Partnership liquidating distribution detailed example
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.Deferred Payment Sale of a Partnership Interest or liquidation of a partnership interest, §§751(a) and (b) are designed to prevent an assignment of one partner’s share of ordinary income to another partner.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.If the partnership’s assets consist of unrealized receivables, substantially appreciated inventory, or both, the timing for the reporting of the retiring partner’s ordinary income can be drastically different in a sale of a partnership interest as opposed to a redemption of a partnership interest.If the partnership or the remaining partners are strapped for cash, an installment sale and the liquidating distribution may be spread over subsequent tax years.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.
Section 751(b) divides the partnership distribution into two steps: 1) The retiring partner receives a distribution equal to his or her proportionate share of hot assets; and 2) the retiring partner then exchanges the hot assets that were deemed distributed to the retiring partner for an increased portion of cold assets (i.e., cash) that the retiring partner actually received.
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.