The best option for Carol executing out of the Partnership to retire in my opinion, would be for
Bob to borrow money to pay Carol’s interest in the business. It is often very expensive for a
buyout and using your own funds or financing through business funds can put a financial burden
on the remaining partner and business. To keep financial flexibility and be able to not impact
capital to reinvest in the business, getting a Partner Buyout loan is the best option. This does not
deplete business funds and put a strain on the business and leaves capital free for reinvesting and
operating.
Also, it allows the other partner to get their money and move on quickly. In this case Carol being
older and retiring if she died it would make it a little harder to do. So, she would need to make
sure a lawyer drew documents first thing and leave a beneficiary that would assume the partner
being bought out. This is easiest and safest way to ensure Carol or her family shall she pass gets
the money. This will let the company move on with ventures and not leave a continuous waiting
game and slowly depleting shares overtime. In my opinion this is by far quickest, easiest, and
most efficient route.
Partnerships are formed by two or more partners. When one of the partners decides to leave the
partnership, the partner’s ownership may be distributed as liquidating distributions or
nonliquidating distributions, as in the case for ABC Partners. Liquidating distributions completely
reduce a partner’s interest through a single or series of distributions (Rupert & Anderson, 10-2).
Furthermore, partner can choose to either receive liquidating distribution or to sell the interest.
Option 3 discusses asking Carol to find an outside buyer for her interest in the business. Under
Sec. 751, the sale of partnership interest creates ordinary income or loss if “consideration
received is attributable to the partner’s share of unrealized receivables and inventory items”
(Rupert & Anderson, 10-17). Partner also must take into consideration the unrecaptured Sec. 1250
gain.
If Carol dies before the plan is executed, then the “IRS accepts the valuation placed on the
retiring partner’s interest in the partnership property by the partners in an arm’s-length
transaction” (Rupert & Anderson, 10-19). These payments are taxed with liquidating distribution
rules. The partnership may not deduct these payments. Carol’s ownership interest can be sold or
others can buy the ownership interest.
When one of the partners decides or is ready to retire from a partnership formed, there are many
options in liquidation to end the relationship. Each one of these options is based on the tax
consequences for the partner leaving and the ones staying. According to Antico (2013), “When
offering a new equity position or buying out a retiring partner, considerations vary depending on the
structure of the practice, so it is important to note the differences when dealing with a partnership, as
distinguished from a corporation. The appropriate structure of a practice depends on the needs and
desires of the practice owners”. d Now having this in hand, the option I will pick and be beneficial for
every partner is Option 1, just because it is considering and giving opportunities equally to everyone.
We have to remember that Carol is the one retiring and Amy and Bob are not, they would like to
continue with the partnership. d
In my personal opinion, in options #2 and #3, you are adding an extra “thought” beside a
partner’s retirement. d Option #2 is considering a new responsibility for the partnership and Option #3,
is considering a new partner, someone that you don’t really know, maybe in the future.
The sale of a partnership interest is treated as the sale or exchange of a capital asset, so
normal taxes will be applied to this sale. The gain or loss will be calculated as the difference between
the amount realized in the transaction and the selling partner’s adjusted basis in the partnership
interest being sold. In case of death, the purchaser’s basis is determined under normal tax rules, by
cost, and according to Section 1015. Also, this death of a partner can lead to tax issues involving the
close of a partnership's tax year with respect to the deceased partner, a possible change in the
partnership's year-end, post-death allocation of income, Sec. 754 elections, and Sec. 743 adjustments,
among other things.
The most logical solution should the remaining partners want to continue the marina business
would be option 3, to ask carol to find an outside buyer, or as an organization, solicit another
partner to take Carol’s share. This option is reasonable because the entire team can asses whether
the new partner would be a good fit for the business and to work with the remaining partners and
the sale wouldnt affect the business. per IRC 708, the partnership can still remain so long as 50%
of the partnership isnt sold (Cornell, 2000). As Carol's stake is only 33% of the business, the sale
would be straightforward and wont have a tax impact on the remaining partners unless the FMW
changes dramatically at the time of sale. should it be discovered that FMV of assets have
changed, a special adjustment can be made. "An IRC Section 754 election allows a partnership
to adjust the basis of the property within a partnership under IRC Sections 734(b) and 743(b)
when one of two triggering events occur: 1) a distribution of partnership property or 2) certain
transfers of a partnership interest" (IRS, 2022)
However, if no special elections need to be made, upon Carol’s retirement, the sale would be
recognized as a capital gain or loss under section 741, as the partnership is a capital asset
(Cornell, 1954). If she should pass away prior to finalizing the terms of the sale, her stake would
go to the estate. A lump sum payment could be paid out by the owners, whereby the cash or loan
mix would be recorded in the statement of cash flows, increase in debt, and increase in asset
allocation (The Federal Register, 2022).
Legal Information Institute. (2000, January 11). 26 CFR § 1.708-1 - continuation of partnership.
Legal Information Institute. Retrieved from https://www.law.cornell.edu/cfr/text/26/1.708-1
Legal Information Institute. (1954, April 16). 26 U.S. Code § 741 - recognition and character of
gain or loss on sale or exchange. Legal Information Institute. Retrieved from
https://www.law.cornell.edu/uscode/text/26/741
Legal Information Institute. (1976, October 4). 26 U.S. Code § 754 - manner of electing optional
adjustment to basis of partnership property. Legal Information Institute. Retrieved from
https://www.law.cornell.edu/uscode/text/26/754
FAQs for Internal Revenue Code (IRC) sec. 754 election and revocation. Internal Revenue
Service. (2022, December 2). Retrieved from https://www.irs.gov/businesses/partnerships/faqs-
for-internal-revenue-code-irc-sec-754-election-and-
revocation#:~:text=An%20IRC%20Section%20754%20election%20allows%20a%20partnership%
20to%20adjust,transfers%20of%20a%20partnership%20interest.
The Federal Register. Federal Register: Request Access. (2022, June 7). Retrieved from
https://www.federalregister.gov/documents/2022/08/05/2022-16271/streamlining-the-section-754-
election-statement
Antico, S. R. (2013). Understand tax implications of practice buy-ins, buy-outs: structure agreements
carefully to maximize benefits when an owner or partner leaves or is brought on board. Medical
Economics, 90(2).
Simmons, D. L. (2013). The Tax Consequences of Partnership Break-Ups: A Primer on Partnership
Sales and Liquidations. Tax Lawyer, 66(3), 653–731.
The Tax Consequences of Partnership Break-Ups: A Primer on Partnership Sale...: Multi-Search
(snhu.edu)
When one of the partners decides or is ready to retire from a partnership formed, there are
many options in liquidation to end the relationship. Each one of these options is based on the tax
consequences for the partner leaving and the ones staying. According to Antico (2013), “When
offering a new equity position or buying out a retiring partner, considerations vary depending on the
structure of the practice, so it is important to note the differences when dealing with a partnership, as
distinguished from a corporation. The appropriate structure of a practice depends on the needs and
desires of the practice owners”. d Now having this in hand, the option I will pick and be beneficial for
every partner is Option 1, just because it is considering and giving opportunities equally to everyone.
We have to remember that Carol is the one retiring and Amy and Bob are not, they would like to
continue with the partnership. d
In my personal opinion, in options #2 and #3, you are adding an extra “thought” beside a
partner’s retirement. d Option #2 is considering a new responsibility for the partnership and Option #3,
is considering a new partner, someone that you don’t really know, maybe in the future.
The sale of a partnership interest is treated as the sale or exchange of a capital asset, so
normal taxes will be applied to this sale. The gain or loss will be calculated as the difference between
the amount realized in the transaction and the selling partner’s adjusted basis in the partnership
interest being sold. In case of death, the purchaser’s basis is determined under normal tax rules, by
cost, and according to Section 1015. Also, this death of a partner can lead to tax issues involving the
close of a partnership's tax year with respect to the deceased partner, a possible change in the
partnership's year-end, post-death allocation of income, Sec. 754 elections, and Sec. 743 adjustments,
among other things.
References
Antico, S. R. (2013). Understand tax implications of practice buy-ins, buy-outs: structure agreements
carefully to maximize benefits when an owner or partner leaves or is brought on board.
Medical Economics, 90(2).
Simmons, D. L. (2013). The Tax Consequences of Partnership Break-Ups: A Primer on Partnership
Sales and Liquidations. Tax Lawyer, 66(3), 653–731.
The Tax Consequences of Partnership Break-Ups: A Primer on Partnership Sale...: Multi-Search
(snhu.edu)
Rupert, T. J., & Anderson, K. E. (2023). Prentice Hall’s Federal Taxation 2023 Corporations,
Partnerships, Estates & Trusts. Pearson Custom.
U.S. Department of Treasury. (n.d.). 26 U.S. Code § 751 -Unrealized receivables and inventory
items. Legal Information Institute. Retrieved March 22, 2023, from
https://www.law.cornell.edu/uscode/text/26/751
ForaFinancial.com (June 29, 2021): Retrieved from: /blog/working-capital/partner-buyout-
financing/
