Partnership Interest – Capital Gain vs Ordinary Income?

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  • #188793
    Anonymous
    Inactive

    The personal service partnership of Allen, Baker & Carr had the following cash basis balance sheet at December 31 of the current year:

    Adjusted basis Market value

    ASSETS

    Cash $ 102,000 $ 102,000

    Unrealized accounts receivable − 420,000

    Total $ 102,000 $ 522,000

    LIABILITY AND CAPITAL

    Note payable 60,000 60,000

    Capital accounts:

    Allen 14,000 154,000

    Baker 14,000 154,000

    Carr 14,000 154,000

    Totals $ 102,000 $ 522,000

    Carr, an equal partner, sold his partnership interest to Dole, an outsider, for $154,000 cash on January 1 of the following year. In addition, Dole assumed Carr’s share of the partnership’s liability.

    What amount of ordinary income should Carr report on the following year’s income tax return on the sale of his partnership interest?

    a.

    $140,000

    b.

    $20,000

    c.

    $34,000

    d.

    $0

    Explanation

    Choice “a” is correct. Carr should report ordinary income of $140,000.

    Rule: An interest in a partnership is generally a capital asset. However, any gain resulting from the sale of a partner’s share of unrealized receivables and/or appreciated inventories is treated as ordinary income

    Share of unrealized receivables (420,000 x 1/3) = 140,000

    Why is this not capital gain? Could I have just taken the share of unrealized receivables (420K x 1/3) and get the answer without going through the first step?

Viewing 8 replies - 1 through 8 (of 8 total)
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  • #609600
    2B.CPA
    Participant

    It would normally be capital gain, but I believe there is a special rule if there are unrealized A/R or appreciated inventories (hot assets) then it is treated as ORD income to the extent of those amounts. You can't skip the first step of calculating the total gain. In this problem, it happens that all 140,000 of unrealized receivables amount is treated as ORD gain, but let's say the total gain was only 50k? Then, only 50k would be ordinary gain, since there are no more gains to even treat as ORD.(Sorry if I confused you more… best i can do.. haha)

    #609601
    Anonymous
    Inactive

    thank you @2B.CPA!

    #3303427
    LilLambLost
    Participant

    Can someone please explain why the cash he received wasn't a factor in this problem?

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    #3303433
    monikernc
    Participant

    Because the question is asking only for the amount of ordinary income that will be reported.

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    #3303451
    LilLambLost
    Participant

    Because the question is asking only for the amount of ordinary income that will be reported.

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    How would the cash be treated? I see that it doesn't belong in ordinary income, but could you explain why, please? That's what I don't understand.

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    #3303454
    CPAHOPE
    Participant

    To prevent tax abuse. Normally, selling partners interest is treated as capital gain but since partnership contains receivable, it needs to be allocated equally among the partners. This is called proportionate distribution. Theres unproportionate distribution which is a complex topic which it doesnt test much thankfully. You should look into this topics.

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    #3303457
    CPAHOPE
    Participant

    Cash is treated as a capital gain.

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    #3303460
    CPAHOPE
    Participant

    My bad, please ignore my post. This is related to sales not distribution. You should look into sales n termination of partnership. The idea is the same, to prevent tax abuse though.

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