When a partner in a partnership is having their interest terminated, often such termination may be through a series of distributions. The series of distributions may be needed due to the cash flow of the buyer or purchaser. Thus, the question arises, are these liquidating distributions? The article below has been drafted by a Denver tax attorney to provide information regarding a series of distributions to a partner in a partnership in liquidation of the partner’s interest. Discuss your partnership tax matters and questions with a tax attorney in Denver by contacting The McGuire Law Firm.
When a withdrawing partner’s interest is terminated through multiple, or a series of distributions to the partner, each distribution can be considered a liquidating distribution as opposed to a current distribution. This is so even if the partner is a tax partner until the final distribution is made (see IRC Section 761) and recognizes gain only after total, actual or the constructive money distributions would exceed the outside basis of the partner’s partnership basis. Therefore, this is not necessarily installment sale treatment, but rather open transaction treatment. It is also important to note that a withdrawing partner can only recognize a loss once the final liquidating distribution is received.
The partnership’s obligation to make the distribution is not treated as a cash equivalent for a cash method taxpayer nor is it treated as an obligation for an accrual method taxpayer. Under IRC Section 736, the obligation to make these deferred payments is not a debt obligation. Thus, the liquidating distributions can be made by the partnership to the partner as a debt obligation that liquidates the interest immediately and thus the withdrawing partner is considered more as a creditor than as a partner of the partnership.
For example, John is withdrawing from J Cubed, LLC and the partnership agreement satisfies the special allocation regulations. John is entitled to receive $100k upon his withdrawal. Half is payable upon withdrawal and the other half in the year after the withdrawal. John’s outside partnership basis is $75,000. Thus, assuming there is no 751 Exchange, John will not recognize gain on the initial distribution of $50,000 because of the $75,000 in outside basis and gain recognition rules. All of the $25,000 gain John will recognize will be recognized upon the second distribution. J Cubed’s obligation to make the second $50,000 distribution is not a debt obligation. The gain of $25,000 may be capital gain, but one should always considerable the collapsible partnership rule. Assuming John had an outside basis of $150,000 and received the same $100,000 total in distributions, the loss could not be recognized until the second payment was made.
If you have tax questions relating to the sale of a business or business interest, discuss these questions and issues with a Denver tax attorney at The McGuire Law Firm. You can schedule a free consultation with a tax attorney in Denver who can assist you with your matters.