Ed receives a $20,000 cash distribution from the EV Partnership, which reduces his partnership interest from one-third to one-fourth. The EV Partnership is a general partnership that uses the cash method of accounting and has substantial liabilities. EV's inventory has appreciated substantially since it was purchased. What issues should Ed consider with regard to the distribution?
What will be an ideal response?
Ed must determine:
• How much is his distribution?
• Does the partnership have Sec. 751 assets?
• If the partnership has Sec. 751 assets, did Ed exchange any interest in Sec. 751 assets for cash?
• How much ordinary income must Ed recognize if he exchanges Sec. 751 assets for cash?
• How must Ed treat any cash distribution received that exceeds the amount deemed to be part of the Sec. 751 exchange?
The amount of the distribution includes both the cash and the relief from liabilities that he received when his interest in the partnership changed from 1/3 to 1/4. It is likely that the partnership has Sec. 751 assets, since we know the partnership inventory is substantially appreciated. Further, it is likely that the cash-basis partnership has unrealized accounts receivable, and the partnership may have recapture potential if it has any depreciable personalty. Again, it is likely that an exchange of Sec. 751 assets for cash occurred, since Ed received only cash and probably gave up a portion of his interest (from 1/3 to 1/4) in each Sec. 751 asset. The amount of ordinary income is the difference between the amount of cash Ed is deemed to have received for the Sec. 751 assets and the adjusted basis that Ed would have had in the Sec. 751 assets had the Sec. 751 assets been distributed to Ed immediately before the deemed Sec. 751 sale (usually a carryover from the partnership's basis in these Sec. 751 assets). Any cash or deemed cash exceeding the amount deemed to be part of the Sec. 751 exchange is simply treated as a current distribution. The current distribution will reduce his basis in his partnership interest. If the current distribution is greater than his basis in the partnership interest, Ed will recognize gain because he receives cash exceeding his basis.
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