Dispositions of Partnership Interests and Partnership Distributions
1. [LO 1] Joey is a 25% owner of Loopy LLC. He no longer wants to be involved in the business. What options does Joey have to exit the business?
Joey’s two most common options are to sell or exchange his interest in the LLC to a third party or to have the LLC liquidate his interest. Joey may also exchange his interest for corporate stock, give the interest away, or transfer the interest upon his death.
2. [LO 1] Compare and contrast the aggregate and entity approaches for a sale of a partnership interest.
Under the aggregate approach, the disposition of a partnership interest represents a sale of the partner’s share of each of the partnership assets. This approach would require complex tax rules because the partner would need to allocate the sales proceeds among the different assets and determine the character of the gain or loss from each asset.
Under the entity approach, the sale of a partnership interest would be very similar to the sale of corporate stock. The partner would recognize capital gain or loss on the sale based on the difference between the sales price and the partner’s tax basis in the partnership interest.
3. [LO 1] What restrictions might prevent a partner from selling his partnership interest to a third party?
Partnership agreements may specify whether a partner may voluntarily leave the partnership. If the agreement does not allow for a voluntary withdrawal, the partnership may need to be dissolved to effect the termination.
A partnership agreement may also specify whether a partner may assign his interest to a third party. This will determine if the partner is free to sell his interest to someone other than the existing partners.
4. [LO 1] Explain how a partner’s debt relief affects his amount realized in a sale of partnership interest.
When a partner sells his partnership interest, often he is relieved of his partnership debt obligations. As is the case in sales of other assets, debt relief will increase the amount realized in the sale of a partnership interest. Because the partner’s outside basis includes his share of the partnership debt, this negates the effect of debt on the gain or loss of the partnership interest sale.
5. [LO 1] Under what circumstances will the gain or loss on the sale of a partnership interest be characterized as ordinary rather than capital?
To the extent that a gain or loss on the sale of a partnership interest is attributable to certain ordinary income assets held by the partnership, the gain or loss is ordinary. §751(a) defines the assets for which the gain or loss will be treated as ordinary.
6. [LO 1] What are “hot assets” and why are they important in the sale of a partnership interest?
Hot assets are assets defined in §751 that will re-characterize the portion of a gain or loss on the sale of a partnership interest as ordinary. The two categories of hot assets under §751(a) are unrealized receivables and inventory items. Unrealized receivables include rights to receive payment for goods delivered or to be delivered, rights for services rendered or to be rendered, and items treated as ordinary income if the partnership were to sell the item at its fair market value.
Under §751(a) inventory items include property held for sale to customers in the ordinary course of business and assets that are not capital assets or §1231 assets that would produce ordinary income if sold by the partnership. To the extent that a seller realizes any amounts from the sale of his partnership interest that are attributable to these unrealized receivables or inventory items, the gain or loss will be classified as ordinary.
7. [LO 1] For an accrual-method partnership, are accounts receivable considered...