So you have worked hard with your partners and built a strong and respectful business. Now you wish to sell your partnership interest. Maybe you are looking to retire, or maybe you just want to try a new endeavor, but regardless you are going to sell your partnership interest. As you begin the process, a thought crosses your mind, what are the tax implications when I sell my interest in this partnership? Will I recognize gain? Will I recognize a loss? The article below drafted by a Denver tax attorney provides general information regarding the recognition of gain or loss when you do sell your partnership interest.
When a partner sells their partnership interest the partner will realize gain or loss. To determine the gain or loss realized on this sale, you must determine the amount realized through the sale of the interest and the partner’s adjusted basis in their partnership interest. The amount the partner will realize will include any cash and the fair market value of any property received. Further, if the partnership has liabilities, the amount realized will include the partner’s share of the partnership liabilities. If the partner remains liable for the debt, the amount realized will not include the partner’s share of the liability. It is important to note that in regards to liability for partnership debt, if a partner indemnifies the selling partner for a partnership debt, the tax court has held that the amount realized will include the amount of which the partner has been indemnified. Thus, once you know the amount realized, and the basis you can calculate gain or loss. Below are some examples we will use to explain the pertinent matters.
Amount Realized: Jeffrey is a partner in the ABC Partnership of which has no outstanding liabilities. Jeffrey sells his entire partnership interest to Doc for $25,000 cash and property that has a fair market value of $75,000. Jeffrey’s amount realized is $100,000.
Amount Realized that Includes a Partnership Liability: Jeffrey is a partner in ABC Partnership and has a $15,000 basis in his interest. Jeffrey’s partnership interest is 1/3 of the partnership. When Jeffrey sells his 1/3 interest for $25,000 the partnership has a liability of $9,000. Jeffrey’s amount realized would be $28,000 ($25,000 + $9,000 x 1/3).
Now that we have looked at examples in regards to amount realized, we will look at an example regarding gain realized. From Example 1 above, assume that Jeffrey’s basis was $50,000. Jeffrey’s realize gain would be $50,000 ($100,000 – $50,000). Amount realized less the partner’s adjusted basis will provide the partner’s gain or loss through the sale of their partnership interest.
Now that you know the gain or loss, what is the next important question to ask? What is the character of the gain? Generally, the character of the gain would be determined by referencing the asset so. Generally, a partnership interest is considered a capital gain and thus gain or loss through the sale of such interest would be considered a capital gain or capital loss. However, under the collapsible partnership rules, it is possible to realize ordinary income.
I was once asked if the non-recognition provisions of a like kind exchange under IRC Section 1031 could apply to exchanges of partnership interest. As far as I know, the like kind exchange provisions cannot apply to the exchange of partnership interests. However, Subchapter K of the Internal Revenue Code does allow the exchange of a limited partnership interest for a general partnership interest in the same partnership to qualify for non-recognition, but this is not due to a like kind exchange rule.
If you feel you or your business needs assistance with tax matters or business issues and would like to speak with a Denver tax attorney or business attorney, please contact The McGuire Law Firm.