Differences between liquidating and nonliquidating distribution
A sale of all the partnership interests would transfer the partnership‟s assets just as would a direct asset sale, but by selling the higher-basis interests, aggregate gain is reduced.
Equivalently, if inside basis were higher, the assets rather than the interests would be sold.
It should not be difficult to figure out how to tax two individuals who contribute equal amounts of cash to start a joint business in which each will own a one-half interest.
But it quickly becomes problematic when one if the two partners wants a greater share of early receipts in exchange for a lower share of back-end gains.
Given that P contributed cash of 0 and the partnership‟s only asset grew by 0 while P was a 50% owner, this means that the distribution will have reduced P‟s total return from 0 to 3.
In particular, transactions between a partner and the partnership should be tax-free as much as possible, with the taxable events being dealings between the partnership (or the partners) and third-parties.Now– and despite the lack of any real statutory support – an incoming partner will in effect take a share of inside basis in each of the partnership‟s assets equal to that partner‟s share of each asset‟s fair market value, an outcome so reasonable that one could only have wished the Congress rather than Treasury had seen fit to specify it.But the regulations applicable to section 734(b) adjustments were not much changed, and that is unfortunate.Thus, most contributions and distributions are tax-free, but transfers of partnership assets or interests to non-partners generally are taxable. A corollary of tax transparency is the general equality of aggregate inside and outside bases.“Inside basis” is the partnership‟s adjusted basis in its assets, while outside basis is a partner‟s adjusted basis in his partnership interest.
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The partnership tax provisions – Subchapter K of the Internal Revenue Code – work pretty well.