Question

If a partnership within five years disposes of ______________, the gain or loss is treated as ordinary rather than capital.

Answer 1

If a partnership within five years disposes of unrealized receivables or inventory items, the gain or loss is treated as ordinary rather than capital

Gains or losses from partnership distributions, liquidations, or sales are generally capital gains or losses. However, any gains or losses attributable to unrealized receivables or inventory items are characterized as ordinary income.

Example. In December 2007, E receives a share of inventory items (basis of $20,000) in a nonliquidating distribution from a partnership. In February 2008, E sells the inventory for $30,000. Even though the inventory is a capital asset in E’s possession, the $10,000 gain is taxed to E as ordinary income. 16.

Unrealized receivables are those amounts due from property or services previously provided but not yet included in income (for example, the accounts receivable of a cash basis taxpayer). Unrealized receivables also include depreciation recapture in the partnership assets. 17. The term inventory means all assets other than cash, capital assets, and § 1231 assets.

To be included as ordinary income, before 2003, the inventory items must have been substantially appreciated. This means that the fair market value of the inventory items exceeds 120 percent of its basis to the partnership. Beginning in 2003, all inventory is treated as a ‘‘hot asset for purposes of a sale but not for purposes of a distribution.’’

More details at http://www.cengage.com/resource_uploads/downloads/1424069882_172019.pdf