Example 19-2 Liquidation and Termination with Debt...

19-3Example 19-2 Liquidation and Termination with Debt and Negative Capital Accounts

Jack and Jill are general partners in the JJ equal partnership, an active business.

The partnership terminates: ceases operations, sells all of its noncash assets, and distributes the remaining cash to the partners.

Pre-liquidation balance sheet:

JJ Balance Sheet Partner’s Outside

BasisAssets Tax Basis FMV

Cash $100,000 $100,000Accounts Receivable $0 $100,000Inventory $40,000 $100,000Land $60,000 $100,000

Total Assets $200,000 $400,000

Debt $600,000 $600,000Capital

Jack <$200,000> <$100,000> $100,000

Jill <$200,000> <$100,000> $100,000

Total Capital <$400,000> <$200,000>

Debt + Equity $200,000 $400,000

19-4

The partnership sells its assets and pays off $400,000 of debt.

J and J each contribute $100,000 to pay the lender

Game over

19-5Business Bad Debt

19-5

19-7

See Example 19-4

Termination Example 19-5

Deemed Termination Without Sec 754 Election

See balance sheet on next slide. Section 1245 recapture income is $60,000.

New Partner N purchases C and D’s (1/4 each) partnership interests in the ABCD Partnership for a total cost of $750,000 (plus assumption of $75,000 share (50%) of partnership debt).

The ABCD Partnership is terminated by Code Sec 708(b)(1)(B).

Assume no Sec 754 election (nor a Sec 732(d) election by N).

Partner'sBasis FMV Outside

Cash 110,000$ 110,000$ BasisAccounts Receivable -$ 110,000$ Inventory 130,000$ 200,000$ Sec 1245 Prop 100,000$ 160,000$ Land 110,000$ 270,000$ Goodwill -$ 800,000$

Total Assets 450,000$ 1,650,000$

Bank Loan 150,000$ 150,000$

Partner A (1/4) 75,000$ 375,000$ 112,500$ Partner B (1/4) 75,000$ 375,000$ 112,500$ Partner C (1/4) 75,000$ 375,000$ 112,500$ Partner D (1/4) 75,000$ 375,000$ 112,500$

Total Debt and Equity 450,000$ 1,650,000$

ABCD Partnership

Before Sale by Partners C and D to N

C and D each recognize total gain of $300,000 on their sales to N ($600,000 total). Amount realized of $412,500 ($375,000 cash received + $37,500 debt relief) minus $112,500 outside basis.– $60,000 of the gain is ordinary income

per Code Sec 751(a).– $240,000 is long-term capital gain per

Code Sec. 741.

N’s outside basis is $825,000 ($750,000 plus $75,000 debt share).

Per Reg. 1.708-1(b)(4), the old partnership (ABCD) would contribute its assets to a new partnership (ABN), and the new partnership interests would be distributed to partners A, B and N.

Per Sec 731, no gain or loss would be recognized by the partners and, under Sec 732(b), Partners A and B (the old continuing partners) would continue to have a $112,500 outside basis and Partner N would have a $825,000 outside basis.

The balance sheet of ABN is on the next slide.

The MACRS life on the Sec 1245 property would re-start for ABN, as if newly purchased.



Total Assets 450,000$ 1,650,000$

Bank Loan 150,000$ 150,000$

Partner A (1/4) 75,000$ 375,000$ 112,500$ Partner B (1/4) 75,000$ 375,000$ 112,500$ Partner N (1/2) 150,000$ 750,000$ 825,000$


ABN Partnership

After Sale by Partners C and D to N

Reg. sec. 1.704-1(b)(2)(iv)(l) provides “that the deemed contribution and liquidation with regard to the terminated partnership are disregarded in determining the capital accounts of the partners and the books of the new partnership”. Quote from Example in Reg. 1.708-1(b)(4)

Reg. sec. 1.704-1(b)(2)(iv)(l) also provides that with a deemed termination, “the capital account of the transferee partner and the capital accounts of the other partners of the terminated partnership carry over to the new partnership that is formed as a result of the termination of the partnership under §1.708-1(b)(1)(iv).

Termination Example 19-6

Deemed Termination With

Sec 754 Election

Reg Sec 1.708-1(b)(5): “the bases of partnership assets are adjusted pursuant to sections 743 and 755 prior to their deemed contribution to the new partnership.”

Reg Sec 1.743-1(h)(1): “A partner with a basis adjustment in property held by a partnership that terminates under section 708(b)(1)(B) will continue to have the same basis adjustment with respect to property deemed contributed by the terminated partnership to the new partnership under §1.708-1(b)(1)(iv), regardless of whether the new partnership makes a section 754 election.”

Same facts as example 19-5 except assume that an IRC sec. 754 election has been made.



Total Assets 450,000$ 1,650,000$

Bank Loan 150,000$ 150,000$

Partner A (1/4) 75,000$ 375,000$ 112,500$ Partner B (1/4) 75,000$ 375,000$ 112,500$ Partner C (1/4) 75,000$ 375,000$ 112,500$ Partner D (1/4) 75,000$ 375,000$ 112,500$


ABCD Partnership

Before Sale by Partners C and D to N

C and D again each recognize total gain of $300,000 on their sales to N ($412,500 amount realized - $112,500 outside basis).– $60,000 of the gain is ordinary income

per Code Sec 751(a).– $240,000 is long-term capital gain per

Code Sec. 741.

N’s outside basis is $825,000 ($750,000 plus $75,000 debt share).

Partner N can now take advantage of an upward adjustment to N’s share of the inside basis of the ABCD assets.

Reg. sec. 1.708-1(b)(5) clarifies that N’s share of the bases of any partnership assets are adjusted pursuant to sections 743 and 755 prior to their deemed contribution to the new partnership.

Sec 743(b) Adjustment

Partner N’s Sec 743(b) adjustment is $600,000--the excess of N’s outside basis ($825,000) over N’s share of the inside basis in the ABCD Partnership assets--$225,000*.

* $225,000 = N’s previously taxed capital of $150,000 + N’s debt share of $75,000.

Sec 755 AllocationPer Sec 755, Partner N’s $600,000 Sec 743(b) adjustment would be attributed to ABCD assets as follows:

Accounts Receivable + $55,000Inventory + $35,000Sec 1245 Prop + $30,000Land + $80,000Goodwill + $400,000

Total Adjustment $600,000

The new partnership has the same $600,000 IRC sec. 743(b) adjustment for the new partnership as the terminated partnership.

It is NOT a common balance sheet adjustment.

Clearly, the IRC sec. 743(b)

adjustment does not trigger a book capital account

adjustment

Reg Sec 1.743-1(h)(1): “A partner with a basis adjustment in property held by a partnership that terminates under section 708(b)(1)(B) will continue to have the same basis adjustment with respect to property deemed contributed by the terminated partnership to the new partnership under §1.708-1(b)(1)(iv), regardless of whether the new partnership makes a section 754 election.”


Cash 110,000$ 110,000$ BasisAccounts Receivable 55,000$ 110,000$ Inventory 165,000$ 200,000$ Sec 1245 Prop 130,000$ 160,000$ Land 190,000$ 270,000$ Goodwill 400,000$ 800,000$

Total Assets 1,050,000$ 1,650,000$

Bank Loan 150,000$ 150,000$


Total Debt and Equity 1,050,000$ 1,650,000$

ABN Partnership




Total Assets 450,000$ 1,650,000$

Bank Loan 150,000$ 150,000$



ABN Partnership


Example 19-2 Liquidation and Termination with Debt...

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