Dissolving a Partnership

[nypreparer]

A two-member partnership (1065 return) is dissolving. Each partner is starting their own business in the same field and taking equipment with them. The depreciation is recaptured on the partnership return and then the assets are put on the individuals new Schedule Cs, correct?

[RAG1775]

Each member should have maintained their tax basis. What is happening here is a liquidating distribution. The property distributed will take a "substituted" basis. No recapture at this point. Recapture will occur when the property is disposed of at the Schedule C level. This substituted basis will then be used on the respective Schedule C. You need to look at IRC Sections 731 and 732 to provide direction. In general, I doubt there is any gain to either member.

[nypreparer]

So, if partner A contributed equipment valued at $100,000, they would have a property distribution on their K1 of $100k? If there is any residual value, they pick that up on their new depreciation scheduled tied to their schedule C?

[RAG1775]

No. The additional facts have now potentially complicated the issue. If a partner contributed property, then the rules of 704(c) would have come into play. Regardless, each partner should have been maintaining their tax basis. When the partnership liquidates, the provisions of Section 731 and 732 dictate the tax ramifications. There are a number of rules that come into play; did the cash exceed their tax basis? If yes, then there will be gain. If not, then the next step is to allocate the remaining tax basis to the property distributed....hence "substituted basis". The last issue that needs to be reviewed is whether any "hot assets" were disproportionately distributed. The regulations under 732 provide examples of basis allocation. It is the "substituted basis" of the property that will be the new beginning point for the Schedule C.