Form 541 - Partnerships - Department Of Treasury Internal Revenue Service

Each partner’s basis would include his or her

However, see Payments for Unrealized Receiv-

interest in partnership property and other pay-

share of the liability, $30,000.

ables and Inventory Items, later, for certain ex-

ments. The partnership’s payments include an

If Jane is required to pay the creditor if the

ceptions. Gain or loss is the difference between

assumption of the partner’s share of partnership

partnership defaults, she has an economic risk

the amount realized and the adjusted basis of

liabilities treated as a distribution of money.

of loss in the liability. Her basis in the partnership

the partner’s interest in the partnership. If the

For income tax purposes, a retiring partner

would be $80,000 ($20,000 + $60,000), while

selling partner is relieved of any partnership

or successor in interest of a deceased partner is

Ted’s basis would be $20,000.

liabilities, that partner must include the liability

treated as a partner until his or her interest in the

relief as part of the amount realized for his or her

partnership has been completely liquidated.

Limited partner. A limited partner generally

interest.

has no obligation to contribute additional capital

Liquidating payments. Payments made in

to the partnership and therefore does not have

Example 1. Fred became a limited partner

liquidation of the interest of a retiring or de-

an economic risk of loss in partnership recourse

in the ABC Partnership by contributing $10,000

liabilities. Thus, absent some other factor, such

ceased partner in exchange for his or her inter-

in cash on the formation of the partnership. The

as the guarantee of a partnership liability by the

est in partnership property are considered a

adjusted basis of his partnership interest at the

limited partner or the limited partner making the

distribution, not a distributive share or guaran-

end of the current year is $20,000, which in-

loan to the partnership, a limited partner gener-

teed payment that could give rise to a deduction

cludes his $15,000 share of partnership liabili-

ally does not have a share of partnership re-

(or its equivalent) for the partnership.

ties. The partnership has no unrealized

course liabilities.

receivables or inventory items. Fred sells his

Unrealized receivables and goodwill.

interest in the partnership for $10,000 in cash.

Payments made for the retiring or deceased

Partner’s share of nonrecourse liabilities.

He had been paid his share of the partnership

A partnership liability is a nonrecourse liability if

partner’s share of the partnership’s unrealized

income for the tax year.

no partner or related person has an economic

receivables or goodwill are not treated as made

Fred realizes $25,000 from the sale of his

risk of loss for that liability. A partner’s share of

in exchange for partnership property if both of

partnership interest ($10,000 cash payment +

nonrecourse liabilities is generally proportionate

the following tests are met.

$15,000 liability relief). He reports $5,000

to his or her share of partnership profits. How-

•

($25,000 realized − $20,000 basis) as a capital

Capital is not a material income-producing

ever, this rule may not apply if the partnership

factor for the partnership. (Whether capital

gain.

has taken deductions attributable to nonre-

is a material income-producing factor is

course liabilities or the partnership holds prop-

explained in the discussion under Family

Example 2. The facts are the same as in

erty that was contributed by a partner.

Partnership near the beginning of this pub-

Example 1, except that Fred withdraws from the

More information. For more information on

lication.)

partnership when the adjusted basis of his inter-

the effect of partnership liabilities, including

est in the partnership is zero. He is considered to

•

The retiring or deceased partner was a

rules for limited partners and examples, see

have received a distribution of $15,000, his relief

general partner in the partnership.

sections 1.752 – 1 through 1.752 – 5 of the regu-

of liability. He reports a capital gain of $15,000.

lations.

However, this rule does not apply to payments

Exchange of partnership interests. An ex-

for goodwill to the extent that the partnership

change of partnership interests generally does

agreement provides for a reasonable payment

not qualify as a nontaxable exchange of

to a retiring partner for goodwill.

Disposition of

like-kind property. This applies regardless of

whether they are general or limited partnership

Payments for unrealized receivables or

Partner’s Interest

interests or interests in the same or different

goodwill are not treated as made in

partnerships. However, under certain circum-

exchange for partnership property

CAUTION

The following discussions explain the treatment

stances, such an exchange may be treated as a

under any circumstance if the partner retired or

of gain or loss from the disposition of an interest

tax-free contribution of property to a partnership.

died before January 5, 1993 (or retired on or

in a partnership.

See Contribution of Property under Transac-

after that date if a written contract to buy the

tions Between Partnership and Partners, earlier.

partner’s interest in the partnership was binding

Abandoned or worthless partnership

An interest in a partnership that has a valid

on January 4, 1993, and at all times thereafter).

interest. A loss incurred from the abandon-

election in effect under section 761(a) of the

ment or worthlessness of a partnership interest

Internal Revenue Code to be excluded from the

is an ordinary loss only if both of the following

Unrealized receivables are defined later

partnership rules of the Code is treated as an

tests are met.

under Payments for Unrealized Receivables

interest in each of the partnership assets and not

•

and Inventory Items. However, for this purpose,

The transaction is not a sale or exchange.

as a partnership interest. See Exclusion From

they do not include the items listed in that dis-

•

Partnership Rules, earlier.

The partner has not received an actual or

cussion under Other items treated as unrealized

deemed distribution from the partnership.

Installment reporting for sale of partnership

receivables.

interest. A partner who sells a partnership in-

If the partner receives even a de minimis actual

Partners’ valuation. Generally, the part-

terest at a gain may be able to report the sale on

or deemed distribution, the entire loss generally

ners’ valuation of a partner’s interest in partner-

the installment method. For requirements and

is a capital loss. However, see Payments for

ship property in an arm’s-length agreement will

other information on installment sales, see Pub-

Unrealized Receivables and Inventory Items,

be treated as correct. If the valuation reflects

lication 537.

later.

only the partner’s net interest in the property

Part of the gain from the installment sale may

(total assets less liabilities), it must be adjusted

Partnership election to adjust basis of part-

be allocable to unrealized receivables or inven-

so that both the value of and the basis for the

nership property. Generally, a partnership’s

tory items. See Payments for Unrealized Re-

partner’s interest include the partner’s share of

basis in its assets is not affected by a transfer of

ceivables and Inventory Items, later. The gain

partnership liabilities.

an interest in the partnership, whether by sale or

allocable to unrealized receivables and inven-

exchange or because of the death of a partner.

tory items must be reported in the year of sale.

Gain or loss on distribution. Upon the re-

However, the partnership can elect to make an

The gain allocable to the other assets can be

ceipt of the distribution, the retiring partner or

optional adjustment to basis in the year of trans-

reported under the installment method.

successor in interest of a deceased partner will

fer. See Adjusting the Basis of Partnership Prop-

recognize gain only to the extent that any money

Liquidation at Partner’s

erty, later, for information on making the

(and marketable securities treated as money)

election.

Retirement or Death

distributed is more than the partner’s adjusted

basis in the partnership. The partner will recog-

Sale, Exchange,

nize a loss only if the distribution is in money,

Payments made by the partnership to a retiring

or Other Transfer

unrealized receivables, and inventory items. No

partner or successor in interest of a deceased

loss is recognized if any other property is re-

partner in return for the partner’s entire interest

The sale or exchange of a partner’s interest in a

in the partnership may have to be allocated

ceived. See Partner’s Gain or Loss under Part-

partnership usually results in capital gain or loss.

between payments in liquidation of the partner’s

nership Distributions, earlier.

Page 16

Form 541 - Partnerships - Department Of Treasury Internal Revenue Service - 2002 Page 16

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