Option 2: Borrow money to pay for Carol’s interest in the business.
If Carol chooses to take a liquidating distribution of less than her basis in the partnership, she will
recognize a loss for tax purposes. z If she takes anything other than money, unrealized receivables, and
inventory she will recognize no loss. z She will recognize a gain only if she receives more money than
what her pre distribution basis is in her portion of the partnership. Section 751 requires partners to
recognize ordinary income or loss on the sale or exchange of a partnership interest if it is attributable
to the partner’s share of unrealized receivables and inventory.
The general rule for partnerships is that no gain or loss is recognized by the partnership in a liquidating
distribution to one partner, unless it is a section 751 sale or exchange.
If Carol dies before the liquidating distributions are made, her successor-in-interest would take
payments from the partnership for Carol’s interest in the partnership. Payments made for property will
not be deductible for the partnership and may not be income for the successor-in-interest. z If payments
exceed the value of that partner’s share of partnership property and are treated as a guaranteed
payment, Carol, or her successor-in-interest, recognizes ordinary income, and the partnership
generally has an ordinary deduction.
If the partners choose to liquidate the partnership, they are distributing the partnership assets to the
partners. The partner will recognize a gain if deemed money is distributed that exceeds their pre
distribution basis. Deemed money includes cash, a reduction in liabilities, or FMV securities. In a
liquidating distribution a partner is able to recognize a gain or loss unlike a current distribution which
can recognize a gain only. If the liquidating distribution has deemed money, unrealized receivables, or
inventory and no other property while the partner’s basis in the partnership interest is more than the
total basis the partnership has of the distributed property, a loss can be recognized. If there is other
property distributed the partner can’t recognize a loss and the partner’s basis is allocated the property.
After a liquidating distribution a partner has zero basis in the partnership. If there are Sec 751 assets
the partner must determine the gain or loss on those assets and record it as ordinary income.
If Carol was to perish before any of the transactions occurred, her ownership would be part of her
estate. All the partners should develop a plan to determine what happens when one of them dies, do
they want a designated heir to take part in the partnership, do the other partners buy the estate out of
the partnership, or do they liquidate the partnership. With planning they can think ahead which will
make their passing easier for their loved ones and their business partners.
When a partner retires or dies and is in a partnership, the remaining partners have a few options to
discuss. They can sell the business outright and circulate the profits amongst the partners. They can
take on debt and buy the partner’s interest in the business. Lastly, the partner leaving could sell their
stake in the business to a new buyer. In the case of ABC Marina, Amy and Bob have just been
informed of Carols intention to retire.
After much deliberation, Amy and Bob decided to ask Carol to find a new buyer to take over Carol’s
interest in the business. The new partner does not need to have a name that starts with “C”, but it sure
would be nice. When Carol sells their interest in ABC Marina, this will have no tax consequences on
the partners. Carol, however, will need to recognize capital gains or loss because partnership interest is
generally a capital asset. “Section 751 requires the partner to recognize ordinary income or loss to the
extent of the partner’s share of unrealized receivables and inventory items” (Anderson 2023).
Partnership liabilities are part of each partners’ basis in the partnership. When Carol sells their interest
in ABC, Carol will be relived of partnership liabilities. They will become part of the new partner’s
basis in the firm.
If Carol were to die before the sale is executed, payments made to their estate for unrealized
receivables and goodwill are not considered payment for property. These payments are considered as
other payments. These payments can be deducted or used to reduce the distributive share allocable to
the other partners. Hopefully, Carol has a robust estate plan and funds can flow easily to the
designated person/people/trust(s).
Reference:
Anderson, Kenneth, et al., editors. Pearson’s Federal Taxation 2023 Corporations, Partnerships,
Estates & Trusts. Pearson Education, Inc, 2023.
Anderson, K. E., Rupert, T. J., & Hulse, D. S. (Eds.). (2023). Pearson'sFederal Taxation 2023
Corporations, Partnerships, Estates & Trusts. Pearson
Anderson, Kenneth, et al., editors. Pearson’s Federal Taxation 2023 Corporations, Partnerships,
Estates & Trusts. Pearson Education, Inc, 2023.
