Question

The December 31, 2019 balance sheet of the LCM Limited Partnership appears below:

                                                            Adjusted           Fair Market

                                                              Basis                  Value

Cash                                                     $210,000          $210,000

Receivables                                                        0            108,000

Property, Plant & Equipment                     42,000              81,000

                                                            $252,000          $399,000

Larry, Capital                                        $  84,000          $133,000

Curly, Capital                                            84,000            133,000

Moe, Capital                                             84,000            133,000

                                                            $252,000          $399,000

Each partner shares equally in the partnership’s capital, income, gains, losses, deductions, and credits.  The partnership manufactures high-quality widgets and capital is a material income-producing factor.  On December 31, 2019, Curly, the General Partner, receives a distribution of $140,000 cash in retirement of his partnership interest. Nothing is stated in the partnership agreement about goodwill.  Curly’s outside basis in his partnership interest immediately before the distribution is $84,000.

Required:  

(1) What are the amount and nature of Curly’s gain that result from the distribution?  Explain your answer and provide supporting computations.

(2) What are the tax consequences to the partnership of making the distribution?

(3) What action should the partnership consider and what effect would that action have?

Answer 1

a) Partnerships may distribute money or property to the partners, which is usually not taxable, since earnings are taxed whether the income is distributed or not. However, if the partnership distribution exceeds the partner's tax basis in the partnership, which is generally known as the partner's outside basis, then the excess will be recognized as a capital gain.

Capital Gain : $140,000 - $ 84,000 = $ 56,000

b) No gain or loss is recognized to a partnership on a distribution of property or money to a partner.

c) Although a partnership is not a “taxpayer” in the sense that it pays an income tax on its earnings, it nevertheless must compute its gross income, its deductions, and its gains and losses as if it were before passing those items through to its partners.