Partnership Distributions

[calcpa5]

What are the rules regarding partnership distributions and interest deductibility?

A partnership owns a $20M apartment building and is planning to refinance the building and take out $10M. $2M of this will be used to do earthquake retrofit and $8M will be distributed to the partners based on their interest in the partnership. Is this a taxable distribution to the partners and if so, would this be capital or ordinary and secondly is the higher interest expense fully deductible to the partnership?

[Roland Slugg]

Reply

Dear calcpa5

Distributions by a partnership are generally not taxable to the partnership, but they can be taxable to the partners even in a non-liquidating distribution. A distribution is taxable to the extent it exceeds the receiving partner's basis in his partnership interest. See Code §731(a).

Interest on the $2M used for earthquake retrofit on the building would be deductible. Interest on the other $8M would not be deductible by the partnership, but should be treated as an additional distribution to the partners. In turn, the individual partners may be able to deduct some or all of their respective shares of that interest, depending on how the proceeds were used. The allocation/tracing rules apply.