CPA Quiz: Apply Partnership Distributions And Liquidations
20 questions · exam conditions
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Apply Partnership Distributions And LiquidationsQuestion 1 of 20

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?

$0, because current distributions never trigger gain recognition.
$15,000, the excess of cash received over the partner's outside basis.
$40,000, the full amount of cash distributed.
$25,000, the partner's outside basis before the distribution.
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CPA Quiz

CPA Quiz: Apply Partnership Distributions And Liquidations

Practice Apply Partnership Distributions And Liquidations in CPA with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

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This quiz focuses on Apply Partnership Distributions And Liquidations, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA.

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Question 1

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?

  1. $0, because current distributions never trigger gain recognition.
  2. $15,000, the excess of cash received over the partner's outside basis. (correct answer)
  3. $40,000, the full amount of cash distributed.
  4. $25,000, the partner's outside basis before the distribution.
Explanation: 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 = 15,000gain.Thisgainistypicallycapitalgain.AnswerAisincorrectbecausecashdistributionsexceedingoutsidebasisdotriggergain.AnswerC(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.

Question 2

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?

  1. $15,000
  2. $30,000 (correct answer)
  3. $35,000
  4. $50,000
Explanation: 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 30,000isallocatedtotheequipment.Thepartnership′sbasisintheequipment(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 30,000basisintheequipment,absorbingthefullremainingoutsidebasis.AnswerA(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)incorrectlyaddscashtotheremainingbasis.AnswerD(35,000) incorrectly adds cash to the remaining basis. Answer D (50,000) ignores the cash received.

Question 3

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?

  1. All assets receive basis equal to their fair market value, regardless of the partner's outside basis.
  2. 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. (correct answer)
  3. All assets share the outside basis equally, divided by the number of assets received.
  4. Basis is allocated first to capital assets, then to Section 1231 assets, and finally to inventory.
Explanation: 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.

Question 4

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?

  1. Basis in land = $45,000; remaining outside basis = $0.
  2. Basis in land = $30,000; remaining outside basis = $0.
  3. Basis in land = $20,000; remaining outside basis = $10,000. (correct answer)
  4. Basis in land = $20,000; remaining outside basis = $0.
Explanation: 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.

Question 5

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?

  1. Nadia recognizes $20,000 of ordinary income because the distribution exceeds her outside basis.
  2. Nadia recognizes $20,000 of capital gain because the cash received in a liquidating distribution exceeding outside basis is capital gain. (correct answer)
  3. Nadia recognizes no gain because liquidating distributions are always tax-free.
  4. Nadia recognizes $120,000 of capital gain equal to the full liquidating distribution.
Explanation: 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.UnderSection741,gainontheliquidationofapartnershipinterestisgenerallytreatedascapitalgain(subjecttoSection751recharacterizationforhotassets,whicharenotpresenthere).AnswerAisincorrectbecausethegainiscapital,notordinary,intheabsenceofhotassets.AnswerCisincorrectbecausedistributionsofcashexceedingoutsidebasisdotriggergainrecognition.AnswerD(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.

Question 6

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?

  1. Partner Z has no obligation because general partners are not required to restore negative capital account balances.
  2. Partner Z must recognize the $30,000 as capital gain income in the year of liquidation.
  3. Partner Z must contribute $30,000 to the partnership to restore the negative capital account balance before the final distribution. (correct answer)
  4. The $30,000 is forgiven as a discharge of indebtedness income to Partner Z.
Explanation: 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.

Question 7

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?

  1. $0, because the distribution exceeds half the partnership's value.
  2. $50,000, equal to the cash distributed.
  3. $30,000, reduced by the cash distributed. (correct answer)
  4. $80,000, unchanged because current distributions do not affect outside basis.
Explanation: 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.Nogainisrecognizedbecausethecashdistributed(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.

Question 8

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?

  1. $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. (correct answer)
  2. $25,000, the partnership's adjusted basis in the property.
  3. $40,000, the fair market value of the distributed property.
  4. $15,000, the difference between FMV and partnership basis.
Explanation: 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.Nogainisrecognizedinacurrentdistributionofproperty(onlycashdistributionsexceedingoutsidebasistriggergain).Thezerobasismeansthatwhenthepartnerlatersellstheproperty,thefullproceedswillbetaxable.AnswerB(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.AnswerC(FMV)wouldapplyifgainwererecognized.AnswerD(25,000. Answer C (FMV) would apply if gain were recognized. Answer D (15,000) has no basis in Section 732.

Question 9

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?

  1. $25,000 (correct answer)
  2. $20,000
  3. $35,000
  4. $65,000
Explanation: 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,butinaliquidatingdistributiontheSection732(b)allocatedbasis(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)isthepartnership′sbasisintheasset,whichwouldapplyinacurrentdistributionunderSection732(a).AnswerC(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.

Question 10

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?

  1. $50,000
  2. $70,000 (correct answer)
  3. $90,000
  4. $20,000
Explanation: 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 50,000basisintheland,whichmeansPartnerXhasastep−upembeddedintheproperty(whichmaybeadjustedviaSection734(b)ifaSection754electionisineffect).AnswerA(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)istheFMV.AnswerD(90,000) is the FMV. Answer D (20,000) is the excess of outside basis over partnership property basis.

Question 11

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?

  1. Payments for the partner's share of unrealized receivables and goodwill (unless the partnership agreement provides for goodwill), which are treated as distributive shares or guaranteed payments.
  2. Payments that are always deductible by the remaining partners.
  3. 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. (correct answer)
  4. Payments made over time under an installment arrangement that are taxed entirely as capital gains.
Explanation: 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.

Question 12

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?

  1. Long-term capital gain of $10,000.
  2. Section 1231 gain of $10,000.
  3. Ordinary income of $2,000.
  4. Ordinary income of $10,000. (correct answer)
Explanation: Quinn's basis in the distributed inventory = lesser of partnership basis (12,000)oroutsidebasis(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 10,000gainisordinaryincome.AnswerAisincorrectbecauseinventorytriggersordinaryincome,notcapitalgain.AnswerBisincorrectbecauseSection1231treatmentdoesnotapplytoinventory.AnswerC(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.

Question 13

Under the Section 754 election, when a partnership makes a distribution of property that causes a difference between a partner's basis in distributed property and the partnership's inside basis, what is the effect of the election?

  1. The Section 754 election eliminates the partner's gain on any future sale of the distributed property.
  2. The Section 754 election converts the character of the partner's gain from ordinary to capital.
  3. The Section 754 election allows the partnership to adjust the basis of its remaining assets under Section 734(b) to reflect the difference caused by the distribution. (correct answer)
  4. The Section 754 election allows the distributing partnership to recognize gain on the distributed property at the time of distribution.
Explanation: A Section 754 election, when in effect, triggers two types of optional basis adjustments: Section 743(b) adjustments on transfers of partnership interests, and Section 734(b) adjustments on distributions of property. When a distribution causes a basis disparity (such as when a partner takes a higher or lower basis in distributed property than the partnership's inside basis), Section 734(b) allows the partnership to adjust the basis of its remaining assets to eliminate the inside/outside basis imbalance. This prevents other partners from being harmed or benefited by the disparity. Answer A is incorrect because the election adjusts the partnership's inside basis in remaining assets, not the distributee's basis. Answer B is incorrect because the Section 754 election does not affect the character of gain. Answer D is incorrect because the distributing partnership does not recognize gain on a distribution subject to Section 734(b).

Question 14

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'?

  1. Unrealized receivables and inventory items (including substantially appreciated inventory). (correct answer)
  2. Depreciable equipment and real property held for more than one year.
  3. Cash and marketable securities held by the partnership.
  4. Capital assets and Section 1231 assets held by the partnership.
Explanation: 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.

Question 15

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?

  1. Kim recognizes a $20,000 gain.
  2. Kim recognizes no gain or loss.
  3. Kim recognizes a $10,000 loss. (correct answer)
  4. Kim takes a $70,000 basis in the inventory.
Explanation: 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.Thislossistypicallyacapitalloss.AnswerA(10,000. This loss is typically a capital loss. Answer A (20,000 gain) is incorrect because cash (70,000)doesnotexceedoutsidebasis(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.

Question 16

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?

  1. The partner treats the income as capital gain because the receivables were received in a partnership distribution.
  2. The partner treats the income as Section 1231 gain because the receivables were used in a trade or business.
  3. The partner treats the income as capital gain only if the receivables are held for more than one year after distribution.
  4. The partner treats the income as ordinary income regardless of how long the receivables are held after distribution. (correct answer)
Explanation: 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.

Question 17

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?

  1. $100,000, the fair market value of the distributed property.
  2. $60,000, limited to the partner's outside basis before the distribution. (correct answer)
  3. $80,000, the partnership's adjusted basis in the property.
  4. $20,000, the excess of the property's basis over the partner's outside basis.
Explanation: 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.Nogainorlossisrecognized.AnswerA(FMV)wouldapplyonlyifgainwererecognized.AnswerC(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.

Question 18

A partner contributes property to a partnership and later receives a distribution of different property. Under Section 704(c)(1)(B), if the contributed property is distributed to another partner within seven years of the contribution, what is the tax consequence to the contributing partner?

  1. The contributing partner must recognize the pre-contribution gain (or loss) that would have been allocated to that partner at the time of the contribution. (correct answer)
  2. The contributing partner recognizes no gain because the property left the partnership rather than being sold.
  3. The contributing partner recognizes gain only if the distributed property is sold by the distributee partner within one year.
  4. The contributing partner's gain is permanently deferred under Section 721.
Explanation: Section 704(c)(1)(B) provides that if contributed property is distributed to any partner other than the contributing partner within 7 years of contribution, the contributing partner must recognize the built-in gain or loss that existed at the time of contribution as if the property had been sold at its fair market value on the date of distribution. This prevents the shifting of pre-contribution gain through the partnership. Answer B is incorrect because the distribution triggers gain recognition for the contributing partner even though no sale occurred. Answer C is incorrect because the trigger is distribution within 7 years, not a subsequent sale by the distributee. Answer D is incorrect because Section 721 defers gain at contribution; Section 704(c)(1)(B) requires recognition when the property is distributed to another partner within 7 years.

Question 19

Under Section 731(a)(2), in which of the following situations may a partner recognize a loss on a liquidating distribution?

  1. When the liquidating distribution consists solely of cash, unrealized receivables, and inventory, and the cash and the basis of the unrealized receivables and inventory is less than the partner's outside basis. (correct answer)
  2. When the fair market value of property distributed in liquidation is less than the partner's outside basis.
  3. When the partner's share of partnership liabilities decreases as part of the liquidation.
  4. When the partnership distributes appreciated property and the partner has a low outside basis.
Explanation: Under Section 731(a)(2), a partner may recognize a loss on a liquidating distribution only if the distribution consists solely of money, unrealized receivables, and inventory items, and the sum of money received plus the basis of unrealized receivables and inventory is less than the partner's outside basis. No loss is recognized if the liquidating distribution includes any other property. Answer B is incorrect because loss is not recognized simply because FMV is below outside basis; the distribution must meet the all-cash/receivables/inventory test. Answer C is incorrect because a decrease in partnership liabilities is treated as a deemed cash distribution, which can trigger gain but the scenario described does not automatically produce a recognizable loss in the way Section 731(a)(2) requires. Answer D is incorrect because distribution of appreciated property does not trigger a loss for the distributee partner.

Question 20

Under Section 732(b), how is a partner's basis in property received in a complete liquidation of the partnership interest determined?

  1. The basis equals the fair market value of each asset received, allocated proportionally.
  2. The basis equals the partnership's adjusted basis in each asset distributed.
  3. The basis equals zero for all assets received in a liquidating distribution.
  4. The basis equals the partner's outside basis reduced by any cash received, with the remainder allocated among the distributed assets. (correct answer)
Explanation: Under Section 732(b), in a complete liquidating distribution, the partner's total basis in all distributed property equals the partner's outside basis reduced by any cash received in the same distribution. This remaining basis is then allocated among the non-cash assets under the Section 732(c) ordering rules: first to unrealized receivables and inventory (up to their partnership basis), then to any remaining assets. Answer A (FMV basis) would apply only if gain were fully recognized. Answer B (partnership's adjusted basis) is the rule for current distributions under Section 732(a), subject to the outside basis cap, not the liquidating distribution rule. Answer C ($0 basis) has no basis in the Code.