- A general partnership is being wound up and liquidated. The partnership agreement requires each partner to restore any deficit in their capital account upon liquidation. After all liabilities are paid, the remaining assets are distributed to the partners in proportion to their positive capital account balances. Partner Z has a negative capital account balance of $30,000. What is Partner Z's obligation upon liquidation?
Answer: Partner Z must contribute $30,000 to the partnership to restore the negative capital account balance before the final distribution.
When a partnership agreement includes a deficit restoration obligation (DRO), a partner with a negative capital account must contribute the deficit amount to the partnership before final distributions are made. Partner Z must contribute $30,000 to restore the capital account to zero; those funds may then be distributed to partners with positive capital account balances. Answer C is correct. Answer A is incorrect because the partnership agreement here expressly requires deficit restoration - absent such an obligation, the analysis would differ. Answer B is incorrect because a negative capital account creates a contribution obligation, not capital gain income. Answer D is incorrect because this situation involves a capital account deficit governed by the partnership agreement, not a discharge of indebtedness under Section 108.
- A partner's outside basis is $0 when the partnership distributes property with a partnership basis of $25,000 and FMV of $40,000 in a current distribution. What is the partner's basis in the distributed property?
Answer: $0, because the partner's outside basis is $0 and Section 732(a) limits the basis to the lesser of partnership basis or outside basis.
Under Section 732(a)(2), the partner's basis in distributed property in a current distribution cannot exceed the partner's outside basis reduced by any cash received in the same distribution. Since the partner's outside basis is $0 and no cash was distributed, the basis in the property is $0. No gain is recognized in a current distribution of property (only cash distributions exceeding outside basis trigger gain). The zero basis means that when the partner later sells the property, the full proceeds will be taxable. Answer B ($25,000) would apply if outside basis were at least $25,000. Answer C (FMV) would apply if gain were recognized. Answer D ($15,000) has no basis in Section 732.
- Partner Kim has an outside basis of $90,000. In a complete liquidation of her partnership interest, she receives only cash of $70,000 and inventory with a partnership basis of $10,000. What is the tax result to Kim?
Answer: Kim recognizes a $10,000 loss.
Under Section 731(a)(2), a loss is recognized in a liquidating distribution when the distribution consists solely of cash, unrealized receivables, and inventory, and the total basis of amounts received is less than the outside basis. Cash received = $70,000; basis of inventory = $10,000; total = $80,000. Outside basis = $90,000. Loss = $90,000 - $80,000 = $10,000. This loss is typically a capital loss. Answer A ($20,000 gain) is incorrect because cash ($70,000) does not exceed outside basis ($90,000). Answer B (no gain or loss) is incorrect because the conditions of Section 731(a)(2) are met and a loss is recognized. Answer D is incorrect because Kim's basis in the inventory is $10,000 (carryover from the partnership), not $70,000.
- A partner with an outside basis of $60,000 receives a current distribution of property (not cash) with an adjusted basis to the partnership of $80,000 and a fair market value of $100,000. What is the partner's basis in the distributed property?
Answer: $60,000, limited to the partner's outside basis before the distribution.
Under Section 732(a), in a current distribution of property other than cash, the partner's basis in the distributed property equals the lesser of (1) the partnership's adjusted basis in the property, or (2) the partner's outside basis reduced by any cash distributed in the same transaction. Here, partnership basis = $80,000; partner's outside basis = $60,000. Since $60,000 is less than $80,000, the partner's basis in the property is limited to $60,000. No gain or loss is recognized. Answer A (FMV) would apply only if gain were recognized. Answer C ($80,000) exceeds the partner's outside basis and is therefore not available under Section 732(a). Answer D ($20,000) has no valid basis in the Section 732 formula.
- Under Section 736, payments made to a retiring partner or to a deceased partner's successor in liquidation of the partner's interest are classified as either Section 736(a) or Section 736(b) payments. Which of the following correctly describes Section 736(b) payments?
Answer: Payments for the partner's share of partnership property (other than unrealized receivables and goodwill not provided for in the partnership agreement), which are treated as liquidating distributions.
Section 736(b) payments are payments for the retiring or deceased partner's interest in partnership property (other than unrealized receivables and, in general service partnerships, goodwill not specifically provided for in the partnership agreement). These payments are treated as liquidating distributions under Section 731 and Section 732, resulting in capital gain or loss to the recipient. Answer A describes Section 736(a) payments, which cover the residual - payments for unrealized receivables and unstated goodwill - and are treated as distributive shares of income or guaranteed payments. Answer B is incorrect because Section 736(b) payments are not deductible by the partnership; Section 736(a) payments may be deductible. Answer D is incorrect because installment treatment does not change the character classification under Section 736.
- Under Section 732(c), when the total adjusted basis of property distributed in a liquidating distribution must be allocated among multiple assets, which of the following describes the correct allocation order?
Answer: Basis is first allocated to unrealized receivables and inventory up to their partnership basis; any remaining basis is allocated to other assets using a fair-market-value proportional method with specific adjustments.
Section 732(c) establishes a two-tier ordering rule for allocating basis in liquidating distributions. First, basis is allocated to unrealized receivables and inventory items in an amount equal to the partnership's adjusted basis in those assets (but not to exceed the total basis being allocated). Second, any remaining basis is allocated to other distributed properties. If the remaining basis exceeds the total adjusted basis of the other assets, the excess is allocated proportionally based on fair market values (positive adjustments). If basis is insufficient, reductions are made based on depreciation potential and then FMV. Answer A (FMV basis for all) ignores the statutory ordering. Answer C (equal split) has no basis in Section 732(c). Answer D reverses the correct priority.
- Under Section 736(a), payments to a retiring partner classified as Section 736(a) payments are treated as which of the following?
Answer: Either distributive shares of partnership income (if determined by partnership income) or guaranteed payments (if fixed or minimum amounts), both of which are ordinary income to the recipient.
Section 736(a) payments to a retiring or deceased partner (for unrealized receivables and, in general service partnerships, unstated goodwill) are treated as either (1) a distributive share of partnership income if the amount is determined by the partnership's income, or (2) guaranteed payments under Section 707(c) if the amount is fixed or a minimum is guaranteed. In either case, the payments are ordinary income to the recipient. The partnership may deduct guaranteed payments but not distributive shares (which flow through). Answer A describes Section 736(b) payments, not Section 736(a). Answer C is incorrect because Section 736(a) payments are ordinary income, not return-of-capital distributions. Answer D is incorrect because Section 736(a) payments are taxable ordinary income to the retiring partner.
- Under Section 751, when a partner sells a partnership interest, a portion of the gain or loss may be recharacterized as ordinary income. Which of the following assets are classified as Section 751 'hot assets'?
Answer: Unrealized receivables and inventory items (including substantially appreciated inventory).
Section 751 hot assets include unrealized receivables and inventory items. Unrealized receivables include rights to payment for goods delivered or services rendered, as well as recapture amounts under Sections 1245 and 1250. Inventory items include not only stock-in-trade but also any property that would not be a capital asset or Section 1231 asset if held directly. On a sale or exchange of a partnership interest, gain or loss attributable to hot assets is treated as ordinary income or loss. Answer B (depreciable equipment and real property) describes Section 1231 assets, not hot assets. Answer C (cash and marketable securities) are generally capital assets, not hot assets. Answer D (capital and Section 1231 assets) describes non-hot assets that receive capital gain treatment.
- A partner's outside basis is $50,000. In a liquidating distribution, the partner receives cash of $20,000 and equipment with a partnership basis of $15,000 and FMV of $30,000. What is the partner's basis in the equipment?
Answer: $30,000
Under Section 732(b), the partner's basis in property received in a liquidating distribution = outside basis minus cash received = $50,000 - $20,000 = $30,000. This $30,000 is allocated to the equipment. The partnership's basis in the equipment ($15,000) does not cap the liquidating distribution basis since Section 732(b) (not 732(a)) applies. The partner takes a $30,000 basis in the equipment, absorbing the full remaining outside basis. Answer A ($15,000) is the partnership's basis, which serves as a cap in current (not liquidating) distributions. Answer C ($35,000) incorrectly adds cash to the remaining basis. Answer D ($50,000) ignores the cash received.
- In a partnership liquidation, the partnership distributes assets to its two equal partners. Partner X receives land (partnership basis $50,000, FMV $90,000) and Partner Y receives equipment (partnership basis $50,000, FMV $90,000). Each partner has an outside basis of $70,000. What is Partner X's basis in the land?
Answer: $70,000
In a liquidating distribution under Section 732(b), the partner's basis in distributed property equals the partner's outside basis reduced by any cash received. No cash was received by Partner X. Therefore, Partner X's basis in the land = $70,000 (the full outside basis). This basis exceeds the partnership's $50,000 basis in the land, which means Partner X has a step-up embedded in the property (which may be adjusted via Section 734(b) if a Section 754 election is in effect). Answer A ($50,000) is the partnership's basis, applicable in current distributions under Section 732(a), not liquidating distributions. Answer C ($90,000) is the FMV. Answer D ($20,000) is the excess of outside basis over partnership property basis.
- A partner receives a liquidating distribution of cash of $40,000 and a capital asset with partnership basis of $20,000 and FMV of $35,000. The partner's outside basis before distribution is $65,000. What is the partner's basis in the capital asset?
Answer: $25,000
Under Section 732(b), in a liquidating distribution the partner's total basis in distributed non-cash property = outside basis minus cash received = $65,000 - $40,000 = $25,000. This $25,000 is allocated to the capital asset. Note that the capital asset has a partnership basis of $20,000, but in a liquidating distribution the Section 732(b) allocated basis ($25,000) is used rather than being capped at partnership basis. Answer B ($20,000) is the partnership's basis in the asset, which would apply in a current distribution under Section 732(a). Answer C ($35,000) is the FMV of the asset. Answer D ($65,000) is the partner's full outside basis before the cash distribution.
- Under Section 735, when a partnership distributes unrealized receivables to a partner, which of the following correctly describes the tax treatment when the partner subsequently collects on or sells those receivables?
Answer: The partner treats the income as ordinary income regardless of how long the receivables are held after distribution.
Under Section 735(a)(1), unrealized receivables distributed by a partnership retain their ordinary income character in the hands of the distributee partner permanently, regardless of the holding period after distribution. When the partner collects on or sells those receivables, the income is always ordinary income. Answer A is incorrect because unrealized receivables never convert to capital gain in the partner's hands after distribution. Answer B is incorrect because Section 1231 treatment does not apply to unrealized receivables, which are inherently ordinary income items. Answer C is incorrect because the ordinary income character is permanent, not dependent on any holding period test.
- A partnership has two equal partners with outside bases of $80,000 each. The partnership distributes $50,000 of cash to each partner in a current (non-liquidating) distribution. What is each partner's outside basis after the distribution?
Answer: $30,000, reduced by the cash distributed.
Under Section 733, a partner's outside basis is reduced (but not below zero) by the amount of money distributed in a current distribution. Each partner's outside basis = $80,000 - $50,000 = $30,000. No gain is recognized because the cash distributed ($50,000) does not exceed the outside basis ($80,000). Answer A is incorrect because the distribution does not reduce basis below zero, and no gain is recognized here. Answer B is incorrect; the remaining outside basis is $30,000, not $50,000. Answer D is incorrect because cash distributions do reduce outside basis under Section 733.
- Under Section 731, a partner receives a current (non-liquidating) cash distribution of $40,000 from a partnership. The partner's outside basis immediately before the distribution is $25,000. How much gain must the partner recognize?
Answer: $15,000, the excess of cash received over the partner's outside basis.
Under Section 731(a)(1), a partner recognizes gain on a current distribution only to the extent that money distributed exceeds the partner's outside basis immediately before the distribution. Cash of $40,000 minus outside basis of $25,000 = $15,000 gain. This gain is typically capital gain. Answer A is incorrect because cash distributions exceeding outside basis do trigger gain. Answer C ($40,000) ignores the basis offset. Answer D ($25,000) is the outside basis itself, not the recognized gain.
- Partner Quinn receives a current distribution of inventory with a partnership basis of $12,000 and FMV of $20,000. Quinn's outside basis before the distribution is $18,000. If Quinn subsequently sells the inventory for $22,000, what is the character of Quinn's gain?
Answer: Ordinary income of $10,000.
Quinn's basis in the distributed inventory = lesser of partnership basis ($12,000) or outside basis ($18,000) = $12,000 under Section 732(a). Under Section 735(a)(2), inventory distributed by a partnership retains its ordinary income character for 5 years after distribution, regardless of the distributee's holding period. Quinn sells for $22,000, basis = $12,000, gain = $10,000. Because this is inventory and the 5-year rule applies (assuming sale is within 5 years), the entire $10,000 gain is ordinary income. Answer A is incorrect because inventory triggers ordinary income, not capital gain. Answer B is incorrect because Section 1231 treatment does not apply to inventory. Answer C ($2,000) would be the gain only if basis were $20,000 (FMV), which is incorrect.
- Partner Leo has an outside basis of $30,000 and receives a current distribution consisting of land with a partnership basis of $20,000 and FMV of $45,000. What is Leo's basis in the distributed land and his remaining outside basis after the distribution?
Answer: Basis in land = $20,000; remaining outside basis = $10,000.
Under Section 732(a)(1), in a current distribution of property other than cash, the partner's basis in the distributed property equals the lesser of the partnership's adjusted basis in the property or the partner's outside basis. The partnership's basis in the land = $20,000; partner's outside basis = $30,000. Lesser = $20,000. Leo takes a $20,000 basis in the land. His remaining outside basis = $30,000 - $20,000 = $10,000. Answer A uses FMV as basis. Answer B uses the full outside basis. Answer D correctly states $20,000 basis in the land but incorrectly reduces remaining outside basis to $0.
- Partner Nadia has an outside basis of $100,000 and a 40% interest in partnership profits and losses. The partnership distributes $120,000 of cash to Nadia in complete liquidation of her interest. What are the tax consequences to Nadia?
Answer: Nadia recognizes $20,000 of capital gain because the cash received in a liquidating distribution exceeding outside basis is capital gain.
Under Section 731(a)(1), a partner recognizes gain in a liquidating (or current) distribution to the extent money distributed exceeds the partner's outside basis. Gain = $120,000 - $100,000 = $20,000. Under Section 741, gain on the liquidation of a partnership interest is generally treated as capital gain (subject to Section 751 recharacterization for hot assets, which are not present here). Answer A is incorrect because the gain is capital, not ordinary, in the absence of hot assets. Answer C is incorrect because distributions of cash exceeding outside basis do trigger gain recognition. Answer D ($120,000) ignores the outside basis offset.
- Under Section 751(b), when a partnership makes a disproportionate distribution that shifts a partner's interest in Section 751 hot assets, what is the tax result?
Answer: The distribution is treated as a deemed sale and purchase of assets between the partner and the partnership, triggering ordinary income to the extent hot assets are involved.
Section 751(b) applies when a partnership distribution is disproportionate with respect to hot assets (unrealized receivables and substantially appreciated inventory). The disproportionate distribution is treated as if the partner sold the hot assets they gave up in exchange for the other assets they received (or vice versa). This deemed sale triggers ordinary income to the extent the transaction involves hot assets. Answer A is incorrect because Section 751(b) specifically overrides the general nonrecognition rules for disproportionate distributions. Answer B is incorrect because the character of income triggered by hot assets under Section 751 is ordinary, not capital. Answer C overstates the scope; only the hot asset component is recharacterized as ordinary, not the entire distribution.
- Under Section 737, a partner who contributed property to a partnership and later receives a distribution of other property from the partnership must recognize gain under what circumstances?
Answer: The partner must recognize gain equal to the lesser of the pre-contribution gain in the contributed property or the excess of the FMV of property received over the partner's outside basis, if the distribution occurs within 7 years of the contribution.
Section 737 is the anti-mixing bowl rule that prevents a contributing partner from extracting other property from the partnership tax-free when contributed property with built-in gain remains in the partnership. If, within 7 years of a contribution, the contributing partner receives a distribution of other property with an FMV exceeding the partner's outside basis, gain is recognized equal to the lesser of (1) the net pre-contribution gain in the contributed property still held by the partnership, or (2) the excess of the FMV of distributed property over the partner's outside basis. Answer B is incorrect because gain is limited to the lesser of pre-contribution gain or the FMV-over-basis excess. Answer C is incorrect because Section 737 triggers even if the contributed property has not been sold; the sale triggers Section 704(c)(1)(B) instead. Answer D is incorrect because Section 737 specifically overrides the general nonrecognition rule in these circumstances.
- When a limited partnership is liquidated and assets are distributed, in what order are distributions generally made under the Uniform Limited Partnership Act and standard partnership agreements?
Answer: First to creditors, then to partners in accordance with their positive capital account balances or as provided in the partnership agreement.
Upon winding up a limited partnership, distributions are made in the following priority: (1) to creditors (including partner-creditors) for debts and liabilities, and (2) to partners in accordance with their positive capital account balances or as the partnership agreement provides. This creditor-first priority reflects basic principles of entity law and partnership statutes. Answer A reverses the priority by paying partners before creditors. Answer B is incorrect because the order is not based on partner type (limited vs. general) but on the claims hierarchy of creditors first, then equity. Answer C is incorrect in suggesting unpaid distributions take priority over creditor claims.
