Form 541 - Partnerships - Department Of Treasury Internal Revenue Service

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The amount of any gain or loss attributa-

tion) over the basis of the property to

tions 734(b) and 743(b) of the Internal Revenue

ble to capital gain or loss on the sale of

the distributee, or

Code. Once a valid election has been made, it

the partnership interest.

applies in succeeding years until it is revoked.

2) Decreasing the adjusted basis of the re-

If the election cannot be made with the re-

tained partnership property by:

turn, a partner or the partnership can request an

Partner’s disposition of distributed unreal-

automatic extension of 12 months to make the

ized receivables or inventory items. In gen-

a) Any loss recognized by the distributee

election. See section 301.9100 – 2 of the regula-

eral, any gain or loss on a sale or exchange of

partner on the distribution, plus

tions for more information.

unrealized receivables or inventory items a part-

b) The excess, if any, of the distributee

ner received in a distribution is an ordinary gain

partner’s basis for the distributed prop-

Revoking the election. Generally, the elec-

or loss. For this purpose, inventory items do not

erty over the partnership’s adjusted ba-

tion can be revoked only with the approval of the

include real or depreciable business property,

sis for the property (immediately before

IRS. An application to revoke the election must

even if they are not held more than 1 year.

the distribution).

be filed with the IRS director for your area. This

application must be filed within 30 days after the

Example. Mike, a distributee partner, re-

close of the partnership tax year for which the

ceived his share of accounts receivable when

Timing of adjustment. If a partnership

change is to be effective. The application must

his law firm dissolved. The partnership used the

completely liquidates the interest of a partner by

be signed by one of the partners and state why

cash method of accounting, so the receivables

making a series of cash payments treated as

the partnership wishes to revoke the election.

had a basis of zero. If Mike later collects the

distributions of the partner’s interest in partner-

receivables or sells them, the amount he re-

Examples of sufficient grounds for approving

ship property, the basis adjustments to partner-

ceives will be ordinary income.

the application include the following.

ship property must correspond in timing and

amount with the recognition of gain or loss by

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Exception for inventory items held more

A change in the nature of the business.

the retiring partner, or a deceased partner’s suc-

than 5 years. If a distributee partner sells in-

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cessor in interest, with respect to those pay-

A substantial increase in assets.

ventory items held for more than 5 years after

ments.

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the distribution, the type of gain or loss depends

A change in the character of the assets.

on how they are being used on the date sold.

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Example. Alan owns a one-third interest in

An increased frequency of retirements or

The gain or loss is capital gain or loss if the

the partnership Sylvan Associates. Sylvan has

shifts of partnership interests.

property is a capital asset in the partner’s hands

an optional adjustment to basis election in ef-

at the time sold.

fect. When Alan retires, Sylvan continues with-

However, the IRS will not approve an applica-

out dissolution and agrees to liquidate Alan’s

tion to revoke the election if its primary purpose

Example. Ann receives, through dissolution

one-third interest in the partnership property by

is to avoid decreasing the basis of partnership

of her partnership, inventory that has a basis of

making a series of cash payments to Alan that

assets upon a transfer or distribution.

$19,000. Within 5 years, she sells the inventory

are treated as distributions. The total amount of

for $24,000. The $5,000 gain is taxed as ordi-

payments Alan will receive is fixed and exceeds

nary income. If she had held the inventory for

the adjusted basis of Alan’s interest in the part-

more than 5 years, her gain would have been

Form 1065

nership.

capital gain, provided the inventory was a capital

Sylvan increases the adjusted basis of its

asset in her hands at the time of sale.

Example

property by Alan’s recognized gain in each part-

Substituted basis property. If a distributee

nership tax year during which Alan recognizes

partner disposes of unrealized receivables or

gain with respect to the payments.

This filled-in Form 1065 is for the AbleBaker

inventory items in a nonrecognition transaction,

Book Store, a partnership composed of Frank

Transfers. When there is a transfer of a part-

ordinary gain or loss treatment applies to a later

Able and Susan Baker. The partnership uses an

nership interest because of a sale or exchange

disposition of any substituted basis property re-

accrual method of accounting and a calendar

or a partner’s death, the partnership makes the

sulting from the transaction.

year for reporting income and loss. Frank works

optional adjustment by:

full time in the business, while Susan works

1) Increasing the adjusted basis of the part-

approximately 25% of her time in it. Both part-

nership property by the excess of:

ners are general partners.

Adjusting the Basis of

The partnership agreement states that Frank

a) The transferee’s basis for his or her

Partnership Property

will receive a yearly guaranteed payment of

partnership interest, over

$20,000 and Susan will receive $5,000. Any

b) The transferee’s share of the adjusted

profit or loss will be shared equally by the part-

Generally, a partnership cannot adjust the basis

basis of all partnership property, or

ners. The partners are personally liable for all

of its property because of a distribution of prop-

partnership liabilities. Both partners materially

erty to a partner or because of a transfer of an

2) Decreasing the adjusted basis of partner-

participate in the operation of the business.

interest in the partnership, whether by sale or

ship property by the excess of:

In addition to receiving income and paying

exchange or because of the death of a partner.

expenses in its partnership operations,

The partnership can adjust the basis only if it

a) The transferee’s share of the adjusted

AbleBaker made a $650 cash charitable contri-

files an election to make an optional adjustment

basis of all partnership property, over

bution, received $150 from dividends, and re-

to the basis of its property upon all distributions

b) The transferee’s basis for his or her

ceived $50 tax-exempt interest from municipal

and transfers. A partnership does not adjust the

partnership interest.

bonds.

basis of partnership property for a contribution of

Frank completes the partnership’s Form

property, including money, to the partnership.

These adjustments affect the basis of part-

1065 as explained next.

nership property for the transferee partner only.

Distributions. When there is a distribution of

They become part of his or her share of the

Page 1

partnership property to a partner, the partner-

common partnership basis.

ship makes the optional adjustment by:

The IRS sent Frank a postcard with the

Making the election. The optional adjustment

partnership’s preaddressed label, asking if he

1) Increasing the adjusted basis of the re-

to basis is made by filing a written statement with

tained partnership property by:

needed a Form 1065 package. He returned the

Form 1065 for the tax year in which the distribu-

postcard and the IRS sent him the package.

tion or transfer occurs. For the election to be

a) Any gain recognized by the distributee

When Frank completes the return, he places the

valid, the return must be filed on time, including

partner on the distribution, plus

partnership’s label in the address area on page

extensions. The statement must include the

b) The excess, if any, of the partnership’s

name and address of the partnership, be signed

Frank supplies all the information requested

adjusted basis for the distributed prop-

by one of the partners, and state that the part-

at the top of the page.

erty (immediately before the distribu-

nership elects under section 754 to apply sec-

Page 18

Form 541 - Partnerships - Department Of Treasury Internal Revenue Service - 2002 Page 18

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