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Partnership
Distributions & Liquidations

Master the tax rules governing current distributions, liquidating distributions, and how they affect a partner's outside basis on the CPA REG exam.

CPA Regulation (REG)

What Is a Partnership Distribution?

A partnership distribution occurs when a partnership transfers cash or property to a partner. The tax consequences depend on the type of distribution and whether the partner continues in the partnership or exits entirely.

Current Distribution
Partner stays in the partnership. Distribution reduces outside basis but the partnership continues.
Liquidating Distribution
Partner's entire interest is terminated. The partner completely exits the partnership.

Understanding Outside Basis

A partner's outside basis tracks the partner's tax investment in the partnership. It is the foundation for determining gain or loss on distributions. Think of it as a running balance sheet of what you've "put in" minus what you've "taken out."

Two Types of Distributions

Partnership Current Liquidating Current Distribution Partner stays Basis reduced, not eliminated Generally no gain Liquidating Distribution Partner exits Entire basis consumed Gain or loss possible

Core Rules: Current Distributions

1
Cash distributed: Reduces outside basis dollar-for-dollar. Gain recognized only if cash exceeds basis.
2
Property distributed: Partner takes a carryover basis (same as the partnership's inside basis), limited to the partner's remaining outside basis.
3
No loss recognized on a current distribution: you are only partially withdrawing, so no final settlement occurs.
4
Ordering rule: Reduce basis for cash first, then allocate remaining basis to property received.

Core Rules: Liquidating Distributions

1
Cash distributed: Gain recognized if cash exceeds outside basis. Loss recognized if only cash, unrealized receivables, and/or inventory are received and cash is less than basis.
2
Property basis: Partner's remaining outside basis (after cash) is allocated to the property received: basis is substituted, not carried over.
3
Loss recognition: Only possible in a liquidating distribution and only when the partner receives solely cash, unrealized receivables, and/or inventory.
4
Result: After a liquidating distribution, the partner's outside basis becomes \( \$0 \). The interest is fully terminated.

Current vs. Liquidating: Key Differences

Current Liquidating
Partner's status Continues Exits partnership
Gain on cash If \( \text{Cash} > \text{Basis} \) If \( \text{Cash} > \text{Basis} \)
Loss recognition Never Possible (limited cases)
Property basis Carryover (limited) Substituted basis
Ending outside basis \( \geq 0 \) Always \( \$0 \)

Step-by-Step Application

1
Determine outside basis before the distribution: contributions + income − losses − prior distributions.
2
Identify distribution type: Is the partner staying (current) or leaving (liquidating)?
3
Apply cash first: Reduce basis by cash received. If cash exceeds basis, recognize gain.
4
Allocate remaining basis to property: Current = carryover (capped at remaining basis). Liquidating = substitute remaining basis to property.
5
Check for loss: Only in liquidating, only if receiving cash/receivables/inventory, and only if basis remains after accounting for everything received.

Example 1: Current Cash Distribution

Partner A has an outside basis of \( \$50{,}000 \). The partnership distributes \( \$30{,}000 \) cash in a current distribution.

Outside Basis: $50,000 Cash: $30,000 Remaining: $20,000
\( \text{Gain Recognized} = \$0 \)
\( \text{New Outside Basis} = \$50{,}000 - \$30{,}000 = \$20{,}000 \)
Cash did not exceed basis: no gain

Example 2: Cash Exceeds Basis

Partner B has an outside basis of \( \$20{,}000 \). The partnership distributes \( \$35{,}000 \) cash in a current distribution.

Outside Basis: $20,000 Basis: $20,000 Cash Distributed: $35,000 Excess = $15,000 Gain Basis goes to $0

Example 3: Property Distribution (Current)

Partner C has an outside basis of \( \$40{,}000 \). The partnership distributes property with an inside basis of \( \$25{,}000 \) (FMV \( \$60{,}000 \)) in a current distribution.

1
No cash: Skip the cash step.
2
Property basis to partner: Lesser of partnership's inside basis (\( \$25{,}000 \)) or partner's outside basis (\( \$40{,}000 \)). Result: \( \$25{,}000 \).
3
New outside basis: \( \$40{,}000 - \$25{,}000 = \textcolor{#4ade80}{\$15{,}000} \).
4
Gain recognized: \( \$0 \). FMV is irrelevant for gain recognition on property distributions.

Example 4: Liquidating Distribution

Partner D has an outside basis of \( \$80{,}000 \). In a liquidating distribution, D receives \( \$30{,}000 \) cash and property with an inside basis of \( \$20{,}000 \).

1
Reduce by cash: \( \$80{,}000 - \$30{,}000 = \$50{,}000 \) remaining basis.
2
Substitute basis to property: In liquidation, the entire remaining basis goes to the property. Property basis = \( \$50{,}000 \) (not the \( \$20{,}000 \) inside basis).
3
Ending outside basis: \( \$0 \). The partner's interest is terminated.
4
Gain recognized: \( \$0 \). Cash did not exceed original basis, and remaining basis was absorbed by property.

When a Loss Is Recognized

Partner E has an outside basis of \( \$60{,}000 \). In a liquidating distribution, E receives only \( \$40{,}000 \) cash. No property, no receivables, no inventory.

Hot Assets and Section 751

Certain partnership assets get special treatment because they represent ordinary income potential rather than capital gains. These are called "hot assets" under IRC Section 751.

Unrealized Receivables
Income earned but not yet received (e.g., accounts receivable for a cash-basis partnership), plus recapture amounts.
Inventory Items
Partnership inventory, including items that would produce ordinary income if sold (substantially appreciated inventory).

Common Mistakes to Avoid

✕ Using FMV for Basis
Property distributions use inside basis (current) or substituted basis (liquidating), never fair market value.
✕ Recognizing Loss on Current
Losses are never recognized on current distributions. Only liquidating distributions can produce a loss.
✕ Forgetting the Loss Limitation
Even in liquidation, a loss requires receiving only cash, unrealized receivables, and/or inventory: no other property.

Summary Comparison

Current Liquidating
\( \text{Cash} > \text{Basis} \) Gain (capital) Gain (capital)
\( \text{Cash} < \text{Basis} \) No gain, no loss Loss possible (if only cash/receivables/inventory)
Property basis Carryover (capped) Substituted (absorbs remaining basis)
Ending basis \( \geq 0 \) \( = 0 \)
Hot assets (Sec. 751) May apply May apply

Question 1 of 5

Partner F has an outside basis of \( \$45{,}000 \). In a current distribution, F receives \( \$45{,}000 \) cash. What is the tax consequence?

Question 2 of 5

In a current distribution, Partner G (outside basis \( \$30{,}000 \)) receives property with an inside basis of \( \$50{,}000 \) and FMV of \( \$80{,}000 \). What is the partner's basis in the property received?

Question 3 of 5

Partner H has an outside basis of \( \$70{,}000 \). In a liquidating distribution, H receives \( \$20{,}000 \) cash and land with an inside basis of \( \$10{,}000 \). What is H's basis in the land?

Question 4 of 5

When can a partner recognize a loss on a partnership distribution?

Question 5 of 5

Which of the following are considered "hot assets" under IRC Section 751?