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Partner retains status until discharged from partnership liabilities.

The Tax Court recently held that a partner remained a partner for tax purposes until he was ultimately discharged from partnership liabilities pursuant to state law. In McDaniel, TC Memo 1999-133, the taxpayer was a partner in a general partnership that owned real estate. The real estate secured a partnership mortgage also guaranteed by the taxpayer and the other general partners. The partnership began to experience negative cashflow from its operations, forcing the partners to make monthly cash contributions to fund the partnership's operations.

After several months, the taxpayer was unable to continue making monthly contributions to the partnership and transferred his interest in the partnership by quitclaim deed to another partner when his capital account in the partnership was negative. (The liabilities guaranteed by the taxpayer exceeded his negative capital account balance; thus, the taxpayer had a positive tax basis in his partnership interest.)

The mortgagor did not relieve the taxpayer of his guarantee in connection with the quitclaim. In addition, there was no agreement between the taxpayer and the other partners to indemnify him for any amounts that would become due as a result of his guarantee. Two years later, the partnership successfully refinanced the mortgage with a different lender, thereby relieving the taxpayer of any potential liability associated with the partnership's mortgage.

The Tax Court's decision relied heavily on the fact that the taxpayer remained liable for the partnership's mortgage as a matter of state law. Citing Weiss, 956 F2d 242 (11th Cir. 1992), the Tax Court ruled that the taxpayer did not receive a deemed distribution of cash under Sec. 752(b) until the partnership refinanced the mortgage some two years later. Accordingly, the taxpayer did not recognize gain equal to his negative capital account balance until the mortgage was refinanced and he was relieved of liability under state law.

Taxpayers should be mindful of the effect of liabilities on the sale or redemption of a partnership interest. In typical guarantee arrangements, as well as situations involving recourse liabilities of a general or limited partnership, a partner may not be relieved from liability for state law purposes on the sale or redemption of an interest. This continuing liability could affect the amount of gain or loss currently recognized on the sale or redemption, as well as the basis of property distributed to a partner in redemption of a partnership interest. Thus, proper planning before the sale or redemption may be required to seize a potential opportunity or to avoid an unfavorable result.

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Article Details
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Author:Knudson, Brian J.
Publication:The Tax Adviser
Geographic Code:1USA
Date:Nov 1, 1999
Previous Article:"Threat" of involuntary conversion defined for sec. 1033 Purposes.
Next Article:Burden of proof shifts to IRS.

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