Generally, a partner is not
taxed on distributions from a partnership. This is because tax was already
paid on partnership income, regardless of whether the income was
distributed. However, a partner will recognize gain on a distribution if
the amount of money received in a distribution exceeds the partner’s
adjusted basis in the partnership.
The two types of distributions that a
partner may receive from a partnership are:
1) Current Distribution: Does
not completely retire the partner’s interest in the partnership.
A current distribution can be either:
– Draw against income that reduces the
partner’s capital account, but does not reduce ownership interest, or
– Distribution that reduces ownership interest, but does not completely
liquidate partnership interest.
2) Liquidating Distribution: One
that completely retires the partner’s interest in the partnership. If a
series of distributions are intended to eventually retire the partner’s
interest, they are all treated as liquidating distributions.
Current Distributions [IRC §731]
The partnership never recognizes a gain or
a loss when money or property is distributed to a partner. This is true
for both current distributions and liquidating distributions. However, the
partner who receives the money or property may recognize a gain or loss.
The tax consequence to the partner will depend on whether it is a current
distribution or a liquidating distribution.
A partner will recognize a taxable gain on
a current distribution to the extent that money distributed exceeds the
partner’s adjusted basis in the partnership immediately before the
distribution. Gain is never recognized by a partner who receives a current
distribution of property (other than money). Loss is never recognized by a
partner who receives a current distribution.
The partner’s basis of property received
in a current distribution is the adjusted basis to the partnership
immediately before the distribution, limited to the partner’s adjusted
basis in the partnership [IRC §732(a)]. If both money and property are
distributed together, the money reduces the partner’s adjusted basis
before the property received. The holding period of the property in the
hands of the partner includes the partnership’s holding period, plus any
holding period of the original partner who contributed the property to the
partnership.
Any gain recognized by a partner on a
current distribution is treated as a gain from the sale or exchange of a
partnership interest. The gain is a capital gain, except to the extent the
partnership has unrealized receivables. For purposes of determining gain
on a distribution of money, a current distribution is treated as being
made on the last day of the partnership year.
When more than one distribution is made
during a year, basis adjustments are made in the order in which the
distributions are made. It is important to distribute cash before
property.
Partnership Basis Of Property Retained
Generally, the basis of property retained
by a partnership after distributions of other property to partners or
transfers of interest, remains the same after the transaction.
