis adjustment
(800,000)
$(110,000)
Although beyond the scope of the textbook, the allocation of the basis adjustment is as
follows:
Partnership
Allocation to
Gain (Loss)
Larry (1/3)
Allocation to inventory
$270,000
C:10-30
$ 90,000
Allocation to land
(600,000)
pp. C:10-27 and C:10-28.
C:10-31
(200,000)
C:10-53a.
The ABC Company (an LLC) will be treated as a partnership. Alex will report his
one-third share of each income item reported by the LLC.
Ordinary income
Short-term capital gain
Long-term capital loss
$10,000
4,000
( 2,000)
The distribution is not taxable because it does not exceed Alexs basis in his ABC
Company interest.
b.
Beginning basis
$40,000
Plus: Share of ordinary income
14,000
Minus: Capital loss
( 2,000)
Distribution
(12,000)
Ending basis
$40,000
p. C:10-30.
C:10-54a.
$5,426,300 ordinary income, calculated as follows:

Ordinary income before adjustments
Minus: Charitable contributions
Plus: Net short-term capital gain
Ordinary income
a
b.
$ 5,200,000
( 164,000)
390,300a
$5,426,300
$827,400 STCG - $437,100 LTCL
Separately stated items:

Rental loss (passive)
$2,000,000
pp. C:10-32 through C:10-34.

C:10-55 a.
$592,200 of ordinary income, calculated as follows:

Ordinary income before adjustments
Minus: Net Sec. 1231 loss
Ordinary income
$ 700,000
( 107,800)a
$ 592,200
$ 27,000
( 134,800)
($107,800)
Sec. 1231 gains

Minus: Sec. 1231 losses
Net Sec. 1231 loss
b.

Passive income
Long-term capital gains
General business tax credits
$3,000,000
437,600
43,000
pp. C:10-32 through C:10-34.
C:10-32
Comprehensive Problems
C:10-56a.
Formation of Lifecycle Partnership:
Able, Baker, and Lifecycle Partnership recognize no gain or loss on the transfer of
land to the partnership. Lifecycle Partnership takes the following tax basis and book values in the
land:
Tax Basis
Book Value
Land A
Land B
$16,000
22,000
$30,000
20,000
The partnerships tax holding period for the land includes Ables and Bakers holding periods prior
to the transfers. Ables beginning basis in his partnership interest is $16,000, and Bakers
beginning basis is $22,000.
b.
(1) Partnership ordinary and separately stated items:

2016
2017
2018
Sales
Minus: Cost of goods sold
Gross profit
Minus:
Depreciation
Interest expense
Salary expense (guaranteed payment)
Operating expenses
$964,000
(450,000)
$514,000
$990,000
(500,000)
$490,000
$500,000
(280,000)
$220,000
( 94,000)
(140,000)
-0( 30,000)
(150,000)
(130,000)
( 12,000)
( 40,000)
(115,000)
(125,000)
-0( 60,000
)
Partnership ordinary income (loss)
$250,000
$158,000
$
( 80,000)

Dividend income
STCG; LTCG
Tax-exempt interest
Charitable contribution
Qualified production activities income
reported to partners
-0-0-0-0-
$250,000
(2) Book capital accounts:
2,000
1,000
1,500
500)
$158,000
Able
Contribution of land (FMV)

Plus: Partnership ordinary income
Balance 12/31/16
Plus: Partnership ordinary income
Dividend income
Tax-exempt interest
$ 30,000
150,000
$180,000
94,800
600
1,200
900
C:10-33
-03,000
-0-0None
Baker
$ 20,000
100,000
$120,000
63,200
400
800
600
Minus: Charitable contribution

Distributions to partners
Balance 12/31/17
Plus:
Long-term capital gain
Minus: Partnership ordinary loss
Balance 12/31/18
(
300)
( 42,000)
$235,200
1,800
( 48,000)
$189,000
(
200)
( 28,000)
$156,800
1,200
( 32,000)
$126,000
Able
Baker
$ 16,000
1,200,000
150,000
$1,366,000
94,800
600
1,200
900
(
300)
( 42,000)
( 60,000)
$1,361,200
1,800
( 48,000)
( 18,000)
$1,297,000
$ 22,000
800,000
100,000
$922,000
63,200
400
800
600
(
200)
( 28,000)
( 40,000)
$918,800
1,200
( 32,000)
( 12,000)
$876,000
Able
Baker
$ 105,000
$70,000
Able
Baker
14,000
105,000
$ 119,000
$( 2,000)
70,000
$ 68,000
(3) Basis in partnership interests:

Contribution of land (tax basis)
Plus:
Increase in partnership liabilities
Partnership ordinary income
Balance 12/31/16
Plus:
Partnership ordinary income
Dividend income
Tax-exempt interest
Minus: Charitable contribution
Distributions to partners
Decrease in partnership liabilities
Balance 12/31/17
Plus:
Long-term capital gain
Minus: Partnership loss
Decrease in partnership liabilities
Balance 12/31/18
c.
(1) Results of asset sales:
Sale of assets for books:

Total
Selling price
Minus: Total book value
Book gain
$1,366,000
(1,191,000)
$ 175,000
Sale of assets for tax:

Total
Selling price
Minus: Total adjusted basis
Tax gain
$1,366,000
(1,179,000)
$ 187,000
Precontribution gain (loss)

Postcontribution gain
Total
12,000
175,000
$ 187,000
C:10-34
(2) Book capital accounts:

Able
Balance 12/31/18
Plus: Book gain on asset sales
Balance before liquidating distributions
Baker
$ 189,000
105,000
$ 294,000
$126,000
70,000
$196,000
(3) Basis in partnership interests:

Able
Basis 12/31/18
Plus: Tax gain (loss) on asset sales:
Precontribution
Postcontribution
Minus: Decrease in partnership liabilities
Basis before liquidating distributions
Baker
$1,297,000
$876,000
14,000
105,000
(1,122,000)
$ 294,000
2,000)
70,000
(748,000)
$196,000
(4) Upon liquidation, Able receives $294,000, and Baker receives $196,000,
which are the amounts of their book capital accounts. Able, Baker, and
Lifecycle Partnership recognize no gain or loss on the liquidating distributions.
The partners have no basis in the partnership because it has terminated.
C:10-57
a.
Anne must recognize a guaranteed payment of $28,640, other ordinary income of

$33,280, and capital gain of $69,280, determined as follows:
Cash payment
Liability relief
Total payment
$220,000
31,200
$251,200
Sec. 736(b) payment (52% of asset FMV)

Sec. 736(a) payment [Total - 736(b)]
$222,560
$ 28,640
This Sec. 736(a) payment of $28,640 is a guaranteed payment (ordinary income) to

Anne.
Analysis of Sec. 736(b) payment ($222,560):
First separate out the Sec. 751 portion of the Sec. 736(b) payment. Assume the partnership first
distributed her share of these assets to Anne and then purchased her share of these assets for their
FMV.
Deemed distribution of Sec. 751 assets to Anne:
Annes basis before the Sec. 751 transaction
Basis of Sec. 751 assets deemed distributed
Annes basis after the Sec. 751 transaction
C:10-35
$120,000
12,480
$107,520
Deemed sale to the partnership at FMV:

FMV of 52% of Sec. 751 assets [0.52 x ($64,000 + $24,000)]
Adjusted basis of 52% of Sec. 751 assets
Ordinary income Anne must recognize
Analysis of remaining Sec. 736(b) payment ($222,560 - $45,760):
Annes basis after Sec. 751 transaction
Cash distribution ($222,560 - $45,760)
Cash distribution in excess of basis (capital gain)
$ 45,760
12,480
$ 33,280
$107,520
176,800
$ 69,280
Partnership tax results:

Deduct the guaranteed payment of $28,640 paid to Anne. (In addition, the partnership
would increase its basis in its accounts receivable to reflect the fact that some receivables were
deemed purchased from Anne for $33,280.)
b.
On the sale of her partnership interest, Anne recognizes $33,280 of ordinary income
and a $97,200 capital gain, determined as follows:
Application of step 1 yields the following gain on Annes sale of her partnership
interest:
Total gain realized
$251,200
( 120,000)
$131,200
Application of step 2 yields the following allocation to Sec. 751 property: Partnership
gain on receivable = $64,000; Annes share = $64,000 x 0.52 = $33,280.
Thus, on the sale of her partnership interest, Anne recognizes ordinary income of $33,280.
Total gain realized
$131,200
( 33,280)
$ 97,920
Partnership tax results:

ABC Partnership terminates because more than 50% of the capital and profits interest of
the partnership has been sold. The new partnership will elect a tax year and make all necessary
accounting elections. The assets of old ABC will be assumed contributed to new ABC.
Accordingly, the basis and holding period of the assets will be unchanged by the termination and
formation of a new partnership.
C:10-36
Tax Strategy Problem

C:10-58 a.
The three options are analyzed below.
Option 1 (disproportionate distribution of cash)
Beginning
Partnership
Amount
(1)
Daniels
Interest
Before
Distribution
(1/3)
(2)
Daniels
Interest
After
Distribution
(-0-)
(3)
(4)
(5)
Hypothetical
Proportionate
Distribution
(3)=(1)-(2)
Actual
Distribution
Difference
(5)=(4)-(3)
Sec. 751
Assets:
Receivables
$ 60,000
$20,000
-0-
$20,000
-0-
($20,000)
$ 60,000
60,000
$120,000
$20,000
20,000
$40,000
-0-0-0-
$20,000
20,000
$40,000
$60,000
-0$60,000
$40,000
(20,000)
$20,000
Other
Assets:
Cash
Land
Total
Deemed distribution of receivables (adjusted basis)

Daniels deemed sale of receivables for cash:
Amount realized
Minus: Adjusted basis of receivables
Daniels recognized gain (ordinary income)
-0-
$20,000
(
-0-)
$20,000
Daniels basis in partnership interest:

Beginning basis
$30,000
Minus: Deemed distribution of receivables
(
-0-)
Distribution of remaining cash ($60,000 - (40,000)
$20,000)
Ending basis (but not less than zero)
$
-0Because the $40,000 remaining cash distribution exceeds Daniels partnership basis
($30,000), he recognizes a $10,000 capital gain.
Summary of results:
Current ordinary income
Current capital gain
$20,000
10,000

Regulations.
C:10-37
Option 2 (proportionate distribution of assets)

Daniel receives the following assets:
Cash
Receivables
Land A
Total
Basis
FMV
$20,000
-010,000
$30,000
$20,000
20,000
20,000
$60,000
Because Daniels partnership basis exceeds the amount of cash distributed, he

recognizes no gain on the distribution. His partnership basis is $10,000 after reduction for the
cash distribution. He takes a zero basis in the receivables and a $10,000 basis in Land A.
Daniel recognizes gain or income when he sells the assets.
Summary of results:
Deferred ordinary income
Deferred capital gain
$20,000
10,000
Option 3 (sale of partnership interest)

The results of the sale are determined as follows:
Application of step 1 yields the following gain on Daniels sale of his partnership interest:
Total gain realized
$60,000
( 30,000)
$30,000
Application of step 2 yields the following allocation of Sec. 751

property:
Partnership
Gain (Loss)

Receivables
Land A
Land B
Land C
Daniels Share (1/3)
$60,000
10,000
10,000
10,000
$20,000*
3,333
3,333
3,333
*Thus, on the sale of his partnership interest, Daniel recognizes ordinary income of $20,000.
Total gain realized
C:10-38
$30,000
( 20,000)
$10,000
Summary of results:
Current ordinary of income
Current capital gain
$20,000
10,000
b.
Options 1 and 3 yield the same results: current gain recognition, a disadvantage, and
current receipt of cash, an advantage. Conversely, Option 2 defers gain recognition and cash
collection until Daniel collects on the receivables and sells the land. Thus, if Daniel has
immediate need for cash, he should select Option 1 or Option 3. If he does not have immediate
cash needs, he should consider Option 2.
Case Study Problem

C:10-59 The points presented below are the major ones that should be covered in the
memorandum to the two brothers. This information should be incorporated by the student into a
properly structured memorandum using good form with proper grammar and punctuation. The
analyses do not take into account present values of the results.
Option 1: Michaels purchase of interest.
Amount realized = ($120,000 cash + $330,000 installment note
+ $200,000 liabilities)
Minus: Adjusted
Realized gain (LTCG)
$650,000
( 300,000)
$350,000
Because the sale is an installment sale, Mark would recognize his gain on an installment
basis. In the first year, he would recognize gain of $93,333, calculated as follows:
Gain realized
Contract price
x Installment =
$350,000
$450,000
x $120,000 = $93,333
Assuming an 18.8% capital gains tax rate (including the 3.8% net investment tax), the gain
would result in taxes of $17,547, leaving Mark $102,453 ($120,000 - $17,547) of after-tax
proceeds for the first year. In each of the following three years, he would recognize gain of
$85,556, calculated as follows:
Gain realized
x Installment
Contract price
= $350,000
$450,000
x $110,000 = $85,556
Assuming an 18.8% tax rate on the capital gains each year, the gain would result in taxes
of $16,085, leaving Mark $93,915 ($110,000 - $16,085) of after-tax proceeds each year. Total
proceeds for Mark for the four years are $450,000, and total taxes are $65,800 ($350,000 x
0.188). Thus, Marks total undiscounted after-tax proceeds are $384,200 ($450,000 - $65,800).
Note that Michael is using after-tax dollars to pay Mark each year. Because this
transaction is an installment sale between related parties, Mark would have to recognize any
unrecognized gain if Michael later resold this partnership interest to another partner.
C:10-39
If no other partner is admitted to the partnership, the partnership will terminate when
Michael buys Marks interest. Michael would receive all the partnership assets in a liquidating
distribution. The basis of the partnership assets would be changed as follows:
Michaels partnership interest basis
Basis of partnership interest purchased from Mark ($450,000
installment sale + $200,000 share of liabilities)
Deemed cash contributed by Michael because
he assumes the partnerships liability
Balance before distributions
Minus: Cash and deemed cash distributed
Accounts receivable
Remaining basis allocable to land
$ 300,000
650,000
400,000
$1,350,000
( 600,000)
( 90,000)
$ 660,000
Notice that this basis adjustment has greatly decreased the potential capital gain that Michael will
recognize on the subsequent sale of the land investment.
Option 2A: Retirement from the partnership for $150,000 plus 50% of partnership profits for
the next three years.
Assuming the brothers correctly project income to be approximately $200,000 for each of
the next three years, Mark will receive a total of $450,000 over the four years. His gain will be
$350,000, calculated as follows:
Amount realized
Realized gain
$650,000
(300,000)
$350,000
In the initial year, Mark will receive $150,000 cash that he will treat as a normal
partnership distribution that reduces his basis. In future years, he will be allocated a 50% share of
the partnership earnings (with the character they have at the partnership level), which will increase
his basis. He also will receive a distribution from the partnership equal to the amount of income
he recognizes, and this distribution will reduce his basis by the same amount the income
recognition increases it. Accordingly, he will not be taxed on the distribution. After the final
payment, Mark no longer will be a partner, so his final payment will include the deemed cash from
the release of his liability share. Mark will report approximately $300,000 of income under this
method, and the character of the income is determined at the partnership level. Because the main
source of partnership income is the sale of investment land, most of the gain Mark will recognize
also will be capital gain.
Assuming all partnership income is capital gain for the three years, each year Mark will be
allocated $100,000 in capital gains and will pay taxes of $18,800 so that he has after-tax income
of $81,200. The first years payment is nontaxable so he has after-tax receipts of $150,000 for the
first year. Cash received over the four years is $450,000, and he will pay taxes of $56,400
($18,800 x 3), leaving undiscounted after-tax receipts of $393,600 ($450,000 - $56,400).
Michaels share of income for the three years is reduced by the income allocated to Mark.
The partnership will continue in operation under this option until Mark receives his final payment
from the partnership.
C:10-40
Option 2B:
Retirement from the partnership for $150,000 cash plus $100,000 guaranteed
payment for three years.
In this option, as in the preceding one, Marks first year payment is simply a distribution
from the partnership, which reduces his basis in the partnership interest. Likewise, in the final
year Mark will be deemed to receive cash equal to the share of liabilities that he no longer will be
liable for. Assuming the liabilities do not change, these two distributions will have the following
results:
Beginning basis
Minus: Year one cash
Basis after cash distribution
Minus: Year four liability release
Basis (but not less than zero)
$300,000
(150,000)
150,000
(200,000)
$
-0-
Mark will recognize a $50,000 long-term capital gain in year four. At an 18.8% capital
gains tax rate, he will owe taxes of $9,400. Because this gain is caused by the deemed cash
distribution from the liability release, Mark is not receiving any cash to pay these taxes. The
$100,000 guaranteed payment will be taxed as ordinary income in each of the next three years.
Assuming Marks ordinary tax rate is 33% each year, he will pay $33,000 in taxes for an after-tax
amount of $67,000. Over the four years, Mark will receive cash of $450,000 and will pay taxes of
$108,400 [($33,000 x 3) + $9,400] for undiscounted after-tax receipts of $341,600 ($450,000 $108,400).
Option 3: Outside purchase of interest.
Under this option, Mark will report a $350,000 long-term capital gain determined as
follows:
Realized gain (LTCG)
$650,000
(300,000)
$350,000
Assuming an 18.8% tax rate on capital gains, the gain would result in taxes of $65,800,
leaving Mark $384,200 ($450,000 cash - $65,800 taxes) of after-tax proceeds. (Mark receives
the same after-tax benefit that he receives if Michael is the purchaser, ignoring discounting.)
However, recognizing the entire $350,000 gain in one year could push Mark into a high enough
income bracket such that his capital gains would be tax at 23.8% (20% + 3.8%). If so, his tax on
the gain would be $83,300, and his after-tax proceeds would be $366,700 ($450,000 - $83,300).
Although this option technically terminates the partnership because of the 50% sale, the
partnership nevertheless continues as a new partnership. This results contrasts with Option 1,
where the partnership goes out of existence. If Michael wants to continue the partnership form of
conducting the investment, he should consider this option. Also, unless the partnership has made
a Sec. 754 election, no increased basis for the investment land occurs under this option.
Summary: Marks after-tax receipts are highest for Option 2A -- the retirement from the
partnership for $150,000 cash plus a 50% distributive share for the next three years. The
C:10-41
memorandum should emphasize to Mark that this option is the only sales arrangement under
which uncertainty exists about what he will receive. If land sales are unusually slow for the threeyear payout period, Mark may receive little more than the $150,000 first year payment.
Accordingly, students may want to recommend the sale to John or the sale to Michael
depending on whether or not Michael wants to continue as a sole proprietor or as John Watsons
partner.
Tax Research Problems

C:10-60
Tax Results:
Revenue Ruling 84-111, 1984-2 C.B. 88, requires that the tax results for incorporating a
partnership must follow the results generated by the form of the transaction. Accordingly, the
formation of the corporation is nontaxable to the transferor partnership under Sec. 351 and is
nontaxable to the transferee corporation under Sec. 1032. The liquidation of the partnership is
subject to the rules of Sec. 731, and the ex-partners basis in the new corporations stock is
governed by Sec. 732.
Asset and Liability Transfer:
Each asset will take a carryover basis from the partnership transferor under Sec. 362, so
the total basis of corporate assets will be $360,000. Under Sec. 358, the partnership, as the sole
shareholder, has a basis in its corporate stock equal to the carryover basis of its assets ($360,000)
reduced by the partnerships liability assumed by the corporation ($100,000), or $260,000.
Partnership Liquidation:
Upon liquidation of the partnership, neither the partners nor the partnership recognize
gain or loss under Secs. 731(a) and (b). The partnership terminates under Sec. 708(b)(1). Under
Sec. 732(b), the partners bases in the corporate stock distributed equals their basis in the
partnership as shown in the following table, and, under Sec. 1223(1), the holding period for the
stock includes the holding period of the partners interest in the partnership.
Partner
Basis in pshp. int. before transfer
Minus: Liab. reduction
Basis in pshp. int. before distribution
Basis in stock distributed
Arnie
Becky
Clay
Total
$120,000
(25,000)
$ 95,000
$ 95,000
$120,000
(25,000)
$ 95,000
$ 95,000
$120,000
(25,000)
$ 95,000
$ 95,000
$360,000
(75,000)
$285,000
C:10-42
Financial Accounting Results:

Generally, when a business combination occurs, the acquiring entity records the assets
received at fair value. If the fair value differs from the tax basis, deferred tax assets and liabilities
may have to be recorded. However, Accounting Standard Codification (ASC) 805-50 provides
special rules for transactions between entities under common control. These rules lead to a
different recording measure than fair value.
ASC 805-50-15-6 provides several examples of common control transactions, one of
which includes an entity that charters a newly formed entity and then transfers some or all of its
net assets to that newly chartered entity. The incorporation of the ABC General Partnership falls
into this classification. ASC 805-50-30-5 provides the following:
When accounting for a transfer of assets between entities under
common control, the entity that receives the net assets shall initially
measure the recognized assets and liabilities transferred at their carrying
amounts in the accounts of the transferring entity at the date of transfer.
In the current situation, the assets transferred to ABC Corporation have a carrying
amounts (book value) that are the same as their tax bases. Therefore, the corporation records the
assets for financial accounting purposes in the same amount as the tax bases, thereby negating the
need for deferred assets or liabilities.
If the assets had carrying amounts that differed from their tax basis, presumably, the entity
would record deferred tax assets and/or liabilities for the difference between the carrying amounts
and the tax bases. However, because of the common control transaction rule, the new entity still
would not record assets at their fair value.
C:10-61 Dellas share of property:
Sec. 736(b) property - Cash
Receivables
Equipment
Building
Land
Goodwill
Total
$16,667
10,000
16,667
33,333
13,333
7,000
$97,000
All payments based on partnership income also will be Sec. 736(a) payments taxed as distributive
shares.
Total fixed payments = $20,000 x 5 = $100,000
Sec. 736(b) payments as portion of fixed payments: $97,000/$100,000 = 97%
C:10-43
Allocation of payments for years 1-5:

$20,000 payment: Sec. 736(b) (97%)
Sec. 736(a) (3%)
$19,400a
600 guaranteed payment that
is taxed as ordinary income
5,000 distributive share
$25,000
5% of partnership income: Sec. 736(a)

Total
a
Sec. 736(b) payment

Minus: One-fifth basis in partnership interest
$19,400
(14,000)
Capital gain
$ 5,400
Taxation of the partnership is not affected by the payments made for Dellas interest in
property. It takes no deduction and does not reduce the continuing partners distributive share of
the payments made for the interest in property. The small guaranteed payment each year is
deductible by the partnership. The $5,000 distributive share results in a smaller distributive share
for each of the remaining partners.
C:10-62 Transfer of an interest in a partnership by gift does not terminate the partnership tax year
for the donor. (Little authority exists to suggest how a part-sale, part-gift will be treated, but most
practitioners agree that it will be treated the same as a gift transfer for this purpose.) However, the
donor must recognize income from the partnership up to the date of the gift. Because the
partnership tax year does not close on the date of the gift, the income is included in the partners tax
year that includes the normal partnership year-end (Reg. Sec. 1.706-1(c)(5)). On his tax return for
the tax year ending June 30 of the current year, Pedro will report partnership income from the tax
year that ended on December 31 of last year. He will report partnership income earned between
January 1 of the current year and his June 15 gift on his tax return for the tax year that ends on the
next June 30. Juan and the American Red Cross must report all partnership income earned after June
14 of the current year.
Transfer of a majority interest by gift does not constitute a sale or exchange that can
terminate a partnership (Reg. Sec. 1.708-1(b)(1)(ii)). Although part-sale, part-gift transactions
like this one are not clearly covered by the Treasury Regulation, the sale portion of the transaction
does not appear to be a majority interest.
The transfer to Juan is a part-sale and part-gift. See Victor P. Diedrich v. CIR, 47 AFTR
2d 81-977, 81-1 USTC 9249 (8th Cir., 1981). The 30% interest transferred to Juan is
considered sold to him because the liability is one-half of the FMV ($50,000 liability $100,000
FMV of partnership interest transferred). Pedro must recognize gain on the sale of a 15% interest
of $30,000 ($50,000 liabilities transferred - $20,000 basis). The remaining 15% interest is a gift
to Juan. Pedro must report the gift portion for gift tax purposes at its FMV of $50,000.
The transfer to the American Red Cross also is a part-sale and part-gift but the allocation of
basis to the sale and gift differ from the allocation above (Rev. Rul. 75-194, 1975-1 C.B. 80). Only a
pro rata portion of the basis is allocated to the sale transaction, so basis of $10,000 ([$50,000
liability $100,000 FMV] x $20,000 basis) is allocated to the sale, and the remaining $10,000 of
basis is
C:10-44
allocated to the gift portion of the transaction. On the sale transaction, Pedro must recognize gain
of $40,000 ($50,000 liability transferred - $10,000 basis allocated to sale transaction). Pedro makes
a charitable contribution of the remaining partnership interest, which has a basis of $10,000 and
FMV of $50,000. The contribution is eligible for a charitable contribution deduction.
C:10-63Helens Gain (Loss):
On the sale of her partnership interest, Helen recognizes $32,540 of ordinary income and
an $8,400 capital loss, determined as follows:
Application of step 1 yields the following gain on Helens sale of her partnership interest:
Amount realized on the sale
Total gain realized
$190,000
( 165,860)
$ 24,140
Application of step 2 yields the following allocation to Sec. 751 property under Reg. Sec.
1.751-1(a)(2):
Gain (Loss)
Asset 1 (all Sec. 1245 recap.)

Asset 2
Helens Share (1/3)
$97,620
( 25,200)
$32,540
( 8,400)
All the gain on Asset 1 is ordinary income under the Sec. 1245 recapture rules and is
therefore an unrealized receivable as defined in Sec. 751(c). Thus, Helen recognizes $32,540 of
ordinary income.
Application of step 3 yields the following residual allocation to capital loss:
Total gain realized
$24,140
( 32,540)
$( 8,400)
Hanks Optional Basis Adjustment and Allocation:

Hanks optional basis adjustment under Sec. 743(b)(1) is $24,140, calculated as follows:
Initial basis in partnership (purchase price)
Minus: Share (1/3) of partnerships basis in assets
Optional basis (Sec. 743(b)) adjustment
$190,000
( 165,860)
$ 24,140
Under Reg. Sec. 1.751-1(a), the Sec. 1245 recapture attributable to Asset 1 is ordinary
income property, and Asset 2 is capital gain property because it meets the definition of Sec. 1231
property. For purposes of allocating the Sec. 743(b) adjustment, Reg. Sec. 1.751-1(b)(1)(ii)
requires
C:10-45
a hypothetical asset sale computation similar to the one shown in step 2 of Helens calculations
above. Regulation Sec. 1.751-1(b)(2) then requires that the Sec. 743(b) adjustment first be
allocated to ordinary income property to the extent of any hypothetical gain inherent in that
property, in this case, a positive $32,540. The total Sec. 743(b) adjustment minus the amount
allocated to ordinary income property then gets allocated to capital gain property. This
calculation results in an $8,400 negative adjustment to Asset 2, specifically, $24,140 - $32,540.
Hanks Allocable Depreciation Deductions in 2016:
Under Reg. Sec. 1.743-1(j)(2), a partnership first determines its items of income,
deduction, gain, or loss and allocates them among the partners in accordance with Sec. 704. The
partnership then adjusts a partners distributive share to reflect any Sec. 743(b) adjustments.
Under Reg. Sec. 1.743-1(j)(4)(i), the increased basis to depreciable property is treated as
newly purchased property while the unadjusted basis, or the partnerships common basis,
continues to be depreciated as before the sale of the partnership interest. Accordingly, Hanks
share of 2016 depreciation on Asset 1 is as follows:
Partnership depreciation ($600,000 x 0.1249)*
Times: Hanks percentage
Hanks distributive share of common depreciation
Plus: Hanks depreciation on Sec. 743(b) adjustment
(Year 1, $32,540 x 0.1429)
Hanks total depreciation on Asset 1 in 2016
*Appendix C, Table 1, Recovery Year 4
$74,940
1/3
$24,980
4,650
$29,630
Under Reg. Sec. 1.743-1(j)(4)(ii), the negative Sec. 743(b) adjustment to depreciable
property decreases the partners allocable partnership depreciation according to the following
formula:
Partnership depreciation for the year
Adjusted basis at time of transfer
x Negative Sec. 743(b) adjustment
In
Hanks case, this formula results in a $3,360 reduction as follows:
$46,080 ($240,000 x 0.192)*
x $(8,400)
$115,200
Thus, Hanks share of 2016 depreciation on Asset 2 is as follows:
Partnership depreciation ($240,000 x 0.192)*
Times: Hanks percentage
Hanks distributive share of common depreciation
Minus: Sec. 743(b) adjustment
Hanks total depreciation on Asset 2 in 2016
*Appendix C, Table 1, Recovery Year 3
$46,080
1/3
$15,360
( 3,360)
$12,000
C:10-46
What Would You Do In This Situation? Solution

Ch. C:10, p. C:10-4. A New Kind of Tax-Free Exchange?
You probably should tell Betty and Thelma that the transaction will not be tax-free. First,
Sec. 704 requires that the contributing partner recognize any remaining precontribution gain (up
to the amount of precontribution gain that would be recognized if the property were sold on the
distribution date) when contributed property is distributed to another partner within five years of
the contribution. Therefore, both Betty and Thelma would recognize gain when the properties
were distributed unless the partnership held the property for more than five years.
Second, Treasury Regulations might prevent tax-free treatment even if the partnership held the
property for more than five years. Several years ago, the Treasury Department issued regulations
to stop the abusive use of the partnership form to get tax treatment that is not available otherwise.
These regulations require that all transactions be entered into for a substantial business purpose,
and Thelma and Betty have no apparent business purpose for contributing these properties to the
partnership or for distributing the properties from the partnership. Further, the regulations
provide that if the partnership is used to frustrate any IRC provision, the IRS can treat the
partnership as an aggregate of the partners. Because the exchange contemplated by Thelma and
Betty clearly does not qualify as a nontaxable like-kind exchange if the exchange were made
directly between the two women, it is unlikely that they can make it nontaxable by routing the
exchange through their partnership.
C:10-47

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Chapter C:10

Special Partnership Issues

Issue Identification Questions

Does Kayla recognize a gain or loss on the current distribution?

Copyright 2017 Pearson Education, Inc.

How much is Joels distribution?

Does the partnership have Sec. 751 assets?

Application of step 2 yields the following allocation to Sec. 751 property:

The sale as contemplated will terminate the partnership. Is termination of the

David should consider:

Could the transaction be structured in such a way that a liquidation by the

Does the partnership terminate for tax purposes?

Should Krypton choose to be taxed as a partnership or as a corporation?

Copyright 2017 Pearson Education, Inc.

Ending partnership interest basis is $7,000, determined as follows:

Lisa recognizes no gain. Her basis in the land is $14,000.

Ending partnership interest basis is zero, determined as follows:

Ending partnership interest basis is zero, determined as follows:

Ending partnership interest basis is zero, determined as follows:

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FMV of land distributed

FMV of land distributed

One-half the $16,000 gain passes through to Lisa.

pp. C:10-2 through C:10-7.

Land: Amount deemed realized

Inventory: Amount deemed realized

pp. C:10-2 through C:10-7.

Copyright 2017 Pearson Education, Inc.

$0 receivables + $4,166 inventory + $500 supplies + $0 depreciation recapture.

Note: The discussion in this chapter pertaining to disproportionate distributions conforms to

Sec. 751 Assets:

$600 receivables + $1,050 inventory + $0 recapture.

Note: The discussion in this chapter pertaining to disproportionate distributions conforms to

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Deemed cash distribution

Basis in partnership interest:

Paulas basis in inventory:

Note: The discussion in this chapter pertaining to disproportionate distributions conforms to

First allocate to property basis

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Basis to allocate (but not less than zero)

pp. C:10-12 through C:10-16.

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*$33,000/($33,000 + $8,000) x $1,000 remaining decrease to be allocated.

Copyright 2017 Pearson Education, Inc.

C:10-36 a, b, c, and d. Larrys basis in his partnership interest:

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But not more than the unrealized appreciation.

But not more than the unrealized appreciation.

Step 3: Allocate the remaining $3,500

But not more than the unrealized depreciation.

Summary of asset bases:

pp. C:10-12 through C:10-14.

Kellys January 1 basis

Kellys Share (1/3)

Copyright 2017 Pearson Education, Inc.

Application of step 3 yields the following residual allocation to capital gain:

$65,000 = $45,000 cash paid + $20,000 share of partnership liabilities.

pp. C:10-16 through C:10-19, C:10-26, and C:10-27.

Application of step 2 yields the following allocation to Sec. 751 property:

Deemed Sale of Assets

Clays Share (60% x 0.50)

Also, Clays ending basis in his remaining partnership interest is $84,000

Copyright 2017 Pearson Education, Inc.