The TRA '97's new basis allocation rules for property distributions.In an attempt to prevent basis shifting, Congress, in the Taxpayer Relief Act of 1997, changed the method by which basis is allocated when multiple assets are distributed to partners. This article explains this change in the context of both liquidating and nonliquidating distributions, and offers planning tips. The Taxpayer Relief Act of 1997 (TRA TRA Training TRA Transfer TRA Transition TRA Tennessee Regulatory Authority TRA Telecommunications Regulatory Authority (Oman) TRA Tax Reform Act (1976, 1984, or 1986) TRA Teachers Retirement Association '97) enacted several provisions affecting entities taxed as partnerships.(1) The most significant change, TRA '97 Section 106, amending Sec. 732(c), effective for tax years beginning after Aug. 5, 1997, relates to the allocation The apportionment or designation of an item for a specific purpose or to a particular place. In the law of trusts, the allocation of cash dividends earned by a stock that makes up the principal of a trust for a beneficiary usually means that the dividends will be treated as of a partner's basis in property distributed to him by the partnership for which he cannot take a carryover carryover n. in taxation accounting, using a tax year's deductions, business losses or credits to apply to the following year's tax return to reduce the tax liability. (See: carryback) basis. Inability to take a carryover basis in distributed assets occurs in a nonliquidating distribution when the partner has insufficient in·suf·fi·cient adj. 1. Not sufficient. 2. Incapable of proper functioning. basis in his partnership interest to allocate To reserve a resource such as memory or disk. See memory allocation. to the assets, and in a liquidating distribution when his basis in his partnership interest must be allocated to the assets distributed.(2) Under pre-TRA '97 Sec. 732(c), when a partner was required to take a basis in property that differed from the partnership's basis, basis allocations were assigned as·sign tr.v. as·signed, as·sign·ing, as·signs 1. To set apart for a particular purpose; designate: assigned a day for the inspection. 2. according to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. each property's adjusted basis to the partnership, a process that sometimes produced results inconsistent Reciprocally contradictory or repugnant. Things are said to be inconsistent when they are contrary to each other to the extent that one implies the negation of the other. with the property's fair market value (FMV FMV - full-motion video ).(3) This discrepancy DISCREPANCY. A difference between one thing and another, between one writing and another; a variance. (q.v.) 2. Discrepancies are material and immaterial. in basis allocation distorted the gain or loss on ultimate disposition Act of disposing; transferring to the care or possession of another. The parting with, alienation of, or giving up of property. The final settlement of a matter and, with reference to decisions announced by a court, a judge's ruling is commonly referred to as disposition, regardless of of the property, or produced abnormally ab·nor·mal adj. Not typical, usual, or regular; not normal; deviant. [Alteration (influenced by ab-1) of obsolete anormal, from Medieval Latin high depreciation expense when the property was depreciated Depreciated may refer to:
Nonliquidating Distributions From the distributee partner's perspective, there are two important issues when distributions are received from partnerships. The first is the tax effect of the distribution; the second is the partner's basis in the property received. Most distributions are tax-free tax-free adj. Not subject to taxation; tax-exempt. tax-free Adjective not needing to have tax paid on it: a tax-free lump sum Adj. 1. to partners. Generally under Sec. 733, the amount of cash(4) and the adjusted basis of the property distributed to a partner reduce his basis in his partnership interest; the partner usually takes a carryover basis in the distributed property, under Sec. 732(a). Example 1: J's basis in JKL JKL Jyväskylä (Finland) JKL Jammu Kashmir and Ladakh (Indian State) Partnership is $8,000;JKL distributes $2,000 of cash to her. Because the cash does not exceed J's basis in her JKL interest, she does not recognize gain on the distribution. J's basis in her JKL interest is reduced to $6,000 ($8,000 - $2,000). Example 2: The facts are the same as in Example 1, except that J also receives property with an adjusted basis to JKL of $1,000. J's basis in her JKL interest is further reduced to $5,000 by JKL's $1,000 basis in the property; J takes a $1,000 carryover basis in the property received. If the cash received exceeds the partner's basis in his partnership interest, Sec. 731 (a) provides that the distribution in excess of basis is treated as a sale or exchange of the partnership interest. Because partnership interests are usually capital assets capital assets n. equipment, property, and funds owned by a business. (See: capital, capital account) to partners under Sec. 741, such gain is capital gain.(5) Example 3: K's basis in her JKL Partnership interest is $10,000; she receives a $12,000 cash distribution. K has owned her JKL interest for five years. Because the cash distribution exceeds K's basis in her JKL interest, the excess is treated as a sale of such interest. Accordingly, K has a $2,000 long-term capital gain Long-term capital gain A profit on the sale of a security or mutual fund share that has been held for more than one year. ; her basis in her JKL interest is zero.(6) Insufficient Basis In a nonliquidating distribution, a partner generally reduces his basis in his partnership interest by the partnership's adjusted basis in the assets distributed and takes a carryover basis in the assets received. If the partnership's basis in cash and property distributed exceeds the partner's basis in his partnership interest, the partner must allocate his basis in his partnership interest to the property received, according to Sec. 732(c).(7) If the cash distributed is less than the partner's basis in his partnership interest, the partner will have basis remaining to allocate to the distributed property. The distributed property is classified into two groups, according to Sec. 732 (c) (1): (1) unrealized receivables Receivables An asset designation applicable to all debts, unsettled transactions or other monetary obligations owed to a company by its debtors or customers. Receivables are recorded by a company's accountants and reported on the balance sheet, and they and include all debts owed and inventory(8) and (2) all other property. Basis allocations are made first to unrealized receivables and inventory; if basis remains, it is allocated to the other property received. Under Sec. 732(c)(1) (A) (i), partnership basis is first allocated to inventory and unrealized receivables to the extent of the partnership's adjusted basis in those assets. If insufficient basis exists to allocate carryover basis to these assets, Sec. 732(c)(1)(A)(ii) requires the partner to make a negative adjustment to the partnership's basis in those assets equal to the difference between the partnership's basis in the assets distributed and the partner's basis in his partnership interest. New Sec. 732(c)(3) prescribes a two-step process for allocating the negative adjustment. First, the bases of assets that have declined in value are decreased, but not below FMV. Second, any remaining negative adjustment is allocated to the properties in proportion to their adjusted bases, after any adjustment to FMV. Example 4: G has a $6,000 basis in his UGA UGA opal codon, one of the three stop codons. Partnership interest; in a nonliquidating distribution, he receives the following: Asset UGA's adjusted basis FMV Inventory 1 $14,000 $17,000 Inventory 2 $8,000 $1,000 Equipment $20,000 $25,000 G should allocate his basis to the inventory items to the extent of UGA's basis in those items, but he has insufficient basis; thus, a negative adjustment to the partnership's basis in these items is required. The total adjustment is $16,000, the difference between G's $6,000 basis in his UGA interest and UGA's $22,000 adjusted basis in the inventory. This adjustment is allocated first to assets that have declined in value to reduce their bases to FMV; accordingly, the basis of Inventory 2 is decreased by $7,000 to its $1,000 FMV. The remaining $9,000 ($16,000 - $7,000) negative adjustment is allocated to each inventory item based on its relative adjusted basis after any adjustment to FMV; thus, the remaining $9,000 negative adjustment is applied to Inventory 1 based on its basis of $14,000 and to Inventory 2 based on its new basis of $1,000, as follows: Inventory 1: [$14,000/($14,000 + $1,000)] x $9,000 = [$14,000/$15,000] x $9,000 = $8,400 Inventory 2: [$1,000/($14,000 + $1,000)] x $9,000 = [$1,000/$15,000] x $9,000 = $600 After these additional negative adjustments, G has a $5,600 basis in Inventory 1 ($14,000 - $8,400) and a $400 basis in Inventory 2 ($8,000 - $7,000 - $600). G will take a zero basis in the Equipment he received) Prior to the TRA '97, G would have allocated $3,818 (($14,000/$22,000) X $6,000) of basis to Inventory 1 and $2,182 (($8,000/$22,000) X $6,000) of basis to Inventory 2. Thus, the effect of the TRA '97 is to allocate more basis to the asset that has appreciated (Inventory 1) and less to the asset that has declined in value (Inventory 2). The same methodology applies to post-Aug. 5, 1997 nonliquidating distributions in which basis is allocated to property other than inventory and unrealized receivables. If the partner has sufficient basis to apply to cash, inventory and unrealized receivables distributed to him, but insufficient basis to apply to any other property received, he will apply his remaining partnership basis to such other property by allocating the negative adjustment to the partnership's basis via the same two-step process, per Sec. 732(c)(1)(B).(10) The negative adjustment decreases the carryover basis of such other property received to FMV; any remaining negative adjustment is allocated to the property in accordance Accordance is Bible Study Software for Macintosh developed by OakTree Software, Inc.[] As well as a standalone program, it is the base software packaged by Zondervan in their Bible Study suites for Macintosh. with its relative adjusted basis, after considering the reduction to FMV. Example 5: C has a $9,000 basis in her ABC ABC in full American Broadcasting Co. Major U.S. television network. It began when the expanding national radio network NBC split into the separate Red and Blue networks in 1928. Partnership interest. In a nonliquidating distribution, she receives the following: Asset ABC's adjusted basis FMV Inventory $3,000 $4,000 Equipment $10,000 $2,000 Land $16,000 $14,000 C first allocates basis to the inventory item, taking a $3,000 carryover basis; her basis in her ABC interest is thus decreased to $6,000. Because C now has insufficient basis to allocate to the other property received, she must allocate her remaining basis to those assets by making negative adjustments to ABC's See Win abc's, MSW abc's, XL abc's, DOS abc's and PKZIP abc's. basis in those assets. The total negative adjustment required is $20,000, the difference between C's remaining basis in her ABC interest ($6,000) and ABC's adjusted basis in the other property distributed ($26,000) . The adjustment is first applied to decrease the basis of the property to FMV; thus, the basis of the Equipment is decreased by $8,000 and the basis of the Land is decreased by $2,000, leaving a negative adjustment of $10,000 ($20,000 - $8,000 - $2,000) to be allocated to each property in accordance with its relative adjusted basis (after the adjustment to FMV): Equipment:. [$2,000/($2,000 + $14,000)] x $10,000 = [$2,000/$16,000] x $10,000 = $1,250 Land: [$14,000/($2,000 + $14,000)] x $10,000 = [$14,000/$16,000] x $10,000 = $8,750 Thus, C will take a basis of $750 in the Equipment ($10,000 - $8,000 - $1,250) and $5,250 in the Land ($16,000 - $2,000 - $8,750). Before the TRA '97, the basis allocation would have been $2,308 (($10,000/$26,000) x $6,000) to the Equipment and $3,692 (($16,000/$26,000) X $6,000) to the Land. Thus, the comparative effect of the TRA '97 in this example is to allocate significantly less basis to the Equipment and more to the Land. This reduces the total disparity dis·par·i·ty n. pl. dis·par·i·ties 1. The condition or fact of being unequal, as in age, rank, or degree; difference: "narrow the economic disparities among regions and industries" between C's basis in, and the FMV of, the properties received. Under Sec. 732(c)(3)(A), if more than one asset distributed after Aug. 5, 1997, has declined in value, but the total decline in value is greater than the negative adjustment required, the decrease to each asset's adjusted basis is allocated according to the relative decline in the value of each asset. Example 6: S has a $16,000 basis in his USF USF University of South Florida USF Universal Service Fund (often part of phone bill in US) USF University of San Francisco USF University of Sioux Falls USF University of St. Partnership interest. The partnership distributes the following assets to him: Asset USF's adjusted basis FMV Decline in value Equipment $11,000 $5,000 $6,000 Building $9,000 $7,000 $2,000 Normally, S would take a carryover basis in the assets received, for a total basis in both assets of $20,000; however, he is limited to his $16,000 basis in his USF interest. Thus, a $4,000 negative adjustment is required. The total decline in value for both the Equipment and the Building is $8,000. Because the total decline in value ($8,000) is greater than the negative adjustment required ($4,000), the negative adjustment is allocated to the two assets based on their respective declines in value: Equipment:. [$6,000/$6,000 + $2,000)] x $4,000 = [$6,000/$8,000] x $4,000 = $3,000 Building: [$2,000/($6,000 + $2,000)] x $4,000 = [$2,000/$8,000] x $4,000 = $1,000 As a result of the negative adjustment, S take a basis in the Equipment of $8,000 ($11,000 USF basis - $3,000 negative adjustment) and an $8,000 basis in the Building ($9,000 USF basis - $1,000 negative adjustment). Pre-TRA '97, S would have assigned an $8,800 basis (($11,000/$20,000) x $16,000) to the Equipment and a $7,200 basis (($9,000/$20,000) x $16,000) to the Building. If no distributed assets have declined in value, Sec. 732(c)(3) 03) provides that the negative adjustment is allocated to all the distributed assets based on their relative adjusted bases. In such case, the result would be no different than under prior law. Example 7: A's basis in her ABC Partnership interest is $6,000; she receives the following nonliquidating distribution: Asset ABC's adjusted basis FMV Land 1 $10,000 $60,000 Land 2 $20,000 $25,000 The total adjusted basis of the property distributed is $30,000, but Mill be limited to A's $6,000 basis in her ABC interest; accordingly, a $24,000 negative adjustment is required. Because neither asset has declined in value, the negative adjustment is applied to each asset in proportion to its adjusted basis: Land 1:[$10,000/($10,000 + $20,000)] x $24,000 = [$10,000/$30,000] x $24,000 = $8,000 Land 2: [$20,000/($10,000 + $20,000)] x $24,000 = [$20,000/$30,000] x $24,000 = $16,000 Thus, the basis of Land 1 to A is reduced by $8,000, from $10,000 to $2,000; the basis of Land 2 is reduced by $16,000, front $20,000 to $4,000. Thus, when all properties have appreciated in value, properties with the highest basis receive the largest negative adjustment, regardless of FMV. This result is identical to that obtained under prior law. In nonliquidating distributions of partnership property, downward adjustments to the partnership's basis in the distributed assets are necessary when the partner's basis in his partnership interest is less than the partnership's adjusted basis in the distributed assets. Upward adjustments are never encountered, because the partner is limited to a carryover basis in distributed assets in a nonliquidating distribution. However, both upward and downward adjustments can be encountered in liquidating distributions. Liquidating Distributions Receipt of Cash, Inventory and Unrealized Receivables In a liquidating distribution, the partner terminates his interest in the partnership. If he receives cash in excess of his basis in the partnership interest, he will recognize gain under Sec. 731 (a) and take a zero basis in any other property received in the transaction. If he receives only cash, unrealized receivables and/or and/or conj. Used to indicate that either or both of the items connected by it are involved. Usage Note: And/or is widely used in legal and business writing. inventory, Secs. 731(a)(2) and 732(c)(1)(A)(i) provide that he will recognize loss to the extent his basis in his partnership interest exceeds the partnership's adjusted basis in the unrealized receivables and inventory. Example 8: J has a $15,000 basis in his XYJ Partnership interest. J receives $20,000 cash in a liquidating distribution. He Mill recognize a $5,000 capital gain if the XYJ interest is a capital asset to him.(11) Example 9: L has a $20,000 basis in her ABL Partnership interest. In complete liquidation The collection of assets belonging to a debtor to be applied to the discharge of his or her outstanding debts. A type of proceeding pursuant to federal Bankruptcy of her interest, L receives $10,000 cash, $4,000 of unrealized receivables (with zero basis to the partnership) and inventory with a $2,000 basis to ABL.(12) L's $8,000 capital loss under Sec. 731 (a)(2) is calculated as follows:
L's basis $20,000
Less distributions:
Cash (10,000)
Unrealized receivables 0
Inventory (2,000)
Loss recognized $8,000
Receipt of Other Property If a partner receives property other than cash, inventory and unrealized receivables, his gain or loss on the liquidation of his partnership interest will be postponed until he disposes of such other property. This is accomplished by allocating his basis in his partnership interest to the assets received in liquidation, under Sec. 732(b). Insufficient basis (downward adjustment): After the TRA '97, if a partner receives property from the partnership other than cash, inventory and unrealized receivables, but has insufficient basis in his partnership interest to allocate to those assets, he will make a negative adjustment to the bases of the assets received. The downward adjustment is calculated under Sec. 732(c)(3) in the same manner as for nonliquidating distributions (Examples 4-7, above); i.e., first to assets that have declined in value down to their FMVs, then to all assets in proportion to their adjusted bases. Excess basis (upward adjustment): Unlike a nonliquidating distribution, if a partner receives partnership property in a liquidating distribution and his basis in his partnership interest is greater than the partnership's basis in the distributed assets, he will make an upward adjustment to the partnership's basis in the assets distributed. Under Sec. 732(b) and (c)(2)(A), for post-Aug. 5, 1997 distributions, the increase is first allocated to assets that have appreciated in value, up to their FMVs. If the partner has basis remaining, he then further increases the basis of each asset received in proportion to their respective FMVs, under Sec. 732(c)(2)(B). Example 10: S has a $15,000 basis in her' USF Partnership interest. She receives a liquidating distribution consisting of the following: Asset USF's adjusted basis FMV Cash $5,000 $5,000 Inventory $2,000 $3,000 Typewriter $200 $100 Land $800 $7,000 S recognizes no gain on the liquidating distribution, because the Cash received does not exceed her basis in her USF interest. She first allocates $5,000 of her basis to the Cash, under Sec. 732(b); next, she allocates $2,000 of her remaining basis to the Inventory, under Sec. 732(c)(1)(A)(i). S has $8,000 ($15,000 - $5,000 - $2,000) of basis remaining to allocate to the Land and the Typewriter typewriter, instrument for producing by manual operation characters similar to those of printing. Corresponding to each key on the instrument's keyboard is a steel type. , under Sec. 732 (c) (1) 03); initially, she will allocate a carryover basis of $200 and $800 to the Typewriter and Land, respectively. An upward adjustment of $7,000 is then required under Sec. 732(c) (1) 03) (ii), the difference between S's remaining partnership basis ($8,000) and the carryover basis in the other property ($200 + $800). This adjustment is first allocated, under Sec. 732(c)(2)(A), to assets that have appreciated in value to increase their bases to their FMVs. Thus, $6,200 of the upward adjustment will be allocated to the Land. The remaining $800 upward adjustment ($7,000 - $6,200) is allocated under Sec. 732(c)(2)03) to the Typewriter and the Land based on their relative FMVs: Typewriter: [$100/($100 + $7,000)] x $800 = [$100/$7,100] x $800 = $11 Land: [$7,000/($100 + $7,000)] x $800 = [$7,000/$7,100] x $800 = $789 The basis of the Typewriter is increased by $11 to $211 and the basis of the Land is further increased by $789 to $7,789 ($800 + $6,200 + $789). S's entire $15,000 basis in her USF interest has now been allocated to the assets received in liquidation of her partnership interest: $5,000 cash, $2,000 Inventory, $211 Typewriter, and $7,789 Land. Under prior law, S would have taken a basis of $1,600 (($200/$1,000) X $8,000)in the Typewriter and $6,400 (($800/$1,000) X $8,000) in the Land. The new law more closely aligns the distributed property's basis with its FMV; for example, if S sells the Typewriter for its $100 FMV, she will recognize a $111 loss; pre-TRA '97, she would have recognized a $1,500 loss .(13) If more than one piece of other property received has appreciated in value, but the partner's remaining basis is insufficient to increase the basis of each piece of appreciated property to its FMV, the partner will increase the basis of each appreciated asset according to its relative appreciation, under Sec. 732(c)(2)(A). Example 11: M's basis in her MR Partnership interest is $32,000; she receives the following assets in complete liquidation of that interest: Asset MR's adjusted basis FMV Decline in value Land 1 $5,000 $15,000 $10,000 Land 2 $15,000 $30,000 $15,000 Because MR's basis in the assets is only $20,000 ($32,000 - $20,000), M has to allocate a $12,000 upward adjustment to the carryover basis of the distributed assets. However, the upward adjustment is not large enough to increase the basis of each asset to its FMV; thus, M will allocate the upward adjustment to each asset based on its relative appreciation, as follows: Land 1: [$10,000/($10,000 + $15,000)] x $12,000 = [$10,000/$25,000] x $12,000 = $4,800 Land 2: [$15,000/($10,000 + $15,000)] x $12,000 = [$15,000/$25,000] x $12,000 = $7,200 M increases her basis in Land 1 by $4,800 to $9,800 and her basis in Land 2 by $7,200 to $22,200. Prior to the TRA '97, M would have taken a basis of $8,000 ([($5,000/$20,000) x $12,000] + $5,000) in Land 1 and $24,000 ([($15,000/$20,000) x $12,000] + $15,000) in Land 2. Once again, the TRA '97 more closely aligns the partner's basis with the FMV of the property received. If none of the other property received by the liquidating partner has appreciated in value, the first step (increasing the basis of appreciated property to its FMV) is eliminated; the positive adjustment is simply allocated to all the properties distributed based on their relative FMVs.(14) Example 12: N's basis in the NSF NSF - National Science Foundation Partnership is $40,000; she receives the following in complete liquidation of her partnership interest: Asset NSF's adjusted basis FMV Equipment 1 $15,000 $3,000 Equipment 2 $15,000 $12,000 Because N's $40,000 basis in her partnership interest is greater than NSF's adjusted basis of the assets distributed ($30,000), she has a $10,000 upward adjustment to allocate. Neither asset has appreciated in value; thus, N cannot allocate any of the adjustment to increase the bases of the properties to FMV. Instead, N allocates the entire adjustment to the properties in relation to their FMVs, as follows: Equipment 1: [$3,000/($3,000 + $12,000)] x $10,000 = [$3,000/$15,000] x $10,000 = $2,000 Equipment 2: [$12,000/($3,000+ $12,000)] x $10,000 = [$12,000/$15,000] x $10,000 = $8,000 N will thus increase her basis in Equipment 1 by $2,000 to $17,000 and in Equipment 2 by $8,000 to $23,000. Prior to the TRA '97, N would have allocated her $40,000 partnership basis equally ($15,000/ $30,000) to the two assets, resulting in a basis of $20,000 in each. Planning Considerations In contrast with the prior law, the TRA '97 generally minimizes any future gain (or loss) on the ultimate disposition of property received, by increasing (or decreasing) the basis of property that has appreciated (or declined) in value. If the property received is depreciable depreciable Of, relating to, or being a long-term tangible asset that is subject to depreciation. property to the distributee, the effect of the new law is immediate; it modifies the allocation of basis to the distributed assets and, thus, changes the depreciation the partner can deduct de·duct v. de·duct·ed, de·duct·ing, de·ducts v.tr. 1. To take away (a quantity) from another; subtract. 2. To derive by deduction; deduce. v.intr. . Overall, the new law limits (but does not completely eliminate) the potential for basis shirking Shirking The tendency to do less work when the return is smaller. Owners may have more incentive to shirk if they issue equity as opposed to debt, because they retain less ownership interest in the company and therefore may receive a smaller return. . Whether the adjustment is positive or negative, an appraisal of the distributed property should be performed to ascertain and substantiate To establish the existence or truth of a particular fact through the use of competent evidence; to verify. For example, an Eyewitness might be called by a party to a lawsuit to substantiate that party's testimony. its FMV for basis allocation purposes. This requirement could prove costly to the partnership and/or the distributee partner. From a planning perspective, the new basis allocation rules reinforce re·in·force v. 1. To give more force or effectiveness to something; strengthen. 2. To reward an individual, especially an experimental subject, with a reinforcer subsequent to a desired response or performance. 3. the need to conduct a careful evaluation before a partnership (or LLC (Logical Link Control) See "LANs" under data link protocol. LLC - Logical Link Control ) makes a current or liquidating distribution of multiple assets. Consequently, it is important that practitioners have a comprehensive knowledge of these allocation rules and their impact on both partners and their partnerships. As under prior law, the precise strategy employed to help clients achieve favorable fa·vor·a·ble adj. 1. Advantageous; helpful: favorable winds. 2. Encouraging; propitious: a favorable diagnosis. 3. tax results depends on the facts. The partnership's basis in property distributed, the distributee partner's outside basis and the intended use of the distributed property continue to be of prime importance in selecting the actual properties to distribute. However, for the first time, the inherent appreciation or decline in value of each property distributed must also be considered, because it will often play a prominent role in the analysis. Example 13: The RST Partnership will make a liquidating distribution on Aug. 15, 1998 to T. The FMV of T's RST interest is $45,000; T's basis in that interest is $30,000. To liquidate To pay and settle the amount of a debt; to convert assets to cash; to aggregate the assets of an insolvent enterprise and calculate its liabilities in order to settle with the debtors and the creditors and apportion the remaining assets, if any, among the stockholders or owners of the T's interest, the partnership will distribute Land plus one or more of the following pieces of equipment:
RST's Relative
Asset adjusted basis FMV appreciation
Equipment 1 $0 $7,500 $7,500
Equipment 2 $5,000 $7,500 $2,500
Equipment 3 $10,O00 $15,000 $5,000
Land $15,000 $30,000 $15,000
If T receives the Land, Equipment 1 and Equipment 2, the $10,000 upward adjustment is allocated to the assets distributed based on their relative appreciation, resulting in the following basis to T: Asset T's basis Equipment 1 $3,000(*) Equipment2 $6,000(**) Land $21,000(***) (*) $0 + $3,000; [$7,500/($7,500 + $2,500 + $15,000)] x $10,000 (**) $5,000 + $1,000; [$2,500/($7,500 + $2,500 + $15,000)] x $10,000 (***) $15,000 + $6,000; [$15,000/($7,500 + $2,500 + $15,000)] x $10,000 Alternatively, if T received Equipment 3 and the Land in a liquidating distribution, the $5,000 upward adjustment would be allocated to both assets based on their relative appreciation, resulting in the following basis to T: Asset T's basis Equipment 3 511,250(*) Land $18,750(**) Thus, T can maximize In a graphical environment, to enlarge a window to the full size of the screen. See Win Maximize windows. his future depreciation deductions or minimize In a graphical environment, to hide an application that is currently displayed on screen. For example, in Windows and Mac, the application's window is removed from the screen and represented by an icon on the Windows Taskbar. In the Mac, the icon is placed in the Dock. See Win Minimize windows. his eventual gain on the sale of the equipment if he receives Equipment 3 (basis to him of $11,250) in liquidation of his partnership interest rather than receiving Equipment 1 and 2 (combined basis to him of $9,000). Alternatively, if T intends to sell the Land and keep the equipment, he would prefer to receive Equipment 1 and 2 so as to allocate more basis to the Land and recognize a lower gain on its sale. (15) If the RST Partnership has a Sec. 754 election in effect, it must decrease its basis in remaining assets to the extent of the increase in the assets' bases in T'S hands.(16) Thus, the other partners would probably like to distribute to T assets with the highest basis (i.e., Equipment 3 and Land) so they will have a minimal decrease to the bases of the remaining partnership assets. However, if no Sec. 754 election is in effect, the other partners would probably wish to distribute to T assets with the lowest partnership bases (Equipment 1, Equipment 2 and Land), because he will obtain an increased basis in those assets with no effect on the basis of the remaining partnership property. The partnership (and remaining partners) then retain high-basis assets, which will minimize any future gain (or maximize any future loss) they recognize on their eventual disposition. Thus, depending on the distributee partner's intended use of the distributed assets and the partnership characteristics (e.g., presence or absence of a Sec. 754 election), the interests of the retiring and remaining partners may diverge diverge - If a series of approximations to some value get progressively further from it then the series is said to diverge. The reduction of some term under some evaluation strategy diverges if it does not reach a normal form after a finite number of reductions. . If the distribution to T had required a negative adjustment to RST's basis in the distributed property, the planning opportunities would have been different. As under prior law, distributions of property with a partnership basis greater than the distributee partner's basis in his partnership interest should generally be avoided, because the distributee partner never fully recovers that lost basis.(17) Conclusion Each situation must be considered on its own merits The strict legal rights of the parties to a lawsuit. The word merits refers to the substance of a legal dispute and not the technicalities that can affect a lawsuit. A judgment on the merits is the final resolution of a particular dispute. MERITS. . A distribution of property with a partnership basis greater than the distributee partner's basis in his partnership interest could be beneficial if the partner had capital losses that could be used to offset any gain on the subsequent sale of the asset, especially if the partnership had a Sec. 754 election in effect and all partners could recover the lost basis of the distributed asset. In such case, a distribution of property with a basis greater than the distributee partner's tax basis may be recommended. Any distribution that will require a basis adjustment by the partner invites consideration of the distributee's intended use of the property and the effects on the remaining partners. (1) Limited liability companies (LLCs) can choose to be taxed as partnerships. The TRA '97 changes discussed herein apply to all entities taxed as partnerships. (2) Nonliquidating distributions occur when the partner remains a partner after the distribution is received. A nonliquidating distribution may reduce the partner's basis to zero, but the partner remains a partner, receiving his share of partnership income and losses. Liquidating distributions occur when the partner liquidates his entire interest in the partner ship and is no longer a partner after the distribution; the partnership may be liquidated DAMAGES, LIQUIDATED, contracts. When the parties to a contract stipulate for the payment of a certain sum, as a satisfaction fixed and agreed upon by them, for the not doing of certain things particularly mentioned in the agreement, the sum so fixed upon is called liquidated damages. (q.v. or may remain in existence. The TRA '97 change affects only the allocation of the partner's basis for his partnership interest to multiple assets received when he cannot take a carryover basis. If only one piece of property is distributed, the partner's basis in his partnership interest is still allocated to the single asset received. (3) See Joint Committee on Taxation, Review of Selected Entity Classification and Partnership Tax Issues OCS OCS - Object Compatibility Standard 697, 4/8/97). (4) "Cash" includes deemed cash distributions (e.g., a decrease in partnership liabilities under Sec. 752(b) and marketable securities Marketable Securities Very liquid securities that can be converted into cash quickly at a reasonable price. Notes: Marketable securities are very liquid as they tend to have maturities less than one year, and the rate at which these securities can be bought or sold has treated as cash under Sec. 731(c)(1)). (5) Sec. 741 provides that the sale or exchange of a partnership interest generally results in a capital gain or loss to the partner unless the partnership owns Sec. 751 property (i.e., inventory and unrealized receivables). The effects of Sec. 751 are beyond the scope of this article; however, distributions from partnerships that own such "hot assets" may trigger (1) A mechanism that initiates an action when an event occurs such as reaching a certain time or date or upon receiving some type of input. A trigger generally causes a program routine to be executed. its application. TRA '97 Section 1062(a) amended a·mend v. a·mend·ed, a·mend·ing, a·mends v.tr. 1. To change for the better; improve: amended the earlier proposal so as to make it more comprehensive. 2. Sec. 751(a)(2) to remove the "substantial appreciation" requirement for inventory to be considered a hot asset for purposes of sales or exchanges of partnership interests; it is still a requirement for distributions at the partnership level. Long- long- Adverb (in combination) for or lasting a long time: long-established, long-lasting or short-term capital gain Short-term capital gain A profit on the sale of a security or mutual fund share that has been held for one year or less. A short-term capital gain is taxed as ordinary income. or loss status is determined in part by the partner's interest in the partnership. Long-term Long-term Three or more years. In the context of accounting, more than 1 year. long-term 1. Of or relating to a gain or loss in the value of a security that has been held over a specific length of time. Compare short-term. status occurs if the partner has owned the partnership interest for more than the required length of time. If the partner has not held the partnership interest for the required length of time, but has held the underlying capital or Sec. 1231 assets that he contributed to the partnership in exchange for his partnership interest for more than the required length of time, the partnership interest is deemed to be long-term, because the holding period for capital and Sec. 1231 assets carries over to the partnership interest under Sec. 1223(1). (6) When a partner recognizes a gain due to a cash distribution greater than basis, the partnership's tax-basis balance sheet does not balance. The assets are reduced by the full amount of the cash distribution, but the capital section is decreased only by the partner's tax basis in his partnership interest; thus, assets are less than liabilities. This result can be cured if the partnership has a Sec. 754 election in effect; the partnership increases its basis in remaining capital and Sec. 1231 assets. (7) When a partner's basis in distributed property is limited to his basis in his partnership interest, the tax-basis balance sheet does not balance, because the assets are removed at the partnership's adjusted basis, but the partner's basis in the partnership interest is zero; thus, assets are less than liabilities and capital. This "lost basis" can be cured with a Sec. 754 election, under which the partnership increases its basis in remaining partnership property under Sec. 734(b). (8) The effects of Sec. 751, disproportionate dis·pro·por·tion·ate adj. Out of proportion, as in size, shape, or amount. dis  pro·por distributions of
unrealized receivables and inventory, are beyond the scope of this
article; however, Sec. 751 may apply to a disproportionate distribution
of such hot assets.(9) If a partner has sufficient basis after allocating to unrealized receivables and inventory, it is allocated to any other property received. In this example, G's partnership basis would have to exceed UGA's $22,000 basis in the inventory before he could allocate any basis to the equipment. (10) If the partner does not have sufficient basis to allocate to cash, inventory and unrealized receivables, he allocates his partnership basis to those assets as described above and takes a zero basis in any other property received. (11) See note 5. (12) The inventory and unrealized receivables received represent L's proportionate pro·por·tion·ate adj. Being in due proportion; proportional. tr.v. pro·por·tion·at·ed, pro·por·tion·at·ing, pro·por·tion·ates To make proportionate. share of the hot assets; thus, Sec. 751 does not apply. (13) This alignment Alignment is the adjustment of an object in relation with other objects, or a static orientation of some object or set of objects in relation to others.
(14) This positive adjustment allocation rule, which applies when no assets have appreciated in value, differs from the negative adjustment allocation rule that applies when no assets have declined in value. The negative adjustment is allocated to each asset based on its relative adjusted basis, not relative FMV. (15) Although allocating more basis to the Land would decrease the depreciable basis of the equipment, T could use the Land's increased basis to offset his gain on the immediate sale of the land, versus receiving higher future depreciation deductions on the equipment. (16) See Keene Keene, city (1990 pop. 22,430), seat of Cheshire co., SW N.H., on the Ashuelot River; settled 1736, inc. as a city 1873. It is a trade and manufacturing center in a farming and resort area. , "Making the Sec. 754 Election Decision for a Family Partnership After the TRA '97," 29 The Tax Adviser 33 (January January: see month. 1998). (17) If such a distribution is made, however, and the partnership has a valid Sec. 754 election in effect, the partnership will increase its bases in remaining assets. All partners, then, receive the benefit of the lost basis when the partnership disposes of the remaining assets. If the distribution is nonliquidating, the distributee partner will receive only his pro rata [Latin, Proportionately.] A phrase that describes a division made according to a certain rate, percentage, or share. In a Bankruptcy case, when the debtor is insolvent, creditors generally agree to accept a pro rata share of what is owed to them. share of any benefit from the step-up in basis Step-Up In Basis The readjustment of the value of an appreciated asset for tax purposes upon inheritance. With a step-up in basis, the value of the asset is determined to be the higher market value of the asset at the time of inheritance, not the value at which the original party when the remaining partnership assets are sold. If the distribution is a liquidating distribution, the distributee partner never recovers any of the distributed assets' lost bases. RELATED ARTICLE: EXECUTIVE SUMMARY * The new law's goal is to more closely align align (  līn),v to move the teeth into their proper positions to conform to the line of occlusion. basis of distributed property with its FMV. * If insufficient partnership basis exists to allocate carryover basis to assets, the partner must make a negative adjustment to the partnership basis in those assets. * In a nonliquidating distribution, when all distributed properties have appreciated in value, properties with the highest basis receive the largest negative adjustment, regardless of FMV. |
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