Partnership liquidating distribution detailed example
If Canes’ assets are cash and fixed assets with a basis and value of ,000, and substantially appreciated inventory with a basis of ,000 and a value of 0,000; and each partner’s outside basis is ,000, the §751(b) exchange apparently comes first out of the §736(b) payments.
If this is so, the first ,000 of the fixed payments (the first eight years and part of the ninth year with ,000 fixed payments, and, presumably all fixed payments with ,000 fixed payments) are part of the §751(b) exchange.
The parties can, apparently, agree to alter these amounts by putting the §736(a) payments first or last, as described in Figure 1.
Payments to a retiring partner under §736 must first be divided between payments under §736(a) and §736(b). Section 751(b) does not apply to payments made to a retiring partner to the extent that, under §736(a), such payments constitute a distributive share of partnership income or guaranteed payments.
Example — A retires from the ABC partnership and is to receive ,000 in two annual installments of ,000 each in liquidation of his interest in §736(b) property, none of which is §751 property.
The partner’s basis in his partnership interest is ,000.
Professor Manning’s Approach While scholars differ as to the correct tax treatment, surprisingly, there is no direct administrative guidance on this issue by the IRS or case law.
This means ,300 of ordinary income under §751(b) in each of the first eight years and ,600 in the ninth year (total ,000) when the fixed payments are ,000, and ,500 each year when the fixed payments are ,000.Thus, Professor Manning suggests that the parties should agree to accelerate §736(a) payments before §736(b) payments, thus, not taking the hot assets (i.e., no ordinary income taxation upfront) into account right away while the partnership distributes §736(b) payments to the retiring partner in later tax years.The redemption payment will be ,000 a year for the next seven years, plus a §735(a) payment equal to five percent interest on the unpaid balance.When a partner in a business partnership retires with a buyout agreement in place, the buyout agreement typically requires either a sale of the retiring partner’s interest to the remaining partners (a cross purchase agreement) or a redemption of the retiring partner’s interest by the partnership.If the partnership does not have unrealized receivables or substantially appreciated inventory, the choice to the retiring partner between a cross purchase (a sale by the retiring partner) or a liquidating distribution is generally income tax neutral.
If the partnership’s assets consist of unrealized receivables, appreciated inventory items, or both (commonly referred to as “hot assets” ), the retiring partner should be aware of the uncertainty under Subchapter K and the regulations of a looming ordinary income tax trap when receiving liquidating distributions spread over multiple tax years.