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. b If she takes anything other than money,
unrealized receivables, and inventory she will recognize
no loss. b She will recognize a gain only if she receives
more money than what her predistribution basis is in her
portion of the partnership. b Section 751 requires partners
to recognize ordinary income or loss on the sale or
exchange of a partnership interest as long as 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. b
Payments made for property will not be deductible for the
partnership and may not be income for the successor-in-
interest. b 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.
