My 1040 Client Selling Ownership Of Partnership

[RitaB]

My client is planning on selling his 25% ownership in a partnership to another existing partner on July 1. He is a general partner. No guaranteed payments are made.

Let's say the Partnership makes $5,000 during the period Jan - Jun, and makes $3,000 Jul - Dec. His ordinary income subject to SE will be 5000 x 25%, correct?

Further, if his capital account on Jul 1 is $10,000 and he sells his 25% ownership to another partner for $12,000; he will be getting a $10,000 distribution (not taxable) and incurring a $2,000 capital gain, correct?

He called this morning and asked about these issues. (It is refreshing to acually have someone ask questions before they hand me their stuff on April 10.) I told him what I thought, and that I would check further. I am working on three WC and one general liability audit right now, so I am starting my study here.

Finally, do all your clients buy insurance at the same time, or is just mine?

[dsi]

What is your client's basis in the PS?
Start with what he contributed to get the 25% interest.
Add his share of the profits over the years, subtract his share of the losses.

This is a start.

[luke]

my take is

My client is planning on selling his 25% ownership in a partnership to another existing partner on July 1. He is a general partner. No guaranteed payments are made.

Let's say the Partnership makes $5,000 during the period Jan - Jun, and makes $3,000 Jul - Dec. His ordinary income subject to SE will be 5000 x 25%, correct?

Further, if his capital account on Jul 1 is $10,000 and he sells his 25% ownership to another partner for $12,000; he will be getting a $10,000 distribution (not taxable) and incurring a $2,000 capitial gain, correct?

Your client, the selling partner, should receive a K-1 for 25% of 1/2 the partnership income as shown on the 1065 (in your example 25% of ($5000 + $3000)/2 = $1000).

[abctax]

"he will be getting a $10,000 distribution (not taxable) and incurring a $2,000 capitial gain, correct?"

I disagree with the 'getting a $ 10,000 distribution'. He isn't getting a distribution from the partnership, he's selling his 25% interest to another partner for $ 12000. If his basis (see Dave's comments) is truly $10,000, then your assumption of a $ 2000 gain is correct.

[veritas]

Two more factors to consider

Will your client have liabilities assumed by the remaining partners?

Are there hot assets in the partnership?.


The sale of a partnership interest is a sale of a capital asset but it can generate ordinary income.

[RitaB]

Thanks to all

Yes, his basis is really $10,000, and there are no liabilities. So, he will have a $2000 capital gain. (Correct me if I'm wrong.)

Back to the matter of his share of income for the year. I have noticed that IRS arithmetic is usually very logical, and I am wondering if that is the case here. Forgive me for not knowing all the terminology, but my client will not be interested in that, anyway.

So, if we start the year with four equal partners, A, B, C, and D, and A sells his ownership to B on July 1, I see only two logical ways to divvy up the income on the K-1's. One is very accurate, and the other, I think, is not so accurate but would be acceptable:

Option 1 (which is in keeping with what actually happened for the year) is for A to get 25% of the profit at June 30. B will get 25% of the profit at June 30, and 50% of the profit for July - Dec.

Option 2 (which is what I think the accountant will do because it is easier) is for A to get 12 1/2% of the profit at Dec 31. And for B to get 37.5% of the profit at Dec 31. I believe this is exactly what Luke said, too.

I believe the accountant will do something that is correct, and I believe EITHER Option 1 or Option 2 would be allowed by law. It will make a difference to the client, and he wants to know. Of course, he is going to have to ask the other accountant what he's going to do if there are two options here. Or, more accurately, the partners will tell the other accountant what to do if there is a choice.

[BOB W]

You could close the books ( for computational purposes) on June 30. See what the profit is and use that dollar amount for the selling partner's income. If I recall correctly, there is an election for just such a book closing when a sale of interest is made.

[JON]

Your guy is out in June

lets say it is a retailer who breaks even the first six months and profits with the holidays. So he would get assigned the income for the holiday season, but all it would do is increase his basis, because they are not going to distribute it to him.

The one thing you have going for you is this is a partnership you can assign income in almost anyway that the partners agree to, including assigning 0 to him.

[RitaB]

That's what I wanted to hear

That's what I wanted to hear, Bob W and Jon.

"He isn't getting a distribution from the partnership, he's selling his 25% interest to another partner for $ 12000. If his basis (see Dave's comments) is truly $10,000, then your assumption of a $ 2000 gain is correct.

Yeah, I see that, now, abctax. I guess I thought his capital account would go to zero, and that's how it would happen. You can see I am not too savvy on Partnership Balance Sheets.

Most of the experience I've had with Partnerships has been two idiots with a bad idea who lose money then close, often way too late. Thanks again.

[veritas]

Depending on what assets are in the partnership

Yes, his basis is really $10,000, and there are no liabilities. So, he will have a $2000 capital gain. (Correct me if I'm wrong.)

You may have ordinary gain.

[RitaB]

Ok

You may have ordinary gain.

OK, thanks, I will do some studying.

[Burke]

You could close the books ( for computational purposes) on June 30. See what the profit is and use that dollar amount for the selling partner's income. If I recall correctly, there is an election for just such a book closing when a sale of interest is made.

I believe you are correct. And if I remember correctly, there are two 1065's prepared for the sale year, one with 4 partners from 1/1 to 6/30, and one from 7/1 to 12/31 with 3 partners, to use your example, because the ownership percentage will change in that case for the remaining partners.